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Fred Smith: “Keeping America Competitive: the View from ‘Commerce Street’”

February 11, 2009

On February 10, Fred Smith addressed Town Hall LA on the economy’s impact on industry.  The outline of Mr. Smith’s remarks are provided below.

“Keeping America Competitive:  the View from ‘Commerce Street’"
Frederick W. Smith
Chairman, President and CEO, FedEx Corporation

Good afternoon.  What a pleasure to be in southern California in the middle of winter.  Not only do I get to enjoy great weather and speak at the prestigious Town Hall LA, but I also get to visit my two daughters who live here. 
•    Both of them are in the movie business, and that reminds me of my own acting career.  I played myself giving a speech in the Tom Hanks movie “Cast Away” a few years back.  He got an Oscar nomination; I didn’t.  As you can see, I’ve kept my day job.
•    Tom’s character ends up alone on a tropical island for four years, mostly talking to a volleyball named Wilson. With the current economic situation, I know spending time alone on a tropical island may sound good to a lot of people right now.  But I’m not one of them.  I think I am a realistic optimist and firmly believe we can do several things to get American back on track, which I’ll talk about today.  However, there’s no question this is the most serious economic situation I can remember.

To illustrate my point, let me tell you a story. 
•    There once was a company that made plastic molded parts.  One of their customers owed them $80,000, but was having a hard time paying the bill because their bank had, without notice, lowered their credit limits after the customer had sent the check.  So the $80,000 check bounced. 
•    Eventually the customer straightened out the funding and paid their bill to the plastics company.  But the customer’s reduced access to money meant they couldn’t pay the plastics company to make more parts.  In short, the customer company had orders, but they didn’t have the capital to produce the orders with the plastics company’s parts. 
•    Right now the plastics company—and its customer—are struggling to keep their businesses afloat—so we don’t know yet if the story will have a Hollywood ending. But the story is true, and the plastics company is located here in LA County. Unfortunately, this intertwined situation is all too common in California and throughout the U.S. It has contributed to the business failure rate, reduced tax revenue, and the loss of jobs for many talented people.

The fact is that in this economic downturn, most people, especially politicians and the press, talk about Wall Street and Main Street, but few talk about what I call “Commerce Street,” the industrial economy in between…and the one with just as many victims as the other two sectors. 

Let me shine a spotlight on how important such industries are to our American economy.
•    The industrial sector includes businesses that are usually rich in assets—big service companies, health care providers, warehousers, manufacturers, agriculture, mining and energy producers.  This sector is a major driver of our economy.  Industry may not be as sexy as finance, housing or retail, but it’s a critical component of GDP.  Industrial job creation and loss parallel exactly the rise and fall of corporate spending in the U.S.
•    Here in southern California, despite job losses, LA County is still the largest manufacturing center in the country, ahead of Chicago and Detroit.
•    One thing that has really benefitted the industrial sector, as well as other sectors, is fast-cycle logistics, which offers increased inventory flexibility.  It gives companies more clarity at point of sale and more visibility of inventory in motion and at rest. So these companies can adjust to market conditions quickly.  Thus, goods don’t stockpile in warehouses, and store shelves don’t go bare. I might add that FedEx has been a large contributor to this more flexible economy.
•    Well, yes, you may say, that works until an economic maelstrom like the one we’re in now.  In the last few months, we’ve seen huge retail markdowns, plants being shuttered, workers furloughed or fired, and inventory levels either backed up or not being replenished.  I do believe this situation would have been much worse, had it not been mitigated through a combination of fast-cycle logistics and advance supply-chain information systems.

Even so, as more industrial businesses have slowed down or closed, the United States has begun to lose its edge in the global marketplace. How can we fund technological innovation if companies are strapped for cash? How can we fund alternative fuel research if chemists have lost their jobs? 

So today I’d like to try to answer the question, “How can we make American companies more competitive in the global marketplace and increase their ability to offer American workers good jobs? 

My answer? Three things:
•    Accelerate the expensing of capital investment,       
•    Reduce our dependence on imported petroleum, and 
•    Champion free trade.

Let’s talk capital investment first. 
•    For many years now, U.S. tax policy has favored the financial sector of our economy over the industrial sector, and as a result, the financial sector has grown disproportionately.
•    Twenty-five years ago, the financial sector comprised a little over 15 percent of the economy and last year, before the meltdown, it had doubled.
•    And why shouldn’t it grow?  As the U.S. Treasury Department concluded in a 2007 report on tax reform options, our current system heavily favors debt financing. Interest on debt used to buy business assets is deductible. You and I can deduct the interest on the money we borrow to buy a house. But businesses using their own money to buy equipment or software, cannot deduct the cost of those expenditures.  Such assets must be depreciated over several years.
•    In our business, for every dollar of equity, you might have 10 or 15 cents of debt.  In contrast, in the financial sector, for every dollar, you may have 10, 20 or even 100 times the debt.  Such overleveraging, of course, led to the dramatic failure of so many financial institutions, beginning last fall.  Winston Churchill once said he would like to see finance “less proud and industry more content.” It certainly looks as if the first part of that wish has come true.

Instead of penalizing capital-intensive companies in this way, we urge Congress to change the tax code to permit U.S. companies of all sizes to write off all of their capital expenditures for equipment and software when the assets are put into service, as opposed to the current system of long-term depreciation.  Why does this make sense?  
•    Tax and economics experts Ernie Christian and Gary Robbins have said that over time, every dollar of tax reduction for expensing adds about nine dollars of GDP growth.
•    Expensing helps workers too. Three-fourths of the benefits of capital investment go to the workforce. 
•    Stephen Entin of the Institute for Research on the Economics of Taxation, said in a recent Wall Street Journal article that expensing is a good policy that “more fully reflects the real cost of equipment than depreciation, raising after-tax returns on investment.  It would boost capacity and employment.”  He also urged a lower corporate tax rate—we have the second-highest rate, after Japan.
•    Authors Chris Edwards and Daniel Mitchell say in their book, Global Tax Revolution, that “If corporations are not building factories and investing in the United States due to high taxes, labor productivity will fall, and that will drag down American wages.”
•    Conversely, expensing will incent companies to invest in training, equipment and software, which ultimately leads to more jobs and higher wages.
•    And even without counting the benefits to the economy of new jobs, it’s a relatively cheap option for the U.S. Treasury, since the only cost to the government is the time value of money.
•    The situation is similar to what the cardinal said to Michael Corleone in Godfather III—that he should go to confession:  “What have you got to lose?”  The Congress’s decision should be just as easy in this regard.
 
How does quicker expensing impact the economy and grow American jobs?  Let me use an example from FedEx. 
•    If we buy a 777 airplane from Boeing, under the current tax code, we generally write that asset off over seven years for tax purposes.  But buying a $100-200 million airplane is a big risk because you don’t know what the market’s going to be like when that plane is delivered some four years after the initial order. 
•    So the best way to mitigate the risk of making that capital purchase, which in our case provides jobs for pilots, mechanics, hub workers, and couriers, is to allow the buyer to get that money back quicker.  It reduces risk and encourages investment more quickly in new equipment, facilities and jobs.

While faster capital expensing is smart tax policy in any case, it is particularly so in times of economic downturns such as the one we are in now. 
•    Every corporate board wants to lower capital spending right now, but to stimulate the economy, such spending needs to be accelerated!
•    As everyone knows who has bought high-end computers or data servers, technology becomes obsolete very quickly.  Companies must spend the money to update their technology, which in turn will allow them to become more productive, cut costs and hopefully pass some of those savings on to their customers. Accelerated depreciation will help industry adopt new productivity-enhancing technology quicker.

The second initiative we propose is reducing U.S. dependence on imported oil. 
•    Nothing demonstrates the danger of this dependence more than the run-up of gas prices last summer.  When oil hit an all-time-high of $147 a barrel, that was the match that lit the prime-mortgage tinderbox. It forced people to choose between putting gas in their cars to get to work or paying mortgages and other debt. They had to go to work.
•    Right now 60 percent of our petroleum is imported, as compared to 30 percent in the 1970s.  That puts a huge dent in our balance of payments account–around a billion dollars a day.   Ninety percent of all oil reserves are now owned by national oil companies, many of which are located in countries with ambivalence or antipathy toward us and our way of life. Many of these reserves are in expensive and inhospitable locations as well.
•    Our dependence on these sources means that foreign petroleum is an enormous national security issue as well as an economic one.
•    I am the Co-Chair of the Energy Security Leadership Council (ESLC), an organization of business CEOs and retired four-star military leaders whose goal has been to recommend policies that reduce oil dependence.
•    One of our members testified last month before the Senate Energy Committee and made the case for our three core recommendations:
o    the diversification of U.S. transportation fuels, primarily by electrification of the short-haul, personal transportation sector;
o    accelerating the development of new energy-related technologies; and
o    increasing our access to domestic oil and natural gas supplies.

The ESLC urges research of all kinds of alternative fuels with the goal of making them fully competitive economically as quickly as possible. We’re talking solar, wind, natural gas, biodiesel, geothermal, and one of my favorites—algae.
•    Did you know that algae, which is a prolific eater of carbon dioxide, can double in mass quickly, sometimes in four to six hours?  Sounds like a screenplay for a horror film, doesn’t it?
•    Algae has 30 times the amount of oil inside its molecular structure than cellulose ethanol does.  That gives it big potential for the production of jet fuel.  In fact, you could produce enough jet fuel for the entire world in a land mass about the size of West Virginia, as compared to other biofuels, which would take a land mass the size of the United States.  Amazing what you can do with a little pond scum!
•    Over the past year, there have been four successful demonstration flights with biofuels made from jatropha and algae, so this is not pie-in-the-sky thinking.

At FedEx, we very much believe in researching and using alternative sources of energy. For example…

•    Here in California, we have three solar-powered facilities—in Whittier, in Fontana and in Oakland.
•    We are upgrading our air fleet by replacing narrow-body aircraft with planes that reduce fuel consumption up to 36 percent, while providing 20 percent more capacity.
•    We pioneered, along with the Eaton Corporation, the first commercial hybrid pickup-and-delivery fleet and now have the largest fleet of this type in North America, with some hybrid electric trucks here in the LA area.
•    In England, we introduced liquid petroleum gas vans that reduce carbon emissions by 12 percent, and in Italy have begun testing hybrid diesel-electric vehicles designed for the European market. In Japan, we teamed up with General Motors to test a fuel-cell delivery vehicle.
•    Our goal is to improve fuel efficiency for our FedEx Express vehicle fleet 20 percent by the year 2020. So far, we’re at 13.7 percent.

We believe the quickest and easiest way to wean American industry and consumers away from imported oil is to promote electric vehicles, another recommendation of the ESLC. 
•    Right now about 75 percent of all personal car travel is less than 40 miles a day.  For our own pick-up-and-delivery trucks, it’s less than 100 miles a day on average.
•    Electric power can be produced by many sources that are environmentally friendly—water, wind, natural gas and solar to name a few.   
•    Already we have the basic infrastructure to power millions of vehicles, and if we overhaul the electric grid, we can take care of millions more. To power the next day’s driving, most recharging could be done overnight at garages, businesses and homes. Recharge cycles are becoming shorter and in a few years, many will be less than an hour.
•    Entrepreneurs throughout the world are already working on improved battery technologies for longer range. One company, Better Places LLC, is working on a system in which you could drive in, swap your depleted battery for a fully charged one in about the time it would take to pump a tank full of gas. Better Places is rolling out pilot projects in San Francisco, Hawaii and Israel right now.
•    So there’s lots of creative thinking on this already. If we passed legislation to incent manufacturers, consumers, and state and local governments through tax credits or production credits, we could rapidly shift American electric-vehicle production into overdrive.

While we can and must do many things to reduce our need for foreign oil, the fact is that America’s need for oil won’t disappear any time soon. So we must also expand the domestic supply of petroleum
•    What we at the ESLC urge is increasing the access of the U.S. to oil and natural gas reserves. 
•    I know this may not be popular with some people, but environmental protection methods and technologies have greatly improved in the past few years, and I believe the case for increased production is clear.
•    Not only does the purchase of foreign oil put a big dent in our balance of payments, but we also spend far more than that protecting it. As much as 60 percent of our defense budget is directly or indirectly related to protecting the oil trade.  Is that how we want to keep spending our limited resources for the foreseeable future?
•    Reducing dependence on foreign oil must be a serious, sustained national effort.  It does involve trade-offs and I understand this is difficult.  But I hope both political parties will commit themselves to this effort in a spirit of principled compromise.

How will oil independence boost the American economy?  It will spur new technology on many fronts, which in turn grows jobs, particularly in the energy field and in the ailing auto industry. 

The third way we can jumpstart the American economy is by continuing to promote the benefits of free trade. 
•    In his inaugural speech President Obama reminded us that the market is unmatched in its ability to generate wealth.  He said, “The success of our economy has always depended not just on the size of our gross domestic product but on the reach of our prosperity.”
•    Quite simply, trade creates jobs, here in the U.S. and around the world.  Trade-related jobs account for one in five American jobs (Business Roundtable 2007), and they are higher-paying positions at that.  Here in California, almost 4 million jobs are trade-related and nationwide, the net impact of trade upon manufacturing is positive.
•    Trade will become even more important to America’s future.  By 2030 there will be seven billion people in the world and Americans will be about five percent of that.  So we should look at the other 95 percent of the world as our customers.   As middle classes expand in other countries, our potential markets will grow too…faster than our domestic market will, by all accounts.
•    So to maintain our prosperity we must champion trade.  And that includes exports and imports—both are critical to our success. 
•    While some eschew the purchase of so-called “foreign goods,” remember that foreign-owned companies often create American jobs.  Honda, Toyota, Nissan, BMW and other car makers have created tens of thousands of American jobs in plants in California, the South and the Midwest. By the way, did you know that an article in the Wall Street Journal last month reported that the Toyota Sequoia is 80 percent domestic content while its competitor, the Jeep Patriot, is 65 percent domestic content?
•     There’s a temptation now for countries to retreat into their own economic shells, and one misguided manifestation of that is the “Buy American” proposal in the stimulus package.  Trade is the main reason the world has enjoyed greater prosperity and higher standards of living. Ask the people of China, India and Vietnam how their standards of living improved when they gained access to the open market and its goods, services and new ideas.  Ask the people of North Korea how they’re doing walled off economically and politically from the rest of the world.
•    Now I realize that while we all enjoy the benefits of trade, some of us also experience the pain of it.  Well-known economist Burton Malkiel said just last week in a Wall Street Journal editorial. “The pain tends to be localized while the benefits are spread broadly.  But the total benefits do exceed the costs.”  Malkiel goes on to recommend that displaced workers receive job retraining and a better safety net during the transition period.  He also recommends revamping our educational system to prepare workers for current jobs but also to give them the flexible skills needed for jobs in the future. 
•    Protectionism will not keep America or any country competitive in the long run. We live in a truly borderless economy, and our trade practices must reflect that.
•    That’s why we must urge Congress to pass free trade agreements with Colombia, Panama and South Korea. Your California Chamber of Commerce supports these agreements because they are good for the state’s powerful economy, especially as a key player in the Asia-Pacific market.
•    That’s why we must resume the Doha talks to lower trade barriers around the world. 
•    And that’s why we must reform immigration laws to make it easier for talented people from other countries to work in the U.S.  Immigrants played key roles in the formative years of the movie and garment industries in southern California and in Silicon Valley in northern California. Shutting the door on legal immigrants who bring new ideas to American is shutting the door on our future. 

Over the past decades, shared global prosperity has lifted millions out of poverty and bound nations together. Particularly in this time of worldwide economic instability, we must work together with all nations to increase access to goods, services and ideas, not decrease it. If nations turn their backs on each other through protectionist measures, instead of using the R-word—recession, we might be using the D-word—Depression.  Back in 1930, the Smoot-Hawley tariffs helped tip the nation over into the Great Depression.

In summary, I believe that we can face down today’s challenges with that famous American ingenuity, determination and optimism that have kept us a world leader for so long. 

The three topics I’ve discussed today require little in the way of direct government money.  By stimulating the industrial sector to invest more in equipment and software; by reducing our dependence on imported oil; and by helping world markets remain open, we can begin to move the U.S. economy in the right direction.  The only thing we really need is the political will to make these things happen. If we do, then we can transform “Commerce Street” into a more powerful force in California’s economy, and we can help straighten the crown America has worn for so long as the world’s economic leader.   
                       

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