SCDigest: FedEx’s Fred Smith Agrees U.S. Needs to Return to a ‘Product Economy’
By SCDigest Editorial Staff
Through a special arrangement, presented here for discussion is an excerpt of a current article from Supply Chain Digest.
In a recent interview with The Wall Street Journal, Federal Express founder and CEO Fred Smith crisply summarized how things have become so out of whack in the financial sector versus the rest of the product economy that has to play by traditional rules. Mr. Smith covered similar ground offered by SCDigest editor Dan Gilmore in his recent column, “Back to the Product Economy?”
“Rather than in our business, where you have to have a dollar of equity for 10 cents or 15 cents of debt, it’s exactly the opposite in the financial sector where you have one dollar of equity for 10, 25, 50 times risk,” Mr. Smith told the Journal.
Mr. Smith said a key part of the problem is that U.S. tax and other policies are unfair to asset-heavy businesses, such as manufacturers and the service providers like FedEx, with its fleet of 300 planes and thousands of trucks.
“The United States has a completely uncompetitive tax structure in general and it has a particularly onerous tax structure for firms that are asset-intensive,” Mr. Smith said. “If you run an industrial company like FedEx, which employs 290,000 folks, most of whom are blue-collar people, the way we have to run this business is to equip those workers with billions of dollars of assets that allow them to pick up and deliver millions of things around the world.”
Mr. Smith also cited, as did Mr. Gilmore, that the potential for vast salaries and bonuses in the financial sector siphoned off too much of America’s top talent in recent years, especially those coming out of college.
“Not too many young people coming out of school are studying to be production managers at General Motors,” Mr. Smith said, adding that most of FedEx’s first-line managers come not from the topflight universities, but out of community colleges and the military.
“The top talent has wanted to go to Wall Street,” he said.
The Journal article said Smith “views the heroes of the U.S. economy as the companies that actually produce real goods and services. He sees the Wall Street collapse as an inevitable byproduct of investment bankers building multi-trillion dollar debt pyramid structures.”
Discussion Question: Do you think we can – or should – focus more on the “real product” economy? What can the U.S. and European countries do to put more vigor back in the manufacturing sector? Is U.S tax policy harmful to manufacturers here?
[Author’s Commentary] Dan Gilmore’s “Back to the Product Economy?” column concluded: “We can’t rely on the financial sector any more to be the world economic leader. The U.S. still has by far the largest GDP, but I believe we will need to rethink where our attention, resources and investment go. Our manufacturers have among the highest tax and health care costs in the world. We are the about the only country that adds duties on offshore components coming into Free Trade Zones for final assembly. Most of the Harvard Business School graduates have been looking at Wall Street or consultancies instead of companies that actually make things. We’re giving too much intellectual property away to China and others, and often ignoring the ‘cost innovation’ that is increasingly the basis of Chinese competition – not just low wages.
“We just need to re-assess and act based on what adds real value to the economy. It isn’t an endless series of derivatives and other new financial instruments. The design, innovation, and (where it makes sense) actual production of real products needs to move up the priority list – in a hurry.”
Who could possibly argue with this? A production economy provides more decent jobs than a service economy. A return to production would raise our standard of living. Thankfully, we may get this opportunity as international shipping costs have gone sky high with the rise of oil costs. Even though those costs are subsiding now, much is due to the rise in the value of the dollar.
This will not affect an exporter in Asia sending product to the US unless it is in Japan. All of the rest of the Southeast Asia currencies have taken a beating as have their stock markets. We catch a cold, they catch the flu.
If we get some industry-friendly politicians in office who will institute tax policies that encourage new businesses, it might again be possible to produce in the USA at costs that are competitive with China. No, I don’t mean that our labor cost will get that cheap. It’s just possible that a widget made here could be as cheap as a widget made there. We have the automation, the capacity, the great transportation system the infrastructure, etc, to cut many of the costs associated with production if only we could get some people in Washington interested in liberating people rather than have people dependent on the dole.
The creative money making schemes dreamed up on Wall Street are a direct reflection of our 30 plus years of ever-increasing spending. It would be nice to think that our ever-increasing spending was a result of a healthy GDP base, yet I don’t believe that to be true.
The spending was dependent not upon a healthy mixture of manufacturing, technology and services, but upon a blind trust or hope in ever rising valuations in real estate and the stock market, which fueled the ability of consumers to leverage ever greater deficit spending.
Those times are over and the market is going to experience a good bit of correction as people and institutions (business and government) correct the imbalances and restore order to our economic formula.
I too believe that our economy must move from one dependent largely upon consumption and revert to one more balanced with goods and services. This will require a more thoughtful approach by both business and government to remove tax and other financial barriers and return ethics to the board rooms.
While I am sympathetic to Mr. Smith’s position, we’re not likely to be able to repeal the global economy. We simply cannot manufacture many products competitively. The dollar is the world’s currency of choice, and most of the world’s financing flows through the U.S. Our expertise, and competitive advantage, remains in ‘thinking’, in design, creativity, innovation, and research.
ABCNews.com reported that in 2007, Wall Street’s five biggest firms, Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley, paid out $39 billion (“B”…billion) in employee bonuses. The shareholders lost $74 billion over the same period. Why, oh, why would the best and brightest not go work in the financial sector? Where else could such bad performance generate so much income for the employee?
Yes, the business tax system stinks. But not because it is so high. Because it is convoluted. U.S. companies have the highest tax rate in the industrialized world. However, the aggregate net rate they pay is only about 22%, one of the lowest.
Further, does it really make any difference? Consider the auto companies. They complain about taxes, labor and benefit costs being a burden. But that really isn’t where the problem is. Foreign car makers can sell their cars at vastly higher prices than U.S. cars. If the U.S. auto companies could get the same pricing as foreign makers the financial performance would be much different.
The U.S. will never be a “real product” economy because the same attitude that permeates the financial sector permeates the manufacturing sector. U.S. manufacturing executives are paid many times the multiples of their counterparts in Europe and Asia, yet they continue to deliver poor product and gather big incomes and huge bonuses.
I have always admired Fred Smith, but his comments perpetuate the problem. The U.S. must stop kidding itself. The problems at the heart of the manufacturing sector are ingrained in U.S. management philosophy. Let’s not pretend that we are going back to the industrial model. There is no saving General Motors and the like. There are new industries that may rise up, but they too will end up out of the U.S. unless U.S. managers see themselves personally competing with managers in other countries.
In the choice between building an economy based on working people’s brains versus brawn: we need both. When we sent the high-wage manufacturing jobs overseas in the 80s and 90s, we told the displaced workers to go to college and become knowledge workers – to join management. Then we started sending the knowledge work overseas. So now we have a situation where college – or technical school, maybe; certainly, some post-secondary education – is the new high school. You pretty much can’t do anything that pays a remotely living wage without it, and a well-educated population is a thing to celebrate under any circumstances.
But the idea of getting a job with a company – especially a big one – and building a career there, or even with a series of companies, is a less realistic goal for most people with every passing year; only the truly exceptional or well-connected survive.
So now the answer is entrepreneurship – you’re really only safe if you work for yourself. (Indeed, the BrainTrust panelists are mostly entrepreneurs.) And chances are, if you’re over 55, a corporate job is likely unattainable once you lose one. Yet in a country of almost 50 million people aged 55-75 who still presumably need to make a living, is it realistic to expect that most can start and run profitable businesses?
One way or another it seems we have a basic problem – we have many more productive, capable adults in the population (at all ages) than our economy seems be able to employ at the income levels it takes to keep those same adults participating as customers – so they can afford enough of the goods and services the economy produces, to keep the companies that produce those goods and services in business.
I suggest, then, that what we have is a sort of natural oligopoly. And as technology advances, it will continue to take fewer and fewer people to produce the goods and services we need – even the new fun stuff we want – and yet we’ll have more and more people, getting smarter and smarter (the average IQ has been going up for decades) who need a way to make a living. This situation is not going to improve absent a national catastrophe.
From that standpoint the good news about manufacturing is that it can take a lot of bodies to do everything from designing the products and the technology behind them to the technology to build them, to organizing the production of the products, the production lines, the transportation and a million other things I’m too far from that sector to have any idea about. So it’s at least a partial solution to that problem.
But it would take a conscious act of policy – or many of them – to make it happen. In that case, is it the best use of all those extra bodies and brains? If we’re going to use policy to employ people beyond what the natural oligopoly needs, should we favor manufacturing over, say, infrastructure or basic science, or revitalizing our educational system? The big priority should probably be energy – without it we’ll all be back to the Stone Age, and this whole discussion will be moot.
But assuming we solve energy, or keep it at bay, we could turn our attention to a lot of other problems the world over – and get together with the excess brain power coming out of other countries, too, because they, too, will experience the same issues as their economies develop.
Ultimately, though, we will have to do something, and it will have to be a conscious decision. Or we will become a society of overeducated paupers.
This is a good start, but it won’t fix everything. As we have discussed numerous times in this space, there is an increasing trend on the part of at least U.S. consumers towards reducing consumption, and we’ve heard often that baby boomers in particular have enough “stuff.” So, I’m not sure that focusing everyone on producing more stuff is going to solve everything.
This is exactly the reason I am optimistic about the second half of 2009. Once the “credit crises” is averted, we will learn quickly how unimportant the financial industry has become to the “Real Economy.” The joke amongst economists is that the goal of the financial industry is to “pass around a dollar’s worth of savings until there is nothing left.” We’ve seen what Credit Default Swaps and Collateralized Debt Obligations can do….
A few less financial analysts and a few more bankers on main street that finance real businesses makes a lot of sense.
I would like to see some arguments on the opposite side but don’t think we will find many here.
Most people want more house than they can afford and a job that pays more than it produces. So now we have the problem. What is the answer?
It sure does not sit in Washington.
This question is very interesting, but I fear that emotions stemming from the current sentiment about the economy will get people to the wrong answer.
One tremendous long-run benefit of a free market economy is that resources flow to the areas that yield the highest return on those resources. If the government skews the risks and returns, like Greenspan handing out money at negative real interest rates or Fannie/Freddie removing substantial amounts of real risk from mortgage lending, then the allocation will get out of whack. And apart from the government there may be some misallocation in the short term. But both of these effects are (at least to date) blips on the overall trend towards finding the highest and best use of capital, labor, and brain power.
In the developed world, this has meant a shift over the past 50 or so years away from product manufacturing and into software, services, finance, etc. Even within U.S. manufacturing, it has meant a shift away from the production of low-end goods to the production of higher-end, more value-added products. In the 100 years before that, it meant a shift away from farming and local-scale manufacturing to more intelligent large-scale methods of production of goods. Over the life of the country, work in the U.S. has increasingly become more oriented around the brain and less around the muscles. The result: enormous gains in GDP per capita. This shift is a good thing.
To really think about this question, one needs to think in terms of a 10 to 30 year timescale. In that context, a dramatic move back to product manufacturing–i.e., our best and brightest becoming GM production line managers as they did in the 50s–would be a debacle.
Just one word.
Absolutely.
I don’t know the answer to Mr. Smith’s thoughtful question. But one point in this piece deserves a comment.
When regulating entities consider what financial instruments to approve, they should consider the “grandma test.” Would your grandma think, for instance, that a debt-to-asset ratio of 50-1 was reasonable? (Not bloody likely.) Would your grandma think that people should have been able to purchase a home without a penny of down payment? (Uh, no.) We’re going to have to return to some common-sense policies and procedures if we want to get our economy back on track.
As a nation we have tended to diminish the essentiality of a product economy while aggrandizing our lofty financial economy and its financial ecstasies. But the financial economy balloon is losing its air–poof–and our tax structure isn’t competitive with other product economies’ lower tax structures and labor.
Unless our leaders after November 4 can create an energy economy to supercharge the next financial decade, we better review our competitive position versus the tax structures of the world’s product economies, roll up our sleeves, plan to get our hands dirty, and entertain the necessities for a product economy today.
Fred Smith is absolutely right! We should be focusing on a “product” or “manufacturing” economy. Such an economy should not be limited to just a few industries such as aerospace and defense but should include consumer products. World history is full of examples of countries whose fortunes declined as their manufacturing prowess declined and vice versa. Just look what happened to England over the years and look at what happened to Japan, South Korea, Taiwan, China, etc.
In a service economy, people end up selling hamburgers to each other and eventually, people do not even have money to buy hamburgers! So, while we still have time, there should be a concerted effort toward bringing all kinds of manufacturing back to U.S.A.
Listen to Fred!
There are other factors that are relevant as well. During economic recession and depression a “product” or “manufacturing” based economy will bounce back much quicker than a “service” based economy. It also puts your basic sovereignty at risk. When components and whole products are produced out of country it places complete reliance on the producing county for support! What happens if China decides not to ship the components to manufacture the boot that is worn by our military? The effects are far more reaching than just economic resilience and sovereignty but those two alone should be enough to move back to building American!