In the aftermath of Hurricane Maria, officials at the Puerto Rico Electricity and Power Authority (PREPA) told residents to expect six months without power. The commonwealth’s antiquated power grid was no match for the powerful storm and will take months to stitch back together.
The fact that Puerto Rico’s power grid is not up to modern standards may come as a surprise to municipal bondholders who lent PREPA over $8 billion before it entered bankruptcy in July. Instead of modernizing its facilities, PREPA spent the bond proceeds on “a bloated payroll, among other things,” according to The Wall Street Journal.
To understand why Puerto Rico has an inefficient state-owned energy utility, and a bloated public sector generally, one must go back to the days of Franklin Delano Roosevelt, when New Deal ideas were imposed on Puerto Rico. Back then, the island’s governor was a presidential appointee. FDR chose Rexford Tugwell to be Puerto Rico’s governor in September 1941.
Tugwell was a Columbia University economist who visited the Soviet Union in 1927. Impressed with the Soviets' ability to produce goods and distribute prosperity more broadly, he hoped to bring the benefits of central planning to the United States. During Roosevelt’s first term, Tugwell helped to create and implement a number of New Deal programs, including the Agricultural Adjustment Administration, which paid farmers not to grow food.
Shortly after Tugwell took charge of Puerto Rico, he obtained a presidential decree authorizing a government takeover of the island’s two private electric utilities. The decree was justified as a wartime measure, part of a plan to switch the island over to hydroelectric power, thereby conserving oil for use by the Navy. But Tugwell’s socialist agenda was apparent in his 1942 annual report in which he claimed that nationalizing the private providers would allow the Puerto Rico government to “furnish electricity to all the people directly, effectively and without profit.”
The two power companies were operated under the auspices of the Federal Works Administration between 1942 and 1944, while the larger of the two firms – Porto Rico Railway Light and Power Company – litigated the government’s condemnation order. The litigation concluded with Puerto Rico agreeing to purchase the two companies. The Water Resources Authority issued $20 million in bonds to finance the purchase, more than doubling the territorial government’s debt.
In addition to the Water Resources Authority – which later became PREPA – Tugwell created or expanded other public corporations, including the Puerto Rico Aqueduct and Sewer Authority (PRASA), the Transportation Authority (which later became the Highway & Transportation Authority, PRHTA), the Land Authority and the Government Development Bank (GDB). These entities provided a way for the territorial government to circumvent debt limitations imposed by the 1917 constitution. By 1952, when Congress ratified Puerto Rico’s current governing document, public corporation debt of $99 million dwarfed the $28 million in outstanding bonds issued by the commonwealth government.
The rest of the story is well known both to the lenders stuck with worthless Puerto Rico corporation debt and island residents who receive inefficient services. And the solution should be equally obvious: privatize the public corporations, thereby giving them the incentive to provide better service and invest for resiliency.
As Margaret Thatcher and her many imitators have shown, denationalization — when implemented properly — can transform inefficient state enterprises into competitive market institutions. Bondholders could be given shares in the newly privatized firms, just as creditors of bankrupt companies often receive equity during Chapter 11 bankruptcies. Following the best practices of Thatcher-era privatizations, remaining shares in the denationalized corporations should be spread widely among the Puerto Rican public to encourage political support and avoid cronyism.
While institutional reforms cannot prevent destructive hurricanes from pounding American shores, the human penchant for innovation can minimize the damage from these storms and accelerate our recovery from them. Such innovation rarely arises from bureaucracies bloated with borrowed funds. Instead, it is more likely to come from individuals and companies taking initiative free of government ownership and control.