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How Puerto Rico stepped back from an economic abyss

The transformation of Puerto Rico’s dysfunctional economy has begun to attract attention.

Joe Raedle/Getty Images/Joe Raedle/Getty Images

An American territory in the Caribbean, Puerto Rico – "island of enchantment" – hit the wall in 2006, well before the mainland United States did.

By some standards, the island economy (population: four million) was exemplary. With median household income of $18,300 (U.S.), one of the highest in North America, Puerto Rico was economically comparable with Poland or Latvia. But it was running a spiralling deficit (revenue: $6.6-billion a year; expenditures: $9.9-billion) that it could not sustain.

When the credit-rating agencies cut Puerto Rican bonds to junk, its government was compelled, for the first time in its history, to shut down. It sent 100,000 public-sector workers home, closed all of its 1,500 schools and shuttered 242 government agencies and departments.

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As markets crashed around the world in 2007-2008, Puerto Rico imposed a 7-per-cent sales tax, prolonging and intensifying its economic anguish.

On Jan. 2, 2009, 18 days before the inauguration of U.S. President Barack Obama, the fortuitously named Luis Fortuno assumed office in Puerto Rico, the first Republican governor in 50 years.

"We were closer to the abyss than most states," Mr. Fortuno recalled in a recent interview with Deroy Murdock, a columnist with Scripps Howard News Service and a contributing editor with National Review online.

"When I came into office, we were facing not just the worst recession since the Thirties, but the worst budget deficit in America, proportionally. We were literally broke. We did not have enough money to meet our first payroll," Mr. Fortuno, 51, recalled. "We had to take out a loan to meet it." (At that point, he added, "my wife asked me if we could ask for a recount.")

What to do? Facing a $3.3-billion deficit, Mr. Fortuno did something almost unprecedented in contemporary public finance: "We cut expenses." He took a 10-per-cent pay cut; senior bureaucrats got a 5-per-cent reduction. He cut 20,000 public sector jobs permanently and more temporarily – saving more than $900-million. In his first year in office, he slashed government spending, in absolute dollars, by 20 per cent.

Mr. Fortuno also cut taxes. He lowered the corporate tax rate to 30 per cent from 41 per cent (with further cuts coming in each of the next two years). Personal income tax rates dropped by 25 per cent (with further cuts coming in each of the next five years).

He gave homeowners a five-year property tax holiday, and scrapped capital gains and death taxes. These reforms put a floor under property values. In 2011, existing home sales increased by 35 per cent (compared with an average decline of 7.9 per cent in the continental states); new-home sales increased by 92 per cent (compared with an average decline of 9.9 per cent in the continental states).

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To do anything in the old economy, Mr. Fortuno said, "You needed to obtain 28 permits … and go to 20-plus different agencies to do that." Today, you need go to only one agency for a permit, "or you can go to and get it online."

In another fundamental reform, he transferred public sector workers from "old-fashioned, statist defined-benefit pensions" to "market-friendly, defined-contribution pensions."

The transformation of Puerto Rico's dysfunctional economy has begun to attract attention. Retailers such as Nordstom, PetSmart, Saks Fifth Avenue and Victoria's Secret have announced store openings in San Juan in 2012. Honeywell International and Merck & Co. have announced expansion of their manufacturing operations on the island.

Standard & Poor's has upgraded Puerto Rico's credit rating to "positive" from "stable" – its first upgrade in 28 years. Moody's took Puerto Rico bonds back to triple-A, the highest rating in 35 years. "We are moving in the right direction," Mr. Fortuno said. "So we can keep lowering taxes."

In three years, Puerto Rico's budget deficit has been reduced to $600-million from $3.3-billion. In 2009, its deficit equalled 44 per cent of its revenue; in 2011, it stands at 7 per cent. In 2009, as a ratio of deficit to revenue, Puerto Rico ranked 51st among American states, at the bottom of the pack. In 2011, it ranked 15th.

Thus, the 2011 Austerity Player of the Year Award goes – drum roll, please – to Puerto Rico and to Gov. Luis Fortuno, its enlightened leader.

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About the Author
Neil Reynolds

Neil Reynolds is an Ottawa writer whose columns on national economic issues appear in Wednesday's and Friday's Globe and Mail. He is the former editor-in-chief of The Vancouver Sun and the Ottawa Citizen. More

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