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THE ALLENTOWN MORNING CALL
The Little Economy That Could, Then Couldn't
Island struggles as tax breaks that fueled industry disappear
By Matthew Hay Brown
July 21, 2002
LARES, Puerto Rico | After 12 years at the Pan Am Shoe Co., Stevan González was earning $450 a week, shipping Dexter-brand footwear around the world.
In December, the Pan Am factory in the north coast town of Camuy began laying off workers in preparation to move its production line to China. The 43-year-old foreman was left to support his disabled wife and their two children on $233 a week in unemployment and other benefits.
Now González spends his days in a government training program in Lares, where he is one of 185 former workers from Pan Am and other closed plants in the area who are taking classes in typing, accounting, computer literacy and other skills to become medical billing secretaries.
"Basically, Im just starting from the bottom again," says González, articulate in accentless English. "Im hopeful. The only thing that scares me a bit is that theres so much unemployment right now. Are there going to be jobs when I get out of here?"
To many, its the central question confronting Puerto Rico.
Fifty years of tax breaks for U.S. corporations doing business here, along with low wages and free access to U.S. markets, transformed this Caribbean island from a sleepy sugar plantation to a humming manufacturing center.
Rapid industrialization reshaped Puerto Rican society, drawing impoverished rural campesinos to urban factories, funding new businesses, schools and government services, and training a skilled managerial middle class.
U.S. corporations invested and made billions. The U.S. State Department presented Puerto Rico to Latin America and the rest of the world as a model of overseas-funded "development by invitation."
But that growth has long since slowed to rates matching those of the wealthier and the more mature U.S. economy, leaving the Connecticut-size commonwealth well behind even the poorest states in employment, income and other measures of economic health. The statistics likely would be worse were it not for the continuing exodus of university graduates and skilled professionals unable to find work at home, a safety valve for unemployment figures, but a further drain on island resources.
Meanwhile, the advantages that made an island with high energy and transportation costs attractive to overseas investors are disappearing. The federal tax breaks are being phased out, the labor force has grown more expensive and much of the world now has similar access to U.S. markets.
With limited ability to cut local taxes further, and no authority to strike foreign trade deals, Puerto Rico is finding it increasingly difficult to compete for investment not only with its peers, the still-expanding economies of Ireland, Malaysia and Singapore, but also such emerging nations as Chile, Costa Rica and China.
In the five years since Congress eliminated the broadest of the tax exemptions U.S. Internal Revenue Code amendments that attracted and kept high-tech development the island has lost tens of thousands of jobs.
The loss of the federal breaks has made the island economy more dependent on federal aid, which now is growing as a proportion of income.
While elected officials jostle over the islands legal status the main choices of commonwealth, statehood and independence each carrying different implications for economic development public and private planners say a long-term, multipartisan plan is needed if local business is to continue to compete in the globalizing world economy.
"If we continue running Puerto Rico on a four-year cycle, were committing economic suicide," says Ramón Cantero Frau, the island secretary of economic development and commerce. "If we can take economic development out of the political process, we will make a great contribution."
Dawn of development
Organized development came to the island in the Depression-era New Deal policies of President Franklin D. Roosevelt. In a sugar economy rife with hunger, poverty and disease, the Puerto Rican Reconstruction Administration of the 1930s built concrete housing, health clinics and schools, and planned state-operated cement, glass and cardboard factories, and public energy and water utilities.
Statistics at the end of the decade show the enormity of their task. Manufacturing employed only 23,000 on an island of 1.87 million. The annual per-capita income was $121. More than two thirds of the population lived in rural poverty, where there was one dwelling for every six residents. Fewer than one in three of those homes had electricity, and fewer than one in four had running water. Life expectancy was 46 years.
It was those pressures that led to Operation Bootstrap, in which officials in Washington and San Juan privatized the state-operated factories and focused on promoting tax breaks to lure U.S investment. During the 1950s, hundreds of firms invested nearly $500 million in textile, leather and other manufacturing.
But they did not provide enough jobs for the growing population; 25 percent of the population left Puerto Rico, primarily to look for work on the mainland, and unemployment on the island still rose.
For those who stayed and found work, wages did go up, ultimately pricing Puerto Rico out of the market for low-tech, low-profit manufacturing.
While such firms fled to poorer countries in Latin America and Asia, island officials began to focus on more sophisticated and expensive production. A planned petrochemical industry became unprofitable when world oil prices leapt in the 1970s. But makers of pharmaceuticals, electronics and high-tech products came and stayed, enabling the island to begin developing a skilled work force and managerial class.
Congress helped that growth in 1976 by amending the U.S. Internal Revenue Code to include the broadest tax breaks yet. Then, American firms doing business on the island could send profits back to the mainland tax-free. By the mid-1990s, 650 firms were taking advantage of the exemptions outlined in Section 936, which was said to be responsible for one in three jobs on the island.
Drugmakers in particular took advantage of the exemptions. Major U.S. manufacturers on the island now employ a tenth of all U.S. pharmaceuticals workers and produce 15 of the 20 best-selling prescription drugs in the United States, including Darvon, Percodan, Percocet, Provera, Xanax, Halcion and several types of penicillin. Puerto Rico facilities also produce Tylenol, Immodium, Dilantin, Efferdent, Rolaids, Dentyne, Trident and Certs.
The real benefits of Section 936 for Puerto Ricans still are debated. Up to the early 1970s, per-capita income on the island grew steadily until it reached nearly 40 percent of U.S. per-capita income. Since then, it has fallen back to less than a third. During the 1990s, overseas backers saw the return on their investment double, but wages for island workers remained flat.
Tax code coda
It was for other reasons that Congress in 1996 ordered the 10-year phasing out of Section 936. Officials in Washington said the exemptions were depriving the U.S. Treasury of $3.5 billion per year, and pro-statehood Gov. Pedro Roselló was happy to see the end of special treatment.
Since then, the island has lost 28,000 manufacturing jobs. After ranking in the 20s among U.S. states in manufacturing job growth, Puerto Rico fell to last.
The pharmaceuticals sector has remained a bright spot. A deep pool of skilled labor and trained management, and an extensive network of support businesses are expected to keep that development on the island. Eli Lilly & Co., Amgen Inc., Johnson & Johnson, Metronics, Baxter International Corp., Abbot Laboratories and Bristol-Myers Squibb Co. all have recently announced plant openings or expansions.
Other sectors are less certain. Non-pharmaceutical manufacturing is down, as is tourism, construction and shipping. Unemployment is 11 percent.
Puerto Rico, its fortunes so closely aligned with those of the United States, is behaving like a mature economy without having matured. Per-capita gross national product for the year 2000 was $11,218, less than a third that of the United States, but similar in growth rate. By comparison, the gross national products of Chile, Ireland, Malaysia and Singapore were growing more than twice as quickly; Chinas was expanding at more than four times the rate.
José Villamil, president of the Chamber of Commerce of Puerto Rico, says that federal aid, government employment and a large underground economy have lulled the island into a false sense of economic security.
"People feel very comfortable with a 3 percent rate of growth, which is basically what weve had over the last 20 years," says Villamil, who also is president of the islands largest economic consulting firm and chairman of one of its largest banks.
"In Puerto Rico, we become accustomed to things that would be unacceptable if this were really a first-world country, like the state of the roads, the state of the infrastructure, the efficiency of government services. But most of the time, you turn on the switch and the light goes on. You open the faucet and the water comes out. I think one of the reasons that people become so complacent is that theres no crisis."
Island officials have pursued a couple of projects to prod development. Planning continues on the Port of the Americas, the deep-water megaport in Ponce and Guayanilla on Puerto Ricos southern coast envisioned as a stopping point for ships too large to pass through the Panama Canal.
Officials anticipate the project will generate as many as 10,000 direct jobs and 20,000 indirect jobs and ultimately fuel $6 billion in economic activity annually. But one key to its success remains out of their authority repeal of the provision of the 1917 Jones Act that requires island trade to be carried on U.S. flagships. Officials say the requirement costs the local economy $500 million per year; they have long lobbied Congress to lift it.
Officials also have asked Congress to amend Section 956 of the Internal Revenue Code to create incentives for investment in the island to replace those that were lost with the changes to Section 936.
"Those are areas that I call fine-tuning the relationship" between Puerto Rico and the mainland United States, says Cantero Frau, the economic development secretary.
Some are skeptical. Labor economist Francisco Catala says constraints imposed by Congress prevent the island from pursuing the policies it needs to compete with its independent peers.
"The last two years, Singapore saw the level of growth declining," Catala says. "They signed a commercial treaty with Australia. Another with Malaysia. They are negotiating a treaty with Chile, and another with Mexico. At the same time, they were negotiating for lower excise taxes both with the U.S. and Japan.
"While they were doing that, we were just asking the Congress of the United States for an amendment of Section 956 that isnt going anywhere. That doesnt amount to an economic strategy. Singapore has an economic strategy, because it has the instruments to articulate an economic strategy. In Puerto Rico, the instrument is, Hey, can we qualify for an increase in food stamps? Can you make an amendment of 956 because you eliminated 936? We are good American citizens ... ."
Puerto Rico also is pursuing a new area for development: local ownership. The government has passed tax breaks in the hope of luring back the estimated $10 billion to $15 billion in Puerto Rican assets now held in the United States and has set up incubator programs to support locally held startups.
Laura Gorbea, president of the Internet solutions firm Altamente.com in San Juan, heads a committee of high-tech entrepreneurs at the Chamber of Commerce. They have joined to discuss common concerns and lobby for increased public and private funding and incentives for local businesses.
"We have to stop waiting for big outside companies to save and stabilize our economy," Gorbea says. "We have to take control of our own destiny."
Avant Technologies is one business that is trying. Ten years ago, when the multinational computer giant Wang closed its plant in Caguas, the local management team bought its assets. In addition to manufacturing computers and servers, the firm recently won a contract to outfit Banco Popular, the islands largest bank, with surveillance systems using compressed streaming video technology it has developed.
Stefan Antonmattei, vice president of Avant, says the firm could be a model for locally owned research, development and manufacturing operations.
"Puerto Rico has great engineering talent," he says. "The problem is, the engineering is made to be employees. We need to develop entrepreneurship.
"I have this dream of a steel-and-glass building on the beach filled with the best 500 minds on the island providing technology with commercial applications that make it to market in six to 18 months."