the U.S. Treasury, so that the Section is a cost-effective instrument for promoting economic development on the Island. Puerto Rico's present and future level of economic development depends critically on the preservation of Section 936. The Economic Impact of Section 936 The enactment of Section 936 in 1976 had a strong immediate impact on Puerto Rico's economy, but it also had a more pervasive longer-term effect. The immediate impact consisted in buffering the Island's severe economic crisis of the mid 1970s, the first in Puerto Rico's modern economic history. More important, however, is the longer-term contribution of Section 936 to facilitating the transition away from light, labor-intensive manufacturing to an industrial structure characterized by the application of advanced technologies, of which the pharmaceutical and electronics industries are the foremost examples. The movement away from traditional, labor-intensive industries to high technology manufacturing processes was necessary because Puerto Rico has experienced a loss of its competitive advantage as a low labor cost site. Section 936 has been an important factor in facilitating this transition, together with the Commonwealth's own tax incentives. It is unlikely that any of the firms operating under Section 936 in Puerto Rico would have located here had it not been for the existence of the Section. The unsatisfactory trends in employment and investment since the mid-1970s would have been much worse without the growth of hightechnology manufacturing spurred by Section 936. It should be pointed out that in 1988 manufacturing was responsible for 56% of total Gross Product and 40% of Gross Domestic Product. Of net manufacturing income, 73% was produced by high-technology industries in 1988. It is also important to mention that investment in machinery and equipment, most of which was in the 936 manufacturing sector, in the period between 1976 and 1988 grew in every year except one. The experience with construction, however, was quite different, with decreases in five of those years. Source: The Impact of Section 936 on Puerto Rico's Economy and Banking System. Puerto Rico Bankers Association, January 1989 Section 936 also had a strong positive impact on the financial sector, as the inflow of 936 deposits provided much-needed liquidity at a critical moment. Commercial banks were under great pressure in the early 1970s owing to the crisis in the construction industry and the overall weakness of the local economy. More recently, in the early 1980s, federal savings banks were endangered by the sharp rise in interest rates that affected the entire industry in the United States. In both cases, 936 funds were instrumental in facilitating adjustment and recovery for local financial institutions. The liquidity and soundness made possible by 936 deposits have also shielded local savings and loans associations from the crisis that besets the industry on the mainland. While the federal government estimates that as much as $200 billion will be needed to bail out ailing savings and loans on the mainland, no such bail-out effort will be required in Puerto Rico. The reason is that, on average, local savings and loans are on a sounder footing than their U.S. counterparts, owing largely to the healthy effects of 936 deposits. For example, in the third quarter of 1988, the five local thrifts with publiclytraded stock, which together account for 75% of deposits in the industry, had a return on average equity of 12.16%, more than double the U.S. average of 5.38%. Similarly, these institutions had a ratio of net income to average assets of 3.22% compared with a national average of 2.01%. 936 Deposits and Puerto Rico's Financial System Since the 1960s, Puerto Rico's commercial banks had been facing a declining growth rate of deposits which eventually would have affected their lending capacity. After 1976, the inflow of 936 deposits helped to maintain the growth of total deposits at close to historical rates, which in itself represents a substantial contribution of these funds to the local economy. In the 27 years since 1960, deposits at commercial banks grew at an average annual rate of 14%, but the growth was not even during the period. In fact, the expansion of private deposits--the bulk of the total--decelerated significantly during 1960-1977. From an average annual growth of 16.1% in 1963-1976, the growth of these deposits slowed to 12.6% annually in 1973-1977. Following the enactment of Section 936, the growth of deposits picked up again during 1978-1982, although it still remained below the rates observed in the early 1960s. 1 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 四 936 Other Source: Estudios Técnicos, Inc., based on data from the Commissioner of Financial As of the end of fiscal year 1987, private commercial banks had $18.3 billion in deposits, of which 96% were private deposits. Funds deposited by 936 corporations amounted to $6.9 billion, representing 38% of all deposits and 39% of private deposits. In the absence of 936 funds it would have been difficult for private commercial banks to extend credit in the amounts actually observed since the mid-1970s, given the slowdown in the growth of non-936 deposits. The ratio of total loans and discounts to non-936 deposits exceeded 100% in four of the eleven years after 1976, and in another four years during that period the ratio was over 90%. This is a clear indication that non-936 funds alone could not have sustained the growth in the banks' loan portfolio observed since 1977 Source: The Impact of Section 936 on Puerto Rico's Economy and Banking System, Puerto Rico Bankers Association, January 1989 Financial institutions authorized to receive 936 deposits in Puerto Rico are subject to regulations governing the use of such funds. The Commonwealth's Commissioner of Financial Institutions is responsible for enacting and enforcing the applicable rules, currently embodied in Regulation 3582, which replaced the previous Regulation 3087 on March 1, 1988. The crux of the regulations is the definition of eligible activities to which funds may be channeled and the establishment of minimum and additional eligible-activity generation requirements. Eligible activities are defined in Regulation 3582 as those lending and investment activities that constitute utilization within Puerto Rico of eligible funds and which tend directly to |