Puerto Rico’s budget problems are well known, but some analysts say its weak economy is an even more fundamental problem for the commonwealth.
They say that Gov. Alejandro García Padilla has made some progress on addressing the government’s fiscal and budget problems that have made investors nervous, pushing up secondary market yields for Puerto Rico paper.
But they say the governor faces an even more difficult challenge with the commonwealth’s overall economy.
The magnitude of the problem was emphasized at the end of August when the island’s July economic activity index was down 5% year-over-year.
The commonwealth’s planning board anticipates commonwealth gross national product growth at 0.2% in fiscal year 2014, which runs July 1, 2013 to June 31, 2014. Some analysts think even this may be optimistic. They say the government’s measures to repair its fiscal health may bring short term economic pain even as they put the island on the road to long-term economic gain.
Things have been bad enough already. From 2005 to 2012 the inflation adjusted gross national product declined 10%. In July the unemployment rate was 13.5%.
Some might assume that Puerto Rico has always had a weak economy. But the truth is more complicated.
After World War II, Puerto Rico enjoyed a booming economy in the late 40s, parts of the ’50s, and all of the ’60s. After 1972 GNP growth rates moderated but more often than not were above 2% until this past decade. Even in the past decade the GNP grew by more than 2% in 2003 and 2004.
Puerto Rico’s GNP per capita is one-third of that on the U.S. mainland. However, GNP per capita is substantially higher than that found in most other regional countries including the Dominican Republic, Mexico, Venezuela, and Panama.
Despite long periods of healthy growth in the last 50 years, the island’s unemployment rate has nearly always remained above 10%. Indeed, the rate went briefly above 20% in the mid-’70s and above 25% in the early ’80s.
In this context, the current 13.5% rate is less extreme. The ratio of the island’s unemployment rate to the U.S. unemployment rate was generally higher in the ’70s and ’80s than it is today.
Puerto Rico’s economy took an even sharper dive in the Great Recession than did the U.S. economy for two or three reasons, observers said.
Until 2005 U.S. based corporations enjoyed federal income tax benefits by locating in Puerto Rico. They were phased out, hurting the island’s economy, said Janney Capital Markets managing director Alan Schankel.
Rising world oil prices hit an island over-reliant on oil to generate electricity, a spokeswoman for the Puerto Rico governor said.
In 2010 the Federal Deposit Insurance Company shut down three local banks, said Sergio Marxuach, public policy director at the Center for the New Economy in Puerto Rico. Some of the assets were switched to other local banks and these local banks are still trying to work through some of the nonperforming loans.
It may take another year or two for the banks to put this behind them and gain a stronger financial footing. This would allow them to make more of the loans that would help the economy grow, Marxuach said.
In this past recession the Puerto Rico government had already borrowed so much money it could not borrow substantially more to rev up the economy, Marxuach said.
The island economy’s disproportionate reliance on manufacturing has contributed to unemployment as manufacturing becomes increasingly mechanized, Axios Advisors managing partner Triet Nguyen said.
Puerto Rico’s government cut its payroll expenses by 34% from 2009 to 2011, Schankel said. This was bad for the economy and employment in the short term, even if it helps the government to move towards fiscal balance, he said.
As for the weakness in the last few months, Government Development Bank for Puerto Rico interim director José Pagán said it was the aftermath of previous governor Luis Fortuño’s pump priming at the tail end of his term. He initiated an array of construction projects in the run-up to the November 2012 election to boost employment and the economy, Pagán said.
Challenger García Padilla won the election with 47.73% of the vote to Fortuño’s 47.13%.
Now that the new government is taking a more responsible spending approach, the construction industry has weakened and so has the economy, Pagán said in late July.
Recent tax and fee increases have probably dampened economic activity, Nguyen said.
The Puerto Rico legislature and governor passed a budget that included a $1.4 billion tax increase in late June. This tax increase amounts to 2% of the island’s gross domestic product and is certainly contributing to the weak economy Marxuach said.
Puerto Rico’s economy has limited prospects over the next year, some analysts say.
“Stagnation might be the best case scenario,” Nguyen said.
“We may not have growth at all, but we may be on the road to recovery,” said Jorge Cañellas Fidalgo, president of the Puerto Rico Chamber of Commerce.
On a brighter note, Puerto Rico does have some competitive assets, all agree. The island’s economy benefits from a great geographic location, federal law, and a dollar-based economy, Marxuach said. The workforce is well-educated, there is a great engineering school, and there is a vibrant health care research sector.
A spokesperson for the governor added that Puerto Rico was ideally located to become an international hub of services. It could become a center for outsourced knowledge services in the Americas, she said.
As for the current administration’s policies, there is little optimism about the short-term. García Padilla’s increases of taxes and water and sewer rates “will hurt economic growth in the near-term, without any doubt, but fiscal stabilization is the first order of business,” Nguyen said.
The governor’s spokeswoman indicated that the governor was focused on long-term economic health. She said the governor has a five-pronged strategy for Puerto Rico.
First, the administration is defending core economic sectors like manufacturing and, in particular, pharmaceutical manufacturing.
Second, it is seeking to develop opportunities in generics medication manufacturing and medical devices, as an evolution from the island’s specialization in traditional pharmaceuticals.
Third, to aid small and medium sized businesses, the government has offered tax breaks, energy credits, favorable rents on government-owned property, and expedited permit processes.
Fourth, the government is trying to establish the island as a knowledge-services center for Latin America, the Caribbean and the U.S. by bringing in outside companies and forming alliances with other countries.
Fifth and finally, the government is seeking to expand and diversify the island’s tourism offerings. It is seeking to improve the island’s airplane access and tailor its marketing efforts to niche markets like: luxury, ecological, cultural, and culinary tourism.
Given the overall situation in Puerto Rico, the government needs to focus on attracting foreign capital investment, Marxuach said. The current administration is working to do so but its approach has been “scatter-shot,” he said.
The current Popular Democratic Party administration needs to develop a three- to five-year plan for rejuvenating the economy, Marxuach said. It needs to develop a strategy with the opposition New Progressive Party, he said. This way, if the opposition comes to power in the next elections, there would be continuity of economic policy.
