Puerto Rico’s governor announced this week that the small island territory would be unable to repay its $70 billion in outstanding debt. The commonwealth is in its tenth year of a depression and is losing its tax base as thousands of residents relocate to the mainland for better economic opportunities.
The Puerto Rican government, which has spent wildly, is principally at fault for the crisis. But Washington, D.C. deserves a large portion of the blame for Puerto Rico’s mess.
Flawed policies from Washington have aided Puerto Rico’s descent into fiscal insolvency in a number of ways. Washington inflated the island’s transportation costs, destroyed the island’s labor market with an abnormally-high minimum wage and lavish entitlement programs, and pushed flawed tax policy that created an economic bubble.
Islands have higher-than-normal transportation costs due to their remote locations, but a pre-New Deal era law drives up the cost even more for Puerto Rico. The Jones Act decrees that goods being shipped between U.S. ports must be on U.S. chartered ships with a U.S. crew. That means goods coming from the mainland can’t come on the most cost-competitive vessel. They must go with one of four U.S. shippers operating that route. The limited competition increases costs. Puerto Rico’s shipping costs are twice those of its island neighbors, making items more expensive to purchase on the island. It also limits Puerto Rico’s ability to export its products to the mainland.
“Bad policies from Washington have made the pain much worse.”
The federal minimum wage of $7.25 an hour applies on the island. The minimum wage’s effects are well-known, but it has disproportionate influence in Puerto Rico.
The island’s median income is only 40 percent of the mainland. Twenty-eight percent of Puerto Rico residents earn $8.50 an hour or less, compared to 3 percent on the mainland. So the minimum wage greater impact in Puerto Rico. It would be like if the mainland had a $19 an hour minimum wage.
The high minimum wage raises the cost of employment and prices many employers out of the market, causing unemployment to rise and thus tax revenue to dry up. The minimum wage is a partly why the island’s unemployment rate is almost three times that of the mainland.
The minimum wage is coupled with lavish entitlement benefits. A household of three in Puerto Rico can earn $1,700 a month in benefits from Medicaid, food stamps, utility subsidies, and aid for dependent children, compared to $1,150 a month in take-home benefits from the minimum wage. Individuals are better off not working, and many chose that option. Only 40 percent of Puerto Rico residents are employed or looking for work, compared to 63 percent on the mainland.
Finally, Washington fueled the Puerto Rico bubble with inconsistent tax policy. Per Congress, Puerto Rican municipal bonds are exempt from federal taxation—like other states—but they are also exempt from state and local taxes too. Triple tax exempt bonds are a great investment. That attracted buyers to the bond market, allowing Puerto Rico to issue billions and billions in debt cheaply, and postpone spending restraint.
In 1976 Congress allowed U.S. corporations with subsidiaries in U.S. territories, including Puerto Rico, to avoid federal taxation on dividend payments to the parent company. In essence, U.S. firms could relocate large portions of their business to Puerto Rico to avoid federal taxation. As expected, many firms took advantage and the island’s economy grew rapidly, but nothing lasts forever. In the mid-1990’s, Congress and President Clinton phased out this provision over a ten year period. Firms closed up shop on the island and moved. Puerto Rico’s 10 year depression began in 2006, the first year after tax preference ended.
Puerto Rico’s inability to limit spending, reform its protectionist labor laws, and institute broad pro-growth tax reform all contribute to its precarious debt situation. But it isn’t alone. Bad policies from Washington have made the pain much worse.Nicole Kaeding is a budget analyst for the Cato Institute.
Greece’s economic turmoil will come to a head this Sunday when Greeks vote in a referendum on whether to accept EU bailout funds. The expectation that Greece will leave the eurozone and default on its IMF loans has led to a run on Greek banks, the imposition of capital controls and volatile financial markets.
But while these financial woes are roiling Greece and destabilizing Europe’s economic order, the security implications of a potential “Grexit” could be at least as ominous as the financial ones.
First, it is almost certain that a Greek exit from the eurozone would push the country closer to Russia, a scenario that would deepen divisions within NATO. Greek ties with Russia have been improving since the victory of the left-wing Syriza party in January’s elections, and Greek leaders have made no secret of the fact that they consider Moscow a possible alternative source of funding if their European negotiations fail.
“A closer Greece-Russia relationship could have long-term security implications for the European Union and for NATO.”
Syriza’s traditionally strong relations with Russia have been strengthened through a series of recent visits between Moscow and Athens. During his visit last month at the St. Petersburg International Economic Forum, for example, Greek Prime Minister Alexis Tsipras spoke of the Greek and Russian relationship, hinting that Greece was “ready to go to new seas to reach new safe ports.”
Russian officials deny that they have offered financial aid to Greece, yet the Russian energy minister just recently announced a $2.77 billion pipeline project in Greece, and Moscow followed this with an informal invitation to Greece to join the BRICs’ New Development Bank.
It is true that the initial impact of a Grexit would simply be to provide Russia with a wonderful propaganda coup, allowing anchors on Russian state TV to highlight further evidence of the decline of the European Union and of Western civilization more broadly. Yet a closer Greece-Russia relationship could also have bigger long-term security implications for the European Union and for NATO.
Though the European Union’s Ukraine-related sanctions on Russia were renewed without objection on June 22, that extension is only good through January. Greek leaders have strongly objected to sanctions on Russia in the past. If it exits the eurozone, but remains a member of the European Union, Greece would have little to lose in choosing to veto any future extension of the sanctions on Russia.
And even if Greece exits the European Union entirely, it will remain a member of NATO. Greece was a Cold War battleground and an important player in the struggle against communism. Yet today, a Greek government with strong ties to Russia would not only perpetuate the Russian narrative that NATO is weak and divided but could easily exert veto power over NATO operations or any NATO response to potential Russian aggression in the Balkans or Eastern Europe.
Greece also has a strategically important location in the southeast of Europe and on the Aegean Sea. Closer ties between Greece and Russia raise the possibility that Athens might permit Russian ships the friendly use of Greek ports. This would be a major strategic concern for NATO, allowing Russia to expand its military influence not only in Crimea and the Black Sea, but to obtain a stronger foothold in the Mediterranean. The Greek-friendly Cypriot government, though not itself a NATO member, already permits such use.
It’s even possible that a Grexit and closer Athens-Moscow ties could lead Greece to withdraw entirely from NATO, moving instead toward closer security cooperation with Russia.
There is precedent: Greece has previously withdrawn from NATO, from 1974 to 1980. While relatively unlikely, a new Greek withdrawal from NATO would result in the loss of strategically placed bases, placing an increasing burden on Turkey to support NATO’s southern security needs.
To be sure, despite implied promises, it is unlikely that Russia could entirely bail out Greece in the event of their exit from the euro. After all, Russia is suffering substantial economic problems as a result of low oil prices combined with American and European sanctions and might itself face balance of payment problems in the next few years.
But given Russian President Vladimir Putin’s demonstrated willingness to accept domestic economic pain to further foreign policy objectives, a Grexit would almost certainly be followed by favorable financing deals and Russian support for major infrastructure projects, such as the recently agreed Turkish Stream pipeline, as well as increased cultural and political ties between Athens and Moscow.
All this means that if Greeks reject the terms of the euro bailout this Sunday, United States and European leaders will have to worry not only about the financial fallout, but also the unsettling security implications of an EU and NATO member state slipping into Moscow’s orbit.Emma Ashford is a visiting fellow with the Cato Institute.