The Multinational Monitor


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Peurto Rico

The Making of a Corporate Paradise

by Emilio Pontojas Garcia

Since 1947 Puerto Rico has been transformed into a laboratory of corporate organization, pinning its hopes for development and gearing its social and economic policies to one objective: attracting U.S. capital. Using the unique circumstances of the island's colonial relationship with the United States and its condition as a relatively poor Third World country, a succession of Puerto Rican administrations have offered investors a corporate paradise where wages are low, government docile, and taxes virtually nonexistent.

In the process, Puerto Rico has become a cog in the international circuit of production, a dependent satellite whose prospects ebb and flow with the needs of multinational capital. The result has been a society transformed, where some benefit while others are removed from the land and the country, where Puerto Ricans own less than half the island's wealth, and where billions in unused profits garner interest at Citibank and Chase Manhattan while unemployment stands at 20% and the island languishes in chronic economic crisis.

The development plan's first phase was designed to attract North American manufacturers. Its cornerstone was a 1947 industrial incentives law offering ten year tax exemptions, primarily for light industry. Beyond this, Fomento, the agency created to lure foreign investors, promised cheap labor, scarce, weak unions, unfettered trade with the US market and political stability, guaranteed in the final instance by the presence of the US military.

The package attracted a wave of small and medium-sized labor intensive companies geared to the U.S. market. Though the new arrivals included firms like General Electric, Phelps Dodge and W.R. Grace, most were textile, clothing, food processing and leather goods operations with an average investment of less than a million dollars per plant.

The new American capital remade Puerto Rico's economic and social landscape. It reinforced the colonial relationship, supplementing the already integrated Puerto Rican and U.S. marketplace with a new integration of production. It restructured the ruling class as old sugar barons gave way to small and medium capitalists. Businessmen attempting to compete with U.S. capital were bankrupted or absorbed while those serving the North Americans with complementary products saw their enterprises prosper. The hitherto minor service sector expanded, providing vital support for both the capital importation model and the colonial political system on which it rested. Finally, there emerged an urban industrial proletariat with living standards higher than those prevailing under the old sugar model. It was they who provided the principal political base for continuation of the corporate incentive strategy.

For other workers, however, the impact was altogether different. Those displaced but not absorbed by industrial development were physically removed from the country through the mass immigration to the United States of nearly half a million Puerto Ricans (then a quarter of the population) during the 1950s. This contributed to an amelioration of tensions within the working class as the total dispossession of these hundreds of thousands was "erased" from the daily sight of their fellow workers.

The Model Self--Destructs

In spite of the dramatic changes wrought by the capital import model, there were inherent contradictions that militated against its continued expansion. The very colonial relationship that served as its base also imposed limits on its growth, limitations which began to undermine the model from the early years of the 1960s.

The first of these was Washington's decision to extend a federal minimum wage to Puerto Rico. The U.S. labor movement feared that the island's cheap, non-unionized labor would stimulate the relocation of a substantial part of the eastern U.S. textile industry and thereby debilitate the unions. For their part, U.S. manufacturers who lacked the capacity to relocate their operations complained that competitors established in Puerto Rico had unjust advantages that could drive them to ruin, disturbing the U.S. economy. With these and other arguments, the two sectors pressured the U.S. congress to limit competitive advantages for companies operating on the island.

Under federal intervention, the median Puerto Rican wage rose from 42 to 94 cents per hour between 1950 and 1960, an increase of 124%. During this same period the U.S. average rose 53%, from $1.50 to $2.30. Although the absolute margin increased, the narrowing relative gap disrupted low wage industries such as clothing and textiles. The federally mandated increases made it increasingly difficult to cover the costs of shipping products back to the mainland and still maintain the high profit margins the companies had come to expect.

The year 1958 brought the additional blow of a 29% increase in maritime tariffs for U.S.-Puerto Rican shipping. Due to the shipping firms' oligopoly power and the fact that all such commerce was regulated by U.S.-and not Puerto Rican--agencies, there was little the island's investment strategists could do. They could not turn to foreign carriers-almost all of whom were far less expensive-as that was explicitly prohibited by U.S. law.

Other factors, such as the rise of union activity during the early 60s, made evident the need for change as the conditions that had made possible the "success" of the corporate incentive strategy began to fade away.

The chosen solution was to deepen the capital import model. The two key moves were the approval of a new incentives law in 1963 and the adoption-by President Kennedy at the urging of Puerto Rican officials and oil industry lobbyists-of special quotas expanding foreign oil imports to Puerto Rico in order to facilitate expansion of the local petrochemical industry.

The incentives law extended the manufacturing tax exemption from ten to sixteen years as well as providing mechanisms for individual companies to stretch it longer still. The law was designed to attract heavier industry less sensitive to wage increases and oriented to long term rather than immediate profit, the principal target being petrochemicals.

Fomento director Rafael Durand, with the support of Phillips Petroleum, lobbied in Washington to revise the oil quotas and drafted a plan for a petrochemical core plant and a series of intermediate facilities.

The aim of the quota revision was to enable Puerto Rico to import larger quantities of foreign oil and gas-then much cheaper than U.S. petroleum. The idea was that given the island's tax exemptions and less expensive labor, Venezuelan or Middle Eastern crude could be refined in Puerto Rico and shipped to the U.S. at a lower cost than if it were produced in the U.S. itself.

The new petrochemical complex became the fulcrum of industrial development through the mid 1970s. Two small refineries established after 1955 to meet local demand, the Union Carbide and Commonwealth Oil Refinery Corporation (CORCO) facilities, expanded enormously and Phillips and Sun Oil established new plants.

The Era of Big Capital

The years after 1965 saw the arrival of an entirely new group of multinationals linked to the petrochemical sector, as well as other representatives-such as pharmaceuticals and electronics-of big monopoly capital. The focus of accumulation shifted, as light labor intensive industry was displaced by heavy capital intensive operations.

As a result of this new turn, by 1974 110 of the Fortune 500 were operating in Puerto Rico. They ran a total of 336 subsidiaries, of which 333 had received special (and free) factory construction, training, financing or legal assistance from Fomento. Of the total of 1720 Fomento-promoted factories on the island, 994 were North American property. By 1979 the roster of Fortune 500 firms had grown to 139. The number of multinational companies--as opposed to smaller foreign firms -taking advantage of Puerto Rico's largesse increased in both absolute and relative terms.

By 1973 U.S. capital had achieved near absolute control of Puerto Rico's most dynamic industrial sectors. Commerce Department figures indicate that by that year foreign investors controlled 98% of all assets in the drug, petrochemical, chemical, metal fabrication, machinery, and electrical machinery industries, 89%95% in the oil refining and primary metals industries, and 60% in the petroleum products sector. These enterprises produced 44% of all industrial value added and 48% of the value of all shipments. These calculations do not take into account a number of other major industries dominated or heavily penetrated by U.S. capital, including scientific instruments, food, clothing and textiles.

The concentration of capital in North American hands grew to such proportions that a 1975 study by a special committee presided over by U.S. economist James Tobin concluded that "of the tangible, reproducible capital stock that has been built up in the Island in the last quarter century, Puerto Rican residents own less than half."

According to the calculations of the Tobin Report of a total of 22 billion dollars in tangible and reproducible assets, only $9.7 billion, or 44%, were in the hands of Puerto Rican residents; $6.1 billion, or 27.7%, was direct foreign investment, and the rest, $6.2 billion, or 28%, was public and private debt to foreign creditors.

Under this second phase of the capital import model the island's character as an exclusive U.S. enclave continued, with the difference that the principal products were no longer clothing and textiles but petrochemicals and electronics.

In 1974 Puerto Rico produced 40% of all paraxylene consumed in the United States as well as 30% of the cyclohexane, 26% of the benzene, 24% of the xylene, 23% of the propylene and 12% of the vinyl chloride. Forty-four percent of all electrodes used in the United States came from Puerto Rican factories.

Under the impulse of this mass arrival of big capital, Puerto Rico emerged as the most important site of direct U.S. investment in all of Latin America.

While some heavy industries saw Puerto Rico as the ideal productive backyard, many were drawn by incentives that existed only between the covers of corporate account books. The key measure was section 931 of the U.S. Intemal Revenue Code which offered U.S. companies in Puerto Rico special treatment in the repatriation of profits.

Corporations deriving 80% of their gross income from operations of plants in U.S. possessions such as Guam or Puerto Rico were exempted from taxes on their subsidiaries' income as long as the profits were not repatriated immediately. When the subsidiary liquidated its possession plant the accumulated profits could be sent back home without paying U.S. taxes.

This provision has inspired two practices that have proven lucrative for the companies concerned but negative for the development of Puerto Rico. First, the investment of tax exempt profits in liquid assets such as bank deposits and bonds rather then job-producing manufacturing. And second, the practice of liquidating subsidiaries at the end of the island exemption period and repatriating the profits.

The Tobin Report offered this description of the life cycle of a typical North American subsidiary in Puerto Rico:

"Since the operation has been established as much, or more, for the exemption from federal and local taxes as for the low-cost labor or other advantages of Puerto Rico, there are large profits. The Mainland corporation has strong reason to locate in Puerto Rico those of its interdependent operations which are the most profitable. Federal tax regulations currently prevent profits from being returned at once to the Mainland parent. Therefore the subsidiary begins to accumulate financial assets. The income from these assets will also be exempt from federal taxes if the investments are in U.S. territories, and this explains the popularity of high-interest certificates of deposit in banks in Guam. By the time its Puerto Rican tax exemption period expires the subsidiary holds substantial financial wealth as well as its depreciated operating capital in Puerto Rico. The assets are then sold, the subsidiary is liquidated, and the accumulated profit of the entire operation is absorbed into the Mainland parent, free throughout of both Puerto Rican and Federal taxes. The physical facilities are still in Puerto Rico, of course. They will be operated only if some firm, perhaps a new child of the old parent, finds them profitable, and this in turn may depend on whether or not a new tax exemption can be arranged."

According to Tobin, a typical subsidiary maintains 80% of its assets in financial form. This, the report argues, obscures the real nature of what is called direct investment in Puerto Rico, since an important part of this - half, according to the report - is composed of financial assets. Due to this, the rate of return on physical assets of a typical subsidiary is between 35% and 60%.

This arrangement induces multinationals to locate their most lucrative product lines in Puerto Rico and adopt a policy of transfer pricing that inflates income figures for Puerto Rico and reduces them for other, higher-tax areas. In 1977, for example, a group of multinationals derived more than a fifth of their global profits from their Puerto Rican operations. Pepsi Cola registered 21% of its world profit at its Puerto Rican subsidiary; Union Carbide 25%; Digital Equipment 57%; Abbott Laboratories, 71%; Eli Lilly, 22%; Smith Kline, 64%; Motorola, 63%. The pinnacle was reached by G.D. Searle which registered losses on all operations except Puerto Rico, where it recorded 150% of its worldwide profit.

In 1976 the U.S. Congress amended Section 931 (renaming it section 936) and eliminated the old restrictions on profit repatriation. To avoid the immediate flight of capital the Puerto Rican government imposed a 10% "tollgate tax." To avoid paying this tax, corporations were required to invest their accumulated profits in specially created certificates of deposit. By 1977 $1.6 billion of a total estimated $5 billion in accumulated profits had been deposited in such certificates. Two U.S. banks - Citibank and Chase Manhattan - received 55% of the funds. Soon after, two Spanish banks and three of the largest U.S. firms - Bank of America, Continental Illinois and Bank of Boston - opened branches in Puerto Rico. At the same time, four local banks were absorbed by two Canadian banks and the two new Spanish institutions.

An Economy in Crisis

Despite these financial machinations, trouble was brewing in the realm of productive industry. In 1973, the exceptional conditions that had made the petrochemical boom possible disappeared abruptly. President Nixon ended the oil import quota program, substituting a system requiring payment of a license fee for each importation of foreign oil. Although the license system was to be applied to Puerto Rico gradually, all special advantages would disappear by 1980.

The problems brought on by the end of the quota system were aggravated by the 1973 oil embargo. The price of Puerto Rico's oil imports rose from $3.05 in 1972 to 4.06 in 1976. Gas leapt from 6 cents per gallon in early 1973 to 37 cents in 1976. The price changes reversed the old differential between U.S. and foreign oil. By December 1974 U.S. oil was going for $7.39 per gallon while imported petroleum stood at $12.82.

The changes threw industry's most dynamic sector into crisis. The rate of return on assets in the refining and petroleum products industry fell from 25.8% in 1973 to 6.9% in 1976. In chemicals, profits dropped from 34.1 % in 1973 to 17.6% in 1976. By 1978 CORCO, which had grown to become the largest corporation in Puerto Rico, was operating in bankruptcy. The petrochemical industry thus arrived at the limit of its growth possibilities.

The special problems of petrochemicals and refining were compounded by the global recession. In a period of two years the fragile base of the capital import model-preferential treatment for the petrochemical sector and the vertical integration of industry into the international circuit of production-collapsed, The very forces which had integrated Puerto Rico into the petrochemical circuit now excluded the island from its role in the process.

The immediate impact of the crisis was dramatic. Between 1973 and 1976 direct fixed capital investment grew only 0.7% per year, while having grown 15.3% during the 1960s. Gross National Product in this period grew at only though during the previous decade it had risen at 7% per annum. Unemployment rose to a level of 20% in 1976 and has maintained that level ever since. Public debt. used as a means to surmount the effects of the crisis doubled from $2.55 billion in 197 -1 to $5. L billion in 1975, which served to further aggravate the situation and stimulate the emergence of a fiscal crisis in its own right.

The crisis demonstrated the limits of the capital import model in such form that even the strategists of the governing Popular Democratic Party (PPD), which had initiated the development strategy in the '40s, were moved to admit that-:, recent events have intensified an old preoccupation about the competitive position of Puerto Rican products in the U.S. market and their potential for future expansion of manufacturing industry. This worry has even raised doubts about a development strategy that rests fundamentally on the growth of manufacturing for export."

The PPD was incapable of resolving the crisis and went so far as to implement a highly unpopular income tax increase, a measure which came to be known popularly as "the vampire." i.e.. a device to "suck the blood" from wage

The only remedy the PPD could procure for the crisis was the extension to Puerto Rico of the federal food stamp program. By 1976-77 50% of Puerto Rican families were participating in the $802.1 million program. Food stamps were instrumental in braking the slide in family purchasing power. In this way the program acted as a political stabilizer in a double sense. First, in immediate form, limiting the negative impact of the crisis on the incomes of the working classes and tempering their political reaction. And, second, making the North American government appear as benefactor in the midst of crisis reinforcing the notion that national progress and welfare are assured by the colonial relationship.

The PPD's inability to address the crisis contributed to its defeat by Carlos Romero Barcelo and his pro-statehood Puerto Rican Nationalist Party (PNP) in the 1976 elections. The PNP, closely linked to finance capital, shifted the investment promotion focus to the service sector.

At Your Service

The new industrial incentives law of 1978 attempted for the first time since 1947 to redefine the terms of the heretofore total tax exemption, reducing it to 90% during the first five years and 75% for the next five for companies that locate in already heavily industrialized areas. In areas of medium development companies could receive a 55% exemption for another five years, while those locating in least developed regions would get a final five year break of 55%.

But unlike previous measures aimed exclusively at industry, the new law made service businesses eligible for exemptions and other Fomento inducements. The favored enterprises ran the gamut from commercial distributors, banking and investment houses to international public relations firms, consultants, computer service operations, insurance companies and service and maintenance firms catering to machinery, ships and planes. The aim was to reinsert Puerto Rico into the production circuit by turning the island into a service center for multinationals attacking the Caribbean market.

The PNP development policy, however, failed to bear fruit. Unemployment has hovered between 17% and 20% since 1976 rising to 21.7% in 1982. GNP growth continued to slow, and during the recession actually contracted, with a rate of negative 3.9% in 1982.

Traumatic as such shocks have been for Puerto Rico, transnational capital has continued to reap substantial benefits. Throughout the local crisis and the recession that damaged global revenues multinationals have used Puerto Rico as a center of financial operations to bolster profits through tax avoidance. It is this which has maintained the flow of North American investment to the island, keeping the crisis from reaching catastrophic levels.

PNP development strategists, searching for a solution that would maintain their hold on power and further the cause of statehood, concluded that industries seeking advantage in low labor costs had left Puerto Rico for good and that the island could not compete with the countries of the Third World to attract them. Instead they seized upon the idea of turning Puerto Rico into a zone of the North American economy, one oriented to export not just to the U.S. but the region as well.

Fomento has been explicit about its vision of Puerto Rico as the Caribbean center of operations for multinational capital. "Our objective is to convert ourselves into the port of entry through which European companies penetrate the Latin American market and at the same time make it possible for North American products produced on the continent and on the island to reach the markets of Central and South America. It is thus that, through the productivity of our manufacturing sector and the development of our services that we will arrive in a position where it will be possible for us to absorb greater numbers of our population into the work force. It is through this opening and integration with the continental United States that Puerto Rico can convert itself into a catalytic and productive agent."

The reasoning of the PNP strategists is that to the extent that Puerto Rico integrates itself as a region of the U.S. economy and expands the orientation of its production to the markets of the Caribbean Basin, the economic basis will be laid for political annexation. It is a strategy of transition to statehood using the advantages that remain under the colonial relationship.

Ironically, a major element of this strategy involves placing other Caribbean islands in an economic satellite relationship with Puerto Rico somewhat analogous to that which has existed between Puerto Rico and the United States. Puerto Rico would serve as the base for U.S. companies with subsidiaries in the Caribbean. These subsidiaries, called twin plants, would provide the mother plants with components that use large quantities of labor. Final processing and distribution would be done from Puerto Rico.

The principal objective of this proposal would be the proliferation of satellite electronics plants, producing components for computers in the Eastern Caribbean. The Caribbean Basin Initiative (CBI) would contribute by eliminating duties on the imported components. At the same time, the CBI would facilitate the access of U.S. producers operating on the island to these Caribbean markets.

With the defeat of the PNP in the November, 1984 elections the statehood advocates themselves have been removed from power but the twin plant development plan remains very much alive. PPD Governor Rafael Hernandez Colon has endorsed the idea and his administration has begun to follow through (see accompanying article by George Black).

The crisis of the capital importation model has spurred a process of restructuring which is still under way. The fundamental decisions on the outcome of that process will be made overseas by the corporations, financiers and industrialists that control the production and movement of international capital. In the final analysis, what the Puerto Rican junior partners and intermediaries have to say about it will be relatively little. They can only, as they have in the past, propose, request, and initiate experiments on which multinational capital will give the final word.

Emilio Pantojas Garcia teaches economic development at the University of Puerto Rico and the University of Illinois. This article was translated and adapted by Allan Nairn from Pantojas' study: La Crisis del Modelo Desarrollista y la Reestructuracion Capitalista en Puerto Rico; Hacia Una Redefinicion del Rol de Puerto Rico en la Economia Hemisferica published as Cuaderno de Investigacion y Analysis #9 by CEREP, the Centro de Estudios de la Realidad Puertorriquena. CEREP may be contacted at Apartado 22200, Estacion U.P.R., Rio Piedras, Puerto Rico 00931.

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