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Restoring Confidence: Dr. Neil Harl, ISU Economist

posted on November 21, 2008

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Borg: Restoring confidence. Global economic chaos drains business and family assets. We're getting Iowa and international perspective from Iowa State University professor emeritus Neil Harl on this edition of Iowa Press.

Funding for Iowa Press was provided by Friends, the Iowa Public Television Foundation. The Iowa Bankers Association, for personal, business and commercial needs Iowa banks help Iowans reach their financial goals.

On statewide Iowa Public Television this is the Friday, November 21st edition of Iowa Press. Here is Dean Borg.

Borg: Rising unemployment, falling retail sales, failing banks, anorexic stock markets, those descriptors are causing headaches for most everyone from factory workers to Wall Street investors and sending world leaders scrambling for remedies. Although the economic effects in Iowa appear muted there are increasing signs of trouble here and some Iowa communities are really feeling very sharp economic pain. Iowa State University professor emeritus Neil Harl is a long-time expert on economic matters, particular expertise in agricultural economics and on China. Dr. Harl, nice to have you back on Iowa Press.

Harl: Not under these circumstances but good to be back.

Borg: We're really seeking expert advice today and we expect to leave here with a remedy.

Harl: I'm somewhat amused by that. We're all trying to see around corners. It's not easy to see around corners but if we each contribute a little bit we may learn more about what we're facing. But this is a most unusual time.

Borg: I'm going to turn to two fellows who are going to guide the conversation here, Des Moines Register political columnist David Yepsen and Associated Press senior political writer Mike Glover.

Glover: Dr. Harl, everybody says it's bad out there, give us your expert opinion on how bad it is and how bad it's going to get. Put a label on it, recession, depression, deep recession?

Harl: Well, officially we have a recession if you have two quarters of negative growth. At the end of the year I think we officially will be in a recession. I have been calling it a recession for some time because it's happening so rapidly. The decline has been so precipitous and it's hitting the heart of our economic system to the point that I don't think there's any question about whether we're in a recession. And it hopefully will not get worse than that but I think it's a grim time.

Glover: How do you compare Iowa -- clearly on Wall Street, the financial meltdown that's going on out there, nationally it's bad -- how is Iowa faring?

Harl: If Iowa were in isolation and we weren't watching the news and reading it every morning, television, radio, Iowa would be getting along pretty well because we've had a good year in Iowa. We've had good commodity prices. But people are reading that it's happening elsewhere and it's going to hit Iowa without any question in my mind sooner or later. So, if we don't get this headed off, if we don't get it in a plateau mode then it's going to hit Iowa, really hit Iowa.

Glover: I'm an Iowan and my 401K has felt it.

Harl: Yes and that's part of it, part of reality. So, although the Iowa economy is not doing really bad, unemployment is not unreasonably high in Iowa people are beginning to feel it and they're seeing it and they're reading about it and they are concerned, very concerned.

Borg: Dr. Harl, you emphasized really hit Iowa. Did you mean that Iowa, when it does hit, is going to be very hardly hit?

Harl: It will catch up with the rest of the country and unemployment will rise, I don't think there's any question about that, state revenues will fall, I don't think there's any question about that. We're already seeing the finance sector in Iowa being hit and hit rather significantly with one of the major companies getting a sizeable bailout and finance has been a big and growing segment of the Iowa economy. Farm equipment manufacturing has been doing very well. In fact, there's been a waiting period to get a new tractor at John Deere in Waterloo. But that is beginning to change as well. So, all of the forces that are now operating on the rest of the country's economy is going to show the same effects in Iowa.

Yepsen: Dr. Harl, is it still true that Iowa lags the country going in and then lags coming out?

Harl: That has been the case for a very long time. Every recession we've had in recent time since the 30s I think you can say that about Iowa. You remember in the mid 70s we hardly knew there was a recession but then in the 80s we had a little bit of a depression from that. We were the ones who were in deep trouble in the 80s in the farm crisis because that was centered on the agricultural sector heavily.

Yepsen: Write me some prescriptions, Dr. Harl. We all know it's bad, what is the way out? What things should Congress, the president, what should we be doing?

Harl: I think first we have to realize that this may not be a conventional decline. A conventional decline there's a fairly sharp drop and then a climb out that usually is completed in two to five years at most. This one I don't think is quite of that type. I've been saying that the signals are pointing in a different direction to what I call a down shifting, to a new lower level and that's why I don't think our remedies are working particularly well. So, if that's the case then we have to focus on the longer term, what are the problems? And I think this second scenario that I mentioned is really attributable to two or three factors and one factor is that we have been living beyond our means, we have been living well beyond our means, governments have lived beyond their means and we're hitting a new record almost daily in the federal budget deficit. Secondly, companies have been using debt and this has not been accompanied by the usual warning debt does carry risks. The belief has been if you can borrow it it's the same as equity practically but we know it isn't. So, too much debt at the level of the companies and corporations. And thirdly, too much debt for individuals. There are too many who are borrowing against their houses, for example, and then as their house went up in value they would ratchet up their loans and that was a dangerous move because when the collateral value began to decline in homes that left people exposed. And that was the early part of this, that was last winter when that began to surface. So, that's one big factor. The second big factor is we've lost a lot of economic buoyancy through the loss of jobs, jobs have followed manufacturing overseas and we really haven't paid a price for that and I think we have to at some point. And what we had was a triggering effect that came through the housing market but the economy was vulnerable, it was very vulnerable at the time this began to happen.

Yepsen: What do we do now?

Harl: I think we have to do several things. I think one thing we have to do is take another look at regulation. I think that has been a big factor, not the only factor. I was on seven federal commissions starting in '67 and running on through 2003 and I was in Washington a lot and starting with the '79 move on airlines, Alfred Conn from Cornell University sold Congress on the idea that we need better efficient air travel, if we were to deregulate that aspect. Through the 80s it slowly gained strength, the deregulation movement. But it wasn't until the '94 elections that it really took off. I was an OTA, officer of technology assessment advisory committee during that time period and I chaired it in '93 and '94 and we were hearing stories like, well, we don't need regulation any more, markets will do anything, get government out of the way and we'll really see economic growth and that picked up steam after the '94 elections and they started going after the major regulators, FCC, the regulators in the USDA on meat packing and so on, get them out of the way and the market will take care of this. Well, some of us tried unsuccessfully to get them to see there is a down side to that.

Yepsen: So, more regulation?

Harl: More meaningful regulation.

Yepsen: Is that it?

Harl: No, I think that's not it. I think in addition to that we have to take a close look at our policies in other areas that have contributed to this and I think the matter of too much debt and how that could be approached I'm not certain. Maybe there will be enough in this downturn to cause people to have more discipline than they've had.

Borg: Is there any lesson there for state government? You said too much debt and you've already alluded to the federal debt. I'm trying to get into now the effect on state revenues that you project as a result of what you think will be an eventual downturn in Iowa's economy.

Harl: Of course we have limits on deficit spending in Iowa and many states do.

Borg: Except for bonding.

Harl: Except for bonding, that's exactly what I was going to get to. But we have also engaged in this matter of anticipating our future revenues through the bonding process and I think we need to take a long look at spending at the state level. I think if I'm correct in terms of my assessment that this is not a normal downturn, that this is a down shifting to a new lower plateau, at least for a time, then I think Iowa is vulnerable if it doesn't take a look at its expenditure patterns because of the points we've been talking about.

Glover: One of the first steps that was taken in the wake of this financial meltdown is the Congress approved a $700 billion bailout of the financial sector. Was that a good idea? Is it working? Is it a good idea but not being handled well? Give us your assessment.

Harl: Eventually by late September I was convinced we probably had no other choice. However, I have worked on this problem in February and March of last year, last winter because one of the foundations was working on the other end of the problem, on the consumer end of the problem, had contacted me because he had seen some of our research on the Internet and wanted to know what we did in agriculture in the 1980s. They said, we think that may work. And I said, I think it will too and I've been feeling that way for quite a while. So, we put together a bill, 2636 and it would have provided essentially the same approach that we had worked on in agriculture and that was to realize that when collateral values have fallen loss has already occurred. It doesn't help to stand around and say pay your bills if you can't and the loss has already taken place. So, what do you do? Well, you strip the debt down to the value of the collateral and they prolong the payment. If it's a fifteen year loan make it a twenty and so on and maybe reduce interest rates which is anathema to most lenders -- if they're causing a risk for us and our institution we should raise interest rates, not lower them -- this we call debt restructuring and it involves stretching that payment, reducing interest rates and maybe even forgiving some principal. And so what we were proposing was much the same that went into Chapter 12 bankruptcy ...

Glover: And is the bailout being structured that way? Is that working? Is it being handled right?

Harl: I think it worked well in agriculture in the 80s, it came within just a few votes of passage in March of 2008, it was a clincher vote, required 60 votes and the votes were like 55, 56. But I think if that had been passed and put some money into that side and stretch out these losses then I think we might have headed off a fair amount of what we're now going through.

Yepsen: Something like that still work?

Harl: I think it would, I'm still supporting. Bair, who is head of FDIC, has also announced support for that and I think what we've been doing is pouring money into the top and not only is it not working but it's turning off the American people. They are not convinced and without the support of the population it's probably not going to work.

Yepsen: That leads to me asking you about the next bailout, an auto bailout, auto industry bailout, rescue package. Are you for that idea or against it?

Harl: I'm really torn because there are three million jobs at stake and I'm very sensitive to that. But on the other hand I don't want us to have to be continually pouring resources into those three companies. So, I think we either have to wait and have them file Chapter 11 bankruptcy or fasten on any firm that gains benefits from the federal government, not just the auto industry but all the others, essentially the same limitations that bankruptcy would impose and I don't think it perhaps makes a lot of difference if you do it right. I think the first mistake we made was in doling out money by asking very little of the recipients of those funds.

Yepsen: You said a moment ago that you think this is a permanent downshifting and we're moving to a lower plateau. What do you mean by that? Our standard of living? Are we in danger of a great depression?

Harl: Let me answer your second one first. I think there is a possibility, I think the probabilities are low simply because we don't know what's coming. But back when I was an OTA we spent about a year asking a question and trying to answer it. In the face of free trade, totally free trade, free movement of capital and availability of technology everywhere is it possible to maintain a premium standard of living. We concluded no, probably isn't unless we develop technology faster than we have been and milk it for more than it's worth. That's very difficult because today if someone commercializes technology in the United States in the morning you'll see it in China in the afternoon, you'll see it in South America the next morning and so it's very difficult to do that. So, what this does is lead to a leveling around the world. We've seen incomes rise in the lower incomes countries heavily through globalization, outsourcing, trade. And now the question is can we maintain a premium standard of living. There's been a theorem, an economic theorem for some time that says if capital is freely available everywhere, if technology is also available everywhere and if there's totally free trade across boundaries returns to labor and returns to land will trend toward a common level where the same quality exists. This is why one of our solutions is very long-term. We've got to put more money into education so that our people are not competing with the millions around the world and so I think that is part of this. We need to be thinking long-term in terms of how to deal with this problem of maintaining a premium standard of living in a world that is gradually seeing a rise in incomes for low income countries. Now, to be fair that is probably the best thing that could happen in terms of increasing the level of harmony in the world. We have a great deal of disharmony and part of that is because of the differential in incomes and the belief that low income countries didn't have a chance. So, there's some extremely important issues here that deal with our fundamental policies and what our place in the world is going to be.

Glover: Let's take it down to the land, you mentioned the land. People look at the ag economy and they say commodity prices are pretty good right now, farmers look to be making a lot of money, the ag economy looks real good. What is your take on it?

Harl: It has been strong and that's one reason why Iowa is not heading into this recession as rapidly as it probably would have otherwise. Now, the problem is that agriculture, farmers are the world’s best economic citizens, give them half an incentive and they'll increase production every time driving the price down. You don't see price staying high for a very long period and indeed the last couple of months we've seen corn drop almost half in price, we've seen soybeans drop a good third, actually it's probably closer to 40% now and one of the big boosters of profitability in agriculture in this state has been ethanol and we know the ethanol business is in deep trouble. We have had more than 20 plants file bankruptcy around the country and so they will continue to produce ethanol as long as they can cover their variable costs, they may not cover their fixed costs, but if they can cover their variable costs they're going to stay in production which means that keeps that corn price higher. But agriculture is very sensitive to supply and demand and we also have government programs that help to stabilize but I don't think we can count on $8 corn and $16 beans.

Yepsen: Dr. Harl, how important is agriculture to the Iowa economy? I'm going to get us both in trouble here but I've heard your former colleagues say that it's only about 20% of the gross state product. Is it as important as it used to be? Isn't financial services -- aren't industries like that really as important if not more important?

Harl: I think it's not as important as it used to be. I would readily agree with that. However, it's not an insignificant part of the state's economy and we see that, food prices are low, incomes have declined in the period between 2000 and 2007, that was the case in 2006. And so it is a major factor because Iowa is not a big state in terms of its economy.

Yepsen: There's one issue that has gone on in northwest Iowa particularly with VeraSun, an ethanol producer, and it's a narrow question I have here about the farmers who sold them this expensive corn are now upset that they may be out of luck. Is there any legal recourse? What happens?

Harl: Well, it's tied up with Chapter 11 bankruptcy and when you're in Chapter 11 bankruptcy you can accept or reject contracts and this, of course, gives some leverage to the debtor in Chapter 11 and that's what we're seeing played out. However, you soon learn as a debtor going into Chapter 11 that you don't make friends when you do things like that. And so almost the whole state is arrayed against that philosophy. But, yes, you can play some games with Chapter 11 in terms of manipulating your contracts. This is a perfect example of that.

Borg: I'm going to take you back to what David said just a moment ago and you have repeated, reducing asset value to a new plateau. Does that include Iowa land values because land values have been soaring?

Harl: Yes, I would certainly agree with that. I just published this week an article on that very issue and my take is this -- that we have seen a very rapid run up and now we've seen a decline in corn price, decline in soybean price so there's less to capitalize and to bid into cash rents and capitalize on land values. Now, in addition although a lot of the land purchased in the last two or three years has been paid for by heavy amounts of equity capital by the purchaser. We're just beginning to get into the situation where other people were willing to get in because the same factors in the 70s, wanted to take advantage of this run up in land value they were starting to borrow and so that's when it gets to be serious. So, I think we're going to see first a plateauing in Iowa land values and then I think we can see a decline, not a huge decline as long as the price of corn and soybeans are maintained near present levels which is around $4 in corn and about $8.50 in soybeans, that's still an important issue. But we're also seeing a very dramatic increase in the input costs and so people are paying, farmers are paying so much more for fertilizer and seed and everything else that it would have been three years ago if corn was $4 and soybeans were $8.50.

Glover: You're talking about macroeconomic trends, big economic picture issues. In a couple of months the legislature is going to be coming into session and they tend not to deal with that kind of thing. But give them some advice. If you're an Iowa state legislator and you're coming into session what is the best thing they can do and what is the worst thing they can do?

Harl: Well, I think the best thing they can do is to be cautious and a little on the conservative side. I think we should be thinking in terms of how we can reduce government spending in the state on a contingency basis. If I were in Governor Culver's position I would be working actively behind the scenes to get a good line on where we can cut spending. I think we're going to have less revenue. He's going to hit sales tax first and then he'll hit the other taxes and I think we're going to be scrambling here in the next two sessions of the legislature.

Glover: But you've got a democratic governor and a solidly democratic legislature, they don't have a strong history of reigning in spending, they like spending.

Harl: But they understand politics and they want to get elected and so I think the prudent thing for the party to do is to move a little bit towards the cautious side for this next session at least and watch carefully what is happening. Harl may be wrong, the others may be wrong, we don't know, we're trying to see around corners but the prudent thing to do in my view is to be cautious now and look for ways we can redo employment maybe through attrition and to try to stretch our revenues as much as we can because the pressure is going to be there I think.

Yepsen: Dr. Harl, one of the issues confronting the legislators is the question of raising the gas tax. There is a lot of talk about the need to rebuild infrastructure during hard economic times, creates jobs, creates an asset, people don't like raising the gas tax but other people say it's a good time. Where do you come down on that question of raising the gas tax?

Harl: It was up on the table last session, it was pulled off.

Yepsen: That was an election year.

Harl: This is not an election year, I'm very much aware of that. There's no doubt that we need to spend money on infrastructure. I think there may very well be federal programs that will weigh in on some of those issues and so I would be inclined to factor that into our budget priorities but to keep an eye out because I think the federal government may be moving in that direction as well. Now, what that means down in Iowa we may not get all that much money but I think there will be some funding for that.

Glover: Let's look across the ocean. One of the things you're an expert on is the economy in China. What is happening there? Why should anyone in Iowa even care about it?

Harl: They are frightened and they are taking steps to deal with this on their terms. They have still high levels of growth by world global terms. They are still doing reasonably well but I have been very concerned about China for at least the last three years or so because their growth rate has been so fast that any significant withdraw of capital could cause them serious problems. As a matter of fact, I'll share this with you, I have feared a meltdown, not of the type we're going through, but a meltdown originating in China because of the extremely high levels of growth and the almost phrenetic pace of activity which wasn't very well governed. Their government system is even less coordinated ...

Borg: How is that going to affect Iowa if at all?

Harl: It will affect Iowa in the sense that it would be -- it would affect trade and they are increasingly one of our big trading partners.

Yepsen: We've got one minute left and I want to ask you this question. What should an individual do, someone sitting here watching this program right now? What steps does an individual take?

Harl: It's a little late to be really aggressive here. I think we could see asset values plateau between 50% and 60% of where they have been and we're not too far from that with the Dow yesterday and late last week performing as it did. So, I don't really believe it's the prudent thing to just throw everything over the side and go to cash. I think you look at your own situation and what can you endure? How much of this can you go through? Can you endure a Dow at 5000? I think we're going to see a Dow of 5000. And if you can't then you better do some liquidating before it's too late. But if you've got enough to get through this then I think the big losses have already taken place.

Yepsen: Sell land?

Harl: Well, I haven't sold any but I suppose if one were totally rational you might think in terms of selling -- lightening up your investment in land if you're heavy in it. Don't be too -- certainly don't ignore it and if you're heavy in one area you may want to lighten up a bit there. But take the longer view -- can you get through this period without causing too much travail and straining your marriage.

Borg: I guess the rhetorical question we don't have time for an answer is stay out of debt.

Harl: That's right.

Borg: Thank you Dr. Harl. On our next edition of Iowa Press we're shifting to state government and legislative politics. We've been talking about it, republicans have new leaders in both the Iowa senate and the house and we're going to be questioning one of them. He's Representative Kraig Paulsen of Hiawatha, he'll be leading the house republican minority. We'll see it at the usual Iowa Press airtimes, 7:30 Friday night, 11:30 Sunday morning. I'm Dean Borg. Thanks for joining us today.

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Funding for Iowa Press was provided by Friends, the Iowa Public Television Foundation. The Iowa Bankers Association, for personal, business and commercial needs Iowa banks help Iowans reach their financial goals.

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