Fed sees pitfalls, opportunities on PR’s path to economic competitiveness
Issued : Sunday, July 1, 2012 07:40 AM
By CB Online Staff
Puerto Rico’s economy has been underperforming for decades and has yet to show concrete signs that it is pulling out of a long and deep downturn that stretches back some six years, the Federal Reserve Bank of New York said in a report issued Friday.
The Federal Reserve Bank of New York’s “Report on the Competitiveness of Puerto Rico’s Economy” highlights the challenges facing Puerto Rico’s economy and offers recommendations to make the island more competitive.
“The report is intended as nonpartisan technical analysis and should be viewed in that vein,” New York Fed President William C. Dudley said in remarks prepared for delivery at the Puerto Rico Chamber of Commerce convention in Fajardo on Friday.
The Fed report touches on the island’s rapid economic progress during the early part of the twentieth century, but says that momentum has been “stalling” since the 1970s.
“The island has been operating below its potential and the competitiveness of the economy has been deteriorating,” the report said, citing Puerto Rico’s long-standing high unemployment and “strikingly low labor participation rate as chief concerns.
“Compounding this long-term economic stagnation, the current cyclical downturn on the Island has been deeper and more protracted than that on the U.S. mainland, and activity has yet to show strong signs of recovery,” the report said.
The New York Fed noted that on several measures Puerto Rico has features that make it a strong — and potentially a highly competitive—economy:
— The literacy rates and educational attainment of Puerto Rico’s adult population compare favorably with those of most economies in the region, and have nearly caught up with those on the U.S. mainland.
— The labor force is largely bilingual.
— The economy is open and is favorably located, occupying a central position in the Caribbean and providing a gateway between the U.S. mainland and Latin America.
— The island has extensive experience as a host to a variety of major U.S. multinational corporations.
The report defines competitiveness in terms of productive efficiency, or getting the most output from available resources. For Puerto Rico, being competitive means that its workforce and capital stock are fully utilized and allocated to their most productive uses. In a more dynamic sense, being competitive implies that conditions and policies are in place to support business development and innovation. Increasingly, competitiveness also encompasses the capacity to adapt quickly and efficiently to the many changes taking place in the global economy.
“This latter dimension is particularly important for Puerto Rico, because as a small island economy, it faces stiff competition from a variety of alternative locations,” the report said.
The Fed report says the island also benefits from close ties to the U.S. mainland economy: The residents are U.S. citizens with unrestricted access to the mainland, the dollar is the official currency, the legal system affords the protections of the U.S. constitution, and federal grants support a number of programs available to U.S. mainland residents, particularly in the areas of health and education.
“The challenge to policymakers is to marshal the island’s considerable strengths to raise living standards and restore growth,” the report said.
The report identified five factors that the Fed says pose significant competitive challenges to the island:
― Improving labor market opportunities ― Puerto Rico’s labor force participation rate is among the lowest in the world, with less than half of eligible workers participating in the formal economy. Moreover, the unemployment rate has been persistently well above the U.S. mainland’s, and is especially high for the young and less educated.
― Developing human capital ― Although the island’s workforce overall is among the world’s most educated, Puerto Rico still lags the U.S. mainland, and there is a particularly high abundance of low-skilled workers. There are also growing concerns that the quality of the education system has deteriorated, especially at the primary and secondary levels.
― Reducing the costs of doing business ― The business environment in Puerto Rico makes it costly and cumbersome to establish and grow new businesses and expand existing ones. In particular, regulations, the elevated cost of electricity, and an underdeveloped and costly transportation infrastructure are barriers to a more dynamic environment.
― Mobilizing finance for business development and growth ― Weak banks and limited alternatives to bank funding have reduced credit availability to local businesses.
― Lowering dependence on a shrinking industry ― Tax incentives led to an outsized presence of the pharmaceuticals industry on the Island. The incentives have been phased out and employment in the industry has declined. Going forward, there appears to be only a limited prospect for the sector to be a driver of growth.
“Puerto Rico has made noteworthy efforts in recent years to address different aspects of these complex and interrelated challenges. But more can be done,” the report said.
The Fed presented five policy recommendations, including several that reflect themes that have been actively discussed and debated —a nd in a few cases, already addressed — on the island.
“The recommendations should not be viewed as providing a quick fix, but rather as important steps to help improve Puerto Rico’s competitiveness over time,” the report said.
Recommendation 1: Reduce barriers to job creation and labor force participation
Creating jobs and encouraging active participation in the labor market should be a top priority for policymakers. Opportunities for the young and less educated in Puerto Rico are particularly limited, and these workers are in danger of becoming disconnected from the labor market. We recommend focusing on policies that spur the creation of job opportunities and improve incentives to work. One possible first step would be to consider a young-worker subminimum wage that targets workers under the age of 25. The minimum could be stepped up at regular intervals as the worker continues employment and builds skills with a given firm, so that the worker’s wage would match the federal minimum over a number of years. A wider reexamination of the application of the federal minimum wage and the design of entitlement programs may also be warranted in order to improve incentives to seek employment and increase the number of jobs available for workers on the Island.
Recommendation 2: Reform the energy industry
An efficient and competitive energy sector is essential for the wider success of the Puerto Rican economy. Best practice suggests that a regulatory commission should be established to oversee the Puerto Rico Electric Power Authority to protect consumers and improve the efficiency of the utility’s operations. It is standard on the U.S. mainland as well as in other countries for a monopoly utility to be subject to regulatory oversight, even when the utility is government owned. The rules to allow the renewable-energy industry access to the power grid should be clarified; one solution would be to adopt the wholesale market rules used on the U.S. mainland.
Recommendation 3: Lower the costs of doing business
Independent studies suggest that Puerto Rico continues to lag the mainland and regional peers in ease of doing business, though these studies find some progress in recent years. Continued systematic effort to further streamline regulatory processes and reduce red tape appears to be warranted. Separately, the high cost of shipping is a substantial burden on the island’s productivity. Puerto Rico is in a distinctive situation with respect to the Jones Act because of its status as an island economy. One option could be to seek a temporary exemption from the Jones Act, for instance for five years, in order both to evaluate whether or not these restrictions really are a substantial cause of elevated shipping costs and to allow for assessment of the costs and benefits of a permanent exemption.
Recommendation 4: Foster partnerships between industry and higher education
Colleges and universities are important assets that can help Puerto Rico actively participate in the knowledge economy. One way the island can build on these assets is to foster partnerships between private industry and higher-education institutions. These partnerships tend to offer localized economic benefits by increasing economic activity associated with the creation, development, and commercialization of new products or processes. One way forward would be for the government of Puerto Rico or a non-profit institution on the island to help establish a center of excellence focusing on the development of globally important technologies by providing seed funding and incentivizing industry investment. Moreover, commercialization of academic research should be more actively supported. An initial step in this process might be the formation of a task force made up of members of academia, industry, non-profit institutions, and government to identify the most promising opportunities in Puerto Rico.
Recommendation 5: Promote independent policy evaluation
The economy’s growth potential is strongly influenced by the quality of government policies. Accordingly, greater efforts should be made to evaluate specific policies routinely to determine if the benefits exceed the costs; in this way, the best ideas will have a chance to be adopted while those found lacking can be eliminated. The effectiveness of government policies also depends on data on the economy’s structure and operation. More resources should be devoted to improving and expanding economic indicators for the Island in order to bring them into line with the indicators regularly used to track regional conditions on the U.S. mainland.
“The report is intended as nonpartisan technical analysis and should be viewed in that vein,” New York Fed President William C. Dudley said in remarks prepared for delivery at the Puerto Rico Chamber of Commerce convention in Fajardo on Friday.
The Fed report touches on the island’s rapid economic progress during the early part of the twentieth century, but says that momentum has been “stalling” since the 1970s.
“The island has been operating below its potential and the competitiveness of the economy has been deteriorating,” the report said, citing Puerto Rico’s long-standing high unemployment and “strikingly low labor participation rate as chief concerns.
“Compounding this long-term economic stagnation, the current cyclical downturn on the Island has been deeper and more protracted than that on the U.S. mainland, and activity has yet to show strong signs of recovery,” the report said.
The New York Fed noted that on several measures Puerto Rico has features that make it a strong — and potentially a highly competitive—economy:
— The literacy rates and educational attainment of Puerto Rico’s adult population compare favorably with those of most economies in the region, and have nearly caught up with those on the U.S. mainland.
— The labor force is largely bilingual.
— The economy is open and is favorably located, occupying a central position in the Caribbean and providing a gateway between the U.S. mainland and Latin America.
— The island has extensive experience as a host to a variety of major U.S. multinational corporations.
The report defines competitiveness in terms of productive efficiency, or getting the most output from available resources. For Puerto Rico, being competitive means that its workforce and capital stock are fully utilized and allocated to their most productive uses. In a more dynamic sense, being competitive implies that conditions and policies are in place to support business development and innovation. Increasingly, competitiveness also encompasses the capacity to adapt quickly and efficiently to the many changes taking place in the global economy.
“This latter dimension is particularly important for Puerto Rico, because as a small island economy, it faces stiff competition from a variety of alternative locations,” the report said.
The Fed report says the island also benefits from close ties to the U.S. mainland economy: The residents are U.S. citizens with unrestricted access to the mainland, the dollar is the official currency, the legal system affords the protections of the U.S. constitution, and federal grants support a number of programs available to U.S. mainland residents, particularly in the areas of health and education.
“The challenge to policymakers is to marshal the island’s considerable strengths to raise living standards and restore growth,” the report said.
The report identified five factors that the Fed says pose significant competitive challenges to the island:
― Improving labor market opportunities ― Puerto Rico’s labor force participation rate is among the lowest in the world, with less than half of eligible workers participating in the formal economy. Moreover, the unemployment rate has been persistently well above the U.S. mainland’s, and is especially high for the young and less educated.
― Developing human capital ― Although the island’s workforce overall is among the world’s most educated, Puerto Rico still lags the U.S. mainland, and there is a particularly high abundance of low-skilled workers. There are also growing concerns that the quality of the education system has deteriorated, especially at the primary and secondary levels.
― Reducing the costs of doing business ― The business environment in Puerto Rico makes it costly and cumbersome to establish and grow new businesses and expand existing ones. In particular, regulations, the elevated cost of electricity, and an underdeveloped and costly transportation infrastructure are barriers to a more dynamic environment.
― Mobilizing finance for business development and growth ― Weak banks and limited alternatives to bank funding have reduced credit availability to local businesses.
― Lowering dependence on a shrinking industry ― Tax incentives led to an outsized presence of the pharmaceuticals industry on the Island. The incentives have been phased out and employment in the industry has declined. Going forward, there appears to be only a limited prospect for the sector to be a driver of growth.
“Puerto Rico has made noteworthy efforts in recent years to address different aspects of these complex and interrelated challenges. But more can be done,” the report said.
The Fed presented five policy recommendations, including several that reflect themes that have been actively discussed and debated —a nd in a few cases, already addressed — on the island.
“The recommendations should not be viewed as providing a quick fix, but rather as important steps to help improve Puerto Rico’s competitiveness over time,” the report said.
Recommendation 1: Reduce barriers to job creation and labor force participation
Creating jobs and encouraging active participation in the labor market should be a top priority for policymakers. Opportunities for the young and less educated in Puerto Rico are particularly limited, and these workers are in danger of becoming disconnected from the labor market. We recommend focusing on policies that spur the creation of job opportunities and improve incentives to work. One possible first step would be to consider a young-worker subminimum wage that targets workers under the age of 25. The minimum could be stepped up at regular intervals as the worker continues employment and builds skills with a given firm, so that the worker’s wage would match the federal minimum over a number of years. A wider reexamination of the application of the federal minimum wage and the design of entitlement programs may also be warranted in order to improve incentives to seek employment and increase the number of jobs available for workers on the Island.
Recommendation 2: Reform the energy industry
An efficient and competitive energy sector is essential for the wider success of the Puerto Rican economy. Best practice suggests that a regulatory commission should be established to oversee the Puerto Rico Electric Power Authority to protect consumers and improve the efficiency of the utility’s operations. It is standard on the U.S. mainland as well as in other countries for a monopoly utility to be subject to regulatory oversight, even when the utility is government owned. The rules to allow the renewable-energy industry access to the power grid should be clarified; one solution would be to adopt the wholesale market rules used on the U.S. mainland.
Recommendation 3: Lower the costs of doing business
Independent studies suggest that Puerto Rico continues to lag the mainland and regional peers in ease of doing business, though these studies find some progress in recent years. Continued systematic effort to further streamline regulatory processes and reduce red tape appears to be warranted. Separately, the high cost of shipping is a substantial burden on the island’s productivity. Puerto Rico is in a distinctive situation with respect to the Jones Act because of its status as an island economy. One option could be to seek a temporary exemption from the Jones Act, for instance for five years, in order both to evaluate whether or not these restrictions really are a substantial cause of elevated shipping costs and to allow for assessment of the costs and benefits of a permanent exemption.
Recommendation 4: Foster partnerships between industry and higher education
Colleges and universities are important assets that can help Puerto Rico actively participate in the knowledge economy. One way the island can build on these assets is to foster partnerships between private industry and higher-education institutions. These partnerships tend to offer localized economic benefits by increasing economic activity associated with the creation, development, and commercialization of new products or processes. One way forward would be for the government of Puerto Rico or a non-profit institution on the island to help establish a center of excellence focusing on the development of globally important technologies by providing seed funding and incentivizing industry investment. Moreover, commercialization of academic research should be more actively supported. An initial step in this process might be the formation of a task force made up of members of academia, industry, non-profit institutions, and government to identify the most promising opportunities in Puerto Rico.
Recommendation 5: Promote independent policy evaluation
The economy’s growth potential is strongly influenced by the quality of government policies. Accordingly, greater efforts should be made to evaluate specific policies routinely to determine if the benefits exceed the costs; in this way, the best ideas will have a chance to be adopted while those found lacking can be eliminated. The effectiveness of government policies also depends on data on the economy’s structure and operation. More resources should be devoted to improving and expanding economic indicators for the Island in order to bring them into line with the indicators regularly used to track regional conditions on the U.S. mainland.
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