-
Puerto Rico in the Post War: Liberalized Development
Banking and the Fall of the Fifth Tiger
JOSE A. PADIN *Portland State University, Oregon, USA
Summary. This paper analyzes the long-term effects of a
liberalized regime of developmentbanking on the growth and
investment trajectory of a newly industrializing country using
PuertoRico as a case study. The paper analyzes conflicts between
domestic business and the state over theform of state involvement
in development during the critical juncture of the 1940s; the
leading roleof domestic business in the push to liberalize the
developmental state project; and the effects thisliberalization had
on development banking, and on Puerto Ricos long-term growth
trajectory. 2003 Elsevier Science Ltd. All rights reserved.
Key words Puerto Rico, Latin America, newly industrializing
countries, developmental states,
development finance, political economy
1. INTRODUCTION
Puerto Ricos development experience hasbeen a matter of
controversy over the decades.In the early postwar it was
optimistically con-sidered a model for the modernization of
un-derdeveloped regions (Annals, 1953). With theonset of protracted
economic woes, startingwith the early 1970s, and arguably
continuinginto the present, assessments of the islandsdevelopment
experience became markedly crit-ical and pessimistic. Some studies
brought at-tention to the dominance of ideology oversubstance in
the workings of the governmentsdevelopment program (Pantojas-Garca,
1990;Santana Rabell, 1989), while others found in-dications that
the Puerto Rican experiment wasthwarted by the larger forces of
dependency(Villamil, 1979) and imperialism (Dietz, 1979).Although
the Puerto Rican case received theattention of development scholars
some de-cades back, partly because it appeared to con-firm all the
promise of W. Arthur Lewisinfluential model of development with
unlim-ited supplies of labor (Lewis, 1954, 1958), it israre to find
a reference to this case in the pro-digious literature analyzing
newly industrial-ized countries (NICs). A recent exception tothis
neglect is Baumol and Wolff (1996), whohighlight the impressive
achievements of thePuerto Rican economy in the last four
decades.One of Baumol and Wolffs most interestingfindings is that
Puerto Ricos unique political
ties to the United States had a negligible effecton the islands
postwar growth trajectory.Having dispelled this notion, Baumol
andWolff ask rhetorically, should Puerto Rico thennot be considered
the fifth tiger of the post-war era? The answer, as I will argue,
is that itdepends. Be that as it may, however, PuertoRico
resurfaces as a case of legitimate interestto comparative
scholarship on the long-termdynamics of development in NICs.
Puerto Ricos growth and productivity figuresover the course of
40 years are indeed tiger-like, as Baumol and Wolff show. But, if
we aresensitive to qualitative shifts in the postwartrajectory of
the Puerto Rican economy, itseems necessary to qualify this
characterization.Though Baumol and Wolff emphasize four-de-cade
averages, their own data show two verydistinct phases, a pre-1970
trajectory, and apost-1970 trajectory. During 195070 PuertoRicos
real per capita GDP growth averaged5.84% per annum, but in 197090
it droppedconsiderably, to 2.49%. Even this last
figureunderestimates the degree to which the PuertoRican economy
was faltering after 1970. Bau-mol and Wolff find that the combined
effect ofPuerto Rico-US links on growth was negligibleduring the
golden agefrom 195070 Puerto
World Development Vol. 31, No. 2, pp. 281301, 2003 2003 Elsevier
Science Ltd. All rights reserved
Printed in Great Britain0305-750X/03/$ - see front matter
PII: S0305-750X(02)00193-6www.elsevier.com/locate/worlddev
*The author wishes to acknowledge the valuable feed-back of the
anonymous reviewers Final revision accep-
ted: 13 October 2002.
281
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Rico was indeed pulling itself up by the boot-straps. For
197090, however, institutionallinks to the United States had a
positive andvery considerable effect on growth. In the ab-sence of
this US bailout effect, growth wouldprobably have been a whole
percentage pointlower during the low-growth years of 197990.With
this in mind, Puerto Ricos proper place ina typology of late
developing regions seems tobe among former tigers, or stunted NICs.
Thisactually makes the case even more interestingto
comparative-historical scholars.
This paper analyzes the relationship betweenthe nature of a
developmental state programand the long-term fate of export-led
late in-dustrialization. When Puerto Ricos industrial-ization
program was still in its infancy, Mason(1958) observed that Puerto
Ricos institutionalframework of development represented theliberal
end in a spectrum of state-market ar-ticulations. Nearly four
decades later, we are ina position to assess some of the long-term
ef-fects of a liberal development program. Thefindings should yield
some valuable lessons ofpertinence to the critical reassessment of
indis-criminate liberalization currently under way.
Puerto Ricos developmental state projectchanged substantially
over the course of the1940s, a decade of intense conflict between
thestate and the local business class. The liberalstate-market
articulation that Mason observedin the 1950s was a result of this
conflict, and itneeds to be understood as the product of agradual
accommodation between state plannersand the domestic business
class. This accom-modation was made necessary by stern
businessopposition to an ambitious developmental stateproject. Over
the course of the 1940s stateplanners were forced to reach a
compromisewith the business opposition, and finally, toabandon most
of the key components of thedevelopmental state project. Of all the
com-promises made, to anticipate an importantfinding of the
analysis that follows, the mostfateful was probably the
liberalization of theframework for financing development. The
ex-tensive pruning of the Government Develop-ment Bank in response
to pressures fromdomestic business left the state ill-prepared
toconfront predictable problems at the end of theeasy stage of
export-industrialization. This isan important and neglected part of
the storybehind fall of the fifth tiger of the postwarera.
The paper is organized as follows. First,Puerto Ricos
development trajectory needs to
be analyzed keeping in mind the role of states inlate
development. Therefore, I begin with adiscussion of the relevant
literature in devel-opment economics and developmental states.Next,
I offer a brief historical background toPuerto Ricos early
industrial transition. Fi-nally, the core of the paper is devoted
to ananalysis of the evolving state-business rela-tionship that
shaped the institutional featurethat proved to be a fundamental
weakness ofPuerto Ricos development project over thelong run.
2. THE STATE IN THE PROCESS OFECONOMIC DEVELOPMENT
East Asian industrialization and the crisis ofLatin American
development in the 1970s and1980s initiated a productive debate
aboutprospects for economic development in poorcountries and the
conditions under which thismight occur. The contrast in regional
modelsand performance offered a rich field for em-pirical
adjudication between competing theo-retical claims. Careful studies
of the unique roleof the state in East Asian development
havediscredited facile and misguided portraits ofthese states as
paragons of free-market virtue. 1
Comparative evidence has borne out a long-standing proposition
in heterodox developmenteconomics: economic development is a
discon-tinuous process, thus, initiating and sustaininga successful
take-off requires state interven-tions with the ability to
coordinate a well-timedsequence of changes in the orientation
ofindustrialization (Fei & Ranis, 1964; Gers-chenkron, 1962;
Nurske, 1958; Rosenstein-Rodan, 1958). Sequencing successive
phasesof import-substitution and export-orientation,for example,
depends on the leadership of anactor with unusual foresight, a
strategic com-mitment to the health of the national economy,and a
capacity to hold private industry to per-formance benchmarks.
States in developingregions potentially have the incentive, the
le-gitimacy, and the organizational scale andscope to lead the
development process (Gers-chenkron, 1962; Rueschemeyer & Evans,
1985),although there is no guarantee they will displaythe capacity
and the interest (Evans, 1995;Lewis, 1957), or even the necessary
credibility(Huff, Dewit, & Oughton, 2001).
A burgeoning comparative historical litera-ture makes a strong
case that East Asian de-velopment successes are in some
important
WORLD DEVELOPMENT282
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measure explained by the particular role playedby developmental
states (Amsden, 1989; Evans,1987, 1995; Hart-Ladsberg, 1993;
Johnson,1982; Wade, 1990; Woo, 1991). Even skepticshave conceded,
albeit timidly, that the stateplayed an important role in the
developmentsuccesses of East Asian miracles (cf. Dollar
&Sokoloff, 1994; World Bank, 1993). Thus, wefind a convergence
between classic work indevelopment economics and the
comparativehistorical scholarship of East Asian NICs: aview of
development as a discontinuous process.The economic development of
national econo-mies comes with no long-term guarantees;phases are
punctuated by uncertain junctureswhere established formulas fail
and the field ofpossibilities is again opened. Because of
theuncertainty, at these junctures market actorswill run for the
exits rather than bear the costsof a socially optimal transition.
Sustaining so-cially optimal development requires foresightand
coordination, in short, something like avirtuous developmental
state. 2
A predictable discontinuity in the process ofeconomic
development occurs some time aftertake-off. It can be identified
precisely in thecontext of W. Arthur Lewis well-known modelof
industrialization with unlimited supplies oflabor (a model
particularly pertinent to thepresent study). The predicament of
poor re-gions is typically an abundance of poor people,a dearth of
capital, and a weak internal market.W. Arthur Lewis modeled one way
out of thispredicament: matching the boundless domesticsupply of
cheap labor with foreign capital, andexporting much of the output.
(States withlarger internal markets have other
well-knownalternatives, but they rely too exclusively on
animport-substitution strategy at their own peril.)In the Lewis
model, unemployed or underuti-lized labor in the traditional sector
can betransferred to infant industries without dis-rupting, and
arguably improving agriculturalproductivity, while industry
benefits from avirtually unlimited supply of labor at very
low,fixed, real wages (Lewis, 1954, 1958). The stateacts as
facilitator in this take-off scenario: itpeddles the low-cost labor
site; reduces infor-mation costs to foreign investors; shores
upbusiness confidence, and prepares the laborforce for industrial
work.
States pursuing the Lewis strategy inevitablyreach a critical
transition where the sustain-ability of a development momentum
becomesuncertain. This occurs when relative labor sur-pluses are
exhausted (and they are always rel-
ative in a world where the solution ofinformation and incentive
problems elsewhereimmediately open new labor surplus frontiersfor
investors). Investors cannot be expected tocontinue pouring in
while their principal sourceof advantage starts to disappear, and
theeasy stage of export-industrialization withforeign capital comes
to an end. This is thereason why an export-processing zone
strategyis so often viewed with skepticism by develop-ment scholars
(Deere et al., 1990), and recentevidence shows that the payoffs of
export pro-cessing zones are real but quite limited (Mor-timore,
2000; Buitelaar & Padilla Peerez, 2000).
At the end of the easy stage of export in-dustrialization with
capital imports a develop-ing country faces the challenge of
finding a newformula to maintain the investment and growthmomentum.
Foreign investors are market ac-tors who react to changing market
opportuni-ties and will not solve this problem for the hostsociety.
The burden of a solution falls back tothe host state, although it
is another matterwhether it is up to the challenge, or even
ac-knowledges the problem. In short, it is evidentthat states that
pursue a Lewis-type take-offstrategy need, simultaneously, to
prepare for atransition from an economy driven by low-costlabor to
an economy with higher order sourcesof competitive advantage. This
implies thatsuch states have to undergo a transformation inthe
processfrom promotional states to whatwe know as a developmental
states. East Asiantigers showed a unique ability to undergothis
transformation and to move beyond anexport processing zone
stage.
Finance is a central problem tackled by de-velopmental states.
States seeking to initiateand sustain a development take-off have
toaddress the problem of channeling economicsurpluses into new
investment. Because thehorizons of developmental states and
privateeconomic agents are different, and, becausepoor regions tend
to have underdeveloped fi-nancial systems, a push for national
develop-ment has typically required state intervention inthe
process of financing this development(Cameron, 1967; Gerschenkron,
1962; Haggard& Cheng, 1987; Stallings, 1990). States
maydirectly manage the flow of credit, regulate theprivate banking
sector, or do a combination ofboth. The optimal type of state
interventionin structuring the financial system will varyfrom one
stage of development to another;tighter state control and bank
dominationin early stages, nimbler systems later on
PUERTO RICO IN THE POST WAR 283
-
(Choe & Moosa, 1999). Systems with tightbank and state
control are not as good at cross-sectional risk sharing, but are
better at inter-temporal risk sharing and making
long-termcommitments (Allen & Gale, 1995). In spite ofthe
considerable allocation inefficiencies thatcan be created by state
control of finance, evenin extreme cases these can be outweighed
bypositive accumulation and investment gains, asthe case of India
shows (Bell & Rousseau,2001). Indeed, standard economic theory,
Sti-glitz (2000) forcefully argues, has placed undueemphasis on
cross-sectional efficiencies andneglects the positive externalities
associatedwith retaining investment tied to domestic ac-tivities
(this has not always or everywhere beenthe standard argument; cf.
Chaudhry, 1993).State control and direction of the financialsystem
was central to the postwar growth ofJapan (Aoki & Hughes, 1994;
Johnson, 1987;Mabuchi, 1995), and critical to the develop-ment of
South Korea and Taiwan beyond anexport processing stage (Chang,
1999; Cho,1989; Woo, 1991). In contrast, evidence onsecond-tier
NICs seems to show that financialliberalization has made it
difficult to mount atransition from the easy stage of
export-ledindustrization (Akyuuz, 1998). Even in first-tierNICs,
the relaxation of state controls throughhasty and indiscriminate
liberalization has ar-guably had an adverse effect on
development,as Chang (1998) argues for South Korea.
It follows from the preceding discussion thatthe trajectories of
NICs will tend to divergeafter the critical juncture where
effective laborsurpluses are exhausted: (a) some make thetransition
to an upgrading NIC trajectory,characterized by continued high
growth andemployment; (b) others do not, and insteadfollow a
stunted NIC trajectory, characterizedby low growth and growing
unemployment.The ability of states to maintain the momentumwill
depend critically on their capacity to har-ness the financial
system towards domestic de-velopment ends (this is one among
otherfactors, of course, including the ability to en-sure that the
accumulation thus promoted be-comes internationally
competitive).
Puerto Ricos transition in the early 1970s fitsthe second
profilea rapid late developer at anearly stage nonetheless detours
into a slowgrowth, stunted NIC, trajectory. Growth ratesdropped to
less than half what they were be-tween 195070 (even with the
substantialbailout effect on growth noted above), andunemployment,
after reaching a low of 10% in
1970, doubled and has stayed in the vicinity of20% since. A
reasonable hypothesis for the fateof the Puerto Rican miracle
follows from thereview of the comparative literature: PuertoRicos
stunted NIC trajectory was caused(among other factors) by the
states inability toset the groundwork for a transition from
thelabor surplus stage. This paper analyzes struc-tural limits on
the apparatus of the promotionalstate that thwarted its capacity to
begin per-forming as a developmental state, specifically inthe
critical area of financing development. 3
3. BACKGROUND: PUERTO RICOSINDUSTRIAL TRANSFORMATION
The 1940s were a transitional decade inPuerto Rico. A
nationalist movement chal-lenging US imperialism crested, then
subsided,its thrust stopped to a large extent by the re-pressive
measures of the US colonial adminis-tration. A new political party
emerged fromthis context to capitalize on widespread popu-lar
discontent with US colonialism and UScorporations that seemed to
dominate themonocrop sugar economy. The Partido PopularDemocraatico
(PPD), founded in 1938, rosequite unexpectedly and defeated
establishedpolitical parties and coalitions in the 1940
leg-islative and municipal elections (at the time, thegovernor was
still a colonial appointee). Withthe campaign slogan Pan, Tierra,
Libertad(Bread, Land, Liberty) the PPD popularized
ananti-imperialist platform that made a plea fornational
sovereignty on economic and politicalfronts, economic
reconstruction, and re-dis-tributive justice (Anderson, 1965).
Over the course of the 1940s the PPD es-tablished an electoral
dominance that extendedfor 28 years. By the mid-1940s, the party
star-ted to focus more tightly on electoral ends, andbitter
internal conflict flared up between the topleadership and a
majority of party cadre overcommitment to the original
anti-imperialistplatform. After months of deft maneuvering,and
successive party purges, the charismaticleader Luis Mu~nnoz Marn
forced the party toleave behind its anti-imperialist platform
(An-derson, 1965).
Economic reconstruction and social justicewere also central to
the original PPD platform.Proposals on this front included land
redistri-bution and breaking the overwhelming powerof landed
interests tied to sugar; agriculturalrestructuring to foster
diversification and in-
WORLD DEVELOPMENT284
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ternal linkages; and, finally, a program of in-dustrialization
hinging on limited import-sub-stitution, strategic but limited
participation ofstate enterprises in areas where private
capitalproved too risk-averse, and promotion of adomestic
capitalist class. Public powers of thestate were prevailed upon to
plan, direct, exe-cute, and coordinate economic
reconstruction.Without question, in the early 1940s the PPDwas a
party at the helm of a developmentalstate project (Anderson, 1965,
pp. 6872; Dietz,1989; Moscoso, 1985; Perloff, 1950).
The PPDs developmental state project wentthrough two distinct
phases: first, a statecapitalist phase lasting from 194146;
andthen, without making any major strategicpronouncements, the PPD
shifted to a liberaldevelopment strategy some time between 194647.
One by one, the state administered by thePPD started to abandon
most projects fromthestate capitalist phase: the limited programof
import substitution and state enterprises,land reform, and
state-directed agriculturaldiversification efforts. As this
occurred, thefoundations were laid for an
industrialization-by-invitation program modeled after the
Lewistake-off strategy (Dietz, 1989; Edel, 1962).
In light of the earlier theoretical discussion,one can
appreciate how, knowingly or not, thistransition could seal the
long-term fate ofPuerto Rican postwar development. On the onehand,
the state embarked on the path outlinedby Lewis model of
industrialization with un-limited labor surpluses; on the other, it
did so ina context where state instruments for economicintervention
were being radically scaled back.Over the long run, did this impair
the ability ofthe Puerto Rican government to contend withthe
predictable problems toward end of thelabor surplus stage?
There are two prevalent types of analysis ofthe 194647
transition and of subsequent de-velopment, but neither is of much
help in ex-plaining the problems that eventually boggeddown the
Puerto Rican economy. According toone set of accounts, the course
of developmentduring and after the critical transition of 1947was
determined almost exclusively by the ra-tional choices of
autonomous state managersmaking pragmatic decisions under
changingeconomic constraints. This is the typical anal-ysis offered
by executives and former executivesof key development agencies
(e.g., Moscoso,1985; Picoo, 1962). These argue, quite
plausibly,that a number of factors forced pragmatic statemanagers
to reconsider the feasibility of earlier
plans involving significant state direction,regulation, and
participation. State financialresources were too meager to lead an
industri-alization drive with state enterprises; resourcesto
complete land reform were lacking; the statelacked managerial
resources to run its enter-prises; the states dual interest in
developmentand legitimacy undermined its ability to runstate
enterprises effectively, etc. Deliberately ornot, these analyses
reduce all pragmatic con-straints on state managers to a matter of
re-sources, as if their choices did not havedistributive
consequences, and ignoring theextent to which they generated a
considerabledomestic opposition, especially from the PuertoRican
business class.
Alternative explanations are critical of thispragmatic state
manager account. Accordingto these, the direction of Puerto Ricos
eco-nomic development in the 20th century wasalways determined by
overbearing externalforces. These external forces are
variouslyunderstood as US imperialism (Dietz, 1979),a situation of
dependency (Villamil, 1979),transformations in the hierarchical
interna-tional economic order (Pantojas-Garca, 1990),or simply
capitalism (Santana Rabell, 1989).These external forces were the
real constraintsoperating on pragmatic state managers. Thevarious
explanations stressing external deter-mination have a richer
conception of the pos-sible constraints affecting Puerto Rican
statemanagers, but they are also myopic. Both ac-countsthose
stressing the pragmatism of statemanagers, and those that stress
external deter-minationtend to ignore how the domesticpolitical
economy shaped the course of PuertoRicos economic development.
Many studies that stress external determi-nants of Puerto Rican
development havelargely focused on the crisis of the Puerto
Ricanmodel in the 1970s. The 1940s, by omission, aresimply assumed
to follow the pattern of exter-nal determination. An examination of
thosestudies that have analyzed the transitional1940sDietz (1989),
Santana Rabell (1989),and Pantojas-Garca (1990)however, revealsno
concrete evidence to support the hypothesisthat overbearing
external forcese.g., US im-perialismwere the cause behind the
liberalturn of Puerto Rican state managers. More-over, what we do
know about the turn to liberalindustrialization in Puerto Rico does
not lendsupport to the external determination thesis.US firms
attracted to Puerto Rico in the 1950swere relatively small,
labor-intensive operations
PUERTO RICO IN THE POST WAR 285
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in declining sectors with a grim future in theUnited States
(notably, shoe and textile man-ufacturers and subcontractors).
These US cap-italists did not have a political or economicpresence
before 1947 that could explain thePPDs decision to abandon its
statist program.In fact, Puerto Rico at the time was such
adifficult sale that it took three or four years ofhard and
uncertain promotional work beforethe Puerto Rican Economic
DevelopmentCompany (FOMENTO) was able to attractany significant
number of US companies. Theturn to private foreign private
investment wasinitially so uncertain that each new plant
wascelebrated with the orchestrated fanfare of adevelopment agency
fearful of losing publicsupport for its efforts (Ross, 1976, pp.
9597,117122). Ironically, the most significant in-tervention by the
US government in domesticeconomic affairs was on behalf of US
unionsfighting so-called runaway shops, not UScapitalists (Galvin,
1979). Available evidencesimply does not reveal a collusion of US
gov-ernment and segments of US capital lurkingbehind the PPDs turn
away from a statist modeof development. 4
US capital was poised for an unprecedentedoverseas expansion on
the wake of WWII, andthe US government was certainly at the helm
ofefforts to build global framework for liberalizedtrade and
investment favoring US corporations(McMichael, 1996). Had the
question of PuertoRican development been put to Washingtonpolicy
makers in the form of a menu of choices,it is likely they would
have selected a liberalinvestment regime over a program with
con-siderable state intervention. But Puerto Ricohas seldom been a
central policy concern inWashington, and the responsibility for
PuertoRican affairs has never been clear within thefederal
structure (Lewis, 1963). It is also worthkeeping in mind that US
imperialism wasquite flexible and pragmatic in accommodat-ing
heterodox economic regimes during thepostwar eraeconomic
nationalism in LatinAmerica and Asia, shades of social democracyin
Europe. There is no a priori reason to be-lieve there was less
elbow room for a creativecompromise with imperialism in a
Caribbeanterritory whose residents could expect someleniency from
their colonial patron, particularlyin the early 1940s, in the
aftermath of a deepcrisis of legitimacy for the colonial
adminis-tration.
When the United States was badly in need ofa local ally capable
of rebuilding its legitimacy,
the PPD entered the historical stage, and itmade every effort to
exploit this opportunity.The PPD distanced itself from anti-US
na-tionalists and socialists, and was always carefulto draw a
distinction between the evils ofsugar imperialism and the
essentially benign,if neglectful, US government (Quintero
Rivera,1985). Even when it proposed national in-dependence and
unorthodox development stra-tegies, the party assiduously
cultivated thesupport of the Roosevelt administration. Allthings
considered, it is fair to imagine the de-velopmental state project
of the PPD enjoyedsufficient autonomy from US imperial
interestsduring the 1940s. With this in mind, the anal-ysis that
follows turns attention to the roleplayed by the domestic business
class in theprocess of dismantling the PPDs developmentalstate
project, and more importantly, the long-term effects of this
liberalization.
4. A TIGER OUT OF STEAM
(a) First approximation: economic causes
Nineteen seventy-four was the year whena crisis in the vaunted
Puerto Rican industri-alization model became obvious,
althoughproblems were evident earlier. After averaging7.7% per
annum real GDP growth rates overthe previous 15 years, there was no
real GDPgrowth that year. Over the decade that fol-lowed, annual
growth averaged a paltry 1.9%(Curet, 1986, pp. 49, 84, 91). The
first OPEC oilshock and the economic downturn in theUnited States
(principal market for PuertoRican exports) had an undeniable
impact, butthe economy never recuperated its previousluster, which
suggests that a more complicatedarray of factors produced the
crisis. Manyother countries entered a period of slow growthat this
juncture, and in this sense Puerto Ricowas certainly not unique
(Maddison, 1991). ButPuerto Ricos trajectory did start at this
junc-ture to diverge markedly from that of the fourAsian tigers,
the most relevant comparatorsin the context of the analysis at
hand: in the1960s Puerto Ricos growth rates were in theballpark
with the four Asian NICs; startingwith the 1970s Puerto Rico was no
longer in thesame category (see Table 1).
A great number of factors are surely involvedin the crisis of
any development model, someglobal and beyond the reach of any
configura-tion of domestic actors, and some domestic. In
WORLD DEVELOPMENT286
-
spite of the adverse global economic climate ofthe 1970s (which
the other NICs weathered),economists have identified endogenous
factorspointing to what seemed like an impendingcrisis.
Productivity (measured as output peremployed persons) started to
decline in theearly 1970s, and this coincided with a markeddecline
in gross domestic investment (a pre-condition of growth in some
well-knownmodels) from 31.1% of GNP in 1970 to 13.9%in 1984 (Curet,
1986, p. 50). Investment in plantand equipment a key component of
investmentfor long-term growth, started a long and sharpdecline in
1970 (investment gross fixed do-mestic investment from both private
and publicsources, though overwhelmingly from privateexternal
sources; it excludes public infrastruc-ture spending) (Curet, pp.
57, 140141). Thisdecline in investment antedated the first
OPECshock and 197475 recession by a couple ofyears, which indicates
Puerto Ricos model wasexperiencing internal problems before
theseexternal economic shocks had their impact.
Sources of investment shifted markedly be-tween 195070, and this
had a bearing on theinvestment slowdown. External sources ofsavings
increased their share from 54.9% to97.9% (54.776.3% if only private
sector sav-ings are considered), with a concomitant de-cline in
domestic sources (Curet, 1986, p. 138).The growing importance of
foreign capital isnot surprising, since the Puerto Rican
devel-opment program actively focused its efforts onpromotion of
foreign investment. Without adoubt the economy benefited immensely
frominfusions of foreign capital; among otherthings, this allowed
the economy to sustain achronic deficit in its trade balance
(Curet, 1986,p. 78). Over the longer term, however, a lop-sided
dependence on foreign investment carriedits own risks. A
significant slackening in the
flow of external capital would have dire con-sequences, and it
did.
A set pattern of easy access to US capital,and chronically low
rates of domestic savings,probably made it difficult to imagine any
degreeof domestic self-sufficiency in financing growth(if that were
a desirable goal). Nonetheless, alate 1960s study of growth and
finance con-cluded, provided the political will, moderatesteps
toward the reduction of extreme depen-dence on foreign investment
were feasible(Freyre, 1969). Twenty years later, an economicreport
for the Puerto Rico Economic Devel-opment Administration still
identified invest-ment dependence as a critical problem.
Itpoignantly underscored a serious governmentfailure and contrasted
the Puerto Rican casewith Asian NICs.
In 1965, [Puerto Ricos] gross domestic investmentwas equal to
29% of gross domestic product. This levelof investment compared
favorably with that in othermiddle income developing economies
[Singapore 22,Hong Kong 36, Taiwan 23, South Korea 15]. Sincethe
level of domestic savings in Puerto Rico was only8% of GDP, the
remaining investment was being fi-nanced by transfers and
investments from outsidethe island. [. . .] In 1965, domestic
savings in the NICsvaried from a low of 8% in South Korea, the
latest ofthe NICs to begin rapid industrialization, to a high of29%
in Hong Kong. By 1983, the NICs had allachieved investment rates of
between 27% and 45%and domestic savings rates had risen to levels
varyingfrom 25% to 42%. Net resource inflows had
declinedproportionately. But in Puerto Rico the investmentrate had
fallen to slightly over 8% of GDP, domesticsaving was still only 8%
and the net resource balancewas down to 0.9% (Stuart, 1987, pp.
23).
The GNP/GDP ratio steadily declined fromthe 1960s to the 1980s
(Curet, 1986, pp. 191192), dropping to 0.70 by 1990 (Junta de
Pla-nificacioon, 1993, Table A-1), reflecting a
steadydenationalization of the economy. More-over, while the role
of foreign capital steadilyincreased, so did the risk of depending
on it. Bythe 1980s, net factor payment outflows ex-ceeded net
long-term capital inflows by a ratioof 2.651 (Stuart, 1987, Table
3). The gap hasbeen filled by a massive inflow of US govern-ment
transfers, but these go principally towardindividual and government
consumption, notproductive investment, so the impact on growthis
limited.
In sum, the crisis of the Puerto Rican modelwas caused by a
conjunction of causes, butthe scissors effect created by (a)
chronicallylow domestic savings, and (b) long-term
Table 1. Average annual growth rate, Puerto Rico andEast Asian
countries
196070197082
GDPGNPpc GDP
Puerto Rico 5.9 7.2 1.9a
Singapore 5.5 8.8 8.5Hong Kong 8.7 10 9.9Taiwan 6.3 9.2 8.0South
Korea 6.4 8.6 8.6
Source: World Bank, cited in Barrett and Chin (1987).a Puerto
Rico figures are for 197584; calculated fromCuret (1986, pp. 49,
91).
PUERTO RICO IN THE POST WAR 287
-
dependence on foreign investment for domesticcapital formation
was a key structural flaw.Chronic dissavings exacerbated a
long-termhyperdependence on foreign investment, and asthe easy
labor-surplus stage came to an end,rates of reinvestment became
predictably ad-verse. Foreign investment can provide both thespark
and the fuel for an industrial take-off,but it is uncertain over
the long run. Over thelong run the solution lies in building
alternativesources of competitive advantage, and stabi-lizing the
continuity of investment by cultivat-ing a sturdy supplement of
domestic investmentsources. It was at this juncture that East
Asiandevelopmental states intervened, increased theshare of
domestic investment sources anddomestic participation in exports,
and success-fully made a transition from the early exportprocessing
zone strategy (Amsden, 1989; Gra-bowski, 1998; Woo, 1991). Those
NICs con-tinued on a high-growth path for another 20years. The
government of Puerto Rico, incontrast, did not make any fundamental
ad-justment to its development strategyforeigninvestment promotion
on the basis of produc-tion cost advantagesand paid dearly in
termsof economic performance. Why did the PuertoRican government
not make similar adjust-ments to deal with the erosion of its
labor-costadvantages? 5 An answer to this question re-quires an
analysis of the political economy thatshaped the Puerto Rican
program of economicdevelopment.
(b) The domestic political economyof stunted development
(i) The elusive class of Puerto Rican capitalists
The establishment of the pre-conditions of economicgrowth is so
handicapped by existing political interestsin some underdeveloped
areas as to make it unlikelythat much can be accomplished without a
forcibleoverthrow of those interests. The revolutionary move-ment
need not be communist . . .
(Mason, 1958).
The Puerto Rican capitalist class disappearedfrom historical
accounts and sociologicalanalysis after 1940 on the unwarranted
as-sumption, it seems, that the power of this classwas
inconsequential. 6 Weak domestic busi-ness classes ought to be
taken more seriously,even where they seem to be overshadowed
byforeign corporate interests. Weak domesticcapitalists have unique
resources at their dis-
posal that give them a power far in excess oftheir direct share
of control over investment.Their leverage comes from the important
inte-grative role they play in the economy. Domesticcapitalists set
the tone for the relationship be-tween foreign investors and the
state; they canfacilitate, or they can foul the relationship.Their
knowledge of the local economy, andtheir business and government
contacts, arevaluable to the state and foreign capitalistsalike.
Their mediating role puts them in theposition to shape perceptions
about the do-mestic business climate: their good word canredeem the
states credibility with foreignbusiness; their vote of confidence
in thegovernment is a proxy for investment risk. 7
Governments wishing to work with foreign in-vestors unavoidably
need to nurture a goodrelationship with local capital; foreign
investorswishing to maximize information and minimizerisk may use
domestic capitalists as feelers.Thus, while weak domestic
capitalist classeslack the structural power that comes withability
to threaten or execute the proverbialinvestment strike, 8 they are
in a good positionto precipitate such a strike. This is the
structuralpower of weak domestic capitalists. 9 Domesticbusiness
classes have in addition another purelypolitical source of
leverage: they enter the frayof national politics and policy
formation witha certain amount of legitimacy that foreignbusiness
lacks.
Strategists within the PPD correctly appre-ciated the early
1940s were a propitious junc-ture for economic reconstruction. The
sugareconomy was in its final throes on account ofadverse US quotas
and declining prices, andthis offered an opportunity to lay the
founda-tions for a new economy before a new impe-rialist combine
could take form (Anderson,1965; Dietz, 1989; Navas Daavila, 1978;
Quin-tero Rivera, 1985). Conditions were also morefavorable for PPD
reformers in the 1940s thanthey had been earlier. In the 1930s,
reformerswere in the political opposition, but with thePPDs 1940
victory they entered government.Finally, as US legitimacy reached
its lowestpoint, the President for the first time appointeda
colonial governor who did not cater to theinterests of privileged
classes. Rexford Tugwell,a member of Roosevelts brain trust
marginal-ized by the rightward turn in the New Deal,was the last
US-appointed governor. He sawthe appointment as an opportunity for
eco-nomic experimentation that was no longerpossible in the United
States, and became a
WORLD DEVELOPMENT288
-
strong supporter of the PPDs statist develop-ment program.
In spite of the unique opportunities affordedby the war years,
the early PPD developmentproject threatened the interests of most
sectorsof the domestic business class. First, the landreform
program sought to redistribute alllandholdings exceeding 500 acres.
While partyrhetoric tended to equate landed power withabsentee
sugar corporations, most corporatefarms above the limit were in
fact domesticallyowned. Four US corporations collectivelyowned some
98,000 acres (Curtis, 1966, p. 10,Table 2), but nearly as much land
was ownedby the largest six Puerto Rican corporateholdings. Over
three-quarters of all holdingsabove 1,000 acres, some 341,000
acres, werethe property of 152 Puerto Rican corporationsor
owner-operators (Dietz, 1989, p. 125). Sec-ond, the PPDs
developmental state projectsought to regulate the monopsonistic
power ofsugar mills. While the American big fourowned 11 sugar
mills in 1938, 31 belonged toPuerto Ricans. Thirty-seven of these
mills werestill in business in 1947; 27 were Puerto Rican-owned,
and these produced more than 60% ofthe islands sugar (Perloff,
1950, pp. 7677).Third, the government established profit-sharing
farms which competed directly withprivate farms and mills, and
which threatenedto raise the wage floor in rural labor
markets.Fourth, plans for agricultural diversificationand
substitution of imports posed a directthreat to oligopolistic food
importers. Finally,state and business agendas clashed over
theideologically charged subject of state enter-prises. Five state
enterprises were establishedby 1946, conceived principally as
demonstra-tion projects to crowd-in risk-averse do-mestic
capitalists. In and of themselves, thesesmall enterprises were not
real threat to theprivate sector.
The governmental enterprises of the insular regime ac-counted
for only 1.2% of total net incomeproving,incidentally, that the
characterization by its critics ofthe Puerto Rican economy under
the New Deal asone of state socialism constituted an
extravagantexample of poetic license (Lewis, 1963, p. 169).
Yet, as a piece of a broader program that had thestate meddling
in areas of traditional businessprerogativeproperty ownership,
management,labor markets, and price determinationstateenterprises
could appear, or be made to appear,particularly threatening.
Considering the impact of the PPD devel-opmental state project
on domestic capitalists,it is intriguing that their influence on
thepragmatism of state managers has not beenstudied carefully. 10
Several studies have notedthat many of the 1940s economic reforms
hadbeen attempted during the Great Depression,and were at that time
defeated by a recalcitrantPuerto Rican elite (Mathews, 1960;
NavasDaavila, 1978, p. 66; Santana Rabell, 1989, pp.5152; Tugwell,
1958, p. 79). It would be indeedsurprising if the elite that
opposed economicreconstruction in the 1930s had not resistedsimilar
efforts in the 1940s. This class in factbecame a considerable
obstacle in the way ofthe early 1940s developmental state
project.
During the 1940s the Puerto Rican businessclass led a broad
offensive against the PPDsdevelopmental state project. This
occurred onseveral fronts simultaneously. A press cam-paign to
discredit the developmental projectviciously attacked it with
charges of state so-cialism, bureaucratic excess, and
incompetence.Conservative US Senators were invited to in-vestigate
charges of state socialism, while do-mestic business tried to
cripple state enterprisesby refusing to purchase their product
(ironi-cally, these were in part established to meet theneeds of
this class amidst wartime inducedshortage). Land reform was bogged
down byyears of litigation and in the end abandonedaltogether. 11
Finally, the domestic businessopposition was able to redirect the
orientationand priorities of the developmental state pro-ject
through direct participation in the admin-istration of key
agencies.
Their participation was more at the level of policy-making than
political activism. Puerto Rican entre-preneurs from private banks
and industries wereincorporated into the board of directors of
Fomentoand of all of its subsidiaries. According to David F.Ross,
they provided a measure of conservatism and re-spectability to the
states industrialization program.Indeed, their participation
ensured that the interestsof the local bourgeoisie were part of the
developmentprogram (Pantojas-Garca, 1990, pp. 5253).
Insofar as the state did not have the capacityto replace the
private sector with a state-man-aged economy (and it was not
considering thisin any event), it had to rely on private
invest-ment. To sustain this private investment, thestate had to be
mindful of the business cli-mate, and this, in turn, meant coming
to termswith the structural power and interests of itsweak domestic
business partner. Domestic
PUERTO RICO IN THE POST WAR 289
-
capitalists, for their part, were aware that thesugar sector
that had dominated the economyfor four decades faced a dead end.
Conse-quently, they had an interest in securing a placefor
themselves in the new economy the statewas trying to build. The
disruptive campaign ofthe Puerto Rican business class put the state
ina position where it needed to placate domesticcapital but not so
obviously that it wouldthreaten its populist electoral credentials.
12
The Puerto Rican business class, for its part,had every
incentive to fend off the statist pro-gram of economic development
and to pusheconomic liberalizationbut to do so underthe convenient
cover of the PPDs populistrhetoric, or else risk a popular
backlash. Inshort, domestic capital and the PPD adminis-tration
faced strong incentives to find someform of mutual
accommodation.
(ii) Development financeA decisivecompromise
Finance is a central problem of economicdevelopment. On the
question of finance, aswith the multiple other areas where a state
cancontribute to development, the success of stateefforts depends
in part on the quality of itsagencies and personnel; but it also
depends ona tricky balance of power, and on the qualityof relations
between the state and the differ-ent domestic sectors in control of
key produc-tive assetsbanks, industry, landed interests(Evans,
1998). This section examines how thedomestic political economy, and
specifically,the tensions and accommodation between thegovernment
and private banks, shaped theframework of development banking for
PuertoRicos export-led development. The analysisthen turns to the
long-term negative effects ofthis government-bank compromise.
PPD reformers during the 1940s were clearlymindful of the
importance of finance, and oneof their first state-building moves
was to es-tablish a government development bank tosupport the
governments development pro-gram. Law 252 of May 13, 1942,
established theGovernment Development Bank (GDB), aninstitution
charged with facilitating long-termfinancing for the projects of
the Industrial De-velopment Company, the Land Authority,other
government development efforts, andwith promoting domestic
manufacturing gen-erally. The law also entrusted the Bank
withfiscal agency functions, which authorized andrequired it to
manage Treasury deposits, andthe public debt of the state and
public corpo-
rations (Dietz, 1989, p. 206; Maldonado, 1970,p. 55; Perloff,
1950, p. 39). A development bankwas an indispensable tool to
support publicinvestment projects, and to overcome the aver-sion of
domestic business to investments out-side areas where they
traditionally enjoyedprotected rents and reduced riskimport
lux-uries, land-speculation, commercial expansion,and hoarding
(Perloff, 1950, p. 166). Develop-ment finance is a demanding task
for any state,in no small measure because it seeks to imposesome
discipline on market actors that wouldrather do without it. In the
1940s this put thePPD on a collision course with commercialbanks,
the most robust segment of the PuertoRican business class.
Commercial banks were the only significantfinancial institutions
in Puerto Rico on the eveof industrialization (Maldonado, 1970, p.
46).Puerto Rican banks were the strongest segmentof the domestic
business classnone otherproved more resilient in the face foreign
com-petition, or gained so much ground over thefirst four decades
of the 20th century. WhenPuerto Rico became a US possession in
1898,commercial banks were feeble institutions witha short history;
at that time the three banks thateventually survived through 1930
had total as-sets that did not reach $180,000 (Sanz, 1969,pp. 58).
By 1928, there were four US andCanadian banks operating in Puerto
Rico, andthe number of domestic banks had increased to14. Puerto
Rican banks accounted for approx-imately 40% of commercial bank
capital on theeve of the Depression, in spite of governmentdeposit
polices that favored a US bank, theAmerican Colonial Bank (Sanz,
1969, pp. 89;Clark, 1930, p. 376). Puerto Rican banksprospered by
working niches that US andCanadian banks could not serve as well:
theyfinanced sugar and coffee producers, andextended personal loans
secured against realestate, while US and Canadian banks tended
toconcentrate on financing importexport activ-ity. Puerto Rican
banks were favored by familyand business networks that spread into
nu-merous areas of economic activity, and by abetter understanding
of the local clientele.Their successful participation in New
Yorkcapital markets and adaptation to US regula-tory agencies
allowed them to survive foreigncompetition (Cochran, 1959).
Although Puerto Rican banks more thanheld their ground through
1940, the next twodecades were the start of their golden age.During
the 1940s banking assets increased at a
WORLD DEVELOPMENT290
-
yearly rate of 11.5% (up from 6.6 for 190740),and from 195067,
the glory years of the PuertoRican industrialization, their annual
rate ofgrowth was 12%. By 1967, eight domesticallychartered banks
held 62.5% of all assets in theprivate commercial banking sector
(Maldo-nado, 1970, pp. 9192). Given the importanceof bank finance
in the early stages of develop-ment, state planners could not avoid
the taskof seeking a mode of cooperation with thedomestic banking
sector.
The new era ushered by the Partido Popularsdevelopment project
clearly proved to be aboon for domestic banks, but this outcome
wasnot at all certain when the party first took officein 1941.
Economic development is in the in-terest of banks, insofar as it
increases demandfor private financial services. Nevertheless,
stateefforts to direct the financial system towarddevelopment goals
are a matter to concernprivate financial institutions.
Theoretically thereare long-run gains that result from state
stew-ardship, but long-term development dividendsare always
uncertain. In the short term, stateefforts to regulate the use of
savings and debtcompete with private banks for a fixed pool
ofdomestic savings and external capital. In addi-tion, when state
bureaucracies become activelyinvolved in regulating a market there
is theproverbial slippery slope of bureaucratic over-extension. It
is not difficult to see why efforts toestablish a Development Bank
in 1942 addedto the mounting tensions between the statedevelopment
program and the domestic busi-ness class.
A relationship developed between the gov-ernment of Puerto Rico
and private domesticbanks after 1940 that has not been examined
todate, but which in retrospect had a determinanteffect on the fate
of the Puerto Rican industri-alization program. Before 1940,
governmentdeposits were held by US chartered banks, upto 90% by the
American Colonial Bank (Sanz,1969, p. 9). After 1940, the year of
the PPDsfirst electoral victory, the Treasury Departmentinitiated a
new policy of favoring Puerto Ricanbanks. Interestingly, although
this policy seemsquite consistent with the early nationalist
pri-orities of the Partido Popular, it was never anexplicit theme
in the partys platform, nor has itsurfaced as a matter for
examination in studiesof the period. This change in Treasury
policywas a boon for domestic banks. By the mid-1940s Treasury
deposits were already evenlydivided between Puerto Rican and US
banks;by 1950, two-thirds of these deposits were
placed with Puerto Rican banks. Treasury de-posits were not that
critical for US-charteredbanks because these had access to
statesidedeposits. For domestic banks, however, thechange in
Treasury policy was a blessing, rais-ing deposits anywhere between
50100% in theearly part of the decade. Government depositsmeant a
substantial increase in volume, but alsoacted as a form of
insurance at a time whendomestic banks were not insured.
Domesticbanks were able to parlay these new advantagesinto a decade
of unprecedented growth in de-posits, assets, and market share.
Between 194253 total deposits quadrupled and capital assetstripled
(US banks, in contrast, increased de-posits by only 35% in the same
period) (DiVenuti, 1955, pp. 4344, 46, Tables 1013).
The new Treasury policy was undoubtedly aboost to Puerto Rican
banks, but relations withthe government did not end there.
Governmentplans to establish a development bank were asource of
consternation among bank execu-tives. In the course of an interview
with a USSenator investigating allegations of state so-cialism in
Puerto Rico, a member of the Roigbanking family expressed fears
about the plansfor a development bank, and in particular,about the
unfair extension of state prerogativeswhich this entailed (Tugwell,
1947, pp. 529530). There was a matter of unfair directcompetition
for individual deposits, but moreimportantly, with the founding of
the devel-opment bank, private bankers also faced therisk of losing
part of their share of Treasurydeposits. These deposits offered
state develop-ment planners a source of leverage, and theycould be
made conditional on bank coopera-tion with development plans.
Considering thefull ramifications of the proposed developmentbank,
it is not difficult to appreciate why localbankers were
apprehensive.
The worst fears of domestic bankers, how-ever, did not
materialize. Rafael Buscaglia wasthe first Treasurer of the first
PPD adminis-tration, and on his watch, the depository policystarted
to favor Puerto Rican banks. Buscagliahad good relations with
private sector bankers,supported them, and was held in high
esteemamong bank executives (Sanz, 1969, pp. 21, 15).While Puerto
Rican banks had reasons to beconcerned about the establishment of
theGovernment Development Bank, in Buscagliathey had a trusted
supporter; and Treasurysupport in the battle over development
bank-ing was important because the Treasurerwas directly
responsible for the Government
PUERTO RICO IN THE POST WAR 291
-
Development Bank. From the Treasury De-partment Buscaglia moved
on to become thefirst President of the Government DevelopmentBank,
a move that could only allay the con-cerns of private bankers. A
member of thePlanning Board that later became president ofthe
Development Bank, commented on how, infact, at the beginning the
Bank developedslowly; it had to be brought along under
thediscipline and heat of the Secretary of theTreasury (Picoo,
1962, p. 247) [my italics].
An accommodation between the Treasury andthe private banking
sector was consistent with alarger pattern of accommodation taking
placebetween the state and the private sector on manyfronts. It is
against this backdrop that theTreasurys slow and cautious
stewardship overthe Development Bank should be understood.On the
agrarian front, the Land Authoritystopped pursuing land reform in
1944, and mostof the land acquired after that date either
per-tained to consent decrees signed by 1944, or wassimply
purchased in the open market (Edel,1962). In FOMENTO, the
industrial develop-ment agency, Teodoro Moscoso was active be-hind
the scenes, at least as early as 1945, layingthe groundwork for a
shift from a statist to aliberal industrialization program founded
onforeign investment promotion (Ross, 1976,Chapter 5). FOMENTO
managed five state en-terprises, and was so central to the state
devel-opment program, that Moscosos efforts couldnot have been a
mystery to his colleagues in theDevelopment Bank and the Treasury.
Finally,Luis Mu~nnoz Marn, the charismatic PPD leaderwho led the
charge against sugar imperialism,distanced himself from
programmatic commit-ments to state-led development and
nationalindependencegingerly at first, and in an openand
acrimonious public fight with other partymembers in 1946 (Anderson,
1965). With each ofthese shifts, the PPD drifted further from
theinitial commitment to a developmental stateproject. In this
context, the Planning Boardfound itself under attack by officials
formerlycommitted to the state development program(Descartes, 1946,
pp. 1213), and its role ineconomic planning was reduced to
planningfor public infrastructure. By 1946, GovernorTugwell was the
only ranking member of theadministration still committed to strong
statestewardship in the development process, butended up resigning
the post, fully aware of hisgrowing political isolation.
Ultimately it was the Government Devel-opment Bank that was
starved of Treasury
support during much of the 1940s, not privatebanksin spite of
bankers fears. Treasurydeposits with the Government DevelopmentBank
were very limited for the greater partof the decade, until about
1947. After thatyear, the Treasury literally, and
figuratively,started to deposit more trust in the Bank (seeTable
2). Treasury deposits with the Govern-ment Development Bank only
reached a stableplateau after 1949. The Development Bankwas
virtually on a short leash until the originaldevelopment program
that so upset the do-mestic business class had been
effectivelydismantledland reform halted, state enter-prises
privatized, and the activities of thePlanning Board narrowed to
infrastructuredevelopment.
The Government Development Bank itselfwent through some
transformation before itstarted to receive Treasury support. Two
leg-islative acts, Law 272 of 1945, and Law 15 of1948, reorganized
the development bank andnarrowed its functions. The Bank ceased
ser-vicing private savings accounts (and hencecompeting with
private banks), and its workwas focused more narrowly on fiscal
agencyfunctions that are by nature conservative. By1948, articles
defining the Banks charter madeno reference to development
functions that hadbeen part of the Banks original chargefinancing
industrialization, nurturing domesticcapital, etc. Only a vague
rhetorical commit-ment to development remained in the
1948charter:
To aid the Commonwealth Government in the perfor-mance of its
fiscal duties and more effectively to carryout its government
responsibility to develop the econ-omy of Puerto Rico, particularly
with respect to its in-dustrialization . . . (Act 17 of 1948,
Section 1).
The obligations specifically mentioned in therevised charter
were narrow, and symptomaticof the broader liberalization of the
develop-
Table 2. Development bank treasury deposits as a % oftotal
treasury deposits
1943 01944 2.91945 91946 6.71947 13.2194953 2025%
Source: Calculated from Di Venuti (1955, p. 44, Table
14).
WORLD DEVELOPMENT292
-
ment program under way. The Bank was in-structed to
invest its funds in direct obligations of the UnitedStates or
obligations guaranteed as to both principaland interest by the
United States. [. . .] or obligationsof Puerto Rico, or guaranteed
as to both principaland interest, by Puerto Rico [. . .] The Bank
may alsoinvest its funds in bank acceptances or other obliga-tions
or certificates of deposit endorsed or issued, asthe case may be,
by banks organized or authorizedto do business under the laws of
the Commonwealthof Puerto Rico, the United States, or any State
ofthe Union (Act 17, 1948, Charter, (E), as amendedby Act 3, 1957,
Act 55, 1965, Act 1, 1986).
By law, the only obligation of the re-re-structured development
bank was to maintain avery conservative portfolio, and within
thatconservative mandate, it was instructed to keepa portfolio that
stabilized the domestic bankingsector as a whole. The Bank was
reorganized tobecome a judicious fiscal agent for the state,and an
effective banking sector stabilizer, but inthe process it was
stripped of all but rhetoricalcommitments to development banking
with along view.
Angel Sanz, president of the Banco Creedito yAhorro Ponce~nno in
the 1940s, took some pridein observing that an esteemed colleague,
andhis successor, Esteban Bird, actively partici-pated in drafting
the charter and restructuringthe Government Development Bank
(Sanz,1969, pp. 8, 21). Bird later went on to becomepresident of
the Government DevelopmentBank. Bird succinctly described the
qualitativetransformation in the relations between theGovernment
Development Bank and privatebankers.
When the [development] program started in 1942Esteban Bird was
with a private bank, and like nearlyall the businessmen and bankers
he knew, opposed theprogram. Six years later he was working for it
as ahigh executive of the Governments DevelopmentBank. I
interviewed him there. Today, he said,these men [bankers] have
become convinced of theintegrity of the administration and the
soundness ofthe Fomento idea. Ive been here two years now,and no
political pressure of any kind has ever beenput on this office
(Chase, 1951, p. 33).
The establishment of Government Develop-ment Bank was of clear
concern to privatebankers; to placate banker opposition the
statechanged its own priorities, and representativesof the domestic
banking sector participateddirectly in the process of restructuring
the
Government Development Bank and liberaliz-ing the framework of
development banking.
(iii) The long-term effects of the compromise ondevelopment
finance
Having the Government Development Bank of PuertoRico set the
terms of our developmentand it doesis analogous to having a goat
look after your cabbagepatch. Government planner, 1990s.
As a fiscal agent, the Development Bank hasbuilt a strong track
record over the years. Ex-cept for a brief period in the mid-1970s,
PuertoRican debt instruments that financed publicinfrastructure
maintained high ratings throughthe late 1970s (US Department of
Commerce,1979). Every significant economic study since1950 concurs,
however: the Government De-velopment Bank never became an
effectivemechanism for industrial development (Comiteepara el
Estudio de las Finanzas, 1976, pp. 8283;Consejo Asesor, 1989, pp.
7072; Di Venuti,1955; Maldonado, 1970, p. 57; Perloff, 1950, p.106;
Puchi-Acu~nna, 1984). In the late 1940sPerloff observed, in a
seminal study of PuertoRican development,
[D]evelopment Bank . . . loans for industrial purposeshave been
quite limited in scope and amount. Duringthe fiscal year 1947
direct industrial loans of 2,065,000were made. As of June 30, 1948,
total legislative ap-propriations for the bank amounted to
$20,500,000.The bank has the power to issue its own bonds, butno
bond issue has yet been floated (Perloff, 1950,p. 107).
In the mid-1950s a study of the Puerto Ricanfinancial sector
again noted about the Bank:structurally it still is not organized
to carry onan intensive lending operation of the kind es-sential to
the promotion of economic develop-ment (Di Venuti, 1955, p. 88; see
also Comiteepara el Estudio de las Finanzas, 1976, p. 82). In1962,
a former executive of the DevelopmentBank lamented: We still need
mechanisms andsources for the creation of investment with
along-time-view (Picoo, 1962, p. 239, my trans-lation). Decade
after decade, studies havepointed to the institutional deficiency
of theGovernment Development Bank. We have seenthat faulty
institutional design was only theproximate cause of the Development
Bankspoor performanceultimately this institutionalweakness was the
result of a compromise be-tween the government and private
bankers.
PUERTO RICO IN THE POST WAR 293
-
Between 195067 the Government Develop-ment Bank played a key
role in financing publicinfrastructure, but, notwithstanding its
nameand rhetoric, its role as a development bankwas marginal at
best. During these years, 75%of all long-term investment in Puerto
Rico wentinto housing, with mortgage bankers the prin-cipal source
of long-term investment (54%),followed by the US government (17%),
and thePuerto Rican government (16%). Only 25% oflong-term finance
went into areas other thanhousing, including investment in
productiveassets (Maldonado, 1970, p. 49). Here thecontribution
made by the Development Bankwas negligible until the late 1960s;
during thecrucial years of industrial take-off, the
Bankcontribution to financing nonhousing develop-ment (1951 0%)
(see Table 3).
A cautious look at Table 3 might suggest thatthe Development
Bank simply took some timeto get on with the business of financing
long-term investment, but the Banks asset portfolioin the late
1960s shows this continued to be avery marginal part of its
business. Over half ofthe Banks assets were in low-risk
governmentsecurities, much of this contributing to capitalformation
outside Puerto Rico (US securitiesplus an undisclosed proportion of
municipalbonds that were not Puerto Rican governmentissues). Even
the modest loan activity, 33% ofits portfolio, shows no clear
commitment toindustrializationa mere 16% of bank assetswere in the
form of industrial development fi-nance, the purported priority of
the govern-ments development program (see Table 4). 13
Almost as early as the industrialization-by-invitation program
got underway the Gov-
ernment Development Bank of Puerto Ricohad become something
other than a develop-ment bank and this deficiency continued
intothe 1990s. Chronic domestic dissavings coupledwith a weakening
foreign investment were ear-lier identified as underlying causes of
theslowdown in Puerto Ricos export-led indus-trialization. A state
intent on sustaining a de-velopment momentum might use its
financiallevers to counteract the weak investment func-tion
underlying slowdown; the GovernmentDevelopment Bank, however,
instead added tothe problem. Figure 1 is a simplified chart
offinancial flows between government, the devel-opment bank,
private banks, and the domesticand external sectors. The magnitude
of differentflows, by origin, and by destination, gives arough
sense of the role and priorities of thedevelopment bank through the
early 1990s.Flows originate in two types of financial
inter-mediariesthe development bank and privatecommercial banks,
and they reach several des-tinations: US government securities,
PuertoRico government bonds, commercial banks,consumer loans, real
estate, industrial andcommercial enterprises. Total flows,
brokendown by destination, are as follows (in billionsof dollars):
US government securities, 3.8 bil-lion; Puerto Rico government
bonds, eightbillion; commercial banks, 3.6 billion; con-sumer
loans, 3.5 billion; real estate, 3.8 billion;and industrial and
commercial loans, 5.387billion, for a total of 28.47 billion. Of
the creditmade available by all banking intermediaries,about 18.92%
reaches industrial and commer-cial enterprises. Whether this figure
is high orlow by comparative standards is a matter Ileave aside
here. Instead, what I wish to high-light is the meager contribution
of the Devel-opment Bank. While 25.6% of outflows fromcommercial
banks go to industry and commerce(5.2/20.3), only a paltry 2.4% of
DevelopmentBank outflows reach commerce and industry
Table 3. Supply of long-term finance, excluding
housing,195167
Distribution % oftotal
1951 1957 1967
Commonwealth Government 12.3 77.8 43.3Government
DevelopmentBank
0 5.3 19.7
Industrial Development Co. 12.3 72.5 17.6Other 0 0 5.9
Commercial Banks 58.9 7.4 1.5
Private Nonbank 0 0 37.7Insurance Companies 0 0 30.9Other 0 0
6.8
Source: Maldonado (1970, p. 53, Table 4.3).
Table 4. Government development bank asset profile,1967
Government Securities 50.8US Government (32.4)Municipal Bonds
(incl. Common-wealth Bonds)
(18.4)
Loans 33Industrial (16)Commercial (10)Misc. (5)
Source: Maldonado (1970, p. 57).
WORLD DEVELOPMENT294
-
(the figure for industry alone, which is notshown in Figure 1,
is around 1%). The publicinstitution that purports to finance
develop-ment, and, one expects, ought to place a goodportion of its
bets on industry and commerce(not to mention riskier industrial and
com-mercial bets), turns out to be far more conser-vative than even
private sector commercialbanks (all figures, Junta de
Planificacioon, 1993).
By the early 1990s, the share of GovernmentDevelopment Bank
assets in low-risk govern-ment securities and bank deposits
reached97.6%. Almost half of these assets were actuallyinvested
outside Puerto Rico in the form of USGovernment securities.
Government Develop-ment Bank investments outside Puerto
Ricoexceeded loans to industry and commerce by afactor of 20 (and
exceeded loans to manufac-turing by a factor of 45). Domestically,
Devel-opment Bank deposits with commercial banksexceeded loans to
industry and commerce by afactor of 11, and loans to industry by a
factorof 25 (all figures are from Junta de Planifi-cacioon, 1993,
Chapter 6). Meanwhile, Bankpolicies bolstered profits in the
commercialbanking sector, as it injected liquidity into
thefinancial system (in the early 1990s it accountedfor 42% of all
certificates of deposit in domesticcommercial banks), and
considerably reducedthe cost of money to domestic banks
(Junta,1993, Chapter 6). Banking sector growth aver-
aged 15% per year from the early 1980s to theearly 1990s (Junta,
1993, Chapter 6); in con-trast, real GDP scarcely averaged 2%
growthper annum, and the share of domestic firms inoverall profits
dropped below 2% (Stuart,1987).
5. DISCUSSION
An investment bottleneck, resulting from acombination of weak
internal savings and aslowdown of external inflows caused by the
endrelative labor surpluses seems to underliePuerto Ricos
transition from a stage of highgrowth and declining unemployment to
a stageof low growth and high unemploymentfrommiracle to debacle.
The problem of chro-nic domestic dissavings was well known in
thelate 1960s (Freyre, 1969), and the slowdown offoreign investment
with declining labor costcompetitiveness was predictable. In spite
ofthis, the government had no effective mecha-nism or plan to
counteract this structuralweakness in the investment function.
Given thispredicament, it is surprising that through theearly
1970s, and for an additional two decades,the Government Development
Bank contrib-uted only marginally to long-term financing
ofindustry. This was neither coincidental nor asimple flaw of
vision or leadership.
consumer loans
real estate
industrial & commercial loans
U.S. Govt Securities
U.S. municipal bond market
Banks
Dev Bank
Govt. of Puerto Rico
Bonds
Revenue
External Capital Markets
3.5
3.8
0.187
3.4
1.09
6.3
2.1
1.7
1.5
3.8
3.5
5.2
Commercial
Figure 1. Financial flows of the Puerto Rican banking system,
1992.
PUERTO RICO IN THE POST WAR 295
-
The Government Development Bank func-tioned efficiently within
the parameters of itscharter. But that charter was gradually
nar-rowed in the course of the 1940s in a way thatruled out a
leading role for the Bank in fi-nancing any type of industrial
transition. TheBanks contribution to the development processwas
circumscribed in response to domesticbusiness opposition, and
specifically, the op-position of domestic bankers. During theeasy
stage of export industrialization thispresented no problems;
orderly government fi-nances and infrastructure development
wereenough to abet the growth momentum. But atthe end of the easy
stage the government ofPuerto Rico found itself bereft of a
mechanismto counterbalance the chronic shortfall in in-vestment and
domestic savings that startedweighing the economy down; it lacked
amechanism to lead the process of industrialrestructuring away from
dependence on laborcost advantages.
Bound as it was by a conservative charter tostabilize domestic
banking and government fi-nances, the Government Development Bank
insome ways exacerbated the problem: its con-tribution to
industrial and commercial capitalformation in the island was
negligible andmuch of the asset portfolio was outside theeconomy.
It should not come as a surprise ifprivate investors, foreign or
domestic, decidenot to reinvest vigorously in an economytheyhave
unique priorities and a world of choices. Itis striking, however,
to discover that, as thisoccurred, there was no visible change in
De-velopment Bank policy to counteract thesetrendsthe proportion of
Bank assets placedoutside the Puerto Rican economy
actuallycontinued to rise through the early 1990s.State- and
bank-dominated financial systemsplay a critical role in financing
early stages ofindustrialization, but in Puerto Rico, we haveseen,
the state gave up any means to redirectsome sizable pool of
domestic and externalsavings into accumulation. Over the long
term,the liberalization of development bankingturned out to be a
serious institutional inca-pacity for a state committed to
development.Notwithstanding its name, the GovernmentDevelopment
Bank was clearly designed not tobecome directly involved in
financing industri-alization. Its principal role was of fiscal
agentand stabilizer for the domestic banking sector.Both are
critical functions, but in this instancestabilizing private banking
has come at a highcost: an institutionalized long-term pattern
of
bets against domestic capital formation.Here the divergence
between private and socialoptimality has been indeed wide.
The precise nature of the causal argumentmade in this paper
should be clearly restated toavoid confusion. Strictly speaking,
was theDevelopment Bank one of the causes of crisis inthe Puerto
Rican model? Strictly speaking, no,but in fact yes. Development
Bank practicesor portfolio management preferences werenot the
immediate cause behind the weakeningin external capital inflows and
re-investmentratesthis was the endogenous product of alabor-surplus
strategy whose time horizon isinherently limited. Neither were
DevelopmentBank practices the direct cause of other
factorsassociated with the crisis of the Puerto Ricanmodel, to wit:
a negative marginal propensityto save, one of the lowest ratios of
productiveinvestment in the world (measured as a ratioof investment
in plant and equipment to hous-ing investment), and an excess
concentration ofexternal capital financing short-term consumerdebt
(Gutierrez, Saanchez, & Caldari, 1979). Allthese problems point
to deficiencies in the fi-nancial system as a whole. The
DevelopmentBanks was a sin of omission. When the privatefinancial
sector can or will not solve problemsof socially suboptimal
financing of develop-ment, the responsibility falls back on state
en-tities representing the public trust in thatsphere. But the
Government Developmentsimply continued the established pattern
ofstabilizing domestic commercial banking as itexistedin fact, as
we have seen, over time itspractices became even more conservative
thatthose of the private sector. There are neverguarantees that a
state promoting developmentwill succeed when it tackles problems
that standin its way; but when the problems are known,and a
response is not forthcoming, the stateshares in the responsibility
for the outcomes.The fact that some or even most of the prob-lems
were not created by the DevelopmentBank in the first place makes
little difference.Little credence would go to a top managementteam
in a corporation facing bankruptcy thatabsolves itself by arguing
we were not thecause of bankruptcy, it was the changing
envi-ronment in our industry. Some organizationsare charged with
reaching goals within achanging environment; states with strong
rhe-torical commitments to development areamong them. It is in this
sense that the devel-opment banking practices of the Puerto
Ricangovernment are implicated as a cause in the fall
WORLD DEVELOPMENT296
-
of the fifth tiger. The remote historical causesof this
complicity were the accommodationbetween state and private sector
on the eve ofthe export industrialization program.
Development finance and the orientation ofthe development bank
have been the focus ofthis paper, but it is important to bear in
mindthat they were part of a broader developmentstrategy, and that
strategy itself was flawed.None of the principal government
agencies fordevelopmentIndustrial Development Corpo-ration
(FOMENTO), the Planning Board, orthe Bankmade a qualitative change
in theircourse to either anticipate the end of the laborsurplus
stage or to counteract the investmentsqueeze. Industrial
development continuesto mean promotion, and planning per-tains
exclusively to infrastructure development.Against reason, the
entire Puerto Rican devel-opment modelshaped in the heat of
battlebetween business and state developmentalistswas premised on
the effectiveness, in perpetuity,of a hands-off promotion strategy.
The Bankis thus not single-handedly responsible forthe socially
suboptimal transition of the early1970s. Its deficiency is related
to a larger prob-lem with the Puerto Rican developmental
stateproject. In the present, as in the 1940s, thedesign of the
development project has beendefined by the political economy.
6. CONCLUSIONS
Baumol and Wolff have called attention toPuerto Rico as possibly
the fifth tiger of thepostwar era. Over the entire period
PuertoRicos development has been, by many mea-sures, quite
impressive. It is equally importantto note that Puerto Ricos
tiger-like recordreally comes to an end in the early 1970s.
Thetrajectory of any national economic develop-ment program is
influenced by a complex con-figuration of factors, some domestic,
someexternal. The analysis of what went wrong inPuerto Rico has
neglected the critical role ofdevelopment finance. The purpose of
this paperhas been to fill that void. What went wrong,Evans (1998)
notes in a reassessment of the roleof the state in East Asian
development, almostcertainly includes deterioration of the
genera-tive institutional context and diagnosing dete-rioration
requires a clear understanding of theoriginal. In the Puerto Rican
case, the orig-inal institutional framework for developmentwas set
during the 1940s. This paper has shown
that its contours were decisively influenced bythe domestic
political economy, in particular,by conflicts between banks and the
state overthe latters role in financing development.
Wade (1990) has one of the last words in theongoing state
intervention vs. market liberal-ization controversy when he notes
that whatreally matters are unique national
state-marketarticulations. Four decades ago, Mason (1958)hinted at
an interesting comparative questionregarding long-term development
when heidentified Puerto Rico as a case on the liberalend of
state-market articulationsthe statesupplies public goods, but
almost exclusivelyon criteria agreeable to the private sector.
Withthe benefit of historical hindsight, this paperrevisited Masons
observation to identify someof the long-term consequences of a
liberal de-velopment formula. In the specific area of de-velopment
finance, the evidence is troubling.
The key finding is that a compromise be-tween domestic bankers
and the state in the1940s gave bankers a stabilizing mechanismthey
soughtand such a stabilizer should bethought of as a public goodbut
stripped thestate of a capacity it needed but banks feared.The
state was unable in this compromise toextract a development-minded
quid pro quo,and was left to hope that development bankingguided by
private optimality would never muchdiverge from social optimality.
Although thefindings of this paper do not warrant a
blanketindictment of liberalization, the analysis doesidentify a
long-term development problem thatgrows out of insufficient state
capacity to eitherdiscipline private financial actors, or to take
thelead when social and private optima begin todiverge. Over the
long-term this episode ofliberalization was too indiscriminate, and
thismust be considered a critical weakness of thePuerto Rican
model.
Financial liberalization can be a source ofsignificant
short-term economic instability, butas the analysis presented
shows, some problemsmay show up only over the long term. This
begsthe question, what political economy configu-ration will allow
for a design of developmentinstitutions that balance the present
and thefuture? An answer to this question is beyondthe scope of
this paper. Preliminarily, theanalysis does suggest a need for a
clear insti-tutional division of labor, and a system ofchecks and
balances, between those publicagencies with a focus on fostering
short-termefficient functioning of markets and others witha view on
the long term. Blanket liberalization
PUERTO RICO IN THE POST WAR 297
-
sacrifices the latter. But there is an additionallesson. Key
problems with the Puerto Ricanmodel have their roots in the
political economythat shaped state-building in the 1940s; itwould
be naive to simply rethink or redesignthe institutional scaffolding
of the model with-out considering how the contemporary
politicaleconomy will impinge on this.
Finally, this case study has significance be-yond Puerto Rico.
It adds to a growing lite-rature that cautions against
indiscriminate,doctrinaire, and misguided prescriptions
forliberalization that threaten the stability andgrowth of poor
societies (Adelman, 2000;Chang, 1998; Stiglitz, 2000; Stretton,
2000).Puerto Ricos case stands as another cautionarytale. In this
particular case, the exhaustion ofthe Puerto Rican tiger called
forth a massive USbailout package in the mid-1970s: a mix
ofsubstantial and weakly targeted investment in-
centives for US corporations and massive sup-port for needy
persons. 14 This has de facto beenthe Puerto Rican model since. It
has notworked, and, in any event, it is fair to assumethat
institutions of global management and af-fluent states are neither
prepared nor willing tounderwrite a bailout on this scale for
thedeveloping world as a whole. All are welladvised to consider
carefully the mounting evi-dence of long-term problems with
indiscrimi-nate liberalization prescriptions. Poor
countriesurgently need development assistance on amassive scale,
but all of this would be self-defeating if institutions overseeing
the extensionof global economic governance put nationaldevelopment
institutions in a position wherethey have to place bets against the
future oftheir own populations. On a smaller scale this ispart of
the story behind Puerto Ricos crisis ofdevelopment.
NOTES
1. Whether, and to what extent, East Asian state-led
development is an asset or a liability is still a heated
debate, especially since the 1997 Asian crisis, and in the
midst of a nearly decade-long recession in Japan. One
thing is clear; nowhere in the mainstream business press
does one find an inclination to present East Asian
countries, particularly Japan and Korea, as textbooks
cases of free market development.
2. Stiglitz (2000) reiterates the importance of this
distinction between social and private optimality.
3. A structural incapacity of would explain why, by the
early 1970s, the developmental ideology of the promo-
tional state appear shopworn and hollow. Cf. Pantojas-
Garca (1990) for a critical analysis of this ideology.
4. Imperialism was an important rhetorical figure
wielded by all parties to the conflict between the
nationalist and the Mu~nnoz factions of the Partido
Popular in the 1940s. An analysis of the rhetorical uses
of the terms imperialism is, however, outside the scope
of this article.
5. We have been doing the same thing for thirty
years was the typical comment of a career staffer of the
industrial promotions office with FOMENTO inter-
viewed by the author.
6. Only three studies in the last 40 years have examined
any aspect of the Puerto Rican business class (Cochran,
1959; Gonzalez Daz, 1991; Steward, 1956). None has
examined the interests of this class, its internal organi-
zation, its relation to the state, or its influence on
development policy.
7. Stephens and Stephens (1986) analysis of the first
Manley period in Jamaica shows how even the weakest
local capitalist class can act as an effective spoiler.
8. This argument is an extension of Fred Blocks classicand
succinct analysis of the relation between the state
and capitalists (Block, 1977).
9. This power is clearly a variable; it is more or less
considerable depending on the absence or existence of
more formal institutional arrangements for regulating
and assessing the risk of a foreign investment site. In the
1940s, prior to the formation of a global financial
infrastructure for risk assessment and underwriting the
mediating role and the structural power of Puerto Rican
capitalists was probably more considerable than it is
today.
10. There are only isolated references to business
opposition buried in a few of the studies of the era but
no careful study of the phenomenon. Part of the reason
for this is myopia, I suspect, has been the immense
cultural influence of the Partido Populars populistrhetoric.
Quintero Rivera (1985) and Gonzalez Daz
(1980) discuss how that rhetoric effectively dissolved
classes into an amorphous national community.
WORLD DEVELOPMENT298
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11. It has already been noted that the campaigns of
Puerto Rican capitalists and their effects have not been
studied carefully. A number of known studies are
nonetheless peppered with references to this business
opposition. References to business campaigns against
the government can be found in Tugwell (1947), Edel
(1962), Lewis (1963), Picoo (1962), Ross (1976, Chapter
4), Navas Daavila (1978), Palau de Loopez (1985), Dietz
(1989) and Pantojas-Garca (1990).
12. This image of a state that compromises the
substance of its developmental state project without
abandoning the rhetoric is consistent with the analysis
of Pantojas-Garca (1990).
13. Table 4 shows that the Industrial Development
Corporation (a subsidiary of FOMENTO) was making a
significant contribution to long-term nonhousing invest-
ment. This went to land and manufacturing shells
facilitated on demand to firms promoted by FO-
MENTO. It did not directly finance industrial under-
takings.
14. Weisskoff (1985) aptly refers to the new model a
regime of factories and food stamps. Pantojas-Garca
(1990) offers a useful discussion the post-1976 incentives
scheme. After 1976, new US tax exemptions to US
corporations in Puerto Rico became the crucial promo-
tion enticement. This was not a substantial change in
development strategy: the Puerto Rican government
simply used these tax breaks to compensate foreign firms
for the deterioration of labor cost advantages. US
intervention in this case arguably allowed successive
administrators in Puerto Rico to avoid responsibility for
the consequences of development failures; it is also
symptomatic of the absolute loss of economic sover-
eignty suffered by the Puerto Rican government as a
result of the collapse of its economic program.
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