Puerto Rico, an American territory, risks a Greek-style bust. With $70 billion of debt outstanding, the equivalent of 70% of its GDP, it is more indebted than any of America’s 50 states. (Puerto Rico is not technically a state, but its bonds are treated as if it were.) Yields on its bonds have soared as high as 10%, as investors fret it may be heading for a default.
Like Greece, Puerto Rico is a chronically uncompetitive place locked in a currency union with a richer, more productive neighbour. The island’s economy is also dominated by a vast, inefficient near-Athenian public sector. And, as with Greece, there are fears that a chaotic default could precipitate a far bigger crisis by driving away investors, and pushing up borrowing costs in America’s near-$4-trillion market for state and local bonds. Yet the Hellenic comparison is also helpful: it should show the Americans what not to do.
For decades Puerto Rico has been sustained by federal subsidies. Its people, far poorer than the American average, get lots of transfers, from pensions to food stamps. Until 2006 the economy was buoyed by tax incentives for American firms that manufactured there. As drug companies took advantage, the territory became a vast medicinal maquiladora.
This tax break disappeared in 2006, and Puerto Rico’s economy has shrunk virtually every year since. It has been able to keep on borrowing, thanks to another subsidy: interest on Puerto Rican debt is exempt from state, local and federal taxes in America, making it artificially attractive to investors.
Some Puerto Rican bonds that are just dyin’ to meet you
No growth and heavy debt are a toxic combination. In 2010 Puerto Rico’s previous governor tried—and failed—to boost the economy with tax cuts. The current one, Alejandro Padilla, has raised taxes sharply, and hopes for a balanced budget in 2016 (see article). Puerto Rican officials insist their country is solvent. And with some heroic assumptions about future growth and rising tax revenue, you can get the numbers to add up.
This is where Greece’s experience warrants study. It suggests that austerity alone is no route to solvency in a chronically uncompetitive economy. Puerto Rico’s priority should be structural reforms to boost growth, from breaking up monopolies to reducing red tape. The island scores 41st in the World Bank’s Doing Business index, whereas America is fourth. Labour costs are too high, not least because the federal minimum wage, which applies in Puerto Rico, is almost as much as the average wage. Politicians in Washington must help, not least by getting rid of crazy rules that force all cargo between the island and American ports to be carried on American ships.
The second lesson from Greece is that if debt does need to be restructured, it is best to do it sooner rather than later. Greece waited far too long. America’s Congress is unlikely to provide official loans to pay off private bondholders, as the Europeans did for Greece. But America’s policymakers could, and should, ensure that a Puerto Rican debt restructuring is orderly. The federal government could provide interim finance to assist the restructuring, much as the IMF does elsewhere. Even the legal details of Greece’s bond swap could be a model.
None of this would be easy even if policymakers in San Juan and Washington were bold and far-sighted. But the former are pussyfooting, and the latter are not even paying attention. Expect Puerto Rico’s debt crisis to get worse.