NS4540 Winter Term 2019 The Cuban Economy Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

Cuba: Major Indicators

Cuban Economy Strengths/Weaknesses

Cuban Governance Patterns

Caribbean Regulatory Quality

Overview I Structure of the Cuban economy very unusual State owning most enterprises A dual exchange rate system Many prices set by the state and Public services (particularly health and education) account for an exceptionally large proportion of national income and employment These characteristics make it difficult to determine the equivalent value of Cuban production and therefore size of the economy Middle range of estimates puts Cuban national income at $90,000m. With a population of 11.2 m suggest income per capita around $8,000 slightly below average for Latin America and the Caribbean region

Overview II Also uncertainty over estimates of annual growth rates Base year 1997, and with shifts in the structure of the economy hard to get an idea of growth rates Consensus is that real GDP growth is roughly in line with the average for the region over the past decade. However growth has not been sufficient to restore Cuba’s income and production to its 1990 level Legacy of the economic recession of the 1990s remains with Continued hardship for many Cubans Far greater inequality than before, and Severely decapitalized infrastructure and productive capacity To understand recent performance and current challenges necessary to trace evolution of Cuba’s economic structure and performance since it lost support of the Soviet bloc.

Economic Crisis in the 1990s I Cuba’s integration into the Soviet economic bloc had created a economic structure that was Highly dependent on exports of sugar at very favorable prices in exchange for petroleum and other imports and Propped up with generous grants or concessional loans to cover any trade deficits. Direct result of the loss of those favorable prices and financing when the Soviet bloc collapsed in 1989-91 was a 70% decline in foreign exchange inflows Resulted in a 35% decrease in national income between 1990 and 1994

Economic Crisis in the 1990s II Cuba’s recovery has been hampered by restricted access to international markets and finance US sanctions were tightened during the worst years of hardship Torricelli Act, 1992 and Helms-Burton Act in 1996 U.S. policy not only blocked trade with U.S. but also with subsidiaries of U.S. companies Included restrictions on Cuban access to US technology and additional provisions designed to deter third country businessmen from involvement in Cuban trade of investments US measures meant Cuba had no access to support from official multilateral financial institutions and exceptionally limited access to international financial markets

Economic Crisis in the 1990s III Cuba now has an unusual and unbalanced economic structure due largely to. US restrictions on Cuban trade and financing, and an Unorthodox approach to economic adjustment With import deliveries interrupted, the central planning system which was similar to the Soviet model stalled in 1990-91 Cuban government refused to follow the “transition” model of other former Soviet bloc partners Instead responded by appealing for mass mobilization as if the country were under war conditions Wanted to pre-empt unrest and preserve social safety net and universal health and education services

Economic Crisis in the 1990s IV Planning authorities still had a monopoly on international transactions Sought to prioritize essential food imports Despite reducing oil imports by 70% and other products by more than 80% they still only had enough foreign exchange to purchase half as much food as before. A “food program” sought to encourage self-provision and innovative methods while Government attempted to minimize economic and social disruption by maintaining fixed salaries and prices for basic goods and Keeping state employees (90% of total labor force) employe work

Economic Crisis in the 1990s V Inevitably as output declined, productivity per worker decreased sharply Cost of subsidies rose and The fiscal deficit increased dramatically Deficit was monetized with the result that the black market value of the Cuban peso collapsed from around seven pesos per dollar in 1990 to more than 100 pesos in 1993 For Cuban state employees decline in living standards felt in acute shortages of all but the most essential goods Because of the decline in the black market value of the peso imported goods were priced beyond their means

Economic Crisis in the 1990s VI However most jobs secure All Cubans had access to a basic food ration, utilities and public services Legalization of the US dollar and establishment of an official exchange market for personal transactions together with stabilization program halted the Cuban peso’s decline Domestic currency had strengthened to 25 pesos per dollar by end of 1995 – remained there for two decades Exchange rate for official transactions remained at one peso per dollar

Economic Crisis in the 1990s VII Policy achieved main objectives Social protection broadly achieved – health statistics stable “Transition recession” saw economic decline, but not as severe in some of the former areas of the Soviet Union Economy began to recover from 1994 on. Legacy of crisis years remains Economic structure that has remained overspecialized and distorted Deep monetary imbalances Growing income inequality, and Flourishing black markets which have hampered economic efficiency and dynamism.

Unbalanced Growth I Cuban recovery efforts focused on seeking new sources of international earnings Constitutional reform 1992 and foreign investment law of 1995 opened the economy to new sources of financing, management skills in sectors with most potential for foreign exchange earnings Policy of channeling resources into a few areas resulted in a recovery built around a small number of industries: Tourism Nickel Professional services, and Petroleum processing – joint venture with Venezuela

Unbalanced Growth II Tourism provided a high return for relatively little investment Tourist arrivals grew by 18% in the 1990s, rising from 340,000 arrivals in 1990 to 1.7m by 2000 Tourism receipts overtook sugar earnings in 1994 by 2000 were more than four times as large totaling US$1,900m Since 2000 industry has matured average annual growth has been 4% with 3m arrivals in 2014 bringing in $2,700m gross revenue

Unbalanced Growth III Cuba’s external accounts reveal extent of specialization. By 2012 the five categories listed above accounted for 90% of the country’s US $16,000m foreign exchange earnings Economy’s vulnerability to external shocks resulting from such export product concentration compounded by a high dependence on a single trade partner – Venezuela. For past decade all of Cuba’s oil imports (one half of all import spending) came from Venezuela These are paid for by Cuban earnings from the sale of professional services to Venezuela Leaves Cuba very exposed to political changes in that country Since death of Hugo Chavez in early 2013 Cuba has been seeking new markets for its medical services South Africa an Brazil have emerged as important customers

Unbalanced Growth IV Current Challenges Beyond a handful of export industries, few other areas of economic activity that have recovered to their 1990 levels Task of reversing the severe decapitalization that occurred during the economic recession of the 1990s is incomplete Process has been hampered by chronic shortage of investment finance and very restricted access to foreign exchange. Favorable trade agreement with Venezuela produced a brief surge of activity in 2005-07 with annual GDP growth rising above 10% -- soon petered out Annual growth in 2009-14 moderated to 2.3%, and The aggregate level of investment remains around 10% of GDP – less than one half average for LAC and too low to prevent further erosion of the national capital base

Unbalanced Growth V Dual currency system obstructs the integration of the external and internal economies, and Contributes to increasing income inequality For Cubans who receive incomes in convertible currencies and some who are self-employed living standards have improved substantially since the 1990s crisis For the rest whose incomes are in the undervalued Cuban peso living standards are still worse than in 1990 Prices of the many goods and services that are denominated in convertible currency or sold at market prices completely out of reach

Unbalanced Growth VI Low productivity remains a burden for the state budget which continues to subsidize production and prices While wide income inequality with chronic hardships and shortages provides poor incentives for work, fertile ground for corruption, and fuels a desire for changes in the economic system There is a guideline document initiated by Raul Castro to cover a five year process of updating the economy Liberalization in some markets with State still owning most of the production Aim has been to introduce a new dynamism into parts of the economy that have been languishing

Unbalanced Growth VII Prospects for Cuban economic growth and development have been transformed by the breakthrough with the US following December 17, 2014 statement that diplomatic relations to be normalized Has led to speculation about the possibility of the removal of economic sanctions As yet impact on economy has been modest with an increase in US visitors to Cuba being the main effect However until further major changes in US sanctions are introduced Cuba will continue with its gradual process of economic recovery and restructuring.

Reforms and Virtuous Circles Typically stagnant non-market economies like Cuba’s eventually adopt liberalizing reforms out of necessity Often these reforms lead to a virtuous circle whereby Initial growth leads to follow-on investment from home and abroad Growth expands government revenues enabling increased social investment in infrastructure and human capital As growth accelerates government and the private sector see mutual gains from improved governance and growth-enhancing institutions Improved rule of law, control of corruption and secure property rights facilitate greater savings and investment further augmenting growth And the cycle continues.

Virtuous Circle Model

Cuba’s Partial Reforms I Cuba’s reforms Fell far short of creating a virtuous circle Did not even intend to create a virtuous circle Modest changes introduced by Raul Castro in 2010 motivated more by fiscal pressures driving him to scale back a bloated public sector Reforms dubbed “market socialism” which Allowed self employment, especially in tourism and Encouraged the establishment of small restaurants and bed and breakfasts All under tight government controls However did not create a pure vicious circle

Vicious Circle Model

Cuba’s Partial Reforms II Instead the private sector grew dramatically Business not only flourished but paid wages considerably above those in pubic sector Wage differential in part result of new dual currency system designed to lure workers out of redundant government jobs Under the system Public sector workers paid in Cuban pesos than can only be converted at a very unfavorable rate to dollars (needed to buy consumer goods) Workers in tourism are paid in the Cuban convertible peso

Cuba’s Partial Reforms III Eight years after Castro put new market socialism model in place Average wages in the state sector still around $30 a month measured at the unprivileged exchange rate Making goods and services with prices determined by the small free market unaffordable Government efforts to expand price controls to protect access to staples for state workers backfired These have reduced supplies in formal market by diverting them into the underground economy

Cuba’s Partial Reforms III A more flexible government would have built on the success of the tourism sector by instituting follow on reforms Instead government has focused on the increased inequality facilitated by the dual-currency system In summer of 2017 It suspended new licenses to private firms, and Introduced a series of burdensome regulations limiting the size of enterprises In early 2018 Castro’s successor Miguel Diaz-Canel introduced even more stringent regulations limiting scope of private sector activity as well At least for now growing inequality driven by private enterprise is seen as riskier to regime than economic stagnation.

Cuba’s Partial Reforms IV In keeping private sector down in the short run, government can protect state-owned enterprises that still dominate economy However in longer run this compromise will not be able to assure an adequate standard of living

Future Possibilities I Current situation not sustainable and something must change Option 1 Prioritizing market decentralization and increased global integration would lead to greater inequality Risky because government’s reputation centers on eradication of poverty Option 2 Developmental state model similar to Ethiopia where central planners are actively pursuing economic growth without allowing widening income gaps Cuba does not have natural resources like Ethiopia Need technocrats that can function without political interference Unlikely Cuban Communist party would relinquish power to this group

Future Possibilities II Option 3 Vietnam model – in many ways Cuba today like Vietnam before its takeoff In both major land reform and decades long effort to create a relatively equal distribution of income and wealth proceeded market based reforms Like Vietnam Cuba has a rural population with the health and literacy to become a fairly flexible urban workforce Vietnam eventually generated high rates of economic growth by introducing market reforms and welcoming foreign direct investment

Assessment Communist leadership in a situation where it reduces its power if it reforms the economy, but in danger if it does not. Vietnam experience offers a possibility that allows Communists to maintain political control Castro still head of Communist party until 2021, so major changes may not take place until then.

Summing-up: The Future I Results of Raul Castro’s economic reforms have been modest in terms of economic performance Annual GDP growth just 2.6% from 2008-14. Living standards for most Cubans remain low and income inequality has been increasing Structural changes are taking place. Since 2008 the non-state sector has been expanding and the state sector contracting. Half a million people (10% of the workforce) are now officially registered in the non-state sector – up from less than 150,000 in 2008 Government spending which peaked at 78% of GDP in 2008, declined to 59% in 2014

Summing-up: The Future II These trends are expected to continue, despite a shift in the Government’s fiscal stance in 2015 from a conservative one (with the deficit restrained to an average of just 3% of GDP for the previous 20 years) to an expansionary one with the target for the budget deficit in 2015 was set at over 6% of GDP By April 2016 when the 7th Congress of the Cuban Communist Part is due to approve guidelines for the next five years economic system will be very different from the one that existed in 2011 Prices and markets will be playing a greater role in the allocation of resources, with more non-state enterprises, and the government’s management will be more focused on indirect than on direct control,

Summing-up: The Future III Other changes to expect Government emphasis will be on monitoring, providing key public services and welfare, strategic planning and regulation. External debts will have been cleared through agreements at the Paris Club, and the opening to foreign investment will be wider. In addition to this structural transformation within Cuba, any further relaxation of US sanctions will contribute to the reintegration of the economy into the international market.