Ivan Alvarado / Reuters A man stands near former Cuban President Fidel Castro's birthplace in Biran, Cuba, December 2016.

Cuba's Road Ahead

Havana Faces a Challenge, Not a Crisis

On November 25, Fidel Castro, the former president of Cuba and communist revolutionary, died at the age of 90. Castro ruled the island, under various titles, for nearly five decades, and his death has prompted speculation on what lies ahead for the country that he did so much to shape. Especially on economic questions, most experts accept the view that Castro’s legacy—that of attempting to build and maintain a centrally planned, socialist economy—is one of failure. Cuba’s only hope for the future, in this view, is to dismantle the existing system and replace it with one oriented toward private businesses and free markets, as did the ex-communist countries of Eastern Europe in the 1990s. This consensus, however, overlooks not only the constraints faced by Cuban policymakers today, but also the country’s history of weathering difficult storms. Cuba faces serious economic challenges, but its system has proved resilient, and the island’s future is likely to be one of reform rather than revolution.

SOLE SURVIVOR

Although the Cuban government’s economic management has a bad reputation, it is difficult to conduct an objective assessment of the country’s long-term performance, particularly in the years between 1959 and 1991. At issue is the difficulty of measuring the relative costs of U.S. sanctions versus the benefits derived from Soviet aid, as well as weighing the value of Cuba’s strong social security system against estimates of the growth it might have seen if it had switched to a more market-oriented economy. The dominant narrative in the English-speaking world, which is disproportionately influenced by the views of free-market economists and U.S.-based Cuban exiles, tends to skew negative on both factors. But others have produced more positive assessments. In 1984, for example, the economist Claes Brundenius argued that despite some weaknesses, the Cuban economy presented a unique example of what he called “growth with equity,” posting sustained growth from 1970 on, while also achieving a relatively equal wealth distribution.

But although Cuba may have performed better in these years than is generally acknowledged, over-dependence on the Soviet bloc left it acutely vulnerable. The economy began to stagnate in the mid-1980s before collapsing altogether with the end of the Cold War. Between 1989 and 1991, Cuba’s import capacity was cut in half, and by 1993, with its international currency reserves exhausted, its import spending was down to just one-quarter of 1989 levels. Between 1990 and 1993, GDP had contracted by around one-third. U.S. sanctions, moreover, not only ensured that Cuba was cut off from the U.S. market but also ensured that, unlike its former allies, it had no access to international financing from international organizations (such as the IMF and World Bank). The social impact of the recession—measured in terms of life expectancy—was far less severe for Cuba than for most of its former socialist partners.  

The immediate aftermath of the Cold War was thus a disaster for Cuba. In such circumstances, it was inevitable that ordinary Cubans would face deprivation. The effects of the recession, referred to by the government as the “special period,” were demonstrated vividly by the absence of cars on the streets (due to a lack of fuel imports) and the meagerness of food rations—the average Cuban adult lost over 10 pounds in the years 1990–1995. Yet arguably more remarkable is that the hardship was not even more severe. Defying the predictions of almost every outside observer, not only did the Cuban system not collapse entirely, but its recession in the first half of the 1990s, measured by the decline in national income per head, was actually no worse than the average for other post-communist countries making the transition to capitalism where the external shock was less severe and official international financial support was available. And the social impact of the recession—measured in terms of life expectancy—was far less severe for Cuba than for most of its former socialist partners. Between 1990 and 1993, Cuban life expectancy held steady at almost 74 years, while it fell in most of Eastern Europe. (In the case of Russia, the deterioration was particularly sharp, with average male life expectancy falling from 65 to 62 in just three years.) And although GDP took a decade-and-a-half to return to the 1990 level, Cuban life expectancy improved over the same period from the third-highest among ex-COMECON members to the highest, at 78 years.

A MIXED BAG

To describe Cuban economic management as a failure during this period is therefore misleading. Although the economy did very badly after the Soviet collapse, the evidence does not suggest that the cause was bad economic stewardship. Indeed, a number of effective government policies contributed to Cuba’s resilience throughout the special period.

Probably the most important of these was the government’s commitment to maintaining the guarantee for the provision of basic needs—ensuring a minimum supply of food through the use of a quota system, and maintaining universal access to health care. Although its ability to do so  was severely strained by lack of resources, an exceptionally comprehensive health, education, and welfare system made it possible to sustain essential services: the central government had the power to direct national resources to these priorities, and regional- and municipal-level institutions had the pre-existing capacity to deliver the necessary goods and services. Cuba also benefitted during the initial crisis from the many tools available in a state-dominated economy, such as government control of employment, prices, wages, and foreign exchange, which made it possible to avoid the mass unemployment, hyperinflation, and capital flight common in other post-Soviet states. Other important factors that contributed to the regime’s survival were its efforts to fight corruption (even as economic conditions created ideal conditions for it to flourish) and its ability to appeal to national unity in the face of tightening U.S. sanctions. By 2015, Cuban earnings from exports of goods and services were more than $16 billion: three times their 1990 level.

Cuba was eventually able to recover economically by restoring its foreign exchange earnings, although it took until 2004 to bring them back to pre-crisis levels. Havana managed this feat by transforming the structure of Cuba’s export economy: while sugar exports provided over 70 percent of Cuba’s foreign exchange earnings in 1990, today they account for less than 3 percent. Because the state was able to direct investment, it was, in the first decade-and-a-half following the Soviet bloc’s demise, able to replace income from sugar exports with more lucrative industries such as tourism and nickel-mining. More recently, exports of professional services, refined petroleum, and medicines, as well as remittances, have further increased Cuba’s foreign exchange earnings. By 2015, Cuban earnings from exports of goods and services were more than $16 billion: three times their 1990 level. This is despite continued U.S. sanctions. Although the rapprochement that began in December 2014 has resulted in an increase in U.S. visitors, which has boosted private sector businesses (particularly in Havana), sanctions continue to block other avenues for trade and financing, and so thus far the macroeconomic impact of the thaw has been slight.

MONEYBALL

But important as they are, the Cuban government’s achievements in maintaining welfare provision and restoring foreign exchange earnings have not been enough to create sustainable economic development. Indeed, they have only been achieved by building up acute imbalances, the legacies of which continue today. Most important, the measures taken during the crisis led to the development of a dual exchange rate system that now presents a serious obstacle to economic improvement.

The dual currency system was the unintended consequence of the very policies that made it possible for the country to weather the special period. In the early 1990s, the government spent heavily in order to preserve public-sector jobs and provide basic goods. The resulting fiscal deficits, which were effectively financed by printing Cuban pesos, led to the erosion and eventual collapse on the currency’s value, which fell from a black-market exchange rate of around seven pesos to the U.S. dollar in 1989 to more than 100 pesos to the dollar by 1993. A series of measures introduced in 1994 and 1995 succeeded in reducing the deficit and partially restoring the value of the peso to around 25 to the dollar by 1995. Unable to prevent the flourishing black market, the government legalized currency exchange at market rates for Cuban citizens at institutions knows as “Cadecas,” but maintained the official exchange rate of one Cuban peso to the dollar for state-run enterprises in order to minimize economic disruption. The government also maintained strict wage and price controls in the Cuban peso, or domestic, economy, while allowing prices in the external economy (which includes the lucrative tourism industry) to be determined by the market.

Edgar Garrido / Reuters Fidel Castro's ashes are driven to the cemetary in Santiago, Cuba, December 2016.

As a result, Cuba now has a two-currency system. The Cuban peso (CUP) is used for state salaries and for prices within the domestic economy, but can be exchanged at the Cadecas for the “convertible peso” (CUC), which trades at a fixed rate of one CUC to the dollar. Since 2012, the Cadeca rate has been set at 24 CUP per CUC. 

The effects of the two-currency system are economically, socially, and politically pernicious. The prevalence of low fixed prices for basic goods within the domestic economy means that the CUP is heavily undervalued at the Cadeca rate (that means the spending power of a U.S. dollar greatly increases when converted to CUP—a bus fare, for instance, costs two cents). The Cadeca rate provides enormous relative privilege to individuals with access to hard currency or CUC, who can enjoy incomes many times greater than the average state salary of 688 CUP per month ($29 at the Cadeca rate). It is therefore easy to understand why the country is facing a serious problem of internal brain drain, in which skilled public-sector workers abandon their careers for relatively unskilled CUC-earning jobs in the private sector.

At the same time as it promotes social divisions, the undervaluation of the CUP chronically drains state resources. Whenever Cubans (or indeed foreigners) pay for fixed-price goods or public services with CUC, they are enjoying a state subsidy, because the cost of producing these goods, measured in hard currency, is greater than the price in CUP paid by consumers. Most of this subsidy, moreover, is not measured in any accounting. Imported goods are also subsidized for those, such as state enterprises, with access to the overvalued CUC, meaning that state companies that use imported inputs to make goods for the domestic market have no incentive to produce efficiently. To deal with this evident distortion, the government has to ration access to foreign exchange for Cuban importers. But this is a cumbersome process that obstructs an enterprise’s ability to respond to changing international market conditions and discourages innovation.

The effects of the two-currency system are economically, socially, and politically pernicious.

The currency system also hampers export growth. For potential exporters, anything using produced using CUP-denominated domestic inputs would struggle to report a profit. Again, the state bureaucracy is obliged to intervene to compensate for the exchange rate and price distortions: central planning provides mechanisms for directing resources to support exporters, but opportunities are still systematically obstructed through the absence of meaningful price signals and the burden of bureaucratic delays. The result is that despite the government’s stated intention to diversify exports and reduce import dependence, exports remain limited to a handful of products, domestic production remains uncompetitive, and the economy remains trapped in a slow-growth trajectory that is highly vulnerable to external shocks.

GETTING TO REFORM

Since taking over the presidency in 2006, Raúl Castro has sought to tackle the legacy of this lopsided economy. One of the objectives of his economic reforms has been to widen the scope for non-state enterprises to operate and to increase what policymakers refer to as “the use of the market mechanism.” The choice of words is telling. The economic “adjustment” or “improvement,” as described in the official guidelinesfor economic policy (lineamientos) set out in 2011 and updated in 2016, does not envisage mass privatizations or the end of state-directed economic development. But it does acknowledge that more decentralized economic decision-making and increased competition are required to diversify the economy. For the market mechanism to produce these positive outcomes, however, prices need to adjust to reflect relative scarcities, and as long as the dual currency system persists, distorted prices will continue to prevail.

Currency reform, therefore, was one of 313 lineamientos from 2011, and among the most talked-about and anxiously awaited. Yet it was not achieved during the intended five-year period. At first, a plan was drawn up to eliminate the CUC on an unspecified date, but this was quietly abandoned. Since then, the government has conducted pilot studies in which the official exchange rate has been adjusted for individual enterprises, using a rate of around 10 CUPs to the dollar, but there have been no clear indications yet that these pilots will be generalized. Given the huge implications of the reform and its potential for creating economic instability, perhaps it is not surprising that the government has dragged its feet.

Given the huge implications of the reform and its potential for creating economic instability, perhaps it is not surprising that the government has dragged its feet. This reflects Raúl Castro’s generally cautious approach to economic policy-making. In his view, change should be designed to minimize economic disruption in order to prevent social dislocation, although he is no doubt motivated by an awareness of the political risks of economic upheaval as well. But an excessively gradual approach is also risky, as it leaves the rest of the economy burdened with economic distortions and costly subsidies.

The slow pace of currency adjustment partly explains the sluggish pace of economic growth—just 2.5 percent per year—under Raúl Castro. Cuba has been hamstrung by the drop in oil prices, which has cut into the windfall from its agreement with Venezuela, in which Cuba sent doctors and received oil in return.  Economic growth has has also been constrained by the government’s determination to reschedule old debts and strictly meet new obligations. These efforts should eventually help to build a stronger and more resilient economy. But in the meantime the living standards of wage-earning Cubans remain miserably low, and hopes for more rapid improvements have been repeatedly frustrated. 

SIN PRISA, SIN PAUSA

Raúl Castro has promised a steady process of change, “sin prisa, pero sin pausa” (without haste, but without pause). But he has also promised to step down from the presidency in 2018 and must surely want to leave the economy in a stronger condition. While other economic changes will be important, reforming the country’s exchange rate is the most fundamental. It is a necessary condition for further decentralizing economic decision-making, which is needed in order for the economy to diversify and grow.

Yet given the potential instability that could accompany any serious currency reform, Castro would have been hoping to take this step at a time when relations with the United States were relatively favorable. And they were, until Donald Trump was elected in November, creating new uncertainties about U.S. policy. This leaves Raul Castro with a major dilemma: will he take a risk, or leave his successor to deal with the problem? If he chooses the latter, he will leave the Cuban economy weak, stagnant, and vulnerable. To rescue his own legacy, and that of his late brother, he will need to take the leap – and wage the final battle of his 60-year career.

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