Commonwealth and the economics of development by Teodoro

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COMMONWEALTH AND THE ECONOMICS OF DEVELOPMENT
TEODORO MOSCOSO and HUBERT BARTON
Since World War II, international economic development strategy has focused on investment.
Patterns of
investment have varied depending on the resource mix of
different developing countries and on differences in the
roles of the government and private sectors in investment
decision making.
In Puerto Rico, government has actively
promoted and subsidized private sector investment in
agriculture, manufacturing and tourism and has itself
invested directly in the essentials of economic infrastructure notably education, health, public utilities and trarisportation.
This is the essence of what has been recently
baptized as "supply side" economics but it has been de facto
government strategy in Puerto Rico during most . of the last
four decades.
This is not to say that there has been an official,
clearly articulated policy of investment priorities for the
past forty years.
Not all political leaders in San Juan and
Washington have recognized the primacy of investment in the
development process nor has there been anything like concensus on who should invest nor on how investment can best
be maximized and guided into the most productive channels.
Over the years, there have been numerous shifts in the
details of development policies and in the roles of the
government agencies involved.
Some changes have been planned
and deliberate, others have been inadvertent,' even accidental.
Some have been related to the political status of Puerto Rico,
others have not.
The economic development history of Puerto
Rico is rich in the diversity of the techniques employed but
it has also had a consistent focus on investment in both
human and material resources.
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-2In the 1930's much of the "investment" in Puerto
Rico reflected remedial actions taken by the Federal government to deal with the ravages of the great depression.
The
principal agency involved was the Puerto Rico Reconstruction
Administration (PRRA) .
This well run Federal "work relief"
agency reported that 79¢ out of each dollar of PRRA wages
was spent for food and clothing imported from the States so
that little PRRA money was left in the Island for
~·second
or. third commercial turnover".
It was recognized by PRRA that the "open" nature
of the economy limited the "multiplier" effect of consumer
expenditures in Puerto Rico in comparison with the United
States or other economies in which most of the goods and
services consumed are produced domestically .
.Thus, deficit
spending by government ori anti-poverty programs, which can
be sound "demand side" economics in a large integrated
economy, is much less effective in a small, island economy.
It should be noted that about two-thirds of
the Federal funds flowing into Puerto Rico today go directly
to individuals.
An even smaller proportion is invested
than had been by PRRA half a century ago.
Such Federal
expenditures are of great social benefit since they flow
to low income families and individuals.
They have made the
pattern of income distribution in Puerto Rico among the
most egalitarian in the world.
However, their effect on
the economy is limited and transitory.
In fact they probably
contribute more to the U.S. economy than to the economic
development of Puerto Rico.
PRRA investments, however, left a legacy for
Puerto Rican development in the 40's and into the 50's--
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a cement plant that was transferred to the Industrial
Development Company and plans for other enterprises that
were undertaken by the Company during World War II.
Even more important was the training of a cadre of young
Puerto Rican planners and administrators who would provide dynamic leadership for the reorganized and revitalized
Insular Government created during the 1941-46 administration
of Governor Tugwell.
1940 Zimmerman
The 1930 Brookings Reportl/ and the
Report~/ had stressed the need to improve
the quality of the Insular Government and the governments
of the municipalities which were not only ineffectual but
riddled with petty corruption.
Governor Tugwell, with the
support of Senator Munoz, built a modern, action-oriented
executive branch and staffed it at the top with technically
trained and highly dedicated individuals from PRRA and
elsewhere.
The financial muscle for the rapid development
of the economic infrastructure of the Island during the
1940's and early 50's was provided by an unprecedented
revenue windfall.
About $160 million in "extra" Federal
excise taxes on Puerto Rican rum sold in the States during
the World War II whiskey shortage was returned by Federal
law to the Insular treasury.
By comparison, Insular Govern-
ment receipts from all sources had amounted to only $28
million in 1939-40.
ll
Puerto Rico and its Problems, The Brookings Institution,
Victors. Clark and Associates, Washington~ D.C., 1930.
~/ Staff Report Interdepartmental Committee On Puerto Rico,
Washington, D.C., 1940.
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-4Nearly all of this windfall was invested in
nine government corporations instead of being , spent on the
immediate consumption needs of an impoverished population.
It was a hard decision for a young, populist government
but the new corporations soon began to have a financial
life of their own.
By 1950 they were generating $38
million in annual sales, borrowing $41 million from private
sources, retiring $17 million of debt and investing
$32 million in expanded facilities.
They received only
$14 million from the public treasury and as time went on
they became even more independent of government contributions.
By 1950, total public debt had risen to $168
million from the very low figure reached at the close of
World War II.
Debt of the public corporations was $122
million, 73% of the total.
The corresponding figures for
1983 are, total public debt, $8,440 million of " which the
public corporations account for $6,276 million or 74%.
Most 0£ this debt was then and is now externally held and
it is clear that the public corporations have been the
primary generators of public funds used for economic
devel.o pment financing.
Total public debt which was 23%
of annual Gross Domestic Product in 1950 is 50% today.
Debt financing has accelerated economic development and,
as evidenced by the ratings of Puerto Rico bond issues,
both investment policy and debt management have been
generally productive as well as prudent.
Puerto Rico's current problem is not an unmanageable public debt, as in many of the developing countries,
but rather the recent decline in the proportion of its
Gross Product that is spent for investment.
It was
...
-513% in 1950, 21% in 1960, 30% in 1970, 15% in 1980 and
10% in 1983.
The increase in investment during the 50's
and 60's and the drastic decline after 1972 was mainly
in the private sector, which can be influenced but not
controlled by government.
Most of the nine original public corporations
and some 30 others that have been established since are
performing conventional public utility functions: electric
power, water supply and sewage disposal, telephone, public
housing, mass transit and construction and maintenace of
ports, highways and public buildings.
Some were established
or purchased from private own'e rs to enable lower cost
financing of construction and . a more rapid expansion of
operations via the sale of municipal bonds
~han
could have
been financed either fro.m the general budget of the government or through private corporate borrowing.
the University of Puerto Rico and the
Others, like
In~titute
of Culture,
were constituted as public corporations mainly for administrative convenience, combining a degree of general public
control and financial support with internal operating
autonomy and independence from the rigidities of central
government personnel, budgetary and procedural regulations.
All were expected to operate with the efficiency of private
e~terprise
but for public purposes.
At first, nearly
all of them did.
Three of the original nine corporations, the
Development Company, the Land Authority and the Agricultural Company, were established to own and operate factories,
farms and supermarkets and sell their output at competitive
market prices, functions traditionally regarded as . belonging in the private sector.
The Government Development
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Bank also had a private sector lending function
as well
as its primary responsibility for acting as fiscal agent
for the Insular and municipal governments and for the
public corporations.
The traditional boundries between the public
and private sectors that prevailed prior to the depression
and World War II were no longer sacrosanct.
However,
administration of some agencies of government, especially
in the field of agriculture, became increasingly difficult
for lack of clear definition of purpose and functions.
As seen by Munoz, the basic responsibility of the Land
Authority was land . reform, which had been a principal
campaign pledge in his election campaign, while Tugwell
was more concerned with agricultural development, production of food crops for lpcal consumption and fostering
cooperative enterprises.
The Land Authority was the first of the original
nine public corporations to be established and it had the
highest capital appropriations.
The Agricultural Company
was intended to be a development company.
It was funded
in 1946 at the end of Tugwell's administration as the
last of the original nine public corpoiations.
Its liquida-
tion was recommended only four years later by the Planning
Board in its first Economic Report because ''In the case of
the Agricultural Company, the desire for financial success
has tended to rest;ict expenditure on purely developmental
activities, while the developmental character of certain
of its activities has forstalled any chance of commercial
success."
The Planning Board recommended in its first
three Economic Reports that the Land Authority be given
a separately funded developmental subsidiary but the
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-7necessary legislation was vetoed or dropped.
Puerto Rico
has never had an effective agricultural· development
organization.
Government expenditures "on agriculture"
have averaged about four times those on manufacturing
development but, for the most part, they have been for
rural social programs rather than for agricultural
development.
By 1950 the Land Authority had purchased nearly
half the sugar land owned by private corporations in excess
of the unenforced Federal "500 Acre Limitation Act".
About 64,000 acres were put into 48 large "proportional
benefit" farms which operated on a profit sharing system.
About two-thirds of these farms were profitable in 1950
and their workers received a share of the profit in addition to the going wage of about $1.25 a day.
In its early
sugar operations the Authority was accomplishing a kind of
land reform but it made little contribution to agricultural
development and its original base in sugar production has
now been almost completely eroded.
There were 87,000 field workers employed in sugar
cane production and 11,000 in the mills
in 1950.
There
were also about 51,000 workers, mostly rural women engaged
in home needlework.
Today, only 4,000 workers ·have jobs
in the sugar industry and home needlework has completely
disappeared.
A subsidiary of the Land Authority, the
Sugar Corporation
~stablished
in 1973 now owns and operates
what little remains of the sugar industry into which it
has poured well over half a billion dollars of public funds
in a vain salvage effort.
Except in 1974, the Corporation's
cost of producing sugar has been about double the market
value of the sugar produced.
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A more lasting aspect of land reform was
accomplished by the transfer of tracts of Authority land
of limited agricultural value to the Social Programs
Administration for the resettlement of landless farm
laborers and their families.
By mid-1950, 23,610 families
had been resettled in 169 rural communities at a cost of
$2.6 million and these numbers were to about double before
the program ended.
Since these landless laborers were
the poorest of the poor, the social justice of this land
reform measure is evident.
Its low cost was made possible
by a highly developed system of self-help housing that is
still being copied, often under USAID auspices, in the
more densely populated underdeveloped countries.
Employment in rural Puerto Rico is now very
small, the total in agriculture being about 37,000.
Rural
population, however, is still in excess of a mi.llion people,
partly as a result of land reform and the many other social
programs intended to improve the quality of life in rural
areas.
Most homes are owner occupied, nearly all have
electricity and public water supply and fewer than one
in five has more than one person per room.
Most
worke~s
commute to work in their own cars but public vehicle routes
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blanket rural areas and factory employment has been spread
to every municipality in the Island.
Rural areas have
become pleasant and accessible low density bedroom communities for the more densely populated town and cities.
Land reform was a political necessity in 1940.
Like the frontier in early U.S. history, it held out the
hope of escape from economic slavery and extreme poverty.
By 1950, however, it was no longer a real issue.
Land
. .. ..
-9ownership was merely an asset--it was no longer a means
of control and oppression over those who had none.
How-
ever, although economic slavery had been largely abolished,
poverty had not.
Government priorities, therefore, shifted
from land reform to job creation and income generation.
A minimum family income of $2,000 a year soon
became the accepted development objective.
In its first
Economic Report in 1950 the Planning Board recommended an
impeccable priority system for a government economic
development budget with direct investment in industrial
and agricultural development heading the list of Priority
Group I and rural resettlement and public housing well
down in Priority Group III.
The problem was that, even before 1950, land
reform programs and a land reform stance had been built
into all government agricultural programs and agencies.
Both the programs and the agencies themselves became
invested . with a moral rectitude that prevented penetration
of developmental ideas and even of matured projects into
the agricultural scene.
To defend the status quo in
agriculture became synonymous with defending Puerto Rico .
Puerto Rican intellectuals and artists, many of them
advocates of independence, returned the favor.
They have
tended to delineate Puerto Rico as rural long after this
was the fact and to portray the (usually elderly) rural
Puerto Rican as tha embodiment of "national" virtue.
With some recent exceptions like the Israeli
projects on the South Coast, outside investors in agriculture have seldom _ received effective support from the
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-10agricultural bureaucracy and efforts by other government agencies to promote and develop agricultural
projects and agro-industries have been declared ultra
vires.
Many critics of Puerto Rico's economic develop-
ment policy complain that government abandoned agriculture.
They are wrong, it was killed with kindness.
The industrial development program resembled
the agricultural program in several ways.
Both programs
were administered by a public corporation, both received
initial public financing in 1942 with most of the rum
windfall coming in 1946 and both invested initially in
production facilities which they themselves would manage
and operate.
But there was one critical difference--
the Land Authority bought farms that were already in
production while the Industrial Development Company
financed and built new factories.
The Land Authority changed the pattern of land
ownership and the distribution of . agricultural income
but it made little change in the total investment in
agriculture, in technology or in total production and
income.
The Industrial Development Company, however,
was "developmental".
It inherited, expanded and operated
the PRRA cement plant and it invested in, built and
operated a structural clay products and sanitary ware
plant, a glass bottle plant and a paperboard mill.
By
1947 it also had a· shoe factory and several handicraft
projects in operation plus plans and financing for what
were to become the Textron cotton mill and the Caribe Hilton
Hotel.
These establishments were to be built and owned by
the Company but to be privately managed and operated.
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Getting these operations underway in wartime was
uncommonly difficult.
Priorities had to be obtained for
equipment and materials.
all that was available.
Used equipment was sometimes
Installation and maintenance
problems were magnified by delays in deliveries, lack of
experienced personnel and market uncertainties.
Many
mistakes were made, some were corrected, others could not
be.
Most problems were not attributable to the fact that
the Development Company was itself a government entity.
But some were.
With Munoz as President of the Senate and Tugwell
as governor, government was being professionalized but
the general political orientation of its leaders was
pro labor with populist and socialist leanings.
~trongly
Labor
relations in the new plants had no adequate philosophical
or institutional underpinnings.
Even among the· regular
agencies of government there was as yet no well established
civil service "merit system''.
Strikes at the cement plant
and the glass plant were protracted and costly.
The under-
lying conflict between the longer range development objectives of government and the shorter range objectives of
organized labor had not been resolved and it persists today
in our public utilities.
The ordinary considerations of
collective bargaining do not apply when labor. knows that
there is nothing to prevent a utility company from continually financing wage increases by successive increases
in rates.
Even with problems like these, the Industrial
Development Company (PRIDCO) would probably have continued
its program of direct investment had we not realized that
-12we would soon run out of investment funds.
With most of
the Company's original appropriations invested or committed
with the war induced rum bonanza coming to an end and with
only a small net income from Company operations, expansion
would cease.
were needed.
Some 2,000 jobs had been created but 100,000
The idea of promoting or attracting private
investment in manufacturing and tourism projects was not
new but how to do so effectively and at a reasonable cost
had to be worked out.
Exemption from corporate income
taxes was believed, a priori, to provide the strongest
incentive and at a very low cost.
However, Governor
Tugwell vetoed the tax exemption bill we introduced in
1944.
We were offering rental factory buildings which had
~roved to be mildly successful in Mississippi's BAWI program
but this inducement standing by itself did
strong enough in more distant
no~ · · seem
to be
and unfamiliar Puerto Rico.
We had ·a small office in New York, we had produced a modest
promotional booklet and we had placed some experimental
advertising.
We also had a labor cost advantage as compared with
the federated states.
After a witless application of the
Fair Labor Standards Act of 1938 with its 25 cent an hour
minimum had shut down most of the existing apparel industry,
Puerto Rico obtained an amendment to the Act which enabled
special industry committees to recommend minimum wages in
Puerto Rico below the Federal statutory figure.
As a result
of this special provision of the Act, average hourly earnings of manufacturing production workers were considerably
below the Federal statutory minimum through the 1950's,
t. · "
-13about equal to the Federal minimum in the 1960's but they
rose far above it in the 1970's.
During the SO's and 60's this special provision
in the Fair Labor Standards Act for Puerto Rico (also for
the Virgin Islands and American Samoa) served us well.
Lower
labor costs were usually the only cost advantage
enjoyed by new manufacturing operations established in
Puerto Rico as compared with their competitors in the
States.
Exemption from income tax has zero incentive
value unless a company is making profits that would otherwise be taxable.
The labor cost advantage made tax exemp-
tion meaningful, once a workable tax exemption law was
finally passed in 1947.
Five years after PRIDCO was established we thus
had the basic' legal and institutional
environm~nt
that
would enable and even foster a program . for the promotion
of private investment in manufacturing and tourism industries.
We had an embryonic overseas promotion base in
New York and a local organization that could provide rental
buildings and some "special incentives" (subsidies), a growing understanding of the interests and requirements of
corporate and individual investors plus the key factors:
a labor cost advantage, e x emption from corporate profits
taxes and duty free access to the U.S. common market, then
and now the largest in the world.
At the time, no other developing country had so
favorable an institutional and political environment.
This is one reason why many outsiders have denigrated the
subsequent success of the "Fomento" program and the unprecedented rate of increase in employment and incomes that
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-14was - achieved in the SO's 60's and early 70's.
Up to a
point these critics are justified in regarding the Puerto
Rican development program as
~
special case.
They tend
to forget, however, that "duty free access" is a two-way
street and that nascent industry in Puerto Rico had no
protection from established industry in the mainland with
its many advantages of scale, location and markets.
In
all likelihood Puerto Rico would still be at a stage of
development and a level of living below .that of Cuba or
the Dominican Republic had it not enjoyed these special
advantages in its relations with the United States.
Cer-
tainly our natural resource endowment is very scanty
compared to that of our larger Caribbean neighbors.
We had already learned, however, that the mere
existence of incentives is not enough to attract .investment
in manufacturing and tourism.
The underlying l°egal and
institutional incentives provided by territorial status had
existe~ for many years,
some of them since 1898--yet little
investment had been attracted.
It remained for a purposive
and planned development effort to seize upon them, shape
them, legislate an effective incentive program and then
implement it.
The incentive ingredients of the program
were largely defined by 1947 but its implementation has been
an evolving promotion process.
At the outset, the kinds of investment needed by
Puerto Rico were qliite unfamiliar to U.S. investors and
virtually unknown to investors in Puerto Rico.
U.S. over-
seas investment had been largely confined to mining and
agricultural operations to obtain raw materials needed
by U.S. industry or to establish plants abroad to manufac-
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-15ture U.S. consumer products for sale within host countries having high tariff barriers.
Neither manufacture
abroad to obtain a lower cost ·product for sale at home
nor building a hotel abroad for American tourists was a
familiar practice.
An entirely new set of factors was
involved in making such investment decisions.
Corporate
investors, moreover, are notoriously conservative and our
surveys showed that only a few of them knew enough about
Puerto Rico and our development program to even consider
it as a plant or hotel site.
For most firms that were
persuaded in the early years to establish an operation in
Puerto Rico it was to be their first experience overseas.
Since then such overseas investment in production
facilities has become an established practice in Europe
and Japan as well as in the United States.
Investment
promotion efforts, however, are even more necessary than
before and much more costly.
Dozens of very low wage
countries throughout the world, dozens of countries with
a variety of tourism attractions as well as almost every
state of the United States and province of Canada are now
in competition for investment dollars and the jobs they
will create.
Investment promotion is no longer the sale of a
new idea.
It has become competitive selling of the specific
advantages of each country site.
tive, it became more e x pensive.
As it became more competiMore advertising space and
time and more sophisticated techniques were required to
stand out from the competition and capture the attention of
potential investors.
Mo r eover, other factors increase costs
as a program of investment promotion begins to yield results.
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-16As the economy expands it requires increasing amounts of
investment to maintain any given rate of economic growth,
while a growing population with rising economic and social
expectations creates pressures for an accelerating growth
rate.
Moreover, the development process itself tends to
increase some production costs, notably wage rates, thus
reducing a "natural" competitive advantage and increasing
the need for promotion and its costs.
Our investment promotion program began to produce
results almost immediately.
By the end of the 1953 fiscal
year 213 newly promoted .plants were in operation employing
over 18,000 people.
Tourism also increased rapidly follow-
ing the opening of the Hilton.
Year round occupany averaged
75% in the tourism hotels and embarrassing room shortages
occurred during the January-March peak.
The rum promotion
program with an annual budget of $1 million was yielding
more than $10 million of extra revenue for the Commonwealth
Treasury.
Construction was well advanced on the Port Develop-
ment project in Puerto Nuevo and the new Isla Verde airport.
We had outgrown our basic infrastructure and would outgrow
the new port and airport even before they were completed.
These Fomento programs and projects were creating
jobs and income, expanding the economy as a whole at a more
than 7% annual rate and in spite of tax exemption, providing
millions of dollars of additional Treasury revenue.
Yet
budget reductions wisely made in anticipation of the 1954
recession were unwisely concentrated in the Priority I
Fomento programs which were cut from about 7.5% of the total
budget in 1953 and earlier years to 4.8% for 1954, a trend
which, with some interruptions, still continues.
Today
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-17the Fomento budget is less than 1% of the Commonwealth
total.
The effect .of these early budget reductions on
operations was blunted by a 1950 reorganization of PRIDCO
that had spun off its non revenue producing functions
(promotion, research, technical services, general administration) to form a new regular government agency, the
Economic Development Administration (EDA) to be funded - by
the annual government budget.
PRIDCO remained as a nearly
self-financing subsidiary of EDA, financed by the earnings
from its extensive real estate and more limited lending
operations and, in the process, expanding its assets and
borrowing capacity.
1983.)
(Total assets were $483 million in
Together, the two organizations became known as
Fomento (Fomento Econ6mico and Fomento Industrial).
Operating unity came from the top with the Administrator of ED.A acting as the board of directors of
PRIDCO.
PRIDCO's continued status as a public corporation
enabled all of Fomento to act expeditiously and decisively
in d~aling with its investor clientel and helped Fomento
per~onnel
to avoid some of the more frustrating restric-
tions of a well meaning bureaucracy, especially when
operating overseas.
This attracted the action oriented
achievers needed by a promotional organization and Fomento
soon earned its reputation as an elite organization.
Unfortunately, neither its reputation for performance nor the basic importance of its function gained
Fomento the financial support it needed after investment
promotion became more difficult and much more expensive.
It had taken years to convince strong minded governors
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-18' and loyal
legisl~tors
to enact tax exemption.
Now that
it was working they would say "Why do you need more money-you have tax e x emption . "
This sounds like the conventional wisdom of
bureaucrats but the Fomentd program had other and more
thoughtful critics.
As early as the late 1950's, a number
of responsible people, including the governor, began to
have doubts about the matter of "balance" in our social and
economic progress.
Was the economic outpacing the social?
Certainly industrial development was outpacing agriculture.
Were local entrepreneurs being displaced by outsiders?
Was Puerto Rico's cultural identity being jeopardized by
urbanization and massive migration to the U.S.
mainlan~?
Should government efforts be concentrated on improving some
of the conditions of Conunonwealth status?
Underlying much of this questioning ahd criticism
was undue faith in the Fomento program .
have become automatic.
It appeared to
It was pushing up the economy
every year at a rate that would double incomes every decade.
There was still widespread poverty but it was disappearing
rapidly.
Jobs were waiting in the States for . those who
could not find one at home.
reached $3,000 .
Average family income had
Only some minor adjustment in the flow
of income was needed to meet our $2,000 a year minimum
income goal.
Critics with $10,000 a · year incomes were
already complaining about the "consumerism" of a $3 , 000 a
year middle class.
They could live well enough and even
with "serenity" if only-- Walden like- -they would t ,r im
their wants to what they could now afford.
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-19De facto changes in budget priorities made in
response to opinions such as these were formalized in a
1968 report of a legislative commission for the study of
"The l?urpose of Puerto Rico".
The Commission was inspired
by former Governor Munoz and its report was candid in
advocating a change in the 1950 priorities:
"The rapid and continuous development of
the Puerto Rican economy in recent years
has reached a point at which, with more
than 3,300 million dollars of gross product
a year and with an annual growth of 11 percent, priorities in legislative and governmental effort can be changed so as to attack
more directly the problems that must be
resolved in attaining the kind of civilization
to which the people of Puerto Rico aspire."
The "problems" ,to be attacked more directly were
education, health, housing,
rui~l
development,!ocal entre-
preneurship and, last on the list, poverty.
Even in local
entrepreneurship and the attack on poverty, Fomento was
given no special role.
It was tacitly assumed that its
contribution and the eleven percent growth rate of the
economy would automatically continue.
Events were to prove otherwise.
The year 1968
marked the end of the long period of rapid and sustained
economic growth that had begun about 20 years earlier.
It also marked the election of the first of the recent
administrations
th~t
favored statehood for Puerto Rico.
Statehood would automatically deprive us of
the tax exemption and minimum wage advantages which, along
with duty free access to the U.S. market, had enabled
Fomento to function and generate the income that could
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-20finance "The Purpose of Puerto Rico".
Investors were,
of course, fully aware of this situatioh so that even the
very remote practical possibility of statehood made those
with existing operations hesitant to expand and prompted
many new investment prospects to look elsewhere.
Our minimum wage advantage had already begun to
weaken by 1968.
Until then, flexible minimum wage rates
established in accordance with the ability to pay of the
different industries covered by the Act had held average
hourly earnings of all production workers in Puerto Rico
to a figure fairly close to the overall statutory minimum
prevailing in the States.
However, it allowed six large,
labor intensive industries employing 70,429 production
workers in 1968 to operate with average hourly earnings
of $1.43 compared with the Feder_a l statutory minimum of
$1.60.
By 1976 average hourly earnings in these six lower
wage industries had been pushed up to
$2~36
and the number
of jobs had been cut back to 53,275, a loss of more than
17,000 jobs that had taken years of effort to create.
In the face of this job loss, the Chamber of
Commerce of Puerto Rico petitioned the Congress in 1977
to postpone until 1979 the application to Puerto Rico of
a further increase in the Federal statutory minimum.
The
statehood oriented government of Puerto Rico, however,
disassociated itself from the position of the Chamber and
urged that Puerto Rico be treated like a state to which
the increases in the statutory minimum would automatically
apply. This idealistic position of the Government has
earned wage increases of about $1.00 an hour for the
production workers remaining in these six industries but,
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-21by March 1983, another 12,000 of them had lost their jobs.
On that same date the annual Census of Manufacturing
Industries showed total employment of manufacturing production workers about 2,000 below the figure that had been
attained by October 1968.
Loss of existing jobs is only part of the cost of
excessively rapid wage increases.
Another and larger loss
is the new jobs that do not materialize because profit
expectations in the industry have declined, investors have
lost interest and projects are abandoned by their sponsors
I
on account of the increase in labor costs.
In addition,
there is an indirect job loss in the secondary industries
like trade and services that depend on the primary income
generated by manufacturing.
An examination of the market position of the apparel
industry suggests that the most serious damage inflicted
by excessive wage · increases is curtailment of new investment.
In
1968~
Puerto Rico shipped $370 million of clothing to the
United States, accounting for 30% of the $1,226 million
total of U.S. apparel imports.
By 1974, U.S. apparel imports
had nearly doubled, rising to $2,299 million.
Meanwhile,
however, apparel wages in Puerto Rico had been pushed up
by 87 cents an hour, from 13¢ below the Federal statutory
minimum in 1968 to 4¢ above it in 1976.
New investment in
the industry virtually ceased and shipments
f~om
Puerto Rico
declined slightly to $363 million, amounting to only 16%
of U.S. imports.
We lost nearly half our share of the
U.S. apparel market in less than a decade.
In 1968, 38,168 production workers were employed
in the apparel industry.
Had the industry kept pace with
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-22total U.S. apparel demand and retained its 30% market share,
production worker employment would have almost doubled by
1974, say to about 70,000, and might easily have reached
something like 100,000 by 1983 as U.S. imports of apparel
continued to e x pand.
Actual 1983 production worker employ-
ment in the apparel industry, however, was only 28,062.
Employment loss plus the deficiency in new jobs
in the apparel industry has thus amounted to about 70,000
during the past 15 years.
There were similar employment
losses in other low wage industries that had also previously
benefited
from flexible administration of the Fair Labor
Standards Act.
The sacrifice in jobs may have reached
100,000 in manufacturing with an approximately equal loss
in the dependent sectors of the economy.
Even though we
can never know the exact numbers, it seems likely that
over zealous administration of minimum wage legislation is
responsible for most of the heavy unemployment burden
we carry today.
We are paying a doubly heavy price for our failure
to defend the system of flexible minimum wages since, without this flexible control over labor costs, corporate
income tax exemption became meaningless for many manuf acturing operations, especially in the low wage industries.
Tax exemption is not an incentive unless a firm earns a
profit that would otherwise be taxable.
For most manufac-
turing operations, all important costs except labor costs
and property taxes are higher in Puerto Rico than in the
United States.
It usually takes a_labor cost advantage to
make a firm profitable in Puerto Rico but, once profitable,
it can be doubly so because of exemption from corporate
income taxes.
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Since the early SO's Fomento has been well aware
of the limitations imposed by high costs on our efforts to
attract investment in new enterprises.
Its daily efforts
have been focused on finding and promoting projects that
fit into what cost advantages we have had and its longer
range plans have been designed to open up new areas of
competitive advantage into which our promotional efforts
could be directed.
The success of the Fomento program has been mainly
founded on the imagination, technique and mass of its
investment promotion effort.
Here we pioneered and among
our many disciples only those governments willing to donate
a bigger budget have obtained comparable results.
In the creation of new industrial opportunities
we have been less succeisful and so has everyb?dy else.
One of our earliest efforts dates from . the mid-SO's when
we tried to create a center for industrial research and
'
development in Puerto
Rico that would lead to the establish-
ment of high technology factory operations based on successful research.
It took years of effort, we even bought the
necessary . land, before it became clear that the only
incentive that would enable development of a center that
would be competitive with those already existing around
major universities in the United States and Europe was
personal tax exemption for the scientific personnel involved.
It was the only
si~nif icant
attraction that would be
unique to Puerto Rico and, therefore, effective in a competitive world.
However, just as our first effective
corporate tax exemption legislation was vetoed in 1944,
personal tax exemption legislation for R&D experts was
pocket vetoed thirty years later.
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-24We did have a few successes in opening new
avenues for economic development.
One of these was a
food production complex that could satisfy much of the
growing local market for high protein foods at a lower
cost than direct imports.
The key to lower costs was bulk
imports of grains, promotion of large scale and efficient
milling operations and of efficient processing plants for
meat, milk, poultry and eggs.
No one of these operations
could have been successful without the others.
It was
economic development promotion as distinct from project
promotion.
A substantial number of other developmental projects were undertaken by Fomento, some successful like
concrete reenforcing bars based on local scrap and rice
milling based on more efficient bulk transportation of
unmilled rice.
Some like those based on paper · and paper-
board manufacture from bagasse, the fibre byproduct of
sugarcane, have been failures.
By far the most ambitious
of all these development projects was based on bulk import
of low cost petroleum and a highly developed capital
intensive complex of refineries and petrochemical industries intended to provide low cost materials for a variety
of labor intensive fabricating industries.
·our e x perience in trying to build a strongly
competitive
pet~oleum
based manufacturing sector is
instructive because it illustrates both the advantages
and the difficulties of developing an industry that derives
its competitive capability from something other than lower
wage rates.
The economic and social advantages of higher
wages are obvious.
Wage rates of the production workers
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still employed in the oil refineries and petrochemical
plants today are close to $10 an hour, double the manufacturing average and, of course, immune from the effects of
increases in the statutory Federal minimum wage which is
now only $3.35.
The difficulties of developing such high
wage industries in an island comparatively remote from
almost all sources of industrial raw materials and from
its principal markets may not be so evident.
The principal motivation for constructing the two
small oil refineries established in Puerto Rico in 1947
and 1955 was increasing local demand for fuel oil and
gasoline.
Although the refineries were granted tax exemp-
tion and had considerable support from Fomento, they were
mainly private entrepreneurial initiatives
an existing market situation.
re~ponding
to
These plants consumed low
priced Venezuelan crude, sold fuel oil and gasoline at
prices below those prevailing in the States and were
initially quite profitable to their sponsors and owners.
Fomento saw in this experience a related opportunity
to introduce a low
material
p~iced
economically transportable raw
into the base of the economy on which to build a
downstream complex of basic and intermediate petrochemical
plants.
More important for job creation would be the sub-
sequent promotion and development of fabricating plants
producing finished plastic products, synthetic fibers,
rubber and a variety of paints
~nd
finishes.
Shortly after
the start up of the first small petrochemical operation . of
Union Carbide in 1959, however, this development plan was
interrupted ..:by the imposition of mandatory quotas on imports
of low-priced crude and unfinished oils.
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-26After about five years of government-to-government
negotiations, favorable treatment for Puerto Rican imports
was obtained and foreign crude and naptha could again be
imported at 30 to 45% less than U.S. prices.
Thereafter,
promotion and construction of new plants was very rapid.
By 1973 a private investment of about $1.5 billion had
been made in about 45 petrochemical plants and a few
producing end products.
Then, unexpectedly and unpre-
dictably, OPEC price increases of about 400% intervened
pushing overall 1974 operating costs in Puerto Rican
petrochemical plants about
Gulf Coast which
40% above those in the U.S.
use domestic feedstocks.
The past two decades (1964-74 and 1974-84) of
the Puerto Rican petrochemical experience are .opposite
faces of the same coin--input costs.
Feedstock and energy
inputs are a very high proportion of the total . : ~ost of
petrochemical production, about 80% for a basic ethylene
plant.
(Even in the typical manufacturing operation
materials costs exceed 5~% of total costs in contrast to
about 15% for labor.)
In petrochemicals during the
1964-74 period, savings in input costs more than covered
payroll costs for many operations and high profits stimulated reinvestment and expansion. r ·n the subsequent decade
the cost of inputs escalated, losses were prevalent, operations were shut down and some plants were dismantled and
sold outside Puerto Rico.
A small labor cost advantage ·
was obliterated by a very large disadvantage in materials
cost.
Other plans to develop materials based industries
were frustrated by a change of administration. A joint
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-27venture in steel, combining low cost steel from Venezuela
with rolling mills and fabrication plants in Puerto Rico
that would have unimpeded access to the U.S. market, was
proposed by Fomento and a feasibilit y study jointly
financed by the two governments demonstrated high probabilities of success.
However, the Fomento expert in charge
of the project was released by the new administration which
was unable to obtain a qualified replacement to carry the
project forward.
Plans for a major shipyard met a similar·
political fate as had long standing plans for copper mining,
processing and fabricating.
Development of a new industry takes time, far more
than the promotion of an additional plant in an established
industry that already has a number of successful plants.
This puts a premium on continuity of policy and personnel
in an economic development organization.
Much .· of Fomento's
success is attributable to its initial quarter century of
policy and operating continuity.
But government in Puerto
Rico has failed to develop a strong public service tradition
comparable to that in the United States and most countries
of Europe.
It is
rarely found in developing countries
but the records of Ireland, Israel and Barbados provide
impressive evidence that it can be done and that it is
worth doing.
Continuity is important not only for complex
industry developmeFlt plans but also in the "rules of the
'
game" for what has become a fairly standardized and conventional program of investment promotion.
Investors need
constant reassurance that they are welcome, that their
investment is needed and that they will continue to receive
red carpet treatment.
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Continuity does not mean that rules should be
unchanged but it does mean that whatever changes are made
should be in a positive direction.
In 1·976, we finally
negotiated with the U.S. Treasury and the Congress an
advance in the attractiveness of our tax exemption program
that we had sought since the 1950's.
Enactment of Section
936 of the Internal Revenue Code permitted tax free repatriation of the profits of a subsidiary of a U.S. firm operating
in Puerto Rico without liquidating the subsidiary, as had
previously been required.
A well meaning Congress, however,
insisted that Puerto Rico itself impose a "tollgate'' tax
on the profits being transferred as compensation for the
loss of reinvestment in Puerto Rico that might otherwise
take place .
.This tollgate tax, though quite low, immediately
became controversial.
It was said to be an ex · post facto
tax on the accumulated earnings of firms that had been
promised 100% tax exemption.
In. fact, it was not a tax on
earnings but on their repatriation under Section 936.
A
more realistic objection was that if a firm opted to repatriate before setting up a reserve for the required tollgate
tax, its securities would presumably drop in price because
of the decline in current net income occasioned by current
payment of the tax.
The Commonwealth Treasury had, anq still has, a
strong interest in .the tax because the firms interested in
repatriation had very high earnings and even a low tax on
repatriation promised a substantial tollgate revenue.
As
a matter of record, established firms have been able to
accommodate their accounting to the tollgate tax and it
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has yielded about a billion dollars in Cornmonweath Government revenue over the intervening years.
From the standpoint of industrial promotion, however, the merits of this controversy are unimportant.
What is important from a promotional point of view is that
a 30 year record of continued liberalization of tax exemption
seemed to have ended.
Puerto Rico was made to appear less
interested than it had been in attracting new investment,
even though Section 936 itself actually provided a strong
additional investment incentive.
Existing investors would
be pleased with the opportunity to repatriate profits but
we could no longer offer "100% tax exemption", our strongest
appeal to new investors and most direct route to additional
investment and increased employment and income.
The damage done to the program in 1977 by denouncing
the flexible system of minimum wages and in
1~78
by enacting
a watered down industrial incentives act was more fundamental
and may be impossible to correct.
As we have noted, denuncia-
tion- of the flexible system of minimum wage administration
resulted in a heavy loss of existing jobs in the lower wage
industries.
Less attractive tax incentives have hampered
promotion of new jobs that would have replaced some of those
that were lost.
As a result of these program changes plus
the loss of our petroleum price advantage and worldwide
"stagflation", total factory employment in the last three
fiscal years ('82 -
'84) has averaged 145,400, somewhat
' below the corresponding period a decade earlier ('72 when it had already reached 146,900.
Although total factory employment has declined
somewhat, factory payroll and manufacturing Net Income
'74)
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-30have continued to increase because of a change in the
industrial structure or mix of manufacturing industries.
Employment declines have been concentrated in low wage
industries while higher wage, high profit industries, like
pharmaceuticals and computers, have continued to expand.
This gradual shift to higher wage industries was
the result of the special appeal of tax exemption to high
profit-high wage industries and of an early Fomento effort
to promote industries that would have a larger investment
and stronger roots in Puerto Rico and would pay high enough
wages to be immune from minimum wage increases.
A "Special
Incentives'' program administered by PRIDCO offered subsidies
for investment in "core" industries, high wage industries
and others having special value for the program.
During the
1950's and 60's, additional promotion efforts, including use
of these PRIDCO subsidies, were focused on sue~ selected
"target" industries.
As they began to respond they provided
visible "success stories" that could be literally shown to
other prospective
i~vestors
who were often unaware of . the
diversity of the manufacturing operations that had already
been established in Puerto Rico.
Since many of these "target" industries had high
skill requirements in their manufacturing processes as well
as for R&D, Fomento supported an early expansion in the
Mayaguez College of Engineering which since 1960 has produced
/
three times more graduate engineers than have found employment
in Puerto Rico.
This ample supply of engineers has been an
important factor in the current expansion of the computer
industry for which the supply of electrical and electronic
engineers is a critical locational 'factor.
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-31It is sheer profitability, however, that has
brought most of the high wage industries to Puerto Rico.
Industries with a high R&D
content ~ ~ave
been producing
"miracle" drugs, "quantum leaps forward" in information
processing and communication equipment and many other
revolutionary changes in processes a nd products.
Much of
this has been patentable and successful firms have been able
to sell at prices yielding extraordinarily high profi ts--and
correspondingly high income tax obligations.
Ex emption from
income tax could almost double an already high after tax
profit--and it was available only in Puerto Rico.
Moreover, as profits on industrial investments go,
those realized on investments in Puerto Rico are quick to
materialize.
As soon as a plant could be put . into produc-
tion it would almost double the profit that could be reported
to stockholders.
This has been of increasing .importance for
U.S. corporate money managers and has strongly stimulated
re~~nt
promotion of high investment, high profit industries
which are now almost alone in responding favorably to the
current Fomento program.
High profit industries like :pharmaceuticals, computers and scientific instruments, <an afford to pay high
wages, construct their own manufacturing facilities and,
hopefully, do some of their essential technical research in
Puerto Rico.
They also draw heavily on local business and
professional services as well as generating income and consumer demand for other industries serving the local market.
We are now benefiting from our early efforts to attract such
industries.
The successful record of plants established
by General Electric, Westinghouse, Sylvania, Parke Davis,
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Digital Equipment and many other firms promoted in the
1950's and 60's has led to the establishment of many more
since then.
But without question, our current overall
economic development efforts fall far short of our needs.
The level of income in Puerto Rico .·is less than a third the
U.S. average and below the level of many small independent
countries including Trinidad, Singapore, Israel and Ireland
that learned much from our earlier development experience.
We need not have lost so many jobs in the low wage
industries.
We have not yet negotiated with the U.S. Treasury
or the Congress a durable role for Section 936 in the Federal
component of tax exemption.
Fomento has not had adequate
budget support since the early 1950's.
The shrinkage in its
promotional organization and in available subsidy funds has
accelerated in the last 10 years precisely when world economic
conditions were worsening and competition for manufacturing
and tourism investment funds was becoming more acute.
The
competition of the Far East and other low-wage developing
countries for private investment in industry, tourism and
agriculture has now been joined by the United Stat~s itself,
which not only allows accelerated depreciation on domestic
investment but also for U.S. investments in competing
countries in the Caribbean Basin.
In their efforts to force Puerto Rico to assume
a "state like" posture, statehood advocates have cut our own
tax incentives to q point where existing tax exemption has
comparatively little net attraction for many U . S. industrial
investors.
U.S. investment incentives have become com-
petitive with ours.
Accelerated depreciation is said to
have given the typical U.S. industrial f.irms an effective
...
-33tax rate in the neighborhood of 14% compared with the long
standing 48% rate.
Our current tax "exemption" with however
small a tollgate tax does not provide much tax advantage
except in the few industries having very high rates of
return legally attributable to their,manufacturing operations.
The United States is not going to develop the economy ·
of Puerto Rico.
Transfer payments to poor families and other
Federal measures to relieve poverty will continue to apply
to Puerto · Ricans because we are U.S. citizens.
We can con- _
tinue to benefit from minorities legislation, especially
in sales to the military.
An "Enterprise Zone Act" would
help some regions in the states but would probably add little
or nothing to existing investment incentives in Puerto Rico.
On the contrary, unless carefully drafted it
~ould
increase
the strong stateside competition for private investment
dollars we are already facing.
We do need help from Washington--kinds of help that
could not be extended to any particular state but· have been
and can be provided to us as a Commonwealth.
We need
legislated "permanence" for se:ction 936 and "most favored"
tax treatment for U.S. corporate investments in Puerto Rico.
Section 936 recognizes the fiscal independence of Puerto
Rico.
But merely as a matter of equity, it seems to us that
if our government is willing to exempt the 936 corporations
from tax, it is. not too much to ask the Treasury of the
United States to fpllow suit.
Similarly, it seems to us
only fair and just for the United States to extend at least
as favorable corporate tax treatment to firms investing in
Puerto Rico that it does to those investing elsewhere in
the Caribbean Basin.
-34The rest is up to us--clarif ication and simplification of our own rules of the game, a fresh start in
agriculture, unified administration of key economic development programs and an increase by multiples in the promotional
efforts of a revitalized and reunified Fomento to stimulate
investment from ·all available sources in every creative
aspect of our economy and society.