What do I See in the Future for the Economy of Puerto Rico? I have tried to answer this question in a systematic fashion. Although I have made a version of this article available to my web log readers, I believe it is important enough to go over the issues once more.

Using an econometric model of the macroeconomic system developed for this purpose, I have explored alternative feasible futures. The exercise provides a very long-term view through simulated interventions of the Commonwealth’s government.

The dynamics of the present macroeconomic structure are assumed to remain in place during the period. The results obtained are not heartening. They underscore the difficulties stemming from the rigidities built into the economy throughout the years. Current predicaments reflect the dwindling number of options open to action from the public sector. Excessive use of government expenditures to stimulate aggregate demand together with an unsustainable public payroll, limits intervention possibilities without radical changes in tax and subsidy structures. The economy has become addicted to the expansionary public sector policies. The unintended results include very high transaction costs and a political environment that has become increasingly hostile to private capital. There are particularly worrisome aspects derived from the exploration, because they have political roots.

The nature of the problems being faced by the economy of Puerto Rico is not in the nature of the economic cycle experience periodically by mature capitalistic economies. However, for decades Commonwealth administrations have been applying the remedies prescribed for precisely that sort of condition. The prescription calls for stimulating aggregate demand through government expenditures financed through public borrowing. The structural nature of the limitations faced by Puerto Rico´s economy cannot be remedied by a strategy of permanent anti-cyclical fiscal policy. The result, of that policy has been a bloated public payroll, a dangerous level of public debt, an unjust and heavy tax burden that is being shouldered in disproportionate incidence by the middle class (especially working class families), and an economy that has grown insensitive to increasing doses of the same medicine.

The structural nature of Puerto Rico’s economic problem lies in a basic disequilibrium between aggregate demand and aggregate supply. Aggregate demand has achieved very high levels on aggregated and per capita basis. Aggregate supply, however, is basically satisfied through imports. Local production activities are highly subsidized and, paradoxically, taxed. Ideologically driven political efforts have been successful doing harm to the productive potential of the island. The incentives that supported a thriving and technologically world-class manufacturing sector were attacked from multiple directions and, eventually, sabotaged. Recent initiatives proposed by the executive to overhaul the tax code in order to make less punitive on income, saving, and investment were blocked by the Legislature. Populism continues to fuel public opinion toward policies that do more harm than good. These have resulted in a maze of regulatory requirements that thwart development and competitiveness. From the early stages, development of tourism met cultural obstacles and premature labor unionization.

This economy is not in a position to respond quickly even to a significant and sustained investment effort from the public sector. The supply side of aggregate demand has been weakened by a wounded productive sector. The consumption components, on the other hand, fueled by transfer payments, cash flows generated by growing underground activities, and sheer needs of a population undergoing demographic restructuring, remain strong and growing. The natural unwillingness of the electorate to accept sacrifices has crystallized into a system that has become almost ungovernable.

Political forces exert tremendous pressures to shift resources to satisfy immediate needs and ignore the consequences for the future living standard potential of an aging population. Moreover, political forces impede the reallocation of priorities in the public sector. They resist essential changes in the tax structure to correct the present bias against saving and investing. They resist unavoidable restructuring of the government retirement funds. They resist restructuring of management practices and strategies at the public corporations in charge of building and managing utilities and other infrastructure.

The question then is: what is the most likely scenario in the long run? The answer to this question is not easy, and searching for it is even more difficult. The tools at the disposal of economists and planners draw on the past and tend to be linear in their projection into the future. The social system, however, is not build on linear relations. Trends tend to generate forces that will eventually force changes in intensity and direction.

The long view in the horizon can be characterized with few phrases: stagnation of production, expansion of consumption needs, increasing dependency of growing segments of the population, emigration of a larger fraction of the middle class and of the younger labor force. On the social dimension the view is of turbulence and immobility.

However, as pointed out previously, the conditions seen in the long view horizon are of a nature that has caused radical course corrections in other places. This may very well be what the future will bring, i.e., stagnation in the initial years, a resulting decline in the standard of living, more political turbulence, and then, a radical restructuring. The process would follow a non-linear response to unacceptable conditions. In colloquial words: it may be that things must get worse for them to get better. The danger lies in the fact that non-linearity is not guaranteed to produce a change in the right direction for this economy. In fact, it may be that a situation that is even worse than anticipated may ensue. Such a situation would have no feasible satisfactory exit.

Stagnation is compounded by demographics and current the current structure of family balance sheets. Puerto Rican families have highly leveraged balance sheets. The savings capacity has not been cultivated and the safety net of public sector pension funds has been jeopardized by predatory legislatures and irresponsible past administrations. The long view scenario describes a Puerto Rican society on the verge of increasingly becoming one where poor older residents become an unsustainable proportion of the population. An unthinkable non-linearity could very well manifest itself in a reversion of life expectancies. That phenomenon has occurred in other social systems, e.g., the former Soviet Union. A reduction in life expectancies could trigger all sorts of economic, social and political effects. Non-linearity could manifest itself in a chaotic unraveling of the social infrastructure.

It must be said that the economy of Puerto Rico has potential. This potential is even now evident. It manifests itself especially in the services sector. However, substantial investment is required. Investment in physical infrastructure and management systems is essential in order to increase export potential in quality services. Travel and tourism is a case in point. Other components of the service industries include financial and insurance industries and higher education.

As concluded recently by a commission named by the Governor of which I am a member, in order to become a true competitor in the global economy, Puerto Rico needs cities. Something we still do not have. None of Puerto Rico’s urbanized areas reach the category of a city. Economic globalization is a phenomenon created from and by cities. The creation of a city serving as platform to participate in the world economy would open many opportunities and generate the activities most needed to break the stagnation long run trend.