Will the proposed economic reforms in Cuba succeed?

May 5, 2011

Yes: Omar Everleny Pérez; No: José Antonio Ocampo

  • These reforms will update the Cuban model and spur economic growth.

    by Omar Everleny Pérez

    Will Cuba's Economic Reforms Succeed? Yes

    Cuba's recent economic reforms to its economic model are not entirely new. What is new is the perception and the importance placed on them, especially on the role of the non-state sector. Once implemented, these reforms will update the country’s economic model.

    In announcing the “Draft Guidelines for Economic and Social Policy”—upon which the reforms are based—at the Sixth Congress of the Cuban Communist Party in October 2010, Cuban officials acknowledged inefficiencies in the economic model. These included: low economic growth, especially in industry and agriculture; inefficiencies in investment; low levels of investment in productivity and infrastructure; the gap between workers’ incomes and the rising prices of goods and services, both in markets free from price controls and the state foreign currency, and convertible peso markets; lack of connection between workers’ productivity and salaries; excessive economic centralization; increased state restrictions on certain goods and services; the low level of housing construction; and the foreign and domestic deficits.

    To counter these inefficiencies, the government proposed a series of adjustments designed to improve productivity by promoting entrepreneurship, establishing a more efficient tax system, and balancing public finances.

    The most important adjustments focus on incentives for creating non-state employment. For instance, the government will now recognize 178 categories of work or trade. In the agricultural sector, it promises to put unused land into productive use. Cubans will no longer be forbidden from selling homes and vehicles—even to foreigners or temporary residents. Businesses will be granted greater autonomy, and multiple licenses will be available for conducting business not only in one’s hometown but anywhere in the country. Private restaurants can expand from 12 to 20 seats. And in a move toward ensuring food self-sufficiency and eliminating rationing, individuals will be allowed to lease state facilities, including those in the food industry.

    Among the measures, those targeting self-employed workers will undoubtedly have the greatest positive impact. The policy is being encouraged at all levels of government, and for good reason. Under its reorganization plan, the Cuban state intends to move between 1 million and 1.3 million state workers off state payrolls within the next few years, making self-employment policies the most urgent.

    The openings providing for self-employment will permit the creation of microenterprises. Since October, the number of licenses granted to micro-enterprises has surpassed 113,000, a nearly 50 percent increase from before the start of the reforms.

    These developments will expand supplies of consumer goods and services. There are already signs that the measures have had a positive impact. The number of workers hired by other self-employed workers has increased. So has the number of microenterprises dedicated to the preparation and sale of food, the manufacture of household goods and transportation. For many people, microenterprise has constituted an alternative source of income to state salaries and pensions. For the state, it will provide a source of new tax revenue.

    The new measures also focus on balancing public finances by decreasing public payrolls and unemployment compensation. And as the state reduces total payroll expenses and increases revenue from taxes on self-employed workers, it will be able to increase public-sector salaries.

    To improve productivity, details have also emerged about a more efficient form of contracting labor. Companies will be able to count on greater funds for salaries to distribute among fewer employees.

    This will be done through a system of results-based payments, which will mean an increase in productivity and, consequently, growth in the economy as a whole. Under the proposed adjustments, it has been estimated that new non-state annual tax contributions will exceed $1 billion per year.

    At the core of the reforms is an acknowledgement by the Cuban state that it must relinquish control over those activities and sectors, such as retail, that do not serve it strategically and that it believes have the capacity to absorb the growing labor force in coming years.

    However, the proper functioning of the private sector depends on nondiscrimination and competition. For this, a number of conditions will be important. Among them: access to technical and material supply markets; access to sources of financing and insurance to cover risk; access to fair and competitive domestic consumer markets and export markets; regulations that do not impose undue burdens in their compliance or administration; and a tax burden consistent with the desired activity and size of the project.

    If these conditions are established, non-state employment will meet its expected contribution to the economy, above all in terms of job creation and the production of goods and services. I estimate Cuba could grow at a rate of 5 percent after the reforms.

    It will be a complex task to effectively design and implement the steps needed to unleash the production forces of a “handmade” economy, where discretion has prevailed over rules, institutions and respect for regulations.

    Time has changed the functions and needs of our socialist project. Those changes, along with the success of other countries’ experiences, demonstrate that the Cuban state is in vital need of updating its economic model.

    This means the market must play an ever-increasing role in the Cuban economy, even if planning will officially prevail over the market. The measures that the authorities have taken are a first step in the right direction.

  • The reforms do not go far enough to jump-start the economy and protect the vulnerable.

    by José Antonio Ocampo

    Will Cuba's economic reforms succeed? No

    The economic reforms announced in Cuba in 2010 are indispensable to correct the huge structural imbalances of the Cuban economy and to sustain the social advances achieved on the island over the past half century.

    If anything, the reforms were late in coming. They are also risky because they may increase the number of Cubans in vulnerable situations and widen income inequality. And they are incomplete and must therefore be deepened. Due to their social costs, however, support for them may weaken through time, further risking their success.

    In retrospect, it is clear that the major problem was the insufficiency of the reforms of the early 1990s, adopted following the collapse of the Soviet Union. Those reforms succeeded in attracting foreign investment and launching the boom in tourism and mining. However, they were incapable of increasing the supply of food and of reversing the collapse of the sugar industry. And although they initially generated a dynamic response from self-employment, reforms in this area were partly reversed in the late 1990s and never allowed wage employment in small domestic private firms. Most important, little was done to reform the state production sector, where inefficiencies are vast.

    In short, Cuba missed at that time the opportunity to follow the examples of the Chinese and Vietnamese, who, by complementing their large state sectors with a market economy, were able to facilitate the transfer of excess labor in state-owned enterprises to the growing private sector. Cuba’s reforms will now have to be more radical, since structural problems have continued to mount.

    It is also clear that the growing dependence on Venezuela over the past decade became a double-edged sword. It generated a boom in 2004-2007, when Cuba grew at annual rates of over 9 percent thanks to sales of services to Venezuela—most probably overpriced. But this generated the same problem created by dependency on the Soviet Union: the severe crisis that Venezuela experienced in recent years spread to Cuba, in addition to other effects of the global financial crisis. Growth came to a standstill in 2009 and 2010, as production of goods for the domestic market contracted.

    Cuba also missed the opportunity during the boom years to build the capacity for countercyclical macroeconomic policies. When the crisis hit, the response was fiscal austerity and monetary contraction. Equally important, the boom of the mid- 2000s was not used to increase the extremely low investment rate of Cuba: 12.8 percent at its peak in 2006, versus a Latin American average of 19.8 percent at the time (at 2000 prices). The investment rate is now under 10 percent compared to a regional average of 21.4 percent.

    Success of the reforms will be measured by their capacity to generate growth in the incipient domestic private sector and to restructure the inefficient state firms, while avoiding the potentially large social costs. Other things will help, particularly the renewed growth of Caribbean tourism, in which Cuba is likely to be a winner, and the expected recovery of its major trade partner, Venezuela. High commodity prices can help the mining sector and the redesign of the sugar industry, but will hurt the island through high food prices.

    In contrast to the reforms of the 1990s, the freedom provided to small domestic firms to hire labor and sell their goods and services to the state are major steps forward.

    However, the list of allowed activities is still short, and there is a need to provide credit to these firms and develop markets for the inputs they require. The government also has to reduce the high tax burden that was imposed upon them and avoid the temptation to unduly regulate their prices.

    Increasing the productivity of the state firms will be even more challenging. Reducing redundant labor will help. So will the autonomy given to managers and the incentives provided to productive workers. The elimination of government transfers to state firms also operates as a strong demand to improve. But we have to see whether individual managers will perform and whether other things will function properly, particularly, again, the supply of credit and inputs.

    The potential social costs of the transition are large. Employment poses the toughest challenge. The Minister of Finance mentioned last December a figure of 1.8 million workers to be dismissed by 2014, basically an estimate of the redundant labor force in the public sector. But this represents 37 percent of the Cuban labor force!

    Even the much lower target set for March, of half a million workers, is challenging, as it would be impossible to generate this number of jobs in the private sector in such a short time. This creates the risk of an immediate increase of unemployment from 1.6 percent to over 10 percent. Equally important, there is likely to be a significant mismatch between the low skill levels demanded by the new jobs and the relatively high educational qualifications of the Cuban labor force unless new opportunities for highly skilled labor are created.

    The social tensions will come from other areas. One common external observation about Cuba is that the average monthly wage is $18, an estimate that comes from dividing the nominal wage in Cuban pesos by the exchange rate. This estimate is wrong, because a Cuban worker today spends most of his or her income at highly subsidized prices, which include the ration card, housing and utilities (all provided possibly in insufficient quantities and qualities), as well as other essentials, such as medicines.This mismatch is the reflection of an extreme dual price and exchange-rate system, with differences in the latter being 24 to 1. However, no matter how inefficient the system is, the announced elimination of the ration card will make estimates of the dollar wage mentioned above more accurate.

    The reduction in real wages (and real pensions) will have an adverse effect on income distribution on top of the inequality that freer markets can generate. The dual price system is already generating inequalities associated with differing access to dollars from remittances and the tourism sector.

    This means that the challenge of eliminating subsidies for consumers and gradually dismantling the dual price and exchange rate system is colossal. The government may therefore want to proceed at a slower pace. Slower transition in this area will help ensure adequate support from the population for the rest of the program.

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