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Commonwealth Economic Performance: Economic Miracle Or Urban Legend?


August 19, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

In the eyes of many, the past 50 years have been a time of miraculous economic growth and performance in Puerto Rico. Others disagree, and say high unemployment and poverty levels, slow growth rates, and limited opportunities are the true faces of the island’s economic reality. In this special report, CARIBBEAN BUSINESS examines Puerto Rico’s economy under commonwealth, presenting the economic strategies the government has implemented and their impact, as well as providing official statistics and data concerning the island’s economy since 1950.

Throughout the 1940s, Puerto Rico’s economy progressed substantially. Harvey S. Perloff, in his 1951 Puerto Rico Planning Board report, said, "Levels of living have been raised and the productive plant of the island has been enlarged." Despite advances, Perloff still had concerns. "Job opportunities, however, are still far from adequate and the existing sources of income haven’t built as strong a foundation as might be desirable," he added.

In the report, Perloff not only reviewed Puerto Rico’s economic performance, but more important, he prepared a road map for economic policy and guidelines for the government’s development plan. Usually known as the Perloff Plan, it included targets for Puerto Rico’s economy for 1960 and beyond.

Perloff was just one of the many economists and social scientists from the U.S. mainland to contribute to shaping Puerto Rico’s early economic development strategy. Wassily Leontief, John Kenneth Galbraith, Ben Dorfman, Simon Ruttenberg, Eric Wolff, and Sidney Mintz also contributed. Dorfman, who had prepared negative economic reports on what would happen if Puerto Rico became independent, reportedly had a transcendental impact on Luis Muñoz Marin’s position regarding the island’s political status during the second half of the 1940s.

The figure that shaped Puerto Rico’s economic development strategy was Teodoro Moscoso. Gov. Rexford Tugwell recruited Moscoso to the government in 1941. A pharmacist by profession, he became the main promoter of Puerto Rico’s industrialization efforts and was instrumental in the creation of the Puerto Rico Industrial Development Co. (Pridco) in 1942.

By 1945, Moscoso had opened an office in New York City to attract investors from the mainland U.S. In 1947, he pushed the local Legislature to approve the Puerto Rico Industrial Incentive Act to provide local tax exemption to U.S. mainland companies. In 1948 and 1949, with a $250,000 budget, he carried out public relations and tourism campaigns, and in 1950, he promoted the creation of the Economic Development Administration (EDA).

Although many sectors criticized tax exemptions, Moscoso was committed to an industrialization program that would create employment opportunities. Moscoso reportedly told a U.S. senator he would do business with the devil himself if he established operations in Puerto Rico.

The local tax exemption, which complemented existing federal tax exemptions on earnings in Puerto Rico, was expected to attract U.S. mainland firms to the island and create needed jobs. Another selling point: Puerto Rico’s wages were lower than those stateside.

The Perloff Plan’s employment objectives, embraced by the Popular Democratic Party administration, were to be achieved by a sustained and strong industrialization program, which in its earlier stages would emphasize low-capital, high-employment industries and diversification of agriculture.

The employment targets included the creation of more than 200,000 nonagricultural jobs between 1950 and 1960. With the acceleration of the industrialization program, manufacturing was supposed to provide approximately one third of these new jobs while absorbing jobs lost from a reduction in the home needlework industry, an important source of employment at the time.

Trade, services, and government, meanwhile, were to absorb 55,000 workers. Agricultural employment was to remain stable at slightly more than 200,000 jobs. The targets set for agricultural development were based on the general assumption that, through improved farm practices and higher yields, enough suitable land would be released from main commercial staples to allow for the diversification of the island’s agriculture.

The Perloff Plan had Moscoso’s complete support and became the basis of the government’s economic development strategy, later dubbed Operation Bootstrap. James L. Dietz, professor of Economics & Latin American Studies at California State University and author of "Puerto Rico: Negotiating Development & Change," pointed out: "Whoever was responsible for conceiving the Operation Bootstrap program is perhaps unimportant. The facts are that Gov. Muñoz Marin, [Pridco] under Moscoso, and the Planning Board all lent their support to the outward-oriented, externally financed industrialization-by-invitation strategy."

The plan recommended a system of four groups of priorities. Priority Group I included direct industrial and agricultural development, education (especially primary and vocational), external transportation (ports, shipping, air travel), and electric power for industrial use. At the bottom of the list, Priority Group IV included public welfare, public assistance, social security, food distribution for relief efforts, and pensions.

As a substantial increase in revenue was necessary for the success of economic development, the plan recommended implementing a vigorous tax program. To be effective, it had to involve both an increase in the intake of existing revenue and the implementation of new taxes. The Perloff Plan concluded, "The people of Puerto Rico can’t afford to jeopardize the development of the economy through failure to assume an adequate tax burden. The investment in development efforts today will bring high returns in the form of more adequate employment opportunities and decent levels of living for all people in the future."

It didn’t happen. Under commonwealth, Puerto Rico has suffered from low participation rates in the labor force and high unemployment. Official statistics from Puerto Rico’s Department of Labor & Human Resources present a dismal picture of the Commonwealth’s job-creation performance. If we accept that job creation is one of the basic criteria to evaluate an economic development strategy, Commonwealth’s strategy has failed.

In 1950, the potential labor force—comprising civilians 14 years and older, the measurement at the time—was 1.3 million people; participation rate of the labor force stood at 53.1%, putting the number of employed people at 596,000 and unemployed people at 88,000. With the unemployment rate at 12.9%, the ratio of people employed to the total potential labor force was 46.2%.

Participation rate is the portion of the working age civilian population that is employed or actively looking for work. Unemployment rate is the portion of the participating labor force that is looking for work but remains unemployed.

By 1960, the labor-force participation rate had fallen almost 8% to 45.3%. There were 53,000 fewer people employed than 10 years before, for a 13.3% unemployment rate. The projections of the Perloff Plan never materialized.

In 1954, the local Legislature amended the Puerto Rico Industrial Incentive Act to extend its benefits until 1964, contrary to original plans. This amendment coincided with the revamping of the U.S. Internal Revenue Code, which reorganized possessions’ tax-exemption statutes under Section 931 to allow for tax-free repatriation of profits from mainland U.S. firms to the mainland U.S. upon liquidation of local operations. Ghost liquidations became a standard procedure at the time.

In 1963, during Muñoz Marin’s last term as governor, Puerto Rico again extended tax-exemption benefits in parts of the island for up to 30 years. Commonwealth government was showing no interest in observing the temporary nature of its local tax exemptions; the so-called social revolution was rapidly becoming an endless corporate tax holiday.

Although local and federal tax exemptions had existed prior to commonwealth, Commonwealth leaders’ idea of converting Puerto Rico into a permanent tax haven based on its political status began taking shape in the 1960s. It didn’t solve the problem. In 1963, the work-force participation rate was 44.2%, 9% less than in 1952; the employment rate hadn’t budged from where it had been when commonwealth was enacted 11 years earlier.

By 1966, the competition from lower-wage jurisdictions had intensified, and Puerto Rico shifted its economic development strategy to attract industries from more capital-intensive sectors with less dependence on low wages. Cheap oil was the new attraction. Phillips Petroleum and International Fibers in Guayama, Union Carbide, and PPG and Corco in Peñuelas and surrounding municipalities are just some of the companies that should remind Puerto Rico of the hundred of thousands of jobs that were to be created by the petrochemical industry cluster. The jobs never materialized.

In the days before the creation of the Organization of Petroleum Exporting Countries, the U.S. imposed tariffs on cheap foreign oil through a complex entitlement system allowing companies to avoid tariffs once the oil was processed and refined in Puerto Rico. The era of cheap foreign oil is gone forever as are the petrochemical complexes built on the expectation of access to foreign, mostly Venezuelan, oil costing only $2 a barrel.

By 1970, during Gov. Luis A. Ferre’s administration, 686,000 people were employed, and the unemployment rate averaged a historical low of 10.9% for the four-year period. But the good news was short-lived. Not until Gov. Pedro Rossello’s second term, more than 30 years later, did the unemployment rate fall again to 10.5%, although for a shorter period.

In 1979, a U.S. Department of Commerce report summarized Commonwealth’s early problems. "In the 1950s, as the economy was engaged in the first phase of the transition from a monocrop agricultural system to an industrialized system, total employment contracted. The absorption of labor into the newly developed manufacturing sector fell behind the rate at which agricultural workers were being laid off. It was only after 1963 that a persistent employment expansion got underway. Under the momentum, spurred primarily by capital investment induced to enter the economy under the revisions in the Industrial Incentives Act, employment improved for a decade. Between 1963 and 1973, employment increased by an average of nearly 3% a year. During that time, the average rate of unemployment dropped to just over 12.5%—as an average, it was still unsatisfactory," the report said. The unemployment rate has remained at unsatisfactory levels since 1973.

From 1976 to 1996, when Congress decided to phase out Section 936 of the Internal Revenue Code, Puerto Rico’s average annual unemployment rate was 17.7%. Not once, from 1976 to 1995, did the annual unemployment rate drop below 14%. In 2000, for a period of three months, the unemployment rate declined to single digits, but these figures were also short-lived. During fiscal year (FY) 2003, the unemployment rate again jumped to 12.1%.

The inability of Commonwealth’s economic model to generate enough jobs has caused discouraged workers to drop out of the labor force. Therefore, they aren’t counted among the unemployed, which is one reason Puerto Rico suffers from a low labor-force participation rate.

The low participation rate, in turn, hides the island’s real state of unemployment. It is actually much higher than official statistics portray. In 2003, if the work-force participation rate had returned to 50%, which was where it stood in the early 1950s, the unemployment rate would have shot up to 18.1%. If the labor-participation rate were 60%, as it is for Puerto Ricans stateside, the unemployment rate would exceed 30%.

According to comparative figures from the 2000 Census survey, the unemployment rate in Puerto Rico was triple that of the U.S. mainland (19.2% vs. 5.8%), and the participation rate was 23% lower (63.9% vs. 40.7%).

The gap between Puerto Rico and the U.S. mainland’s participation levels has been widening. In the early 1950s, they were only a couple of percentage points apart; today, with the labor-force participation rate in the mainland U.S. exceeding 66%, the difference is almost 20%.

Emigration: An escape valve

For Commonwealth government, migration to the States has proved an effective way of clearing the island of its unemployed. The right of free movement between Puerto Rico and the States, granted under U.S. citizenship, has been used as a safety valve by Commonwealth government to disguise the system’s inability to create jobs for its residents. At the same time, it has also provided an escape valve for Puerto Ricans to leave.

Perloff pointed out in 1951 that "… it is a fact of general knowledge that without outmigration, the unemployment problem would be much more serious than it is today. Emigration…must be relied upon in the immediate future as one of the means of making the full employment goal accessible and…of realizing the democratic ideal of giving each individual the best possible opportunity for full development."

Dietz, in his 1986 book "Economic History of Puerto Rico," estimated that if migration had been half of what it was in the 1950s and 1960s, the unemployment rate in Puerto Rico would have been 24.8 % (or 11.5 points higher than the actual rate) in 1960 and 22.2% (or 11.9 points higher than the actual rate) in 1970.

During Commonwealth’s glory days (1950 to 1970), more than 600,000 Puerto Ricans, net (that is almost 30% of the island population in 1950) emigrated. The Puerto Rico Planning Board reported that from 1952 to 2002, about 1.7 million more people traveled from Puerto Rico to the U.S. mainland than vice versa. During FY 2001 to 2003, the reported number topped 98,000.

The 2000 U.S. Census said more than 1.3 million people born in Puerto Rico were residing stateside. Many accuse the U.S. Census of undercounting, especially when it comes to minorities. As such, it isn’t unreasonable to assume the number of Puerto Rico-born stateside residents is higher than the reported numbers.

Contrary to stereotypes, research indicates Puerto Ricans migrate not to receive welfare benefits, but to find jobs. For most Puerto Ricans, the move to the U.S. mainland has meant jobs or better pay.

Undeniably, under Commonwealth, Puerto Rico has been an exporter of the best of Puerto Rico: its people.

Government employment: Another safety valve

With the economic model unable to generate sufficient job opportunities in the private sector, Commonwealth officials found another economic safety valve: government employment.

The Department of Labor Establishment Survey put the average number of public-administration or government workers in FY 2003 at 298,800, or 31% of Puerto Rico’s nonagricultural, salaried work force, which stood at 992,400 people.

The Department of Labor’s Household Survey provides a historical overview of the island’s public-sector job growth. In 1940, almost 20,000 people worked in government, 4% of a labor force of approximately 500,000 workers. By 1950, the number had reached 45,000 or 7.6% of a total work force of 596,000. By 2003, government employees numbered 274,000, a six-fold increase over 1950, and this doesn’t count the employees in the various public corporations. From 2000 to 2003 alone, the number of government workers has increased by 10%.

Federal transfers and poverty

Commonwealth’s inability to provide needed job opportunities has kept approximately 50% of the U.S. citizens in Puerto Rico living below the federal poverty level. This situation should be as unacceptable to Washington, D.C. and Commonwealth officials as it is to the rest of the island’s population.

Although poverty rates have fallen in terms of the percentage of the total population, a closer look reveals that in 2000, approximately the same number of people (1.8 million) was living below the federal poverty level as in 1970.

According to the U.S. Census, local poverty levels declined from 65.2% in 1970 to 58.9% in 1990 and to a low of 48.2% in 2000. Nevertheless, the success of the industrialization plan or growth in earned income can’t be credited with lowering poverty levels.

Poverty declined because federal government transfer payments to island residents increased. These payments, including welfare and social security, compensated for the development programs’ failures to reduce the incidence of poverty via adequate employment and earnings generation, said Dietz in a recently published paper "Puerto Rico: The Three-Legged Economy."

"The simple and painful answer is that the Operation Bootstrap program and the normal functioning of Puerto Rico’s economy can’t be credited with the reduction in measured poverty," said Dietz. "Such transfers acted as a safety valve, insulating the economy from criticism and from facing the need for change, much as unrestricted migration did."

Federal transfers of income not only helped to directly reduce poverty, but they also contributed to some of the employment growth observed in the economy by virtue of the multiplier effects of increased spending on production and services that such spending induced," Dietz added.

In 1952, total transfer payments from the federal and local governments represented 8.2% of personal income; by 2003, it had increased to 32.8%. The problem isn’t that transfer payments are high; U.S. citizens stateside also receive transfer payments. The problem is that other components of Puerto Rico’s personal income, such as employees’ income and the proprietors’ income, haven’t grown as they should have.

A unique situation

Commonwealth’s unemployment and poverty levels can also be partially explained by the fact that for over three decades, Puerto Rico’s Gross Domestic Product (GDP) has exceeded its Gross Product (GP).

The GP measures all income staying in Puerto Rico regardless of its source. The GP is available for household and government spending and potentially for investment and is therefore the relevant measure of local residents’ well-being.

The GDP, in contrast, is the monetary value of a country’s goods and services. The substantial number of pharmaceutical companies and other producers of high-value products in Puerto Rico contributes to a very high GDP.

But not all the GDP stays in Puerto Rico. Only 64% contributes to the local economy in the form of wages, purchases, and services. The rest is the value of these goods sold outside Puerto Rico and the revenue and profits go to the manufacturers. It is the GP that remains in Puerto Rico to contribute to its economy.

According to Planning Board statistics, in 1950, Puerto Rico’s GP was higher than the GDP. By 1960, they had evened out. By 2003, Puerto Rico’s GDP was $74.4 billion; $27 billion more than its GP.

The difference between the two is usually no more than 10% either way, according to international data obtained in August by CARIBBEAN BUSINESS from the Penn World Tables Version 6.1, from the Center for International Comparisons at the University of Pennsylvania.

For example, of the countries for which 2000 data are reported, only Equatorial Guinea (37.2%) and Angola (53.8%) had lower ratios of GNP to GDP than Puerto Rico. In 2000, Ireland’s ratio was 85.5% and Singapore’s 106.6%. According to the Penn World Tables, Puerto Rico’s ratio has been on a steady decline; from 99.1% in 1960, it dipped to 93.1% in 1970. When Section 936 was enacted in 1976, it was 84.2%. By 1997, it had plummeted to 67.3%.

Puerto Rico’s real GDP has been growing at a faster rate than its real GP. Planning Board data show that in real terms (based at 1954 constant dollars; the resulting figure allows comparisons over time since the effects of inflation have been removed), Puerto Rico’s GDP increased approximately 12.6 times, from $844.1 million in 1950 to $10.6 billion in 2003; the GP grew by just 7.6 times, from $878.7 million to $6.6 billion.

From the time the U.S. Congress enacted Section 936 in 1976 until its phase-out began in 1996, the real annual average growth rate of Puerto Rico’s GP was a weak 2.5%. The future doesn’t look very promising either. According to the Planning Board, the rate of growth won’t average more than 3% for the next two years.

Puerto Rico’s real rate of economic growth has been deteriorating since the early 1970s. From 1950 to 1959, the average real annual growth rate of Puerto Rico’s GP was 5.3%; it increased to an average 7% during the 1960s and for the first two years of the 1970s. Since then, the rate of growth has for the most part fallen. The average annual growth from 1973 to 1979 was 2.9%; in the 1980s, it was 2%. In the 1990s, it increased to 2.7%, including an average of 3.3% from 1993 to 1999. Since 2000, the average real growth has stagnated at 1.5%.

The reduction in the GP’s growth rate per capita, which provides a clearer picture of the economy’s aggregate welfare than the total GP does, is even more dramatic. The average annual real growth per capita was 4.7% during the 1950s, 5.4% in the 1960s, 2.3% in the 1970s, and 1% in the 1980s. It increased in the 1990s to 1.9% but has averaged 1% since 2000. As seen, in terms of Puerto Rico’s real economic conditions since the 1970s, growth rates have shown little improvement.

Commonwealth has counted on a strategy of granting perennial tax exemptions to selected economic sectors, transferring the burden to local corporations and individual taxpayers, but this has failed to reap the expected economic benefits for Puerto Rico. Meanwhile, under Section 936, stateside corporations have claimed upwards of $60 billion in possessions credits on their federal taxes since 1976. The conditions governing how these credits could be earned have been subject to constant review by the U.S. Treasury Department and U.S. Congress.

Section 936 has gone through a number of changes. The Tax Equity & Fiscal Responsibility Act first introduced amendments to it in 1982; in 1986, further amendments were made by the Tax Reform Act; and in 1993, the Omnibus Budget Reconciliation Act modified it once more. In 1996, the Small Business Protection Act called for its 10-year phase-out. On Dec. 31, 2005, Section 936 is scheduled to expire. The uncertainty from the lack of a stable, long-term economic strategy has also been a contributing factor to Puerto Rico’s economic performance under commonwealth.

Until Puerto Rico resolves its political status, politicians will continue to pass the buck from the mainland U.S. to the island and back again. The economy will continue to languish as it has for decades, and because of the political status, Puerto Rico will continue to be unable to jump-start its economy. Commonwealth creates structural and institutional obstacles to Puerto Rico’s economic development and its residents’ well-being.

Economist Manuel Maldonado assisted with this series. Elisabeth Roman edited the articles.

In the next issue, CARIBBEAN BUSINESS will compare Commonwealth’s economic performance with other U.S. jurisdictions.

Puerto Rico Gross Product (GP) vs. Gross Domestic Product (GDP)

In Millions of $

2003: 74,362 / 47,354

2000: 61,702 / 41,419

1990: 30,604 / 21,065

1980: 14,436 / 11,065

1970: 5,035 / 4,688

1960: 1,692 / 1,676

1950: 724 / 755

Puerto Rico Real Gross Product vs. Real Gross Domestic Product

In Millions of $

2003: 10,668 / 6,686

2000: 9,945 / 6,487

1990: 6,618 / 4,930

1980: 4,662 / 4,007

1970: 3,068 / 2,901

1960: 1,432 / 1,473

1950: 844 / 879

Puerto Rico Real Gross Product (GP)

Average Growth Rate by Years

1950-1959: 35.3%

1960-1969: 7.0%

1970-1979: 4.0%

1980-1989: 2.0%

1990-1999: 2.7%

2000-2003: 1.5%

Puerto Rico Real Gross Product Per Capita

Average Growth Rate by Years

1950-1959: 4.7%

1960-1969: 5.4%

1970-1979: 2.3%

1980-1989: 1.0%

1990-1999: 1.9%

2000-2003: 1.0%

Source: Puerto Rico Planning Board

Analysis: CB Research & QBS Intelligence Unit

This Caribbean Business article appears courtesy of Casiano Communications.
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