| Puerto Rico’s power to attract new manufacturers–and keep the ones it has–is fading with the emergence of tough competition from Ireland, Singapore, Mexico and the Dominican Republic.
The gradual erosion of the island’s competitiveness in labor costs, power supply, infrastructure readiness and business friendliness, have led many to believe that federal tax incentives, such as Internal Revenue Code Section 936 were nothing but icing on a crumbling cake.
Favorable tax treatment of your bottom line means little if there’s little on it. So now that federal tax incentives for Puerto Rico are on death row to be axed in 2005, industry analysts, both professional and the armchair variety, are taking a hard look at the items above the tax line.
A line item comparison between Puerto Rico, the U.S. mainland, and some of the world’s manufacturing powerhouses reveals why the island might be losing the manufacturing competitiveness battle.
While the island is at a clear disadvantage on big ticket items like labor costs, it remains competitive in others.
It is those strengths that ought to dictate the strategic development of our manufacturing industry into the future.
"While most countries have lower wages than Puerto Rico, the island remains competitive with highly developed European countries and the U.S.," says John Stewart Puerto Rico Industrial Development Co. (Pridco) executive assistant director for economic analysis and strategic planning. "Wages in less developed countries may be cheap but they don’t have the human capital or infrastructure we have. This is not to say we can’t improve."
Indeed, there’s a growing sense that Puerto Rico must improve. And that tax or other economic incentives notwithstanding, the island must remain competitive by improving on factors that are within our control.
"Economic incentives help and it is better to have them than not have any to offer," said Estudios Tecnicos President Jose J. Villamil. "But they need to be accompanied by other factors such as better educational facilities, a superior infrastructure, and support from the government to encourage projects."
Chart 1 - Cost of Doing Business in…
| . |
USA |
Mass. |
Puerto Rico |
Dom. Republic |
Ireland |
Mexico |
Singapore |
| Labor comp./hr |
$19.20 |
$14.65 |
$12.28 |
$1.44 |
$13.57 |
$2.12 |
$7.18 |
| Minimum wage/hr. |
$5.75 |
$5.75 |
$5.75 |
. |
. |
$1.92 |
. |
Industrial electricity
Cents/1 kWh hr. |
4.5 to 8.3 |
8.18 |
9.3 to 15.4 |
18 |
6.0 |
5 to 6 |
7.2 to 9.1 |
Indust. real estate
Rental rates/sq. ft. |
$4.70 (aver.) |
. |
$1.75 to $4.75 |
$1.50 to $5.00 |
$4.60 to $10.92 |
$3.90 to $8.92 |
$1.72 to $7.70 |
Cost of living 2000
(New York=100) |
176.3 |
155.1 |
84.3 |
66.3 |
75.8 |
78.2 |
94.7
|
| Effective corporate Income tax rate |
35%-39% |
. |
2%-7% |
5.7% |
10% |
35% |
0%-4.7% |
| Property tax |
S.S. |
|
10% |
|
0% |
20% aver. |
12% |
| Municipal license tax |
S.S.1 |
. |
40% exempt. |
100% exempt |
. |
. |
0% |
| Tollgate tax |
S.S.1 |
|
0% |
100% exempt |
0% |
|
0% |
| Excise tax |
S.S.1 |
9.5% and prop. value |
0% on raw mat./equip. |
100% exempt |
0% on raw mat./equip. |
0% on raw mat./equip. |
0% on raw mat./equip |
| Sales tax/VAT |
S.S.1 |
5% |
n/a |
n/a |
0%-21% |
15% |
3% |
Labor costs
At $12.28, Puerto Rico’s 1999 average hourly labor compensation in the manufacturing industry was competitive with Ireland’s $13.57, but was 60% higher than Singapore’s $7.18.
When it comes to Mexico’s $2.12 and the Dominican Republic’s $1.44, Puerto Rico is not even in the same ballpark. It’s easy to see why Puerto Rico’s labor intensive manufacturing industry–such as the traditional apparel and footwear sectors –are struggling to survive.
Electricity costs
Some of what Mexican and Dominican industrialists save in labor costs they must use to foot the electric bill. While in Puerto Rico, industrial electric power rates range from 9 to 15 cents per kilowatt hour (kWh), rates in Mexico and the Dominican Republic are twice as much.
By contrast, at 6 cents in Ireland and 7 cents to 9 cents in Singapore the cost per kWh in both those countries is considerably cheaper than in Puerto Rico.
Real estate
Because of the considerable government subsidy behind Pridco’s industrial real estate development and lease program, Puerto Rico does offer attractive industrial real estate rental rates averaging between $1.75 and $4.75, per square foot. That’s lower than Ireland’s $4.60 to $10.92; Mexico’s $3.90 to $8.92, and Singapore’s $1.72 to $7.70. The Dominican Republic is competitive with Puerto Rico, offering rates ranging from $1.50 to $5.00 per square foot. The mainland U.S. average is $4.70
Tax rates
Puerto Rico’s Tax Incentives Act of 1998 brought down effective corporate income tax rates to a range between 2% and 7% for all manufacturing companies established on the island after 1947, following the renegotiation of their tax exemption agreements with the government. In 1998, the average corporate tax rate assessed in Puerto Rico was 5.4%.
While Ireland’s equivalent rate is 10% the government exempts corporations from other corporate taxes found in Puerto Rico, such as property and municipal license (patentes) taxes.
Singapore’s effective corporate income tax rate for the manufacturing industry ranges between 0% and 5%. In 1998 the average corporate tax assessed in Singapore was 4.7%. But the lower end of that range is available only to high technology research & development companies. "Singapore’s corporate tax incentive is more limited than Puerto Rico’s. In fact, the government’s decision to attract only high technology industry has encouraged the transfer of manual intensive labor to Malaysia," said Stewart.
Mexico’s maximum corporate tax rate is a substantial 35%, but it does offer some exemptions from taxes applicable in Puerto Rico.
Meanwhile Puerto Rico’s 5.2% inflation rate is also higher than Singapore, Ireland, Dominican Republic, and U.S. rates, only surpassed by Mexico’s 15% inflation rate.
In addition, manufacturing companies in Puerto Rico, like other businesses here and elsewhere in the U.S. and even Europe, have to factor in costs associated with a whole slew of federal occupational safety, health, environmental, and other regulations that add significantly to the cost base. That’s partly why it’s so difficult to compete with Asian and Latin American countries with no Occupational Safety and Health Act (OSHA), Americans with Disabilities Act (ADA) or Environmental Protection Agency (EPA) regulations.
"Asian countries that are highly developed may outdo us with lower industrial labor costs. But in comparison with highly developed European countries and the U.S., Puerto Rico remains competitive," said Stewart.
"Wages may also be cheap in the Dominican Republic but it doesn’t have the human capital or infrastructure Puerto Rico has, which is not to say that it can’t improve.
"Regarding electricity, it is still a problem in Puerto Rico but there are other countries with higher rates than ours. And Puerto Rico’s communications capability is pretty good but we need to improve infrastructure such as electricity, which could be cheaper and more reliable," said Stewart.
Cost control
According to industry experts, Puerto Rico must cut costs where it can. And where it can’t, it must prevent actual costs from rising beyond control.
"In Puerto Rico we have two choices: cut our wage benefits costs, which is very difficult because they are legislated and acquired rights; or keep fringe benefit increases to within reasonable limits," said Villamil.
"Either way, our costs are still going to be beyond our real competitors, which are Singapore and Ireland," he said.
Hewlett-Packard and Puerto Rico Manufacturer’s Assoc. (PRMA) President Lucy Crespo agrees. "We need to look at Puerto Rico’s employee benefits. Compared to the U.S., the island contributes $3.00 to each benefit dollar in the U.S."
Business climate
Most corporate executives agree that beyond cost containment there’s a lot Puerto Rico must do to improve its overall business climate to a competitive level.
"Puerto Rico has several advantages, one being its competitive human resources . . . but we need to work with improving our infrastructure, lowering energy costs and expanding our transportation network," says Crespo, whose company has successful operations in both Ireland and Singapore. "Puerto Rico’s permit process must also be redesigned and simplified. In countries such as Singapore, incorporating your business can be done through the Internet!"
In a reversed pattern of sorts, MTS is the first private manufacturing company from Puerto Rico to establish a company in Ireland. Its president and CEO Luis Rivera Oyola believes Puerto Rico should emulate Ireland’s model.
"Ireland is extremely prepared to do business with foreign businesses. I have never felt better treated in any foreign country. Enterprise Ireland–Pridco’s equivalent–uses a private company, Shannon Development, to help set up companies. After visiting us in Puerto Rico, their promoter arranged for the necessary permits, real estate contract, and tax incentives and exemptions," said Rivera Oyola.
Ireland’s aggressiveness in attracting foreign investment is by now legendary. "They are very active and aggressive in processing tax incentives," says Eli Lilly del Caribe Tax Advisor Carlos Bonilla.
"They are able, within a limited time, to determine the rules of engagement and basically agree on a plan based on a handshake. There are no revisits, renegotiations, or clarifications about the terms after this step has been taken. Ireland is also proactive and accommodates the specific needs of a company."
Although diplomatic, Bonilla does not accord the same reviews to Pridco. "In the past, Puerto Rico has been lax in this area. The speed in terms of permits and agreeing on incentives has been less than optimum. The renegotiation of the terms of our incentives with the new administration following our announcement of a new biotechnology plant to our complex has been somewhat of a refreshing experience," he said.
Puerto Rican David Susarret, founder and chief scientist of Caribe Submarine and Space Technologies is more poignant. "In 1997, I met with Pridco officials and explained the concept–building satellite tracking systems and robotic submarines. Pridco offered a $100,000 grant for a project that would produce submarines selling at $5 million each!"
Susarret also bemoans the effect of politics on the business climate. "All the projects are on stand-by at this time because of the change in administration. Other countries’ governments change all the time but progress continues and projects do not stop."
He also laments the chilling effect of recent political events. "A venture capital fund had agreed to invest $34 million [in a Technology Corridor project] but when news about the problems in Vieques was publicized nationally, the company backed down," he said.
Chart 2 — Countries Business’ Characteristics
(for 1999 unless otherwise noted)
| . |
USA |
Mass. |
Puerto Rico |
Dom. Republic |
Ireland |
Mexico |
Singapore |
| Population |
275.6 M |
|
4 M |
8.4 M |
3.4 M |
100.3 M |
4.2 M |
| Labor force |
139.4 M |
|
1.3 M |
2.4 M |
1.8 M |
38.6 M |
1.9M |
| Unemployment rate |
5% |
|
12.5% |
13.8% |
5.5% |
2.5% |
3.5% |
| Net migration rate/1000 pop. |
3.5 |
. |
-2.14 |
-4.04 |
5.3 |
5.6 |
26.8 |
| Overall product. per capita |
$33,900 |
|
$9,800 |
$5,400 |
$20,300 |
$8,500 |
$21,814 |
| Real GDP growth |
4.1% |
. |
4.2% |
8.3% |
7.4% |
3.1% |
5.5% |
| Currency/Exchange rate per US $1 |
US $1 |
US $1 |
US $1 |
Dom.Peso/16.16 |
Irish Pound/0.99 |
Mex. Peso/9.5 |
Sing. $/1.67 |
| Inflation |
2.2% |
. |
5.2% |
5.1% |
1.7% |
15% |
0.5% |
| R&D expenditure |
$70 B |
|
$59 M |
|
$894 M (1998) |
$886 M |
$1.5 B |
| Balance of trade (‘99) |
($249B) |
|
$9.6 B |
($3.1 B) |
$22 B |
($5.3 B) |
$3 B |
| Electricity Production kWh (1998) |
3.62 T |
|
18.8 B |
8.476 B |
19.7 B |
176 B |
26.6 B |
| Computers/1000 pop. |
580 |
|
|
|
353 |
57.8 |
391 |
| Internet connections/1000 pop. |
|
|
|
7.63 |
16 |
2.40 |
22 |
| Internet Service Providers |
7,600 |
|
18 |
1 |
14 |
167 |
8 |
| Telephones |
178 M |
|
1.2 M |
569,000 (1995) |
1.6 M |
9.6 M |
54.6 M |
| Cellular phones |
55.3 M |
|
171,000 |
33,000 (1995) |
941,775 |
2.02 |
1.02 M |
| Airports |
14,572 |
|
11 |
28 |
44 |
1,806 |
9 |
| Major ports & harbors |
22 |
|
2 |
5 |
9 |
15 |
1 |
Game plan
"What Puerto Rico should aim for is developing the types of economic activities that are relatively immune from the impact of high labor costs. These are high technology, value-added intensive activities such as biotechnology, information technologies, communications, pharmaceuticals, and other technology areas," said Villamil.
"Next, we should develop two types of industries. The first industry would consist of companies that develop technology or are directly related to new technology. The second type of industry would be composed of companies that apply new technology to traditional industrial activities in order to make them more productive.
"For example, you have the computer and electronics industries per se. But there is also the application of advances in those industries to traditional sectors such as furniture, electronic appliances, and apparel," said Villamil.
Avant Technologies president Luis G. Ramirez agrees. "Services and manufacturing are two sectors with a highly visible impact on the economy. But it is research & development (R&D) with its respective marketing that generates the most wealth. The synergism of R&D, marketing, manufacturing…makes up a stable value chain, creating a snowball effect on continuous improvement and growth," said Ramirez.
According to the technology entrepreneur, Puerto Rico’s best bet is to concentrate its marketing efforts on companies with high value added activities such as marketing and R&D in order to achieve a stable value chain.
Accelerate new economic activity creation
For all their blessings, high technology industries are not labor intensive. According to Villamil, Puerto Rico must accelerate the creation of new economic activity because as time passes, it will be more difficult to generate the same amount of employment with the same investment.
"An example of this is Abbott Laboratories’ recent announcement that it would invest $100 million in its Barceloneta complex. Number of additional jobs created: 20, a $5 million investment per job. Ten years ago that investment was probably $1 million per job. We have to accelerate the creation of economic activity in Puerto Rico," said Villamil.
How do we catch up? "Work hard," says Stewart.
And look to Ireland, says Rivera Oyola. "Ireland knows that time is valuable and uses it efficiently to develop economic opportunities," he said. "In the last six years, unemployment in Ireland has decreased from 13% to less than 4%. There’s no reason why Puerto Rico cannot do the same."
"With the demographic transition, the task is not as overwhelming as it may seem. Our birthrates are coming down steadily… But we still need to create 20,000 or 30,000 jobs a year to get ahead of where we are," said Stewart.
"As we create more jobs more people will come into the labor force. Our labor force participation is low and, because we have free migration, people will not migrate to the U.S. while we create jobs. Our strategy must include upgrading our infrastructure and human capital," he added.
According to Stewart, in the educational sector, Puerto Rico is doing pretty well, at least better than any middle income country except Korea and better than some high-income countries.
"Our production of science and engineering bachelor’s degree graduates is 53% of the comparable U.S. statistic. But master’s degree graduates and PhD’s in Puerto Rico need to increase," he said.
Most experts agree that Puerto Rico has fallen behind in the creation of a competitive business environment. Other countries have been improving their infrastructure and expanding communications for years, and it may cost the island a sobering adjustment period during which companies may leave for more prepared environments.
"I am very concerned about the economic future of Puerto Rico. We worry too much about the short term and don’t see the long term, where you have advance planning time. A country needs to have the will and the capacity to think long term," said Villamil.
"It worries me that science & technology initiatives keep getting postponed. The Dominican Republic already has a cyber park under construction. Panama’s technology by the locks program will build an industrial park, giving participating companies contact with research, consulting and training opportunities.
"In Spain, the government of Valencia is building a 300,000-square-foot biomedicine research center and the University of Barcelona’s Parque Cientifico has a 500,000 square foot research facility. And Cuba recently licensed Glaxo to distribute worldwide the meningitis vaccine it developed.
"If we do not wake up pretty soon, we may not be able to wake up at all," said Villamil. |
. |
Ireland
"Ireland is reaping the rewards of building a high tech workforce 20 years ago, offering economic incentives and leveraging its geographic position," said Estudios Tecnicos President Jose J. Villamil.
"Years ago, Ireland decided that its best opportunity to be successful in the global order was emphasizing education. It has made extraordinary investments in the educational system and infrastructure. This allows them to be the telemarketing hub for Europe and creates very agile promotional structures."
According to Villamil, Ireland has made good use of the economic assistance it receives from the European Community. While the amount is similar in amount to what Puerto Rico receives annually from the federal government in unemployment, nutritional assistance and similar programs–which mostly go into consumer spending–European assistance to Ireland is mostly invested in infrastructure and the educational system.
"Few people know that back in 1995, when the U.S. started to discuss the elimination of Section 936, Ireland’s Prime Minister personally called the CEOs of Puerto Rico’s pharmaceuticals and other manufacturing companies to let them know about their availability. That’s how aggressive they are. They have a commitment towards economic development," said Villamil.
Singapore
Singapore is the fastest growing market in Asia, and even the world. A small island very similar to Puerto Rico, its history speaks of conquests by Great Britain and Japan through the centuries, a brief spell as part of Malaysia; ending with its separation to become an independent republic in 1965.
Its strategic location on major sea lanes encouraged Singapore’s government to design economic policies favorable to business and export oriented activities. In 1999, Singapore’s real GDP growth was 5.5%, with a 3.5% unemployment rate and an enviable 0.5% inflation rate.
To date, there are more than 3,000 multinational corporations established in Singapore, spread among different sectors of the economy. Manufacturing accounted for 24% of its 1999 gross domestic product (GDP), while financial/business services are 25% and electronics makes for 43% of their total industrial output. The government has also begun to encourage biotechnology and chemical companies.
Dominican Republic
In the Dominican Republic, much of the economic development has been related to the growth and expansion of industrial free zones for the past 15 years. With more than 50, it ranks fourth in the world in the number of free zones.
Foreign companies can operate tax free under customs and fiscal incentives in the Dominican Republic that allow for duty free importation of equipment, raw materials and components for assembling products or providing services. Companies within the zones have the right to repatriate profits and can sell up to 20% of their production in the local market.
"The Dominican Republic is the fourth biggest shipper of apparel to the U.S. It is taking away industries that Puerto Rico is losing anyway. But this does not mean that it won’t become more competitive in the future and present more of a challenge in the more high value added and technology areas," said Pridco’s John Stewart.
Mexico
In Mexico, the introduction of maquiladoras (Mexican assembly plants near the U.S. border) provided U.S. companies low labor costs, along with proximity to its manufacturing facilities. With average manufacturing industry wages as low as $2.12 per hour, cities along the U.S. border have experienced explosive population growth, providing unlimited amounts of labor.
With an educational budget of $23 billion for 2000, Mexico’s educational levels are increasing substantially, with mandatory education from ages six to 18. College enrollment in 2000 was more than two million.
In 1994, Mexico joined the U.S. and Canada in the North American Free Trade Agreement (NAFTA). The agreement eliminates restrictions on the flow of goods, services and investments in North America and phases out all tariffs by 2010. Mexico ranks second as a U.S. trading partner with $87 billion in U.S. exports and $110 billion in imports from Mexico.
Mexico’s manufacturing sector also accounted for 21% of the country’s 1999 GDP and 19% of its employment. Along with manufacturing, there are other segments of economic importance such as services (32.2%), commerce (16.9%), construction (5.6%), and transportation and communication (4.5%). |
