NS4540 Winter Term 2019 The Cuban Endgame Robert Looney, Socialist Cuba’s Endgame, Milken Institute Review, October 16, 2018

Overview Under the Castro’s regime, the Cuban economy did well during period of generous assistance from: The USSR/Russia Venezuela In the 1980s aid from the USSR boosted Cuba’s average growth to 4.1% Following USSR’s collapse growth fell to 2.0% In 2000s growth increased to 5.6% with aid from Venezuela Growth dropped to 2.1% in 2010-17 as Venezuelan economy collapsed.

Foreign Exchange Constraint Cuba’s main economic problem Suffers from a serious foreign exchange constraint with only competitive exports: Raw materials (nickel) Tourism Medical services Ambitious efforts of achieving relative independence from imports sagging Government appears unwilling to undertake reforms needed to Improve the business environment and Position the service sector to take advantage of export markets

Cuban Governance Patterns

Caribbean Regulatory Quality

Growth Patterns Economy’s structural weaknesses not only inhibit exports but have led to declines in productivity Economy largely a relic of Soviet Union’s old extensive growth model. Under that model growth tied to the sheer expansion of capital and labor slows rapidly when these slip. Between 1997 and 2007 the Cuban labor force expanded at an average annual rate of 1.2% gross capital formation expanded at 7.4% Since the 2008 beginning of Raul Castro’s administration Labor force grew at an average rate of 0.5% annually Gross capital formation 3.6%

Reforms and Virtuous Circles Typically stagnant non-market economies like Cuba’s eventually adopt liberalizing reforms 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 has instituted a series of reforms to prop up the economy which 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 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.