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The Federal Minimum Wage Is Killing Puerto Rico's Economy

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The Federal Minimum Wage Is Killing Puerto Rico's Economy

July 5, 2015

Governor Alejandro García Padilla of Puerto Rico announced last week that the U.S. territory would not be able to pay off the $72 billion it owes in debt, stoking fears that the island could become America’s Greece. While there are a myriad of reasons for Puerto Rico’s situation, part of the blame lies with the U.S. government, which subjects Puerto Rico to the federal minimum wage of $7.25 an hour despite the fundamentally different nature of the island’s economy.

High minimum wages reduce employment by increasing the cost of hiring for businesses. One way to estimate how well an economy can absorb a minimum wage is by looking at the ratio of the minimum wage to the median wage—the exact middle of the wage distribution in the economy. As this ratio rises, more people are in danger of unemployment because their skills are not valuable enough to employers to justify paying them the minimum wage.

The minimum-median ratio in most states is between 35 and 50 percent, as the following chart shows. In Puerto Rico, however, the ratio is 77 percent. That is 24 percentage points higher than Florida, the U.S. state with the highest ratio. Federal labor policy is making vast numbers of Puerto Ricans unemployable.

 

A study by Alida Castillo-Freeman (NBER) and Richard Freeman (Harvard) concluded that subjecting Puerto Rico to the federal minimum wage reduced employment in the territory by 8 to 10 percent. More recently, the inability to find jobs has driven Puerto Ricans to emigrate in search of employment. According to the Pew Research Center, Puerto Rico has experienced net emigration of 144,000 people, equivalent to 13 percent of the labor force, since 2010, with 42 percent of emigrants saying their reason for leaving was "job-related."

Data shows that the employment situation in Puerto Rico is dire. The unemployment rate is 12.4 percent, over twice the mainland rate of 5.5 percent. In 2014, the employment-population ratio, a broad metric that accounts for people who have given up looking for work, was 35 percent on the island, compared to 59 percent for the mainland United States. It is so difficult to find a job in Puerto Rico that many people are not even looking.

So what does this have to do with Puerto Rico’s debt crisis? Fewer jobs means fewer people paying taxes, and more reliance on welfare and public services. The minimum wage is not responsible for all of this—blame also lies with the island’s high energy prices and bloated public sector, which deter investment. But it does not help that the U.S. government neglects the interests of its Caribbean territory when setting federal labor policy. For instance, President Obama’s proposal to raise the federal minimum wage to $10.10 an hour would overtake the island’s median hourly wage of $9.42, putting over half of hourly-paid Puerto Rican jobs at risk.

Congress should recognize that Puerto Rico’s economy is fundamentally different from that of the rest of the United States and act to exempt the island from federal minimum wage laws. That will not solve all of the island’s problems, but it would give many Puerto Ricans the opportunity to find a job. Then the island can take advantage of its untapped labor power, emerge from bankruptcy, and get up to speed with the rest of the country.

 

Preston Cooper is a Policy Analyst at Economics21. You can follow him on Twitter here.

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