More than Debt: Puerto Rico’s dysfunctional Labor Market

by Andres Rodriguez Brauer

June 23rd, 2016

    Puerto Rico’s economy has been in recession since 2006. Today, the country’s Real GNP per capita is 5.85% lower than it was at the start of 2006. Meanwhile, national debt has increased successively and is now at over 72 billion dollars, bringing wide public attention. However, such focus has distracted many from recognizing Puerto Rico’s deeper structural issues–its astonishingly problematic labor market.

    In 2006, Government Development Bank of Puerto Rico (GDB) stated that 43.3% of the Puerto Rican population over age 16 reported being employed. Ten years later, the employment rate has dropped to 35%, which is significantly lower than that of the United States. Puerto Rico’s employment rate is tied with war-stricken Iraq for third lowest in the entire world, further highlighting the gravity of the situation. The issue derives from the extraordinarily low labor force participation rate of only 39.4% according to the GDB. The International Labor Organization(ILO) estimates from 2014 show that Puerto Rico’s labor force participation rate for individuals aged 15-24 was a mere 25%, fourth worst in the world, and 50.6% for ages 15-64, which is still the eleventh worst in the world.

    While a lot of people attempt to dismiss the astonishingly low labor force participation numbers by attributing the issue to the underground economy, it is extremely unlikely that this fact can explain the majority of the effect, simply due to the magnitude and abnormality of the problem. The truth of the matter is that Puerto Rico is clearly suffering from chronic labor underutilization, which greatly limits the island’s economic potential and reduces the amount of goods and services that are able to be produced. The large majority of these issues are caused by underlying structural issues that characterize the Puerto Rican labor market.

    First of all, Puerto Rico has the issue of the federal minimum wage. Puerto Rico’s median hourly wage is $9.61, and thus the federal minimum wage is $7.25 an hour, 75.44% of the median wage. According to Aridrajit Dube, one of the many pro-minimum wage economists, the ideal minimum wage would be about 50% of the median wage. Too high of a ratio could constrain employment as a large part of the labor force would find itself at a point where their marginal contribution would be less than their marginal cost, given the specific minimum wage. In Puerto Rico, 28% of hourly workers earn $8.50 or less, versus 3% in the United States, making the price floor a lot more binding than in the United States and causing the employment effect of the regulation far more impactful. As a result, there are a large amount of people being priced out of the labor market due to this federal minimum wage, contributing to the incredibly low employment rate of the island.

    Additionally, labor regulations in Puerto Rico are more costly and restrictive than those in the United States. For example, overtime is calculated after the day of work instead of at the end of the week; paid vacation is longer than the United States; dismissals are harder to go about without breaking any “unjust dismissal” laws. All of these regulations increase the cost of hiring workers and therefore reduce both wages and employment. The impact becomes even more profound when combined with the other effects mentioned.

    Lastly, the island’s welfare system also contributes to the low employment rate by discourage work. According to Anne Krueger, “one estimate shows that a household of three eligible for food stamps, AFDC, Medicaid and utilities subsidies could receive $1,743 per month – as compared to a minimum wage earner’s take-home earnings of $1,159”.  As a result, low income individuals in the island would be financially better off not working. Given that most people tend to be rational decision makers, this system creates a disincentive for labor participation and discourages low income individuals from working. The system’s design makes it so that if one chooses to work, they would no longer be eligible for a lot of these benefits and the losses in benefits outweigh the benefits of being unemployed. This phenomenon was shown by Laurence J. Kotlikoff and David Rapson’s study of the United States market. However, the actual effect is likely to be far greater in Puerto Rico, given that so many more individuals earn wages near the federal minimum wage and the fact that the island enacts utility subsidies for qualifying low income residence.

    In order for Puerto Rico’s economy to reach its potential, it is imperative for them to enact serious labor market reforms. These problems are far more impactful and consequential in the long term than the national debt, and they should therefore warrant at least as much attention as the debt problem does. Without this attention, Puerto Rico will always linger behind and will never be able to match the economic potential it possesses. Deep structural change is needed in order to increase the national employment rate and bring the country out of this recession.

References

States and selected areas:  Employment status of the civilian noninstitutional population, January 1976 to date, seasonally adjusted. (n.d.). Retrieved June 12, 2016, from http://www.bls.gov/lau/ststdsadata.txt
Puerto Rico – May 2015 OES State Occupational Employment and Wage Estimates. (n.d.). Retrieved June 12, 2016, from http://www.bls.gov/oes/current/oes_pr.htm
Labor force participation rate, total (% of total population ages 15-64) (modeled ILO estimate). (n.d.). Retrieved June 12, 2016, from http://data.worldbank.org/indicator/SL.TLF.ACTI.ZS
Puerto Rico Economic Indicators – Time Series. (n.d.). Retrieved June 12, 2016, from http://www.gdb-pur.com/economy/pr-monthly-economic-indicators-time-series.html
Economic Reform to the Governor, Statistical Appendix 2013. (n.d.). Retrieved June 12, 2016, from http://www.gdb-pur.com/economy/documents/ApendiceEstadistico2013.pdf
Labor force participation rate for ages 15-24, total (%) (modeled ILO estimate). (n.d.). Retrieved June 12, 2016, from http://data.worldbank.org/indicator/SL.TLF.ACTI.1524.ZS
Employment to population ratio, 15+, total (%) (modeled ILO estimate). (n.d.). Retrieved June 12, 2016, from http://data.worldbank.org/indicator/SL.EMP.TOTL.SP.ZS/countries
Krueger, A. O., Teja, R., & Wolfe, A. (2015, June 29). Puerto Rico: A Way Forward. Retrieved June 12, 2016, from http://www.bgfpr.com/documents/puertoricoawayforward.pdf
Dube, A. (n.d.). Designing Thoughtful Minimum Wage Policy at the State and Local Levels. Retrieved June 12, 2016, from http://www.hamiltonproject.org/assets/legacy/files/downloads_and_links/state_local_minimum_wage_policy_dube.pdf
Kotlikoff, L. J., & Rapson, D. (n.d.). Does It Pay, at the Margin, to Work and Save? — Measuring Effective Marginal Taxes on Americans’ Labor Supply and Saving. Retrieved June 21 2016, from http://faculty.econ.ucdavis.edu/faculty/dsrapson/DIPW_METR_1006.pdf