Puerto Rico is an island of 3.5 million people that owes $73 billion in government debt. Last week, Puerto Rico started defaulting on at least part of that debt, missing $37 million in payments due, and indicating more missed payments to come.
Not widely enough understood is why this is America’s problem. Puerto Rico is a territory of the United States, governed under American law, including the Constitution, which applies there. Its people are American citizens, free to travel anywhere in the United States. Puerto Rico is to the U.S. what Greece is to the EU.
The root of the problem is Puerto Rico’s economy, which no longer reflects the island’s name. Only 40 percent of the adult population is even in the workforce, with about a third working for the government, paid by the Island’s taxpayers. With 12.5% unemployment, the Island’s population is declining, down 5% in the last 5 years. Those leaving are the most productive professionals, taking their incomes and tax payments with them.
Under U.S. law, cities and towns can file for bankruptcy, but states and territories cannot. Yet, special legislation enacted by Congress in 1984 denied bankruptcy for Puerto Rico’s municipal governments, agencies and bureaus, as well as for the entire Island’s government. Moreover, all of the Island’s government bonds are exempt from U.S. taxation. Counterproductively, these two factors made lending to Puerto Rico’s government at low interest rates intensely attractive for U.S. lenders.
Conservatives and Republicans cannot support a taxpayer bailout of Puerto Rico. That would just reward fiscal profligacy and failure. Such a bailout would become a model for every liberal, overspending city in America to avoid overdue policy reforms and paying back its debt. The politics of the 2008 Wall Street bailouts were murder for Republicans, and they cannot go anywhere near that again.
The Obama sdministration has proposed addressing the problem through emergency Congressional legislation creating a special “territorial bankruptcy regime,” which would protect the Island from lawsuits to collect its debts, which have already begun. But that is the opposite of the way out, making the problem worse rather than better.
Puerto Rico’s debt is over three times greater than Detroit’s, so bankruptcy would be even more complex and expensive than that litigation, which dragged on for years and cost the city $178 million in professional fees. Worse, that litigation became an excuse for avoiding any of the policy and structural reforms necessary for Detroit’s economy to grow out of bankruptcy.
Pension costs were the single largest line item in Detroit’s budget. But the bankruptcy litigation failed to reduce those costs at all, while cutting bond debts by 90%. City bureaucracies avoided virtually all recommended cost efficiencies, including adjustments to infrastructure planning to reflect the two-thirds decline in Detroit’s population. The city’s 28 agencies continued virtually undisturbed.
Moreover, Puerto Rico’s loans were made under the promise of no bankruptcy. Rewriting those rules after the fact would set another precedent for doing the same any time for any part of the entire $3.6 trillion U.S. municipal bond market. That would raise borrowing costs for all cities and towns across America.
What is needed are structural reforms that would restore rapid economic growth to Puerto Rico’s economy. Instead of disrespecting the rule of law with after the fact bankruptcy, Puerto Rico can collaboratively enter renegotiations with lenders outside of bankruptcy, as it has already been doing. Instead of discouraging essential capital investment on the Island, that would encourage and promote such investment.
To aid this, Congress can pass a package of pro-growth legislation for Puerto Rico. That would provide for immediate expensing for all capital investment on the Island, elimination of Jones Act requirements for use of U.S. flagged vessels for transport to the island, and suspension or reduction of the federal minimum wage law on the island, which substantially increases unemployment. That legislation should also suspend excessive EPA overregulation on the Island, which would require Island government authorities to borrow billions more in the next couple of years, for rebuilding compliance that would counterproductively raise energy costs on the Island sharply.
Puerto Rico can also adopt complementary pro-growth reforms. The entire welfare system needs to be reformed around a work requirement, like the federal welfare reform of 1996, so the extensive welfare assistance will stop discouraging workforce participation. Business regulation needs to be reformed and streamlined to encourage more new business startups. Labor regulation needs to be reformed to encourage more flexibility in work force management.
With economic growth on the Island revived, and more workers working, revenues would surge, while spending demand for public assistance will decline. That will enable the government to service its debt, under renegotiated terms.
This is a Puerto Rico debt plan with real promise to work. If President Obama won’t cooperate in enacting it, he and his party will bear the political liability.
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