David M. Cote on Emerging Markets

David M. Cote on Emerging Markets

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from Bernard L. Schwartz Lecture and The Bernard L. Schwartz Lecture on Economic Growth and Foreign Policy

David M. Cote, chief executive officer of Honeywell, joins Rana A. Foroohar, assistant managing editor of Time magazine, to discuss the role of emerging economies in the global economy. Cote begins by assessing the current state of major Asian emerging markets, including China and India. He focuses on the recent volatility in Chinese equity markets and Indian Prime Minister Narendra Modi's economic reforms. Over the course of the conversation, Cote addressed U.S. legislative politics, taxation and education reform in the United States, and factors that affect his decision-making as the chief executive of a major multinational conglomerate.

The Bernard L. Schwartz Lecture on Business and Foreign Policy was established in 2002 and is funded by Bernard L. Schwartz, retired chairman and chief executive officer of Loral Space and Communication. The lecture focuses on the relationship between business and government in the making of foreign policy.

The CEO Speaker Series is one way CFR seeks to integrate perspectives from the business community into ongoing dialogues on pressing policy issues.

FOROOHAR: My name is Rana Foroohar. I’m the economics editor at Time Magazine and a global economic analyst for CNN. And I’m very, very pleased today to be here with David Cote, the head of Honeywell, for the Bernard L. Schwartz lecture on business and foreign policy.

Many thanks to Bernard L. Schwartz, who is the retired chairman and chief executive of Loral Space and Communications, for his support for this lecture series.

This meeting, as I’m sure some of you know, is also part of the CFR CEO speaker series in which leading global CEOs share their insights on the global economy, foreign policy, and so on and so forth. And just FYI, the next meeting is with Edward Alden, Maria Teresa Kumar, and Doris Meissner on the future of U.S. immigration policy, a hot topic, which is part of CFR’s Renewing America series.

So just a reminder; this meeting is on the record. If you could turn off your mobile devices. We’re going to speak for about 30 minutes in Q&A here and then we’re going to open it up to the floor so members can ask questions. And there will be folks with mics around.

So Dave, such a pleasure to be here with you. We had a great conversation before we came on stage today. And you are running a company that is at the nexus of so many of the big news issues that’s going on—trade issues, currency issues, the shifts in the global economy, where it was in the 1990s, where it’s heading in the next couple of decades. And I know that you have some strong thoughts about that.

So maybe we’ll just begin. You showed me a slide, a graphic, earlier that kind of marks out the percentage of the U.S. economy that made up the whole of the global economy in the 1990s versus what it’s going to be in 2030. And as everybody knows, that’s a big shift. So maybe walk us through what you see happening and how that’s affecting your business and U.S. companies in general.

COTE: OK. Yeah, the page you referenced we actually have available somewhere if anybody wants to see it. And I just happen to have a page myself. The reason that we reference this page is this has informed a lot of how I think about how Honeywell and what we’ve tried to advocate for policies.

And what you’ll see is it just lists 1990, 2010, 2030. And it represents a percent of global GDP by region, broken out from the U.S., other developed regions, and developing regions. And what you end up seeing—and this is all from Global Insight, a very well-recognized economics outfit—what you end up seeing is the U.S., this bottom line, in 1990 was 27 percent of the global economy; in 2010 was 23 percent; and by 2030 goes to 19 percent.

When you look at other developed regions—so think Europe, Japan, Australia, Canada, places like that—1990 it was 50 percent of the global economy; 2010 is 42 percent; and by 2030 is 34 percent.

The big change is that if you take a look at developing regions, and a big part of that influenced by China and India, 1990 was 23 percent; 2010, 35 percent; and by the time you get to 2030, it’s 47 percent of the global economy, meaning half the global economy will be coming from what we refer to today as emerging regions.

I think that’s a trend that’s just—even though we all see it happening and we’re all kind of participating in it, I don’t think U.S. businesses and U.S. policy is really that cognizant of how important this trend is and what we need to be doing in order to participate in it and be able to compete in that kind of an economy.

FOROOHAR: So we’ve all heard obviously of the growth in emerging markets. It’s hard to characterize that as one story anymore. Obviously it’s an incredibly bumpy story, particularly in the last few years.

Let’s run through a little bit which markets you’re bullish on, which you’re concerned about, and what you think businesses are getting wrong in terms of thinking about the emerging-market growth story.

COTE: Yeah. You’re correct. I mean, just because it’s emerging markets doesn’t mean they’re all going to proceed to grow at an 8 percent rate every year for the next 20 years. It’s going to be bumpy. And for me, one of the things that I tend to look for is are they changing their government systems? Are they building trust in their institutions? And if they’re building trust in their institutions, I have a tendency to believe that, OK, the changes are going to be real and more sustainable.

I was always cautious about both Brazil and Russia when it came to investing there because I didn’t feel they were making the changes that were necessary to really change their systems. Conversely, China, I felt very strongly that they were making the changes and continue to make the changes. That doesn’t mean they don’t have problems, but it does mean I think do think they’re devoted to changing.

India I was a little cooler on until P.M. Modi has gone in. And now that you see the changes that are occurring there or the changes that he’s trying to drive, you really feel like they’re working to change their institutions and make it a more sustainable and robust country going forward.

FOROOHAR: OK. I want to come back to India, but let’s drill down for a minute on China because so much of the overall emerging and really global economic story is flowing from China right now. You met—you were with the U.S. delegation in Seattle that met with Xi Jinping.

COTE: Yeah.

FOROOHAR: You’ve said that you think that he’s a real reformer, that he’s the real deal. Tell us why. What evidence do you give for that?

COTE: I was also there last week, so I—in China, not—China, not Seattle.

FOROOHAR: (Laughs.)

COTE: The—we have about 13,000 people there now. In 2013 China became our biggest country for sales outside the U.S. And 55 percent of our sales come from outside the U.S. So we focus a lot of attention on it because I want to participate in that trend.

I do believe that he’s a real reformer and he wants the changes that all of us know are important for them to become a more sustainable economy going forward. Despite how we talk about it oftentimes in the U.S. press, and we’ll say even in the U.S. Congress, the political dynamics in a country like China are just as intense as they are in the U.S. The thing is you just don’t see it because it’s all happening behind closed doors. And they argue vehemently amongst themselves. And they often—their kind of thought process is that one China, one voice, whereas they have difficulty understanding the U.S. sometimes where it’s one U.S., 30,000 voices—

FOROOHAR: (Laughs.)

COTE: —depending upon what anybody feels like that particular day.

FOROOHAR: Right.

COTE: But I do believe that his commitment to reform is real. But he has a hardline faction he has to deal with, just like we do in the U.S. And as I’ve often said, every system, every society, has the hard-liners, people who are ruled more by their fears than their opportunities. But you have to deal with them. They’re part of the system. And he’s going through some of that same thing himself. But at the end of the day, I do believe he’s a reformer. And the anti-corruption push that he has is extremely well received by the population.

FOROOHAR: That’s interesting. So one of the things actually that I’ve always been interested in in terms of building trust in institutions in China is how do you pivot from the current system you’ve got now, where you’ve got incredible vested interests—I mean, some of the richest people in the country are also the most closely tied to the party. There’s a system of state-run banks funneling money into infrastructure projects. I mean, despite the rise in consumer spending, you’ve still got this state system with a lot of rich and powerful people who, you know, really have no motivation to shift things.

How do you get the sense that they are pivoting from that? And, you know, given that they’re in the midst of the party plenum right now, what kinds of actions would you like to see in the future to show you that this is really happening?

COTE: Yeah. That’s going to be the 21st century question. I can’t say that I have a—I can’t say that I have a big answer for how they should do that. If we took a look at their overall economic problems versus ours, I would rather have our problems than their problems. But at the end of the day they also show a commitment and a willingness to do something about them. And I think you’re going to see some of that coming out of the—out of the plenum; if not this time, then the second five-year, say, re-up of President Xi. I do think you’re going to start to see the changes then.

Some of the basic ones would just be having SOEs become a lot more market-competitive, which today, as you know, anybody dealing with an SOE will learn they have a whole different agenda. That would be a big one. On the banking side, freeing up some of the banking work.

I do believe that in the 21st century we have a tendency to look at China sometimes as like the Japan phenomenon and say, OK, Japan grew. Here’s how it did it. This is what’s going to happen in China. I’m not sure that’s the right parallel. And I’ve often said that I really believe that when we get to the end of the 21st century that it could very well be that China was to the U.S. in the 21st century as the U.S. was to the U.K. in the 19th century, that that could very well be the parallel, because they could—their economy is the number two economy in the world now. Thirty years ago they were the number 20 economy.

I don’t think they’re going to keep growing at 8 percent, but there’s a very good chance they continue growing at 5 or 6 while we grow at 2 ½.. And if you start to match up those curves or just run those curves out, you find in 20 or 30 years the biggest economy in the world still have a lower GDP per capita, meaning a lot more potential growth to come. And I think that could be the 21st century story that gets written at some point. And I just don’t think we’re paying that much attention to it as Americans.

FOROOHAR: That’s interesting. Let me ask you one more question about China. You talked about the importance of freeing up the financial markets, liberalizing financial markets, as part of that process and moving towards reform and more openness. This past August there was—you know, obviously there was the emerging-market correction in China. Chinese markets plunged. There was a real sort of herky-jerky policy reaction where the government spent a lot of time and hundreds of billions of dollars propping up markets and then all of a sudden let them fall.

What should we make of that? I mean, a lot of people felt like this doesn’t seem like a real coherent policy move here.

COTE: I would say that’s correct.

FOROOHAR: (Laughs.)

COTE: (Laughs.)

FOROOHAR: OK, good. I’m glad my analysis was right.

COTE: I mean, I sometimes refer to China that they’re a bit of a steroidal teenager.

FOROOHAR: (Laughs.)

COTE: And you don’t always get the best judgment calls out of that.

FOROOHAR: Yeah.

COTE: But at the same time they weren’t. They’re quick learners. I think they recognized that that was not their finest moment. And this is part of the learning process. I don’t think you’ll see it happen again.

FOROOHAR: OK. All right. Well, let’s move on to India. I know you’re very bullish. And I had asked you earlier whether you thought that the sort of pro-India story was partially a result of people being less bullish on China. And you said no, that you felt India was its own standalone—

COTE: Story.

FOROOHAR: —positive reform story. So talk about that a little bit.

COTE: Yeah, I do. China (sic; India) is another country that has enormous potential. They have a corruption issue they need to address also. We’ve got about 13,000 people there too, so it’s a big country for us, especially when it comes to software engineering. And this is one where they had a great moment about 20 years ago when Manmohan Singh was the finance minister and they made a number of changes that they were able to live off of for a long time, really. But they stagnated. They really stopped changing. And I was pretty vocal four or five years ago in the press there about how they needed to start doing something.

P.M. Modi wants to make those things happen. And his track record in Gujarat is tremendously good. Interestingly, as he tries to make all these changes, he’s running into the same political dynamic we do here sometimes where, yeah, you’re in favor of something but you don’t want the other party to have a win. And if you looked at the goods-and-services tax, for example, that he’s trying to get done, that was actually a Congress Party initiative that the BJP used to resist. Now the BJP is in charge. They’re trying to get SGT done and the Congress Party is resisting.

FOROOHAR: (Laughs.)

COTE: So it’s kind of—human nature seems to be the same around the world—

FOROOHAR: Yeah. We’re not the only one. (Laughs.)

COTE: —generally. But at the end of the day, he’s very committed to reform. And the reforms are needed. I’ve often said that India took British bureaucracy, doubled it, and added 10 times the people.

FOROOHAR: (Laughs.)

COTE: And that’s what you end up dealing with. It’s really just remarkable sometimes. And they know it.

FOROOHAR: Yeah.

COTE: But they’re in the process of making a number of those changes to, I think, the betterment of the economy.

FOROOHAR: So what does this mean for U.S. relations—I mean, both the sort of pivot that China’s trying to make, the rise of India—what does that mean for U.S. relations in the Pacific? What does it mean for trade issues? And maybe you can also talk a little bit about TPP in this context—or, sorry, TPP in this context and whether you think it’s a good deal, you know, what your views on that are and how it would affect your company and others?

COTE: Yeah. I guess, starting with the end part of that, I’m one of the guys in favor of TPP. I’m in favor of reasonable trade deals generally. I don’t think you want to give away the story but you want to be in favor of trade. And from what I know of this one so far, it seems to be very reasonable. As you know, China and India aren’t a part of this, but I fully expect that they will be at some point.

But you can’t have the kind of trend that we’re talking about here and have the U.S. be, we’ll say, 20 percent of the global economy, 4 percent of the people, and say we’re not going to play with the rest of the world. We’re not going to trade. We’ll let others do it. It just doesn’t make sense. So I’m all in favor of it.

When it comes to China and India and what U.S. policy ought to be there, I’m not good enough to be a foreign policy expert, despite the name of the society here.

FOROOHAR: (Laughs.)

COTE: But I would say with India I think there’s a greater chance, an easier chance, to develop peaceful ties. When it comes to China, I’m a big believer that we ought to be very focused on two things. One is how do we develop a peaceful relationship with China in this 21st century? And some people will say, well, that’s not—we don’t think that’s possible. The system is different. And I’ll point out that, well, our best—what we point to is our best ally today is the U.K. And it was 200 years ago they burned down our White House. Most people would not say that was a friendly act.

FOROOHAR: (Laughs.)

COTE: A hundred and fifty years ago we were trying to keep them neutral in our Civil War because they were—they leaned towards protecting the South. So it’s not like this is impossible. It doesn’t mean that we should just acquiesce to anything they want. But by the same token, we ought to be actively engaged with how do we develop peaceful relationships with them.

The second thing that I’ll talk about is we need our own competitiveness agenda. We’ve been on the top for so long that I don’t think we really foresee a future where we might not be the number one economy in the world. And we’ll talk about stuff like, geez, well, we’re more innovative. They’ll never be innovative. They’re good at this low-cost, low-quality production. They’re never going to be able to do what we do.

Interestingly, if you read a book called “Dawn of Innovation” by Charles Morris, who’s associated with the Council on Foreign Relations, where he talks about the development of the Industrial Age in the U.K. and the U.S., if you read all of those statements about what Brits were saying about Americans and just took off the nationalities, you would swear that this was stuff that the U.S. citizens, Americans, were saying about China today.

FOROOHAR: Interesting.

COTE: So I just don’t think we think about it enough, and we need our own—we need to start focusing on our own competitiveness.

FOROOHAR: OK. So I want to ask you what that agenda would look like. But also just on China, do you—because you have such deep operations there, do you feel that technological innovation in China is really at a level where they have their own important amount of IP to protect, that that will create a shift in attitudes towards the legal system, towards, you know, the way technology is and isn’t protected in China? Do you feel like we’re at a turning point there?

COTE: Yes, I do. And it’s not going to be driven because we push them to do it. By the way, in the 1800s do you know who the big technology thieves were? Us. Not Honeywell. America.

FOROOHAR: (Laughs.)

COTE: (Laughs.) Just so we’re clear. But you read through—read all the stories that used to go on then about how the U.K. tried to protect trade secrets and not let any papers leave the country.

FOROOHAR: Right.

COTE: But Americans would go there, study, mentally retain everything, come back, do the same thing here. I mean, so it’s not like just the—it’s the first time this movie’s played. It doesn’t mean that you just, again, acquiesce.

FOROOHAR: Yeah.

COTE: But we shouldn’t just say they’re evil.

FOROOHAR: Yeah. Yeah.

COTE: But there’s a shift coming, because they’re starting to develop their own technologies. And as they develop their own technologies, now you have kind of the push from local companies saying, hey, wait a minute; this is not right. I developed this in Guangzhou and this guy in Chongqing is stealing it from me. You need to do something.

FOROOHAR: Mm-hmm.

COTE: You’re starting to see that shift happen. And I actually had this conversation with Premier Li, I guess, about two years ago where I asked him about IP. And he got actually a little snippy about it and said we’re going to do it, but not because you Americans say we need to do it. We’re going to do it because our economy needs it because of where we are today.

FOROOHAR: That’s interesting.

COTE: So I really think that’s going to happen. And we just had a big win ourselves in trying to protect one of our own brands in China that was being ripped off. And it went to their supreme court and they ruled in our favor—

FOROOHAR: Interesting.

COTE: —in favor of our brand. That happened about a month ago.

FOROOHAR: OK. So to go back to—

COTE: It doesn’t mean it’s perfect, by the way.

FOROOHAR: Right.

COTE: I’m not saying everything’s great. But I do believe that that’s the trend line.

FOROOHAR: Yeah. OK. To go back to the U.S. economy and innovation, we were talking earlier about the 2 percent economy and whether or not this is sort of a permanent thing, the secular stagnation idea that Larry Summers and others have put forward. And you were saying that you had a conversation with Hank Paulson about this and that, you know, the point is that we’ve been in a 2 percent economy, if you count non sort of debt-financed sort of growth, for some time now.

COTE: Yeah.

FOROOHAR: What do we need to do to get out of that? And maybe you can talk a little about your innovation ideas in those terms.

COTE: Well, if we exclude the debt component, people smarter than me would say if you go back to about 1990 we’ve been about a 2, 2 ½ percent growth economy, and that what we’re seeing now is really the same thing we saw in the 1990s and the 2000s without the debt increases.

And I keep coming back to this competitiveness agenda is that we need to start recognizing again what it is that did allow us to grow at 3 and 4 percent a year. And it’s things like we should get our debt under control. We all know the problem that’s coming there. Interestingly, on the trend that we’re on today, in about 20 years our debt will be over 100 percent of our GDP. And that’s just about the same time that China will become the biggest economy in the world if we grow at 2 ½ percent and they grow at 4 ½ or 5. I always thought that was an interesting juxtaposition that we ought to think about. But we need to address our debt.

Our patent system still doesn’t make sense; takes too long, too difficult to sort out. All of you already know the math and science issues that we deal with in our own school system. So there’s a number of things that we ought to be—infrastructure. All of you have been to Kennedy, have an idea of that. So there’s a number of these things that we need to be doing as a country. And I have eight of them, only four of which I seem to be able to remember off the top of my head.

FOROOHAR: (Laughs.)

COTE: But there’s a number of things that we ought to be doing, and just recognizing it in the context of that trend again.

FOROOHAR: Well, and of course, I mean, infrastructure alone people have been talking about for quite some time. We’ve had an incredibly polarized political system; haven’t been able to get anything done there, even though it’s kind of a no-brainer with rates so low.

That brings us to both the political discussion and perhaps currency issues and what the Fed is doing. Let me start with the former. You mentioned debt issues. And we’re coming up again to another sort of debt—potential debt-ceiling issue. Are you more hopeful about what might happen this time around?

COTE: I would say I’m less anxious for the—

FOROOHAR: (Laughs.) A little different.

COTE: I’m a little less anxious than I have been in the past when we had the fiscal cliff, for example, just because we see the leadership in both the Senate and the House making very proactive statements about this will not happen, we will not allow this to happen, which they did not do in the past. They quietly would say it, but they didn’t say it publicly, whereas this time I think they’re kind of calling out the crazies who are willing to say stuff like, ah, we ought to just shut it down or we ought to just default on our debt and just kind of deal with it afterwards. I think they’re really kind of shutting them down early rather than giving them the kind of voice they’ve had in the past.

So while I’m less anxious, we should still all be calling our congressmen and our senators to say please don’t do it. (Laughs.) Don’t be silly. Don’t throw away a 230-year credit rating. Don’t shut down the government again. Just don’t do that kind of stuff.

FOROOHAR: So you’re a registered Republican, but you’ve been very close to the Obama administration. You’re a moderate. What do you make of the current very interesting political environment—(laughs)—the slate of candidates? Debate’s tonight. We’ll see what happens there. What does this mean to you, the fact that we are in this moment where outsiders seem to be really taking the stage? There’s a lot of populism on both sides of the aisle. Is that about the economy at some point? What is that about to you?

COTE: Well, I think one dynamic has been it’s made the Post even more fun to read—

FOROOHAR: (Laughs.)

COTE: —than it normally is. As you might imagine, I’m not going to opine on any candidate. I’m not in a position where that would be a good thing for my company. So I won’t say anything along those lines. But right now I’d say there’s probably two things happening. One is it does tap into kind of a sentiment in the country that people are just unhappy on both sides. And I found it kind of interesting, as a Republican, that my Democrat friends were absolutely gleeful with what was happening on the Republican side right up until the same dynamic started occurring on the Democrat side and realize, OK, there’s something in the American psyche that’s going on now that I don’t think we quite understand. And John Kasich made that point in the first debate.

I’d say the second dynamic is I don’t know that Americans are truly paying attention yet. Right now there’s still a lot of entertainment value to everything that’s going on. The New Hampshire primary is not until March or so. So I don’t know that everybody’s truly paying attention yet. And it’s too easy to just kind of respond superficially to things until you actually have to pull the lever and say here’s what I—here’s who I’m going to vote for.

FOROOHAR: So let’s talk about monetary policy and the Fed, because, of course, you know, one of the reasons that the Fed has had to take such unprecedented actions in the last few years is that we didn’t have any political cohesion. We weren’t able to push through some of the fiscal sorts of stimulus that you were talking about earlier.

I know you have to be somewhat sensitive because you sit on the board of the New York Fed. And please don’t read into anything into—(laughs)—more into what Dave is saying than you should. But how has this period of unprecedentedly low rates affected the markets? Do you think that we are—that there’s a bubble that is in the process of popping? What does it mean for U.S. companies in terms of currency arbitrage and the fact that Europe is on a—and Asia, to a certain extent—is on a different path policy-wise than we probably will be? What do you think about that?

COTE: Well, first, I’m glad—what I like to say is I’m on the board of the New York Fed, which means I know nothing.

FOROOHAR: (Laughs.)

COTE: So don’t—please don’t read anything into anything I say, because I’m just reflecting what it is I think about things.

The fact that rates have been so low for so long, I’m glad they did it, because if we hadn’t done it, I really think there was a risk of a depression, not a great recession, because things were—I mean, I never saw things so panicky. It was—everybody was just scared to death at the time. If they hadn’t done that and continued with it, I really think we’d be in a much worse spot than we are today.

That being said, we’ve been at this for a while. And it almost—it feels to me like market trepidation has gone in the other direction. And there’s so much discussion about will they? Won’t they? What’s the reaction of the markets? I have to say all in all I don’t think a quarter-point increase would be all that big a deal at this point. It certainly wouldn’t affect my behavior. It might affect markets, but it certainly wouldn’t affect how I think about things or what I do. And I think most companies are the same way.

FOROOHAR: This kind of dovetails with a conversation we were having at the table earlier about the pressure on companies to hand back cash. You know, the short-termism in the markets right now—we were talking about share buybacks. You were saying that they’re OK, but, you know, in some ways they might signal that you don’t have anything better to do with the cash. You know, talk a little bit about how you as a CEO deal with that pressure, because it’s constant these days. Yeah?

COTE: Yeah. I’d say when it comes to activists—I don’t know if we have any in the audience—but I’ve always likened it to a free press—

FOROOHAR: (Laughs.)

COTE: —where it’s said 70 percent of it is good—

FOROOHAR: Uh-huh.

COTE: —30 percent of it they have absolutely no idea what they’re doing.

FOROOHAR: Uh-huh.

COTE: But overall, you know, would you rather have a free press than not? Yes. Are activists overall a good phenomenon for the country? I think yeah.

FOROOHAR: Yeah? Carl Icahn telling Apple to give back—

COTE: Well, like I said, what’s in the 70, what’s in the 30, I’ll leave to your judgment.

FOROOHAR: (Laughs.) OK.

COTE: But at the end of the day, I go back to the 1980s. And this is one of the few advantages of getting older is some of the movies you’ve seen before. And we were having the same discussion in the `80s and early `90s, and it had to do with private-equity guys and what they were doing in, you know, destroying companies, pillaging short term; I mean, all that kind of stuff.

But at the end of the day, I really think that that’s what drove the restructuring of the American economy that made us a heck of a lot more competitive. And if you recall the—everybody was afraid of Japan at the time. And for all of you New Yorkers who remember when they bought Rockefeller Center and how everybody panicked over that. And I can remember, I was kind of a young business guy at the time and looking at it. And I was trying to figure it out, because they said, OK, they bought Rockefeller Center. We should be scared. Why? Are they taking it back to Japan? (Laughter.) No, it’s just interesting to see how people panic over stuff sometimes.

FOROOHAR: This is so funny because my dad was an engineer. And I was 12 in 1982. He made me start taking Japanese lessons. So—(laughter)—it would have been Chinese today.

COTE: Yes, exactly. But I do think that’s—that phenomenon that causes American businesses to have to say, OK, I’ve got to do long term and short term, it’s not one or the other, I don’t know that that’s a bad dynamic. But at the same time, it’s not a case where ever activist is doing something that’s smart for their investor or smart for the company that they’re attacking.

FOROOHAR: Well, it’s interesting because it opens up a political discussion too which certainly Hillary and some others have touched on about unprecedented corporate wealth, how it’s being shared. You know, there’s going to be pressure over tax inversions, corporate tax reform issues like that. How do you imagine that’s going to shape up, post-2016?

COTE: Boy, tough to figure out. First of all, our tax system—anybody who’s dealt with it understands what I’m talking about. And I’ve often related the development of a tax system to this physics theory called entropy where over time every organized system evolves to chaos—which is true if any of you have ever dealt with an organized system. That’s what happens with our tax system over the course of 20 or 30 years. So it’s like you do a reset, which we did in the Reagan era. And we need another reset. It’s a time for a redo of this thing.

FOROOHAR: I like the physics of taxes. That’s really cool. (Laughter.)

COTE: But it is true. Any of you have dealt with any kind of organized system knows that its tendency is to evolve to chaos. And that’s what happens with a tax system. With every year changes get made. It just doesn’t make sense anymore. And we’ve got a policy in the country where anybody who has any kind of global operations, because of the tax system we have, you automatically build cash outside the U.S. and build debt inside the U.S. And it’s just the way it—because it’s the way the system is constructed. So I’m an American company. We’ve got about 10 billion (dollars) in cash now. We’ve got about 9 billion (dollars) in debt. All the cash is outside the U.S. All the debt is inside the U.S.

And the reason for that is all my shareowners are in the U.S., because I’m a U.S. company so the shares have to be U.S. issued. Any dividend I pay, any stock repurchase I do has to be done with U.S.-generated cash. I can’t use Europe-generated cash or India-generated cash. And with 55 percent of my sales outside the U.S. and generating cash, because we’re doing a good job, I can’t use any of it for any of the U.S. stuff I do. So if I want to repurchase shares and I haven’t generated the U.S. cash to do that, well, I got to borrow to do it. It just doesn’t make sense.

FOROOHAR: Let me ask you one final question, and then I’m going to open it up to the floor. If there was a tax holiday—corporate tax holiday at 10 percent, something like that—would you bring money back and would you invest it and do capex, you know, in factories, training, things in the U.S.? Or would you do share buybacks?

COTE: Well, first, I think the two are unrelated. And I think this is one of the issues that U.S. business had back with the—kind of the last tax holiday, as it was called. And the way U.S. business convinced politicians that this policy made sense—which, by the way, the policy does make sense, to repatriate, we should allow it—is they said that if we do this there’ll be unprecedented investment in capex, job creation all that kind of stuff. It’s not going to work that way, because if I need money in the U.S. I can get it. It’s not like it’s a problem. I just borrow it and I’ve got cash outside.

So it was just not a good argument to make. And you had a lot of politicians who felt like they got the short end of the stick, that they did something that they thought was going to be good for their state or this district or whatever, and it never materialized. It was never going to materialize, because this is just a matter of what’s smart economic policy for the cash that you do have. And even if you did come back and you used it for buy-backs or you used it for an additional dividend, that still puts money back into people’s hands to be able to use, instead of sitting in a bank somewhere. Not that there’s anything wrong with banks. (Laughter.) So I—

FOROOHAR: Especially not in this audience. (Laughter.)

All right, we’re going to open it up to the floor. If you want to just raise your hand and there’s folks with mics of to the side there. And introduce yourself before you speak, please. Question up front here. Yeah, we’ll get a mic over here.

Q: I’m Mary Clark (sp) with H1 Capital.

I want to talk about adaptability today. So China was doing a lot with infrastructure and manufacturing, now more consumer. It really played to your sweet spot. How do you adapt as that shift occurs?

COTE: Well, the sweet spot hasn’t disappeared. And I’d say, the other advantage that you have as a U.S. company, if you’re focused on becoming a Chinese competitor, which we are—so as an example, if I’m in China I don’t view my U.S. competitors or my European competitors as my Chinese competitors. What we try to do is find out who are the local guys in every market and make sure that we can compete with them. If you look at it that way, you find out that we actually have pretty small shares across the board. Even though it’s the biggest country for sales for us now, there’s still a lot of upside for us just on share gain, having more local—more local product.

And at the end of the day, they’re still investing. It’s not like it’s not happening and that there’s no construction. There’s still 300 million people that need to come from rural areas back into urban areas. That’s not going to change. So I don’t worry about it all that much. It’s, OK, instead of growing sales at 25 percent a year, we’re growing now in, say, that controls business at about 14 percent year-to-date. OK, that’s not that bad. I would take that across my entire company. So, yeah, you know, that dynamic’s going to change. They’re going to move more to a consumer economy. But I don’t think it’s going to—it’s not going to be painful for us.

FOROOHAR: OK. Mr. Schwartz (sp), you have a question?

Q: You talk about debt as if it is one thing and we that we have to attend to it in our policy decisions and economists have to attend to it. But debt for spending for operating expenses or entitlement programs is considerably different from debt to build the Grand Coulee Dam, which created an enormous amount of wealth and still creates income for the country. By lumping debt into one category, we’re preventing ourselves from making investments in infrastructure and other wealthy—wealth-creating issues. Why don’t we start making that distinction?

COTE: Well, first of all, I agree. There’s a big difference between transfer payments and investment accounts. However, if you were to look at what’s our actual investment, if you take a look at our total spending, it’s really an extremely small piece of the total. So if you just took mandatory spending and entitlements, for example, that’s close to three-quarters of our total 3 trillion (dollars) spend every year today. And if you took defense out of the rest of that and said, OK, I’m not going to look at that truly investment in terms of is it improving our infrastructure, that accounts for, like, another seven or eight points. And you end up with a very small piece that’s actually investment.

And at the end of the day, you still owe all of the money, whether it’s investment or whether it was spent for entitlements. You still owe it all. And that’s a thing that I’d like to see addressed, have more on the investment side, to your point, less on the entitlements side, and less spending overall so that it’s more consistent with where our economy’s going.

Q: Just one comment. You talking about spending less as compared to more. The issue really is whether or not we’re going to make investments in infrastructure or other kinds of wealth-creating circumstances. That argument should not be burdened by the rest of the discussion. For $100 million invested in infrastructure today, we would create millions of jobs and great wealth. Why should that be burdened with the fact that we have too much entitlement program?

COTE: I’d say you could argue that we’re just going to spend more overall, but we’re going to spend on the investment side, and that that’ll help to alleviate the overall debt problem. I’m not sure that’s how it would actually work in political practice.

Q: It has for 200 years. It has worked for 200 years.

FOROOHAR: (Chuckles.) This is—we need another—

COTE: I’d say except for World War II, we’ve never had debt at the levels we do today—never.

Q: We’ve never had wealth like we have today. Just one other thing, I don’t want to burden you—

FOROOHAR: (Laughs.) One last—one last comment.

COTE: I’m not going to vote for you, Bernie, I can tell you that. (Laughter.)

Q: We don’t keep our accounting in the government as you keep your accounting in your company. And if you have an investment in a factory that creates wealth for you anywhere in the world, you create an asset and you have debt for that. In the U.S. government, there is no asset accumulation. There is only a debt accumulation. And that argument continues to dissuade us from making necessary, appropriate infrastructure investment and other kinds of investments. I think we ought to look at that again.

FOROOHAR: OK. We’re going to move on here. Question over there? (Chuckles.)

Q: Very well done, Dave.

COTE: This will be a difficult question, I know.

Q: No, no, no. Do you have a point of view about why business investment and productivity gains have been so low during the period following the Great Recession?

FOROOHAR: Good question.

COTE: Yeah, I have, I’d say, greater difficulty addressing it for, let’s say, business in general, because for us it’s actually been quite good. And productivity’s been one of the things that we’ve relied on significantly to drive our earnings growth, even in a low-sales growth environment. So I’m not—I’m not really sure why productivity isn’t showing up around the board, because I doubt I’m the only company that’s doing that. Now, one of the ways that it’s showing is that I don’t hire as much as I used to. And if I had a situation where I’ve got attrition, for example, across the board that averages, let’s say, 400 a month, I hire back at about 300. So I’m still hiring. If people were to look in the newspaper, they’d see us still hiring. But I’m not hiring at a rate that replaces attrition. And as long as my sales go up 1 or 2 percent overall, which they are, I still can do very well. I doubt I’m the only guy that this is kind of dawned on. So I wonder sometimes about the metric and how well it’s done.

FOROOHAR: Well, I was going to ask you about that, because you were saying earlier that you felt we were in this sort of technological boom period, software really growing, Internet of things, is there some way in which we’re not capturing that, and the productivity effect of technology, because we’re basically geared up to measure widgets and not data?

COTE: Yeah, as I said, I’m not an economist, so I don’t know that I’m good enough to know. But I know some of the stuff that Marty Feldstein, for example, who’s in Britain, has talked about that same thing, about this iPad that you spend 2(00) or 300 bucks for now does so much more than what you spent $3,000 for just a few years ago, that there is an advantage to that, that there is a benefit to it. I’m not good enough to know, is that all being captured? I do believe that businesses have been more productive than—at least on the industrial side—have been more productive than some of those metrics would indicate. I just know in our company that productivity metrics look very good.

FOROOHAR: OK. Let’s get some from the back there—way in the back.

Q: Andrew Gundlach, First Eagle Investment Management.

How do you see Obamacare affecting—now that it’s implemented and you’re starting to see how it works, also looking at the Cadillac tax—how do you see that affecting corporate benefits, specifically corporate health care for the middle class? There’s a wide range of companies talking about scrapping it all. Hillary’s even talked about delaying the tax. What is Honeywell doing to prepare for this, which is a major change for the company?

COTE: Yeah, actually, neither one of those things is going to have much impact on this. The Cadillac tax or Obamacare overall really has little impact on us or how I even think about it. As you might imagine, I did run the statistics for our own company at one point to say should we even be in health care anymore if Obamacare is a reality? And the answer was, we should stick with what we—what we had already.

The phenomenon that has concerned me more over the—in the past, and I think we still have to deal with—is just health care increases overall. That’s painful. And that’s extremely costly. And I would say all the stuff that we tend to think about when it comes to this is how people will behave is not true when it comes to medical care. And I’ll give you just a great example, because I focused early on on the idea that if I could get better outcomes for employees, then that would be better for them, and it would be lower cost for us.

So we took four highly variable operations—so back surgery being one of them. And Dr. John Wennberg up in Dartmouth has done some great work here that says if you live in Santa Barbara, California, you’re nine times more likely per capita to have back surgery than if you live in Providence, Rhode Island. If you do the analysis and all the correlations, you find there are nine times more back surgeons in Santa Barbara per capita than there is in Providence. And it’s a highly variable operation.

So I set up this system where you had to go through to get a second opinion. And you could do it all over the phone with the Mayo Clinic. And if you did it, regardless of whether you chose to have surgery or not, I would give you $500 additional reimbursement for your surgery, or lack of surgery, whatever it was you chose—500 bucks. Had people go through the system, had them surveyed again a year later to say are you happy, 99 percent satisfaction level. So what was the issue? Only one quarter of people having back surgery bothered to go through the system, even though I was going to give them $500.

So I read this book, “Nudge,” by Cass Sunstein, where it said that people were, like, three times more likely to react to a negative—a potential negative than a positive. So I said, OK, I’m sick of this. I’m going to go to a $1,000 penalty. If you don’t go through the system, I will tag you with a $1,000 penalty. We have now have over 99 percent participation.

FOROOHAR: That’s amazing.

COTE: Isn’t it?

FOROOHAR: Great story, yeah.

COTE: So this is—so we have a tendency to think about, OK, well, people are rational. So for 500 bucks, of course they’ll do this. You know, I thought the same thing. People are not rational. And at the end of the day we need to take that into consideration as to how do we think about health care and our system and what are we going to do.

FOROOHAR: Fascinating, yeah, absolutely. Question back here, the lady in black.

Q: Thank you. Paula DiPerna, NTR Foundation. And I’ve worked closely with Honeywell in my prior life at the Chicago Climate Exchange. And I applaud you for your great leadership on that.

But just to unpack and get a little bit down to Earth, and just pick up on the point you just made about rationality. If there weren’t so-called gridlock, you know, how would you go about reversing, let’s say, this cash is outside debt is inside? I mean, operationally, talking to Congress, you know, what is an operational plan for actually getting at some of the things that you’ve highlighted?

FOROOHAR: Good question.

COTE: You mean what would I recommend to them as a—

Q: No, how would you do it.

FOROOHAR: Yeah.

Q: Like, who do you go to, can you get access. Obviously, you have access, but what is—what is missing now?

COTE: Well, there’s a couple of things that I would so on the—and I assume this is a repatriation question, or in total?

Q: In general.

COTE: In general, I was on the Simpson-Bowles Commission and spent a lot of time developing what I thought the tax plan ought to be. So this is going to be very consistent with what we recommended there. When it comes to simplification, I really think we ought to just eliminate almost all the deductions that we allow today, and just go to a much lower rate overall.

FOROOHAR: What would it be, in your—

COTE: We got it down to 23 or 24 percent overall, and just eliminate almost all deductions. I would eliminate the capital gains benefit, which will annoy a number of people in the audience, I’m sure. But I don’t see why there’s a difference between capital gains income, even though I understand they’re risking capital, versus wage income. And what I used to say then was it’s almost like we’re making the argument that as you’re trying to build a nest egg, we’ll make it more difficult for you. However, once you have one, we’ll let you keep it. I’m not sure that that entirely makes sense.

When it comes to corporate taxes, I think in the question for fairness we kind of get it backwards. And at the end of the day, we’d be better off letting companies have more money to be able to deploy, investment, return as dividends, or repurchases if they wanted to, and allow them to be more competitive. When it comes to repatriation, I kind of like the Germany/France type system. I know it’s hard to believe that’s possible, but it is.

FOROOHAR: What is the Germany/France—

COTE: Where 95 percent of what you generate outside can be repatriated. You pay tax on 5 percent of it. Seems to me to make more sense. When it comes to how you—one of the foibles, I think, or one of the issue that we have in the U.S. system is that technology developed in the U.S. using a higher rate to be able to deduct and getting an R&D tax credit, companies are able to sell it to an overseas affiliate that then is able to manufacture there, we’ll say, in a low-tax area. But that doesn’t seem to make sense to me. We shouldn’t have a situation where you get a deduction for developing it in the U.S., yet the manufacturing profits will all then be derived outside. That doesn’t seem to make sense. But those would be the things that I would advocate changing. And all this was in Simpson-Bowles.

FOROOHAR: So that’s a great layout of the plan. What are the political levers to get there, in your opinion? I mean, you have relationships on both sides of the aisle. Is this going to—are we finally going to get some corporate tax reform in 2016, do you think? And if so, what’s the path to that?

COTE: I would say it’s definitely not going to happen in 2016, because they’re really not working on it yet. And it’ll take a year and a half or two years from the point you say you want to do it to actually getting something. It takes 18 to 24 months. I’d say there is a lot of interest in it on both sides that everybody seems to recognize today that debt is an issue and our tax system is an issue. And that’s very different from where we were, say, pre-Simpson-Bowles. However, there’s still—while there’s interest, there’s other things they’re more interested in right now.

FOROOHAR: (Laughs.) Right, as always.

COTE: So it’s not coming yet.

FOROOHAR: OK, question here.

Q: Hi. I’m Dan Allen (sp).

When does being a conglomerate of unrelated businesses go from an advantage—competitive advantage to a competitive disadvantage? You guys are clearly one of the most successful, or if not the most successful, conglomerate, under your leadership, over the last 10 or 12 years. But it seems like maybe the natural state of conglomerates is eventually to implode and get sold off as you look at so many of them.

FOROOHAR: Good question.

COTE: I really like you, for some reason. (Laughter.)

Q: I actually own a business where you are our largest competitor, so—(laughter)—

COTE: I’ll be very careful of what I say. Well, first of all, there’s a tendency to think of industrial conglomerates. But there’s financial conglomerates, media conglomerates. It’s not like the concept of conglomerate is unique to industrials. So I don’t quite understand the hang-up when it comes to industrials. I still think that if you’re going to be an industrial conglomerate, which I’m more familiar with, you still need an organizing theme. And what is it that’s going to drive your company and how are you going to think about acquisition, divestiture, improving your portfolio, improving the performance of your businesses. It can’t just be I’m a holding company. And you can’t run it as kind of a single entity. But at the end of the day, it is possible to run businesses better than other people do. And that’s entirely possible, and I’d say we do it with every acquisition. If I couldn’t, I mean, we wouldn’t do it.

Our organizing principle is that we want to have a great position in a good industry, and I want to be able to—I want to be able to differentiate with defendable technology. And I spend a lot of time making sure that we can do that. And as long as we can do that and apply our process capability when it comes to implementing the Honeywell operating system and factory, velocity product development for how do we get new products, and then how we drive functional transformation to really just overall reduce the overall cost to staff functions while improving service levels, it works pretty darn well. And every acquisition we do we get anywhere between eight and 15 percent of sales in cost synergies.

FOROOHAR: This is a really interesting point. Can you elaborate on the defendable technology issue, maybe give us an example of either a business you did or didn’t get into based on that?

COTE: I tend to avoid anything where the technology changes too fast, or where somebody can, with a totally new technology, just totally supplant you. And I—

FOROOHAR: That’s a lot of businesses these days.

COTE: Well, I stay away from all those. (Laughter.) I just don’t think that’s a good place for Honeywell to be, because all you have to do is make a mistake once, right? If you’re in an industry, as Honeywell—if we’re in an industry where if I—there’s a new product introduction every three years and if you miss one of those your market share gets cut in half, that’s not a place I want to be.

FOROOHAR: It’s a tricky moment though because, you know, there—it does feel like a couple of guys with some really great software can disrupt almost any industry out of the blue these days. How do you kind of cope with that?

COTE: I’d say yes and no. That’s more true on the digital-to-digital side than it is on the digital-to-physical side. And if you look at a lot of the stuff that’s been truly disruptive, it’s been on the kind of digital-to-digital side. When it comes to digital-to-physical, that’s still a little tougher—I mean, much tougher. I wouldn’t say it’s impossible. So you got to be aware of it. But it is possible to have an expertise in that digital-to-physical interface that others don’t have.

As an example, if you were to take a look at Honeywell, you’d say, geez, those guys make jet engines, axillary power units, cockpits, control systems, security systems, turbo chargers, chemicals, they develop process technologies for refineries. Geez, you know, the mechanical, electrical, chemical—what do they actually do? OK, so now I say, well, you know, I’m going to—through the representation of the engineering workforce, I’m going to determine what this company does. We’ve got a little over 22,000 engineers.

And if you were to break it out into those disciplines, you’d find that more than half of those engineers are developing software—more than half. So even though you would think of this, OK, the jet engine, very mechanical, control systems, very electrical, if you’re selling caprolactam that’s a chemical. At the end of the day, software’s a significant driver of everything we do—whether it’s a simulation, the product enablement we do, or selling software as a service.

FOROOHAR: OK. We have time for maybe one or two more questions. Here, the gentleman in the blue tie.

Q: David Bard, American Securities. Thanks for coming in. Thanks for talking about a wide range of issues.

Going back to the political discussion from before, there’s something in the American psyche you alluded to. One thing I’d throw out there, that folks throw out there in the press is, you know, the average worker, their income isn’t going up. Labor share is statistically and economically speaking been declining for a shockingly long time. How do you view that issue? And do you see any particular solutions? There’s probably no silver bullet. And how does that tie back to your competitiveness framework?

FOROOHAR: Great topic.

COTE: Yeah. This is going to be a tougher one over the IT revolution that we’re going through. And the way I’ve tried to describe it for my own folks is that the industrial revolution went on for, I don’t know, say 150 years, starting back early 1800s and going through the ’60s and ’70s. The IT revolution, we’re only about 40 years into it. That shift from an agricultural to an industrial economy was huge. And I think turn of the last century there was 50 percent of people who were on the farm. Now, it’s 2 or 3 percent. We’re going to be going through the same thing. And it was very disruptive back then. That’s why we ended up getting labor unions, because of how companies treated people. The education system had to change to support it.

And I wouldn’t be surprised if we’re going to go—see the same kind of disruption this time. And I’d rather see us get ahead of it and do things like a math and science education, have people become—be really familiar with software and software development when they’re coming out of school. And I just don’t feel like our school systems really get that yet today. And I saw it even when I went back for my own 40th high school reunion. First of all, I was shocked it was my 40th and I had to get past that. (Laughter.)

But as I walked through my own high school, they had, you know, all the anti-bullying posters, which is nice. They had all the spirit stuff, which was nice. They had the art class exhibit, which took up a whole wall, which was nice. Nothing on a math club. Nothing on a science fair. Nothing on a chess club. Nothing that rewarded intellect. And, geez, being smart meant something, and trying to do well in school meant something. And I worry about that as just a trend, and think if we’re going to be able to handle this emerging region shift that we’ve talked about, and this IT revolution shift that we’re going through, we need to be acting differently than we are today. And the education system’s got to be a fundamental part of that.

FOROOHAR: OK. Well, we’re almost at time, so I think we’ve got call to action for educational reform. We will end today. Dave, thanks so much for your time.

COTE: Oh, thank you.

FOROOHAR: And thank you everybody for being here.

COTE: Thanks. (Applause.)

(END)

This is an uncorrected transcript.

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