Invest Like the Best with Patrick O'Shaughnessy
· Shyam Sankar
We were the sole superpower in the 90s, and we spend a fair amount every year on defense. People want to talk about narrow things like acquisition reform or the mix of weapons. I think it comes back to people. It comes back to the heretics. At the dawn of World War Two, we were the best at mass production. Effectively, our country invented it. And in order to create an industrial base, we took the number two at GM, who was previously number two at Ford, Bill Knudsen, who was a Danish emigre, who was really the perfecter of mass production. And we direct commissioned him a three-star general and we put him in charge of war mobilization. And Knudsen was a world class engineer. And what did we do? We gave him the authority to go meet other world class engineers all around America. We had one key advantage in World War Two in terms of timing, which is that we had Lend-Lease. There was a period of time that we actually mobilized production when we were not fighting. We were building stuff that we gave to our allies, to the Brits in particular, and the Soviets. But that allowed us to build factories and retool existing factories and hit a production ramp so that after Pearl Harbor happened, we were basically at full rate production and were able to go after these things. And put this in context of our adversary, the Germans, they were actually better engineers than we were. They just made a very small number of very exquisite things. Now, if you come to the present moment, we sound like the Germans. We make a very small number of truly exquisite, eye-wateringly exquisite thing, and our adversary is the world's best at mass production. So this should give us all a little bit of discomfort here. The second part of this is the nature of the industrial base. Today, we call it the defense industrial base. I think it used to be the American industrial base. Until the fall of the Berlin Wall, only 6% of spending on major weapons systems went to defense specialists, i.e. companies that only did business with the Defense Department. Most of that spending, 94%, went to what I call as dual-purpose companies. A missile is single use. There's no dual-use missile. But the idea that Chrysler would build missiles and minivans meant that all the R&D that they were doing on production, material, equipment, machine tooling could be leveraged.
· Shyam Sankar
And it was subsidizing our national security, that we recognized that freedom and prosperity were two sides of the same coin. We're so far away from that world today. General Mills, the cereal company, used to build torpedoes and inertial guidance systems. Kodak, the film company, also was a key supplier to CORONA, which is our first spy satellite. But this is the industrial base that won World War II, won the early Cold War, and really deterred our adversaries. And it's only a consequence of becoming the sole superpower that everything changed. And it changed in two ways. One, that 6% number today is 86%. So 86% of major weapons systems come from defense specialists only. The other part of it is the nature of the industrial base. We think about it as Northrop Grumman. Much more accurately, it was Jack Northrop. It was Leroy Grumman. It was William Lear. It was Henry Ford. It was Henry Kaiser. You had founder figures. They were their own sort of heretics. What we would recognize in the Valley today, that's where this talent was. It was in the industrial companies of America. And we were betting on these people, not just their institutions, to deliver this sort of capability. In 1993, there was a very famous dinner at the Pentagon called The Last Supper. We had won the Cold War. I think in a democracy, it's very reasonable for the people to say we want to spend less on defense. What exactly is our threat? So we slashed the defense budget. And in this dinner, the Secretary of Defense told a subset, I think it was 15 of the 51 primes. We had 51 primes. Today, we have five. They told them, "You're all not going to survive. The budget's getting cut. We give you permission to consolidate. Maybe some of you should exit the defense business altogether and know that some of you may go out of business and we're not going to save you." And this just set off a merger frenzy that led from the consolidation from 51 down to five. Now, most people look at this and I think they take away the wrong conclusion, which is like, oh, this is when we lost competition. When we had competition, it was much more dynamic. I think the much more profound consequence is, this is the moment of profound financialization and conformity in the industrial base. You lost the crazy people. They went to tech.
· Shyam Sankar
They went to other parts of our economy where there was enough positive sum energy and growth, and it wasn't just about dividends and buyback ratios and financial engineering. It was about real engineering. The world class engineers – why should we celebrate a Hyman Rickover or a Kelly Johnson? Kelly Johnson was the founder of Skunk Works at Lockheed. In his lifetime, he built 41 airframes. That is insane. Many of which we still fly today. He built the U-2 in 13 months. The timelines we're talking about are just incredible. You can't look at that and think anything other than this is an artist. This is like divine, what he's able to do. And so much of what I think we've gotten wrong is those things were messy and chaotic and hard and friction-filled. And over time, we've tried to install lots of process to make these things less messy, less chaotic. As a consequence though, they end up not working. We need a little more crazy back to get these things to work.
· Patrick O'Shaughnessy
[00:00:00] S0: How do we undo this? I'm reminded of the Churchill quote – won't get it exactly right – something like the U.S. always does the right thing after trying everything else first. And a lot of what's happened is that we have shipped the capability to produce physical things off our shores, to optimize for a variety of things. But it's much cheaper and more scalable and easier. And we've become primarily a country with all the market cap that rests on technology and IP and extreme talent. The small number of exquisite things, exquisite people, exquisite researchers. We've done an amazing job there, but we don't make much here anymore. A lot of it happens in China and overseas. How can we reverse that? It seems so imbalanced and so daunting as to seem impossible. But of course, I know you think it's critical. So what is even the first step in being able to do this?
· Shyam Sankar
[00:00:00] S1: What you said is exactly right. It is daunting, but critical. So we have no choice but to lean into that and start. The best time to start would have been yesterday. The next best time is today. Let me also give the case for why it's critical, because I think we're screwed if we don't do this. The biggest lie that we bought from globalization is this concept that we will do the innovation and they will do the production. Well, you have to recognize that innovation is itself a consequence of productivity. To put it in terms that I think our audience here would understand most directly, what motivated Google to do the research behind the "Attention Is All You Need" paper in 2017? If you ask them, they'll say well, the team was working on an incremental 3% improvement to Google Translate. You cannot think of something more banal leading to something more revolutionary than that. So if you don't have the input stimulus on improving production, you're actually not going to be able to capture the innovation. And that's literally what we're seeing play out in the marketplace today, which is OK, they went from making a battery to making the whole car. WuXi went from being basically a cheap pair of hands for pipetting contract research in the pharma industry, to actually now 50% of all clinical trials are drugs that are created in China. So we have ceded the innovation. It's not that it was taken away from us. We just ceded it because we had a completely incorrect preset. So now we have to reattack that. We should do this with some asymmetric advantage. I think we have a couple of them. I don't think it's true that we're not great at building things in this country. Look at Elon and the progeny of Elon. We do know how to manufacture things here. And we're going to have to think about manufacturing things in new and novel ways. In addition, it doesn't all have to be new. It's like Ford, General Motors. These are world class manufacturers, too. We have that capability. But we also have new ways of thinking about this with much deeper, vertically integrated production. Thinking about the production process itself is something that's more iterative and software-like that you're going to keep upgrading, co-locating R&D with production itself. So I think these sorts of trade crafts are the things that we can lean on.
· Shyam Sankar, Patrick O'Shaughnessy
And probably the last piece I'd say is, AI is David's slingshot here. If we can give the American worker superpowers, if you can make the American worker 50 times more productive than a worker anywhere else, you're going to change the efficient frontier of what can be made here. I think as a consequence, we should be reindustrialization maximalist. The free traders out there like to say, like, maybe we can friend-shore or whatever. I think that stuff can let us off the hook too easily. It fails to solve the problem. The other example I'll give you from Patrick McGee's book "Apple in China" is that [00:00:00] S0: Great book.