Puerto Rico’s economy is extremely fragile and on the brink of depression now

Puerto Rico has not always been in an economic depression. According to the world data gathered by Angus Maddison (see https://www.rug.nl/ggdc/historicaldevelopment/maddison/original-maddison), from 1955 to 1980, the economy of Puerto Rico was among the top growing countries in the world. In particular, the Gross Domestic Product per capita in 1980 was 210 percent higher than in 1955. Such growth was double the world's rate (83 percent) during that period and ranked the island among the top-14 countries in the world in terms of income per capita growth. The economic model at the time was rather simple: attracting manufacturing corporations from abroad based on federal and local tax incentives. One of the major drawbacks of this model was its high fragility. That is, the economic model of industrializing by becoming a tax haven for U.S. corporations, without linking foreign investment to local sectors or growing domestic capabilities in other sectors, was becoming weak since at least the 1980s, and this problem was related to institutional limitations (Catala-Oliveras 2007; Quinones and Seda-Irizarry 2016). In 2005, a year before Puerto Rico's great depression (a long and deep downturn in the GNP) began, the Economic Commission for Latin America and the Caribbean (ECLAC) stated that one of the fundamental problems of Puerto Rico's economy was its low job creation (Martinez, Mattar and Rivera 2005). A year later, Puerto Rico entered a depression, the greatest in more than 100 years (Caraballo-Cueto and Lara 2018). That is, if one uses U.S. manufacturing as the reference or control group, it may be observed that trade liberalization affected manufacturing employment in both Puerto Rico and the United States, but Puerto Rico had a larger fall despite having much lower wages than the United States that reduced its exposure to foreign competition. What happened in 2006 to cause the economy to enter such a depression? In 2006, a federal tax incentive for U.S. manufacturing located on the island was removed, without a federal complement to the local industrial incentives program. This was the decision of the U.S. Congress and its president when they phased out Section 936 of the U.S. Tax Code over a ten-year period beginning in 1996. That effect, combined with trade liberalization, exacerbated the structural weaknesses of Puerto Rico's growth model, triggering the economic depression. Given that manufacturing employment had also declined in the United States and in many other high-income economies, how much of this decline in manufacturing can be related to the removal of Section 936? According to the data gathered by the Federal Reserve Bank of St. Louis, during the period 1990-2006, manufacturing employment in the United States declined by 20 percent, but in Puerto Rico it declined by 30.8 percent. For instance, in 1996, the average wage in multiple occupations in Puerto Rico was between 6 percent and 59 percent lower than the same occupations in the United States (Simpson 1998). These wage differentials did not disappear later: according to the Quarterly Census of Employment and Wages (QCEW), the annual average pay for manufacturing in Puerto Rico in 2001 was $25,319 compared to $42,969 in the United States. Non-academic reports have pointed out other factors that triggered the economic crisis in Puerto Rico. One of them was the Krueger Report (Krueger, Teja and Wolfe 2015), and another was the report by the New York Federal Reserve (2012), which related the crisis to the federal minimum wage, to welfare programs, and to fiscal mismanagement, among others. Even though those factors may have had some effect on the crisis, they are not free from controversies. For instance, the arguments that welfare programs were excessively generous was challenged by Cordero-Guzman (2016), who argues that it is not common that individuals participated in different welfare programs at the same time, and the statement that the federal minimum wage caused unemployment in Puerto Rico was challenged by Caraballo-Cueto (2016), who found that at least in 2007-2009 the minimum wage had virtually no employment effects in the aggregate. Many indicators show the deepness of the economic crisis. For instance, the Real Gross National Product (inflation-adjusted GNP) in fiscal year 2017 (July 1-June 30, 2016) was below the GNP of 1998, and public debt represented over 98 percent of the GNP. Public debt is defined as bonds and loans of the central government, government-owned corporations, and municipalities. If one includes debt in employees' retirement funds, the ratio rises to approximately 170 percent of the GNP. Even though average income in the United States in 2016 was 232 percent higher than in Puerto Rico, percapita public debt (excluding retirement funds) in Puerto Rico was $21,818 in 2016, while in the United States, it was $9,657. (1) Other macroeconomic proxies pointed in a similar direction. Real personal consumption in 2017 was close to the level of 2005, as shown in Figure 1. This is not surprising when one considers the number of jobs lost during this great depression. According to the data published by the Puerto Rico Planning Board, from 2006 to 2017, close to 274,000 jobs were lost and the real average wage remained static. In Figure 1, we can also observe that real personal consumption increased after Hurricane Maria during fiscal year 2018, but by a moderate 1.1 percent. This probably reflects the effect of post-Maria reconstruction, when at least $13.8 billion was disbursed by the federal government and insurance companies (Quiles 2019). Based on these reconstruction funds, the fiscal plan of April 2018 predicted that the 2019 GNP would grow 6.7 percent. At the time of the writing of this paper, the 2019 national accounts of Puerto Rico had not been published, but based on the economic activity index, which has a high correlation with the GNP, it would be difficult to assume that the economy grew by more than 2 percent during fiscal year 2019. What many economists and the fiscal control board (the Board) agree with is that this economic crisis in Puerto Rico is not cyclical, but structural, and that reconstruction will create ephemeral economic growth and, thus, structural policies are needed. The disagreements emerge in the recommendations. Some (e.g., Krueger et al. 2015) emphasize the role of supply-side reforms such as privatizations, austerity, and labor market reforms, but those were established over the last ten years with no observable positive impact on economic growth or on social equality. For instance, the labor market reform was approved in 2017, and the Secretary of the Labor Department admitted that it only created two hundred jobs (Cortes Chico 2018). Examples of privatization are Highway 22, whose toll rates increase every year, and the Luis Munoz Marin Airport, whose privatization hinders the development of Ceiba's airport, the largest and yet underutilized airport in Puerto Rico. In the case of austerity, the large reduction in government employees (shown in Figure 1 above) did not pull the economy out of its depression. Researchers from the International Monetary Fund (IMF) state that "Austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand--and thus worsen employment and unemployment" (Ostry, Loungani and Furceri 2016, 40). We argue for other sets of policies in section five below.