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STRUCTURAL TRANSFORMATION IN THE ECONOMY
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AN INPUT-OUTPUT ANALYSIS

presented by

Samuel Torres Roman

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STRUCTURAL TRANSFORMATION IN THE ECONOMY
OF PUERTO RICO FROM 1940 TO 1972:
AN INPUT-OUTPUT ANALYSIS

By

Samuel Torres Roman

A DISSERTATION

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Economics

1978

ABSTRACT

STRUCTURAL TRANSFORMATION IN THE ECONOMY
OF PUERTO RICO FROM 1940 TO 1972:
AN INPUT-OUTPUT ANALYSIS

By

Samuel Torres Roman

In this study the structural transformation of the
economy of Puerto Rico from 1940 to 1972 is examined to
determine how the changes have affected the capacity to main-

tain self-sustained growth.

Puerto Rico has been transformed from the colonial
agricultural economy of 1940 into a modern industrial economy,
with the help of a government "Bootstrap" program to attract
private investment using various incentives. The rate of
economic growth was remarkable up to 1972, but stagnatedafter
that year. The unemployment rate never fell below llpercent
in the best years, in spite of rapid growth in the gross
national product and a hugh migration to the United States.
After 1972 unemployment increased steadily, reaching 20 per-

cent in 1977.

The possible causes of the recent stagnation are

investigated by looking into the way structural changes

Samuel Torres Roman

during transition have affected the capacity of the Puerto
Rican economy to create output and to generate employment

in a self-reinforcing process.

The method of study was a historical, holistic
approach presented from two perspectives. In one, the inter-
relations among major economic activities (1. e., production,
consumption, savings, imports, exports and employment) are
examined in light of the transactions that they generated
among the agricultural, industrial and service sectors of
the economy. Data were analyzed in accordance with general
theories and by comparison with the experience of other
countries. The second perspective uses input-outputanalysis
for a more detailed examination of the structural trans-
formation. The structures of the economy of Puerto Rico
for 1963 and 1972, represented by 44-order input-output
matrices, are compared to determine changes in the degree
of integration, labor requirements, productivity, import
dependence and export dependence. The input—output frame—
work is also used in a counterfactual analysis in which
hypothetical situations are simulated to distinguish changes
in output, employment, imports and exports explained by
changes in final demand, both domestic and external, from

those due to changes in the structure of production.

It was found that the Puerto Rican economy has

been transformed as may be expected in a successful economic

Samuel Torres Roman

development effort, shifting its dual condition into a
well-integrated, modern, industrial economy. An adapt-
ability for applying innovations and responding to chang-

ing economic conditions has been developed.

Economic growth in Puerto Rico, however, is not
self-sustaining. The economy is vulnerable directly and
indirectly to external economic conditions and depends on
external trade and capital to continue its growing momentum.
This dependence, however, is understandable since the small
size of the island makes an outward orientation necessary
to maximize the advantages of access to a large United

States market.

Evident in the analysis is an increased domestic
integration implying positive steps toward Self-"reinforcing
growth and growing internal demand for intermediate input
which stimulates domestic production. This increased
domestic integration resulted in considerable substitution
of intermediate input for imports, which has lessened

external dependence somewhat.

Labor absorption in the expanding industrial sectors
has been only moderate due to rapid productivity gains. The
service sectors have been prominent in absorbing the grow—
ing and shifting labor force. This will continue to be
crucial as significantly greater labor absorption in

industry cannot be expected. Thus, it is essential to

Samuel Torres Roman

design policies which treat the service sectors as impor—
tant elements in economic development strategy. Revital-
ization of agriculture could also provide an important

source of increased employment.

The major portion of the changes in output, employ-
ment and trade in Puerto Rico were due to change in final
demand which is mainly determined by external forces.
Economic fluctuations also come in large part from out—
side the island. The influence of structural change has,

nevertheless, been substantial.

ACKNOWLEDGMENTS

A number of people helped me in various ways to

accomplish this study.

My principal debt is to W. Paul Strassmann who
encouraged me to finish the dissertation and, as committee
chairman, guided me during the study. My gratitude also
goes to Anthony K00 and Victor Smith, for their generous

assistance as members ofthe thesis committee.

I also wish to express my appreciation to Angel
L. Ruiz, Associate Professor, the University of Puerto
Rico, who allowed me to use the input-output table he
adjusted for his research and for the orientation he

provided in technical aspects of the input—output analysis

Finally, my sincere gratitude is expressed to my
family for their continuous encouragement and moral

support.

ii

TABLE OF CONTENTS

LIST OF TABLES . . . . . . . . . . .

LIST OF FIGURES . . . . . . . . . . .
Chapter

I. INTRODUCTION . . . . . . . .

The Problem . . . . . . .

Objectives of the Study .

The Outline of the Study .

II. RELEVANT THEORIES OF ECONOMIC

GROWTH

Balance vs. Unbalanced Growth . . .

Growth in Dual Economies .
Growth in Open Dual Economie
Stages of Growth . . . . .
Summary . . . . . . . . .

III. METHODOLOGY, NOTATION AND DATA

Introduction . . . . . . .

The Aggregative View . . .

The Disaggregative View .
The Input- Output Technique

Structural Change . .

The Input-Output Model .

S O I O

and

Applications of the Input-Output

MOdel O O O O O O 0

Limitations of the Input- Output

Analysis . . . . . . .
Sources of Data . . . . .
' Macroeconomic Data . . .

The Input-Output Data .

IV. STRUCTURAL TRANSFORMATION IN P
RICO: AN OVERALL VIEW . . .

A Brief Historical Review of

Rico's Development Strateg,

iii

UERTO

Puerto

v C O O

Page

vi

U11>N

11
15
23
36

43
43
44
47

48
51

55
61'
64

64
66

7O

7O

Chapter

St

The Period Before 1947 . . . . . .
The New Strategy After 1974:
"Operation Bootstrap" . . . . . .
Revision of "Operation Bootstrap"
Summary . . . . . . . . . . . . .
ructural Transformation: A General
View . . . . . . . . . . . . . .
The Economic Growth Achieved . . .
Change in the
Change in the
Change in the Structure of Foreign
\_Trade . . . . . . . . . . . . .

Structure of Production
Structure of Employment

V. STRUCTURAL TRANSFORMATION:

Change in the
Process and in the Sources of
Financing . . . . . . . . . .

Structural Transformation:
with Other Countries . . . . . .

The Structure of Demand . . . .
The Structure of Trade . . . .
The Structure of Production . .
The Accumulation Process . . . .
Summary . . . . . . . . . . . .

VIE»! I I I O O O O O O O O O O O O 0

VI.

Capital Accumulation

A DETAILED

Comparison

Change in the Structure of Production

from Input-Output Viewpoint . . .
Change in Interdependence and
Integration . . . . . . . . . .
Import Leakages and Import
Substitution . . . . . . . . .
Change in Employment an Labor
Productivity . . . . . . . . .
The economic effects of Change in
Demand and Change in Structure .
Output Changes . . . . . . . . .
Employment Changes . . . . . . .
Trade Effects . . . . . . . . .
Summary . . . . . . . . . . . .

SUMMARY AND CONCLUSIONS . . . . . .

Summary . . . . . . . . . . . .
Conclusions, Recommendations and
Suggestions for Further Research

APPENDIX A O C O O O O O O C 0 O O O O O 0

iv

Page
71
79
83
85
86
87
93

107

115

126

139
142
146
148
153
155

159

160
160
179
192
210
211
217
221
230
235
235
249

261

Chapter Page

Definitions of Variables and the
Source of Data for the Regression

Equations I I O O O O O O O O O O O

. 269

261

BIBLIOGRAPHY . . . . . . . . . . . . . . . . .

LIST OF TABLES

Page
The Input-output FlOWS o o o o o o o o 0 51

Relative Importancecfi Major Puerto
Rican Exports, Years of 1895, 1901,
1940 (In million dollars) . . . . . . . 74

Net Income by Industrial Origin, Puerto
Rico, 1940 . . . . . . . . . . 76
Some Selected Indicators of Growth,
Fiscal Years 1940, 1947, 1955, 1963,
1972 and 1977 (In per capita constant
dollars, 1954 = 100) . . . . . . . . 88

Rate of Growth of Some Economic
Indicators of Growth for Some
Selected Periods (In percentages) . . . 89

Some Indicators of Economic Growth and
Industrialization for Puerto Rico,
Jamaica, Dominican Republic and Haiti,
Year 1972 . . . . . . . . . . . . . . 92

Domestic Income of Puerto Rico,
Percentage Distribution per Industrial
Origin and Total for The Year, Fiscal
Years 1947, 1955, 1963 and 1972 (In
percentages and million of dollars) . . 94

Employed Persons in Puerto Rico,
Percentage Distribution per Industrial
Origin and Total for the Year, Fiscal
Years 1940, 1947, 1955, 1963 and 1972
(Percentages and thousand of workers) . 108

Employment Status of Persons 14 years
of Age or More, Labor Force
Participation Rate and Unemployment
Rate, Fiscal Years 1940, 1947, 1955,
1963, 1972 and 1977 (In thousand of
workers and percentages) . . . . . . . 113

vi

Table

4.15

Page

Value of Exports, Imports and Trade
Balance and as Percentage of the
Respective Gross National Products,
Fiscal Years 1940, 1947, 1955, 1963
and 1972 (Value in million of dollars,
1954 = 100) . . . . . . . . . . . . . . . 117

Imports, Exports and Trade Coefficients
for Some Selected Small Industry
Oriented Countries, Year 1972 . . . . . . 119

Traditional and Selected New Products
Merchandise Exports, Total Values and
Percentages of Total, Fiscal Years 1950,

1963 and 1972 (Values in million of
dollars) . . . . . . . . . . . . . . . . 122

Merchandise Imports Classified by
Consumption, Capital and Intermediate
'Goods, Total Value and Percentages of
the Total, Fiscal Years 1947, 1955, 1963,
and 1972 (In million of dollars and
percentages) . . . . . . . . . . . . . . 124

Gross Fixed Domestic Investment in Puerto
Rico, in Total Value and Percentages
of Total, Fiscal Years 1947, 1955, 1963
and 1972 (In million of constant
dollars, 1954 = 100, and percentages) . . 128

Average Annual Rates of Growth of
Construction, Machinery and Equipment
and Total Gross Fixed Investment for
Some Selected Periods (In percentages). . 129

Sources of Capital Funds in Total Value
and as Percentage of Total, Fiscal
Years 1947, 1955, 1963 and 1972 . . . . . 131

Trade Balance, Unilateral Transfers and
Capital Movements to and from Puerto
Rico, Fiscal Years 1947, 1955, 1963 and
1972 (In million of dollars) . . . . . . 133

vii

Page

Gross National Product, Gross Domestic
Product and Factor Payments from and
to the Rest of the World, Fiscal
Years 1947, 1955, 1963 and 1972 (In
million of dollars) . . . . . . . . . . . 135

Normal and Actual Values of Variables
Explaining Accumulation and Resource
Allocation Processes, Years 1947, 1955,
1963 and 1972 (As percentage of GDP or
corresponding aggregate) . . . . . . . . 143

Sectoral Value Added as a Share of Total
Value Added, 44 Sectors, Years of 1963
and 1972 (In percentages) . . . . . . . . 165

Domestic Production Total Linkage Index
and Index of Dispersion, 44 Sectors,
Years 1963 and 1972 . . . . . . . . . . 170

Direct plus Indirect Intermediate
Imported Inputs per Dollar of Output
Delivered to Final Demand, Years 1963
and 1972 . . . . . . . . . . . . . . . . 183

Alsolute Change from 1963 to 1972 in
Direct Domestic Intermediate Input
Coefficients and in Direct Imported
Input Coefficients, 44 Sectors(Dollars
per dollar of output) . . . . . . . . . 188

Average Hourly Earnings for Some Selected
Manufacturing Industrial Sectors and
Average Annual Rate of Growth, 1954,
1963 and 1972 (Earnings in dollars and
change in percentages) . . . . . . . . . 194

Relative Changes from 1963 to 1972 in
Direct Domestic Intermediate Input
Coefficients, in Direct Imported
Intermediate Coefficients and Direct
Labor Coefficients, 44 Sectors (In
percentages) . . . . . . . . . . . . . . 201

viii

Table

5.12

Direct plus Indirect Labor per Million
Dollars of Final Demand, 44 Sectors,
Years 1963 and 1972 . . . . . . . . . .

Change in Output, from 1963 to 1972, Due
to Change in Demand and Change in the
Structure of Production, 44 Sectors
(In million of dollars) . . . . . . . .

Change in Output, from 1963 to 1972, Due
to Change in Demand and Change in the
Structure of Production, as Percentage
of the Total Change of the Sector and
as Percentage of the Source of Change,
Five Groups of Sectors . . . . . . . .

Change in Employment, from 1963 to 1972,
Due to Change in Demand and Change in
the Structure of Production, 44 Sectors
(Thousands of workers) . . . . . . . . .

Change in Output Attributable to Exports,
from 1963 to 1972, Due to Change in
Demand and Change in the Structure of
Production, 44 Sectors (In million of
dollars) . . . . . . . . . . . . . . . .

Total Output and Output Attributable to
Exports, Difference and Ratio, Years
1963 and 1972, Six Groups of Sectors
(In million of dollars and decimals) . .

Change in Intermediate Imported Inputs,
from 1963 to 1972, Due to Change in
Demand and Change in the Structure of
Production, 44 Sectors (In million of
dollars) . . . . . . . . . . . . . . .

Direct plus Indirect Intermediate Immnted
Inputs as a Ratio of Total Output, Six

Groups of Sectors . . . . . . . . . . .

Regression Equations of Processes and
Variables Explaining Structural Transformation

ix

Page

205

213

214

219

223

225

229

232

268

LIST OF FIGURES

Figure Page

5.1 Sums of Direct Intermediate Input
Coefficients from all Sectors for
1963 and 1972, Primary, Manufacturing
and Service Sectors (Dollars per
dollar of total output) . . . . . . . . 166

5.2 Sums of Intermediate Direct Sales
Coefficients to all Sectors for
1963 and 1972, Manufacturing Sectors
(Dollar per dollar of total output) . . . 176

5.3 Sums of Direct Intermediate Imported
Input Coefficients from all Industries,
Primary, Manufacturing and Service
Sectors (Dollars per dollar of total
output) . . . . . . . . . . . . . . . . 182

5.4 Sums of Direct Labor Coefficients for
1963 and 1972, Primary Products,
Manufacturing and Service Sectors
(Workers per thousand of dollars of
output) . . . . . . . . . . . . . . . . 197

5.5 Changes in Direct and Total Labor
Coefficient Ratios 1972/1963, Primary,
Manufacturing and Service Sectors . . . . 206

CHAPTER I

INTRODUCTION

The purpose of this research is to study the struc-
tural transformation of the economy of Puerto Rico and to
investigate howstructuralchanges have affected the cap-
acity of the economy to create output and generate employ-

ment 0

Puerto Rico has been transfimmed from a dual colon-
ial agricultural economy in 1940 into a modern industrial
economy. This transformation was achieved with the helpof
'Operation Bootstrap', a government program designed to
attract private business investment by various incentives
such as tax exemptions, low plant rental, low interestloans,
training of labor, and others. The intent of the program
was to elevate both income and employment by attracting
labor-intensive plants that could use the abundant andcheap
labor available in Puerto Rico.. It was expected that the
income of the newly employed workers would be translated
into increased demand for consumer goods and a rise in the
domestic multiplier engendered by local production of an
increased share of intermediate input. A rise in employ-

ment in existing local indUstries and newly created indus-

tries was also expected, induced by increased demand for
consumer and intermediate goods. This chain of events was
expected to eventually bring the island economy into a

cycle of self-sustained growth.

Puerto Rico's growth in the post World War II period
was remarkable. The average ratecflfgrowth in real gross
national product from 1947 to 1972 was 7.1 percent this
year. Other indicators of economic growth were equally

impressive.

The Problem

 

In spite of the rapid economic growth, the rate of
unemployment in Puerto Rico never fell below 11.0 percent
in the best years, even though huge annual migration to
the United States took pressure off the local job market.
Unemployment has been increasing in the Nineteen Seventies,
reaching a level of 20.0 percent in 1977, although partici-
pation in the labor force fell to 42.0 percent. Further-
more, the average annual rate of growth in real gross
national product for the 1970-1977 period dropped to al-

most zero.

Some people, particularly government leaders, attri-
bute the economic slow-down in Puerto Rico to the economy's

vulnerability to the recession in the United Stateseconomy

during the first half of the decade. The vulnerabilityof
the export-oriented island economy to United States business
recessions was demonstrated by the recession that came with
the end of the Korean War, when the promotion of new fac-
tories was substantially reduced. In addition, export firms
established on the island reacted to reduced demand by clos—

ing their entire Puerto Rican establishments.

An alternative explanation of the stagnation holds
that structural changes in the economy of Puerto Rico have
been hindering its growth, limiting the capacity for both
output and employment. The potential for such self-defeat-
ing changes was suspected as early as the mid Nineteen
Seventies when the emphasis of the industrialization program
shifted to more capital intensive industries capable of pay-
ing higher wages and supplying a larger share of the inter-
mediate inputs needed on the island. It was realized then
that fast wage increases had reduced the competiveness of
labor intensive manufacturing. Additionally, it wascharged
that existing industrial activity was poorly linked to the
rest of the domestic economy so that its feedback effects

were weak.

An extreme position of this structuralist view of
the stagnation attributes the economic ills of the country
to a complete failure of the economic development program.
It is argued that Puerto Rico's economy is an example of

growth without development, to the point that itis incapable

of maintaining growth on its own and of reducing the per-

sistent unemployment to acceptable levels.

Objectives of the Study

 

The main objective of the study is to investigate
the relative importance of these possible causes of the slow-
down of the Puerto Rican economy. Special attention is given
to structural transformation. One crucial aspect of struc-
tural tranmhmmation that is closely explored is its employ-
ment implications. In this connection, the research explores
the extent to which the changes in output, employment and
trade can be attributed to changes in the structures of pro-
duction as opposed to changes in domestic and external final
demand. It is hypothesized that changes in demand, particu-
larly those of external origin, explain a large part of the

changes in output and employment.

The examination of structural changes will determine
the extent to which Puerto Rico has experienced full economic
development. The hypothesis for this part of the analysis
is that Puerto Rico has undergone structural change that
makes the economy capable of more self-sustained growth than

has been actually realized.

Special attention is given to the way actual struc-
tural changes compare with those that can be expectedaccorde

ing to theory and the experiences of other countries which

have gone through the process of economic development. It
is hypothesized that Puerto Rico has closely followed the
path of other countries with similar characteristics ofsur-

plus labor and small open economies.

One crucial aspect requiring careful exploration is
the degree of domestic integration in the Puerto Ricanecon-
omy and the output and employment implications of structual
changes affecting integration. This exploration will permit
testing of the extent to which attempts to improve the local
lhmages in the domestic economy, emphasized in the last re-

vision of the development program, have been successful.

The Outline of the Study

In Chapter II several theories of economic development
are discussed, with special emphasis on those relevant to
this study. Theories presented in this chapter provide the
framework for evaluating growth in the economy of Puerto

Rico.

The methodology, notation and sources of data for the
study are discussed in the third chapter. An input-output

_model, which is the main tool of analysis, is presented.

Chapter IV and Chapter V contain the analysis. In
the fourth chapter, macroeconomic data from the economy of
Puerto Rico for thetnriod 1940 to 1972 are analyzed from the

perspective of the theories presented in Chapter II. The

growth path of the Puerto Rican economy from 1947 to 1972
is compared to a normal path drawn from a cross-sectional
analysis of 101 countries made by Hollis Chenery and Moises

Syrquin in 1975.1

In Chapter V a more disaggregated view of the

economy for 1963 and 1972 is presented using input-output
analysis. The structural transformation, analyzed in the
previous chapter from a macroeconomic perspective, is further
examined with a more detailed general equilibrium type of
analysis. Economic integration and its output and employment
implications are examined from this perspective. How much
changes in Output, employment and trade can be attributed to

structural changes is also discussed.

Finally, in the last chapter, the findings of the
study are summarized, the conclusions are presented, and
some recommendations are made. Here, the final question of
the extent to which Puerto Rico has made economic development

self-sustaining is explored.

 

1Hollis Chenery and Moises Syrquin, Patterns of Devel-

opment 1950-1970 (Londmn Oxford University Press, 1975).

 

 

CHAPTER II

RELEVANT THEORIES OF ECONOMIC GROWTH

The purpose of this chapter is to present a brief sum-
mary of theories of economic development which deal with
the problem of how to begin and maintain economic growth in
underdeveloped countries. Emphasis is placed on those
theories that discuss characteristics important in the economy
of Puerto Rico. The theories will provide a framework for
evaluating the structural changes in this economy during

economic growth.

Until the Nineteen Forties, theories of economic growth
concerned developed economies and placed emphasis on the dy-
namics of growth. Existing models stressed the importance
of capital / output ratio; study of the multiplier asaameans
of evaluating new investments; measures to control the sav-
ings ratio, and hence consumption; and placed emphasis on
continuing growth.1 However, they had nothing to say about
starting growth in an underdeveloped country seeking to in-

itiate growth mainly from its own resources. Economists

 

_

1For comprehensive coverage of these growth theories,
together with a very good introduction by the editor, see A.
Sen, Growth Economics: Selected Readings (Harmondsworth;
Penguin, 1970).

 

turned their attention to these questions in the post-war
period, stimulated by pressures coming from many underdevel-

oped countries seeking growth.

Balanced vs. Unbalanced Growth

 

The basic problem of underdeveloped economies was how
to overcome the self-perpetuating circle of low production,
small market, small savings, little capital, low production,
and so on. Economists agreed about thaneed for increased
investment, but differed about how to spread the investments

across the economy.

Some, like Ragnar Nurkse,2 were in favor of a "bal-
anced growth" approach, spreading investment across a wide
field of economic sectors and industries, thus enlarging the
size and volume of the market. Nurkse emphasized the prob-
lem of generating savings. In this connection, he stressed
the role of the state in controlling trade movements and en-
forcing savings through taxation. Nurkse's version of bal-
anced growth placed emphasis on complementarities between
different industries in the demand of goods. He claimed
that one industry started in isolation may face insufficiency
of real demand. Its product may not be absorbeddomesti-
cally since those who earn factor incomes in the single in-

dustry will hardly spend their entire incomes on theproduct

 

2Ragnar Nurkse, Problem of Capital Formation in Under-
developed Countries and Patters of Trade and Development (New
York: Oxford University Press, 1953).

of that single isolated industry. Adequate real demand will
be forthcoming, he argued, only if sufficiently large numbers
of industries are established at the same time, so that they

will provide markets for each other.

Another approach to the balanced growth hypothesis is
that of P. N. Rosestein-Rodan.3 He proposed a "big push"
method of transformation, basing his argument on complemen-
tarities and external economies in the supply of goods. His
prescription was to invest simultaneously on a large number
of fronts making it more profitable by capturing external-
ities which exist horizontally between industries at thesame
stage of production and vertically between different stages

of production.

Another exponent of the balanced growth paradigm is
W. A. Lewis.4 He distinguishes between three sectors:manu-
facturing for the home market, agricultural production for
the home market and exports. According to his conception,
given the rate of growth of exports, manufacturing and agri-
cultural production must expand at rates corresponding, but
not identical, to their respective income-elasticities of
demand. If agricultural production does not grow at anappro-

priate rate either the internal commodity term of trade

 

3P. N. Rosestein—Rodan, "Notes on the Theory of the
'Big Push'", in Readings in Economic Development, edited by
Morgan, Betz and Choudry (California, 1963).

4W. Arthur Lewis, Theory of Economic Growth (London:
Allen and Unwin, 1955).

10

between agriculture and manufacturing will move in favor of
agriculture, thus checkingtfluaexpansion of the manufacturing
sector, or the balance of payments will deteriorate due to
increase in the demand for food imports. Like Nurkse, Lewis
doubted that savings could be generated by the subsistence
sector and argued that one has to look to the capitalist be-

cause those who receive more will save more.

Albert Hirshman5 dissented with the balanced growth
view of Nurkse and advocated an opposing strategy of "unbal-
anced growth." He argued for development through a "chain
of disequilibria", a theory that the expansion of industry A
will create external economies for industry B whenever the
two industries are in a complementary relationship of any
kind. Investment in a key industry will generate outputelse-
where with something like a multiplier effect operating
through "backward and forward linkages"6 between parts of
the economy. This argument also had a spatial dimension.
Development takes place through a"master industry" having a
specific location. New plants will locate close to the master
industry and a "growing point" will be established. Accor-

dingLy,growth is necessarily unbalanced geOgraphically.

 

5Albert 0. Hirshman, The Strategy of Economic Develop-
‘ment (New Haven; Yale University Press, 1958).

6The backward and forward linkages concept will be dis-
cussed in Chapter III.

11

Growth in Dual Economies

 

A group of economists examining developing countries
has postulated that these economies are divided in two sectors
which are so different structurally and behaviorally that
they deal with one another almost as though they form two
different societies and economies. This observation has been
captured in growth models which dichotomize the economies in
these sectors; one advanced modern sector is assumed to be
capital-intensive and mainly industrial, and a backward sec-
tor is characterized as labor-intensive and overwhelmingly

agricultural.

The first statement of such economic dualism is that
of W. A. Lewis7. His formulation deals with two co-existent
sectors and the conditions governing the supply of labor
fromtfluaagricultural into the growing industrial sector. He
argues that a large volume of labor can be transferred into
the industrial sector without loss of agricultural output,
assuming that there are excessive workers, and hence dis-
guised unemployment, in the agricultural sector. Underthis
condition of surplus labor in the agricultural sector, the
wage rate required to attract labor into the industrial
sector need be only slightly above the productivity per unit
of labor in the agricultural sector. Workers will be avail-

able to the industrial sector at that wage as long as surplus

 

7W. Arthur Lewis, "Economic Development with Unlimited
Supplies of Labor" Manchester School of Economics and Social
Sciences 22 (1954): 139-191.

 

12

labor exists. All the surplus product above the wages of
labor accrues to the industrial class and will promote ex-

pansion there.

Such a favorable situation for industrial expansion
is ended when so much labor is drawn from the agricultural
sector that a shortage of workers develops there; or, if the
expansion of production in the agricultural sector is so con-
strained that shortages of food develop, and the real wage
of labor rises due to changes favorable to agriculture in
the term of trade between the two sectors. Under these cir-
cumstances there will be an increase in the real wages of
labor intheuagricultural sector and so the minimum wage
necessary to attract labor out of the sector will have to

rise.

The dual-economy model was modified by a theory of
"factor-proportions dualism" proposed by R. S.Eckaus8. In
this model the modern sector is capital intensive and factor
proportions there are relatively fixed, so that an increase
in employment can only be generated by a rigidly propor-
tionate increase in capital investment. In the traditional
sector, on the other hand, technical co-efficients are var-
iable, meaning that a wide range of techniques and factor
combinations could be used to yield the same output. An in-

crease in available labor given the limited absorptive

 

8R. S. Eckaus, "The Factor Proportions Problem in
Underdeveloped Areas", American Economic Review 45 (1955):
539-65.

13

capacity of the modern industrial sector, will be channelled
into the traditional sector and absorbed there by the use
of more labor intensiwamethods. There is, thus, no incen-
tive for capitalization in the agricultural sector, and the
gap in productivity per unit of labor in the two sectors

widens as the economy grows.

Characterizing models of economic dualism as models
for economic growth was emphasized in the Nineteen Sixties.
The main thrust of the new models was the inter-relating and
consequent transformation of the two sectors so that the
vicious circle of underdevelopment is broken and the economy
achieves self-sustained growth.9 One of the outstanding
models of this approach is one J. C. H. Fei and G. Ranis10

postulated in 1964. Like Lewis, Fei and Ranis assumed a

labor surplus in the agricultural sector that can, in the

 

9This widely used concept was originated in W. W. Rostow,
The Stages of Economic Growth: A Non-Communist Manifesto (Cam-
bridge: Cambridge University Press, 1960). Rostow argues
that all societies in the world can be located at some point
along a continuum marked by five stages: "traditional society,"
"pre-conditions for take-off," "the take-off to self-sustained
growth," "the drive to maturity" and the "age of high mass con-
sumption." In his wafit he tries to identify, using historical
analysis, the conditions under which transformation takes place
to bring a society into a more or less automatic growth cycle
which is what self-sustained growth is all about.

10John C. H. Fei and Gustav Ranis, Development of the Labor
Surplus Economy, (Homewood: R.D. Irwin, Inc., 1964). This model
is summarized critically in B. Higgins, Economic Development:
Principles, Problems, and Policies, rev. ed. (New York: Norton

Press, 1968).

 

14

first stage, be drawn on without negative effects in agricul-
tural production and, hence, at a constant real wage. Beyond
this stage, however, they explored not only the labor inter-
relationship of the two sectors, but also the consumption

of foods produced in each sector by the members of the other.
Additionally, investment by landlords, who have holdings in
both sectors, acts as stimulus for the growth of the indus-
trial sector. Variable, rather than fixed, factors propor-
tions were assumed in the industrial sector. Hence, growth
may be supplied by accumulation of either capital or labor,
or both. All technical innovation was assumed to take place

in the industrial sector.

In this model, "developmentll"

requires a shift of
savings at a rapid rate from the agricultural to the indus-
trial sector. The growing industrial labor force depends on
the food coming from the agricultural sector. Hence, tech—
nical progress in agriculture determines the rate at which
labor can be released from the agricultural sector and ab-

sorbed into the industrial sector. As Fei and Ranis express

it,

"When the economy tries to push forward its
industrialization effort in the open economy
neglecting its agricultural sector, it runs
the risk of having the growth process come to

 

11The emphasis in this model is on economic develop-
ment which comes when the structure of the economy is trans-
formed so that economic growth is self-sustained.

E:

15

a complete halt. Under the pressures of
population growth, food shortages caused by
stagnant subsistence sector become so over-
whelming that the country has to import food
at an increasing rate, thus depriving the
industrial sector of the needed foreign exchange
to import capital goods . . . . In the close
economy case, a forced draft industrialization
effort in the face of agricultural stagnation
will ultimately come to a halt. This results
from the diminution of the economy's invest-
ment fund due to the disappearance of the
agricultural surplus and from the tendency

of wage inflation caused by thedeterioration

of the terms of trade of the industrial sector

D. W. Jorgenson13 varied somewhat the assumptions of
this model, explaining economic dualism with emphasis on
economic growth. He assumed that the marginal productivity
of labor in agriculture is always positive, so that labor
is never available to the industrial sector at a constant
real wage. Therefore, transfers of labor from the agricul-
tural to the industrial sector cause losses of agricultural
output. The real wage thus rises continuously through the

process of growth and different development paths may emerge.

Growth in Open Dual Economies

The models explaining economic dualism reviewed so
far have assumed a closed economy, thus, neglecting for-

eign trade and international capital movements as agents of

 

12Fei and Ranis, p. 305.

13
Economy," Economic Journal 71 (1961): 309-304.

D. W. Jorgenson, "The Development of a Dual

16

growth. From the 1960's surge of decolonization a consider-
able number of countries emerged, clamoring for growth and
characterised by underdeveloped economies largely dependent
on foreign trade. This fact, together with the widespread
opinion that a shortage of foreign exchange constituted a
major developmental bottleneck, underlined the need to bring
an "open-economy" assumption into the growth models explain-

ing dualism.

Fei and Ranis realized the need to bring foreign trade
into their model and discussed this possibility in one chap-
ter of their booklA. According to them, a development
oriented economy benefitted from foreign trade in four ways.
First, and most important, the export sector, together with
the foreign sector, constitutes a "powerful new production
function available to the economy" through which the input
required to produce the food and industrial consumer goods
needed by the workers in the export sector are converted into
exportable goods which can be exchanged for imported capital
and raw material needed for the expansion of the industrial
sector. This, in their opinion, gave access to a foreign
production function more efficient than any alternative dom-
estically available. Secondly, and related to this, a whole

range of technological alternatives assembled abroad be-

comes available, from which the country can pick those best

 

14Fei and Ranis, Chapter 8.

 

l7

suited to its resource endowment and development strategy.
Thirdly, the foreign sector can be viewed as an important
additional source of savings to finance expansion of the
domestic industrial sector. Last, and less conspicuous, the
export provides, in itself, an additional source of savings

available for the expansion of the domestic industrial sector.

Fei and Ranis, however, saw foreign trade, not as an
engine of growth, but just a facilitator of it. After bring-

ing trade into their model they concluded that:

"The basic structural characteristics which
dominate the preponderant domestic subsis-
tence sector in the closed economy must
continue to receive the planner's prime atten—
tion in the open economy. In other words,what
we believe to be the heart of the matter, the
expansion of the agricultural productivity to
fuel the development process via a consistent
and balanced pattern of resource allocation
within the dualistic economy, is still at the
center stage when the economy is open to trade
and foreign capital inflow." 5

Pessimistic views about the role of international
trade appeared in the under-developed countries long before
foreign trade was incorporated into growth models. A dis-
tinctive pattern of development thinking began to evolve
among economists in Latin America, centered in the U. N.Econ-

omic Commission for Latin America (ECLA) under the leadership

of R. Prebischl6. The central argument was an attack on

E

15Ibid., p. 206.

16ECLA, A Contribution to Economic Integration in Latin America,(New
York: United Nations, 1961) andTn R.Prebiséh;, "The Economic Development of
Idltin America and its PrinCiple Problemsf'Economic Review of Latin America,

7 (1962): part 1.

 

l8

traiflflcnal theories of international trade in which special-
ization is assumed to bring benefits to all participants, to
the primary producer as well as the industrial. The analysis
was focused in three main directions: first, an analysis of
trade relations among countries on the basis of a "centre-
periphery" dualism stressing terms of trade imbalance that
worked in favor of the industrial countries; second, a strong
emphasis on industrialization with the objective of correcting
the imbalance; and third, a concentration on the social and

structural problems of underdevelopment.

Deterioration in the terms of trade, the negative
consequences of import-substitution industrialization which
increased dependence on intermediate and capital goods, the
inroads of transnational companies and conglomerates (TRANCO)
and the growing volume of debt repayment and repatriated
profits which exceeded capital inflows and aid, led to a
growing emphasis on viewing the Latin American economies as

"dependent" rather than "peripheral."

One of the first to lay the foundations of "dependency
economics" was the Brazilian, Celso Furtado.17 He was init-

ially a revisionist, strongly in favor of industrialization

 

l7Celso Furtado, "Capital Formation and Economic
Development" in The Economics of Underdevelopment. A. Agar—
wala and S. P. Singh, eds., (New York: Oxford University
Press, 1963) and C. Furtado, Development and Underdevelopment
(Berkeley:University of California Press, 1964).

35

wit

9111'

em

to

the

th.

fi:

ca

na

it

ti

all

du

th

of

19

as a way to overcome the term of trade imbalance. Disenchanted
with this approach, he presented a theory of underdevelopment
which relied on the manner in which the capitalist system
achieved only partial penetration in the underdeveloped econ-
omies, resulting in a disequiliberated dependent economy yet

to be transformed.

Furtado argued that in the underdeveloped countries
the industrial sector developed in a condition of permanent
competition with imports, and the technologies adopted in-
hibited faster transformation of the economic structurethrough
the absorption of the subsistence sector. At the same time
there was continued reliance on primary exports in order to
finance the risingauuiincreasingly essential import bill for
capital goods, intermediate goods for established industries
and imported produce for urban markets. Thus, neither exter-
nal dependence nor dependence on primary exports have in real-
ity been reduced by industrialization. An essential assump-
tion in this view is that the industrial employment was small
and low waged and that the high profits obtained by the in-
dustrialist remained in the hands of the ruling oligarchy so
that the feed-back effects to the rest of the economy were
small. Moreover, most of the industrial activity was geared
to the substitution of goomspreviously imported so thatwhen
import substitution exhausted its possibilities, the growth

of the industrial sector was drastically reduced.

in

53'

eff

Yr

......\r\

 

20

A new wave of thinking in dependency economics surged
in the Caribbean in the 1960's, influenced in its early stages
by the work of the English economist Dudley Seers18 on the
effects of large scale business on small, open economies.The
main preoccupation in this new thinking was the small sized

national economy, which was natural in the Caribbean region.

A thorough analysis of the policy options open to
small countries seeking development by W. G. Demas19 was the
first major theoretical statement. He saw structural trans-
formation as the essential ingredient of self-sustained econ-
omic growth. In regard to structural transformation he

wrote:

I include seven basic elements in the term
"transformation of the structure of produc-

tion." These are the capacity to transform

as determined by political and social processes
and attitudes; the unification of the national
markets for goods and services; the shift of
production and of labor as between primary,
secondary and tertiary sectors of the economy; the
development of an increasing degree of inter-
dependence among domestic industries and activ-
ities; changes in the importance and composi-

tion of foreign trade; the reduction of dualism

in the economgé and the development of appropriate
institutions.

 

18Dudley Seers, "Big Companies and Small Countries:
A Practical Proposal," Kiklos 16 (1963): 599-608.

19William G. Demas, The Economics of Development
in Small Countries, with Special Reference to the Caribbean,
(Montreal: McGill University Press, 1965),

20

Ibid., p. 8.

int

mar

ZEI‘

 

21

Demas saw structural transformation, however, as
difficult to achieve in a small economy because of skewed re-
source distribution, the need to specialize to take advant-
age of economies of scale, the corresponding dependence on
international trade, and the small size of the internal
market. He advocated integration of the region into a common

market system as the most hopeful escape from this trap.

The hoped for integration in a common market among the
Caribbean countries has proved very hard to achieve because
of the dependency of the individual economies on a metropole
and TRANCO establishments. Thinking along these lines has
lead to a historical approach which emphasizes the institu-
tional and structural disadvantages of dependent economies

and their continuity through times.

This new approach, a shifting away from considerations
of size to considerations of structure and historical process,

has been proposed by K. Levitt and L. Best21 to bring to-

gether a model of export-based growth from Canada and the

model of dependency economics. A model of a plantationecon-

omy is evolved as a special case of export-based growthunder
expansive capitalism. This model is elaborated in stages gen-
eralizing experience from the Sixteenth to the Nineteenth

Centuries.

 

21Karl Levitt and Lloyd Best, "Character of the
Caribbean Economy" in Caribbean Economy, G. L. Beckford,
ed. (Kingston, Jamaica: University of the West Indies,
(1975), pp. 34-60. '

plat

cul

l0

5

are

tio

he

.1;

5L

SU

ab

ch

‘1'

,t
Ci

NMTW.

22

George L. Beckfordzz, in a wider examination of
plantation economies, stressed the importance of the agri-
cultural sector. He believes the contribution to income
from this sector can be considerable but that the benefits
are offset by structural rigidities which hinder transforma-
tion and induce a "dynamic process of underdevelopment." He
views the contemporary scene in a typical Caribbean economy
as consisting of two broad segments: the "overseas" and
"residentiary." The overseas component comprises all sectors
in which domestic resources are dominated by foreign owned
capital. The residentiary component contains those sectors
in which residents own and control basic resources. He argues
that the bulk of the region's population derives their liveli-
hood from residentiary activities while the bulk of the domes-
tic resources are concentrated in the overseas component.
Thus, income accruing to residents remains low while large
surpluses from the exploitation of domestic resources accrue
abroad. Furthermore, he points out that "the self-sufficient
character of the producing units in the overseas component
of the economy stifles the development of internal linkages
within the Caribbean economy so that, over time, development

of the overseas component generates very limited spreadeffects

 

22George L. Beckford, Persistent Poverty: Underdevelop-
ment in Plantation Economies of the Third World (London:
Oxford University Press, 1972).

 

23
to the residentiary component."23 Thus, he claims, linkages
and spread effects are lost because linkages and their multi-

plier effects jump toward metropolitan economies.

Beckford's view is not necessarily an attack on the
principle of foreign investment and its right to an accept-
able return. His quarrel is with the overwhelming control of
domestic natural resources by foreign interests, control ac-
quired most of the time under very advantageous conditions,
and their explotation with very small feedback effects on the
local economy. This situation is not too uncommon in the Carib—
bean, particularly in those countries emerging from colonial

plantation economies.

Stages of Growth

 

Celso Furtado24 looked into the economies of Latin
America and identified three distinct phases in the develop—
ment process going on in this area. The pointhe'had in mind
while determining these phases was that structural change is
inherent in any process of economic development and takes the
form of sudden or gradual changes in the demand schedule and

and in the composition of supply. According to him, "the

 

23George L. Beckford, "Caribbean Rural Economy" in
Caribbean Economy, G. L. Beckford, ed. (Kingston, Jamaica:
West Indies University, 1975), p. 83.

2['Celso Furtado, 'Economic Development of Latin Amer-
ica, (Cambridge: Cambridge University Press, 1970).

and

n

u-..

s.-__
.

‘lb

24

study of development can be regarded as the identification
and anticipation of such changes and of the interaction and
possible relations between them."25
Initially, Latin America was integrated into the
system of international division of labor in which she
serves as a supplier of primary products. Exports of these

goods constituted the major sources of income and consumer

goods were largely provided through imports.

Expansion of the world demand for ravmaterialsbrought
improvements in the productivity of the export sector. The
rise in productivity and consequent increase in the purchas-
ing power of the population led to diversification in the
pattern of overall demand, and a proportionate rise in the
demand for manufactured goods. This process, by facilitating
the formation of a domestic market nucleus for manufactured
products and the creation of an infrastructure, was the start-

ing point for industrialization.

This initial phase of industrialization, however,
had intrinsic limitations. The industrial activity was
limited to the production of non-durable consumer goods--
textiles, leather goods, processed food stuffs and clothing--

which are provided by processing local raw materials or

finishing imported semi-manufactured consumer goods. There

is little need to assimilate modern technology in an

 

 

00C

2b

14:..8

ad

in:

760

In

W

AU
P5 1

25

industrial complex geared to the production of consumer
goods. Increased industrial output is due largely to the
addition of new units of production similar to those already
in existence and is dependent on imported equipment and inter-
mediate input. There is no question of creating a system of
industrial production by steadily diversifying production.
Moreover, expansion of industrial output is dependent on the
expansion of exports. Thus, stimulus to the industrial

sector come from the outside instead of within the local

economy.

A comment is pertinent about this emphasis cuxmodern
technology. This concept has been interpreted by many, un-
fortunately some times by policy makers, as meaning the adop-
tion of the latest technology. However, the most appropriate
meaning is the encouragement of managerial skills and the
training of skilled personnel equipped with a thorough know-
ledge of technical process so that enough flexibility ismain—
tained to incorporate those innovations that may increase
productivity. The flexibility to choose the most convenient
technology available is very important in a genuine industrial

outlook.

The world economic crisis of 1929, according toFmrtado,
stimulated the emergence of a second phase of industrializa-
tion characterized by import substitution. Contraction of
the export sector, that came with the economic crisis, led

some countries already in the first phase of industrialization

ex

Cl

’41

'11

26

to expand the industrial sector geared to the home market
in an effort to replace, wholly or, in part, goods previously
purchased abroad. The 1929 crises, by initially taking the
form of a contraction in the capacity to import, provoked
exchange depreciations which induced inflationary pressures
in almost every country. Both the exchange depreciation and
inf lation had the effect of raising the profitability of the
industrial nucleus geared to the domestic market. Domestic
production improved its competitive position when import
Pri ces rose. The existence of unused capacity in the exist-
ing industrial sector gave to its supply a certain degree
of elasticity needed to increase its output without raising
its marginal cost. Moreover, the increased industrial activity

Created an additional flow of income which compensated for

the loss in income induced by the contraction of exports.

Development thus passed from the stage in which it
toOk the form of changes in the composition of demand, the
fit‘st phase, into a stage in which it could proceed only if
the supply structure was transformed. Imports, which had
giVEn flexibility to overall supply in the preceding period
enabling it to respond promptly to the evolution of the demand
SCIledule, are in relative or absolute decline in the second
stage and consist increasingly of industrial inputs needed
in Producing goods for the domestic market. In fact, as

Furtado points out, imports now become the instrument to use

in Changing the production infrastructure to serve the home

Inarket.

tut:

9!

C0

27

Although industrialization induced by import substi-

tutionin Latin America was principally a response to a crisis

of the export sector, Furtado argues that the process could

have started sooner in the countries already in the first

phase of industrialization, if they have had the benefit of

appropriate policies. The importance of appropriate policies,

he points out, is underlined by the fact that as import sub-

sti tution progressed, industrialization becomes more amd more

dep endent on state action designed to concentrate investment

on strategic sectors.

According to Furtado,

the role of government is still

more important in a third phase of industrialization, in

which state action promoting the establishment of basic in-
dUS tries is needed to move the economy to a more complex

Stage of industrialization. In this phase the industrial

SEC tor expands to supply durable consumer goods for which
do‘ulestic production capacity does not exist, and the inter-

mediate products needed for the increased production of final

conSumer and investment goods. The industrial sector gen-
erates, now, part of its own demand and thus the economy be-

e ome s more self-sustaining.

Furtado did not elaborate on precisely what the

go"ernment was expected to do. However, he stated that, "the

degree of development depends on the effectiveness of the

strategic decision centers. and the flexibility of structures."

He fllrther argued that, "what matters is to identify the

28

changes that condition further changes, the agents responsible
for the decisions that engender these changes and the elements--
situations or agents-—that offer the greatest resistance to
change."26 From this it can be inferred that the state is one
of the strategic decision centers and that its role is to keep
the structure as flexible as possible by promoting those agents
and situations that engender changes favorable to growth and
to lessen the resistance of those that hinder this type of
change. The government role is, then, that of a facilitator
0f growth and, as such, its participation is more direct or

indi rect depending on the relative strength of these opposing

forces.

Furtado, at that time was very much biased in favor

of industrialization. His arguments gave the impression

that he believed industrialization was always favorable to

gI'O‘Mth. Later on, however, he changed his position on this

iSSUe,

Another model that deals with stages of growth is

that of D. S. Paauw and J. C. Fei.27 They combined insti-

tutional, structural and size considerations into a model

to eXplain growth and development in an open dualistic econ-

omy. Their emphasis was transitional growth from an under-

Cleveloped, colonial, primarily agricultural economy, contain-

1
“3 an enclave dedicated to the export of primary exports,

\
26

27 .Ibid, p. 94.
omies.DOuglas S. Paauw and John C. H. Fei, The transition on Open Dualistic Econ-
Neory and Southeast Asian Experience (New Haven: Yale Univ. Press 1973).

.4-
r)

5

A.-

‘J
.40.

(1‘!
(‘5)

r)
(‘J

Evy

r)
n:

F!

29

into a new economy operating in an, "epoch of modern growth."

The theoretical aspect of the model emphasized a triangular

pattern of interaction among agriculture, industry, and the

foreign sector and stressing structural changes along the path

of growth. The institutional aspects are interpreted as the

poli tical and economic-geographic factors which influence

government policy and thus shape the course of transitional
growth.

5

Given that the background factors inherited from

Colonialism are intrinsically heterogenous, Paauw and Fei

hYPO thesized that a diversity of actual growth experiences

can be found. As they point out, the implication is that

real istic developmental theory must be typological in nature.

They see the typological approach to development as a prag-

mati c compromise along the spectrum between an all-inclusive

get'leral theory of universal applicability and individual case

by Case studies of each country.

In the colonial economy, according to their view,
priulzary product exports dominate growth and income is mainly

generated by the utilization of land-based resources in the

induStrial sector. In modern economic growth, on the other

hand. the economic output is primarily created in the indus-

t
rial sector by human and capital resources. The transition

process between these economies thus involves gradual modifica-

t
ion of a land-based export economy through an industrializa-

t
ion process requiring significant structural transformations

30

that change the inter-relationships between the agricultural,

industrial and foreign sectors.

Transitional growth analysis focuses on the process
through which these interrelated changes take place as modern
growth is gradually initiated. The transition resembles a
process of evolution in which two principal sets of changes
occur: those having to do with the economy's mode of opera-

tion , and those concerning the economy's mode of organiza—
tion - Changes in the mode of operation involve a shifting
0f t he importance of major economic variables-~such as pro—
dUC—t :lon, consumption, savings, investment, export and import
and the role these play in the interactions among key sectors
of the economy. The economy's mode of organization refers to
the method of social decision making through 'which essential
intersectoral functions are carried out. The roles played
by alien entrepreneurs, indigenous entrepreneurs, government

officials and the significant personnel are an important con—

Sid e ration.

Although countries emerging from colonialism share
many common characteristics, the pattern of transition varies.
Val'Zl-éitions appear in the sequence and nature of the transitional
Phages.

Economic and political backgrounds are important con-
Siderations in explaining different growth patterns. The

ec .
Onomic background concerns economic-geographic factors such

3.3

ll

p:

00

31

as the supply of indigenous entrepreneurs, the relative back-

wardness of the agricultural sector, the supply of natural

resources for primary product exports,and the availability of
foreign aid. The political background refers to the society's
composition in terms of economic interest groups which con-

tend for political power such as remaining aliens, landlords

and indigenous entrepreneurs.

Paauw and Fei identify three distinctive phases of

transitional growth which may be combined into different

pat terns of transformation from colonial economy to modern

growth. These are: import-substitution growth, export-

Promotion growth and export-substitution growth.

The emphasis of import—substitution growth is the
diversion of primary product export earnings to importation
of Producer goods in order to create domestic industrial
caI3£icity, enabling production of consumer goods to gradu-

ally replace imported goods in the domestic market.

Export-promotion growth represents an alternative to

11“va rt-substitution during the initial transition from the

colOt‘iial economy. In this growth system the dominate phen-

o
menon is the expansion of primary product exports. Thus,
11
nder export promotion, the industrial sector's output consists

Inainly of productive input required for expansion of primary

product exports.

In an export-substitution growth phase manufactured

 

32

goods displace primary products as the dominant exports.

The
manufactured goods exported are usually labor intensive, sig-
naling a shift from land-based to labor—based growth. Thus,

exp art-substitution growth with emphasis on labor intensive

manufacturing is a phenomenon unique to the labor-surplus

type of open dualistic economies and at the center of its

analysis is an understanding of how an abundant supply of

labor in the traditional agricultural sector is made available

to industry.

Paauw and Fei viewed successful transitional growth
as growth which progressed from colonial epoch to the modern

growth epoch, through a combination of these three phases.

Col-1n tries with dual open economies and appropriate land endow—
ment could progress from export promotion to import substitu-

tion to export substitution and,

then, modern growth. For

Conn tries with open dual economies and a labor surplus, how-
err

, export-promotion growth was ruled out and transition

wc>111d start with import substitution move into export sub-

stitution and, then, to the modern growth epoch, if trans-

itional growth was successful.

They emphasized that for small
and

Open labor surplus economies, import substitution was a

28
preparatory phase necessary for export substitution to emerge.

H. Chenery and M. Syrquin in a recent study also

Paauw and Fei, p. 244.

-— ' fit...“

33

focused on the identification of alternative patterns of
development.29 The main objective of their study was to pro-
‘vicie a comprehensive description of the structural changes that
.ac<:<3mpany the growth of developing countries and to analyze
ttleaer interrelationships. Their focus was the major features
of? Iresource mobilization and allocation, particularly those
asspzeeczts needed to sustain further growth and, therefore, of

primary interest to policymakers.

They defined a development pattennas a systematic
VEII‘j_£1tion in any significant aspect of the economic or social
Stzr‘Lxczture associated with a rising level of income or other

indices of development. As they put it,

In describing the processes of develop-
ment we have tried to replace the notion

of a dichotomy between less developed and
developed countries with the concept of a
transition from one state to the other.
This transition is defined by a set of
structural changes that have almost always
accompanied the growth of per capita income
in recent decades.

The authors selected ten basic processes, defined
EDy' trwenty-seven variables, to represent structural character-

istics that provided the dependent variables of the statist-

1
C‘il- analysis: investment, government revenue, education,
\

 

‘v 29Hollis Chenery and Moises Syrquin, Patterns of De—
‘*£ililEEggg£, 1950-1970 (Oxford: Oxford University Press, 1975).

3OIbid, p. 135.

34

domestic demand, production, foreign trade, labor allocation,
urbanization, demographic transition, and income distribution.
Taken together these ten processes are expected to describe
different dimensions of the structural transformation as a

poor country develops into a rich one.

Available statistics covering the period 1950-1970
for a maximum of 101 countries were analyzed usingregression
analysis. Ordinary least squares regressions specified all
the structural characteristics as a function of per capita
gross national product, population, net resource inflow, and
a time trend. The first two independent variables appear in
logarithmic form, and squared,to account for non-linearities.
Uniform cross-section estimates of the structural transforma-
tion were derived and it was found that most of the processes

can be described by S-shaped curves, having asymptotes at low

and high levels of income.

Chenery and Syrquin's analysis leads to identifica-
tion of four main patterns of development. The level and
orientation of exports and the orientation of production were
used as the basic criteria for their typology. A trade orien-
tat ion index and a production orientation index were developed,
13‘3st on the deviations of each country's actual values from
an eitpected value, derived from the regression equations. With
the help of these indexes four principal development strategies
were isolated: primary specialization, balanced production

a
nd trade, import substitution and industrial specialization.

 

 

 

35

Primary specialization corresponds to the established
concept of an export-led growth pattern based on favorable
primary resources. The study shows that this strategy delays

at ructural transformation, but a late acceleration results
in a structure similar to all other countries when they reach
hi gh levels of per capita income. The authors point out that
t h is strategy has its limits since non-oil primary exports are

81‘ owing at very slow rates.

Balanced allocation and import-substitution strategies are more
ty 13 :ical of large countries. (Population over fifteen million).
Imp crt substitution emerged as the least successful strategy
and explains low growth rates in many Latin American countries.
TWO Latin American countries, Brazil and Mexico, which shifted
it on import-substitution into manufacturing exports did achieve

high growth rates.

Industrial specialization, characterized by above
n(>3E‘Tnal trade and an industrial production orientation, has
led to relatively high rates of growth for most small countries
in this group. The pattern of resource allocation in these
coLitatries more closely resembles that of large countries
ratliner than other small countries. All countries following
thi a pattern have required large amounts of external capital
for a period of ten or more years but have been able to reduce
dep andence on external capital after the shift to manufactured

e
RD orts becomes well established.

 

 

 

 

 

 

 

36

Chenery and Syrquin concluded that the four basic
,paatterns they identified have their counterparts in the
(Jeexrelopment plans and policies of the transitional countries
air1<i that the experiences of the more successful countries in
eeza.c:h of the four groups indicates the opportunities as well
alas the problems that characterize each type of strategy.31
71‘!) (e,y also pointed out that, "most developing countries must
Ell: some point shift toward non-primary exports if they are to

32

c:<>1rm.tinue to expand" and that, "a country's success in devel-

C’I> fiL mg non-primary exports is largely a result of government

po 1 :icy."33

W

This chapter has presented theories of economic de-
"e=:1—<:pment designed to resolve the problem of how to initiate
53¢:CD Iaomic growth and maintain it in countries which are signif-
1Czéa-‘Intly underdeveloped. It is pertinent now to re-emphasize
t:k;() sse issues that are relevant to an evaluation of growth in

't11‘3 economy of Puerto Rico.

Special emphasis has been placed on models of economic

'i‘léi.JLism, that is, those dealing with economies organized in
\

31Chenery and Syrquin, p. 106.

32

 

 

 

 

37

two parts which are structurally and behaviorally so dif-

ferent that they deal with one another almost as though they

formed two separate societies and economies. The major thrust

has been interrelating and transforming the two sectors so

that a self-perpetuating cycle of underdevelopment is broken and

the economy can achieve self-sustained growth.

A number of models have been presented that deal with

growth in a small, open, dual economy which is the situation

in Puerto Rico and many of its Caribbean neighbors. Trade
ha 3 emerged as a facilitator of growth in that it gives access
to foreign production functions that may be more efficient than

any domestic alternative available; and, at the same time,

makes available a range of technological alternatives from

WI": 1 ch the country can pick those best suited to its resources

and development strategy. The foreign sector is also an im-

PO rtant source of capital to finance expansion of the domes—

tic industrial sector. A critical view of export-led growth

has also been presented since some authors feel the dependency

it generates may hinder self-sustained growth. They express
Col"Cern about unequitable distribution, between foreign and

domestic interests, of the benefits accruing from this type

of growth.
A point of crucial importance in the literature is the
d
ef inition of development as structural transformation that
Self-

m
a”1‘98 an economy capable of self-sustained growth.

a
“Stained does not, however, mean self-sufficient.

 

 

 

38

Seven basic elements in the structural transformation of the

economy have been considered. These elements, which will

play a significantrole in the evaluation of economic change

in Puerto Rico, are:

l.

The capacity to trmnfiorm. This is the
capacity of an economy to continually apply
innovations that can improve social produc-
tivity and to adapt promptly to changing con-
ditions, such as changes in prices and market
situations. The capacity to transform is in-
herently linked to basic socio-cultural and

political attitudes and practices.

The unification of the national market for
goods and services. This implies increased
transactions for markets rather than mere sub-
sistence production. The unification of frag-
mented local markets into a national market is
essential to capture potential economies of
scale, exploit fully the national resources and
achieve efficient distribution of goods and

services.

A shift of production and labor between primary,
secondary and tertiary sectors of the economy.
This means a continuous process of relocating

factors of production in accordance with changes

 

 

 

 

 

39

in relative productivity and changes in demand
patterns as per capita income rises. This

process manifests itself in altering the dis-
tribution of the labor force and changing out-
put composition from primary to secondary and

tertiary activities.

The development of an increasing interdepen-
dence among domestic industries and activ-
ities. This implies forging links in the dom-
estic production structure so that industries
become more interdependent. The interdepen-
dence manifests itself in a network of forward
and backward linkages within the production struc-
ture so that the products of an increasing num-
ber of industries become the input for other
industries. This, in turn, implies a rapid
growth of domestically produced intermediate

and capital goods.

Changes in the importance and composition of
foreign trade. The transformation of an economy
is accompanied by an increase in the absolute
volume of foreign trade and a change in the
composition of imports away from consumergoods.

This islfluenet effect of Opposing tendencies

40

such as an increased need for imported

capital and intermediate goods arising from
the expansion of industrial activity and in-
creased demand for all consumer goods in-
cluding imports arising from improvement in
real income, on one hand, and the changing
composition of demand from goods to services,
on the other. The latter is dictated by rela-
tive income-elasticities of demand, internal
linkages which provide local intermediate input
and technological progress which economizes in

the use of imported raw materials.

The reduction of dualism in the economy.Trans-
formation involves some reduction in the dis-
parities between return to factors of produc-
tion within the national economy, disparities
which constitute the essence of dualism. In

this connection, it should be pointed out that
the existence of a large surplus of labor, either
unemployed or in some form of disguised unemploy-
ment, may be interpreted as a form of dualism
since the marginal product of this labor is too

low to have any significance in the economy.

The development of appropriate institutions.

41

This includes a complex of supporting insti—
tutions that make structural transformation
and a high rate of savings and investment pos-
sible. Important elements of this complex are
tax mechanisms, financial institutions, and
the administrative systems that facilitate

savings and investment, both public and pri-

vate.

Another important consideration required in the defin—

.a t:jion of economic development is self-sustained growth. Such

gyr‘cawth is self-reinforcing and requires sufficient domestic

sszafixrings, both public and private, to support a significant

[>c3‘xrtion of domestic investment. It also requires generation
o;f’ adequate internal demand to continually stimulate growth

Wi t hin the local economy, even when foreign demand is an im-

Por tant engine of growth.

Another important issue in the literature is the
I’l’c’F>er role of industrialization in the development process.
'rPIGE industrial sector must be expanded to be capable of pro-
vw1<3iitug an increasing supply of domestic consumer and invest-

Ineztltl goods to substitute for the traditional primary exports

OI) t:he decline in world markets. The expansion of industrial

a
ct 1vity also absorbs part of the excess labor existent in

t
flea ‘traditional sector of the dual economy. Moreover, the

in
c:(Dme it generates creates demand for its own output and

 

42

for that of the agricultural sector. In this connection,

agriculture could be an important source of savings to in-

itiate further expansion of the industrial sector and once
this is underway, agricultural activity must continue to be

vigorous, capable of providing an increasing supply of con-

:sumer goods to an expanding and wealthier industrial labor
.fcarce. If agriculture fails to grow at a concomitant rate,
(emcpansion in the industrial sector and in the whole economy

<2c>tJld come to a halt.

A final issue relevant to analysis of the Puerto

Rti.c:an is the proper role of government in the development
p>r‘<3vcess. The state is a key decision center promulgating de-

ions vital to the flexibility of the economic structure.

czi s;

I't £3 proper role is that of a facilitator promoting conditions
t11.51 t favor growth and opposing those that would hinderchanges
Re C essary for growth.

CHAPTER III

METHODOLOGY, NOTATION AND DATA

Introduction

This study is centered on the structural changes that

have occurred in the economy of Puerto Rico between 1947 and

19 72, while the economy was going through transition growth.

Transition growth, as was explained in the previous chapter,

emp hasizes a triangular pattern of interaction among agricul-
tur e, industry and the foreign sector. The focus of this anal—

ys i s is the interaction that took place between these sectors

Whi 1e the Puerto Rican economy was shifting into a more highly

developed state. The frame of reference for evaluating this

transformation is the set of economic development theories dis-

cuSSed in the previous chapter.
The method is to be a historical approach. This

ap'Pli‘oach is reflected in the very concept of transitional

growth as a process of change from an underdeveloped into a

more highly developed economy. Growth in this study is pre-

8e
IIted from two distinctive viewpoints. One, close to the

ma
Q1‘<>economic tradition, deals with economic magnitudes con-

Si .
8 t etit with an aggregative view of the economy. In the

43

44

closer to the general equilibrium approach, a more

0 ther,
in which an input-out-

clisaggregative viewpoint is presented,

Both perspectives, however,

put framework is employed.

jfrollow a holistic approach emphasizing intersectoral relation-

ships in the economy as a whole and the change in these over

I: :ime.

The Aggregative View

This view conforms to a design which emphasizes macro-

onomic relationship; the majoreconomic activities such as

e: c:
I) I? oduction, consumption, savings, investments, exports, im-
r><:> rts and employment are the focus of this perspective of the

an alysis. The interrelatedness of these economic activities,
the terms of the transactions they generate among the key

1.13L
as well as the pattern of change in

(:tors of the economy,

£342:
forms the core of the analysis.

tffj;<ese relationships,

The key sector concept appropriate for the study of

such as the

tllr.zinsition growth in an open dualistic economy,

Puerto Rican, is a level of aggregation which singles out

three sectors: the agricultural, the industrial and the for-

e’i-EEIJ. Thus, the above mentioned economic magnitudes are

gathered at this level of aggregation.
Data about the performance of these economic vari—

ables were collected for selected years of the period 1940-1972

._‘~‘~“_»
JL

fiflLJL l3ent Hansen, A Survey of General Equilibrium Systems (New York: MtGraw—
1 Book Company, 1970), Chapter 4.

45

when Puerto Rico was undergoing transition growth from a
colonial economy. However,some statistical series start

on a later date, in the first year for which data by sec-
tors were available, and others are occasionally extended
up to 1977. The years selected were chosen to make them
correspond to years when major changes in the developmental

strategy were undertaken.

The evidence gathered shows the sequence of transition

growth, that is, to what extent the economy of Puerto Rico

is transformed through a smooth evolutionary process or a
:sequence of steps which define distinctive phases. Alter—
jnative pattenm,of resource utilization are analysed in terms
(sf relationships amoung the key economic sectors to test to
‘cdhat extent Puerto Rico has gone through stages such as
fitmport-substitution, export-promotion and export-substitu-

tion.

The secular trends of variables representing struc-
t: ural characteristics are compared by means of tables and
:i.nferences are made about the relationships they suggest.
jPlaese are also related to the changes which have occurred

i.r1 the economic developmental strategy.

The growth patterns of strategic variables represent-
j-rlg production, trade and employment processes are also
e3‘tamined in terms of the deviations of the real value of

eEach variable from an expected normal value. The normal

46

growth pattern for each variable is considered to be similar
to the intercountry pattern summarized in the regressions
equationsesthmued in Chenery and Syrquin's cross-section
study.2 The assumption is that these regression equations
capture the effect of universal factors--simi1arities in
production relationships, in domestic demand and opportun-
ities for trade—-which affect all countries alike. Devia-
tions from the norm are interpreted as changes in the devel-
¢3pmental pattern influenced by policy decisions or the ab-
ssence of them, in response to Puerto Rico's changes in re-
ssource endowments, trade opportunities, social organization,

<:>r other elements.

The normal growth level for each variable for 1947,
:1. 955, 1963 and 1972 is found by substituting in the regres-
53 :ion equations Puerto Rico's per capita income, population,
a rd net resource inflow for these years. It is assumed that
t: Ine cross-sectional relationships depicted in the regressions
11nc31d intertemporally so that a time pattern for the behavior

(3 if these variables can be established.

The real value of each variable is compared with the
I1(3'I‘mal value for each year. The pattern of deviations is
a-1'1£Ellyzed for meaningful trends in terms of the developmental

theory presented in Chapter II.

\

2Hollis Chenery and Moises Syrquin, Patterns of Devel-
2—Pm\ent 1950-1970, (London: Oxford University Press, 1975),
pp- 16-18; 48-49; 205.

47

The Disaggregative View

The methodology proposed in this section takes the
It examines the

saunalysis discussed above one step further.
(1 etailed intrasectoral composition of the major sectors pre-
‘xrhjously analyzed. From this perspective intrasectoral trans-
if (armation can be further analyzed.

One of the most comprehensive ways of investigating

1: tie interdependence of different sectors of the economy is
Leontieff .

t: he input-output analysis developed by Wassily W.
this technique the economy is broken into small sectors

Ilia:
212:1.d the flow of goods and services among the sectors is re-
4

c:<:> Ided to indicate systematically the relations among them
dividing the economy into finer units, input-output tech-

13:9?
Insz <que is capable of tracing out effects undetectable by macro-

an alysis.
The main purpose of input-output analysis is to ex-

F’J_-Eiin the magnitude of the interindustry flow in terms of
Inflow is the

tit) e3 level of transactions in each sector.

‘

The Structure of the American

3Wassily w. Leontieff,
Iac=<>l1omy, 1914-1939 (New York: Oxford University Press, 1941

and 1951) .

“In the input-output terminology "industry" and "sector"
are used interchangeably to refer to a small portion of the
e(:c’l'lomy. This study adheres to this usage. Each major sector
:eferred to in the aggregative analysis will be subdivided in-

C) "£irious subsectors (or industries) in the input-output
analysis. '

48

input each industry requires in order to produce a given

Linit of its own output. Outflow is the product an industry

can sell both to final demand and to other industries to

meet their intermediate input requirements.

The Input—Output Technique and Structural Change

The input-output framework is very convenient for

s tudying interindustry structural relationships and their change

over time. An imput—output matrix represents the structure

0 f the economy at a given point in time. By comparing the

matrices for two different periods inferences about structural

c: h anges can be made.

The first to use input-output analysis to study

S t ructural changes was Wassily Leontieff in a study of the

Un :ited States economy. Anne Carter also used this approach

in studying the United States economy for technological

Ch anges which had affected industrial specialization, as
as reflected in

he 1: input-output tables for 1939, 1947 and 1958.6

We 11 as direct primary input requirements,
These

st:I—ldies will supply major methodological roots for the one

1.1:; d ertaken here.

\-

5W. W. Leontieff, The Structure of the American Econ—

% 1914-1939; also in W. W. Leontieff et al., Studies in
t1)\e8tructure of the American Economy (New York: Oxford Univer—
Sit), Press, 1953).

6Anne P. Carter, Structural Change in the American

W (Cambridge: Harvard University Press, 1970).

 

49

There are several other studies of the changing in-
put-output structure. The bulk of the work in this field
concerns countries for whom sequences of comparable input-
output tables have been available for some years such as
the Netherlands, Norway and Japan7. In general, the em-
phasis of these studies of structural change has beenlnainly
statistical and methodological in contrast to Carter's
study and the one proposed here, which are more factual and
concerned with specific developments of the economy and

their impact on specific economic variables.

The principal study in Puerto Rico which dealt with

structural change using input-output was made by Angel L.
28312.8 He made estimates of capital coefficients anddirect
zand indirect capital and labor requirements per unit of
final demand and output, all defined in input-output termin-
<:>logy. Making use of his data which covered the period
:EFrom 1954 to 1963, and some mathematical models with an in-
lavut-output framework, he shed some light on various con-

<:.epts about capital-output ratios and their usefulness for

 

7Christian B. Tilanus, Igput-Output Experiments: The
_£1etherlandsJ 1948-1961 (Rotterdam: Rotterdam University Press,
1-5966); Per Sevaldson, "Changes in Input-Output Coefficients,"
1LT! Structural Interdependence and Economic Development, ed.
uriilaor Barna (New York: St. Martin's Press, 1963), pp. 303—28;
I”1‘3nri Theil, "Applied Economic Forecasting," in Vol. 4, Studies
thl JMathematical and Managerial Economics ed. Henri Theil
(4(3111cago: Rand McNally Company, 1966).

8Angel L. Ruiz, "Capital Imports and the Economic De-
"‘3llopment of Puerto Rico; Studies in Input-Output Framework"
(:I?11. D. Dissertation, University of Wales in England, 1976).

 

50

planning purposes, the labor absorption problem in a

labor surplus economy, the capital and labor content of
exports and competitive imports and related problems. Al-
though Ruiz's interest was mainly methodological, he com-
pared two different structures of the economy, one for 1954
and one for 1963, as represented by input-output tables for
those two years. He discussed the implications of structural
changes in these two periods for the employment structure
of the Puerto Rican economy. He found large increases in
labor productivity, in almost all sectors of the economy,
resulted in a drop in sectoral labor requirements, both
direct and indirect. The matrices he compared were based
on total domestic plus imported input only. However, to
study structural change in an open economy, the domestic
Imatrices alone are also needaito enable the researcher to

single out local impacts.9

Richard Weisskoff10 examined the same period, also
lasing input-output analysis. He looked into movement in
janome and employment and the distribution of each in Puerto
TFiico between 1954 and 1963. The foundation for this analysis,
.1.ike the previous one, is the structural differences in the

€3<2onomy as reflected in the gross input-output tables for

\

9See James Riedel, "Factor Proportions, Linkages and
t1113 Open Developing Economy," Review of Economics and Sta-
t istics 57 (November 1975): 487-94.

10Richard Weisskoff, Colonial Industrialization in the
—Sifigibbean: The Economic Development of Puerto Rico, Department
(315' Economics, Iowa, 1976, (to be published).

51

the total economy during the two years chosen. He found in-
creased industrial interdependence in several sectors dur-
ing this period, but observed that the interdependence was

weakened by import and export leakages.

The Input-Output Model

 

The input-output flows are summarized in Table 3.1.

Table 3.l--The Input-Output Model

 

   
 

 

 

 

 

Inputs to Industry J Final Total
from 1 2 . . . . n Demands Output
9
a 2 X21 X22 ' ' 'in y2 X2
>‘ O O O I O .
ir “
J. U 0 o o o o o
1 {D
1 a O O O O O 0
w I O O O O O
4 C'-
J H n an x2 Xnn yn Xn
‘U'alue Added V1 V2 . . .Vn
1?
i <>ta1 Inputs X1 X2 . . .Xn % X1
1 i=1

 

 

 

 

 

 

From the table the following notation and definitions can

b e set forth:

t = output of sector i in year t as input

ij in sector j.

52

 

Xt = gross domestic output flow
vector in year t (nxl)
t xt
ai.==_ij* = direct requirement of the output
J Xt of any sector i per unit of output
j of any sector j in year t
t t .
,A = [ai.] = input coefficient or technical
J coefficient matrix of Leontieff
system in year t (nxn)
Mt = foreign imports vector in year t
(lxn)
t t
mij== Mij = direct requirement of imports from
X any sector 1 per unit of output
j of sector j in year t
t t .
Am ==[mi.] = import component of technical
J coefficient matrix in year t (nxn)
t t t t
Ad ==[ai -mi.]-mi.]= domestic component of technical
J J J coefficient matrix in year t (nxn)
Yt = final demand flow vector in year t
(nxl)
Yt = import component of final demand
m
in year t (nxl)
Y3 = domestic component of final demand

in year t (nxl)

Given the above definitions and assuming linearity and
h(Dmogeneity of the production functions in the producing sectors,
tille balance equations of the input—output models, in matrix

r1<3tation, can be stated as:

X = AX = (Y - M) (l)

53

meaning that gross domestic output equals intermediate produc-

tion plus domestic final demand.

Solving for X, equation (1) becomes
-1
(Y - M) (2)

'1 "l . g . . 11
(1 - A) = (l - aij) , or Leontieff s inverse matrix, gives

the total requirement (direct plus indirect) of the output of
any sector i per unit of output of sector jdelivered to final
demand. The Leontieff inverse ‘makes no distinction between im-
portedznuilocally producedinput requirements.However,to measure

local impact the latter are the meaningfulones. Th isolate

local impact the Leontieff model can be modified as follows:

The import vector can be broken down into its inter-

mediate and final demand
M = A x + Y (3)

and the balance equation of the system in matrix notation can

be expressed as

x = AX + [ Y - (Am x + Ym) ] (4)

‘which solved for X becomes

1

X = (1 — A + Am) (Y - Ym). (5)
Since A = A - A and Y = Y - Y , equation (5) can be stated as
d m d m
X=(1-A)-1Y (6)
d d

11The inverse existsif the (l — A) matrix is non-singular

54

*which can also be expressed as

d. (7)

dij gives the locally produced input requirement

of the output of sector 1 per unit of output of sector

j and (i - d )-1 gives the direct plus indirect locally

13

produced input requirement per unit of output delivered

to final demand. Since d . = a.. - m equation (7) can

13 13 ij’

also be expressed as
-1
X = (l - a.. + m .) Y (8)

Introducing the following definitions for labor re-

quirement

NC = (n?) = direct labor requirement coef-
J ficient vector in year t (lxn)

n? = direct labor requirement per
3 unit of output of sector j in

year t

Eind, then, pre—multiplying the labor requirement vector of

bqt by the domestic inverse matrix (1 - dij)—1, we find the
(iirect plus indirect labor requirement per unit of output

<>f each sector delivered to final demand, or

t t -1
= - o 9
e N (l dij) ( )
In this, e is a row vector (lxn) giving the direct plus in-
clirect labor requirement for each sector per unit of output

<1elivered to final demand.

55

Domestic final demand Y can be broken down in its com-

ponents:

c . .
Yd = domestic consumption
YI = domestic investment

d

E = exports
Yd

and, then, the direct plus indirect production of each sector
attributable to exports can be obtained by post-multiplying

the export vector of final demauiYg by the domestic inverse,

(1 _ dij)-l or
w = (1 - d )‘1 YE (10)
inhere W is a column vector (nxl) which gives the direct plus
:indirect production of each industry 1 attributable to ex-
Iaorts.

jg§pplications of the Input-Output Model

The direct and total (direct plus indirect) coeffi-
czients of the input-output matrices for 1963 and 1972 are
(:0mpared for a first impression of the structural trans—
fFormation that occurred in the Puerto Rican economy dur-
iung this ten year period. From these comparisons some in-
fPerences can be made about changes in the degree of inter-
clependence among domestic industries and activities.

The total coefficient is used to build a backward

1fiinkage index to measure the degree of integration in the

56

domestic economy.12 The backward linkage of a sector indi-
cates the output expansion potential of the attempt to supply,
through production in other domestic sectors, the inputneeded
in the sector in question. Thus, a high linkage index points
to a better integrated sector which may stimulate economic
production in other sectors and have a greater multiplier
effect on growth. It must be emphasized that the linkage
index gives no assurance that this is actually going to happen
but it points toward this possibility. This point will be

discussed further in a later section.

Operationally the backward linkage of sector j, L?’ is
(defined as the column sum of the input inverse (Leontieff in-
xaerse), modified to consider local impact only;13 or

LB = g (1 - d ‘1 (11)

12An analogous forward or output-utilization index which captures the
(Output potential of the utilization of the output of one sector as in-
puts in the activities of other sectors, is also defined in the litera-
ture. However since both indexes look at the same transaction from the
viewpoint of a purchasaor a sale, only one is needed in using the index
as a measure of economic integration. Hence, the less equivocal back-
‘ward linkage index is used in this analysix.

13The concept of linkage was first introduced by Albert 0. Hirshman

in the Strategy of Economic Development (New York: Yale University
IPress), 98-119. It has been defined operationally in different ways
by several authors. See, for example, Pan A. Yotopoulos and Jeffrey
IB. Nugent, "A Balanced Growth Version of the Linkage Hypothesis,"
jguarterszournal of Economics, 87 (May, 1973): 157-72; Michael
lBoucher, "Some Further Results of the Linkage Hypothesis," Quarter-
;ly Journal of Economics, 90 (May, 1976): 313-18; and Leroy P. Jones,
"The Measurement of the Hirschmanian Linkages," Quarterly Journal
_5;f Economics, 90 (May 1976): 323-33. The Yotopolous and Nugent

\7ersion is used here.

 

57

To complement the linkage index a coefficient of dis-

jpersion (Vj) is computed for each sector. This may be de-

 

 

;fined as
n n
% z (21' _-I1-1- Z z”)2 (12)
1-1 3 i=1 13
V. _
J - _

n

l

”a z 213'
i-l

-1 V can be interpreted as an index

‘vvhere Z , = (l - d .
11 11) j
sshowing to what extent industry j draws evenly on the system

c>f industries-~in the case of a relatively low value of Vj'

C)r it may indicate that industry j draws from just a few
ssectors in the system of industries--in the case of a large

‘Jj. The higher the linkage index and the lower the index of
(flzispersion the better integrated to the rest of the economy

£3 sector is, in the sense of having noticeable effects on

C>tzher industries, effects which are well spread over the

S ystem of industries.

The direct and total (direct plus indirect) labor re-

Ԥ.Llirements are determined for 1963 and 1972 and then compared

of em-

t1C> examine the production structure from the viewpoint

I)3—-<)yment requirements. The total labor requirements are com-

I>Llted according to the formula given in equation (9) above.

 

\
Studies in Intersectoral Rela-

4Nooregard P. Rasmussen,
ti'~<:>ns (Amsterdam: North-Holland, 1956): pp. 140-42.

58

Likewise, direct and total (direct plus indirect) im-
ported input coefficients for the two economic structures
are computed and compared to examine changes in the struc-
ture of production from the viewpoint of import dependence

and import leakages.

The direct imported input coefficients (mj) represent
tlie difference between the direct coefficients computed from
true total (domestic plus imports ) matrix and the direct
cc3efficients computed from the domestic matrix alone. Simil-
arrly the direct plus indirect imported input coefficients(gj)
alre the difference between the direct plus indirect input co-
eifficients obtained from the total matrix, and the direct
P1413 indirect coefficients calculated from the domestic

‘maitrix. In terms of the notation used above

n t
m =2 (a.. - t>
1 i=1 13 ij (13)
and
n
r -1 r -1
gj =1: (1 - aij) - (1 - dij) (14)

All the structural changes mentioned above are ob-
taimed from a comparison of the economic structure of 1963 and
that of 1972. The results are presented by way of tables and

seatt:er diagrams.

59

The input—output framework can be used in a counter-
faactual analysis in which hypothetical situations are simul-
EitEd to interpret changes in an economy from one period to
another.15 The technique is used in this study to anal)’ze
tlie output, employment and balance of payment effects which
Inaive occurred; and to determine the extent to which these
clianges can be attributed to changes in the structure of

[>Iroduction and the extent to which they can be traced to

clianges in demand.

In the first simulation, dealing with output effects,
tlie structure of 1963 is combined with the final domestic
deemandfor 1972 to generate a hypothetical production for
11972 due only to changes in demand. This hypothetical pro-
dllction is then compared to actual productionin.l9fl2andthe
dilfference is attributed to changes in the structure of pro-
dllction. In terms of the notation and formula defined above

tliis output effect can be expressed as:

72 -l 72 63 -1 72
(l - dij ) Y - (1 - dij ) Yd . (15)

15The 'counterfactual' historical analysis is very
faShionable among some economics' writers and has been used
3y economics' historians and economic theorists. See for ex-
auVPIle, Robert W. Fogel, "The Reunification of Economic History
‘w1-t11 Economic Theory," American Economic Review 55, Supple-
Inent (1965): 92-98; John R. Meyer and Alfred H. Conrad, "Econ—
onlilz Theory, Statistical Inference and Economic History,"
$31.11 of Economic History 17 (1957'): 524-53; Allen c.
.ley and Jeffrey C. Williamson, Modeling Economic Devel-
0‘3nhent and General Equilibrium Histories," American Economic
eView 65, Supplement (1973): 450-58.

60

An analogous simulation may be created to analyze

the changes in employment. The 1963 domestic inverse matrix

and the 1963 manpower coefficient matrix are used with the 1972

final demand to determine the hypothetical manpower that would

have been required if only the demand had changed. The dif-

ference between this hypothetical manpower requirement and

the actual requirement of each sector is attributed to change

in the structure of production. Again, in terms of the nota—

tion and formula given above, the employment effect that is

attributable to structural change can be written as:

72 72 -1 72 63 63 —l 72
N (l - dij ) d N (l - dij ) Yd . (16)

To break down the changes in trade into those attrib-

utable to changes in the structure and those attributable to

changes in demand, two simulations are needed. In one, the

1963 structure and the export portion of 1972 final demand

are combined to find a hypothetical production attributable

t° Changes in the export level alone. This hypothetical pro-

duct ion is then compared to the real one, that is, the one
generated by the 1972 structure and the 1972 export vector,

and the difference is the change in production attributable

to airport due to changes in the structure of production. In
t
81:11:, of the notation used above this export effect is:
72 -1 E72 63 -1 E72
(1 - dij ) Yd - (l - dij ) Yd . (l7)

61

In the other simulation the change in direct plus in-
direct imports attributable to alteration in production struc-
ture is obtained. The first step is to make a simulation sim-
ilar to one above but using an inverse matrix for 1963 and
1972 which includes both domestic and imported inputs. Then,
the output effect obtained from the earlier simulation using
the domestic inverse alone is deducted from the output effect
obtained from this simulation. The difference is the change
in direct plus indirect imports attributable to changes in the
structure of production. In symbolic terms this importeffect

is summarized as:
-l 72 63

[(1 - a. ) y - (1 - a

-l 72]. (18)

Limitations of the Input-Output Analysis

 

While a column of input-output coefficients gives a
fairly detailed description of how a particular product or
group of products was made, it is a compressed summary of a
much greater body of information. No matter how detailed the
classification, each product category will represent a mix of
products. Thus, some changes in coefficients in the matrices

of two difference periods may be due to changes in "product

62

mix" instead of changes in the technology of production.
Hence, structural changes inferred from the observation of
changes in technological coefficients may be somewhat dis-

torted by this possibility.

Furthermore, since each product category is an aggre-
gate of several parts, its path of change is affected by the
pattern of growth of its components. Thus, growth in some
components may be neutralized by decline in others, giving a
false impression of stability in the sector. A possible way
to deal with the problem of aggregation is to disaggregate as
much as possible and keep each category as similar as possible
within a category from one matrix to another. In the study,
the different input-output tables were reconciled to keep
them as comparable as possible. However, this provision does
not entirely correct the distortion brought about by the

aggregation.

Difficulties in allowing for qualitative change in
a fixed classification framework bring another source of dis-
tortion. A fixed classification scheme tells nothing about
the changing quality composition of each category. To the
extent that "different" cannot be expressed as "more" or
"less" it is not measured at all. Hence, a unit of improved
product measured in quality units may represent a larger
amount of input compared to a unit of older product. To
the extent that quality improvements are ignored the input

used are underestimated.

63

Another limitation of input-output has to do with the
proper use of analysis. Input-output analysis may be an effec-
tive tool to diagnose sectors susceptible to policy changes
and, thus, may be useful in establishing general guidelines
for policy. It does not provide, however, enough information
to tell specifically how to deal with these sectors and what
specific policy changes may be appropriate. This kind of in-
formation may be obtained by applying other types of analysis

to the sectors in question.

A high value of:Umutflnmputcoefficients, used here as
a linkage index, simply indicates a high interdependence among
sectors. But, as L. Jones has argued, this interdependence is
translated into "linkage" only if it can be made effective in
a causal sense, that is, if the intermediate input required
by a sector induces other sectors to increase their produc-
tion. However, since interdependence is a necessary condi-
tion for linkage to exist, high coefficients suggest poten—
tial linkages that may be further examined for causality in

a case - by - case basis.16

Moreover, input-output analysis is not a substitute
for the crucial economic critera of profitability. No matter
how large its linkage coefficient, the economic activity is
justifiable only if it is profitable, that is, its benefits

must be larger than its costs; and optimization criteria

 

16

L. Jones,"The Measurement of the Hirshmanian Indexes," p. 322.

64

require that those activities in which this difference is
largest be favored. However, high linkage indexes may help
to detect sectors in which large disparities between social
and private benefits and costs may exist. This possibility
can be further explored with other tools such as cost-benefit
analysis and, if confirmed and the means of financing are
available, correctives measuressuch as subsidies,could be
considered. Or, a thorough investigation of the production
process in an industry singled out by input—output analysis
as having high output and employment linkages, may help to
determine crucial links that need to be strengthened to make
those linkages effective and thus may affect private benefits

or costs in other sectors.

In conclusion, the role of input-output as a diagnos-
tic tool and the need to use it in combination with other
toolscfi'analysis must be kept in mind so that the analysis

may be put to proper use.

Sources of Data

 

Macroeconomic Data

 

The data for the aggregative view come from Puerto
Rican national accounts, trade statistics and manpower statis-
tics collected and published by the Puerto Rico Planning

Board.

65

National accounts have been published in Puerto Rico
consistently since 1947, although some estimates previous
to 1939 do exist. The conceptual basis for the Puerto
Rican Income and Product statistics follows very closely
those of the United States Department of Commerce. Gross
product is defined, as in many countries, as the value, at
market prices, of goods and services produced in theeconomy
during the year. The most important charge is the payments
to the factors of production, i. e. salaries, profits, rent
income and interest payments. These payments are known
as net income or alternatively, net product, at factor cost.

The major accounts of the system are five:

(1) Gross Product and Net Income;
(2) Income and Expenditures of Persons;

(3) Income and Expenditures of Commonwealth and Munici-
pal Governments;

(4) Transactions with the Rest of the World; and

(5) Savings and Investments.

In spite of the fact that because of its association
with the United States, Puerto Rico cannot be politically
classified as a nation (see Chapter 4 on this), the Puerto
Rico Planning Board estimates closely resemble a national
concept. In other words, they include the income received
from Puerto Rican investments and salaries earned by Puerto

Rican seasonal workers abroad. The estimates exclude the

66

income received in Puerto Rico by investors and salaries
earned by workers from abroad. In this connection,trans-
actions with the United States are considered as transactions

with the rest of the world.

The manpower statistics are gathered by the Puerto
Rico Department of Labor. This information is summarized

and published annually by the Planning Board.

The external trade statistics are compiled by the
bureau of the Census of the United States of the Department
of Commerce and sent to the Puerto Rican Planning Board.
This information is summarized there and published annually.

The macroeconomic data needed for this study were
obtained from several issues of three publications of the
Puerto Rico Planning Board where the information is col-

lected annually. They are: Income and Products of Puerto

 

Rico, the Economic Report to the Governor, and External

 

Trade Statistics. The detailed definitions of the vari-

 

ables used and the specific source from which they were

obtained are indicated in Appendix A.

The Input-Output Data

 

The input-output data come from a different social
accounting system, one in which the concept of output in—
cludes all intermediate transactions plus the value added,

in contrast to the national accounting system where inter-

62

mediate transactions are deducted.

Input-output studies of the Puerto Rican economy be-
gan as early as 1949, initiated by the Social Science
Research Center of the University of Puerto Rico and super-
vised by W. Leontiefff and A. Gosfield, the latter in
charge of the statistical work and organization of the re-
sults. The study culminated in a 33—order total flow matrix
for the fiscal year 1948.18 An Aggregated version of this
table was later used in two studies in an updated form (up-

dated to 1953) for the purpose of comparing the 1953 and

1963 structures of the Puerto Rican economy.

The most important, and by far the most elaborate
input-output table developed in Puerto Rico, was that for
1963. The development of this table followed the prin-
ciples applied in the accounts of Norway, adapted for the
statistics available in Puerto Rico. The study, conducted
under the supervision of Mr. Erik Homb from the Central
Bureau of Statistics in Norway, followed as closely as

possible, the United Nations recommendations.20 Another

 

18See Amor Gosfield,"Input—Output Analysis of the Puerto Rican
Economy," in National Bureau of Economic Research, Input—Output Analysis:
An Appraisal (Princeton: Studies of Income and Wealth, Vol. 18, 1955).
The author gives a fairly detailed explanation together with some method-
ological procedures used in the construction of the tabLebut unfortun-
ately does not include the table.

19

20United Nations, Proposals for the Revision of the Social
National Accounts, August 1957, E/CN. 3/356.

 

A. L. Ruiz, Op. cit. and R. Weisskoff, op. cit.

 

 

68

table of similar making was constructed for 1972.

The Norwegian method, as adapted to Puerto Rico is based on
the principle that the supply of each commodity from various
suppliers is balanced by the total use by various users.

The supply at producer's prices is divided into (1) local
production; (2) imports; (3) local excise taxes; and (4)
Federal (U. S. A.) import duties. In this scheme imports
are classified as"competitive" and "non-competitive." Total
use is estimated at purchaser prices and is disaggregated
into: personal consumption; government consumption; ex-
ports; investment in machinery and equipment, in con-
struction in three types of inventories; and, finally, in
intermediate consumption. Using estimates of profit margins
("markups") these accounts are adjusted to make them com-
parable to supply accounts which are valued in producer's

prices.

The input-output tables for 1963 and 1972 provide the
foundation for this part of the study. The tables for
these two years are selected because they are the only ones
that provide information about the domestic, as well as the
total, flows. This separation is very important when the
import portion of the total flow is as significant as it

is in an Open Puerto Rican economy.

 

21The Norwegian national accounting system is summarized
in T. Schiétx "The Use of Computers in the National Accounts
of Norway," Review of Income and Wealth 12 (December 1966):

69

Each set of the available tables for 1963 and 1972
includes the transaction, direct coefficients, inverse co-
efficients and matrices for the total flows as well as the
domestic flows between 44 sectors in the Puerto Rican econ-
omy. These matrices, in producer prices, are available in
both current prices and 1963 constant prices. The latter

will be used in this study.22

Labor requirements per unit of output for the year

1963 and 1972 are also needed. Those given in A. L. Ruiz's

doctoral dissertation are used.23

 

22The 1973 and 1972 tables, as originally computed,
are not exactly similar. However, they were made comparable
by A. L. Ruiz, head of the Economic Research unit of the
Economic Department of the University of Puerto Rico, tobe
used in ongoing research there. This version is the one
used in this study.

23Ruiz, Chapter IV.

CHAPTER IV

STRUCTURAL TRANSFORMATION IN PUERTO RICO: AN OVERALL VIEW

An overview of some of the structural transformations
which have occurred as the economy Of Puerto Rico under-
went economic development is presented in this chapter.

The changes perceived are contrasted with the experiences
other countries have gone through during the same process
and against what can be expected according to accepted

theory.

A Brief Historical Review of Puerto Rico's
Development Strategy

 

 

The main purpose Of this section is to offer a brief

historical overview of the Puerto Rican development strategy}

 

1Puerto Rican economic development has been reviewed by sev-
eral authors. See,for example, Werner Baer, The Puerto Rican
Economy and United States Fluctuations (University of Puerto
Rico: Social Science Research Center 1962): H. Barton,Puerto
Rico's Industrial Development Program,1942-l960(HarvandUni-
versity Center for International Affairs 1959); Gordon K.Lewis
Puerto Rico, Freedom and Power in the Caribbean (New York:
Monthly Review Press, 1963); Lloyd Reynolds and P. Gregory,
Wages and Productivity and Industrialization in Puerto Rico
(Homewood; Richard D. Irwin, Inc., 1965); David F. Ross, 322
Long Uphill Path (Puerto Rico; Editorial Edil, Inc., 1949).
Before 1940, see Victor S. Clark and Associates, Puerto Rico
and Its Problems (Washington: The Brookings Institution, 1960).

 

 

 

 

7O

71

This discussion is restricted to those aspects which are

most relevant to an understanding of Puerto Rico's develop-
ment prOgram. Special emphasis is placed on the period after
World War II when the deveIOpment program took form. A very
brief description of the period before 1947 is given as
background for understanding the major changes which

occurred in the post-war period.

The Period Before 1947

 

This period is divided into two sections. One corres-
ponds to what has been called the "stagnation period." The
other can be considered a transition before the economy
"takes-Off" on the path toward development of the modern

economy.

Before 1940: The Stagnation Period

The island of Puerto Rico was under Spanish rule until
1897 and was integrated into the United States after the
SpanishAmerican War of 1898. From 1898 to 1900 she was
ruled by a military government which was changed to a civ-
ilian one by an act of the United States Congress known
as the "Foraker Act." Under this Act, Puerto Rico was in-
cluded in the tariff and monetary system of the United

States. The "Jones Act" of 1917 gave United States citizen-

 

2W. W. Rostow, The Stages Of Economic Growth: A Non-
Communist Manifesto (Cambridge: Cambridge University Press,
1960).

72

ship to the Puerto Ricans and declared the island a terri-
tory of the United States, "organized but unincorporated."

From an economic viewpoint the two acts had the com-
3

bined effect of:
l. The establishment Of a free trade area between
the two countries which allowed for the free
movement - in either direction - of capital, labor

and merchandise and services.

2. Free accessibility of Puerto Rico to United

States financial markets.

3. The inclusion of Puerto Rico under the regulation
Of United States coastal shipping laws which
limit merchandise transportation to and from the

island to United States built and owned vessels.

The new politico-economic relations had the immediate
impact of increasing imports and exports between the two
countries and of reducing, in relative terms, trade between
Puerto Rico and foreign countries. The value of imports
from the United States, in current prices, increased from

6.9 to 100.5 millions of dollars between 1901 and 1940

3For a full discussion of the relationship between
Puerto Rico's political status and her economy, see U. S.
Congress, Hearipgs before the United States-Puerto Rico
Commission on the Status of Puerto Rico: Economic Factors
(Washington: U. S. Printing Office, 1966).

73

while imports from foreign countries increased from 1.9

to 6.5 millions Of dollars for the same period. The rela-
tive share (in total imports) of imports from foreign
countries, dropped from 21.9 percent in 1901 to 6.1 percent
in 1940. Likewise, the value of exports to the United
States increased from 5.6 millions of dollars in 1901 to
90.6 millions in 1940, while exports to foreign countries
decreased from 3.0 to 1.4 millions of dollars. The relative
share of exports to foreign countries was reduced from 34.9

to 1.5 percent.

The composition of trade between the two countries
also changed. The sugar industry was particularly favored
by the protection Offered under the American Tarrif system
while non-protected industries, like coffee, suffered a
sharp decline. Table 4.1 clearly shows these changes. The
growth of the needlework industry in the manufacturing sector
can also be Observed. The economic activity of this industry
was mainly piece-work performed at home by women, an activity
that by 1940 provided about 45 percent of manufacturing em-
ployment.5

A picture of the economy up to 1940 can best be summar-

ized by a view of the industrial structure of the island at

 

4A. L. Ruiz, "Capital Imports and the Economic Develop-
ment of Puerto Rico: Studies in Input-Output Framework"(Ph.D.
Dissertation, University Of Wales, England, 1972).

5See Table 4.7 below.

.omH .m .amva .mmoua coax Opposm mo xuflmuo>fiss "sash :mmv
ucosmofio>oo possefia ca scapm < "spawns Owsosoom m.oumm Opuosm .mmo~nom .m xo>ym= "mumsom

 

 

74

 

 

 

 

oo.ooH on.~w oo.ooH mw.s oo.oo~ mm.v~ q<909
om.mH on.mH oH. Ho.o . . gnozoavooz
mw.H om.H om.~ oH.o so.o Ho.o wanna
ov.s o~.c om.w ou.o on.v no.c OoomaOH
nw.o H5.o os.n 00.0 ow.m vm.o mommmaoz
NH.os mm.sm om.oo ~s.e om.s~ Hm.m esmsm
Hm.o Nv.c os.HN os.H o~.vo om.m oommou
Hench muuomxm HmuOH manomxm “much mahomxm

mo accused mo osfim> mo vacuums mo osam> mo ucooaom mo osam> xufiwoseou

ovmfi Homfl mawa

 

.Aneszsoe seesase shy
coma .Hosfi .mme mo ossos oesoexm sneer oeeose eons: mo ooeoeeooes o>eesfiom--.fi.s mam<s

75

that time. This is represented in the net income by in-

industrial origin presented in Table 4.2. It shows the
important role played by the agricultural sector, which

was responsible for 30.9 percent of total net income. Half
of this was accounted for by sugar cane cultivation. More-
over, about two-fifths of net manufacturing income was

accounted for by industries related to sugar cultivation,

i.e. sugar mills, refineries and beverages. (mostly rum
distilleries) In total, agriculture related manufactur-
ing constituted more than half of manufacturing net income.
One can also observe the large share of the government in
total net income. The federal government contributed about
half Of this share from the coffers of the "New Deal" Pro-

grams.

It can be concluded that, in spite of the large in-

crease in the sugar industry and the massive federal emer-

gency aid during the decade of the "Great Depression" in
1940 the island remained a typical example of colonial

economy dependent on agriculture for its main economic

activity, and over dependent on one plantation crop export-
able to the metropolis. The economic picture of 1940 was a
poor base from which to start an economic development

program.

76

TABLE 4.2.-~Net Income by Industrial Origin, Puerto Rico, 1940.

 

 

Value Percent of
Sector (in million dollars) Total
All Industries 227.8 100.0
Agriculture 70.5 30.9
Sugar Cultivation 35.8 15.7
Other Agriculture 34.7 15.2
Manufacturing 26.4 11.6
Sugar Mills 9.3 4.1
Beverages 2.2 0.9
Needlework 5.8 2.5
Tobacco Products 2.4 1.0
Other Manufacturing 6.7 2.9
Contract Construction 2.6 1.1
Trade 24.3 10.7
Transportation 13.5 5.9
Communications 0.7 0.3
Finance 1.9 0.8
Insurance 1.2 0.5
Real Estate 21.4 9.4
Services 20.5 9.0
Power and Gas 1.8 0.8
Government 42.1 18.5
Miscellaneous 4.2 1.8
Net International Flow of
Capital Returns -3.6 -1.6

 

SOURCE: Puerto Rico Planning Board, Puerto Rico Income and Product.

 

77

1940 to 1947: Transition Toward Industrialization

The conditions propitious to a push toward economic
growth were realized from 1940 to 1947. The first steps
toward industrialization were made possible by political

and economic changes which took place during this period.

In 1940 the popular Democratic Party won control of
the Legislature of Puerto Rico, a party with a strong will
to break the "vicious circle" of poverty. At the same
time, Rexford Tugwell, a political economist and planner
with considerable experience in the New Deal administration
was appointed governor of Puerto Rico by the President.
Thus, both branches of government shared a common ideology
for economic change which they put to work to change the

institutional base of the economy.

From 1942 to 1945 most of the present day institutions
concerned with providing the infrastructure and facilities
needed for economic development were created. In 1942 the
Puerto Rico Planning Board, the Puerto Rico Industrial De-
velopment Company, and the Government Development Bank all
were established key institutions for economic planning.
From 1941 to 1945 the Water Resource Authority, the Trans-
portation Authority, and the Aqueduct and Sewer Authority

were organized to provide badly needed infrastructure.

 

6Up to 1947 the governors could not be Puerto Rican
and were appointed by the President of the United States.
From 1952 onward they were elected in Puerto Rico.

78

A big economic push came from the war boom which
provided the funds to underwrite the operations of these
institutions. In the first place, rum exports to thefiUnited
States boomed,bringing the Puerto Rican government a large
increase in income. Rum imports from Puerto Rico pay excise
taxes in the United States that, under the existing fiscal
arrangement, are remitted back to Puerto Rico and become
part of income there.7 The traditional exports, parti-
cularly sugar and tobacco, also increased a great deal.
Moreover, a considerable amountof net transfer payments
flowed to the island from the federal goverment and from

Puerto Ricans participating in the war.

The initial strategy of the development program was
government initiated industrialization by Ownership and
Operation of certain industries. The Puerto Rico Industrial
Development Company was entrusted with this task. The
Development Act creating the company specified it was to
establish plants oriented to the local markets and the use
of local raw materials. It also emphasized local ownership

of industrial enterprises.

Guided by the above criteria, a few plants in the

glass, shoe, paperboard and clay products industries were

 

7The proceeds of this tax during the first half of
the 1940's were estimated to be in 160 millions dollars.

79

created. However, the program confronted serious diffi-
culties right from the beginning. First of all it was not
a program which would win enthusiastic support from the
established economic interesmion the island or in the
United States Congress. Secondly, the government lacked
management and marketing expertise to successfully engage
in such an operation. Moreover, it is not clear how much
weight was given to profitability considerations in the
investment criteria since it seems the demand projections
for some Of the industries, like shoe manufacturing, were
over estimated. Funds ran short by the second half of the
decade when the ending of the war cut short the export
boom.

Thus, the development program failed to create the
number of jobs it hoped for and most of the government
owned plants were operating with losses by 1947. However,
not all of the results were bad since a valuable infra—
structure much needed for economic development was built
during this period. The Puerto Rican authorities became

convinced that a revision of the program was long overdue.

The New Strategy after 1947: Operation Bootstrap

 

Attracting private business investment by various in-
centives became the emphasis of the development program

after 1947. In that year "Operation Bootstrap" was init-

 

8Ross, p. 64-65.

80

iated, a new emphasis which gave government institutions
the role Of creating an "atmosphere" for the attaction and

development of private industrial enterprises.

The backbone of "Operation Bootstrap" was a new tax
exemption law which granted manufacturing firms which were
expanding or starting operations in Puerto Rico, exemption
from income and property taxes.9 The law also provided
numerous complementary incentives such as low rental rates
on properties and plants leased from the government, low

interest rate on loans, training of laborers and others.

The Puerto Rico Industrial Development Administration
was reorganized into a new agency known as the Economic
Development Administration which became the island's most
important economic planning and coordinating unit. Its
basic functions were to perform industrial and economic
research, to do promotional work, and to provide service
work. (Mainly labor training and plant construction suit-
able for newly established plants). The government built
manufacturing plants were sold to private enterprises from

1948 to 1950.

In the first stage of this second phase of the economic
development program, major efforts were made to attract those

industries which could make good use of the abundant and

 

9See Milton Taylor, "Industrial Tax Exemption in Puerto
Rico." National Tax Journal 7 (1954): 349-71 for a criticism
of tax incentives as a means of promoting economic development
in Puerto Rico.

 

81

cheap labor supply on the island. This factor, of pro-
duction, in the opinion of some people, provided the main

comparative advantage of Puerto Rico.10

The immediate impact of the new economic development
strategy was the establishment of 418 new manufacturing
plants between 1947and 1954. Most of these new plants were
successful. Almost all the industries attracted during this
period were in the fields of apparel, textiles, shoes and
the assembly of electrical and electronic goods. The maj-
ority were subsidiaries of United States firms, "externally"
integrated to the mainland operation. Raw materials were
imported from the United States and the output was exported
back sometimes in an unfinished state. On the other hand,

local markets were mostly satisfied through imports.

Again, war was propitious for growth in Puerto Rico
during this period. The labor market in the United States
was very tight because of the Korean War and many firms
were attracted to Puerto Rico where labor was abundant and
cheap. At the same time, a massive migration of Puerto
Ricans to the United States took place. From 1948 to 1955
the net migration rate was 19.2 persons per thousand in
the population, an outflow that reduced the potential popu—
lation growth from 3 percentto 0.6 percent.11 This fact,

and the additional income generated by the new industrial

 

10Hollis B. Chenery,"Comparative Advantage and Development
Policy," American Economic Review 51 (March 1961): 44-45

11Ruiz, p. 14.

82

establishments, were major factors respnsible for the in-
crease in real (1954 = 100) per capita gross national product

from 328 dollars to 510 dollars between 1947 and 1955.

However, the new strategy was not without difficulties.
The United States business recession of 1953-1954, which
came with the end of the Korean conflict, convinced the
Puerto Rican authorities of the vulnerability of the highly
export oriented island economy to business recession on the
mainland. In the first place, the recession reduced the
successful promotion of new factories. In addition, many
of the labor intensive industries operating in Puerto Rico
responded to the reduction in demand from the mainland by
closing down their entire operations on the island. Fur-
thermore, the reduction of job opportunities in the United
States diminished Puerto Rican emigration from 30,000 in
1953 to almost none in 1954.12

Another factor that threatened the new economic devel-
opment strategy was an increase in wages induced by federal
minimum wage legislation. Although a modified version of
this legislation was applied in Puerto Rico on an industry
by industry basis,13 its economic impact was considerable
since the majority of industries and workers were below the

minimum and, hence, affected by the legislated wage increases.

In the United States, on the other hand, the minimum wage

 

 

13The U. S. Secretary of Labor is empowered to appoint
Special committees to fix the minimum wage for each industry.

83

legislation affects only marginal industries at the bottom
of the labor market. Moreover, labor unions unhappy with
the competition from cheaper products coming from Puerto
Rico, put pressure on the government for the elimination

of wage differentials between the island and the mainland.

A relatively faster rate of wage increase in Puerto
Rico, together with rising ocean freights,14 brought relative
costs upward thus reducing theattraction of tax incentives
and labor intensive manufacturing. At the same time, com-
petition from areas like Taiwan, Hong-Kong, Brazil, and
later South Korea, became evident. This competition
affected Puerto Rico's industrialization program in two ways.
First, by competing for the United States consumer market
with the same goods that Puerto Rico was producing.Second,
by taking away investment funds that were attracted to these

areas because wages were even lower than Puerto Rican wages.

All the above mentioned problems led the Puerto Rican
authorities, once again, to reevaluate the industrialization

program and to change its orientation.

Revision of "Operation Bootstrap"

 

To cope with decreased competiveness due to wage in-

creases, "Operation Bootstrap" was reoriented to promote

 

14As mentioned above, Puerto Rico is subject to U.S.
Coastal Shipping Laws which make compulsory the use of U.S.
built and owned vessels. However, Puerto Ricans have no in-
fluence on the freight rates that are established.

84

industries that could afford to pay higher wages. This
meant emphasis on more capital intensive industries which
still required large amounts of labor but with upgraded
skills. Moreover, due to their heavier investment, these
industries were believed to be less prompt to leave the
island during a recessionary phase of the United States

business cycle.

Another revision had to do with attracting industries
that could supply the intermediate input needed by indus-
tries already established or potential on the island.

This new emphasis was prompted by the realization that
demand increases were generating weak output and employ-
ment multiplier effects in the local economy, due to the
external orientation of its industrial activity. It was
hoped that improved local integration would enhance the
output and employment “multiplier-effects" on the whole
economy and at the same time tend to reduce that part of

the production cost related to the increasing ocean freight
rates. It was also expected that the improved economic
wholeness of the economy would raise indirect employment
sufficiently to compensate for the loss in direct employ-
ment due to the promotion of less labor intensive industries.
This new emphasis of promoting industries capable of supply-
ing other industries, corresponds to investment criteria

geared to favor industries with large "backward linkage

85

effects."15

Finally, one last aspect of the "new economic policy"
was to give more impetus to tourism. It was realized that
the tourist industry could be an important source of poten-

tial employment and output.

Summary

Puerto Rico's development strategy has been reviewed

very briefly in this section.

An industrialization program was started in 1940 to
bring the economy of Puerto Rico out of its colonial condi-
tion of heavy dependence on agricultural activities, almost
exclusively sugar cane, a plantation crop exportable to the
metropolis. The first emphasis of this prOgram was on
government owned plants oriented to the production of goods

for a local market and to the use of local raw materials.

In 1947, after the first effort failed, the industri-
alization emphasis was shifted to attract private capital,
mainly of United States origin. The backbone of the new
emphasis was a set of incentives including tax exemptions,
subsidized rentals, low interest, low utility rates, and
labor force training. The program concentrated on labor
intensive Operations that could use the abundant and cheap

labor supply available in the country. Emphasis was placed

 

15Backward linkage effects were explained in Chapter III,

above.

86

on the production of goods exportable to the United States
to take advantage of the unrestricted accessibility of this
market arising from the political relationship between the
two countries. This outward orientation was a radical
departure from the inward orientation of the first indus-

trial program.

The emphasis was shifted around 1955 to the promotion
of more capital intensive firms, capable of paying higher
wages which could supply a larger share of the intermediate
inputs needed by plants already in operation or potential
on Puerto Rico. This change was prompted by rapid wage in-
creases, by increased competition from other areas for
labor intensive activities, and by the awareness ofweak.out-
put and employment domestic multipliers arising from in-
creases in final demand. It was expected that an increased
economic roundaboutness could improve the output and em-

ployment multipliers in the local economy.

Structural Transformation: A General View

In this section the structural transformation of the
economy of Puerto Rico will be explored from a macroeconomic
perspective. Some key variables related to the seven basic
elements of structural transformation summarized in Chapter
II, are examined from the viewpoint of their growth ten-
dencies. Their behavior is evaluated in terms of what

might be expected according to existing theories of growth.

87

In the first subsection some indicators of growth are
analyzed, for the period 1940 to 1977, to establish how
much growth has been achieved in the Puerto Rican economy.
Then, the structural transformation is examined for changes
in the structure of production, employment, foreign trade,

and the sources of capital accumulation.

The Economic Growth Achieved

 

The economy of Puerto Rico experienced remarkable
growth during the post-war period according to the customary
indicators of growth. Table 4.3 illustrates some of the
principal indicators in per capita terms in constant 1954
dollars, for selected years after 1940. Table 4.4 gives

their rate of percentage change for five different periods.

The rate of growth was high and steady up to 1972,
whether it is represented by the gross national product
(GNP), the gross domestic product (GDP),or net income. It
is interesting to note that the GNP grew at a rate very
similar to that of the GDP for the period 1947-1955 but,
for the periods 1955-1963 and 1963-1972 the growth rate of
the GDP was significantly higher. It must be recalled that
the GDP measures the value, at market prices, of goods and
services produced within the geographic limits of a country
while the GNP takes into consideration only that part of
this production that generates income for the residents of
the area. The difference between the two equals the net

effect of payments received for domestic factors of produc-

88

 

 

 

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vacuum assosoom use msma .posvosm use oeoosm coax canons .vnmom mcflsswmm Oowm canons "mumaow

 

 

mmH mum vma mm em ma unoEumo>cH voxwm mmOHu
chm nwm vow NNH mm we moow>hom :H

5mm mmv vvm vow an mmH mwooo eggshzaucoz :H

HmH NmH mm 0v on ma mvooo Oanmuzo :H
moHH NnoH nmc va oom mHN COMHQESmcou HmuOh
HVOfi onoH mmc nmv mwm NHN oEoo:H ofinmmommfla Hmcomhom
MHHH omHH Hoe ovv mam mam oEoo:H Hmcomhom
mam «mm 0H0 mmv Nam HHN oEoocH uoz
mmmfi mama Hmn use mom 1: possess Ofiumosoo mmOHu
owed NNHH 0mm on wmm mom nonvOHm HMQOflumz mmonu
55mg whoa mama mmmfi nvma ovma

 

mosHm> «cameo you

Hepmowpcm anocoom

 

.floo~ u vmmfi .mswaaov usmumcoo muwmmo pom :MU nnmfi
pen mass .momH .mmoH .seoH .osmH neon» Loosen .sszoeo mo neossoeoeH ooooosom meow--.m.e mgm<s

89

.oHnm~Mm>m Ho: :Oflmehomcum

m.v ofinwh EOHM woumHSOHmu "mumaom

 

m.oH- N.s H.s m.- m.m proseno>sH ooxse nnoeo
oo.- s.s o.o o.o . o.» noos>eom sH

s.H H.s e.m s.m s.m noose osssssp-soz sH

o.o m.w o.m o.ss ~.s nooou passeso sH

m.o o.o o.m s.s o.e soeooeonsou soreness Hseos
m.o- o.m m.e m.m m.s oeoosH ososnooneo aseooeoe
m.o- H.o o.m m.m m.s oeoosH Hononeoe
s.o- s.e o.e s.e w.e oeoosH.soz
w.H m.m m.m m.m m «Osmond Owumosoa mmosu
o.c- m.e s.e s.m o.~ suppose “stoesoz noose

 

unmaumnma Numfiamooa mcmanmmaa mmmuunvma nvaucvafi

 

Hoquflvcm assocoum
nusouo mo ovum euwmmu you

 

.nwommp:OOhom sag
mwOflnom wouoofiom meow pom :pzouu mo maoumowusH ufleocoom meow mo cuzoso mo ouemnn.v.v mqm<h

90

tion employed abroad minus payments made in the country to
foreign-owned factors of production. Thus, the disparity
in the rate of growth of these two indicators can be ex-
plained by increases in payment outflow which came with the
expansion of foreign-owned industrial capacity, resulting

from change in the development strategy after 1947.

Also of interest is the comparison of net income and
personalincmmn The latter grew faster for all the periods
after 1947 up to 1972. Significant increases in transfer
payments, particularly in Federal transfers, explain the

major part of these differences.

Also notable is the fact that, up to 1972, personal
consumption kept a steady rate of growth either similar to
or higher than that of personal income while gross fixed
investments has grown at even higher rates. However,
according to accepted theory, part of the additional in-
come must be saved in order to keep investment growing.
Thus, as investment has been growing so fast some sacrifice
in consumption was expected, reflected in a slower rate of
growth in consumption compared to personal income. Capital
inflow from abroad, as well as transfers and loans, made
possible the high rates of growth in investment without
much sacrifice in consumption.16 It is important to ob-
serve the changes in relative importance of differenttypes

of consumption. Durable goods and services have grown at

a very fast rate thus increasing their share of total

 

16See section below on changes in the capital acumulation
process and source of finance.

91

consumption at the expense of consumption in non-durable
goods which grew at a lower rate. This behavior agrees
with that expected as income rises due to differences in

income demand elasticities of these goods.

It is observable in Tables 4.3 and 4.4 the striking
decline in most of these economic indicators during the 1972—
1977 period when the economy stagnated. All the rates of
growth decreased and most of them turned negative except
that of personal consumption and GDP. It seems that the
decrease in the per capita magnitude of these indicators
is due to a rate of growth of the total magnitude too low
to compensate for the growth in population for the period
which was 3.2 percent per year. For gross fixed investment,

is evident that the total magnitude decreased.

In Table 4.5 a comparison is made between Puerto
Rico and some of her Caribbean neighbors, in terms of some
economic indicators used to judge growth and industrializa-
tion, as judged from the economic indicators presented in
the table, have been much above those of other Caribbean
economies. These differences between Puerto Rico and
other island economies in the area may be of help in
interpreting the structural transformation which has occurred

in Puerto Rico.

The indicators of growth examined in this section have
clearly shown the fast growth of the Puerto Rican economy

up to 1972. They have also shown the stagnation of the

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.mufiumwpmum anonmg mo xoonumo» .OOfimmo gonna HmsowumsnoucH was Amsma .mcowumz mouse:
"egos 3ozv «has .m .> .moeonmenum messooo< Hscofieoz mo xoonuso» .nsosanz noose: "mmumoom

 

 

mo. we. as. om. osoesoseem House
as ucosonmEm weansuommscmz mo onmcm

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9.
9
OH. as. om. om. oeseeosooxm prosono>eH mo renew sou
as Noe mm» moss finesfiflon .m.= shy

mufimwu Mom weapons Oflumosoa mmono

 

OfiHnsmom moseseh coax nonwOfivsu vasoeoom

swam: smowcwsoo canons

 

.msma use» .fluww: new OHHnsmom seaflsaeon
.mowmsmn .oowm Osgood pom sowumuaamsspmsvsH use suzonu assocoum mo whoumOfivcm meowuu.m.v mam<~

93

economy during the Nineteen Seventies. In the section be-
low the structure of the economy is examined to see how it
was transformed while the economy was growing up to 1972,
to see if some of the changes help to explain part of the

stagnation of the Nineteen Seventies.

Changes in the Structure of Production

A comparison of the percentage share of groups of in-
dustries in the toal domestic net income, for different
years, is presented as an indicator of the changes which
occurred in the structure of production of the Puerto Rican
economy. Table 4.6 shows these distributions for 1940, 1947
1955, 1963, and 1972. The years were chosen to correspond
to the end or the beginning of periods of major changes in

the strategy of Puerto Rico's development program.

There are some discrepancies between the 1940 sec-
toral shares shown in this table and those presented for
that year in Table 4.2 above. The latter is based on dom-
estic income, or the income generated in the geographical
area of the country while the former is based on the in-
come retained in the area, or net national income. The
difference between the two concepts of income is the net
effect of payments made to foreign owned factors of produc-

tion used abroad.

Some outstanding points can be observed in Table 4.6.

First, there is the sharp decrease of the agricultural share

94

 

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o.ooH o.ooH o.ooH o.oo~ o.ooH nowoesooeoe es .s<sos
o.oH m.- m.- m.oH ~.m grosseoeoo
m.oH s.m m.s o.o o.o noom>eom
o.H~ w.o~ s.m H.s m.HH oenenm Hsoa pen pursuancH .ooessee
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m.N e.m m.H e.o m.o asseneosmssoz porno
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.manHHov

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of domestic income from 33.7 percent in 1940 to 4.0 per-
cent in 1972. The decline affected the whole sector but

the drop was most dramatic in sugarcane production, the main
economic activity in 1940, which went from 17.1 percent to

only 0.5 percent during this period.

A brief digression to explain the sharp decline in
the sugar industry is in order, given the importance this
industry had in the Puerto Rican economy.17 The rapid de-
cline of the sugar industry was manifested in a reduction
of the sugarcane cultivated area, a decrease in the pro-
ductivity per acre, and a drop in the sugar yield per ton
of sugarcane produced. These three factors reinforced each
other to cause a sharp decline in the industry's output
from 12.5 millions of tons of sugar in 1952 to 4.4 million

in 1972.

The main causal factors of the decline were the be-
havior of sale prices and production costs and the effect
of urbanization and industrialization. In the Nineteen
Fifties the sugar price remained stagnant while production
costs were rapidly increasing. Many farmers reacted to the
net income loss by cutting production expenses by decreas-
ing the amount of fertilizer used and reducing the frequency
of weed elimination and plantation renovation. These prac-

tices reduced productivity per acre and sugar yield per ton

 

17The causes of the decline of the sugar industry are
explained in Eliezer Curet Cuevas, El Desarrollo Economico
de Puerto Rico: 1940-1972 (Puerto Rio: Management Aid Center,
Inc., 1976), pp. 148-58.

96

of sugarcane produced which, in turn, brought further de-
creases in income forcing many farmers to quit sugarcane
production. Enhanced urbanization and industrialization
claimed some of the best coastal lands suitable for sugar-
cane production and induced further declines in the industry.
Furthermore, the expectation of higher wages in the in-
dustrial sector induced many workers to abandon the sugar-
cane fields, causing labor shortages which made it necessary
to lengthen the crop season. This was detrimental to sugar
yields since the season was extended to the rainy season

when sugar yields were lower.

These factors were compounded in a chain reaction that
has brought the sugarcane industry close to disappearing.
Some sugarcane farms have been turned into dairy farms,
an agricultural activity that has remained profitable.
Others have been divided into small lots and sold for resi-
dential purpose. Still others remain idle orarefikept in
marginal agricultural activities waiting until land specu-

lation bring prices high enough to reap a profit.

Referring back to Table 4.6, the increase in manufac-
turing activity during this period is also remarkable. It.
increased its share in domestic income from 12.7 percent
to 23.6 percent, taking a leading role as a key sector in
the development process. This shift in economic activity
from primary production to manufacturing is an essential

feature of the successful transformation of an under-

97

developed dual economy, as was emphasized in the literature
reviewed in Chapter II. Its importance makes necessary a
more detailed analysis in order to judge the depth and
stability of this structural transformation. This analysis
is developed in the remainder of this section. As the first
step in this investigation, it examines the question of how
much of the industrial transformation observed corresponded
with the strategy pursued in the Puerto Rican development

program.

Consistency between the Structural Transformation
Observed and the Development Strategy Pursued

A close examination of Table 4.6 shows the extent to
which the transformation of the industrial activity illus-
trated there corresponds to the periodic changes in emphasis

in the Puerto Rican development program.

First, it is noticeable that food, beverages and tobacco
manufacture, whose 11.1 percent of domestic income contributed
almost three-fifths of total manufacturing domestic income
in 1947 has by 1972 dropped to 4.2 percent, which was slightly
over one-sixth of total domestic manufacturing income that
year. Thus, agriculture-based manufacturing, which was
the traditional manufacturing and export activity up to
1947, has followed the same diminishing trend as agricul-
ture in general. This decline reflects the development
policy after 1947 which placed emphasis on industrializa-

tion but with a different type of manufacturing.

98

The sharp decline of agriculture and agriculture-
based manufacturing, in part reflects the slower growth of
non-durable consumer goods shown in Table 4.4. But it also,
in part, reflects the failure of agriculture to shift its
production to those goods whose demand was increasing. This
possibility is even more realistic when it is considered
that very little of the agricultural output in 1972 was for
the domestic market, since about three-fifths of the reduced
share of agricultural-related manufacturing that year was
Iin rum, tobacco and canned tuna fish, production which is
mainly geared to the export market. It is thus possible
that the emphasis on industrialization has provoked an un—
wanted neglect of agriculture which has generated rigidities
in that sector which have contributed to the sharp decline
of agriculture and agriculture based manufacturing. How-
ever, there is always the possibility that the decline was
completely justified in terms of changes in comparative ad-

vantages and shifts in demand.

If the decline of agriculture was more than what was
justified, this was perhaps a limiting factor in Puerto
Rico's development path. As Fei and Ranis have argued, "the
opening up of the economy to foreign trade by no means
alleviated the need to activate fully the agriculture

sector."18

 

18John C. Fei and Gustav Ranis,Development of the Labor
Surplus Economy (Homewood: Richard Irwin, Inc. 1964),

 

99

Failure to do this, however, in the case of Puerto
Rico was not necessarily a sufficient obstacle to halt econ~
omic growth, as these authors predicted. From the beginning
Puerto Rico's subsistence sector was relatively small and
free access to United States markets with a common currency
lessened balance of payment difficulties. But, the sharp
decline of agriculture is probably an important factor in
explaining the island's difficulties in lowering the rate

of unemployment.1

The table also makes it evident that the apparel and
textile industries experienced some increase from 1940 to
1955 in accordance with the importance of needlework
activities up to 1947 and the emphasis on labor inten-
sive manufacturing from 1947 to 1955. The share of this
sector in domestic income remained almost unchanged from
1955 to 1963 and decreased from 1963 to 1972, in tune with
the new emphasis after 1955 on favoring capital intensive
manufacturing. This change in emphasis is also reflected
in the considerable increase in the share of chemicals,
metal products and machinery. The chemical industries
share went from 0.9 percent in 1955 to 4.7 percent in 1972.
Likewise, the share of metal products and machinery rose

from 2.3 to 5.3 percent in the same period.

Another structural change that reflects the policy

orientation of the develOpment strategy is the increasing

 

19See table 4.8 below

100

role of the government, which steadily increased its dom-
estic income share from 9.3 percent in 1940 to 16.6 in 1972.
The rise from 1940 to 1963 may be considered normal in view
of the increased complexity of society as development pro-
gressed. The sharp increase from 12.3 percent in 1963 to
16.6 percent in 1972, on the other hand, may reflect govern-
ment efforts to employ the excess labor unable to find em-

ployment in the less labor intensive industrial sectors.

Of interest also is the large share of trade in total
domestic income. The importance of this sector may be par-
tially explained by steadily increasing disposable income
and the proximity and free access to United States product
markets that has induced the Puerto Ricans to copy United
States consumption patterns. Franchised marketing of United
States goods in Puerto Rico and direct operation of sub—
sidiaries of mainland chain stores, aided by large adver-
tisement budgets and credit availability, have become im-
portant economic activities on the island and, consequently,

trade has been booming.

Ready access to United States financial markets and
increasing disposable income also explain, in part, why
the share of construction in domestic income has climbed
steadily from 1.2 percent in 1940 to 8.7 percent in 1972.
Residential construction has been an important component

of the expansion in this sector.20

 

20See table 4.14 below.

101

Distinctive Stages of Growth

Some of the models discussed in Chapter II dealt with
different growth experience. Table 4.6 can help to estab-
lish to what extent some distinctive stages of growth, ex-
plained in these models, are present in the island growth
pattern.

Celso Furtado identified three phases in the industrial~

l
ization process of Latin America.2'

Two of them, with some
modifications,seem to be present in Puerto Rico. In the
initial phase, industrial activity is limited to the produc-
tion of non-durable consumer goods of the kind more prom-
inent in Puerto Rico from 1940 to 1955, i. e., processed
foodstuff, leather goods, textiles and clothing. Food,
beverage, tobacco, and apparel and textiles manufacturing
contributions to Puerto Rican domestic income were at 10.2
percent in 1940, 15.0 percent in 1947 and 11.3 percent in
1955. The shares of these industrial activities in total
manufacturing for these years were one-ninth, four-fifths,
and three-fifths respectively. Furthermore, according to
Furtado, the expansion of industrial output in this phase
is dependent on export and, hence, stimulation of the in-
dustrial sector comes from outside instead of within the

local economy. In addition, he pointed out that most of

the needed infrastructure is built during this phase.

 

21C. Furtado, Chapters 10-1].

102

These characteristics were also present in the Puerto
Rican economy between 1940 and 1955. Thus, it can be said
that the country was in Furtado's first phase of indus-
trialization during this period.

The second phase of industrialization, according to
Furtado's analysis of Latin America experience, is that of
import substitution. In this phase domestic production
gradually replaces imports in the local non-durable consumer
goods market. This phase is almost absent from the Puerto
Rican growth experience since free access to the mainland
markets and the impossibility of raising trade barriers to
protect domestic production make import substitution very
difficult. However, Governor Tugwell was thinking along
those lines in 1945 when the plants mentionedcnlpage 78

were set up.

In the third phase, the industrial sector expands to
provide a larger share of the local market of final goods,
particularly durable consumer goods and investment goods,
and to supply a larger share of intermediate products needed
for the production of final goods. The industrial sector
thus generates part of its own demand and the economy becomes
more self-sustaining. Some changes toward this end can be
observed in Puerto Rico's industrial activity after 1955 by
looking at Table 4.6. Chemicals, metal products and mach-

inery, and other manufacturing22 increased their share of

 

22Other manufacturing includes petroleum refining and re-
lated products, rubber and plastic products.

103

domestic income from 5.0 percent in 1955 to 8.9 percent
in 1972. The increased shares of these sectorscontributed
one-fourth,twoiifths, and more than one-half of total man-
ufacturing respectively for the three years. These sectors,
although primarily oriented toward the export market, also
serve the domestic intermediate goods market.23

The transition growth model of Douglas Paauw and John
C. Fei also identifies three stages of growth somewhat
similar to the ones presented by C. Furtado. These stages
are export-promotion, import-substitution and export substi-
tution.24 According to these authors, the three stages may

be combined into different patterns Of transformation from

a colonial into a modern growth economy.

In export-promotion growth, primary product exports
provide the means for industrial sector expansion. The
dominant phenomenon in this first stage is the expansion of
primary product exports and the output of the industrial
sector consists mainly of productive inputs required for
the expansion Of primary product exports. This strategy
with some modifications was present in the Puerto Rican
economy in the period 1940-1947. The modification was that,
instead of primary product exports as such, the bulk of ex—

ports during this period consisted of processed primary

 

23This assertion is thoroughly examined in a detailed
analysis in Chapter V.

24See Chapter 11 above.

104

products, e. g. food, beverage and tobacco products. As
mentioned above, the government income arising from these
exports was used to establish glass and cardboard factories,
important inputs into rum production which was one of the
most important exports. The export proceeds were also

used effectively during this period to build the infra-

structure needed for further development.

From 1947 to 1955 the economy of Puerto Rico exper-
ienced export-substitution growth, according to the Paauw and
Fei classification scheme. In this stage, labor intensive
manufactured goods replaced primary products as the dominant
export. This change in strategy meant a shift from a land-
based to a labor-based growth which, according to the
authors, is a phenomenon unique to the labor-surplus type
of open dualistic economy that the Puerto Rican economy was.
During this period the share of processed primary products
in Puerto Rico's total domestic manufacturing income dropped
from three-fifths in 1947 to a little more than one-third
in 1955, while the share of other types of manufacturing
increased from two-fifths to two—thirds during the same
period. As mentioned before, most of the industrial
output during this period consisted of labor intensive man-

ufacturing geared to the export market.

After 1955 the Puerto Rican economy went into what
may be called a prolongation of the export-substitution

phase, in which unskilled labor intensive manufactures

105

were replaced by skilled labor intensive products as the
predominant source of exports. From 1955 to 1972 the
proportion of skilled labor intensive manufactures in
total domestic manufacturing income increased from one—

fourth to a little more than one-half.25

The import-substitution stage, for reasons already
mentioned, is not found in Puerto Rico's development pat-
tern. This is in contradiction to the Paauw and Fei asser-
tion that for small, open, labor surplus economies import-
substitutionisEinecessary preparatory phase for export-

substitution.

Puerto Rico experienced a shift from export-promotion
to export-substitution without a transitional import
substitution phase. However, the analysis in Chapter V
will make it evident that some import substitution of inter-
mediate inputs, primarily Of the backward linkage type,
occurred in Puerto Rico during the 1963-72 period as part

of the structural transformation.

Summary

The analysis above has made evident a shift in Puerto

Rico's structure of production that increased the industrial

 

25The portion of chemical, metal products and machinery, and

other manufacturing, in total manufacturing domestic income,
is taken as a proxi for this relationship under the assumption
that the bulk of this activity is oriented toward exports. The
increase in the share of these industries in total exports,
shown in Table 4.12 below, confirm this changeimltrade com-
position

106

output relative to the agricultural output, an expected
change during the successful transformation of a dual
economy. It has also shown that, at first, industrial out-
put consisted mainly of agriculture-based manufactures,
shifting to labor intensive industrial goods and to more
capital intensive goods in later stages of the industrial-
ization effort. This shift in emphasis of the industrial
output closely corresponded to changes in the strategy pre-
scribed for Puerto Rico's development program as responses
to changing conditions. The changes in industrial output
also marked distinctive phases of growth somewhat similar
to those pointed out by some authors as possibilities dur-
ing the transformation of a dual economy to a stage of modern
growth. It is evident that Puerto Rico at first experienced
a stage of export-promotion growth in which industrial out-
put was geared to the support of agricultural-based exports
shifting later on to a stage of export-substitution growth
in which a change to labor intensive manfactures permitted
the substitution of land-based for labor—based exports.This
export-substitution phase was prolonged by a shift to more
capital and skilled labor intensive industrial goods, when
the competitiveness of unskilled labor intensive products
was decreased. In this export substitution stage, which is
a more complex phase of the industrialization effort, in-
creased attention was given,as expected, to final and in-

termediate goods for the home market. The analysis also

107

suggests that the import-substitution phase has been almost
absent in Puerto Rico transitional growth which contradicts
D. S. Paauw's and C. H. Fei's assertion that an import sub-
stitution phase is necessary before export substitution

can emerge.

Changes in the Structure of Employment

 

Changes in the structure of Puerto Rican employment
also corresponded to those expected in a dual economy going
through economic development. Economic transformation for
these economies, as was discussed before, means a drastic
shift of labor from primary into industrial economic activity.
Table 4.7 shows that the share (in total employment) of the
labor employed in agriculture, Puerto Rico's main primary
product activity, sharply declined from 44.7 percent in 1940
to only 7.9 percent in 1972. Sugarcane employment dropped
from 24.2 percent to 1.6 percent, while the rest of agri-
culture declined from 20.5 to 6.2 percent. This decrease
has been steady throughout all the periods examined and has
followed the same pattern as the changes in production

already explained.

A look at Table 4.7 gives the erroneous impression
that the shift toward industrial employment did not happen,
since the percentage of labor employed in manufacturing in
1940 is almost the same in 1972. However, the apparent

stability of this share is due to the large proportion of

108

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n

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o.oo~ o.ooH o.oo~ o.oo~ o.ooH snowsesoosoe .a<sos
w.s~ s.HH m.s e.s m.~ osoeeeo>ou
H.s~ ~.eH w.~H w.- n.4H nooseeom
o.o o.o e.o m.s o.m mossessea oefinso soreo use roseseeoensses
N.~ m.H 0.0 u- 0.0 cuspmm Hmom new oocmhsmcm .oucmeam
m.w~ w.sH m.oH H.4H m.oH opens
o.HH s.» m.o ~.m u.m meets: use soesosesnsoo
s.~H a.” e.m N.s m.~ msseseosmsssz porno
m.e H.s N.» ~.m m.m nfioesoe< one messages
s m.H e.m s.s e.w geosoapooz oeo:
m.o m.o v.0 e.o o nowseo>om oesosoos<.
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H.mH H.oH o.su o.m~ s.oH msessoosmsssz
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new sfimflno HmwnumsvcH son cowusnwnumwo ommusoopom .oowa canons ca mnemuom pesoHnamnu.n.v mam<h

109

home needlework activity classified as manufacturing employ-
ment in 1940 and its sharp drop to nothing in 1972. If home
needlework, which is a low productivity occupation typical

of the traditional economy, is taken out of the manufacturing
grouping, the employment share of the remaining new manu—
facturing activities rises from 10.9 percent in 1940 to

19.1 percent in 1972.

One important observation is that the bulk Of the in-
crement in manufacturing employment is concentrated in the
"other manufacturing" grouping which, in this table, includes
the more capital and skilled labor intensive industry em—
phasized after 1955. However, textiles and apparel, which
were at the core of the industrialization effort for the
1947-1955 period, show only modest employment increases in
this and subsequent periods. The limited employment in-
creases in this and subsequent periods. The limited employ-
ment increases in this sector may be due to productivity in-
creases simultaneous with the expansion of the sector, on
the one hand, and the closing of some of the already exist-
ing labor intensive plants, on the other. Both happenings
may be influenced by the reduced competitiveness of unskilled
labor intensive operations, discussed in the first part of

this chapter.

An interesting point in Table 4.7 is the increasing
importance of construction activity as a source of employment.

Construction's share in total employment has steadily gone up

110

from 3.1 percent in 1940 to 10.7 percent in 1972. The pos-
sibility of construction activity assuming a more propul-
sive role in small export-led economies suffering structural
unemployment, has been recognized by some authors.26 This
has been the case in Puerto Rico, as well as in Hong Kong
and Jamaica, where export-led growth has been supplemented
by construction activity.27 This activity, since it is geo-

graphically localized, has natural protection against import

competition.

The largest employment increases in the Puerto Rican
economy were found in the service sectors; the remaining
sectors in Table 4.7 after excluding agriculture, manu-
facturing, mining, and construction activities. The service
sectors increased their share of total employment from 32.5

percent in 1940 to 62.0 percent in 1972.

Expansion of the tertiary sector is expected as income
increases with economic growth. This expansion is, in part,
attributed to a high income elasticity of demand for ser-
vices. Another explanation ascribes part of the employment
growth in the tertiary sector to the expansion of the in-
dustrial sector that makes necessary an increase in comple-
mentary services. The service employment originating from
these two sources is demand-induced and has been called its

"modern" component. However, not all service employment is

 

26See,for EXMPIE,W. Demas,p. 47 and 49 and C. Furtado, p. 83.
27W. Demas, p. 47.

lll

demand-induced. There is also a "traditional" component
which is supply-determined. The bulk of this employment

is to be found in such traditional and unorganized services
as shoe-shining, petty retail trades, and other forms of dis-
guised unemployment. The more developed the country, the
larger the modern component and the smaller the traditional
service employment. The opposite holds true for less devel-

oped countries.

The traditional component of service employment in
Puerto Rico is believed to be relatively small since a sub-
sistence sector has been almost non-existent there for many
years. Moreover, unemployment insurance, other forms of
social assistance, and the prevalence of the extended family
system make that type of employment activity less necessary
in order to subsist. Moreover, Table 4.6 above shows that
in 1972 the service sectors contributed 63.5 percent of net
domestic income, which matched the 62.0 percent share of
service employment that year. This indicates that most of

the service employment activity that year was productive.

It is possible, however, that traditional service
employment contributed to the increase in employment in the
tertiary sector. In Table 4.7 the sharp increase of trade
employment from 10.5 percent in 1940 to 18.3 percent in

1972 is noticeable. The expansion of the employment of

 

28See A. S. Bhalla, "The Role of Services in Employ-
ment Expansion" International Labor Review. 101 (May 1970):
519—539.

 

112

this sub-sector may reflect some increase in petty trade
activities, although not much of this type of trade is
visible on the island. However, trade perhaps includes

some part-time employment, which is another form of sub-
employment. The sharp increase in government employment
from 2.5 percent in 1940 to 17.8 percent in 1972, observable
in the table, perhaps also reflects the absorption of re-
dundant labor into the public sector. The share of govern-
ment employment almost doubled from 1955 to 1972. The
period when the emphasis of the development strategy shifted
to a less labor intensive manufacturing. Fast labor absorp-
tion by the government of Puerto Rico has been aided by a
large amount of federal transfers. The programs funded

with federal grants, especially the manpower programs, fre-
quently place more emphasis on the social assistant element

than on productivity considerations.

In spite of the increases in industrial, construction
and service employment, unemployment in Puerto Rico re-
mained high, as shown in Table 4.8. The rate of unemploy-
ment had a moderate decrease from 15.0 to 12.0 percent be-
tween 1940 and 1972 and it seems that this decrease was
helped by a reduction in the rate of participation in the
labor force. According to Table 4.8 the rate of labor
force participation, which indicates the percentage of
the population 14 years or older that is either employed or

looking for employment, diminished from 52.2 percent in 1940

113

 

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m.He m.me s.mn 0.0e o.~m N.~m s0 room eowusmflowoesa meson Hones
own can on so as on pesoHQEoss
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sees mesa moms mmms sens owns neoeH

 

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coaummauwpsmm oosom Home; .0902 so Ow< mo mums» ea m:Ompom mo magnum ucoexoflmEmaa.w.v mam<h

114

to 45.2 percent in 1972. This drop in rate of labor force
participation may be partial indication that failure to
find employment has discouraged some workers from search-

ing for a job and they have dropped from the labor force.

Summary

The analysis of changes in the structure of employ-
ment has shown that the expected shift of labor from the
traditional into the industrial sector has actually happened
in accordance with the shifts in production. However, the
absorption capacity of the industrial sector has been
moderate and the construction and service sectors have pro-
vided a considerable part of the jobs needed to employ a
growing population and a rapidly shifting agricultural labor-
force. A large part of the service employment seems to be
of the "modern" type, that is, demand-induced productive
services arising from increased incomes and expanded in-
dustrial activity. However, a rapid expansion of trade
and goverment employment suggests that some of the increase
in service employment may be due to traditional supply-
determined low productivity services and other form of
disguised unemployment. The analysis also shows that, in
spite of the expansion of employment in industry, construc-
tion, and services, the rate of unemployment remained high

and the rate of labor force participation diminished.

115

Changes in the Structure of Foreign Trade

 

Some important points must be kept in mind while ex-
amining how the volume and composition of trade has changed

in Puerto Rico in the post-war period.

First, as has been explained before, Puerto Rico's
strategy of economic development has been that of an export
oriented economy. However, export orientation in Puerto
Rico differs significantly from that in other small countries
that have used this strategy. In the case of Puerto Rico,
most of the external trade is between the island and the
United States and takes place without any trade barriers,
as in a free trade area of common market, with a free move-
ment of resources, goods and financial assets and a common

currency between the two trading partners.

Furthermore, in contrast to the outward looking
vstrategy followed by some developing areas, which stress
exports of primary commodities, Puerto Rican exports are
manufactured goods that compete in the United States and
world markets with United States and foreign manufacturers.
In addition, inward looking policies such as import substi-
tution, face the limitation that no trade barriers, or any
sort of customs protection, can be given to Puerto Rican

manufactures in the home market.

116

Change in the Level of Trade

Table 4.9 shows exports and imports for some selected
years between 1940 and 1972, in value terms at constant
prices and as percentages of gross national product. It
is evident in the table that the relative magnitude of ex-
ports did not have a discernible trend of change, fluctuat-

ing somewhat above fifty percent of GNP.

Imports, on the other hand, had a clear increasing
trend from 59.9 percent of GNP in 1940 to 102.8 percent in
1972. Thus, it is evident that imports grew at such a pace
that by 1972 they surpassed the GNP. This has been made
possible by large transfer payments from abroad that have
allowed the disposable income to grow at a rate as large
or larger than that of GNP and heavy direct investments and
loans permitted an even greater rate of growth in gross
fixed investment.29 The faster growth of imports relative
to exports has resulted in an expanding trade deficit that
by 1972 was almost half as big as GNP. The large increases
in imports is no surprise given the industrial nature of
Puerto Rico's exports which have a large import component
due to capital and intermediate goods requirements. More-
over, the free trade area and common currency relationships

with the United States eliminates balance of payment

 

29Table 4.3 above showed the average annual rate of
growth of these variable for different periods. The im-
portance of transfers, direct investment and loans from
abroad as a source to finance expenditure is discussed in
a section below.

117

 

 

 

 

 

 

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118

limitations as a constraint on imports. The absence of
trade barriers eliminates another possible constraint on

imports.

Puerto Rico's trade dependence can be better judged
by comparing it with that of other countries. The trade
dependence is measured by a trade coefficient which is
defined as the ratio of exports plus imports to gross dom-
estic product. Table 4.10 shows 1972 trade coefficients for
a selected group of countries which, like Puerto Rico, have
followed the path of export-led growth.30 It may be Observed
that Puerto Rico outranked, in trade openness, all the

countries except Hong-Kong.

It must be kept in mind that a large dependence on
trade makes an economy more vulnerable to exogenous forces
working in the world economy. This vulnerability is increased
when that dependence is almost exclusively on one country,
as in the case of Puerto Rico. As of 1972 Puerto Rico de-
pended on the United States for 73.4 percent of her exports
and 88.6 percent of her imports.31 Thus, the Puerto Rican
economy is much affected by the ups and downsof the United
States economy, and there is very little monetary and fiscal

policies can do to offset the negative impacts. However, the

 

 

 

30See Hollis Chenery and Moises Syrquin, Patterns of
Development 1950-1970 (London: Oxford University Press, 1975)
p. 73.

31

Economic Report to the Governor (San Juan: Puerto
Rico Planning Board, 1973), p. 83.

119

TABLE 4.10.--Import, Export and Trade Coefficients for some Selected
Small Industry Oriented Countries, Year 1972.

 

 

Country C Import a EXPOFt Trade c
oeff1c1ent Coefficient Coeff1c1ent
Hong Kong 90.4 80.6 171.0
Puerto Rico 74.3 44.5 118.8
Belgium-Luxembourg 42.2 44.0 86.2
Switzerland 28.5 23.0 51.5
Norway 28.2 21.1 49.3
Finland 24.2 22.3 46.5
Austria 25.4 18.9 44.3
Israel 27.6 15.6 43.2
Portugal 25.8 15.0 40.8
Sweden 19.4 21.0 40.4
Kenya 24.8 13.3 38.1
Tunisia 21.1 14.3 35.4

 

SOURCE: Gross domestic product data from United Nations, Yearbook
of National Accounts Statistics, 1974; and trade
statistics from United Nations, Yearbook of International
Trade Statistics, 1972-1974.

 

 

 

aImports as percentage of gross domestic product.
bExPorts as percentage of gross domestic product

cImport plus exports as percentage of gross domestic
product.

120

desirability of reducing trade dependence must be approached
with care since it might be possible that increased sta-
bility can be achieved only at the cost of reducing the

rate of income growth. This trade-off must be considered

in a long term perspective as a strategy geared to maxi-

mize the performance of the economy.

Change in the Composition of Trade

It was observed in a previous section of this study
that growth in Puerto Rico in the 1940-1947 period corres-
ponded to Paaw and Fei's export promotion phase of trans-
itional growth in which a high level of exports as a share
of GNP and the dominance of primary exports in total ex-
ports were two essential characteristics. Table 4.9, al-
ready explained, showed that, for the period in question,
exports constituted a large fraction of GNP. Unfortunately,
comparable data on the composition of exports for 1940 and
1947 are not available. However, from Table 4.1 above,
which was obtained from a study made by Harvey S. Perloff,32
it can be inferred that total exports for 1940 were tradi-
tional activity. According to T. Hibben, in 1946 more
than 80.0 percentof anal exports were attributed to needle-

work and agricultural based exports.33 This data somewhat

 

2Harvey S. Perloff. Puerto Rico's Economic Future: A
Study in Planned Development (Rio Piedras: University of
Puerto Rico Press, 1949), p. 136.

33T. Hibben, Industrial Development of Puerto Rico and
the Virgin Islands (Caribbean Commission: Report of the
U. S. Section, 1946) pp. 77-78.

 

121

confirms the existence of the export-promotion phase in

Puerto Rico in the Nineteen Forties.

Table 4.11 shows the composition of exports for 1950,
1963, and 1972. It shows a sharp decline in the traditional
export share of total exports from its high of 86.4 percent
in 1950, down to only 35.5 percent in 1972. At the same
time exports of new manufactures went up from 13.6 to 64.5
percent. This shift in the composition of exports in favor
of manufactures agrees with the development strategy of Puerto
Rico after 1947, as was discussed before. In agreement with
the strategy also is the fact that textiles and apparels,
the more labor intensive manufactured goods constituted about
two-thirds of new manufacture exports in 1950 but dropped
to about two-fifths in 1963 and three-tenths in 1972. On
the other hand, the more capital intensive exports such as
machinery, equipment and electronic goods, and chemicals
increased their share in the total from just below one-tenth
in 1950 to three-tenths in 1972. These two movements are
in accord with the shift in emphasis from unskilled labor
intensive manufacturing to a more capital intensive indus-

trial output.

The transformation of the composition of exports
after 1950 also confirms the previous observation that this
period was similar to the export-substitution phase of Paauw
and Fei's classification scheme. It may be recalled that

during this phase exports maintained a high level in

122

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123

proportion to gross national product and that labor inten-
sive manufactures dominated exports. This has been the
case in Puerto Rico since (as Table 4.9 showed) for 1955,
1963, and 1972 exports comprised more than 50 percent of
GNP and (in Table 4.11) it is evident that labor intensive
textile and apparel output constituted the largest share
of total manufactured exports. These shifted toward more
capital intensive exports after 1963 which may be con-
sidered a prolongation of the export-substitution phase

in which skilled labor intensive manufactures substitute

for the unskilled labor intensive ones.

Table 4.12 shows changes in the level and composition
of merchandise imports for the chosen years. It can be
observed that the share of capital goods and intermediate
and raw materials in total imports has increased, from 48.3
percent in 1947 to 59.1 percent in 1972, an expected change
in a developing economy following an export-led strategy
and with poor natural resource endowment. As was mentioned
before, industrial exports of a developing economy have a

large import component.

Perhaps a more interesting point is the decrease in
the share of consumption goods in total imports and the fact
that within that grouping, the non-durable goods are dropping
faster than the durable ones. However, this drop cannot be
interpreted as a reduction in the absolute level of imported

consumer goods. When the average annual rates of growth

124

 

 

 

 

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125

are calculated it is found that while imported consumer
goods grew at a high average rate of 8.3 percent between
1947 and 1972, total merchandise imports grew at the
higher average annual rate of 9.3 percent. It was the
slower rate of growth of imported consumer merchandise
which caused the drop in its share of the total. The
drop in the share of non-durable consumer merchandise im-
ports, especially food, is also in relative, not absolute,
terms. The average annual increase in food imports be-
tween 1947 and 1972 was 7.7 percent, as opposed to an
average rate of increase of 6.6 percent in disposable in-

come 0

Summary

The analysis in this section showed that exports main-
tained a high level as expected in a small country pursu-
ing an export-led growth strategy, keeping a stable share
of the GNP. In the first stage its composition emphasized
traditional exports, which in the case of Puerto Rico were
mainly agricultural-based manufactures shifting to labor
intensive industrial manufactures when the economy moved
into an export-substitution phase. In the later stage
capital intensive goods increased their share in export

composition.

The import level, on the other hand, had a sharp in-

crease in both relative and absolute terms. In accordance

126

with the structural transformation expected, its composi-
tion shifted in favor of capital and intermediate goods
needed in the industrialization effort. However, imports

of consumer goods also increased in absolute terms, perhaps

a reflection of the sharp decrease in agricultural activity
mentioned before. The sharp increase in imports has caused

a widening of the trade deficit in both absolute and relative

terms 0

Compared to other small countries that have pursued
an export-led growth strategy, Puerto Rico has one of the
highest coefficients of trade dependence. The large trade
dependence and the fact that trade is almost exclusively
with the United States, makes the Puerto Rican economy
highly vulnerable to fluctuations in the United States
economy. This vulnerability is enhanced by the free trade
area condition of the economic association between the two
countries, since it makes the utilization of monetary and
fiscal corrective measures difficult. However, the incon-
venience of this vulnerability should be weighed against
the convenience of free accessibility to a large rich

market.

Changes in the Capital Accumulation Process
and in the Source of its Financing

 

 

In this section the capital accumulation process that
has permitted a fast rate of economic growth in Puerto Rico

is examined. The changes in gross fixed domestic investment

127
are investigated as well as the sources of its financing.

Changes in Gross Fixed Domestic Investment

Investment in Puerto Rico has grown at a very fast
rate since 1947, as can be expected in an economy that has
enjoyed a fast rate of economic growth. Table 4.13 shows
that gross fixed domestic investment increased from 74.1
to 966.7 millions of dollars, at constant prices, between
1947 and 1972. The average annual rate of growth for the
period, shown in Table 4.14, was 10.8 percent. As percent-
age of GNP gross fixed investment went up from 14.8 percent

in 1947 to 30.5 percent in 1972.

Table 4.13 also shows gross fixed investment class-
ified by type. From this viewpoint the large and increas-
ing share of construction activity in total fixed investment
is outstanding. This share has grown from 35.7 percent in
1957 to 70.7 percent in 1972, a confirmation of the lead-
ing role played by the construction sector in Puerto Rico's
economic growth, as previously discussed. The average
annual rate of growth for the whole period, given in Table
4.14, was 12.5 percent. More than two-thirds of the con-
struction activity, for all the years analyzed, has been
in industrial and commercial building and for public works,

investment activities directly connected to economic growth.

Noticeable also is a steady decrease in the share

of machinery and equipment in total investment in spite

128

 

 

 

 

 

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129

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130

of the emphasis after 1955 stressing the promotion of more
capital intensive industries. However, an examination of
the average annual rates of growth of machinery and equip-
ment investment for different periods, given in Table 4.14,
show that for 1955-1963 this type of investment grew at an
average of 7.9 percent per year and for 1963-1972 at 9.0
percent, an acceleration of the growth rate that is in
accordance with the development strategy pursued. The
decrease in the share of machinery and the equipment in
total investment is due to its slower rate of growth rela-
tive to that of the construction industry, as is evident

in Table 4.14.

Source of Finance

An important question is how this high rate of invest-
ment is possible, considering that consumption has also
grown at a lower but still considerable rate, as shown in
Table 4.4 above. The answer is that, as in a typical case
of an open economy, Puerto Rico has financed her economic

development mostly with foreign capital.

Table 4.15 presents the sources of finance and the
uses of capital funds for 1947, 1955, 1963 and 1972. It
is evident there was a large share of external capital
during all the years and its trend increased after 1955.
This share was 55.8 percent in 1947, 40.7 percent in 1955,

53.0 percent in 1963 and 70.2 percent in 1972. The share

131

 

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132

of external capital in total capital funds is still larger

if one takes into consideration that a significant portion

of depreciation charges and undistributed profits, two im-
portant sources of local financing, accumulate to foreign
firms. The low level of private savings, that were even
negative for 1947 and 1972, is evident from the table. A
high level of consumption relative to disposable income

has kept personal savings low to neutralize business savings.
Noticeable also is a steady decrease in the share of public
savings as a source of capital funds. Thus, domestic fin-

ancing of investment has been very low.

The increasing dependence on external capital ob-
served in the Puerto Rican economy is contrary to what is
expected after economic growth sets in and is maintained
for several years. According to Paauw and Fei, the depen-
dence on capital inflow should be lessened during the export-
substitution phase,34 the state of growth which Puerto Rico
has been since 1955. Chenery and Syrquin also found a nega-
tive functionalredationship between increases in per capita
GNP and changes in capital inflow in the countries included

in their study.35

In Table 4.16 the balance of payments for Puerto Rico
is brought into the picture by taking together the trade

balance, unilateral transfers and capital movements. The

 

34Paauw and Fei, p. 98.

5Chenery and Syrquin, p. 20.

133

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134

table tells how the hugh deficits in the current account
have been balanced year after year. Both unilateral trans-
fers and capital inflow from abroad havehad a prominent
role. For 1947 and 1955 unilateral transfers were almost
similar to or larger than capital inflow. For 1963 and
1972, however, the importance of net capital inflow in
balancing the trade deficits surpassed that of unilateral
transfers, financing 54.4 and 66.6 percent,respectively,

of the deficits in these two years. In 1972 the adjusted
trade deficit was 1,872 million dollars of which unilateral
transfers financed 621 millionsand capital inflow 1,251
millions. Thus, it is evident how much capital inflow has
grown in importance as a balancer of the deficit, both in

absolute and in relative terms.

Factor income paid by Puerto Rico to the rest of the
world had been growing fast as a consequence of the increased
capital inflow. This is evident in Table 4.17 where net
factor payments are shown together with GNP and GDP for
1947, 1955, 1963 and 1972. By 1972 the net factor payments
outflow amounted to 584.6 million dollars, or 9.3 percent
of the GNP, increasing from 62.6 million, or 2.7 percent
of GNP, in 1963. For 1947 and 1955, on the other hand,
there was a net inflow of factor payments as payments re-

ceived were larger than payments made abroad.

For any country a long term dependence on unilateral

transfers and capital inflow to finance huge and persistent

135

 

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136

trade balance deficits will eventually create some balance

of payment problems. According to many people, this situ-
ation would not hold true for Puerto Rico since its special
relationship to the United States renders the island's econ-
omy similar to that of a region on the mainland. Her money
supply is automatically determined by the capital market

and the market for goods and services.36 For a region with-
in the nation there is no exchange control, commercial policy
as a means of adjustment is non-existent, and the region is

mainly a "price taker."

Some authors disagree with this view that for a region,
balance of payments problems are non-existent. For example,
Jenaro Baquero argues that, if "unproductive use" is made
of capital imports, external debt will grow at a higher rate
than the capacity to serve it.37 Thus, a balance of pay-
ments problem may occur in the region, linked to the out-
flow of payments arising from servicing the external debt.

The important question is how long capital inflow can keep

its role as the balancer of the disequilibrium particularly

 

36See Federal Reserve Bank of N. Y."Private Invest-
ment and the Industrialization of Puerto Rico, Monthly
Review (May 1960); p. 71; and J. C. Ingram, "Some Impli-
cations of the Puerto Rican Experience", in International
Finance, edited by R. N. Cooper (Hammondsworth: Penguin
Books, 1969) pp. 87-104.

37

Jenaro Baquero "La Importacion de Fondos Externos
y la Capacidad Absorbente de Nuestra Economia." Revista

de Ciencias Sociales (March-June, 1963).

137

if, as in the Puerto Rican case, it is a major and persis-
tent one.38 A crucial consideration is whether the economy
has a limited absorptive capacity of investment funds. This
capacity exists as long as there are profitable investment
opportunities that create the ability to pay. Thus, what
matters is making sure all investment decisions are sub-
jected to a profitability test, including those in the

public sector, and that the burden of payments is distributed

equitably among those who are benefited by the investment.

Summary

Total investment in Puerto Rico has been increasing
rapidly in accordance with the fast rate of economic growth,
increasing at rates even higher than those of the GNP and
GDP. A large and increasing portion of this investment has
been in construction activity, about two-thirds of it de-
signed to provide the infrastructure needed for economic
development, giving additional evidence of the important

role played by this sector in the economic development of

 

38For more detailed discussion of this problem see
Harris Seymour, International and Regional Economics (New
York: McGraw-Hill Book Co. Inc., 1957); J. C. Ingram, "State
and Regional Balance of Payment Mechanism," Quarterly
Journal of Economics 73 (November, 1959): 619-632; and
Jorge Freyre, External and Domestic Financing of the Econ-
omic Development of Puerto Rico (San Juan: University of
Puerto Rico Press, 1969).

138

Puerto Rico. Machinery and equipment have decreased their
relative share in total investment. However, their average
annual rates of growth have been high and have been increas-
ing since the investment strategy was shifted in 1955 to

favor more capital intensive industries.

Since 1955 external capital, both debt and equity,
has become increasingly important as a source of investment
financing, reaching a 1972 level equal to seven-tenths of
the total capital funds available that year. The contribu-
tion of private savings to capital funds was either negative
or very minimal; public savings impact has been positive
but declining in relative terms. The increasing dependence
conflicts with previous expectations that this dependence
would be lessened and domestic sources increased aseconomic

growth is achieved and maintained.

Both capital inflow and unilateral transfers from
abroad have had a prominent role in financing deficits in
Puerto Rico's balance of payments. However, the importance
of capital inflow has increased relative to unilateral trans-
fers, to the point that, by 1972, two-thirds of the deficit
was financed from this source. The increased importance of
capital inflow has raised the net outflow of factor payments,

which had reached a level equal to one-tenth of GNP by 1972.

The rapid increase in capital inflow and the rapid

factor payment outflow it has generated, have been pointed

139

out as a source of possible problems for the Puerto Rican
economy. However, there is no cause for concern as long

as the investment funds are put, as they should be, to
profitable use and the payment burden is distributed equit-

ably among those benefiting from the investments.

Structural Transformation: Comparison
with other Countries

 

The structural changes experienced in Puerto Rico,
while the economy was undergoing economic growth, can be
better understood in comparison with those occurring in a
group of countries going through the same process. Chenery
and Syrquin's cross-section study of patterns of develop-
ment is used as the basis for comparison.39

As explained in Chapter II, these authors selected
ten basic processes and 27 variables to represent structural
characteristics whose behavior, taken together, describes
different dimensions of the overallstructural change as a
poor country is transformed into a rich one. Ordinary least
square regressions were used to specify the structural char-
acteristics as a function of per capita gross national pro-

duct, population growth, net resource inflow, and time trend.

The following statistical formula was used:

3
2 2
x - a + 81 1n + 82 (1n) + le + 72(N) + 6F + §=1 dj Tj

 

393. Chenery and M. Syrquin, op. cit.

140

where X the dependent variable representing one process
Y = GNP per capita in constant dollars (1964 = 100)
N = population in millions
F = net resource inflow (imports minus exports of
goods and non factor services) as a share of GDP.

T = time period ( j = l for 1950-54, j = 2 for 1955-

1959, and j = 3 for 1960—1964)

The dependent variable (X) is generally used in ratio
to GDP or to its corresponding aggregate. Per capita GNP
(Y) serves as an overall index of development, as well as
a measure of output. The country population (N) is intro—
duced as an independent variable to bring in size considera-
tions which are independent of income level, such as econ-
omies of scale and transport cost. Net resource inflow (F)
is also taken into consideration for its direct effect on
various processes. The time trend (T) is brought into
account for shifts in structural relationships over time

which are independent of income changes within countries.

Available data covering the period 1950-1970, for a
maximum of 101 countries and a minimum of 55, was used by
Chenery and Syrquin to derive uniform cross-section estim—
ates of the structural transformations. A detailed empir-
ical definition of each variable is presented in Appendix
A, as well as an explanation of how the variable have been

interpreted in the analySis of Puerto Rican data.

141

Five of the ten basic processes and fifteen of the
27 variables were selected for analysis of structural
transformations in the economy of Puerto Rico. The processes
and variables chosen are shown in Table 14.18. The re-
gression equations that explain their structural trans-
formation are presented in Table A.l in Appendix A. where
regressions from a sample of small, industry-oriented countries
were available, they were used since they most accurately
reflected the structure of the Puerto Rican economy.401@w

gressions from the basic sample are used for all the other

variables.

The regression equations chosen were used to determine
a "normal" or expected value for each variable in 1947,
1955, 1963 and 1972. The variable%:normal value for each
year is found by substituting Puerto Rico's per capita GNP,
population and net resource inflow for the corresponding
year in the regression equation. The normal value, shown
in Table 4.18, is thus the expected value in a country with
per capita GNP, population and capital inflow similar to
Puerto Rico but with an average structural relationship
similar to the one depicted in Chenery and Syrquin regres-

sions.

The actual value for each variable was calculated

 

40These regressions were available for all the variables
for which the break-down of the basic sample, according to
size and trade orientation, gave significantly different
structural relationships than the ones obtained from thebasic
sample.

142

using Puerto Rico's national account statistics as ex-
plained in Appendix A. The calculations are presented in
Table 4.18. The actual value of each variable is compared
to its normal value for each year. The behavior of both
the normal and the actual value through time were analyzed
to see if their transformation corresponded to the ones
postulated by generally accepted theory and the deviations
of actual value from the normal pattern, were evaluated in
terms of the policy orientation of the Puerto Rican de-
velopment program. From these two perspectives,the struc-
tural changes in demand, trade, production, employment,
and accumulation processes are examined in the following

sections:

The Structure of Demand

 

The behavior of private consumption, food consumption
and investment are used as the main variables to explain

transformation in the structure of demand.

Private consumption of imported and domestically pro-
duced goods, as a share of GDP,has steadily decreased be-
tween 1947 and 1972 as income increased, in terms of actual
value as well as the value expected according to the Chenery

and Syrquin regressions. This drop, as income has expanded

is evidence of relatively low income elasticity in the

143

 

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144
demand for consumer goods.41 An actual to normal ratio,
larger than one for all the years except 1972, indicates
that for these years the actual share was larger than nor-
mally expected. However, the fact that this ratio has
steadily decreased shows that the actual share decreased
faster than the normal share, a finding that suggests the
possibility that the income elasticity of the demand for
consumer goods in Puerto Rico has been decreasing. However,
this has to do with the demand for all consumer goods,
those imported and those domestically produced, since the
share of consumer goods measured here includes consumption
from both sources. But, it is possible that the income
elasticity of the demand for goods from the two sources is
not the same. The importance of imported goods in total
consumption makes it difficult to make inferences about the

demand for domestic consumer goods alone.

The larger than expected GDP share of domestic con-

sumption over a long period confirms the assertion made

 

41In a semilog equation, such as the one used by
Chenery and Syrquin, income elasticity of any variable X
is given by

E = 81 + 282 lnY
X°y 2

 

where B1 and 32 are the estimated coefficients of the

regressions given above and X is the predicted value
corresponding to the level of income for which the
elasticity is being computed. See Chenery and Syrquin,
p. 143.

145

in previous sections about the existence of an abnormally
high level of consumption in Puerto Rico which has hindered
personal savings. It can be added now that it seems that

this bias against savings is being gradually corrected.

Consumption of imported and domestically produced
foods, as a percentage of GDP, also declined steadily
during the twenty—five years analyzed, dropping from 37
percent in 1947 to 22 percent in 1972, in terms of its
expected value, and from 40 to 17 percent in terms of its
actual magnitude. Engel's law of a declining share of food
consumption with rising income levels may explain the be—
havior of this variable. It can be observed that by 1947
the actual value was larger than the normal one but, since
then, the actual value has been decreasing faster, as illus-
trated by a decreasing actual to normal ratio of the shares.
Again this suggests the possibility of a decreasing income
elasticity of food demand in Puerto Rico of both imported

and domestic origin.

The gross domestic investment share of GDP in 1947
was below its expected value. However, since 1955 it has
been either equal to or above the normalvalue. The actual
GDP share went up from 20 percent in 1955 to 29 percent in
1972, when it was expected to increase from 20 to 25 percent.
This shift of the share of investment above that normally
expected may be explained by Puerto Rico's easy access—

ibility to United States financial markets and an active

146

government policy to attract external investment after

1947.

The Structure of Trade

 

Both import and export GDP shares are above the normal
values expected for all the years investigated, as is in-
dicated by the actual to normal ratio of the share of these
variables larger than one, shown in Table 4.18. This is a
reflection of the large degree of openness in the Puerto
Rican economy which is a consequence of the export-led de-
velopment strategy pursued. Given Puerto Rico's per
capita GNP, population, and capital inflow for these years,
the export shares would be expected to fluctuate between
33 percent and 36 percent between 1947 and 1972. However,
the actual shares fluctuated above 40 percent during this
period. The above normal behavior of exports reflects
Puerto Rico's development policy of aggressively promoting
export oriented industries. This policy orientation is
justified in terms of comparative advantages derived from
changing factor proportions which favored labor-intensive
industrial activities.42 In 1947 an abundance of labor
made possible an emphasis on unskilled labor intensive manu-

facturing which took advantage of the availability of rela-

 

42Theories of international trade, like the Heckscher-Ohlin

model, provided the theoretical basis for this explanation.
See Herbert G. Grubel, International Economics (Homewood:
Richard D. Irwin, Inc., 1967). pp. 11-133 for an explana-
tion of this theory.

 

147

tively cheap labor. Later on, rapid growth of capital, both
human and physical, facilitated the shift toward manufac-
tured exports of a more capital and skilled labor intensive
content. The smallness of the island and the unrestricted
access to the United States markets also justified the out-
ward outlook of the industrialization program to benefit
from economies of scale arising from the accessibility of

a wider market.

It is evident in the Table 4.18 that almost all the
export stimulation came from manufactured goods. The GDP
shares of manufactured exports were above their expected
values by a very large proportion for 1955, 1963 and 1972,
the years for which data were available. Primary export
shares, on the other hand, were considerably below their

expected values.

Imports also reflect an above normal share of GDP
for all the years which may be explained, in part, by the
heavy dependence on imported consumer goods due to the
above normal consumption just mentioned, the adoption of
United States patterns of consumption induced by heavy
advertizing from United States firms selling in Puerto Rico,
and by the dependence on imported capital and intermediate
goods arising from the rapid growth of an industrial sector
largely dependent on imported capital and intermediate
goods. The table shows that the actual shares have decreased

but between 1947 and 1955 it dropped from 70 to 64 percent

148

and since then has only dropped from 64 percent in 1955 to
61 percent in 1972. The slow decrease in the actual share
after 1955 is perhaps explained by the increased need for
capital and the intermediate goods made necessary by in-
creased capital intensive manufacturing after that year
that offset, in part, the slow down of imports due to rela-

tive decreases in consumption.

The Structure of Production

 

As the level of income rises the pattern of production
is expected to change in favor of industrial goods and away
from primary production. This shift results from the inter-
action of the, already mentioned, demand effect of rising
income and the supply effect of changes in factor proportions

and technology.

The principal demamieffect is a rise in nonfood con-
sumption relative to food consumption due to differences
in the income elasticity of demand for these types of goods.
As seen above, the normal GDP share of food consumption was
expected to decrease as income increased but, in the case
of Puerto Rico, the actual decrease was sharper than antic-
ipated. Much of the decrease in private consumption was
accounted for by decreases in food consumption. This is
demonstrated by comparing the share of food consumption with

that of nonfood consumption, which is shown by the differ-

149

ence between the share of total private consumption and the
share of food consumption. When the comparison is made,

it is found that while actual food consumption dropped from 40
percent in 1947 to 17 percent in 1972, nonfood consumption
only decreased from 61 to 57 percent over that period. Thus,
in relative terms, the proportion of nonfood consumption

in total consumption has increased indicating a shift in
demand in favor of industrial production. Moreover, if
part of the reduction in the share of food is saved, it may
be inverted and thus may reinforce demand for investment
goods brought about by heavy capital inflow. This change

strengthens still more the demand for industrial output.

The change in the compositimnof exports may also help
to explain the shift in the pattern of production toward
industrial goods. As was discussed, a change in compara-
tive advantage has shifted exports in favor of industrial
goods and away from primary products. This shift is streng-
thened by appropriate government policies promoting export-
led growth, as has been the case in Puerto Rico. Table
4.18 indicates the wide gap between the actual and the
normal GDP share of industrial exports in Puerto Rico for

all the years examined, which was discussed earlier.

In accordance with these changes in the demand and
production structures the actual GDP share of the indus-
trial output in Puerto Rico has grown from 21 percent in

1947 to 32 percent in 1972. Although somewhat below it,

150

this share has been very close to its expected value for
all the years examined. This is somewhat surprising since
an actual share above that normally expected was suspected
in view of the aggressive industrialization efforts in
Puerto Rico's development program. This lag of industrial
output below its expected value, in spite of a strong in-
dustrialization effort, is, perhaps, a reflection of the
fact that most of the stimulus for industrial production
in Puerto Rico comes from the export market. In this
market, however, Puerto Rican manufacturers face strong
competition from United States and other foreign producers
that somewhat limits the possibilities of industrial expan-
sion. An inward orientation of the industrialization
effort is also limited by the small size of the domestic
market, which precludes economies of scale in many indus-
tries, and by the inability to protect the domestic market

from foreign competition through trade barriers.

Another surprising result observed in Table 4.18 is
that for 1947, 1955, and 1963 the actual share of primary
output was above its normal value. This finding apparently
contradicts previous assertions made about the neglect of
agriculture in the Puerto Rican development program. How-
ever, it must be kept in mind that agriculture, particularly
sugarcane production, although rapidly declining remained
an important economic activity for some time. Moreover,

value added, which is used as the measure of output in this

151

study, is very high in agricultural activities. The indus-
trial activity being established in Puerto Rico, on the

other hand, frequently used intermediate goods from abroad
which were in an advanced stage of manufacture. Hence the

value added by these activities was frequently low. Together
the two factors perhaps explain the above normal level of
agricultural output, on the one hand, and the below normal

level of industrial output, on the other, in spite of the

concentrated emphasis on industrialization in the develop-

ment program.

The increasing importance of service output,as already
discussed, can also be observed in Table 4.18.It is interest-
ing to note that in 1947 the actual level of the service output
share was low in relation to its expected value. However while
the expected value of service output has decreased with the
changes in per capita GNP,population, and capital inflow;
the share of actual value has been increased. Thus,the gap
between the two was gradually reduced and by 1972 the actual
share was already above its normal level. As was explained
before, the government and trade sectors made the largest

contributions to the rapid growth in service output.

The Structure of Employment

Changes in the structure of employment follow closely
the changes in the structure of production. Employment
graduaLbrshifted, as expected, in favor of industrial and

service labor and away from primary labor. It is interesting

152

to note that the actual share of primary employment in
total employment, which was above the normal expected value
for 1947, has been below the normal value since then and
the below normal gap between the actual and expected has
widened. This is indicative of a faster than expected out-
flow of labor from primary production. Another interesting
observation is that while the actual share of primary labor
was below its normal level after 1955, the actual value of
primary output as mentioned before, was above its expected
level in 1955 and 1963. This fact points toward rapid pro-
ductivity gainsimxprimary production in Puerto Rico during

this period.

The fast outflow of labor from primary production may
be explained by the rapid increase in industrial wages men-
tioned before. The "supply price" of labor in the low pro—
ductivity traditional sectors of the economy may have in-
increased because the relatively high wage rates paid by
the modern sector raised workers' expectations as to what
wasarsatisfactory return for their labor.43 These high
expectations and the existence of social assistance programs
may have given impetus to a reluctance to engage in such
low-productivity occupations as traditional agriculture.
Under these circumstances, the outflow of labor from agri-

culture is accelerated and the "surplus-labor" in theeconomy

 

43See Gene M. Tridick, "Wage Spillovers and Unemployment
in a Wage Gap Economy: The Jamaica Case," Economic Develop-
ment and Cultural Change 23 (January 1975): 322-323

 

153

manifests itself in open,rather than disguised,unemployment.
The agricultural sector is thus forced to adoptlabom'saving
techniques of production to raise labor productivity. Further-
more, the unemployment rate tends to remain high in spite of job

opportunities existing in other low wage sectors of the economy.

The actual level of industrial employment has also
been less than its expected value for all the years, perhaps
as a reflection of the early emphasis on capital and skilled
labor intensive manufacturing. Expanding industrial activity
has thus been unable to absorb much of the labor outflow
from primary activities. Expansion in the service sectors
has been the main source of new employment, as can be in-
ferred from a rapid increase in the actual share of service

labor observed in Table 4.18. This share, which was ex-
pected to increase from 40 percent in 1947 to 52 percent

in 1972, actually increased from 44 percent to 62 percent.
The faster rate of increase in the actual share, compared

to what would be normally expected, is evidenced by a widen-
ing gap between these two magnitudes after 1955. The above
normal expansion of service labor, however,has not been

enough to reduce the unemployment rate significantly.

The Accumulation Process

 

Table 4.18 also shows that the level of the actual GDP
share of gross savings which includes private savings, public

savings and depreciation, was negative and below its expected

154

value in 1947 and 1955. This corresponds to the above
normal level of private consumption for those years shown
in the table. For 1963 and 1972, however, when the above
normal gap in the share of private consumption was gradually
closed, actual gross savings turned up and were above the
normal levels in 1963 and 1972. It seems that as private
consumption slowed down the negative value of private
savings tended to disappear allowing gross domestic savings
to go up. By 1977, however, the share of gross domestic
saving was negative again at the level of 1.0 percent of
GDP. This was due to negative private savings and a sharp
decrease in public savings that year, both influenced by

44

the slow down in the economy.

Gross domestic investment, which was below normal in
1947, went up faster than was expected, as illustrated by
the below normal gap vanishing between 1947 and 1955 and
turning into an above normal gap in 1963 and 1972. This
change was made possible, in part, by the increased gross
domestic savings in 1963 and 1972 commented upon in the pre-
ceding paragraph. However, the bulk of the increase in
investment has been supported by a hugh above normal level
of capital inflow for all the years, which can be observed
in Table 4.18. As mentioned before, this has been the main
source of investment funds in Puerto Rico. By 1977 the

share of investment had been cut down to 18 percent of GDP,

 

44Informe Economico al Gobernador (Puerto Rico: Junta
de Planificacion, 1977) p. 159.

 

155

but was more than enough to finance the investment that

year.

Summary

This section has focused on a comparison of the
structural transformation in the Puerto Rica economy,
while it was undergoing economic growth, with the average
changes expected according to a cross-sectional study of a
group of countries at different stages of economic growth
made by H. Chenery and M. Syrquin using data that covered
a 20 year period from 1950 to 1970. Fifteen variables
representing five basic economic processes were chosen to
compare Puerto Rico's structural transformation to an expected
transformation given by the normal value of each variable
summarized in regression equations computed from the data

in the cross-sectional study.

From this comparison it was determined that the
GDP share of private investment in Puerto Rico was larger
than the expected value but decreased at a faster rate to
close the gap between the actual and the expected share.
While this was happening, the gross savings share was in-
creased, turning its relative level from a negative value
into a positive one but still below normal level. This
seems to confirm the earlier assertion that above normal
levels of personal consumption in Puerto Rico have been a

hindrance to private savings, thus keeping gross savings

156

either too low or even negative. Most of the decrease in
the share of private consumption was due to a relative

decrease in food consumption below its normal level.

The GDP share of exports and imports was above its
expected value during all the years examined. The above
normal behavior of exports, which was concentrated in in—
dustrial goods, reflects Puerto Rico's development strategy
of promoting export-oriented industries. This policy
orientation is justifiable in terms of the comparative
advantages derived from changing factor proportions in
favor of labor intensive goods; the smallness of the dom-
estic market due to the small size of the island; and un-
restricted access to rich United States markets which made
economies of scale feasible. The above normal requirement
of imports may be explained by the high percentage of imports
for private consumption, which has been above its normal
level, and byailarge requirement of imported capital and
intermediate goods for the enlarged industrial output.
Imports share has been decreasing slowly since 1955, per-
haps an indication that the decreased import requirement,
due to the reduced consumption, has been partially offset
by the increased import requirements of capital and inter-

mediate goods.

As expected, the structure of production shifted in
favor of industrial goods and services and away from

primary production, indicated by a declining share of primary

157

output and an increasing share of industrial production.
This shift has resulted from the interaction between the
demand effect of rising income and the supply effect of
changing factor proportions. Both changes have favored

industrial and service production.

A surprising result was that the actual share of in-
dustrial output was either equal to or below the value
normally expected, although an above normal share was sus—
pected, given the aggressive industrialization efforts
undertaken in Puerto Rico. This finding has been attri-
buted to the limits that foreign competition impose on the
expansion of industrial goods produced for the export

market.

The changes in the structure of employment have
followed closely the changes inthe structure of production,
shifting to industrial and service labor and away from primary
labor. The analysis showed a rapid outflow of labor from
primary employment which seemed to be based on large pro-
ductivity gains in primary production indicated by the
fact that, while the primary labor share was below its ex-
pected value, the output share was above its normal level.
Another finding was that the actual share of industrial
labor was under its expected value for all the years studied,
an indication that the industrial sector has been unable to
absorb much of the labor released from the primary sector.

The bulk of labor absorption has been in the service sectors

158

as indicated by a widening, above normal gap between the

actual and the normal share of service employment.

Investment has increased rapidly and reached an above
normal level in 1963 which was widened in 1972. Savings,
on the other hand, have been much below expected value.
Thus, the bulk of the increased investment has been sup—
ported by a hugh, above normal level of capital inflow from

abroad.

CHAPTER V
STRUCTURAL TRANSFORMATION: A DETAILED VIEW

In this chapter a closer look is taken at the struc-
tural tranformation in Puerto Rico with emphasis on the
effects of change in the structure of production. The in-
put-output technique provides the basic tool for this

analysis.

As was explained in Chapter III, the input-output
matrices of a country's economy for a particular year give
a picture of the structural relationships prevailing among
the sectors of the economy for that point in time. Infer-
ences can be made about changes in the structure of pro-
duction by comparing the matrices for two different years.
The advantage of this approach is that input-output analysis
allows for breaking the economy down into any number of
producing sectors and thus making possible a more detailed

analysis of structural change.

The structural changes in the Puerto Rican economy
between 1963 and 1972 were analyzed from this viewpoint.
The analysis was limited to these two years because they
were the only two for which matrices were available which

singled out the domestic from the total (domestic plus

159

160

external) input-output relationships. This distinction,

as discussed in Chapter III, is very important when dis-
CUBSingstructural change in an economy as open as the

one under analysis.

The chapter is divided into two parts. In the first,
a detailed analysis of the change in the structure of pro-
duction is approached from three different perspectives:
the change in sectoral interdependence, the change in im-
port leakages and import—substitution, and the change in
labor productivity. In the second part, three specific
economic effects of structural change are analyzed: the

output effect, the employment effect, and the trade effect.

Change in the Structure of Production
from an Input-Output Viewpoint

 

The working hypothesis here is that a significant
structural change in the Puerto Rican economy between 1963
and 1972 was an increase in sectoral interdependence and
that, in spite of its openness to trade, this interdepen-
dence was translated into a better integrated domestic

economy.

A fundamental criterion for economic development is

the extent to which an economy has undergone structural

transformation and has acquired the continuing capacity

161

to adapt and to apply innovation.1 This element is a
necessary condition that must come together with those
underlined by the common meaning of development as the
state of affairs in which a country can experience contin-
ued economic growth by relying on its own domestic sav-
ings to finance its domestic investment. Although struc—
tural transformation is usually associated with a contin-
ous increase in real income per capita, with an increase

in the rate of domestic investment, and with the tendency
to finance such investment largely from domestic sources;
the converse is not necessarily true. In the case of an
enclave economy, dependant on a booming exportable primary
product, certain important economic indexes, such as income
per capita, rate of investment and rate of domestic savings,
may attain high levels without significant transformation

in the dual economy.

In Chapter II, seven basic elements were enumerated
which, in the opinion of William G. Demas, are part of the
transformation of the structure of production. Among the
seven elements, he singled out the development of an in-
creasing degree of interdependence among domestic indus-
tries and activities as very important. Increased inter-

dependence means forging links between the various parts

 

1William G. Demas, The Economics of Development in
Small Countries with Special Reference to the Caribbean, p.
6. See also, Celso Furtado, Economic-Development of Latin
America, (Cambridge: Cambridge University Press, 1970Lp.94.

2W. Demas, p. 7

162

of the domestic production structure. The interdependence
manifesu;itself in the development of a whole network of
backward and forward linkages3 within the internal structure
of production, whereby the products of an increasing number
of industries become the input of other industries. This,
in turn, implies a rapid growth of domestically produced
intermediate and capital goods. Other authors, examining
the industrialization process in underdeveloped countries,
have also stressed the appearance of an advanced stage in
which the country develops the capacity to supply inter-

mediate and capital goods.4

Anne Carter, explaining the increasing interdependence
in maturing economies, argued that as an economy develops,
it sometimes becomes advantageous for individual establish-

"a

ments to become more specialized. This means covering
shorter vertical sequence or a narrower horizontal assort-
ment of activities." She pointed out that "division of
labor, as Adam Smith suggested, depends on the extent of
the market. Thus,we might expect increased industrial
specialization, as the total volume of production expands."

Specialization, as used here, is synonymous with increased

sectoral interdependence.

 

3

1‘See for example, Dudley Seers, "The Stages of Economic
Development of a Primary-Producer in the Twenty Century,"
The Economic Bulletingpf_Ghana, (1963): 57-69.

See Chapter II, above.

 

5Anne Carter, p. 37.

163

The extent of economic interdependence in Puerto Rico,
in 1963 and 1972, was measured by direct and total (direct
plus indirect) domestic input-output coefficients. The
first gives the amount of direct intermediate domestic input
required per dollar of total output.6 The second tells
the amount of direct plus indirect intermediate domestic
input required per dollar of output delivered to final de—
mand. The changes in the degree of interdependence were
obtained by comparing the coefficients of each sector for

the two years.

This analysis was based on the domestic input-output
matrices. In this way, only the sectoral interdependence
manifested in the local economy was considered. Hence, the
degree of economic interdependence observed can be considered

to be the degree of sectoral domestic integration.

The input-output tables break down the economy of
Puerto Ricoinu>44 sectors. These are enumerated in Table
5.1 and classified as primary, manufacturing, or service
sectors. The table also shows the value added of each sector
as a percentage of total value added, to give an idea of

their economic importance.

The direct domestic coefficients for 1963 and 1972
are compared by using the scatter diagram shown in Figure

5.1. In this diagram each axis measures the direct input

 

6In the input-output analysis total output includes
that delivered to intermediate demand as well as deliveries
to final demand.

164

coefficient value for a particular year; the 45 - degree
line, which tells when the coefficients for the two years
are identical, indicates whether the coefficients are larger
for one year than for another. Sectors with coefficient:
larger in 1972 than in 1963 appear above the 4S - degree
line and the converse is true for points below the diagonal.
Logarithmic scales are used, so that the distance from the
diagonal measures the relative rate of coefficient change.
In Figure 5.1 each sector is identified by the number in

Table 5.1.

It is obvious in Figure 5.1 that 30 of the 44 sectors
increased their direct coefficients, while only 14 reduced
them. Moreover, for most of the 30 sectors with increased
coefficients, the change was more than 25 percent as can
be discerned by the distance of each sectors from the diagonal.
These changes give a clear indication of increased interde-

pendence.

An interesting point from Figure 5.1 is that of the
seven manufacturing industries that reduced their direct co-
efficients, five are in the agriculture based manufacturing
sectors. The reduction in the coefficients of these sectors
matched the drop in primary agriculture activity, as in-
dicated by the decrease in their share of value added, shown
in Table 5.1. In the non-agricultural manufacturing group,
which includes the new manufacturing promoted under the

government development program, most sectors experienced

1655

TABLE 5.1.--Sectora1 Value Added as a Share of Total Value Added, 44 Sectors,
Years 1963 and 1972 (in percentages).

 

 

 

 

 

Sector 1963 1972 Change
Primary Production 9.04 3.01 -6.03
1. Sugarcane 3.22 0.38 -2.84
2. Other Agriculture 5.55 2.51 -3.04
3. Mining 0.27 0.12 -0.15
Manufacturing and Construction 29.48 31.05 1.57
4. Construction 6.67 6.76 0.09
5. Dairy Products 0.42 0.30 -0.12
6. Bakery Products 0.41 0.43 0.02
7. Sugar Refining 1.77 0.08 -1.69
8. Malt Beverages 1.12 0.33 -0.79
9. Alcoholic Beverages 2.98 2.11 -0.87
10. Soft Drinks 0.25 0.36 0.11
11. Other Food 1.03 0.63 -0.40
12. Tobacco Products 1.09 1.20 0.11
13. Apparel and Textiles 3.72 4.55 0.83
14. Furniture and Wood 0.59 0.48 -0.11
15. Paper Products 0.27 0.27 0.00
16. Printing and Publishing 0.50 0.41 -0.09
17. Chemicals 1.59 4.60 3.01
18. Petroleum refining 1.10 0.97 -0.13
19. Leather Products 0.65 0.43 -0.22
20. Stone glass 1.38 1.15 -0.23
21. Primary Metals 0.17 0.19 0.02
22. Fabricated Metals 0.57 0.88 0.31
23. Nonelectrical Machinery 0.22 0.23 0.01
24. Electrical Machinery 1.57 2.30 0.73
25. Transportation Equipment 0.05 0.07 0.02
26. Professional Instruments 0.54 1.25 0.71
27. Misc. Manufacturing Industries 0.82 1.06 0.24
Services 61.48 65.94 4.46
28. Transportation 5.04 4.26 -0.78
29. Communication 1.24 1.50 0.26
30. Electricity and Gas 2.27 3.56 1.29
31. Aqueduct 0.67 0.74' 0.07
32. Trade 18.48 18.77 0.29
33. Finance 1.74 2.41 0.67
34. Insurance 0.62 0.89 0.27
35. Real Estate 7.47 11.91 4.44
36. Hotels 1.05 0.92 -0.13
37. Personal Services 0.67 0.60 -0.07
38. Business Services 1.20 1.07 -0.13
39. Amusement and Recreation 1.60 0.41 -l.19
40. Health Services 1.62 1.55 40.07
41. Other Services 4.03 3.46 -0.57
42. Commonwealth Government 8.85 10.31 1.46
43. Municipal Government 0.99 1.21 0.22
44. Federal Government 3.94 2.38 1.56
TOTAL 100.00 100.00 100.00

 

166

0 Agriculture based manufactures
0 Non agriculture manufactures and construction
L 0 Primary products I

__ 0 Services

(notNéniD'o

 

 

I972 DIRECT INTERMEDIATE INPUT COEFFICIENTS
01

.l .'2 .3 .1; .5? A .i .é ér'o
I963 DIRECT INTERMEDIATE INPUTS COEFFICIENTS

FIGURE 5.l Sums of Direct Intermediates Inputs Coefficients From All Sectors
For I963 and l972,Primary, Manufacturing and Service Sectors.
(Dollars per dollar of Total output ) -

167

large increases in their coefficients. Nine out of 15 in-
dustries in this group more than doubled their direct co-
efficients. On the other hand, only two sectors of the non-
agricultural manufacturing group, paper products and primary
metals, decreased their coefficients. It is interesting
also that eight of the non-agricultural manufacturing sectors
that increased their coefficients, according to Figure 5.1,
at the same time increased their share of value added. This
finding indicates that those were dynamic sectors which sim-
ultaneously increased their direct contributions to the
economy and improved their capacity to stimulate the contri-
butions of other sectors. These sectors were apparel and
textiles, chemicals, fabricated metals, non-clerical mach-
inery, electrical machinery, transportation equipment, pro-

fessional instruments and miscellaneous manufacturing.

Seven of 17 sectors in the service industries group,
according to their position below the diagonal in Figure
5.1, decreased their interdependence with the rest of the
economy. The large drop in the coefficient of the insur-
ance sector, which was reduced by about two-fifths, and
coefficient of "other services" which were cut in half, is
significant. The fact that the share of value added in the
insurance sector increased, as is shown in Table 5.1,
indicates that part of the coefficient decrease was due to
a larger portion of the activity being performed within

the firms composing the sector. Interesting also is the

168

fact that the coefficients of hotels and amusement and
recreation diminished while their share of value added

also went down. The two sectors are closely related to
tourism, which is supposed to have a propulsive role in

the economy, according to the expectations of the new
development program. This finding suggests that this pro-
pulsion has not yet been realized. A definite conclu-

sion, however, can not be made because other important ben-
efits of tourism, such as tourist expenditures on the island,

must also be considered.

In contrast to these seven sectors, eight service
sectors increased their direct technological coefficients
while at the same time improving their share of value added.
These sectors, which can be considered dynamic, are con-
centrated in the utilities and public administration
activities and are strongly dependent on central government

expenditure decisions.

The direct coefficients, analyzedsuafar, take into
consideration only the first round effects of production
increases in one sector on the rest of the economy. There
are later impacts derived from the increased production
arising from the first round. Hence, the domestic integra-
tion of the structure of production can best be evaluated by
an index that takes into consideration both the sector's
direct and its indirect output responses to changes in

demand. Such an index can becmtmhmd from the modified

169

Leontieff inverse explained in Chapter III. This index

has been called a total backward linkage index to stress

the fact that it measures the direct plus indirect produc-
tion required from each sector per dollar of output delivered

to final demand.7

Table 5.2 illustrates the total backward production
linkage indexes for the 44 sectors of the Puerto Rican
economy for 1963 and 1972. Again, from this point of view,

a considerable increase in the domestic integration of the
economy is evident. Only 12 of the sectors experienced a
reduction of their linkage indexes. Four of these sectors
are agriculture based manufacture, six belong to the ser-
vice group and two to the new manufacturing industries.

It is interesting that other food and hotels, whose direct
coefficients in Figure 5.1 decreased, experienced an in-
direct increase large enough to make their total linkage
indexes go up. As expected, the linkage indexes for the
agriculture based manufacturing industries were very high,
sectors that have decreased rapidly in economic importance

as agricultural activity has shrunk. A recuperation of these
sectors, with a strategy more favorable to agriculture, would

undoubtedly have a large impact on the domestic economy.

A sign of favorable structural Change is the consider-
able improvement in the domestic integration of most of the

new manufacturing sectors. Their linkage indexes have gone

 

7See Pan Yotopoulos and Jeffrey B. Nugent, "A Balanced
Growth Version of the Linkage Hypothesis: A Test" Quarterly
Journal of Economics 87 (May 1973): p. 61.

 

170

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171

up from a low level in 1963 to a high level in 1972 rela—
tive to the average index for the economy in those years.
In 1963, when the average linkage index was 1.38, all these
sectors were below average; while nine sectors were above
the 1.44 average linkage index for 1972. The average for
the whole economy was obtained by weighing each sector's
index by its total output and computing a weighed average.
This average index is considered a "coefficient of inter-
dependence" and can be used in time series comparisons of
changes in the "depth" of the industrial structure.8 The
fact that the average index was increased between 1963 and
1972 is another indication of increased domestic integra-

tion in the Puerto Rican economy.

In Chapter IV, the observation was made that new
manufacturing firms attracted to Puerto Rico were externally
integrated to parent companies in the United States, a con-
dition that hindered their linkage with the rest of the
local economy. This condition is reflected in the rela-
tively low coefficient for the new manufacturing sectors
in 1963. George T. Beckford argued that the self-suffic-
iency of the "overseas" component of the Caribbean economies
stifled the development of internal linkages and claimed
that linkages and spread effects were lost because linkages

and their multiplier effects jumped toward the metropolitan

 

8Leroy P. Jones, "The Measurement of Hirshmanian Link-
ages." Quarterly Journal of Economies 90 (May l976),p. 239

172

area.9 However, the Puerto Rican data in Table 5.2 and
Figure 5.1 contradict Beckford with evidence that, in spite
of the branchplant situations, new industrial plants in-
creased their linkages within the Puerto Rican economy
considerably, improving the domestic integration of the

whole.

The service industries, earlier described as the
fastest growing sectors in the economy, had relatively slow
improvement in their integration. Only four sectors had
linkages above average in 1972 compared with eight in 1963.
Moreover, three of the four diminished in economic impor-

tance as measured by their decreasing value added shares.

The degree of integration can be also evaluated from
the dispersion index shown in Table 5.2. The dispersion
index as defined in Chapter III, measures the spread effects
of the production in each sector. A low index means that
the industry is drawing intermediate inputs evenly from
the system of industries; while a high one indicates that
the drawing is one-sided in just a few sectors. A decrease
in the index means improvement in the economy's integration
since the impact of the sector is spread more evenly over
the whole economy. Spread effects of industrial expansion

are exceedingly important from the standpoint of economic

 

9George L. Beckford, Caribbean Economy (Kingston:
Institute of Social and Economic Research, University of
the West Indies, 1975), p. 94.

 

173

develOpment,10

The ideal complementary values for these two in-
dexes oftotal integrationareaahigh value for theproduction

linkage index and a low value for the index of dispersion.

Table 5.2 shows that, of the 32 sectors that had an
improvement in their linkage indexes, 30 also had a decrease
in their dispersion indexes. Hence, these 30 sectors im-
proved their economic impact both from the point of view
of the intensity as well as the spread effects of their pro-
duction activity. Six other sectors improved their spread
effects as indicated by a reduced dispersion index, although
their linkage indexes were reduced, and two others improved
their linkage index while worsening their dispersion. Only
six industries had simultaneous linkage and dispersion in-
dexes indicative of reduced integration with the rest of
the economy. These sectors were dairy products, bakery
products, primary metals, real estate, business services,
and "other" services. Thus, the dispersion index corrobor-

ated the increased integration of the economy of Puerto

Rico.

The interdependence explored so far is of the back-
ward linkage type. That is, one that emphasizes the econ-
omic influence of a sector according to the purchases of
intermediate inputs it makes from other sectors. However,
there is also the interdependence of the forward linkage

type which places emphasis on the influence of a sector

loMichael Boucher, p. 318.

174

upon other sectors of the economy through the sales of
intermediate inputs made to them. These two concepts of
linkage look at the same transaction from two different per-
spectives. Thus, only one of them is needed to measure

interdependence, as discussed in Chapter III.

The concept of forward linkage, however, is useful
for other analysis. For instance, it can help to find out
the extent to which expanded manufacturing sectors in the
Puerto Rican economy are supplying a larger proportion of
their output to other sectors as intermediate inputs. It
may be recalled that in the more advanced stages of indus-
trialization, a larger proportion of the demand for indus-
trial output would be originated internally, due to in-
creased need for intermediate goods.11 Moreover, one of
the goals of revised 1955 economic development strategy was
to attract firms capable of supplying existing or potential

local enterprises.

A partial forward linkage of a sector is given by its
direct sales to the intermediate demand of other sectors,
12
as a percentage of its total sales (intermediate plus final).

In terms of the notation presented in Chapter III, this

intermediate sales coefficient,(Si)of a sector (1) in year

 

11

See Chapter II.
12This is only a partial forward linkage because it con-
siders direct effects only. A total linkage includes both
direct and indirect effects arising from expanded demand
from other sectors.

175

(t) can be expressed as:

 

The scatter diagram in Figure 5.2 shows these co-
efficients for the manufacturing sectors for 1963 and 1972.
It is clear in Figure 5.2 that 17 of the 23 manufacturing
sectors increased their coefficients, evidenced by their
position above the 45- degree line in the diagram, meaning
that they were selling a larger proportion of their total
output to other sectors to be used as intermediate input.
Twelve of these sectors more than doubled their original
coefficients, as may be observed by their distance from the
diagonal. In non-agricultural manufacturing, in particular,
11 of the 15 sectors improved their intermediate sales co-
efficients. Thus, it is evident that in Puerto Rico the
expansion of the industrial sectors, as expected by the
government planners,made available an increased amount of

intermediate input to other sectors.

Summary

This section has explored the extent to which the
economy of Puerto Rico increased its economic interdepend-
ence among domestic industries, which means the forging of
links between the various parts of the domestic production
structure, singled out. as one of the seven basic elements

of structural transformation that comes with economic develop-

176

LOO

. . 2|

: 0 Agriculture based manufactures o 22
-— .7 o Nonogticulture manufactures :3 ° '5

Io
__ 5 9 I4
u 5 26 e o
.- o
C
.4 27 7
6 o ’ g
.3 0 I03

 

I972 INTERMEDIATE DIRECT SALES COEFFICIENT I f .ljj.)

 

 

0| 1 1 1 1 11111 1 1 14 111
m 02 03 0405060743310 2 .3 .4 55.78MB

J_l

I'I
l963 INTERMEDIATE DIRECT SALES CDEFFICIENTIZ' 3m)
. J: ‘i

FIGURESZ Sums of Intermediate Direct Sales Coefficients to All Sectors for I963
and l972,Manufacturing Sectors(Dollarsper dollarof Total Output)

177

ment. Increased integration was also emphasized when devel-
opment strategy for Puerto Rico was revised in 1955. The
increased interdependence of the domestic economy was ex-
pected to bring rapid growth in domestically produced inter-
mediate input, as internal demand for this type of goods

was enhanced.

The extent of economic interdependence in Puerto
Rico in l963and 1972 was measured by the direct domestic
input-output coefficients, which gave the amount of direct
intermediate domestic input required by a sector per dollar
of its total output; and by the total input-output coeffi-
cients, which indicate the amount of direct plus indirect
intermediate domestic input needed in a sector per dollar
of output delivered to final demand.. The analysis was
based on domestic input-output matrices so that only the
sectoral interdependence manifested in the local economy
was considered. Hence, the degree of economic interdepen-
dence observed could also be taken as the degree of sec-

toral domestic integration.

The analysis gave a clear indication of increased
domestic economic integration in Puerto Rico between 1963
and 1972. More than two-thirds of the 44 sectors increased
both their direct and their total coefficients, and in most
cases the increases were considerable. However, the weighed
average of theto¢a1.coefficients, considered as an index

of interdependence for the whole economy, only went up from

178

1.38 to 1.44 which may not be statistically significant.
The degree of integration was also evaluated with an index
of dispersionthat measured the spread effects of the pro-
duction of each sector on other sectors of the economy.

Increased integration in 36 of 44 sectors was found.

In non-agricultural manufacturing sectors, which in-
clude the bulk of the new manufacturing enterprises pro-
moted under the economic development program sponsored by
the government, 13 of 15 sectors increased their degree
of interdependence, most of them more than doubling their
1963 coefficients. The increase in the coefficients of
these sectors suggests that the branch-plant condition of
the new manufacturing firms attracted to Puerto Rico has
not stifled the emergence of internal linkages there, as
one author pointed out was the case in other Caribbean econ-
omies. The increased coefficients point toward some success
in achieving the goal of Puerto Rico's development program
by attacting firms better integrated with the local economy
in order to enhance domestic output and employment multi—

pliers.

Ten of the 17 service sectors increased their coeffi-
cients. However, increases in these sectors were slower
than those in the manufacturing sectors. Moreover, half
of the sectors that decreased their coefficients of inter-

dependence belonged to the service group.

179

The other concentration of sectors that experienced
a reduction in their degree of integration were in agri-
culture-based manufacturing. The reduced integration of
these sectors matched the decline in agricultural activity
in general. In the previous chapter this was in part
attributed to the failure of agriculture to shift its pro-

duction in accordance to changes in final demand.

A partial forward linkage, computed to measure the
direct sales of one sector to fulfill the intermediate in-
put needs of other sectors, showed that 11 of the 15 non-
agricultural manufacturing sectors, which includes most of
the new manufacturing firms, increased the proportion of
their output sold as intermediate input to other sectors.
This indicates that in Puerto Rico a larger proportion of
demand for industrial output is generated internally from
an increased need for intermediate input, a condition that,
in the opinion of some authors, comes in an advanced stage
of industrialization and makes an economy more self—sustain-

ing.

Import Leakages and Import Substitution

 

Small open economies going through the process of de-
velopment are expected to have higher levels of imports com-
pared with large countries.13 First, because the increase

in real income that comes with the transformation of the

 

13w. G. Demas, p. 22.

180

economy results in an increased demand for all goods, in-
cluding imports. Second, to the extent that early stages

of transformation are accompanied by an increase in the

rate of investment, there will be an increased demand for
capital goods. Third, industrial development may give rise
to increased imports of intermediate products, particularly
raw materials. Moreover, since resources in a small country
are likely to be highly skewed they must, of necessity,
exchange the products of their few specialized resources

for a great variety of imported goods.

On the other hand, as a consequence of the changing
composition of demand away from goods toward services and
as dictated by relative income—elasticities of demand, trans-
formation tends to reduce import demand. The creation of
internal linkages in the economy, as seen in the last
section, and technological progress, which economizes in
the use of imported natural raw materials and makes avail-
able domestically produced synthetic materials, are also

instrumental in decreasing the demand for imports.

This section explores the net effect of these opposing
tendencies on the various sectors of the Puerto Rican economy
as they are reflected in the imports of intermediate goods.
It is believed that these effects manifest themselves dif-
ferently on the various sectors but that their net effect
on the economy of Puerto.Rico has been to increase imported

input coefficients.

181

Change in Import Leakages

In an open economy the domestic outputlinkages may
be reduced by import leakages that hinder the translation
of the full potential of the gross interdependence into
domestic integration. The domestic input coefficients are
decreased to the extent that input, which could be effi—
ciently produced locally, are imported. To be examined
here is the extent to which the domestic input coefficients
in Puerto Rico have been affected by changes in imported
input leakages. To determine this, the imported inter-
mediate input coefficients for 1963 and 1972 were determined
by subtracting the domestic coefficients, already discussed,
from gross coefficients that included imported and dom-
estically produced intermediate input. This methodology

was fully explained in Chapter III.

In Figure 5.3 the direct intermediate imported input
per dollar of total output are compared by a scatter diagram
similar to those previously used. The total (direct plus
indirect) imported input coefficients are compared in
Table 5.3. The figure shows that 24 of the 44 sectors in-
creased their direct imported input coefficients, thus in-
tensifying their import leakages. When both the direct and
indirect imported input were considered the number of sec-
tors with increased import leakages increased to 27, as is

shown in Table 5.3.

182

me
33E 0 Agriculture based manufactures
.70 0 Non agriculture manufactures and construction

50' a Primary products
.sa- . Services

.40

    
 
      

sai-

.20

I972 DIRECT INTERMEDIATE IMPORTED INPUTS COEFFCIENTS

 

1 1 1111111 I l

1 1 1 1 [L
.Ol .02 .03 .04 OSDGO'INOSJO .2 .3 .4 .5 .6 .7 8.9

1
I.

0

I963 DIRECT INTERMEDIATE IMPORTED INPUTS COEFFICIENTS

FIGURESS Sum of Direct Intermediate Imported lmputs Coefficients From All Industries;
Primary, Manufactunng and Service Sectors( Dollars perdallars of total output)

183

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184

The increases in import leakages were considerable
in many sectors. They were outstanding for primary produc-
tion and agriculture-based manufacturing, in which 9 of 11
sectors increased their direct intermediate input coeffi-
cients and for five of them the coefficients more than
doubled. This provides additional support to the belief
that the rapid decline of agricultural activity in Puerto
Ricohas hindered the capability of these sectors to
supply the input needed in agriculture-related manufactur-
ing, thus increasing dependence on imported input. Also
notable is the sharp increase in the direct import co-
efficient of the insurance sector, which went up from 0.02
to 0.12 per dollar of output. This indicates that part of
the reduction in the direct domestic input coefficient of
this sector, observed in the previous section, was par-
tially due to a shift from domestic to foreign supply

SOUI'CES.

Twelve of the 20 sectors that experienced a reduction
in import leakages were concentrated in the manufacturing
industries group and most were the new industries promoted
under the development program. Two-thirds of the 15 indus-
tries in this sub-group decreased their imported input co-
efficients, almost all by more than 25 percent. This is an
encouraging sign since these sectors had the highest import
leakages. The reduction in their imported input coeffi-

cients gives an indication that these sectors have somewhat

185

reduced their external dependence and have enhanced their
multiplier impacts in the domestic economy. The other
sectors that reduced their import leakages are located

in the group of service industries.

When the coefficients that included direct plus in-
direct imported intermediate input, summarized in Table
5.3, were considered, it was found that 27 sectors increased
their import leakages, three more than when only the direct
coefficients were considered. It is evident that these
three sectors using less direct imported input in 1972,
were then using domestic intermediate input with a higher
import content. The average direct plus indirect imported
input coefficients for groups of sectors, as well as for
the whole economy, are shown in Table 5.3. These are
weighted averages where the output of each sector is used
as the weight factor. It is evident that in spite of the
large number of manufacturing sectors that decreased their
imported input coefficients, for the manufacturing sectors
as a group the average coefficient increased largely pushed
up by the food and tobacco industries. The service sectors
also had an increase in their average coefficient in spite
of decreases in some of the utilities industries. However,
the increase in the service sector was the smallest among
all the different groups and they also had the lowest im-
ported input coefficients. For the economy as a whole the

average coefficient increased from 47 cents in 1963 to 60

186

cents in 1972, per dollar of output delivered to final
demand. These averages, however, perhaps are somewhat dis-
torted by the use of total output (intermediate plus final

output) as the weight factor instead of final demand alone.

It may be concluded that Puerto Rico has increased
its dependence on imported intermediate input. Large de-
pendence on imported input is normal in a small open economy,
such as the Puerto Rican, which is oriented toward exports
of industrial goods but whose most abundant resource is
labor. The outward orientation of the industrial output
is needed in order to take advantage of economies of scale
that otherwise would not be feasible in the small domestic
market. Imports are needed to produce industrial goods at
competitive prices in the export market. However, it is
always possible that there are opportunities for efficient
domestic prmhmximaof some of the goods that are imported.
To the extent that these opportunities exist and are not
used, import leakages limit domestic integration to the
full potential of the existing economic roundaboutness. The
next section explores to what extent some sectors have taken
advantage of such opportunities in the economy of Puerto
Rico. The scope of the substitution of domestically pro-
duced intermediate input for imported input will be inves-

tigated.

187

Import Substitution

As has been pointed out before, an import substitu-
tion in Puerto Rico is very difficult to implement. However,
it has also been argued that in the more advanced stages
of industrialization a developing economy should be capable
of supplying from domestic sources an increasing share of
the intermediate and capital goods needed. Thus, one expects
to find in the deveIOpment process import substitution of
the backward linkage type, that is, an increased capacity

to supply locally the intermediate input currently imported.

This section explores the magnitude of Puerto Rican
import-substitution in intermediate goods. Table 5.4 shows
the changes in direct domestic input coefficientsand the
changes in direct imported input coefficients for the 44
sectors of the economy from 1963 to 1972. An increase in
the domestic input coefficient, together with a decreased
imported input coefficient, indicates that the sector has

input-substitution in intermediate goods.

Fourteen sectors, according to the table, experienced
import substitution of this kind. It is significant that
10 of these sectors belong to the manufacturing group and
nine of them are industries engaged in new manufacturing

promoted under the development program. For most sectors

the improvement in the domestic coefficient was very similar

in magnitude to the reduction in the import coefficient.

1118

TABLE 5.4.--Absalute Changes from 1963 to 1972 in Direct Domestic Intermediate
Inputs Coefficients and in Direct Imported Intermediate Inputs
Coefficients, 44 Sectors (dollars per dollar of output).

 

Change in Direct

Change in Direct

 

Sector Domestic Intermediate Imported Intermediate
Inputs Coefficient Inputs Coefficient
Agriculture
Sugarcane .119 .085
Other Agriculture .093 .069
Mining .036 .018
Construction .063 .041
Manufacturing
Dairy Products -.186 .177
Bakery Products -.034 .038
Sugar Refining .083 .075
Malt Beverages .186 .183
Alcoholic Beverages -.017 .012
Soft Drinks .151 -.119
Other Food -.037 .079
Tobacco Products -.042 -.076
Apparel and Textiles .208 -.139
Furniture and Wood .184 -.178
Paper Products -.005 -.081
Printing and Publishing .164 .064
Chemicals .186 -.082
Petroleum Refining .288 -.l71
Leather Products .181 -.127
Stoneglass .065 .061
Primary Metals -.094 .071
Fabricated Metals .155 -.146
Nonelectrical Machinery .121 .039
Electrical Machinery .052 -.088
Transportation Equipment .145 .023
Professional Instruments .183 -.193
Misc. Manufacturing Industries .203 -.220
Services
Transportation -.099 .011
Communication .091 .002
Electricity and Gas .094 -.012
Aqueduct .071 -.120
Trade .042 .012
Finance .114 .009
Insurance -.228 .108
Real Estate -.035 -.004
Hotels -.006 -.007
Personal Services .058 -.040
Business Services -.078 -.097
Amusement and Recreation -.029 .071
Health Services .133 .008
Other Services -.150 -.009
Commonwealth Government .070 -.042
MUnicipal Government .151 .087
Federal Government .079 .107

 

189

This successful import-substitution points toward a flex-
ible economy which can utilize the available opportunities
to supply locally the intermediate input needed; thus clos-

ing some of the existing import leakages.

Sixteen other sectors that increased their domestic
input coefficients also increased the imported input co-
efficients. These sectors were able to supply from domes-
tic production part of the increase in their gross inter-
mediate input requirements. This also reflects flexibility

in the economy.

For eight sectors the increase in the imported input
coefficient was at the expense of a reduction in the dam-
estic input coefficient. These sectors are substituting
imported for domestic intermediate input, the reverse of
import-substitution. Four of these sectors were agricul-
ture-based manufacturing industries that, given the fast
decline of agriculture, perhaps had no other choice. These
are sectors that could benefit from a concentrated effort
to modernize agriculture, making this primary sector cap-
able of supplying agricultural intermediate input at com-

petitive prices.

Summary

This section has explored the changes in intermediate

input import leakages in the economy of Puerto Rico from

190

1963 to 1972, and how these changes have affected the dam-
estic input coefficients, which were taken in this study

as indicators of economic integration.

The analysis suggested considerable increase in the
dependence on imported intermediate input as judged by the
changes in imported input coefficients. Three-fifths of
the 44 sectors increased their import leakages and the in-
creases were considerable in many sectors. Most of the
sectors in primary activities and agriculturally related
manufacturing increased their dependence on imports. The
other industries with increased import leakages were in the

service sectors.

Twenty sectors experienced reductions in their im-
ported input coefficients. Half of them were the new
industries promoted under the governmental development pro-
gram, and were also sectors with the highest import leakages.
This is a positive result of the government's goal of en-
hancing the domestic multipliers in the economy of Puerto

Rico.

Considering together all the increases and decreases
in the imported input coefficients of the different sectors,
it was found that the average coefficient for the whole econ-
omy increased. In 1972, on the average, each dollar of out-
put delivered to final demaairequired 60 cents of imported
intermediate input in contrast to only 47 cents required in
1963. Thus, the conclushntthat the overall dependence of

the economy on imported input has somewhat increased.

191

Large dependence on imports by itself is not ab-
normal, particularly in small open economies oriented
toward exporting industrial goods. However, it is impor-
tant that the country in question takes advantage of exist-
ing opportunities for the efficient substitution of domes-
tically produced intermediate input for imported input so
that the economic integration of the domestic economy can
be brought closer to its full potential. The analysis showed
that import-substitution in intermediate input occurred in
14 sectors of the Puerto Rican economy between 1963 and
1972. Two-thirds of these sectors were engaged in the new
manufacturing activites promoted under the government devel-
opment program, which by 1972 constituted the largest manu—
facturing activities. The analysis also showed that in-
creases in the gross intermediate input coefficients in 16
sectors were partially captured by domestically produced
goods. These two findings indicate some flexibility in the

domestic economic structure.

Six sectors, on the other hand, increased their im-
ported input coefficients while they decreased their dom-
estic coefficients. These sectors, four of which were
engaged in agriculture-based manufacturing, substituted
imported input for domestic input. These are sectors in
which a possibility for import-substitution seems to exist,
particularly those related to agricultural activities. A

concentrated effort to stimulate agricutural output by

192

modernizing this sector may bring an increased domestic

supply of some intermediate input at competitive prices.

Changes in Employment and Labor Productivity

The reduction of direct labor requirements within a
firm might be caused by the use of less labor and more
capital (increased automation), or less labor and more inter-
mediate goods (increased specialization). It is believed
that both changes are present in Puerto Rican production;
labor that has been saved at a very fast rate, in spite of

the government's emphasis on employment.

The reduction in labor utilization due to increased
automation is a logical consequence of industrialization
based on export goods. An increase in wage rates14 faster

than the growth in productivity will lead to increased cost

 

14Anne Carter has argued that the relative increases in

wages is a natural consequence of economic progress. If a
fundamental objective of the economy is to furnish a larger
and larger product to consumers, then more consumption per
unit of services contributed by households (larger payment
per effort) constitutes progress. The more successful the
system is in accomplishing this objective, the greater will
be the rise in the price of labor relative to other products
and the greater the incentive to substitute other input for
labor. Hence structural changes that reduce labor require-
ments, she concluded, have clear economic appeal. See Anne
Carter, p. 153.

193

in the particular industry or industries concerned, and
given the fact that the industry is likely to be a price
taker rather than a price leader in the export market,
production can become uneconomic. Thus, an industry fac-
ing wage increases, (which in the case of Puerto Rico are
exogenously pushed upward by federal minimum wage legis-
lation and national labor union pressures) and unable to
pass these increases to the purchaser, will introduce
technology that increases labor productivity to levels
where higher wages can be afforded. The Puerto Rican plan-
ners recognized this fact and, accordingly, after 1955
changed their promotional program to favor more capital
intensive industries. Table 5.5 clearly shows that wage

increases in Puerto Rico have been considerable.

Moreover, in Puerto Rico American firms have generally
adopted methods of production similar to those used by their
parent companies on the mainland. This is not surprising
since there is a tendency among less developed countries
to assimilate the modern techniques available in developed
countriesls; this trend is more pronounced in Puerto Rico,
where the firms being established are subsidiaries of enter-

prises operating in a developed country. Some economists

working with problems of development and planning have argued

 

15Werner Baer and Michael E. A. Herve, "Employment and
Industrialization in Developing Countries" Quarterly_Journal
of Economics 80 (February 1966): 93-94

 

194

 

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..e oe.. ae.o ~4.o eoonoonn nonoeo.
e.e oo.~ e~.. no.0 eeonoono .eoonono
N.e me.~ me.. eo.o en.on.no one euonoonn oo...< one noneo
4.e .o.. eo.o m4.o onno.nnnn one ooo: .noonn.
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e.o 4N.~ .N.. eo.o eoonoonn oonon.. one ooon
omnenu no ooen mam. moo. one.

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oueno>< one whouoom .e.Aumsv:H wcwhsuoemssez oouooHow oaom you mwcfinuem ».uao: ownho><II.m.m mqm<h

195

that increasing the use of modern technology will be one

of the most important ways to accelerate economic develop-
ment.16 Furthermore, in the modern world most of the avail-
able techniques tend to be highly capital intensive. Thus,
factor substitution after equipment installation is rather
limited. Deteriorating machinery is usually replaced with

equipment utilizing a more capital intensive technique.

Labor is also saved when a firm becomes more special-
ized because more of the total output comes from intermediate
input. A larger proportion of intermediate input means lower
value added and less labor employed. However, when the
labor reduction is of significant force, a smaller reduc-
tion in total (direct plus indirect) labor requirement as
compared to its direct component may be expected, since
the additional intermediate input demand requires addi-
tional labor. This is the rationale supporting Puerto Rico's
latest strategy of seeking higher waged industries (less
labor intensive) in hope of getting the needed extra em-
ployment from the indirect labor impact of the increased

economic roundaboutness.

In this section the researcher examines the direct
and total labor requirements for each of the 44 sectors of
the economy of Puerto Rico for 1963 and 1972. Large in-

creases in labor productivity were expected in most sectors

 

16See, for example, P. N. Mathur, "An Application of Dynamic Input-
Output Models for Planning," in Economic Analysis in Input-Output Frame—
work, ed. P. N. Mathur (Poona, India, 1967), pp. 109-130.

196

due to the factors discussed above. It has not been pos-
sible to separate unequivocally' the effect of increased
automation from the effect of increased specialization
because of lack of data on capital requirements. However,
an attempt was made to point out the possible sources of

the change in labor requirements.

Direct Labor Requirements

The scatter diagramin.Figure 5.4 shows the direct
labor required by the 44 sectors per million dollars of
total output for 1963 and 1972. The sectors are identified
in Table 5.1. It is immediately noticeable that 36 of the
44 sectors experienced increases in labor productivity, as
can be inferred from the decrease in their direct labor re-
quirements illustrated by the position of these sectors
below the diagonal in the diagram. The dramatic drop in
these coefficients can be judged from the distance of each
sector from the 45- degree line in the scatter diagram that
gives the relative magnitude of the change. It is evident
that only one primary, four services, and three manufactur-
ing industries decreased their labor productivity, as illus—
trated by their position above the diagonal. Of these, only
three-sugar refining, amusement and recreation, and miscel-
laneous services-had relatively large increases in their

labor coefficients.

197

 

I.
so . .
.0 e Agnoulture based manufactunng
.70 o Non angculture manufactunng
a Primary products
50 eServices
A 37
e
I9 3°
2
E 39 .
(2 2° 8 so
I.
u. 3'
8 42 ‘3
32
U z 2, 3 e .
m JOI- 2. 4 4‘
O 09' .403.
“3" °° ' '°"
0 4 o , g 27
° 0
fi 05 8 as. 2
.0 I5 26
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.0l 0'. 35 111 1 1 1 111144
m .02 osmosasoroeasio 2 3 .45578910

 

 

I963 LABOR COEFFICIENTS

‘ FIGURE 54 Sums of Direct Labor Coefficients for I963 and I972 , Primary Products,
Manufacturing and Service Sectors (workers per thousand of dollars -
on an

198

Figure 5.4, together with Table 4.18 above, shows the
following interesting points about the different sectors.
First, the increase in productivity in the agricultural
sectors was remarkable. This sharp rise explains the fast
release of labor from agriculture which was made evident
in the last chapter. It can be recalled that according to
Table 4.18, for all the years the actual shares of agri-
culture in total employment were below the normal level
expected and the drop in the actual share was sharper than

expected.

Second, it is noticeable that most manufacturing
sectors also experienced considerable increases in labor
productivity. Only sugar refining, malt beverages, and
electrical machinery, among this group, decreased their
productivity. It can be observed in Figure 5.4 that from
the beginning the direct labor coefficients of these sectors
were not too large and, to make things worse, they have been
decreasing. This explains the low labor absorption of
these sectors in spite of their larger importance in the

economy, as was made evident by the analysis in Chapter IV.

The service, or tertiary sectors, also experienced
increases in their productivity that is reflected in lower
direct labor coefficients. However,the:hfltial high level
of these coefficients in most of these sectors is striking.
So, in spite of their increased productivity, the direct

labor coefficients of the service sectors remained relatively

199

high, thus explaining their large labor absorption ob-
servable in Table 4.18. It is evident there that the
actual share in the total employment of these sectors has
been above the share normally expected in comparison to

other small countries.

An important question is how much of these changes
in labor productivity are attributable to increased auto-
mation and how much to increased specialization? As men-
tioned before, lack of data on capital requirements per unit
of output limited the possibility of categorically separat-
ing the two effects. However, an attempt was made to eval-
uate the importance of those two forces in explaining the
changes in labor coefficients which have occurred in the

economy of Puerto Rico.

A previous study of labor productivity in Puerto Rico
concluded that the reaction of established plants to rapid
wage hikes was to increase productivity so as to offset most
of the higher wage cost but with little change in the cap-
ital - output relations.17 Using this study as reference,
Lloyd Reynolds argued that there was a sharp reduction in
the use of labor relative to both capital and output. He
pointed out that management found ways of dispensing with
labor and of getting greater output from those who remained

but that the introduction of labor saving machinery in response

 

17Lloyd Reynolds, Peter Gregory and Luz Torruellas, Wage
Productivity and Industrialization in Puerto Rico. (Homewood:
Richard D. Irwin, Inc., 1965), Chapter 3.

200

to wage increases did not seem to have been of major im-

18
portance.

If the findings of this study are true, and the large
reductions in direct labor coefficients were not asso-
ciated with large increases in the ratio of capital to out-
put, then it seems that increased use of intermediate input
might have been an important source of labor savings. In
the following pages an attempt is made to establish to what
extent increased specialization may have been conducive to

labor reductions.

As was maintained before, an increase in the use of
intermediate input within a firm enables savings of primary
input such as labor. The intermediate input used may be
imported or locally produced. Thus an increase in the
direct imported intermediate input coefficient and the
direct intermediate input coefficient may be associated
with a reduction in the direct labor coefficient, implying
that increased specialization has been a significant factor

in labor savings.

Table 5.6 compares the relative changes in these
three coefficients from 1963 to 1972. These changes are

derived using the formula

2("72 ’ X63)

 

x72 + X63

 

18Lloyd Reynolds, "Wages and Employment in. Labor-Surplus Economy,‘
American Economic Review 55 (March 1965): 31—32.

 

201

TABLE 5.6.--Re1ative Changes from 1963 to 1972 in Direct Domestic Intermediate Import
Coefficients, in Direct Imported Intermediate Coefficients and Direct
Labor Coefficients, 44 Sectors (in percentages).

 

Direct Domestic Direct Imported

 

Intermediate Intermediate Direct
Sector Inputs Inputs Labor
Coefficient Coefficient Coefficient
Agriculture
Sugarcane 50.2 70.2 -24.2
Other Agriculture 44.6 67.0 -70.5
Mining 7.3 16.2 1.0
Construction 15.4 26.9 -43.
Manufacturing
Dairy Products -28.8 114.9 -22.9
Bakery Products - 7.1 18.3 -42.0
Sugar Refining 11.0 67.3 91 2
Melt Beverages 50.7 101.9 18 4
Alcoholic Beverages - 7.2 22.9 - 7 2
Soft Drinks 31.9 —52.2 -45 7
Other Food - 6.4 27.7 - 8.7
Tobacco Products -10.7 -38.5 -53 6
Apparel and Textiles 95.4 -39 9 -52 1
Furniture and Wood 87.2 -51 5 -45.7
Paper Products - 2.0 -22.1 -28.6
Printing and Publishing 68.3 29.7 -24 4
Chemicals 77.2 -29.0 - 2 7
Petroleum Refining 118.6 ~28.7 -60 3
Leather Products 88.2 -31.2 -20.7
Stoneglass 15.3 48.7 -20.4
Primary Metals -40.0 16.9 -41.2
Fabricated Metals 85.6 -32.7 -20 9
Nonelectrical Machinery 39.3 12.1 -44.9
Electrical Machinery 25.1 -29.4 3.6
Transportation Equipment 41.4 9.0 -61.0
Professional Instruments 84.3 -89.0 -50.1
Misc. Manufacturing Equipment 85.3 -57.9 -54.3
Services
Transportation -3l.0 14.7 -24.4
Communications 39.9 4.8 -54.0
Electricity and Gas 47.2 - 7.9 -114.5
Aqueduct 46.2 -77.3 15.4
Trade 23.3 37.7 -48.9
Finance 52.3 11.0 -86.0
Insurance -53.6 154.1 -12.0
Real Estate -16.2 -13.0 —111.9
Hotels - 1.9 -20.9 -10.5
Personal Services 18.0 -32.8 -74 3
Business Services -22.6 -S4.8 0.8
Amusement and Recreation - 7.0 98.4 94 5
Health Services 49.6 8.2 -29.3
Other Services -66.3 -15.0 -39.7
Commonwealth Government 42.3 -43.9 -l7.2
MUnicipal Government 44.9 67.2 -60.5
Federal Government 54.8 117.6 50.1

 

202

where

H
II

the relative change

M
II

the variable being measured

The table shows 12 sectors that decreased their labor
coefficients, and increased both the domestic and the im-
ported intermediate input coefficients. Thirteen others
decreased their labor coefficients while increasing one
intermediate coefficient and decreasing the other, but the
rising value showed a larger relative change. For these
25 sectors, labor savings due to increased specialization

was very likely.

Five sectors have a reduction in their labor coeffi-
cients despite decreases in both intermediate input co-
efficients. Six others decreased the labor coefficients
while having a decrease in one of the intermediate coeffi-
cients relatively larger than the increase in the other.
For these 11 sectors labor savings due to increased auto-

mation were more likely.

Three sectors that experienced an increase in their
labor coefficients had a decrease in one intermediate co-
efficient relatively larger than the increase in the other;
an indication that these sectors became less specialized
and thus increased their labor input. These sectors were

electrical machinery, aqueduct, and business services.

Five other sectors increased their direct labor re-

203

quirements, with four increasing both intermediate input
coefficients, while the fifth had a larger increase in
the imported coefficient relative to a decrease in the
domestic coefficient. These sectors-mining, sugar refin-
ing, malt beverages, amusement and recreation, and the
federal government--probab1y turned to more labor inten—

sive technology.

The aboVe analysis seems to confirm that increased
specializatimtwas more responsible for rising labor pro-

ductivity than increased automation.

Total Labor Requirement

As pointed out above, when the reduction in direct
labor requirement caused by the use of less labor and more
intermediate input is significant, smaller reductions in
total (direct plus indirect) labor requirement relative to
its direct component are expected--additional intermediate
input demanded requires additional labor. It is suspected
that in the case of Puerto Rico the decreases in total labor
are very close, in relative terms, to the decreases in
direct labor, since the input structures of individual in-
dustries are theoretically sensitive to changes in the
relative prices of the input. Input whose prices have in-
creased the most will be used less intensively as inter—

mediate input; and this input probably has a higher labor

204

content, assuming that the price of labor has risen rela-
tive to the price of other products. This type of primary
factor saving, which involves adaptation of any given
sector to changes elsewhere in the system, makes for sig-
nificant indirect labor saving, causing the reduction in
total labor to be in close proportion to the decrease in

the direct labor requirement.

Thetotal.labor requirements are computed by premulti-
plying the row vector of direct manpower coefficients by
the inverse of the domestic imput-output coefficient matrix.
The result is a vector of total labor requirements per unit
of final demand. This procedure was summarized in matrix

notation in equation 9 of Chapter III.

The results of these calculations for 1963 and 1972
for the 44 sectors are shown in Table 5.7. These results
are analyzed and compared to the direct coefficients with
the help of the scatter diagram shown in Figure 5.5. The
diagram presents in the horizontal axis the 1972/1963 ratio
of the direct labor coefficients of the two years, and in
vertical axis the 1972/1963 ratio of thetotaJ.labor co-
efficients. Points below a line drawn through the 1.00 co-
efficient ratio on the vertical axis parallel to the hori-
zontal axis, and to the left of another line drawn through
the point 1.00 on the horizontal axis and parallel to the
vertical axis, represent sectors for which both the direct

and the total coefficient decreased. Within the small square

205

TABLE 5.7.--Direct Plus Indirect Labor per Million Dollars of Final Demand,

44 Sectors, Years 1963 and 1972.

 

Total Labor Coefficientsa

 

 

Sector
1972/1963
1963 1972 Change Ratio
Agriculture
Sugarcane 450.1 356.3 - 93.8 .79
Other Agriculture 508.9 254.4 -254.5 .50
Mining 172.3 142.5 - 29.8 .83
Construction 194.1 132.7 - 61.4 .68
Manufacturing
Dairy Products 379.9 126.7 -253.2 .33
Bakery Products 190.3 158.1 - 32.2 .83
Sugar Refining 341.0 360.7 19.7 1.06
Malt Beverages 66.8 101.0 34.2 1.51
Alcoholic Beverages 51.8 75.2 23.4 1.45
Soft Drinks 131.8 112.9 - 18.9 .86
Other Foods 221.7 124.6 - 97.1 .56
Tobacco Products 234.8 159.3 - 75.5 .68
Apparel and Textiles 152.2 114.8 - 37.4 .75
Furniture and Wood 140.8 104.1 - 36.7 .74
Paper Products 98.8 85.3 - 13.5 .86
Printing and Publishing 124.6 125.5 0.9 1.01
Chemicals 40.0 64.8 24.8 1.62
Petroleum Refining 19.3 20.1 0.8 1.04
Leather Products 156.9 148.0 - 8.0 .95
Stoneglass 136.3 114.2 - 22.1 .84
Primary Metals 94.0 49.3 - 44.7 .52
Fabricated Metals 67.4 68.8 1.4 1.02
Nonelectrical Machinery 119.0 111.5 - 7.5 .94
Electrical Machinery 85.7 86.9 1.2 1.01
Transportation Equipment 163.7 135.3 - 28.4 .83
Professional Instruments 99.2 72.0 - 27.2 .73
Misc. Manufacturing Industries 132.2 149.6 17.4 1.13
Services
Transportation 171.3 113.9 - 57.4 .66
Communication 126.7 97.6 - 29.1 .77
Electricity and Gas 70.8 37.3 - 33.5 .53
Aqueduct 146.2 173.6 27.4 1.19
Trade 196.4 125.9 - 70.5 .64
Finance 119.6' 65.6 - 54.0 .55
Insurance 137.8 85.0 - 52.8 .62
Real Estate 192.2 20.3 -171.9 .11
Hotels 182.2 165.3 - 16.9 .91
Personal Services 825.5 349.3 -476.2 .42
Business Services 417.5 196.5 ~221.0 .47
Amusement and Recreation 135.4 278.3 142.9 2.06
Health Services 384.4 288.9 - 95.5 .75
Other Services 171.0 195.8 24.8 1.15
Commonwealth Government 179.4 159.2 - 20.2 .89
Municipal Government 265.6 171.2 - 94.4 .64
Federal Government 180.0 103.1 - 76.9 .57

 

aIncludes direct plus indirect labor requirements.

206

3.00 I

 

 

 

 

 

 

g e Agricultue based mmuto4turing
zoo - 0 Non agriculture manufacturingmd contraction
E 6 Primary products
Q 250 C Services a
m I '
I-
Z I.80
I?
g Isa °
9 e'
8 0
L40
5
SI
: I! Is ’22 J 4 e“ 07
8 “0° as I.“ 8 a!"
o. 3
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Z 432. “ as
Q 00 0 e4
(3 o e m 33 2 4 :3 2. d.
_| o e as
(L 0.40 03? 3
E e
m I o
35 3°
L_I___I__I._.1_”_I._I__I
ozaaeaaeoaaawatza I.4OI.GO|802.GOZNSILD

 

DIRECT LABOR COEFFICIENT, I972/ I973

FIGURE 55 Changes in Direct and Total Labor coefficients Ratios I972/l963,
Primary, Manufacturing and Service Sectors

207

formed by these two lines and the axes,points above the
diagonal represent sectors for which the decrease in total
coefficient was smaller than the decrease in their direct
coefficient, while the reverse holds true for points below
the 45 degree line. Points on the diagonal, or very close
to it, indicate that the two coefficients have closely
similar relative changes. Points above the line parallel
to the horizontal axis show those sectors that increased
their total coefficient, while points to the right of the
line parallel to the vertical axis indicate sectors for

which the direct coefficient increased.

Figure 5.5 illustrates the comparison of the direct
and total (direct plus indirect) labor coefficients of all
44 sectors. It shows that the 30 sectors within the small
square decreased both direct and total coefficients. Six
sectors, on the other hand,increased both coefficients as
accorded by their position in the his square. The remain-
ing eight sectors had increases in one coefficient and de—

creases in the other.

The 22 sectors above the diagonal within the small
square have reductions in their total coefficients relatively
smaller than the decrease in their direct coefficients. For
these 22 sectors the indirect labor effect was strong
enough to partially compensate for the employment loss due
to the decrease in their direct labor requirements. For

the six sectors in the rectangle above the small square,

208

their total coefficient increased while their direct labor
requirements decreased. For these six sectors the indirect
labor effect more than compensated for the loss in employ-

ment due to decreased direct labor requirements.

Eight sectors, on the other hand, experienced a de-
crease in the total coefficient relatively higher than the
decrease in the direct coefficient. For two others, the
direct requirement slightly increased while the total re-
quirement decreased. For these 10 sectors the indirect
labor effect worsened the labor absorption as it failed to
compensate for the labor loss due to the reduced direct

labor requirements.

The above evidence indicates that the indirect labor
effect has been strong enough in 28 sectors to provide some
compensation for the employment loss. However, in only six
of them, all manufacturing sectors, was the indirect effect
sufficient for full compensation. For a few more, also
manufacturing sectors, the indirect effect was strong enough
to provide significant compensation as can be judged by their
distances from the diagonal. Thus, it seems that the Puerto
Rican economy is still far from being able to fulfill the
expectations of the government planners: compensation through
indirect labor effects for the employment loss suffered due
to their promotion of less labor intensive industries.

Although partial success is noticeable, particularly in some

of the non-food manufacturing industries targeted by the
development program, the achievements are not large enough

to claim a complete success.

Summary

This section examined the direct and the total
(direct plus indirect) labor requirements for each of the
44 sectors of the economy of Puerto Rico for 1963 and 1972,
with the intent to establish how much of the change ob-
served was due to increase automation and how much to
increased specialization. The analysis showed large in-
creases in labor productivity in most sectors, which reduced
significantly their labor absorption. The increases in pro-
ductivity were particularly large in the agricultural and
manufacturing sectors. It also showed that increased
specialization was more responsible for increased labor
productivity and reduction in labor absorption, than in-
creased automation. This seems to confirm the finding of
other studies--that the introduction of labor saving
machinery in response to wage increases did not seem to

have been of major importance in Puerto Rico.

The analysis also explored the extent to which the
increased specialization, that is, the use of more inter-
mediate input, has generated indirect labor effects to off-
set the labor loss due to the increased productivity, as

was hoped by the Puerto Rican planners. It was found

210

that the Puerto Rican economy was still far from being

able to fulfill this expectation, although some success was
observed. In a few sectors, especially among the manu-
facturing industries, the indirect labor effect was strong
enough to compensate either fully, or partially but sig-
nificantly, for the direct labor loss brought about by more

specialization.

The Economic_Effects of Change in
Demand and Change in Structure

 

 

The content of this Chapter so far has focused on
changes in the structure of production as reflected in
economic interdependence, import leakages and labor pro-
ductivity; and their effects in output, employment and
trade. The behavior of these variables, however, is not
affected by structural changes alone. Changes in final
internal and external demand might be also an important
source of change in these variables both directly and in-
directly. The changes in the composition and lewfl.of out-
put, employment, and trade - which in Chapter IV were taken
as a proxy of structural change - may be explained by struc-
tural change in the sense of this chapter as change in the

structure of production, and by change in final demand.

This section analyzes changes in the composition and
level of output, employment, and trade in the economy of

Puerto Rico as caused by change in the structure of

211

production and by change in final demand (internal and
external). However, it should be realized that a change

in external demand may actually imply a structural shift

for or against Puerto Rico as a source of supply. It is
hypothesized that the change in final demand has been a more
important source of flux since, as was seen in Chapter IV,
personal income has increased very fast and the propensity
to consume has remained high in spite of a high rate of
investment.

A counterfactual analysis using the input-output
technique is the basis for this investigation. In this
type of analysis, hypothetical situations are simulated
which allow one to separate the differences caused by
change in the structure of production as reflected in the
input-output matrixes, from those attributable to change
in demand. A detailed explanation of the simulation used

in this study was presented in Chapter III.

Output Changes

 

The first simulation explored the changes in total
output (intermediate plus final) of each sector to establish
how much could be attributed to change in the structure of
production and how much to change in the composition and
level of final demand. The economic structure of 1963

represented by the input-output matrix of that year was

 

19See Table 4.3 above.

212

combined with the final demand of 1972 to generate the
hypothetical production for 1972 which would have resulted
if demand alone varied. This hypothetical production was
then compared to the actual 1972 production and the dif-
ference was attributed to change in the structure of pro-
duction alone. The changes attributable to difference in
demand were obtained by deducting the actual 1963 total

output from the hypothetical output.

The output changes for each of the 44 sectors obtained
from this calculation are shown in Table 5.8. These results,
summarized for groups of sectors, are also presented in
Table 5.9 as percentages of the total for the sector and

as percentages of the total for the source of change.

These tables indicate that 85.9 percent of the 5,040
million dollars increase in total output from 1963 to 1972
was explained by changes in demand and only 14.1 percent
by change in the structure of production. For the agri-
cultural sectors, both the changes in the final demand and
the change in the structure of production induced decreases
in their output Closely similar in magnitude. Construction
had a large increase in output of 584.1 million dollars
caused by change in demand while the change in the struc-

ture of production generated a small output reduction of

1.4 millions.

Both the change in demand and the change in thestnuxure

TABLE 5.8.--Change in Output, from 1963 to 1972, Due to Change in Demand and Change

in the Structure of Production, 44 Sectors (in millions of dollars).

 

 

 

 

 

Due to Due to Change
Change in in the Structure Total
Demand of Production Change
Agriculture -21.8 -25.0 -46.8
Sugarcane -69.1 - 3.5 -72.6
Other Agriculture 47.3 ~21.5 25.8
Mining 33.0 ~32.7 0.3
Construction 584.1 - 7.9 576.2
Manufacturing 1342.8 669.6 2011.9
Dairy Products 13.1 5.9 19.0
Bakery Products 17.3 18.4 35.7
Sugar Refining -135.3 5.6 -129.7
Malt Beverages - 4.8 22.4 17.6
Alcoholic Beverages 25.6 16.5 42.1
Soft Drinks 9.4 32.7 42.1
Other Food 156.4 ~10.9 145.5
Tobacco Products 55.5 - 5.9 49.6
Apparel and Textiles 224.4 144.3 368.7
Furniture and Wood 7.6 13.8 21.4
Paper Products 17.7 - 5.6 12.1
Printing and Publishing 19.7 9.1 28.8
Chemicals 324.6 139.5 464.1
Petroleum Refining 190.6 167.1 357.7
Leather Products 15.5 4.1 19.6
Stoneglass 108.6 -27.4 81.2
Primary Metals - 2.8 16.3 13.5
Fabricated Metals 40.1 41.4 81.5
Nonelectrical Machinery 31.3 — 3.6 27.7
Electrical Machinery 139.9 0.6 140.5
Transportation Equipment 7.3 1.2 8.5
Professional Instruments 37.6 46.7 84.3
Misc. Manufacturing Industries 43.0 37.4 80.4
Services 2393.8 105.5 2499.3
Transportation 130.0 -28.5 101.5
Communication 40.9 27.7 68.6
Electricity and Gas 168.5 38.3 206.8
Aqueduct 27.5 - 1.0 26.5
Trade 623.2 37.0 660.2
Finance 104.0 25.7 129.7
Insurance 26.8 17.2 44.0
Real Estate 399.0 106.9 505.9
Hotels 40.6 -12.3 28.3
Personal Services 25.0 - 0.3 24.7
Business Services 62.1 444.6 17.5
Amusement and Recreation -18.9 -14.7 -33.6
Health Services 105.4 -26.8 78.6
Other Services 88.2 -29.9 58.3
Commonwealth Government 411.5 3.6 415.1
Hmicipal Government 107.7 - 1.6 106.1
Federal Government 52.3 8.8 61.1
TOTAL 4331.7 708.9 5040.6

 

214

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215

of production induced increases in output in the entire man-
ufacturing sector for a total of 4,011.9 million dollars,
the latter explaining about one-third of the total change.
However, in spite of the overall increase in output attri-
butable to structural change for the whole group, six of the
manufacturing sectors, as is shown in Table 5.8, experienced
decreases in output due to change in demand. Considering
the two sources of change together, the table makes evi-
dent that among the manufacturing sectors only sugarcane
refining had a net decrease in output, a consequence of a
large decrease due to change in demand and a small increase

due to change in the structure.

Almost 96 percent of the output increase of 2,499.3
million dollars in the service sectors was explained by
change in demand while only 4.2 percent by change in the
structure of production. Looking individually in Table 5.9
at the sectors forming the group, it is noteworthy that 9
out of 17 service industries experienced decreases in out-
put due to structural change while only one diminished its

output due to change in demand.

It can be concluded from the evidence presented above
that, as expected, most of the output increases in Puerto
Rico from 1963 to 1972 can be attributed to changes in
final demand, both domestic and foreign, and very little

to change in the structure of production.

The last three columns of Table 5.9 show the change

216

in output of each group of sectors as a percentage of the
total output change and as a percentage of the output
arising from the two Sources being examined. It is evi-
dent that half of the total output increase originated

in the service sectors and about two-fifths in the manu-
facturing industries. The contribution of agriculture,

on the other hand, was negative. The service sectors

also contributed 55.3 percent of the output increases ex-
plained by changes in demand while the manufacturing sectors
contribution was 31.0 percent. The role of these two
groups of sectors, however, is reversed when explaining
the output increases induced by changes in the structure
of production. The manufacturing sectors contributed 94.4
percent of the increase in output coming from this source
while the service sectors generated only 14.9 percent. The
contribution of agriculture, mining, and construction to
the output growth coming from structural change was nega-

tive.

This data corroborates the remarkable contribution
of the service sectors to output growth in Puerto Rico as
observed before. The data also stress the importance of
demand induced growth. For the manufacturing sectors, how-
ever, changes in the structure of production are a notice-

able source of output change.

217

Employment Changgs

The analysis in Chapter IV showed that the manu-
facturing sectors have been a key factor in generating the
high rates of growth in the Puerto Rican economy in the
last 30 years. This analysis has also demonstrated that
these sectors, contrary to what many dualistic models postu-
late, are not labor absorbing sectors. The findings in
the previous sections of this chapter confirmed these con-
clusions as it made evident sharp increases in productivity
that have drastically reduced labor requirements. The im-
proved integration brought about by the increased inter-
dependence of the domestic economy has induced some indirect
labor effects to partially compensate for the employment
losses induced by the increased productivity, but these are

not sufficient to produce a significant compensation.

This section takes this analysis one step forward

and attempts to separate the labor changes induced by

structural change from those induced by changes in final
demand. This approach will serve to test the hypothesis
that the major portion of the increases in employment in

the Puerto Rican economy are explained by changes in demand.

The role of the manufacturing sector in relation to
job creation has been indirect. as has been stressed by an
authority in labor matters who argued that in a developing

economy manufacturing's role

218

. . . . is not likely to be that of a major
source of new employment. Rather it will
tend to generate the effective demand lead-
ing to employment expansion in other sectors.
This multiplier effect is apt to be more
significant than any direct contribution

that the manufacturing sector can make to

the alleviation of mass unemployment.

The simulation used in this analysis is analogous to
the one explained above. But now the 1963 structure, repre-
sented by the domestic input-output matrix, and the 1963
manpower coefficient vector were combined with the 1972
final demand to determine the hypothetical total (direct
plus indirect) manpower that would have been required to
deliver the final demand of each sector in 1972 if only
demand had changed. The difference between this hypo-
thetical manpower requirement and the actual requirement
for 1963 are attributed to changes in demand alone. The
difference between the hypothetical manpower requirement
and the actual requirement for 1972 gives the change due

to structural change. ChapterIIIgave anmre detailed pre-

sentation of this procedure.

Table 5.10 shows the results of these calculations
for each of the 44 sectors singled out in the input-output
matrices, summarized by groups of sectors. It is observ-
able in the table that the change in the structure of pro-

duction induced negative changes in the total labor require-

 

20W. Galenson, "Economic Development and the Sectoral Expansion of
Employment," International Labor Review 87 (june 1963): 506-507

219

TABLE 5.10.--Change in Employment, from 1963 to 1973, Due to Change in Demand and
Change in the Structure of Production, 44 Sectors (in thousands of

 

 

workers).
Due to Due to Change
Sector Change in in the Structure Total
Demand of Production Change
Agriculture - . -6 -72.0
Sugarcane -2 . - -34.0
Other Agriculture 2 . -6 -38.0
Mining -
Construction 8 . -4 3
Manufacturing 8 -1 6 .

Dairy Products

Bakery Products

Sugar Refining

Malt Beverages

Alcoholic Beverages

Soft Drinks

Other Food

Tobacco Products

Apparel and Textiles

Furniture and Wood

Paper Products

Printing and Publishing

Chemicals

Petroleum Refining

Leather Products

Stoneglass

Primary Metals

Fabricated Metals

Nonelectrical Machinery

Electrical Machinery

Transportation Equipment

Professional Instruments

Misc. Manufacturing Industries
Services

Transportation

Communication

Electricity and Gas

Aqueduct

Trade

Finance

Insurance

Real Estate

Hotels

Personal Services

Business Services

Amusement and Recreation

Health Services

Other Services

Commonwealth Government

Municipal Government

Federal Government

TOTAL

04

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220

ment in about one-fourth of the sectors; this is not sur-
prising considering the increases in productivity already
discussed. The effect of the change in demand on total man—
power requirement, on the other hand, was positive for all
but five sectors. Table 5.10 shows that for the whole
economy approximately three additional jobs were induced

by the change in demand for every two jobs eliminated by

the change in the structure of production.

It is evident in the table that of 12 sectors exper-
iencing increases due to change in the structure of produc—
tion, eight of them were manufacturing sectors. This may
be explained by the previous finding that indirect labor
effects in some manufacturing sectors compensated for jobs

lost due to improved productivity.

Of the 512.9 thousand jobs induced by change in demand
347.0 thousand, or about two-thirds, originated in the ser-
vice sectors. The change in the structure of production
on the other hand, induced decreases of 336.9 thousand
workers in the total manpower requirements, and the ser-
vices sectors contributed about three-fifths of this de-
crease. When the two sources of change are combined,there
is a net increase in jobs requirements of 176 thousand
workers, and the contribution of the service sectors to

this total is of 144.7 thousand of workers, or 82.2 percent.

This evidence supports a stronger assertion than the

one posited in the hypothesis stated in the opening paragraphs

221

of this section. It is evident that the changes in demand
have induced almost all the increase in manpower require-
ment while the changes in the structure of production have
decreased them. It is also evident that most of these

increases originated in the service, or tertiary, sectors.

Trade Effects

 

This section investigates the effects of changes in
demand and changes in the production structure on total
exports and imports. This question is very important in
an open economy such as the Puerto Rican verifying to what
extent trade dependence has lessened or increased. Another
important consideration for policy purposes is the source

of the changes in trade dependence.

Dependence on Exports

This analysis examines how much Puerto Rico's depen-
dence on exports has changed by comparing the output attri-
butable to exports in 1963 and 1972. It also explores the
source of the change in export dependence. Again, the
counterfactual analysis technique was used in a simulation
that combined the 1963 structure and the 1972 export portion
of the 1972 final demand. This simulation generated a hypo-
thetical vector of total output for the economy of Puerto
Rico in 1972 attributable to exports alone, which when com-

pared with the corresponding 1963 actual vector of output

222

(the one generated by combining the 1963 structure and

the export portion of the 1963 final demand) gave the
changes in output attributable to export demand alone.

The difference between the hypothetical output vector and
the corresponding 1972 actual output vector gave the change
in output attributable to exports explained by changes in
the structure of production alone. This procedure, in

matrix notation, was presented in Chapter 111.

Table 5.11 shows the results of this simulation for
each of the 44 sectors, individually and summarized for

five groups of sectors.

Several relevant points are noticeable there. First,
for the economy as a whole, the total output attributable
to exports increased 1,330.4 million dollars, and three-
fourths of this increase was attributable to change in the
demand for exports, while one-fourth was explained by change
in the structure of production. Second, the manufacturing
sectors contributed 1,080.4 million dollars, or 81.2 per-
cent, of this increase of which nearly three-fourths was
induced by change in demand for exports and one-fourth by
structural change. Third, the contribution of the service
sectors was 304.1 million dollars. or 22.9 percent of the
total increase: the demand change accounting for a little
over four-fifths of this contribution and structural changes
the rest. Finally, the contributions of agriculture and
construction were negative and that of mining negligible;

the change in the demand for exports explained most of

223

TABLE 5.11.--Change in Output Attributable to Experts, from 1963 to 1972, Due to

Change in Demand and Change in the Structure of Production,

44 Sectors (in millions of dollars).

 

 

 

 

 

Due to Due to Change
Sector Change in in the Structure Total
Demand of Production Change
Agriculture -41.2 - 2.6 ~43.8
Sugarcane -77.3 - 1.4 -78.7
Other Agriculture 36.1 - 1.2 34.9
Mining 0.7 0.9 1.6
Construction - 8.5 - 3.2 -11.7
Manufacturing 793.3 287.1 1080.4
Dairy Products - 1.4 - 0.3 - 1.7
Bakery Products - 0.5 8.1 7.6
Sugar Refining -151.4 0.7 —150.7
Malt Beverages 1.1 5.8 6.9
Alcoholic Beverages 32.8 4.8 37.6
Soft Drinks 8.3 10.6 18.9
Other Food 89.9 - 0.3 89.6
Tobacco Products 37.6 - 9.8 27.8
Apparel and Textiles 130.8 96.7 227.5
Furniture and Wood - 0.2 3.4 3.2
Paper Products 3.3 - 4.9 - 1.6
Printing and Publishing 7.1 - 2.6 4.5
Chemicals 284.2 81.9 366.1
Petroleum Refining 111.3 28.1 139.4
Leather Products 32.0 3.2 35.2
Stoneglass 6.5 14.1 20.6
Primary Metals - 5.3 5.2 - 0.1
Fabricated Metals 18.8 18.5 37.3
Nonelectrical Machinery 21.7 - 0.6 21.1
Electrical Machinery 104.7 - 0.8 103.9
Transportation Equipment 1.9 0.4 2.3
Professional Instruments 29.8 15.4 45.2
Misc. Manufacturing Industries 30.3 9.5 39.8
Services 251.9 52.2 304.1
Transportation 64.4 -14.2 50.2
Communication 5.2 16.3 21.5
Electricity and Gas 8.0 15.0 23.0
Aqueduct 1.8 - 0.7 1.1
Trade 49.7 30.7 80.4
Finance 10.5 7.6 18.1
Insurance - 2.3 2.8 0.5
Real Estate 13.9 16.0 29.9
Hotels 43.9 - 2.9 41.0
Personal Services 0.2 1.4 1.6
Business Services 14.4 -18.7 - 4.3
Amusement and Recreation 2.2 - 2.0 0.2
Health Services 13.8 - 3.5 10.3
Other Services 9.5 0.7 10.2
Commonwealth Government 0.0 1.8 1.8
Municipal Government 0.1 0.0 0.1
Federal Government 16.6 1.9 18.5
TOTAL 996.3 334.1 1330.4

 

224

the reduction. Another interesting point is that of the
993.3 million dollars increase in output attributable to
change in the demand for exports, the manufacturing sectors
generated four-fifths. These sectors also contributed

85.7 percent of the increase of 334.1 million dollars in

export related output attributable to structural change.

The above discussion underscores the importance of
the change in the demand for exports as the main source of
increase in export related output, with the.manufacturing
sector as the main contributor to this growth. However,
it is important to note that the contribution of struc-
tural change to export induced output growth was not negli-
gible and that most of it originated in the manufacturing

SECEOI’.

Table 5.12 shows the total output and the output
attributable to exports for five groups of sectors of the
Puerto Rican economy for 1963 and 1972. The changes in
these two variables during this period are shown as well
as the output attributable to exports as a ratio to total
output. It is evident in the table that there is a slight
decrease in trade dependence as is reflected in the small
reduction in the ratio for the whole economy from .34 to
.30. The service and the manufacturing sectors also ex-
perienced small decreases in their ratios, slightly below
the average decrease for the whole economy. The small

decrease in the ratio for the total and for the manufactur-

225

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226

ing and service sectors was due to the fact that the total
output is increasing a little faster than the output attrib-

utable to exports.

For the economy as a whole, in 1972, 30 cents of
every dollar of total output was induced by exports. This
pnnwrtflnl does not seem too large for an economy pursuing
a strategy of export led growth. However, for the manu—
facturing sectors, which constituted an important segment
of the economy, more than half of the output was attrib-

utable to exports. For the service sectors, on the other
hand, a little less than one—sixth of their output was in-

duced this way.

It can be concluded from this evidence that Puerto

Rico's dependence on exports was not too large and has even
dimhfishmia little. However, the vulnerability in being

somewhat dependent on external demand is exacerbated by the

fact that the dynamic sectors of the economy are the manu-
facturing industries and, for them, the export dependence

is almost twice as much as that of the whole economy. More—
over, the income generated in the manufacturing sectors be—
cause of export expansion induces changes in the internal
final demand which also have output effects which can be

attributed to export activities.

227

Import Dependence

To test for changes in import dependence, information
is needed on final demand of imported goods as well as
demand for intermediate imported input. In this section,
however, only a partial Check of import dependence is made
as only the change in direct plus indirect intermediate
input was measured. The emphasis is on how much of this
change in intermediate imported input was explained by

structural charge and how much by change in final demand.

To measure the change in direct plus indirect imports
attributable to change in the structure of production, a
two step simulation was needed. The first step was to
make a simulation similar to the one used above to measure
the output changes but using inverse matrices for 1963 and
1972, including both domestic and imported input. Then,
the output effect attributable to structural change ob-
tained from the simulation which used the domestic in-
verse alone, was deducted from the output effect obtained
from this simulation and the difference was taken as the
change in direct plus indirect intermediate imported input
arising from change in the structure of production. The
change in total intermediate imports attributable to change
in demand was calculated by an analogous procedure. These

procedures were summarized in symbolic terms in Chapter III.

Table 5.13 presents the results of these calculations

228

for the 44 sectors individually, and summarized for groups
of sectors. Several interesting points can be observed

in the table. First, three-fourths of the 2,305.5 million
dollars increase in total intermediate imports was induced
by change in final demand, both internal and external, and
one-fourth by change in the structure of production. The
manufacturing sectors contributed 1,804.7 million dollars,
or 78.3 percent, to this increase of which a little more
than one-third was induced by structural change. The in-
crease in intermediate imported input attributable to
change in the structure of production amounted to 584.7
million dollars; the manufacturing sectors contributed
most of it--p1us some more to offset decrease in con-
struction and mining. However, it seems that the import
substitution of intermediate imported inpug which as
discussed above was concentrated in the manufacturing
sectors, prevented the increase in intermediate imported
input from being higher. The manufacturing sectors also
contributed about two-thirds of the 1,720.8 million dollars
of increase in direct plus indirect intermediate imported
input attributable to change in final demand. Thus, the
importance of demand changes is again evident as the main
inducer of economic changes, in this case, as the main
source of increase in direct plus indirect intermediate im—
ported input. However, these data show that the contribu-

tion of structural change to this increase cannot be neg-

2129

TABLE 5.13.--Change in Intermediate Imported Inputs, from 1963 to 1972, Due to
Change in Demand and Change in the Structure of Production,
44 Sectors (in millions of dollars).

 

 

Due to Due to Change
Sector Change in in the Structure Total
Demand of Production Change
Agriculture 59.6 7.0 66.6
Sugarcane 3.1 0.1 3.2
Other Agriculture 56.5 6.9 63.4
Mining 180.0 -86.7 93.3
Construction 11.0 - 8.7 2.3
Manufacturing 1162.4 642.3 1804.7
Dairy Products 13.0 -14.2 - 1.2
Bakery Products 0.3 15.2 15.5
Sugar Refining 6.0 2.9 8.9
Malt Beverages 0.4 19.7 20.1
Alcoholic Beverages 0.6 12.9 13.5
Soft Drinks 12.0 5.2 17.2
Other Food 82.7 25.3 108.0
Tobacco Products 10.8 85.5 96.3
Apparel and Textiles 164.0 45.5 209.5
Furniture and Wood 51.3 -39-0 12.3
Paper Products 90.2 -33.1 57.1
Printing and Publishing 28.7 -12.5 16.2
Chemicals 179.0 81.8 260.8
Petroleum Refining 57.9 122.3 180.2
Leather Products 11.8 - 9.6 2.2
Stoneglass 33.7 22.2 55.9
Primary Metals 163.7 63.5 227.2
Fabricated Metals 69.1 72.5 141.6
Nonelectrical Machinery 66.4 -76.4 -10.0
Electrical Machinery 68.6 -28.2 40.4
Transportation Equipment 8.7 94.8 103 5
Professional Instruments 6.4 82.8 89.2
Misc. Manufacturing Industries 37.1 103.2 140.3
Services 307.8 30.8 338.6
Transportation 69.6 - 9.4 60.2
Communication 13.6 15.8 29.4
Electricity and gas 23.9 0.0 23.9
Aqueduct 3.7 - 4.7 - 1.0
Trade 35.7 50.6 86.3
Finance 7.0 6.9 13.9
Insurance 40.0 21.4 61.4
Real Estate 21.6 22.1 43.7
Hotels 2.0 - 3.7 4 1.7
Personal Services 0.3 .4 0.7
Business Services 14.2 - 5.5 8.7
Amusement and Recreation 4.7 - 4.6 0.1
Health Services 1.6 - 2.5 - 0.9
Other Services 68.1 -62.0 6.1
Commonwealth Government 0.2 2.3 2.5
Municipal Government 0.1 0.0 0.1
Federal Government 1.5 3.7 5.2
TOTAL 1720.8 584.7 2305.5

 

230

lected, considering that 25 cents of every dollar of in—
crease in intermediate imported input originated from

this source. The role of the manufacturing sectors as the
main contributor to changes in intermediate imported in-

put has also been underlined.

Table 5.14 shows the total intermediate imported
input for 1963 and 1972 as a ratio of total output (inter-
mediate plus final), a measure that partially indicates
to what extent the dependence on imports has changed. It
is clear in the table that from 1963 to 1972 the depen-
dence on intermediate input increased as is evidenced by
an increase in the ratio from .34 to .40. It is notice-
able, however,that the manufacturing sectors have a very
large ratio and it increased from .66 to 79. This means
that by 1972 every dollar of total output in these sectors,
required 79 cents of imported input. Thus this analysis
leads to the same conclusion as the previous discussion
although it used a somewhat different index of depen-
dence. It is evident that the dependence on imported
input has increased and this dependence is concentrated
in the manufacturing sectors. However, it is worth repeat-
ing the observation that much of this dependence is neces-
sary in an open economy which is pursuing a development

strategy led by industrial exports.

231

Summary

The changes in the composition and level of output,
employment, and trade - which in Chapter IV were taken as
a proxy of structural change - may be explained both by
change in the structure of production and by change in
final demand, both internal and external. This section
focused on these two possible sourCe of change to estab-
lish the extent to which they explained changes in output,
employment and trade in the economy of Puerto Rico be-,

tween 1963 and 1972.

It was found that most of the output increase in
Puerto Rico was explained by change in final demand and
very little by change in the structure of production. The
service sectors contributed more than half of the output
increase attributed to change in demand while the manu-
facturing sectors contributed most of the output increase

explained by change in the structure of production.

The analysis also separated the change in total
labor requirement between those induced by change in
demand and those induced by change in structure. It was
found that the latter explained all the increase in man-
power requirement while the former induced negative changes.
However, some manufacturing sectors experienced an increase
in total manpower requirement due to change in the struc-

ture of production, perhaps a consequence of the positive

232

TABLE S.14.--Direct Plus Indirect Intermediate Imported Inputs as a

Ratio of Total Output,a Six Groups of Sectors.

 

 

1963 1972
Group of Sectors Ratio Ratio Change
Agriculture .23 .56 .33
Mining and Construction .38 .25 -.13
Manufacturing .66 .79 .13
Services .12 13 .01
TOTAL .34 .40 .06

 

aIncludes final and

intermediate output.

233

indirect labor effects in these sectors of the increased
economic roundaboutness. The analysis also made evident
that most of the net job increase originated in the service

SQCEOI‘S 0

Export dependence was also investigated and the
change observed was explained in terms of change in demand
and change in the production structure. As expected, the
change in demand for exports was the main source of in-
crease in export related output and the manufacturing
sectors were the main contributors to this growth. However,
it was found that the contribution of structural change to
export induced output was not negligible and most of it
originated in the manufacturing sectors. A comparison of
the output attributable to exports relative to total out-
put (intermediate and final), taken as an index of depen-
dence, made evident that Puerto Rico's overall dependence
on exports was not as large as believed and in fact
slightly declined between 1963 and 1972. However, the vul-
nerability of being dependent on external demand, perhaps
is larger than the overall index of dependence suggests;
for the manufacturing sectors the dependence on export is
twice as large as that of the whole economy, and these are

dynamic sectors with large influence over the whole economy.

The effect of change in final demand and change in
the structure of production in import dependence was exam-

ined from the point of view of direct plus indirect inter-

234

mediate input requirements. Again, the importance of the
change in final demand as the main inducer of change became
evident. However, the data showed also that the contribu-
tion of structural change to the increase in imported inter-
mediate input cannot be neglected, as 25 cents of every
dollar of increase in imported input originated from this
source. The role of the manufacturing sectors as main
contributors to increase in import of intermediate goods
was also stressed. This analysis corroborated a previous
conclusion that the overall dependence an intermediate
imported input increased between 1963 and 1972 which is
normal in a small economy oriented toward industrial ex—
ports. The increase for the overall economy has been mod—
erate. However, for the manufacturing sectors the increase
was large and the ratio of imported inputs to total output

was very high.

CHAPTER VI

SUMMARY AND CONCLUSIONS

Summary

The purpose of the research was to study the struc-
tural transformations in the economy of Puerto Rico, in-
vestigating how these changes have affected the capacity

of the economy to creauaoutput and generate employment.

Puerto Rico was transformed from the colonial econ-
omy of 1940 into the modern industrial economy of today,
with the help of a government program to attract private
business investment. It was the intent of "Operation Boot—
strap" to boost income and employment by attracting indus-

trial plants to employ the island's abundant labor supply.

A remarkable annual rate of post war growth from
1940 to 1972 averaged 7.1 percent in realper capita GNP.
Other indicators of economic growth were equally impres-
sive. In spite of the rapid economic growth, however,
unemployment never fell below 11.0 percent even though
migration to the United States removed large numbers from

the job market. Unemployment has continued to spiral

235

236

upwards in the Nineteen Seventies, reaching 20.0 percent
in 1977. Furthermore, growth in real GNP per capita has
stagnated to an average annual growth rate for the 1972-

1977 period of almost zero.

Stagnation of the Puerto Rican economy has been attributed
by some to its vulnerability to the recession in the
United States economy during the first half of the decade.
This opinion is based on Puerto Rico's large dependence
on trade with that country. Others believe that the
vulnerability to external recessions, induced by open
trade, is one among other structural changes which have
limited the economy's capability to create output and
employment. An extremist position of this view attributes
the economic ills to failure of the development program.
Such extremists believe the Puerto Rican economy is an
example of growth without development, to the point that
it is incapable of maintaining growth momentum and reduc-

ing unemployment to acceptable levels.

The main objective of the study was to investigate
the relative importance of these possible causes of the
slow down. With this purpose in mind, the structural
transformation that accompanied economic growth was ex-
amined to determine the extent to which its changes cor-
respond to those expected from successful economic develop-

ment capable of continuOus and self-reinforcing growth

237

of output and employment. In this connection, economic
development was interpreted as structural transformation

that renders the economy capable of self-sustained growth.

The following basic elements of structural change

in the direction of self—sustained growth were considered:

1. A shift of production and employment away from

primary to secondary and tertiary sectors of the economy.

This shift meant a continuous process of realloca-
tion of factors of production among sectors of the econ-
omy in accordance with changes in relative productivity
and alterations in the composition of demand with in—
creased per capita income. This process manifested it-
self in changing the distribution of the labor force and
the composition of output from primary to secondary and

tertiary activities.

The analysis of Puerto Rico's growth revealed a sharp
shift in production from agriculture to industrial and ser-
vice output, as expected in a successful transformation
of a dual economy. Industrial output at first was mainly
agriculture-based manufactures, shifting later to labor in—
tensive industrial goods, and still later to increasing
capital and skilled labor intensive manufactures. These
shifts in output were responses to changing conditions in
comparative advantage and were in accordance with the

development strategy pursued by the Puerto Ricangovernmenn

238

The share of industrialoutput in the gross domestic
product, however, was not above average when compared
with similar small industry-oriented economies in the
process of growth. This was surprising in view of the
aggresive industrialization effort undertaken in Puerto
Rico and has been blamed on the competition from Asian
countries that limited the sale of labor intensive indus-
trial goodsto the United States market. The study showed
that more than half the industrial output in Puerto Rico

depended,directly or indirectly, on exports.

Domestically produced agricultural output and agri-
culture-based industrial production was also geared to the
export market and had become a very small fraction of dam-

estic consumption.

The service sectors experienced the fastest growth,
increasing their GDP share from three-sevenths in 1940 to
four-sevenths in 1972. This sharp increase was more than
that normally expected according to the average performance
of a group of small industry oriented countries. Sharpest
increases were in trade activities and in public adminis-

tration.

The structure of employment closely followed the path
of production, shifting workers to industrial and service
jobs and away from primary labor. The shift from agri—

cultural employment was accelerated by a sharp decline in

239

production and technologically increased productivity

per worker. The absorptive capacity of the industrial
sectors, on the other hand, was only moderate due to
increased productivity and the shift in emphasis toward
less labor intensive but higher waged industrial activity.
Construction and service activity provided a considerable
share of the additional jobs needed to absorb the growing
and rapidly shifting labor force. A large part of the
service employment seemed to be of the modern or demand-
induced productive type, arising from increased income and
expanded industrial activity. However, some increase in
the supply-determined low productive services seemed likely
in view of sharp increases in government and trade shares
in total employment. Analysis showed that in spite of the
expansion of employment in these sectors and large labor
emigration, unemployment remained high and labor force par-

ticipation diminished.

2. Changes in the importance and composition of

foreign trade.

The transformation of the economy was expected to
produce an increase in the absolute volume of foreign trade
and changes in its composition. The expansion of exports
in Puerto Rico was a consequence of the outward focus of
her industrialization program, a logical strategy for a
small island economy. The opportunities to take advantage

of economies of scale, made possible by unrestricted access

240

to the United States market, enhanced the logic of this
strategy. An abundance of labor and scarcity of natural
resources justified the emphasis on labor intensive indus-

trial exports.

Analysis showed that exports, as expected, comprised
a large share of output. In a first stage, output composi—
tion emphasized traditional exports, which in the case of
Puerto Rico were mainly agriculture-based manufactures;
shifting to labor intensive industrial manufactures and,
later on, to capital and skilled labor intensive goods
according to changes in comparative advantage. As already
mentioned, the manufacturing sector was the main contributor

to export induced output growth.

Imports were also expected to increase and their com-
position to shift in emphasis from consumer goods to inter-
mediate and capital goods. This is the net effect of oppos-
ing tendencies. On the one hand, there is the increased
need for imported capital and intermediate goods arising
from expansion of industrial activity and the increased
demand for all consumer goods, including imports, arising
from the improvement in real income. On the other hand,
there is the changing composition of demand away from goods
toward services, as dictated by relative income elastic-
ities of demand; the creation of internal linkages, which
provide local intermediate inputs; and technological prog-

ress which economizes in the use of imported rawmaterials.

241

The analysis made evident an increase in the import
level in both absolute and relative terms. As expected,
its composition shifted in favor of capital and intermediate
goods. The level of consumer goods imported decreased in
relative terms but in absolute terms showed noticeable
growth during the period under investigation. The depen-
dence on imported intermediate input increased absolutely
and relative to total output. The manufacturing sectors

were responsible for most of the increase.

3. The development of an increasing degree of interde-

pendence among domestic industries and activities.

This implies forging links between various parts
of the domestic production structure so that domestic in-
dustries become more interdependent. (The interdependence
manifests itself in the development of a whole network of
forward and backward linkages within the internal structure
of production, whereby the products of an increasing number
ofindustriesbecome the input of other industries. This,
in turn, implies rapid growth of domestically produced
intermediate goods. This increased roundaboutness of the
economy to bring rapid growth in domestically produced
intermediate input and to enhance domestic output and employ-
ment multipliers was a new emphasis of Puerto Rico's revised

development strategy in 1955.

The analysis of the structure of production gave a

clear indication of increased domestic economic integration

242

in Puerto Rico between 1963 and 1972. The degree of inte-
gration increased for more than two-thirds of the 44 sec-
tors of the economy, both from the point of view of a
backward linkage index that measured the strength of the
influence of one sector on other sectors through the pur—
chases of intermediate input made from them, and a dis-
persion index which measured the spread effects of those
purchases in the system of industries. In the non agri-
cultural manufacturing sectors, which includes the bulk

of the new manufacturing firms promoted under the govern-
ment's development program, 13 out of 15 sectors increased
their degree of interdependence, most of them more than
doubling their 1963 coefficients. This increase in linkage
suggests that the branch-plant situation of the new manu-
facturing firms attracted to Puerto Rico has not stifled
the emergence of internal linkages there, as George L. Beck-

ford pointed out was the case for other Caribbean economies.

Some of the sectors that experienced a reduction in
their degree of domestic integration were concentrated in
agriculture-based manufacturing. These sectors also in-
creased their intermediate imported input requirements.
This suggests that the decline of primary agriculture lim-
ited the possibility of these sectors for securing raw

materials and intermediate input from domestic sources.

 

1George L. Beckford, ed., The Caribbean Economy (King-
ston: Institute of Social and Economic Research, University
of the West Indies, 1975), p. 94.

 

243

The sectors with the highest imported input leakages
were the new manufacturers promoted under the development
program. However, in this group also were concentrated
sectors that decreased their imported input coefficients,
a positive result from the point of view of the govern-

ment's goal of improving domestic linkages.

About three—fifths of the sectors increaséd their
imported input coefficients, one-third of them at the ex—
pense of decreasing their domestic linkage coefficients

and thus their degree of integration.
4. The capacity to transform.

This refers to the capacity of the economy to contin-
ually apply innovations to improve social productivity
and to adapt promptly to changing conditions, such as
changes in price, market conditions and comparative advan-

tage.

The analysis of the structure of production showed its
flexibility to change and adaptability to different condi-
tions. It was found that about two-thirds of the sectors
experienced import substitution in intermediate goods or
were able to supply from domestic production part of their
increased gross intermediate input requirement. This in-
dicates the capability of the economy to take advantage of
available opportunities to increase the domestic supply of

intermediate input. This behavior lessened somewhat the

244

increase in imported input dependence. Most of the new
manufacturing sectors were among those showing this be-

havior.

The flexibility of the Puerto Rican economy to adapt
to change was demonstrated by considerable increases in
labor productivity observed in most sectors from 1963 to
1972. The increases in labor productivity were particu-
larly significant in the agricultural and industrial sec-
tors. The increased productivity came as a response to
non-market wage increases and the inability to raise prices
accordingly, enhanced by the price taker situation of many
industries in the export market. The analysis showed that
increased specialization, that is, greater use of inter-
mediate input and fewer primary factors, more than in-
creased automation, was responsible for the increased
labor productivity. This conclusion confirmed the find-
ings of another study which pointed out that the introduc-
tion of labor saving machinery, in response to wage in-
creases, did not seem to have been of major importance in
Puerto Rico. Labor savings by way of increased specializ-i
ation show the adaptability of the economy to take advantage

of efficiency improvements elsewhere.

5. The unification of the national market for goods

and services.

This implies an increase in production for markets

as against subsistence production and the unification

245

of fragmented localized markets into a national markets,
and if possible into an export market, so that all poten-
tial economies of scale can be fully exploited and an

efficient distribution of goods can be achieved.

Subsistence production in Puerto Rico rapidly dis-
appeared and a wide system of roads and highways in the
small territory of the island has made possible the uni-
fication of the home market. Moreover, unrestricted access
to the United States economy has allowed the expansion of
the market beyond the national boundaries making possible
economies of scale otherwise not feasible. Thus the unifi—
cation of the national market and its expansion into the
wider export market has been achieved in many sectors,
particularly in those engaged in induStrial activity. In
the agricultural sectors, however, some fragmentation still
seems to exist. The sophisticated marketing requirements
of supermarkets and chain stores, (which handle large part
of food retail distribution in Puerto Rico) and of hotel,
restaurants and other institutional outlets, does not match
the limited facilities and know-how of the small farmer
engaged in vegetables, fruit and other staple food produc-
tion. Hence, these outlets do not provide a market for
the small farmer, forcing them to sell in fragmented mar-
kets, competing among each others, at very low prices that
discourage expansion of production. Moreover, occasionally

the industrial establishment, oriented to the export market,

246

takes advantage of the existing opportunities to sell
part of their output in the local market, forcing unneces-

sary imports.
6. The reduction of dualism in the economy.

Economic dualism has been interpreted as the exis-
tence of an economy organized in two parts, structurally
and behaviorally so different that they deal with one an-
other almost as though they formed two different societies
and economies. A narrower interpretation of dualism views
it as the existence of wide disparities between the returns,
(net of taxes) to factors of production within the national
economy. The existence of large amounts of surplus labor
with disguised unemployment may be interpreted as a form
of this type of dualism, since the marginal product of

labor in this situation is very low.

Dualism in the first sense has been non-existent in
Puerto Rico for a long time. Some dualism in the second
sense may still be present although it has not been measured.
However, its existence is suspected from the indirect evi-
dence examined. The outflow of labor from agriculture has
been rapid while labor absorption in industry has been
moderate. Service sectors have provided the bulk of new
jobs and, although it seems that much of the employment
has been demand induced productive services, some increase
in supply-induced low productivity employment is suspected.

considering the sharp increases in government and trade.

247

These sectors have traditionally accomodated surplus labor

in different forms of disguised unemployment.
7. The emergence of self-reinforcing growth.

Self-reinforcing growth is a condition for self-
sustained growth. It requires the generation of sufficient
domestic savings, both private and public, to support a
significant part of the domestic investment; and the gen-
eration of an adequate internal demand so as to maintain
an adequate stimulus to growth within the local economy,

even when foreign demand is an important engine of growth.

Total investment in Puerto Rico grew at a very fast
rate up to 1972 in accordance with the fast rate of econ-
omic growth. A large and increasing portion of this in-
vestment was in construction, about two-thirds of it to

provide economic development infrastructure.

External capital from the United States, both debt
and equity, was the main source of investment funds and its
importance steadily went up. Domestic savings were low
and largely offset by dissavings. Above normal levels of
private consumption kept net private savings negative or
insignificant and public savings have been decreasing as
employment in the public sector has risen rapidly. Uni-
lateral transfers from the United States have been another
important source of financing to close the deficit in the

trade balance. The rapid increase in capital inflows has

248

generated a fast outflow of factor payments; these have
been pointed out as a problem for the Puerto Rican economy
as it is feared that debt servicing may become an unbear-

able burden if the capital is not put into profitable uses.

Puerto Rico's dependence on external demand has been
high, which is normal in a small economy that has oriented
its development to industrial exports. The study of the
structure of production made evident that this dependency
has been somewhat lessened as it showed that the export
induced output decreased relative to total output. The
analysis also showed the capability of the economy to take
advantage of increases in internal demand for intermediate
input. It was found that the change in final demand
explained most of the increases in output, employment,
exports and imports between 1963 and 1972. The effect of
the change in the structure of production on the increase
in output was very small and in the case of employment
its effect was generally negative. For exports and imports,
although relatively small, the effect was not negligible
as one-fourth of the increase in these economic variables
was explained by change in the structure of production.
Most of the output and employment increase explained by
change in demand originated in the service sectors, activ-
ities where the influence of external demand is the small-

est.

249

Conclusions and Recommendations

 

The evidence examined above leads to the follow-
ing conclusions, recommendations and suggestions for fur-

ther research:

1. The Puerto Rican economy has been altered in
accordance with the transformation expected in a success—
ful economic development effort. The economy shifted from
its dual condition into a modern, well integrated indus-
trial economy capable of sustained growth, by developing
the flexibility to apply innovations and to respond to chang-
ing economic conditions. The dynamic force in this trans-
formation has been industrialization, under the auspices

of private investment geared to export market.

2. Economic growth in Puerto Rico is not self-sustain-
ing as the economy is very much dependent, directly and in-
directly, on external economic conditions. This dependence
is particularly conspicuous in the strong influence of
external trade and the increasing need of external capital

to continue the growth momentum.

However, the concept of self-sustained growth must
be qualified when dealing with a small economy such as the
Puerto Rican. The degree of acceptable "self—sustenance"
is not the same for all countries and varies inversely with
size. But even for large continental countries it should
not be interpreted as self-sufficiency. The small size

of a country limits its domestic market and the availability

250

of resources, so that openness to trade is needed to in-
crease the productivity of the existing resources by en-
hancing the economic benefits of specialization and econ-
omies of scale. Thus a high ratio of foreign trade to

GNP is a necessary condition in such countries for a trans-
formed high growth economy. Self-sustaining growth in
these circumstances becomes an issue of incorporating

into the local economy as many elements of self-reinforc-
ing growth as possible, so that vulnerability to external
fluctuations is lessened and also flexibility is added

for a quick adaptation to changing opportunities.

The large dependence on foreign capital is also
typical of the small economy. It should not be a cause of
concern as long as the incoming capital is put into profit-
able uses that create the condition for future repayment.

To assure this, it is crucial that the profitability test

be among the investment criteria used to attract private
investment,by way of incentive,(which may alter the con-
ventional commercial criteria) and in the selection of public
projects to be financed with debt capital. However, it is
important that in these decisions social profitability

not be neglected, that is, a profit concept that takesinto
consideration all the benefits and cost of the proposed
investment. The comparison of private and social profit
should guide policy decisions to structure a system of taxes

and subsidies, if necessary, to attract the vital investment

251

and to distribute equitably the rewards and costs among

those benefitting from the investment.

The insignificant level of net private savings in
Puerto Rico should be a cause of concern. An adequate
balance between foreign and local ownership of the means
of production is desired to improve the stability of the
system. Moreover, it is reasonable to expect that some of
the riches produced in the system be reinvested to generate
future growth. Special emphasis should be placed on
mechanisms to stimulate domestic savings and to channel
them into productive investment. Both considerations are
crucial to assure an adequate flow of domestic investment.
This emphasis, however, does not mean a call to discourage
external envestment which has proven to be a valuable

promoter of growth in Puerto Rico.

3. The increased domestic integration of the Puerto
Rican economy indicates positive steps toward self-rein—
forcing growth as it reflects a growing internal demand
for intermediate input, which constitutes an additional
stimulus for domestic production. The effort to bring
more integrated industries to the domestic economy, which
means taking into consideration the feedback effects of
the prospective investment, should continue to receive
attention among the investment criteria. This emphasis,
however, should complement, not substitute, for the profit-

ability criterion which is basic in optimizing decisions-

252

A profitable investment should be preferred; but even
better would be those that through feedback effects help
to increase the profitability of other enterprises,
existing or potential. Both effect should be summed to
establish the social profitability of the investment
project. From this point of view, a project with lower
private profits could be preferred if the feedback effects
were large enough to bring its social profitability above
that of other investment; and if an appropriate mechanism
of taxes and subsidies can be implemented to redistribute

the benefits and cost in an acceptable manner.

The linkage index used in this study by itself does
not provide such an investment criterion. Nevertheless,
it helps to identify sectors where these indirect benefits
are possible and to single them out for further investiga-
tion; and establish the social profitability of specific

enterprises in the sector.

4. The increased integration resulted in a consider-
able amount of import substitution in intermediate input.
This consequence of integration, which has been so far
mostly spontaneous, should be actively pursued in the
development strategy. This emphasis, however, should not
be a substitute for export promotion but its complement.

It should aid to bring into the island those links of the
production chain which could be locally produced at com-

petitive prices. This requires an integrated approach to

253

industrial promotion in which a whole production complex

is studied at once and strategic missing links can be
identified. The linkage analysis could help in this in-
vestigation. Again, profitability considerations should
not be neglected and under no circumstances should firms

be promoted at the cost of eroding the competitive position

of already established export oriented firms.

5. Moderate labor absorption in the industrial
sectors has limited its contribution to decreasing the
persistent unemployment in Puerto Rico. The labor absorp-
tion in industry is due to large labor saving adjustments
induced by increasing wages, on the one hand, and upward
price inflexibility arising from the price-taker condition
of the Puerto Rican producers in the export market due to
strong competition from Asian producers, on the other.
This pattern has affected primarily the more labor intensive
firms producing bottom—of-the-line operation for United
States firms. This low level branch-plant operation forms
part of a very competitive system where entry is easy and
orders can easily be shifted from one source of supply to
another. Thus prices are rigid and only low labor cost
suppliers can survive. This condition is likely to con-
tinue in the future as wages continue to rise and other

firms are affected.

To cope with this situation the promotional effort

to attact export oriented industry should continue to be

254

concentrated, as in the last few years, in light modern
manufacturing that can afford to pay higher wages without
losing its competitiveness in the United States market.
Since these relatively labor intensive industries require
more highly skilled 1abor,strong public support should be
given to training programs that assure a better supply of
labor with adequate skills. This requires a better
coordination between vocational education and industrial
development needs, a coordination which up to the present

has been minimal.

Moreover, the incentive structure of promotion
should be gearmito the establishment of higher product
lines rather than in bottom-of-the-line operations,
preferably of established brand names, which are less
affected by foreign competition. Attempts to retain in-
dustries no longer competitive, by holding wage increases
below those justified by changes in the demand for labor,
should be discouraged. No wage freeze could begin to match
the long run labor costs of competing Asian producers in
very labor intensive industrial goods. Moreover, a low
wage policy leads to stagnation as it undermines incentive
for labor savings (productivity increasing) technological
improvements. However, labor cooperation on keeping wage
increases moderate so that labor savings could be minimized,

should be encouraged.

255

6. The prominent role of the service sectors in
absorbing new and shifting labor will continue to be
crucial, given their considerable labor absorption. The
importance of these sectors is such that in Puerto Rico,
for both employment and output creation, it is essential
to design policies which consider them not as a residual,
but as a sector which would promote economic development.
An exhaustive study is needed of the demand and supply of
services, to establish the proper role of this sector in

economic development.

Information is needed about the derived demand for
services, that is, ones that are dependent on income and
industrial expansion, and about the capability of the
economy to make available services that could satisfy this
demand. Special attention should be given to sectorswhere
expansion is warranted. Also to be explored, is the pos-
sibility of expansion of services that may substitute for
the consumption of durable goods not producted in Puerto
Rico. An example of this avenue is the expansion and up-
grading of maintenance services that could delay the
replacement of durable goods such as automobiles, refriger-
ators, ranges, television sets, furniture and others, by

prolonging the useful lives of the existing stock.

Information is also needed on autonomous services
which are those that have the potential for independent

growth. Puerto Rico already has one such industry in

256

tourism, an activity whose performance has as yet been
below its full propulsive potential. This industry has
been plagued lately by unused capacity built to accomodate
high income tourists. Traffic in this area has fallen off
since the immediate years after Cuba was closed to tourist
traffic. The potential of a lower income tourist market
should be determined and the necessary conditions to make
the existing capacity suitable to this market should be
established. This transformation of the tourist industry
seems possible with low investment and high benefits through
direct and indirect employment, output, and income crea-

tion.

The study of the service industry should also
establish the magniture of residual Service activity, that
is, those supply-induced services that appear in the economy
to accomodate surplus labor in various forms of disguised
unemployment. The residual service employment which does
not have negative implications should be tolerated until
more productive uses are found for these resources. Those
with negative implications, such as public employment
expansion that divertppublic funds from more productive

investment, should be discouraged.

7. For the reasons given above, it seems that
persistent unemployment in Puerto Rico will not diminish
significantly in the coming years (relative to the levels

existing before the unemployment surge in the latest

257

recession. However, it is possible that the actual employ—
ment figures do not give a true picture of the unemployment
situation. On the one hand, there are people outside the
labor force, because they were discouraged by their un-
successful effort to find employment, who are willing and
able to work. On the other hand, people are classified as
unemployed in order to qualify for food stamps and unemploy-
ment benefits. They are not actively looking for a job
which would offer a salary income not much higher than the
income received from the social assistance programs. Some
are employed in informal service activities,which are some-
times very lucrative, that are not reported in the statis-
tics. Research is needed to determine the magnitude of
these two opposing forces, and thus establish the true
unemployment level. These corrected figures should be the
ones on which the employment policy of the development

program is based.

8. The reconstruction of the agricultural sector
should be given high priority in the development strategy,

in a complementary relationship with the industrial activity.

The reactivation of agriculture has a big potential
for job absorption, given its large labor requirements;
and for output and income stimulation, given its large
multiplier impact (due to large requirement of intermediate
domestic input) and its potential for import substitution

of food products. Although in relative terms foodconsumption

258

has decreased, in absolute terms it has increased sub-
stantially while agricultural output has declined. Thus,
food imports have risen considerably, providing about
four-fifths of total food consumption. The application of
the food stamp program to Puerto Rico has increased still
more the demand for food, especially vegetables, fruits,
and sources of animal proteins, increasing still more

the dependence on imports.

A recent study showed that the agricultural sector
has the potential to supply a considerable part of the
domestic market.2 Some subsectors such as poultry, milk
and livestock have already increased their production,
although not so far as to cover substantially the local
needs. In food and vegetable production progress has been
negligible. The study also showed that agricultural pro-
duction in Puerto Rico is not yet limited by the absolute
scarcity of land, but rather by the unproductive use of
available land, insufficient capitalization, the inability
of existing agricultural activities to pay high enough
wages, the inflexibility in moving from traditional

crops into those whose demand and prices has increased,

 

2"Realidades Puertorriquenas Asociadas con la
Agricultura y el Desarrollo Agricola." Report by the
Department of Agriculture of the Commonwealth of Puerto
Rico, 1975 (mimeographed).

259

and by marketing and distribution deficienities.

Revitalizing agriculture will require an integrated

approach in which agriculture is treated as a complex

process from the initial stage of land and capital acquis—
ition up to the last stage of distribution for final con-
sumption. Crops that promise a large return for the farmer
should be singled out and any obstacles to making these
returns obtainable should be determined. Three links
between land acquisition and successful marketing that
represent significant constraints should be given special

attention. They are: long-term financing with amortiza-
tion schemes that will allow the farmer an adequate level
of consumption in the short-run, risk reduction through

crop insurance, and an adequate distribution system which
will assure the farmer a reasonable return from the price
paid by the final consumer. Furthermore, an adequate
mechanism should be established to facilitate the transfer

of the land now in unproductive use into the hands of those
willing and able to engage in a profitable new agriculture.
Badly needed technical assistance should also be provided.
Family size farms and agricultural activites not intensive

in land use should be given preference to assure an adequate
supply of labor and a better distribution of social benefits

among the population. Several family farms could be grouped

260

in a production complex through which those operations

requiring a large scale to be efficient, could be provided.

APPENDIX

APPENDIX A

DEFINITIONS OF VARIABLES AND THE SOURCE OF

DATA FOR THE REGRESSION EQUATIONS

The definitions of economic variables in the
Chenery and Syrquin study were based on the Standard Inter-
national Classification System1 (SICS) of the United
Nations and specialized agencies. They were interpreted
and applied to Puerto Rican data as follows:

1. Gross national product. GNP, at constant
factor cost (in millions of U.S. dollars), is the value of
gross national product, excluding indirect net tax subsi-
dies, to minimize the possible distortion effect of differ—
ing tax policies on relative country ranking. For Puerto
Rico, this value was taken as equivalent to the net income
plus depreciation, as defined in the national accounts,
both in constant 1954 U.S. dollars. The value obtained
was divided by the population to express it in per capita
terms as required by the regression equations.

2. Papulation. The data are midyear estimates

published by the Puerto Rican Planning Board.

 

1United Nations Statistical Office, International
Standard Industrial Classification for all Economic Activi-
ties, Statistical Papers, Series M, No. 14 rev. (New York:
United Nations, 1968), and United Nations Statistical
Office, Standard International Trade Classifications, Sta-
tistical Papers, Series M, No. 34 (New York: United
Nations, 1961, rev. ed.).

261

262

3. Gross domestic investment as a percentage of
‘QQP. Gross domestic investment, valued at current market
prices, consists of gross domestic fixed investment plus
the increase in stocks in both private and public sectors.

4. Gross domestic saviggs as a percentage of GDP.
Gross domestic savings includes gross domestic investment
at current prices, plus export of goods and nonfactor
services, less imports of goods and nonfactor services.
Transfers in all categories are excluded.

5. Capgtal ipilow as a pprcentagp of GDP. This
is equal to total imports of goods and services less
total exports of goods and services. Factor payments and
transfers to and from abroad are excluded from the calcu-
lation. It is also equal to gross domestic investment
minus gross domestic savings.

6. Private consumption as a percentage of GDP.
Private consumption is measured as the value at current
market prices of final expenditures by households and
private non-profit institutions on current goods and
services (not including households purchases of land and
buildings).

7. Food consumption as a_percentage of GDP.
Consumption of imported and domestically produced foods
(excluding beverages and tobacco) measured at current

purchaser's values.

263

8. Output by sector as a percentage of GDP at
factor cost. This is value added by sector, the distribu-
tions calculated on the basis of values at current factor
cost, as a percentage of GDP also at factor cost.

9. Primary output as a percentage of GDP at
factor cost. Primary production is the share of GDP con-
tributed by agriculture; including forestry, hunting and
fishing; and mining, including quarrying. (ISIC Divisions
0 + l)

10. Industrial output as a_percentage of GDP at
factor cost. Industrial output is that part of total
production contributed by manufacturing and construction.
(ISIC Divisions 2 - 4)

11. Service output as a percentage of GDP. Services
contributed by the wholesale and retail trade; banking,
insurance, and real estate; ownership of dwellings; service
industries such as education, medicine, and recreation;
public administration, and defense; and other branches else-
where classified (ISIC Division 6 + 8 - 81). This excludes
utilities such as electricity, gas, water, transportation
and communication.

Value added for agriculture and mining, as given by
Puerto Rican national accounts, was taken as an approxima-
tion of agricultural output in Puerto Rico. Likewise, value
added in manufacturing and construction was taken as indus-

trial output and value added in service industries, as the

264

service output. The Puerto Rican national accounts classi-
fication is close to the 1510 classification. GDP at
factor cost, which is required for this calculation, was
approximated, adding domestic income plus depreciation.
Domestic income is the total payments to factor payments
including factor payments to and from abroad.

12. The labor force by branch total. This repre-
sents the total number of economically active persons as a
sum of those in the various branches of economic activity,
as defined by the ISIC. In the Chenery and Syrquin study,
the percentages were calculated for the total labor force,
i.e., the employed and the unemployed. However, in this
study they are approximated using employed labor only, since
data on the unemployed by economic branch were not available
for all the years.

13. Share of primary labor. This includes all
persons employed in agriculture, forestry, fishing, hunting,
mining, and quarrying.

14. Share of industry labor. Included here are all
persons employed in manufacturing and construction.

15. Share of service labor. All persons employed
in all other sectors.

16. Exports as a percentage of GDP. Exports of
goods and nonfactor services is the value, at current market
prices, of merchandise (f.o.b.), transportation, insurance,

and other services sold to the rest of the world, not

265

including factor payments from abroad (i.e., payments
accruing to domestically owned factors of production oper-
ating abroad, which represent the claims of domestic resi-
dents on the GDP's of other countries).

17. Primary export agga percentage of GDP. The
classification of primary exported goods includes products
contained in the U.N. Standard Industrial Trade Classifi-
cation (SITC), sections 0 to 4, excluding certain processed
food products, alcoholic and nonalcoholic beverages and
products of petroleum refining, which are included in
industrial exports.

18. Industrial export as a pgrcentgge of GDP.
Exported industrial output includes products in SITC;
section 5 to 8, plus the products in section 0 to 4
excluded from the agricultural classification.

The value of primary and industrial exports for
Puerto Rico were obtained from the external trade statis-
tics published by Puerto Rico's Planning Board.3 These

statistics follow closely the SITC classification.

 

2The classification of goods as primary and manu-
factured follows the definition prepared at the request
of the Special Committee on Preferences set up by the
Secretary-General of the United Nations Committee on Trade
and Development (UNCTAD) entitled, lpe Definition of

Primary commodities, semi-manufactures and manufacturgg
CTD/B/C.2/3).

3External Trade Statistics (Puerto Rico: Junta
de Planificacion, years 1955, 1958, 1963, 1967, and 1972).

 

 

266

Products in SITC groups 0 to 4, but not belonging to ISIC
divisions 0 and l, were the ones excluded from the agri-
cultural class and brought into the industrial classifi-
cation.4 Total exports were calculated by subtracting
from total exports, wages and other factor income received
from the rest of the world. Both figures obtained from
Puerto Rican national accounts.

19. Imports as a percentage of GDP. Imports of
goods and non factor services is the value, at current
market prices, of purchases of merchandise (f.o.b.),
transportation, insurance, and other services from the
rest of the world, not including factor payments abroad.
For Puerto Rico total imports were obtained by subtracting
from total imports factor payments abroad as reported in
Puerto Rican national accounts.

The data used to calculate the values of the dif-
ferent variables for the chosen years were obtained from
Puerto Rico Incoggiand Product, 1975, and from various
issues of Theigconpplngeport to the Governor. The data

on exports and imports by industries was obtained from

 

4The exclusion was made using as reference the
United Nations Statistical office, Classification of
Commodities byilndustrial Origin: Relationship of the
Standard International Trade Classification to the
International Standard Industrial Classification,
Statistical Papers, Series M. No. 43 (New York: United

Nations, 1966) to identify these products.

267

_§§ternal Trade Statistics (various issues). These are

 

publications of the Puerto Rican Planning Board.
In Table A-1 are shown the regression equations

used to obtain the normal expected values for each variable.

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