Ernest H. Preeg, Center for Strategic and International Studies (CSIS)

See also Comments by Luis Locay

Part I.

This paper presents a projection for the response of the Cuban economy to a fundamental market-oriented restructuring in conjunction with a lifting of the U.S. embargo. The projection is drawn from Chapters 4 and 5 of the full study, Cuba and the New Caribbean Economic Order (Center for Strategic and International Studies, 1993), but this presentation is fully self-contained and has been, in a few respects, updated from the earlier publication.

I. The Political Assumption

The projection is for a five-year period, beginning at the time the embargo is lifted, and is referred to as "Cuba restructured plus five," or "CR plus five," for short. Because the economic projection needs to be based on assumptions about an accompanying political transition, however, the political transition is addressed first. There is, in fact, an interaction between the paths of political and economic change. Reasonably favorable political circumstances are prerequisite for a successful economic restructuring, while a clear prospect of economic success will tend to encourage the necessary political change. In this latter sense, the CR plus five projection will, it is hoped, convey an element of self-fulfilling prophecy.

The political assumption is for a two-stage transition to democratic government, as explained below. This assumed course is not a "most likely" prediction but, rather, a normative statement as to an optimistic yet realistic course of events. Underlying the assumption is the need for a spirit of reconciliation both within Cuba and across the Florida Straits with Cuban-American expatriates. More explicitly, the political assumption would preclude a negative course of prolonged instability and violence, perhaps even civil war, which would not only retard the economic transition but would poison political and social relationships over a much longer period, with corresponding negative impact on the investment climate and economic recovery more broadly.

The first stage of democratic transition is assumed to run for a period of up to two years and would be a rather confused and tense period of organizing the return to elected government and implementing the first steps of economic reform. Some form of interim government, broadly representative of the people and based on the need for reconciliation, would be charged with constitutional reform leading to free and open elections. An elected constituent assembly, or constituyente, with a mandate to draw up a new constitution, could be part of the process. Internationally observed presidential and legislative elections would follow at the end of this first stage.

The second stage, comprising years three to five of the economic projection, would proceed under the duly elected government. Again, a degree of confusion and discord can be anticipated for a new democratically elected government after more than three decades of nondemocratic rule. The assumption here is not for outstanding or even very good performance but, rather, a minimum ability to carry forward the basic restructuring of the economy, as explained in greater detail below, while maintaining domestic peace and reasonable tranquility. The newly elected government would engage with the international financial institutions for technical assistance to carry out economic reforms as well as for mobilizing official development finance and private investment. The relationship with the United States is assumed to be very positive.

Lessons Learned from Eastern Europe

Further specification is necessary about initial steps that the government can and should take for transition to a market economy, particularly during the initial two-year stage. The experience of Eastern Europe since 1989 has relevance, to varying degrees, in each of four priority areas --financial institutions, private property rights, infrastructure, and foreign debt-- that would need to be addressed.

Relations with International Financial Institutions

The earliest possible contact with the international financial institutions --the International Monetary Fund (IMF), the World Bank, and the Inter-American Development Bank (IDB)-- is an important step. Technical assistance from these institutions, together with that from other governments and the private sector, will be critical for creating the institutional framework for a market economy, including financial services, investment laws and regulations, and private property rights. Also, membership in these institutions should come as early as possible, first in the IMF, as prerequisite for participation in the development banks. IMF membership will require presentation of coherent fiscal, monetary, and international financial programs, worked out in advance with Fund staff, which can, in itself, be a valuable learning process. Membership in the development banks will make Cuba eligible for substantial long-term project and other financing.

Establishment of Private Property Rights

Early establishment of private property rights is essential for transition to a market economy, and privatization in key sectors, including tourism, the service sector more broadly, construction, and small- to medium-scale agriculture, should get early attention. These are the sectors that can provide the quickest response in employment, food supplies, and foreign exchange earnings, as demonstrated, for example, in Poland. Privatization of larger state enterprises, such as those for sugar, mining, and petroleum, will be more complicated and politically sensitive and would probably be left to the second stage of constitutionally elected government.

The issue of private property rights is linked to expropriation claims by Cubans and U.S. citizens, the latter totaling about $5.5 billion. Based on the experience of Eastern Europe, a general approach of compensation rather than restitution would be more expeditious and would alleviate fears within Cuba of people being dispossessed from their homes. The approach for some industrial and agricultural enterprises, however, could be tailored so as to give special bidding status to former owners during the privatization procedure.

An early understanding on expropriation claims by U.S. citizens is important, among other things, because it is a precondition for the provision of U.S. economic assistance. Such an understanding would have to take account of agreements reached by the Castro government on expropriation claims of other third country nationals as well as any overlapping property rights from recent joint ventures with foreign firms undertaken by the Castro government.

Priorities for Infrastructure

A restructured private sector will face many needs for economic infrastructure, especially in the transportation, telecommunications, and power generation sectors. At the outset, the development banks will play a key role, together with bilateral aid donors and the private sector, in the financing of such infrastructure projects. The inevitable confusion during the initial period, and needs that will far exceed available financing, however, will make the establishment of priorities for such infrastructure project financing a critical area of decision making. The Cuban government will have a unique opportunity to begin anew in building a modern infrastructure for its economy, but it must make the right decisions with respect to first-priority needs, most appropriate technologies, and environmentally beneficial results. This is an issue that Russia and the other former Soviet republics have not yet fully addressed.

Foreign Debt

Foreign debt is a most fluid issue with respect to transition from a Communist to a democratic, market-oriented government. Poland was able to negotiate a 50 percent write-down of its official foreign debt, while Russia thus far has sought a five-year moratorium on servicing debt incurred prior to democratization. No former Communist country has yet formally stated its wish or intent to repudiate debt of the earlier Communist regime. Negotiations elsewhere in Latin America to reduce and restructure external debt, under the Brady plan, are also relevant, with Costa Rica, for example, having negotiated an effective 70 percent to 80 percent reduction in its foreign debt.

In this context, Cuba has an $8 billion debt with Western creditors, none of which is with the United States, and an estimated 15 billion to 20 billion ruble debt with the former Soviet Union. None of this foreign debt has been serviced by the Castro government in recent years. The Soviet debt is apparently denominated in rubles, which would make its market value as of mid-1993 less than $100 million.

At this stage, the best that can be said is that the Cuban economic transition team should include nimble debt negotiators who will keep abreast of precedents elsewhere in the former Communist world. A moratorium on debt servicing for at least the first two or three years of transition would be a reasonable starting point.

Invidious Comparison with the former Soviet Union

In addition to lesson-learning parallels with the East European experience, there are even more important contrasts that would face a restructured Cuba. Five such contrasts stand out, in each case to the great comparative advantage of Cuba.

The Industrial Dinosaurs

The massive and greatly overstaffed industrial and defense production complexes in the former Soviet Union, and to a lesser extent in Poland, constitute the most intractable obstacle to market-oriented reforms in those formerly Communist countries. The Russian defense complex alone employs 10 million workers and has high regional intensity. The city of Nizhny Novgorod, for example, had 450 defense plants. Attempts to convert these obsolete "dinosaur" industries to commercially competitive enterprises are largely futile. Closing them down, however, would throw millions of people out of work, which is deemed politically unacceptable, so thousands of state enterprises continue to operate with huge government subsidies, producing products that nobody wants to buy.

The situation in Cuba appears far less grave in relative terms. State heavy industry and military production play a smaller role in the economy. The main Cuban steel complex at Antillana de Acero employed only 7,000 workers before recent layoffs. Some industrial facilities, such as cement and fertilizer plants, should be convertible to profitable private production. In any event, 60 percent to 70 percent of industrial plants have reportedly been shut down, partially or fully, and the workers discharged, under the Castro zero-option autarky program. Labor reabsorption through new manufacturing and service industries should also be easier because Cuban dinosaur industries have lower regional concentration than the former Soviet Union's, while labor mobility is higher within the relatively small island.

The Unemployed Military

The more than 2 million personnel of the former Soviet armed forces present a dilemma for Russia similar to its dinosaur industries. The budget cost of maintaining such forces is crushing, while the cutbacks in personnel thus far have created enormous problems in the absence of civilian jobs and housing for those discharged. The return to Russia of several hundred thousand troops based in Eastern Europe and elsewhere poses especially acute housing problems. Loss of prestige and economic hardships for the officer corps could develop into a political threat to the fledgling democratic government in Moscow.

Cuba also has a large military establishment for a country with fewer than 11 million people: an army of 145,000, a navy of 14,000, and an air force of 22,000. The absorption of sharp cutbacks in military spending and personnel could be much easier in Cuba than in Russia, however, if managed properly. A reintegration of Cuba into the Caribbean regional economy would create very substantial civilian employment opportunities for Cuban air force and navy personnel. Civil passenger and freight air traffic, particularly to the United States, would expand rapidly, presumably including a major share for Cuban airlines. Similar growth would emerge for maritime traffic, including cruise lines, auto ferries, and all classes of cargo and fishing vessels, with corresponding needs for port facilities and ship maintenance. Trained Cuban air force and navy personnel should need little encouragement to move into these expanding job markets.

The Cuban army is much larger and would likely require more targeted assistance to facilitate transition to private-sector employment. Nevertheless, the officer corps and noncommissioned technicians are generally well trained and educated and thus potentially valuable as managers and skilled workers. U.S. foreign assistance to a restructured Cuba should place priority on the retraining of military personnel, with linkages to U.S. business schools and vocational training centers.

The Fiscal Hemorrhage

Russian inflation exceeded 1,000 percent in 1992 and could spiral even higher in 1993 unless the fiscal deficit of up to 20 percent of gross domestic product is greatly reduced. The alternative of uncontrolled inflation financed by the Central Bank printing press will inevitably lead to the collapse of the Russian reform program--sooner rather than later. The principal causes of the Russian fiscal deficit/hyperinflation dilemma, however, are the two preceding issues: the industrial dinosaurs and the unemployed army.

A noninflationary fiscal program during the initial stage of Cuban restructuring will be a central and immediate challenge for whatever government is in place. Nothing focuses the official mind more than the need to draw up financial accounts that are in reasonable balance. Financial management under the Castro government apparently has been in considerable disorder, and thus the new fiscal accounts will have to be developed largely from scratch. IMF and other foreign technical assistance will play an important role in this central task.

The fiscal challenge for a restructured Cuba in comparison with that facing Russia, however, will be much less daunting to the extent that subsidies to state enterprises and military expenditures can be rapidly reduced. As explained above, this would be far more manageable in Cuba than is currently the case in Russia.

Environmental Degradation

The former Soviet Union faces overwhelming environmental problems. In the energy sector, dangerously unsafe nuclear reactors could cost tens of billions of dollars to replace or make safer, while low-quality, coal-generated electricity pollutes the atmosphere. Lakes and rivers are highly poisoned, causing severe health risks. Large industrial complexes combine all of the above in concentrated environmental disaster areas.

Cuba also has major environmental problems. Havana's harbor is highly contaminated from industrial, maritime, and urban waste disposal. The sugar, nickel, and paper industries are polluting rivers and coastal waters. Air pollution at cement plants and other industrial sites is serious. The nuclear power plant under construction at Juragua would likely be unsafe if completed, while planned peat exploitation in swamp lands for power generation would cause wide-ranging environmental degradation.

The difference for Cuba, however, is that its environmental problems are not as extensive or far advanced as those in Russia, and they are more amenable to remedial action. New private investment together with financial resources from the multilateral development banks could be mobilized relatively quickly to stem and reverse the problems enumerated here.

Absence of an Export Strategy

Russia and the other former Soviet republics have no apparent export strategy for short- to medium-term economic recovery. Petroleum and natural gas exports accounted for two-thirds of former Soviet export revenues, and production of these products is declining, with little hope of a turnaround for at least several years. Most other former Soviet exports went to other Communist countries or were based on noneconomic barter arrangements with developing countries. Very few of these products are now commercially competitive. The former Soviet Union also does not have a natural or regional export market to develop. The European Community (EC) is a closed market for agricultural products and gives preferences to its members, which should soon include the Czech Republic, Hungary, Poland, and Slovakia but not Russia and other former Soviet republics.

Cuba, in contrast, is at the center of the Caribbean regional economy, with immediate prospects for a surge in job-creating investment and foreign exchange earnings once market forces are unleashed and the U.S. market is reopened. This is by far Cuba's greatest advantage in comparison with the former Soviet Union, although it is also the most controversial and the least clearly understood. Fidel Castro has repeatedly denied that it even exists. A Cuban export-oriented economic strategy would have a number of distinct facets that need careful examination in the context of the Caribbean regional economy of the 1990s. The conclusion drawn here, as will be seen, is decidedly optimistic for a restructured Cuba.

II. The Cuba Restructured Plus Five Projection

A five-year projection --the Cuba restructured or "CR plus five" projection-- has been made for the Cuban economy based on the foregoing political assumption. The projection is principally in terms of foreign exchange receipts, which will constitute the driving force for broader economic growth. Increased foreign exchange enables a higher level of imports, which leads, in turn, to still higher levels of investment and job creation. In this sense, it is an export-oriented strategy in keeping with the concept underlying the Caribbean Basin Initiative of the 1980s. Indeed, a restructured Cuba should become the outstanding success story for what the CBI was meant to achieve.

The initial year of the five-year period is not specified. Instead, the projection simply begins at the point when the United States lifts the embargo and grants MFN status to Cuba and Cuba begins comprehensive restructuring to a market economy. What the beginning phase of such restructuring would mean in more specific terms was explained, in part, in the preceding discussion of lessons learned from Eastern Europe and is elaborated further in the sector-by-sector discussion of the projection below. Except when otherwise specified, the projection is based on 1992 prices and levels of national income and therefore does not reflect increases in dollar values over the five-year period resulting from inflation and income-generated market growth.

The projection is an aggregate of 15 components that together come close to the total foreign exchange inflow available to the Cuban economy. The projections for some of the components (exports of sugar, nickel, and fish) are based principally on existing conditions within Cuba. Other projected components (assembly industry, remittances, economic aid, and foreign direct investment) are derived in large part from recent experience elsewhere in the Caribbean region, while still others (tourism and nontraditional agriculture) draw on both internal Cuban and regional market conditions. A few components (services other than tourism and residential construction for nonresidents) have no quantifiable comparative measure and are projected on what are believed to be reasonable yet conservative estimates.

Such five-year projections under greatly changed political as well as economic circumstances within Cuba are not meant to be precise. As described in the sector-by-sector discussion, however, the rough orders of magnitude are highly plausible, and the relative magnitudes and differing growth paths among the components over the five-year period are reasonably well established. Most important, the central conclusion of the projection is clearly substantiated, namely, that the Cuban economy can be transformed in a relatively short time into one of high economic growth and job creation, increasingly integrated with the North American/Caribbean region.

The CR plus five projection is presented in the attached Table 1. The bottom line of total foreign exchange receipts, which in Chapter 3 of the referenced CSIS study was estimated at $2.7 billion in 1992, rises sharply to $4.4 billion in the first year of restructuring and then progressively up to $9.5 billion in the fifth and final year. This represents an extraordinary three- to fourfold increase from the depressed 1992 level and contrasts sharply with a virtually flat or declining projection out to 1995 for the current Castro reform program. The approximate $9 billion to $10 billion level at the end of five years is substantially higher than the 1989 level when Soviet aid was still in full bloom.

The projection also highlights the contrasts in the relative importance of the components between the initial two-year phase and years three through five. During the first two years, tourism, remittances, and, to a lesser extent, economic aid and export credits account for almost all of the increase, more than $1.5 billion in the first year alone. Then, in years three through five, these components, except for tourism, level off or decline somewhat, while strong growth shifts to private-sector-driven components such as assembly industry, nontraditional agriculture, mining, and foreign direct investment.

The sugar component is projected to grow only moderately, and its share of total foreign exchange receipts drops from 27 percent in the first year to only 16 percent in year five. This low and declining figure compares with 67 percent as recently as 1989, based on Soviet sugar purchases above world prices, and marks the end of two centuries of Cuban history during which sugar was king.

The Components of Foreign Exchange Receipts

A more detailed understanding of the plausibility and significance of the projection requires a closer look at each component.

Exports of Goods

Sugar. Sugar exports are projected to grow moderately from $1.2 billion to $1.5 billion over the five-year period, which, at the 1992 price of 9 cents per pound, translates to an increase from 6.3 to 7.6 million tons. Some of this increase will be in sugar-derived products such as high-sucrose syrups and packaged refined sugar. The projection is based on the assumption that there will be no substantial change in U.S. sugar import policy. U.S. sugar import quotas on a global basis totaled 1.4 million tons in 1992 and are scheduled to drop to 1.2 million tons in 1993. Even if Cuba were allotted 100 or 200 thousand tons at the expense of other countries, which would involve great difficulties for U.S. trade policy, this would only amount to 2 percent to 3 percent of Cuban sugar exports. It is also assumed that privatization of sugar lands will be a lengthier and more complicated process than in some other sectors, which could delay new investment to make sugar refineries less energy intensive and thus profitable at world prices of 10 cents or less per pound. The adoption of more stringent environmental controls could also hold back growth of production. This projection might be considered a conservative estimate, and a more ambitious alternative is discussed in the concluding section of the paper on possible Cuban membership in NAFTA. Each additional million tons of sugar exports, however, would bring in less than $200 million of revenues, and thus sugar, even in the best of circumstances, will play a relatively small and declining role in Cuban export performance.

Other agriculture. The base level of $330 million of agricultural exports other than sugar is an estimate based on 1991 export levels of citrus, coffee, and tobacco of $250 million and 1989 levels (the most recent available year) for various other products. These exports are projected to grow 10 percent the first year and about 20 percent per year thereafter. Access to the U.S. market should quickly attract financing for fertilizer, new plantings, and export marketing. A trained agricultural work force and high-quality arable land are abundantly available. A quick and sharp rise in citrus export revenues, which were $120 million in 1991, can be anticipated. Current exports are of lowest-grade citrus for concentrate, a highly competitive market dominated by Brazil. With one season's application of appropriate pesticides, however, Cuban citrus can be upgraded to juice or fresh fruit quality for the U.S. market. Other likely export growth products would include mangoes, melons, pineapples, and tomatoes.

Fish. Fish exports are projected to grow from $130 million in the first year to $220 million in year five. Cuban exports were almost at the $150 million level in 1987 and 1988 but then declined to an estimated $120 million in 1992 when gasoline shortages shut down some motorized vessels. The projection here is considered reasonable if not conservative with access to the U.S. market, particularly if substantial investment in fish farming is forthcoming.

Nickel. Nickel exports are projected to rise from $300 million in year one to $500 million in year five. Based on the 1992 world price, this translates into an increase from 42,000 tons to 70,000 tons. This can be achieved by upgrades of the three existing facilities and completion of construction on the new facility at Las Camoriocas for at least partial utilization (projected full utilization is 30,000 tons). Cuba has huge reserves of nickel ore that could attract large additional foreign investments. Questions, however, about energy cost for refining the relatively low-quality Cuban ore, tightened pollution standards, and property rights for the mining sector make it unlikely that new production for export from such large new investments would come on stream during the five-year period. Foreign exchange inflow from such larger investments would fall within the foreign direct investment component, below.

Other mining. The $10 million level in year one reflects the limited exports of copper and chrome recorded in 1989. Cuba has substantial resources in these and other minerals, including manganese, laterite, and gold. Foreign mining companies are interested in developing these mineral resources but have hesitated because of the political uncertainty of mining rights obtained from the Castro government and the closed U.S. market. The projection of an increase in exports of other minerals to $150 million by year five is low compared with the longer-term potential, reflecting again the likely slower and more complicated process for establishing new mining operations.

Manufactures (mostly assembly industry). This category is projected to increase dramatically from $100 million in the first year to $900 million in year five, or by $800 million. The principal vehicle for this growth would be assembly industry within free trade zones producing textiles, footwear, electronics, sporting goods, toys, auto parts, and various other products. The projection is based on the extraordinary experience of the Caribbean regional economy during the 1980s and especially during the second half of the decade. Fore example, a representative three-country grouping of the Dominican Republic, Jamaica, and Costa Rica, with two-thirds the population of Cuba, increased its manufactured exports to OECD countries by $932 million from 1985 to 1990; Costa Rica and Jamaica, whose population together is only half that of Cuba, increased such exports by $431 million and $233 million respectively. Mexico increased manufactured exports, mostly from assembly industry, from $9 billion in 1985 to $22 billion in 1990, which indicates the full scope of the regional market. For each of these countries, 86 percent to 94 percent of the export growth went to the United States.

This rapid expansion of manufactured exports in the second half of the 1980s can be attributed to the earlier learning experience of both the private sector and government policymakers, which a Cuban government can adopt at the initial stage of restructuring. Private companies can now organize and build free trade zone facilities quickly, while at the same time recruiting assembly industry to occupy them. This means that hard currency begins flowing in from the outset of construction and the hiring of workers and that export shipments can begin within a year of ground breaking. Free trade zone enterprises can and should be financed by private investors with no foreign economic aid involved. The requisite host-government policy actions include making land available for free trade zones, placing priority on finance for telecommunications, container ports, and air freight infrastructure, and adopting supportive economic policies such as a convertible exchange rate and reasonable tax treatment.

The projected rapid growth of manufactured exports in a restructured Cuba would likewise require early government actions. The Castro government has already adopted laws to establish free trade zones and to attract assembly industry, although little will happen as long as the U.S. market remains closed. These laws would have to be broadened to permit private ownership in the construction and operation of the facilities. In addition, early agreements between the Cuban and U.S. governments on CBI eligibility for Cuba and access to the Overseas Private Investment Corporation for political risk insurance would give further stimulus to assembly industry.

Free trade zones of efficient scale require a land tract of about 1 million square feet, a local labor pool to provide 10,000 direct and another 10,000 to 20,000 indirect jobs, and a location within 15 miles of a container port and 30 miles of an international airport. There would likely be several such zones in the Havana region, drawing on the population concentration and the transportation infrastructure of the city. Others could be located on the northern coast, closest to the U.S. market, while the heavily populated Santiago region in the south would also lend itself to one or two zones. Yet another attractive location is Guantanamo Bay, close to nickel and tobacco production, which will lose its strategic justification to the United States as a military base once a friendly, democratic government is established in Havana. Location of free trade zones in agricultural areas, drawing on underutilized sugar land and workers, might attract, in addition to manufacturing industry, food processing industry for nontraditional farm crops.

An early infrastructure decision of broader potential for the Cuban economy would be the selection of one port, probably on the northern coast, not only as a shipping point for assembly industry and other Cuban exports but also as the Caribbean transshipment hub for regional container traffic, similar to facilities in Hong Kong and Singapore for the East Asian market. Cuba is favorably located for such a role, and existing transshipment facilities in the Dominican Republic, Puerto Rico, and Jamaica have significant drawbacks. A state-of-the-art modern container port in Cuba could be constructed and operated with the participation of private shipping companies and financed in large part by the World Bank.

Other exports. The "other export" category is a residual that was $90 million in 1992. It apparently includes some food products as well as mining and manufactured products not included in the earlier figures. This category is projected to grow about 10 percent to 20 percent per year to $200 million in the fifth year, which can be considered reasonable in view of the strong export performance projected elsewhere. In any event, this is a relatively small component of the overall projection.

Continue to Part II