Many observers have recently claimed that Puerto Rico’s problems are the result of the federal government’s unequal treatment of the island as compared to other states. The island’s non-voting member of Congress, Pedro Pierluisi, recently argued in The New York Times that if Puerto Ricans received the full panoply of U.S. social welfare benefits, the government wouldn’t have had to take on so much debt.
If only Puerto Rico were a state, this line of thinking goes, it wouldn’t be in a financial mess. That’s probably true—but not for the reasons most people think.
If Puerto Rico took on debt to address social welfare problems, it did so in an incredibly inefficient way. To create jobs, it built up a huge public sector, which now employs one in four workers in the territory. That’s good for those in government employ but bad for everyone else. If Puerto Rico were a state (or an independent nation), it wouldn’t have been able to expand public payrolls so dramatically. It’s the island’s commonwealth status that created the conditions for government bloat.
Puerto Rico has a population (3.5 million) the size of Connecticut’s but a debt load ($72 billion) the size of New York’s. Over the last 15 years, public debt has risen from 60 to 100 percent of the island’s GDP. To make matters worse, it’s suffering from a middle-class outmigration crisis and its prospects for economic growth are dim.
The governor, Alejandro García Padilla, has declared that its debts are “not payable.” (Recall that Detroit, when it declared bankruptcy, was on the hook for “only” $18 billion). A default threatens the $4 trillion U.S. municipal bond market by creating higher borrowing costs for cities across the country.
A big slice of Puerto Rico’s debt problems stem from its state-owned enterprises. The electrical authority, known by its initials PREPA, has $9 billion in outstanding debt. These entities were created to help industrialize the island’s economy but have now mutated into monsters that threaten its fiscal future. In addition to the power company, the government owns the water and sewage authority and some 50 other corporations, including banks, cultural institutes, and a tourism company. The total debt of the government-owned corporations was $49 billion in 2012.
Why are these government organizations in such dire straits? Answer: the structure of Puerto Rican party politics, which turned them into tools of political favoritism.
Political parties in Puerto Rico are structured around the question of whether the island’s should become the 51st state, maintain its current status, or seek independence. There are two principal political parties: the Popular Democratic Party (PDP) and the New Progressive Party (NPP). In an unusual twist, it’s the leftist PDP that is more nationalistic and favors maintaining the island’s current status and possibly seeking greater legal autonomy from the U.S., than the centrist NPP, which favors statehood.
Then there is the tiny Puerto Rican Independence Party, which wants independence from the U.S. The pro-independence party is so small because many pro-independence voters regularly pull the lever for the PDP in order to prevent the NPP from coming to power.
Consequently, Puerto Rico’s parties are not clearly organized along liberal-conservative lines. One party does not favor limited government and social traditionalism, while the other favors big government and social liberalism. Both have mixed coalitions, which reduces ideological coherence, transparency, and accountability.
Nor do the parties line up neatly with Republicans and Democrats on the mainland. In general, the PDP is closer to the Democratic Party, while the NPP has both a Democratic and Republican line within it. (The last governor, Luis Fortuño, was from the Republican line, while the current Resident Commissioner, Pedro Pierluisi, is from the Democratic line).
In economic policy, both of the major parties have supported various experiments with government intervention. Over the years, they have used the government utilities and corporations as vehicles to subsidize other industries or make other sorts of income transfers. For instance, some hotel chains didn’t have to pay their electrical bills for years. The government itself hasn’t paid its electric bills—despite being the island’s largest consumer. Such practices are at the root of the dismal state of the public utilities’ finances.
In order to cover the cost of those subsidies the state-owned enterprises would have to either forgo new investments or charge its paying customers higher rates. Instead, they borrowed to make up the difference. Creditors were easy to find because Puerto Rico’s bonds are tax-exempt at all levels of government. This allowed whichever party was in power to pursue industrial policies that favored particular firms or industries without paying for them. It didn’t help that both parties used the public corporations for patronage appointments. Not surprisingly, many of them are highly inefficient.
Puerto Rico’s public corporations create other problems as well. As the source of much government employment—25 percent of the labor force works for the government—they are the base of the island’s labor movement. Organized labor is a formidable force in Puerto Rico and can be counted upon to oppose any effort to privatize the public corporations or to reform the labor market. Like the vicious cycles created by public-sector unions elsewhere, in Puerto Rico the unions lobby politicians, who assist the public corporations, whose workers then underwrite the unions.
Consequently, public corporations have been vehicles for political manipulation and financial shenanigans. In the coming years, privatizing many of these state-owned enterprises will be one of the biggest challenges confronting the island’s political leaders. In fact, it is such a political conundrum that some believe only an unelected financial control board could take such a controversial step.
In the meantime the bill has come due. The utilities have hiked prices, which creates yet another barrier to restoring economic growth. With utility costs 15 to 50 percent higher than a decade ago, individuals have fewer dollars to spend and businesses less revenue to expand their operations.
This is one of the many reasons that Puerto Rico has been in a recession for over a decade. The Puerto Rican labor force declined from 1 million workers in 2000 to 900,000 in 2015. Outmigration has cut the island’s population by 7 percent since 2004. Today there are more Puerto Ricans living on the mainland than on the island.
The underground economy is very large—30 percent of all economic activity by some estimates—and tax evasion rampant. With limited prospects for restoring growth—GDP is currently at the same level it was in 1994—default looks increasingly likely.
In the short term, there are two scenarios. One is for the U.S. Congress to amend the federal bankruptcy code to include Puerto Rico, or grant the island the legal authority to pass its own bankruptcy statue, so that it can proceed through an orderly process to secure debt relief. The other is for Puerto Rico to default without congressional action, which would lead to years of litigation to settle the territory’s debts with negative implications for the U.S. bond market. This would also threaten the financial stability of ordinary Puerto Ricans, who hold $20 billion of the island’s debt.
In the long term, settling the statehood question would go a long way toward making Puerto Rican government more accountable, transparent, and efficient. Whether the island becomes a state or an independent nation, the public sector will have to shrink. But as long as maintaining the commonwealth status remains an option, getting a clear picture of what the majority of Puerto Ricans want is impossible, and inflated public payrolls are likely to persist.
This piece originally appeared in The Daily Beast