In search of an identity
Originally published in Hispanic Business magazine
In little more than half a century, Puerto Rico has rushed through transitions from an agricultural economy to one based on low-wage manufacturing and on to increasingly high-skill, high-tech production.
"We leapfrogged in 40 years what happened at a more subtle pace in the nation over 90 years," says Carlos Vivoni, Puerto Rico's secretary of commerce and economic development.
Now, with the North American Free Trade Agreement (NAFTA) eroding the island's advantage as a U.S. territory and federal tax incentives falling one by one in Congress, Puerto Rico needs a new road map. The intense focus on manufacturing is giving way to the goal of diversifying the economy. The government's priorities are privatizing state-owned enterprises and creating a fertile business climate.
Governor Pedro Rosselló recently announced a new package of local tax incentives intended to spur investment. The incentives were the result of two years of study of successful economic development strategies in six states and six countries around the world, from Michigan and North Carolina to Malaysia and Ireland.
"This will make Puerto Rico equal to these other jurisdictions that have been especially successful in promising economic development," Mr. Vivoni says of the new package.
The incentives lower the top corporate tax rate from 14.5 percent to 7 percent, eliminate the "toll-gate tax" on repatriated profits, and offer a 200 percent tax deduction for spending on research, development and employee training. Private sector response has been positive, though many would like to see the incentives applied to existing businesses, not just to expansions or new investments.
Statehood or independence?
The uncertain future of Puerto Rico's political status was one reason cited by the International Olympic Committee in not naming the island as a finalist for hosting the 2004 Games. But business leaders generally agree that the status question has not deterred investment nor hampered economic growth.
Congressman Don Young, a Republican from Alaska, is trying to settle the long-running status debate once and for all. His bill, now in Congress, would hold a plebiscite on the issue next year -- the 100th anniversary of U.S. rule.
Congressman Young's bill would move Puerto Rico either toward statehood or independence, the two status options he considers permanent. The current commonwealth arrangement is just dressed-up colonialism, he contends. His bill calls for repeated plebiscites until Puerto Ricans eventually choose either statehood or sovereignty.
Although the bill marks the most serious attempt yet by Congress to address Puerto Rico's political status, it has not created enough uncertainty to affect investment, for three simple reasons. First, it faces a fight in Congress from opponents of statehood. Second, if a plebiscite is held next year, polls show support for statehood is weak, so the status quo is likely to continue. And if at last Puerto Ricans should opt for statehood, Mr. Young's bill specifies a 10-year transition.
"If things change, it's going to take time," says Banco Popular Senior Executive Vice President Jorge Junquera. "Time and stable rules are what investors want. Ten years is enough time."
Movement in either direction, though unlikely in the short term, would have major effects on business. Under statehood, all federal taxes would apply, raising the tax burden for corporations and many individuals. The General Accounting Office of Congress estimates Puerto Ricans would receive at least an additional $3 billion a year in federal benefits for which they are not now eligible.
The real benefit of statehood would be the full integration of Puerto Rico into the U.S. economy, says Ivar A. Pietri, a former investment banker and pro-statehood businessman.
From the 1950s to the 1970s, Puerto Rico's economy grew rapidly and gained ground on the United States, but growth has been unremarkable since. As a result, 59 percent of Puerto Ricans remain below the federal poverty level and per capita income is one-third the U.S. level.
Mr. Pietri notes that the U.S. had five, large, off-shore territories at the turn of the century. Hawaii and Alaska prospered under statehood; Cuba and the Philippines languished under independence; and Puerto Rico "has mucked along this entire century, showing a potential that will never be fulfilled until we become a state."
Meanwhile, support for independence lingers in the single digits in the polls, and thus is not likely any time soon, unless Congress imposes it. As an independent nation, Puerto Rico could write its own laws and business regulations and sign its own trade agreements, completely changing the business climate.
For now, although the status question keeps Puerto Rico's politics at full boil, it hasn't left any investors feeling burned.
The local incentives arrive just as federal tax incentives have died in Washington. In 1996, Congress mandated a 10-year phase-out of IRS Section 936, which offers tax breaks on profits generated by Puerto Rican subsidiaries of U.S. companies. The elimination of the tax break, which had been the centerpiece of the island's industrial development effort for 20 years, was part of the bill that raised the federal minimum wage; Puerto Rico's interests were overwhelmed by the broader, national implications.
Again in 1997, Puerto Rico lobbied to save a related federal tax break, Section 30A. Unlike Section 936, which rewarded profits more than the creation of jobs, Section 30A was a wage-based credit and easier to defend against charges of "corporate welfare." But Puerto Rico's lobbying for 30A suffered a familiar fate. It was erased as the details of a five-year federal budget plan were ironed out. With no votes in Congress, Puerto Rico again lost a federal tax incentive.
Governor Rosselló faced intense criticism from his political foes because he did not vigorously defend Section 936, and the issue was heavily covered in local media. The governor argues the importance of 936 is overstated.
"The problem here is that everyone thinks the economy of Puerto Rico is dependent on one factor or on one sector," Governor Rosselló says, noting that the federal tax breaks only helped some -- not all -- businesses in one of the 10 categories the administration's new economic model addresses.
"If the question is, 'Do you want 30A?,' the answer is, 'Yes,'" Governor Rosselló says. "But that's just one part of the big picture."
Business leaders in Puerto Rico miss the tax break, however. The Puerto Rico Manufacturers Association, the island's most influential trade group, supported Governor Rosselló's tax incentive package, but PRMA President Enrique Cortés notes that "it does not constitute a substitute for the federal incentives that Puerto Rico has lost and continues to lose."
Miguel Ferrer, president of Paine Webber of Puerto Rico, Inc., says Puerto Rico needs both local and federal tax incentives. Section 936 rewarded corporations for keeping their Puerto Rico-generated profits on the island for several years before repatriating them, and that element is lacking from the local tax incentives package. If a few changes were made in the Rosselló administration's package, including an incentive to keep capital in Puerto Rico, "it would be a gangbusters program," Mr. Ferrer says.
While the 936 tax break is being phased out over 10 years, the incentive for keeping profits in Puerto Rico disappeared overnight, and banks have felt the pinch, adds Jorge Junquera, senior executive vice president of Banco Popular, the islands largest bank and the largest Hispanic-owned bank with operations on the mainland.
"We were expecting something of a liquidity problem," says Mr. Junquera. At the end of 1996, $2.3 billion in Section 936 funds were invested in Puerto Rico with a maturity of one year or less, and 61.1 percent of that amount was deposited in Banco Popular. But Mr. Junquera says the withdrawal of funds has been more gradual than expected and banks have absorbed the shift so far.
The incentives, either federal or local, are only one small part of the overal picture, argues Mr. Vivoni, the man at the helm of the government's economic strategy. The true centerpiece of the Rosselló administration's strategy is its New Economic Model, a blueprint unveiled in 1994. The keys are diversification, privatization, and facilitation. The implementation of these goals has incited controversy, however.
Every since Operation Bootstrap, a government program born in Puerto Rico in the 1940s that rapidly attracted industry to Puerto Rico, factory jobs have been seen as better paying and more desirable, while service-sector work was frowned upon. Manufacturing spurred economic growth rates of about 6 percent a year during the 1950s and 1960s, but that rate has since declined and manufacturing is no longer the wave of the future.
Furthermore, the bias toward manufacturing stunted other sectors, Mr. Vivoni says. From the 1970s to the early 1990s, the number of hotel rooms in Puerto Rico remained stable at around 8,000 while other Caribbean islands greatly expanded their tourism trade. "To me, that is a manifestation of how we have overlooked opportunities," says Mr. Vivoni. The Rosselló administration's tourism incentives have helped raise the number of hotel rooms to 12,000 today.
To some of Mr. Rosselló's political opponents, however, "diversification" is just a code word for losing good manufacturing jobs and getting service-sector work instead. "Moving away from the notion that manufacturing is the backbone of the economy creates a lot of apprehension," Mr. Vivoni acknowledges.
The Rosselló administration's privatization efforts have met increasing opposition as well. Hotels, a maritime shipping agency, a pineapple processor, and other enterprises have been sold. Private companies have been hired to manage the financially strapped, heavily troubled Aqueduct and Sewer Authority and some of the island's prisons.
But the plan to sell the Puerto Rico Telephone Co. has drawn thousands of protesters into the streets and threats of an island-wide general strike by labor unions. Led by opposition party politicians and the telephone company's unions, opponents of the sale have portrayed Governor Rosselló as trying to sell off part of Puerto Rico's "patrimony."
The telephone company's monopoly was ended by the Federal Telecommunications Act of 1996. Governor Rosselló believes it makes sense to sell the company to the private sector rather than have a public agency try to compete in the marketplace. Polls show most Puerto Ricans oppose the sale.
The third prong of the New Economic Model is improving the climate for business. Puerto Rico's complex labor laws and slow-moving permit processes are decried throughout the business community, and numerous holidays cut into the work week. The government is the largest single employer, and Governor Rosselló's attempts to rein it in have only slowed its growth, not cut the ranks of the bureaucracy.
Instead, the governor put his muscle behind upgrades to the island's infrastructure. The previous government spent $4 billion from 1989 to 1992 on infrastructure. The Rosselló administration spent $5.4 billion from 1993 to 1996 and plans to spend $7.4 billion between now and 2000. The $1.2 billion Urban Train project is beginning in San Juan, new highways are under construction, and the Port of San Juan will get a facelift.
New facilities are under construction at the Luis Munoz Marín International Airport just outside San Juan and a former air base on the northwestern corner of the island, with the longest landing strip in the Caribbean, is just begging for users, Mr. Vivoni says.
A new power plant and a 50-mile pipeline are in the works to solve water and power problems in the San Juan metropolitan area. The telephone company has spent $1.5 billion over the past five years on fiber optic, cable, and wireless networks.
In addition to tourism and infrastructure development, Mr. Vivoni sees exporting as another opportunity. The concentration of drug companies in Puerto Rico, where 20 percent of the pharmaceutical goods sold in the United States are made, can be developed further. The presence of so many pharmaceutical companies means the necessary support businesses are already in place. Electronics and medical devices tie into this market sector, according to Mr. Vivoni.
Those industries require skilled workers, however. That's one reason behind Mr. Rosselló's effort to improve the island's public school system, as well as the 200 percent tax credit for corporate employee training.
"The time has passed for Puerto Rico to compete on the basis of low wages," says the governor. "If Puerto Rico is going to compete today, it must be based on infrastructure, and that includes human infrastructure, human resources."