The Washington Consensus is dead wrong on Puerto Rico

There is a new consensus on Puerto Rico among Washington entities that is similar to the old Washington Consensus, created roughly 30 years ago, on the rest of the world: Local governments are solely responsible for their crises, and solutions are brought about by a combination of sharp and unequal austerity mixed with privatization and labor reforms.

In the old Washington Consensus, the International Monetary Fund (IMF) and the World Bank led the efforts to address crises.

{mosads}The consensus on Puerto Rico is led by Congress in consultation with the General Accounting Office (GAO), by members of the American Enterprise Institute and by former IMF economists now employed by universities in Washington.

 

The recent publication of the GAO is the latest evidence on this new Washington Consensus: a review of anecdotes from some unidentified “experts” that barely mention the role of U.S. policies on Puerto Rico’s economic structure.

The low quality of this report is also evidenced by the absence of academic references and the confusion of symptoms with causes: It argues that outmigration and diminished participation rate are factors that contributed to the economic contraction. 

Many structural reforms recommended in the so-called “Krueger Report” are based on similar analyses: anecdotes based on what other “experts” think. Likewise, the Fiscal Control Board, created by Washington, is proposing to change Puerto Rico’s economic structure without a rigorous diagnosis.

Take the case of the recent “study” by one of its consultants: 33 pages describing desires and 2,165 pages of appendix of selected articles. With no evidence, it argues that, “about one-quarter of Puerto Ricans work informally.”

Many identification methods have been developed in the discipline of economics in the last century but few were used in these “studies,” the recipes of which will impact millions of people.

This board would state that there are no good data on the island, but that’s exactly what they should be investing in. They should be gathering data instead of giving consultants blank checks from a devastated society.

Ironically, this consensus accuses the local government of making decisions without counting the requisite hard data.

Using econometric techniques, professor Juan Lara and I found that the main underlying factor contributing to the current crisis in Puerto Rico was deindustrialization: The removal of Section 936 from the federal tax code caused a collapse in the economy by disincentivizing manufacturing on the island, a sector that represented half of the Puerto Rico’s economy.

The collapse reduced government revenues, triggering a debt crisis. Thus, the recipe of the Fiscal Control Board, based on the idea that mismanagement alone caused the crisis, is perverse. Furthermore, the findings of professor Juan Suárez found that eliminating Section 936 was a bad policy even for the U.S.  

Surely, changes are needed. But, we need to consider the whole spectrum of alternatives and base our decisions on empirical research.

Regarding fiscal policy, I proposed to this board that a re-engineering program for the government would tackle inefficiencies while producing savings, but the board prefers austerity although this just exacerbates inefficiencies by maintaining the same processes with fewer workers.

Knowing that Puerto Rico has the largest income inequality in the U.S., I also asked them to include changes on social inequality in their policy modeling, because almost all of their policies affect only the working class and the poor.

Regarding economic development, the main strategy of this consensus is based on the relaxation of labor laws, but such labor reform would not push companies to hire more if their sales do not increase. In economic jargon: that would lead to a zero marginal productivity of labor! 

The best arguments of this consensus are based on anecdotes. For instance, they referred to entrepreneur surveys that don’t have external validity: One can state that the lack of business success is caused by labor laws, but it may really be caused by a suboptimal marketing strategy. 

One can argue that this relaxation can attract more foreign direct investment, but the labor reform approved in January 2017 already relaxed almost all protections for new hires and so far it has created, according to the government’s own confessions, 200 jobs (about 0.2 percent of the total employment). Thus, it seems that this Washington Consensus is “pushing on a string,” this time with labor proposals. 

The economy of the island is not like the economy of the average U.S. state: A relatively large migration makes it a small open economy, and its relatively large informal market resembles Lewis’ dual economy.

Even under these conditions, labor productivity has been increasing on average during the last 30 years, but wages have remained stagnant. Thus, problems in the labor market can be better explained by a weak demand for labor caused by deindustrialization and by the relatively small size of the local private sector.

Puerto Rico needs industrial policies to boost labor demand, but barely any of the members of this consensus raise their voice against the recent federal tax reform that imposes new taxation on research and development done by many U.S. manufacturing corporations located in Puerto Rico, potentially eroding further Puerto Rico’s competitiveness.

There is another consensus on Puerto Rico among prominent economists, but the Washington Consensus would likely ignore it and impose unnecessary pain upon Puerto Ricans with their counterproductive policies.

Just as before, when the old Washington Consensus was applied to foreign countries, this new consensus is presently failing in a U.S. territory. Different players, same game.

José G. Caraballo, Ph.D., is an assistant professor at the Business Administration College, a researcher at the Interdisciplinary Research Institute and director of the Census Information Center at the University of Puerto Rico at Cayey.