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Things in Puerto Rico are getting really bad: What you need to know

Construction workers make repairs to a street in Old San Juan, Puerto Rico, in May. (Susana Gonzalez/Bloomberg)
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Alejandro García Padilla, the governor of Puerto Rico, is expected to say publicly Monday afternoon that the government of the island territory cannot pay its debts. The consequences could be serious both for the island and the rest of the United States. If you're trying to catch up on Puerto Rico and how it accumulated so much debt, we have you covered below.

What is Puerto Rico?

It's an important question. The Commonwealth of Puerto Rico is not a state, but it's been under the control of the United States since the Spanish-American war in 1898. It's an island in the Caribbean, southeast of Florida and east of Cuba and the island of Hispaniola, which is where Haiti and the Dominican Republic are located. The population is 3.7 million, which is about as many people live in Oklahoma.

What's the economy like?

Not so great. While the rest of the country has been recovering from the financial crisis, things in Puerto Rico keep getting worse.

The chart, taken from a new report commissioned by the island's government and issued Monday, shows that Puerto Rico has been doing worse than the rest of the country for the past 15 years. The economy began to contract in 2007, a couple of years before the economy collapsed on the mainland.

It's no surprise that people have been leaving Puerto Rico if they can. The population is declining at an alarming rate of 1 percent per year.

What's wrong?

Puerto Rico's problems aren't just a result of the financial crisis.

First of all, Puerto Rico is an island. As on any island, stuff is just more expensive there. Yet because of an obscure law known as the Jones Act, which bans foreign vessels from shipping goods between U.S. ports, businesses in Puerto Rico have to use the U.S. merchant marine to import anything. They can't just hire whatever boats and crew are available, which makes shipping even more expensive. The cost of transportation in Puerto Rico is twice that in the neighboring Caribbean nations, according to the report, which was written by economists Anne Krueger, Ranjit Teja and Andrew Wolfe.

The economists also note that the past decade's high oil prices have been hard on the island's economy, which relies on imported fossil fuels for power. A kilowatt-hour of electricity costs 22 cents, which is more than twice the average rate of 10 cents in the United States as whole.

For decades, Puerto Rico’s economy was powered by U.S. firms, particularly shoe factories and pharmaceutical firms. These companies set up factories that hired relatively low-cost workers and book profits under favorable tax laws.

Some economists say that the island's recent troubles began when a lucrative tax credit for manufacturers that was helping to prop up the economy was phased out in 2006.

Another problem is that just 40 percent of the population has a job—or is even looking for one. That figure has plummeted in recent years. In the United States as a whole, it is 62.9 percent.

Why are so few people working or looking for work?

The report cites one surprising problem: the federal minimum wage, which is at the same level in Puerto Rico as in the rest of the country, even though the economy there is so much weaker. There are probably some people who would like to work, but because of the sickly economy, businesses can't afford to pay them the minimum wage.

Someone working full time for the minimum wage earns $15,080 a year, which isn't that much less than the median income in Puerto Rico of $19,624.

The report also cites regulations and restrictions that make it difficult to set up new businesses and hire workers, although it's difficult to know just how large an effect these rules might or might not have on the labor market.

A report by the New York Fed also suggests that Puerto Rico has a relatively large underground economy employing a big part of the population. These workers aren't taxed or counted in formal employment numbers.

In any case, it's relatively expensive to hire and pay workers in Puerto Rico, which along with the high cost of transportation, energy and other goods, means that fewer tourists are planning trips to Puerto Rico than they were a decade ago and the number of hotel beds is the same as it was four decades ago, according to Krueger and her colleagues.

What has the government tried to do about it?

The economists have some harsh words for the government on this point. They write that if anything, the government has made things worse by regularly spending more than it gets in tax revenues.

For 15 years, the government has consistently made unrealistic assumptions about how much it will collect in taxes, given the weak economy, the economists write. In the middle of each year, government agencies are ordered to make do with less, but they rarely comply. Instead, they carry on with business as usual, and the government is forced to borrow more.

Already, the government often doesn't pay its bill immediately, according to the report.

Given its desperate need for cash, the government has gotten into some bad habits, Krueger and her colleagues write -- like negotiating with citizens who evade taxes to get them to pay and granting businesses fat subsidies to locate on the island, The result is that fewer taxpayers and investors seriously believe the government will make them pay all of what they owe.

The result is some $72 billion in debt, which García Padilla said he doesn't think the commonwealth will be able to pay. The uncertainty around that debt is just another reason for businesses and investors to keep their money out of Puerto Rico, and for people who think they can get a job on the mainland to leave.

Gov. Alejandro García Padilla wants to restructure Puerto Rico’s $73-billion debt under the U.S. bankruptcy code. (Video: Reuters)

What happens now?

It isn't clear. The laws determining who would get paid first if the island goes bankrupt are ambiguous. That $72 billion includes debts owed to retirees with public pensions as well as to firms on Wall Street that have loaned their client's money to the commonwealth.

The Puerto Rico Electric Power authority has a $400 million bill coming due July 1, which it might not be able to pay. Other public agencies could run out of cash this summer as well, in which case the government would shut down.

Should Americans on the mainland worry?

For one thing, Wall Street might hesitate to lend to money cities around the country. A huge mess in Puerto Rico after smaller bankruptcies in Detroit and other cities might suggest to some investors that loaning money to local governments in this country isn't always a safe bet -- and that would make new roads, new schools and other projects more expensive.

Ordinary investors could also lose money, since Puerto Rico's bonds are widely held. By one recent estimate, three out of four municipal bond funds held island debt. Those funds won't be worth as much if the debt isn't paid.