Puerto Rico’s Debt Trap

WASHINGTON, DC – The Caribbean island of Puerto Rico – the largest United States “territory” – is broke, and a human calamity is unfolding there. Unless a constructive course of political action is found in 2016, Puerto Rican migration to the 50 states will rival the scale of the 1930s Dust Bowl exodus from Oklahoma, Arkansas, and other climate-devastated states.

With public debt service (principal plus interest) projected to reach nearly 40% of government revenue in 2016, Puerto Rico needs a new set of economic policies. But austerity will not work; this must be an investment-led recovery, with official measures oriented toward boosting growth by reducing the cost of doing business.

The question is whether Puerto Rico will have that option. Much of its $73 billion debt has been issued by government corporations. But, though federal law allows such municipal debt to be restructured under Chapter 9 of the bankruptcy code in all 50 states, this does not apply to US territories like Puerto Rico. As a result, a protracted series of confusing legal battles and selective defaults looms. The cost of essential infrastructure services – electricity, water, sewers, and transportation – will go up while quality declines.

One response has been to demand further belt-tightening, for example, in the form of wage reductions and healthcare cuts. But residents of Puerto Rico are also US citizens and they vote with their feet – the population has fallen from 3.9 million to 3.5 million in recent years as talented and energetic people have moved to Florida, Texas, and

ther parts of the mainland.

The more creditors insist on lower living standards and higher taxes, the more the tax base will simply leave the island – causing bondholders’ losses to rise. Disorganized defaults by public corporations will make it hard for any part of the private credit system to function.

Leading conservatives in the US – including at the Hoover Institution – have long argued in favor of using established bankruptcy procedures when large financial firms fail. The same logic applies here: A judge can remove any doubt that actual insolvency exists, while also ensuring that credit remains available during a restructuring. During that process, a judge can rely on precedent and ensure fairness across creditor classes based on the precise terms under which loans were obtained.

Although congressional Republicans have so far refused to allow for a judge-supervised bankruptcy process, bipartisan agreement remains possible. Democratic Senators Richard Blumenthal, Elizabeth Warren, and Charles E. Schumer have proposed legislation that would introduce a stay on creditor lawsuits until March 31, 2016. No one, including Republican Senator Chuck Grassley, Chair of the powerful Senate Judiciary Committee, believes that debt restructuring by itself will bring back growth; but extending Chapter 9 of the bankruptcy code to Puerto Rico would help.

Puerto Rico needs private-sector investment, which requires taking three steps. For starters, bureaucratic hurdles to job creation should be eliminated, including by using state-of-the-art technology to make government more transparent. Pedro Pierluisi, Puerto Rico’s representative in Congress, has long emphasized this point.

Second, the cost of essential inputs for industry needs to fall. Electricity on the island is significantly more expensive than in Florida, in part because of underinvestment. More broadly, there are pressing needs for public investment to improve infrastructure, which implies great opportunities for private-sector participation. But none of this will happen until the debt overhang is removed.

Finally, Puerto Rico needs better fiscal management. The island’s idiosyncratic tax and expenditure system – and the lack of effective local control over fiscal policy – has become part of the longer-term problem. Puerto Rico should, over time, become more like one of the 50 states in its fiscal relationship with the federal government. If Congress is willing to commit to that path, a reasonable quid pro quo would be strong fiscal rules – and a powerful monitoring body.

With congressional support and pro-growth policies, Puerto Rico can attract talented Americans (and legal immigrants) to move to the island, start companies, and work hard. Higher education in Puerto Rico remains strong, but more than 80,000 people leave every year (and only 20,000 move in).

In part, high levels of net migration reflect Puerto Rico’s badly frayed health-care system. The federal government provides significantly more support to every state health-

are system through Medicare (for pensioners) and Medicaid (for low-income households), despite the fact that Puerto Ricans pay the same federal payroll taxes that fund much of the Medicare program.

Likewise, to become eligible for more robust support, including through the earned-income tax credit – a program supported by leading conservatives, such as Speaker of the House of Representatives Paul Ryan – hard-working low-income Puerto Ricans must move to one of the 50 states.

Puerto Rico doesn’t need a bailout. It needs to reduce the cost of doing business – cut the red tape, encourage investment, and attract people to work (and pay tax in) a beautiful place.

It also needs what has been a constructive part of the American economic model over 200 years – the ability to restructure municipal debt through bankruptcy. Simon Johnson is a professor at MIT’s Sloan School of Management and the co-author of White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.

By Simon Johnson

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