Where are the new jobs?

Where are the new jobs?

Published on November 25, 2009

Sergio portrait
Policy Director

On May 28th, 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 percent.  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.