Puerto Rico panic

SYMPATHY VS. PRECEDENT-SETTING IN THE CARIBBEAN: The U.S. territory of Puerto Rico is $72 billion in debt, Gov. Alejandro García Padilla says he has no money to pay the interest due Jan. 1, and liberals and conservatives propose different solutions to the fiscal crisis. The eventual resolution will affect not only 3.5 million Puerto Ricans but 315 million other Americans.

Liberals are trumpeting a looming “humanitarian crisis” that demands a federal bailout: Otherwise, Puerto Rico will have to cut spending on schools and hospitals. Conservatives are emphasizing a governance crisis: Many Puerto Rican politicians have won votes by overspending; and if they get away with it, their counterparts in California, Connecticut, Illinois, Massachusetts, New Jersey, New York, and other states will keep running toward the cliff.

One piece of political evidence: New York Gov. Andrew Cuomo and New York City Mayor Bill de Blasio flew to Puerto Rico last month and marched with thousands who demanded that Washington send more money to San Juan. Yes, the governor and the mayor have native Puerto Ricans among their constituents, but they were also looking ahead to a time when they or their successors will demand bailouts of their own. As is typical in such protests, politicians said they had to speak up for the sake of the children.

Some Puerto Ricans would like to have the island declare bankruptcy, but U.S. states and territories, unlike cities, cannot legally do that. A “Detroit solution” is not possible unless Congress changes the law, which would be precedent-setting: If territories and states can declare bankruptcy, state bond holding will become riskier and states will have to pay more interest, which means state government costs and debt will increase even faster.

Some Washingtonians propose a “middle ground”: Put new billions for Puerto Rico in a lockbox controlled by a tough federal board to make sure funds are used responsibly. That promise leaves many giggling, given Washington’s tendency to turn lockboxes into readily breakable piggy banks, but it’s also a nonstarter for Pedro Pierluisi, Puerto Rico’s non-voting member of Congress, who lashed out at a “blatant exercise in colonialism.”

Suite-level rhetoric and action have an enormous effect at street level. Erwin Ferri, a resident of Sabana Grande, Puerto Rico, said “many people have been affected by depression and hopelessness” as they see a deteriorating healthcare system, a fall in home values, and the prospect of unpaid pensions. The question at hand: Does concern for poor Puerto Ricans demand acquiescence to political blackmail?

THE COMMONWEALTH OF PUERTO RICO has a higher per capita gross domestic product than any Latin American country but a lower one than any U.S. state: 45 percent of residents sit below the federally defined poverty line. The island has a lot going for it: natural beauty, warm winters, free and easy access to U.S. markets, a good location for regional commerce, and many bilingual workers. But a drive through San Juan, the capital, reveals economic decline. One major thoroughfare, Avenida Ponce de León, used to be busy: Now many buildings on it are closed, with graffiti-covered walls. Rush hour is less rushed.

Some grim statistics: Puerto Rico’s economic productivity has declined every year since 2006. Its population is down 7 percent (Puerto Ricans are U.S. citizens and can move freely to any of the 50 states), and its fertility rate is 1.6 children born per woman (below the replacement rate). Puerto Rico’s youth unemployment rate is 27 percent, and its overall unemployment rate is 12.4 percent.

Grim government housing projects display fences topped by razor wire, yet illegal drug profiteers fill expensive restaurants and make parking spaces at the Caribbean’s largest mall hard to find. Puerto Rico’s illegal drug trade comprises perhaps one-fifth of the economy of an island now known as “the perfect trampoline to the mainland.” For local consumption xylazine (aka horse tranquilizer) is the scariest new object of desire: It may be even worse than heroin, with users weaving in and out of consciousness for six hours and walking in a bent way that makes them look like movie zombies. (A National Geographic Channel video recently referred to Puerto Rico as “zombie island.”)

The drug trade has pushed up the island’s homicide rate, now four times higher than New York City’s. Problems seem distant during a walk around the lovely San Juan campus of the University of Puerto Rico, but students worry. Freshman chemistry major Gabriel Maldonado said, “The economy is going down. I don’t see how students can achieve a future here.” Business major Natalie Ramos said, “It’s bad. I don’t see a future here for me.” Tomas Gonzalez, a poor senior who travels with his bongo via bicycle to make some money playing street music, plans to move to Europe or Latin America: He says, “The government people here are just [obscene insult].”

The spiritual deficit may be even larger than the fiscal one. Nominally, Puerto Rico is 75 percent Roman Catholic and 15 percent Protestant. In practice many put their trust in saints’ miracles, witchcraft, and ways to ward off “the evil eye.” Last month at a Reforma Dos (Second Reformation) conference on the island attended by more than 600 Puerto Ricans, Pastor Gadiel Ríos spoke of how for 30 years many mile-wide, inch-deep churches have tolerated heresies including the prosperity gospel and quasi-occult practices. His biblical solution: “Preach the Word.”

WHEN THE UNITED STATES GRABBED Puerto Rico from Spanish control in 1898, Gen. Nelson Miles, fresh from two decades of Indian fighting, led the U.S. occupation force. He told Puerto Ricans they “for centuries had been oppressed,” but rule from Washington would “promote your prosperity [and] bestow upon you the immunities and blessings of the liberal institutions of our government.”

Government “blessing” No. 1: A century ago Puerto Rico moved from subsistence farming to production of a cash crop in high demand, sugar. By 1930 sugar plantations took up nearly half of Puerto Rico’s arable land. That may have been temporarily helpful to the island’s workers, but in the long run it became a big problem, as Puerto Rico tied its fortunes to the fluctuating price of a single crop.

“Blessing” No. 2: In 1941 President Franklin D. Roosevelt made one of his most left-wing advisers, Rexford Tugwell, governor of Puerto Rico. Although Puerto Rico has a perfect climate for agricultural development, Tugwell favored manufacturing over farming and had the government own and run companies making cement, pulp board, paper, glass, shoes, and clay products. The inefficient enterprises lost money: Tugwell left in 1946, and by 1951 the government had sold all the factories to private companies.

“Blessing” No. 3: In 1974 and 1977 Congress amended the Fair Labor Standards Act to bring the Puerto Rican minimum wage to the U.S. level. Problem: The minimum wage is now 77 percent of Puerto Rico’s average wage, versus 28 percent of the average wage para afuera, “over there” on the mainland. The change, according to a National Bureau of Economic Research study, “reduced total island employment by 8 [to] 10 percent compared to the level that would have prevailed had the minimum been the same proportion of average wages as in the United States.”

“Blessing” No. 4: The Economist calls Puerto Rico not “zombie island” but “Welfare Island.” Over the past three decades some welfare payments have remained lower than those para afuera, but a household of three can pull down $1,743 per month in food stamps, Medicaid, needy family payments, and utility subsidies, compared with $1,159 in minimum-wage take-home earnings. That’s a huge disincentive to work, so it’s no surprise that only 4 in 10 adults are working or even looking for work, compared with 6 in 10 in the United States. Since Puerto Ricans do not pay federal income tax, they are ineligible for the one welfare program that rewards work, the earned income tax credit.

Much of the help that ends up hurting has come from Washington, but Puerto Rican legislators have added their own wrinkles. Many government offices are overstaffed, with employees who take 30 vacation days and have a reputation for hardly working. Employees of every private company have at least 15 vacation days and 12 sick days. Everyone must receive el bono de Navidad, a $600 Christmas bonus. Anyone who works more than eight hours in a day gets time-and-a-half pay. (Para afuera, the overtime bonus comes only after working a 40-hour week.) Hiring often depends on whom you know, not competence, and three months is all it takes to become a quasi-tenured employee.

THE FAILURE OF WASHINGTON’S BLESSINGS suggests that Puerto Rico will be better off in the long run making its own hard choices. I’ve plowed through reports and articles on Puerto Rico debt all fall and still have not found a better analysis than Puerto Rico: A Way Forward, put out this summer by Anne Krueger, former president of the American Economic Association, and other financial brains. The report begins, “Structural problems, economic shocks and weak public finances have yielded a decade of stagnation, outmigration and debt.” It emphasizes that “restoring growth requires restoring competitiveness.” It proposes government expenditure control and welfare reform along with ways to encourage employment through changes in labor laws and the minimum wage.

Unless Puerto Rico gets a federal bailout, it will be unable to keep borrowing money and increasing its deficit, so the government has to cut expenses. Politicians say school costs cannot be cut for the sake of the children, but the Krueger report shows that in the past decade the number of students has declined by 40 percent while the number of teachers has grown by 10 percent. That makes it possible to save $400 million per year by cutting public school employment so it is consistent with the lower number of students. Competent teachers who lose their jobs have a ready alternative: para afuera, where school systems are hungry for Spanish-speaking teachers.

Other analysts are proposing to reduce employment at overstaffed public utilities and other government offices. They say annual revenues could increase by $250 million if Puerto Rico installed a broad-based 10 to 15 percent corporate tax instead of the current 35 percent tax riddled with exemptions. According to the accounting firm KPMG, Puerto Rico now misses collecting nearly half of sales taxes owed.

In testimony before Congress, economist Douglas Holtz-Eakin criticized calls for bankruptcy and bailouts, saying those “would not increase economic growth [or] alter the fundamental fiscal trajectory.” He urged privatization of the Puerto Rico Electric Power Authority, which prices electricity higher than on other Caribbean islands, partly because of mismanagement. Other economists say Puerto Rico’s airports and seaports are ripe for privatization, with proceeds used to pay down the territory’s debt, as Greece has done. Three freight-handling ports—San Juan, Mayagüez, and the under-construction international megaport at Ponce—could also be privatized.

Such changes would generate protests, particularly if officials followed Krueger recommendations and saved $500 million per year by reducing subsidies to the University of Puerto Rico, where undergraduates—many of whom went to expensive private high schools that charge up to $20,000 per year—pay only $55 per credit. (Typical undergrad tuition at the University of Texas at Austin, one of the less expensive major public universities para afuera, is $400 per credit hour for state residents and $1,400 for nonresidents.) Good but poor students could receive scholarships.

What won’t create long-term change, fiscal analysts say, are temporary “fixes” like those developed in past years. For example, tax breaks Congress created in 1976 drew pharmaceutical companies to Puerto Rico, but when legislation in 1996 phased out those breaks, the companies left. Last year Puerto Rico passed Act 20 and Act 22, which give tax breaks to particular kinds of companies and 100 percent tax exemptions to several hundred millionaires moving to the island. Congress (worried about revenue loss) and old island residents (not amused by higher taxes for themselves and free rides for wealthy new arrivals) may nix such tricks.

LIBERAL BAILOUT PROPONENTS SCOFF at “American exceptionalism” but buy claims of Puerto Rican exceptionalism, arguing that Washington has abused Puerto Rico in unique ways.

It’s true that the federal Jones Act, a century-old shipping measure that restricts competition from foreign merchant ships, has raised prices for transporting goods to Puerto Rico. It’s also true that NAFTA made Mexico rather than Puerto Rico a favored southern trade partner. And yes, nuances involving Medicaid and Medicare payments, territorial bonds, and other aspects need examination. Furthermore, on Dec. 4 the U.S. Supreme Court jumped in by agreeing to rule next year on whether some governmental bankruptcies could occur in Puerto Rico, even without congressional action. (For a week starting Dec. 11 I am writing about these wrinkles on WORLD’s website.)

But Puerto Rico has also hurt itself. The United States finishes seventh (out of 189 countries) in the World Bank Group’s Doing Business rankings, but if Puerto Rico were an independent country it would be 92nd in enforcing contracts, 158th in providing construction permits, and 163rd in registering property. Corruption is rampant, and one missionary on the island—identifying him as criticizing his hosts could cost him his job—said, “Everyone knows Puerto Rico is in crisis. Few know they’re part of the crisis.” He noted that a spiritual crisis is at the root of the financial one: “People are disillusioned. Irresponsible churches abuse them theologically. The gospel is not being presented.”

San Juan economist José Villamil says, “The last four administrations have kicked the can down the road. At this point, there is no more can to kick. So we’re going to take some very strict measures and some very profound measures. It’s going to hurt, but there’s no way out.” One kind of hurt involves tax hikes, and Puerto Rican legislators are proving themselves semisadists: In March the import tax on crude oil jumped 68 percent, from $9.25 to $15.50 per barrel. In June the sales tax rate increased from 7 to 11.5 percent, and sewage rates rose by 60 percent. Next April Puerto Rico will institute a value-added tax of 10.5 percent in an attempt to gain more revenue for the government.

Such increases will push more people out of the aboveground, taxed economy and into black market pursuits. The greater need is to unleash entrepreneurs and cut government expenditures, which means cutting bloated payrolls—and politicians hate to lose the ability to hand out jobs to friends and relatives. Puerto Rico officials have floated plans to consolidate public schools, amend license fees, and reduce $166 million from the University of Puerto Rico budget, but that last proposal led to student protests in May.

Mainstream media over the next month are likely to run sky-is-falling accounts generated to produce bailout pressure. The real measure of whether politicians face reality will come on Jan. 11, when leftist student leaders at the University of Puerto Rico are likely to push for a student strike: It’s an every-five-years-or-so tradition there, with the last big one coming in 2010-2011. Architecture professor Jorge L. Lizardi Pollock said most of his students come from affluent families: “I often tell them, ‘Once you close down the campus, think about the poorest students. For them it’s not a game.’” He noted a typical student reaction: “My generation needs to strike. Others did.”

If there is no strike, that will mean politicians are kicking cans down the road again and trying to avoid boomerangs. It may also mean that para afuera has come through with a bailout that will give states like Illinois (see sidebar) permission to go further into debt. Just as Canada is America’s judicial canary in the coal mine, providing early warning of social trends that later come to the United States, Puerto Rico is our financial canary, alerting us to what happens when governments pass out Christmas presents all year long (without the cash to cover the cost) and an economy declines.

State of embarrassment

“For all intents and purposes, we are out of money now.”

Government officials rarely speak in such blunt terms, but that’s what Illinois Comptroller Leslie Geissler Munger told reporters in October. And with good reason: Decades of overspending leave Illinois likely to end December with $8.5 billion in unpaid bills for this year alone, and overall debt above $146 billion. The bond-rating house Moody’s ranks Illinois as the nation’s worst state, its bonds just three steps above junk.

With Republican Gov. Bruce Rauner and Democratic House Speaker Michael Madigan at war, Illinois is operating without a budget. Nonprofit groups that depend on state checks are spending down their reserves, cutting back services and salaries, and laying people off or closing altogether. The secretary of state has quit sending out license plate renewal notices. The Illinois State Lottery has suspended payouts over $600, replacing them with IOUs—predictably leading to a sharp drop in ticket sales, making the state’s budget crisis even worse.

The biggest financial problem Illinois faces is a bloated pension system that gives middle-aged government employees hefty payments amounting to most of their final average salary. About half of current government pensioners have retired at age 59 or earlier, many taking advantage of salary spikes at the end of their careers: 6,000 retired teachers rake in six-figure pensions. The Chicago Tribune’s “Pension Games” series spotlighted state and union officials gaming the system by claiming two pensions, receiving pensions for one day of substitute teaching, and so on.

Meanwhile, Illinois legislators over the years have underfunded or postponed payments into the pension funds so they could spend money elsewhere. In 2005, Gov. Rod Blagojevich—later imprisoned for (among other things) trying to sell Barack Obama’s U.S. Senate seat—even signed a two-year “pension holiday” letting the state skip half of those payments.

Mix in some accounting miscalculations and economic downturns and you had a recipe for disaster. Today, the Illinois pension system is less than 43 percent funded. The system cries out for a fix, but in May the Illinois Supreme Court unanimously swatted down a pension-reform law, citing the state constitution’s provision that promised benefits—including cost-of-living adjustments—“shall not be diminished or impaired.”

Gov. Rauner has advocated a constitutional amendment to change that, but an amendment is a political long shot that would require support from two-thirds of legislators and three-fifths of voters and would surely face fierce resistance from retirees and unions.

With pension savings off-limits, that leaves Illinois’ discretionary spending on the chopping block. “We’re just starting to see the first big signs of trouble,” says Ted Dabrowski, vice president of policy for the Illinois Policy Institute, a conservative-leaning think tank. “Very soon, more than half of our state education dollars will go to retirement, and less than half to the classroom. We’ll see more and more cuts to core programs we rely on, like education and public safety.”

With Illinois in the danger zone, other states—also weighed down by grossly inflated public pensions—are competing to see which will go broke first. California, New York, and New Jersey are leading contenders. Dabrowski has a message for these states and any others traveling the same path: Turn back before it’s too late—if it isn’t already.

“The key lesson of Illinois is the same as Detroit: You can’t allow a problem to fester,” he says. “If you do, then eventually people leave, companies leave, you lose your tax base, and you get into trouble you can’t get out of. The lesson for other states is to begin action on your own pension reforms now—and the bolder the action, the better.”

See Marvin Olasky’s additional reports on Puerto Rico.

Listen to Marvin Olasky discuss “Puerto Rico panic” on The World and Everything in It.