Puerto Rico’s Debt Crisis: Why There’s No Quick Fix

San-Juan

Facing $70 billion in debt and a 45% poverty rate, Puerto Rico’s leaders are expected to meet with creditors soon in an effort to negotiate a debt restructuring deal. But experts caution that there is no quick fix to getting the island Commonwealth back on solid footing and allowing it to emerge from the crisis on a more sustainable path.

The root of the island’s crisis, points out Jose Villamil economist at Estudios Tecnicos, a San Juan consultancy, is that both the population and the economy of Puerto Rico have become smaller, and are projected to continue to contract. The island’s population dropped from 3.8 million in 2000, to 3.64 million in 2012 to 3.548 million in 2014, Villamil says. “By 2030 the population is now estimated to be around 2.8 million, way below … the 2000 projection of close to 4.0 million by 2020.” He adds, “There is not a general awareness of what 10 years of economic contraction means” for the Commonwealth and its population.

More than 250,000 jobs have been lost since 2006; manufacturing employment has dropped to 74,000 from a peak of 165,000 in 1996; Investment in construction is down from a high of $6.6 billion in 2004 to $4.3 billion in 2015; home foreclosures reached a record high 4,000 in 2015. “What has happened in the economy over the past five decades is a collapse of the capacity to generate growth,” Villamil notes. “The recent experience beginning in 2006 is clearly not a recession, but rather the culmination of a long process of weak economic performance.”

According to Villamil, Puerto Rico’s economic malaise refers mostly to production, since consumption has held up fairly well over the years. There are several reasons for that: the federal transfer payments that make up more than 20% of the island’s personal income, government employment, though reduced recently, remains above 20% of total employment, and a very large informal economy that is estimated to be about 28% the size of the formal economy. “These three factors sustain consumption and isolate part of the population from economic volatility but, on the other hand, do little to stimulate investment and production since consumption is mostly imported,” Villamil says.

The economy is not expected to reach 2006 real GNP levels until the next decade if present trends continue. Assuming growth rates of 1.8% in real GNP beginning in fiscal 2015, Puerto Rico will reach the 2006 level in 2023. Forecasts are for at least three more years of zero growth or contraction, so 2023 is an extremely optimistic projection, Villamil adds. “What this tells us is that the economy will have lost close to 20 years of economic evolution.”

“The recent experience beginning in 2006 is clearly not a recession, but rather the culmination of a long process of weak economic performance.”–Jose Villamil

David Lewis, a former assistant secretary of state of Puerto Rico, says that “Puerto Rico’s problem is that the rest of the world has changed to what we call ‘open market competition’ in all industries and sectors, but Puerto Rico has not.” Open market competition makes economies more efficient, more productive and more competitive, Lewis adds. “We’ve seen [elsewhere] in the Caribbean and Latin America, [countries] whose economies are structurally closer to Puerto Rico, that the [processes of creating open market economies] take 10 to 15 years. And they are very difficult and contradictory processes. So there is no quick solution, and during that period there are a lot of winners and a lot of losers.”

Dealing with the Debt

Puerto Rico will be unable to muddle through without restructuring its debt, according to University of Pennsylvania law professor David Arthur Skeel. “The Commonwealth is probably going to have to restructure its debt, in addition to whatever else is done to help it out. Puerto Rico’s governor and congressional representative have been pushing for access to bankruptcy, at least for its municipalities, maybe for Puerto Rico itself.”

But Puerto Rico doesn’t have either option now because the island’s municipalities were excluded from Chapter 9, the municipal provisions of the bankruptcy laws, in 1984. “There has been discussion about some sort of federal funding — some kind of bailout,” Skeel adds. “There’s also been discussion about other legislative changes such as relaxing the minimum wage requirement, which many economists on both sides of the aisle think is too high for Puerto Rico.”
In Skeel’s view, “the most plausible — almost the only plausible — strategy starts with some kind of control board to oversee Puerto Rico’s finances, as was done with New York City back in the 1970s. It’s been done with Washington, D.C. and other cities since then. In addition, I think Congress needs to give Puerto Rico’s municipalities, at least — and probably Puerto Rico itself — access to bankruptcy.” Skeel notes that “if bankruptcy isn’t made available, it’s going to be a mess. It’s already turning into a mess now. Several bond funds have sued because of defaults, so there’s already litigation against Puerto Rico. There’s really no clear process for deciding who gets what if there’s no bankruptcy option.”

“Puerto Rico’s problem is that the rest of the world has changed to what we call ‘open market competition’ in all industries and sectors, but Puerto Rico has not.”–David Lewis

Lewis, now vice president of Manchester Trade, a Washington, D.C.-based consultancy, says the only solution that people seem to agree on is a piecemeal one. In such a scenario, the government may agree to do better on tax collections, or increase some taxes to raise more money or attempt to receive bankruptcy protection, as have American states under their Chapter 9 provisions. “Such a statute would enable Puerto Rico to set up a procedure for doing the payments.”
In terms of the restructuring, there are two main pieces, Skeel says. “First, there needs to be a control board and it needs to be set up by Congress but with significant Puerto Rico involvement. And second, I think there needs to be some bankruptcy or restructuring option. In my view, if you don’t have both of those pieces — if you try to do just one of those things — what you are doing, in essence, is building half of a bridge.” He adds that Puerto Rico has to conclude that whatever is put in place is a good idea, and has to agree to it as a political matter. “They don’t have to agree to it as a legal matter. Congress has a great deal of flexibility in what they can do unilaterally, but for it to work, Puerto Rico has to be convinced that it’s right.”

A major political challenge, according to Lewis, is that even under normal situations, “that’s an uphill battle in Congress, but when you’re doing it when you’ve got some water right at your nose, and there is urgency and there are so many vested interests, everyone with a vested interest is arguing pro or con. And in an election year, I do not see that there will be a consensus in Congress to grant Puerto Rico Chapter 9 as a way out of this.” It’s not a high enough priority, he notes, and there are too many contradictory positions within the Republican and the Democratic delegations in Congress. “And within the administration, [Treasury Secretary Jack] Lew is putting the whole onus on Congress. He’s saying that if Congress helps you out, well help you out the way we helped Detroit, but it’s not that simple” to get Congress to help out.

For its part, CNE, a San Juan-based think tank, argues in a recent report that “Puerto Rico’s most urgent need at this moment is a legal framework to restructure its debt in a fair and orderly manner under the supervision of a federal bankruptcy court. The next few days provide a small window of opportunity for a constructive resolution. It would be catastrophic for Congress not to take full advantage. Though we face a dire state of affairs, we believe we are also before the best opportunity San Juan and Washington have had in almost a century to craft a political and economic arrangement equal to that centenary challenge.”

According to CNE, success in that arena, however, will depend on three principles. First, the response from Washington must be comprehensive. Second, whatever concessions the federal government provides must require Puerto Rico to meet certain conditions. “Only through the use of external leverage will we be able to wrest the rudder of government from the skeletal hands of ideology and inertia,” CNE notes.

Finally, the CNE report says that Puerto Ricans must be the “principal architects” of the island’s long-term reconstruction. “No plan imposed from Washington will ever have the support needed to make it successful, much less enduring and legitimate. As important as the short-term measures are, it is this long-term growth plan that must ultimately take center stage.”

Skeel agrees with those who argue that resolving the debt issue is only one step in a longer-term strategic solution to the island’s current troubles. “Simply reconstructing Puerto Rico’s obligations and even getting the budget in order is not going to be enough if there is not a growth plan.” In that regard, he adds, “There are a couple of ideas that people seem to be gravitating towards. Some people have emphasized the cost of Puerto Rico losing the tax benefits that had brought manufacturers there until 2006. There is another strategy that suggests that Puerto Rico ought to cut costs so it can be more competitive. Another is that they ought to seek a waiver from the minimum wage law so they can allow lower wages.”

Would Repealing the Jones Act Help?

“If bankruptcy isnt made available, its going to be a mess. Its already turning into a mess now.”–David Arthur Skeel

In search of a quicker fix, some lawmakers from Puerto Rico have joined forces with their counterparts from Hawaii, Alaska and Guam to pressure the U.S. Congress for relief from the Jones Act, a maritime cabotage law passed in the 1920s. Designed to protect domestic shipping industry, the Jones Act states that only those ships made in the U.S. and flying the country’s flags can deliver goods between U.S. ports. That means that a cargo ship filled with goods from China can only make one stop in the U.S. at a time. It cannot stop in Hawaii to exchange goods before heading to Los Angeles. [Cabotage is defined as the transportation of goods or passengers between two places in the same country by a transport operator from another country.]

Critics say that the Jones Act punishes the people of Alaska, Puerto Rico, Guam and Hawaii with high costs of living. “All of our areas are specifically impacted by the Jones Act,” Hawaii state Sen. Sam Slom said at a conference last November. “It is now known that the Hawaiian cost of living, primarily because of our additional shipping cost and because of the Jones Act, is now 49% higher than the U.S. mainland. And this is becoming unbearable. It’s difficult for individuals. It’s difficult for families. It’s difficult for small businesses as well.”

But while Villamil thinks the law needs to be amended, he suggests that eliminating it wouldn’t make a difference in Puerto Rico’s economy. According to a 2013 study conducted by Villamil’s firm, “should international shippers enter [U.S.] domestic trade,” as a result of the repeal of the Jones Act, “they would be subject to federal regulations, which would erase much of the advantage in costs” that they currently enjoy. “Comparisons between Jones Act costs and international costs have overlooked this factor…. The four Jones Act carriers have invested in port infrastructure, which international lines do not. Replacement value of these investments has been estimated at $250 million.”

Overall, notes Villamil, “The Jones Act discussion is a good example of why decision-making based on intuition and ideological preferences could lead to wrong policies. Much of what is legislated unfortunately does not comply with the requirements of fact-based decision-making.” On the contrary, eliminating the Jones Act could lead to “greater uncertainty, the need for larger inventories, and higher terminal-to-terminal costs.”

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