A Long-Term Recovery Plan for Puerto Rico

Antonio DeFrank
WRIT340EconFall2022
12 min readDec 6, 2022
(Photo by Spencer Platt/Getty Images)

Executive Summary

The economic and debt crisis that has been ongoing in Puerto Rico since 2006 which culminated in Puerto Rico defaulting on its billions of dollars in debts in 2016 has the people of Puerto Rico facing dire consequences. The resulting economic austerity programs have cut public spending on education and healthcare. Puerto Rico’s inability to pay back its debts and the significant amount of Wall Street creditors has led to the U.S. Federal Government stripping Puerto Rico of its economic autonomy by creating an oversight board that has complete control over Puerto Rico’s finances.

The U.S. government’s solution is only a short-term solution to pay back creditors that does not ensure a similar situation will not occur again in Puerto Rico. The solution does not contain long-term policy changes to stop Puerto Rico from becoming a serial defaulter.

To progress toward a bright and autonomous future, the policies that have perpetuated Puerto Rico’s economic crisis must be eliminated. Further, workforce and educational development programs to stabilize the economy must be implemented. Policymakers need to use the funds from the U.S.’s bailout to stimulate growth in the economy through workforce/educational programs that will increase the low labor force participation rate. Additionally, the elimination of colonialist policies, like the Jones Act, that restrict Puerto Rico’s economy is essential to stimulating a natural growth of the economy.

Rationale

From 2004 to 2020 annual economic growth and population in Puerto Rico have shrunk by 12.5 percent and 16 percent, respectively. Further, public debt in Puerto Rico was at $70 billion in 2020 which equated to 68 percent of gross domestic product. (Cheatham & Roy, 2022). Natural disasters, mismanagement of government funding, government corruption, and the COVID-19 pandemic have compounded the economic policy issues that have caused Puerto Rico to be in a sustained economic recession.

The legislative factors that are responsible for Puerto Rico’s economic crisis are failed tax reforms and outdated legislation that fuels the Puerto Rican economy to be heavily reliant on debt to fill federal funding gaps (Joffe & Martinez, 2016). The failed tax reform that jumpstarted the Puerto Rican economic crisis was the phaseout of Section 936 of the Internal Revenue Code.

Section 936 permitted American corporations to operate tax-free in Puerto Rico. Critics of Section 936 argued that it was a loophole for American corporations to avoid paying taxes. But the ten-year phaseout that ended in 2006 was instrumental in starting the sustained economic recession that Puerto Rico is still facing today. Section 936 created an economic bubble that left the economy vulnerable if the tax incentives were to be reversed.

Since 1917 bonds issued by the government of Puerto Rico are exempt from local, state, and federal taxes. The triple tax-exempt bonds caused Puerto Rico to be heavily reliant on debt (Greenberg & Ekins). These bonds continued to be attractive to Wall Street hedge funds even after Puerto Rico’s economic bubble was burst by Section 936’s phaseout in hopes of a debt repayment plan that is profitable for bondholders. The bonds became unattractive after Puerto Rico started to default on debt obligations in 2016, which is when all major bond rating agencies took the bonds off their rating lists.

Puerto Rico’s status as a commonwealth meant it could not receive aid from the International Monetary Fund or file for Chapter 9 bankruptcy, so in 2016 the U.S. Congress and President Obama’s administration created the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).

PROMESA was granted full control over Puerto Rico’s finances by The White House and Congress to bring forth a plan to restructure Puerto Rico’s debt to get out of bankruptcy. In March 2022, a federal court approved the oversight board’s plan to cut Puerto Rico’s debt by 80% (Stojanovic & Wessel, 2022).

However, more structural reforms are required because PROMESA’s plan is not a long-term solution to prevent Puerto Rico from defaulting again in the future.

Proposed Policy Options

The current approach consists of PROMESA continuing to control Puerto Rico’s finances until the Commonwealth can access credit at reasonable rates and has four consecutive years of balanced budgets.

What has PROMESA Achieved?

“The deal cuts $33 billion in total debt obligations down to $7 billion, lowering Puerto Rico’s annual debt payments from nearly $4 billion to just over $1 billion,” (Cheatham & Roy, 2022). The plan also does not cut money going towards public pensions.

The oversight board also imposes stricter debt management that will not allow annual debt services to outpace Puerto Rican yearly revenue.

Additionally, PROMESA has helped Puerto Rico’s municipal-bond market make a comeback since the end of the debt restructure. Puerto Rico is now able to pay on its high-yield general obligation bonds. The bonds are still likely years away from being rated by major rating agencies, but they should still attract some investment from riskier buyers. There is no more legal risk to deter investors from Puerto Rican municipal bonds, just the standard credit risk.

Why is PROMESA Unpopular in Puerto Rico?

Debt limits are only temporary and will eventually expire. PROMESA does not require long-term structural reforms to prevent future defaults by Puerto Rico. PROMESA will not stop Puerto Rico from defaulting in a comparable way in the future because of the way the United States has cut Puerto Rico’s debt. The policies that led to Puerto Rico’s debt crisis are still in place and PROMESA has no path toward reforming tax and bond systems. The control board’s focus seems to lie in the short term in fixing the current crisis and just hoping another crisis will not arise. This strategy could lead to Puerto Ric o defaulting again once their bonds become rated by the major credit agencies, which will allow Puerto Rico to heavily borrow on public markets again.

Congress created PROMESA and uses Puerto Rico’s status as a territory to the United States to take complete control over Puerto Rico’s finances without voting representation in Congress. The oversight board are comprised of White House appointed officials that can overrule Puerto Rican government policies leading to it being labeled as American colonialism. PROMESA is “very unpopular among residents, who have viewed it as taking away the island’s autonomy and ability to govern itself,” (Kaske, 2022). The residents are unhappy with the United States’ decision to step in and take power away from the Puerto Rican government and give immense power to officials that were appointed by a president that was elected in an election process that excludes Puerto Ricans from the electoral college. The only representation Puerto Rico has in the federal government that appointed these officials is a non-voting delegate of the House of Representatives. Additionally, citizens and officials of Puerto Rico are unhappy with the projected expenses of the oversight board, which is projected to be more than $1.5 billion in legal and financial advisor’s fees. Puerto Rico’s taxpayers are responsible for PROMESA’s fees and Luis Dávila Colón, Puerto Rican attorney and political analyst, says: “They are wasting more than a billion dollars in consultants and operational expenses. This is so much money, that those funds would have been enough to cover all pensions for 15 years,” (Ruiz 2022).

The economic austerity to come from PROMESA is also a problem for Puerto Ricans. Puerto Rico was forced into accepting austerity measures when the oversight board felt “pressure from creditors, who rejected a restructuring offer as high as 77 cents for every dollar on general obligations and 58 cents for each dollar from sales-tax bonds,” (Ruiz, 2022). Since hedge funds were conservatively estimated to own 24% of all Puerto Rican debt (some estimate it as high as 50%), their stake in the crisis was large and came with the power to influence the future of Puerto Rico. PROMESA decided to appease the bondholders and put their focus solely on debt repayment in the short term by siphoning the little resources Puerto Rico had into debt repayment. The austerity measures that followed have hurt Puerto Ricans by way of cutting spending toward education, healthcare, and wages for public workers. The resulting austerity is pushing citizens out of Puerto Rico in droves and is hindering the Commonwealth’s future.

Recommended Strategies

Puerto Rico’s status as a Commonwealth will not be changed anytime soon according to the United States government so Puerto Rico and the U.S. government must work together to ensure a sustainable economic future for Puerto Rico.

(Graph 1: The Oversight board responsible for the debt restructure projects fiscal deficits to be over $20 billion by 2051 without any deeper structural reform after restructuring debt.)

PROMESA itself is aware of the grim long-term economic outlook with the “[Oversight board] itself [projecting] that, even if they manage to achieve balanced budgets throughout the next decade, the island will once again fall into fiscal deficits from the year 2036 onwards,” (Ruiz, 2022).

An economically sustainable future must consist of increased autonomy by investing in the modernization of the workforce and increasing autonomy through the removal of colonialist policies.

Develop Workforce and Education Programs

Workforce Development Programs: Stimulate economic growth through an increase in labor-force participation rate through enrichment of career and technical education system. Only 18.3% of adults in Puerto Rico have obtained a bachelor’s degree (U.S. is 37.9%) and granting Puerto Ricans better access for higher education will potentially increase income, increase job prospects, and increase opportunities for career advancement for a territory that’s poverty rate is twice as high as the poorest state in the union, Mississippi. (Cheatham & Roy, 2022).

The Benefits of Developing a Workforce

More labor-force participation (Puerto Rico’s average labor-force participation 1990–2022: 44.53%. U.S. average: 62.85%) to increase labor resources. An increase in labor resources means there will be more resources available for the production of goods and services. Better education levels and higher skill sets for a more robust workforce that is better equipped for the future. Developing programs for the purpose of collaboration between industry and education will create career pathways that will lead to a more experienced workforce. A career pathway for prospective employees is also important for stabilizing the falling population of Puerto Rico because of increased career and education opportunities. Further, a more educated and skilled workforce will be more equipped to deal with future shocks to the economy, like the COVID-19 Pandemic, by being able to quickly set up alternative options and economically recover quicker similar to the United States’ quick transition to remote work.

(Graph 2: “a post-pandemic recovery between the years 2021 and 2022, followed by an average real growth of 0.2% from 2023 and 2029. After 2030, the oversight board projects that the island will return to its historical trend of economic decline,” (Ruiz, 2022))

Graph 2 points out the current plan’s long-term shortcomings with a negative real growth rate projected by PROMESA itself by 2030. But workforce and educational programs will buck the trend of economic decline by spurring investment and innovation in the private sector through a more robust workforce and increased production of goods.

Additionally, investing in modernizing Puerto Rico’s workforce through education could pay for itself in the long-term. Individuals with more years of education tend to have higher earnings and those higher earnings means more dollars paid in taxes (Denning, Marx, & Turner 2018). The tax revenues that would come from the higher earning potential could result in educational programs paying for themselves in the long-term.

Short-term Challenges of Workforce Development

Puerto Rico is need of workforce right now as poverty rates increase and population decreases and developing resources to better equip the workforce is a long-term strategy. The short-term needs of Puerto Rico are difficult to meet during the current outmigration of citizens that are part of the working-age population, so there needs to be policy that will incentivize working-age citizens to stay in Puerto Rico. Waiving the Jones Act could provide the incentive needed to reduce outmigration.

Waive the Jones Act

Waive the Jones Act, officially known as the Merchant Marine Act of 1920, for Puerto Rico. “The Jones Act is a protectionist law dating back to the 1920s that requires that all interstate commerce within the United States be conducted on U.S.-owned, crewed, and manufactured ships,” (de Jesus & Rodriguez 2021).

Economic Gains from Waiving the Jones Act

Essential goods like food will be more affordable for Puerto Ricans and aid in the event of a natural disaster will be available quicker if a natural disaster occurs. Markets will become more competitive, and it will create jobs. Estimates show that waiving the Jones Act could create 13,270 additional jobs and add $1.5 billion into Puerto Rico’s economy (Dunham, 2019). The jobs that waiving the Jones Act would create in the immediate aftermath would be a tremendous boost to Puerto Rico’s economy. Further, the same study concluded the manufacturing industry would stand to gain more than 2,700 jobs and $793.4 million in output, which is an industry that has been hurting since many manufacturers left Puerto Rico after the announcement of Section 936’s ten-year phaseout in 1996. It is understandable that the U.S. wants to support American shipbuilding and create jobs for American sailors, but these goals are increasing costs for a Commonwealth with over 40% of its population living below the poverty line.

Economic and National Security Concerns

There will be a decrease in national security because the Jones Act provides merchant marine transport for goods between U.S. ports. But this measure of national security was mainly meant for times of war when German U-boats were targeting cargo vessels, and there is currently not evidence of how the loss of this security would affect Puerto Rico outside of wartime.

The requirement of ships sailing to and from U.S. ports to be American owned, built, and crewed has no doubt kept the shipbuilding and merchant mariner industries afloat in the United States as many industries have looked outside of the U.S. for cheaper labor. Economically, abolishing the Jones Act would cause severe damage to the shipbuilding and merchant mariner industries in the United States because the increase in competition for domestic trade would drive down costs.

The Jones Act is viewed as a policy that is essential in protecting the maritime industry of the United States and should not be abolished outright. However, the act should be waived for Puerto Rico since the federal government has indicated there is no path for Puerto Rican statehood, which might have been a reason to keep the Jones Act because it could possibly grow their maritime industry (still at the expense of higher costs for goods). But Puerto Rico is not becoming a state anytime soon and as an island territory that relies on shipping, being exempt from the Jones Act would lower costs of goods and create thousands of jobs.

Policy Recommendations

a. PROMESA acts as a stopgap and controls Puerto Rico’s finances until a plan is set forth to ensure a solution to the debt crisis that provides Puerto Rico with long-term economic stability.

b. Develop Puerto Rico’s workforce through programs that encourage higher education and technical skills to increase labor-force participation as a way to stimulate economic growth in the long-term.

c. Waive the Jones Act to create thousands of jobs, inject $1.5 billion into the economy, and increase competition for lower costs for essential goods.

References:

Bond, C. A., Strong, A., Smith, T. D., Andrew, M., Crown, J. S., Edwards, K. A., Gonzalez, G. C., Gutierrez, I. A., Kendrick, L., Luoto, J. E., Pratt, K., Patel, K., Rothenberg, A. D., Stalczynski, M., Tong, P. K., & Zaber, M. A. (2020). Challenges and Opportunities for the Puerto Rico Economy: A Review of Evidence and Options Following Hurricanes Irma and Maria in 2017. (). RAND Corporation. Retrieved from Policy File Index http://libproxy.usc.edu/login?url=https://www.proquest.com/reports/challenges-opportunities-puerto-rico-economy/docview/2468068382/se-2

Cheatham, A., & Roy, D. (2022, January 3). Puerto Rico: A U.S. territory in Crisis. Council on Foreign Relations. Retrieved September 26, 2022, from https://www.cfr.org/backgrounder/puerto-rico-us-territory-crisis

de Jesus, F., & Rodriguez, L. (2021). An Urgent Rescue Plan for Puerto Rico. (). Center for American Progress. Retrieved from Policy File Index http://libproxy.usc.edu/login?url=https://www.proquest.com/reports/urgent-rescue-plan-puerto-rico/docview/2552826131/se-2

Denning, J., Marx, B., & Turner, L. (2018). Propelled: The effects of grants on graduation, earnings, and Welfare. SSRN Electronic Journal, 1–41. https://doi.org/10.2139/ssrn.3249906

Dunham, J. (2019, February). The jones act: A legacy of economic ruin for Puerto Rico. Docslib. Retrieved October 3, 2022, from https://docslib.org/doc/9718230/the-jones-act-a-legacy-of-economic-ruin-for-puerto-rico

Gonzalez, G. C., Edwards, K. A., Zaber, M. A., Andrew, M., & Strong, A. (2020). Supporting a 21st Century Workforce in Puerto Rico: Challenges and Options for Improving Puerto Rico’s Workforce System Following Hurricanes Irma and Maria in 2017. (). RAND Corporation. Retrieved from Policy File Index http://libproxy.usc.edu/login?url=https://www.proquest.com/reports/supporting-21st-century-workforce-puerto-rico/docview/2468068398/se-2

Greenberg, S., & Ekins, G. (2015, June 30). Tax policy helped create Puerto Rico’s fiscal crisis. Tax Foundation. Retrieved September 27, 2022, from https://taxfoundation.org/tax-policy-helped-create-puerto-rico-fiscal-crisis/

Joffe, M., & Martinez, J. (2016, April). Origins of the Puerto Rico Fiscal Crisis — Mercatus Center. Origins of the Puerto Rico Fiscal Crisis. Retrieved September 28, 2022, from https://www.mercatus.org/system/files/Joffe-Puerto-Rico-Fiscal-Crisis-v1.pdf

Ruiz, J. (2022, June 14). An unfulfilled promise: Colonialism, austerity, and the Puerto Rican Debt Crisis. Harvard Political Review. Retrieved October 3, 2022, from https://harvardpolitics.com/unfulfilled-promise-2/

Stojanovic, L., & Wessel, D. (2022, August 19). Puerto Rico’s bankruptcy: Where do things stand today? Brookings. Retrieved September 27, 2022, from https://www.brookings.edu/blog/up-front/2022/08/17/puerto-ricos-bankruptcy-where-do-things-stand-today/

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