Are Things That Bad For Puerto Rico?

by: The Motley Monetarist

Summary

The Newfoundland near-default in the 1930's provides some interesting historical perspective to Puerto Rico's current troubles.

Despite the dramatic escalation of Puerto Rico's indebtedness, recent trends in the growth of both the internal and external deficit provide a positive indicator for Puerto Rico's future.

Analogies with Newfoundland are strengthened by the "liquor tax indicator", almost identical for the two economies.

Unlike Newfoundland in the thirties, however, Puerto Rico may be able to grow itself out of its current problems.

Are things that bad for Puerto Rico?

Default-o-mania fear is sweeping the world, a little bit like Trump-o-mania. First Greece, now Puerto Rico. With the devaluation of the yuan, these bearish signals are probably more ominous symbolically than in reality. But symbols are extremely important and may carry the day in these troubled times.

With that said, there have been cases, historically, of small provinces that were part of a larger country that have come close to default. One such example is Newfoundland, which, once part of Britain, came close to default in 1934. There are instructive parallels between the stories of Newfoundland then and Puerto Rico now.

Newfoundland's fishy story

Between 1928 and 1932, Newfoundland, based on a single product economy (cod), found itself caught in the currents of the Great Depression. Of course, in some sense the comparison with Puerto Rico is misplaced. Newfoundland has an area of 42,000 square miles to Puerto Rico's 3,500 square miles. Puerto Rico has a population of 3.6 million to Newfoundland's then population of 182,000. Before its threatened default in November 1934, Newfoundland was a self-governing dominion in the English empire. Like Puerto Rico, it was buffeted by forces beyond its control. In response to these events, Newfoundland gave up its system of self-government and thereafter until it joined Canada in 1949, Newfoundland was governed by six commissioners.

The following figures from Newfoundland's Royal Commission Report in 1933 provides some perspective to Puerto Rico's current situation.

Growth in external deficit

Growth in internal deficit

Interest payments as % of tax revenues

Growth in public debt

Income taxes as % of total tax revenue

Excise taxes as % of total tax revenue

Liquor taxes as % of total taxes

1928-29

1930-31

-.6%

-85%

44%

10%

6.9%

77%

4.5%

1931-32

21%

1425%

39%

5.6%

8.5%

78%

3.5%

1932-33

30%

22%

5.4%

8.7%

71%

2%

Several interesting points emerge from the above Table. The first is that indirect taxes dominated the Newfoundland government's revenue intake. The second is that there was a huge spike in the internal deficit just before the onset of the crisis in Newfoundland in 1934. Thirdly, like in Puerto Rico, liquor taxes were a not insignificant component of tax revenues. Finally Newfoundland's external deficit stabilized just before the crisis, which seemed to have been one related more directly to Newfoundland's internal deficit.

Puerto Rico has seen a stabilization in the growth of the external deficit.

By contrast to the above Table, Puerto Rico has seen a stabilization in the growth of its external deficit in recent years. The following data from the Economic Report of the Government Development Bank of Puerto Rico highlights the salient differences between the data above from Newfoundland and the recent developments in Puerto Rico. While the current indebtedness of $72 billion for an economy like Puerto Rico's may seem excessive, it should be noted that in contrast to Newfoundland, manufacturing is at a solid 47.5% of GDP in Puerto Rico followed by real estate, at 15.7%. Of greater interest is the recent stabilization in the growth of the non-US external deficit.

Growth in external deficit

Growth in internal deficit

Interest on debt as a % of total tax revenues

Excise tax as a % of total revenues

Liquor tax as % of revenues

2010

-141%

-8%

2.7%

7%

2%

2011

-374%

-13%

.14%

12%

2.1%

2012

147%

-24%

.4%

20%

2%

2013

-11.7%

-12%

4.3%

18%

1.97%

Is the liquor tax indicator a leading indicator of Puerto Rico's future?

Any comparison between Puerto Rico's situation now and Newfoundland in the 30's may seem a little too flip, but if the "liquor tax" indicator is any good, there is a rough analogy between Puerto Rico's situation today and that of Newfoundland. While it does not seem likely that any commission is going to come riding in on a white horse to redress the situation in Puerto Rico, it would seem, notwithstanding the uptick in the interest in debt, that 2013 saw a broad decrease in important indicators for the Puerto Rican economy. The slowing down in the growth of both the internal and external deficit might be positive medium-term trends for this island economy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.