America’s Greece -Puerto Rico A Failed Welfare State
http://www.wsj.com/articles/americas-greece-1435874404
Puerto Rico is a failed welfare state that needs a Detroit-like overhaul.
The Obama Administration is delighted to tell everyone that Greece isn’t America’s problem, but hold the schadenfreude. The U.S. has its own version of Greece in Puerto Rico, and the meltdown could be nearly as ugly when it arrives.
Puerto Rico Governor Alejandro Garcia Padilla this week admitted the open secret that the territory’s $72 billion debt “is not payable.” Europeans will notice the Greek-like reasons: excessive borrowing, anti-growth policies, human and capital flight, and the refusal of local politicians to address the failure of entitlement state politics. Oh, and don’t forget the policy damage from Washington.
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Puerto Rico’s economy has been contracting for nearly a decade, and employment has shrunk by 14% since 2005. Its 12.4% jobless rate would be higher if not for its astonishing 40% labor participation rate, compared to 63% nationwide. The island’s population has declined by roughly 300,000 in a decade as young people flee to the mainland, where they can work as U.S. residents.
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For those who stay, rich welfare benefits provide a disincentive to work. A household of three can receive $1,743 per month in food stamps, Medicaid, utility subsidies and welfare compared to minimum-wage take-home pay of $1,159. Employers are required to provide 15 days of vacation and 12 sick days annually and a $600 Christmas bonus. Government employees make up a quarter of the island’s workforce.
To pay for all this, politicians have borrowed and taxed to the limit. Public debt has tripled since 2000 and exceeds 100% of gross national product. In 2006 the territory instituted a 7% sales tax, which this year was raised to 11.5% and next year will become a value-added tax. Since 2013 Mr. Padilla Garcia has raised the petroleum tax to $15.50 from $3 per barrel, imposed a 1% tax on insurance premiums and the gross income of financial institutions, and increased sewage rates by 60%.
Puerto Rican officials like to blame destructive Washington policies, and they have a point. The U.S. minimum wage is a killer for a territory with relatively low labor productivity. A 1992 study from the National Bureau of Economic Research found that Congress’s 1974 minimum wage hike reduced Puerto Rican employment by 8% to 10% compared to what it otherwise would have been.
Yet in 2007 Congress raised the minimum wage to $7.25 in 2009 from $5.15 amid the recession. Speaker Nancy Pelosi was happy later to carve out a lower-wage exception for American Samoa, where the San Francisco-based StarKist operates a manufacturing plant. But Puerto Rican employers got no such help.
Puerto Rican politicians exaggerate the impact of the island’s manufacturing tax credit phaseout in 1996. But they are right to blame the 1920 Jones Act, which requires goods transported between U.S. ports to be on ships manned and constructed by American workers. This raises the cost of imported petroleum, the island’s main energy source. Electric rates are twice the U.S. average.
The island has made some reforms at the margin, including a 10% cut in the public workforce and a pension reform. But the government and most of its public agencies are still running deficits with liquidity crises looming. All three public pension funds, which are $34 billion in the red, will run dry by 2020. The Puerto Rico Electric Power Authority is seeking to restructure $9 billion in debt.
The upshot is American Greece. The territory can’t finance its current expenses much less its debt, while ever-higher taxes punish the growth essential to revival. The bleak prospects have caused Pedro Pierluisi, the territory’s non-voting Member of the U.S. Congress, to seek legislation to let Puerto Rico’s public corporations—which owe about a third of the territory’s public debt—file for Chapter 9 bankruptcy.
U.S. states can’t declare bankruptcy, but this constitutional constraint doesn’t apply to Puerto Rico since Article 4 gives Congress the “Power to dispose of and make all needful Rules and Regulations” of territories. Hedge funds that have piled into the island’s general obligation bonds like this idea because it would free up cash. The Obama Treasury and many Democrats are also in favor.
Bankruptcy would be painful and carries risks, but an orderly restructuring under a legal framework in federal court is preferable to a creditor brawl that would likely follow a default. Hedge funds, mutual funds and bond insurers would have to take haircuts for mis-pricing the risk and enabling Puerto Rico’s political mismanagement. Incredibly, yields on the island’s general obligation bonds were as low as 6% two years ago—below Illinois and Michigan GO bonds. They are now 12%.
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But Puerto Rico also needs a wholesale political restructuring, not a mere debt rescue. Detroit’s bankruptcy provides a model for how Chapter 9 can help a basket case. Steered by emergency manager Kevyn Orr, the city used bankruptcy to rewrite labor contracts, trim pensions, restructure public agencies and reinvest in services like public safety.
If Congress does give Puerto Rico access to Chapter 9, it should cover all of the island’s debts, not merely its public companies. And it should require a financial control board that can enforce changes in governance and other reforms that its politicians refuse to consider.
Hillary Clinton tweeted the other day that Puerto Rico needs “real tools & real support,” which suggests she thinks this will help her with the Hispanic vote. OK, Madam Candidate, how about an exception to the Jones Act and minimum wage?
We doubt that bailing out Puerto Rico would be popular on the mainland, especially as Americans learn more about its profligate welfare-state politics. If Republicans want to use bankruptcy to help Puerto Rico avoid becoming another Greece, they should do it the Detroit way.
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