Comparative Analysis Between Puerto Rico And Rupublica

Dominicana Essay, Research Paper

The first economic evaluation for this class was on the

Commonwealth of Puerto Rico. In keeping with the Caribbean theme,

the country that was selected for comparison was the Dominican

Republic. The policies that will be examined are privatization policies and corporate acquisition/merger policies in the two nations. In order to provide a quality analysis of the two countries economic policies, a general description and basic comparisons of the two nations are provided.

Geographically, the Dominican Republic (48,730-sq. km.) is

much larger than Puerto Rico (9,104-sq. km.)[Puerto Rico][Dominican

Republic]. For a more tangible perspective on size, the Dominican

Republic is twice the size of New Hampshire and Puerto Rico is less

than three times the size of Rhode Island [Puerto Rico][Dominican

Republic].

The two nations are climatically identical. They both have

tropical marine climates with little seasonal temperature changes.

The two also have natural resources of metals with Puerto Rico having

the potential for oil mining.

The Dominican Republic s population (over 7 million) is bit less than double the amount in Puerto Rico (about 3.8 million)[Age

Structure][Dominican Republic]. Their birth rates are similar as well

but the Dominican Republic s is slightly higher.

Culturally they share similar backgrounds. Both countries

have Black and Hispanic origins and the official language spoken in

each is Spanish. They also share Roman Catholicism as their

dominant religion.

There are vast differences in each country s economy. Puerto

Rico has one of the best economies in the Caribbean; being the only

island in the region where its industrial sector has surpassed the

agricultural sector as the primary source of income. The Dominican

Republic still has heavy emphasis on agriculture and the economy

relies heavily on trade. Tourism is very big and lucrative in Puerto

Rico, and the Dominican Republic has only recently begun to

increase its importance. Puerto Rico has a very strong, reliable and

productive work force while the Dominican Republic fights with both

underemployment and unemployment. Lastly, Puerto Rico has the

U.S. dollar for currency and the Dominican Republic has the

Dominican Peso. The exchange rate as of March 1996 was $13.50 D.

Peso per U.S. $1 [LatinFinance, March 1996].

In terms of legislation, Puerto Rico s has been shaped by the

United States and is based on the Spanish Civil Code while the

Dominican Republic s structure is based on the French Civil Code.

Both countries are democratic in nature but the Dominican Republic

has more political parties. Universal suffrage is at age 18 for the two nations but although Puerto Ricans are U.S. citizens, they are unable to participate in the United States presidential elections. Dominican Republicans can also receive suffrage if married before 18 but members of the armed forces and police cannot vote.

Privatization Policy

To understand the history of state ownership and privatization

in Puerto Rico it is important to know certain basic facts about them. Its history has strongly influenced its economic existence and

position regarding public/private ownership.

Puerto Rico s unique social, economic and political

circumstances distinguish its privatization capabilities from others in Latin America. The island is tied to the U.S. both economically and politically. Puerto Rico was officially part of the U.S. in 1898 and their people have been U.S. citizens since 1917. Although being an U.S. citizen has great international benefits, there has been a

constant struggle with the U.S. to become independent. It was not

until 1948 that the people of Puerto Rico received the power to elect

their own governor. Although still part of the U.S., Puerto Rico s chief of state is the President of the United States and everyone is

protected under the U.S. Constitution as well as Puerto Rico s own

constitution which was adopted in 1952. Since that time Puerto Rico

has become unofficially self-governing.

Businesses that were state owned in Puerto Rico have just been

utility and other public service companies and facilities that

contribute towards the industrialization of the island. The start of

state ownership was due to the consolidation and operation by the

government of electrical power, water, and sewer facilities during the

early to mid 1900 s.

Puerto Rico had not been a primary sector economy (sugar

cane) since the 1940 s. From that point, manufacturing has been its

main industry. The industrialization of the island began in 1942

when the Puerto Rico Industrial Development Company was created.

This commenced a program of state ownership of factories for the

manufacturing of glass, cardboard, shoes, ceramics, and cement

[LatinFinance, Jan.-Feb. 1993]. The only successful state-run

business was the cement business. Consequently, most of these

factories were sold to local businesses and thus spawned privatization

of government business.

With the industrial era came changes that assisted in its

maturation like the creation of tax breaks and incentives, and projects that attracted private investment. These strategies focused towards businesses in the U.S. Tax benefits existed such as Section 936 of the U.S. Internal Revenue Code which permitted subsidiaries of U.S. companies to operate in Puerto Rico and repatriate their earnings

entirely free of U.S. tax [ Puerto Rico Firms Carve Post-936 Strategies].

Minimal changes have been made in policies that affect state

ownership. This does not mean there were not any major acquisitions

of private companies by the government. They just were not in

association with a government policy. If the government made an

acquisition, it was for the intention of ensuring job protection or

heightening services made available to the mass public. In 1993,

government was the third largest sector of the economy, which was a

significant amount of GDP and total employment [LatinFinance,

March 1994]. Government purchases included the Puerto Rico

Telephone Company and the main shipping lines serving Puerto Rico

which were bought in the 1970 s. The shipping lines were later

distributed to the Puerto Rico Maritime Shipping Authority. Other

notable acquisitions made by the government in the recent past

included being the sole operator of the sugar and pineapple industry

of the island.

The Puerto Rican government also owned businesses in

competitive industries like hotels and fruit processing. It was also

providing services in competition with other enterprises such as

construction and the operation and maintenance of housing/penal

institutions, operations of tourist attractions, medical and insurance

services, hospitals, and service administration services. The

government also operated a plant that processed excess milk products

into dairy products too.

A privatization program was never formally adopted but a

movement gearing towards privatization had been in effect. In 1992,

the Puerto Rican government sold a company that handled overseas

telephone operations to Telefonica de Espana, but maintained a

minority interest in the enterprise. Also at this time legislation was passed allowing the construction of public works (bridges, highways, etc.) by private enterprise. In addition, negotiations took place with private companies that provided co-generation facilities to the Electrical Power Authority, and private operators for the main truck lines of San Juan s Metropolitan Bus Authority. It was also decided that the utilities would be privately contracted at the management level. There was not a specific schedule or order of privatization in regards to any government business.

The present government, which came into power in 1993, had

intentions to take government out of business by privatizing all

government businesses except basic utility services like power

generation and distribution, water and sewer, and basic telephone

communications services. The initial goal was to disown businesses

that competed with private enterprises and allow the private sector to

run these operations more efficiently. This was the primary

motivation of privatization.

In 1994, Governor Pedro Rosello established a goal to reduce

the government s share in total employment and GDP to less than

15% by allowing the private sector to undertake incremental

investment in infrastructure and services, and by transferring certain

government activities and institutions to the private sector

[LatinFinance, March 1994]. To assist in the government reaching

this goal, the Puerto Rico Privatization Task Force was established. Its basic role was to coordinate the privatization of government owned

businesses in competitive markets and promote private ownership of

these enterprises. It consisted of leaders of government agencies and

public corporations. The integral players involved in this group are

the Secretary of Treasury, the President of the Government

Development Bank for Puerto Rico and the Executive Director of the

Task Force.

Although the main goal of the task force is privatization, it is actually just a piece to a bigger puzzle to restructure the

government s activities and responsibilities. The government s role is switching from provider of the island to facilitator. This shift provides a long-term stable economy as opposed to just focusing on one

aspect- the quick fix.

The Government Development Bank for Puerto Rico (GDB) also

is an essential player in the government s efforts to privatize. It not only maintains fiscal stability of the government but also assists the government and private sector in the privatization program by assessing and negotiating proposals to make sure the government gets the best deals.

Looking at the basic objective of the Privatization Task Force, privatization is viewed as the sale of business in competitive

industries, greater involvement in government services by the private

sector, a reorganization of government structure and the revision of

the rules and regulations that affect both government and private

sectors. Based on these four objectives, the task force identified the businesses that it felt needed to be sold to allow the government to reduce its spending so that it may distribute its resources to more

traditional public responsibilities (i.e. health care, education,

housing, drug prevention, job training, etc.):

- Puerto Rico Maritime Shipping Authority: the main shipping line

servicing Puerto Rico and the U.S. The GDB finalized the sale to BT

Investment Partners, Inc., a subsidiary of Bankers Trust in March of

1995. This was purchased for $29.5 million in cash and assumed

$102.9 million in leases and other liabilities. The government

assumed responsibility for approximately $283 million in outstanding

indebtedness from the previous twenty years [Westland, R.].

-Pineapple Operations: one pineapple canning plant is the sole

producer of pineapple products in Puerto Rico. The land used for

growing the fruit is included in the deal. The products are produced

under the Lotus brand. Terms are in negotiations with bidders.

-Sugar Corporation: This is comprised of four sugar mills and one

sugar refinery. This too is the sole provider of refined sugar for the Puerto Rican market. Since the 1970 s, the government has been

operating at a loss. This sale is currently being negotiated.

-Hotels: there are seven government owned hotels located in

different parts of the island. However private companies manage

these. One hotel, the El Convento in Old San Juan, has been sold.

Others are in negotiations.

-Highways and Bridges: legislation was passed in 1990 to improve

the ground transportation facilities (highways and bridges) and to

allow the Highway Authority to enter into contracts with private

businesses for the construction, maintenance and operation of these

facilities. The island s most visible symbol of privatization is the

Teodoro Moscoso Bridge that was built in 1994 at a price of $83

million. Ninety percent of it was financed by tax-exempt special

revenue bonds issued by the Puerto Rico Highway and Transportation

Authority and ten percent with private capital from the Autopistas de

Puerto Rico (APR). APR is a partnership of local and foreign firms,

one of Europe’s largest construction firms and Puerto Rico s largest

contractor. The bonds are being repaid from toll revenues [Paretta, E.]

-Telecommunication Facilities: the telephone manufacturing

facilities as well as the cellular phone company are both government

owned and are for sale.

Dominican Republic s distribution of property that is state or

privately owned can also be explained looking at history. In the

1970’s, Latin America went through a movement advocating state

ownership of industry. By mid 1980 s most of the governments in

Latin America believed that financial stability and low levels of

inflation were necessary to spark investment and economic growth;

marking privatization as the means to achieve this desired prosperity. Therefore, some countries directed their efforts towards privatization. Unfortunately, the Dominican Republic did not follow that school of thought. The government owned a sizeable amount of companies but it was more due to the dictatorship rule of Rafael L. Trujillo than economic policy.

With a dictatorship government, the ruler or dictator controls all aspects of the government and the lives of the people. Thirty years of dictatorship rule in the Dominican Republic ended in 1961 with the death of Trujillo. After his death, the government confiscated Trujillo s estate, which totaled 56 commercial and industrial companies accounting for a substantial amount of the assets of their country. The state became the majority shareholder in 35 companies and the minority shareholder in 18 others. As of 1993, companies owned in full or in part by the government generated forty percent of the GDP of the Dominican Republic [Guerrero, C.].

The commercial enterprises were liquidated leaving the

industrial companies which formed three governmental organizations

in 1966: the Corporacion Dominicana de Electricidad (CDE), which is

the state electric utility company; the Consejo Estatal del Azucar

(CEA), which is the sugarcane company; and the Corporacion

Dominicana de Empresas Estatales (CORDE), which is the holding

company for the state owned enterprises.

The previous governmental policies and the change of rule

definitely caused the country to be in debt and economically

inefficient. Yet, despite the knowledge that other Latin American

countries had taken steps to incorporate industrial policies, the

Dominican Republic did not officially direct its efforts towards

privatization. During the 1980’s, the CEA relinquished some of its

land to diversify from the sugarcane industry. An example would be

Dole Dominicana, S.A. that gave up a pineapple plantation in order to

plant African palm trees. This contributed towards a joint investment

project of the CEA and a private enterprise in building a free zone

park.

In 1990, the President of the Dominican Republic, Dr. Joaqun

Balaguer, had expressed support of privatization. Meanwhile the

country did not implement a formal program. In fact, some state

owned businesses were forced to shut down due to financial

struggles, with many others in serious debt.

In addition to the president s support, two other factors

encouraged this school of thought. One factor was the Stand-By

Agreement with the International Monetary Fund (IMF) signed in

August of 1991. This was a letter of intent for a new agreement sent

by the IMF that included a condition stipulating the privatization of

state enterprises. This agreement never materialized. The second

condition was the Framework Agreement with the U.S. that took place

in 1991 and included an immediate action agenda acknowledging the

need for domestic and foreign private investment.

In October of 1992, the Economic and Development Foundation

(or Fundacion Economica y Desarrollo) gave the Dominican Republic

government a privatization proposal of the government s CEA, CDE,

and some of the CORDE businesses [Guerrero, C.]. The contents of

this study were never publicly disclosed. Progress has been made in

the following Dominican Republic state companies since Balaguer s

leadership:

-CDE (electric utility): privatization has been growing since the

deterioration of the Dominican Republic government s ability to

provide sufficient service of electricity. The government signed

agreements with two multi-national corporations, Wartsila Diesel and

Mitsubishi, for the generation of electrical power. In addition, a

Spanish firm was contracted through the CDE that provided technical

and administrative support to the CDE for a year (1994-1995) in

hopes to turn things around.

The government’s last attempt to solve the problem was through

legislation. Law 14-90 was a government promotion the sale of

electricity generated by private plants and creating the National

Council of Power Development [Aristry, Dominican Republic]. This law

was later revoked by a tax code passed in 1992. Privatization is still desired for the CDE.

-Compania Dominicana de Aviacion (CDA): this is the national

airline. It was at one time a high priority on the privatization plan

because neither the airline had the necessary equipment to cover the

routes nor the funds needed to pay its debts. Fortunately, the CDA

signed an agreement in 1993 with Air Europe. This private group

operates five flights per week. It has also received an offer by the

Russian airline, Aeroflot, but nothing definite.

Included in the privatization of the national airline was the

Aeropuerto Internacional de Las Americas (AILA). This is the

country s largest airport. This achieved privatization of the ramp and maintenance services. They were bought by a subsidiary of American Airlines in 1991. Other services that have been privatized are baggage handling, ground transportation and airplane maintenance.

-Garbage Collection: this service was sold to the private company

Attwoods Dominicana, S.A., a subsidiary of a British company.

Nevertheless, the government due to problems with the company and

the Santo Domingo City Council again seized control of this service.

The mayor of the city accused the private enterprise of deception and

Mafia techniques”. Thus, the company was not paid several monthly

quotas agreed upon for garbage collection [Giraldez, J.].

The privatization process has begun in the Dominican Republic

but at a very slow, unorganized rate. It seems like it has been

occurring spontaneously, without any planning or future agenda.

Their first step towards the ability to privatize is the development of a concrete plan. Included in that agenda is a total restructuring of the government to facilitate a growing and efficient economy. This will necessitate legal reforms and regulations. Without them public monopolies will be replaced by private ones having the same

difficulties and inefficiencies.

Puerto Rico is much farther in the privatization race as well as total industrialization and development. They have both voiced a

desire for it and have instilled plans to attain it. Its future

privatization focus will be on improved lines of communication

between the public and private sectors. This governmental shift will

then allow an alternate source of capital, less responsibility for the

country s GDP status, free market competition, and increase

employment. The government will be able to focus on public and

socioeconomic responsibilities.

The Dominican Republic has only acknowledged the concept of

privatization and had signs of it without intention. They have more

constraints due to its stage of growth. The country must also reform

legislation to include the reduction of foreign investment restrictions to allow equal treatment to domestic and foreign investors, the deregulation of the transfer of public assets (currently rigid limits), and the creation of anti-trust laws that will stimulate private ownership.

Corporate Acquisition and Merger Policy

The conditions for foreign investment in Puerto Rico follow

those of the United States. Of course they are not identical, but

without certain bank policy differences, it compares with the United

States by not placing restrictions on foreign investor actions.

International investors are given the same general rights as domestic

ones.

The Dominican Republic, however, regulated foreign investors

by Law Number 861, also known as the Foreign Investment Law, until

1995. This law required foreign businesses to register themselves

with the Central Bank before official approval to invest [Mera, O.]. It also contained other regulations including a twenty-five percent limit on profits accrued from registered foreign investments, which can be repatriated [Gomez, R.]. The new law encourages greater investment in the country by allowing foreign investment in all areas of economic activity, not requiring investors to register with the Central Bank.

This law also expands the ability to withdraw funds from the country in freely convertible currency. Another enhancement is the easing of previous restrictions on technological transfer agreements.

Puerto Rico has a corporate law mandating corporations to

register by filing a sworn statement, a balance sheet, and a corporate

charter. In order to do business on the island, enterprises have to

keep business records and file an annual report with the state

department.

The only time there have been difficulties in entering Puerto

Rico was with foreign banks. Licensing requirements exist mostly for

financial enterprises. Otherwise foreign investors have minimal

barriers to entry in the market for both corporate acquisitions and

formation of new organizations. However, banks have usually been

denied applications to operate in Puerto Rico unless the bank sets up

conditions where it will contribute to the nation’s economy. Other

licensing rules are present for mortgage lenders, small personal loan

and personal property leasing companies.

Mergers in Puerto Rico are achieved through the approval of

shareholders and board of directors of each of the participating

corporations. The revamped or new corporation can be either a

domestic or a foreign business. If the surviving company is foreign, it must be qualified to do business in Puerto Rico to continue its

operation. Besides the corporate law, no other special regulations

regarding mergers exist.

Laws on acquisitions vary based on if the company acquired is

private or public. The public acquisition is a rather complicated

procedure. Looking at the process of the government who has been

attempting to sell many public enterprises it owns, the government

starts the selling process by requesting bids. That is followed by

separate negotiations with the bidders. The sale cannot just go to the entity with the highest bid. The authorization of legislature is

required. Because of the many factors that are included in the

business deal (employment levels, etc.), both delays and even denials

are likely.

The acquisition of private businesses can be done through the

purchase of stock or assets in that company. The buyer can be

anyone from a single individual to another company or business.

Only foreign corporations have to register in Puerto Rico. Generally,

the government does not play a role in private acquisitions unless the

conduct of business requires a license (financial enterprises). The

exception to this rule is with hotel operated casinos. These hotels

mandate a complete investigation by the Puerto Rico Justice

Department to ensure illegal connections do no exist.

The Dominican Republic does not place specific regulations on

business mergers besides what is listed in their Code of Commerce.

A minimum of seven stockholders is required in the starting of a

business by law. Also, there are fiscal and advertising requirements

that must be agreed upon or the merger process is terminated.

The most common mergers take place in the banking sector. In

this sector, a merger requires the union of two or more banking

organizations as a condition for the provision of multi-banking

systems. If the merger is with two bank entities, they must each have

U.S. $5 million in capital available; three or more entities require U.S. $3 million each [Mera, O.] In addition, the banks to be merged as well as the resulting bank must be identified in some kind of

documentation which contains a description of the manner in which

the merger is being done. Other minor things are needed such as

audited financial statements, business transaction records, and

stockholder meeting information.

Acquisitions in the Dominican Republic involve the purchase of

the entire stock of the corporation on sale. The agreement also

identifies all parties involved, includes the total corporate worth, the purchasers commitments as far as the new corporations liabilities and the court’s role in the case of default.

Another way of acquiring a company is to purchase the

corporate assets only. This way the purchasing party is not liable for the corporation. Buying just the assets involves organizing a

company to purchase the assets and an agreement that in case of a

purchase of a well-known company, that the name can be changed to

avoid public confusion. Once bought by way of either stocks or

assets, there are not any legal ties to publishing or recording the

transaction.

Special considerations exist in both the Dominican Republic

and Puerto Rico regarding corporate acquisitions and mergers. First,

labor laws must be reviewed and accepted. There may be difficulties

with enterprises being able to follow or adhere to the labor laws in

Puerto Rico because they are very protective of its people. Employees

are granted rights to severance, vacation, sick and overtime pay [Work

Force]. In the Dominican Republic, businesses are faced with the

employees’ ability to unionize and collectively bargain.

Taxation is another vital issue. Under the taxation code in the Dominican Republic, two percent of the value of shares assigned

trader will be retained as tax [Mera, O.]. Therefore it will be deducted from the total amount of the sale of the stock. The submission of a retention statement to the internal revenue department must follow this. In Puerto Rico, the tax laws are similar to the U.S. and control many factors of an acquisition. Concerns would be with the liabilities of the intended company, the tax base of the stock or asset being acquired and other taxes (income, excise, property, license, etc.). It should be recognized that Puerto Rico uses U.S. currency and corporations operating in Puerto Rico only have to comply with U.S. taxation on income deriving from the U.S. or connected with business operations in the United States. Puerto Rican corporations and businesses do not pay U.S. tax as well as foreign companies that do business in Puerto Rico.

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