The juxtaposition of this past week’s news headlines, “Greece will not pay IMF loan due on Tuesday” and “Puerto Rico governor says island can’t pay” brought a much ignored truth home.
Just as Greece’s economy is an unsustainable element within the European Union, so is the economy of Puerto Rico within the United States. The Balkan nation and the Caribbean territory share two key characteristics: Both have followed self-destructive fiscal policies exacerbated by demographics that run against them and both are small units in larger politico-economic entities and thus are locked into a currency that is highly overvalued for their circumstances, but over which they have no control.
There are more parallels. Neither has a clean path — politically or economically — to getting out of their quandaries. And in both cases, the governmental and financial establishments of the U.S. and EU turned a blind eye to a looming catastrophe for years.
Both serve as examples of the economic overhang created when long-term economic ties are created in reaction to short- or medium-term foreign policy considerations.
But there also are some key differences. The EU says it seeks deeper economic union, and a majority of its members now participate in the euro. But fiscal policy still largely rests with individual nations. Greece has borrowed from private lenders in other EU nations and from EU governments to pay unfunded pensions, for example, but there is no program in which payments flow directly from an EU treasury to Greek households.
That differs from Puerto Rico, where residents participate in Social Security and Medicare and are eligible for some, but not all, other income transfer programs. If the government of Greece cannot borrow more money, at least in the short run, it will be difficult to not cut payments to retirees. But the government of Puerto Rico could be frozen out of additional borrowing with no effect at all on retirees’ regular benefits .
Moreover, Greece can set its own minimum wage and other labor rules. Under existing law, the U.S. federal minimum wage applies to Puerto Rico even though it is far higher than existing market wages or average company earnings than anywhere in the 50 states. This is a problem for the island and its businesses.
Finally, Greece had its own currency from independence until adoption of the euro in 1999. But Puerto Rico has never had one of its own. For Greece to go back to the drachma is daunting, but not impossible. Puerto Rico spurning the dollar and issuing its own currency is impossible.
It is useful to step back and recognize that political considerations– rather than economic — caught both in their current institutional traps.
We grabbed Puerto Rico, along with Cuba and the Philippines, in a burst of jingoistic colonial expansion nearly 120 years ago. The people of Puerto Rico had no real say in the matter. We did relinquish control of Cuba and the Philippines over time, but Puerto Rico, which had produced no real indigenous independence movement the way the other two had, stayed in the fold.
It’s an example of Colin Powell’s “Pottery Barn” metaphor: “You break it, you buy it.” In grabbing it as a colony, we assumed responsibility for the island over the longer term.
Greece was able to join the EU in the 1970s and the emerging Eurozone in the 1990s largely for political reasons. The Cold War was still on. Greece was the “soft underbelly” of Europe but occupied a strategic location over Soviet access to the Mediterranean.
Once in the EU, Greek national pride, and the desire for an external constraint to limit inflation, fostered popular support for joining the euro, even if it meant colluding with Goldman Sachs to fraudulently hide the fact that Greece did not meet the public finance criteria for participation.
In both cases, economists and policymakers who should have known better were willfully oblivious to the fact that a nation or colony with low labor productivity that is locked into using the same currency as a larger entity with higher and rising productivity condemns itself to being a high-cost producer of whatever it may want to sell to foreigners.
For both, tourism is an important sector, but both face sharp competition. There are many nations offering sunny Mediterranean or Caribbean beaches.
Especially because it must pay the U.S. minimum wage, it is hard to see how Puerto Rico can compete with the Dominican Republic or myriad smaller islands, much less Cuba, in becoming a tourism powerhouse. And, despite decades of sundry tax subsidies, it is not really a competitive player in manufacturing.
In both cases, lenders took on risk under the implicit assumption that if push ever came to shove, someone would bail out the borrowers. Indeed, the much touted financial rescue of Greece just a few years back was a bailout of private lenders, making them 100 percent whole. It did little for Greece’s government or households. In both cases, it is important that lenders take a haircut, a big one. But it is not at all clear that will happen.
Most current news on Greece and Puerto Rico focuses on the short-run.
One may be able to finesse the current short term crises the two face, but even with some restructuring from the current status quo, neither probably is viable over the long term. Continued out-migration can be expected from both. There already are more people born in Puerto Rico living in the mainland U.S. than on the island itself. The Greek diaspora is large and long-established. It will grow.
Given the transfer of tax dollars to Puerto Rico via Social Security, Medicare and other programs, the territory probably can continue to limp along indefinitely.
As many now argue, Greece is small compared to the rest of the EU. It’s economic collapse is not likely to bankrupt large financial institutions or touch off a world financial crisis. But there are many worms in this can and many possible bad outcomes for Europe and the world economy as a whole. Given both sides unwillingness to compromise, we well may see what such harsh consequences are.