Report

Sea Changes: The New Cuban Economy

By Pedro Monreal
September 25, 2007

Over the course of the 1990s Cuba has dramatically changed its trade, technology and investment partners, modified its institutions of foreign trade, opened the door to foreign investment, developed international tourism at a breathtaking pace, and changed, albeit not so dramatically, the product composition of its exports. These changes represent the beginnings of the country’s reinsertion into the international economy, or to be more precise, into the capitalist world system. This reinsertion—or “relinking”—follows a previous long period of “delinking” from that same world system, particularly during the 1980s.

During the 1970s and 1980s Cuba had a very open economy based on its interaction with countries of the former socialist bloc, and particularly with the former Soviet Union. In 1989, 80% of Cuba’s total trade was with the socialist economies. Relations with the “capitalist world” were very modest and perceived to be neither fair nor advantageous in comparison with socialist-bloc patterns of trade and credit, which had built-in mechanisms for preferential prices, soft loans and arrangements for the re-export of oil in hard currency.

After the abrupt disappearance of “really existing socialism” in Europe, the challenge for Cuba was to reestablish its links to the world economy. Reinsertion has always been a priority and autarky was never seriously considered as a long-term strategy for development in the new context. A shifting pattern of relinking has taken place in Cuba through the 1990s. Two different but interconnected policy goals have been in force since the beginning of the process. These goals are “survival” (sobrevivir or resistir) and “progress” (avanzar). The first means simply “securing a place under the sun,” even a very modest one, in the global system. The second requires “upgrading” within the system—the absorption of new knowledge and technology in one industry after another and consequently the achievement of higher levels of national income.

It is important to keep in mind that when, in the wake of the collapse of its socialist trading partners, the Cuban government sought to reestablish economic well-being by reinserting itself into the trade and investment networks of the capitalist economies, the very survival of the Cuban economy was in question. This article will examine the process by which Cuba shifted gears under extreme duress, and will critically discuss some options the country faces in the very near-term future.

The first phase of the relinking process began in 1990 and 1991, and the emphasis was on survival. The great concern at the beginning of the crisis was simply not to be left outside the system. It is useful to recall that in 1991 it was not clear at all what the demand for traditional Cuban exports—primary products like sugar, tobacco and minerals—would be in world markets. New markets and suppliers had to be found in a very short period of time. Cuba, with inadequate institutions and little knowledge, had to secure a minimum level of imports, purchased with export earnings, in order to avoid a downward spiral in the economy.

Reinsertion was not postulated as leaving all decision-making to the market; it was taken for granted that control of the Cuban economy would remain in the hands of Cuban policy makers. Authorities did not interpret the economic downturn of the early 1990s to be the product of deficiencies in the economic system, but rather the consequence of a foreign-trade shock—the loss, that is, of Cuba’s socialist bloc trading partners. It was therefore the task of the foreign-trade sector to achieve a new point of equilibrium so that the country could resume economic growth. Therefore, most of the adjustment, it was thought at the time, would be confined to the external sector of the economy. It was assumed that a successful relinking would solve most of the problems of the economy.

The government decided to base its strategy of economic recovery on the construction of a dual foreign-trade sector in which a “modern” component would provide dynamism and the potential for upgrading, while a “traditional” component maintained a basic export floor. The modern external sector was basically comprised of what were called the new exports, particularly tourism and pharmaceuticals.[1] Indeed, since the early 1990s, the tourism and pharmaceutical sectors were identified as Cuba’s “shining stars” of competitiveness. That perception was a crucial factor in the government’s decision to allocate scarce investment resources to these industries.

There was not much hope in the future of traditional exports like sugar, minerals and tobacco, but they were needed to maintain a minimum level of exports. At the time, policy makers believed that traditional exports required huge quantities of resources just to sustain their current levels and that those resources were simply not available.[2] In addition, the numbers simply did not add up. Traditional exports would not be able, under the most favorable scenario, to reach the levels to pay for the imports of capital and consumer goods that were considered necessary for the normal operation of the economy. In the early 1990s the government viewed the traditional industries as the way to provide hard currency to secure a minimum level of imports, with the goal that by the latter part of the decade, they would attain medium to satisfactory levels of exports plus a certain degree of import-substitution production. Tourism and pharmaceuticals, on the other hand, were seen as having greater growth potential and possibilities for upgrading.

At the beginning of the process, the predominant notion was that the functioning of a dual economy was possible even in the absence of well-developed linkages between the two sectors. Given its estimated high-growth potential, the modern sector was simply perceived as the emergent hard-currency provider for the entire economy. By 1993, however, it was clear that the approach to relinking had to be revised, this time as part of a broader reform which would introduce substantial modifications to the domestic side of the economy. Total exports in 1993 were only one-fifth of the export level of 1990; imports had been reduced by 75%, and the gross domestic product (GDP) had contracted by almost 35%.[3] The first phase of relinking, in other words, had not been successful in providing survival at a tolerable level. Both the economy and the “social contract”—political consent supported by an acceptable standard of living and opportunities for social mobility—seemed to be rapidly falling apart.

Policy makers realized that successful reinsertion into the world economy would require diverse and stronger linkages between the modern and traditional sectors, as well as domestic macroeconomic stabilization. In a general economic context of inflation, currency devaluation and lack of working incentives, any micromanagement approach that limited itself to certain sectors of the economy, no matter how successful on its own terms, would be insufficient to revive the economy. Macroeconomic instability was creating an unpredictable economic environment, and this was preventing producers, investors and policy makers from taking the actions necessary for recovery with any degree of confidence.

It had also become clear that the traditional sector was more important for survival than initially believed. Traditional exports were not able to secure a tolerable minimum floor, which only aggravated the relatively weak performance of the modern sector. This was partly the result of inadequate investment and inputs, but authorities also perceived that micromanagement had failed, particularly in key areas such as sugar production. Indeed, throughout the early 1990s, annual sugar output declined steadily.

Finally, the modern sector showed an uneven pattern of performance and the volume of its exports was considerably lower than initial expectations. On the one hand, tourism was performing very well; there was potential for growth, and foreign capital was available for financing the sector’s further development. Also its net contribution and its potential for upgrading were closely associated with the establishment of linkages with the traditional sector, especially agriculture, food processing, construction, building materials, engineering services, light industry and equipment production. On the other hand, despite strong expectations of upgrading for pharmaceuticals, the sector, in terms of volume, had performed below expectations.

It is difficult to identify an exact date for the beginning of the second phase of relinking, which involved a greater emphasis on upgrading—an activity which had now become de facto redefined to include activities of both the modern and traditional sectors. The logic of upgrading was no longer limited to developing high value-added exports. It also now included the absorption of technology and knowledge to increase the efficiency of traditional exports, the development of new sources of hard-currency income from traditional products, and the reduction of imports.

Survival continued to be the primary goal of relinking, at least until early 1995, when economic policy makers began to see that recovery was taking hold, making it possible to focus more on longer-term issues. The period connecting the worst of the crisis (1993) and the clear beginning of recovery (the second half of 1994) can be best understood as a transition between the first and the second phases of relinking. That was the period of the “great experiments”: the legalization of the holding and free circulation of U.S. dollars; the modification of the organization of agriculture; the establishment of free markets for agricultural products; the legalization and extension of self-employment; and the financial package for macroeconomic stabilization. Reform was then relatively broad.

By late 1994, the focus had clearly shifted from survival to upgrading. The perception that some kind of minimum floor in exports and imports had finally been established—sustained by tourism income and family remittances—created more room to look for ways to absorb technology and knowledge in order to maximize the benefits of international insertion. To be sure, the goal of survival has never been abandoned, but upgrading has achieved pride of place during the second phase.

Nickel production, for example, has been notably upgraded to the point that it is now possible to question its classification as part of the traditional sector. At least a portion of Cuban nickel production is so well integrated and upgraded that it has produced outstanding results, even in a context of lower world prices and intense competition. The 50-50 partnership established between the state-owned Compañía General del Níquel S.A. and the Canadian mining company, Sherrit, Inc., in December 1994 has given Cuba a stake in the profits from refining, on top of its share of the proceeds from resource extraction and intermediate processing. In addition, this joint venture is considered the world’s most technologically innovative in nickel metallurgical processing. Upgrading has also been partially extended to other important traditional export industries such as sugar cane, citrus, tobacco, fisheries, mining and telecommunications.

Pharmaceuticals, the sleeping giant of the modern sector, is still considered a strategic industry but expectations are lower than in the early 1990s for its actual export volume. It is interesting that while tourism is a high-volume sector with a rather modest potential for upgrading by itself—most of its activities performed in Cuba are labor intensive and relatively low-technology services—the pharmaceutical industry is currently a low-volume activity but with a great potential for upgrading.

In the case of tourism, upgrading has extended to traditional activities financed with tourism income. The upgrading of tourism has thus had a dual effect. On the one hand, the Cuban tourist industry now retains a larger share of income relative to its foreign partners. On the other hand, by selling to tourists, some traditional industries have become indirect exporters. Among these industries are traditional exporters like beverages, fisheries and fruits, and increasingly a rather wide variety of activities with no previous export background such as furniture making, interior-design services and the production of engineering products such as elevators, steam boilers and electrical equipment.

The establishment of a dollarized economy along chains of enterprises supplying both the tourism sector and the retail stores trading only in dollars has resulted in sales generated by enterprises of the traditional sector which are now “exporting within the borders.” Here, the crucial factor, perhaps more important than tourism itself, has been family remittances. According to scattered public information, sales in U.S. dollars now account for around 54% of total domestic retail sales, a proportion considerably higher than the 46% reported by the tourism sector.[4] There are many sources of dollars in the Cuban economy, including income obtained by providing “personal services” to tourists, but by 1997-1998 remittances were the main net provider of hard currency for the country and a vibrant and important component of Cuba’s current modern economy. Remittances are acting, in fact, as a major force in the restructuring of the Cuban economy.[5] It is evident that personal demand supported by remittances has been playing a key role by bolstering demand for domestic products and services. One of the greatest ironies of the remnants of the Cold War in the Caribbean is precisely the upgrading of Cuban industry funded by savings originating in the United States.

The combined effect of tourism and remittances on the upgrading of other activities not directly relinked to the world economy has been very significant. Their capacity to establish backward linkages throughout the domestic economy has been effectively utilized to create a vast semiprotected market which has allowed segments of the national economy to become relinked indirectly. The structure of sales in hard currency of so-called light industry—textiles, apparel, shoes, furniture and toiletries, for example—is highly illustrative of the importance of the domestic market in dollars supported by tourism and remittances. Of these total sales in dollars, two thirds take place on the dollarized retail market, less than one quarter is sold to the tourism sector, and only one-eighth is actually exported.[6]

Another attempt to relink traditional activities to the global economy—but one which, in fact, does not seem destined for success—has been the creation of export-processing zones (EPZs). This approach was created in the second phase of the reinsertion process when new foreign-investment regulations allowed for the creation of free-trade zones and industrial parks. By 1998 there were three free-trade zones in Cuba with 190 foreign operators, with immediate plans to create two more.[7]

The standard outcome of EPZs is the establishment of a pattern of limited linkages between the free-trade enclave and the rest of the economy, with predominant use of low-skilled and low-wage jobs. Production is for export only, and foreign partners are typically interested in keeping the costs of production very low. In general a small amount of value added stays within the country. This model has been adopted in countries such as the Dominican Republic and China, which have large numbers of impoverished, poorly educated workers. Cuba, on the other hand, has a highly skilled industrial labor force. It has been argued that EPZs in Cuba will create job positions for skilled workers and that they will be a means to increase export revenues and obtain high technology.[8] But the likelihood that EPZs in Cuba might be different from those in other countries seems remote. In fact, the EPZ model is unlikely to bring much upgrading to the Cuban economy since most successful cases of insertion into global industries have followed a pattern of activities that has allowed for the development of strong local networks of products and services.[9]

In any case, large-scale reinsertion will be dependent on a systematic process of upgrading of the traditional sector—something that cannot at present be fully achieved due largely to continuing shortages of investment and inputs. Limited reinsertion, therefore, is a more plausible outcome but even this will require a significant upgrading of the traditional sector, a process which will require massive investment. The substantial transformation of the current structure of traditional output will thus be determined by the availability of investment funds. The process of reinsertion is therefore incompatible with low levels of economic growth. Simply put, low growth is neither conducive to a domestic high-savings environment nor particularly attractive for external funding.

This last conclusion is very important because it suggests that if a sizeable reinsertion is proposed as a goal and upgrading as one of its cardinal mechanisms, then the pursuit of a path of high economic growth—sustained rates of growth of at least 8% per year—should be adopted as a priority and all other factors should be considered instrumental to it. This will require a relatively significant reorientation of the general framework of current economic policy. In the absence of the development of a sizeable domestic private sector, sustained high economic growth may be difficult to achieve in Cuba. Under the official assumption of an annual average growth rate of 4% over the next few years, the recovery of the level of output that existed in 1989 would be reached by the year 2005. Fifteen years of economic growth would thus have been lost for the country.

Rapid economic growth is not, however, only a matter of accelerating the process of recovery and minimizing the duration of long-term stagnation. It is, above all, a necessary condition for the vast structural transformation that the Cuban economy requires. If autarky is discarded as a realistic option, then the long-term viability of Cuba’s international insertion will depend on a relatively large share of the country’s total output finding its way onto world markets. Only a high rate of growth can secure the vast amount of resources needed for such a structural transformation.

Since it is evident that the Cuban state has no means of its own to successfully implement the required economic transformations, private funds will be required to achieve these high rates of growth. This is simply to say that a mixed economy is needed in Cuba. Economic reform should also include the revitalization of state-owned enterprises, which can still play an important role in the economy. Indeed, the possibility of creating an efficient state productive sector should be seriously considered, though given past experience, the burden of persuasion may be more on the side of its proponents than on the side of its critics. In any case, private capital will be needed as a source of funds, technological learning and efficiency.

Foreign capital has played a role in recent transformations of the Cuban economy, though by policy design, its role has been relatively limited until now. That, of course, could change to accommodate larger potential flows of investment. Private domestic capital has a very limited presence in Cuba—basically confined to agricultural production—although the cooperative sector is relatively large. The so-called self-employed sector is the result of the formalization of the informal economy and, other than providing a survival mechanism for a sector of the population, plays no important role in economic strategy. Under current policies then, which have discouraged the formation of private domestic capital, the non-state sector can only play a limited role in investment and economic growth.

An efficient domestic private sector, however, could make the key difference between paths of low and high economic growth. The potential of a developed private sector to attract remittances and allocate them to investment—as well as its potential to attract foreign investment itself—might be the most cost-effective mechanism to attract foreign savings. In addition, profits from domestic private enterprises could become an important source of savings and capital accumulation within the country, and the transfer to the private sector of assets inefficiently utilized by the state would improve—through efficient taxation—the state’s potential for accumulation.

Current policies which have promoted downsizing and industrial restructuring in the traditional manufacturing sector have been conducive to leaner and more efficient enterprises. The process has been facilitated in those limited cases where associations with foreign capital have been possible, and have generally been directed towards “exports within the borders.” There are not yet adequate data to analyze the consequent relocation of workers who have been displaced by downsizing, but it seems that such relocation would have to take place outside manufacturing. Productive demand for the highly skilled Cuban labor force would then be determined by investment and technological change, two factors apparently well beyond the current capabilities of the Cuban government. The current situation of structural mismatch between the quality of the skilled work force and available unskilled job placements reveals the critical impasse that exists in this area.

The global economy has had a visible “pull effect” on policy making in Cuba. Important sectors of the Cuban economy are—like tourism and nickel production—already market-oriented and have found “a place under the sun” in the global economic system as well as potential for upgrading within the system. In addition, decentralized and market-oriented notions are now part of the mainstream equation of economic management in Cuba, no matter what the ideological explanation may be.

Reality clashed with the idealized models of reinsertion into the world economy of the early 1990s. A trial-and-error process revealed important lessons about efficiency among alternative options for economic policy and institutional change. The trajectory of the transformation adopted in order to facilitate insertion has created a growing presence of private property and an expanded role for markets. We cannot assume, however, that this is a linear and totally predictable process, and the notion that insertion dictates transition to a market economy is mechanistic. Such a transition is a possible but far from necessary—much less desirable—outcome. The development of a capitalist economy is certainly not the solution to the current problems of Cuba.

Most of the limits which shape the options in the area of reinsertion can be modified by social action. Economic policy is therefore a key factor and political considerations are paramount. A mild approach to reinsertion, like the one now in operation in Cuba, is an option, but stronger modalities of reinsertion can also be considered. None of those alternatives would be free of social and political problems. It is not reasonable to assume beforehand that a mild approach to reinsertion is more acceptable because it is gentler in terms of its social costs. Social exclusion and increasing inequality brought about by dollarization—a central mechanism in reinsertion—has been partially compensated by social programs, but the fact remains that even a mild model of reinsertion can be conducive to outrageous forms of social exclusion. Such social programs have their own political logic, and are rooted in the social commitments of the political system. It is feasible that they could be utilized to address the inequalities and dislocations a stronger form of reinsertion would imply.

Economic decisions made within this period of relinking—or the failure to make those decisions—will strongly affect the coming decades of the country’s development. This is the time for those difficult choices to be made.

ABOUT THE AUTHOR
Pedro Monreal is a research economist at the Center for International Economic Research (CIEI) an the University of Havana. This article draws on a paper co-authored with Claes Brundenius, “The Future of the Cuban Economic Model: The Longer View,” presented at the Workshop on Globalization, Changing Paradigms and Development Options in the Third World: Cuba and Vietnam, Copenhagen, June 11-13, 1998.

[Note: The following “boxes” appeared scattered throughout the article by Pedro Monreal, but were not written by him. Source is as attributed.]

*********** Standard of Living ***********

In his address to the Cuban Assembly in late December, Finance Minister José Luis Rodríguez noted that the living standards of the Cuban people were improving, if slightly. More Cubans have dollars—14% more than 1997—and the purchasing power of the peso increased by 5.45% in the last year. Sales in the free markets for farm produce were up by 10.2% and those in hard-currency stores by 16.1%, while government sales of rationed foodstuffs were up 12%. Nonetheless, he admitted that in 1998 there were shortfalls in deliveries of some rationed goods, such as kerosene and eggs. He noted that the average monthly salary had increased by 1.4% to 217 pesos. But at the exchange rate of 20 pesos per dollar, this keeps the hard-currency stores out of the reach of most Cubans, and even the free agricultural markets are too pricy for many. Omitted from Rodríguez’s report was the fact that inflation last year reached 5%, 4.6 points more than the increase in average pay. The number of Cubans who now enjoy what Rodríguez described as “hard-currency incentives and other equivalent forms” increased last year by 21%, to 1.2 million.