Puerto Rico’s drift toward statehood–and dependence (Fortune, 1979)

November 3, 2013, 7:00 PM UTC

By Herman Nickel

Editor’s note: Every Sunday Fortune publishes a favorite story from its magazine archives.This week, we turn to a 1979 feature about Puerto Rico’s attempt to gain statehood, and the economic ramifications of that quest. Nearly 35 years later, the commonwealth is struggling with debt and is being called the next Detroit.

The grand old man of Puerto Rico, Luis Muñoz Marin, sits in a straight-backed rocking chair on the porch of his house in Trujil lo Al to, nestled in the verdant hills that gently ascend from the coastal plain. When he bought the property after World War II for just $15,000, the bustle and congestion of San Juan were far away, but years of growth have brought the city almost to his doorstep. It was 1940 when Munoz took charge of what was then a Caribbean poorhouse and turned it into one of the postwar era’s most hopeful laboratories of industrial and political development. He is now eighty-one years old, and a stroke has slowed his speech. But his mind is quick and alert, and nothing has dimmed the old man’s pride in Puerto Rico’s progress and his faith in its people’s talents and energies.

Despite all the difficulties of recent years, as  Muñoz notes with relief, the Puerto Rican economy is expanding again. The island’s growth this year is running at a respectable rate of 5 percent. Employment in manufacturing stands at a new high of 157,000. The tourist season last winter was good enough to justify the reopening of three major hotels. The influx of companies continues, albeit at a slower pace, despite the island government’s decision to end the 100 percent tax exemption granted newcomers and to phase in some corporate levies to broaden the narrow tax base. Although factory wages have ceased to be competitive with those in other developing countries, the average $3.66 an hour is still only 61 percent of the U.S. average. And corporate profits in Puerto Rico are sti!J shielded from the federal tax collector.

It is not Puerto Rico’s ability to get along that most troubles a concerned witness like Muñoz, but rather the drift away from the political idea to which he dedicated his life. The Commonwealth concept of a voluntary association with the U.S., a status midway between independence and statehood, matured in his mind more than three decades ago. The vision seemed to dispel the twin anxieties that have long haunted most Puerto Ricans–the fear of losing their cultural independence in the great American melting pot and the fear of embarking on a political independence that would be economically precarious.

The Puerto Rican independence movement has remamed a fringe phenomenon to this day. Though its leader, Ruben Berrios Martinez, is perhaps the most articulate and attractive political figure on the island, the Independence party garnered only 5.7 percent of the vote in the last elections. As for the Cuban model, the lack of its appeal may be judged by the fact that the Marxist-Leninist Puerto Rican Socialist party, led by Juan Mari-Bras, managed to attract only 10,800 votes, less than 1 percent of the total.

While the independence cause seems so listless in Puerto Rico, the twenty-seven-year-old Commonwealth compact between the peoples of the U.S. and Puerto Rico is itself suffering from a want of energetic commitment on the part of both San Juan and Washington. As a consequence, the political initiative has now been seized by the advocates of statehood.  La Fortaleza, the historic sixteenth-century governors palace in SanJuan, is today occupied by Carlos Romero Barcelo, forty-six, a vigorous proponent of statehood. His allies control both houses of the legislature. If, as expected, the statehood forces win next year’s election, Romero plans to sustain the momentum by holding a plebiscite in 1981.

He expects the majority to favor statehood. The political behavior of the U.S. currently seems to be working in the same direction. Durmg the annual anti-American rites staged by Cuba in the U.N. General Assembly’s Decolonialization Committee, the U.S. representatives no longer stand up for Commonwealth states; they simply contend that the Puerto Ricans have the right to choose whatever status they prefer. The statehood forces in Puerto Rico have always had close links to the Republican party on the mainland, but they were taken by surprise when Gerald Ford, at the end of 1976, committed his lame-duck Administration to statehood for Puerto Rico.

As for the Democrats, Jimmy Carter has been somewhat more prudent. When Governor Pomero persuaded the President in 1977 to launch an interagency study of Puerto Rican economic and social conditions, he hoped that the findmgs would bolster the case for statehood. But Carter was careful to instruct the bureaucracy to steer clear of the contentious status issue. His admonition has not, however, kept the political side of the Carter White House from working closely with the Puerto Rican statehood backers, who last fall ousted the Commonwealth advocates from their traditional control of the island’s Democratic organization. Even though they cannot vote in the presidential election, the Puerto Ricans control no fewer than forty-one convention ballots. What distresses Mufioz Marin is something more basic than these partisan maneuverings. His fear is that the proud quest of “Operation Bootstrap” for self-reliance is now being undermined by a sense of dependence-a welfare mentality epitomized by the food-stamp program.

It may always have been a flaw of the Commonwealth idea that it appealed more to reason than to emotion. As a longtime American resident of San Juan puts it, “You can feel patriotic about statehood, and you can feel patriotic about independence. But Commonwealth is an affair of the mind.” Perhaps this is why the concept appealed so much to intellectuals like Carl J. Friedrich, the late Harvard constitutional scholar for whom the Commonwealth idea was the “middle road to freedom.” In 1956, Chief Justice Earl Warren hailed the new Commonwealth formula as ”perhaps the most notable of American experiments in our Lifetime.” At the time, Munoz Marin’s dynamic leadership had captured people’s imagination in Puerto Rico as well as in Washington. The industrialization drive of Operation Bootstrap seemed a steady march forward, as mainland firms flocked to the island to enjoy the benefits of total exemption from corporate income taxes, plenty of d1eap oil from Venezuela, and a large and easily trained pool of cheap labor. After decade of the poverty of a one-commodity sugar economy, Puerto Rico seemed at last to have found the way to overcome it almost complete lack of natural resources. s long as its G.N.P. kept growing at 10 percent or more, even the failure to bring the unemployment rate below 10 percent did not dim expectations of ever greater prosperity.

When these gleaming prospects abruptly faded in the wake of America’s 1974-75 recession, the effect was traumatic. Future historians may well date from that time the turning of the tide against Commonwealth. The G.N.P. that had grown in fiscal 1973 by 7.3 percent, in constant dollars, almost stopped growing the next year, and declined by 2 percent in 1975. The booming construction business suddenly foundered. The oil-price explosion made the island’s reliance on Venezuelan crude and naphtha a major liability and crippled the petrochemical industry. The island’s biggest single industrial project, the Commonwealth Refining Co. (CORCO) had to seek protection under Chapter XI of the federal bankruptcy laws to get out from under now disastrous long-term, fixed-price contracts to supply feedstocks to island petrochemical firms. In 1977, unemployment reached an all-time official high of nearly 23 percent. In contrast to the U.S., where forty-two out of every 100 people were working, only twenty-three of every 100 Puerto Ricans held jobs. Meanwhile, the population has been growing at an annual rate of 3 percent, due partly to a 1.7 percent birth rate and partly to return migration from the mainland, now running at a rate of about 30,000 a year.

Seeking to cushion the impact of the recession, the administration of Rafael Hernandez Colon reacted like most governments- by spending more than its narrow tax base could cover. Before long, Puerto Rico’s bond rating had tumbled. In December, 1975, a “Committee to Study Puerto Rico’s Finances,” under the chairmanship of Professor James Tobin of Yale, prescribed the bitter medicine of an austerity program, including a balanced budget and a wage freeze for the public sector-especially needed since employment in government has been growing faster than in manufacturing. Such stringent measures hardly helped Hernandez Colon’s reelection campaign in 1976. To make matters worse, the opposition New Progressive party was led by Carlos Romero-Barcelo, the popular mayor of San Juan and a man endowed with the kind of machismo that is as effective in the barrios of the cities as among the jibaros in the mountains. Romero focused on economic issues rather than on the island’s political status, which he insisted was not at stake. While his party’s sweep of offices (and its consequent control of forty out of seventy-eight municipalities) was impressive, the election’s outcome could hardly be taken as an explicit mandate for statehood.

But the political conclusion to which many Puerto Ricans seemed driven by the rough weather of the recession was that the island needed to strengthen its lifeline to Washington, rather than move toward greater autonomy. It is easy to, understand such a view. An unprecedented amount of federal spending not only had made the recession bearable but also had provided the impetus behind the recovery. From about $1.3 billion in 1974, federal outlays leaped to $2.8 billion in 1976. In fiscal 1978, they ran at a rate of 3.4 billion, more than one-third of the island’s $8.9-billion gross product-and more than $1,000 for each of the island’s 3.3 million residents. The per capita personal income of the islands in 1978 was only $2,681.

The island’s chronic dependency is dramatically demonstrated by the food-stamp program. No less than 53 percent of Puerto Rico’s populace makes use of food stamps. The current $793 million worth of food stamps pumped into the island’s economy has inevitably turned into a second currency-and the figure will rise to $915 million in fiscal year 1980. The ubiquitous “cupones” have become an accepted, if illegal, means of exchange for all kinds of transactions other than those for which they were intended.

Although many Puerto Ricans question whether cupones in such quantity were really needed to keep people fed, there is no doubt that they played a key role in stabilizing the economy. Former Governor Luis Ferre, a statehood advocate who is now president of the Puerto Rican senate, asserts that the cupones saved Puerto Rico from economic disaster. And he sees them and other welfare benefits not as “gifts” but as “the application of the principle of equal treatment under law for all American citizens.”

On all this, however, the feelings of Munoz Marin are decidedly mixed. “So long as people really go hungry, I suppose, giving them food stamps is the Christian thing to do,” he concedes. “But the sooner we can do without it, the better it will be. It creates a sense that you can have something for nothing.” What worries Munoz Marin is that the bulk of federal funds comes in transfer payments geared to individual welfare rather than to the kind of economic development that might create a self-reliant society. It is hard to question the transfer payments-such as veterans’ and Social Security benefits-that Puerto Ricans, like other American citizens, have personally earned. But the fact is that the difference made by working or not working has become so small in some cases that there is hardly any incentive to take a job at the lower end of the pay scale. Domestic jobs generally go begging among Puerto Ricans, unless the employer agrees to pay the wage into the “left pocket,” i.e., the one the welfare officer and tax collector do not pick. The manufacturing sector is affected as well. “Whenever we have had to shut down one of our plants, we have had trouble getting enough of our people to come back when we reopened,” reports one of the biggest employers on the island.

Such signals are particularly ominous for an economy whose work force is just about its only substantial asset. American managers find that the productivity of Puerto Rican workers compares favorably with mainland standards. This fact has helped somewhat to offset the loss of wage competitiveness vis-a-vis other developing countries, a deterioration that was hastened by the introduction of federal minimum-wage rates into the island in the late 1960’s. It would thus seriously harm Puerto Rico’s appeal to potential investors if the economy were to become renowned for its nonworkers. ·

Some time back, U.S. companies discovered that the way to make the most of their federal tax exemption is to make Puerto Rico the base for their most profitable operations. Going to the island has meant a move away from such labor-intensive industries as textiles and leather goods to capital-intensive operations like pharmaceuticals.

Even Puerto Rico’s emergence as a major manufacturing center for the pharmaceutical industry has created only about 9,200 jobs, at a cost, in forgone taxes, of almost $35,000 per employee. Job creation has steadily fallen behind population growth. And the level of employment in the Seventies is relatively lower than it was in the Forties and Fifties.

The critical issue is how federal funds can be mobilized to promote employment and economic development. Resolving the question will test the flexibility of policymaking in the American federal system, regardless of whether Puerto Rico finally remains a Commonwealth or becomes a state. But in Puerto Rico, where politicians are obsessed with the subject, the debate is inextricably linked with the divisive status issue.

To Munoz Marin and the politicians now leading his Popular Democratic party, only the autonomy of Commonwealth status can ensure a truly Puerto Rican development strategy. They contend that statehood would sooner or later mean an end to the federal tax exemption and its power to attract new companies to Puerto Rico. The specter that most dismays them is that of a permanent welfare island in the Caribbean, under a government forced to deplete its meager revenues in order to participate in matching-grant federal programs.

The alternative long favored by Commonwealth supporters would entail a shift of emphasis in the U.S. Congress from transfer payments to block grants made to the Commonwealth government for its disposition. Former Governor Hernandez Colon, who expects to be the “Populares” gubernatorial candidate next year, has prepared a program to modify the present Commonwealth compact in the direction of even greater autonomy. He would vest in the Puerto Rican legislature the right to decide which federal legislation should be enforced on the island, especially in the areas of wages, labor relations, and environmental regulations. He also speaks of the possibility of tariffs to protect Puerto Rican agriculture from the competition of neighboring islands.

But Governor Romero is determined to march in exactly the opposite direction. For him, statehood is above all a matter of equality. Why should Puerto Rican citizens be denied the right to vote in presidential elections and to choose their own representatives in Congress? At the same time, Romero sees the voting right as the best means to give Puerto Rico the political punch that it now lacks in Washington. And he believes that making Puerto Ricans subject to the federal tax system would strengthen their case and free them from the ignominy of asking for federal funds without making their due contribution.

To avoid the shock effect of suddenly lifting the federal tax exemption, Romero talks of persuading Congress to phase in federal taxes by increments over a twenty-year period, at a 5 percent yearly rate. There may be some doubt whether this scheme is compatible with the equal-treatment provisions of the Constitution. But two constitutional scholars, the late Alexander M. Bickel of the Yale Law School and Arthur E. Sutherland of the Harvard Law School, found no fundamental difficulty with Romero’s position.

Despite Romero’s zeal, there is little likelihood that these problems will reach Congress anytime soon. To begin with, Romero will have to win reelection in 1980. With another recession quite likely, this is no foregone conclusion, even considering his party’s control of both federal and Commonwealth patronage. If he does win, a status referendum in 1981 would not necessarily produce a landslide in favor of statehood. On the basis of recent opinion polls, Romero expects the pro-statehood vote to be in the 60 percent range.

With more bravura than realism, he vows to petition Congress for admission even if it is only 51 percent. In the “inconceivable” case of Congress turning him down, he has issued an implausible warning that he would then jump to advocating full independence instead. Judging by the many years Congress took to act in the far simpler cases of Hawaii and Alaska, Puerto Rican statehood could not come soon. And it would be foolish to try to rush it. As even Romero concedes, in Puerto Rico the divisive issue of status is “as emotional as the racial issue was in the States in the 1950’s and 1960’s.”

Both in Puerto Rico and in Congress, it should be recognized that a change of status is a matter of such far-reaching importance that it requires a broad Puerto Rican consensus rather than just a narrow majority. The question, after all, touches the nerve of a pervasive cultural nationalism, which is why Romero constantly reassures Puerto Ricans that their Hispanic language and culture are “non-negotiable.”

Historically, the admission of the first fully Hispanic state would also raise questions that have never been posed before.

Precisely because Americans are a people of many races and origins, the common language has played a crucial integrating role. One appreciates Walter Cronkite’s role as a national institution when one discovers that neither he nor any of his network competitors are carried by Puerto Rican television stations. The case of Puerto Rico thus raises substantial questions about the meaning of American nationhood–questions that would have to be mainly faced not in the potential fifty-first state, but in the existing fifty. In the meantime, the political debate should not distract attention from the economic issues facing the island. The partisan arguments over status can tend to obscure these continuing problems. One need not be an advocate of Commonwealth or statehood to agree that the present mix of federal transfer programs and economic development grants for Puerto Rico needs to be corrected in favor of the latter.

Governor Romero and his opponent, Hernandez Colón, along with Munoz Marin, concur on this-as does Jerry Jasinowski, the Commerce Department official in charge of the interagency study. “No matter how the data are presented, the statistics indicate that there are few programs which are directly and specifically designed to promote economic growth,” the study concludes. (The CET A program is cited as an exception.) Even as staunch a supporter of statehood as Manuel Dubon, until recently the head of Puerto Rico’s Economic Development Administration (FOMEN TO), wistfully wonders how much more productive it would have been if, instead of more transfer payments, Congress had given Puerto Rico block grants to use as seed money to attract risk capital, thus creating more jobs.

Almost all Puerto Ricans now agree that some intrinsic flaws of the Operation Bootstrap approach must be remedied. In the rush to industrialize, agriculture was prematurely abandoned. Without any illusions about self-sufficiency, both major parties now perceive that a revived agriculture could at least reduce the island’s 80 percent dependence on imported food-and create jobs in the process.

In recent years, moreover, the indiscriminate nature of the 100 percent exemption from corporate taxes had the effect of making it impossible for the government to raise enough revenues to meet industry’s mounting infrastructure needs, such as sewerage systems, roads, and water supplies. The newly revised tax-incentive program, although it suffers from complexity, marks at least a start in using the exemption tool selectively.

Finally, the importance of creating stronger horizontal linkages between industries in Puerto Rico has come to be generally recognized. One reason why the multiplier factor of capital invested in Puerto Rico has remained inadequate is that the island often serves as nothing more than the production point for materials that are imported and then reshipped as finished products. Difficult as it was to draft an analysis of the Puerto Rican economy that skirts the status issue, the Carter Administration’s forthcoming report has the virtue of establishing an agenda that can and should be tackled now.

Unfortunately, the responsibility for Puerto Rican policy in Washington is so fragmented that any effective followthrough on the report looks unlikely. No one department in the executive branch is in clear charge, and congressional treatment of Puerto Rico has always been haphazard. “When Congress does treat Puerto Rico as a ‘state,’ it does so without consideration of the unique circumstances and problems existing on the island,” the interagency study finds. At the same time, it adds, “There is no apparent consistent rationale underlying the mixture of exclusions, ceilings, and differential matching rates that are currently applied by Congress to Puerto Rico in its federal program participation.”

In these circumstances, the unhappy prospect is that the present administration in San Juan will continue operating a Commonwealth system it doesn’t believe in, while Washington’s policy continues to ramble and drift.