Friday, December 18, 2015

Commentary: An Easy Fix For Puerto Rico

Puerto Rico, a political subdivision of the United States, is mired in an economic crisis and the Federal government is doing nothing.  That's very odd, considering that the economic performance of the US mainland is among the strongest in the developed world.  But even stranger is the fact that the strongest, most technically capable nation on earth is simply sitting back while 3.5 million of its citizens face economic depression and stagnation.  The decisive actions of the Federal Reserve and the Administration to address the economic crisis in 2008 are to be lauded and praised.  They were the actions of the great power, and helped pave the way for the strongest recovery from the recession among the advanced economies.  Today, the President Obama must summon the political will to act again to ensure a prosperous economy for ALL US citizens living both on and off the mainland. 

The problems facing Puerto Rico are simultaneously simple and complex.  Today, Puerto Rico faces a debt burden roughly 72 billion dollars, about 70 percent of the island's GDP.  Some of that debt is municipal debt owed by the Commonwealth government.  A large chunk of it is debt owed by state owned utility companies.  On January 1st, Puerto Rico must make interest payments of 957 million dollars.  Governor Garcia Padilla has announced his intention to default on this payment because it is impossible to pay creditors and continue to provide essential services.  

What got Puerto Rico in trouble fundamentally comes down to the loss of economic competitiveness, misguided economic policy, and bad luck.  Puerto Rico lost a key tax advantage in 2006. (companies could book profits in Puerto Rico and send them to the mainland tax free) This was the ultimate death knell for the manufacturing sector.  The Island government then tried to heavily subsidize electricity and energy to convince manufacturing firms to stay.  Ultimately, however, these subsidies failed to prop up manufacturing because of the huge pool of cheap labor which was mobilized around the world by the forces of globalization.  In the end, these subsidies only further indebted the Island government and the public power company.  Finally, a bit of bad luck brought on crisis. The global recession killed the tourism sector, and the island has never recovered.  Per capital income is down nearly five thousand US dollars in PPP terms since 2006. 

Puerto Rico is currently barred from declaring bankruptcy, since it is an unincorporated territory.  This prevents the island from restructuring its debt in the courts.  Therefore, Puerto Rico is in the unenviable position of begging for mercy from its creditors or going hat in hand to international lenders like the IMF or World Bank.  This inevitability is beneath the dignity of the United States.  The strings attached from an IMF loan would essentially give a foreign entity significant leverage over a US territory.  It would also signal to the world that the United States lacks the political will to stand up for its own citizens. 

Fortunately, the United States is not caught in an economic straight jacket despite political dysfunction.  The Exchange Stabilization Fund, a special Treasury account that the President can use without the authorization of Congress, must be mobilized to aid Puerto Rico.  Presidents of both parties have used the ESF to stabilize the economy at home and abroad when Congress has failed to act.  President Clinton used to the ESF to lend 20 billion dollars to Mexico in 1994 after Congress refused to pass the Mexican Stabilization Act. (Mexico repaid the loans early with interest) President Bush tapped the ESF to guarantee the solvency of key money market mutual funds during the 2008 financial crisis.  

 Since it is unlikely that Puerto Rico can reach a timely deal with its creditors, the United States should offer the holders of Puerto Rico's debt the following deal.  The United States will pay 70 cents on the dollar to all of the island's bond holders.  Most of the bond holders would gladly except this offer, given it is highly uncertain when, how much, or if even investors will be paid without intervention from the Federal government.  Next, by imposing some losses, we can address the moral hazard problem.  However, by quickly resolving the question of the debt, Puerto Rico will gain the space to reform its economy and keep the government open.  This is essential, especially given the depressed state of the Puerto Rican economy.  

Finally, Puerto Rico would still owe money back to the US Treasury, again stopping the moral hazard issue and giving the island ownership over an economic reform package (ending fuel and electricity subsidies, modernization of infrastructure, and ending the "tax haven" culture and focusing on building up real economic advantages such as an educated workforce would be high on the agenda) which could be implemented in partnership with the Federal government.       

Puerto Ricans, like all Americans, deserve and equal shot, and equal shake, and chance at the American dream.  The Federal government has a duty to all of its citizens, not just those living on the mainland.  In sum, it's high time that the Federal government get its act together and underwrite a credible debt restructuring plan for the Commonwealth of Puerto Rico. 

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