(Bloomberg)—On the day after Puerto Rico’s latest debt default, Nick Prouty was feeling plenty upbeat about his $110 million building project in the island’s capital. Less so about the vacuum that surrounds it.
“Those are the only cranes you’ll see on the skyline of San Juan,” Prouty said in his office next to the condominium construction site. With politicians preoccupied by a debt deal, the developer - one of the island’s richest men - sees little attention being paid to its economic future. “There’s talk of either a bailout or austerity, and I think those are false choices,” he said. “You need to have a growth-based model here in order to emerge.”
Washington is gearing up to put the island’s finances under federal oversight, so a deal can be worked out with bondholders and more revenue raised to pay them. Puerto Rico’s debt debacle entered a new phase with this month’s $370 million default. Missing from the effort, so far, is a plan to end the economic malaise that’s lasted a whole decade, even though a return to growth is the only way Puerto Rico’s creditors are likely to get much at all of their $70 billion back.
If that sounds familiar, it should -- because it’s already happened, in Greece.
“The parallels are very close,” said Desmond Lachman, a resident fellow at the American Enterprise Institute and former deputy director of the International Monetary Fund. When policy makers set out to squeeze extra cash out of a country without its own currency or central bank, “you’re just doing the fiscal tightening. We saw in Greece that all that does is, it weakens the economy. Then, the budget doesn’t improve like you thought it would. The debt ratios keep rising.”
That’s a drawback of Puerto Rico’s limbo status as neither a sovereign nation nor a U.S. state. In the past, it’s tried to turn that to its advantage, with development plans largely based on some kind of tax gimmick.
One of them worked fairly well for a couple of decades. Pharmaceutical companies flocked to the island to avail themselves of a federal rule that allowed them to get a tax break on profits. The incentive was eliminated in 1996, though companies were given a 10-year grace period to move elsewhere. They did, marking the beginning of the island’s slow-motion economic collapse.
“Since then, the Puerto Rican government has been improvising, changing laws every two years, and we’ve never replaced it,” said Antonio Fernos Sagebien, an economics professor at the Interamericana University of Puerto Rico in San Juan. Among the latest tax breaks is a controversial provision dating from 2012 that sought to attract wealthy investors, offering massive tax savings on interest, dividends and capital gains.
Prouty, 49, was one of those to answer the call. A New York native who had set up a distressed real-estate fund in Greenwich, Connecticut, he moved with his family to Puerto Rico in 2013. He says he doesn’t personally gain much from the tax program because he doesn’t own a lot of financial assets.
He thinks the island could be extracting more economic benefit out of the plan, though. “It’s hot money,” he said. “Those people need to become engaged in Puerto Rico, or that program runs the very real risk of creating tremendous resentment.” He argues there should be a job-creation requirement to gain the exemption.
Prouty himself employs about 2,000 people in Puerto Rico directly and indirectly. His firm Putnam Bridge Funding is investing as much as $120 million in the Puerto del Rey marina. Then there’s the Ciudadela condo complex, which he’s currently extending. The work should be finished in 18 months. He built a plaza there for residents, populating its gardens with hummingbirds, butterflies and native frogs, called coqui, that are known for their loud mating calls. A one-bedroom unit, with floor-to-ceiling windows and quartz kitchen counters, costs about $165,000. Prouty says his target market is young professionals.
If they stick around, that is. Puerto Ricans have the right to live in the mainland U.S. and, as the economy slumps, they’re exercising it. The population has fallen 9 percent over the past five years, leaving it at 3.5 million, according to the Pew Research Center. Recent migrants have tended to be less educated, but many professionals are leaving too. Doctors departed at the rate of more than one a day last year.
Stemming the outflow will require a fix for the economy. For now, the focus is on finding revenue to stave off further defaults. As a result, everything from water bills to sales taxes has been ramped up.
While the community of wealthy migrants enjoy their exemptions, Puerto Ricans who run businesses feel like “every day they get another tax,” said Ricardo Alvarez-Diaz, who has an architecture and interior design firm and is chairman of the island’s builders association. “Every day there is another permit they need to open their business. It gets to a point where you either close your business or you leave.”
So where does Puerto Rico go from here? “I’ve been asking the same question for 18 months, and nobody has a response,” said Fernos Sagebien, the economics professor. “Once the debt service is reduced, what are the emblematic projects on which you’re going to spend the savings, to make the economy run?”
Local business leaders say Puerto Rico must again make use of its in-between status. In tourism, for example, it has the white-sand beaches of a Caribbean island, but with an infrastructure that’s closer to U.S. standards than some competitors. It has a bilingual professional class and labor costs that are low for the U.S., if not for Latin America.
Fernos Sagebien says Puerto Rico can get more into manufacturing of sophisticated products like medical devices, taking advantage of its engineering programs to make products for the U.S. market. Prouty says the island can lure retirees, with a combination of mainland-like emergency medical care and year-round sunshine.
One step that could be adopted in the Congress rescue package, because it has the backing of House Republicans, is reduction of the minimum wage to below mainland levels.
Lachman, the former IMF official, thinks that makes sense. But he says the U.S. will probably have to take more drastic action to revive the island’s economy - “give them some sort of tax break,” or maybe even inject funds, though only to stimulate the economy, not to pay off creditors. Congress is adamant that whatever measures it adopts won’t be a “bailout.”
Prouty says he’s pushing for a growth-friendly plan for Puerto Rico by knocking on every door he knows. That includes lawmakers in Washington, and even Hillary Clinton: Prouty has a photo of himself with the Democratic presidential candidate on display in his office.
“Businesses like certainty, and there’s a lot of uncertainty for sure,” he said. But Prouty says he doesn’t regret his decision to move to the island and invest there. “I don’t make those decisions based on my gut,” he said. “I also believed - and still do - in the Puerto Rican economy."
--With assistance from Alexander Lopez. To contact the reporter on this story: Jonathan Levin in Rio de Janeiro at [email protected] To contact the editors responsible for this story: David Papadopoulos at [email protected] Ben Holland
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