The Development of Puerto Rico
OCTOBER 01, 1982 by DENNIS BECHARA
Mr. Bechara is an attorney in Mayaguez, Puerto Rico.
The Development of the Puerto Rican economy sheds light on the true causes of economic growth. The history of the island’s development is peculiar to it, but the policies implemented in Puerto Rico to achieve progress hold universal appeal. A review of the economic situation since the turn of the century may help us grasp the lessons of the Puerto Rican experience.
As a result of the Spanish-American War, the United States assumed jurisdiction over Cuba, Puerto Rico and the Philippines. Subsequent events led to the political independence of Cuba and the Philippines, but the relationship between Puerto Rico and the United States continues.
Economic conditions were dismal in Puerto Rico at the turn of the century. Life expectancy in 1900 was 32 years. The literacy rate at the time was only 15 per cent. The island’s economy consisted of subsistence agricultural efforts. The production of coffee, once one of the island’s most successful crops, began to languish when access to the Spanish market was lost.
The nature of the political relationship between Puerto Rico and the United States began to change as Congress gradually granted more autonomy to the island. In 1917 American citizenship was granted to Puerto Ricans and certain measures of self-government were enacted. The President, however, continued to appoint the governor and it was not until 1948 that the people were allowed to elect one.
In 1952, Congress approved a Puerto Rican-drafted constitution, and the island became known as the Commonwealth of Puerto Rico. Puerto Ricans are allowed to elect a non-voting member of Congress. Though they are citizens, they are not allowed to participate in Presidential elections.
The Sugar Economy
One of the immediate effects of the Spanish-American War was to place Puerto Rico within the U.S. tariff wall. In 1870, Congress had enacted a tariff to protect domestic producers of beet sugar, and this had the effect of driving many of the island’s sugar producers into bankruptcy. Once the United States acquired jurisdiction over Puerto Rico, however, there was free trade between the two. Capital flowed into Puerto Rico with the effect of modernizing its sugar processing mills. A glance at the production figures illustrates the magnitude of sugar in the Puerto Rican economy. In 1899, approximately 40,000 tons of sugar were produced, whereas in 1934, Puerto Rico produced approximately one million tons. By 1940, the sugar industry employed one-fourth of the labor force. “Sugar . . . paid the major part of the insular taxes, employed the major part of its workers, created the major part of its business, supported seventeen of Puerto Rico’s twenty seaports in the sense that those seventeen handled sugar exclusively and had no warehouses or other facilities for anything else.” In spite of its importance in the island’s economy, sugar became the subject of many attacks. Puerto Rico was not immune to the ravages of the Great Depression. The island, which was poor to begin with, had made some progress but it was nevertheless insufficient to drastically change matters. The rise of the sugar industry, however, provided the scapegoat upon which to blame the poor conditions of the island.
There is no doubt that Puerto Rico, during this time, was impoverished. Theodore Roosevelt, Jr., who in 1929 was governor of the island, wrote the following in The New York Herald Tribune: “We were and are a prey to diseases of many kinds. In the fiscal year ending June 30, 1929, 4,442 of our people died from tuberculosis. Our death rate from this disease was 4V2 times the death rate in the continental United States. Our death rate from malaria was 21/2 times the rate in the continental United States. Some 35,000 people in our island are now suffering from tuberculosis, some 20,000 from malaria, and some 60,000 from hookworm.”
The prevailing conditions during this period of time, however, were not unusual given the historical background of Puerto Rico. To put the blame on the sugar industry for conditions which existed before sugar became the most prominent industry is glaringly unfair. The island, moreover, did make strides in many areas during this time which bene fited the entire population. As an example of this, life expectancy had risen to 42 years in 1930 and 46 years in 1940; economic conditions had improved concurrently with these developments.
Stumbling Blocks Erected
The sugar industry confronted its first obstacle when in 1934 Congress enacted the Costigan- Jones Act. This statute empowered the U.S. Secretary of Agriculture to administratively determine the sugar consumption requirements of the country and to set production quotas from the different areas that supplied sugar to the U.S. market. A consequence of this statute was to freeze the growth of Puerto Rico’s sugar industry. This, coupled with future land reform, served to cripple the industry permanently.
During the later part of the 1930s, public discussion revolved around the low wages paid by the sugar industry as well as by the industry’s large landholdings. In 1937, for example, the average hourly wage rate of agricultural employees in the sugar industry was 12 cents. This was thought to be convincing enough evidence to condemn the industry, and served as a justification for the government’s continued intervention. Yet, the Bureau of Agricultural Economics reported the average hourly wage rate for agricultural employees for that year in Puerto Rico to be higher than prevailing farm wage rates in fourteen states.
Another of the perceived evils of the sugar industry was its alleged displacement of thousands of farmers who became unable to support themselves after losing control of their land. The statistics concerning land ownership, which are mentioned below, are sufficient to refute this. However, it should be pointed out that as a result of the implementation of modern sanitation and health practices, the island’s population nearly doubled by 1930. Even had the sugar industry not flourished, it is doubtful that the island would have been able to be agriculturally self-sufficient. In fact, now that land has been redistributed’ in order to curb these alleged injustices of the sugar industry, the island is still not agriculturally self-sufficient.
As a result of the desire to uproot the perceived evils of the sugar industry, a land redistribution program was enacted in 1941. During a frenzied period of time, the Land Authority, the administrative agency empowered to take over all corporate lands that exceeded an arbitrary 500 acre limit, acquired thousands of acres and either administered the land on its own or subdivided it into smaller plots and transferred them to those deemed deserving. By 1950, the Land Authority had “acquired nearly half the corporate holdings in excess of 500 acres and was operating 48 proportional-profits farms, as well as two sugar mills.”
Why corporate holdings in excess of 500 acres were repugnant may be traced to a Congressional Resolution pertaining to the Foraker Act of 1900, which established Puerto Rico’s position with regard to the federal government. Under this federal statute, Congressmen expressed a fear that Puerto Rico’s inclusion within the U.S. tariff system would encourage corporate holdings by the sugar and tobacco “trusts” that would dwarf the local population. Consequently, Congressional Resolution No. 23 o£ May 1, 1900 was enacted whereby Congress expressed its displeasure about the matter. Years later, an energetic politician, Luis Muñoz Marín, who was later to become Puerto Rico’s first popularly elected governor, campaigned on a platform of enforcing this Congressional Resolution.
True, in order for the sugar industry to efficiently compete and produce, it was altogether necessary for modern sugar processing equipment to utilize large holdings of land in order to lower the unit costs of raising sugar cane. As a result of this, the average yield per acre increased from a half a ton of sugar per acre in 1899 to 3.3 tons of sugar in 1937.
According to the U.S. Soil Conservation Service, Puerto Rico has a total of 2,103,000 acres, of which, 1,222,284 are tillable. The four largest sugar corporations controlled, before 1941, an estimated 166,000 acres, which represented less than 20% of all tillable land. If one investigates the available data more deeply, one can discover the astonishing fact that in 1899 there were 39,021 farms in Puerto Rico whereas in 1935 the number increased to 52,790. In 1910 there were 539 farms which exceeded 500 acres, whereas in 1938 the number had decreased to 335. On the other hand, farmland with an area of no more than twenty acres had increased during this same period of time from 38,274 to 42,004, which represented over three quarters of all tillable land.
However convincing these statistics may be, when confronted with an emotional “share-the- wealth” argument, the downfall of sugar became inevitable. No sugar mill was able to compete efficiently with a 500 acre limitation. Interestingly, in recognition of this, the government’s position after acquiring all of those landholdings was to drastically reduce the scale of any further significant land expropriations. But by then the damage was done. Sugar never recovered from these setbacks. One by one all of the sugar mills in Puerto Rico either closed or declared bankruptcy. Naturally, in the 1970s the government, recognizing sugar’s importance to the economy, stepped in and created a government agency called the Sugar Corporation which leased some of the mills and proceeded to run them on a profit and loss basis. Predictably, the Sugar Corporation has succeeded in amassing substantial losses, at the present totalling more than $600 million dollars.
The long term effects of the Great Depression are still being felt in Puerto Rico. As a result of the New Deal’s welfare-oriented policies, the Puerto Rican economy became the object of governmental intervention with land reform as only one of its consequences.
In 1933 the Federal government created the Puerto Rico Emergency Relief Administration, which by 1935 became the Puerto Rico Reconstruction Administration. This agency was endowed with an operating yearly budget of $40 million with which it began social experimentation.
One of the PRRA’s first activities was to purchase a sugar mill owned by a French corporation, called the Lafayette Central and proceeded to operate it as a model plant. As is usually the case whenever government operates a business, this did not prove to be profitable. Subsequently, the agency proceeded to subdivide the 10,000 acres it had purchased and to let the farmers who acquired these lots run the mill as a cooperative. Once again, the experiment proved to be a failure and the mill ceased to operate.
But the efforts of the PRRA went beyond operating a cooperative farm. The agency commenced building subsidized housing and built a cement manufacturing enterprise and a hydroelectric system. The agency became defunct by 1939 and most of its projects floundered. However, it set a pattern future island governments would follow.
Fair Labor Standards Act
In 1938, Congress extended the Fair Labor Standards Act to Puerto Rico. The immediate effect of this law was devastating. The U.S. Commerce Department, certainly no enemy of the minimum wage law, admits this in its 1979 Economic Study of Puerto Rico: “Significant job losses followed the introduction of Federally mandated minimum wages on the island, the most serious being a drop in home needlework exports from $20 million in 1937, to $5 million in 1940.”
As a result of the devastating effects of the minimum wage law in Puerto Rico, Congress approved an amendment, in 1940, whereby industries operating in Puerto Rico were allowed to pay wages below the federally mandated minimum, and tripartite committees, which represented industries, unions and the government, were set up to periodically upwardly revise the mandated minimum wages.
Parallel with this development, the island’s government proceeded to enact provisions for mandatory paid vacations, sick leave and other conditions of employment to be applicable on an industry-by-industry level. The justification for this was that since the federal minimum wage was not completely applicable to Puerto Rico, local legislation was needed to supplement this measure.
Subsequent amendments to the Fair Labor Standards Act, however, have eliminated the exemption granted to Puerto Rico. As of now a substantial amount of industry which affects interstate commerce in Puerto Rico must comply with the provisions of the Fair Labor Standards Act. The mandatory decrees instituted by the Puerto Rican government to grant vacations, sick leave, and other conditions of employment, however, have not been abolished. Instead they continue to be amended in order to raise the benefits conferred therein. In addition to this, the Puerto Rican government has subsequently enacted provisions requiring employers to pay maternity pay, dismissal pay, nonoccupational disability coverage as well as a mandatory Christmas bonus.
The economic consequence of this so-called social legislation has been to raise the cost of hiring employees with an inevitable high unemployment rate. Unemployment has consistently been in the 10 to 12 per cent range during the past forty years. Presently, the unemployment rate exceeds 20% while the rate for those in the 14-24 age group is nearly double that figure.
Rexford G. Tugwell
In 1941, President Roosevelt appointed Rexford G. Tugwell governor of Puerto Rico, and with this appointment the welfare-oriented policies initiated by the Roosevelt administration took hold in Puerto Rico at a dizzying speed.
Tugwell’s administration truly revolutionized the island, as he took an active part in the drafting of interventionist policies which have held Puerto Rico captive to this day. Under his leadership, countless statutes were enacted which followed and even exceeded in their zealousness the tenets of the New Deal.
Tugwell’s administration was influenced in part by World War II, which had a substantial economic impact on the island. This was so because as the production of whiskey was curtailed in the continental United States by the federal government, the sales of Puerto Rican rum in the mainland soared. As part of the Organic Act that governed Puerto Rico’s relationship with the United States, it was specified that all excise taxes collected in the mainland from any products originating from Puerto Rico would be returned to the Puerto Rican treasury. This meant that during the course of World War II the Puerto Rican treasury received a bonanza in excess of $160 million. As Henry Wells, author of The Modernization of Puerto Rico, put it:
During 1940-41 the Puerto Rican government received only $4.5 million from federal internal- revenue payments, but a year later it got $13.9 million. Enemy interference with shipping in the Caribbean during 1942-43 held the federal payments to $13.6 million, but with the resumption of more normal trade in 194344 the amount turned over to the insular treasury came to a phenomenal $65.9 million. After that peak year the mainland thirst for Puerto Rican rum slack ened and federal excise-tax yields declined accordingly, but in 1944-45 the insular government still received $38.6 million, and $35.3 million the following year.
The funds available from the rum excise tax served to finance many projects which were commenced after the War ended. According to Earl Hanson:
Puerto Rico’s budget, which before 1940 had been around $22,000,000, shot up to as high as $150,000,000; with such funds the government could build factories, purchase lands held in excess of five hundred acres by the sugar corporations, provide machinery for the working and distribution of those lands, stimulate its public-health service, implement its new social legislation, foster co-operatives, and engage in all the multiple activities of a stricken society reshaping itself . . .
Government Agencies Assume Role in Economy
During Tugwell’s tenure, numerous government agencies were created which in turn assumed an active role in the economy. Among these were the Development Company and the Development Bank. Under their leadership, the government acquired the cement company which had been founded by the PRRA, as well as a pulp board factory, a paper company, a glass fac tory, a clay products company and a shoe company.
The experience of government handling and management of all of these enterprises, however, was very disappointing to the planners; eventually, by 1951, all were sold to private enterprise. This decision was motivated by the fact that those enterprises were inefficient, incurred losses and created only approximately 2,000 jobs, when the unemployment level stood at 200,000.
The local politicians reluctantly came to the conclusion that government investment was not the panacea it was thought to be. A change in policy was formulated, which could not be implemented because Tug-well opposed it. According to David F. Ross: “Governor Tugwell was firmly and emphatically opposed to the kind of development program which relied primarily on the offering of inducements to private capital and enterprise.”
Governor Tugwell, however, resigned on June 29, 1946, and this paved the way for the enactment of the Industrial Incentives Act of 1947, which granted tax exemption status to any company that settled in Puerto Rico to produce or manufacture designated articles.
The enactment of the Industrial Incentives Act of 1947 marked a new episode in the development of the Puerto Rican economy. The law took advantage of the fact that Puerto Rico is exempt from federal income taxes, and consequently, plants operating on the island would be free from this expense. The provisions of the Internal Revenue Code applicable both then and now permit United States companies to transfer the profits generated by their subsidiaries in Puerto Rico to the mainland tax free. There is presently a controversy between the IRS and some of these companies over the matter of intra-company pricing and its effect on profits. However, its resolution is not expected to adversely affect the tax exemption program.
The effects of Operation Bootstrap, as the incentive system is called, have been outstanding. Over 2,000 manufacturing entities have established plants in Puerto Rico as a result of the tax advantages, with more than 100,000 jobs created. This has been considered the economic miracle of the century, comparable to Germany’s recovery after the war. The GNP figures for the applicable years are similarly impressive. In 1940 the GNP was $287 million, by 1952 it had risen to $963 million, in 1964 it was $4,531 million, and in 1981 it had reached $11,780 million.
However prosperous or fortunate the policy of granting tax exemption was, it was nevertheless insufficient to overcome the tremendous unemployment problem which has chronically affected Puerto Rico. As the 1979 U.S. Commerce Department study put it: “In the fifties, as the economy was engaged in the first phase of the transition from a mon-ocrop agricultural system to an in dustrialized system, total employment contracted. The absorption of labor into the newly developed manufacturing sector fell behind the rate at which agricultural workers were being laid off. It was only after 1963 that a persistent employment expansion was underway. Under the momentum, spurred mainly by capital investment induced to enter the economy under the revisions in the Industrial Incentives Act, employment improved for a decade. Between 1963 and 1973 it increased on the average nearly 3 per cent a year. In that span of years, the average rate of unemployment dropped to just over 12.5 per cent as an average—still highly unsatisfactory, how ever.”
Petrochemical Developments in the 1960s and 1970s
In light of the fact that unemployment was still at politically unacceptable levels, the Puerto Rican government redefined its industrial promotion in the 1960s and proceeded to attract oil- related industries. This approach was encouraged by the complex federal legislation which, in pre-OPEC days, placed a tariff on foreign oil but permitted the introduction into the country of cheap foreign oil, once it was processed and refined in Puerto Rico. During the early 1970s oil was imported to Puerto Rico at $2.00 a barrel, and this led to the massive construction of petrochemical complexes in the island. As a result of OPEC’s policies, however, imported oil is no longer cheap, and Puerto Rico’s distance from the mainland market has made most of those industries nonviable. Over 155 oil related plants alone closed operations in the years 1973 to 1975, and many of the remaining petrochemical complexes have filed for bankruptcy.
Migration has relieved the unemployment problem in Puerto Rico. Since American citizenship was granted in 1917, there are no barriers to migration to the United States and nearly one million Puerto Ricans now reside in the United States. During the 1950s, the average yearly migration was approximately 50,000 persons. The Planning Board, an agency of the Puerto Rican government, in commenting on the effects of migration on the unemployment statistics during the 1940s said the following: “Without emigration during the decade . . . unemployment would have mounted to 201,000 as compared, to the actual unemployment figure of 101,000 in June, 1950.”
Yet, in spite of the government’s concerted effort in attracting foreign capital to Puerto Rico and the effects of migration on unemployment, the economy has reached a standstill since 1973. Fewer industries have settled in the island and many of those that were already operating have closed their operations.
Reasons for a stagnant Puerto Rican economy can be traced to institutional factors. The laws of Puerto Rico, coupled with federal regulations, are very burdensome on business. Labor legislation is indeed one of the causes of unemployment in the island. But beyond that, the massive amounts of federal aid have served to create malinvestments of the greatest magnitude. The Puerto Rican government presently receives over $200 million a year in excise taxes from the U.S. Treasury. This sector provides about 9% of the Commonwealth’s budget. During the 1970-77 period alone, over $1,000 million was thus received. This has been sufficient to perpetuate the government’s power and to expand its role, while minimizing the taxpayer’s cost of the government.
As a result of Federal aid, which represents approximately 30% of the island’s GNP, the local government has been able to engage in many functions beyond the scope of the traditional role of government. The Federal government is currently providing Puerto Rico with such generous benefits that a majority of the island’s families receive food stamps. The U.S. Commerce Department has acknowledged the role of federal aid when it stated that “Federal funds directly and indirectly supply such a large share of total Puerto Rican income that personal income exceeds the value of all goods and final services produced and remaining in the Commonwealth.”
Puerto Rico offers certain statistics that confound anyone knowledgeable in economics, but which portray the magnitude of Federal assistance to the island. As is well known, in order to purchase imports, any country must export goods or services to pay for the imports. Puerto Rico, however, during the past thirty years has consistently run a deficit in its balance of payments. Economists similarly decry the fact that there is no internal saving, but rather that Puerto Rico has become a “net dissaver” over this period of time.
The local government, following Tugwell’s example, has continued its welfare orientation and consequently controls a large area of the economy. Government is by far the largest employer in the island—employing 20% of the labor force. The sugar corporation, the electric company, the shipping lines, the telephone company and other enterprises are owned by the government. Not unrelated to this, a Federal Power Commission study indicated that Puerto Rico’s electricity rates were the highest in all of the United States. This undoubtedly places the island at a disadvantage in attracting capital for energy-intensive industries.
The government’s impressive stature in the economy, however, has not followed a classic pattern. Many of the government’s functions are performed by so-called public corporations which in turn are able to float bond issues. The Commonwealth government’s debt, as a percentage of GNP was 15% in 1978. But if one adds the debt of all other governmental agencies and entities, the figure exceeds 70%. It is apparent that the government’s future borrowing capacity is very limited.
Trade between Puerto Rico and the United States, which represents over four-fifths of the island’s commerce, is governed by the Jones Act, a federal statute which requires that all trade between domestic ports be conducted in U.S.-flag ships. The effect of this statute has been to remove foreign competition from domestic shippers and to strengthen the grip of the maritime unions on this industry. Consequently, cargo rates of domestic shipping lines are among the highest in the world. This legislation has also served as an institutional roadblock impeding Puerto Rico’s growth, since Puerto Rico’s trade is so dependent on shipping.
The Welfare Mentality
Yet, the most serious of all of the obstacles facing Puerto Rico today is the inculcation of the collectivist and public welfare ideology which was started during the New Deal. This ideology views private enterprise negatively.
Conventional wisdom in Puerto Rico holds that the government, either Commonwealth or Federal, is the source of all wealth. This is not hard to understand in light of the fact that government is so omnipresent in the economy. The “share-the-wealth” philosophy has become so embedded that subsidies of all types abound for substantial portions of the population. It would be beyond the scope of this article to mention the different subsidies that exist in Puerto Rico today. However, historically the most important one was the expropriation on the part of the government of large tracts of land and their subsequent subdivision and transfer to thousands of people. The power of eminent domain in Puerto Rico is very strong and undoubtedly its effects have shaken the island’s economy. The largest landholder at the moment is the government, which owns 130,000 acres of land.
Perhaps a reflection of the welfare mentality that is rampant in Puerto Rico is the flurry, over the past decade, of land squatters claiming their alleged right to hold property. After all, government had been expropriating land for so long that it seemed altogether natural to simply take over the land. It has been estimated that there are over 2,000 acres of land that have been squatted on during this period of time. Politicians have rushed to the scene in many cases to show their compassion for this, and it has not been unknown for the legislature to enact benefits that reward the efforts of the squatters.
The economic crisis which prevails in Puerto Rico today cannot continue for long without further adverse consequences such as an appalling crime rate and a continued increase in unemployment. The much-publicized tax cuts that were implemented recently, following the advice of Arthur B. Laffer, have been quietly interrupted. The last phase of the tax reduction has been rescinded for fear that it might create a deficit. The miraculous effects it was supposed to create were nonexistent because the government’s role in the economy has continued to assume a greater importance.
Tourism, which represents an important industry for the island is nevertheless limited in what it may be able to achieve for it represents only 5% of GNP. Agriculture is similarly situated.
Prospects for the Future
As a result of receiving massive infusions of federal funds as well as experiencing the effects of migration into the continental United States, Puerto Rico’s policymakers were able to attenuate the consequences of their economic policies. As the Commonwealth’s government enacted more restrictive regulations, as it encroached more and more into the workings of the economy, the results of these decisions had to be malinvestments and unemployment. But precisely because migration served as a safety valve, and federal funds assumed a major importance in the economy, the policymakers became convinced that the interventionist legislation they favored could not adversely affect the economy. When the federal minimum wage became completely applicable to enterprises that operated in interstate commerce in Puerto Rico, for example, the government’s position was that this could have no adverse effect on unemployment. The government obviously was wrong.
Many factors influence the workings of an economy, so that one governmental policy may partially offset the effects of another. This has been the case in Puerto Rico. As progress was taking place in the island during the decades of the 50s and 60s, people became convinced that the main reason behind such progress resided in the collectivistic policies enacted by the politicians who followed Tugwell’s lead.
The Effects of Freedom
Yet, in analyzing all of the governmental efforts at promoting the local economy, one can fairly say that most of them achieved distortions and malinvestments in the economy. However, when private enterprise was granted a substantial tax holiday which offset many of the other costs implicit in starting an operation in Puerto Rico, growth spurted. Foreign visitors came to study the economic miracle that was taking place. Unfortunately, the costs of operating in Puerto Rico, in large part due to the local government’s policies, have finally caught up with the tax exemption program, the result being that fewer industries are willing to locate in the island.
If there is anything to be learned from Puerto Rico’s experience during the past four decades, it is that private enterprise has been the most efficient mechanism for increasing the productivity and the wealth of the people. Policymakers should recognize this and attempt to deregulate the economy in order to permit the private sector to bring its dynamism into the economy.
It is encouraging to observe that, in spite of the spending policies of the federal and local governments, the entrepreneurial spirit has not been completely quashed. Regardless of all the subsidies, privileges and controls that exist in the economy, people are willing to invest and take risks. The effects of these efforts would be magnified if the economy were freed of all the restraints that hold back its growth. The most significant change, however, is that the collectivist mentality which has been so successfully ingrained must be erased if individualism and liberty are to prevail.