Running Head: PUERTO RICO’S ECONOMIC CRISIS

Puerto Rico’s Economic Crisis

Embry Riddle Aeronautical University

ECON 211

Abstract
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Why is the migrant population’s departure having such a negative impact on the

economy? This paper explores the current economic crisis facing the Commonwealth of Puerto

Rico. With a debt of more than $70 billion the island nation is in a situation not much different

than that of Detroit a couple years ago, except that because it is not a state it does not qualify for

bankruptcy rights covered under Chapter 9. In economics, supply and demand are the driving

forces in the economy and its stability depends on various factors. For Puerto Rico the problem

originated from years of overspending but it also seems that the ratio of the migrant population is

affecting the economy in a negative way. With a population decrease of 7% over the last 10

years, Puerto Rico searches for answers to solve its crisis. The inability to adjust its currency for

inflation plus uncontrolled government spending has crippled the economy. A contributing factor

to this has been the wrongful application of Keynesian methodology. Restructuring the

government and economic policies at this point seems the only viable solution to revive this

Caribbean jewel. This and other factors will be discussed in further detail for this research.

Puerto Rico’s Economic Crisis

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The question many Puerto Rican’s now face is simple, “With the economic crisis at hand

is it better to stay or flee?” Puerto Rico is an island nation belonging to the US as a result of the

Spanish-American War. With a population of approximately 3.5 million it is one of the most

developed islands in the Caribbean. In terms of the economy the island uses US currency and it

does not control its money supply or interest rates creating a special situation which many

sovereign countries do not face. As of recent years however, an ever worsening economic

recession has plagued the island leading to an astronomical debt that is engulfing the nation.

With price levels, interest rates, and unemployment rising, many individuals have chosen to

leave the island in pursuit of the American dream. This decrease in the supply of the labor force

is having adverse effects in the economy which we will discuss in further detail. Also Keynesian

politics have led to abuse of government powers leading to excessive over spending.

The Debt, GDP, and Real GDP

As of 2016 Puerto Rico is facing a $70 billion dollar debt and a rising 45% poverty rate

(2016, n.a.). This debt accounts for roughly 68% of the nation’s gross domestic product which

currently sits near $103 billion. This means that

the debt, accounts for 68% of the total market

value of all final goods and services produced

annually. Although this is a significant number,

we can see from the chart below that even

though there is debt the GDP has been

increasing up until 2013, which is the last data

Figure 1: This graph shows the GDP increase for Puerto Rico in
comparison to the Dominican Republic and Costa Rica (2016, found. Consequently, the per capita GDP, which
Jan 21)
is the country’s population divided by the GDP
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has also been on the rise. In Puerto Rico one of the main reasons for this, is that many

individuals are leaving the island. Therefore, per capita GDP has increased in part due to the

population decrease and not so much because of economic growth. The chart above can be

misleading giving the appearance that the economy is improving and does not show the effects

of the national debt or actual growth adjusted for price changes. Arnold states (2015), that “to

gauge the health of the economy, economists want to know why GDP increased. If GDP

increased simply because price increased, then the economy is not growing. For an economy to

grow, more output must be produced.” This statement is a perfect example that illustrates what is

happening to the Puerto Rican economy. On the other hand the real GDP is adjusted for price

changes and shows a true measure of growth. The Real GDP rises only if output rises due to

more goods and services being produced. By finding the value of the output for different years

in terms of the same prices also known as base

year prices, we can compute Real GDP

(Arnold, 2015).

The graph to the right shows the decrease in

Figure 2: Real GDP growth percentage from 2006-2014
(Trading Economics, n.d.)
Real GDP growth for the period of the great

recession that is currently affecting the economy (2012, n.a.). It has been in a negative growth for

6 years. The year 2012 does show a positive increase but unfortunately this was only an anomaly

not a positive trend.

Population, Labor Force & Wages

The population has seen a decline of hundreds of thousands of Puerto Ricans since 2006

from 3.8 to 3.5 million in 2015. Consequently, this causes a decrease in the labor force. This

decrease is due to a combination of things such as, the lack of jobs, increase in government taxes,
Running Head: PUERTO RICO’S ECONOMIC CRISIS
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price level and cost of utilities. Another

factor affecting the nation’s economy is

the monetary value, wage rates and

welfare benefits. Monetary supply often

ends with a change in aggregate demand

Figure 3: Labor force decrease from Jan 2005 to Jan 2015 (2016, Feb 21)
(Arnold, 2015). Because of the inability to

regulate currency and wage rates Puerto Rico is forced to adhere to the high minimum wages

imposed in the U.S. As Flannery states (2015), “Puerto Rico is a relatively poor island economy

but it is subject to U.S. minimum wage laws, meaning that its wages are uncompetitive compared

to other Caribbean economies.” This creates an issue for companies and workers since they

cannot hire as many employees and many prefer to not work at all, causing the quantity

demanded of labor to fall and unemployment and price levels to rise. These job losers and job

leavers, eventually lead to discouraged workers that migrate elsewhere in search of better

opportunities or stay home to live off the generous welfare and disability benefits (Norbert,

2016). For example, the federal government spent more than $2 million for food stamps in

Puerto Rico of which 25% is untraceable. This means that this 25% of money could be being

used for all kinds of items and not food (2013). Harrington (2013) comments, that because of

these generous and un-regulated benefits, 37 percent of Puerto Ricans are of food stamps paid by

the federal government. In turn, this has various effects in the Short Run Aggregate Supply

(SRAS) curves. Arnold (2015) states that, “higher wage rates mean higher costs and, at constant

prices, translate into lower profits and a reduction in the number of units that firms will want to

produce.” If this was to be depicted graphically it would lead to a left ward shift in the SRAS

curve. Because productivity and wage rates have a linear relationship, decreases in productivity
 Running Head: PUERTO RICO’S ECONOMIC CRISIS
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also cause a leftward shift of the SRAS curve. Additionally because the US Economy affects

Puerto Rico, recessions and changes in currency value affect it, leading to increased levels of

inflation in an economy where the U.S. dollar is of a higher value than an economy of Puerto

Rico’s size would normally have.

ding Economics, Classical vs. Keynesian Applications

In discussing the two types of economists we have Classical and Keynesian economists.

Classical economists believe the economy is self regulating, wages are flexible, and that the

government should have a “lasses faire” or hands off policy in which the private sector controls

aggregate demand in the economy. Also they believe that saving is equal to the amount of

investment (Arnold, 2015). Opposing, Keynesian economists believe that the economy is not self

regulating, wages are inflexible, the private sector cannot move the economy out of recession

and the government plays a primary role in the economy. Conversely they believe that savings

does not necessarily equate to investments as some will change their consumption amounts or

change their habits.

In Puerto Rico it appears that the government has been utilizing a misinterpreted form

Keynesian economics. Norbert (2016) states, “this situation is merely a government-financing

problem, one that should be solved by changing the rules of the game and increasing government

oversight.” Puerto Rico’s government has for years been endlessly borrowing and spending

money even during prosperous time. This was not what Keynes had in mind when he suggested

that governments should be involved in a country’s economic affairs. In fact, Puerto Rico has

become a classical economist’s worst nightmare. It has turned into an economy being regulated

by government demands and inflexible wages, unable to climb out of an ever deepening

recession with a diminishing private sector. Classical economists would perhaps argue that
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separating the government from the private sector would allow the market to fall back into

equilibrium. But with such a deep hole it seems that a complete restructuring of the government

and the economy, may be the only solution. Puerto Rico’s economic contraction and inability to

generate growth could be mitigated by changing to an open market competition. Also it would

have to restructure its debt. Unfortunately, these 2 options are not available due to Puerto Rico’s

state as a Commonwealth of the US making any current viable solution a political battle for

correctness.

Conclusion

Several issues have been plaguing the Puerto Rican economy for some years now. With

the $70 billion debt and bond payments that may go into default looming on the horizon, a much

needed economic reform must take place. The declining population which has decreased by 7%

over the last 10 years is also creating further strains on an already fragile situation. We were able

to see from the research that GDP is not a true measure of output rise and that it is greatly

affected by the price level. Only by measuring Real GDP can we determine growth by using base

years as a bottom line from which to compare present data. With that in mind we come to the

question asked initially, should Puerto Rican’s stay or flee? The decrease in migrant population

is continually collapsing the capacity to generate growth (2016, Jan 12). In my opinion it

depends on your situation and needs. If you are in a dire economic situation leaving might be

your best option, if not then taking the risk and allowing the economy to recover is worth it. We

have seen that eventually economies return to their equilibrium, it is just a matter of how long it

will take.
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References

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rentId=71610034

Flannery, N. P. (2015, Jul 29). How Bad Is Puerto Rico's Economic Crisis? Forbes.

http://www.forbes.com/sites/nathanielparishflannery/2015/07/29/how-bad-is-puerto-

ricos-economic-crisis/#625431541b97

Harrington, E. (2013, May 10). 1/3 Population of Puerto Rico gets Food Stamps--$2 billion in

2012. CNSNEWS. Retrieved from http://cnsnews.com/news/article/13-population-

puerto-rico-gets-food-stamps-2-billion-2012

Norbert, M. (2016, 25 Jan). Obama's Misguided Solution To The Keynesian Crisis In

Puerto Rico. Forbes. Retrieved from

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the-keynesian-crisis-in-puerto-rico/#65fa20e733e7

N.a. (2016, Jan 28). Puerto Rico’s Debt Crisis: Why There’s No Quick Fix. Wharton University

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N.a. (2016, Jan 12). World Bank. Retrieved from

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https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_pcap_

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http://www.breckinridge.com/pdf/whitepapers/March_2012_Puerto_Ricos_Challenge.pdfN.a.

(n.d.) Trading Economic. Retrieved from http://www.tradingeconomics.com/puerto

rico/gdp-per-capita