Feeling blue in Puerto Rico

24-hour news pundits may not be the most reliable sources, but even non-partisan, reputable economists and political scientists have long failed to predict the consequences, or benefits, of their favorite red or blue state fiscal policy . . . except when it comes to Puerto Rico.

Those who are trained in the sciences understand that, without a “true experiment,” it’s impossible to really know the impact of specific economic policies.  When researching policy and economics, there is no research lab, no controlled environment, and little room for experimentation.  Experiments are performed through the lens of history and with only theories as results.  There are millions of variables that contribute to economic decisions at any given moment, making it impossible to separate the one that your favorite political party advocates. 

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In the case of corporate taxes, for example, conservatives argue that increasing taxes in one state will provoke a mass exodus of businesses, along with their jobs, to its closest neighbor with a lower tax rate.  Take Maryland Governor O’Malley’s surfeit of tax increases over the last few years and claims that Virginia - its more tax-friendly neighbor - has reaped the benefits of economic growth and increased public revenues.  Although this seems intuitive, and probable, it’s impossible to know whether businesses have moved for cheaper taxes and reduced compliance costs or if owners are just afraid that a hurricane will sweep Maryland into the ocean.

Being an island, however, Puerto Rico’s economy represents an opportunity closer to a true experiment than any state in the continental U.S.  Considering that most of the island’s residents and businesses don’t pay federal taxes, Puerto Rico has a level of autonomy greater than anywhere else in the U.S., and the costs to move outside of its jurisdiction are far more prohibitive than for businesses in other states, local policy has become the greatest economic driver in Puerto Rico (although IRS tax policy and U.S. demand are still major forces).   

Although Puerto Rican political parties also aren’t defined by the typical socio-economic concerns that drive allegiance to our Republican and Democratic parties, choosing instead to divide (and divide they emphatically do) along the lines of their preference towards the island’s future status as a state, independent nation, or more refined status quo, liberal and conservative ideologies still pervade local politics. 

Over the past 30 years, Puerto Rican politics has been dominated by more liberal, blue state-leaning policies.  Of the eleven governors who presided over the Commonwealth of Puerto Rico, nine have been Democrats.  By total time in office, Republicans have been in power for about 12 per cent of the time.  In general, these governors have opted for increased spending, expanding governments, increasing welfare and other transfer payments from the Federal Government, and higher taxation in the hopes that revenues would come close to supporting government spending programs.   

The result isn’t pretty.  Since become a Commonwealth, the percentage of unemployed workers in Puerto Rico has been higher than anywhere in the U.S., oftentimes hovering in the mid-teens, while at times reaching the low 20s.  Labor force participation is also very low, recently falling to 40 per cent (compared to 63 per cent in rest of country).  Crime is extraordinarily high, entrepreneurship is falling, the informal economy is estimated to account for nearly 30 per cent of GDP (I think it’s closer to 40 per cent), nearly half of the island is dependent on welfare, the population is declining rapidly, bureaucratic red-tape is unreasonable, legislators refuse to divest the inefficient public corporations pushing utility costs to record highs, and, in case you haven’t seen in recent news, Puerto Rico has debt and deficits that are bringing it to the brink of insolvency.  In fact, the only thing keeping it afloat is a bond market full of speculators hoping to make a quick buck before the island does have to ask (beg) for federal assistance. 

There was one brief hiatus from Democratic rule during the previous administration, which, not so coincidentally, was also met with the only reversal of the economic downturn in recent history.  Impaired by a deficit greater than $3 billion (more than 30 per cent of revenues), high unemployment, a post-recession economy, a large and growing government payroll, a bureaucracy that, in some cases, forced entrepreneurs to wait years to obtain the proper licensing, and deficit-laden public corporations and pension funds, Republican Governor Luis Fortuño insisted on policies that slashed spending and taxes, while privatizing the government’s biggest burdens.  The conservative governor reduced the deficit by 80 per cent, reinvigorated manufacturing and export investment, lowered the time to obtain a business license to 90 days, increased the government’s credit ratings, improved small business growth, and lowered the unemployment rate resulting in the first period of economic expansion in six years. 

Regrettably, voters decided to place their faith back in the hands of a blue state politician, the current governor of Puerto Rico . . . and things could not be worse.  Unemployment quickly rose by a full percentage point during the first year of the new administration, pension liabilities make up more than 40 per cent of total debt, which continues to grow at well over 100 per cent of GDP, utility costs are often twice as high as on the mainland, domestic corporate taxes were increased by as much as 60 per cent, entrepreneurial and business grant programs were cut, professionals are leaving the island in droves, the economic activity index has fallen for the last fourteen months, and credit rating agencies have again lost faith.  All three major raters reduced their outlook on Puerto Rico, while some analysts now consider default an inevitability.

Thanks to Democratic policies, Puerto Ricans are feeling bluer than ever.

Unfortunately, we’ll never have a chance to plan a real scientific experiment that pits red state against blue state fiscal policies.  But, if Puerto Rico is the closest thing to it, it doesn’t take a trained researcher to understand the results:  if governments lean a little more red, its citizens will feel a little less blue.

Vélez-Hagan is executive director of The National Puerto Rican Chamber of Commerce, economic policy researcher at the University of Maryland-Baltimore County, and author of the upcoming book, Nousonomics: The Common Sense behind Basic Economics.