Cuba's Domestic Makeover

In 1960, self-appointed Cuban Prime Minister Fidel Castro nationalized all American-owned businesses without providing compensation, increased trade with the Soviet Union, and levied taxes on all American imports. In response, the United States promptly ended diplomatic relations with the island nation and imposed a trade embargo that still stands today. It is estimated that this embargo has resulted in a loss of $1.126 trillion during the 50 years it has been in effect.
But in 2006, Castro handed over control of the government to his younger brother Raúl, and within a decade the first meeting between a sitting U.S. president and the Cuban head of state since 1961 took place. Many say this landmark reopening of diplomatic relations between the two countries points—achieved via executive order—to better economic prospects for Cuba. However, it is important to note that the U.S. trade embargo has not yet been lifted. In fact, the Helms-Burton Act, which became law during the Clinton administration, specifies that the embargo can only be lifted following congressional approval and significant improvements to the economic and social freedom of Cuban citizens.
But the continued sanctions are arguably not such a bad thing. Cuba’s gradual growth in trade with western nations—most notably the recent $957 million investment by Brazil to refurbish Mariel Harbor—is preferable to a sudden jump into tariff-free exchange. Pursuing a policy of gradual reintegration enables and incentivizes the country to enact key domestic reforms in both agricultural and fiscal policy that must be actualized before Cuba can be attractive for the foreign investment it desperately needs to expand its economy.
Nudging Along the Private Sector
The country needs extensive reform to tackle the depleted productive base that currently plagues its agricultural sector. Declining Cuban food production since 1959 seems to have been at least partially a result of the lack of Soviet equipment, spare parts, and aid that had previously subsidized the sector. Faced with low production capabilities and a growing population, Cuba has been forced to import large quantities of food in order to meet domestic demand. Given current economic difficulties, it is questionable whether this level of importation is sustainable.
The government took significant steps toward agricultural reform in 1994 when it established the Basic Units of Cooperative Production, a type of agricultural co-op system, from the former state-owned farms and opened new, free agricultural markets. However, the food prices in these markets remain too high for the average consumer, and the Cuban government has done little to combat a number of other obstacles—like the proliferation of black markets—that have historically hindered the agricultural sector.
Currently, agriculture accounts for only 4.3 percent of Cuban GDP. This is particularly troubling considering the service industry, a highly unreliable and fluctuating source of profit, accounts for 74 percent. Immediately lifting the U.S. trade embargo would only encourage these high levels of importation and thus eliminate the possibility of Cuba developing agricultural industry into a domestic economic engine. With a market flooded by cheap subsidized American produce, Cuban farmers wouldn’t stand a chance
Private sector development seems to be the most promising option for invigorating Cuba’s inefficient farming industry. However, business growth in the country also hinges on a few key domestic policy changes. Many have called for improvements to the country’s dilapidated physical infrastructure, which would expand the productive potential of the economy by improving transportation throughout rural and urban Cuba (travel restrictions currently limit many in the workforce). This would aid small businesses in two ways: by increasing the number of potential employees to hire and by decreasing the costs of production and transportation.
The present dual-currency system is another remnant of Fidel’s regime that continues to hinder the private sector’s ability to compete with state-owned enterprises. The Cuban peso is the currency in which most worker salaries are paid. However, the Cuban convertible peso, worth around 25 Cuban pesos, is pegged to the dollar and serves as the primary currency for the tourism sector. This means that workers in the travel industry enjoy much higher incomes than employees in state or privately owned businesses. Also, because the CUC and CUP are considered equal between state enterprises—a policy established to insulate CUP prices from the economic crisis following the collapse of the Soviet Union—economists aren’t able to accurately estimate the value or cost of operation of state-owned businesses, making the relative value of a privately owned business difficult to judge.
Finally, a number of tax concessions for small business owners would stimulate economic activity and development, particularly in the agriculture sector. The most pressing tax issue impeding the development of privately owned businesses is Cuba’s labor system. Cuba has one of the world’s highest taxes on labor, pushing down wages while simultaneously downsizing the workforce—a combination that makes for especially low productivity. Lowering tax rates would increase employer demand for labor, possibly raising tax revenues in the process. Additionally, the 50 percent income tax for earnings over $2,000 remains a heavy burden for self-employed businesses and farms.
And these domestic reforms to encourage business growth are actually more likely to succeed if there is a slow easing of trade restrictions with the United States, as the more relaxed migration laws that would surely follow the lifting of the embargo could have traumatic effects on the island state. While less government intervention in migration seems like a victory for social rights in Cuba, it actually poses a threat to the strength of the Cuban workforce. Given that a third of Cuba’s population will be over the age of 60 by 2030, an increased number of young citizens leaving the country could seriously impact the number of potential employees for private and public sector businesses. If domestic reform encouraged increased opportunities for private-sector employment before a shift in emigration policy, young citizens would be less inclined to leave the country.
Limited Progress
To Cuba’s credit, the government has been taking important steps toward encouraging privately owned businesses. For example, in 2013 the state enacted a new progressive tax code that has subjected state-owned business to a 35 percent tax rate on profits. Under the old system, SOEs simply handed all of their profits over to the government, which then allocated resources for them.
The gradual but radical overhaul of the relationship between state-owned enterprises and the private sector in Cuba is perhaps best demonstrated by Castro’s commitment to eliminate state jobs, thus encouraging more Cubans to enter the private sector workforce. Castro has pledged that the government would cut public sector payrolls by 500,000 in an effort to incorporate 1.8 million people into the private sector by 2015. However, the fact that this effort has fallen remarkably short of the goal—only eliminating 137,000 jobs thus far—shows how difficult and probably sluggish the restructuring of the Cuban economy and workforce will be.
Additionally, the movement to curtail the state’s economic role will likely be counter-balanced by the regime’s unwillingness to transition out of the one-party system. A certain degree of political finesse will be required to permit the emergence Cuba into a public-private hybrid with many forms of production, property ownership, and private-sector investments while still maintaining its autocratic character.
The highly publicized nature of the current reform movements has led many to be hopeful. Like any reform process, stimulating Cuba’s nascent industries and thus increasing production potential is a work in progress. However, the combination of Prime Minister Castro’s progressive agenda and the gradual reopening of Cuba to foreign investment are major steps to a new, more modern Cuban state.
Image source: Wikimedia // Bin im Garten