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Executive Summary
Despite being an island paradise, Puerto Rico is far from an economic one.
ing a need for substantial policy shifts at the local level, as well as consideration
Few are aware, however, of the decisions that have led to Puerto Ricos
recently distressed state, nor the policies that developmental economists would rec-
how Puerto Rico developed from an agrarian-dominated society in the early 20th
granted sovereignty in some areas, while also limiting policymakers tools in oth-
ers. Economic parallels to other countries who share Puerto Ricos Latin American
roots offer some insights into Puerto Ricos economy today, nonetheless, Americas
Puerto Ricos economy remains closely tied to that of the U.S., yet it is more
expansions. Specific incentives and federal tax policies have been enacted in an at-
tempt to counter the effect, however, some policies have led to deeper dependence
and little growth, and in some cases, countercyclical fiscal and monetary policies
When compared to the rest of the U.S., Puerto Ricos current economy is
relatively tenuous. Total outstanding public debt has grown substantially, doubling
in the 1980s, and again in the 1990s, while tripling since 2000. Despite numerous
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new reforms and policy shifts, as well as a recovering American economy, Puerto
Rico still has a number of economic impediments to overcome, including, but not
limited to: borrowing costs that outpace current or projected growth, high unem-
of Americans have some exposure to Puerto Ricos bonds, whose fluctuations could
and Puerto Ricos current status have implications for the rest of the U.S. Last,
since Puerto Ricans are American citizens, federal policymakers have an obligation
Although there are many specific recommendations that can, and should,
be implemented, the report discusses several broad changes that must be made,
including:
Shift long-term and current taxes and other incentives to focus on investment
Ensure that policies emphasize growth in labor intensive versus capital inten-
sive industries;
opment;
grams;
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Adjust public assistance programs to ensure that reservation wages do not de-
Make a quick and permanent status decision (i.e. whether to remain a territory,
become a state, or gain independence) that will again give confidence to future
framework within which policymakers across the country can work to ensure that
Puerto Rico does not continue to rely upon policies that have little positive impact
Introduction
Puerto Ricos economic and social history began very similarly to that of
many other countries traditionally considered Latin American. Yet, despite being
among the first discoveries of Spanish explorers, Puerto Ricos economic similari-
ties diverged when it became a colony of the United States, instigating an argument
trajectory has been largely impacted by external policies enacted by U.S. legisla-
tors, ensuring that its economy has closer ties to the U.S. economic system than
others in the Western Hemisphere. Nonetheless, this paper will analyze Puerto
America, as well as its relatively more recent one to the U.S. - by first providing the
historical basis for its current economy, then discussing the reforms that have been
implemented in recent decades, while considering the impacts that reform policies
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have had on economic growth, poverty, and income inequality. Finally, it will pro-
vide an analysis of recent and current policies and their effectiveness in promoting
economic development.
Brief History
Puerto Rico was founded by Spanish expeditions in 1493, subsequently be-
coming a colony of the Spanish crown for more than 400 years. When the United
tories, including Puerto Rico. The U.S. introduced a government that was subject
to federal law, but given a range of latitude and autonomy in setting local policies.
After a series of Supreme Court cases, known as the Insular Cases, Puerto Rico
was officially deemed an unincorporated territory that would not be subject to the
rights (Gerow, 2014). Puerto Ricans were granted U.S. citizenship in 1917 and
Economy
Although offered some autonomy, Puerto Rico has never had full authority
over its own economy and government. The Jones Act of 1917 granted Puerto
Rico authority over its own local tax policy, yet, in 1920 the Merchant Marine Act
ensured that ships had to first go through U.S. ports before heading to Puerto Rico,
inflating the costs of goods brought to the island. Puerto Rico is also required to
maintain the federal minimum wage, and has to apply the same labor and envi-
ronmental standards as the rest of the U.S., while not being allowed to negotiate
bilateral trade agreements and having to adhere to fiscal policy directed by the U.S.
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U.S. enacted a series of polices that allowed Puerto Rico to use its tax autonomy to
its own advantage. Section 931 of the Revenue Act of 1921 (originally section 262)
sought to boost economic growth by providing corporate tax exemptions for all
U.S. corporations with income derived in Puerto Rico, while Puerto Rico doubled
down with its own local income and other tax incentives. As a result, combined
with a less expensive labor force and the advantages of being a U.S. territory, labor
intensive manufacturing grew dramatically in Puerto Rico. Between 1950 and the
mid-1970s, output per employee grew by nearly 5 percent per year, a rate compa-
rable to the well-known, dramatic growth of East Asia (Collins, et al., 2006). In
1950, GDP per worker was about 30 percent of the U.S. average, while in 1980 it
peaked at todays level of approximately 74 percent, making Puerto Rico one of the
worlds most developed Latin societies (Griffin, et al., 2011). Despite macroeco-
nomic growth, labor force participation has remained below 50 percent since 1960,
while the U.S. rate has climbed to above 60 percent. Gross National Income (GNI)
has also declined as a fraction of Gross Domestic Product (GDP) during this time
period, meaning that more foreign entities and individuals were transferring their
the U.S. Congress, in 1976, to replace the tax exemption policy in favor of one
that allowed domestic tax credits for foreign taxes paid. The new Section 936 still
allowed for favorable tax treatment and, in fact, contributed to the vast growth of
wholly-owned subsidiaries in Puerto Rico, but instead shifted the incentive from la-
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over the next two decades regarding the continued benefit of Section 936 to Puerto
economy is still directly tied to that of the U.S. and is more greatly impacted by
contractionary periods in the American business cycle than the mainland itself.
During the U.S. recessions in the 1970s and 1980s, Puerto Rico suffered from eco-
nomic contractions that were longer than in the rest of the country, which were
sometimes exacerbated by policy changes related to its tax incentives. While mak-
ing some economic gains during the U.S. boom of the 1990s, since the start of
the new millennium Puerto Rico again suffered through nearly a decade-long con-
traction, while becoming heavily dependent on transfer payments and other public
assistance from the U.S. Federal Government. Federal transfer payments equaled
27 percent of GDP in 2010, while more than half receive some type of government
Todays economy has been widely criticized as being on the brink of eco-
nomic collapse (El Nuevo Da, 2015; Caribbean Business, 2015; Vlez-Hagan,
2013; Greece, 2013; Green, 2013). Puerto Rico has had a budget deficit for more
than a decade, which has contributed to a growing public debt which, in total, has
surpassed more than 100 percent of GNP (total economic output by Puerto Rican
citizens within its borders), while some estimate it to be much higher (Government
Development Bank, 2015; El Nuevo Da, 2015; Colegio CPA, 2014). Unemploy-
ment is also rampant, stagnating at around 14 percent (not including the large in-
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while labor force participation remains low at nearly 40 percent (U.S. Department
of Labor, 2015). Puerto Ricos economy has been contracting for nearly a decade,
while analysts see little opportunity for growth, which has resulted in credit down-
grades from all of the major rating agencies leaving few opportunities for addi-
reforms that have been enacted between the late 1970s and today, and will continue
with a short description of the reforms that the government has considered recently
that other Latin American countries were required to undertake (per IMF and World
Bank lending requirements) following their economic crises (Franko, 2007), it has
implemented a number of structural reforms, many at the direction of the U.S. Fed-
eral Government, that have had varying repercussions. It should also be noted that,
unlike in independent countries, Puerto Rico is limited to reforming only its local
fiscal policy, leaving monetary and major fiscal policy to the discretion of the U.S.
Federal Government.
the new Section 936 tax credit law in 1976 and American corporations began
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new incentives Puerto Rico enacted its own Industrial Incentive Act of 1978,
which lowered the effective tax rate on corporations even further. However, after
labor intensive manufacturing to the island, the new law incentivized corporations
to shift intangible property to Puerto Rico, leaving large investments in R&D be-
hind to take advantage of lucrative tax credits on the mainland (Weisskoff, 1985).
Instead, products would only be finished in Puerto Rico to apply tax breaks that
among the most adept at implementing these tax policies, as more than 80 percent
of the most prescribed drugs in the U.S. were manufactured in Puerto Rico by 1990
(GAO, 1992).
The Federal Government also greatly improved the amount and efficiency of
transfer payments and other public assistance to Puerto Rico during the late 1970s
and 1980s. For the first time, Puerto Ricans became eligible for the Food Stamp
program in the 1970s, while other public assistance doubled during the 1980s as
cially created, while it also began investing in programs to facilitate regional exports
ing increased considerably during the 1980s, doubling outstanding public debt from
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During the 1990s, economic growth both in the mainland U.S. and in Puerto
Rico was positive, however, Puerto Ricos economy was met with another series of
reforms that had lasting economic impacts. After extensive welfare reforms were
passed in the U.S. in 1996, Puerto Rico too incurred reductions in the transfer pay-
ments that supported nearly one-third of the economy. In the same year, Congress
also decided to abolish Section 936, which Puerto Ricos manufacturing and phar-
maceutical industries relied upon, citing a lack of meaningful employment gains for
Puerto Rico as well as revenue concerns at the U.S. Treasury (Gerow, 2014).
Although Congress allowed for a ten year phase-out of Section 936, manu-
facturing immediately declined; less than one-third of those previously taking ad-
vantage of the law accounted for total manufacturing employment. To counter the
effects, Puerto Rico attempted to shift the economy to greater emphasize tourism
and the service sector, yet 40 percent of GNP remained dependent upon the manu-
during this period as well. Administrators funded public works projects that cre-
ated an urban train system, a new super-aqueduct water system, the Coliseum of
Puerto Rico, and a new convention center (Ayala & Bernabe, 2007).
the 1990s. As government agencies and public corporations were consolidated and
As a result of the public spending initiatives, total public debt again doubled
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between 1990 and 2000, from nearly $12 billion to $24 billion (Government Devel-
the decade of the 2000s has been especially harmful to the economy of Puerto Rico.
Due to these periods of contraction, the government of Puerto Rico took especially
Public investment again led to major deficits and growing long-term debt.
and created other new programs to reduce poverty and government dependence, all
of which helped to increase public employment by nearly 12 percent in just the first
and fiscal stability, Puerto Rico simultaneously lobbied the Federal Government to
ending in 2006, Puerto Rico has ensured that some tax deferral policies still remain
(Gerow, 2014). However, the shifting tax code continued to lead to greater con-
solidation within the manufacturing industry and a shift to more capital intensive
benefits from certain trade agreements, as well as its relationship with other coun-
tries in the Hemisphere. Puerto Rico again sought to reestablish and build new
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agreements with both CEPAL and CARICOM, among others, hoping to boost trade
and export opportunities for its local businesses (Ayala & Bernabe, 2007).
combined with the U.S. Banking Crisis and a large and growing deficit and public
debt, the economy was pushed into one of the worst recessions on record, prompt-
ing even more drastic measures to be enacted. Public employees salaries were
major utility subsidies were eliminated, taxes were increased on the banking sector,
and an island-wide sales and use tax was created (Harvard Law Review, 2015).
it would counter the ever-increasing $3.3 billion deficit, which equaled nearly one-
third of the islands total annual revenues (Government Development Bank, 2015).
The governments liquidity problems required that the Governor had to immedi-
ately take out a loan to cover the first public payroll under his new administration
(Casey, 2012). The following several years heralded a drastic structural adjustment
period. More than 20,000 public employees were laid off, government spending
was reduced by 10 percent, taxes were raised in some sectors and on high-end real
estate and earners, contract negotiations and pay raises were frozen, corporate tax
rates were flattened and reduced, toll roads and the islands biggest international
airport were privatized, and more than $4 billion was borrowed to cover govern-
ment liquidity needs (Vlez, 2011). The government also enacted two major laws
intended to boost foreign investment by reducing, almost to zero, income taxes on
returns in real estate and passive income (Government Development Bank, 2015).
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At the same time, government transfer payments were again increased sub-
sequent to the passage of the Affordable Care Act, which also allowed for increased
Reforms Today
economic policy. Deficits and employment remain major issues, while a mass ex-
odus of professionals to the mainland U.S. continues to reduce the number of con-
population decreased by 4.7 percent from 2010 to 2014) (Abel & Dietz, 2014). In
order to counter the deficit, major tax provisions from the previous administration
come, domestic earners, while funding for schools and other social investments
have been reduced, public employee salaries were again frozen, public employ-
were enacted on some of the more inefficient utilities, and even more incentives are
Knowing that the current levels of debt will continue to inhibit Puerto Ricos
ability to return to economic growth, the current administration has attempted to re-
structure some of its existing liabilities. Courts, both in Puerto Rico and in the U.S.
yet, Puerto Rico has also begun to lobby Congress to allow the territory to restruc-
ture its debts under Chapter 9 of the Bankruptcy Code, an option currently unavail-
able to the islands government. In order to find alternative means for increasing
revenues to cover debt service as well as continuing government operations, the
island has recently passed a tax on crude oil, while now debating a value-added tax
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considering overturning an IRS tax law that allows foreign corporations to deduct
corporate taxes that it pays to Puerto Ricos government, which Puerto Rico has
recently used to help boost corporate tax revenues without decreasing the incentive
Much like in other parts of Latin America, reforms in Puerto Rico have had
substantial, if not always immediately evident, effects on the economy, which will
During the late 1970s, annual GDP growth improved significantly, reaching
a peak of 5.4 percent in 1979, while unemployment fell from a high of 20 percent
growth continued through the end of the 1980s, while public debt also increased
dramatically (Vlez, 2011). The boom in manufacturing from Section 936 is often
While nearly two-thirds of all households were under the official poverty
line in 1969, poverty declined in both the 1970s and 1980s, most significantly re-
duced among the most impoverished (Sotomayor, 1996). After the Food Stamp
program and other major increases in transfer payments were extended to Puer-
to Rico, income among the poor increased dramatically in the 1970s and public
assistance income doubled in the 1980s (Table 1, Appendix). Rising wages and
household incomes increased income inequality over these two decades, however
transfer payments negated this effect, leading to reduced inequality and a lower
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1990s
The increasing importance of the Internet in commerce, along with new free
trade agreements in the 1990s, led to greater globalization and competitiveness for
Puerto Ricos manufacturing and export sectors; its competitive advantage was fur-
ther reduced after the repeal of Section 936 tax incentives. Yet, substantial growth
still continued throughout all of the 1990s, with GDP growth averaging above 3
more than 16 percent unemployment, by the end of the decade Puerto Ricos unem-
tance benefits occurred in the 1990s as they began to comprise a lower percentage
of total income (Segarra, 2006). Tables 2 and 3 reveal how a simultaneous increase
2000s
Some economists have come to call the 2000s Puerto Ricos lost decade.
Growth since 2000 has been effectively zero, while contracting during the Great
Recession through today. The recession of 2001 exacerbated the flight of manufac-
turers that resulted from the repeal of Section 936 in 1996, leading to a subsequent
Development Bank, 2015), losses that continue through today. After reaching new
after the recessions, reaching as high as 16.9 percent in 2010 and remains near
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14 percent today (U.S. Department of Labor, 2015), while combined with a large
that the repeal of Section 936 decreased GDP growth by as much as 5 percent after
the recession of 2001, continuing through today (GAO, 2006), although many point
to multiple other factors that have attributed to the depressing the economy.
During the last decade, the Gini coefficient officially declined from .56 to
.53, despite the impact of two recessions that had an even greater negative impact
on Puerto Ricos economy than that of the rest of the U.S. (Census, 2010). Some
have suggested that this can be attributed to the emigration of professional and
high income earners that have disproportionately left Puerto Rico since the mid-
2000s (Abel & Dietz, 2014), while others point to accounting and inflation adjust-
ment considerations in both the Gini Index and official poverty statistics (Guerrero,
2004).
Given the number of varying reforms with even more disparate impacts
that Puerto Rico has implemented over the last several decades, there are numerous
analytical opinions and suggestions for future economic growth that can be drawn
upon.
of the manufacturing sector in Puerto Rico, federal tax policy should not be relied
upon as a major driver for long-term economic growth. Numerous analyses and
studies have shown that federal tax policies that were created with the intention
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of boosting employment in Puerto Rico have fallen far short of their goal (Gerow,
2014), by instead bringing capital intensive industries to Puerto Rico which have
little impact on job creation. By adding its own incentives, Puerto Rico is helping
Instead, Congress, and the Puerto Rican government, should invoke policies which
environment, is also adding to the lack of development on the island. Recent ini-
tically, which has reduced the incentive for native Puerto Ricans to develop busi-
nesses and has perpetuated the exodus of Puerto Rican entrepreneurs and business
Industry Diversification
cial crises throughout Latin America. Due to both U.S. Federal Government and lo-
cal tax incentives, Puerto Rico became dependent on the manufacturing sector, which
has become highly concentrated over the years. Puerto Rico should invest in the
growth of sectors that traditionally have higher rates of employment and can employ
the existing workforce, including and especially the service sector. Analysts consid-
opportunity for growth, job creation, and long-term positive economic development.
Recent incentives have been enacted with some success, however, they are again cre-
ating an opportunity for low levels of diversification and shallow employment returns
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Human capital has been shrinking in Puerto Rico as its population ages and
the number of people migrating to mainland has increased. Failure to invest in the
retention and development of human capital can lead to and continue to exacerbate
existing high levels of poverty, unemployment, illiteracy, and other social ills.
Compared to the rest of Latin America, Puerto Rico has historically made
al., 2011). However, recent initiatives may counter this comparative advantage as
spending cuts have been pushed throughout Puerto Ricos education system from
Puerto Rico should act to ensure that investments in education are not re-
duced and should combine them with skill-training programs to make more skilled
Puerto Rico. Although Puerto Rico has had some success in the field of engineer-
ing, there are numerous opportunities for improvement. A recent shift in emphasis
towards targeted hiring credits should be reconsidered, both because specific hiring
credits have been found to have little effect (Neumark, 2013) and because sectoral
job training programs have been substantially more successful throughout the U.S.
Poverty and inequality have been reduced due to the increase in transfer
payments and public assistance programs from both the U.S. Federal Government
as well as Puerto Rico, as can be demonstrated in the Tables of the Appendix. How-
ever, the rapid expansion of government transfers in 1970s and early 1980s had a
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simultaneous effect of reducing work effort. Puerto Ricans essentially have devel-
oped a reservation wage that has depressed job creation, which compares what
could be earned on the mainland or through public assistance and places a floor
upon market wages (Collins, et al., 2006). For this reason, Puerto Ricos labor par-
ticipation rate has fallen from nearly 50 percent before the 2000s to a current low
and poverty, the programs should be redesigned to make them more conducive to
employment gains.
Deregulation
Like many other Latin American countries, Puerto Rico has had a long his-
tory of high barriers to business creation. Both the previous governor and the cur-
rent one have cited the problems associated with a complex bureaucracy and its
impact on business development and competition, while economists have cited the
et al., 2006). High energy and transportation costs add to these compliance costs,
making it oftentimes more costly to do business than in other parts of the U.S.,
while excessive labor laws have also made for an inefficient labor market.
Fiscal Policy
Due to Puerto Ricos lack of control over monetary policy, some suggest
that it has excessively used its fiscal authority to attempt to stimulate its economy.
Puerto Rico has borrowed against future revenues for decades, despite the islands
balanced budget requirement, which is having a crowding out effect on private ac-
tivity through the increased cost of productive resources. Furthermore, its relative-
ly high rate of debt and unfunded pensions have substantially increased the risk of
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a fiscal crisis similar to the debt crisis in Latin America during the 1980s, in which
total debt owed to foreigners outweighed its ability to earn income, resulting in an
economys debt exceeds its current and projected growth rate, it becomes impos-
sible for an economy to fully recover (Blanchard & Weil, 2001). Few economists
will concede the possibility of Puerto Ricos growth rate reaching or exceeding ex-
isting interest rates that lenders are willing to offer Puerto Rico, given its currently
Status
One of the key debates surrounding Puerto Ricos economy is the impact
that a change in its status will have. While Puerto Rico is currently considered an
autonomous territory of the U.S., three groups of advocates surround this issue:
those who wish to maintain the status quo, those vying for the creation of an in-
dependent country, and those who believe that Puerto Rico should become the 51st
state of the United States. As most recent debates revolve around the possibility of
statehood, this paper will continue with a brief discussion on its economic implica-
tions.
There are numerous arguments, both for and against, Puerto Rico statehood.
Economic arguments for statehood have suggested that, where capital intensive
industry development has failed, a Puerto Rican state would have a similar fate
to that of Hawaii. When Hawaii first became a state, it reaped rapid rewards by
quickly developing a substantial service sector due to its new connection to the U.S.
and free marketing received from the statehood process (Gerow, 2014). Puerto
Rico may also benefit from an employment boost from a labor-intensive industry
and would be afforded the higher public assistance and transfer payment bene-
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fits that states currently receive, which may substantially contribute to reducing
poverty and income inequality (as was the result of similar increases in the 1970s
and 1980s). Contrarily, the substantial increase in public assistance benefits could
further contribute to the depressed labor market and incentive for accepting labor
market wages, while increased federal taxes on businesses could also depress eco-
Considering the political rift among Puerto Ricos legislators its appointed
representative in D.C. advocates for statehood, while its governor prefers the status
quo it may be unlikely that a permanent decision will be reached until greater
political unity is achieved. However, it should be noted that future investors, and
even native Puerto Ricans considering their own residency and investments, may
consider the rift a sign of continued economic instability and uncertainty. Regard-
less of the outcome, there will be economic benefits to a permanent and conclusive
Conclusion
Whether or not Puerto Rico decides to change its status in the near future,
it is clear that Puerto Rico has had a storied economic history that has led to its
currently indebted, yet opportunity-rich climate. On one side, there are those who
see Puerto Ricos fiscal situation as one of disrepair, unable to sustain itself in the
near future. However, on the other side of this negative outlook is one that, at the
very least, concedes that Puerto Ricos economy may have nowhere to go but to-
long-term impediment to any sign of future growth, will rest upon the shoulders of
those in power. Officials may continue to put off hard decisions for current political
victories, unite to implement a tough, yet fruitful, long-term economic plan, or have
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Table 1
Table 2
Gini Coefficients for Household Income and
Household Earnings, 1970-2000
Household % Household %
Year
income Change Earnings Change
Table 3
Gini Coefficients for total household income, with exclusions 1970-2000
Total
Household
Household
Income
Total Income
% % (Excluding %
Year Household (Excluding
Change Change Public Change
income Social
Assistance
Security
Income)
Income)
25
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