Puerto Rico's best shot at economic recovery

Anne O. Krueger, senior research professor, Johns Hopkins University
Key Points
  • Puerto Rico has a once in a generation chance to enact real economic reform post Hurricanes Maria and Irma.
A man surveys a house that was washed away by heavy surf during the passing of Hurricane Maria in Manati, Puerto Rico on October 6, 2017.
Ricardo Arduengo | AFP | Getty Images

More than three years ago, I led a team preparing a report on Puerto Rico's economy at the request of the Commonwealth. Puerto Rico was in dire straits: real GDP had been falling since 2006; migration out was accelerating; and the Commonwealth's debt had risen to the point where further borrowing could take place, if at all, only at a very high interest rate. The situation has gotten worse. But Puerto Rico now has a once in a generation opportunity to change course.

Recent governments controlling the island believed that Puerto Rico was in recession, and sought to remedy the situation with increased government spending. But Puerto Rico was not in recession: it was in decline. Years of fiscal stimulus failed abysmally. We found that a panoply of growth-inhibiting policies adopted by Puerto Rico and others imposed by the US government had contributed to the dismal performance.

It remains clear to this day that changes in economic policies need to be made, and there will be difficult years of transition. When countries find themselves in such severe difficulty, they can approach international organizations for support.

Puerto Rico, however, has no such lifeline. There is virtually no prospect of a resumption of sustainable growth without policy reforms, funding for pensions has run out, the government is no longer creditworthy, and the tax burden is already relatively high. PROMESA, which mandated the establishment of an Oversight Board to, among other things, oversee the budget and debt-servicing relief, did not authorize any new money.

The situation is further complicated by Irma and Maria. The electric utility, PREPA, inefficient and costly, which had failed to invest in maintenance and resiliency and is saddled with unsustainable debt, has failed completely. Add to this the damage to other infrastructure and productive capacity, and it is no surprise that an additional 200,000 persons have left the island.

Yet there is an opportunity in the midst of this tragedy. The significant hurricane assistance authorized by Congress and continued suspension of debt service could cushion the impact of much-needed reforms through the short-term rebound from the undertaking of construction and other activities.

The most important prescription for change is in Puerto Rico's labor market. Labor force participation is estimated to be under 40 percent (versus 63 percent on the mainland). Reasons for this include costly regulations governing conditions of work and disincentives for participating in the formal labor market (no earned income tax credit and full access to federal welfare programs).

Puerto Rico is also subject to the federal minimum wage, which is harshly binding, deterring employment (Puerto Rico's per capita income of about two-thirds that of the poorest state, hence the requirement bites hard); a required Christmas bonus of one-month's pay compounds the problem. Other areas of structural reform that are needed include improving the business climate, relaxing regulations governing youth employment, and infrastructure modernization (especially the provision of reliable and competitively priced electricity).

Puerto Rico will also have to overcome disadvantages relative to U.S. states and territories. If it were a state, per capita federal support for Medicare and Medicaid (which covers 60 percent of the population) would be 2.5 times larger than present levels. Puerto Rico receives less than half the lowest supported state (Nevada) and the total shortfall (excluding exceptional financing) is about $2 billion a year. The Jones Act requires that Puerto Rico (but not the U.S. Virgin Islands) use more costly U.S. vessels to ship to and from the mainland.

Puerto Rico must seize the opportunity at hand. Federal disaster relief money gives the Island breathing room to offset deflationary pressures from needed targeted fiscal downsizing. Deep structural policy reforms can reverse the negative economic spiral and spur growth. At the same time, debt restructuring should give room for deep economic reforms to put Puerto Rico on a new growth trajectory. The return to creditors will be higher and reforms can turn the Island into the jewel of the Caribbean.

If, however, federal funds are expended without reforms, the prospects will be dismal. The one-time stimulus from the infusion of cash for reconstruction and other relief efforts will have dissipated. The island's economy and population will return to a world of economic contraction.

Commentary by Anne O. Krueger, senior research professor of International Economics, School of Advanced International Studies at Johns Hopkins University.

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