Cuba - US Reconciliation and Limited Reforms

It is hardly a secret that the economy of Cuba is in a sorry state.  Visits to Cuba provide testimony as to widespread poverty, food and housing shortages and the marked decay of buildings, infrastructure and machinery.  Official GDP per capita of $6800 for 2013 places Cuba below the $8700 average of the 12 Latin countries of the Caribbean Basin.  Moreover Cuban GDP is biased upwards as a result of the highly overvalued exchange rate of 1 Cuban peso per US dollar used in the national income accounts compared to CUP 24 = CUC 1 = US$1 against the convertible peso and dollar.  Use of a CUP 5 = US$1 rate, still clearly overvalued, would place Cuba’s GDP per capita at the bottom just above Haiti.  Importantly the economy is not creditworthy and is in payments arrears on the bulk of its external debt obligations.  International  liquidity is precarious, making the country highly vulnerable to potential shocks.  Gross domestic investment at  9% of GDP is insufficient to lift economic growth and productivity needed to improve real incomes.  The lack of market mechanisms for the allocation of consumption and resources in three fourths of the economy and the use of an unwieldy system of multiple exchange rates illustrate some of the severe operational difficulties facing the economy. Reconciliation between Cuba and the United States leading to a broadening of travel, trade and eventually financial flows and investments will boost the Cuban economy.  The initial impact of increased visits and remittances was estimated at around 0.5% of GDP in the first year after Obama’s measures of December 17, 2014.  Given the recent announced increases in transportation capacity between the US and Cuba, this estimate may prove to be conservative as US visitors to the island surge. The long term impact of fully opening the US market and allowing the free flow of US investments is much larger.  Prospects for this are uncertain in the absence of congressional action on legislation restricting trade and finance between the two nations. Voluminous legal claims by US citizens and corporations and adjudication by US courts also need to be resolved before full economic relations are reestablished. Nonetheless taking into account potential tourism, trade and direct and portfolio investment, the impact on the Cuban economy will be sizable.  Round numbers gauging gross domestic investment in the island at an additional 5% of  GDP (3% from foreign investment and 2% financed from national savings) as a result of reconciliation could raise average yearly economic growth to about 6% from 3.8% according to a growth model of the Cuban economy.   While this mechanical calculation shows a favorable potential path of economic growth it does not answer the question:  Is this potential growth rate sustainable? Sustainability will depend of a favorable business environment for foreign investors as well as for domestic firms.  This will require the application of fair rules in a stable legal framework.  Such a legal framework exists but implementation is subject to considerable discretion that raises risk and delays investment decisions.  The operating environment will have to show large improvement in employment conditions, domestic market regulations, flexibility of product pricing and currency convertibility to mention some key areas.  The absence of freely operating product and labor markets for enterprises will disuade foreign investment and hinder the efficiency of domestic firms, including state companies, which benefit from faster growth.  The resulting pattern of foreign investment may largely be of the “enclave” type of operations in tourism and mining, with reduced linkage to the economy.  The growth pattern would be uneven with lower benefit for the population. Just as importantly greater operating flexibility for private firms will help boost domestic investment, raise productivity and widen the array of products available to the population.  Currently the self-employed are injecting dynamism to sectors such as restaurants and private lodging, highlighting the benefits of market liberalization. Will the government continue to control tightly the pace of market reforms?  The answer is unclear. As long as key elements of the Cuban leadership continue to view the spread of the market as a threat there is scant hope for deep advance in economic reforms.  In this regard ideological arguments also play a role within the Party.  The recent history in communist  economies such as China and Vietnam suggests that pragmatism should win the day but then here we are dealing with Cuba. Oficina Nacional de Estadisticas and World Bank data base. The government has announced its intention to unify the two currencies but a plethora of old and new exchange rates for different sectors and firms creates a challenging task. Luis, L.R., “Economic Impact of the New Cuba Measures”, ASCEBLOG, December 24, 2014. Luis, L. R.,“Cuba’s Growth Strategy: Human Capital and Foreign Investment”, Cuba in Transition, Volume 24, 2014.  An additional 5% of GDP corresponds to $4 billion per year in terms of 2014 GDP. For a discussion of policies that enhance the benefits of reconciliation see Ernesto Hernandez-Cata, “Preparing for a Full Restoration of Economic Relations Between Cuba and the USA”, ASCEBLOG, January 5, 2015.