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Preparing for a Full Restoration of Economic Relations Between Cuba and the USA

The actions announced by the United States on December 17, 2014 will have a limited immediate impact on the Cuban economy.[1] More important consequences will need to await repeal of the Helms-Burton Act (H-B) and other laws by the U.S. Congress. I don’t know when that will happen, but the recent agreement between Cuba and the United States probably means that it will be in the not-too-distant future.

For Cuban policy-makers, the key question is how best to prepare the economy to take advantage of a full opening of relations with the United States. This note is concerned with actions in the economic, not the political, area—although of course economic measures have political consequences. Repeal or changes in sanctions legislation could have very significant effects on Cuban trade in goods and services, including tourism, capital movements, and access to international financial organizations. Appropriate action by the Cuban government will allow the Island to take full advantage of these changes at an early stage.

Responding to the opening up of merchandise trade with the United States

It is often said these days that the scope for increasing Cuban exports of goods to the United States is limited to a few products (cigars and rum, although the latter will have to compete with Bacardi rum). This may be true in the very short term. Sometimes it is also said that the government should try to identify those products which, with adequate state support, will have a chance to eventually compete in the U.S. market. That is the bureaucratic, dirigiste approach; it will lead to picking losers, encourage amiguismo and corruption, and increased subsidies—as if the effort to reduce the subsidies that accumulated after the end of Soviet assistance had not been painful enough. Over time, the Cuban economy will develop a comparative advantage in other products (there is nothing wrong with Cuban imagination or entrepreneurial capacity). The proper task of the government is not to micromanage the process, but to provide a favorable environment for trade by eliminating the constraints on both state enterprises and the non-state sector, including excessive taxation and regulation. The government could also help the process by speeding up the unification and liberalization of the exchange rate system and by improving the capacity of the banking system to provide payments facilities and credit to trade-oriented producers.

The scope for increasing imports of goods from the United States is large. In fact, the accumulated hunger for U.S. products may be so intense in Cuba that an initial surge in imports could trigger a serious balance of payments problem. Of course, imports can continue to be limited by quantitative controls, but this will introduce distortions and foster corruption. If the value of the Cuban peso is fixed at the time of the import surge, there could be an attack on the Central Bank’s foreign exchange reserves. Attempts to defend the peso through intervention may lead to the depletion of reserves and ultimately a severe crisis, as discussed below in section 3. If the peso is floating, it will depreciate, perhaps sharply, which will help to reduce the demand for imports. This may occur with a lag, however, and in the meantime the central bank should be prepared to raise, perhaps substantially, the interest rates paid on the banking system’s deposit liabilities (or whatever financial instrument it manages to create from now on). The recent Russian experience shows the efficacy of such an action to counter an excessive depreciation of the national currency. This of course implies that some liberalization of the capital account has taken place (see section 5, below). If not, balance of payments equilibrium will have to be restored entirely through an adjustment of the current account, including a fall in national income.

Liberalization of travel by the United States.

A substantial increase in the number of U.S. tourists wishing to visit the Island will require, as a preparatory step, an increase in the capacity of the Cuban hotel industry. In particular, attention will have to be given to the development of the luxury end of the market, so that Cuba can compete with The Bahamas and other Caribbean destinations for high-spending U.S. tourists. U.S. investment could play a useful role in this area, provided the process is managed carefully to avoid favoritism and corruption, always a danger in dealing with large foreign enterprises.

Exchange rate policy.

To help the development of the export and tourism sectors, Cuba should move as rapidly as possible towards a single, market-determined exchange rate based on a unified currency—a process that is already underway. The stability of that currency will depend crucially on the quality of Cuba’s macroeconomic policies, particularly fiscal policy. After the post-Soviet crisis of 1989-2003, Cuba demonstrated it was able to keep the fiscal deficit within a tolerable range and achieve a current surplus for the central government. But things went astray in 2008, when a loose fiscal policy coupled with an unfavorable external environment led to a surge in the overall budget deficit and a serious financial crisis. The situation has now improved, but only after fiscal policy turned towards restraint, which led to a softening of aggregate demand and slow growth in recent years. This lesson must not be forgotten.

With strong macroeconomic policies, the choice between a fixed and a floating rate becomes less crucial. A floating rate would allow policy-makers a bit more flexibility while reducing the need for foreign exchange reserves. Fixed exchange rates in developing and transition countries have often ended with damaging, earthquake-type crises (Mexico, Argentina, Russia, Turkey and the Asian countries, among others); in most cases this was associated with excessively loose fiscal policy, aggravated in some cases by a lack of transparency. The consequences of these crises were severe, and the risk of repeating the experience is not worth taking.

Capital account policy.

Cuba has recently enacted a new direct investment law which has the potential to increase foreign saving, technology and management. By how much will depend mostly on how the law is administered on the Cuba side. But the potential will surely increase considerably with the repeal of Helms-Burton. There is little doubt that U.S. direct investment, particularly in areas such as tourism, could be helpful. At the same time, Cuba should be prepared to deal carefully with large foreign investors to avoid any infiltration of organized crime.

The other side of the capital account is portfolio investment. It is clear that some liberalization of private financial flows will strongly benefit the Cuban economy by helping the development of a more sophisticated financial system and, as discussed below, by increasing saving and capital formation. To that end, Cuba will have to develop a legal and accounting framework to register and monitor liabilities to foreigners. Initially, foreign capital is likely to flow into the Cuban banks’ deposit liabilities, and the central bank will have to ensure that these deposits pay reasonably competitive interest rates. Over time, however, Cuba should introduce other financial instruments, such as Treasury bills and bonds, yielding market-determined interest rates. With good policies these assets could become attractive to foreign and domestic investors while facilitating cash management by the government.

In sum, the case for capital account liberalization is strong. However, the experience of other developing countries suggests that full capital mobility capital may not be immediately desirable for a small economy, given the huge size of international financial markets and the sharp swings in confidence that frequently occur (whether they trigger capital flight or excessive inflows resulting from undue exuberance). In this context, temporary measures such as differential reserve requirement on foreign private assets held in Cuba (similar to those introduced in the past in Chile) could prove useful.

Raising productivity and domestic investment.

By now, a vast empirical literature has established that GDP growth is determined fundamentally by capital formation and multifactor productivity. The administration of Raúl Castro has already introduced number of productivity-raising measures, most notably the large transfer of inactive employees from the state to the private sector. These measures probably have already helped to increase total factor productivity, although so far the effects on output have been masked by a policy-induced (and inevitable) slowdown of government spending and aggregate demand. There is still considerable scope for additional productivity-expanding measures in Cuba, including price and labor market liberalization. But the surest and most direct way to set the stage for higher growth is to increase investment.

Capital formation is a fundamental determinant of growth. No serious economist disagrees with that statement.  Since the end of Soviet assistance, investment in Cuba has been basically limited by the availability of national saving, which itself is constrained by low incomes.  Higher investment in the period ahead can be achieved without squeezing domestic consumption by increasing foreign saving, and there lies the case for higher inflows of foreign capital, as argued above in section 4. Of course, a rise in domestic investment can also be financed by reducing the government’s absorption of saving by cutting unnecessary government expenditure and subsidies—never a politically easy task. Some of these cuts have already been made since the 2008 crisis. Subsides to state enterprises enterprise will have to come down in any event if Venezuelan oil deliveries are reduced, and this will hurt the performance of enterprises and diminish their contribution to the state budget, which has been substantial in recent years.

Joining international organizations.

With the repeal or changes in sanctions legislation, the U.S. government will be allowed to support a request by the Cuban government to join the International Monetary Fund.  (A country must join the IMF before it can apply for membership at the World Bank). With U.S. support, the proposal is certain to be approved by the IMF’s Board of Directors. Therefore the decision to apply for membership will be in Cuba’s hands.

  1. Membership in the Bank and the Fund could bring important benefits to the Cuban economy. It would bring financial support from the IMF in times of balance of payments difficulties, so that the government would not be forced to resort to excessive deflation or to freeze external accounts. The IMF would become a lender of last resort, which Cuba has sorely missed during the 2008-09 crisis. Of course, these benefits would be subject to IMF conditions, but these could be negotiated or refused; the violation of national sovereignty by the IMF is a myth. IMF membership also would provide technical assistance in the monetary, fiscal and statistical areas. Last but not least, the IMF’s Article IV consultation mechanism, if properly understood, could provide a valuable source of advice and discussion on macroeconomic issues and policies.

  2. World Bank membership would provide access to the Bank’s financial resources and project expertise, which will be essential in the development of Cuba’s infrastructure in a variety of sectors including tourism and agriculture. The Bank’s technical assistance assets would also become available. Similar benefits would accrue if Cuba were to re-join the Inter-American Development Bank, which will require re-admission in the Organization of American States.

  3. Cuba could also obtain technical assistance and advice from other institutions such as the European Bank for Reconstruction and Development.

Access to the IMF will involve the submission of a set of various documents and statistics, including international reserves.  Cuba should work in preparation of such requests. It will have to remedy, inter alia to the lack of balance sheets for the banking system and; the lack of capital account and international reserve data; the very long delays in publishing external current account numbers, and the suppression of information on state subsidies. Cuba has much to gain by increasing the availability, transparency and regularity of its statistics, including credibility in world financial markets and provision of timely and well documented information to researchers and its own policy makers. And I don’t know that it has anything to lose.

The labor market.

As was noted above, Cuba has recently engaged in the process of reducing its bloated state payrolls and rationalizing salaries in the public sector to improve incentives and foster discipline and efficiency. These efforts should be pursued vigorously. In addition there is the issue of the huge implicit taxes perceived by the government on Cubans working for foreign companies (and most probably for the teachers and doctors working in Venezuela and other satellites). These practices distort the labor market, they are unjust and discriminatory, and they should be eliminated—the sooner the better. Their elimination would greatly improve the morale of Cuban workers and increase their productivity. The government should also seriously consider joining civilized nations and allowing the free association of workers. I recognize that this goes counter to a long standing ideological position, but that position has no moral or practical value.


A substantial reduction in Venezuelan oil deliveries (and their counterpart, Cuban exports of professional services) will have obvious implications for national income. Using different methods, Luis R. Luis, Pavel Vidal Alejandro and I have estimated the cost at approximately $7 billion—far less than the cost associated with the elimination of Soviet aid in the early 1990 but nevertheless substantial. It would also have a significant effect on the labor market.  Even allowing for similar agreements with other countries like Brazil, a reduction in operations under the Acord with Venezuela could mean the return of a large number of doctors and teachers that could not be easily absorbed by the local labor market. There will be no easy solution, but much could be achieved by allowing these professional to operate in Cuba’s non-state sector. Why not?


For half a century of Cuban history, privatization has been regarded as an evil concept. But if you examine the countries that engaged in the transition from a centrally plan to market, you will find a significant correlation between the private share in the economy and real per capita GDP.[2]  In 2010, the private share in most of these countries was 70% or more, and 80% or more in high-income countries like the Czech and Slovak Republics, Estonia and Hungary. Cuba was at the bottom of the list with a private share of 15%, in the same neighborhood as Uzbekistan, Turkmenistan and the Ukraine.

[1] For an early estimate of the effects of these measures, see Luis R. Luis. Economic Impact of the New Cuba Measures,

[2] Hernandez-Cata, Ernesto “The Institutional Structure of Cuba’s Gross Domestic Product”. Forthcoming in Cuba in Transition, Association for the Study of the Cuban Economy, Vol. 24.

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