It is said that those who cannot learn from history are doomed to repeat it. Sadly, this seems to be the case with respect to the Puerto Rican government and its Financial Oversight and Management Board in their handling of the Puerto Rican economic crisis. By not drawing the right lessons from Greece’s recent failed attempt at fiscal austerity in a Euro straitjacket, the Puerto Rican government is all too likely to exacerbate rather than to cure the island’s current economic crisis.
Puerto Rico’s macroeconomic challenge today is very similar to that of Greece in 2010. As was the case in Greece, Puerto Rico’s public finances have become seriously compromised due to years of economic mismanagement. This has led to a large public deficit, an excessive public debt burden and a mountain of unfunded pension liabilities. Similarly, as was the case in Greece, Puerto Rico is now having to address these public finance imbalances without a currency of its own.
{mosads}Large budget deficit reductions are very difficult to effect without one’s own currency. This is because the government lacks the normal monetary policy instruments to offset the adverse impact of tax hikes and public spending cuts on the economy. Not having its own central bank, the government cannot lower interest rates to cushion the blow of budget belt-tightening. Similarly, not having a currency of its own, it cannot resort to currency depreciation to boost its exports and reduce its imports.
There are reasons to think that Puerto Rico’s challenge of re-balancing its economy today is even more daunting than that which Greece faced in 2010. Whereas Greece started its adjustment process with its macroeconomy in reasonably good health, Puerto Rico is starting its adjustment process with its economy already economy mired in a 10-year slump and with unemployment at over 12 percent.
Greece’s recent, very unfortunate experience with excessive budget belt-tightening within a Euro straitjacket would seem to offer a cautionary tale for Puerto Rico. Since 2010, mainly as a result of an attempt to reduce the budget deficit by more than 10 percent of GDP, Greece is now experiencing a deep economic depression. Indeed, Greece’s loss of output over the last eight years exceeds that experienced by the United States in the Great Depression.
Puerto Rico’s economic prospects do not appear at all favorable considering that its government, under the tutelage of its oversight board, appears to be making three basic mistakes that Greece made in the handling of its economic crisis.
First, like the Greek government before it, the Puerto Rican government is being required by its oversight board to do more budget adjustment than is advisable within a U.S. dollar straitjacket. According to the island’s recent fiscal plan, over the next few years, it is planning on budget tightening measures amounting to around 6 percent of GNP. It is not unreasonable to think that the island’s GNP could decline by a further 9 percent as a direct result of those budget measures.
Second, in much the same way Greece engaged in drastic budget belt-tightening without structural economic reform, Puerto Rico now seems to be doing the same. The lack of economic reform is all too evident in the island’s highly uncompetitive labor market, where labor participation is as low as 40 percent.
Third, as was the case in Greece, Puerto Rico is failing to face up to its debt problem in a timely way. Even though there is widespread recognition that the island is insolvent, it is yet to restructure its public debt mountain or to address its chronic pension situation.
If Greece’s experience with a policy mix of budget austerity without simultaneous economic reform is any indication, unless there is a major change in policy direction, Puerto Ricans should brace themselves for several more years of a slumping economy. The social and economic consequences of such an outcome should not be underestimated.
Puerto Rico is already poorer than any of the 50 states in the United States. In addition, it is already losing around 2 percent of its population each year through migration to the mainland.
It would seem that if Puerto Rico is to avoid a deepening economic depression, it would need to change policy course and come up with a comprehensive plan focused on promoting rapid economic growth. Such a plan might be centered on a more reasonable pace of budget reduction, serious economic reforms — especially to its rigid labor market — and a major reduction in its debt burden.
Needless to add, the island could also benefit from congressional support in the form of the repeal of the Jones Act, which requires Puerto Ricans to buy goods from American-made ships with an American crews, and the restoration some of the tax advantages that the island formerly enjoyed.
Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.
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