Statement before the Puerto Rico Oversight Board
Thank you for allowing me the honor of testifying before this session.
I would like to make three basic points:
a. First, the Puerto Rican economy is in real danger of entering into a downward economic spiral.
b. Reliance on budget discipline alone is all too likely to exacerbate Puerto Rico's economic decline.
c. A piecemeal approach is not going to rescue the island's economy. Rather what is desperately needed is a comprehensive IMF-style structural adjustment program. Such a program should involve budget discipline, serious structural reform, increased US Congressional financial and non-financial support, and major debt relief.
Allow me to elaborate on each of these points:
1. The island is at risk of a downward economic spiral.
Even before Hurricane Maria, the Puerto Rican economy was in a multi-year economic depression. Since 2006, the Puerto Rican economy has contracted by 10 percent and it has lost 10 percent of its population to the mainland. At the same time, in the context of its budget adjustment program, over the next decade, the Puerto Rican economy was officially projected to decline by another 10 percent (Figure 1). This would make the island's depression worse than that of Greece (Figure 2).
Hurricane Maria has substantially darkened what was already a bleak economic outlook. Not only has very major permanent damage been done to the island's economic infrastructure, rather the hurricane has dealt a major body blow to the island's economic output. As a measure of the hit to the island's economic outlook, it is estimated that much of the island remains without electricity and in the three months since the hurricane, the island has lost more than 5 percent of its population to the mainland.
2. Over reliance on budget discipline could exacerbate the crisis.
The Oversight Board would do well to heed two lessons from the European sovereign debt crisis:
The first lesson was that budget tightening in a monetary union can lead to steep declines in economic output unless that tightening was accompanied by major structural reforms that made the economy more competitive. The reason for this was that in a monetary union, the economy does not have its own currency to devalue as an offset to the adverse impact on demand that raising taxes and cutting public spending has. This heightens the importance of fundamental structural reforms to encourage investment.
The second lesson from the European crisis was that budget tightening that leads to a collapse in output can be counterproductive in terms of improving an economy's public finances. This is the case mainly because it results in the erosion of the economy's tax base.
3. Puerto Rico needs a comprehensive IMF-style structural adjustment program.
Had the island been an IMF member country, the present state of the Puerto Rican economy would have been among the worst economic situations with which the IMF would have had to deal in its seventy-year history. This suggests that a piecemeal approach will not work to pull Puerto Rico out of its slump. Rather a coordinated approach involving both financing and structural measure from each of the main parties in the island's economy would be needed along the following lines:
a. The Puerto Rican government would need to credibly commit to both disciplined budget policies and far-reaching economic reform measures to make its economy more competitive especially in the area of the labor market. In particular, the government would need to recognize that the island cannot possibly compete effectively with the same minimum wage level as that prevailing on the mainland and that major reforms are needed to improve incentives to work.
b. Puerto Rico's creditors would need to recognize that there is no way in which the island can possibly repay its debt on anything like its current terms. Accordingly they would have to be prepared to agree to a steep write-down of that debt.
c. The US Congress would need to recognize that the island needs major financial support to rebuild its infrastructure and to finance its budget. Equally important, Congress would need to take measures to make the island a more attractive location for investment. Such measures should include the repeal of the Jones Act and the introduction of tax preferences for US companies to invest in those industries where the island might have a comparative advantage.
A final point that I would like to make is that the Puerto Rican government is unlikely to commit to serious economic reform without assurances of substantial Congressional support. For their part, the US Congress and the island's creditors are unlikely to be prepared to commit large financial resources to the island in the absence of assurances that the island will maintain disciplined budget policies and engage in serious economic reform.
To address this point, serious consideration should be given to the design of an IMF style structural reform program for Puerto Rico where financial support to the island would be phased and would be made strictly conditional upon Puerto Rico implementing serious economic reform and adhering to more disciplined budget policies. Consideration might also be given to the idea of requesting the IMF to provide technical assistance on the design and monitoring of a Puerto Rican economic adjustment program.