bob looney teaches economics at the Naval Postgraduate School in California.
Published October 16, 2018
In a moment of candor, 84-year-old Fidel Castro acknowledged in 2010 that “the Cuban model doesn’t even work for us anymore.” In fact, the Cuban model hadn’t really been working for many decades, producing satisfactory growth only when propped up by massive foreign assistance. In the 1980s, aid from the USSR boosted Cuba’s average annual growth in GDP to 4.1 percent, only to have it fall back to 2 percent in the 1990s following the Soviet Union’s collapse.
Manna from abroad worked its magic again in the 2000s, when Cuba’s average growth rate soared to 5.6 percent thanks to generous inflows from oil-rich Venezuela. But the rate descended again, to 2.1 percent in 2010-17, as the Venezuelan economy spiraled into chaos.
With no new benefactors — indeed, with a new enemy in the form of the Trump administration on the horizon — probably the best Cuba can hope for with business-as-usual is to shuffle along at around 2 percent. And even this pace seems a reach.
No Easy Way Out
Cuba suffers from a severe foreign exchange constraint, with raw materials (specifically nickel), tourism and medical services its only competitive areas in global markets. Ambitious efforts at achieving relative independence from imports are sagging, and the government appears unwilling to undertake the reforms needed to improve the business environment and position the service sector to take advantage of export markets.
The economy’s structural weaknesses not only inhibit exports, but have led to declines in productivity needed to bootstrap growth — a disastrous situation for a government whose approach to development is a relic of the Soviet Union’s old extensive growth model. According to this model, growth is tied to the sheer expansion of capital and labor (at the implicit expense of efficiency and market-driven value) and, consequently, slows remorselessly when these slip. Between 1997 and 2007, the Cuban labor force expanded at an average annual rate of 1.2 percent and gross capital formation grew at an average of 7.4 percent. Since the 2008 beginning of Raul Castro’s decade in charge, labor-force growth has averaged just 0.5 percent annually, while gross capital formation has slumped to 3.6 percent.
Typically, stagnant non-market economies like Cuba’s eventually adopt liberalizing reforms. Success thereafter can create a virtuous circle, whereby harvesting the low-hanging fruit leads to follow-on investment from home and abroad. Growth expands government revenues, enabling increased social investment in infrastructure and human capital.
As growth accelerates, government and the private sector see mutual gains from improved governance and growth-enhancing institutions. Improved rule of law, control of corruption and secure property rights facilitate greater savings and investment, further augmenting growth. Rinse and repeat.
Yet, though Cuba has instituted a series of reforms intended to prop up the struggling economy, it has fallen far short of creating this virtuous circle — and, to be fair, that was never the intent. Indeed, the more modest changes that Raul Castro initiated in 2010 were motivated by fiscal pressures driving him to scale back a bloated public sector. To accomplish this, the government announced a new “market socialism” model that allowed self-employment, especially in tourism, and encouraged the establishment of small restaurants and bed-and-breakfasts (casas particulares) — albeit under tight government control.
Despite the constraints, the new private sector grew dramatically. Businesses not only flourished, but paid wages considerably above those in the public sector. The wage differential was in part the result of a new, dual-currency system designed to lure workers out of redundant government jobs. Under this system, public-sector workers are paid in Cuban pesos that can be only be converted at an extortionate rate to dollars (needed to buy imported consumer goods), whereas workers in tourism are paid in the Cuban convertible peso.
Eight years after Castro put the new market socialism model in place, average wages in the state sector still linger around under $30 a month measured at the unprivileged exchange rate, making goods and services with prices determined by the small free market utterly unaffordable. Government efforts to expand price controls to protect access to staples for state workers have backfired, reducing supplies in formal markets by diverting them into the underground economy.
At least for now, growing inequality driven by private enterprise is seen as riskier to the regime than economic stagnation.
A more flexible government would have built on the clear success of the new tourism sector by instituting follow-on reforms. Instead, the regime has focused on the increased inequality facilitated by the dual-currency system. In the summer of 2017, it suspended new licenses to private firms and introduced a series of burdensome regulations limiting the size of enterprises. Castro’s successor, Miguel Diaz-Canel, followed up in early 2018 with a group of even more stringent regulations limiting the scope of private activity as well. At least for now, growing inequality driven by private enterprise is seen as riskier to the regime than economic stagnation.
By keeping the private sector down in the short run, the government can protect state-owned enterprises that still largely dominate the economy. However, in the longer run, this awkward compromise will not be able to assure an adequate standard of living without an angel from Russia or Venezuela to cover the shortfalls.
A Way Out?
The masters of Cuba’s neither-fish-nor-fowl economy thus seem to be facing a day of reckoning. Prioritizing market decentralization and increased global integration would lead to greater inequality — a risky business with a government whose enduring claim to political legitimacy hinges on the eradication of poverty.
One strategy that has been suggested for Cuba — the development economist’s equivalent of a Hail Mary pass — is the adoption of a model similar to that of Ethiopia, where central planners are actively pursuing economic growth without allowing widening income gaps. However, Ethiopia has been able to leverage underutilized resource endowments in the effort, an advantage that Cuba does not share.
In addition, the developmental state model requires an environment in which technocrats can run the show without interference from the political elite on top or from the citizens below. The recent backlash against privatization within Cuba’s entrenched Communist party suggests that this approach would be highly problematic for the beleaguered island elite.
A more realistic option might be something along the lines of the development model adopted by the Communists in Vietnam. In many ways, the structure of the Cuban economy today is like that of Vietnam before its takeoff. In both, major land reform and a decades-long effort to create a relatively equal distribution of income and wealth preceded market-based reforms. One result: like Vietnam, Cuba has a rural population with the health and literacy to become a fairly flexible urban workforce.
Vietnam eventually generated high rates of economic growth by introducing market reforms and welcoming foreign direct investment. Inequality increased, but the rising tide of productivity still carried all boats sufficiently high to inhibit dissent. One giant question for Cuba, then, is whether there is a discrete way to tip-toe toward a successful market economy while keeping the ideologues at bay and protecting the living standards of less productive households.
It is becoming increasingly clear that the Communist leadership of Cuba is damned if it reforms the economy and damned if it doesn’t. Vietnam’s successes suggest there may be a way forward that allows the old revolutionaries to maintain political control. But the path is narrow and tortuous — and it may require the cooperation of its giant neighbor to the north. But that’s another story.