José F. Alonso, Office of Research, Radio Martí
[2]
and Armando M. Lago, Ecosometrics, Inc.
See also Comments by Luis Locay
Background
This paper presents some initial thoughts on the economic prospects of a post-Castro democratic Cuba. It provides rough figures of the growth prospects, balance of payments and debt-servicing capabilities of a democratic Cuba under three economic scenarios:
1. Partial Privatization à la Nicaragua,
2. Full Privatization / Caribbean Basin Initiative (CBI) scenario, where Cuba privatizes all its economy and becomes member of the CBI,
3. Full Privatization/North American Free Trade Act (NAFTA) scenario, where a post-Castro democratic Cuba achieves membership in NAFTA after a 15-year wait.
Projections of economic prospects are developed for four time periods: the base year t+0, t+5, t+10 and t+15 years after the change to a democratic government in Cuba. A list of sources can be found in Appendix B.
THE SCENARIOS
The first scenario, corresponding to a partial privatization, is akin to the current Nicaraguan governmental policies, where privatization moved very slowly and where members of the former regime (i.e. the Sandinistas) are still part of the government.
In this scenario, privatization proceeds very slowly and in a haphazard fashion, so that land and agricultural endeavors are hardly affected by privatization. This scenario is commonly referred to as "Fidelismo without Fidel" ("Fidelismo sin Fidel") within the Cuban exile community.
In the CBI scenario, a democratic Cuba rapidly proceeds to privatize its economy and by year t+5 has qualified to join the CBI. In this scenario, agriculture is privatized and Cuban agricultural and industrial exports to the United States begin to grow under the CBI trade system.
The third scenario (NAFTA) of full privatization is similar to the second (CBI) except for year t+15, when a post-Castro, democratic Cuba is accepted into the NAFTA pact after a long period of negotiation with the NAFTA trade partners.
THE ECONOMIC MODEL
The develop project an economic model to trace out the interrelationships between exports, investment, debt and their effects on the growth rate of the Cuban economy in a post-Castro democratic Cuba. The specified model is a variation of the model proposed by R.A.P. Thirlwald. [3]
The description of the model begins with the basic relationships from national income accounting:
I - S = M - X (1)
where:
I = investment,
S = savings,
M = imports of goods and services,
X = exports of goods and services.
The foreign sector, F, is defined as the difference between imports and exports, and includes foreign private and public investment, other development assistance (such as balance of payment financing), repatriations of profits and capitals, interest paid on foreign lending and even international reparation payments. Thus the foreign sector is defined as:
F = M - X (2)
F = I - S, and (3)
F = FI + ODA + FPAY (4)
where:
F = net foreign flows,
FI = foreign investment,
ODA = other development assistance and foreign flows,
FPAY = foreign payments for profits and capital repatriations, interest payments to overseas lenders and international reparation payments.
These relationships may be expressed in either domestic currency or in dollars. In this study some relationships are estimated in dollars, while others are estimated in domestic currency. What is important is that the elements in each of the above relationships (and others in the model as well) be valued in the same currency units; that is, care must be made not to add "apples and oranges" (i. e., dollars and pesos). Thirlwald specifies that:
Y = O - FPAY (5)
where:
Y = income,
O = output.
so that the difference between output and income equals the factor payments abroad.
GROWTH RELATIONSHIPS
Two sources of output growth are distinguished in the economic model, namely: growth in the previously state-owned domestic sector, referred to as sector 1, and growth in the foreign sector, or sector 2, which materializes after the privatization and democratic process.
Output, in terms of gross domestic product (GDP t ) is defined as:
GDP t = GDP1 t + GDP2 t (6)
where:
GDP t , GDP1 t , and GDP2 t , are the gross domestic products for the total economy, and for sectors 1 and 2 respectively during year t. All these sectoral outputs are valued in the same currency units (whether dollars or pesos).
The gross domestic product of the domestic pre-democratization period is estimated via a Cobb-Douglas production function specified as follows:
GDP1 t = A o (K1 t ) [[alpha]] (L1 t ) ß (SUB1 t )[[gamma]] (7)
where:
K1 t = value of the capital stock installed in sector 1, the domestic sector in year t,
L1 t = labor employed in sector 1 in year t,
SUB1 t = value of the price subsidies in sugar and oil during year t,
A o, [[alpha]], ß, [[gamma]], are the constant and the output elasticities of the three factors of production specified in equation (7).
The output generated by the foreign sector, sector 2, is calculated by the product of the value of capital in the foreign sector times the inverse of the capital-output ratio, which is assumed to have a value of 3.5, that is, a median range of values estimated by Chenery and Strout: [4]
GDP2 t = (1/(c 2 / o 2 )) (K2 t ) (8)
GDP2 t = (1/ 3.5)(K2 t )
where:
K2 t = value of the capital installed in sector 2, the foreign sector, from private and public sources, during year t,
c 2 /o 2 = capital-output ratio for the foreign sector, sector 2, ( c 2 / o 2 = 3.5).
The capital stock is estimated net of depreciation charges as follow:
K1 t = (I t - D1 t ) + K1 t-1 (9)
K2 t = (FI t - D2 t ) + K2 t-1 (10)
where D1 t and D2 t , are the capital depreciation charges for domestic and foreign capital during year t.
The capital depreciation is estimated at 2% of the previous year's capital stock in the domestic sector and at 4% of the previous year's capital stock in the foreign sector. These capital depreciation charges correspond to the experience in Cuba and in the United States respectively. [5]
ESTIMATION OF THE PRODUCTION FUNCTION OF THE DOMESTIC ECONOMY
A Cobb-Douglas production function was estimated using a GDP data set from 1975 to 1989 assembled from several sources. The production functions estimated are presented in Table 1.
Table 1.
Production Functions of the Cuban Economy, 1975-1989
ln [(GDP1 t / P t) /L1 t] = 0.4069 + 0.3177ln[(K1 t/P t)/L1 t] +.0563ln(SUB1t/P t ) (7.a)
(5.798) (2.618)
R2 = 0.8355; D.W. = 1.0866
ln[(GDP1 t/P t )/L1 t] = -0.8466 + 0.3064ln(I t/P t ) + 0.0624ln[(SUB1 t/P t/)L1 t] (7.b)
(5.455) (2.426)
R2 = 0.7651; D.W. = 1.2262
ln[(GDP1 t/P t)/L1 t] = 0.7742 + 0.3524ln[(K1 t /P t )/L1 t] + 0.0552ln(SUB1 t/P t )/L1 t (7.c)
(6.780) (2.517)
R2 = 0.8308; D.W. = 1.0839
where:
GDP1t = gross domestic product of sector 1 (domestic sector) in millions of pesos during year t,
K1 t = value of capital stock installed in sector 1 (domestic sector) in millions of pesos in year t,
L1 t = labor employed in sector 1 (domestic sector) in thousands of persons during year t,
SUB1 t = value of the subsidy received by Cuba from the former USSR, in millions of pesos in year t,
I t = gross investment in sector 1 (domestic sector), in millions of pesos in year t,
P t = price deflator for the gross social product (GSP t )
D.W. = the serial correlation coefficient,
ln = natural logs, the figures in parentheses represent the t-values of the respective regression coefficients.
Before the estimation results are discussed a few notes on the data sources are in order. The gross domestic product series for the period 1975-1989 comes from Tabares and Hidalgo of the University of La Habana. [6] For the period after 1989, Tabares and Hidalgo's GDP series was projected assuming that the percentage decline in the gross social product mentioned by Carranza [7] applied as well to the decline in the gross domestic product during the post-1989 period. Appendix B documents the data sources used.
The capital figures were developed assuming that the initial value of capital stock in 1961 was 8,900 millions of pesos.[8] Subsequent values were estimated from the Cuban government's official series on gross and net investments. Since there are gaps in the official series of depreciation from 1967 to 1974, estimates of net investments for these years were estimated assuming that capital depreciation charges for these years were 2% of the value of capital stock during the previous year.
The econometric issue of proper identification of production function parameters becomes more complex under socialism, since it is unclear whether the usual competitive market relationships of profit maximization and/or cost minimization in factor markets can be used to identify parameters of the production function at all. Thus, the potential simultaneous equation problem of production function is ignored as unimportant following Zellner, Kmenta and Dreze, [9] who argue that no identification problem occurs when the level of the production function disturbance does not transmit to the inputs, because the inputs were determined before the disturbance could be ascertained.
The collinearity between the capital and labor series made it necessary to estimate a Cobb-Douglas production function with constant returns to scale. The production functions contain the value of Russian oil and sugar subsidies as a factor of production. It is proper that these subsidies be considered as a factor of production in Castro's Cuba, since Russian oil and sugar prices subsidies are close to 20% of the Cuban GDP during the several years of rapid growth in the early eighties. The subsidies are estimated as: quantities of sugar exported to the former USSR multiplied by the difference between Soviet sugar prices paid to Cuba and world sugar prices, plus the quantities of oil imported by Cuba from the USSR multiplied by the difference between world oil prices and oil prices paid by Cuba to the USSR. The values of oil re-exports were not considered in order to avoid double counting.
As shown in Equation (7a) in Table 1, the capital elasticity of production is [[alpha]] = 0.32 and the labor elasticity is ß = 1-0.32 = 0.68. The elasticity of the subsidies is [[gamma]] = 0.06. In Equation (7.c) the sum of the elasticities of all the factors are constrained to add to 1.0 and the labor elasticity is reduced to ß = 0.59. The best function is Equation (7.b), which uses official, Cuban governmental figures on gross investments and which renders inconclusive the problem of serial correlation of residuals. There are few differences between the three functions, which lends some credibility to the capital figures developed in the section on Cuban debt. The capital elasticities, which range from [[alpha]] = 0.30 to 0.35, are lower than capital elasticities of developing countries. [10] This may be due to the material balance system of national accounting used in Cuba and other countries formerly in the Soviet block, where there is no accounting for land rents, interest, housing rents and other capital factor payments. However, these lower capital elasticities may also reflect inefficiencies in capital utilization in Cuba.
BALANCE OF PAYMENTS RELATIONSHIPS
This section focuses on the balance of payments relationships of the Cuban economy during its post-Castro democratic period. The analysis begins by restating the ex-post relationship between imports (M t ) and exports (X t ) of goods and services and net foreign inflows (F t ) as specified earlier:
F t = M t - X t (2)
In this economic model, ex-ante exports are considered exogenous, while imports, except for the autonomous imports (MAUT t ) estimated from the Cuban American National Foundation's Blueprint report, [11] are estimated as a function of the gross domestic product of the total economy (including domestic and foreign sectors). For the purpose of estimating import functions and import elasticities during the period analyzed, the current import categories of Cuba were grouped into four major categories: 1) imports of food, beverages and tobacco (MFOOD t ), 2) imports of machinery and equipment (MMACH t ), 3) imports of miscellaneous manufactures and intermediate goods, except oil, (MINT t ), and 4) imports of oil (MOIL t ). In the case of oil imports, the metric tons of imported oil (net of oil re-exports) were estimated as a function of oil prices and of the gross domestic product, while the price of oil is assumed to be exogenously determined. Specifying oil prices as exogenous will enable us to use the World Bank projections of world oil prices for projecting the import bill of the Cuban economy.
The import demand functions are:
ln MFOOD t = MFOOD o + [[xi]] f ln (GDP t ) (11)
ln MMACH t = MMACH o + [[xi]] m ln (GDP t )
ln MINT t = MINT o + [[xi]] i ln (GDP t )
ln QOIL t = QOIL o + [[xi]] o ln (GDP t, POILS t )
MOIL t = QOIL t x POILW t
where:
QOIL t = thousands of metric tons of oil imports during year t,
POILW t = world price of oil in dollars per barrel, during year t,
POILS t = Soviet price of oil charged to Cuba in pesos per barrel, during yeart t,
[[xi]] f, [[xi]] m, [[xi]] i, and [[xi]] o, are the import elasticities for food, machinery and equipment, miscellaneous manufactured and intermediate goods, and oil quantities to be estimated,
MFOOD o , MMACH o , MINT o , QOIL o , are constants (intercepts) to be estimated.
To estimate the import elasticities, we assembled a data series on imports from the Anuario Estadístico de Cuba. [12] This data series included the following years: 1975, 1977 and from 1979 to 1989. The quantities of oil re-exports were deducted from the import quantities presented by Pérez-López [13] to develop a series of imported oil used by the Cuban national economy. The quantities of oil re-exports were estimated using: 1) the values in pesos of oil re-exports presented in the Anuario Estadístico, 2) the world crude oil price in dollars presented in the World Bank [14] study of prices of primary products, and 3) the exchange rates (pesos per dollar) presented in Cardoso and Hellwege's book. [15]
Simple import elasticities were then estimated, which we present in Table 2 and summarize in Table 3 below.
Table 2.
Import Demand Functions, 1975-1989
ln MFOOD t = 0.8926 + 0.5910ln(GDPt ) (11.a)
(4.542)
R2 = 0.6523, D.W. = 1.8003
ln (MFOOD t/P t ) = 2.6035 + 0.4156ln(GDP t/P t ) (11.b)
(2.646)
R2 = 0.3890, D.W. = 2.0168
ln MMACH t = -4.6419 + 1.2578ln(GDP t ) (11.c)
(8.994)
R2 = 0.8803, D.W. = 2.4763
ln (MMACH t/P t ) = -6.0332 + 1.4006ln(GDP t/P t ) (11.d)
(8.114)
R2 = 0.8568, D.W. = 2.6745
ln MINT t = -2.6473 + 1.0330ln(GDP t ) (11.e)
(6.427)
R2 = 0.7897, D.W. = 1.9342
ln (MINT t/P t ) = -2.5846 + 1.0264ln(GDP t/P t ) (11.f)
(4.844)
R2 = 0.6809, D.W. = 1.9313
ln QOIL t = 4.7981 + 0.4603ln(GDP t ) (11.g)
(6.084)
R2 = 0.7709, D.W. = 1.0411
ln QOIL t = 3.2145 + 0.6224ln(GDP t/P t ) (11.h)
(6.914)
R2 = 0.8130, D.W. = 0.9632
where:
GDP t = gross domestic product, in millions of pesos during year t,
MFOOD t = imports of food, beverages and tobacco, in millions of pesos valued at official exchange rates, during year t,
MMACH t = imports of machinery and equipment, in millions of pesos valued at official exchange rates, in year t,
MINT t = imports of intermediate goods, in millions of pesos valued at official exchange rates, in year t,
QOIL t = quantities of imported petroleum and oil products, in thousands of metric tons during year t,
P t = implicit price deflator for the gross social product (P 1989 = 100.0).
Table 3.
Point Elasticities of Demands for Imports, 1975-1989
Elasticities With Respect To:
Imports
Current GDP (GDP t) Constant GDP (GDPt/Pt)
Food, Bev., & Tobacco (MFOOD t ) 0.59 0.42
Mach. & Equipment (MMACH t ) 1.26 1.40
Intermediate Goods (MINT t ) 1.03 1.03
Quantities of Oil (QOIL t ) 0.46 0.62
Source: See Table 2.
There are no major surprises in the estimated elasticities. Import elasticities for food, machinery and equipment, and intermediate goods all have reasonable values and are within the ranges for elasticities estimated for other countries. Only the import elasticities for oil quantities appear low, in addition to having problems of serial correlation. These lower values for oil elasticities could be the result of inadequate specification for this import function; however, the oil price variable was found to be statistically insignificant. There are other influences at work that we are not able to explain adequately.
SAVINGS AND INVESTMENT RELATIONSHIPS
The discussion of savings and investment relationships begin with restating the basic ex-post relationship between these economic aggregates, as shown in equation 12:
F t = S t - I t (12)
This equation specifies that differences between savings (S t ) and investments (I t ) must be covered by foreign capital flows (F t ).
As percentage of the gross domestic product (GDP t ), the average savings rate of the Cuban economy during the 1950s had a range which varied from 8.4% in 1953 to 11.5% in 1957. [16] After several years of Castro's rule the savings rate began to rise. Luis Landau quoted, from United Nations sources, an average savings rate of 19% of gross domestic product in 1967. [17] By 1975, the average savings rate [18] was 20.55% of GDP, but was by then steadily declining to 14.93% in 1981, to 11.77% in 1985 and to 9.16% in 1989. This paper assumes that free consumer choice in a post-Castro democratic Cuba will initially reduce savings to 8% of GDP, but that the marginal savings rate will be larger, at a level of 19% of GDP. The marginal savings rate assumed for this study corresponds to the median value for this parameter estimated by Chenery and Strout [19] from a large cross section of countries.
The savings function of the Cuban economy is specified as follows:
S t = s o (GDP o ) + s m (GDP t - GDP o ) (13)
or
S t = 0.08 (GDP o ) + 0.19 (GDP t - GDP o )
where:
s o = initial average savings rate (s o = 0.08) at time t+0,
s m = marginal savings rate, (s m = 0.19),
GDP o, and GDP t = gross domestic products in years t+0, and year t.
Investments in the domestic Cuban economy are a function of total imports, terms of trade and the previous year's change in gross domestic product. This specification of demand for investments combines the notion that a key portion of current Cuban investment is imported (imports of machinery and equipment) from abroad, and also includes concepts of the investment accelerator on GDP. The investment demand function specified is estimated in equation 14:
I t/P t = f[(M t/P t ), [[Delta]](GDP t/P t ), (PSUGAR t/POIL t )] (14)
where:
I t = gross investments in year t, expressed in pesos at official rates,
M t = total imports in year t, expressed in pesos at official exchange rates,
[[Delta]]GDP t = GDP t - GDP t-1,
PSUGAR t = price per lb. of Cuban sugar exports to the former USSR, expressed in centavos de pesos at official exchange rates in year t,
POIL t = price per barrel of oil imports imported from the former USSR, expressed in pesos at official exchange rates during year t,
P t = implicit price deflator for the gross social product (P 1989 = 100.0).
The investment demand function estimated is:
ln(I t/P t )=0.7034 + 0.8390ln(M t/P t) + 0.1634ln(PSUGAR t/POIL t) (15)
(5.280) (1.950)
R2 = 0.8237; D. W. = 1.4198
In this equation, the figures in parenthesis denote t-values of the respective regression coefficients, while D.W. represents the Durbin-Watson statistic that measures serial correlation of residuals, and ln represents natural logs. The above investment demand function was estimated with a data series from 1971 to 1990. The source of gross investment figures for the period 1971-1989 is the Anuario Estadístico de Cuba. The data series on gross investments was extrapolated from 1989 to 1992 from estimates presented by Julio Carranza. [20] The accelerator variable was unfortunately not found to be statistically significant. The price deflator for 1990 was taken from Mesa-Lago. [21]
EMPLOYMENT RELATIONSHIPS
The first approximation model can also be used to project employment in the Cuban economy in the free market environments of the post-Castro democratic Cuba.
Labor Supply
The supply of labor is determined from the natural increase of the economically active population (i.e the population of working age) plus net immigration. For simplicity, the combined result of the cohorts of growth in labor supply is assumed to take an exponential form:
N t = N o (1+n)t (16)
where:
N t = economic active population (labor supply) in time t,
N o = economic active population in the initial year t o,
n = annual rate of growth of the economic active population.
The labor supply projections are taken from the International Labor Organization. [22] It measures the economically active population (aged 15-65 years old), which had been growing at annual rates of 3.07% during the seventies and 2.27% during the eighties, but is projected to slow down further during the next 15 years. The ILO projects annual growth rates for the economically active population of Cuba of 1.35% in the nineties, and 0.71% from 2000 to 2010. The economically active population was 3.987 million persons in 1985 and 4.461 million in 1990. Using the ILO's projected annual growth rates, the economically active population of Cuba has been projected as 4.582 million persons in year t+0, 4.966 million persons in year t+5, 5.208 million persons in year t+10, and 5.396 million persons in years t+15.
Labor Demand
The demand for labor or total demand for employment (L t ) is given by the sum of the demand for labor in the domestic sector (L1 t ) and the demand for employment in the foreign sector (L2 t ), as shown in equation 17:
L t = L1 t + L2 t (17)
Making use of the competitive market relationship that wages equal the value of the marginal productivity of labor, the following expression holds:
d(GDP1 t )/d(L1 t ) = ß (GDP1 t /L1 t ) = W1 t (18)
where:
W1 t = average annual wages in pesos in the domestic sector in year t,
ß = production function elasticity for labor,
GDP1 t = gross domestic product originating in the domestic sector in year t,
L1 t = demand for labor in the domestic sector in year t.
The above expression can be translated into a labor demand equation for the domestic sector:
L1 t = (ß) (GDP1 t ) (1/W1 t ) (19)
Evaluating the above relationship with 1989 official wage data [23] results in the following parameters:
GDP1 t/L1 t = 5,173 pesos of 1989,
W1 t = 2,455 pesos for the 1989 average wage and 2,260 pesos for the 1989 median wage,
ß = 0.474 - 0.437 depending on the wage figure used.
Thus, official average wages paid comprise 70% of the value of the marginal productivity of labor. However, the official wage data does not reflect additional benefits the Cuban worker derives from subsidies they receive as the result of state subsidized food and clothing expenditures, which absorbed substantial cost of living expenses. [24] By rationing consumption, Cuba attempts to guarantee the satisfaction of basic needs independent of levels of disposable income resulting from salaries and wages. For this reason we should expect larger labor elasticities than the ones above. In fact we should expect the larger production elasticities (ß = 0.6823) estimated in Table 1. Employment generated by the foreign sector is given by:
L2 t = (l 2/k2) (K2 t ) (20)
where:
(k 2/l2) = capital requirements in constant dollars per unit of labor in the foreign sector. (assumed to be $50,000 per person employed),
K2 t = value of capital installed in the foreign sector during year t. (in constant dollars),
L2 t = labor employed in the foreign sector during year t.
Labor Market Equilibrium
The labor market equilibrium condition is :
L t <= N t (21)
that is, demand for labor L t can not exceed the supply (N t ). If demand for labor is less than the supply, the excess labor (U t ) can be estimated as:
U t = N t - L t (22)
To assist in selecting a target wage rate, the median annual wage of the Cuban economy was estimated in constant 1981 pesos (using the gross social product deflators) in the period 1975-1989. The real wage rate was found to have grown at annual rates of 1.6% annually from 1975-1989 and 1981-1989.[25] Growth at 1.6% annually during the 15 year projection period was then set as the development target for the NAFTA scenario. Because of the difficulties that will be encountered during the first five years of transition, we assumed that wage rates would not grow at all (i.e., no growth in real wages) during the first five years. However, in the CBI scenario the target growth rate in real wages is projected at 1.0%, while the partial privatization scenario assumes that the wage rate will remain the same in real terms.
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