Benchmarking Puerto Rico with 1970s New York is Misguided

Vicente Feliciano
President
Advantage Business Consulting
The Bond Buyer
November 4, 2014
From Puerto Rico’s standpoint, it is certainly worthwhile to look at New York’s 1970s experience. However, what stand out are the differences between the two—rather than the similarities—both in the efforts when the crisis was ongoing and the external environment for the way out.

The main difference between New York and Puerto Rico is that the fundamentals of New York City’s economy were still excellent, even at its nadir. Thus, their problem was a fiscal issue. The answer to a fiscal issue is simple: reduce spending and increase taxes. A growing economy will take care of the rest.

New York experienced the decline of a once thriving apparel industry. The receding competitiveness of this industry led to a decline in jobs, particularly low-income jobs, and population migration. Parallel to this structural issue were the shenanigans of New York City Hall, approving large budget deficits, granting concessions to labor unions, etc.

However, even at the depth of its throes, New York had plenty of world-class sectors that would bring the city back if the fiscal situation was brought under control. Wall Street was the largest financial complex in the world, the U.S. advertising industry had its epicenter in New York, the city was home to many Fortune 500 headquarters, Broadway had no rivals in U.S. theater, world-class hospitals dotted the landscape, and the city remained a major tourist global destination throughout the crisis.

Contrast with Puerto Rico, whose leading world class sector, life science manufacturing (pharma, bio-tech, medical devices), has suffered from the repeal of IRS Section 936 incentives and the enactment of P.R. Law 154, a tax on inter-company sales. Tourism is competitive, but hardly a world-beater. Other industry segments are presently too small to move the needle.

Geography is another major difference. In the 1970s, some jobs and residents of New York moved to the suburbs and New Jersey. Thus, these jobs and people were still part of the New York economy’s ecosystem. In contrast, population emigration from Puerto Rico—a small island in the Caribbean—has a more fearful effect for the long-term growth of its economy and the sustainability of public debt.

On the way out of its debt crisis, New York received substantial support from the state and federal governments. Despite the initial “drop dead” message from President Ford, the federal government came up with a $2.3 billion loan, representing about 15% of the New York City debt at the time. New York State took over the cost of financing the New York City university system and a portion of welfare and court systems. In contrast, Puerto Rico is unlikely to get such support.

While Puerto Rico exhibited many of the fiscal policy traits of NY City Hall up until 2006, this has not been the case since then. Continually, new taxes have been imposed and public sector employment has contracted. Among the measures taken are: a new 7% sales tax in 2006, the dismissal of thousands of employees in 2009, the major restructuring of pension plans in 2013.

Assets have been transferred to the private sector such as the Luis Muñoz Marín International Airport and Highway PR-22 in public-private partnerships with decades-long concessions. In this sense, Puerto Rico has gone beyond what New York City was ever asked to do, since the city still owns and operates its airports.

And yet, Puerto Rico is in dire straits. The reason is that Puerto Rico’s problem is no longer fiscal. As James Carville would say, “It’s the economy, stupid.”

The real problem with Puerto Rico is not a public sector that is too large, but a private sector that is too small. As of 2014, there were approximately 15 residents for every government sector job in Puerto Rico, close to the 14.5 average for the United States. The problem is that Puerto Rico has 5.4 residents for each private sector job, while the United States has 2.3 residents for each private sector job.

The fiscal adjustments undertaken since 2006 have, as expected, contracted the economy, reduced jobs and promoted emigration. This leads to an erosion of tax collections, which in turn leads to another round of fiscal adjustment.

The way out of this predicament is to generate activity in the sectors that compete in the global economy, what economists call tradable goods. New York had, and has, plenty. Puerto Rico’s performance since 2006 has been underwhelming.

Detroit took harsh adjustments, from wage cuts to public sector workers to reduction in pension benefits. It still filed for bankruptcy. The fundamentals of Detroit’s economy were that of a one-industry town. When the auto industry contracted, the capacity of the city to sustain its debt collapsed.

Puerto Rico’s circumstances are not close to Detroit, but they are very far from those of New York.

External Sector: the driver for Puerto Rico’s economic recovery

Vicente Feliciano
President
Advantage Business Consulting
Caribbean Business
October 30, 2014

H.L. Mencken once said, “For every complex problem there is a solution that is clear, simple and wrong.” In other words, all complex issues appear to have a simple solution that is invariably wrong. Thus, Puerto Rico needs to throw away simple answers such as “we need to execute”; “a 25% tax rate would attract hordes of new taxpayers”; or “we should all get together, hold hands and work for Puerto Rico.”

Right now, Ireland’s manufacturing and export of services are growing strongly on the back of tax incentives that are more competitive than those Puerto Rico is offering and a labor force educated in one of the best school systems in the world.

Ireland is getting net positive migration. The driver for this is neither the Ireland 41% personal income tax rate nor its 23% value-added tax. What is attracting this migration are thousands of jobs.

In Puerto Rico, we need jobs that initially can only come from the external sector, from companies that compete in the global economy. The local economy is depressed while the world around us is not. Thus, the turnaround must come from manufacturing, aeronautics, export of services, tourism and agriculture.

The key to this is labor reform, lower electricity costs and a tax system that increases the burden on consumption while reducing the burden on workers and entrepreneurs.

Our youth is fleeing the protection of local labor laws (and the joblessness for which these laws are partially responsible) to move to Texas and Florida, which have fewer labor laws and many more jobs. A sensible reform was to eliminate double pay on Sundays to retail sector workers, but few jobs can be created by the weak local demand. We need labor reforms that impact the external sector.

A hotel room in Puerto Rico is more expensive than a room in Florida partly because of electricity costs. The Island has a limited participation in the booming production of generic pharmaceuticals partly because of high electricity rates. The new regulatory commission on electricity ought to be a bulwark against rate increases.

The tax reform being drafted by the Treasury Department is based on solid evidence and world “best practices.” The KPMG team of consultants is a solid cadre of officers with international experience. The general outline is an increase in revenue through a broad-based value-added tax, allowing for the reduction in corporate and individual income taxes. This would also help increase tax revenue because it would capture unreported income, such as those from the underground economy. Act 154, which taxes the manufacturing sector, is being analyzed. These changes are the right route.

Since labor reforms, lowering electricity rates and tax reform would need time to have a positive impact, we need infrastructure investment to jumpstart the economy now. This will require the restructuring of public corporations. The Puerto Rico Electric Power Authority is undergoing such restructuring. Right now, the corporation is unable to properly invest in upgrading neither its generation plants nor its grid.

For the long-term sustainability of our economy, an overhaul of the education system needs to be undertaken. According to the results of the reputable Program for International Assessment, of PISA, in reading, math and science—used in 65 countries and territories— Puerto Rico not only lags behind the excellence of Singapore and Ireland, not only is below the modest scores of the U.S., but is also below laggards such as Mexico and Costa Rica.

Thus, we need to propel our external sector through labor reform, electricity-cost reduction and tax reform. The external sector would in turn create the economic activity that will impact positively impact the rest of the economy.

PISA derriba la torre de educación

Vicente Feliciano
Presidente
Advantage Business Consulting
El Nuevo Día
1 de octubre de 2014

Cada vez que se anuncia un resultado fatal de nuestros estudiantes en pruebas de aprovechamiento estandarizado, los apologistas del sistema dicen que la prueba está mal diseñada. PISA es diferente y los resultados de las pruebas tomadas en el 2012 y recién anunciadas fueron fatales.

PISA es la prueba internacional de aprovechamiento más reconocida en el mundo. Es un programa de la OCDE, organización oficial de los gobiernos de las economías avanzadas. Adaptan la prueba para poder comparar países tan diversos como China, Suecia y Emiratos Árabes. En el caso de Puerto Rico, para ser representativos, incluyeron estudiantes tanto de escuela pública como privada.

En todas las pruebas, la Isla se ubicó por debajo de países latinoamericanos como Chile, México y Costa Rica. En la prueba de matemáticas, Puerto Rico se colocó en la posición 58 (Singapur fue 2; Irlanda, 20 y Estados Unidos, 36). En ciencias, Puerto Rico fue 55 (Singapur, 3; Irlanda, 14, y Estados Unidos, 28). En lectura, fuimos 53 (Singapur, 3; Irlanda, 7, y Estados Unidos, 24).

El problema no son las pruebas, el problema es nuestro sistema de educación. Pasa un tiempo desde que mejora la educación hasta que una fuerza laboral más educada impacta la economía de un país. Sin embargo, es inevitable. Tanto Singapur como Irlanda crecen a ritmos acelerados, mientras que Puerto Rico se va quedando atrás. Las pruebas de aprovechamiento no miden asuntos importantes como creatividad o iniciativa. Sin embargo, las pruebas PISA tienen tanto reconocimiento que no son algo que se pueda descartar.

Está clarísimo lo que no podemos hacer al respecto. No podemos operar como hasta ahora. Nuestro sistema de educación ha tenido un gran número de secretarios, pero los resultados son pésimos, por lo que no se trata de la labor de este o aquel secretario. No es remar más fuerte, es que necesitamos otro bote.

Necesitamos un Departamento de Educación que sea cuerpo rector, tanto de la educación pública como privada, y que establezca las normas y métricas a seguir. Necesitamos decentralizar el sistema donde quien responda a los votantes por la escuela pública del barrio no sea el gobernador, sino una junta escolar electa como en Estados Unidos o el alcalde, como ya ocurre con algunas escuelas de la Isla. Tenemos que disciplinar a los maestros que no rinden y a los directores que no ejecutan. Y necesitamos dar oportunidades y exigir responsabilidad de nuestros padres y estudiantes.

Dilemas en Gaza e Israel

Vicente Feliciano
Presidente
Advantage Business Consulting
El Nuevo Día
8 de agosto de 2014

Durante los recientes combates en Gaza, una mujer en avanzado estado de gestación murió. Una cesárea a la madre muerta resultó en el nacimiento de una bebé que murió cinco días después. La situación recuerda a Ernest Hemingway, la muerte de alguien es un poco la muerte de todos, ¿por quién doblan las campanas? Las campanas doblan por ti.

 Los palestinos viven en algo así como una reservación indígena del siglo XIX en los EE.UU. Están marginados y controlados por Israel, la potencia dominante. La dinámica de la ocupación israelí hace inevitable la guerra. La dinámica de la guerra hace inevitable la muerte de civiles inocentes. El jefe apache Gerónimo mató civiles, pero se le trata con respeto en la historia americana porque desafió un régimen injusto.

 La posición oficial de los EE.UU. es que debe haber dos estados, uno judío y uno palestino. Curiosamente es la posición oficial de Israel, aunque sea solo nominalmente y en la práctica no negocien de buena fe para el establecimiento de un estado palestino. La razón es que el statu quo es aceptable para Israel, por lo cual están dispuestos a mantenerlo indefinidamente.

 El statu quo no es aceptable para los palestinos, ni en Cisjordania ni en la Franja de Gaza. El grupo Hamas lidera la resistencia a Israel en la franja de Gaza. Podríamos argumentar correctamente que Hamas es un grupo terrorista con elementos ideológicos cercanos a la Edad Media. Sin embargo, la ocupación de territorio palestino por Israel es una de las causas principales de la existencia de Hamas.

Los israelitas pagarán cualquier precio para proteger la permanencia del estado de Israel. Sin embargo, no van a pagar cualquier precio para mantener el statu quo. Cuando el costo del éste ha sido alto, Israel ha realizado concesiones. Después de la guerra del Yom Kippur se retiró del desierto del Sinaí, después de una guerra de guerrillas se retiró del sur del Líbano, después de la Intifada se retiró de Gaza y de las ciudades de Cisjordania.

 A menos que se llegue a un acuerdo político, la lucha contra la ocupación continuará. Por ejemplo, un grupo extremista se rebeló ante la ocupación de su territorio. Sus ataques resultaron en la muerte de civiles inocentes. La potencia ocupante utilizó su superioridad militar y tecnológica para aplastar el desafío, en el proceso provocando la muerte de civiles. ¿Gaza siglo XXI? No, la revuelta judía de Masada contra el Imperio Romano.

Pensiones alimentarias deficientes

Vicente Feliciano
Presidente
Advantage Business Consulting
El Nuevo Día
16 de julio de 2014

ASUME presentó una revisión al reglamento de pensiones alimentarias que representa una mejoría con respecto al reglamento actual. Lamentablemente sigue teniendo un sesgo anti no-custodio, que en su mayoría son padres.

 
La reserva propuesta de $625 para el no-custodio, en vez de 50% del ingreso, es perjudicial para los menores. Supongamos el caso de un hombre con un ingreso bruto de $4,000, un ingreso antes de pensión de $3,125 y un ingreso post-pensión de $625. ¿Puede este individuo rehacer su vida y ser atractivo como pareja? ¿Es en beneficio de los menores aplastar financieramente a su padre?

 
La regla propuesta refleja una visión del no-custodio como una máquina de ATM, cuya función es generar dinero para los menores. No se está considerando que es en beneficio de los menores recibir un poco menos de dinero, en el ejemplo anterior $1,563 mensuales, pero que el padre pueda, además de sustentar a sus hijos, ser feliz. Además, en el ejemplo anterior, ¿sorprendería que el padre desaparezca y no pague pensión? Cuando el estado impone niveles de pensión alimentaria confiscatorios se promueve que no se paguen.

 
El reglamento únicamente otorga un ajuste en la pensión básica si el no-custodio pasa el 20% del tiempo con el menor. El límite arbitrario de 20% es perjudicial para los menores porque provee al custodio (madre) un incentivo económico para limitar las relaciones paterno-filiales. Además, debido a un error matemático en la fórmula de ajuste del reglamento propuesto, el no-custodio (padre) contribuye mucho más que el custodio (madre).

 
En un sesgo anti no-custodio (padre), el reglamento no considera una necesidad de los menores la vivienda con el no-custodio. Cuando se determinan las relaciones paterno-filiales, se toma en consideración que el no-custodio tenga espacio de vivienda para los menores porque se considera necesidad de los menores. Sin embargo, al momento de calcular pensión suplementaria no se reconoce dicho gasto como una necesidad de los menores.

 
Finalmente, sería positivo un balance de género entre los oficiales del tribunal que atienden asuntos de familia. El 58% de los jueces de primera instancia son mujeres. Debería ser factible asignar jueces de tal forma que en los casos de familia haya un balance de género cercano al 50%.

 
Enfatizo que no se trata de que los oficiales del Tribunal actúen en contra de los más altos principios profesionales y morales. Se trata de que por la naturaleza de la materia a ser juzgada, la Administración de Tribunales debería tener una política explícita de promover el balance de género entre los juzgadores.

Advantage president speaks at “Puerto Rico Turnaround” forum in New York

Vicente Feliciano
President
Advantage Business Consulting
Mergermarket Group and Debtwire Municipals
June 17, 2014

Vicente Feliciano, president of Advantage Business Consulting, was among the panelists invited to speak at a recent forum in New York City on Puerto Rico’s economic turnaround. The event, held by Mergermarket Group and Debtwire Municipals, discussed restructuring Puerto Rico’s debt and the opportunities for the revival of the island’s future economic growth. Mr. Feliciano was among the panelists discussing Puerto Rico’s economic outlook. The activity, attended by an estimated 100 investors, was held at the Harvard Club of New York.

Advantage Business Consulting exporting its expertise offshore

Firm ‘seizing opportunity’ from U.S. Virgin Islands to New Mexico

 

Vicente Feliciano
President
Advantage Business Consulting

 

Published: May 22, 2014 | Volume: 42 | No: 19 | Page 8

 

Most island economists have embraced the government’s push for the export of professional services from Puerto Rico as a key strategy to bring back economic growth to Puerto Rico.

Advantage Business Consulting is going a step further, however; it has begun to follow its own advice and is beginning to export its services off-island.

The Hato Rey, San Juan economic consultancy recently undertook projects in New Mexico and the U.S. Virgin Islands, and Advantage’s president, Vicente Feliciano, said the firm would continue to “seize” offshore opportunities when they arise.

The years-long economic recession in Puerto Rico is one reason government officials are aiming to spur exports of professional services, incentivizing the activity with low tax rates and direct help, such as providing intelligence about offshore markets and low-cost financing.

Feliciano said the firm’s move offshore isn’t the result of Puerto Rico’s epic economic downturn, but acknowledged it was a positive development and will help the firm navigate the economic turbulence.

“Getting work offshore helps balance our strong concentration of work within the island; however, I must be frank in that we have been gaining market share in a declining market, and we have been expanding,” Feliciano said.

Advantage now has the most economists employed of any consultancy in Puerto Rico, and the firm recently expanded its Hato Rey office space to make way for its growth.

“The decision to expand wasn’t something we took lightly, given local market conditions. There came a point when we had grown in personnel but not in space, and that was impinging on productivity,” Feliciano said.

Advantage’s first move offshore was to undertake an analysis for the USVI to determine whether the U.S. territory should establish a health-insurance exchange, or use the funding to prop up its health services for low-income residents.

It then undertook a study on the impact on the state of New Mexico using increased revenue from its $13 billion Land Grant Permanent Fund trust to pay for early-childhood education initiatives. The work was undertaken on behalf of Albuquerque, N.M.-based St. Joseph Community Health, a nonprofit that backed the move.

With the help of Advantage’s work, the USVI, like Puerto Rico, decided not to establish a health-insurance exchange. In New Mexico, the move to use more revenue from the fund was detained in the state Legislature, but Feliciano said proponents will continue to push for the move, and he expects his firm may be able to do more work on it in the future.

The economist said the federal government is aiming to increase early-childhood education, an idea also supported by conservative economists who have called it a smart investment.

“It has bipartisan appeal. This isn’t something for bleeding-heart liberals; it is something for hardheaded businesspeople and citizens looking to promote wealth and economic development,” Feliciano said.

Connections and Networking

Advantage relied on its existing connections in academia and business to plunge into other markets.

The USVI job resulted from an experience in San Juan, in which Advantage was subcontracted by Health Management, one of the top health consultants in the U.S., to help undertake a study on whether Puerto Rico should form a health-insurance exchange or use the money to increase the local Mi Salud program.

Advantage performed the analysis of estimating the number and profile of Puerto Rico’s uninsured population, and the firm was able to move on to the USVI to perform basically the same analysis of their uninsured population.

Feliciano defended the government contracting outside experts. “We should be open to global trade and engaging the best talent,” he said. “At the same time, we should take advantage of these assignments to strengthen local capabilities.”

“I believe in retaining firms from outside Puerto Rico, and I believe in joining them with local operations to promote transfer of knowledge,” he added.

The New Mexico project was first referred to Advantage by Feliciano’s former roommate at Harvard University, but the firm had to submit a proposal—and it was in an area that fit the firm’s expertise—requiring “indepth financial knowledge and an understanding of education as a mechanism for an investment in human capital.”

Miguel Gómez, advocacy & public policy director at St. Joseph Community Health, said that while Advantage was initially referred by a mutual colleague, the nonprofit did its own review and background check, and was impressed by Advantage’s accomplishments and reputation.

“Advantage had the added benefits of being familiar with the areas of early-childhood education and health, as well as a strong knowledge of the oil and gas industry. All these factors were critical to the specific report we needed,” Gómez said.

Initially, Advantage being based in Puerto Rico played no role in the hiring decision, but Gómez said he quickly realized Feliciano and his team were able to understand the New Mexico situation due to shared historical, cultural and economic traits.

He also noted that Advantage’s distance from New Mexico allowed it to undertake its work free of any perceived conflicts of interest that can afflict many in-state economic consultants.

“Advantage was able to forcefully make its case without any fears of retaliation, which may not have been the case with a New Mexico firm or organization that does more contract work here,” Gómez said.

Advantage doesn’t have a specific export program, but will continue to “seize the opportunity when something comes our way,” Feliciano said. If enough work comes from offshore, the firm would consider applying for government incentives, such as a 4% tax rate on profits earned from professional-service export income.

“We have a good sense of the local market and are showing that we are comfortable working outside of Puerto Rico,” he added.

Pobres estadísticas en baloncesto

Vicente Feliciano
Presidente
Advantage Business Consulting
El Nuevo Día
15 de mayo de 2014

 

Como a todo economista, las estadísticas me hablan, me describen la realidad que palabras no pueden expresar. No existe deporte con más estadísticas que el béisbol. Durante los pasados días, y como parte de mi función conyugal, he estado viendo partidos de baloncesto. Mi frustración ante lo parco de las estadísticas en baloncesto no tiene límites.

Tomemos como ejemplo el porcentaje de tiros de campo anotados. El equivalente en béisbol sería el promedio de bateo. En béisbol, se entiende que no es lo mismo un sencillo que un cuadrangular. Por lo tanto existe la estadística de “slugging percentage” que es una especie de promedio de bateo donde un cuadrangular equivale a cuatro sencillos. En baloncesto, el porcentaje de tiros de campo no hace distinción entre canastos de dos puntos y canastos de tres puntos y no hay estadísticas que lo tomen en cuenta.

En béisbol, se entiende que conseguir una base por bolas, aunque no es batear, sigue siendo positivo. Por tal motivo existen estadísticas de “on-base percentage”, cuán frecuente el jugador se embasa independiente de si es por un “hit” o por base por bolas. En baloncesto no existen estadísticas que combinen el porcentaje de tiros de campo con ir al tiro libre porque el jugador recibió falta personal.

En el baloncesto, existen estadísticas de puntos por juego, rebotes por juego, asistencias por juego, pérdidas de balón por juego. Aunque importantes, estas estadísticas no hacen distinción de si el jugador estuvo jugando seis minutos o 36 minutos. En el béisbol, los lanzadores son medidos a base de carreras limpias por cada nueve entradas lanzadas (“ERA”). La cantidad de errores que comete un jugador se aquilata como porcentaje del total de gestiones defensivas (“fielding percentage”).

La naturaleza del baloncesto, un juego más fluido que el béisbol, hace más difícil el uso de estadísticas. Además, es cierto que el béisbol puede llegar a lo absurdo. ¿Cuál es el promedio de bateo cuando el conteo es tres bolas un strike, el lanzador es zurdo, y la temperatura en el parque es menos de 60 grados? De todas formas, estoy seguro de que en los próximos años el baloncesto va a mejorar sus estadísticas.

Por el momento voy a tener que seguir viendo los partidos de baloncesto sin el beneficio de buenas estadísticas. Mientras, mi esposa seguirá dando saltos de canguro en la sala de casa cada vez que gana su equipo, ajena a que le hacen falta estadísticas.

Encabulla y Vuelve y Tira

Vicente Feliciano
Presidente
Advantage Business Consulting
El Nuevo Día
24 de abril de 2014

La decisión del Tribunal Supremo sobre el sistema de retiro de maestros fuerza a replantearse cómo garantizar a los maestros un retiro justo. No está en controversia que el sistema está en quiebra porque los maestros reciben muchísimo más de lo que aportan y que en pocos años estará sin los recursos para pagar las pensiones.

 Las propuestas principales del magisterio son que no se toque su monto de retiro ni la aportación que realizan. Para cubrir el déficit en el sistema proponen impuestos a servicios turísticos e impuestos a operaciones de manufactura. En otras palabras, el magisterio desea poner en peligro los empleos de otros con el objetivo de no tener que pagar por sus propias pensiones.

 El turismo en Puerto Rico tiene retos relacionados con competitividad. La mayoría de los hoteles construidos recientemente ha sido particularmente exitoso. A tales efectos, el Banco Gubernamental tuvo que reconocer pérdidas millonarias en sus préstamos hoteleros. Entre el 2013 y 2014 se han dado inversiones importantes como la compra del Condado Vanderbilt, la Concha Resort y el St. Regis Bahía Beach por parte de Paulson & Co. Sin embargo, estas compras se dieron a precios por debajo del costo de construcción de estas propiedades. Tanto los inversionistas originales como los que prestaron a los proyectos perdieron dinero. Si bien es excelente que se hayan dado las transacciones, no es menos cierto que las mismas denotan debilidad en la industria.

 Por lo tanto, impuestos relacionados con el turismo vendrían a expensas de actividad económica y empleo. Algo peor sucede con la propuestas sobre empresas de manufactura.

La propuesta del magisterio es canalizar impuestos de la Ley 154, contribuciones que pagan principalmente las empresas multinacionales de manufactura, hacia su sistema de retiro. Sin embargo, el Fondo General que financia al gobierno de la Isla no tiene la capacidad para prescindir de esos recursos. Sería desvestir un santo para vestir otro.

 La decisión del Tribunal Supremo, inconsistente con su decisión anterior del sistema de pensiones de empleados públicos, trastoca el esfuerzo de solventar el sistema de pensiones de maestros. La decisión, consistente con la decisión anterior del sistema de pensiones de jueces, permite que una generación reciba beneficios de pensión sin pagar por ellos, resultando en una carga para los grupos más jóvenes.

 Al final del día, lo moralmente correcto, es que sean los propios maestros (y jueces) los que paguen por su sistema de retiro.

Ireland, Puerto Rico and the Credit Rating Agencies

Vicente Feliciano
President
Advantage Business Consulting
El Nuevo Día (Translation)
March 21, 2014

The similarities between Ireland and Puerto Rico are so numerous that Ireland’s case is of interest for our Island.

The global recession of 2008 in Ireland was combined with a slump in property prices. The government had guaranteed not only deposits in banking, but also bonds issued by financial institutions. The collapse of the housing market brought down the financial sector and the public sector with them. Residents lost their accumulated wealth in property and the stock market, besides a reduction in income as a result of tax increases, budget cuts and the collapse of the construction industry.

Ireland was declared speculative credit by Moody’s in July 2011 and returned to investment grade in January 2014. Other credit-rating agencies always kept Ireland in the investment grade category.

Similarities

The Republic of Ireland and the Commonwealth of Puerto Rico have similar political control over economic tools. Both have fiscal autonomy, provided they follow certain rules of either the European Union or U.S. Both determine the expenses in which the taxes collected in its jurisdiction will be used. Neither controls the value of its currency nor can Ireland or Puerto Rico devalue either the euro or the dollar. Neither sets monetary policy nor the interest rates of its currency. Both maintain free trade with the larger entity to which they belong and it is the larger entity that negotiates trade agreements.

Both based their development on attracting foreign capital through preferential tax treatments. Geographically, they are islands at the outskirt of the larger jurisdiction to which they belong. The population size is similar (4.6 million in Ireland v. 3.6 million in Puerto Rico). In both, there is a marked difference between the Gross Domestic Product (larger) and Gross National Product (smaller) because the profits of foreign companies established in the jurisdiction are part of GDP but not GNP. To add to the similarities, both have had “issues” with their statistics, including their employment statistics.

Fiscal and Debt Crisis

The fiscal crisis and debt through which Ireland went through was much deeper than that of Puerto Rico. As of today, the Irish fiscal indicators remain worse than those of our Island.

Ireland’s fiscal deficit in 2010 was €48 billion, of which €31 billion represented part of a financial sector bailout. In terms of percentage of the economy (GNP), it was 23% for the bank bailout of only that year and 13% for other issues. Total public debt (central government and agencies) at the start of fiscal 2010 amounted to €104 billion, but by year-end was €144 billion, meaning that in just one year, it went from 78% to 109% of GNP. By 2013, the debt amounted to €206 billion, 153% of GNP.

The comparable figures for Puerto Rico would have been a deficit of about $25 billion, consisting of $16 billion for the bank bailout and $9 billion for other issues. The reality is that on our island, the bank bailout cost about $5 billion (8% of GNP) and was covered by the FDIC. We have never been anywhere near a deficit of $9 billion, even adding the shortfalls of public corporations and retirement plans. The Irish government debt by 2013 would represent $107 billion for Puerto Rico instead of the $70 billion that we have.

The crisis was of such magnitude that Ireland was unable to access the capital markets where their bonds came to trade at a yield of 14%. It was necessary to receive funding from the European Union and the International Monetary Fund to avoid default.

The fiscal measures enacted in Ireland to face the crisis included reduction in the number and salaries of public sector employees, reduction in transfers to the unemployed, increase in income taxes, increase in taxes on pensions of retirees and increase in the Value Added Tax which rose from 21% to 23%, among others.

In Ireland, consensus was sought, but action was undertaken while searching for consensus. Initially, the public sector unions opposed to compromise. The government proceeded to implement wage cuts unilaterally, between 5% and 15% in 2009. Faced in 2010 with a program of further reductions in wages and the possibility of layoffs, the unions opted to negotiate concessions. In June 2010, the Croke Park Agreement was signed. The government agreed not to carry out additional layoffs or wage reductions. The unions agreed not to strike in four years and cooperate with management actions to improve staff productivity, including changes in work rules and employee relocation, plus reductions in some fringe benefits.

Something significant is that the measures in Ireland did not include increases in corporate taxes, even with the pressure exerted by other members of the European Union that supported Ireland with bailout funding and that loose investment vis-à-vis Ireland. There is consensus among the main political parties not to alter the economic model and to attract corporate investment with a tax rate of 12.5%.

The explicit vision of the adjustment package was to reduce the consumption of both individuals and the government in order to generate resources to pay debt, aware of the negative impact it would have on the economic sectors serving domestic demand. At the same time, the sector serving the international market was shielded from additional charges, and it was expected to be this sector, inserted in the global economy, which would drive Ireland forward.

In Puerto Rico, the sectors tied to the global economy (manufacturing, aeronautics, tourism) begin to show signs of recovery. Meanwhile, teachers on our Island seek to preclude adjustments in their pensions and offer as an alternative additional taxes to the tourism sector.

It is projected that by 2015, the debt / GNP ratio in Ireland will begin to decline. At present, the Irish bonds are traded at a yield of 3.5%. The fiscal deficit target is of 3.7% of GNP, which would be equivalent to a deficit of $2.6 billion in Puerto Rico. Government bonds of Puerto Rico carry a near 9% interest and we are aiming at zero fiscal deficit at the central government level.

Economy

The economic situation in Ireland when the crisis occurred was much better than in Puerto Rico. They experienced a deep recession, falling 12% in the four years from 2008 to 2011. Already in 2012, Ireland showed 1.8% growth in GNP, accelerating to 2.7% in 2013. This growth, higher than the average in Europe, is what is expected to reduce the debt / GNP ratio in 2015 despite the projected fiscal deficit.

During the period 1994 to 2007, the growth in Ireland’s economy averaged 6.4%, similar to the rates observed in Puerto Rico during the most successful period of Operation Bootstrap over half a century ago. The unemployment rate in Ireland in 2006 was 4.6%.

The EU forced Ireland to alter its tax incentives’ scheme for manufacturing companies and export services because it discriminated in favor of certain companies. Ireland’s response was to remove the incentives while lowering corporate taxes for all companies. Thus, without discriminating, they offer corporate tax rates that are the lowest in Europe and are highly competitive internationally. At present, the tax rate is 12.5%. To compensate, while maintaining a strong structure of social services, other taxes are high. As an example, the Value Added Tax is at 23%.

Electricity in Ireland used to have ESB, a government-owned company as the dominant entity. In the mid-2000s, there was a reform enacted of the electricity system that united the Northern Ireland system with the Republic of Ireland. All generators, including ESB, sell electricity to a single, mandatory “pool.” The government body EirGrid, originally part of ESB, manages the transmission and distribution in the Republic of Ireland. The prices at which EirGrid purchases and transmits energy are regulated by the Commission for Energy Regulation. In 2012, ESB had 48% of generation capacity, it supplied 36% of all customers throughout the island, made a profit of €415 million and total debt amounted to €4.414 million.

Meanwhile, the Puerto Rico Electric and Power Authority is a monopoly that in 2013 had losses of about $300 million and at present, has a debt burden of approximately $8.6 billion.

Education in Ireland is one of the best in the world, generating a well-prepared workforce. The most recognized international assessment is the Program for International Student Assessment (PISA). The results of Ireland in 2012 were significantly better than those in the U.S. Among the countries that took the test, Ireland was 20 in mathematics (U.S. 36), 14 in science (U.S. 28), and 7 in reading (U.S. 24). Although Puerto Rico does not participate in PISA, the results of the federal No Child Left Behind program suggest that the results of students in Puerto Rico would be lower than the U.S. results.

While tax incentives are important, PayPal was established in Ireland when it was not yet generating profits. It was later acquired by eBay, which now has an operation of 2,000 employees in Ireland. From Ireland, the company handles operations in Europe, Africa and the Middle East. In addition to a large export sector of information technology, Ireland has a large export sector of financial services.

Like Puerto Rico, Ireland is defending its “cluster” of manufacturing, particularly pharmaceuticals. Contrary to what happened on our island, they managed to develop a strong group of local businesses. An example is Warner-Chilcott with 2,700 employees in Ireland and manufacturing facilities in Puerto Rico. In October 2013, it was purchased by Actavis, one of the global leaders in manufacturing of generics, in a transaction of $8.6 billion.

The labor-force participation rate in Ireland is about 60% compared with 40% on our Island. Thus, the generation of employment and the economic situation has an impact on the majority of the population of Ireland. In Puerto Rico, groups living with federal transfers, pensions or other transfers exceed those constituencies that depend on salaries. The political calculation to choose between raising the consumption tax and the corporation tax is different.

The population has been growing in Ireland. While in 2002 the population was 3.9 million, similar to Puerto Rico, in 2011 it numbered 4.6 million. Although during the 1950s it experienced a net emigration of about 40,000 people per year, during the 2006-2011 period there were 25,000 annual net immigrants, many from Eastern Europe.

Conclusion

Ireland had a difficult situation, only surpassed by the experience of the Great Depression of the 1930s. However, the fundamentals of the economy were good. After four years, despite a much higher government debt than Puerto Rico, Ireland began its recovery. In addition to handling urgent financial issues, Puerto Rico needs to address the structural issues of the economy in order to move forward.