Puerto Rico, with more than $70 billion of bonds at stake, has become a testing ground of austerity for an economy in decline. The Oversight Board, created in 2016 to address the territory’s debt crisis, has leaned toward the conservative prescription of spending cuts and tax increases to restore fiscal discipline and restore growth. Liberal economists have warned that austerity will ultimately stall growth, putting both citizens and bondholders at risk of a repeat crisis.

This series, Austerity on the Island, looks into whether the board’s approach to Puerto Rico — which it prefers to call right-sizing or right-rating — is the best way to bring about economic growth and minimize societal pain.

Part 1 examines how the board created its fiscal plan and how austerity fits into the plan, and gives examples of countries and states such Ukraine and Peru that the board says have used similar tools to address fiscal and economic crises.

Part 2 presents the research and arguments of leading proponents and opponents of austerity, finds some shortcomings in the economists’ conclusions, and looks into the past experience of several countries with fiscal crises, most notably Portugal, where alternatives to austerity proved effective.

Part 3 highlights the potential societal costs of austerity in general, and of the Oversight Board’s fiscal plan on the vulnerable population of Puerto Rico in particular, where poverty is about three times the U.S. average.

Part 4 presents the opinions of experts on how to improve the island’s finances, most of them economists whose ideas diverge from those of the board.

Part 5 examines the board’s current predicament. With much of the board’s plan yet to be implemented, it suggests the board could take other approaches to avoid austerity’s pitfalls.

Part 1

Puerto Rico’s sputtering economy shows risk of fiscal plan

Puerto Rico, with more than $70 billion of bonds at stake, has become the latest testing ground of austerity as the right prescription for an economy in decline.

The Oversight Board has embarked on a strategy that leans toward conservative prescriptions to restore fiscal discipline and economic growth as the territory undergoes its historic debt restructuring. In this five part series, The Bond Buyer examines whether the board's approach is likely to succeed, and reviews academic research on economies where the strategy has been applied and the impact austerity has had on vulnerable populations such as Puerto Rico's. It also explores alternative measures that may be needed to guard against a repeat of the crisis that led to the biggest municipal bankruptcy in U.S. history.


Now, after nearly two years of economic growth following Hurricane Maria’s devastation, reports from the Economic Development Bank for Puerto Rico signal the economy may have resumed the decline experienced from 2006 to Hurricane Maria’s arrival in September 2017. The bank’s economic activity index has declined four out of the last five months on a year-over-year basis.

The negative economic readings have raised concern that the austerity measures may undercut the island’s recovery, putting bondholders on a path for a second round of restructuring in a few years, regardless of any deal they work out in Puerto Rico’s bankruptcy court.

“There’s no reason to assume that long-term population and economic decline won’t resume,” said Matt Fabian, partner at Municipal Market Analytics. “This doesn’t, on its own, mean Puerto Rico will default again, but it suggests Puerto Rico’s finances and infrastructure will still be fragile when the next shock occurs.”

In its fiscal plan the Board outlined a schedule requiring $12.78 billion in spending cuts and revenue-increasing measures from fiscal year 2018 to fiscal year 2024. Most of these adjustments are scheduled to be carried out in coming years. The board, which the Puerto Rico Oversight, Management, and Economic Stability Act established in 2016, also set out to reform governmental policies.

The board’s measures were greeted with skepticism from more liberal economists from the start.

“The proposals that have been put forward [by the board] are likely to make the depression in which Puerto Rico has been, continue,” Nobel Prize-winning economist Joseph Stiglitz said in April 2017. “I’ve seen policies like this in other countries around the world and they have almost never worked. In fact, I can’t think of a single example when it’s worked.”

Though the Oversight Board itself projects its measures will reduce Puerto Rico's growth in the short term, Executive Director Natalie Jaresko said Stiglitz's criticisms were misguided.

“He has to look at where our reality is. This is a sustainability issue,” she said in a Dec. 5 interview with The Bond Buyer. Unlike some countries Stiglitz may be familiar with, Puerto Rico can’t print money or change its interest rates, Jaresko said.

In U.S. Congress, where the committee overseeing U.S. territories is weighing amendments to PROMESA, the Board’s fiscal approach has also come under fire.

“Austerity alone does not work and will only lead to further economic contraction,” said House Natural Resources Committee Chairman Raúl Grijalva, D-Ariz., at a committee hearing concerning Puerto Rico on May 2.

Board policies

From its foundation, the board has had the task of bringing structural balance to a budget that then-Gov. Alejandro García Padilla in 2016 projected to be short $58.7 billion from fiscal year 2017 to fiscal year 2026. The board is supposed to do that without decimating essential social services or cutting too much into pension funding, and ultimately restore access to the capital markets, and to do so in a manner that will open a way to economic growth.

Creating the board’s fiscal plan, which lays out the board’s policies, was “an extraordinarily complex process,” Jaresko said.

Yet there are some indications that the board had decided upon its approach very early in its tenure, without getting expert or public input. At the board’s first meeting in September 2016, board member Andrew Biggs said that he had done a study showing that countries in fiscal crises that focus on cutting spending much more than raising taxes have better outcomes. The first version of the board fiscal plan, released in March 2017, had the same balance of fiscal measures.

Also at the first meeting board member Arthur González said the board members had to present a united front concerning their policies. Consistent with this, board discussions of policy prior to then and largely since the release of the March 2017 fiscal plan have been held in private.

Jaresko said the creation of the board’s fiscal plan started with then-Governor Alexandro García Padilla’s submission of a proposed fiscal plan in October 2016. Subsequently, Governor Ricardo Rosselló submitted his own proposed fiscal plan in early 2017.

However, the board didn’t hold any public meetings on the plan before releasing its first version in March 2017. Most of the board’s overall approach was found in that document, even if the board has revised it several times since then.

According to Jaresko, in creating the plans the board solicited advice from consultants and professional economists and demographers. For ideas on how to promote economic growth, it turned to the local business community, Jaresko said. Board members and Jaresko provided input all along, she said.

After major hurricanes hit the island in late summer 2017, the board held three public hearings to help it revise the plan.

To address the structural deficit Puerto Rico’s government needed to be smaller. The board’s cuts to government spending thus didn’t stem from an ideological belief that island’s government should be smaller, she said.

Nevertheless, the board’s approach to addressing Puerto Rico’s problems is at least partly drawn from conservative prescriptions.

For example, the board plans to introduce a work requirement for recipients to participate in the Nutrition Assistance Program. It also pressed to change Puerto Rico’s employment law to make island employment at-will, though it dropped that measure from the fiscal plan in the face of opposition from the local government.

The board’s approach is also conservative in that its fiscal plan's approach to economic growth is usually to reduce impediments to business. As discussed later, some economists suggest other paths.

The board’s fiscal plan includes a range of steps to ease doing business on the island. Among these are steps to speed construction permits and make it easier to fill out tax forms and register property.

With the cooperation of the local government, the board plans to introduce a local version of the federal earned income tax credit.

The board plans to work with the local government to update a program that trains the workforce. It seeks to take steps to increase electricity reliability and lower electrical prices, to make the island a more competitive place for businesses to work.

In the board’s quest to achieve a balanced budget, it plans to raise taxes and cut spending.

“Such policy actions will generate a contractionary impact on the economy in the short term but are necessary to drive fiscal sustainability in the long term,” the board said in a May 2019 fiscal plan.

By the board’s own reckoning, its taxing and spending policies will cost Puerto Rico 5.3% of gross national product growth from fiscal year 2019 to fiscal year 2024.

In the same period, the board projects expenditure cuts of $11.7 billion offset by spending $1 billion for a new earned income tax credit, for a net expenditure cut of $10.7 billion.

The board’s net spending cuts and tax and revenue increases amount to $13.2 billion in the period, compared with anticipated Puerto Rico government spending of $82.2 billion after the measures.

It anticipates its tax and revenue measures will generate an additional $2.5 billion in the period.

PROMESA didn’t give the board legal authority over taxes. However, the board had and continues to have considerable leverage over the local government by indicating that money not found through increased taxes and fees would make the board gain the money through increased program cuts.

The board’s fiscal plans have included increased revenues due to tax and fee increases and to improved tax collection techniques. It discussed and reached these programs through discussions with Puerto Rico governors.

The board usually doesn’t call its measures “austerity.” Instead it describes them as “right-sizing” and “right-rating,” among other things.

However, the fiscal policies follow Wikipedia’s definition of austerity: “Austerity is a political-economic term referring to policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both.”

Natalie Jaresko

Natalie Jaresko, Puerto Rico Oversight Board executive director, is responsible for implementing the board's policies. Source: Bloomberg News

Natalie Jaresko, Puerto Rico Oversight Board executive director, is responsible for implementing the board's policies. Source: Bloomberg News

In December Jaresko cited several examples of political entities in fiscal crises that had pursued policies similar to those of the board and had succeeded. She mentioned Ukraine under her tenure as Minister of Finance in 2014 to 2016, when it had fiscal, debt, and military challenges.

Jaresko also cited Peru in the early and mid-2000s, Turkey from 2001 to 2007, Colombia in 2003, and the former Soviet state of Georgia from 2014 to the present as examples. Peru’s government reduced spending in the period and saw poverty drop to 21% in 2015 from 58% in 2001. Turkey made budget cuts and introduced performance management and saw gross domestic product increased by an average of 7.1% annually from 2002 to 2007.

Colombia introduced taxes in 2003 and saw GDP growth better than the Latin American average during the period. Finally, Georgia in the period reduced spending and experienced healthy GDP growth rates from 2016 to the present.

But Puerto Rico has its own problems, arguably bigger than most of those political entities Jaresko pointed to. And some say the board's approach isn’t the right way to go.

Published on December 23, 2019

Part 2

History provides lessons as austerians battle fiscal crises

At the first Puerto Rico Oversight Board public meeting, Board Member Andrew Biggs said he had done research showing that the best policy practices for countries struggling with debt are ones that place much more weight on spending cuts than on tax increases.

In the paper, “A Guide for Deficit Reduction in the United States Based on Historical Consolidations That Worked,” which Biggs authored with Kevin Hassett and Matthew Jensen, they said that: “The average expenditure share for successful consolidations is 80 percent if inclusive of our calculations and those from [others].” They argued that cuts should be focused on government wages and the provision of social transfers.

Biggs’ preference is in line with that of Alberto Alesina, an exponent of austerity for countries with large debts. The Harvard University professor has been writing about government fiscal policy for much of his 33-year career. He authored a book with Carlo Favero and Francesco Giavazzi, “Austerity: When it Works and When it Doesn’t,” published earlier this year.


Harvard University Economist Alberto Alesina said that austerity has a better track record when it consists mainly of spending cuts rather than tax increases.

Harvard University Economist Alberto Alesina said that austerity has a better track record when it consists mainly of spending cuts rather than tax increases.

The authors argue that government debt in major industrialized countries should be reduced. First, large public debts and unfunded pensions “imply a redistribution between current generations and future ones who cannot vote.” This is unfair, they say.

Second, when interest rates go higher, as they will do sooner or later, it will become much more painful to finance annual deficits.

“Third, in some countries high debt levels may generate default risk, high interest rates, capital outflows (as in Greece), and a debt crisis that may impose austerity when it is particularly costly,” they wrote.

Their book is a study of 200 multi-year austerity plans from 1981 to 2014 in 16 major industrialized free-market economies.

They acknowledge that austerity causes short-term economic contractions. However, they say that austerity is sometimes necessary and desirable, and that it can promote long-term economic growth.

Through a mathematical analysis of the 200 cases, the authors claim to show that plans that try to reduce government deficits through spending cuts have better outcomes than those that focus on tax-increases. Spending cuts-based plans have led to reduced government debt-to-gross domestic product ratios, while tax increase-based plans have had the opposite effect. Spending cuts-based plans have also harmed the economy less.

Alesina and his co-authors say that governments that cut spending give society’s participants confidence that the deficit problem will be permanently addressed. And this confidence helps promote economic growth.

For contrast, perhaps the best-known contemporary economist arguing against austerity policies is Paul Krugman, a City University of New York professor and New York Times columnist.

He made a case against austerity in a 2015 essay in The Guardian newspaper, “The Case for Cuts was a Lie. Why Does Britain Still Believe It? The Austerity Delusion.”

In 2010 British Prime Minister David Cameron warned that Britain’s growing government debt could trigger a crisis and argued for austerity policies to cut the annual deficit. Krugman was writing in response to the policies of Cameron and his successors in Britain. Krugman wrote primarily about the experience of European countries in the preceding eight years.

Not all of Krugman’s arguments are completely relevant to Puerto Rico and some of them concern countries in different circumstances than Puerto Rico.

Krugman presented a scatterplot of countries on a graph with the rate of gross domestic product growth on a y-axis and the harshness of austerity on an x-axis, both measured 2009 to 2013. The International Monetary Fund is the source of his data. Generally, those countries with the least austerity had the best economic growth and those with the most had the greatest contraction. Greece had the most austerity and the greatest contraction.

Krugman says this shows that some pro-austerity economists’ talk of the expansionary impact of austerity back in 2010 was “foolish.” He said that Alesina and others have looked at cases that are quite different from those in Europe since 2010 to argue for the value of austerity there.

Alesina and many other pro-austerians have acknowledged austerity’s short-term negative economic impacts. After the period depicted by Krugman’s scatterplot, most of the countries that had experienced austerity achieved economic growth. Britain, Portugal, and Spain’s economies have been growing since 2014. Indeed, Britain, which was going through austerity at the time, in general had gross domestic product growth from 2009 to 2014, albeit at a low level.

Among other critics of austerity is Brown University Professor Mark Blyth, who said in his book “Austerity: The History of a Dangerous Idea,” that excessive government spending wasn’t the primary factor in Europe’s sovereign debt crisis of the past decade, except in Greece. “For everyone else, the problem is the banks that sovereign [governments] have to take responsibility for, especially in the Eurozone.” The “Eurozone” refers to the 19 European countries that use the euro as their currency.

The European banks’ assets were a far larger portion of gross domestic product in the Eurozone nations than the U.S. banks’ assets were in the U.S. GDP. Prior to the Great Recession many of the European banks were over-leveraged and had lent to many questionable borrowers, Blyth said. Europe’s leaders were worried about the effects of deep or widespread debt markdowns on the banking system and how this would affect their economies, Blyth added.

According to Blyth, in the context of their inability to expand their own money supply or devalue individual countries’ currencies (because they were all linked in the euro), European countries in the midst of a downturn might normally have considered defaulting on debt, Blyth said. But since this would have blown up the banking system at the heart of the economy, Europe’s leaders turned to austerity.

In this way Blyth explains the prevalence of austerity policies in some European nations this past decade. While some economists have argued that with austerity some European countries returned to a long overdue responsibility, Blyth said the policies were just the result of peculiarities of Europe’s economy and the use of a single currency by many countries.

Blyth criticized an essay by Alesina and other pro-austerity economists that aimed to show that in an economic downturn government spending should be cut decisively. He said that the economists used poor examples to support their thesis: Denmark in the 1980s and Ireland in the late 1980s.

Blyth cited a Congressional Research Service report that found: “Withdrawing fiscal stimuli too quickly in economies where output is already contracting can prolong their recessions without generating the expected fiscal saving. This is particularly true if the consolidation is centered around cuts to public expenditures … and if the size of the consolidation is large.”

Blyth said that pro-austerity economists frequently cite the experience of Estonia, Latvia, Lithuania, Romania, and Bulgaria in the Great Recession to support their conclusions. During this period their economies underwent great stress but, according to the austerians, austerity helped them return to economic growth in this decade’s early years.

Blyth said that Latvia was a poor example because it returned to economic growth not during austerity but after it ended. By 2013, when Blyth’s book was published, the country still wasn’t experiencing growth at the same levels as before the recession, he said. What’s more, sovereign debt levels as a percent of gross domestic product rose in the period.

Blyth pointed to Ireland and Iceland to show what he saw as the bad and good approaches to handling simultaneous economic and banking crises of the Great Recession.


Anti-austerity march in Galway, Ireland in 2012. Source: Newscom

Anti-austerity march in Galway, Ireland in 2012. Source: Newscom

When a housing price bubble popped in Ireland in 2008, three major Irish banks teetered. Over the following months and years the Irish government instituted austerity and spent enormous resources propping up the banking system, Blyth said. Writing in 2013 he said Ireland had, since the recession, remained a bad place to be, with high unemployment, high ratios of debt to GDP, and heavy government spending cuts.

Blyth presented Iceland as a contrast. Prior to the recession many Europeans parked their money in Icelandic banks. The ratio of bank assets to GDP reached more than 11. During the recession international faith in the banks withered, pushing the banks into default.

While Iceland’s government chose to guarantee its residents’ deposits, it didn’t extend the guarantee to foreigners’ deposits.

“Where Ireland followed the mantra of austerity, slashed spending, and bailed its banks, Iceland let its banks go bankrupt, devalued its currency, put up capital controls, and bolstered welfare measures,” Blyth said. Because of this, the Great Recession had a more moderate and short-lived impact on Iceland, he said.

According to Blyth, Iceland shows that a country can let its banks collapse.

However, the situation of Iceland’s banking system was quite different from that of most banking systems as the vast majority of its deposits were made by those outside of the country. The damage that resulted from Iceland’s refusal to backstop foreign deposits almost entirely fell on the economies of other European states.

Further, the reality is that while Iceland’s government let key banks collapse, under International Monetary Fund pressure for a loan in 2010, it voted to pay Britain and the Netherlands up to 6% of Iceland’s GDP from 2017 to 2023 to help cover British and Dutch losses of Iceland bank deposits.

Iceland is also different from many European countries and Puerto Rico in that it had its own currency, the króna, which could devalue on the currency markets. The independent currency was both a positive and a negative to the economy in the Great Recession period and its aftermath.

Since the publication of Blyth's book, the economies of both Ireland and Iceland have done well. Iceland’s inflation-adjusted gross domestic product grew 24.6% to 2018 from 2013, according to the Organization for Economic Cooperation and Development. Its unemployment rate declined to 3.4% in August 2019 from 5.6% in January 2013, according to Eurostat.

Ireland’s inflation-adjusted gross national income grew 18% to 2018 from 2013. Its unemployment rate declined to 5.3% in August from 14.5% in January 2013.

In this past decade’s European economic crises, most of the countries turned to some form of austerity. As mentioned before, Iceland took a different route but was in a unique economic circumstance.

However, Portugal took a somewhat alternative path to dealing with economic contraction, excessive debt, and, for a brief period, inability to borrow more for its deficit spending. Also making it similar to Puerto Rico, Portugal adopted the euro currency from 1999 to 2002.

Portugal had weak economic performance from 2000 to 2014. Indeed, per capita income was lower in 2012 than it was in 2000. Despite repeated government austerity policies, the debt-to-GDP ratio rose from 50% in 2000 to 68% in 2007 and to 126% in 2012.


Portuguese police protest austerity in Lisbon in 2011. Source: Bloomberg News

Portuguese police protest austerity in Lisbon in 2011. Source: Bloomberg News

In 2011 the government could no longer borrow private capital to finance its deficit and it turned to the International Monetary Fund, European Financial Stabilization Mechanism, and European Financial Stability Facility for a 78 billion euros ($86.6 billion) bailout.

After several years of intense austerity from 2011 to 2014, voters in November 2015 brought António Costa to power.

Costa, a leader of Portugal’s Socialist Party, raised the minimum wage, pensions, public sector salaries, and restored the number of vacation days to pre-crisis levels. Creditors like Germany and the International Monetary Fund objected to the policies.

According to the World Bank, Portugal’s inflation-adjusted GDP was slowing its fall from the start of 2012 to mid-2013. By the third quarter of 2013 Portugal’s economy was growing. Thus Portugal’s economy had already been improving for two years when Costa became prime minister. However, it is notable that the economy continued to grow with Costa, lowering the unemployment rate from 12% in late 2015 to 6.2% in August.

Costa has also managed to reduce the government deficit from 4.4% of the GDP when he took office to less than 1% by July 2018. Yet government debt outstanding remains high, according to Moody’s Investors’ Service. It has declined from 130.3% of GDP in 2016 to 123.6% of GDP in 2018 and is expected to continue to shrink in the next few years.

Economic growth alone didn’t achieve this shrinkage. Costa also cut spending on infrastructure and some other areas. So he used at least one classic tool of austerity — cutting government spending — even if he focused on cutting non-traditional areas.

Moody’s rating of Portugal’s debt reached its lowest point since 1986 in Feb. 2012 with a rating of Ba3 with a negative outlook. As of Dec. 18, 2019, Moody’s rated the debt Baa3 with a positive outlook.

Portugal’s economic and fiscal improvement impressed many Europeans. In December 2017 the group of finance ministers whose countries used the euro, the Eurogroup, elected Portugal finance minister Mário Centeno to be its president. Centeno has been the finance minister since Costa became prime minister in late 2015.

Published on December 24, 2019

Part 3

Puerto Rico fiscal plan may hurt the most vulnerable

While arguably necessary in the long-term, the Puerto Rico Oversight Board’s austerity may be painful to many residents.

Puerto Rico’s residents are especially vulnerable, with 44.9% living in poverty, compared with 13.4% of the U.S. populace who are under the poverty line. According to the Puerto Rico Institute of Statistics a third of the island's residents are “food insecure.”

Puerto Rico

Source: Reuters

Source: Reuters

The board’s first fiscal plan, adopted in March 2017, specified that effects on the budget of measures cutting spending would be 1.85 times that of tax revenue measures. That plan covered fiscal years 2017 through 2026. The latest fiscal plan, adopted in May, indicated that the spending cuts would be expected to create 5.33 times the effect of the revenue measures. The plan covered fiscal year 2018 to fiscal year 2024.

At points the board has rejected the use of the term “austerity” to describe its actions. Rather, it has said the fiscal plan’s increases in taxes and fees would be to “right-rate” them. Similarly, it has said the plan’s cuts in departmental spending would be to “right-size” them. Yet the cuts to spending and increases to taxes meet the definition of “austerity.”

Though such austerity may be at least somewhat necessary, scholars tell us it has a social cost.

David Stuckler and Sanjay Basu argued in 2013 that austerity policies lead to suicides, deaths, and poor health. In an opinion piece in the New York Times titled “How Austerity Kills,” they said in the Great Recession, “Countries that slashed health and social protection budgets, like Greece, Italy and Spain, have seen starkly worse health outcomes than nations like Germany, Iceland and Sweden, which maintained their social safety nets and opted for stimulus over austerity.”

Unemployed man in Greece

Unemployed man in Greece looking at job listings in 2014. Source: Bloomberg News

Unemployed man in Greece looking at job listings in 2014. Source: Bloomberg News

After the collapse of the Soviet Union from 1989 to 1991 those countries that followed a “shock therapy” programs of transition to the free market, like Russia, Kazakhstan, Estonia, Latvia, and Lithuania had the worst rises in suicides, heart attacks and alcohol-related deaths. Belarus, Poland and Slovenia took a gradualist approach and had better health outcomes, Stuckler and Basu said.

“Like the fall of the Soviet Union, the 1997 Asian financial crisis offers case studies — in effect, a natural experiment — worth examining,” Stuckler and Basu said. “Thailand and Indonesia, which submitted to harsh austerity plans imposed by the International Monetary Fund, experienced mass hunger and sharp increases in deaths from infectious disease, while Malaysia, which resisted the IMF’s advice, maintained the health of its citizens.”

In his book “Austerity: The History of a Dangerous Idea,” economist Mark Blyth said when government services are cut to balance budgets, it is those on the bottom 40% of the economic ladder who are generally hurt.

By contrast in their book, “Austerity: When it Works and When It Doesn’t,” by Alberto Alesina and two other economists, say that many governments can make cuts to spending without hurting the poor.

Many observers have raised concerns about the impact of the Puerto Rico board’s social policies.

In a March 2017 paper posted to the site of the Center for a New Economy, Policy Director Sergio Marxuach said that economists have varying models about the negative economic impacts of spending cuts and tax increases on economic activity. He said the board’s then current 10-year fiscal plan would lead to reductions in the island’s gross national product of between 11.5% and 18.2%, depending on which model one used. “This in an economy that has already contracted about 14% since 2006,” Marxuach said.

The board disagrees with Marxuach’s economic predictions. They say that the fiscal adjustments will have a negative impact. However, “stabilization is a precondition of growth,” Oversight Board Executive Director Jaresko said. The positive economic impact of federal aid will outweigh the negative effects of the fiscal adjustments, she said.

The board’s fiscal plan includes increases in revenues through measures to improve tax-paying compliance and through tax increases on gaming, tobacco, licenses and other things, and by introducing taxes on medical marijuana and Airbnb rentals. None of these are broad-scale increases on the poor. However, a greater percentage of low income people than high income people smoke, so the tobacco increase will hit them disproportionately. Other poor people will have a hard time paying the increased fines and license and permit costs.

The board’s spending cuts are more likely to incur pain on residents. The agencies expected to experience the biggest cuts from fiscal 2019 to fiscal year 2024 are K-12 Education with $2.226 billion and Corrections with $665 million. Current fiscal year General Fund spending totals $2.4 billion for K-12 education and $396 million for corrections.

The board, through its fiscal plan, has made an effort to minimize the spending cuts’ impact on the populace. In many circumstances the board plans to gain savings through reorganizing the provision of services rather than through cuts in services.

It’s unclear whether this approach in the best of circumstances could succeed in reducing spending as much as the board hopes. By the board’s own admission in its document “Commonwealth Fiscal Plan Risks” from September there is a real danger that the approach won’t be properly implemented.

In that document the board said there was a danger that municipalities and the University of Puerto Rico won’t make enough progress in reducing their costs, forcing the commonwealth government to continue to subsidize them. The document also mentions the possibility that “poor implementation and new federal benefit requirements” might make health care costs rise more quickly than projected.

According to the Urban Institute, 35.4% of Puerto Ricans report fair or poor health versus 17.9% of U.S. residents. So if the board was to go beyond structural approaches to cutting health care costs, it would be affecting an already suffering population.

The board plans to introduce a work requirement for recipients to participate in the Nutrition Assistance Program, the local version of food stamps.

However, a December 2018 research paper by analysts with the U.S. Department of Agriculture showed that enforcement of similar programs in the 50 states have not increased the likelihood that aid-recipients will hold jobs. The programs have reduced the number of people receiving food stamps, raising the possibility that these people are turning to local food banks and/or simply eating less.

In the fiscal plan the board acknowledges the possibility that its health care spending cut approach won’t lead to adequate savings. As a backup it suggests that the island’s Medicaid program, Vital, might end coverage of certain things that some other states don’t cover. Examples of these include dentistry, vision and hearing exams, prescription glasses, and physical therapy. Cuts of these things would certainly incur real pain in the populace.

Even the cuts to funding of the healthcare industry may harm provision of healthcare on the island. According to the U.S. Department of Health and Human Services, the island has half the per capita presence of critical field medical specialists compared to the mainland. According to the board, prior to Hurricane Maria in September 2017, 500 doctors per year were leaving the island.

On July 1, 2017, Puerto Rico reduced fees paid to medical providers and particularly specialists. This led some to leave the island for the continental U.S.

From January 2018 to September 2019 the federal government provided additional funding for Vital through the Bipartisan Budget Act of 2018, allowing Puerto Rico’s health administration to relax the reduction in medical fees “in response to a sharp increase in emigration of specialty providers that was hindering delivery of necessary care,” the board said in its May certified fiscal plan.

With the loss of that the act’s money, Puerto Rico’s government has increased its contribution to Vital to maintain the level of funding. In December that government got President Trump to approve two years of Medicaid funding, at a somewhat lower level than the local government had requested. The local government had also requested four years of funding.

Among the features of the approved funding will be continued payments to providers at levels equal to 70% of Medicare scheduled levels. Without this funding the payments would have gone to well below 70%.

If reimbursement levels go down again in two years or thereafter, the island may again experience rapid emigration of needed doctors. This is an example of how the board’s cuts to non-service items can end up having a harmful impact on services.

The board is also requiring cuts to pensions being paid to Puerto Rico retirees. While these are fairly modest at 8.5%, they do address all seniors being paid more than $1,200 a month in pensions. About 61% of retirees will see no cut because they make less than that. Most of the rest are paid less than $2,000 per month, so the cut will have a real impact.

According to the Gov. Alejandro García Padilla 2016 proposed fiscal plan, the average annual pension benefit per beneficiary in Puerto Rico was $14,112, compared with an average of $26,455 for public pensions across the U.S.

The board plans to introduce a work requirement for recipients to participate in the Nutrition Assistance Program, the local version of food stamps.

However, a December 2018 research paper by analysts with the U.S. Department of Agriculture showed that enforcement of similar programs in the 50 states have not increased the likelihood that aid-recipients will hold jobs. The programs have reduced the number of people receiving food stamps, raising the possibility that these people are turning to local food banks and/or simply eating less.

In April 2018, Center of a New Economy Policy Director Sergio Marxuach wrote of the deeper cuts in pensions that were then proposed: “The social effects are foreseeable: chronic illnesses become acute when spending on medicines is cut, increases in the poverty rate and malnutrition among the elderly segment of the population, there is an increase in people postponing retirement and the number of people who literally die working, an increase in the abandonment of the elderly and an eventual decline in life expectancy.”

In response, Jaresko said the board was seeking to avoid the social impacts described by Marxuach. Without some cuts there would be no pensions for anyone, she argued, adding that the board isn’t cutting pensions for people near the poverty level.

Given the retirees are unsecured creditors, the court won’t approve a plan of adjustment without cuts to pensions, she said. “The goal has been to do the minimum necessary [pension cuts] to get it approved.”

Published on December 26, 2019

Part 4

What critics say the Oversight Board overlooked

Even if austerity has negative social effects and at least temporarily negative economic effects on Puerto Rico, there is a question as to whether there are alternatives. After all, Puerto Rico does need to balance its budget.

Center for a New Economy Policy Director Sergio Marxuach said that it was difficult to expand an economy while the board is cutting spending and increasing taxes. However, he said there were things that could be done now and more that could be done after structurally balanced budgets had been achieved and the board was gone.

Sergio Marxuach

Center for a New Economy Policy Director Sergio Marxuach said the island's economy needs a fundamental rethinking of its economic and political relationship with the U.S.

Center for a New Economy Policy Director Sergio Marxuach said the island's economy needs a fundamental rethinking of its economic and political relationship with the U.S.

The Puerto Rico Oversight, Management and Economic Stability Act directed that Congress create a task force to release a report with proposals to promote economic growth on the island. In December 2016 the task force, which consisted of four U.S. senators and four members of the U.S. House of Representatives, released the report making dozens of recommendations. Most of them were for federal government actions that could help Puerto Rico.

Marxuach complained that nothing was done with the task force’s report. An Oversight Board spokesperson pointed to a section of the board’s annual report to Congress, submitted in August, where it asked the federal government to enact several of the policies found in the report.

Among the recommendations were for the Medicaid system to treat the island treated in a more equitable, generous, and sustainable manner. This wouldn’t only improve health outcomes, but also “reduce the incentive for migration from” the island to the states and “stabilize and strengthen the fiscal condition of the territory governments.”

The task force recommended that Congress make the full amount of the rum cover-over-payment to Puerto Rico and the U.S. Virgin Islands permanent. Currently part of it is permanent and part of it is subject to federal tax extenders legislation.

The task force said that a domestic production activities tax deduction, enjoyed by about one-third of corporate activity in the 50 states, be extended to Puerto Rico. Affected companies are allowed to deduct 9% of their taxable income from qualified production activities.

The federal Small Business Administration should give a higher than existing guaranty rate to the Puerto Rico loans made under its 7(a) loan program, the task force said. These loans are used to expand existing, operate, or acquire businesses.

Puerto Rico residents currently are ineligible for federal Supplemental Security Income, which proves benefits to low-income aged, blind, and disabled persons in the states. Puerto Rico has a program called AABD that attempts to do something similar. The task force said that Congress should consider including the island in SSI.

“Puerto Rico has yet to establish a comprehensive economic development strategy that exploits the island’s many comparative advantages, both intrinsic and acquired, and that endures after power passes from one local party to the other,” the task force stated. “The task force recommends that the government of Puerto Rico take this constructive criticism to heart.”

Marxuach said if the island could get federal incentives or some of the other recommendations from the task force report, there could be growth even in the midst of austerity.

Federal hurricane aid will be coming in the next few years and this will help the economy, Marxuach said.

In the short term, business permitting and the overly complicated tax system need to be reformed and the cost of electricity must be reduced, Marxuach said. He acknowledged that the government and the board were working toward these goals.

In the long term, Puerto Rico must create something quite different from what has prevailed, Marxuach said. There must be change to its political and economic system and its relations with the federal government.

What Congress will do with Puerto Rico in terms of its status as a state or territory is important. However, Marxuach said he thought the status wouldn’t change much in the next two to three years.

Marxuach said Puerto Rico doesn’t have control over monetary or trade policy for the island, and that this lack of control is central to the island’s current economic problems. If the island were to become independent it could control both. If it became a state it would have more input on federal trade treaties.

Marxuach brought this conundrum up and these two possible ways of addressing them not to advocate for one or the other. Rather, he said he did it to say that since the Oversight Board took over in the summer of 2016, “Puerto Rico’s economic policy took kit is empty."

“That situation calls for a fundamental rethinking of Puerto Rico-U.S. economic interactions/relations. The status quo is simply not working,” Marxuach said.

Once the board disappears, Puerto Ricans will have leeway to change education, healthcare, and move toward a more environmentally sustainable energy system, he said.

The island needs to try to develop an economic plan or growth strategy now, Marxuach said. But it will be hard to put together an effective one in the next few years, until its debt is consolidated and it regains access to the capital markets, he said. It is worth working on now but it may not have a major impact in the next few years.

José Villamil, chairman of Puerto Rico-based economic and business consultant Estudios Técnicos, agreed with some of Marxuach’s suggestions.

While the board has necessarily imposed austerity measures on government spending, austerity and stimulus measures are not mutually exclusive, he said. They can be combined, he said in an October essay. Earlier this decade “Portugal did so and was very successful. These initiatives include those that stimulate competition, ease of market entry, productivity and flexibility in the economy, lower transaction costs, and minimize social costs.”

He went on: “In comparing Puerto Rico and Portugal, a number of differences exist that make it impossible to transfer the latter’s experience to the former without significant adjustments. One major difference is the industrial structure that is quite different.”

In an email he explained the difference saying that Portugal’s exports are very diverse and include automobiles, electrical machinery, mineral fuels and computers. There has been a growing European demand for all of these exports.

By contrast, Puerto Rico’s exports are highly concentrated in pharmaceuticals and medical instruments. “For recovery, diversification is much better than concentration.”

While external direct investment will continue to play a role in Puerto Rico’s economy, “it should not be the only source of growth and perhaps not even the most important,” Villamil said.

“Puerto Rico’s development must rest on mobilizing its internal resources to the maximum and reorienting its export base,” Villamil wrote in an essay with Diego Iribarren.

“Puerto Rico’s future economic prospects will depend … not on federal reconstruction funds or on the [Oversight Board’s] actions, but on reaching a consensus among key stakeholders on a clearly delineated vision for a prosperous and just post-reconstruction economy,” Villamil said. “A commitment to the strategies needed to achieve that vision is also needed.”

Villamil continued, “It will have to be the non-governmental sectors in society that will have to assume a leading role in creating that vision of a future Puerto Rico, in formulating the needed strategies, and in creating the institutional framework that will provide the necessary stability for mid and long-term success.”

More concretely, Villamil said that there should be changes to the island’s tax system, permitting practices, and regulations.The tax system should be changed to be simpler and to support investment and economic activity. Regulations should be more business friendly and permitting should be simplified.

The board and former Gov. Ricardo Rosselló have worked to reform these areas, albeit not to Villamil’s satisfaction.

Other observers of Puerto Rico’s situation had more succinct recommendations for policy.

Heidie Calero, president of a Puerto Rico-based economic and business consulting firm, said board Executive Director Natalie Jaresko "is not interested in any economic plan. She is only interested in fiscal stewardship and says that the economic plan is the responsibility of the governor, so she is not going to help. In my opinion, this is a very narrow view of what is required to get the resources needed to service public debt, which must be restructured.”

Calero, president of H. Calero Consulting Group, continued, “government’s role must be like a steward steering obstacles away from investment by the private local and non-local sector.”

Other analysts say Puerto Rico’s future economic growth needs to be assured by more dramatic cuts in its debt.

In November 2018 the MarketWatch website quoted economist Joseph Stiglitz as saying Puerto Rico’s total central government and authority debt should be cut by 73% and all unpaid interest should be canceled.

“Given the state of Puerto Rico’s economy after Maria, a much deeper restructuring is inevitable,” Stiglitz wrote in November 2018 on a Columbia University website. “By pursuing its new fiscal plan and the [Puerto Rico Sales Tax Financing Corp.] COFINA deal, the oversight board has squandered valuable time, ensuring that Puerto Rico’s decade-long struggle will both continue and grow worse.”

In a U.S. House of Representatives hearing in May, Rep. Nydia Velȧzquez, D-N.Y., said, addressing the Oversight Board, "when we passed PROMESA it was never intended for the board to implement harsh austerity measures on the island residents.

Nydia Velȧzquez

In spring 2019 U.S. Rep. Nydia Velȧzquez criticized the board's austerity, Brian Tumulty Source: The Bond Buyer

In spring 2019 U.S. Rep. Nydia Velȧzquez criticized the board's austerity, Brian Tumulty. Source: The Bond Buyer

“We provided you tools to deal with the debt which I feel you have not used to its full potential to cram the debt,” the representative continued. “And simply put — austerity doesn’t work. It didn’t work in Greece, it didn’t work in the United Kingdom, and it won’t work here. So you must look elsewhere to address the fiscal crisis. It cannot be on the back of the people of Puerto Rico.”

Rep. Raul Grijalva, D-Ariz., said he hoped a May 2 House of Representatives Natural Resources Committee hearing would persuade the board to “strike a more agreeable deal with the people of Puerto Rico so that most of the severe budget cuts can be rolled back and significant debt relief can occur.”

In an August 2015 New York Times opinion piece, economist Paul Krugman said that even with federal aid for social programs in Puerto Rico, too much local government austerity can be “self-defeating.” He said the island’s educational system should be prioritized over paying back the debt.

On Oct. 31 Moody’s Investors Service released a report that was pessimistic about the island’s future. “The commonwealth’s population will continue to decline and age as residents face weak job prospects, while large budget deficits loom as federal aid shrinks.” The analysts said the social trends will lead to resumed economic contraction.

“The commonwealth has two pathways to more sustainable operations: stronger Medicaid funding from the federal government and/or reforms laid out in the federal oversight board’s fiscal plan,” the analysts said. They said achieving them would be difficult.

Published on December 27, 2019

Part 5

How the Puerto Rico board may need to adjust its approach

Nearly all sides in Puerto Rico’s debt crisis have attacked the Oversight Board since its establishment in the summer of 2016. Various local parties have protested the board’s actions and said that it should have found money through further bond cuts. This is despite the board’s already deep restructurings, either proposed or actual, to most of the bonds.

Bondholders and bond insurers have said the board hasn’t respected the bonds enough and have called for cuts to wasteful local spending. However, they haven’t given specifics as to what significant-sized programs should be cut and by how much.

The reality is that, as Oversight Board Chairman José Carríon has said, the local government has made unrealistic promises to many parties and many of these promises cannot be observed. Puerto Rico’s government will have to make deep spending cuts, painful tax increases, and reductions to its debt and promised pensions.

Population in Puerto Rico

With the Oversight Board announcing this month that the central government can continue to pay the Christmas bonus, some observers may conclude that the board’s austerity for Puerto Rico has been and continues to be minimal. The "bonus," a mandated part of government worker pay since the 1970s, has been a sore point for bondholders, who saw it as an item that should be cut to free up money for debt payments.

Bondholders may be right in calling for the end to the Christmas bonus. However, whether or not that occurs wouldn’t materially change things for them. The bonus accounts for just 0.6% of this year’s budgeted General Fund spending.

In fact, while the board in November retreated on cutting the $60 million annual Christmas bonus, it has already implemented significant austerity measures, such as closing at least 255 public schools. The school closings are part of $2.23 billion in education cuts from last fiscal year through fiscal year 2024.

Most of the board’s planned spending cuts and tax raises are due to take place in the current and next few fiscal years, rather than in the last few.

Of course bondholders have suffered considerable pain since Puerto Rico stopped making payments on at least $59 billion of debt, covering a variety of issuers and bond types. The board has given holders of Government Development Bank and subordinate Puerto Rico Sales Tax Financing Corp. (COFINA) bonds deals formalizing cuts to principal ranging from 44 cents to 48 cents on the dollar.

The board is either seeking or appears to be near to imposing losses on other bond types. For commonwealth-issued bonds, it is offering cuts from 28% to 87% and is even threatening to cut 100% from bonds issued after 2011 unless the bondholders accept discounts steeper than those accepted by holders of early issue bonds.

Population in Puerto Rico

Oversight Board members Arthur Gonzalez and Ana Matasantos. Source: Reuters

Oversight Board members Arthur Gonzalez and Ana Matasantos. Source: Reuters

However, the pain that bondholders are experiencing doesn’t necessarily mean that their interests are served by having the board incur as much pain as possible on the local populace, through austerity and cuts in the social safety net. If these policies only lead to a return to the economic contraction that the island experienced with little interruption from 2006 to 2017, then it won’t matter what’s in the court-approved debt restructuring plans, because Puerto Rico and its authorities will ultimately default on their new debt deals.

In September 2018 Moody’s Analytics projected Puerto Rico’s economy would contract by 17% to 19.6% by 2028, though many economists and the board are more optimistic. If Moody’s turns out to be correct, many or all the currently completed or soon-to-be completed bond restructurings probably will be revisited down the road with further cuts.

The board plans spending cuts, increased taxes and fees, and increased tax compliance to balance the budget. However, it remains to be seen whether future revenues will come in as the board is predicting.

The federal government has been slow in releasing money for post-Hurricane Maria aid, raising the possibility that the Trump administration is trying to avoid giving this money to Puerto Rico altogether. This would be important because the board’s projection for the government’s revenue in the coming years depend directly and indirectly on this aid.

In September the U.S. government has said it will revoke support for an excise tax providing 18% of Puerto Rico’s General Fund revenue.

Any solution to Puerto Rico’s conundrum of fiscal and economic problems must involve not just the board but also the federal government, local government, and other sectors of Puerto Rican society.

The board has been poor at predicting revenues. For example, fiscal year 2019 General Fund revenues ended up coming in 34.5% higher than the board had predicted at the fiscal year’s start.

In this context, some will question whether it makes sense to institute all the board’s austerity measures or cut bond payments as much as the board says is necessary.

However, as this series has shown, there are other reasons to question the board’s policy prescriptions.

Even though Democrats appointed three of the seven board members, the board has been promoting mostly conservative approaches to restoring economic growth.

It will be hard to promote economic growth in Puerto Rico even while cutting spending and raising taxes to balance budgets. And there is no doubt that Puerto Rico will have to do these latter two things to gain a structurally balanced budget.

But the solutions to Puerto Rico's problems must go beyond this and beyond the board's structural reform recommendations.

"Puerto Rico is facing the total collapse of economic and political systems," CNE Policy Director Sergio Marxuach said. People need to plan institutional reform and new institutions, he said.

As the experiences of Portugal and some other countries have shown, and as Marxuach and economic consultants Jose Villamil and Heidi Calero have suggested, instead of the board’s mandates and recommendations, there may be better and less painful paths to restore Puerto Rico’s long-term growth, balance its budget, and pay its debt.

Published on December 30, 2019