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How to Save Puerto Rico from Self-Destruction

By: Guest Contributor - Jul 31, 2015, 4:30 pm

By David R. Martin

EspañolPuerto Rico’s government is broke. Its economy is flatlining. Unemployment at 12.4 percent is more than double the US average. The first non-payment on of one of its state-owned entities may occur this week. The government has called its massive US$72 billion public debt “unpayable.”

Given Puerto Rico's open trade and migration with the US mainland, the island has inexcusable poverty. (Steve Hardy)
Given Puerto Rico’s open trade and migration with the US mainland, the island has inexcusable poverty — visible here in La Perla, San Juan. (Steve Hardy)

The primary causes of this disaster are not its high energy and shipping costs. These same costs have not stopped Hawaii’s robust economy with just 4.2 percent unemployment. Separately, Puerto Rico’s territorial status debate is more political theater than anything else.

As part of the United States, Puerto Rico’s inability to negotiate separate commercial treaties is immaterial. It has paltry home-grown exports. The US mainland is practically its only trading partner, but a good party that allows Puerto Rico to freely exchange goods, services, and people as though it were a state. This is precisely the trade agreement that most countries seek, but do not get.

As for the remote possibility of statehood, the main advantage would not be instant economic competitiveness but additional welfare transfers — already blamed for Puerto Rico’s remarkably low 40 percent labor-participation rate when compared with the 62 percent US average.

Instead, the mortal blows to the island are self-destructive policies chosen exclusively by its local leadership. The two sacred pillars of these policies are extravagant tax breaks and preferences for activities in which Puerto Rico is not competitive.

Unsurprisingly, tax breaks deplete the island’s treasury. Meanwhile, the preferred industries have no strategic linkage with the island’s tropical location and the predominant talents and skills of the population.

While sounding heady and bold, scientific manufacturing and complex financial services have little reason to operate in Puerto Rico, other than a dubious tax dodge that is under siege by developed countries, including the United States. While over 50 percent of the island’s $103 billion gross domestic product is attributed to these activities, they employ only 6 percent (and shrinking) of the island’s low-participating workforce. Then, almost 90 percent of the firms’ earnings are spirited off the island, scot-free of tax.

To make matters worse, the tax breaks predominantly favor well-capitalized nonresidents. This discrimination encourages tax defiance and evasion by local residents.

The result: no meaningful job creation and a highly regressive and overly complicated tax system where revenue is less than 10 percent of GDP (PDF). According to an article in the July 11 edition of the Economist, “very poor countries” on average collect 13 percent of GDP while rich, developed countries average 34 percent.

Insufficient tax revenue has unsurprising consequences: these include inadequate government investment in public safety, cleanliness, transportation, education, and human capital.

Many have assumed wrongly that Puerto Rico suffers from “big government” and excess spending. Government is ineffective and inefficient, but not “big” and overly expensive. At 11 percent of GDP, Puerto Rico is the lowest spending jurisdiction among all 50 states (PDF). Per capita, Puerto Rico would rank 37th in government employment among all states, including the District of Columbia.

Another consequence of the low-tax model has been the government’s protracted borrowing binges to make up for revenue shortfalls, while using gimmicks and flirting with illegality to evade the island’s constitutional debt limit.

The final ingredient of this nefarious concoction is the government’s subtle but effective contempt for the industry that normally comes to mind to outsiders who think about Puerto Rico: tourism.

The island has enormous, untapped potential as a world-class destination, not only for tourism but also for large-scale entertainment, including professional sporting events. The problem centers on decades of governmental neglect and underinvestment. Most tellingly, the island has just 15,000 hotel rooms — a smidgen compared with the 65,000 rooms of its next-door neighbor, the Dominican Republic, and the 50,000 of Hawaii.

Moreover, government tourism initiatives overly emphasize San Juan, which has just 9,000 hotels rooms. This is barely enough for small to midsize trade shows. Fossilized by poor urban planning, the metropolitan area has no space for the 50,000 new hotel rooms and infrastructure that the island needs in one concentrated area to become a player in world entertainment.

Dakity Bay on Culebra Island is just one of the attractions available to visitors on Puerto Rico's east coast. (Bill Gracey)
Dakity Bay on Culebra Island is just one of the attractions available to visitors on Puerto Rico’s east coast. (Bill Gracey)

Puerto Rico is particularly well suited as a year-round venue for these activities that do not need tax exemptions to be competitive. Furthermore, Puerto Ricans’ world-famous talents and affinities for the arts, music, dance, film, fashion, and professional sports mesh perfectly with these pursuits.

The logical target market is the 120 million people who populate the East Coast of the United States. They are less than four hours away, closer than Las Vegas but in the same time zone, and need only a driver’s license to visit. But, due to lack of promotion, these fellow US Americans barely know this part of their own country.

Still, Puerto Rico needs a concentrated space and physical infrastructure to receive and entertain visitors in large numbers. Fortunately, a solution to the space problem has emerged. On the east coast of the island, the 13-square mile former US Naval Base Roosevelt Roads, with an airfield larger than San Juan’s international airport, is sitting ripe for development into a new entertainment city. If only the government stopped giving away its tax base in a quixotic pursuit of high-tech manufacturing and offshore finance, this site could be a new city to rival Las Vegas, Orlando, Macau, and Dubai.

The economic impact of such a city would necessarily include the neighboring US Virgin Islands, which have troubles of their own. A robust and truly competitive Puerto Rican economy would lessen reliance on federal subsidies and help its neighbor do the same.

Yet before Roosevelt Roads is divvied up and squandered on special interests and unrealistic pursuits, Puerto Rico must seize this opportunity as a national project. Properly executed by inviting private capital for long-term land concessions, this new city would re-brand the island and commit Puerto Rico to activities truly aligned with the ethos and talents of our people, as well as the privileged beauty and climate of this Caribbean territory of the United States.

David R. Martin is a corporate attorney, member of the Puerto Rican mainland diaspora and author of Puerto Rico: The Economic Rescue Manual. Follow @DrMartinLLC.