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Institute de
Investigaci6n Puertorriqueno
Puerto Rico
Research Institute
P.O. Box 11204
Washington, D.C. 20008
(202) 337-2234
Apartado Postal 11204
Washington, D.C. 20008
(202) 337-2234
OCCASIONAL PAPERS SERIES
Impact of the Caribbean Basin
Initiative on the Puerto Rican Economy
Sara Grusky
April 1988
INTRODUCTION
This paper seeks to examine the impact of the Caribbean Basin
Initiative (CBI) on the Puerto Rican economy. First, it is important
to recognize that the CBI is not merelyaneconomic revital nation
program. The impetus of the CBI lies in the recognition of the
intrinsic relationship between economic, social, and political
development and the U.S. security interests in maintaining stability
in all of these spheres. Therefore, any discussion of the impact of
the CBI on the Puerto Rican economy and the successes or failures of
the Initiative is best undertaken with an integrative understanding of
its social, political, as well as its economic motives.
The first section of the paper will attempt to set the CBI within
the context of the pre-existing trends in the Puerto Rican economy
with the aim of identifying what aspects of the CBI further pre-
existing trends and what aspects may run counter to these trends. In
this context we may be better able to identify possible effects of the
CBI on the Puerto Rican economy. The second section will identify the
plan or proposition of the CBI, both the spoken and the unspoken
aspects, and particularly the role for Puerto Rico within the CBI.
The final section will attempt to answer the question: What effect has
the CBI had on the Puerto Rican economy?
TRENDS IN THE PUERTO RICAN ECONOMY
Probably the most important trend in the Puerto Rican economy is
its increasing integration into the U.S. economy as well as the global )
econoj,- When President Reagan launched the Caribbean Basin
Initiative in 1982, the effects of two major recessions, the energy
crisis, and high inflation had left the Puerto Rican economy weakened,
showing the decade of the 1970s was not the most propitious time for
greater economic integration into the rest of the world. However, by
-. 1986, the Puerto Rican economy again mirrored the U.S. and showed a
significant recovery registering a 2.6% real growth rate in GNP. In
1987, the Puerto Rican economy showed further recovery with a 5.1%
real GNP growth rate.(1)
While the Puerto Rican economy may mirror that of the U.S., its
dynamism is based on distinct features. Beginning in the 1950s,
Puerto Rico's "Operation Bootstrap" promoted private sector
manufacturing investment based primarily on wage and tax incentives.
The "industrialization by invitation' development model showed initial
successes stimulating an average real growth rate of 6.96% between
1948 and 1973.(2) However, rising wage rates on the island,
increasing competition from the East Asian NIC's, and poor global
economic indicators quickly revealed the limitations of this model in
the mid-1970s. Since that time, the Puerto Rican economy has relied
increasingly on direct federal transfer payments (primarily in the
form of food stamps) and capital intensive investment (primarily
pharmaceutical companies) that chose to locate in Puerto Rico because
of significant tax exemptions through Section 936 of the federal tax
code. In summary, the Caribbean Basin Initiative was announced at a
time when the Puerto Rican economy was in state of disarray and the
structural weaknesses of the Bootstrap model had been revealed.
Puerto Rico was finding it increasingly difficult to attract industry
as a low wage site.
WHAT THE CBI PROPOSED FOR PUERTO RICO
The CBI responded initially to the national security implications
of rapid socioeconomic and political changes in the newly emergent
Caribbean nations. Because of significant U.S. security concerns in
Central America, this region was later included with the Caribbean
islands in the newly defined geographical concept called the
Caribbean Basin." In this context, Puerto Rico was periferal to the
more immediate concerns that initially generated the Caribbean Basin
Initiative.
Puerto Rico was not only periferal to the original policy
conception of the CBI, it was also initially opposed by the Puerto
Rican government who argued that opening the U.S. market to the rest
of the Caribbean countries would reduce the competitive advantage of
Puerto Rican industry. The CBI was seen as exacerbating troublesome
pre-existing trends in the Puerto Rican economy such as the decline in
investment and employment. The competitive advantage of investment in
Puerto Rico had already been undercut by the federal minimum wage law,
federal environmental shipping, and safety regulations, and the
Generalized System of Preferences and Tariff Items 806.30 and 807,
which had already increased access to the U.S. market for many
Caribbean products. The CBI was seen as one more blow against the
already weakened Puerto Rican economy.
Eventually certain adjustments were made so as to gain Puerto
Rico's support for the Initiative. U.S. officials recognized that
Puerto Rico was not only an important ally on the diplomatic front,
but as one of the more developed Caribbean islands, it had important
financial, trade, and technological resources without which any
regional development plan would be severely handicapped. From the
Puerto Rican perspective, the CBI, along with the overall increased
geostrategic importance of the Caribbean region, gained for Puerto
Rico new leverage that could be applied toward increased autonomy as
well as other economic and political concerns. The final draft of the
CBI included special tax advantages for Puerto Rico as well as the
definition of Puerto Rico as a beneficiary country for the terms of
the provision that 35 percent of the value of CBI eligible products
must be added in the region. There were also less explicit
commitments to make Puerto Rico a transportation, trade, and financial
hub in the region.(3)
PUERTO RICO AND THE CBI: INTERDEPENDENT FUTURES
In 1985 the U.S. Treasury threatened to alter Section 936 of the
U.S. tax code, potentially removing the tax exemptions provided to
U.S. orponraions in Pnerto Rico. As Puerto Rico's wage advantage has
declined, the tax advantage provided by Section 936 has played
increasing importance in attracting foreign investment. The
investment stimulated by Section 936 has been primarily situated in
the capital intensive pharmaceutical and chemical ind-ustries and
while not stimulating job creation, Section 936 has stimulated the
financial sector generating $20 billion in new deposits from 1980 to
1984 and accounting for 44% of total bank deposits.(4) In order to
preserve the economic benefits of Section 936, Puerto Rico's governor
ernandez-Colon proposed that some of the 936 funds be used to finance
CBI development projects in the region in the form of twin or
complementary plants. The CBI had yet to bring any substantial
revival to the sagging Caribbean economies and therefore concerns of
the Treasury Department were overridden by the Administration's CBI
proponents who hoped the Puerto Rican proposal would help to stimulate
more investment in the region.
The twin or complementary plant program became an important basis
of Puerto Rico's participation in the CBI. This program redefined the
international division of labor with new sophistication placing Puerto
Rico in an intermediary role as the MDC or "more developed country" of
the Caribbean region. With the twin plant program, U.S. corporations
can transfer low-wage assembly aspects of production to other
Caribbean islands while maintaining their base of operation in Puerto
Rico and thereby retaining certain tax and trade advantages, in
particular the 936 tax exemption as well as Puerto Rico's position
within the U.S. customs area. Puerto Rico, although no longer
competitive as a low wage site, has a developed infrastructure that
would provide financial, trade, transportation, and other commercial
services to U.S. corporations or other investors interested in the
twin plant program.
Puerto Rico's proposal to use 936 funds to finance twin plants in
the region was essentially a political solution that attempted to meld
the interests of Washington to promote Caribbean development, the
interests of U.S. corporations in Puerto Rico to maintain their tax
advantages, and the Puerto Rican government's interest in maintaining
Puerto Rico as an attractive investment site for U.S. business. What
at first appeared to be a creative political solution has actually
placed Puerto Rico in an untenable intermediary position between the
reluctance of the U.S. corporations to invest their 936 monies, and
feelings of the small Caribbean countries that run the gamut between
charges of broken promises and charges of Puerto Rican "imperialism."
Puerto Rican officials, after raising expectations of the
Caribbean countries, have had to admit that these are not government
funds. Although they may reside in the Puerto Rican Government
Development Bank, the bank has to account for these monies to the
corporations.(5) In addition, Puerto Rican government officials are
not willing to lend out these funds unless there will be dual benefit,
for Puerto Rico as well as the Caribbean country involved and this has
meant that the projects must take the form of twin plants.
The criticisms that the Caribbean countries have made of the
Puerto Rican twin plant proposal are reflective of criticisms that
Caribbean countries have made of the entire Caribbean Basin
Initiative. Essentially, the 936 funds offered by Puerto Rico would
not be accessible to most small Caribbean producers. They are
appealing to large U.S. companies that are of a scale where a contract
operation in a low wage Caribbean country combined with the tax
advantages of Puerto Rico make an attractive package. Caribbean
government officials have criticized the CBI concept because it tends
to direct resources away from small farmers, small businesses, inter-
regional trade, and regional institutions and directs resources to an
export sector that benefits a narrow elite.(6) Puerto Rico's proposal
to use 936 monies for complementary plants is perceived by Caribbean
officials as perpetuating this thrust of the CBI. There is also the
added problem that many larger U.S. or other foreign companies do not
view the small Caribbean countries as attractive sites because there
is not adequate infrastructure development to support their
operations. There is no funding available through the CBI or the
Puerto Rican proposal to develop this necessary infrastructure. In
addition, Puerto Rico's attempt to cast itself as an intermediary
power in the region has been resented by some of the Caribbean
countries. The late Prime Minister of Barbados, Errol Barrow, was
particularly negative in his characterization of the Puerto Rican
proposal.
"I hope Governor Colon will be able to explain to me
why they are asking us in the Eastern Caribbean to
be relegated to the situation of hewers of wood and
drawers of water, so that the Commonwealth of Puerto
Rico can continue to enjoy the U.S.$700 million worth
of benefits which they now derive from Section 936 ..."(7)
The Puerto Rican program to fund CBI twin plant projects with
936 funds has received a fair amount of attention and debate.
Unfortunately there is little to show for all of the discussion and
this tends to corroborate the view that the Puerto Rican proposal was
more a political gesture to maintain Section 936 of the U.S. Tax Code
that a genuine economic development initiative. Originally $700
million in 936 funds was promised to promote development in the
Caribbean countries. This figure was later reduced to $150 million
and it is estimated that approximately $30 million has been actually
loaned out to twin plant projects.(8) During the recent Congressional
hearings to revise the CBI, attention was brought to Puerto Rico's
failure to make available the promised funds and Congressional
pressure has been used to urge Puerto Rico to fulfill its part of what
was perceived as a "deal" to preserve Section 936.
In addition to the twin plant program, Puerto Rico has
participated in the CBI as a significant recipient of federal
procurement contracts. In 1985 President(ius announced that CBI
eligible countries would be able to compete for federal procurement
contracts in an attempt to add steam to the flagging Caribbean Basin
Initiative. This represented a conjuncture of interests. The
Department of Defense (DOD) had become increasingly concerned about
dependence on Far East producers by prime contractors for electronics
and other goods and was interested in creating a competitive, nearby
regional industrial capacity.(9) At the same time, the Reagan
Administration's CBI was attempting to promote economic development in
the region in response to U.S. national security concerns. Defense
procurement contracts could play a significant role in bolstering the
economies of the region while at the same time meeting DOD objectives
of creating a competitive supplier network nearby.
The Department of Defense has initiated a special program to
increase dLfe-nse procurement contracts in Puerto Rico. The program
has encouraged the use of the twin plant model where the base
operation in Puerto Rico could subcontract for the manufacture of
components and sub-assemblies in other Caribbean islands. The fastest
growing sectors in the Puerto Rican economy are in the pharmaceutical,
and electronics industries. A significant amount of this growth has
been stimulated by federal procurement contracts. In addition, the
Puerto Rican textile industry which had been on the decline due to
Relocation to lower wage sites has been bolstered due to new federal
contracts. Defense prime contracts over $25,000 rose from $187
million in 1983 to $500 in 1985.(10)
CONCLUSION
While the other Caribbean economies continue to suffer, showing
little if any improvement, the Puerto Rican economy has shown
significant revitalization. Puerto Rico's prior level of
industrialization and close political relationship with the U.S. has
enabled it to take advantage of the economic benefits of the CBI as
well as the U.S. national security concerns that such a program
implies.
The economic development plan proposed by the CBI is essentially
similar to Operation Bootstrap, the U.S. plan used to develop Puerto
Rico in the 1940s. As an outgrowth of this economic development
strategy, Puerto Rico has been well suited to further its
implementation. While U.S. and other foreign corporations have not
been as eager as administration officials had hoped to invest in the
smaller Caribbean islands due to lack of infrastructure, services, and
concerns about political risk, Puerto Rico has shown significant
growth in ts manufacturing sector, particularly in pharmaceuticals
and electronics. Net income in the manufacturing sector grew 4.2% in
1986 and 13.5% in 1987.(11) This increased growth is generally
attributed to perceived stability in Section 936 tax advantages,
rather than directly due to the CBI. Federal procurement contracts
have further spurred the Puerto Rican economy and again the smaller,
less developed Caribbean countries have been less able to take
advantage of this aspect of the CBI. Finally, Puerto Rico's service
sector is playing an increasingly important role in the economy
generating 72.5% of total employment on the island.(12) The most
dynamic growth area of the service sector is found in seryi~ses oriented
toward producers such as financial, commercial, trade_ communications
and legal services.
---- "--~~- __ .I
Puerto Rico has benefitted not just from the CBI, but also from
the overall increased importance attached to U.S. national security
objectives in the Caribbean. The CBI essentially links U.S. national
security to economic stability in the Caribbean. Because of this,
Puerto Rican based firms have received priority treatment in obtaining
federal procurement contracts and the 936 tax exemption appears
secure. All of this has contributed to Puerto Rico's economic
revitalization. Puerto Rico's twin plant program, on the other hand,
S appears less successful. Although Puerto Rico has placed new
attention on fostering diplomatic relations with its Caribbean
neighbors and has attempted to market itself as a financial, trade,
and commercial service center for potential Caribbean investors, the
twin plant program does not appear to be having a major impact on
encouraging investment in the small Caribbean nations. Despite the
CBI, the declining U.S. sugar quota has generated a continuing
downward trend in Caribbean exports to the U.S. The CBI and Puerto
Rico's twin plant program cannot claim successes in this regard.
The CBI does not attempt to address the fundamental structural
dependence of Puerto Rico on the U.S. regional economy. Rather, it
has attempted to revitalize the structures of this dependence. Many
would argue that Puerto Rico's current economic vitality is less due
to the CBI and more due to the advantages generated by Puerto Rico's
special relationship with the U.S. An economy that attracts investment
based on the financial benefits of Section 936 of the U.S. tax code
and federal procurement contracts will have a highly dependent and
superficial character. While some have criticized Puerto Rico's
economic and political relationship with the U.S., others have argued
the opposite perspective and stated that the CBI will not be
successful unless it offers the rest of the Caribbean the tax and
trade advantages Puerto Rico enjoys.
FOOTNOTES
1. Government Development Bank for Puerto Rico, "Puerto Rico Business
Review," special supplement, 1988, page 1.
2. Finn, Bertram P., "Puerto Rico's Economic Development: The Old
Formula No Longer Works," Puerto Rico: The Search for National
Policy, ed. Bloomfield, Richard, Westview Press, 1985.
3. Hearings regarding the Caribbean Basin Initiative before the
Subcommittee on Trade, Committee on Ways and Means, U.S. House of
Representatives, March 17, 23, 24 and 25, 1982.
4. Pantojas, Garcia Emilio, "La crisis del modelo desarrollista y la
reestructuracion capitalist en Puerto Rico; hacia una redefinicion
del rol de Puerto Rico en la economic hemisferica," CEREP, San Juan,
Puerto Rico, May 1984.
5. Proceedings of the Symposium sponsored by the Western Hemisphere
Sub-Committee of the U.S. House of Representatives and the Development
GAP Organization at the Barbados Hilton Hotel, September 18, 1987.
6. Ibid.
7. Singh, Rickey, "The Promise and the Reality: CBI Struggling for
Success," Caribbean Contact, September 18, 1987.
8. "Puerto Rico and the CBI," Economic Development Administration,,/
Commonwealth of Puerto Rico, November 1987.
9. Sattler, Roger, "Defense Procurement: A Growing Market," The New
York Times, October 20, 1986.
10. "Informe Economico al Gobernador 1987," Junta de Planificacion de
Puerto Rico, San Juan, 1988.
11. Ibid.
12. "Informe Economico al Gobernador 1987," op.cit.
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