Irresponsible Politicians Have Destroyed Puerto Rico and Greece
While most eyes are on the economic crisis in Greece, another economy is suffering a similar fate: Puerto Rico.
Part of Puerto Rico’s problem is that it is neither a country nor a U.S. state. The island is a U.S. territory or “commonwealth.” Since it is not a sovereign nation, it cannot go to the World Bank or International Monetary Fund (IMF) for emergency loans or bailouts. As a non-state, the commonwealth cannot go to the U.S. government for help, at least not the same way as one of the fifty states.
In a report commissioned by the government of Puerto Rico, economists Anne Krueger, Ranjit Teja, and Andrew Wolfe address many facets of the commonwealth’s economic woes. Krueger and her colleagues explain that the problem is two-fold: Puerto Rico is going through both a debt and economic crisis.
The debt is a result of both stagnant economic growth and irresponsible spending. Without economic growth, Puerto Rico’s tax base remains stagnant while spending continues to rise. As of fiscal year 2015, the commonwealth’s debt was equal to 100.2 percent of its gross national product (GNP). The public deficit is equal to about 2.3 percent of GNP in fiscal year 2015, and is projected to rise to nearly 5 percent of GNP by 2020.
The Puerto Rican government’s budget formulation has been based on overly optimistic revenue projections. From fiscal years 2004 to 2014, revenue projections were consistently overstated by about $1.5 billion each year. Tax revenues have actually fallen relative to nominal GNP, from over 15 percent before 2006 to about 12 percent.
Additionally, Puerto Rico has engaged in a fiscally fatal policy known as “tax bargaining.” During a cash crunch, the government makes deals with large companies by offering discounts on their tax obligations if the companies agree to pay early. This policy enables the government to maintain liquidity in the short-run, but results in reduced revenues in the long-run, further growing the deficit.
On the expenditure side, many of Puerto Rico’s problems come from its three large public enterprises—the water and sewage utility (PRASA), the state electricity company (PREPA), and the highway authority (HTA). Each company has significantly contributed to the rise in public debt. In fact, the debt was rising years before the economy began to contract. There may be deeper problems with the government’s finances than simply reduced tax revenues.
Unlike the U.S. federal government, the Puerto Rican government does not have the credibility to run up a massive debt or a central bank to monetize the debt. Whether intentional or not, the Federal Reserve monetizes the national debt by driving down interest rates, which, accompanied by monetary inflation, lowers the cost of borrowing more money.
Puerto Rico’s lackluster economic growth is a result of a number of factors. The 2008 financial crisis played a major role. The U.S. mainland is the island’s largest trading partner and investor, but, even as the United States began to recover, Puerto Rican industries did not, largely due to a lack of competitiveness.
High oil prices have also hindered growth for the commonwealth. Puerto Rico is dependent on imported oil for all of its energy production. The more money Puerto Rican residents and businesses must spend on energy, the less they can spend on other goods and investments. Oil prices have declined since 2012, which has at least temporarily lowered the commonwealth’s energy costs.
Puerto Rico also faces many internal structural problems. Puerto Rican businesses are reluctant to hire because they must pay the U.S. federal minimum wage. In addition, Puerto Rico has its own onerous labor regulations. Companies must pay a mandatory bonus after the thirteenth month of work, and overtime must be paid to employees who work more than eight hours per day. The island cannot compete with its Caribbean neighbors because high labor costs drive up prices for tourism.
The extensive welfare system makes unemployment attractive for potential workers. Puerto Rican residents can make $600 more per month by receiving means-tested programs than they can by working a minimum wage job.
A combination of the lack of job opportunities and regulations that restrict domestic competition and business investment has led to an increase in emigration of the most talented workers from the island. As the labor force shrinks, both economic growth and tax revenue suffer.
The causes of Puerto Rico’s woes are similar to those of Greece. Some of Greece’s problems are, of course, more complicated. Their integration into the European Union (EU) and adoption of the Euro in 1999 came at exactly the wrong time. Worldwide economic growth masked the fiscal problems of Greece and other European nations. As a sovereign nation and a member of the EU, however, Greece has more options to reform its economy than does Puerto Rico, if Greeks are willing to risk austerity.
Kreuger and her colleagues recognize that economic growth and fiscal adjustment must go hand in hand. Fiscal adjustment alone would result in painful austerity, and economic growth would stagnate or even decline. Economic growth alone will not fix Puerto Rico’s unsustainable fiscal problems. Stagnant growth perpetuates the debt, and the debt hampers growth. Unless both problems are solved, the vicious cycle will continue.
Ultimately, the solution to the crises of both the Greek and Puerto Rican economies must be the same: a return to fiscal responsibility and an adoption of pro-growth economic policies. The austerity caused by fiscal adjustment may be painful in the short-run, but it is the only way for either economy to recover and return to a path to prosperity.
Jonathan Nelson is a contributor to Economics21. Follow him on Twitter here.
Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, e21 delivers a short email that includes e21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the e21 Morning eBrief.