Puerto Rico's Debt Dilemma: America's Little Greece?

Puerto Rico distills 70 percent of the rum consumed in the United States. We might surmise that both borrowers and lenders were imbibing too much if they failed to foresee the island territory’s recent default. Puerto Rico has been in a recession for a decade with little sign of emergence. A chronic budget deficit, a bloated public sector, an economy in shambles and highly tax-advantaged bonds that encouraged investors to stay too long were all warning signs to observers.

The Puerto Rican labor force has declined 10 percent from its peak in 2000 (from over 1 million in 2000 to 900,000 as of June 2015). A quarter of all people employed on the island work for the government—either “state” or local. A declining labor force is symptomatic of a negative trend in the overall population for the island, with a more than a 7-percent decline since the 2004 peak. The GDP has followed population and the labor force lower, exacerbating the debt/GDP ratio in the process.

Some of these issues stem from “mainland” policies that, when combined with local economics, create disincentives. A prime example is the interaction between minimum wage and welfare benefits. According to Krueger, Teja and Wolfe, the combination of a high minimum wage and a swelled welfare benefit produces a significant discouragement to finding work. Further, 28 percent of hourly workers in Puerto Rico earn less than $8.50 (in the United States, it is about 2 percent) and would take home approximately $1,159 per month compared to a welfare benefit of over $1,700.

These dynamics have driven down the labor-force participation rate to around 40 percent. Combined with the population decline, it is exceedingly difficult to imagine how the Puerto Rican workforce will return to pre-recession levels.

Policies that make sense for the U.S. mainland economy should not automatically be imposed on Puerto Rico. Puerto Rico is a tropical island with no exploitable natural resources. While the United States has a low cost advantage in electricity pricing and low fixed costs of manufacturing, Puerto Rico relies on oil to generate its electricity, making it high cost and inefficient.

Until recently, territories received tax advantages for economic-development purposes. The idea was to “assist the US possessions in obtaining employment producing investments by US corporations.” Following 2005, IRS section 936 was no longer available to corporations, and the tax benefits to U.S. mainland firms—particularly pharmaceutical companies—evaporated. (There was a significant amount of skepticism as to whether 936 was useful in developing the economy of Puerto Rico, or simply a way to lower corporate tax bills. On the other hand, it may be coincidental, but the current recession began when the tax advantages ended.)

Puerto Rico's Debt Dilemma: America's Little Greece?