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Puerto Rico can't pay its debt, and the United States is partly to blame

- July 15, 2015

On July 4, a woman walks by a rundown building in Old San Juan, Puerto Rico. (Matt McClain/The Washington Post)
Last week, Puerto Rico’s governor, Alejandro García Padilla, announced that this U.S. commonwealth cannot pay its $73 billion debt. Since then, media coverage has often told a simple story, similar to the one in Greece: a profligate government borrowed too much and now must pay the price by slashing spending and increasing taxes. While Puerto Rico’s government should certainly share the blame, this approach ignores an important contributor to the commonwealth’s problems: the United States government’s economic and tax policies and the island’s status as a colony. Being neither an independent country nor a state constrains the Puerto Rican government’s economic development policy options.
U.S. trade and Puerto Rico’s economic decline
Puerto Rico’s manufacturing sector faces more competition because of the United States’ recent free trade agreements with Latin American and Caribbean states. That’s heightened by the erosion and repeal of a section of the federal Internal Revenue Code that had provided incentives in the form of tax credits for manufacturers to locate in Puerto Rico: Section 936. With these tax credits, and other incentives based on the territorial status of the island, efforts to build a petrochemical industry became one of the main drivers for development.
However, after the 1973 oil crisis, U.S. policy changed, leading to the weakening and collapse of this effort in the 1980s. Puerto Rico then tried for a time being the United States’ intermediary and financial hub in the Caribbean. As that faded, the island tried to use Section 936 tax breaks to keep manufacturers and pharmaceuticals in the commonwealth. That failed when the incentives were repealed by Congress in a phase-out period starting in 1996 and ending in 2005 out of concerns that they encouraged tax evasion.
Manufacturing is the single most important sector of the Puerto Rican economy: it made up to 46.5 percent of GDP for 2013. Puerto Rican exports to the countries covered by the free trade agreement CAFTA-DR have fallen by 15 percent. Meanwhile, its exports to the NAFTA countries, which were supposed to make up for the CAFTA-DR losses, increased by only 1 percent. Many of these economies have lower exchange rates than Puerto Rico while competing directly against the manufacturing capabilities of the island, so the combined result was that the Puerto Rican economy entered into recession in 2006, and has remained there ever since.
Since the recession began, labor force participation has reached record lows: only 39.6 percent in May 2015. Unemployment is down from its peak of 17 percent in 2010, but still hovers around 12 percent, compared to the current U.S. employment rate of 5.3 percent. Puerto Rico’s gross national product decreased by an estimated 14 percent between 2005 and 2015, and has reached levels last seen in the 1990s.
As a result, Puerto Ricans have been leaving en masse for the continental U.S. That exodus began in 2006 and has lately accelerated. Sixty percent of all Puerto Ricans now live outside Puerto Rico. The dwindling tax base and increasing debt obligations made the Puerto Rican government finally accept that the debt is not payable.
Puerto Rico’s government stumbled in responding to its economic dive
Not all of Puerto Rico’s economic troubles were caused by the U.S. government. While Puerto Rico struggled as the incentives in Section 936 of the Internal Revenue Code disappeared, its government had begun to accumulate debt to finish major infrastructure projects in the 1990s and early 2000s. These are intended to stimulate the economy and attract investment, but have failed to do either. A political deadlock during the Aníbal Acevedo Vilá administration (2005-2009), which had to share the Legislative Assembly with the opposition from the pro-statehood New Progressive Party (NPP), made matters worse, as the government could not pass measures to respond to the economic crisis. In the early years of the recession, problems were seen as fiscally-driven, instead of symptomatic of structural problems accumulated from decades of changing policies from Washington and insufficient initiative in San Juan.
Since the problem was identified as a fiscal issue, it was dealt with fiscally, instead of by attending the structural problems of the economy or generating growth focused initiatives. A new 7 percent sales tax was introduced in 2006, which did not generate projected revenues because of low capture rates – the amount of tax collected relative to the actual taxable sales in the economy. This led the government to issue more debt, now backed by the new tax. Budget deficits meant that governments from 1993 to 2012 kept accumulating debt , as you can see below. When the pro-statehood and conservative NPP took office in 2009, it implemented painful austerity measures. From 2009 to 2013 total government payroll fell by nearly 40,000 employees between incentivized retirements and mass lay-offs, that is 13.3 percent of the 2009 figure of 300,000. During that same period, the formal economy lost a total of 125,848 jobs (11.04 percent loss of employment). Massive budget cuts, reforms, and the suspension of collective bargaining rights triggered strikes and social upheaval that lasted months, while income tax reforms cut taxes to the wealthier citizens.
Although the NPP lost to the pro-status quo and centrist Popular Democratic Party (PDP) in 2012, the PDP continued austerity in other forms. The government sold off revenue-generating landmarks like the island’s main international airport to pay debt; reformed public pensions by increasing retirement age increasing monthly contributions, and lowering benefits and monthly pensions; and recently hiked the sales tax to 11.5 percent. But austerity, far from inspiring investors’ trust or generating economic growth, may have deepened the wounds in the economy along with the relative drop in competitiveness. This is because the falling consumption and investment from the government, along with the diminished available income for personal consumption, led to a smaller market, which was already shrinking. In 2009, GNP fell by another 3.8 percent, and in 2010 by yet another 3.6 percent. Puerto Rico’s Planning Board projected negative growth for the next few years, despite a projected primary budget surplus–the balance of the budget before accounting for debt or interest due–of 1.2 percent of GNP.
On June 29, in his televised speech to Puerto Rico, Governor García Padilla proposed to restructure the economy and debt.
U.S. response to Puerto Rico’s economic crisis
The response from the U.S. government has been tepid. The White House has said that Puerto Rico would not receive a bailout. The U.S. administration did show some support for allowing the unincorporated territory’s public corporations to use federal Chapter 9 bankruptcy protections. Meanwhile, the United States Court of Appeals in Boston, which oversees Puerto Rico, struck down a local law that aimed to extend similar protections  currently denied to Puerto Rican public corporations and municipalities.
By contrast, Democratic candidates for the presidential nomination Hillary Clinton and Bernie Sanders have stated that Puerto Rico’s debt crisis was not the island’s alone. Clinton said that for the island’s economy to grow, “they need real tools and real support.” Sanders blamed Wall Street and austerity measures. All Democratic candidates agree, as does Republican nominee Jeb Bush, that Puerto Rico’s public corporations should receive bankruptcy protections to help the territory recover. This bipartisan show of support suggests there may soon be help for the battered territory’s economy.
Rashid Marcano-Rivera is a Ph.D. student in political science at Indiana University.