Opinion: This is just the beginning of Puerto Rico’s economic crisis

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Statements made by Governor Garcia Padilla over the weekend, combined with the release of a government-sanctioned report detailing Puerto Rico’s economic woes (see the “Krueger report”), may have provided evidence that the island is finally ready to meet its financial maker. Despite the nasty wake up call, it may not be enough. Administrators still seem unwilling to make the fiscal adjustments needed to end the crisis, nor the major reforms required to begin a long-term recovery.

Not being able to have autonomous control over all of its policies puts Puerto Rico at a major disadvantage over other economies that it competes with for labor, business investment, and tourism.

— Justin Vélez-Hagan

We have yet to reach the peak of what may become known as Puerto Rico’s worst economic crisis, but the coming main event has been anticipated for years. Obstinate administrators, however, have continued to refuse to consider restraining expensive campaign promises, nor have they realized the long-term impossibility of many of their financial proposals. The Puerto Rican people are now going to be the ones who suffer the consequences.

For those who haven’t been following the strengthening tsunami in the Caribbean, Puerto Rico was able to borrow its way into oblivion for several reasons. First, its municipal bonds have been an attractive alternative to the higher-tax, lower return bonds sold by most other municipalities in the country. Puerto Rico has also come up with an endless supply of schemes to continue repaying its generous lenders (at least, until now), which has managed to keep their fragile confidence.

Financial analysts, government officials, and rating agencies have all raised red flags, including via the highly publicized series of credit rating downgrades, but Puerto Rico’s leaders have failed (miserably) to make the required economic improvements that would usher in long-term growth. For example, after a modest economic turnaround began at the end of 2011, a new administration set out to reverse the tax incentives and government spending cutbacks that were beginning to work.

Governor Garcia Padilla only (very) recently began to concede that his plans were contradicting the positive movement. The interesting thing about the report that the governor sanctioned, and now relies upon, is that it contains very little new information, insight, or analyses that detractors haven’t pointed out for years. Many of the main points included were even put into practice in previous administrations.

Puerto Rico’s economy has been flagging for over a decade as it has struggled to overcome a series of Washington-induced impediments that have only added to the fun. After pulling the plug on a major tax incentive that D.C. deemed an “unsuccessful” benefit to Puerto Rico’s employment (and the Treasury’s coffers), the manufacturing sector’s downward slide has combined with high utility costs and the continuation of unnecessarily expensive wholesale goods perpetuated by the 1920 Merchant Marine Act (more often referred to as the “Jones Act”).

In addition, Puerto Rico has to leave a number of fiscal and monetary policy tools in the hands of the Federal Government. Not being able to have autonomous control over all of its policies puts Puerto Rico at a major disadvantage over other economies that it competes with for labor, business investment, and tourism.

Putting aside the well-known bureaucratic business climate, local tax rates have been almost as volatile as Puerto Rican bonds, while the poor domestic market drives away Puerto Rico’s best and brightest and draws in only investors looking to snatch up as much as they can while everything is “on sale.”

There are no popular solutions to the problem. Puerto Rico’s economy will have to undergo significant shifts in taxes and spending in order to improve its long-term outlook. However, “austerity” shouldn’t simply equate to an increase in taxes. In fact, recent economic research suggests that spending cuts are more likely to provide the evidence of long-term fiscal progress that will improve consumer and investor confidence.

Puerto Rico must also rely upon incentives that promote growth in sectors that employ more Puerto Ricans, while simultaneously making tough labor market improvements. Over the last 15 years, growth has emphasized capital-intensive businesses that require fewer employees – especially Puerto Rican natives – to operate.

One way to do this is to shift away from general hiring tax credits and increase those that target specific sectors that are more profitable to locals. A number of U.S. municipalities have successfully adopted similar policies. But the labor market must also increase wage flexibility and reduce entitlements that incentivize staying out of the labor force.

Puerto Rico has a long, hard road ahead, and it will take a monumental effort by legislators across the country, as well as on the island to begin removing the policies that have merely continued its tenuous economy.

Even if Congress affords (as it should) Puerto Rico the option to restructure its debts through a municipal bankruptcy proceeding, it will be the beginning of what will be a long, tedious crisis that will only be mitigated by the enactment of policies that Puerto Rico needs, not just those that are popular.