J. Tomas Hexner Glenn Jenkins J. Tomas Hexner

E. Recent Changes and Ideas

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E. Recent Changes and Ideas

As in the past, much of what is now happening in the Puerto Rican economy has its roots in events on the U.S. mainland. The push for a balanced budget in the 1990ís made the $3.8 billion tax credit under section 936 a logical target in the U.S. Congress.26 In spite of substantial efforts to persuade lawmakers that reducing or repealing section 936 subsidies would destroy the Puerto Rican economy, Congress took the first steps in 1993 to limit the amount of tax credit that U.S. corporations could claim under section 936. Then, in the 1996 Small Business Job Protection Act, Congress fully eliminated 936 benefits for new claimants and phased out benefits for existing recipients over the next 10 years.27

Puerto Rico's economy has not been devastated by the section 936 repeal and phase-out. Key economic indicators point to the resiliency of the Puerto Rican economy. Total employment increased 3.9 percent from FY 1995 to FY 1996, and total employment during the first seven months of FY 1997 increased 3.7 percent over the same period of FY 1996. Real gross product increased by 3.4 percent from 1994 to 1995, by 3.1 percent from 1995 to 1996, and by a projected 2.8 percent from 1996 to 1997. The fact is that section 936 is in the process of phase-out and, although the grand-fathering period is not yet complete, Puerto Rico remains economically intact. Section 936 has been repealed, and CBOís projections of its impact now appear to be exaggerated in light of Puerto Ricoís economic performance.
The current tone of economic discourse on the island is a start down a promising path, which is confirmed in more frequent calls for the Puerto Rican government to change its role from a provider of services and regulator of industry to a facilitator of private sector development.28 Although this rhetoric is commendable, the past lack of action surrounding new ideas is notable. Several initiatives have actually gone beyond the level of rhetoric and been put into practice, because of efforts both on the mainland and in Puerto Rico. These efforts include:

  1. the U.S. Congressí action on section 936 of the Internal Revenue Code, repealing the credit for new investments and phasing it out over 10 years for existing investments,

  1. the Governor of Puerto Ricoís measures to improve the tax structure, reform the public sector, and encourage investment in tourism, and

  1. the Governor of Puerto Ricoís initiation of privatization in management and ownership of some public corporations.

Appendix II details actions taken recently by the Puerto Rican government. These initiatives represent a potentially sound beginning, which is nevertheless overshadowed by the uncertainty of Puerto Ricoís full integration into the United States economy.

IV. Puerto Rico and Modern Economic Growth Analysis

A. A New Perspective

The convergence theory of economic growth predicts that the rate at which an economy grows during its transition to the steady state is proportional to its distance from that steady state - the further the distance, the faster the growth, and vice versa. Considering that the US is the largest and wealthiest economy in the world, it is not surprising that during the post war period Puerto Rico linked itself with the US and outperformed other economies with lower steady state levels of per capita income.

The principal conclusion of this research is that the economy of Puerto Rico is no longer converging to the steady state level of per capita income of the United States. A recent paper by Fernando Lefort uses econometric analysis to demonstrate that Puerto Ricoís economy has been diverging away from the U.S. and shows no signs of catching up.29 Three other significant results from the research are:

  1. The integrating effect of statehood is actually a vital economic, and not just political, variable. In fact, states grow faster than territories because of their complete economic integration with the U.S. economy. Puerto Ricoís commonwealth status explains why it has failed to converge towards the U.S.

  1. Without statehood, Puerto Rico will never evolve sufficient economic strength to converge with the mainland economy. Because of the lack of economic convergence, statehood is, economically, a sink or swim matter.

  1. Commonwealth has exacted an enormous cost for the Puerto Rican people. In 1994, the average Puerto Rican would have been making $6000 more per year had Puerto Rico been converging to the US economy like the other low-income states. Rather than asking about the costs of statehood, modern growth analysis demonstrates that the opposite question should be asked: what has been the cost of commonwealth.

B. Convergence theory and political status

The ideas forming our assessment of the cost of commonwealth to Puerto Rico are known as convergence growth theory.30 Applied to Puerto Rico, these ideas help formulate an answer to our question about the opportunity costs of commonwealth to Puerto Rico. Historically, U.S. states have experienced growth rates 2% higher than territories.31 This faster growth occurs because the economies of U.S. states are sufficiently integrated that they share similar growth frontiers. That is, U.S. states are converging to a similar endpoint. When a territory becomes a state, its economy becomes much more integrated with the other states than it could have been as a territory. Thus, in addition to the growth a territory is already experiencing on its own, it can expect additional economic expansion on the basis of becoming a state.

As one economy begins to converge toward another wealthier economy, it will initially experience higher growth rates as it ìcatches upî and lessens the gap in per capita income levels between itself and the more developed economy. For this reason, a 3.5 percent higher growth rate is an appropriate estimate of the additional growth that a territory would at first experience as a result of its economic integration with the other U.S. states.32

1. Evidence for Convergence in the United States

There is strong evidence for convergence among the regions of the U.S. States with lower initial incomes have grown faster than wealthier states. Lefort reviews the strong statistical evidence for convergence among the U.S. states over time and cites some examples:33

South Carolina, the poorest state, had 22.4 percent of the per capita income of New York in 1929, [though] by 1990 this ratio had become 71.8 percent. Mississippi was the poorest state in 1940. It had 22 percent of the per capita income of Delaware, then the wealthiest state in America. By 1990, Mississippi, still the poorest state, already had 50 percent of the income of the wealthiest state, now Connecticut. In 50 years, Mississippi has been able to reduce by half the distance that separates it from the wealthiest states. Given the degree of cultural and economic integration among the different states, the convergence effect must be the main reason that Mississippi grew at a rate twice as high, on average, as that of the much wealthier Northeastern states during the last 50 years.

2. Evidence for Convergence in the European Union

There is also growing evidence for convergence among the countries of Europe. Market reform and the political and economic integration effected by the European Union have helped to narrow the gap between more and less developed nations. Analysis of regions within the EU also shows a decline in inequality over time.

A combination of market reforms and integration in the EEC have enabled Spain and Portugal to grow faster than their wealthier European counterparts over the past ten to fifteen years.34 A recent analysis of Portugese economic growth indicates that Portugal has been catching up with the EU since the early 1950ís, with more rapid convergence occurring after 1986 when the country became a full EU member.35 A review of economic growth data by European region by Robert Leonardi of the London School of Economics found evidence for ìfour decades of convergenceî since the 1950ís.36 Leonardi finds a consistent pattern of reduction in inequality between the core and peripheral regions in the EU over time.

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