PUERTO RICO: CONTINUING SOCIO-ECONOMIC DETERIORATION AND THE NEED FOR CHANGE J. Tomas Hexner President of Hex, Inc. Founder and director, Science Initiative Group at the Institute for Advanced Study at Princeton, New Jersey Arthur MacEwan Professor Emeritus of Economics at the University of Massachusetts Boston Development Discussion Paper: 2017-12 ABSTRACT The long-run decline of the Puerto Rican economy, predating the recession of the last decade, is evident in the relative stagnation that emerged from 1980 onward. The roots of both the relative stagnation and the long recession lie in the political status of the island. The option of statehood, however, can be the foundation for a new era of economic expansion. The long-lasting economic problems of Puerto Rico are evidenced by several measures: the low rate of economic growth, the high unemployment rate and the low labor force participation rate, the falling investment rate, the high poverty level, the extreme degree of economic inequality, and the massive exodus to the states. And, of course, there is the very high—crisis level— amount of public debt. In addition and of central importance, the poor treatment of Puerto Rico relative to the states by the U.S. government has contributed to the economic situation on the island and demonstrates the role of status in bringing about economic weakness and decline. The popular belief that Puerto Rico receives ―generous‖ treatment from Washington is belied by the data. Moreover, while many observers viewed Puerto Rico as an economic success story during the late 1900s, this view erred in measuring success by the growth of GDP instead of GNP, the former including the profits of firms based off the island (mainly in the U.S.) and not providing a measure of economic conditions of Puerto Rican people of firms. The detrimental impact of Puerto Rico‘s political status as a U.S. territory—or, if one prefers, a U.S colony—shows up clearly in the unequal treatment of Puerto Rico relative to the states in certain important federal programs. For example, Puerto Ricans have not been eligible for the federal Earned Income Tax Credit (EITC) and only partially eligible for the Child Tax Credit (CTC). A Puerto Rican family with two parents and two children and with earnings of $25,000 would have had a net income in 2011 of $23,587 after all federal taxes. It would not receive the EITC and CTC. An identical family in the states with earnings of $25,000, after all federal taxes and the EITC and CTC would have a net income of $30,013—$6,426 more than the Puerto Rican family. Beyond these vary tangible negative impacts of the current status, and more fundamental, is the broad economic dependency of Puerto Rico. This dependency has led to an underdevelopment of Puerto Rican based economic activity and to government policies that have always looked outward for special favors from Washington and investment from abroad. The results show up in an excessive reliance on manufacturing and a failure to develop economic activity in areas where Puerto Rico has clear advantages—e.g., tourism and specialized business services linking the states to Latin America. The results of dependency also have included a weak and distorted financial sector and a failure to invest sufficiently in infrastructure, education, and science. Keywords: Puerto Rico status, U.S. territory, EITC, CTC, level playing field JEL classification: O1, O2, Z32 I. INTRODUCTION In the summer of 2012, the sad story of economic life in Puerto Rico continues. The severe recession of recent years, with its high unemployment rate and sharply declining rate of investment, is only the beginning of this story. Economic growth has been weak for decades, and a staggering poverty rate and extreme income inequality have characterized life on the island. In Washington, however, the Puerto Rican situation is ignored. In San Juan, during the early months of 2012, an election year, the Puerto Rican government focused on a slight improvement in its index of economic indicators and attempted to portray the economy as on the road to recovery and growth. A report from Wells Fargo Securities, however, stated: ―…the Fortuño administration or administration officials have tried to override the truth by talking about how the economy is better today [May 2012] than several years ago. However, the best they can claim is that the economy seems to not be falling off a cliff any more…‖1 The island‘s continuing economic difficulties are reflected in financial markets. In March 2012, Breckinridge Capital Advisors issued a White Paper on the Puerto Rican situation, stating: ―…the Commonwealth today is flirting with insolvency, and the risk is growing that someday, Commonwealth investors may not be repaid in full. Puerto Rico‘s financial condition is far worse than any U.S. state‘s, and default—though unlikely in the immediate future—is a possibility over the next few years… Breckinridge has long avoided obligations of Puerto Rico, but we believe all municipal bond investors should now be cognizant of its problems.‖2 1 Eugenio J. Alemán, Puerto Rico: Failure of the State, Wells Fargo Securities, Economics Groups, Special Commentary, May 24, 2012, p. 10. Available at http://mediaserver.fxstreet.com/Reports/f94cca42-c3fa- 47e4-88dd-b4c17a0cdced/d8b5822a-a0a2-4400-88cc-dbc573a21a9e.pdf. 2 Breckinridge Capital Advisors, Puerto Rico’s Challenge, Special Commentary, March 2012. Available at http://www.breckinridge.com/pdf/whitepapers/March_2012_Puerto_Ricos_Challenge.pdf 1 A May 29, 2012, Reuter‘s report noted that: ―…some professionals, including specialists in riskier, high-yield municipals, won't go near Puerto Rico debt. Some seem to be betting against the island, judging by trading in Puerto Rico municipal credit- default swap contracts.‖ ―Since early January, the cost for one-year CDS on 10-year Puerto Rico debt has shot up to 482 basis points from 391, according to data-services group Markit. That adds $91,000 to fees now close to half a million dollars to secure shelter against a possible default on $10 million of Puerto Rico debt.‖3 And on June 11, 2012, Bloomberg News told its readers that in the previous week, ―Standard & Poor‘s said it may cut the island‘s general-obligation rating, now two steps above junk.‖4 But it is not only the financial markets that have lost confidence in Puerto Rico. According to the U.S Census, between 2000 and 2010 the population of the island declined by more than 2%. Only one state experienced a population decline in this period—Michigan, with a decline of 0.6%. Taking full advantage of their U.S. citizenship, it appears that many Puerto Ricans are voting with their feet, seeking improved economic conditions by moving to the mainland.5 Why is the Puerto Rican economy in such miserable shape—not just in 2012 and in the immediately preceding years, but as will be pointed out shortly, over the past several decades? There is, after all, wide agreement on many good policies that would improve the island‘s economy: improvement of the schools and support for ―high tech‖ 3 Michael Connor, ―Puerto Rico bets on American tourists to repay debt,‖ Reuters, May 29, 2012. Available at http://uk.reuters.com/article/2012/05/29/uk-puertorico-debt-idUKLNE84S00T20120529. 4 Michelle Kaske, ―Puerto Rico Borrowing Costs Rise on Rating Concerns: Muni Credit,‖ Bloomberg News, June 11, 2012. Available at www.businessweek.com/news/2012-06-11/puerto-rico-borrowing-costs- rise-on-rating-concern-muni-credit. 5 Official Puerto Rican data do not report a decline, but instead show an increase in the 2000 to 2010 period of 4.3%, from 3.814 million to 3.979 million. These data are reported in the Statistical Abstract of the United States 2011, Table 1313. The 2000 U.S. Census reports a basically similar figure, 3.809 million, for 2000, http://www2.census.gov/geo/maps/special/profile2k/PR_2K_Profile_eng.pdf. However, based on the American Community Survey for Puerto Rico, the U.S. Census reports a 2010 figure of 3.722 million, http://factfinder2.census.gov/faces/tableservices/jsf/ages/productview.xhtml?pid= ACS_10_ 1YR_DP02PR&prodType=table. 2 investments; improvement of the physical infrastructure; a better and more effective tax system; inclusion of the island in federal programs designed to reduce poverty (most especially the Earned Income Tax Credit); better support for the tourist industry; and the list goes on. Yet, rhetoric aside, policies of change are not thoroughly implemented. Why? A. Economic Malaise and the Need for Statehood The explanation for Puerto Rico’s economic malaise presented here is that the island’s economic condition is intimately connected to its political status as a “territory” of the United States. Territorial status creates uncertainty, a short-run approach to economic policy, a practice and ideology of reliance on special treatment by the U.S., and continual failure to build up bases for economic development within the island’s own society. Under these circumstances good policies, while recognized and advocated in many quarters, waste away in government reports and statements of good intentions. Continuation of territorial status will mean continuation of economic stagnation and instability. Statehood for Puerto Rico could be the foundation for economic progress, the route for the Puerto Rican people to enjoy a better quality of life in the 21st century. While there is no likelihood that statehood will be established in the near future, interim steps are both possible and desirable. Short of statehood, Puerto Rico must be put on a level playing field with the states, treated the same as the states, insofar as possible, in all federal legislation, executive orders, and programs.