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The meaning of a referendum: Austerity and sovereignty

Two financial crises at the ‘sub federal’ are currently taking place – one in the Commonwealth of Puerto Rico, and the second one in Greece. This column highlights some surprising similarities between them, as well as the main differences. The Eurozone is a voluntary union of states which remain sovereign. But if Greece were part of the US, it could not hold a referendum, and its budget would be drawn up by a federal bankruptcy court. The key political difference is not austerity, but the fact that Greece’s debt is mainly to official creditors, who are ideal targets for political pressure. 

Two financial crises at the ‘sub federal’ are playing out at present in the world. The economic entities involved are of comparable size, but the attention given to them globally could not be more different:

  • In the US, it is the Commonwealth of Puerto Rico which is teetering on the verge of bankruptcy. But few outside the island take notice.
  • In Europe, it is Greece, and the world is riveted (Baldwin 2015).

Even more so as Greece became the first developed country ever to default on the IMF and the announcement of a referendum on austerity to take place on 5 June.

The crucial difference is that Greece is a sovereign state, whereas Puerto Rico is an integral part of the US.

The Greek government can decide not to pay its creditors, and call a referendum on whether the conditions for further financial support are acceptable. The government of Puerto Rico does not have this option. US Marshalls would not allow this to happen. Today the government of Puerto Rico is not even allowed to avail itself of the protection of the US municipal bankruptcy code if it wanted to avoid further budget cutting or ‘austerity’. But even if it were allowed to enter municipal bankruptcy, it would have to abide by the decisions of a US bankruptcy court, regardless of what its people think. Moreover, Puerto Rico also does not have the option to introduce its own currency in order to give its local economy a boost.

The Commonwealth of Puerto Rico, as it is called officially, is legally an integral part of the US. The people living on this Caribbean island are US citizens, use the US dollar and are subject to the US judicial system and law enforcement. US economic policy, including minimum wage rules, apply in Puerto Rico as well. There is little difference between Puerto Rico and the other 50 states, except that it has no representation in the US Senate, and it sends only one (non-voting) ‘delegate’ to the US House of Representatives.1

Puerto Rico vs Greece: Surprising similarities

Greece and Puerto Rico are comparable on most economic indicators, as shown in detail in Gros (2015).

The Greek population is somewhat larger (ten million against less than four million for Puerto Rico). But in per capita terms, many indicators are of a similar magnitude. For both countries, GNP or GNI per capita are at about one-half of their respective ‘union’ average and wages are somewhat above one-half of their respective union averages.

The employment rates (and the fall in employment over the last years) are almost identical. Puerto Rico would have Greek style unemployment rates if emigration had not provided a safety valve.

In terms of the poverty rate, Puerto Rico does much worse than Greece (at over 45% versus 35.7% for Greece). This is surprising given the large transfers that flow to inhabitants of Puerto Rico in various forms of social security payments.

More surprising are perhaps the similarities in the terms of fiscal problems. Public debt is, of course, much lower as a percentage of ‘national’ income. But the more appropriate comparison would be the debt burden relative to public revenues. On this account, Puerto Rico appears even more over-indebted than Greece. Its public debt is higher relative to government revenues (4.5 times) than that of Greece (‘only’ 3.87 times revenues), and its government devotes a higher share of revenues to interest payments (13%) than Greece’s government does at present (‘only’ 8.5%).

Puerto Rico thus appears even more over-indebted than Greece on both accounts. It is therefore not surprising that the ratings of the two governments are almost identical and that the yield on Puerto Rico’s state and state-guaranteed debt is similar to that of Greece.2

Another uncanny parallel between the two cases concerns the quality of local governance. The so-called World Governance Indicators (WGI) from the World Bank show that corruption in Greece is much worse than the rest of the Eurozone. The same is true for Puerto Rico relative to the US. The indicator for the control of corruption has always been lower for Puerto Rico than the US.3

The mechanics of a sub-federal public debt crisis

One important criticism of the Eurozone has been that there is no lender of last resort for EZ governments (de Grauwe 2011). This is also true for state governments and municipalities in the US. The impact of a lack of access to funding can indeed be brutal. During a first liquidity shortage in 2006 the government had to close temporarily all schools and 95 000 employees were furloughed. The government was forced to increase the sales tax before it could go back to the market.4

Puerto Rico was not bailed out then; and Washington is refusing to intervene also now. When faced with a cash crisis, its government thus had to take immediate action to restore the confidence of its investors. One might ask what would have been the reaction in Greece if (either today or in 2010) the government had had to fire all the teaching staff and immediately increase sales taxes.

Like Greece, Puerto Rico is today also pushing for debt relief, but in a different way. On 29 June its government went public with a report drawn up by A Krüger (formerly World Bank) which argues that the public debt of the island is not sustainable given the low growth prospects. The diagnosis of the problems of Puerto Rico seems identical to that for Greece: Low growth due to high wages and poor governance. Not surprisingly, the recommendations of (Krüger 2015) are also very close to those of the various adjustment programmes for Greece – a combination of fiscal adjustment and structural reforms to foster growth.

Sovereignty matters

The real difference is sovereignty.

  • The Eurozone is a voluntary ‘union’ of states which remain sovereign and can at any time secede, break any rule or previous commitment.
  • By contrast, in the US, secession is excluded, and federal decisions can in the last resort always be enforced by the federal administrative and judicial system. This is the key difference between the ‘dollar area’ and the Eurozone.

If Greece were part of the US, it could not hold a referendum, and its budget would now be drawn up by a federal bankruptcy court. Even the most ambitious ‘political union’ one can imagine for Europe would not change this.

The absence of a system of fiscal transfers for the Eurozone is much less important. The very large transfers received through the US federal fiscal system have anyway not prevented long-term economic underperformance and an acute fiscal crisis in Puerto Rico. There is no reason to believe that this would be different in Europe.

  • Sovereignty, and thus the potential to leave the Eurozone, is also the key reason why there has been no bank run in Puerto Rico.

Savers there do not have to fear that one day their deposits have been converted into worthless Caribbean dollars.

One can, of course, argue that the fiscal adjustment imposed by the Troika has been excessive. But in reality the adjustment would have to have been even quicker in the absence of official financing.

The key political difference is not austerity, but the fact that Greece’s debt is now mainly to official creditors, who are ideal targets for political pressure and requests for a haircut. If the debt of Puerto Rico were mainly to other US states, the Federal government there would, of course, also be a strong political push for debt relief. But Puerto Rico knows that it has only the choice between having to come to an agreement with bond investors or accepting the tutelage of a bankruptcy court.


Baldwin, R (2015), “Recent Vox columns on the Greek Crisis”, VoxEU.org, 21 June.

De Grauwe, P (2011), “The Governance of a Fragile Eurozone”, CEPS Working Document No. 346, CEPS, Brussels, May.

De Grauwe, P (2015), “Greece is solvent but illiquid: What should the ECB do?”, CEPS Commentary, CEPS, Brussels, 18 June.

Devereux, J (2014), “Arrested Development? Puerto Rico in an American Century”, draft paper, Department of Economics, Queens College, CUNY, Flushing, NY.

Federal Reserve Bank of New York (2012) “Report on the competitiveness of Puerto Rico’s economy”.

Gros, D (2015), “The Fate of Greece in a ‘Genuine Economic and Monetary Union’: Lessons from a small island state", CEPS, Brussels, June 30.

Gros, D  (2012), “Banking Union: Ireland vs. Nevada, an illustration of the importance of an integrated banking system”, CEPS Commentary 18 October.

Krueger, Anne O, Ranjit Teja, and A Wolfe (2015), “Puerto Rico – A way forward”.


1 See https://www.govtrack.us/congress/members/PR. Full formal statehood, however, would bring little influence on US economic policy decisions since its two senators would give Puerto Rico just 2% of the US Senate (as any other state) and with its roughly 3.6 million of population slightly more than 1% of the US House of Representatives.

2 See http://www.tradingeconomics.com/greece/rating

3 This is not merely due to a difference in perception. Gros 2015 shows that hard data give a similar picture.

4 See https://en.wikipedia.org/wiki/Economy_of_Puerto_Rico#Mining (under Recent Developments).

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