FedEx CEO Fred Smith sounds off on China, the U.S. economy, and much, much more...
by Brian Dumaine, senior editor-at-large at FORTUNE

Fred Smith sees fast growth ahead in the developing world.

When Fred Smith founded FedEx in 1971, he had just returned from the Vietnam War, where he had served as a Marine platoon leader and then a pilot, and he was casting around for something to do. As legend has it, a paper he had written at Yale -- he doesn't remember the grade but is pretty sure it wasn't a good one -- laid out the idea for a hub-and-spoke system for delivering time-sensitive items like computer parts. He borrowed money from his sisters, leased some jets, and started his service. Today FedEx (No. 70 on the Fortune 500), with headquarters in Memphis, has 255,000 employees, 688 planes, and more than 90,000 vehicles that operate in some 220 countries and regions. Here's the world according to Fred Smith. Edited excerpts:

In 2000 you started morphing from your traditional air express delivery business into ground and into freight. What was the thinking behind that strategy shift?

A: Well, in 2000 we were probably competing in a $50 billion annual [sales] market space. Today we're directly competing in about a $350 billion to $400 billion marketplace. Going into ground and freight opened up a market for us with the greatest growth potential over a sustained period of time: the developing world. Middle classes are emerging in various countries, including the BRIC nations [Brazil, Russia, India, and China]. And these middle-class populations are all knit together today for the first time in human history with a low-cost, standardized communication system that can intermediate language differences and show every product on the planet in visual format. And that of course is the Internet. Today if you want a component for an automobile -- Volkswagen or Chrysler or whatever -- you can look worldwide. And so that's the biggest opportunity. The growth of world trade and the growth of those emerging economies dwarfs the growth of GDP in the industrial countries.

What's one of your fastest-growing markets?

We are now the biggest international transporter of goods by air in and out of China. We also have established a FedEx-branded domestic parcel service there. We use this business to move our international traffic to and from the major gateways.

In China, do they get the FedEx concept?

Oh, yeah. You bet. One time Jiang Zemin [the former President of China] had our board of directors to his office, and he probably knew more about the company than a lot of them did, to tell you the truth.

I was surprised to learn about another new area of growth for you: a new service called FedEx TechConnect, where you will repair electronic items like the iPad and the Nook. It doesn't sound as if it's a core business to FedEx.

First of all, we're probably one of the biggest repair shops for devices like that in the world for the very simple reason that FedEx (FDX) basically invented the handheld, package-tracking device. Because a lot of that equipment is built into our DNA, we became very good at repairing it. And it was just a natural progression to tell a lot of our big customers that if you want us to also repair these devices, we can do it for you.

FedEx technicians in Memphis now will repair your smartphone or tablet -- for a price.

How big an opportunity is it?

It's a $15 billion market, and it's also a very sticky application. In other words, nobody has the assets that we do. We have the retail network. We have thousands of people that stop in millions of locations every day, so if you want to send your electronic device to us to be repaired, we've got the transportation networks to get it to a centralized repair shop. We don't have to have 500 of these less efficient repair shops. So it's a niche market, but it's an important niche -- although I don't think we're going to be here in five years talking about that business overwhelming the transportation business.

I'd like to turn to leadership. You wrote a piece recently about reputational intelligence. Can you explain what that means?

Well, what we call reputational intelligence is particularly important in our organization because at the end of the day we're essentially selling trust. People give us some of the most important things that they own. There's medical equipment that's going to a surgery this morning or a part that's going to determine whether the new 787 flies. So reputation is an integral part of the brand, but it's separate and distinct from the brand.

So how do you manage that?

You have to put your money where your mouth is. There isn't a year that's gone by where we haven't invested an enormous amount into trying to make the service better. There have been some years when we could have taken the approach: "You know what? We're not going to try to make the service better. Let's just dial it back by 2%. Most people won't notice that, and we can put another 2% to the bottom line." We've never done that. But it's also directly related to the culture we've tried to create. Ask any FedEx team member anyplace what the Purple Promise is, and they'll tell you, "I will make every FedEx experience outstanding."

So I noticed in a recent letter to your employees that you talked about a video of a FedEx delivery man tossing a computer screen over a fence at someone's home. It got caught on a security camera, posted on YouTube, and it went crazy viral. Not exactly the Purple Promise.

You know, what got into the mind of that young man I will never know. We went back, and the station he operated in was run by a great manager who communicated constantly about the importance of great service. And there's one thing pretty simple in our business: You don't throw or drop a package. That's pretty basic, right?

And of course what he did just made all of the other 255,000 of us just mad as hell because we work like hell and then there it was. We immediately had the head of our express delivery operations record his own YouTube video in which he said, "Look, this is not what we stand for. We apologize." That went viral too. Our quality-driven management says at its heart that you've got to use failures as an opportunity to improve. So that's why I mentioned it in my letter. It's not to hide it, but to make sure everybody looked at it and learned from it.

You're in a great position to see what's going on in the economy. Do you see U.S. growth slowing?

Yeah, we took our projection down a little bit. Our forecast for calendar 2012 is now 2.1% GDP growth, compared with 1.7% for 2011. I think there are some good things, and I think there are some troubling things. We have the European crisis, and hopefully the financial contagion from that won't spill over into the real economy in the U.S. Europe has definitely slowed down, but it's not the disaster a lot of people think that it is yet. Its economy is just not as robust as those in China and the United States.

Isn't part of the problem with the U.S. economy that it doesn't have the supply chains to compete with Asia?

Over the next decade, we will benefit from a lot of manufacturing activities coming back to North America. It may not be all in the U.S. A lot of it may be in Mexico and Central America, but overall we will see stronger U.S. manufacturing aided by the rapidity with which supply chains can be replenished and orders can be fulfilled. And the reason for that is that the high price of oil is making it substantially more expensive to move things from China to the U.S., whether it's by air or ocean.

If you could wave your magic wand, what would you do to make the U.S. more competitive?

The single biggest thing that the U.S. can do is to change the corporate tax system, because as it exists today, the system favors leveraged finance and financial services over industrial activities.

Such as interest payments being deductible?

Absolutely. And in a capital-intensive business, you add leverage at your peril because when the inevitable downturn comes, we've seen what happens. So how do we get more competitive? First the corporate tax rate should be lowered to make it globally competitive. Just set the maximum rate at 20% or 25% across the board and eliminate all the other foolishness. Next, we should go to a territorial tax system so you don't get penalized for bringing money back into the United States. Put a different way, money that is made in China making baby food for Chinese babies should not be taxed if it's brought back into the United States. We want that money to come back in the United States so we can create jobs here.

More: 10 Fortune 500 military CEOs

And then the third thing, depending on how the numbers come out, is to provide tax incentives for investment. Because the only thing that's correlated 100% with job creation -- and particularly good job creation -- is business investment. We strongly promote a 100% expensing of capital. Now, I don't think you could both lower the corporate tax rate and expense 100% of capital investment, because you'd add too much to the federal deficit. But being able to write off investment is preferable to a lower tax rate and the territorial thing.

But isn't it also a demand problem? U.S. corporations are sitting on a couple trillion dollars in cash, but they're not investing it because there's no demand.

Based on my 40 years in business, I think the economy is driven mostly by entrepreneurs and the development of new products and services, which start to create demand that then creates a virtuous circle. When Steve Jobs invented the iPod and iPhone, that helped drive cloud computing and telecommunications systems, and so all of a sudden how many jobs have been created? The point is that if you talk to the people who are demand-side-oriented, they discount Steve Jobs or other entrepreneurs who create their own demand. The most important thing you can do is to incentivize private investment. And I don't think that Lord Keynes ever advocated taking money from one group of citizens and transferring it to another group of citizens. What he advocated was in periods of low demand that government invest -- build roads, build dams, build ports, and so on.

FedEx is expanding its ground service in Beijing as well as other cities in China.

You're a big advocate of rebuilding. Obama's budget includes billions for infrastructure. What do you think?

The only way to produce well-paying blue-collar jobs is with public investment in infrastructure and education, and private investment in equipment. After going to China -- oh, my God, it's embarrassing to fly into J.F.K. We need to pay to improve our infrastructure. One of the biggest opponents to this are the far right-wing Republicans -- the Tea Party fiscal hawks who are against spending on anything. But infrastructure has a multiplier effect, as long as it's good infrastructure. I mean, not the bridge to nowhere.

You've started to buy electric vehicles. Do you think the government's going to put in the incentives to help electrify the transportation system?

We're not seeing a positive return yet on our electric vehicles, so what we've been trying to do is to advocate policies that push down the cost of batteries by getting them built at scale. We advocated, for example, the reimposition of fuel-efficiency standards. Look, this is a national security and economic security matter, and you've got to look at these batteries as if they're an F-35 or a machine gun. Because what we've got to do is to get out of importing as much petroleum as we do from unstable and unfriendly parts of the world. Part of the problem is a political thing. I've watched this issue be pilloried by the right-wing media as an Obama thing. That's not true at all.

You mentioned earlier that investing in education is another key to creating more American jobs.

I personally think that the federal government -- and you're talking to a liberal arts major here -- should restrict its funding of higher-education grants and loans to science, math, and engineering because that's where most of the value added comes. We put so much emphasis on "college degrees." Well, in Germany students at some point come to a fork in the road, and they either go on to university or they go on to a trade school. Say you're a FedEx airplane mechanic working on one of our Boeing Triple Sevens. That's a $100,000-plus job. You don't have to have a college degree to get that job. You don't have to know Chaucer and The Canterbury Tales. You can go right to West Memphis, Ark., where we have a relationship with the community college, and be trained to be a licensed mechanic. Then you can come to work at FedEx.

So, long term, you're bullish on America.

Sure. But look, the U.S. political system is completely broken, and as a wise man once said, "What can't continue, won't." So we're either going to be stopped by the bond market at some point in time, or we're going to fix Washington. And I think we will be able to do it.

This story is from the May 21, 2012 issue of Fortune