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Is the Recovery Real?

The economy may be able to keep growing, but CEOs have big worries-and they aren’t convinced that jobs will rebound.

The U.S. economy is growing, interest rates are at rock bottom, and inflation is quiescent. Massive layoffs are mostly a bitter memory. Companies are seeing their sales improve and profits, too. It looks and feels like a recovery.

But does this recovery have legs? And, if so, what will it look like six months from now? Those are burning political questions that could decide the outcome of November’s presidential election.

Having scant respect for either politicians or economists who make rash predictions, we at Chief Executive posed the question to the people who make decisions about the future of the economy, namely our readers.

Nearly 65 percent of the 226 executives responding to our CEO Confidence Index said “yes,” the economy might continue to expand after the election and into 2005 and beyond.

But that affirmative answer was followed by a resounding “if.” From monetary policy to a shifting regulatory climate to global competition, CEOs see many risks that could derail the economic upswing. Their current investment and hiring plans reflect considerable wariness. Very few predict a robust recovery, and for the second month in a row, their overall confidence declined. “They’re all uneasy,” says American International Group CEO Hank Greenberg. “They’re all being cautious, and you can’t blame them.”


Ron DeFeo Terex

Can we keep growing?
I do feel this recovery is sustainable, but it’ll be one that has its own idiosyncrasies. We live in a world that is very much changing, and the recovery we’re experiencing reflects productivity tools, information capabilities and the creativity those tools have allowed to happen. Unfortunately, politicians have a way of getting in the way. And that’s my biggest concern. Ultimately, business is quite global, due to technology and information and capital flow. Capital will always flow to the friendliest places. So if we make it difficult because of a protectionist mentality, capital will flow elsewhere.

What kind of protectionism are you worried about?
I’m reminded of people who don’t like immigration but then hire an illegal immigrant to clean their house. The government says we don’t want jobs to go overseas, but we need a high minimum wage and a social net. I have no problem with making the social safety net good, but let’s understand that the jobs we do here will be different from the ones done overseas.

Any other challenges?
I’m very worried about currency volatility. Businesses hate volatility. The government thinks a weak dollar helps exports, but it’s a like a little boy with his finger in the dike. The Treasury Department thinks it’s helping business, but most larger American companies are harmed. There are big costs associated with adapting to 30 percent swings in currency value. From my point of view, quit trying to screw with the economy and work with us to keep volatility to a minimum.

The uncertainty is apparent across industries and in companies of every size. Greenberg expects to keep capital spending at his global insurance giant level for the time being, and nearly half of the survey respondents said their companies would do the same. And while 52 percent expect payrolls to increase over the next quarter, none expect job growth to explode any time soon. That’s almost certainly bad news for those who predict massive job growth by Election Day.

Behind the CEO reticence is a sense that the U.S. economy is still undergoing deep structural changes, not just cyclical ones. All through the last recession, productivity kept creeping up-the result of careful cost management by companies and improvements in technology. The downside of productivity gains, however, is that they keep a lid on employment.

At the same time, globalization means that manufacturing and, increasingly, service jobs continue to move overseas to lower-wage countries. As Intel CEO Craig Barrett and others are arguing, the U.S. has become a high-cost place with a relatively slow growth rate compared with India or China. Eventually, executives think, domestic job growth will pick up, but not necessarily in traditional ways. “Job creation may mean different kinds of job creation,” says Joe Wright, CEO of Wilton, Conn.-based PanAmSat, a commercial satellite services provider. “We won’t be hiring someone to go on the factory floor. We’re following a different model.”

Naturally, executives are keeping a close eye on the classic engines of growth, namely fiscal and monetary policy. To get this recovery going, the Federal Reserve reduced interest rates seven times in 2001, then made four more cuts after 9/11. As a result, short-term borrowing costs are at a 40-year low. That, along with $36 billion worth of tax rebates, has put more money into the pockets of consumers, who account for more than two-thirds of gross domestic product. But these stimulative conditions can’t last forever. Says Greenberg: “I’m concerned about this recovery’s long-term viability because fiscal stimulus from tax cuts will run its course. And while there’s no evidence of inflation right now, it’s inevitable that interest rates will have to rise sooner or later.”

That’s not just because the Fed can’t go any lower, but also because of the outsize budget deficits looming ahead. While recognizing that government spending on security measures at home and counterterrorism efforts abroad is a necessity, executives worry about the U.S.’s financial future. “The massive deficit spending and debt we are accumulating are going to come back and haunt us as a nation,” declares J. Doug Pruitt, chairman and CEO of Sundt Construction in Tempe, Ariz. “We have got to get control of the budget, and fast.”


Fred Smith FedEx

What do you think is the biggest variable that will affect U.S. economic performance over the next 12 months?
I think the biggest variables are politics, energy prices and interest and exchange rates. Short term, we are experiencing improving favorable conditions: consumer and marketplace sentiments are high. Momentum in output growth is strong. The labor market is improving and risks of inflation and disinflation are balanced. Capital expenditures are picking up in the durable goods and high-tech/high-value sectors.

But there are concerns such as whether the improvements in durable goods will hold or whether recovery in overseas markets can be sustained. Certainly, you can’t discount overall geopolitical risks. And consumer behavior and public policy will inevitably be affected by political campaigns and the election process. Should interest rates be increased, capital markets are likely to take a hit in major areas like housing and automobiles. In the same vein, persistently high energy prices could be a drag on economic growth.

Some people think the current recovery is different from historical upswings, particularly because of slow job growth. Do you agree?
I think the current economic recovery is different from many historical upswings in that it is likely to be slower, primarily because we didn’t have a sharp recession. Job growth is likely to be the last thing to pick up. But I do think the [positive] signs are there, including household and payroll surveys, initial jobless claim numbers, the civilian unemployment rate and hiring intention surveys.

Lee Schuman, president of Majestic Distilling Company in Baltimore, agrees. “The huge deficits run by the Bush administration,” he says, “are a ticking time bomb that must be dealt with in order to protect the long-term recovery.”

In this context, even the weak dollar, which has helped fuel the expansion by boosting exports, is a double-edged sword. Many are concerned that foreign investors, who hold more than a third of U.S. Treasury bonds, will pull their money out of greenbacks and sink it into stronger euros. That would put further upward pressure on interest rates. In addition, a sinking currency can wreak havoc with corporate cash management. “The government thinks a weak dollar helps exports,” complains Ron DeFeo, CEO of Terex, a $3.5-billion maker of construction equipment in Westport, Conn. “But there are big costs associated with 30 percent swings in currency value, and most large American companies are actually harmed. Business hates volatility.”

Nevertheless, on the micro level, business leaders say they believe the economy can keep eking out gains. “In my opinion, there is pent-up demand for a variety of goods and services postponed for the past two to three years,” says Michael Galinski, CEO of America II Corp., a privately held distributor of electronic components, based in St. Petersburg, Fla. Component sales are forecast to be strong all the way through the second half of 2005, and Galinski sees this as a harbinger of growth in other industries-everything that uses technology, in fact. Nelson Byman, president of MIC Group, a privately held maker of precision machining parts in Brenham, Tex., notes the same trend. “We have seen a nice increase in orders and activity levels from our customers in a broad range of industries,” Byman says. “We are cautiously adding people and putting some of our capital plans into action.”

Some executives believe the recovery is moving into a more dynamic phase, at least as it relates to their own companies’ performance. They have been relentlessly pursuing productivity. Now, they’re ready to reach for higher revenues. “What you’ve seen in the first year or two has been incredible cost management and margin expansion,” says Michael Jordan, CEO of information technology company EDS. “Every CEO in the land is focused on top-line growth, innovation and marketing. We’re seeing companies making decisions to go ahead with new products. Spending that been kept under wraps is now loosening up.” Jordan notes that demand is picking up from Europe, where economic cycles typically lag behind those in the U.S.

While accelerating global growth certainly cheers many CEOs, much of their optimism is based on faith in the resiliency of American consumers, who kept on spending right through the recession and are still buying. PanAmSat’s Wright, who served in President Ronald Reagan’s Office of Management and Budget, explains that despite the body blow from the stock market crash after April 2000, consumers’ discretionary income has risen faster than their spending. On top of the tax rebates in 2001, oil prices fell by a third that year, and home mortgage refinancing put an extra $140 billion into people’s pockets. In 2002, mortgage holders saved almost that much again. And, Wright says, increases in home values more than offset stock losses.

Historically, when Americans feel flush, they spend rather than save, and no one expects that mind-set to change. In fact, U.S. demographics could bolster the trend; many people believe the baby boomers will grow even more profligate as they age. If consumers kept shopping during the recession, CEOs say, they’re unlikely to slow down now, especially with stock prices moving up. “With more money in their pockets, Americans continue to spend, spend, spend,” says Jim Dalton, president and CEO of Dalton Agency Inc., an advertising agency in Jacksonville, Fla.

That makes the nation’s lenders happy. “We never had a consumer recession,” declares Wells Fargo CEO Richard Kovacevich. His bank posted record revenue and earnings growth through the downturn, and he continues to pursue market share gains. As long as interest rates and tax rates remain accommodating, Kovacevich expects consumer purchasing power to stay strong. “There’s a lot of stimulus in the pipeline,” he says.

Many executives think that sustained consumer and business confidence is largely a matter of managing expectations. Since the recession was relatively short and relatively mild in historical terms, it’s counterproductive to look for superhot growth now. “This recovery has not been as dramatic because the recession was not as bad,” says PanAmSat’s Wright. “It wasn’t a V recession-it was more of a flattened U. So we won’t see as much bounce coming out of it.”

Indeed, many CEOs feel that the heady growth of the late 1990s, fueled by the technology boom, set an unhealthy precedent. “The late ’90s was a fantasy land,” declares Jeff Stephenson, CEO of Bennett & Curran, a small distributor of books and audio products in Englewood, Colo. “Today, CEOs recognize and are returning to the basics of building and marketing their businesses. All industries have better management as we enter this century.”

Jordan of EDS agrees. “Management has costs more firmly under control than it did 10 or 12 years ago,” he says. “We all look back to [unemployment of] 4.5 percent in the late ’90s, but that was funded by a lot of speculative technology and telecom activity that cost investors hundreds of billions of dollars.” He and other CEOs think that instead of hoping for a repeat of such excesses, businesses should adjust to a more sober growth pace that in the long run will be far more economically sound.

Nagging doubts remain over the factors beyond executives’ control. The biggest, of course, is the chance of another major terrorist attack on the U.S. or conflict abroad. Another is domestic politics. A number of CEOs expect the incumbent administration to inject more juice into the economy between now and November. “It’s a presidential election year, and that will probably outweigh other variables and give the economy a short-term boost,” says John Edwardson, CEO of logistics giant CDW in Vernon Hills, Ill. “Bush will do whatever he can to pump the economy and increase jobs,” agrees John Shalam, chairman of Audiovox, an electronics maker based in Hauppauge, N.Y. But such stimulus would probably not be effective past mid-2005.

CEOs also cite the high cost of doing business in the U.S. as an obstacle to long-term prosperity. Litigation and regulatory strictures, they say, continue to bite into profitability. According to AIG’s Greenberg, for example, the “out-of-control” tort system costs American companies more than $200 billion a year. Many executives believe the Sarbanes-Oxley Act is crimping corporate risk-taking. And despite the occasional noises about a return to protectionism, few believe that job migration is reversible. “We will continue to see the diminishment of our manufacturing base,” says James A. Junkin, president and COO of Alabama-based Tri-Co Oil.

Large, global companies see their strongest growth on foreign soil. FedEx, for example, is expanding rapidly in China, where its business is growing at more than 40 percent per year. After establishing a regional headquarters in Shanghai, says CEO Fred Smith, he plans to move into 100 new cities in Asia, on top of the 200 FedEx already serves. Smith is making capital investments in the U.S., too. But he thinks the current recovery will be slow. And, he says, “job growth is likely to be the last thing to pick up.”

The outsourcing trend that’s provoking such political drama and troubling so many American workers, however, may spark more innovation and heighten U.S. competitiveness, many CEOs say. AIG’s Greenberg believes that with the right stimuli, the U.S. has the potential to be a powerhouse in high-value-added fields such as biomedical technology. “We have to change the education system to focus on teaching those coming out of school the capabilities to be part of new industries,” he says. “And we have to have the tax and regulatory incentives to create those new industries.”

Until that vision becomes reality, though, CEOs will have trouble getting enthusiastic. The sense that the future will be different from the past makes it difficult to commit capital. Even executives who think this recovery is sustainable don’t think it will have the same shape as previous upswings. “I think the reason there’s still such caution out there is that these are unusual times,” says Wells Fargo’s Kovacevich. “People aren’t sure what’s going to happen.” In that kind of environment, CEOs don’t appear eager to take risks.



Michael Jordan EDS

Is the recovery sustainable?
I definitely think the recovery is sustainable. What you’ve seen has been incredible cost management and margin expansion. Every CEO in the land is focused on top-line growth, innovation and marketing. [But] this is going to look more like the first half of the ’90s.

What are the big economic drivers going forward?
The dollar being where it is is helping the economy a lot, along with low interest rates. The dollar hasn’t gone down as much against our trade-weighted basket as it has against the euro. It’s still a tremendous advantage for exporters. So I expect exports to pick up pretty quickly in the year ahead.

How’s your business?
We’re seeing companies make decisions to go ahead with new products. They’re outsourcing and restructuring their IT environment. Spending that has been kept under wraps is now loosening up. Also, we’re seeing demand picking up from Europe. The market will be in mid-single digits in revenue terms, maybe a little higher.

So does that mean that hiring is going to rebound?
I think job growth will be lower than after the 1991-’92 recession. Management has costs more firmly under control than 10 or 12 years ago. Unemployment today is still below average. I think we all look back to the late 1990s, but that was funded by a lot of speculative tech and telecom activity that cost investors hundreds of billions of dollars. Jobs were funded by gullible investors. But I expect unemployment [now] will drift back to 5 percent.

Japan Bounces Back

Partly thanks to China, Japan’s economy is growing


It’s been several years since many American CEOs started writing off Japan and zeroing in instead on China as a gold mine of profitability. With the exception of a Starbucks Coffee shop here and there and a few specialty ambulance funds for bad loan clean-ups, there has been hardly any big American business foray into Japan since the early 1990s. The thinking has been that the Japanese would have to radically alter their economy before it would again blossom and become an attractive place to invest.

But lo and behold, the Japanese economy is recovering nicely. Embarrassed by the two recovery calls they prematurely made over the past 13 years, Japanese government mandarins say only that the economy is “on the path to recovery.”

The numbers are stronger than that, however. The world’s second-largest economy began recovering in the latter half of 2003, and its GDP grew at an annualized rate of 7 percent in the fourth quarter, the best showing since the 2.5 percent growth in the second quarter of 1990. That was just a few months before “the bubble economy” burst.

The key pillar of the new growth is cyclical domestic demand, including personal spending and corporate capital outlays. Once hailed as the world’s best savers, Japanese consumers appear to have grown tired of driving 10-year-old clunkers and putting up with noisy washing machines. Emboldened by the 40 percent stock market recovery, they are outspending their salaries and dipping into their hard-earned nest eggs. Manufacturers are seducing consumers with big-screen, flat-panel television screens, DVD players and other high-tech digital gadgetry as “you-got-to-have” products.

Adding to that consumer activity is exports, mostly high-tech parts and production machinery to China and elsewhere in the Asian region, not the traditional flow of cars and assembled products to the United States. The 14-year-old nonperforming loan saga, meanwhile, is expected to come to a conclusion by next year. “Both sentiment-wise and figure-wise, the overall record of Japan’s economy is improving,” says Toyota Motor Chairman Hiroshi Okuda, who also heads the influential Keidanren business group. “This recovery should be sustainable.”

Businesses are flexing muscles, convinced that the economy will sparkle further. Canon, Sharp, Sumitomo Metal Industries and NEC are among those bullish about the Japanese economy’s long-term sustainability. They are building new production facilities in Japan to make exports destined for the mainland and other markets, giving rise to the much-hyped fear that Japan would be “hollowed out” by the emergence of China. Why invest in expensive Japan and not in low-labor-cost countries? “Building production facilities for high-end products in Japan is a must to protect Japanese intellectual property rights” against foreign fake goods, says Masakazu Toyoda, director-general of the Ministry of Economy, Trade and Industry’s Commerce and Information Policy Bureau.

Manufacturers’ efforts to catch up with the digital technologies pioneered by the likes of South Korea’s Samsung Electronics also have resulted in a renewed emphasis on making things in Japan. “In this age of fast and short product cycles, especially for digital products,” adds Toyoda, “it has become vital to perform R&D and production at the same location. So, manufacturing, particularly high-end high-tech products such as next-generation cell phones and large flat panels, needs to take place in Japan.”

One example of an R&D-manufacturing consolidation is Hitachi Ltd.’s new 3-D display technology that enables viewing a 3-D image from almost all angles. Manufacturing that display equipment requires close interplay between the engineer and the production shop.

While the clouds have cleared for the Japanese economy, it still faces some challenges. “The greatest concern is the soft employment conditions in Japan, the United States and Europe,” says Teizo Taya, a Bank of Japan policy board member. Job creation has been slow in the United States, and Japan might be following that pattern, he speculates. So Japan’s economy is by no means perfect, but it’s come a long way since the darkest days of “the lost decade.”

About joan warner