Puerto Rico and Economic Independence

Hindsight is the best economist. It always has the solution for everything. On the 1994 Tequila crisis that started in Mexico: “They should have either managed capital inflows through capital controls, or they should have let their exchange rate adapt to those inflows.” On Latin American hyperinflation: “Policy makers should have recognized that domestic debt issuances used to support ISI policies and an overvalued exchange rate led to unsustainable inflationary pressures once the exchange rate was devalued”. On the European debt crisis: “Governments should get their fiscal policies in sync before engaging in a monetary union” So on and so forth…

So what does hindsight have to say about Puerto Rico’s “Silent Crisis”? Its economy has experienced stagnant GDP growth for decades and fiscal deficits continue to grow unabated each year. It has experienced massive capital flights over the last decade, and it has seen a ‘brain drain’ unparalleled in its history.

Economists purport that “it was bound to happen.” Naturally.

In the aftermath of every economic or financial crisis, there is an important rethinking of solutions, implications for future policy options and best practices for future crises. Yet the Puerto Rican economy remains an afterthought for policymakers and pundits alike. Although a miniscule portion of U.S. GDP, it represents an interesting case study of an economy without a central bank to control monetary policy and capital flows, nor a trade policy mechanisms or tools to promote foreign investment. There exsits nothing more than a publicity campaign for tourism and investment that hinges upon the benefit of not having to bring your US passport along for the trip.

As the world economy continues to become increasingly interdependent, the dynamics of economic growth can expand beyond borders and contagion is a constant and everpresent scourge. It is in this vein and of significant import to our understanding to the Puerto Rican economy, and the rationale for its economic independence, that we can distinguish between large economies and small, open economies (SOEs). The economic cycle of large economies have disproportionately large effects on the global economy. SOEs, to a large extent, do not tilt the balance of global economic power or stability. This is not to say that all SOEs are inconsequential to the global economy. Far from it. Indeed, consider how the devaluation of the Thai baht spurred the Asian currency crisis of the ‘90s. Yet an economy’s influence in global markets is often measured by international trade dynamics. At its simplest, if the economy’s output can have an effect on world prices, then it is considered a large economy. If the economy’s output has little or no effect on world prices, it can be considered an SOE.

Puerto Rico is an SOE. No matter how deep its political, social or economic integration is to the U.S., by a measure of its trade patterns and as an island, Puerto Rico has its own, separate economy. For SOEs like Puerto Rico, economic independence is often undermined by their position as ‘price takers’ within the world economy. Consider an SOE with completely free capital mobility. Capital inflows into the SOE will typically originate from large economies. If capital mobility is free, then capital inflows and outflows will likely respond to the state of the economy from which the capital flows originate. Strong growth in a large economy can lead to massive capital inflows into an SOE, generating an unsustainable surplus of credit within the economy. Conversely, if a large economy enters into a recession, capital outflows from the SOE can be devastating to long-term growth and development. In this vein, establishing capital controls on foreign capital flows (say a deposit requirement in the SOEs Central Bank) can go a long way toward promoting stability and can mitigate the impulse of market investors to follow a ‘herd mentality.’ A good success story for this type of controls is Chile during the ‘Tequila Crisis.’ While other Latin American countries experienced massive capital outflows, Chile’s capital flows remained relatively stable, due to the capital controls they established on the back of regulatory reform in their financial sector.

Being an SOE in an increasingly integrated world economy is not easy. However, economic policy independence gives these economies the tools to mitigate the effects of international market volatility. In the case of Puerto Rico, this kind of economic policy independence can only be achieved through the powers and legitimacy of a sovereign state. Therefore, in this case, political independence is a prerequisite for economic policy independence.

Abraham is a senior at Fordham College, studying International Political Economy. He can be reached at amercado@fordham.edu

46 thoughts on “Puerto Rico and Economic Independence”

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