Is Puerto Rico the next Greece?

Professor Daniel Bergstresser of Brandeis International Business School weighs in on the latest debt crisis in Puerto Rico.

Photo/Julian Cardillo '14

Professor Daniel Bergstresser

Are financial crises contagious? With Greece’s economy in free-fall, Puerto Rico has emerged with a giant debt crisis of its own.

Daniel Bergstresser is an associate professor of finance at Brandeis International Business School and is an expert in corporate governance, municipal finance and taxation. He is particularly interested in the economies of Latin America and just returned from a Fulbright project in Medellin, Colombia.

Bergstresser sat down with BrandeisNOW to provide some insight on what’s happening with Puerto Rico:

BrandeisNOW: What factors have led to Puerto Rico’s current debt crisis?

Bergstresser: Puerto Rico is a Commonwealth of the United States, and has had a rather curious status within the U.S. for decades.  As a territory, it enjoys some benefits and suffers some drawbacks relative to the situation that would prevail if it were a state.  The island is wealthy by global standards, but not by U.S. standards; it has a Gross National Product per capita that is somewhat less than half that of the mainland U.S.
Puerto Rico has managed to borrow $70 billion, which is 100 percent of its yearly GNP. That’s an extremely large debt burden, much larger than any state. The governor of Puerto Rico recently described the debt load as unsustainable, and the island’s political leaders appear to be taking steps to prepare the way for a default.

BNow: What makes up the Puerto Rican debt?

Bergstresser: The Puerto Rican debt situation is remarkable for the wide array of different entities that have borrowed money. In addition to direct borrowing by the Commonwealth directly, there are tens of different public benefit corporations, many of which have also borrowed in large amounts.

For example, there is the island’s monopoly electric power provider, PREPA, which has borrowed billions of dollars in the municipal market. The accounting for all of these different entities has not always been ideal, and the municipal marketplace is now waking up to a very messy and complicated reality. 

BNow: Greece is also currently going through a financial crisis. Are Puerto Rico and Greece’s problems related?

Bergstresser: If you gave me a choice between being a young person in Puerto Rico and a being a young person in Greece, I would definitely choose Puerto Rico. Puerto Rico is part of the U.S., and that’s not going to change.  That puts some floor on how bad the situation there can get.  The same floor doesn’t exist for Greece.  It wouldn’t surprise me at all if Greece, in a political sense, isn’t part of Europe within next five years. I could see Greece transitioning from being a first world economy towards something closer to a third world economy. You won’t see that kind of change in Puerto Rico.

BNow: So does Puerto Rico have structural problems within its economy? What are you recommendations for their debt crisis?

Bergstresser: A recent starting point for current problems might be the 1990s, when an agreement was made to phase out corporate tax incentives that were put in place to give American corporations an incentive to do business in Puerto Rico. Whether or not those tax incentives made sense to begin with, the transition was almost certain to disrupt the economy. 

Taking a longer view, Puerto Rico has a problem with competitiveness.  Fortunately, many of these problems are man-made, which means that they can and probably will change. An example is the Jones Act, which protects the U.S. shipping industry from foreign competition. This Act is probably a little bit of a drag for the mainland U.S. economy. 
But for the island’s economy, which depends much more on shipping, it’s that much worse. In addition, inefficient government monopolies raise the cost of electricity and water. And the minimum wage law is the same in Puerto Rico as it is in the mainland U.S.  My view is that the federal minimum wage is set at a level that makes some sense for the mainland U.S. economy. But in Puerto Rico, where labor productivity is much lower, the level of the minimum wage creates serious problems.  It’s part of why the official labor force participation rate in Puerto Rico is barely above forty percent. 

Pro-growth policies, for example a reexamination of the Jones Act, would help make doing business on the island less expensive and allow Puerto Rico to grow out from under its debt burden. 
BNow: How does the overall situation affect American households?
Bergstresser: In addition to being held by local investors, Puerto Rican debt is also widely held by mainland American households. Puerto Rican debt occupies an interesting place in municipal market, since it is exempt from state and federal taxation no matter where you live.  This has made it an attractive investment, for example, for mutual fund managers looking to pick up tax-exempt yield.  So the pain of a Puerto Rican default would be felt rather broadly. 
BNow: What do you see happening with Puerto Rico?
Bergstresser: Whatever we do, we absolutely shouldn’t forget the huge opportunity that Puerto Rico represents. The island has tremendous strengths. It has a well-educated work force.  It is a fantastic environment for tourism. It wouldn’t surprise me if in 50 years Puerto Rico is much better off than it is today. Remember, Puerto Rico is part of both the U.S. and Latin America. The island should be a bridge for doing business between the two communities. 
BNow: Speaking of Latin America, you just returned from Fulbright-sponsored work in Colombia.  What project were you working on?
Bergstresser: Brandeis IBS recently launched a partnership with EAFIT University, a private university in Medellin.  I was in Medellin for two weeks working with the scholars at EAFIT and helping them as they work toward setting up a new PhD program in economics. 
Being in Medellin makes you really hopeful about the world. Like a lot of places in the world, Medellin has had some struggles with violence. These struggles are well-known. But along with much of the rest of Colombia, the city is thriving today. The security situation has improved a great deal, and the business and academic climates in Medellin and in Colombia are remarkable.  The nation has come a long way.  This work is meaningful to me personally, in part because my mother spent a little bit of her childhood in Medellin.  She ended up becoming a professor of Latin American history, and I think that her experience in Medellin may have played some role in her later career choice. 
Whether we’re talking about Puerto Rico, Colombia, or the United States, a lot of our problems have been man-made. This can be frustrating, but it is also cause for hope. When our problems are man-made it means that they are fixable. 

Categories: Business, General, International Affairs, Research

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