Is Statehood the Solution to Puerto Rico’s Default?

August 4, 2015

This weekend, Puerto Rican governor Alejandro García Padilla announced that the U.S. commonwealth would no longer be able to service its debt, despite numerous rounds of austerity measures.

Debt and default have been on the mind all around the world in recent months – from nearly constant speculation over Venezuela’s financial troubles to Greece’s negotiations with the European Union to restructure its sizeable debt burden earlier this summer.

But Puerto Rico’s debt crisis is only making the news now – even though it’s been mounting for years.

So, first of all, what is Puerto Rico’s financial situation, and how has it gotten there?

For decades, Puerto Rico benefited from federal U.S. laws that provided financial incentives to manufacturers that developed production in Puerto Rico instead of outside the United States. But in 1996, Congress decided to phase out those incentives – a process that ended in 2006, launching full-blown recession in Puerto Rico.

The island has yet to recover.

Puerto Rico owes about US$72 billion in debt – but it’s not all held by the government. Some is held by the territory’s government, the rest by the island’s public corporations. Meanwhile, Puerto Rico’s economy is in a recession that began in 2006 and escalated with the 2008 global financial crisis, unemployment tops 14 percent, and nearly half of Puerto Ricans live in poverty. Hundreds of thousands of Puerto Ricans left the island for the continental United States, enabled by an easy migration process and encouraged by the relative lack of opportunity at home.

Even as the economy struggled, U.S. investors kept snapping up Puerto Rican bonds – largely because, unlike U.S. cities and public corporations based in the 50 states, Puerto Rico and its public entities are legally prohibited to default on their debt, essentially guaranteeing creditors their money regardless of the state of the island’s economy. (Plus, federal law makes Puerto Rican bonds triple-tax-exempt regardless of who’s buying them, so investors could purchase them at a sharp discount.)

This also means that the majority of Puerto Rican bondholders are U.S. entities, mostly hedge funds and other investors. So the debt is both held and credited by Americans.

Without the ability to declare bankruptcy, Puerto Rico’s government has implemented rounds of strict austerity measures, slashing its budget and hiking up taxes to save money for debt repayments. The island’s constitution requires that the government pay its debts before meeting any other financial obligations, so unless the constitution is amended, services, benefits, and all public spending will soon grind to a halt.

But this has another effect: the economy can’t grow with the government constantly cutting back, so still more Puerto Ricans leave the island, catching it in what the governor has called an economic death spiral.

Puerto Rico’s situation is more than sticky: it’s uniquely difficult. And that’s because it’s ambiguous legal status under U.S. law as a commonwealth has left the island with little in the way of options or autonomy.

The solution is tricky. Amending Puerto Rico’s constitution to allow the government to keep paying its non-debt obligations is an important step. And Puerto Rico is unlikely to avoid working directly with the U.S. Congress, whether by encouraging lawmakers to permit Puerto Rican default or by being put under the charge of a supervisory budget commission—an option that reeks of paternalism.

Ultimately, one thing is certain amidst all of Puerto Rico’s economic chaos: it may be time to reconsider Puerto Rico’s status, and, if Puerto Ricans prefer so, make the island the fifty-first U.S. state. Access to the same legal and financial protections states (and their cities and entities) enjoy would have allowed Puerto Rico to avert this crisis to begin with – and would certainly help it weather the current storm.

Support on the island is still mixed, with nearly the same number supporting statehood as supporting the continuation of commonwealth status.

The 2016 presidential contest adds context. From 2010 to 2013 alone, nearly 50,000 Puerto Ricans migrated to the mainland. Most of them end up in Florida, changing the dynamics for electoral politics and increasing the chance that Puerto Rico’s status will become an electoral issue. And that’s all the more likely in light of the spiraling chaos.

But if this crisis shows anything, it’s that the current approach is not working.



Carl Meacham is director of the Americas Program at the Center for Strategic and International Studies in Washington, D.C.



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