How the Minimum Wage Helped Spiral Puerto Rico into Economic Chaos

As the push for a $15 per hour minimum wage continues in earnest across America, policymakers had better consider the warning signs flashing from beleaguered Puerto Rico. Minimum wage policy was a major factor leading to the current crisis there.

The Government Development Bank in the US territory is operating under a state of emergency imposed to halt the erosion of its dwindling cash. Governor Alejandro Garcia Padilla declared the emergency earlier this month. The executive order suspends the bank’s lending power and freezes most withdrawals, except for those to fund public safety, health, and education services.

The GDB serves as the US territory’s primary financial agent. According to Bloomberg, the bank has $562 million in liquidity. It is currently negotiating with creditors, trying to avoid default on $422 million payment due May 1. According to a report at Fortune.com, Garcia Padilla says the bank can’t afford to repay the loan.

Puerto Rico faces $70 billion in total debt, a 45% poverty rate, and a shrinking population. Garcia Padilla has said the GDB cannot afford the looming payment. While the island has defaulted on small debt payments in the past, a default at GDB would be the most serious yet.”

Meanwhile, the bank has filed with regulators to sell more debt, according to a Bloomberg report:

The GDB, which lent to the commonwealth and its agencies, filed to sell taxable securities that would mature May 2017, according to the Municipal Securities Rulemaking Board’s website, called EMMA. The notice doesn’t list the amount of the sale or the coupon. The commonwealth hasn’t been able to sell debt since last year.”

So, what does any of this have to do with the minimum wage?

Well, there is growing evidence that Puerto Rico’s high minimum wage relative to its natural wage scale was a key factor in dragging down the island’s economy and spiraling it into the current debt crisis. The island was required to bring its minimum wage in line with the US back in the 70s and 80s. While increasing the minimum always impacts employment, its effects are often hidden from sight. But it was particularly disruptive in Puerto Rico, and obviously so, due to the fact that the wage scale there was significantly lower than on the mainland.

A recent report by the Foundation for Economic Freedom highlights a National Bureau of Economic Research study that demonstrates the negative impact of the minimum wage on Puerto Rico’s economy:

The heavily indebted island demonstrates the tragic consequences of forcing up the minimum wage out of sync with the market price for labor. Between 1974 and 1983, Puerto Rico was forced to increase its minimum wage in line with the federal figure, where it has remained since 1983. The results of imposing this standardized federal minimum wage have been ‘substantially reduced employment on the island,’ as well as swathes of unemployable low-skilled workers who decided to immigrate to the US mainland to seek work…”

The study identified four key impacts of the minimum wage in Puerto Rico.

1. The US-level minimum altered the distribution of earnings to an extraordinary extent, creating marked spikes that dominate the earnings distribution.
2. Imposing the US-level minimum decreased employment 8% to 10% compared to the level that would have prevailed had the minimum been the same proportion of average wages as in the US. It greatly reduced jobs in low-wage sectors.
3. Migrants from Puerto Rico to the US are drawn largely from persons jobless on the island, with characteristics that make them liable to have been disemployed by the minimum wage.
4. Migration to the US was critical in allowing Puerto Rico to institute the minimum wage and played a major role in the long-term growth in real earnings by reducing the labor supply and raising the average qualifications of worker’s on the island.

Minimum wage opponents argue that it primarily hurts the very low-income workers it is meant to help. Puerto Rico’s experience seems to bear this out. On top of that, it ultimately leads to a stagnating economy, as the FEE report asserts:

According to a report by International Monetary Fund economists, only 40% of the adult population in Puerto Rico is employed or seeking work, compared to 63% percent in the mainland. The other 60% are unemployed or working in the vast underground economy. Clearly, there are hundreds of thousands of Puerto Ricans working for less than the federal minimum, employed in the black market. For a nation struggling to service its debt, discouraging economic activity or driving it underground is not a good idea. Puerto Rico’s woes as a result of the minimum wage should be a warning for the mainland.

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