The (in) justice of COFINA

Imagine it is the year 2035 and all international trade and travel has halted to a dead stop due to the sudden appearance of a highly contagious disease hitherto unknown to humanity.  The good news is that Chinese Pharmaceutical Company, which is majority-owned by the Chinese government, has developed a highly effective vaccine against this disease.  The bad news is that it will cost the government of Puerto Rico $2 billion to acquire sufficient doses to protect its population.

As usual, Puerto Rican government officials are scrambling to find the money.  A financial analyst at the Government Development Bank notices that pursuant to the terms of a transaction executed in 2010, Puerto Rico has to set aside $1.3 billion of the sale taxes collected in 2035 to repay bonds issued by the Puerto Rico Sales Tax Financing Corporation, known in Spanish as COFINA.  The analyst writes a memo to his boss suggesting that Puerto Rico should default on its COFINA obligation and use the money to buy vaccines from the Chinese government.  You are the president of the GDB, what would you recommend to the Governor?  Would you recommend default, thereby damaging Puerto Rico’s credit, or would you recommend honoring the obligation to bondholders, thereby depriving thousands of Puerto Ricans of their chance to live through the epidemic?

The above scenario obviously is a hypothetical, except for the part about COFINA and its debt.  COFINA, which was created in 2006, has issued approximately $12.2 billion in bonds.  Of that amount, $4.7 billion were issued by the prior administration and $7.5 billion by the current one.  Total debt service on those bonds amounts to $44.92 billion, to be paid between 2010 and 2057.  The table below sets forth the COFINA debt service requirements for the next 47 years.

Source: COFINA Offering Statement, January 28, 2010, p. 35.

COFINA receives half of the Commonwealth sales tax (2.75% out of a total sales tax of 5.5%), which it sets aside, up to a certain amount, to pay principal and interest on its bonds.  This pledged amount is set to increase by 4% every year, from $550 million in 2009 to $1.85 billion in 2041.

The proceeds from the bond offering, that is, the $12.2 billion that has been issued, can be used by COFINA to pay old government debt and current operational expenses.  No long-term assets, no hospitals, no roads, no bridges, no schools, will be financed with this debt.  Yet, we are sticking the $44 billion bill on future generations, which will derive no benefit from this indebtedness.  By amassing this huge debt, we are passing the cost of our fiscal profligacy to our children and grandchildren.  Some people would call this immoral and unjust.  So, let’s analyze the COFINA transaction through the lens of several theories of justice.

For Aristotle, a just society gives each person his or her due and he developed a complex system to figure out just what people are due and why.  But the bottom line for him was to “do the right thing, to the right person, to the right extent, at the right time, with the right motive, and in the right way.”  Under this theory, it cannot be argued that it is morally right to impose this massive burden on future generations.  Underlying this conclusion is a basic belief about moral desert: the unborn cannot be said to deserve this burden because they have not committed any moral wrong.  If anything, Aristotle’s theory would seem to support imposing a special tax on those government officials that incurred all those obligations without a repayment source, for they are the ones who morally deserve to bear this burden.

For utilitarians, such as Jeremy Bentham, justice means maximizing utility or welfare, the greatest happiness for the greatest number.  By utility he means whatever produces pleasure or happiness, and whatever prevents pain or suffering.  Even if we could argue that the COFINA transaction maximizes utility for those of us living in 2010, there is no way we can know today how it will affect the utility of future generations stuck with this massive repayment obligation.  For all we know, as we demonstrated in the hypothetical above, making those payments could subject future generations to intense pain and suffering, so the overall level of utility associated with this transaction could be negative.

For libertarians, such as Robert Nozick, justice means maximizing freedom and individual liberty.  For people such as Nozick the COFINA deal infringes the liberty of future generations in two ways.  First, taxing future generations violates their liberty to do with their money whatever they please.  Second, even if you accept taxation as a necessary evil, the COFINA transaction limits the uses that future government officials can give to future sale tax receipts because they are pledged to pay COFINA bondholders.

For John Rawls a just society is, among other things, one in which social and economic inequalities are arranged for the benefit of those least well off.  It must be noted that Rawls’s theory is not meant to assess the fairness of this or that financial transaction; it is concerned with the way society is structured and how it allocates certain basic goods such as income, power, opportunities, and wealth.  For Rawls, the important question would be whether COFINA arose as part of a system that, taken as a whole, works for the benefit of those least well off.  Even the most optimistic person would be hard pressed to argue that Puerto Rican society is currently structured for the benefit of the least well off.  In fact, the case can be made that our society is structured to benefit mostly the wealthy and the well connected.

In the end, the inescapable conclusion is that the COFINA transaction is profoundly unjust.  To be fair to the current administration, it is true that it inherited all that debt without a repayment source.  That fact, however, does not excuse its unjust actions.  Indeed, this is a situation where government officials have to choose between two courses of action both of which it would be wrong for them to undertake.  Be that as it may, the payments on COFINA’s bonds are the wages of Sisyphus to be borne by future generations in atonement for the delusions of grandeur and other excesses committed by our dissolute politicians during decades of financial profligacy and mismanagement.

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The author is Director for Policy Development at the Center for the New Economy, a Puerto Rico-based think tank.

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Measuring social progress

What should we consider as progress in the 21st Century?  How can we measure such progress?  These are two provocative questions that the global project on Measuring the Progress of Societies, directed by the Organization for Economic Cooperation and Development (OECD), attempts to elucidate.  The importance of this initiative consists in that it tries to develop economic, social and environmental indicators that provide relevant information about societies’ wellbeing and progress.  In this way, it provides support to the decision making of legislators, government and academic authorities as well as those in charge of the business sector.

Humanity has been thinking about progress for centuries.  For example, Plato and Aristotle thought that the expansion of knowledge allowed the gradual advance from an original or primitive state of nature towards higher levels of culture, economy and politics.  Since then, some of the greatest thinkers of the Western world, people such as Bacon, Comte, Kant, Voltaire, Bentham, Stuart Mill, and Marx, among many others, have developed and refined their ideas and theories about social progress.

Notwithstanding this rich intellectual heritage, or perhaps because of it, during most of the twentieth century it was thought that economic growth was the best indicator of progress: the greater the Gross Domestic Product (GDP) the greater the level of social welfare.  GDP, however, is a measure of production, it is not, and was never intended to be, an indicator of social wellbeing.

The deficiencies of using GDP as an indicator of wellbeing have been known for decades.  The GDP measures the market value of goods and services produced by an economy during any given year.  Non-market transactions are not counted.  Therefore, childcare, cooking, and house cleaning are not included in the national accounts, unless you pay a third party to these things for you.  Other socially valuable things, such as taking you child to ballet classes or to a little league game, taking your elderly parent to a walk in the park, or attending your child’s Christmas play at school are not counted in GDP.  Industrial production is included in GDP but the accompanying pollution is not.  Similarly, GDP includes expenditures on health, public safety, and education but it does not measure the quality of our hospitals, the safety of our streets or whether our children are receiving a better education.  In short, GDP is a good measure of market production but a poor indicator of social wellbeing.

That is why the OECD is undertaking its global project on redefining and measuring social progress in the twenty-first century.  The OECD, aware that during the Cold War the concept of progress was oftentimes used as a cover by the both the United States and the former Soviet Union to impose their respective political systems on societies that were perceived as underdeveloped, has stated clearly that it is up to each society to define what it considers as social progress.  However, the OECD recommends using a broad perspective in defining social wellbeing and proposes the use of the following indicators to measure progress: general context indicators, such as net national income and fertility rates; self-sufficiency indicators, such as employment and student performance measures; equity indicators, such as the Gini coefficient and the poverty rate among children; health indicators such as life expectancy and the incidence of mental illness; social cohesion indicators, such as crime victimization and suicide rates; and environmental indicators, such as CO2 emissions and endangered species.

The idea is to identify and measure the gap between our social reality and where we want our society to be in terms of each of these indicators.  To the extent we know where we are and where we want to be, we will be able to identify what decisions we have to make in order to achieve those objectives.  That is why we at the Center for the New Economy are developing a set of social indicators for Puerto Rico that we will make public and update every year.

In doing this we seek to achieve multiple objectives.  First, we seek to provide accurate, reliable information about Puerto Rico’s economy, society, and environment free of usual government propaganda and public relations spin.  Second, we seek to stop, or at least slow down, what historian Barbara Tuchman called the “march of folly”, which she defined as the pursuit by governments of policies contrary to their own interests, despite the existence and availability of feasible alternatives.  Anyone who reads newspapers in Puerto Rico can attest that the march of folly is well on its way in Puerto Rico.  Third, we seek to change the terms of the public debate whenever a new program or policy initiative is announced.  Instead of asking is it efficient? Is it good for GDP?; we want to inquire: is it good or bad for Puerto Rico?  In other words, we seek to restore moral considerations in public debate.  Finally, we also seek to develop an agenda around which different social groups can converge and create a non-governmental space in which we can freely talk about, debate the meaning of, and advocate for social progress in Puerto Rico.

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Convergencias

En Puerto Rico llevamos no se ya cuantos años hablando de la necesidad de llegar a un consenso para lograr un desarrollo económico sostenido.  Culpamos nuestra inhabilidad de crecer la economía a la falta de ese escurridizo consenso.

A mi, sin embargo, el consenso me causa mucha sospecha.  Creo que muchas veces el consenso lo que nos lleva es al más simple denominador común, a un acuerdo diluido que, como decía Margaret Thatcher, representa el proceso de abandonar todas las creencias, todos los principios y valores para desarrollar algo en lo cual nadie cree pero a lo cual nadie objeta.

A mi me parece que no es la falta de consenso lo que nos tiene detenidos.  Porque muy bien pudiéramos llegar a un consenso para seguir una propuesta incorrecta.  En ese caso, de nada nos serviría el haber llegado a un consenso.

A lo que sí creo que podemos aspirar es a convergencias.  Con eso quiero decir metas compartidas donde, aunque no haya un consenso, haya un sentido de concesión, de que tenemos que llegar a un acuerdo donde no recibiremos todo lo que queríamos pero se creará el ambiente necesario para seguir la lucha.

El año pasado vimos una posible convergencia de este tipo entre las propuestas del CAREF y las de algunos sindicatos.  Ambos grupos consideraron como algo que se debía hacer el evaluar el costo e efectividad de la multitud de incentivos y deducciones en el código contributivo de Puerto Rico.

Las convergencias son posibles y necesarias particularmente en tiempos como el que vivimos.  Ese será unos de los temas a explorar en la próxima conferencia económica del Centro para la Nueva Economía el mes que viene.

En la misma dedicaremos un panel a debatir civilmente la situación del país y las posibles áreas de convergencia donde pudiéramos encontrar metas compartidas y áreas de acuerdo y acomodo.  El panel contará con verdaderos líderes de diferentes sectores de nuestra sociedad.

El momento para esta discusión es oportuno porque el dolor nos esta llegando ya a todos.  Cuando se afectan sólo algunos sectores de la población, particularmente los más desprovistos, es fácil ignorar la necesidad de cambio.  Sin embargo, cuando llegas al momento donde los más fuertes intereses del país se tambalean, como sucede ahora en Puerto Rico, has llegado al punto de una verdadera apertura.

No sé que más evidencia se requiere para demostrar que en Puerto Rico el problema no es la falta de ideas.  Ni es tampoco la falta de consenso.  Me parece que se pierde más por falta de tomar decisiones que por malas decisiones.

Por tiempo he compartido que yo pienso que el cambio en Puerto Rico vendrá no de un gran consenso, sino más bien de un pequeño grupo.  Pequeños grupos de ciudadanos que decidan fortalecer sus capacidades ciudadanas para fiscalizar a sus gobernantes y obligarlos rendir cuentas de su desempeño.  Pequeños grupos de empresarios con visión que entiendan que su agenda tiene que ser más amplia que solamente su negocio particular.  Pequeños grupos de padres y madres que se den cuenta que la educación de sus hijos es el legado más importante por el que puedan trabajar y que exijan se les provea una educación de calidad.   Pequeños grupos de trabajadores que recuerden el orgullo y dedicación que empeñaban nuestros abuelos y abuelas en sus labores.

¿Será todo esto posible?  Sinceramente no se.  He perdido parte de mi optimismo. Pero sigo peleando la buena batalla y conservo la fe; la certeza de lo que se espera, la convicción de lo que no se ve.

Miguel A. Soto Class

Publicado el 28 de enero de 2010 en El Nuevo Día

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The outlook for 2010

In 2009, according to The Economist magazine, world output shrank by more than 1 per cent, the first time since 1945 that it has declined on a year-over-year basis.  At the same time, years of excessive lending and irrational asset pricing finally caught up with the world’s financial system.  Governments across the world responded to the dual economic and financial crises with massive public spending programs, historic liquidity increases, and unprecedented interventions by central banks.  These policy initiatives appear to have worked and by the end of the year all the world’s big economies had stopped shrinking.

That is good news, but hold the celebration: the consensus forecasts of global growth for 2010 are a sluggish 1 to 2 per cent for most advanced economies.  Thus, after a year of economic collapse, multiple bank bailouts, stimulus spending, and large-scale monetary easing, it appears that 2010 will be a year of reassessment, sorting through the wreckage, burying the dead, and regrouping the walking wounded.

A weak, jobless recovery appears to be the best case scenario for many countries.  In the United States, for example, the consensus forecast is for growth to be around 2.5 per cent in 2010, with the unemployment rate stubbornly hovering around 9 or 10 per cent.  There are good reasons for these diminished expectations.  Most of the growth in the U.S. during 2010 will be driven by the restocking of depleted inventories and stimulus spending.  This should keep the U.S. economy going for a couple of quarters, but neither of these factors, however, can sustain growth past 2010 without a self-sustaining cycle of private spending and income.

Unfortunately, it is highly unlikely that private consumption spending will grow vigorously in 2010 because American household balance sheets are weighed down by debt.  Household wealth is down some $12 trillion relative to 2006, a decrease of 19 per cent due mostly to the collapse in house and stock prices.  This means that people in the U.S. are more likely to spend less, save more, and pay down debt.  Indeed, some analysts expect consumer spending to grow more slowly than income for the first time in twenty-odd years.  Weak consumer demand means that business firms will not be hiring in large numbers in 2010.  Relatively high unemployment will hold back wage gains.  Low wage growth, in turn, further depresses consumer demand and the cycle reinforces itself.

Weakness in the financial sector is the other factor limiting growth in the U.S.  Credit flows to businesses are “glacial” in the words of a recent Financial Times editorial.  In the U.S. bank loans to business and consumers are actually falling, as are loans packaged into asset-back securities, this despite unprecedented measures—such as public guarantees of bank debt, equity infusions, and the outright purchase of assets—introduced to address the financial crisis.  This reluctance to lend is due in part to a shortage of willing borrowers; in part to the weigh of toxic assets still festering in banks’ balance sheets; in part to rising delinquency and foreclosure rates among non-subprime borrowers, as well as falling commercial property values; and in part due to the expectation that new stringent capital requirements are on the way.  All these factors encourage bankers to lend less and hoard their capital.

In addition, at some point during 2010 we are likely to see pressure mounting for the U.S. to reduce its massive budget deficit, currently in excess of 10 per cent of GDP, and for the Federal Reserve to begin reducing its bloated balance sheet, currently well over twice its pre-crisis size.  The failure to implement a credible budget plan or any uncertainty generated by the withdrawal of monetary support could adversely impact investors’ assessments of sovereign risk and push up sharply bond yields in the U.S.

If the outlook for the U.S. is somewhat unclear, in Puerto Rico it is pretty much cloudy.  We can expect economic activity to be stagnant or declining during the first half of 2010 as the government finishes the implementation of its fiscal austerity program.  Unemployment should also keep rising during this period.   According to the Economist Intelligence Unit, Puerto Rico should be the  third slowest (out of 180 countries tracked by the EIU) growing economy in 2010.

Growth could turn positive towards the second half of the year, if the government winds down its budget-cutting measures by June, and if it is effective in spending the remainder of the ARRA funds allocated to Puerto Rico.  However, there are several downside risks to this scenario. 

• First, any significant increases in oil prices or in short-term interest rates could stifle the recovery. 
• Second, financial institutions in Puerto Rico are under great strain.  Three of the eight publicly traded local banks are operating under cease and desist orders issued by the FDIC.  According to some analysts this means the FDIC could be active in Puerto Rico next year.  Any intervention by the FDIC in Puerto Rico could further depress consumer confidence. 
• Third, some labor leaders are calling for a general strike early next year to protest government layoffs, the implementation of public-private partnerships, and efforts to turn back the clock on labor legislation.  It is impossible at this time to determine whether this effort will be successful but uncertainty associated with widespread labor and social unrest could adversely affect investment and economic activity.

In sum, in 2010 we can expect a weak, jobless recovery for the U.S. and a sluggish, anemic economy in Puerto Rico.  In both places uncertainty will weigh on the economy and 2010 will be a year of hard work, difficult decisions, and little, if any, improvement in economic conditions.

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Brookings cuatro años después

A casi cuatro años de haber participado de los trabajos del Informe CNE/Brookings sobre la economía de Puerto Rico, el Dr. Barry Bosworth, Senior Fellow del Instituto Brookings, encuentra que la situación económica de Puerto Rico se ha deteriorado marcadamente.  En parte, este deterioro se debe al impacto de la profunda crisis económica y financiera a nivel global.  Sin embargo, es evidente que el modelo de desarrollo de Puerto Rico mostraba señales de debilidad desde por lo menos el año 2006, mucho antes de que comenzara la crisis a nivel mundial.  Por lo tanto, las causas de la crisis económica en Puerto Rico incluyen también un componente local, que es intrínsico a Puerto Rico.

Los problemas básicos de la economía de Puerto Rico identificados en el 2006 siguen presentes: las distorsiones económicas que son el legado de la implementación de la Sección 936; un nivel bajo de inversión; el estancamiento de la productividad laboral; una tasa de empleo sorpresivamente baja; y la explosión del déficit fiscal.

En términos específicos, el Dr. Bosworth encuentra que la tasa de empleo y el déficit fiscal han empeorado significativamente desde su última visita a la isla.  Por el lado de los empleos, es sorprendente que la tasa de empleo en la isla sea tan baja.  De acuerdo con las cifras mas recientes, la tasa de empleo en Puerto Rico era menos de 40% de la de la población con 16 años o mas estaba empleada.  Esta tasa de empleo es solamente 2/3 partes de la tasa de empleo en los Estados Unidos.  Si Puerto Rico lograra cerrar esa brecha el ingreso per capita en la isla aumentaría un 50%, aun manteniendo el diferencial en salarios que existe entre Estados Unidos y Puerto Rico.

El problema principal en cuanto empleo es que la tasa de participación laboral—la porción de la población adulta que se encuentra económicamente activa—es muy baja, de hecho es una de las tasas mas bajas, sino la mas baja, en el mundo.  Este fenómeno es producto de fallas en el mercado laboral de Puerto Rico, tanto por el lado de la oferta como por el lado de la demanda.

Por el lado de la oferta, encontramos que la aplicación en Puerto Rico de los programas de beneficencia social genera fuertes desincentivos al trabajo en el sector formal de la economía.

Por el lado de la demanda, encontramos primero que el sector privado en Puerto Rico está subdesarrollado: solamente 30% de los puertorriqueños trabajan en el sector privado, en comparación con un 60% en los Estados Unidos.  Además, la aplicación a la isla del salario mínimo federal puede ser que este limitando la creación de empleos para aquellas personas con menos destrezas.  Esto se debe a que el salario promedio en Puerto Rico es la mitad del salario promedio en los Estados Unidos.  Por lo tanto, la aplicación de salario mínimo de $7.25 por hora en Puerto Rico es equivalente a tener un salario mínimo de casi $15 por hora.

En términos del déficit, es evidente que el gobierno Puerto Rico tiene una larga historia de deficiencias financieras pero en años recientes la magnitud de estos deficits ha ido aumentando.  El problema radica principalmente en que los recaudos gubernamentales se han desplomado como porcentaje del producto nacional bruto de la isla, y aunque los gastos del gobierno también se han reducido de 30% del PNB a 25%, los recaudos han caído aun más, de 30% del PNB a 22%.

Esta caída en los recaudos se debe principalmente a dos factores: (1) el empleo en Puerto Rico esta decreciendo y por lo tanto hay menos personas y compañías pagando impuestos; y (2) la erosión de la base contributiva que es producto de las múltiples exenciones, créditos, y deducciones que han sido legisladas a través de los años.

El Dr. Bosworth señala además que los recaudos del gobierno de Puerto Rico dependen excesivamente de impuestos sobre las corporaciones, a diferencia de jurisdicciones en el resto de mundo que dependen mayormente de impuestos sobre el consumo y sobre la propiedad.

Por ejemplo, de acuerdo con la data del Departamento de Hacienda para el año fiscal 2009 las corporaciones con operaciones en Puerto Rico pagaron $1,364 millones en contribuciones sobre ingresos y $1,081 millones por concepto de retención sobre el pago de regalías a no-residentes.  En total, por lo tanto, las corporaciones pagaron $2,445 millones en impuestos de un total de recaudos netos de $7,760 millones, lo que es equivalente a un 31.5%.

El aumento en el déficit gubernamental ha provocado un aumento vertiginoso en la deuda pública de Puerto Rico, la cual ha aumentado de 58% del PNB en el 2000 a un 95% del PNB en el 2009.  Esta tasa de crecimiento del endeudamiento publico, según el Dr. Bosworth, simplemente no es sostenible a largo plazo.

Mas preocupante aun es que una buena porción de la deuda emitida recientemente por el gobierno de Puerto Rico se ha destinado a pagar deudas con suplidores y otros gastos operacionales en vez de usarse para financiar la inversión en bienes públicos a largo plazo.  Las emisiones de bonos realizadas recientemente por la Corporación del Fondo de Interés Apremiante (COFINA) son un buen ejemplo.

En junio de 2009 COFINA emitió deuda en exceso de $5,000 millones, cuyo pago esta garantizado por la asignación a COFINA de 2.75%, de un total de 5.5% del impuesto sobre las ventas y el uso que corresponde al gobierno central, por los próximos 40 años.  El dinero producto de la emisión se puede usar, entre otras cosas, para el pago de ciertas deudas del Secretario de Hacienda con el BGF, para el pago de deudas a ciertos suplidores del gobierno, y para sufragar gastos operacionales del gobierno central.  Esto significa que nuestros nietos estarán pagando el IVU en el 2030 para cumplir con el servicio de la deuda pagadero a estos bonistas sin recibir ellos ningún beneficio a cambio.

El sector financiero de Puerto Rico ha desmejorado significativamente desde el 2005.  La crisis financiera comienza antes en Puerto Rico debido a prácticas contables cuestionables.  Más recientemente vemos, como resultado de una burbuja especulativa en el mercado de vivienda local debido a un exceso de oferta, que la morosidad de los préstamos de construcción se ha disparado.  Esta situación, en combinación con la crisis financiera en los Estados Unidos, ha llevado a una contracción del crédito local de todo tipo a corto plazo.

Según datos de la Oficina del Comisionado de Instituciones Financieras los activos de los bancos comerciales en Puerto Rico han disminuido de $101,478,871,000 a diciembre de 2005 a $92,839,089,000 en septiembre del 2009, una reducción en exceso de $8,000 millones, equivalente a un 14% del PNB de Puerto Rico a junio de 2009.  Además, analistas financieros de Keefe, Bruyette, and Woods y de Raymond James, han reseñado que tres bancos locales están operando bajo ordenes de cese y desista del FDIC y que la probabilidad es alta de que el FDIC intervenga una o mas de estas instituciones en el 2010.  En suma, todos estos factores apuntan a que Puerto Rico podría enfrentar una crisis financiera en el 2010 lo que significaría un obstáculo severo para la recuperación económica en Puerto Rico.

Finalmente, el Dr. Bosworth enfatiza que a corto plazo no hay mucho que podamos hacer, pues muchas de las acciones necesarias toman tiempo para llevarse a cabo.   Sin embargo, estamos a tiempo para tomar medidas correctivas a mediano y largo plazo, si se comienza a trabajar ahora.  Se necesitan profundos cambios estructurales en nuestra economía para reestablecer el crecimiento en Puerto Rico. Lo más importante para Puerto Rico es la creación de empleos y ese debe el objetivo principal de toda política publica.  Para lograr esto es necesario hacer de Puerto Rico un lugar atractivo para hacer negocios, implementar una reforma contributiva a fondo, y reformar todo el entramado regulatorio de la isla.

La presentacion del Dr. Bosworth se encuentra aqui.

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Where are the new jobs?

On May 28^th, 2008 then governor Aníbal Acevedo Vilá signed Puerto Rico’s new tax incentives law, which we described as the time as another attempt in the long line of mostly futile efforts undertaken since 1976 to resuscitate Puerto Rico’s flawed economic development model based on tax breaks.  Yet, expectations were high for the new law, as advocates claimed that 15,000 new manufacturing jobs would be created by December 2009 as a result of its implementation.

According to the Labor Department’s household survey, manufacturing employment in Puerto Rico in May 2008 was 125,000, while in October 2009 it was 104,000—a decline of 21,000 jobs, or 16.8 per cent.  If we look at the Labor Department’s establishment survey, which uses a different methodology, the picture is slightly better.  According to this other survey, manufacturing employment in May 2008 was 102,000, while in September 2009 it was 91,400—a decline of 10,600 jobs, which is equivalent to 10.39 per cent.  In both instances, however, manufacturing employment in Puerto Rico has experienced a double-digit percentage decline since the enactment of the new tax incentives law.  Which begs the question: Where are the new jobs?

Now, it could be argued that the recessionary environment has effectively sterilized the job-creating effects of the new law.  However, the recession was a known fact at the time, indeed the local economy was well into the second year of a recession and the U.S. economy was extremely weak, if not already in a recessionary state.  Yet, it was claimed at the time that thousands of new jobs would be created as a result of the new law.  Obviously, this has not happened.  Where are the new jobs?

That issue, in turn, raises the question of how to measure the effectiveness of tax incentives.  The law requires the Secretary of Economic Development to file annual reports stating, among other things, the total amount of investment in machinery and equipment and the number of jobs and payroll generated by exempt businesses.  The Secretary of the Treasury is also required to file an annual report stating the amount of taxes paid by exempt businesses during the past year and a forecast of such payments for the next three years.  To our knowledge, these reports have not been prepared, and if they do exist, then they have not been made public.  Which should not be surprising, the Puerto Rican government has a long history of both ignoring the law and withholding information from the public.

Furthermore, as we stated in 2008, the law’s disclosure and reporting requirements should be fine-tuned in two key dimensions.  First, several reports during the past thirty years, such as the Tobin Report in 1975 and James Dietz’s seminal Economic History of Puerto Rico (Princeton University Press, 1986), have highlighted that Puerto Rico’s dependence on tax exemptions to attract foreign investment has generated an ever growing gap between the island’s Gross Domestic Product (“GDP”), which measures the value of all production generated within Puerto Rico, and the island’s Gross National Product (“GNP”), which measures the value of production that can be attributed to locally-owned factors of production.

The existence of this gap is important because it indicates there is a mismatch between Puerto Rico’s real productive capacity and the amount of “value added” that is measured and reflected in official statistics.  An analysis carried out by Barry Bosworth and Susan Collins for the CNE/Brookings report published in 2006, reveals that over the 1987-2001 period the ratio of capital income to employee compensation in the chemical industry (which includes pharmaceuticals) averaged 10.5 in Puerto Rico and 2.1 in the United States.

According to the authors “differences in relative factor returns of this magnitude cannot be credibly attributed to differences in the underlying production processes.”  Bosworth and Collins estimate that manufacturing output and economy-wide GDP in 2004 were in fact overstated by 45 per cent and 17 per cent, respectively, and conclude that “much of what is recorded as production in Puerto Rico is a simple paper transaction in which income is transferred to Puerto Rico and then taken back out as dividend payments to mainland corporations.”

If the new incentives law is successful in generating real economic activity by locally-owned firms and not merely paper profits by multinational companies, then we should see an increase in Puerto Rico’s GNP growth rate relative to the growth rate its GDP and the gap between both indicators should narrow and eventually close.  Therefore, we recommend that the reports to be filed by the Secretary of Economic Development include an analysis of the GDP/GNP gap and their respective growth rates during each of the previous three fiscal years.

Second, tax incentive programs in Puerto Rico have never been subject to a strict cost-benefit analysis.  This is important because the crucial issue with respect to growth incentives is whether an additional dollar spent in promoting one activity would be more beneficial than a dollar spent elsewhere.  Thus, the question for those who believe a particular activity should be promoted—for example, the pharmaceutical industry—is why they believe the social returns to such an activity will be higher than elsewhere in the economy.

Therefore, we recommend that the reports to be filed by the Secretary of the Treasury include the following information: (1) an analysis of the cost of each of the incentives included in the law in terms of forgone public revenues (tax expenditures); (2) the cost per job created in terms of forgone public revenues and a comparison of this cost with the average wage paid to workers in exempt businesses; and (3) an estimate of the aggregate economic activity generated by the tax incentives and a comparison of these benefits with the cost of the incentives in terms of forgone public revenues.

Proponents of the new law claimed at the time that it was the “best incentives law in the world”.  Yet, so far it seems “that dog don’t hunt”, as Bill Clinton would say.

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One swallow a summer does not make

So said Aristotle, warning his students against making bold predictions based on scant evidence.  It is in this light that we should interpret the most recent change in the Government Development Bank’s Economic Activity Index, which showed a slight increase in its absolute value from 134.27 in August to 135.32 in September, which is equivalent to a month over month increase of 0.78%.

At first glance, this negligible increase in economic activity, as measured by the index, could be interpreted as a sign that “we are seeing the light at the end of tunnel.”  There are, however, several reasons to be cautious.  First, all indices have a measurement error, which, to be fair, can be attributed to the general fallibility of human beings.  In this case, we do not know what this index’s margin of error is.  If it is smaller than 0.78%, then the recently reported increase could be interpreted as significant, if it is equal to or larger than 0.78%, then the month over month change could be just a statistical glitch, the proverbial one swallow of the title.

Second, there could be an endogeneity problem with the index, as the independent variables—payroll employment, gasoline consumption, electricity consumption, and cement sales—may not be completely exogenous with respect to GNP, which is the dependent variable in this case.  There are statistical fixes to this problem, but since the methodology for calculating the index has not been disclosed it is impossible to determine if it has been corrected for endogenous relationships, if any, that may exist between one or more of the independent variables and dependent variable.

Third, even if we assume the index accurately measures economic activity in Puerto Rico, its recent performance does not bode well for the island.  The PowerPoint presentation prepared and released by the GDB includes the linear regression equation that describes the mathematical relationship between the index and Puerto Rico’s GNP at constant 2008 prices.  That equation is y=432.25x – 4,124.27, where x is the value of the index, and y is GNP.  If we calculate the index’s average value for fiscal year 2008-09 and plug it into the regression equation the GNP forecast for that fiscal year is $56.019 billion, which is 7.84% less than the GNP for fiscal year 2008 of $60.787 billion.

If we take the analysis one step further and calculate the average index value for the first three months of fiscal year 2009-10 and do the same calculation, we find that the implied GNP for the current fiscal year declines further to $54.127 billion, a decrease of 3.38% with respect to the previous fiscal year.  Again, with only three index data points for the current fiscal year it may be premature to use the index to forecast GNP.  Yet, we note that the contraction of 3.38% implied by the regression analysis is consistent with a recent estimate done by the Economist Intelligence Unit that foresees Puerto Rico GNP contracting by 3% during the current fiscal year.

In sum, the GDB Economic Activity Index could be a useful tool for determining the general trend of the Puerto Rican economy, but we should careful interpreting and drawing conclusions from it.

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The Impact of ARRA Funds on Employment (Part 2)

The White House reported over the weekend that 17,597 jobs have been “created or saved” in Puerto Rico thanks to the impact of federal stimulus spending in the island.  According to this report, Puerto Rico has been awarded $1,936,135,565 in federal funds under the American Recovery and Reinvestment Act of 2009 (“ARRA”), of which $200,030,374 have been “received”, and thus presumably spent.

Now, there are several reasons to be skeptic about the accuracy of this report.  First, if only some 10% of the total funds awarded has been spent, then, it is at best an exaggeration and at worst downright misleading, to calculate a figure of jobs created/or saved based on spending the total amount awarded so far.

Second, according to an op-ed piece in the Wall Street Journal written by Edward Lazear, a former chairman of the President’s Council of Economic Advisers, the jobs data “were collected from responses by government agencies that received federal funds under the American Recovery and Reinvestment Act of 2009.  Agencies were required to report an estimate of the number of jobs created and the number of jobs retained by the project or activity.” 

Under this system, “recipients have strong incentives to inflate their reported numbers.  In a race for federal dollars, contractors may assume that the programs that show the most job creation may be favored by the government when it allocates additional stimulus funds.”  So, there exists a strong bias for overstating or over-reporting total job creation.

Third, the federal data does not report net job creation, that is, total jobs created less total jobs lost in the economy.  The federal government, according to Lazear, “wants us to believe that the new hires came from the pool of the unemployed and that they are net additions to the stock of employed workers. But the data do not speak to the number of workers who left their current jobs to fill government-sponsored jobs.”  The federal government, in other words, is only reporting the positive gross figure but not the relevant net jobs figure.  Thus, it is impossible to know with certainty the impact of the stimulus on the job market with the data reported.

Finally, the data released by the federal government is inconsistent with local data about Puerto Rico’s economy.  According to data from Puerto Rico’s Labor Department a net total of 97,000 jobs have been lost in the island between September 2008 and September 2009.  The Government Development Bank’s index of economic activity has declined by 4.8% during the same period.  Other data about the real economy, such as construction permits, home sales, and retail sales, are also down significantly during this period.  The island’s unemployment rate is 16.4% and continues to rise.  As of September 2009, the unemployed and their dependents make up about a fifth of the entire 16 and over population of Puerto Rico.  Therefore, we doubt many Puerto Ricans will find anything to cheer about those 17,597 jobs “created or saved” through the expenditure of ARRA funds.

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Bizcocho

Durante uno de mis veranos de universidad, conseguí un trabajo en Inglaterra y viví allí con una familia de Londres por esos meses. Fue interesante conocer una nueva cultura y aprender nuevas costumbres. Entre todas, una de las costumbres de la familia nunca se me ha olvidado. La señora de la casa me enseño una regla que ella tenía para sus dos hijos. La misma consistía en que a la hora del postre, uno de los hijos cortaba el bizcocho y el otro escogía el pedazo que quería. Era una manera ingeniosa de evitar peleas y de ser equitativa en la repartición de bienes, ya que el que cortaba o dividía tenía incentivo de ser justo, pues de cortar un pedazo más grande que otro, sería el otro hermano el que se beneficiaría.

En días recientes he pensado mucha en esta curiosa estrategia pues se ha desatado en Puerto Rico una discusión entre hermanos sobre la repartición del bizcocho. Ha sido interesante ver la reacción a nuestra crisis económica de diferentes perspectivas. No recuerdo haber experimentado una diferencia de opinión tan marcada como la que ha generado la recesión económica de Puerto Rico y sus efectos.

Por un lado he visto los que le achacan a los empresarios la culpa de todo. Sueñan con una utopia social que no existe y no logran ver la llegada de un nuevo momento económico. Por otro, veo una retórica vitriólica hacia las organizaciones obreras y a la izquierda del País, que siempre ha existido en buena sociedad puertorriqueña, pero sutil y veladamente. Ahora esa rabia se ventila con orgullo y atrevimiento.

Pienso que sería apropiado que practicáramos un ejercicio que aprendí de las lecturas del reconocido filósofo John Rawls. Él decía que cada persona debía imaginarse que no sabía bajo qué estación de vida nacería. Es decir, que pudiera nacer dentro de una familia solvente y apoderada o dentro de una familia pobre y humilde. Si no sabes en qué tipo de situación vas a estar, ¿cómo quisieras que fuera la sociedad? Es un ejercicio muy interesante porque te obliga a considerar una realidad distinta a la actual y a revisar tus prejuicios.

Para un desarrollador sería interesante pues debe imaginarse que en vez de ser el gestor de un proyecto en un arrabal, es residente de esa comunidad y el que viene a construirle encima es otro. Si es rescatador de un terreno, debe imaginarse que es el dueño del terreno al cual invaden y que ahora permanecerá por años sin poder darle uso.

Si es patrono, debe imaginarse que es obrero buscando aumentar la dignidad de su trabajo. Y si es obrero debe imaginarse lo difícil que es tratar de crear empleos bajo un esquema reglamentario tan burocratizado.

Lo importante aquí no es decir que un lado tiene más razón que el otro. Es poder imaginar y experimentar el asunto desde la perspectiva del otro. No puedo hablar por nadie, pero si antes de entrar al mundo me dijeran: “No te puedo decir si nacerás rico o pobre. Pero necesito me digas qué tipo de sociedad quieres”, yo pediría la sociedad más justa y equitativa para todos. Porque si me toca ser rico quiero poder ser buen mayordomo de mis bienes y aumentarlos. Pero si nazco pobre, quiero estar seguro que estoy en una sociedad que protege a los más débiles y les da oportunidades iguales a todos para vivir en paz y dignidad.

Hablando de bizcochos y costumbres, en mi casa mi mamá tenía una que le funcionaba muy bien. Si peleábamos por el bizcocho, lo guardaba y no le tocaba nada a nadie.

Miguel A. Soto Class

Publicada el 28 de octubre de 2009 en El Nuevo Día

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The Impact of ARRA Funds on Employment

Yesterday the administration presented a report on the use of funds available to Puerto Rico under the American Recovery and Reinvestment Act (“ARRA”).  To date, Puerto Rico has spent $1.2 billion in ARRA funds, which have generated 1,600 jobs.  Thus, according to official statistics, 1.33 jobs have been created for every $1 million of ARRA funds spent so far.  We suspect this job multiplier is rather low and perhaps not an accurate reflection of the real impact of these expenditures on the local economy.

Although it is not clear from press reports, we assume the number of jobs created includes direct, indirect, and induced jobs.  To explain these concepts let’s assume the government has funded the construction of a new highway.  Direct employment generated by this investment refers to employment directly related to the construction of the highway, that is, to people hired directly by the construction company to work on the construction of the new highway.  As a result of this direct employment, jobs are also generated in the businesses that supply goods and services (cement manufacturers, rebar makers, asphalt producers etc.) to the construction company.  These jobs are referred to as indirect employment.  Finally, when these directly and indirectly generated incomes are spent on a variety of items in the broader economy (e.g. food, clothing, entertainment, etc.), it gives rise to induced employment effects in those other sectors of the economy.

The federal government has calculated that 10.87 direct, indirect, and induced jobs are created for every $1 million of ARRA funds spent in the mainland United States.  The lower job multiplier effect for Puerto Rico could be explained by the large amount of imported goods we consume.  In Puerto Rico approximately 80 to 85% of everything we consume is imported, while in the U.S. only about 17 to 18% of all goods and services are imported.  This means the actual impact on employment in Puerto Rico of every $1 million spent from the stimulus package will be significantly lower than in the mainland U.S. because a considerably larger amount of what we will buy with those funds comes from abroad.  In simple terms, ARRA funds spent in Puerto Rico generate relatively more demand for foreign, instead of local, labor, therefore generating activity that has only a modest impact on the local economy.

Setting aside the technicalities, the question remains of whether the expenditure of ARRA funds will provide a sufficiently strong stimulus to jumpstart the Puerto Rico economy.  The answer, up to now, appears to be no.  In Puerto Rico we have lost 67,000 jobs between January and September of the current year.  That averages out to 7,444 jobs lost every month.  Looking at it in another way, Puerto Rico needs to create an average of 7,444 new jobs per month just to keep even with average monthly job losses.  The 1,600 new jobs created through the expenditure of ARRA funds substitute only for jobs lost during 6.4 days of the current year.

In sum, as we have stated before while spending ARRA funds will do some good, these expenditures are not sufficient to pull us out of the economic quagmire we are in.   We  need to do more, much more, to jumpstart the economy in the short term and still quite a lot more in structural terms to sustain that growth over the long term.

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