After years of irresponsible borrowing to keep a floundering economy afloat, Puerto Rico finally called it quits on June 28, admitting that it will not be able to pay back all of its $72 billion in public debt.
The territory’s economy has been shrinking for nearly a decade. According to the World Bank, Puerto Rico’s GDP on average contracted by 1.7 percent annually since 2005. The island’s debt woes are linked to its lackluster economic growth and repeal of Section 936 of the Internal Revenue Code that encouraged pharmaceutical and chemical companies to locate on the island. Since repeal of the tax provision, Puerto Rico has simply been unable to raise enough revenue to balance its budget while maintaining the social programs its citizens have come to expect.
Because of its low growth, Puerto Rico will not be saved from its debt crisis with austerity and debt restructuring alone. Anne Krueger, co-author of the recent Puerto Rican debt report, recently suggested in a conference in Washington, D.C. that fiscal reforms and accommodations to allow for municipal bankruptcy, while necessary, must be paired with significant structural changes to the territory’s economy. If structural reforms are not made, Krueger believes that Puerto Rico will continue to struggle with debt and quickly fall back into crisis every few years just as Greece is doing now.
Other economists have also called for structural reforms. Their suggestions include offering Puerto Rico an exemption to the federal minimum wage, loosening territorial labor laws, and reducing benefits that disincentivize work. One of the most significant suggestions to improve Puerto Rico’s economy is repealing the Jones Act, named after Senator Wesley Jones from Washington, who served from 1909 to 1932.
While the Jones Act is a hindrance to the U.S. economy, it is especially disastrous for large American islands such as Puerto Rico and Hawaii. To achieve its goal of strengthening the U.S. shipbuilding industry, the law mandates that ships must be built, owned, registered, and crewed by American citizens or permanent residents in order to ship goods between U.S. ports. The Jones Act effectively protects the U.S. shipping industry from foreign competition.
Officially named the Merchant Marine Act of 1920, the Jones Act was passed to strengthen the U.S. shipbuilding industry as World War I ended. Congress wanted the domestic shipbuilding industry to be prepared to create a robust Navy as an answer to the threat of U-boats. But times have changed since the 1920s. Our shipbuilding industry is no longer as vital to our national security as it was at the end of WWI.
Since American domestic shipping is a protected industry, costs are much higher than they need to be. For example, the price of shipping crude oil from Gulf Coast refineries to New England is $6 per barrel. Moving crude oil from the same location to Canada, a slightly longer trip, is nearly a third of the cost. Shipping to Canada is so much cheaper because foreign ships are allowed to compete with American ones on this route, while they are banned from doing so between the Gulf and New England.
But the cost to Puerto Rico is even greater than it is to the mainland. The continental states have many less-expensive options for moving goods, such as trains or trucks. However, Puerto Rico relies on ships for nearly all of its trade with the rest of the United States. Every product sold in Puerto Rico, from food to building materials, has a higher price because shipping costs to the territory are so great.
Puerto Rico’s energy costs are also much higher than they need to be. The Jones Act raises the cost of gasoline by 15 cents per gallon and Puerto Rico’s state-run power authority pays 30 percent more than it needs to for liquefied natural gas.
Hawaii is subject to the Jones Act as well, and as a result it has the highest cost of living of any U.S. state. Shipping prices have elevated the cost of living in Hawaii to nearly 12 percent higher than the next most expensive state in the union, Connecticut. Hawaii’s energy prices are the highest in the country, more than 2.5 times higher than the national average.
Transporting goods on Americans ships is costly due to lack of competition. Wages for foreign crews are substantially lower than American crews. American crews cost nearly 4.5 times more than foreign crews. These wages make up nearly 80 percent of the operating cost difference between the two. If foreign shippers were permitted to enter the U.S. market, American companies would be forced to compete, and lower both their wages and prices to more reasonable levels.
Exempting territories from the Jones Act has successfully lowered costs in the past. The U.S. Virgin Islands, a similar territory in the Caribbean, was exempted from the law in 1992. Predictably, the cost of shipping goods to the Virgin Islands from the mainland is now nearly half that of shipping to Puerto Rico.
Economists have known about the benefits of repealing the Jones Act for years, yet Congress has been unwilling to act. In 2010, John McCain (R-AZ) complained, “I don’t think I would get 20 votes if I were to bring [Jones Act repeal] to the floor.” In 2014, when McCain attempted to bring a vote on the Jones Act to the floor of the Senate, his request was shot down. Unsurprisingly Congress’s resistance to repealing the Jones Act is a result of lobbying from unions such as the Marine Engineers Beneficial Association and the Seafarers International Union. A repeal of the law would lower artificially inflated wages for some workers. As a result, these unions have fought tooth and nail to keep what is effectively a wage subsidy regardless of the cost to the rest of the economy.
Puerto Rico’s debt crisis will continue to drag on far longer than necessary if the federal government and commonwealth government do not work together to make structural changes to the island’s economy. Economists from the University of Puerto Rico have estimated that in 2010 the Jones Act cost the island’s economy $537 million, or half of one percent of Puerto Rico’s GDP. A good first step towards preventing Puerto Rico from becoming another Greece is to break up the U.S. shipping cartel by repealing the Jones Act and allowing shipping prices to fall.
Patrick Holland is a contributor for Economics21. Follow Patrick on Twitter here.
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