Crisis and Status:PUERTO RICO ON THE BRINK

CRISIS AND STATUS: PUERTO RICO ON THE BRINK 1

MARIA DE LOS ANGELES TRIGOAUGUST 2015

THE PUBLIC DISCUSSIONOF PUERTO RICO’S

FISCAL AND ECONOMIC CRISISHAS SHIFTED

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Congress is finally discussing the link between Puerto Rico’s undefined political status and its economic conditions.

Economists, financial analysts, and the press are discussing how its political status restricts Puerto Rico’s prospects for economic growth.

It seems that the discussion of Puerto Rico’s economic and debt crises will start to consider the biggest restrictions on Puerto Rico’s authority to make the structural changes it needs: laws and regulations enacted for a bigger, more developed economy.

Finally.

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The LatestOn 29 June 2015 Puerto Rico issued the Krueger Report, prepared by Prof. Anne O. Krueger, former Managing Director of the IMF. The Report identifies US control on several economic and regulatory variables as having a disproportionately negative effect on Puerto Rico, and restricting Puerto Rico’s authority to make the structural changes needed.

The New York Federal Reserve Board’s Report on the Competitiveness of Puerto Rico’s Economyissued on 29 June 2012 also identified instances in which the political status restricts Puerto Rico economic growth.

Of course many people in Puerto Rico had, before this, discussed and quantified some of these restrictions. But it seems the conversation changer has been that these two reports agree, and that they are issued by institutions and persons whose objectivity and credentials cannot be questioned. Another reason, certainly, is that there is no more deficit financing available to keep a lid on this.

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Let Me Count the WaysTHESE ARE THE MAJOR ISSUES THESE REPORTS HAVE IDENTIFIED AS RESTRICTIONS IN PUERTO RICO’S COMPETITIVENESS AND ECONOMIC GROWTH THAT ARE A DIRECT RESULT OF ITS POLITICAL STATUS

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Jones Act of 1920

The Merchant Marine Act of 1920 (the Jones Act of 1920) was enacted by the US “for the national defense and for the proper growth of its foreign and domestic commerce … shall have a merchant marine of the best equipped and most suitable types of vessels sufficient to carry the greater portion of its commerce and serve as a naval or military auxiliary in time of war or national emergency.”

Among its requirements, no merchandise can be transported by water between points of the US, “either directly or via a foreign port, or for any part of the transportation, in any other vessel than a vessel built in and documented under the laws of the United States and owned by persons who are citizens of the United States, or vessels to which the privilege of engaging in the coastwise trade is extended…”

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• This means all merchandise transported by water between points of the US must be carried by:

• vessels built in the US,

• crewed by US citizens,

• flagged by the US, and

• supplied by US sources.

• The US Merchant Marine has been identified as expensive and inefficient, with inadequate and old vessels.

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• Puerto Rico being an island, most of its trade is done by maritime transport. And since 47% of its imports and 72% of its exports are with the US, its trade is restricted to the US Merchant Marine.

• Hawaii, for example, does the majority of its trade with Asia, so it doesn’t use the US Merchant Marine to the level Puerto Rico has to.

• Alaska has an exemption for the transportation of oil. Puerto Rico has one exemption: for passenger cruise ships.

• While there is a general cry for an increase in the use of natural gas in the production of energy by PREPA, the electric power service authority, Puerto Rico will not be able to buy gas from the cheapest producers in the US southern coast, because the US Merchant Marine doesn’t have vessels that can transport natural gas.

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• Among the reasons the transshipment port in Puerto Rico’s southern coast hasn’t taken off is that the Jones Act increases the transportation costs so much that transportation companies prefer to use foreign transshipment ports.

• Ships use transshipments ports in the Dominican Republic and Jamaica because they can continue their route towards ports in the US. A ship stopping in Puerto Rico on its way to a US port would have to move the cargo to a US Merchant Marine vessel to sail from Puerto Rico to a US port — a very expensive proposition.

• The Jones Act has almost eliminated Puerto Rico’s opportunity to benefit from its geographical location and participate in the maritime transshipment industry.

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International Commerce and Treaties• Since the US controls Puerto Rico’s international relations, Puerto Rico’s interests are not

adequately negotiated or defended. Every time Puerto Rico has tried to establish limited commercial relationships with big economies, the intervention by the US Department of State has put paid to the effort.

• The treaties the US has signed on trade expressly include Puerto Rico as part of the treaty, with no grandfathering and no protection for its productive sectors, and no participation in its negotiation.

• Every free trade agreement the US has signed, like NAFTA, CAFTA, and the many bilateral trade treaties, has eroded Puerto Rico’s competitive advantages. The US has not authorized Puerto Rico the use of additional tools to make up for this erosion. At present, the US is negotiating trade treaties with Asia and Europe, and Puerto Rico cannot plan for the effects those treaties will have in its economic development strategy.

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• Even section 936 of the US Internal Revenue Code, mentioned as the cause for the precipitous decline in manufacturing, was repealed in 1995 because it was prohibited under the Agreement on Subsidies and Countervailing Measures that the US signed in 1994.

• The US didn’t grandfather Puerto Rico; it enacted the 10-year phase-out to be in compliance with the Agreement.

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Automatic Application of Federal Laws• Federal laws automatically apply to Puerto Rico, unless they are “locally inapplicable.” That

means that every law applies in Puerto Rico regardless of its reasons for enactment, except if Puerto Rico is explicitly excluded, or if the inapplicability is obvious. For all the other enacted laws, a court would have to declare whether it is “locally inapplicable.”

• The same happens with regulations, independently of the effect they may have in Puerto Rico.

• And, unsurprisingly, no US Court has ever held that a federal law is “locally inapplicable” to Puerto Rico.

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• The impact in Puerto Rico of the law may be contrary to the law’s purposes.

• This is what economists report happens with the minimum wage. Both the Krueger and FRB Reports discuss the effects, and much better than I could.

• What I will add is that for years, Puerto Rico was exempt from the federal minimum wage and it established its own, per industry, responding to the economic realities of the country and the supply and demand of jobs and workers.

• Under pressure of US labor unions, who alleged this lower minimum wage gave a cost advantage to Puerto Rico, the federal government revoked the authorization. It granted moratoriums of a few years after every change in the minimum wage so industry adapted to the new costs. Eventually it revoked that too, and now the minimum wage applies automatically.

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• The financial assistance programs have the same effect. The Krueger and FRB Reports discuss the effects and recommend modifying the conditions of these programs to adapt them to Puerto Rico’s realities.

• It is important to note that Puerto Rico has already tried, several times, to negotiate this issue with the US government, without success.

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Fiscal Autonomy and Congressional Control• The fiscal autonomy granted to Puerto Rico is quite limited, as has been shown most recently

by the refusal of the US Judiciary to grant Puerto Rico the authority to create a framework to restructure its debt, as an issuer with real fiscal autonomy could.

• But because of the political status, the US Congress has been able to prohibit Puerto Rico’s municipalities to restructure under Chapter 9 of the US Bankruptcy Code. I discussed this in more detail here and here.

• The end result is that both the US Congress and the US Judiciary are blocking Puerto Rico from using the mechanisms that other issuers all over the world have available and can use to deal with the restructuring of their debt.

• In addition, Puerto Rico has no access to debtor-in-possession credit through international institutions, as mentioned in both the Krueger and FRB Reports and briefly in my post here.

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Our (Im)perfect LoveCertainly there are reciprocal benefits to the particular symbiotic relationship between the US and Puerto Rico, most of which are not adequately discussed by financial analysts, much less by credit rating agencies.

But it is time the discussion was more realistic and nuanced. After all, no relationship is perfect.

Some are not even perfectly imperfect.

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On to the FuturePuerto Rico’s government has fallen quite short in its responsibility of monitoring these issues. It is not enough to have researchers investigate, quantify, make recommendations, and propose solutions. It is necessary for the government to act. What good is having the best and brightest if you will discard their recommendations? Ignore the solutions you are proposed? Disregard the warnings?

Many of the issues raised by the Krueger and FRB Reports have been known in Puerto Rico for decades, but nothing was done: it was too difficult, too complicated, too risky, too much, too something. So we let this situation fester when we knew what had to be done.

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The economic consequences of the relationship between Puerto Rico’s political status and the economic crisis are served, and by fiscal conservatives no less.

Puerto Rico, this time, it really is up to you. Dare, and do.

Finally. Do.

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ExtrasA presentation by Prof. Krueger of her report can be downloaded here.

More information on the Congressional Hearing on “Procedures regarding Puerto Rico’s political status and economic outlook” can be found here, with a replay of the hearing and written testimonies. The Hearing Memo can be found here.

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Originally published in LinkedIn

Crisis and status: Puerto Rico on the brink

3 July 2015This presentation has been revised from the original post.

Maria de los Angeles Trigo, an attorney and certified public accountant, helps clients understand Puerto Rico’s public finance market. She advises financial institutions, investors, law firms, and government institutions on Puerto Rico debt’s legal and regulatory framework. Maria de los Angeles worked for 16 years in the Government Development Bank for Puerto Rico and was the highest-ranking career legal officer as Director of the Compliance Department and Acting Deputy Director of the Legal Division.

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