Why all of the excitement?
Three weeks ago Popular Democratic Party Governor Alejandro García Padilla announced that Puerto Rico’s public debt payments have grown too large for the government to meet. At the moment, the total public debt ranks in at about $74 billion. This follows weeks of speculation on the matter and last-minute amendments to the current fiscal year budget in preparation for an eventual default. Governor García’s bold statement echoes a growing number of voices from his own party who had been declaring the debt as non-payable, including those by Representatives José Báez and Luis Vega as well as Senators Ramon Nieves and Ángel Rosa.
Governor García’s statements were unprecedented for Puerto Rican politics as public policy until now has been to faithfully make payments even at the cost of social welfare. Up until the present, administrations have paid the debt payment at all cost, at times resorting to unpopular cost-cutting reforms. The previous administration, headed by Governor Luis Fortuño, for example, laid off and terminated 30,000 public employees. Though not as radical, Governor Garcia has also made structural changes in order to make said payments.
Is it that bad?
It’s not the end of the world. Job creation and employment have slightly increased, with the crime rate – a major worry for Puerto Ricans – improving as well. Nevertheless, unemployment, migration, and poverty rates are still widespread and require attention. Defaults are nothing new, with half of the countries in the world, including United States, have defaulted on debt payments at one time or another. What makes Puerto Rico different is its territorial status with the U.S. Without a doubt, the default also has its political cost on the local level.
How did the debt get so high?
Debt is an aspect of public administration. In fact, at times it is necessary in order to ensure the growth and finance of otherwise costly public infrastructure projects. Nevertheless, in Puerto Rico’s case, administration after administration has left behind large deficits, which in turn were paid for by more debt. For example, the previous administration of Governor Fortuño left behind a $1.3 billion deficit. Prior to that, Governors Aníbal Acevedo Vilá and Sila María Calderón left deficits of $3.2 billion and $1.2 billion, respectively. In essence, these administrations racked up Puerto Rico’s public debt to $16.6 billion, $17.3 billion, and $13.3 billion, respectively, adjusted for inflation. Each administration has added to Puerto Rico’s fiscal woes.
Every so often governments would also take billions of dollars out in order to finance legislative earmarks and pork barrels. These funds are usually divided among city governments and legislative districts to pay for things such as road paving, coliseums, baseball parks, and activity centers. Rarely do these projects generate long term jobs, investments, income, or savings, though they do an excellent job of generating votes. Loans were also taken out at one time to subsidize short term electric costs. Facing angry voters over high electric costs the previous administration opened a $600 million line of credit to artificially lower power bills. This long-term financing of short-term electric costs relief was rolled out only two months prior to the 2012 elections.
As one can see, Puerto Rico’s debt is the result of inefficient government, centralized bureaucracies, vote-buying and political clientelism.
Why can’t the government pay?
Since 2006 the Puerto Rican government has been struggling through a nasty recession. This recession pre-dates that of the United States and has taken its toll on Puerto Rican society. With few jobs, fewer well-paying jobs, and increased cost of living, the economy contracted by 12.2% in five years alone. As U.S. citizens with open access to U.S. borders, Puerto Ricans in turn have migrated in hordes. 176,000 Puerto Ricans have left the island between 2005 and 2010 including 40% of college graduate youth. This pattern not only erodes Puerto Rico’s tax and labor base, but it makes it impossible to accurately project future government revenue. For example, at the close of the most recent fiscal year it was estimated that the shortfall could reach $651 million less than the government had expected.
The crummy economic situation and terrible outlook has in turn decreased investor confidence, resulting in lower credit ratings and higher interest payments. Coupled with short term loans taken out from the previous administration without identified sources of repayment, the overall debt payment has increased radically. Changing demographics and government inefficiencies have also led to deficits for Puerto Rico’s public retirement plans. The largest public sector retirement fund, for example, was estimated to close the previous fiscal year with $700 million in deficit.
The result is a situation where Puerto Rico must continue cutting services and increasing taxes in order to pay its debt. Total debt payment in 2014 was at $3.5 billion with 2018 estimates projected at $4 billion. This is more than what the Commonwealth government spends on its departments of education, housing, public works and transportation, economic development, and agriculture, combined! This is the “death spiral” mentioned by Governor García: government cuts, increased debt payments and a stagnant economy.
So what’s going to happen?
Nobody really knows.
When cities and governments in the United States hit economic difficulties they often restructure their debt utilizing U.S. Bankruptcy Code’s Chapter 9. Puerto Rico is specifically excluded from Chapter 9 and lacks an established procedure for sorting out Puerto Rico’s debt in case of default. Resident Commissioner Pedro Pierluisi has recently filed HR 870 in the House of Representatives with the intention to extend Chapter 9 benefits to Puerto Rico. Despite plenty of lobbyists attempting to block the bill numerous presidential candidates from both parties have come out recently to endorse it.
Nevertheless, a number of actors have questioned whether or not Chapter 9 could be applied retroactively to Puerto Rico’s current debt, including House Judiciary Committee Chairman Robert Goodlatte (R-VA), Antitrust Law Subcommittee Chairman Tom Marino (R-PA), and Rep. Darrell Issa (R-CA). Law 71 – an effort by the Puerto Rican government to create a local bankruptcy procedure – was shot down by federal courts for this very reason. The court ruled that not only did Puerto Rico lack the authority to create such a law but that it violated the U.S. Constitution’s Contract Clause.
The founders of Puerto Rico’s Constitution, on the other hand, worked into its Article 6, Section 2 a prohibition against spending more than 15% of revenue on public debt. Said Article states that debt payments must be made before any other public expenditures. Though the Puerto Rican government has traditionally applied this priority to all of Puerto Rico’s debt, only $14.7 billion of which is backed up by this constitutional clause. Analysts and politicians alike have referred to this difference as the islands “extra-constitutional” debt. Some, such as Representative Manuel Natal consider the extra-constitutional nature of the public debt to be illegal and thus null. Analyst Jay Fonseca echoes this, stating that Puerto Rico’s debt-emitting agency is “unconstitutional since its origin; the very repayment contract that bond holders signed is also illegal, thus making the contract invalid and not enforceable in courts.” Despite this, it is unlikely that the government will assume this stance.
Claims concerning some of Puerto Rico’s debt payments are to be filed in Puerto Rican courts, according to some analysts. Some debt, such as that held by public utility corporations, could end up in federal courts. Creditors have been keen to this, suggesting last year the future loans be given only in cases where the Puerto Rican government renounces judicial sovereignty over the matter. Nevertheless, many of Puerto Rico’s debt battles will most likely end up in local courts.
it is yet to be seen how the courts will handle such claims. The constitutional guarantees for a portion of the debt, the lack of said guarantees for the difference, and the absence of any state or local bankruptcy procedure will surely make for interesting court cases. Courts may very well freeze chunks of the government budget though in government-related cases they must balance civil claims on one hand with public utility and the best interest of the people of Puerto Rico on the other. It is rumored that the government is hiring lawyers to gear-up for the ensuing legal battles.
Government officials are hoping that a default can be avoided by forcing creditors to renegotiate debt payment terms. Though the Commonwealth was able to make its July payments on time, the probability of future default acts as a big incentive for bondholders to sit down at the negotiating table. Governor García proposes a moratorium on payments in order to allow Puerto Rico to roll out a restructuring plan and invest in its economy.
What has been done so far?
At least on the economic front there has been a bit of progress. The government has increased government consumption of locally-produced products; agriculture production earnings rose almost a quarter from 2012 to 2014; the number of small businesses has increased 5.9% from 2013; 10,000 Jobs have been generated in a year; and overall unemployment has dropped to its lowest rate in 6 years. Though these are baby steps, at least many social indicators are improving.
Secondly, by declaring default the government has forced creditors to the negotiating table. México and Argentina, after their respective 1982 and 2002 defaults, were able to negotiate favorable restructuring plans and even significant debt forgiveness.
Thirdly, Governor García has rejected more radical austerity measures, such as teacher layoffs and decreasing the minimum wage. These sweeping proposals, as well as others as equally neoliberal, are part of a government report authored by former International Monetary Fund and World Bank economists.
What can be done now?
Ultimately, the consensus is that the Puerto Rican government needs to be reformed. It has over 125 public agencies and an inefficient bureaucracy that increases the cost for citizens and businesses alike. In coming days the Governor is expected to release an agency reform proposal which ultimately hopes to consolidate the number of these agencies. Nevertheless, reform needs to happen not only in agency size and reach but in the way that they work entirely. Traditional cuts are not sufficient. In February, the government’s Budget Management Office stated that simply they had run out of budget areas to cut.
The government can also initiate the decentralization of its sluggish bureaucracies towards the more efficient local governments. Of the few services that have been decentralized to municipalities, such as school transportation and school and road maintenance, the government has seen up to 21% in savings. City government that collect sales taxes also have collection rates 1/3 to 1/2 higher than the state. In turn, it is estimated that the central government fails to collect up to $900 million in sales tax income each year.
Though approved in 1991, the Autonomous Municipalities Law fell short of the decentralizing that its founders sought. For example, only 8 of the 78 local governments have been able to wrestle through the complex process of achieving the highest level of autonomy possible. Even then, maximum municipal autonomy is miserable when compared to decentralized models in the U.S. and the world. Crucial and potentially bureaucratic services such as education, health, permitting and social services are executed almost exclusively by the central government.
Simultaneously, jobs need to be generated in order to stave mass exodus and increase the tax base. Quite possibly the biggest impediment to this is the outdated, colonial-era Jones Act and its maritime provisions. Said law requires that all shipments between Puerto Rico and the U.S. be carried out on U.S.-built, manned, and flagged ships. These ships often are not only the most expensive, but only two companies share a monopoly on the Puerto Rican shipping industry. The result is high costs for imports. With Puerto Rico importing almost 90% of what it consumes, it is estimated that the local economy loses between $800 to $900 million annually.
What about Puerto Rico’s political status?
Surely, no commentary on Puerto Rican affairs is complete without reference to the island’s age-old status debate. Even before the default, politicians from all spectrums were making claims that their preferred status option would have prevented or solved the crisis. The New York Times ran an article titled “Statehood Is the Only Antidote for What Ails Puerto Rico” while Al Jazeera published, “The cure for Puerto Rico is Independence” by Columbia University lecturer Ari Paul. Meanwhile, radio waves are buzzing with analysis and politicians concerning the role of status in the public debt crisis.
Pro-statehood politicians preach the automatic inclusion of Puerto Rico in the U.S. Bankruptcy Code, access to federal dollars, and the seven legislators that statehood would secure in the U.S. Congress. Independence and pro-sovereignty advocates clamor for exclusion from cost-hiking U.S. maritime laws, access to alternate forms of international finance, and the ability to pass its own debt-restructuring laws. As for advocates of the status quo, misuse of the Commonwealth’s triple-exempt access to bond markets and embarrassing federal court decisions have made for a bad month for Commonwealth advocates.
Though each status option does in fact provide various tools as well as impediments to solving the debt problem, each side seems to be missing the root of the problem: mismanagement. Government inefficiencies, paternalist politics, clientelism, and short-term politicking are the primary causes of Puerto Rico’s public debt; characteristics that would persist no matter the island’s political status. There is absolutely no indicator, for example, that additional federal dollars and representation in the U.S. congress would make the island government more efficient and cost effective. Though this should not deduct any merit from decolonization advocates, it should prove that the status options are not a magic wand for Puerto Rico’s fiscal woes and flawed public administration.
Luis Gallardo Rivera, M.P.A., J.D. is a legislator for the Municipality of Aguas Buenas in Puerto Rico. He is also a member of the Board of Directors for the Association of Municipal Legislators of Puerto Rico and teaches courses in public administration for the University of Phoenix. @LuisGallardoPR
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