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Iowa State University Emeritus Economist, Dr. Neil Harl

posted on March 16, 2012

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Cloudy economy.  Tax uncertainties, drought fears, job market weakness, bringing advice seekers to Iowa State University Economist Neil Harl.  We're hearing his counsel on this edition of Iowa Press.

Borg: Encouraging reports during the past couple of weeks may be hinting an improving economy.  Although the nation's unemployment rate is holding steady at 8.3%, hiring seems to be increasing in manufacturing, business and health services.  Other reports show increasing consumer confidence and that may be helping other sectors of the economy -- bankers and businessmen -- in shaking off paranoia.  Still, there's much to ponder.  And that's why we're seeking comment from Iowa State University Emeritus Economist Neil Harl.  Big tax changes are hovering, both state and nationally.  Iowa's farm economy has been blunting the recession's effects so far but now farmers are investing heavily in a new planting season knowing they'll need more than normal rain to compensate for soil that is bordering on drought.  Professor Harl, plenty to talk about.  Welcome back to Iowa Press.

Harl: Thank you.  It's great to be back, great to be back.

Borg: And across the table Radio Iowa News Director Kay Henderson and James Lynch with the Gazette of Cedar Rapids.

Henderson: Dr. Harl, people are pulling up to the pump and they are having sticker shock at the gas prices.  Will these gas prices just grind to a halt this economic recovery?

Harl: It certainly likely will have an impact.  However, this is based heavily on the futures market.  I think the Middle East will have a lot to do with gas prices and that is very hard to predict, very difficult to predict.  I think what we'll see is some topping out a little higher than we are now and then I think we'll see a plateau during the heaviest season and then some decline if things quiet down in the Middle East.  But that is the big problem there.  It certainly is a big factor in the fuel energy costs, one of the big factors not only for the agricultural sector but for the sectors generally.

Lynch: Let's talk about that impact on the ag sector.  Fuel for tractors, fertilizer that is petroleum based, fuel for the trucks that move our commodities.  What is the impact on the Iowa Farm economy and I guess indirectly on us as food consumers?

Harl: Well, all input costs have been going up and that is one of the problems we have whether we have a spike up in profitability is that these often trail and they go down more slowly than they rise often times in a sector that is in really perfect competition against the sellers of the inputs which are less than perfectly competitive.  So we anticipate this will be the case.  And one of my concerns right now is if we have any significant decline in commodity prices this could really catch farmers in a difficult position.

Henderson: Before we get too far down the road I prefaced my first question with recovery, economic recovery.  Is this a rural recovery?

Harl: I think it is.  I don't think any of you were on Iowa Press back about three or four years ago when we had the first discussion of this and I said this is promising to be a long, protracted, difficult down turn and I think we are nearing the point where we can safely say we are on the climb out phase.  But we're not going to return to pre-2007 conditions any time soon because there's still too much debt.  We still have a housing problem.  We still have a commercial real estate problem.  Europe is on the horizon.  Too much debt in the world.  And so we're in the process of working through this debt and we still are but the system is beginning to deal with it and I just wish they had dealt more quickly with it in the housing sector as we've talked about on this program a time or two before.  But they didn't and so we have to face that.  We learned something from the Japanese back about 20 years ago and that is don't ignore debt.  It's one of the worst things you can do.  Face it, get it behind you.  But we didn't do that in the housing situation.

Borg: Well, if you're worried about debt, that brings me to farmland prices.  I see you shaking your head yes so apparently you've got some comment on that.  But it seems to me that if farmland is selling for $10,000 to $20,000 an acre there's a lot of debt being incurred there.  Does that worry you?

Harl: Perhaps not as much as you might think.  Most of the lenders are placing a ceiling on what they will loan and it is in the vicinity of $5,000, $5,200 an acre for the better land.  A lot of this has been paid for with family money.  And a few are mortgaging other assets but they still are limited by how much they can get from their lenders.  I think the biggest problem we face in farmland right now is that investors are supposed to discount future net income figures back to the present.  And that means over about the next 20 years -- the heaviest weight is on nearby years and it goes down until you get to the 20th year and you're approaching zero in terms of the impact.  But when prices are going up for commodities there is a tendency for investors to put too much weight on the nearby commodity price expectation.  That is one thing I have been trying to warn about is don't get carried away with today's commodity prices because farmers are the world's best economic citizens.  Give them half an incentive they increase production every time, drive the price back down again, they destroy their own prosperity because there's too many of them.  They are like steel or other industries that are heavily concentrated.

Lynch: As we watch these farmland prices rise though and ownership seems to be more consolidated does this sort of preclude a young Iowans from getting into farming unless they have a sugar granddaddy?

Harl: It has always been difficult.  I'll have to share just a brief vignette here.  I wanted to farm myself.  I left the military in 1957 but corn was not in a very good position price wise, hogs were down and I decided not to.  But I thought it was going to be a long slog to be able to buy land and that was when land was a fraction of what it is today.  We bought the farm I wanted to rent quite recently and it has always been that way but it is becoming probably more difficult with this run up.  But then we have commodity prices that are unprecedented as well.  This is the first time I've sold soybeans over $14 a bushel and you shake your head in disbelief and corn at $6 plus.  So yes it is difficult but it always has been.  I think we -- as we look forward agriculture is going to need fewer farmers.  We're talking now about technology that may have a technician running and monitoring three or four tractors that are guided by GPS and this is going to continue the trend toward fewer and fewer actual farmers needed.  So we need to be cautious.  But yes --

Borg: We need to be cautious but you seem to say then there are implications to that consolidation.

Harl: I think there are.  And one of the implications is the difficulty that some see in assuring their children can start.  This gets us in to the tax, the federal tax situation and I'm getting, for the last several months most of my calls have been from people who are worried that we're going to go back to a million dollar exemption after this year.  But Congress hasn't been very helpful.

Lynch: Is Congress going to address that before the end of the year when it drops from $5 million to $1 million?

Harl: I shouldn't say no because I don't really know but I think other things will crowd out tax policy until after the election.  I do think there is a possibility there will be a session after the election.  And there may be a little bit more interest in negotiating depending on how the election comes out.

Borg: So what you're saying, you expect those tax, Bush tax cuts to expire but then to be reconsidered as the new Congress and the new administration takes in?

Harl: I would not be surprised for this to spill over into 2013, at least in some of the tax aspects.  And then they will do like they did before in 2010, enact something.

Borg: You mean an extension?

Harl: Well, in some cases it will be an extension, some cases it will be dropping I think some of the Bush tax cuts, particularly the upper level tax cuts.

Henderson: Let's move to what is happening in Des Moines at the state capitol.  Legislators on the republican side of the aisle are considering a property tax reform package that targets commercial property by significantly reducing commercial property tax rates.  But it also effects residential and ag land.  Are they doing the right thing?

Harl: Well, it is a multi-faceted issue as everyone I think knows.  One thing about property tax, it is like a mortgage on your property and there were people in the last century, one from Oskaloosa, Iowa, the single taxer group, who believe we should tax all gains in property tax form and that it's just like carrying a mortgage and if you give property tax relief you increase the value of the property.  So why do that?  Well, I'm not a single taxer however I think what we need to be careful about is that we not lose the confidence the people of Iowa have in their taxing system.  We saw it happen in California with Proposition 13 many years ago.  The people of that state nearly lost confidence in state government over that issue.  And so I think we need to aim for fairness even though from an economic perspective it may not be all that significant because of the economic relationships.  But nonetheless I think the stability of our taxing system is dependent upon confidence by the people and therefore I think we need to move toward an adjustment but I'm worrying because what it's going to do is increase the property tax on residences and increase the property tax on farms.  Now, you might say farms have had a break here and there's no question that they have with the formula that was used for many years and still is for calculating --

Henderson: That is linked to production.

Harl: Within ag.

Henderson: If you could wave your magic wand, what would be the appropriate mix of property tax collections?

Harl: I would probably set a longer time frame for achieving a modicum of fairness and equality as among the sectors.

Henderson: As you know the plan that is currently on the table from republicans is eight years.

Harl: I think it needs to be longer than that.  It took us longer than that to get it out of whack and I don’t think we want to move too abruptly to adjust this system because I think that will irritate large numbers of taxpayers.

Henderson: The other thing that critics say is that people don't make business location decisions based on property taxes.  As an economist who has seen the data, true or false?

Harl: I think it is a factor but I don't think it is a major factor.

Borg: You spoke of confidence just a moment ago as relating to confidence in tax structure and so on.  There's also consumer confidence that seems to drive the economy and bankers willingness to lend and things like that.  We saw consumer confidence strengthening but we've also seen a hint within this past week a report that consumer prices are also going up.  Worried about inflation?

Harl: Yes, I have been and we'll have inflation, I'm confident, once consumer spending proceeds beyond where it is today.  The latest numbers are showing there has been an increase in consumer spending.  That is one of the indicators, the things that you watch to see if we really are turning around.  And that factor is what drives our economy because the economy is about two-thirds, a little bit more, dependent upon consumer spending.  So as soon as consumer spending picks up we're going to have concerns about inflation.  And although I watch the Fed statements, every one of them to see what they think because that represents a whole staff oriented toward trying to figure out what the economy is going to do but you need to be careful because the Fed can change position on a dime and will if it appears we're generating inflationary pressures in the economy.

Lynch: Professor, another concern on the horizon is the Chinese economy where we're hearing some reports of turbulence, possibly a hard landing and as Iowa's economy has developed relationships with the Chinese economy what are the impacts on Iowa in particular if there's some problems over there?

Harl: Well, I think there are a number of implications for Iowa, important ones.  And I agree -- before I retired we had a seminar for the People's Bank of China which is their central bank in Shijiazhuang and we shared with them the belief that looking at their loans in the seven banks about 30% of them were bad.  And they said, don't worry about this, Harl, this is government, we're not worried with it.  Well, since then they have begun to position those banks for investment so their investment quality, investment possibilities and in cleaning up their portfolios they are discovering a lot of things about banking and about the problems that they had that they weren't aware.  But they are, I think, potentially -- this is running kind of against the conventional wisdom today -- but I think they pose potentially one of the greater global risks because if there is down turn --

Borg: You mean China itself poses a great risk to the world?

Harl: Yes, I think so.

Henderson: Worse than Greece?

Harl: Well, it's different than Greece.

Borg: Why?  Why do they pose a risk?

Harl: Greece simply overspent and overconsumed and lived a life that was beyond their means.  In China they're expanding and expanding and expanding and I don't believe they are well positioned to deal with economic adversity.

Borg: What does that mean for Iowa?

Harl: Well, it means they are one of our big customers and we are one of their big customers.  One of the reasons why agriculture is doing so well is because exports are up dramatically and figuring soybeans to China, some corn, they weren't even importing corn a few years ago, they are heavily dependent upon the western world and the southern hemisphere for their soybeans.  And so a lot of our trade is with China.  And so what I was fearing until about a month ago was that if they didn't contain the problems, the contagion in Europe that was going to affect trade and that would be a big, big, big problem for China.

Henderson: Iowans know a lot more about China because its future leader visited here last month.  Is he a new kind of leader?  Or is he the same old kind of Communist?  Do you have any insight having spent some time inside the country?

Harl: I think he is of a new, a new breed, if you will, of leader.  I think it is partly public relations.  And I think it is also a reflection upon the fact that some of their leadership are beginning to realize they have been going through an economic revolution, they haven't yet gone through a political revolution and there's vulnerability there.  That is part of what I was speaking about a moment ago was we've seen around the world in the last year plus what can happen when people become disenchanted with leadership and it is beginning, perhaps, in China and so they are realizing that they need to be friends with the United States.  They also need to keep one ear out to their own people.  They don't want another Tiananmen Square.

Borg: But there's not much Iowa should be doing in the way of positioning its exports do you think because we're heavily dependent on the Chinese market.

Harl: That's right.  That's exactly right.  But I think we need to play a constructive role, we need to be sensitive, we don't want to wall them off.  There are different points of view -- maybe we should hold them at arms length.  I really think that the Chinese are going to be long-term, a major force in the world militarily, agriculturally, in terms of manufacturing and so we need to deal with them on that kind of basis.  We respect them.

Henderson: You mentioned debt earlier.  Greece, Ireland, Spain, those countries have huge debt.  Of course, U.S. debt was analyzed by the rating agencies and it was downgraded.  Has Congress taken the right steps to renew the confidence of the Wall Street and other markets?

Harl: I don't think they've gone far enough.  I think they're going to have to show that we are getting more revenue into our system and that you can accomplish what we need to accomplish either by deep cuts in spending or by increasing the revenue package coming in now.  I'm very worried right now about the expiration of the tax cuts and the big jolt that is going to come January 1st of 2013.  That I think could cause an interruption in our recovery if they don't do something about it.  That was really a default position because nobody could make a decision, none of the groups could make a decision and I really think that we need to watch that and try to encourage the Congress to do something.

Borg: Be a little bit more definitive -- you used the word jolt -- what kind of a jolt do you expect?

Harl: The jolt is going to be felt in the form of reduced spending that leads to layoffs, it leads to dramatic reduction in the force, it is going to raise unemployment, it is going to hit the military as well and all of these are going to contribute to an adjustment in economic recovery.

Lynch: You indicated earlier that they might keep those higher tax rates for higher income earners --

Harl: I think the chances are pretty good.

Lynch: So some sort of a hybrid tax package?

Harl: It's going to be a bitter fight and it's going to take some time and I don't see the give in there yet on both sides that is necessary.

Borg: I want to take you back to fuel.  Kay led off with a question on gas prices.  But something can be offset, can it not here in Iowa, because farmers are not only producing food and fiber, they are producing fuel.  Yes, it's going to cost them more for diesel fuel to go up and down the fields but they are selling corn for ethanol.

Harl: Right. 

Borg: And that supports the corn price.

Harl: It does.  But one of my concerns is that the health of biofuels is heavily dependent upon our friendly government policy and we've already seen the loss of the blender’s credit.  We are going to see probably the elimination of the tariff barrier, which isn't a biggie right now, but it has been significant and it might again.  And the third is the mandates.  And so if the mood to cut and to reduce government's involvement in the economic system continues this could have a negative impact on biofuels and that I think is a question that we have to face -- how important is it that we become more independent in terms of energy sources?  And what price are we willing to pay?  And an abrupt change here could really add to the adjustment problems.

Borg: Just to be definitive here, you are a big supporter then of government support of biofuels?

Harl: Well, I shouldn't say yes but it's guarded because I believe long-term we need to have a fuels policy that reflects economic reality and economic reality is that we face several variables here, three big ones.  One is to what extent is government willing to continue to be supportive?  Secondly is technology and technology is moving so fast with the economic incentive we have that I'm not sure what role biofuels will play in ten years or fifteen or twenty years.  But we need to keep that in mind, of course.  And then third is the economics of conversion of converting agricultural products into biofuels.  And that is changing too but it has not been all that favorable in times past.

Henderson: We have about 20 seconds left.

Harl: Really?

Henderson: What are the lessons of the farm crisis that we need to keep in mind that we have forgotten because land prices were high in the '70s, commodity prices were good?  What do we need to remember, just briefly?

Harl: We need to be, number one, very concerned about instances where enthusiasm for buying land, for example, lures into that process people who are not prepared to take the risk if there is a down turn.  That message was not disseminated in the '70s, we paid a huge price in the '80s because we had two-thirds of the debt held by one-third of the farmers and it just up-ended a lot of them because that message had not gotten through.  And that is what I've been trying to articulate in the recent months.

Borg: The message that I have to deliver, though, is that we're out of time.  Thank you so much, Professor Harl.

Harl: My pleasure.

Borg: Next week on Iowa Press, University of Northern Iowa President Ben Allen will be discussing proposals for refocusing UNI to meet budget realities.  Back at the regular times next week, 7:30 Friday night and a second chance to see UNI's Ben Allen Sunday at noon.  I'm Dean Borg.  Thanks for joining us today.

Tags: economy government Iowa Iowa State University Neil Harl tax reform