World Development Vol. 31, No. 2, pp.

281301, 2003
2003 Elsevier Science Ltd. All rights reserved
Printed in Great Britain
0305-750X/03/$ - see front matter

www.elsevier.com/locate/worlddev

PII: S0305-750X(02)00193-6

Puerto Rico in the Post War: Liberalized Development

Banking and the Fall of the Fifth Tiger
JOSE A. PADIN *
Portland State University, Oregon, USA
Summary. This paper analyzes the long-term eects of a liberalized regime of development
banking on the growth and investment trajectory of a newly industrializing country using Puerto
Rico as a case study. The paper analyzes conicts between domestic business and the state over the
form of state involvement in development during the critical juncture of the 1940s; the leading role
of domestic business in the push to liberalize the developmental state project; and the eects this
liberalization had on development banking, and on Puerto Ricos long-term growth trajectory.
2003 Elsevier Science Ltd. All rights reserved.
Key words Puerto Rico, Latin America, newly industrializing countries, developmental states,
development nance, political economy

1. INTRODUCTION
Puerto Ricos development experience has
been a matter of controversy over the decades.
In the early postwar it was optimistically considered a model for the modernization of underdeveloped regions (Annals, 1953). With the
onset of protracted economic woes, starting
with the early 1970s, and arguably continuing
into the present, assessments of the islands
development experience became markedly critical and pessimistic. Some studies brought attention to the dominance of ideology over
substance in the workings of the governments
development program (Pantojas-Garc
a, 1990;
Santana Rabell, 1989), while others found indications that the Puerto Rican experiment was
thwarted by the larger forces of dependency
(Villamil, 1979) and imperialism (Dietz, 1979).
Although the Puerto Rican case received the
attention of development scholars some decades back, partly because it appeared to conrm all the promise of W. Arthur Lewis
inuential model of development with unlimited supplies of labor (Lewis, 1954, 1958), it is
rare to nd a reference to this case in the prodigious literature analyzing newly industrialized countries (NICs). A recent exception to
this neglect is Baumol and Wol (1996), who
highlight the impressive achievements of the
Puerto Rican economy in the last four decades.
One of Baumol and Wols most interesting
ndings is that Puerto Ricos unique political
281

ties to the United States had a negligible eect

on the islands postwar growth trajectory.
Having dispelled this notion, Baumol and
Wol ask rhetorically, should Puerto Rico then
not be considered the fth tiger of the postwar era? The answer, as I will argue, is that it
depends. Be that as it may, however, Puerto
Rico resurfaces as a case of legitimate interest
to comparative scholarship on the long-term
dynamics of development in NICs.
Puerto Ricos growth and productivity gures
over the course of 40 years are indeed tigerlike, as Baumol and Wol show. But, if we are
sensitive to qualitative shifts in the postwar
trajectory of the Puerto Rican economy, it
seems necessary to qualify this characterization.
Though Baumol and Wol emphasize four-decade averages, their own data show two very
distinct phases, a pre-1970 trajectory, and a
post-1970 trajectory. During 195070 Puerto
Ricos real per capita GDP growth averaged
5.84% per annum, but in 197090 it dropped
considerably, to 2.49%. Even this last gure
underestimates the degree to which the Puerto
Rican economy was faltering after 1970. Baumol and Wol nd that the combined eect of
Puerto Rico-US links on growth was negligible
during the golden agefrom 195070 Puerto

* The author wishes to acknowledge the valuable feedback of the anonymous reviewers Final revision accepted: 13 October 2002.

282

WORLD DEVELOPMENT

Rico was indeed pulling itself up by the bootstraps. For 197090, however, institutional
links to the United States had a positive and
very considerable eect on growth. In the absence of this US bailout eect, growth would
probably have been a whole percentage point
lower during the low-growth years of 197990.
With this in mind, Puerto Ricos proper place in
a typology of late developing regions seems to
be among former tigers, or stunted NICs. This
actually makes the case even more interesting
to comparative-historical scholars.
This paper analyzes the relationship between
the nature of a developmental state program
and the long-term fate of export-led late industrialization. When Puerto Ricos industrialization program was still in its infancy, Mason
(1958) observed that Puerto Ricos institutional
framework of development represented the
liberal end in a spectrum of state-market articulations. Nearly four decades later, we are in
a position to assess some of the long-term effects of a liberal development program. The
ndings should yield some valuable lessons of
pertinence to the critical reassessment of indiscriminate liberalization currently under way.
Puerto Ricos developmental state project
changed substantially over the course of the
1940s, a decade of intense conict between the
state and the local business class. The liberal
state-market articulation that Mason observed
in the 1950s was a result of this conict, and it
needs to be understood as the product of a
gradual accommodation between state planners
and the domestic business class. This accommodation was made necessary by stern business
opposition to an ambitious developmental state
project. Over the course of the 1940s state
planners were forced to reach a compromise
with the business opposition, and nally, to
abandon most of the key components of the
developmental state project. Of all the compromises made, to anticipate an important
nding of the analysis that follows, the most
fateful was probably the liberalization of the
framework for nancing development. The extensive pruning of the Government Development Bank in response to pressures from
domestic business left the state ill-prepared to
confront predictable problems at the end of the
easy stage of export-industrialization. This is
an important and neglected part of the story
behind fall of the fth tiger of the postwar
era.
The paper is organized as follows. First,
Puerto Ricos development trajectory needs to

be analyzed keeping in mind the role of states in

late development. Therefore, I begin with a
discussion of the relevant literature in development economics and developmental states.
Next, I oer a brief historical background to
Puerto Ricos early industrial transition. Finally, the core of the paper is devoted to an
analysis of the evolving state-business relationship that shaped the institutional feature
that proved to be a fundamental weakness of
Puerto Ricos development project over the
long run.
2. THE STATE IN THE PROCESS OF
ECONOMIC DEVELOPMENT
East Asian industrialization and the crisis of
Latin American development in the 1970s and
1980s initiated a productive debate about
prospects for economic development in poor
countries and the conditions under which this
might occur. The contrast in regional models
and performance oered a rich eld for empirical adjudication between competing theoretical claims. Careful studies of the unique role
of the state in East Asian development have
discredited facile and misguided portraits of
these states as paragons of free-market virtue. 1
Comparative evidence has borne out a longstanding proposition in heterodox development
economics: economic development is a discontinuous process, thus, initiating and sustaining
a successful take-o requires state interventions with the ability to coordinate a well-timed
sequence of changes in the orientation of
industrialization (Fei & Ranis, 1964; Gerschenkron, 1962; Nurske, 1958; RosensteinRodan, 1958). Sequencing successive phases
of import-substitution and export-orientation,
for example, depends on the leadership of an
actor with unusual foresight, a strategic commitment to the health of the national economy,
and a capacity to hold private industry to performance benchmarks. States in developing
regions potentially have the incentive, the legitimacy, and the organizational scale and
scope to lead the development process (Gerschenkron, 1962; Rueschemeyer & Evans, 1985),
although there is no guarantee they will display
the capacity and the interest (Evans, 1995;
Lewis, 1957), or even the necessary credibility
(Hu, Dewit, & Oughton, 2001).
A burgeoning comparative historical literature makes a strong case that East Asian development successes are in some important

PUERTO RICO IN THE POST WAR

measure explained by the particular role played

by developmental states (Amsden, 1989; Evans,
1987, 1995; Hart-Ladsberg, 1993; Johnson,
1982; Wade, 1990; Woo, 1991). Even skeptics
have conceded, albeit timidly, that the state
played an important role in the development
successes of East Asian miracles (cf. Dollar &
Sokolo, 1994; World Bank, 1993). Thus, we
nd a convergence between classic work in
development economics and the comparative
historical scholarship of East Asian NICs: a
view of development as a discontinuous process.
The economic development of national economies comes with no long-term guarantees;
phases are punctuated by uncertain junctures
where established formulas fail and the eld of
possibilities is again opened. Because of the
uncertainty, at these junctures market actors
will run for the exits rather than bear the costs
of a socially optimal transition. Sustaining socially optimal development requires foresight
and coordination, in short, something like a
virtuous developmental state. 2
A predictable discontinuity in the process of
economic development occurs some time after
take-o. It can be identied precisely in the
context of W. Arthur Lewis well-known model
of industrialization with unlimited supplies of
labor (a model particularly pertinent to the
present study). The predicament of poor regions is typically an abundance of poor people,
a dearth of capital, and a weak internal market.
W. Arthur Lewis modeled one way out of this
predicament: matching the boundless domestic
supply of cheap labor with foreign capital, and
exporting much of the output. (States with
larger internal markets have other well-known
alternatives, but they rely too exclusively on an
import-substitution strategy at their own peril.)
In the Lewis model, unemployed or underutilized labor in the traditional sector can be
transferred to infant industries without disrupting, and arguably improving agricultural
productivity, while industry benets from a
virtually unlimited supply of labor at very low,
xed, real wages (Lewis, 1954, 1958). The state
acts as facilitator in this take-o scenario: it
peddles the low-cost labor site; reduces information costs to foreign investors; shores up
business condence, and prepares the labor
force for industrial work.
States pursuing the Lewis strategy inevitably
reach a critical transition where the sustainability of a development momentum becomes
uncertain. This occurs when relative labor surpluses are exhausted (and they are always rel-

283

ative in a world where the solution of

information and incentive problems elsewhere
immediately open new labor surplus frontiers
for investors). Investors cannot be expected to
continue pouring in while their principal source
of advantage starts to disappear, and the
easy stage of export-industrialization with
foreign capital comes to an end. This is the
reason why an export-processing zone strategy
is so often viewed with skepticism by development scholars (Deere et al., 1990), and recent
evidence shows that the payos of export processing zones are real but quite limited (Mortimore, 2000; Buitelaar & Padilla P
erez, 2000).
At the end of the easy stage of export industrialization with capital imports a developing country faces the challenge of nding a new
formula to maintain the investment and growth
momentum. Foreign investors are market actors who react to changing market opportunities and will not solve this problem for the host
society. The burden of a solution falls back to
the host state, although it is another matter
whether it is up to the challenge, or even acknowledges the problem. In short, it is evident
that states that pursue a Lewis-type take-o
strategy need, simultaneously, to prepare for a
transition from an economy driven by low-cost
labor to an economy with higher order sources
of competitive advantage. This implies that
such states have to undergo a transformation in
the processfrom promotional states to what
we know as a developmental states. East Asian
tigers showed a unique ability to undergo
this transformation and to move beyond an
export processing zone stage.
Finance is a central problem tackled by developmental states. States seeking to initiate
and sustain a development take-o have to
address the problem of channeling economic
surpluses into new investment. Because the
horizons of developmental states and private
economic agents are dierent, and, because
poor regions tend to have underdeveloped nancial systems, a push for national development has typically required state intervention in
the process of nancing this development
(Cameron, 1967; Gerschenkron, 1962; Haggard
& Cheng, 1987; Stallings, 1990). States may
directly manage the ow of credit, regulate the
private banking sector, or do a combination of
both. The optimal type of state intervention
in structuring the nancial system will vary
from one stage of development to another;
tighter state control and bank domination
in early stages, nimbler systems later on

284

WORLD DEVELOPMENT

(Choe & Moosa, 1999). Systems with tight

bank and state control are not as good at crosssectional risk sharing, but are better at intertemporal risk sharing and making long-term
commitments (Allen & Gale, 1995). In spite of
the considerable allocation ineciencies that
can be created by state control of nance, even
in extreme cases these can be outweighed by
positive accumulation and investment gains, as
the case of India shows (Bell & Rousseau,
2001). Indeed, standard economic theory, Stiglitz (2000) forcefully argues, has placed undue
emphasis on cross-sectional eciencies and
neglects the positive externalities associated
with retaining investment tied to domestic activities (this has not always or everywhere been
the standard argument; cf. Chaudhry, 1993).
State control and direction of the nancial
system was central to the postwar growth of
Japan (Aoki & Hughes, 1994; Johnson, 1987;
Mabuchi, 1995), and critical to the development of South Korea and Taiwan beyond an
export processing stage (Chang, 1999; Cho,
1989; Woo, 1991). In contrast, evidence on
second-tier NICs seems to show that nancial
liberalization has made it dicult to mount a
transition from the easy stage of export-led
industrization (Aky
uz, 1998). Even in rst-tier
NICs, the relaxation of state controls through
hasty and indiscriminate liberalization has arguably had an adverse eect on development,
as Chang (1998) argues for South Korea.
It follows from the preceding discussion that
the trajectories of NICs will tend to diverge
after the critical juncture where eective labor
surpluses are exhausted: (a) some make the
transition to an upgrading NIC trajectory,
characterized by continued high growth and
employment; (b) others do not, and instead
follow a stunted NIC trajectory, characterized
by low growth and growing unemployment.
The ability of states to maintain the momentum
will depend critically on their capacity to harness the nancial system towards domestic development ends (this is one among other
factors, of course, including the ability to ensure that the accumulation thus promoted becomes internationally competitive).
Puerto Ricos transition in the early 1970s ts
the second prolea rapid late developer at an
early stage nonetheless detours into a slow
growth, stunted NIC, trajectory. Growth rates
dropped to less than half what they were between 195070 (even with the substantial
bailout eect on growth noted above), and
unemployment, after reaching a low of 10% in

1970, doubled and has stayed in the vicinity of

20% since. A reasonable hypothesis for the fate
of the Puerto Rican miracle follows from the
review of the comparative literature: Puerto
Ricos stunted NIC trajectory was caused
(among other factors) by the states inability to
set the groundwork for a transition from the
labor surplus stage. This paper analyzes structural limits on the apparatus of the promotional
state that thwarted its capacity to begin performing as a developmental state, specically in
the critical area of nancing development. 3
3. BACKGROUND: PUERTO RICOS
INDUSTRIAL TRANSFORMATION
The 1940s were a transitional decade in
Puerto Rico. A nationalist movement challenging US imperialism crested, then subsided,
its thrust stopped to a large extent by the repressive measures of the US colonial administration. A new political party emerged from
this context to capitalize on widespread popular discontent with US colonialism and US
corporations that seemed to dominate the
monocrop sugar economy. The Partido Popular
Democr

atico (PPD), founded in 1938, rose
quite unexpectedly and defeated established
political parties and coalitions in the 1940 legislative and municipal elections (at the time, the
governor was still a colonial appointee). With
the campaign slogan Pan, Tierra, Libertad
(Bread, Land, Liberty) the PPD popularized an
anti-imperialist platform that made a plea for
national sovereignty on economic and political
fronts, economic reconstruction, and re-distributive justice (Anderson, 1965).
Over the course of the 1940s the PPD established an electoral dominance that extended
for 28 years. By the mid-1940s, the party started to focus more tightly on electoral ends, and
bitter internal conict ared up between the top
leadership and a majority of party cadre over
commitment to the original anti-imperialist
platform. After months of deft maneuvering,
and successive party purges, the charismatic
leader Luis Mu~
noz Mar
n forced the party to
leave behind its anti-imperialist platform (Anderson, 1965).
Economic reconstruction and social justice
were also central to the original PPD platform.
Proposals on this front included land redistribution and breaking the overwhelming power
of landed interests tied to sugar; agricultural
restructuring to foster diversication and in-

PUERTO RICO IN THE POST WAR

ternal linkages; and, nally, a program of industrialization hinging on limited import-substitution, strategic but limited participation of
state enterprises in areas where private capital
proved too risk-averse, and promotion of a
domestic capitalist class. Public powers of the
state were prevailed upon to plan, direct, execute, and coordinate economic reconstruction.
Without question, in the early 1940s the PPD
was a party at the helm of a developmental
state project (Anderson, 1965, pp. 6872; Dietz,
1989; Moscoso, 1985; Perlo, 1950).
The PPDs developmental state project went
through two distinct phases: rst, a state
capitalist phase lasting from 194146; and
then, without making any major strategic
pronouncements, the PPD shifted to a liberal
development strategy some time between 1946
47. One by one, the state administered by the
PPD started to abandon most projects from
thestate capitalist phase: the limited program
of import substitution and state enterprises,
land reform, and state-directed agricultural
diversication eorts. As this occurred, the
foundations were laid for an industrializationby-invitation program modeled after the Lewis
take-o strategy (Dietz, 1989; Edel, 1962).
In light of the earlier theoretical discussion,
one can appreciate how, knowingly or not, this
transition could seal the long-term fate of
Puerto Rican postwar development. On the one
hand, the state embarked on the path outlined
by Lewis model of industrialization with unlimited labor surpluses; on the other, it did so in
a context where state instruments for economic
intervention were being radically scaled back.
Over the long run, did this impair the ability of
the Puerto Rican government to contend with
the predictable problems toward end of the
labor surplus stage?
There are two prevalent types of analysis of
the 194647 transition and of subsequent development, but neither is of much help in explaining the problems that eventually bogged
down the Puerto Rican economy. According to
one set of accounts, the course of development
during and after the critical transition of 1947
was determined almost exclusively by the rational choices of autonomous state managers
making pragmatic decisions under changing
economic constraints. This is the typical analysis oered by executives and former executives
of key development agencies (e.g., Moscoso,
1985; Pic

o, 1962). These argue, quite plausibly,
that a number of factors forced pragmatic state
managers to reconsider the feasibility of earlier

285

plans involving signicant state direction,

regulation, and participation. State nancial
resources were too meager to lead an industrialization drive with state enterprises; resources
to complete land reform were lacking; the state
lacked managerial resources to run its enterprises; the states dual interest in development
and legitimacy undermined its ability to run
state enterprises eectively, etc. Deliberately or
not, these analyses reduce all pragmatic constraints on state managers to a matter of resources, as if their choices did not have
distributive consequences, and ignoring the
extent to which they generated a considerable
domestic opposition, especially from the Puerto
Rican business class.
Alternative explanations are critical of this
pragmatic state manager account. According
to these, the direction of Puerto Ricos economic development in the 20th century was
always determined by overbearing external
forces. These external forces are variously
understood as US imperialism (Dietz, 1979),
a situation of dependency (Villamil, 1979),
transformations in the hierarchical international economic order (Pantojas-Garc
a, 1990),
or simply capitalism (Santana Rabell, 1989).
These external forces were the real constraints
operating on pragmatic state managers. The
various explanations stressing external determination have a richer conception of the possible constraints aecting Puerto Rican state
managers, but they are also myopic. Both accountsthose stressing the pragmatism of state
managers, and those that stress external determinationtend to ignore how the domestic
political economy shaped the course of Puerto
Ricos economic development.
Many studies that stress external determinants of Puerto Rican development have
largely focused on the crisis of the Puerto Rican
model in the 1970s. The 1940s, by omission, are
simply assumed to follow the pattern of external determination. An examination of those
studies that have analyzed the transitional
1940sDietz (1989), Santana Rabell (1989),
and Pantojas-Garc
a (1990)however, reveals
no concrete evidence to support the hypothesis
that overbearing external forcese.g., US imperialismwere the cause behind the liberal
turn of Puerto Rican state managers. Moreover, what we do know about the turn to liberal
industrialization in Puerto Rico does not lend
support to the external determination thesis.
US rms attracted to Puerto Rico in the 1950s
were relatively small, labor-intensive operations

286

WORLD DEVELOPMENT

in declining sectors with a grim future in the

United States (notably, shoe and textile manufacturers and subcontractors). These US capitalists did not have a political or economic
presence before 1947 that could explain the
PPDs decision to abandon its statist program.
In fact, Puerto Rico at the time was such a
dicult sale that it took three or four years of
hard and uncertain promotional work before
the Puerto Rican Economic Development
Company (FOMENTO) was able to attract
any signicant number of US companies. The
turn to private foreign private investment was
initially so uncertain that each new plant was
celebrated with the orchestrated fanfare of a
development agency fearful of losing public
support for its eorts (Ross, 1976, pp. 9597,
117122). Ironically, the most signicant intervention by the US government in domestic
economic aairs was on behalf of US unions
ghting so-called runaway shops, not US
capitalists (Galvin, 1979). Available evidence
simply does not reveal a collusion of US government and segments of US capital lurking
behind the PPDs turn away from a statist mode
of development. 4
US capital was poised for an unprecedented
overseas expansion on the wake of WWII, and
the US government was certainly at the helm of
eorts to build global framework for liberalized
trade and investment favoring US corporations
(McMichael, 1996). Had the question of Puerto
Rican development been put to Washington
policy makers in the form of a menu of choices,
it is likely they would have selected a liberal
investment regime over a program with considerable state intervention. But Puerto Rico
has seldom been a central policy concern in
Washington, and the responsibility for Puerto
Rican aairs has never been clear within the
federal structure (Lewis, 1963). It is also worth
keeping in mind that US imperialism was
quite exible and pragmatic in accommodating heterodox economic regimes during the
postwar eraeconomic nationalism in Latin
America and Asia, shades of social democracy
in Europe. There is no a priori reason to believe there was less elbow room for a creative
compromise with imperialism in a Caribbean
territory whose residents could expect some
leniency from their colonial patron, particularly
in the early 1940s, in the aftermath of a deep
crisis of legitimacy for the colonial administration.
When the United States was badly in need of
a local ally capable of rebuilding its legitimacy,

the PPD entered the historical stage, and it

made every eort to exploit this opportunity.
The PPD distanced itself from anti-US nationalists and socialists, and was always careful
to draw a distinction between the evils of
sugar imperialism and the essentially benign,
if neglectful, US government (Quintero Rivera,
1985). Even when it proposed national independence and unorthodox development strategies, the party assiduously cultivated the
support of the Roosevelt administration. All
things considered, it is fair to imagine the developmental state project of the PPD enjoyed
sucient autonomy from US imperial interests
during the 1940s. With this in mind, the analysis that follows turns attention to the role
played by the domestic business class in the
process of dismantling the PPDs developmental
state project, and more importantly, the longterm eects of this liberalization.
4. A TIGER OUT OF STEAM
(a) First approximation: economic causes
Nineteen seventy-four was the year when
a crisis in the vaunted Puerto Rican industrialization model became obvious, although
problems were evident earlier. After averaging
7.7% per annum real GDP growth rates over
the previous 15 years, there was no real GDP
growth that year. Over the decade that followed, annual growth averaged a paltry 1.9%
(Curet, 1986, pp. 49, 84, 91). The rst OPEC oil
shock and the economic downturn in the
United States (principal market for Puerto
Rican exports) had an undeniable impact, but
the economy never recuperated its previous
luster, which suggests that a more complicated
array of factors produced the crisis. Many
other countries entered a period of slow growth
at this juncture, and in this sense Puerto Rico
was certainly not unique (Maddison, 1991). But
Puerto Ricos trajectory did start at this juncture to diverge markedly from that of the four
Asian tigers, the most relevant comparators
in the context of the analysis at hand: in the
1960s Puerto Ricos growth rates were in the
ballpark with the four Asian NICs; starting
with the 1970s Puerto Rico was no longer in the
same category (see Table 1).
A great number of factors are surely involved
in the crisis of any development model, some
global and beyond the reach of any conguration of domestic actors, and some domestic. In

PUERTO RICO IN THE POST WAR

Table 1. Average annual growth rate, Puerto Rico and
East Asian countries
196070

Puerto Rico
Singapore
Hong Kong
Taiwan
South Korea

GNPpc

GDP

197082
GDP

5.9
5.5
8.7
6.3
6.4

7.2
8.8
10
9.2
8.6

1.9a
8.5
9.9
8.0
8.6

Source: World Bank, cited in Barrett and Chin (1987).

a
Puerto Rico gures are for 197584; calculated from
Curet (1986, pp. 49, 91).

spite of the adverse global economic climate of

the 1970s (which the other NICs weathered),
economists have identied endogenous factors
pointing to what seemed like an impending
crisis. Productivity (measured as output per
employed persons) started to decline in the
early 1970s, and this coincided with a marked
decline in gross domestic investment (a precondition of growth in some well-known
models) from 31.1% of GNP in 1970 to 13.9%
in 1984 (Curet, 1986, p. 50). Investment in plant
and equipment a key component of investment
for long-term growth, started a long and sharp
decline in 1970 (investment gross xed domestic investment from both private and public
sources, though overwhelmingly from private
external sources; it excludes public infrastructure spending) (Curet, pp. 57, 140141). This
decline in investment antedated the rst OPEC
shock and 197475 recession by a couple of
years, which indicates Puerto Ricos model was
experiencing internal problems before these
external economic shocks had their impact.
Sources of investment shifted markedly between 195070, and this had a bearing on the
investment slowdown. External sources of
savings increased their share from 54.9% to
97.9% (54.776.3% if only private sector savings are considered), with a concomitant decline in domestic sources (Curet, 1986, p. 138).
The growing importance of foreign capital is
not surprising, since the Puerto Rican development program actively focused its eorts on
promotion of foreign investment. Without a
doubt the economy beneted immensely from
infusions of foreign capital; among other
things, this allowed the economy to sustain a
chronic decit in its trade balance (Curet, 1986,
p. 78). Over the longer term, however, a lopsided dependence on foreign investment carried
its own risks. A signicant slackening in the

287

ow of external capital would have dire consequences, and it did.

A set pattern of easy access to US capital,
and chronically low rates of domestic savings,
probably made it dicult to imagine any degree
of domestic self-suciency in nancing growth
(if that were a desirable goal). Nonetheless, a
late 1960s study of growth and nance concluded, provided the political will, moderate
steps toward the reduction of extreme dependence on foreign investment were feasible
(Freyre, 1969). Twenty years later, an economic
report for the Puerto Rico Economic Development Administration still identied investment dependence as a critical problem. It
poignantly underscored a serious government
failure and contrasted the Puerto Rican case
with Asian NICs.
In 1965, [Puerto Ricos] gross domestic investment
was equal to 29% of gross domestic product. This level
of investment compared favorably with that in other
middle income developing economies [Singapore 22,
Hong Kong 36, Taiwan 23, South Korea 15]. Since
the level of domestic savings in Puerto Rico was only
8% of GDP, the remaining investment was being nanced by transfers and investments from outside
the island. [. . .] In 1965, domestic savings in the NICs
varied from a low of 8% in South Korea, the latest of
the NICs to begin rapid industrialization, to a high of
29% in Hong Kong. By 1983, the NICs had all
achieved investment rates of between 27% and 45%
and domestic savings rates had risen to levels varying
from 25% to 42%. Net resource inows had declined
proportionately. But in Puerto Rico the investment
rate had fallen to slightly over 8% of GDP, domestic
saving was still only 8% and the net resource balance
was down to 0.9% (Stuart, 1987, pp. 23).

The GNP/GDP ratio steadily declined from

the 1960s to the 1980s (Curet, 1986, pp. 191
192), dropping to 0.70 by 1990 (Junta de Planicaci

on, 1993, Table A-1), reecting a steady
denationalization of the economy. Moreover, while the role of foreign capital steadily
increased, so did the risk of depending on it. By
the 1980s, net factor payment outows exceeded net long-term capital inows by a ratio
of 2.651 (Stuart, 1987, Table 3). The gap has
been lled by a massive inow of US government transfers, but these go principally toward
individual and government consumption, not
productive investment, so the impact on growth
is limited.
In sum, the crisis of the Puerto Rican model
was caused by a conjunction of causes, but
the scissors eect created by (a) chronically
low domestic savings, and (b) long-term

288

WORLD DEVELOPMENT

dependence on foreign investment for domestic

capital formation was a key structural aw.
Chronic dissavings exacerbated a long-term
hyperdependence on foreign investment, and as
the easy labor-surplus stage came to an end,
rates of reinvestment became predictably adverse. Foreign investment can provide both the
spark and the fuel for an industrial take-o,
but it is uncertain over the long run. Over the
long run the solution lies in building alternative
sources of competitive advantage, and stabilizing the continuity of investment by cultivating a sturdy supplement of domestic investment
sources. It was at this juncture that East Asian
developmental states intervened, increased the
share of domestic investment sources and
domestic participation in exports, and successfully made a transition from the early export
processing zone strategy (Amsden, 1989; Grabowski, 1998; Woo, 1991). Those NICs continued on a high-growth path for another 20
years. The government of Puerto Rico, in
contrast, did not make any fundamental adjustment to its development strategyforeign
investment promotion on the basis of production cost advantagesand paid dearly in terms
of economic performance. Why did the Puerto
Rican government not make similar adjustments to deal with the erosion of its labor-cost
advantages? 5 An answer to this question requires an analysis of the political economy that
shaped the Puerto Rican program of economic
development.
(b) The domestic political economy
of stunted development
(i) The elusive class of Puerto Rican capitalists
The establishment of the pre-conditions of economic
growth is so handicapped by existing political interests
in some underdeveloped areas as to make it unlikely
that much can be accomplished without a forcible
overthrow of those interests. The revolutionary movement need not be communist . . .
(Mason, 1958).

The Puerto Rican capitalist class disappeared

from historical accounts and sociological
analysis after 1940 on the unwarranted assumption, it seems, that the power of this class
was inconsequential. 6 Weak domestic business classes ought to be taken more seriously,
even where they seem to be overshadowed by
foreign corporate interests. Weak domestic
capitalists have unique resources at their dis-

posal that give them a power far in excess of

their direct share of control over investment.
Their leverage comes from the important integrative role they play in the economy. Domestic
capitalists set the tone for the relationship between foreign investors and the state; they can
facilitate, or they can foul the relationship.
Their knowledge of the local economy, and
their business and government contacts, are
valuable to the state and foreign capitalists
alike. Their mediating role puts them in the
position to shape perceptions about the domestic business climate: their good word can
redeem the states credibility with foreign
business; their vote of condence in the
government is a proxy for investment risk. 7
Governments wishing to work with foreign investors unavoidably need to nurture a good
relationship with local capital; foreign investors
wishing to maximize information and minimize
risk may use domestic capitalists as feelers.
Thus, while weak domestic capitalist classes
lack the structural power that comes with
ability to threaten or execute the proverbial
investment strike, 8 they are in a good position
to precipitate such a strike. This is the structural
power of weak domestic capitalists. 9 Domestic
business classes have in addition another purely
political source of leverage: they enter the fray
of national politics and policy formation with
a certain amount of legitimacy that foreign
business lacks.
Strategists within the PPD correctly appreciated the early 1940s were a propitious juncture for economic reconstruction. The sugar
economy was in its nal throes on account of
adverse US quotas and declining prices, and
this oered an opportunity to lay the foundations for a new economy before a new imperialist combine could take form (Anderson,
1965; Dietz, 1989; Navas D

avila, 1978; Quintero Rivera, 1985). Conditions were also more
favorable for PPD reformers in the 1940s than
they had been earlier. In the 1930s, reformers
were in the political opposition, but with the
PPDs 1940 victory they entered government.
Finally, as US legitimacy reached its lowest
point, the President for the rst time appointed
a colonial governor who did not cater to the
interests of privileged classes. Rexford Tugwell,
a member of Roosevelts brain trust marginalized by the rightward turn in the New Deal,
was the last US-appointed governor. He saw
the appointment as an opportunity for economic experimentation that was no longer
possible in the United States, and became a

PUERTO RICO IN THE POST WAR

strong supporter of the PPDs statist development program.

In spite of the unique opportunities aorded
by the war years, the early PPD development
project threatened the interests of most sectors
of the domestic business class. First, the land
reform program sought to redistribute all
landholdings exceeding 500 acres. While party
rhetoric tended to equate landed power with
absentee sugar corporations, most corporate
farms above the limit were in fact domestically
owned. Four US corporations collectively
owned some 98,000 acres (Curtis, 1966, p. 10,
Table 2), but nearly as much land was owned
by the largest six Puerto Rican corporate
holdings. Over three-quarters of all holdings
above 1,000 acres, some 341,000 acres, were
the property of 152 Puerto Rican corporations
or owner-operators (Dietz, 1989, p. 125). Second, the PPDs developmental state project
sought to regulate the monopsonistic power of
sugar mills. While the American big four
owned 11 sugar mills in 1938, 31 belonged to
Puerto Ricans. Thirty-seven of these mills were
still in business in 1947; 27 were Puerto Ricanowned, and these produced more than 60% of
the islands sugar (Perlo, 1950, pp. 7677).
Third, the government established protsharing farms which competed directly with
private farms and mills, and which threatened
to raise the wage oor in rural labor markets.
Fourth, plans for agricultural diversication
and substitution of imports posed a direct
threat to oligopolistic food importers. Finally,
state and business agendas clashed over the
ideologically charged subject of state enterprises. Five state enterprises were established
by 1946, conceived principally as demonstration projects to crowd-in risk-averse domestic capitalists. In and of themselves, these
small enterprises were not real threat to the
private sector.
The governmental enterprises of the insular regime accounted for only 1.2% of total net incomeproving,
incidentally, that the characterization by its critics of
the Puerto Rican economy under the New Deal as
one of state socialism constituted an extravagant
example of poetic license (Lewis, 1963, p. 169).

Yet, as a piece of a broader program that had the

state meddling in areas of traditional business
prerogativeproperty ownership, management,
labor markets, and price determinationstate
enterprises could appear, or be made to appear,
particularly threatening.

289

Considering the impact of the PPD developmental state project on domestic capitalists,
it is intriguing that their inuence on the
pragmatism of state managers has not been
studied carefully. 10 Several studies have noted
that many of the 1940s economic reforms had
been attempted during the Great Depression,
and were at that time defeated by a recalcitrant
Puerto Rican elite (Mathews, 1960; Navas
D

avila, 1978, p. 66; Santana Rabell, 1989, pp.
5152; Tugwell, 1958, p. 79). It would be indeed
surprising if the elite that opposed economic
reconstruction in the 1930s had not resisted
similar eorts in the 1940s. This class in fact
became a considerable obstacle in the way of
the early 1940s developmental state project.
During the 1940s the Puerto Rican business
class led a broad oensive against the PPDs
developmental state project. This occurred on
several fronts simultaneously. A press campaign to discredit the developmental project
viciously attacked it with charges of state socialism, bureaucratic excess, and incompetence.
Conservative US Senators were invited to investigate charges of state socialism, while domestic business tried to cripple state enterprises
by refusing to purchase their product (ironically, these were in part established to meet the
needs of this class amidst wartime induced
shortage). Land reform was bogged down by
years of litigation and in the end abandoned
altogether. 11 Finally, the domestic business
opposition was able to redirect the orientation
and priorities of the developmental state project through direct participation in the administration of key agencies.
Their participation was more at the level of policymaking than political activism. Puerto Rican entrepreneurs from private banks and industries were
incorporated into the board of directors of Fomento
and of all of its subsidiaries. According to David F.
Ross, they provided a measure of conservatism and respectability to the states industrialization program.
Indeed, their participation ensured that the interests
of the local bourgeoisie were part of the development
program (Pantojas-Garc
a, 1990, pp. 5253).

Insofar as the state did not have the capacity

to replace the private sector with a state-managed economy (and it was not considering this
in any event), it had to rely on private investment. To sustain this private investment, the
state had to be mindful of the business climate, and this, in turn, meant coming to terms
with the structural power and interests of its
weak domestic business partner. Domestic

290

WORLD DEVELOPMENT

capitalists, for their part, were aware that the

sugar sector that had dominated the economy
for four decades faced a dead end. Consequently, they had an interest in securing a place
for themselves in the new economy the state
was trying to build. The disruptive campaign of
the Puerto Rican business class put the state in
a position where it needed to placate domestic
capital but not so obviously that it would
threaten its populist electoral credentials. 12
The Puerto Rican business class, for its part,
had every incentive to fend o the statist program of economic development and to push
economic liberalizationbut to do so under
the convenient cover of the PPDs populist
rhetoric, or else risk a popular backlash. In
short, domestic capital and the PPD administration faced strong incentives to nd some
form of mutual accommodation.
(ii) Development nanceA decisive
compromise
Finance is a central problem of economic
development. On the question of nance, as
with the multiple other areas where a state can
contribute to development, the success of state
eorts depends in part on the quality of its
agencies and personnel; but it also depends on
a tricky balance of power, and on the quality
of relations between the state and the dierent domestic sectors in control of key productive assetsbanks, industry, landed interests
(Evans, 1998). This section examines how the
domestic political economy, and specically,
the tensions and accommodation between the
government and private banks, shaped the
framework of development banking for Puerto
Ricos export-led development. The analysis
then turns to the long-term negative eects of
this government-bank compromise.
PPD reformers during the 1940s were clearly
mindful of the importance of nance, and one
of their rst state-building moves was to establish a government development bank to
support the governments development program. Law 252 of May 13, 1942, established the
Government Development Bank (GDB), an
institution charged with facilitating long-term
nancing for the projects of the Industrial Development Company, the Land Authority,
other government development eorts, and
with promoting domestic manufacturing generally. The law also entrusted the Bank with
scal agency functions, which authorized and
required it to manage Treasury deposits, and
the public debt of the state and public corpo-

rations (Dietz, 1989, p. 206; Maldonado, 1970,

p. 55; Perlo, 1950, p. 39). A development bank
was an indispensable tool to support public
investment projects, and to overcome the aversion of domestic business to investments outside areas where they traditionally enjoyed
protected rents and reduced riskimport luxuries, land-speculation, commercial expansion,
and hoarding (Perlo, 1950, p. 166). Development nance is a demanding task for any state,
in no small measure because it seeks to impose
some discipline on market actors that would
rather do without it. In the 1940s this put the
PPD on a collision course with commercial
banks, the most robust segment of the Puerto
Rican business class.
Commercial banks were the only signicant
nancial institutions in Puerto Rico on the eve
of industrialization (Maldonado, 1970, p. 46).
Puerto Rican banks were the strongest segment
of the domestic business classnone other
proved more resilient in the face foreign competition, or gained so much ground over the
rst four decades of the 20th century. When
Puerto Rico became a US possession in 1898,
commercial banks were feeble institutions with
a short history; at that time the three banks that
eventually survived through 1930 had total assets that did not reach $180,000 (Sanz, 1969,
pp. 58). By 1928, there were four US and
Canadian banks operating in Puerto Rico, and
the number of domestic banks had increased to
14. Puerto Rican banks accounted for approximately 40% of commercial bank capital on the
eve of the Depression, in spite of government
deposit polices that favored a US bank, the
American Colonial Bank (Sanz, 1969, pp. 89;
Clark, 1930, p. 376). Puerto Rican banks
prospered by working niches that US and
Canadian banks could not serve as well: they
nanced sugar and coee producers, and
extended personal loans secured against real
estate, while US and Canadian banks tended to
concentrate on nancing importexport activity. Puerto Rican banks were favored by family
and business networks that spread into numerous areas of economic activity, and by a
better understanding of the local clientele.
Their successful participation in New York
capital markets and adaptation to US regulatory agencies allowed them to survive foreign
competition (Cochran, 1959).
Although Puerto Rican banks more than
held their ground through 1940, the next two
decades were the start of their golden age.
During the 1940s banking assets increased at a

PUERTO RICO IN THE POST WAR

yearly rate of 11.5% (up from 6.6 for 190740),

and from 195067, the glory years of the Puerto
Rican industrialization, their annual rate of
growth was 12%. By 1967, eight domestically
chartered banks held 62.5% of all assets in the
private commercial banking sector (Maldonado, 1970, pp. 9192). Given the importance
of bank nance in the early stages of development, state planners could not avoid the task
of seeking a mode of cooperation with the
domestic banking sector.
The new era ushered by the Partido Populars
development project clearly proved to be a
boon for domestic banks, but this outcome was
not at all certain when the party rst took oce
in 1941. Economic development is in the interest of banks, insofar as it increases demand
for private nancial services. Nevertheless, state
eorts to direct the nancial system toward
development goals are a matter to concern
private nancial institutions. Theoretically there
are long-run gains that result from state stewardship, but long-term development dividends
are always uncertain. In the short term, state
eorts to regulate the use of savings and debt
compete with private banks for a xed pool of
domestic savings and external capital. In addition, when state bureaucracies become actively
involved in regulating a market there is the
proverbial slippery slope of bureaucratic overextension. It is not dicult to see why eorts to
establish a Development Bank in 1942 added
to the mounting tensions between the state
development program and the domestic business class.
A relationship developed between the government of Puerto Rico and private domestic
banks after 1940 that has not been examined to
date, but which in retrospect had a determinant
eect on the fate of the Puerto Rican industrialization program. Before 1940, government
deposits were held by US chartered banks, up
to 90% by the American Colonial Bank (Sanz,
1969, p. 9). After 1940, the year of the PPDs
rst electoral victory, the Treasury Department
initiated a new policy of favoring Puerto Rican
banks. Interestingly, although this policy seems
quite consistent with the early nationalist priorities of the Partido Popular, it was never an
explicit theme in the partys platform, nor has it
surfaced as a matter for examination in studies
of the period. This change in Treasury policy
was a boon for domestic banks. By the mid1940s Treasury deposits were already evenly
divided between Puerto Rican and US banks;
by 1950, two-thirds of these deposits were

291

placed with Puerto Rican banks. Treasury deposits were not that critical for US-chartered
banks because these had access to stateside
deposits. For domestic banks, however, the
change in Treasury policy was a blessing, raising deposits anywhere between 50100% in the
early part of the decade. Government deposits
meant a substantial increase in volume, but also
acted as a form of insurance at a time when
domestic banks were not insured. Domestic
banks were able to parlay these new advantages
into a decade of unprecedented growth in deposits, assets, and market share. Between 1942
53 total deposits quadrupled and capital assets
tripled (US banks, in contrast, increased deposits by only 35% in the same period) (Di
Venuti, 1955, pp. 4344, 46, Tables 1013).
The new Treasury policy was undoubtedly a
boost to Puerto Rican banks, but relations with
the government did not end there. Government
plans to establish a development bank were a
source of consternation among bank executives. In the course of an interview with a US
Senator investigating allegations of state socialism in Puerto Rico, a member of the Roig
banking family expressed fears about the plans
for a development bank, and in particular,
about the unfair extension of state prerogatives
which this entailed (Tugwell, 1947, pp. 529
530). There was a matter of unfair direct
competition for individual deposits, but more
importantly, with the founding of the development bank, private bankers also faced the
risk of losing part of their share of Treasury
deposits. These deposits oered state development planners a source of leverage, and they
could be made conditional on bank cooperation with development plans. Considering the
full ramications of the proposed development
bank, it is not dicult to appreciate why local
bankers were apprehensive.
The worst fears of domestic bankers, however, did not materialize. Rafael Buscaglia was
the rst Treasurer of the rst PPD administration, and on his watch, the depository policy
started to favor Puerto Rican banks. Buscaglia
had good relations with private sector bankers,
supported them, and was held in high esteem
among bank executives (Sanz, 1969, pp. 21, 15).
While Puerto Rican banks had reasons to be
concerned about the establishment of the
Government Development Bank, in Buscaglia
they had a trusted supporter; and Treasury
support in the battle over development banking was important because the Treasurer
was directly responsible for the Government

292

WORLD DEVELOPMENT

Development Bank. From the Treasury Department Buscaglia moved on to become the
rst President of the Government Development
Bank, a move that could only allay the concerns of private bankers. A member of the
Planning Board that later became president of
the Development Bank, commented on how, in
fact, at the beginning the Bank developed
slowly; it had to be brought along under the
discipline and heat of the Secretary of the
Treasury (Pic

o, 1962, p. 247) [my italics].
An accommodation between the Treasury and
the private banking sector was consistent with a
larger pattern of accommodation taking place
between the state and the private sector on many
fronts. It is against this backdrop that the
Treasurys slow and cautious stewardship over
the Development Bank should be understood.
On the agrarian front, the Land Authority
stopped pursuing land reform in 1944, and most
of the land acquired after that date either pertained to consent decrees signed by 1944, or was
simply purchased in the open market (Edel,
1962). In FOMENTO, the industrial development agency, Teodoro Moscoso was active behind the scenes, at least as early as 1945, laying
the groundwork for a shift from a statist to a
liberal industrialization program founded on
foreign investment promotion (Ross, 1976,
Chapter 5). FOMENTO managed ve state enterprises, and was so central to the state development program, that Moscosos eorts could
not have been a mystery to his colleagues in the
Development Bank and the Treasury. Finally,
Luis Mu~
noz Mar
n, the charismatic PPD leader
who led the charge against sugar imperialism,
distanced himself from programmatic commitments to state-led development and national
independencegingerly at rst, and in an open
and acrimonious public ght with other party
members in 1946 (Anderson, 1965). With each of
these shifts, the PPD drifted further from the
initial commitment to a developmental state
project. In this context, the Planning Board
found itself under attack by ocials formerly
committed to the state development program
(Descartes, 1946, pp. 1213), and its role in
economic planning was reduced to planning
for public infrastructure. By 1946, Governor
Tugwell was the only ranking member of the
administration still committed to strong state
stewardship in the development process, but
ended up resigning the post, fully aware of his
growing political isolation.
Ultimately it was the Government Development Bank that was starved of Treasury

Table 2. Development bank treasury deposits as a % of

total treasury deposits
1943
1944
1945
1946
1947
194953

0
2.9
9
6.7
13.2
2025%

Source: Calculated from Di Venuti (1955, p. 44, Table

14).

support during much of the 1940s, not private

banksin spite of bankers fears. Treasury
deposits with the Government Development
Bank were very limited for the greater part
of the decade, until about 1947. After that
year, the Treasury literally, and guratively,
started to deposit more trust in the Bank (see
Table 2). Treasury deposits with the Government Development Bank only reached a stable
plateau after 1949. The Development Bank
was virtually on a short leash until the original
development program that so upset the domestic business class had been eectively
dismantledland reform halted, state enterprises privatized, and the activities of the
Planning Board narrowed to infrastructure
development.
The Government Development Bank itself
went through some transformation before it
started to receive Treasury support. Two legislative acts, Law 272 of 1945, and Law 15 of
1948, reorganized the development bank and
narrowed its functions. The Bank ceased servicing private savings accounts (and hence
competing with private banks), and its work
was focused more narrowly on scal agency
functions that are by nature conservative. By
1948, articles dening the Banks charter made
no reference to development functions that had
been part of the Banks original charge
nancing industrialization, nurturing domestic
capital, etc. Only a vague rhetorical commitment to development remained in the 1948
charter:
To aid the Commonwealth Government in the performance of its scal duties and more eectively to carry
out its government responsibility to develop the economy of Puerto Rico, particularly with respect to its industrialization . . . (Act 17 of 1948, Section 1).

The obligations specically mentioned in the

revised charter were narrow, and symptomatic
of the broader liberalization of the develop-

PUERTO RICO IN THE POST WAR

293

ment program under way. The Bank was instructed to

Government Development Bank and liberalizing the framework of development banking.

invest its funds in direct obligations of the United

States or obligations guaranteed as to both principal
and interest by the United States. [. . .] or obligations
of Puerto Rico, or guaranteed as to both principal
and interest, by Puerto Rico [. . .] The Bank may also
invest its funds in bank acceptances or other obligations or certicates of deposit endorsed or issued, as
the case may be, by banks organized or authorized
to do business under the laws of the Commonwealth
of Puerto Rico, the United States, or any State of
the Union (Act 17, 1948, Charter, (E), as amended
by Act 3, 1957, Act 55, 1965, Act 1, 1986).

(iii) The long-term eects of the compromise on

development nance

By law, the only obligation of the re-restructured development bank was to maintain a
very conservative portfolio, and within that
conservative mandate, it was instructed to keep
a portfolio that stabilized the domestic banking
sector as a whole. The Bank was reorganized to
become a judicious scal agent for the state,
and an eective banking sector stabilizer, but in
the process it was stripped of all but rhetorical
commitments to development banking with a
long view.
Angel Sanz, president of the Banco Cr
edito y
Ahorro Ponce~
no in the 1940s, took some pride
in observing that an esteemed colleague, and
his successor, Esteban Bird, actively participated in drafting the charter and restructuring
the Government Development Bank (Sanz,
1969, pp. 8, 21). Bird later went on to become
president of the Government Development
Bank. Bird succinctly described the qualitative
transformation in the relations between the
Government Development Bank and private
bankers.
When the [development] program started in 1942
Esteban Bird was with a private bank, and like nearly
all the businessmen and bankers he knew, opposed the
program. Six years later he was working for it as a
high executive of the Governments Development
Bank. I interviewed him there. Today, he said,
these men [bankers] have become convinced of the
integrity of the administration and the soundness of
the Fomento idea. Ive been here two years now,
and no political pressure of any kind has ever been
put on this oce (Chase, 1951, p. 33).

The establishment of Government Development Bank was of clear concern to private

bankers; to placate banker opposition the state
changed its own priorities, and representatives
of the domestic banking sector participated
directly in the process of restructuring the

Having the Government Development Bank of Puerto

Rico set the terms of our developmentand it does
is analogous to having a goat look after your cabbage
patch. Government planner, 1990s.

As a scal agent, the Development Bank has

built a strong track record over the years. Except for a brief period in the mid-1970s, Puerto
Rican debt instruments that nanced public
infrastructure maintained high ratings through
the late 1970s (US Department of Commerce,
1979). Every signicant economic study since
1950 concurs, however: the Government Development Bank never became an eective
mechanism for industrial development (Comit
e
para el Estudio de las Finanzas, 1976, pp. 8283;
Consejo Asesor, 1989, pp. 7072; Di Venuti,
1955; Maldonado, 1970, p. 57; Perlo, 1950, p.
106; Puchi-Acu~
na, 1984). In the late 1940s
Perlo observed, in a seminal study of Puerto
Rican development,
[D]evelopment Bank . . . loans for industrial purposes
have been quite limited in scope and amount. During
the scal year 1947 direct industrial loans of 2,065,000
were made. As of June 30, 1948, total legislative appropriations for the bank amounted to $20,500,000.
The bank has the power to issue its own bonds, but
no bond issue has yet been oated (Perlo, 1950,
p. 107).

In the mid-1950s a study of the Puerto Rican

nancial sector again noted about the Bank:
structurally it still is not organized to carry on
an intensive lending operation of the kind essential to the promotion of economic development (Di Venuti, 1955, p. 88; see also Comit
e
para el Estudio de las Finanzas, 1976, p. 82). In
1962, a former executive of the Development
Bank lamented: We still need mechanisms and
sources for the creation of investment with a
long-time-view (Pic

o, 1962, p. 239, my translation). Decade after decade, studies have
pointed to the institutional deciency of the
Government Development Bank. We have seen
that faulty institutional design was only the
proximate cause of the Development Banks
poor performanceultimately this institutional
weakness was the result of a compromise between the government and private bankers.

294

WORLD DEVELOPMENT

Between 195067 the Government Development Bank played a key role in nancing public
infrastructure, but, notwithstanding its name
and rhetoric, its role as a development bank
was marginal at best. During these years, 75%
of all long-term investment in Puerto Rico went
into housing, with mortgage bankers the principal source of long-term investment (54%),
followed by the US government (17%), and the
Puerto Rican government (16%). Only 25% of
long-term nance went into areas other than
housing, including investment in productive
assets (Maldonado, 1970, p. 49). Here the
contribution made by the Development Bank
was negligible until the late 1960s; during the
crucial years of industrial take-o, the Bank
contribution to nancing nonhousing development (1951 0%) (see Table 3).
A cautious look at Table 3 might suggest that
the Development Bank simply took some time
to get on with the business of nancing longterm investment, but the Banks asset portfolio
in the late 1960s shows this continued to be a
very marginal part of its business. Over half of
the Banks assets were in low-risk government
securities, much of this contributing to capital
formation outside Puerto Rico (US securities
plus an undisclosed proportion of municipal
bonds that were not Puerto Rican government
issues). Even the modest loan activity, 33% of
its portfolio, shows no clear commitment to
industrializationa mere 16% of bank assets
were in the form of industrial development nance, the purported priority of the governments development program (see Table 4). 13
Almost as early as the industrializationby-invitation program got underway the Gov-

Table 3. Supply of long-term nance, excluding housing,

195167
Distribution % of
total
1951

1957

1967

Commonwealth Government
Government Development
Bank
Industrial Development Co.
Other

12.3
0

77.8
5.3

43.3
19.7

12.3
0

72.5
0

17.6
5.9

Commercial Banks

58.9

7.4

1.5

0
0
0

0
0
0

37.7
30.9
6.8

Private Nonbank
Insurance Companies
Other

Source: Maldonado (1970, p. 53, Table 4.3).

Table 4. Government development bank asset prole,

1967
Government Securities
US Government
Municipal Bonds (incl. Commonwealth Bonds)
Loans
Industrial
Commercial
Misc.

50.8
(32.4)
(18.4)
33
(16)
(10)
(5)

Source: Maldonado (1970, p. 57).

ernment Development Bank of Puerto Rico

had become something other than a development bank and this deciency continued into
the 1990s. Chronic domestic dissavings coupled
with a weakening foreign investment were earlier identied as underlying causes of the
slowdown in Puerto Ricos export-led industrialization. A state intent on sustaining a development momentum might use its nancial
levers to counteract the weak investment function underlying slowdown; the Government
Development Bank, however, instead added to
the problem. Figure 1 is a simplied chart of
nancial ows between government, the development bank, private banks, and the domestic
and external sectors. The magnitude of dierent
ows, by origin, and by destination, gives a
rough sense of the role and priorities of the
development bank through the early 1990s.
Flows originate in two types of nancial intermediariesthe development bank and private
commercial banks, and they reach several destinations: US government securities, Puerto
Rico government bonds, commercial banks,
consumer loans, real estate, industrial and
commercial enterprises. Total ows, broken
down by destination, are as follows (in billions
of dollars): US government securities, 3.8 billion; Puerto Rico government bonds, eight
billion; commercial banks, 3.6 billion; consumer loans, 3.5 billion; real estate, 3.8 billion;
and industrial and commercial loans, 5.387
billion, for a total of 28.47 billion. Of the credit
made available by all banking intermediaries,
about 18.92% reaches industrial and commercial enterprises. Whether this gure is high or
low by comparative standards is a matter I
leave aside here. Instead, what I wish to highlight is the meager contribution of the Development Bank. While 25.6% of outows from
commercial banks go to industry and commerce
(5.2/20.3), only a paltry 2.4% of Development
Bank outows reach commerce and industry

PUERTO RICO IN THE POST WAR

295

External Capital Markets

U.S. municipal
bond market
1.7

U.S. Govt
Securities

3.5
3.8

Revenue
Govt. of
Puerto
Rico
Bonds

3.4

Dev Bank

2.1

1.09
Commercial
Banks

6.3

1.5

3.5
3.8

5.2

consumer loans

real estate
industrial &
commercial
loans

0.187

Figure 1. Financial ows of the Puerto Rican banking system, 1992.

(the gure for industry alone, which is not

shown in Figure 1, is around 1%). The public
institution that purports to nance development, and, one expects, ought to place a good
portion of its bets on industry and commerce
(not to mention riskier industrial and commercial bets), turns out to be far more conservative than even private sector commercial
banks (all gures, Junta de Planicaci

on, 1993).
By the early 1990s, the share of Government
Development Bank assets in low-risk government securities and bank deposits reached
97.6%. Almost half of these assets were actually
invested outside Puerto Rico in the form of US
Government securities. Government Development Bank investments outside Puerto Rico
exceeded loans to industry and commerce by a
factor of 20 (and exceeded loans to manufacturing by a factor of 45). Domestically, Development Bank deposits with commercial banks
exceeded loans to industry and commerce by a
factor of 11, and loans to industry by a factor
of 25 (all gures are from Junta de Planicaci

on, 1993, Chapter 6). Meanwhile, Bank
policies bolstered prots in the commercial
banking sector, as it injected liquidity into the
nancial system (in the early 1990s it accounted
for 42% of all certicates of deposit in domestic
commercial banks), and considerably reduced
the cost of money to domestic banks (Junta,
1993, Chapter 6). Banking sector growth aver-

aged 15% per year from the early 1980s to the

early 1990s (Junta, 1993, Chapter 6); in contrast, real GDP scarcely averaged 2% growth
per annum, and the share of domestic rms in
overall prots dropped below 2% (Stuart,
1987).
5. DISCUSSION
An investment bottleneck, resulting from a
combination of weak internal savings and a
slowdown of external inows caused by the end
relative labor surpluses seems to underlie
Puerto Ricos transition from a stage of high
growth and declining unemployment to a stage
of low growth and high unemploymentfrom
miracle to debacle. The problem of chronic domestic dissavings was well known in the
late 1960s (Freyre, 1969), and the slowdown of
foreign investment with declining labor cost
competitiveness was predictable. In spite of
this, the government had no eective mechanism or plan to counteract this structural
weakness in the investment function. Given this
predicament, it is surprising that through the
early 1970s, and for an additional two decades,
the Government Development Bank contributed only marginally to long-term nancing of
industry. This was neither coincidental nor a
simple aw of vision or leadership.

296

WORLD DEVELOPMENT

The Government Development Bank functioned eciently within the parameters of its
charter. But that charter was gradually narrowed in the course of the 1940s in a way that
ruled out a leading role for the Bank in nancing any type of industrial transition. The
Banks contribution to the development process
was circumscribed in response to domestic
business opposition, and specically, the opposition of domestic bankers. During the
easy stage of export industrialization this
presented no problems; orderly government nances and infrastructure development were
enough to abet the growth momentum. But at
the end of the easy stage the government of
Puerto Rico found itself bereft of a mechanism
to counterbalance the chronic shortfall in investment and domestic savings that started
weighing the economy down; it lacked a
mechanism to lead the process of industrial
restructuring away from dependence on labor
cost advantages.
Bound as it was by a conservative charter to
stabilize domestic banking and government nances, the Government Development Bank in
some ways exacerbated the problem: its contribution to industrial and commercial capital
formation in the island was negligible and
much of the asset portfolio was outside the
economy. It should not come as a surprise if
private investors, foreign or domestic, decide
not to reinvest vigorously in an economythey
have unique priorities and a world of choices. It
is striking, however, to discover that, as this
occurred, there was no visible change in Development Bank policy to counteract these
trendsthe proportion of Bank assets placed
outside the Puerto Rican economy actually
continued to rise through the early 1990s.
State- and bank-dominated nancial systems
play a critical role in nancing early stages of
industrialization, but in Puerto Rico, we have
seen, the state gave up any means to redirect
some sizable pool of domestic and external
savings into accumulation. Over the long term,
the liberalization of development banking
turned out to be a serious institutional incapacity for a state committed to development.
Notwithstanding its name, the Government
Development Bank was clearly designed not to
become directly involved in nancing industrialization. Its principal role was of scal agent
and stabilizer for the domestic banking sector.
Both are critical functions, but in this instance
stabilizing private banking has come at a high
cost: an institutionalized long-term pattern of

bets against domestic capital formation.

Here the divergence between private and social
optimality has been indeed wide.
The precise nature of the causal argument
made in this paper should be clearly restated to
avoid confusion. Strictly speaking, was the
Development Bank one of the causes of crisis in
the Puerto Rican model? Strictly speaking, no,
but in fact yes. Development Bank practices
or portfolio management preferences were
not the immediate cause behind the weakening
in external capital inows and re-investment
ratesthis was the endogenous product of a
labor-surplus strategy whose time horizon is
inherently limited. Neither were Development
Bank practices the direct cause of other factors
associated with the crisis of the Puerto Rican
model, to wit: a negative marginal propensity
to save, one of the lowest ratios of productive
investment in the world (measured as a ratio
of investment in plant and equipment to housing investment), and an excess concentration of
external capital nancing short-term consumer
debt (Gutierrez, S

anchez, & Caldari, 1979). All
these problems point to deciencies in the nancial system as a whole. The Development
Banks was a sin of omission. When the private
nancial sector can or will not solve problems
of socially suboptimal nancing of development, the responsibility falls back on state entities representing the public trust in that
sphere. But the Government Development
simply continued the established pattern of
stabilizing domestic commercial banking as it
existedin fact, as we have seen, over time its
practices became even more conservative that
those of the private sector. There are never
guarantees that a state promoting development
will succeed when it tackles problems that stand
in its way; but when the problems are known,
and a response is not forthcoming, the state
shares in the responsibility for the outcomes.
The fact that some or even most of the problems were not created by the Development
Bank in the rst place makes little dierence.
Little credence would go to a top management
team in a corporation facing bankruptcy that
absolves itself by arguing we were not the
cause of bankruptcy, it was the changing environment in our industry. Some organizations
are charged with reaching goals within a
changing environment; states with strong rhetorical commitments to development are
among them. It is in this sense that the development banking practices of the Puerto Rican
government are implicated as a cause in the fall

PUERTO RICO IN THE POST WAR

of the fth tiger. The remote historical causes

of this complicity were the accommodation
between state and private sector on the eve of
the export industrialization program.
Development nance and the orientation of
the development bank have been the focus of
this paper, but it is important to bear in mind
that they were part of a broader development
strategy, and that strategy itself was awed.
None of the principal government agencies for
developmentIndustrial Development Corporation (FOMENTO), the Planning Board, or
the Bankmade a qualitative change in their
course to either anticipate the end of the labor
surplus stage or to counteract the investment
squeeze. Industrial development continues
to mean promotion, and planning pertains exclusively to infrastructure development.
Against reason, the entire Puerto Rican development modelshaped in the heat of battle
between business and state developmentalists
was premised on the eectiveness, in perpetuity,
of a hands-o promotion strategy. The Bank
is thus not single-handedly responsible for
the socially suboptimal transition of the early
1970s. Its deciency is related to a larger problem with the Puerto Rican developmental state
project. In the present, as in the 1940s, the
design of the development project has been
dened by the political economy.
6. CONCLUSIONS
Baumol and Wol have called attention to
Puerto Rico as possibly the fth tiger of the
postwar era. Over the entire period Puerto
Ricos development has been, by many measures, quite impressive. It is equally important
to note that Puerto Ricos tiger-like record
really comes to an end in the early 1970s. The
trajectory of any national economic development program is inuenced by a complex conguration of factors, some domestic, some
external. The analysis of what went wrong in
Puerto Rico has neglected the critical role of
development nance. The purpose of this paper
has been to ll that void. What went wrong,
Evans (1998) notes in a reassessment of the role
of the state in East Asian development, almost
certainly includes deterioration of the generative institutional context and diagnosing deterioration requires a clear understanding of the
original. In the Puerto Rican case, the original institutional framework for development
was set during the 1940s. This paper has shown

297

that its contours were decisively inuenced by

the domestic political economy, in particular,
by conicts between banks and the state over
the latters role in nancing development.
Wade (1990) has one of the last words in the
ongoing state intervention vs. market liberalization controversy when he notes that what
really matters are unique national state-market
articulations. Four decades ago, Mason (1958)
hinted at an interesting comparative question
regarding long-term development when he
identied Puerto Rico as a case on the liberal
end of state-market articulationsthe state
supplies public goods, but almost exclusively
on criteria agreeable to the private sector. With
the benet of historical hindsight, this paper
revisited Masons observation to identify some
of the long-term consequences of a liberal development formula. In the specic area of development nance, the evidence is troubling.
The key nding is that a compromise between domestic bankers and the state in the
1940s gave bankers a stabilizing mechanism
they soughtand such a stabilizer should be
thought of as a public goodbut stripped the
state of a capacity it needed but banks feared.
The state was unable in this compromise to
extract a development-minded quid pro quo,
and was left to hope that development banking
guided by private optimality would never much
diverge from social optimality. Although the
ndings of this paper do not warrant a blanket
indictment of liberalization, the analysis does
identify a long-term development problem that
grows out of insucient state capacity to either
discipline private nancial actors, or to take the
lead when social and private optima begin to
diverge. Over the long-term this episode of
liberalization was too indiscriminate, and this
must be considered a critical weakness of the
Puerto Rican model.
Financial liberalization can be a source of
signicant short-term economic instability, but
as the analysis presented shows, some problems
may show up only over the long term. This begs
the question, what political economy conguration will allow for a design of development
institutions that balance the present and the
future? An answer to this question is beyond
the scope of this paper. Preliminarily, the
analysis does suggest a need for a clear institutional division of labor, and a system of
checks and balances, between those public
agencies with a focus on fostering short-term
ecient functioning of markets and others with
a view on the long term. Blanket liberalization

298

WORLD DEVELOPMENT

sacrices the latter. But there is an additional

lesson. Key problems with the Puerto Rican
model have their roots in the political economy
that shaped state-building in the 1940s; it
would be naive to simply rethink or redesign
the institutional scaolding of the model without considering how the contemporary political
economy will impinge on this.
Finally, this case study has signicance beyond Puerto Rico. It adds to a growing literature that cautions against indiscriminate,
doctrinaire, and misguided prescriptions for
liberalization that threaten the stability and
growth of poor societies (Adelman, 2000;
Chang, 1998; Stiglitz, 2000; Stretton, 2000).
Puerto Ricos case stands as another cautionary
tale. In this particular case, the exhaustion of
the Puerto Rican tiger called forth a massive US
bailout package in the mid-1970s: a mix of
substantial and weakly targeted investment in-

centives for US corporations and massive support for needy persons. 14 This has de facto been
the Puerto Rican model since. It has not
worked, and, in any event, it is fair to assume
that institutions of global management and afuent states are neither prepared nor willing to
underwrite a bailout on this scale for the
developing world as a whole. All are well
advised to consider carefully the mounting evidence of long-term problems with indiscriminate liberalization prescriptions. Poor countries
urgently need development assistance on a
massive scale, but all of this would be selfdefeating if institutions overseeing the extension
of global economic governance put national
development institutions in a position where
they have to place bets against the future of
their own populations. On a smaller scale this is
part of the story behind Puerto Ricos crisis of
development.

NOTES
1. Whether, and to what extent, East Asian state-led
development is an asset or a liability is still a heated
debate, especially since the 1997 Asian crisis, and in the
midst of a nearly decade-long recession in Japan. One
thing is clear; nowhere in the mainstream business press
does one nd an inclination to present East Asian
countries, particularly Japan and Korea, as textbooks
cases of free market development.

1959; Gonzalez D
az, 1991; Steward, 1956). None has

examined the interests of this class, its internal organization, its relation to the state, or its inuence on
development policy.

2. Stiglitz (2000) reiterates the importance of this

distinction between social and private optimality.

8. This argument is an extension of Fred Blocks classic

and succinct analysis of the relation between the state
and capitalists (Block, 1977).

3. A structural incapacity of would explain why, by the

early 1970s, the developmental ideology of the promotional state appear shopworn and hollow. Cf. PantojasGarc
a (1990) for a critical analysis of this ideology.
4. Imperialism was an important rhetorical gure
wielded by all parties to the conict between the
nationalist and the Mu~
noz factions of the Partido
Popular in the 1940s. An analysis of the rhetorical uses
of the terms imperialism is, however, outside the scope
of this article.
5. We have been doing the same thing for thirty
years was the typical comment of a career staer of the
industrial promotions oce with FOMENTO interviewed by the author.
6. Only three studies in the last 40 years have examined
any aspect of the Puerto Rican business class (Cochran,

7. Stephens and Stephens (1986) analysis of the rst

Manley period in Jamaica shows how even the weakest
local capitalist class can act as an eective spoiler.

9. This power is clearly a variable; it is more or less

considerable depending on the absence or existence of
more formal institutional arrangements for regulating
and assessing the risk of a foreign investment site. In the
1940s, prior to the formation of a global nancial
infrastructure for risk assessment and underwriting the
mediating role and the structural power of Puerto Rican
capitalists was probably more considerable than it is
today.
10. There are only isolated references to business
opposition buried in a few of the studies of the era but
no careful study of the phenomenon. Part of the reason
for this is myopia, I suspect, has been the immense
cultural inuence of the Partido Populars populist
rhetoric. Quintero Rivera (1985) and Gonzalez D
az
(1980) discuss how that rhetoric eectively dissolved
classes into an amorphous national community.

PUERTO RICO IN THE POST WAR

11. It has already been noted that the campaigns of
Puerto Rican capitalists and their eects have not been
studied carefully. A number of known studies are
nonetheless peppered with references to this business
opposition. References to business campaigns against
the government can be found in Tugwell (1947), Edel
(1962), Lewis (1963), Pic

o (1962), Ross (1976, Chapter
4), Navas D

avila (1978), Palau de L

opez (1985), Dietz
(1989) and Pantojas-Garc
a (1990).
12. This image of a state that compromises the
substance of its developmental state project without
abandoning the rhetoric is consistent with the analysis
of Pantojas-Garc
a (1990).
13. Table 4 shows that the Industrial Development
Corporation (a subsidiary of FOMENTO) was making a
signicant contribution to long-term nonhousing investment. This went to land and manufacturing shells

299

facilitated on demand to rms promoted by FOMENTO. It did not directly nance industrial undertakings.
14. Weissko (1985) aptly refers to the new model a
regime of factories and food stamps. Pantojas-Garc
a
(1990) oers a useful discussion the post-1976 incentives
scheme. After 1976, new US tax exemptions to US
corporations in Puerto Rico became the crucial promotion enticement. This was not a substantial change in
development strategy: the Puerto Rican government
simply used these tax breaks to compensate foreign rms
for the deterioration of labor cost advantages. US
intervention in this case arguably allowed successive
administrators in Puerto Rico to avoid responsibility for
the consequences of development failures; it is also
symptomatic of the absolute loss of economic sovereignty suered by the Puerto Rican government as a
result of the collapse of its economic program.

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