How independence could save Puerto Rico from financial ruin

For the island of Puerto Rico to secure its economic recovery, the US mainland must let go of the territory


Puerto Rico is up to its eyeballs in debt; so much so, in fact, that one commentator dubbed it “America’s little Greece”. Currently, the island owes more than $72bn to creditors. Combine this with the fact that debt-to-GDP ratio is more than 70 percent, and it is clear that the US territory is going to struggle to pay that off. In an attempt to try and make a dent in all this debt, Puerto Rico’s government sat down with its creditors, but negotiations broke down in October after the two sides were unable to reach a debt-restructuring deal.

The Puerto Rican government has implemented austerity measures and raised taxes in a desperate bid to shrink spiralling budget deficits, but so far these reforms have done little to reduce public debt in any meaningful way. The situation has become so bad that the Obama administration chose to enter the fray, looking for some way of helping its debt-laden territory out of the red and back into the black.

The proposed plan is ambitious to say the least. The White House wants to provide unparalleled bankruptcy rights to the territory and ramp up fiscal oversight of the island. It also plans to increase its federal Medicaid spending, as there are serious fears about local authorities’ ability to provide adequate services to its people. It is even looking to extend labour supply tax credits to the territory in order to offset the impact of
rising unemployment.

The comprehensive proposal has the ability to protect Puerto Rico from falling into the abyss, but for the plan to be implemented it must be approved by Congress, and fast. Administration officials in a joint statement stressed this point with the National Economic Council Director, Jeffrey Zients and the Health and Human Services Secretary, Sylvia Mathews Burwell.

“The Administration has been working with the Puerto Rico government to ensure that the Commonwealth is able to access all available, existing federal resources”, the statement said. “We have helped Puerto Rico attract job-creating investments, secure new funds to accelerate infrastructure projects, and lower energy costs on the island.

“These efforts are ongoing, but administrative actions cannot solve the crisis. Only Congress has the authority to provide Puerto Rico with the necessary tools to address its near-term challenges and promote long-term growth.

“Working together, Congress and the Administration can help Puerto Rico emerge from the current crisis. Without congressional action, Puerto Rico will face a long and difficult recovery that could have harmful consequences for the residents on the island and beyond.”

Getting any legislation through a Republican-majority Congress has been an uphill battle for the Obama administration, but the President will be hoping the GOP can leave its politics at the door and work with him to save the Puerto Rican economy.

The US mainland is pulling out all the stops in an effort to help the island navigate the tough economic time finds itself in. But despite the administration having the best intentions, there is a strong argument to make that Puerto Rico would be best off if it was left alone.

Welfare payments and Medicaid benefits can exceed the average worker’s salary
on the island

Go away US
Puerto Rico was colonised by Spanish expeditions in 1493 and remained under their control for more than 400 years. In the late 19th century, the American frontier was closed, ushering in a new era in US history – one in which expansion was necessary overseas because it was no longer possible at home. This desire to expand acted as a catalyst for the Spanish-American War, a conflict that would result in the handover of various territories from to the US, Puerto Rico among them.

After the US took control of the island, it introduced a government that was subject to federal law, but that was also granted certain rights that gave it autonomy over specific policies. This arrangement is still in place today, with Puerto Rico considered an unincorporated US territory. It is because of this unique arrangement that the island is unable to make the relevant structural reforms necessary to kick-start its economic recovery.

While it exercises some control over its economic fate, with the local government able to set its own tax policy, for example, the power exerted by the mainland dilutes the effectiveness of these local powers.

The Caribbean heavily relies on tourism to sustain itself, and while Puerto Rico may be home to just as many palm trees and sunny beaches as the Dominican Republic, it is struggling to keep pace with its rivals. Its inability to compete with its neighbours has a lot to do with its ties to the US mainland and the fact that the federal minimum wage of $7.25 applies in Puerto Rico, pushing the cost of labour up. What this means in real terms is that a member of staff working a 40-hour week at a hotel in San Juan will take home $290. Compare that with the $60 a week that a member of staff will take home working at a hotel in the Dominican Republic, and it becomes clear why Puerto Rico is struggling. Not only that, but with the US and Cuba in the process of rebuilding relations, it has yet another rival destination vying for American dollars.

Puerto Rico is also required to adhere to federal labour laws, which means employers must pay employees a mandatory bonus over the Christmas holidays, and are not allowed to ask staff to split shifts, pushing the cost of labour even higher. Not to mention the fact that welfare payments and Medicaid benefits can exceed the average worker’s salary on the island. In short, you have a relatively poor economy that, due to its status as a US territory, is forced to adhere to structural policies it simply can’t sustain.

Governor Alejandro Garcia Padilla has tried to bring down debt by imposing higher taxes, but all that has done is provide Puerto Ricans with an even bigger reason to leave the island for the mainland – a trend that is expected to grow as the economic crisis deepens.

Former IMF economists Jose Rajgenbaum, Jorge Guzmán and Claudio Loser, now working for Centennial Group, produced a report that outlined the steps Puerto Rico should take for economic recovery. Their advice: slash spending by as much as $2bn a year by 2020, and as much as $2.5bn by 2025. Naturally, the cuts will hit those at the bottom hardest, with the report recommending the island lay off teachers in order to “fit the size of the student population”, along with cutting excess Medicaid benefits.


Puerto Rico’s debt


Debt-to-GDP ratio


Recommended annual spending cuts by 2020


Recommended annual spending cuts by 2025

It should perhaps be unsurprising that a group of former IMF economists believe the best option for pulling an economy out of crisis is radical austerity, as it is what the IMF has been pushing on the other side of the Atlantic in Greece.

Keeping the island afloat
In many ways, Puerto Rico and Greece are facing very similar problems and both need similar solutions. Just like Greece, Puerto Rico has spent cheap money with complete disregard. They are both now unable to pay the price of all that reckless spending and have GDP-to-debt ratios that leave little to no hope of them ever being able to repay lenders. But, most problematically of all, they are controlled by a currency they are unable to devalue, making their exports unattractive.

The logical step for both countries is to bite the bullet and take control of their own destiny. Many would be understandably nervous to take such a big step, but the economic situation is only going to get worse if decisive action is not taken. As it stands, Puerto Rico’s level of debt, combined with its lack of autonomy and an inability to find the growth that is essential to paying off its debts, has left the island in limbo.

The plans for recovery put forward by the Obama administration will help the island stay afloat in the short-term, but it is essentially kicking the proverbial can down the road. As is the case in Greece, officials are too focused on the here and now, rather than looking at long-term solutions that will provide a way out of the crisis. It appears political leaders are unwilling to rip off the sticking plaster and address the issues at the heart of the economic crisis. If they do not act soon, an economic collapse may finally force their hand.