Puerto Rico: Who should pay the debt?

Puerto Rico has also been in the limelight recently because of its unsustainable debt. Ariel Noyola Rodriguez explains how this debt arose and the debate it has sparked as to who should pay it.

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PUERTO Rico has failed to meet a new deadline on payments on the island's $72 billion debt. Despite measures taken by the local authorities, many are asking who should really be paying the staggering debt.

Local politicians? Bankers? Puerto Ricans in general? The United States, as Puerto Rico's Congressional representative Pedro Pierluisi has said? The complex issue has led to speculation and confusion amongst observers.

But a closer look at the historical relationship between the island and the US mainland, its economic performance and its most recent crisis may help in explaining who is really responsible for Puerto Rico's astronomical debt.

Some are calling for the island's independence, after 115 years of being under US control, as the only way out. Others believe the economy should default.

However, the economic crisis has been produced not only by the US government but also due to structural and external pressures at work for almost a decade.

A laboratory for the 'free market'

The citizens of Puerto Rico became officially recognised as US citizens in 1917. But, contrary to the common belief that the island is another US state, Puerto Ricans cannot vote for president or for lawmakers while living on the island.

The special status which the nation holds - commonwealth - is regarded by many as a colonial arrangement, where Puerto Ricans are subject to US federal law but have no say in the legislative process which creates these laws. This means the island lacks local autonomy and decisions taken by US federal authorities are legally binding on Puerto Rican authorities.

Since the late 1940s, the US government has promoted investment in the island through an alluring tax exemption programme. Despite being partially halted during the 1990s - causing many companies to leave - the tax cuts were reintroduced shortly after in 2008. In 2013, the local government passed laws allowing new residents to pay zero tax on capital gains and zero tax on income derived from local businesses, in an effort to continue appealing to wealthy investors.

Despite these incentives, Puerto Rico has seen little of the wealth being distributed. The island has the second highest level of inequality when compared to the US's 50 states. Furthermore, profits made on the island are transferred back to the US mainland, based on Section 936 of the tax code, which was designed to stimulate job creation but instead has enabled mass cash outflow.

This has led to an economic model based on dependence on the US that has enabled corporate exploitation, built up over the years in what is referred to as Operation Bootstrap.

Through a series of measures and federal laws, Washington promoted the decline of Puerto Rico's sugar industry and its agriculture, paving the way for US capital to invest in consumer goods industries and - most recently - services.

The idea behind the architecture of the so-called Operation Bootstrap was to counter Cuban influence in the Caribbean by maintaining a stable and prosperous Puerto Rico as an example of the benefits of following US-style free-market policies.

Today, small-scale producers and local shopowners are struggling to compete with US companies and chain stores. Local agriculture is virtually non-existent, and most of the arable land is owned by corporations.

'There's more Walmarts and chain stores per capita in Puerto Rico than any place else,' explained Puerto Rican activist David Galarza during an interview over New York's WBAI radio station.

This partially explains why 90% of the island's exports are destined for the US, most of them manufactured goods, sold by US corporations.

The system imposed by Operation Bootstrap has been largely reflected in the current quagmire; while Puerto Rico's economy has been contracting since 2006, tax evasion is widespread and - due to its political status - federal laws prevent the island's government from requesting loans from international institutions.

Since 2000, Puerto Rico's debt has been growing at a rate that has exceeded its GDP growth.

'Puerto Rico's economy is clearly unsustainable, barely able to generate enough capital to service its debt,' writes Ed Morales in Jacobin magazine.

A disastrous scenario

Furthermore, on 9 July the US Court of Appeals in Boston ruled that Puerto Rico couldn't restructure its own debt. Given that the island is not a state, it cannot file a request for bankruptcy to obtain federal relief.

'The [Puerto Rican] government has tried to offset the failure to grow by thinking it was a recession,' explained former International Monetary Fund (IMF) economist Anne Krueger during an interview in July at WBUR Boston. By doing so, added Krueger, 'they've financed a lot of the [public] spending' through loans.

And public spending is also an important issue in Puerto Rico. Over a third of the island's population receive food stamps and, according to Galarza, between 60% and 70% rely on Medicare or other welfare programmes.

The island's Governor Alejandro Garcia Padilla shocked the world in late June when he publicly acknowledged the debt held by Puerto Rico was unpayable. However, despite such a strong admission, his government is evaluating a series of measures aimed at meeting creditors' demands. 'On Medicare, they are already planning to eliminate some $200-300 million of essential vital funding,' explained Galarza in his interview.

Nevertheless, despite the mounting pressure, Garcia Padilla has vowed not to fire workers or raise taxes, as the most important group of creditors is requesting.

The current crisis has driven thousands out of the country, which in turn has generated a significant fall in the labour force. In 2014, Puerto Rico saw the biggest drop in its population since World War II.

Some in the government have proposed measures to flexibilise work, which include reducing salaries, eliminating the minimum wage and modifying working ages.

Without the option of restructuring the debt, the local government is trying to convince creditors to allow smaller payments over a wider time frame.

Some economists are arguing that the local government should tackle tax evasion and increase taxes. However, as has been pointed out above, the many tax exemptions - some through federal laws - that benefit wealthy investors and US corporations make it very difficult for the local authorities to tax the wealthiest.

As Puerto Rican activist Ed Morales points out, a recent report issued by the Federal Reserve Bank of New York regarding Puerto Rico's economy suggested restructuring the island's tax system.

However, the local government has expressed no intention of changing its tax-exemption policies and continues to see attracting investors to the island as the main way to achieve economic growth.

In fact, tax revenues have remained stagnant over the past 15 years. This means that new taxes would largely affect the middle and lower classes, without tapping into the wealth of those benefiting from decades of tax exemptions.

The sombre scenario leaves few options for the Puerto Rican government alone to solve the crisis, and will require external intervention.

As a recent report by activist group Hedge Clippers documents, hedge funds own up to 50% of the island's debt, which gives them significant leverage when it comes to negotiating.

'The basic idea is to demand that wages go down in Puerto Rico, to demand that taxes go up, to demand that utility rates, water rates, go up, and that all that money be shovelled straight to the hedge fund millionaires,' says Michael Kink, who heads Hedge Clippers.

 If Washington fails to help the island, the local government would not be able to default - because of their Constitution - and would run out of cash, leaving it no choice but to part with public property.

'Right now, these banks and hedge funds have the people over a barrel; it's unconstitutional in Puerto Rico to default over a debt. And you can see a scenario where public utilities, public assets like water, even the tax receipts of the government could basically be impounded by these hedge fund guys...that seems to be what's gonna happen,' predicts Kink.

For Pedro Pierluisi, Puerto Rico's non-voting delegate in the US House of Representatives, the only solution to the current crisis is for the US Congress to modify the island's status and recognise it fully as a state. 'In the near term, Puerto Rico can manage its crisis with smarter policy making, but the only enduring solution is statehood,' he wrote recently in the New York Times.

Statehood aside, the structural failure and the need to reform the economic model of the island is seldom addressed by the mainstream media or politicians.

Despite promises made by Governor Garcia Padilla, he has continued to favour privatisations and other austerity measures, such as cutting pensions, which have been applied by his predecessors in the recent past.

Even the terms on which local mainstream politicians are demanding a restructuring of the debt include a set of policies which would mean further cuts in services and pensions.

Who should pay the tab?

Responsibility over Puerto Rico's debt crisis cannot be equally shared. The island's crippled economy is in large part a product of US foreign policy. And this is not confined to Operation Bootstrap.

With the approval of the US-Central America free trade agreement, the island has been forced to compete with neighbouring countries, which have much lower wages.

US laws have also undermined Puerto Rico's global competitiveness. For example, the Merchant Marine Act of 1920 prohibits non-American ships from carrying goods between the island and US mainland, which has raised transportation costs and made trade with other countries more difficult.

The US federal budget allocation to the island differs greatly when compared to those for similar-sized states and some social welfare programmes exclude the island altogether.

Local governors also bear a big share of responsibility for the current state of the Puerto Rican economy. They have acquired billions of dollars in loans, even when the economy was not struggling to grow.

Furthermore, as in many recent debt crises elsewhere, hedge funds play a larger role than is usually acknowledged. Irresponsible borrowing has been fuelled by irresponsible lending.

Vulture funds have rushed to the island to buy risky bonds in a similar scenario to the one in Argentina (2001) and most recently in Greece. The scheme consists in opportunistic investors - which act through hedge funds commonly dubbed vulture funds - taking advantage of an economic crisis to, in the aftermath, increase the amount of money they originally invested.

'These guys [vulture funds] have bought up the debt in an effort to get it paid to get huge, huge returns. As an example, Paul Singer, one of the hedge fund managers that's in this game, when he pulled a similar stunt with Argentina they made 13,000% profit on the deal. Not double your money, not triple your money, but 15 times your money,' explains Kink.

As the report by Hedge Clippers documents, many of the hedge funds that hold Puerto Rico's debt were involved in the Argentine and Greek crises.

Furthermore, these investors have powerful allies inside the US Congress and are significant financiers of both the Republican and Democratic parties.

Given the current situation, it should not be the Puerto Rican people paying the debt, but the US moguls and corporations that have been taking advantage of the island's tax-exemption scheme, together with the local elite, who have failed to manage the debt and insist on applying austerity measures.

The ideal scenario would be one such as in post-crisis Argentina, where the Kirchner administration (2003-07) implemented a set of policies to reform the economy, implementing financial controls, recovering state-owned assets and boosting local industry. However, none of the major parties in Puerto Rico have suggested such a strategy.

It is up to the US Congress to show if it will back the island against the vulture funds. A solution to the crisis could translate into potential political gain, since both the Democrats and the Republicans are trying to lure the Latino vote (over 17% of the population) for the upcoming presidential elections.

Even though Puerto Ricans within the island's territory cannot themselves vote, helping the island will certainly have an impact on fellow Hispanics and the 5 million Puerto Ricans living on US soil.  

This article is reproduced from the teleSUR English website (www.telesurtv.net/english).

*Third World Resurgence No. 298/299, June/July 2015, pp 10-12