Puerto Rico’s austerity trap

There is a well-known and somewhat worn-out adage that warns against wasting a crisis, in great part because critical moments provide opportunities to take action on important issues that are commonly avoided and often misunderstood. But it seems like Puerto Rico’s political leaders are doing just that by opting to invest valuable political capital in Washington, D.C. on a recent referendum vote, while vital issues like budget cuts and fiscal consolidation threaten to compromise the socioeconomic prospects of generations to come.

Much has been written on the impacts of the debt crisis that is crippling the island, but significant knowledge gaps remain. On numerous occasions, I have heard businessmen, politicians and others suggest, with conviction and authority, that we are too indebted because the government spent too much, and now, in order to solve the problem, we have to do the opposite: slash public budgets until a recovery is in sight. It is an appealing proposition, in part, because it outlines a direct and positive relationship between restraint and well-being. The problem is that it does not pass muster. According to numerous analyses, battered economies do not improve with substantial cuts to public spending. In fact, the opposite happens: in lean times, especially when the private sector lacks dynamism, austerity tends to worsen things.

Perhaps an example recently relayed by my colleague and public debt expert, Martín Guzmán, helps us understand this better. Think of a taxi driver whose main income comes from the transportation service she offers.

Faced with a period of economic troubles, she is forced to tighten her belt: she eats out less often, puts off some home repairs, foregoes a couple of salon visits, and so on. Although she has made numerous budgetary arrangements, the overall situation does not improve, because the waitress, the hardware dealer and the hairdresser, who see their incomes reduced by the driver's prudence, decide to cut costs too, including taking fewer taxi rides. Everyone spends less, their incomes continue falling, but there are still unavoidable expenses and debts to pay. Eventually, our taxi driver does not complete enough rides to meet her financial obligations, and is forced to sell the taxi. Trapped in a vicious circle, she has lost her business and quality of life.

Unfortunately, the noxious sequence described above is not merely a hypothetical example. The people of Greece were forced to adopt severe austerity measures and have paid a terrible price. From 2008 to date, Greece has lost a quarter of their Gross Domestic Product (GDP) and the unemployment rate remains above 20 percent. Those who have opted not to emigrate have experienced what many in Puerto Rico still fail to understand: there is no such thing as "bottoming out" when you are caught in austerity’s downward spiral.

Worse still, a precipitous economic downturn makes the debt burden more unbearable. When public debt increases—or even if it stays put—while the economy shrinks, the ratio between debt and domestic production grows and fiscal matters turn uglier. This is happening in Greece, and in the coming years, the people of Puerto Rico will face a very similar scenario.

This is not an unfounded premonition as the numbers included in the island’s fiscal plan, and approved by the federally appointed Fiscal Control Board, affirm that the economy will continue to deteriorate during the next decade. This is due, in large part, to the adoption of severe budget cuts and tax increases that will have persistent negative impacts. If production falls, and nothing is done to reduce our debt burden, then our debt to GNP ratio will inevitably swell.

Certainly, something can be done stem the decline. For starters, we must aim to reduce the face value of the public debt owed. But determining how much to cut requires accurate and credible calculations that can show how debt restructuring leads towards a more promising development pathway. We are currently working on a study that examines Puerto Rico’s fiscal plan and proposes solutions to effectively address this issue.

Furthermore, while adopting sensible policies on spending and debt is necessary, what will truly help us move towards a sustainable growth trajectory is a new development strategy. Meeting this pressing need is the main goal of the newly created Growth Commission convened by the Center for the New Economy, Puerto Rico’s only independent think tank focused on economic development issues.

Our local government will undoubtedly play a fundamental role in our recovery. Rather than reducing its size and impact through privatizations and austerity measures, we must critically rethink its role in order to improve it, strengthen it, and thus ensure it helps us regain economic growth.  

 Deepak Lamba-Nieves is research director at Center for a New Economy (CNE). 

Puerto Rico’s austerity trap