Improving the measurement of Puerto Rico’s Economic Growth
By Ricardo Fuentes
The shock of the COVID-19 pandemic on Puerto Rico is severe. For the last two months, the Financial Oversight and Management Board for Puerto Rico has been analyzing the effect of COVID-19 on the Puerto Rican economy and soon, the Oversight Board will certify an updated Fiscal Plan for Puerto Rico informed by this analysis.
In this time of uncertainty, the Oversight Board has made every effort to generate the most responsible economic forecast possible, using the most relevant data and methodologies. One of the most important projections is for real Gross National Product (GNP). Unfortunately, there are various issues related to how this indicator is currently being estimated by the Government of Puerto Rico that make the forecasting process much more challenging. The annual estimates that are currently generated by the government have been calculated using 1954 as the base year to adjust for inflation. Needless to say, consumption patterns have changed drastically since then, so this estimate does not provide the most reliable measures of growth for current periods. One lesson from the 2019 estimation is the urgency for Puerto Rico to modernize and improve the availability of its economic data. Accurate data matters a lot to how we all plan for Puerto Rico’s future.
The 2019 Certified Fiscal Plan (CFP) anticipated the Puerto Rican economy would grow in Fiscal Year 2019 (FY19). The impact of Hurricane Maria was reflected in the previous fiscal year, so FY19 represented the rebound fueled by the first wave of disaster relief. Specifically, the CFP projected Gross National Product (GNP) at current prices (also called nominal GNP) would grow 4.7% in Fiscal Year 2019.
The Government of Puerto Rico published last month that the island’s nominal GNP was $70.8 billion in FY19. In other words, the economy grew at current prices by 4.4%, only slightly below the CFP’s forecast. To properly assess how much an economy has grown in terms of what it produces, it is standard to subtract the part of the GNP that rises due to price increases to estimate the amount produced, or real GNP. In the presence of increasing prices, only looking at nominal growth overstates the increase in economic activity.
The 2019 CFP projected the economy would grow, in real terms, 4% in FY19. However, the government has preliminarily estimated the economy only grew 1.5% in real terms. After careful examination, the Oversight Board has concluded this preliminary figure requires much scrutiny, because inflation during FY19 was less than 1%. In a context of very little change in prices, real GNP growth should be closer to 4% (as, roughly speaking, the difference between nominal GNP growth and the rate of increase in prices in the economy should be the growth of real GNP). Further, the Puerto Rico Economic Development Bank’s Economic Activity Index (EAI), which is highly correlated with real GNP growth, grew 5.8% during the same period.
EAI is a coincident index for the economic activity of Puerto Rico composed of four indicators: total payroll employment, total electric power generation, cement sales, and gas consumption. While it is a somewhat crude measure, the EAI is nevertheless very reliable for monitoring trends in the economy and has been shown to be highly correlated with real GNP growth.
For example, while the annual growth rate of real GNP and the annual growth rate of EAI are not identical, they have never differed more than roughly 2 percentage points (see graph below). With an annual EAI growth rate of 5.8% in FY19, a real GNP growth rate of 1.5% would imply the two indicators are over 4 percentage points apart.
Either FY19 is a statistical anomaly, or the government’s preliminary figure has underestimated real growth. Given what we observed in inflation, and revenues for FY19, all evidence points to the latter. The Oversight Board estimates the economy indeed grew close to 4% in real terms in FY19.
As far back as 2011, the U.S. Bureau of Economic Analysis (BEA) issued a series of recommendations to the Government of Puerto Rico to improve the quality of the economic statistics estimated on the island. To date, most of these recommendations have not been incorporated into Puerto Rico’s economic reports. For this reason, the Oversight Board has reiterated some of the most critical of the issues raised by the BEA, through a formal recommendation pursuant to Section 205 of PROMESA on March 6, 2020. Among the most urgent, we recommend publishing GNP estimates quarterly, while ensuring inflation-adjusted (or “real”) growth in output and prices is estimated using a more recent base period that reflects a more appropriate basket of goods and services. We believe the preliminary FY19 real growth figure is flawed in part due to this specific issue.
We urge the Government to engage with the related agencies to develop and implement a plan to modernize the island’s macroeconomic statistics, in line with the BEA recommendations that were already put forward almost a decade ago.
Ricardo Fuentes is the Economist of the Financial Oversight and Management Board for Puerto Rico