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Este informe no está disponible en español. CARIBBEAN BUSINESS What If? Puerto Rico’s Economy: It’s A Matter Of Status By CARLOS MARQUEZ August 5, 2004 What does the future hold for Puerto Rico’s economy under a continued commonwealth form of government? What can be expected with an enhanced or new form of commonwealth? What if Puerto Rico were a state, associated republic, or an independent nation? How did Puerto Rico arrive at its current economic state? How can the island compete in the global economy? Where is Puerto Rico’s relationship with the federal government heading? The responses to these and other important questions are just a few of the issues CARIBBEAN BUSINESS will be examining over the next 12 weeks in a special series entitled "What if?" For several months, a group of economic consultants, researchers, and writers have explored and analyzed Puerto Rico’s future political options and their impact on the island’s economy. Starting today, CARIBBEAN BUSINESS will present decision makers and business leaders who help shape Puerto Rico’s economic future with a comprehensive analysis of the island’s different political status alternatives. These options will be addressed, however, not from the highly emotional perspective that political issues have traditionally been dealt with in Puerto Rico, but from a purely economic standpoint of dollars and cents. Each of the political status alternatives available to Puerto Rico inherently carries its own economic implications. CARIBBEAN BUSINESS will examine these implications, highlighting the benefits and setbacks of statehood, commonwealth (new or enhanced), free association, and independence. Not only will the impact of the different status options on the future economy be carefully analyzed, but also their effect on every one of the island’s residents from all economic levels. CARIBBEAN BUSINESS will present the various "what if…" scenarios for each of the status alternatives that Puerto Rico faces in this defining moment of its history. The goal is to allow readers to make an informed decision based on the economic implications of each status option and its potential impact on the pocketbook of every citizen, absent from the emotional issues that have dominated the discussions on status up to now. The need to solve Puerto Rico’s political status has been with us not for the last 50 or 100 years, as some may believe, but for centuries. The island’s unsettled political situation has led to limited economic growth and development, and to a status debate that seems never-ending and has held Puerto Rico’s economy hostage for generations. There are some who still claim Puerto Rico is not ready to move toward a final resolution of its political status. They maintain that our economy faces substantial competitive challenges; that the economy and its structural problems must first be strengthened; the economy is not growing fast enough; our per capita personal income instead of converging with that of the United States has been diverging from it; that we are falling behind; Puerto Rico’s underground economy and government are too big; and we depend too much on federal transfers, and all these issues need to be addressed before attempting to solve the island’s political status. It is these allegations and arguments that have led CARIBBEAN BUSINESS to address the issue of status from an economic perspective. The more political and business leaders avoid dealing with Puerto Rico’s political status, the more obvious it becomes that a solution is imperative for our economic well-being and future development. Unless Puerto Rico’s political status is permanently solved all else will be like "whistling in the wind"; and the winds are changing globally and changing rapidly, especially in Washington. Federal deficits will continue to place limitations on discretionary appropriations and spending. The ongoing war against terrorism will also create additional pressure to reduce the rate of growth in nondefense discretionary spending. Puerto Rico is already experiencing the trend of reduced federal expenditures for corporate welfare programs, such as the elimination of tax incentives under Internal Revenue Code Section 936. A new world order The world order has changed and Puerto Rico can no longer economically afford not to make a decision regarding its political future. The temporary tactics initiated either in Washington, D.C. or in Puerto Rico, which have characterized the island’s economic development strategies in the past, only serve to satisfy short-term economic needs and are no longer viable. Economic development strategies based on temporary tax or fiscal arrangements provided by the U.S. Congress only generate uncertainties due to their provisional nature and limit Puerto Rico’s ability to walk on solid ground. A clear example of this has been the loss of economic tax incentives granted by Congress to Puerto Rico. On Dec. 31, 2005, Puerto Rico’s economic activity tax credit (Section 30A) and possession tax credit (Section 936) are scheduled to expire and there are no new incentives approved to replace them. Without tax credits, Puerto Rico’s ability to compete in a global economy based on lower wages and labor-intensive operations will be permanently eliminated. The island is already unable to compete with Mexico’s maquiladoras across the U.S. border and the apparel manufacturers in the Dominican Republic. Furthermore, China and its more than 800 million citizens who reside in rural areas and are waiting in line to join the country’s industrial work force have made it nearly impossible for any developed economy to compete for labor-intensive operations. The once competitive advantage provided by a common market and common currency with the U.S. mainland also has been disappearing. In 1992, Canada and Mexico integrated their markets with the U.S. with the enactment of the North America Free Trade Agreement (Nafta). The Central American Free Trade Agreement signed earlier this year, provided for further economic integration between the U.S. and the Central American republics of Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. The Dominican Republic is also joining in. These free-trade agreements have created a new impetus toward the completion of the Free Trade Area of the Americas agreement, which will create an open market of 800 million people in the western hemisphere by 2005. Global and hemispheric changes have altered the rules of the game for Puerto Rico and the island’s existing economic model and political status are unable to compete successfully with open markets and low-wage economies. Puerto Rico’s future economic transformation is based on its political transformation. The people of Puerto Rico, who are U.S. citizens, are entitled to the same life, liberty, and pursuit of happiness and economic opportunities enjoyed by the citizens who live on the mainland. Regardless of the status alternative the island finally opts for, Puerto Ricans have the right to look forward to a secure and prosperous economy. In this edition, the first of 12 issues regarding Puerto Rico’s political status and economic future, CARIBBEAN BUSINESS presents a brief look at the island’s history and economy during the first 50 years of American rule from 1899 to 1950. Puerto Rico’s economic and political development A brief look at history to gain perspective on the present After 400 years of Spanish colonialism and on the threshold of the 20th century, Puerto Rico became a possession of the United States of America. Today, the island’s economic state is a reflection of this history and of its past economic performance, where development has been intrinsically linked to Puerto Rico’s political status. In this issue, the first in a series of in-depth CARIBBEAN BUSINESS reports on Puerto Rico’s political status and economic future, we begin by examining the island’s history and economy over the first half of the past century to attain a perspective on the present. A Spanish colony becomes ‘Puerto Rico USA’ In 1898, as a result of the Spanish-American War and the Treaty of Paris, Puerto Rico was ceded to the United States by Spain. Since then, the island has been a U.S. possession and its economic performance and the well-being of its citizens have depended on decisions made in Congress. In 1899, after 405 years of Spanish colonialism, Puerto Rico was enduring rampant poverty, widespread illiteracy, high unemployment, and an average life expectancy of just over 30 years. At the time, Brigadier General George W. Davis, U.S. military governor of Puerto Rico wrote: "So, great is their poverty that they are always in debt to the proprietors or merchants. A family of a dozen may be huddled together in one room, often with only a dirt floor. They have little food worthy of the name and only the scantiest clothing. It is hard to believe that the pale, sallow, and often emaciated beings are the direct descendants of the conquistadors who carried the flag of Spain to nearly all of South America and one-third of North America." A census conducted in 1899 by the War Department revealed fewer than 20% of the population could read or write. Out of approximately 300,000 school-age children in Puerto Rico only about 20,000 or fewer than 10%, attended school. The average life expectancy for the population of 953,000 was estimated at 33 years. Special Commissioner Henry K. Carroll, described in the 1899 Report on the Island of Porto Rico what he perceived as the population’s aspirations: "They expect under American sovereignty the wrongs of centuries will be righted, that they will have an honest and efficient government; the largest measure of liberty as citizens of the great Republic under the Constitution; home rule as provided by the territorial system …and the general adaptation to the island of all those institutions [that] have contributed to the prosperity, progress, and happiness of the American people." The Foraker Act of 1900, Puerto Rico’s first Organic Act, failed to incorporate Carroll’s recommendations and marked the beginning of congressional control over the island’s political status and its future economy, a condition that still remains today. Early in the 20th century, Puerto Ricans couldn’t comprehend why, despite their relationship with the U.S., they still were not treated as equals. In 1947, Paul Blanchard described their sentiments in his book, "Democracy & Empire in the Caribbean," "They [Puerto Ricans] still can’t reconcile American professions of democracy with the fact that they don’t share as equals in controlling the ultimate source of authority over them, the Congress of the United States." The sentiments described by Blanchard nearly 60 years ago continue to be shared by a majority of Puerto Ricans today. The temporary nature of Congressional actions toward Puerto Rico began as early as 1900. The Foraker Act, which was in effect from May 1, 1900 to March 2, 1917, states: "Temporarily to provide revenues and civil government for Puerto Rico, and for other purposes." The Foraker Act included several important provisions such as: requiring merchandise traded between the United States and Puerto Rico to pay 15% of its regular duty and the duties collected to be used to finance the operations of a civil government. Inhabitants of the island would become citizens of Puerto Rico (not of the United States), and together with the U.S. citizens residing on the island, would constitute a body politic under the name of The People of Puerto Rico with the governmental powers provided by the law. All statutory laws of the United States were applicable to Puerto Rico except the internal revenue laws that weren’t in force in Puerto Rico and the Federal District Court of Puerto Rico was created for judicial purposes. Qualified voters in Puerto Rico could elect a nonvoting resident commissioner to the U.S., as long as he spoke English. With the enactment of the Insular Revenue Act, the dollar replaced the provincial (the island’s currency at the time) and Puerto Rico became part of the U.S. monetary system. Soon after the Foraker Act was enacted, a series of U.S. Supreme Court decisions began constructing the legal theory of an unincorporated territory. These cases became known as the Insular Cases (1901-05). The main issue brought to the high court dealt with the powers and limitations, if any, granted to the U.S. Congress by the Constitution in the administration of territories. In the most important of these cases, Downes v. Bidwell (1901), the Court upheld the validity of imposing duty on goods brought into the U.S. from Puerto Rico. In a concurrent decision, Supreme Court Justice Edward D. White introduced the theory of "incorporated" vs. "unincorporated" territories. According to Justice White, Congress had plenary powers to govern unincorporated territories, limited only by the fundamental individual rights conferred by the Constitution; nevertheless, the Constitution was applied in full force in territories that had been incorporated by Congress. Justice White in his concurring opinion laid down the doctrine that would become the law of the court. In another Supreme Court case, Hawaii v. Mankichi (1903), it was decided that the protection of the fifth and sixth amendments, particularly the right of indictment by grand jury and conviction by a unanimous verdict, were not "fundamental" as to require application in an unincorporated territory. Subsequently, in Dorr v. United States (1904), the high court decided Congress had the right to make laws for the government of territories, without being subject to all the restrictions that are imposed upon it when passing laws for the states; furthermore, until a territory ceded by treaty had been incorporated into the U.S., it was to be governed by Congress, subject only to such constitutional restrictions upon its powers as are applicable to the situation. In the highly significant Insular Case, Rassmussen v. United States (1905), the differences between the treaty with Russia concerning Alaska and the treaty with Spain concerning the possessions ceded to the U.S. came under scrutiny by the Supreme Court. The Court decided that contrary to the case of the treaty with Spain, where Congress had made the determination to reserve the question of the status of the acquired territories for subsequent action, in the case of Alaska, Congress manifested the intention to admit the inhabitants of the ceded territory to the enjoyment of citizenship, and expressed the purpose of incorporating the territory into the United States. On March 2, 1917, Congress passed the Jones Act, Puerto Rico’s second Organic Act. The provisions of the Jones Act applied to "the island of Puerto Rico and to the adjacent islands belonging to the United States." The act provided for a bill of rights and declared all citizens of Puerto Rico, as defined in the Foraker Act, citizens of the U.S. It also allowed the citizens of Puerto Rico to retain their status if they so desired and 288 island inhabitants opted to do so. The concession of U.S. citizenship on Puerto Ricans, however, didn’t change anything in terms of Puerto Rico’s status. The U.S. Congress maintained sovereignty over the island. On April 2, 1917, just 30 days after the Jones Act was passed, President Woodrow Wilson, in a speech to the U.S. Congress, outlined the case for declaring war on Germany, with the formal declaration of war following four days later. Although they had officially been declared U.S. citizens only 34 days before the onset of war, 18,000 Puerto Ricans served in World War I. In 1922, the Supreme Court delivered a unanimous decision on Balzac v. Puerto Rico, which stated: "On the whole, therefore, we find no features in the Organic Act of Puerto Rico of 1917 from which we can infer the purpose of Congress to incorporate Puerto Rico into the United States with the consequences [that] will follow." The court was presided by Chief Justice William Howard Taft (1921-30), who wrote the unanimous decision. Taft previously had been appointed by President McKinley as the first civilian governor of the Philippines in 1901. He was secretary of war in 1904 and president of the United States from 1908 to 1912. 1899-1929: A period of rapid development The first period of the island’s economic development under U.S. sovereignty (1899-1927) was described by Dr. Harvey S. Perloff in his book "Puerto Rico’s Economic Future," published in 1950, as "marked by the extremely rapid development of the tariff-protected commercial crops, especially sugar and tobacco; the large inflow of outside capital to the island; consolidation of sugar holdings; and expansion of processing and handicraft activities." Perloff, who would later become director of the Economic Division of the Puerto Rico Planning Board under Chairman Rafael Pico, stated that per capita purchases from the outside world had increased by 12 times since 1900. It’s important to recall that although terms such as gross domestic product (GDP), gross product (GP), and personal income (PI), among other macroeconomic variables commonly used today, weren’t developed until the 1930s, the use of such economic indicators even during the 1940s was limited to relatively few specialists. As a result, comparative statistics on Puerto Rico’s economic performance before the 1940s are limited. By 1930, according to a study released by the Brookings Institution, "Porto Rico & Its Problems," approximately $120 million in private capital had been invested on the island during the first three decades of American rule. Dr. Perloff also points out the large and steady inflow of U.S. mainland capital profoundly affected Puerto Rico’s economic, political, and social life. On the downside, the island suffered from land monopoly, absentee ownership, and monoculture (sugarcane) with the inevitable creation of a large sector of seasonally employed field workers, who earned an average of 12 cents a day in the sugar fields. During the last three decades of Spanish rule, sugar production amounted to an average of 57,000 tons a year; by the 1930s production had increased to over 900,000 tons. However, new industries were being created, making possible new forms of employment, with banking and credit facilities expanding. Manufactured goods were being produced and exported in much greater quantity, leading to increases in the island’s total output and income. Yet, Puerto Rico’s per capita net income amounted only to $122 in 1929-30, less than one-fifth the per capita income of the U.S. during the same period. The 1930s: Economic assistance gets underway The 1930s started with Puerto Rico suffering from the onslaught of hurricane San Felipe (1928), which devastated most of the coffee industry and agriculture, and destroyed most of the housing. Not long after, the combination of the Great Depression and Hurricane San Ciprian (1933) had shattering effects on Puerto Rico and its economy. The Brookings Institution report indicates that in 1930, "the condition of the masses remained deplorable," mainly as a result of Puerto Rico’s population problem. The island’s population increased from 953,000 in 1899 to over 1.5 million in 1930, a 57% growth in just 30 years. The population growth was brought about by a decline in the death rate. Although the birth rate had not changed considerably from 1899 to 1930, the death rate had declined from 41.4 per thousand in 1887 to 1899, to 22.1 per thousand from 1920 to 1930. Puerto Rico’s annual per capita net income also declined dramatically, reaching a low of $86 in 1932-33. It was not until 1939-40 that the island’s per capita net income would again reach the level reported in 1929-30. In 1933, the Puerto Rico Emergency Relief Administration was established. Prior to this, Dr. Perloff pointed out, "the only aid given by the federal government until the summer of 1933 was hurricane relief grants totaling some $4 million and loans of about $6 million to agricultural producers [this in the face of hurricane damage estimated at about $85 million.]" The Puerto Rico Reconstruction Administration (PRRA) followed in 1935. In a letter dated Aug. 1, 1935, President Franklin Delano Roosevelt wrote: "The administration’s program intends not merely immediate relief but permanent reconstruction for the island. To this end, the projects in contemplation will seek to ensure every person on the island a position of reasonable independence and security. The economy of the island is, of course, agricultural, and the solution to its problems must be in terms of agricultural rehabilitation. The program will seek diversification of agricultural production, so the island may approach a self-sustaining status. Cheap and available electric power, good roads, reforestation, and adequate housing are also essential to effect the administration’s program... I am anxious that the government of the United States shall discharge fully its responsibilities to the Puerto Rican people…" The federal government allocated $57.9 million in funding for the PRRA program through Dec. 31, 1938. When Congress cut off the funds in 1941, PRRA had spent approximately $72 million on Puerto Rico. Perloff estimated federal contributions to the island in the form of expenditures and loans between 1933 and 1941 amounted to $230 million. With the Great Depression; the drastic drop in prices and income; the weakening of sugar, tobacco, and fruit markets; as well as the implementation of sugar quotas, the stream of outside capital and investment, which had characterized the first three decades of American rule, was dramatically slashed. Despite the precarious economic situation, the island’s population continued to climb, from 1.5 million in 1930 to almost 1.9 million in 1940. Although the need to resolve the status situation had been a constant presence through the first 40 years of Puerto Rico’s American history, the population problem continued to dominate the tactical and strategic thinking of economists and planners of the period. 1940-1950: Prelude to commonwealth The 1940s brought about dramatic changes on the island. In 1941, President Roosevelt appointed Rexford G. Tugwell governor of Puerto Rico. Tugwell was described as a different kind of governor, but most importantly he had close ties with the White House, having been part of the president’s brain trust, the architects of the New Deal. The 1940s was characterized by the implementation in Puerto Rico of an agrarian reform, government development of public enterprises, and the impact of World War II. The Puerto Rico Planning, Urbanizing & Zoning Board, the Land Authority, the Water Resources Authority (today the Puerto Rico Electric Power Authority), the Aqueduct & Sewer Authority, the Puerto Rico Industrial Development Co. (Pridco), the Puerto Rico Agricultural Development Co., and the Government Development Bank (GDB) were also created during the early 1940s. Established in 1942, Pridco was modeled after the Chilean economic development model, Corporación de Fomento de Producción. Under Pridco (known in Spanish as Compañia de Fomento Industrial de Puerto Rico), new business enterprises were opened and industrial operations established for the production of glass bottles, boxes, shoes, and ceramics. Pridco also took over the cement company established in 1936 by the PRRA. In spite of the new industries, the economy was not yet able to fully absorb the large and rapidly increasing labor force. Unemployment rate rarely dropped below 10% even in the most active season, the sugarcane harvest. Between 1940 and 1950, Puerto Rico’s gross product (GP) increased more than two and a half times, from $287 million in 1940 to $754 million in 1950. Personal income went from $499.3 million to $878.7 million and per capita net income, which remained at $121 annually, the same level as it had been 10 years earlier, reached $278 in 1950. The per capita gross product also increased from $154 to $342. During the war almost $400 million was invested by Puerto Ricans in U.S. government bonds, in postal saving deposits, and accumulated on the mainland. Manufacturing contributed 12.7% of total net income from 1946 to 1949, compared with 11.6% in 1939-40, with more than half derived from two sectors, sugar and needlework. The industrialization effort of the postwar years had attracted over 100 firms to the island, introducing new industrial categories. These firms had provided 8,000 jobs by 1950 and were expected to provide an additional 7,000 at full capacity. Employment increased from 512,000 in 1940 to 596,000 in 1950. Aided by migration to the U.S. mainland, the unemployment rate declined from 15% to 12.9%. The participation rate in the labor force during the decade increased from 52.2% to 53.1%. The population also increased from 1.86 million to 2.06 million. Trade represented over 20% of net income in 1948-50, an increase of 437% from the beginning of the decade. Construction also increased by 600% during the 1940s, generating a building boom on the island. By 1948, however, the five public business operations established by Pridco failed after an investment of over $10 million. Four, including the cement plant, were sold to the Ferre family and one to the Joyce Shoe Co. The agricultural sector had also declined in relative terms during the 1940s as a source of income, but it still represented 25% of the economy, the single most important economic sector. Bank deposits were drawn down and invested in the economy, and bank loans increased 80% to $130 million between 1946 and June 30, 1950. Federal expenditures had increased steadily since 1934, contributing a large share of the total net income of the island, reaching a peak of almost 25% of Puerto Rico’s net income during the war years. Perloff argued in 1950, "The importance of federal contributions to the Puerto Rican economy cannot be overestimated. In sum, they have given work to man [sic]; helped finance essential public services and governmental economic measures; stabilized basic industries and maintained farmers’ incomes; they have raised income and thereby provided funds for investment and increased the purchasing power of the consumers, making possible industrial expansion as well as increased imports; and finally, they are financing the training of new skills [that] will open up new vistas for many Puerto Ricans." Federal expenditures in Puerto Rico reached almost $1 billion during the 1940s. In 1946, at Tugwell’s recommendation, President Harry S. Truman appointed Jesus T. Piñero, Puerto Rico’s resident commissioner in Washington, as the first Puerto Rican governor. Piñero’s appointment paved the way for the approval of the Puerto Rico Industrial Incentive Act of 1947. Tugwell, who didn’t believe economic development could or should be based on federal tax gimmicks and lower wages, had opposed a similar bill. Originally, the bill contemplated tax exemption for a period of 12 years. The bill would later be amended to clarify that the exemption would last for 12 years after a company began operations on the island and to extend the exemption period. The practical feature of the law was that now U.S. companies with operations in Puerto Rico had a blanket exemption from taxes. They would be exempt not only from federal taxes but also from Puerto Rico income, property, and municipal taxes, as well as from excise taxes on machinery and raw materials. In 1947, Congress enacted Public Law 362 allowing qualified voters in Puerto Rico to elect their governor, starting with the 1948 general elections. By 1949, Puerto Rico’s tax-exemption industrialization program, less than two years old, already was raising concerns in Congress. During his first visit to Washington D.C., as Puerto Rico’s first elected governor, Luis Muñoz Marin, in a hearing before the House Committee on Public Lands on July 12, 1949 testified: "We have a 12 year tax-exemption program which I want to explain in some detail, because there has been some misunderstanding about it up north. We exempt from taxation industries that are defined in the law as new industries, which number about 40 or 42. They are exempted from all taxation for 12 years. That is because we want the exemptions to end… Then there are three years more in which the taxes come in at the rate of 25%, 50%, and 100%. So, it’s a total of 15 years, but the total tax exemption is for 12 years ending in 1959." More than 50 years later, the commonwealth government is still looking toward some form of tax exemption to keep attracting investment and keep its economy growing. In his testimony before the House Committee on Public Lands, Muñoz Marin stated, "We have to make production in Puerto Rico increase much faster than it is increasing now, although it is increasing now at a faster rate than it was a number of years ago. We have to make it increase about three times or four times faster, let us say." During fiscal year 1949, Puerto Rico’s real GP grew by 11.8%, and production has never again grown at a similar rate. In the next issue of CARIBBEAN BUSINESS, the island’s development under commonwealth in the 21st century will be examined. This Caribbean Business article appears courtesy of Casiano Communications. or
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