May 2, 2016 Print

San Juan, Puerto Rico. Photo credit: cogito ergo imago (license: CC BY SA 2.0)

Government planning and management of the economy can have disastrous consequences that last for generations. Puerto Rico today faces a fiscal crisis that traces its origins to profligate public corporations set up during the 1940s, in the style of President Franklin D. Roosevelt’s New Deal, explain a set of recent publications from Atlas Network partner the Mercatus Center at George Mason University, including a research study, expert commentary for the Fiscal Times and the Hill, and a debate between two scholars about potential solutions to the Puerto Rican debt crisis.

“My analytical focus in on public debt, so I had been aware of the Puerto Rico situation for some time,” said Marc Joffe, one of the publication authors and principal consultant at the research group Public Sector Credit Solutions. “We found two issues that have yet to receive sufficient attention. First, a discrepancy in meaning between the English and Spanish versions of the Commonwealth’s 1952 Constitution rendered Puerto Rico’s balanced budget requirement to be very ineffective. Also, public corporations — which were formed or expanded under the New Dealer Rexford Tugwell — issued large volumes of debt as far back as the 1940s. Because of these factors, Puerto Rico’s fiscal issues are chronic rather than acute and require institutional solutions such as amending the Constitution and privatizing public corporations.”

In the research study, co-written with Mercatus research assistant Jesse Martinez, the authors outline a number of additional factors contributing to the long-term nature of the crisis, including a U.S. tax exemption that made the island more attractive to outside investors, an open migration policy with the United States that has led many to leave Puerto Rico as its economy declines, a 1996 sunset to a prior exemption of corporate income from federal taxation, and more. Still, mismanaged public corporations are a primary factor.

“When large business enterprises are owned by the government rather than private shareholders, they often underperform due to cronyism and inadequate management incentives,” Joffe wrote in his commentary for the Fiscal Times. “Today, the alphabet soup of Puerto Rico’s state capitalist enterprises embraces water, sewerage, ports, transportation, housing finance, industrial development and banking. If these entities were privatized, many aspects of Puerto Rico’s economy could become more dynamic. Although state and local governments perform similar functions on the U.S. mainland, it is unusual to see all of these activities handled by the public sector in one place.”

Privatizing these public corporations, with shares spread widely in order to minimize corruption, would go a long way to helping alleviate the conditions that allowed the crisis to build. Joffe and Martinez also suggest that other crucial elements of a full recovery would include “federally appointed financial control board” to balance Puerto Rico’s finances through debt restructuring and oversight, and constitutional reforms that should include “strong and well-defined constitutional spending and borrowing restraints,” as well as new public pension controls.

“New crises will be almost inevitable in the absence of major institutional changes in Puerto Rico,” Joffe and Martinez conclude. “History has bequeathed the island inefficient state-run enterprises and a government unable to balance its budget, but Puerto Rico could have a bright future if it undertakes the right reforms.”