Why Puerto Rico’s Economy Doesn’t Work

0:00 In 1980, Puerto Rico was home to 3.2

0:03 million people— about the same as South Carolina.

0:07 But whereas South Carolina gained another two

0:10 million residents over the next 50 years,

0:13 Puerto Rico gained just two… thousand people.

0:18 2,705, to be exact— a net increase of 0.08%, or 61 people a year.

0:26 In that time, the island experienced a spectacular rise,

0:31 followed by a spectacular and unprecedented fall.

0:35 It went from surpassing the economic growth of the U.S.

0:38 mainland during the Reagan and dot-com booms,

0:41 to a 15-year period of negative growth

0:44 dubbed a “death spiral” by its former governor.

0:47 So, how did Puerto Rico’s economic future become so bleak, so fast?

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1:04 By the late 1940s, Puerto Rico had been a U.S.

1:08 territory for nearly half a century.

1:10 Unlike the rest of the American economy,

1:13 however, it remained almost entirely dominated by agriculture.

1:17 Pressure began growing to close this gap— to develop

1:20 the island into something more than a giant sugarcane plantation.

1:25 …Particularly during the Cold War.

1:27 With Communist Cuba less than 500 miles away, this tiny appendage of the U.S.

1:34 empire took on ideological and geopolitical significance.

1:37 Thus came “Operation Bootstrap”— a multi-decade campaign

1:41 to transform Puerto Rico into a “modern,” industrial,

1:44 export-oriented economy in the style of Hong Kong or South Korea.

1:49 …One component of which was something called “Section 936” of the U.S.

1:55 tax code.

1:55 Section 936 lowered the federal income tax

1:58 to zero on money earned in Puerto Rico.

2:02 This, at the time, was revolutionary.

2:05 U.S.

2:05 corporations were then only flirting with the idea of outsourcing.

2:10 Microsoft, Nike, and Pepsi hadn’t yet left the States for Taiwan,

2:15 Malaysia, and China.

2:16 Puerto Rico gave them a chance to experiment:

2:19 here they got access to cheap labor, generous tax breaks,

2:23 and pristine white-sand beaches …all within the American empire.

2:28 But this was really— really— lucrative

2:32 for one industry in particular: Big Pharma.

2:35 Under Section 936, of course, the goal was to claim as much of your revenue

2:40 as possible in Puerto Rico, making it tax-free.

2:44 This was ideal for pharmaceutical companies because the price

2:47 of a drug is almost entirely attributable to its patents.

2:51 And, as abstract legal property,

2:53 patents can be instantly moved anywhere on the planet.

2:57 A U.S.

2:58 parent company like Pfizer could transfer its

3:00 intellectual property to its Puerto Rican subsidiary.

3:02 Then, when someone in Charlottesville or San Jose bought some Lipitor,

3:07 it could argue those patents were responsible for, say,

3:10 90% of the sale price— shifting that income to the tropics.

3:16 At the same time, you had to prove some

3:19 tangible link between the island and the product itself.

3:22 This, too, was perfect.

3:23 After all, once a drug is developed, tested, and brought to market,

3:28 producing the two millionth tablet is cheap and can be done just about anywhere.

3:33 By 1990, 17 of the top 21 most popular

3:36 drugs in the United States were made in Puerto Rico.

3:40 One factory singlehandedly produced all of North America’s Viagra.

3:45 One by one, as new “blockbuster” drugs exploded onto the U.S.

3:49 market, the island prospered.

3:51 Manufacturing soon accounted for nearly 40% of its GDP,

3:55 twice the average in the region.

3:58 There was just one problem: it all depended on the whims of Congress.

4:03 Section 936 was signed into law with the stroke

4:06 of a pen and it could just as easily be taken away.

4:09 And by the mid-90s, the Cold War was

4:12 over and Puerto Rico had lost its strategic importance.

4:15 Meanwhile, America’s focus turned toward tax reform and reducing the deficit.

4:21 Besides, if the goal was to subsidize

4:23 the development of its distant territories,

4:25 Congress realized, this was a wildly inefficient way to do so.

4:30 For every one employee they hired in Puerto Rico,

4:33 for example, pharmaceutical companies were saving $70,000 in taxes.

4:39 In other words, the U.S.

4:41 government was effectively paying $70,000 to employ a single person—

4:45 in a place where the per capita GDP was about nine thousand dollars.

4:50 Section 936 began looking more and more like a giant,

4:54 wasteful handout to Big Pharma.

4:57 But rather than reform the law— perhaps by creating new

5:00 incentives for corporations to truly invest in the Puerto Rican

5:04 economy— Congress simply deleted Section 936 from the tax code

5:09 and quickly moved on, leaving Puerto Rico in the dust.

5:13 That was bad enough.

5:15 But things soon got worse.

5:18 Previously, Puerto Rico held a privileged position when it came to trade.

5:23 Unlike all other U.S.

5:24 territories— Guam, American Samoa, the U.S.

5:27 Virgin Islands, and the Northern Mariana Islands—

5:30 Puerto Rico is located within the U.S.

5:33 customs area— meaning drugs manufactured on the island and shipped

5:37 to the American mainland weren’t subject to tariffs or trade restrictions,

5:41 while those in, say, the Bahamas, or Trinidad, or Colombia were.

5:46 But as free trade became the norm with the passage of NAFTA,

5:50 China’s joining of the WTO, and dozens of other bilateral trade agreements,

5:54 Puerto Rico became just like the rest of them.

5:58 So, companies left for Ireland, Mexico, China, and elsewhere.

6:03 After Section 936 was fully phased-out in 2006,

6:07 the Puerto Rican economy plunged into freefall.

6:11 And to make matters even worse: the Great Recession came two years later.

6:15 By 2013, 230,000 out of Puerto Rico’s

6:20 1.2 million total jobs had permanently disappeared.

6:24 At this point, the island had been

6:27 losing revenue for decades as companies moved elsewhere.

6:29 At the same time, the government

6:31 had accumulated a large and growing bureaucracy.

6:34 Even between 1960 and 80 alone,

6:37 the number of public employees had already tripled.

6:41 Facing shrinking revenue and rising expenses, something had to change.

6:47 Now, 49 of the 50 states are legally required

6:51 to balance their budgets— spending no more than they earn.

6:55 Of course, cities and states can and do borrow money.

6:59 When the city of Binghamton, New York decides it needs a new freeway,

7:02 it can ask for a loan by selling municipal bonds.

7:05 But when those investors ask how it intends to repay them,

7:09 it can’t shrug its shoulders and say “we’ll

7:12 figure that out later.” It needs a plan.

7:15 And the same is true of Puerto Rico.

7:18 Its constitution states that “appropriations… shall

7:21 not exceed total revenues.” …At least, that’s what it says in English.

7:27 The problem is that when written in Spanish—

7:29 the language widely spoken on the island—

7:31 the word “revenues” in the phrase “total

7:35 revenues” was mis-translated as “resources.” And in 1974,

7:39 it decided that those “resources” included bonds.

7:43 …Meaning, the Commonwealth of Puerto Rico can only spend

7:46 as much as it earns …unless it takes on debt,

7:50 in which case, it can spend as much as it wants with no real plan for repayment.

7:56 So much for a balanced budget.

7:58 This loophole proved far too tempting to resist.

8:01 The alternative, after all, was initiating layoffs,

8:04 and politicians who use the “l-word” tend to lose their re-elections.

8:10 Now, it would be one thing if the government used

8:13 this… creative interpretation of its constitution to invest in its future.

8:16 If it borrowed money to build a new highway to lower

8:20 transportation costs and thus attract manufacturing

8:23 companies to return to the island, that might be a good use of the loophole.

8:28 But these were not one-off, revenue-generating projects.

8:32 The government was borrowing money for regular,

8:35 ongoing expenses— to pay the salaries of the firefighters

8:39 and teachers and garbage collectors it had too many of.

8:43 Before long, it was taking on new loans to pay back

8:45 the old ones— sinking further and further into a giant hole of debt.

8:51 A U.S.

8:52 government report found that 16 out of 20 bonds issued between

8:56 2000 and 2017 were used exclusively to repay or refinance existing loans.

9:02 In 2006, Puerto Rico even introduced a new sales

9:06 tax for this very purpose— effectively making ordinary citizens

9:09 pay directly for the mistakes its politicians made years

9:13 ago— all while scaring away companies and reducing economic activity.

9:18 By 2015, it had one of the highest sales taxes in the United States,

9:22 at 11.5%, despite nearly half of its residents living below the poverty line.

9:29 Normally, this would all end fairly quickly.

9:33 You can’t keep borrowing money if no one is willing to lend it.

9:37 And who would keep lending money to someone who so clearly can’t repay you?

9:42 Normally.

9:42 But Puerto Rico was no “normal” borrower.

9:45 For three reasons: First,

9:47 its constitution states that bondholders are prioritized in case of default.

9:52 Meaning, if the government ran out of money,

9:54 lenders would get paid first— before,

9:56 for example, teachers and doctors got their salaries.

10:00 Second, since 1917, bonds issued by Puerto Rico have been

10:05 “triple-tax exempt.” If you’re an investor living in Greenwich, Beverly Hills,

10:09 or Palo Alto, you could buy bonds from the city of Binghamton,

10:13 but you’d probably have to pay city, state, and federal taxes.

10:18 Or you could buy Puerto Rican bonds— even while living in the Hollywood

10:22 Hills— and never pay a single dime in taxes— not to your city,

10:29 state, or federal government.

10:30 Finally, there was an unspoken assumption that Puerto Rico was too big

10:35 to fail— that Washington would surely step in to bail its territory out.

10:40 For all these reasons, investors just kept buying more and more of its bonds,

10:45 even as its economic picture became darker and darker.

10:49 But all that changed in July of 2013,

10:53 when the city of Detroit, Michigan filed for bankruptcy.

10:56 After Obama decided against a bailout,

10:59 investors in Puerto Rican bonds got very, very nervous.

11:03 Its bonds were downgraded to “junk” status and interest rates soared past 8%—

11:09 an incredibly high number for tax-free government

11:12 bonds in the era of low interest rates.

11:15 It was only a matter of time

11:18 before the island would face its economic reckoning.

11:21 And it finally came in 2015, when the governor admitted the territory was caught

11:26 in a “death spiral” it could never recover from.

11:30 It made Detroit’s $18 billion of debt look like child’s play.

11:35 Puerto Rico owed $73 billion— 120 if you include its unfunded pensions.

11:42 Per capita, it owed fifteen times as much as the median U.S.

11:47 state.

11:47 After months of negotiations, the U.S.

11:49 federal government reached a deal with the Commonwealth:

11:52 the island would effectively be allowed to declare

11:55 bankruptcy— paying its lenders less than they were owed.

11:59 In exchange, to make sure it didn’t make the same mistakes again,

12:02 Congress gave an unelected “oversight board”

12:05 veto power over the Puerto Rican budget.

12:08 And that board decided the government should temporarily

12:11 cut back on its expenses— eliminating sick days,

12:15 reducing pensions, and rationing healthcare.

12:18 Now, that part was not unusual.

12:20 If one of Puerto Rico’s neighbors— say,

12:23 Barbados— defaulted on its loans, it could ask the IMF for help.

12:28 The IMF would then impose conditions—

12:30 laying off excess workers, lowering salaries,

12:33 raising taxes, and so on— just as Congress did with Puerto Rico.

12:39 The problem is that: Puerto Rico is different in one key respect.

12:44 The citizens of Barbados would really have

12:46 no choice but to endure this hardship.

12:49 They wouldn’t enjoy the reduction in sick days or smaller pensions,

12:53 of course, but ultimately, what can they do?

12:56 Puerto Ricans, on the other hand, can simply leave.

13:00 As U.S.

13:01 Citizens, they’re free to study, work, and live anywhere in the United States

13:05 without restrictions— they don’t even need a passport.

13:09 Which means: anyone can opt out.

13:11 If taxes are too high, if salaries are too low, or the bus is too slow,

13:17 you can pack your bags and move to Miami, Orlando, or Brooklyn.

13:21 And that’s exactly what many did.

13:24 Each year, 50 to a hundred thousand Puerto Ricans leave for the mainland.

13:29 Today, nearly twice as many self-identified “Puerto Ricans”

13:33 live on the mainland than on the island itself.

13:36 And even these numbers undersell the economic impact of this migration.

13:41 Those most likely to leave are young, well-educated, and high-earning.

13:46 With a median age of 43,

13:48 Puerto Rico is now older than every state except for Maine.

13:52 Fewer than half of its adults are in the labor force.

13:56 And the more taxpayers leave,

13:58 the higher the burden shared by everyone who stays behind,

14:02 which, in turn, causes even more to flee, in a vicious self-reinforcing cycle.

14:08 Puerto Rico, in other words,

14:10 is less like its Caribbean neighbors— a young, thriving,

14:13 developing economy on the rise— and more like West Virginia— a deindustrialized,

14:18 de-populating, and declining backwater in a globalized world.

14:24 To slow the outmigration,

14:25 the island would first need to improve its economic condition.

14:29 And to improve its economic condition, it first needs to slow the outmigration.

14:34 The odds of successfully untying this Gordian Knot are slim.

14:39 Despite being substantially wealthier, for instance,

14:42 West Virginia has been unable to slow its population decline.

14:46 Or, take China.

14:47 The Chinese government portrays itself as a master

14:50 of social engineering— governing its 1 billion citizens with efficient,

14:56 finely-tuned policing.

14:57 Yet even it has struggled to increase its birth rate or enlarge its labor force.

15:03 In fact, its signature achievement in this domain— the cruel

15:07 yet “effective” One-Child Policy— is something of a myth.

15:11 In truth, there’s very little evidence it worked as intended.

15:15 In the words of one of the policy’s foremost experts, quote,

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