The Plight Of Puerto Rico
As the crisis there deepens and more and more Puerto Ricans become more and more desperate, this next week will be critical in preventing what is an enormous natural disaster from turning into an enormous humanitarian disaster. Puerto Ricans are running out of water, food, medicines, and fuel. It is a credit to the population there to see orderly lines stretching for blocks in order to get necessary supplies. But it is hard to see that kind of civility maintaining itself for weeks on end.
What is clear is that FEMA was in no way prepared to handle a natural disaster on a scale like this. Puerto Rico is basically the size of the state of Connecticut but located 1,000 miles from the US mainland. FEMA would have difficulty dealing with a disaster that essentially destroyed the power, communication, and agricultural infrastructure of Connecticut. It is in no way prepared to handle that kind of emergency one thousand miles away from the US mainland where easy evacuation of those who have lost everything and supplying relief with trucks and buses is not possible. The only quick method to supply relief is by air to an airport that is already severely damaged.
But the fact that the Trump administration has not mobilized additional federal resources, such as the military, and has only just today waived the Jones Act in order to deal with the disaster is just another reminder of how poorly Puerto Rico and other US territories have been treated and managed over the years. Some of that is Puerto Rico’s own making but much of it is enabled by fictions that the netherworld of being a US territory create. Puerto Ricans are US citizens but they have no federal representation. They are covered by US laws, except laws that apply to the states. They are self-governing except when the federal government intervenes.
Even before the hurricane, Puerto Rico was an island in serious decline. It was already suffering an economic crisis, having $72 billion in debt and another $51 billion in pension obligations and only a $100 billion GDP. It still has a population larger than 21 states but a poverty rate twice that of Mississippi. In the past 10 years it has lost 9% of its population. It was suffering from a serious brain drain, as 20% of the working age population had left in the last 20 years. Births have plummeted, its population is aging, and the island has a greater percentage of its population over 60 years of age than any US state. As we saw in the aftermath of Katrina, New Orleans’ population was still 20% lower ten years after the hurricane than it was before. Puerto Rico will suffer a similar, if not worse, fate. The people who can afford to leave the island now can and will, leaving the island even poorer and probably older.
The seeds of Puerto Rico’s economic crisis actually go back to the territory’s constitution, written all the way back in 1952. The version passed by Congress stated that expenditures should not exceed revenues, in other words, a strictly balanced budget. Perhaps intentionally, however, the Spanish translation of the constitution states the expenditures should not exceed total resources. Resources and revenues are clearly not the same thing. This mistranslation allowed the territory to use its own government bonds to balance the budget, essentially borrowing to fill the gap between expenditures and revenues.
This was not an issue or even a problem as the territory maintained balanced budgets for the next two decades. But, in response to the recession in 1974, Puerto Rico started borrowing to fill the budget deficit ,only they hid that borrowing behind a façade of balanced budgets by routinely overestimating the amount of revenue to be received, primarily through taxes. The fact that those estimates continually fell short did not keep the territory from pretending the budget would balance.
This might not have been a problem because Puerto Rico was also constrained by a debt limit that restricted the level of borrowing to just 10% of the tax value of the territory’s property. But, as the island began to prosper, Congress repealed that law in 1961 and allowed the Puerto Rican government to set its own debt limit. That was followed by the island’s boom time as an abundance of low wage workers along with huge tax breaks for capital intensive industries such as pharmaceuticals, oil, and petrochemicals helped the island’s economy grow by leaps and bounds.
Then, in the late 1990s, the US government forced a phase-out of those tax breaks, leaving just one important one in place. That remaining tax break was the tax exempt status on Puerto Rico’s municipal bonds. The phase-out of the tax breaks created capital flight from the island as companies began to leave in droves. At the same time, the tax exempt status of those Puerto Rican bonds provided higher interest rates for yield-seeking buyers. Mutual funds and hedge funds bought those bonds as fast as Puerto Rico could create them even as jobs were fleeing the island.
Accordingly, in 2000, the island found a way to even evade its own, self-imposed debt limit with the creation of so-called “appropriation bonds”, issued by government-owned entities but technically not a direct obligation of the government even though they relied on government appropriations to repay the debt. However, just like FNMA and FHLMC agency debt in the US, investors treated those bonds as though they were backed by the government.
When the legality of appropriation debt was challenged in 2006, the government created COFINA which assumed some appropriation debt and then added an additional $15 billion in debt over the next six years. COFINA debt is now backed by the territory’s sales tax which was raised from 7% to 11.5% in July of 2015, becoming the highest sales tax rate in the US. That again helped shrink the economy and prompted even more flight from the island.
With its overwhelming obligations, the optimal solution would have been for the government to bite the bullet and declare bankruptcy, beginning negotiations to restructure the debt more realistically. But that turned out not to be possible because US Bankruptcy Code only includes “states”. So Puerto Rico wrote its own bankruptcy rules. Creditors challenged those rules and in 2016 the Supreme Court ruled that Puerto Rico was not allowed to write its own bankruptcy rules but, at the same time, it could not take advantage of US bankruptcy law because it was not a state. The only option was to pay the loans back in full. Meanwhile, Puerto Rico privatized two major toll roads, the San Juan airport, and other state assets to provide one-time boosts to its cash flow at the expense of future revenue.
Finally, last year, Congress appointed what amounts to a financial control board to help Puerto Rico control its spending, find some way to restructure its debt, and deal with its pension shortfall. That, of course, means even greater austerity and more flight from the island.
In addition to its own economic problems, the island also suffers from what is essentially a colonial legacy of neglect and exploitation. The Jones Act, which Trump was finally forced to waive today, is a regulation from 1920 that was designed to protect the US merchant marine fleet in the aftermath of World War I. According to Vox, “One section of the law requires goods transported by ship from one US destination to another to be carried on US-flagged ships that were constructed in the United States, owned by US citizens, and crewed by US legal permanent residents and citizens”. While that law may have made sense in 1920 when US ships carried one quarter of the world’s products, not so much in 2017, when US ships carry just 2%. The Jones Act makes shipping between US ports anywhere from two to four times more expensive and a boon to the trucking and railroad industries today. Bizarrely, it is far more expensive to ship goods from the US mainland to Puerto Rico than to, say, Jamaica. Another negative effect of the Jones Act is that it kept Puerto Rico from becoming a major shipping terminus as well, despite being uniquely positioned to become one.
The end result, not only for Puerto Rico but for Alaska, Hawaii, and other territories, is a cost of living far higher than it need be. One estimate is that the Jones Act helps add to the 13% higher cost of living on Puerto Rico. In the US Virgin Islands, which are exempted from the Jones Act, the cost of US made goods is about half what it is in Puerto Rico.
Between the neglect of the federal government and the island’s economic crisis, infrastructure in Puerto Rico was already in poor shape. The storm has already led to the breaching of the Guajataca Dam, owned by a bankrupt state-owned entity and uninspected in the last four years. The power infrastructure on the island was in even worse shape. 47% of the power comes from oil-burning power plants. Another 51% comes from a mixture of coal and natural gas plants. All those fuels have to be imported. Because the now bankrupt Puerto Rico Electric Power Authority (PREPA) spends so much money on importing fuels, maintenance of the grid has suffered. Puerto Ricans have the second highest electric rates in the US after Hawaii yet suffer nearly five times as many blackouts as any state. This on an island with abundant sun and wind, the perfect place for a real investment in renewables.
