Network Effects in the Puerto Rican Debt Crisis
Puerto Rico is in the midst of a major debt crisis. Ever since the US government phased out a tax break for companies operating on the island in 2006, Puerto Rico has been in severe economic disarray, and conditions have only worsened since. This past August, its government defaulted for the first time on a $58M payment to creditors, bringing its total debt to $72B, or about a 70% debt-to-GDP ratio. Puerto Rico is in a uniquely difficult situation – it cannot declare bankruptcy to restructure its debt, its unemployment rate is more than double the national average, and residents are emigrating from the island for better opportunities in mainland America.
The Puerto Rican debt crisis is a depressing example of how network effects influence individuals to follow a crowd. Puerto Ricans are leaving the island by the thousands, mostly for job related reasons. Considering the rampant unemployment on the island, individuals are benefitting from informational effects by following the crowd and relocating to the U.S., where there is a higher probability of finding and securing a job there than it is in Puerto Rico. Puerto Ricans also directly benefit from leaving the island for taxation reasons. Since so many people are leaving, Puerto Rico’s tax base is rapidly shrinking. In order to compensate for the decrease in population, the Puerto Rican government has to increase taxes, effectively increasing the share of the debt burden that remaining residents have to pay. Puerto Ricans who follow the crowd and leave the island directly benefit from not having to pay higher taxes to repay the island’s debt.
Though there are informational and direct-benefit effects incentivizing Puerto Ricans to leave, the massive exodus is forcing the island into “death spiral” in which they have no hope to repay the debt as it stands today. The only hope that the American commonwealth has is if Congress and/or its bondholders grant it some sort of mechanism to restructure its current debt and develops a plan for sustainable economic growth. Otherwise, as we’ve seen in class, the information cascade will continue and people will continue to follow the crowd.
http://www.vox.com/2015/7/1/8872553/puerto-rico-crisis