Economics Laureate Joseph Stiglitz on the Causes of Puerto Rico’s Financial Crisis

Economist Joseph Stiglitz, who won the Nobel Prize in Economics in 2001, was the keynote speaker at the Public Growth Policy Summit convened by the Center for a New Economy in San Juan on December 3.

In his remarks, Stiglitz expressed concern that the actions of the PROMESA Fiscal Oversight and Management Board were not in Puerto Rico’s best interests. He said that the challenge for Puerto Rico is to take advantage of its advantages and manage its disadvantages, with a focus on long-term growth.

The ghost of Section 936

Stiglitz discussed the causes of the recession that began in Puerto Rico in 2006.

He listed a set of contributing factors:

• Puerto Rico was excluded from section 9 bankruptcy laws
• The PROMESA framework for restructuring was “badly flawed.”
• There is uncertainty regarding the legitimacy of the debt.
• The Board did not consider the dwindling population.
• Some of the debt was based on expected tax income.
• The plans to restructure the debt may make things worse.

Importantly, Stiglitz said, the strategy of focusing on tax incentives was not successful and is likely to be even less successful in the future. “Often the costs exceed the benefits and the benefits are only short term,” he pointed out.

There are some claims that the end of Section 936, which benefited multinational corporations, led to the financial crisis in Puerto Rico. Stiglitz disagrees with that assessment.

Labor intensive manufacturing industries such as clothing construction and tuna canning left Puerto Rico for reasons unrelated to the end of Section 936.

Bumble Bee, the last tuna cannery in Puerto Rico, closed its last facility in 2013. It had received $11 million in incentives over 50 years and left 260 people without jobs. While the company said that the plant was no longer profitable, this decision followed losses in market share by canned tuna (compared with fresh fish and with newer pouch packaging), dolphin-safe harvesting requirements, and a price-fixing scandal involving all three major tuna canning companies.

The garment industry was problematic for Puerto Rico in that the industry was large but paid little. Many garment workers left Puerto Rico for New York, which also had a thriving garment industry at the time. When New York’s clothing industry collapsed in the rise of offshore “fast fashion,” Puerto Rican workers were displaced in New York.

Myths and Realities of Manufacturing in Puerto Rico

Manufacturing in Puerto Rico, as in the states, turned away from labor-intensive industries, which came to rely on cheap labor in third world countries. But where manufacturing in the States began to see intensive automation and more skilled jobs, Puerto Rico courted investors who washed revenues through the territory.

Microsoft, for example, created software with hundreds of workers in the states, copied the software onto disks with mere dozens of workers in Puerto Rico, and claimed that the profits from that software were earned in Puerto Rico. By establishing the ownership of intellectual property in Puerto Rico without actually producing the goods on the Island, Microsoft evaded taxes on billions of dollars in revenue.

Pharmaceutical companies did much the same thing, gaining $2.67 in federal tax credits for every $1.00 they spent on wages for Puerto Rican workers, according to a GAO report. Only 20% of their income was based on local work.

The companies that used Puerto Rico to disguise their profits sometimes did not stay in the territory after the end of Section 936. Regardless, they had not brought wealth to the Island while they were there.

Comparative advantages

Stiglitz said that it’s important to be aware of the comparative advantages that can be developed. Puerto Rico, for example, should have amplified its comparative advantages in pharmaceuticals. Actually, the island now exports more pharmaceuticals than any state and is in a good position to amplify that advantage now. As Stiglitz said, identifying the advantages that can be developed is key to long-term success.

The Island’s natural advantages, the economist said, include location, lots of sun which should provide cheap energy, natural beauty encouraging tourism, and opportunities for health tourism in particular.

Social solidarity is an advantage for Puerto Rico. The success with vaccination against COVID-19 proves this. Puerto Rico has a 74% vaccination rate, ahead of all 50 States. Many states have less than half of their population fully vaccinated.

Another advantage available to Puerto Rico is its connections with the United States. Stiglitz pointed out the disadvantages of Puerto Rico’s political status, but also mentioned benefits to Puerto Rico from being considered within the United States as opposed to a foreign country. Some of these advantages, he said, have not been leveraged as they should have been.

Puerto Rico had a privileged position in manufacturing for the States in terms of trade barriers since it is a part of the U.S. for customs purposes, but leadership did not capitalize on that advantage. NAFTA extended that advantage to Mexico, increasing its competitiveness with Puerto Rico.

Manufacturing and export-led growth may not be a successful growth strategy for the 21st century, Stiglitz suggested. Focusing on tax incentives to accomplish this may be especially harmful. “I don’t think that attracting tax avoiders is a good thing” he said. “The people who are coming under Act 22 are really not adding much to the Puerto Rican economy.” Rather than bringing in revenue, they are raising the cost of living.