Ernest H. Preeg, Center for Strategic and International Studies (CSIS)

Part II

Services

Hotel visitors. This is the highest growth component of all, rising from $350 million at the 1992 base level to $1.6 billion in year five of the projection, passing by sugar in the process to become the largest sector in terms of gross foreign exchange revenues. The projection during the initial two-year period is based principally on a sharp rise in the occupancy rates of existing "commercially competitive" hotel rooms and on higher average room rates as U.S. visitors predominate over European and other budget tour visitors. A strong surge of visiting businessmen, government officials, international civil servants, Cuban Americans, and other U.S. tourists can be expected, similar to what happened in Eastern Europe but even stronger in view of the Cuban-American dimension. An increase in average occupancy for existing hotels from 50 percent to 85 percent together with a rise in average expenditure from $500 to $700 per visitor would alone raise the $350 million base figure to over $800 million. In addition, several thousand rooms not now commercially competitive could be upgraded within several months to a year, not to mention the countless smaller hostels and bed-and-breakfast facilities that would sprout forth once dollar-wielding U.S. visitors began to arrive.

To accomplish such growth, the transitional Cuban government would have to give priority to facilitating hotel renovation and support service industries from car rental and tour bus companies to restaurants and sports facilities. Privatization of hotels could move quickly because the process of hotel management by foreign companies has already begun under the Castro government. Strong growth is projected to continue in years three to five as renovation of existing hotels and construction of new hotels gather momentum. This projection also takes account of the higher than average growth of the Caribbean tourism market, compared with national income levels, over a five-year period. The $1.6 billion level of revenues in year five, based on an average per visitor expenditure of $800 in the later years, implies approximately 2 million visitors per year, or a fourfold increase over the reported level for 1992 when the U.S. embargo was still in place. This compares with 11.5 million hotel visitors to other Caribbean island economies in 1990. The projection for Cuba may appear optimistic, but it is certainly feasible, especially if the Cuban government gives priority to supporting infrastructure for tourism, as explained below.

Cruise ships. All Caribbean cruise lines are anxiously awaiting the opening of Cuba for U.S. passengers and will make rapid adjustments in their schedules when this occurs. Many if not most cruises will include one day in Havana or Varadero Beach, which, for popular four-day three-night cruises in particular, will entail substantial rerouting away from the Bahamas and other more eastward islands. The initial constraint will be the lack of adequate docking and anchorage facilities. Cruise lines are optimistic, however, that interim accommodations will be devised pending the construction of permanent modern facilities. Some cruise ships will likely dock or anchor overnight in Cuba as a form of floating hotel. For the later years of the projection, improved facilities for cruise ships will permit further rapid growth. One study projects more than 1.5 million cruise passenger visits by year five, and the figure could be higher depending on available dock facilities. These projections also reflect five-year growth in Caribbean cruise passengers far above the growth in national income levels.

Revenues from cruise line passengers will nevertheless be relatively small. Cruise passenger spending will likely be in the order of $50 to $100 per day, with port fees and expenditures by crew members providing some additional revenue. Based on these assumptions, foreign exchange receipts from cruise ships will rise from $50 million in year one to $150 million in year five. This projection does not include, however, the most innovative concept being considered by cruise lines, namely, direct flights from New York or Chicago to Havana, with one or two nights in a Havana hotel followed by a Caribbean cruise. This would be an attractive vacation package, with considerable additional revenues accruing to Havana hotels.

The annual arrival of 1 million to 2 million hotel guests and a similar number of cruise ship visitors, not to mention anticipated daily high-speed auto ferries from Miami and perhaps the western coast of Florida, will place enormous pressures on infrastructure for the tourism sector. Airports, docking facilities for cruise ships and auto ferries, telecommunications for hotel bookings, and ground transportation all need to be part of a broad strategy. For example, the drive by automobile from Havana to Varadero Beach now takes only an hour because there are few cars and little available gasoline. This will all change when tourists start flooding in and more Cubans are able to drive their own cars. The 60-mile Mariel-Havana-Matanzas-Varadero corridor will require an integrated grid of harbors, airports, and ground transportation infrastructure, perhaps including high-speed trains or other advanced transportation technology.

Residential construction for nonresidents. Relatively few Cuban Americans plan to return to Cuba permanently and resume Cuban citizenship, but almost all talk of vacation or retirement homes there. Many non - Cuban Americans will also see a restructured, democratic Cuba as an alternative to Mexico or Costa Rica as a place to retire. In fact, Cuba should become an extension of the two-decade building boom down both coasts of Florida in condominium and warm-weather residences for vacation, retirement, or both. Anticipated direct flights to Havana from major U.S. cities and daily auto ferries will facilitate access to a Cuba uniquely offering extended beaches and the urban charms of Havana. High-rise condominiums in Havana and Varadero Beach would likely come first. Later, the techniques of Florida developers, who obtain a large tract of waterfront property and build first a golf course and marina and then a planned community of homes, could proliferate along the hundreds of miles of Cuban coastline.

A boom in residential construction for nonresidents will undoubtedly become a major source of foreign exchange inflow as foreign purchasers finance such new construction. One thousand residences at an average price of $100,000 would bring in $100 million. The projection is for a modest level of $50 million in year two followed by a sharp rise to $500 million in year five, implying 5,000 units in the latter year. This is, of course, a best guess about an entirely new phenomenon for Cuba, but a plausible one, which perhaps will prove to be conservative.

Other services. During the 1980s, global trade in services grew faster than trade in goods --7.5 percent versus 5.5 percent annually-- and developing countries have been large beneficiaries. The principal sectors for foreign exchange earnings from services for developing countries have been tourism, transportation, financial services, and wide-ranging information technology activities. There are no comprehensive statistics on trade in services by sector and country, but the Caribbean region has been a region of strong growth, integrated as it is with the highly service-oriented North American economy. A landmark "teleport" project in Kingston, Jamaica has created substantial employment of Jamaicans to supply information technology and other service-based work to the United States via satellite.

Cuba will inevitably benefit from such exports of services. With an educated labor force working for relatively low wages, Cuba could become a regional center for transportation, telecommunications, and financial services. With newly installed business infrastructure, Havana could offer clear advantages over Miami, Mexico City, and Caracas as the location for regional corporate headquarters: central location, low cost, less congestion and pollution, and a higher quality of life.

The projection for foreign exchange receipts from other services --from $50 million in year one to $250 million in year five-- is a rough estimate meant to indicate a low base level and rapid growth. It could well be a conservative estimate as the North American economy becomes increasingly service-based and Cuba becomes more deeply integrated with it.

Foreign Direct Investment

The projection of actual disbursement from new foreign direct investment, from $100 million in year one up to $800 million in year five, depends heavily on the establishment of a legal framework that encourages such investment. The laws adopted by the Castro government through 1992 move in the right direction, but more definitive and far-reaching actions would be necessary, with clearly established private property rights as the starting point. This could be undertaken during the initial two-year phase for many sectors, including hotels, small- to medium-scale service and manufacturing industry, construction, and much of agriculture. Some large-scale industry and agriculture, including sugar, mining, and petroleum, could take longer to adapt to large new private investment, as reflected in the relatively low level of investment projected during the initial two to three years.

The projected levels are based on two factors. The first is a comparison with the three-country composite noted above for assembly industry, where foreign direct investment in 1989-1990 was running at an annual level of $300 million to $400 million and where the investment climate, with some exceptions, was not particularly positive. The second factor is the well-known eagerness of Cuban-American businessmen, Cuban expatriates elsewhere, and U.S. companies in general to invest in Cuba as soon as it opens. Franchises for many U.S. brand name products and services have already been committed or are under discussion with Cuban Americans and other business interests.

Remittances

The 1.1 million Cuban Americans and a substantial number of Cuban expatriates elsewhere will account for a large initial surge of foreign exchange into a restructured Cuban economy through remittances. Much of this will come in conjunction with visits to relatives to help upgrade homes, buy appliances, and improve personal consumption generally. There will likely be some additional outflow of Cubans to the United States in the first years of an open relationship, and these recent arrivals are likely to be especially generous in sending part of their earnings back to Cuba.

The $800 million level of remittances for years one and two are based, in part, on remittances by expatriates from the three-country composite, especially Dominicans and Jamaicans. Fewer than one million of those expatriates remitted $645 million in 1989 and $522 million in 1990. The substantially larger number of Cuban Americans, with a higher average income, will initially wish to do something extra after more than three decades of Cuban isolation. The $800 million projection, tapering off to $700 million in the later years, could turn out to be conservative.

Economic Assistance

Economic aid will come from bilateral donors, principally the United States, the World Bank, the Inter-American Development Bank, and, to a much smaller extent, the UN technical agencies. It is important that the aid be used in ways that directly support the other private-sector-driven components of the projection. A recommended aid strategy elaborated in the reference of CSIS study essentially rejects balance-of-payments support or other so-called cash transfers and is directed toward technical assistance, project loans for economic infrastructure and environmental cleanup, social sector support, and financial intermediaries for the private sector.

The projected level of aid begins at a low level of $100 million in year one, reflecting the slower disbursement time frame of project assistance, and builds to $800 million in year four. A decline to $700 million in year five is an indication that once private-sector-driven growth firmly takes hold, the level of official economic assistance can begin to decline. The $800 million maximum level in year four is based largely on aid levels to the three-country composite --$868 million in 1989 and $805 million in 1990. The approximate projected breakdown of the $800 million level would be multilateral development banks $300 million, the United States $300 million, other bilateral donors $150 million, and UN agencies $50 million.

Official Export Credits

Trade credits from official export credit agencies (the Export-Import Bank and the Commodity Credit Corporation for the United States) would be contingent on some understanding about outstanding official debt contracted by the Castro government, particularly the $8 billion of debt to non-U.S. Western creditors. Early agreement on an initial period of moratorium for prior debt would be reasonable, enabling new trade credits to the transitional government. Later negotiation of the old debt could presumably be kept separate from the servicing of export credits provided after the initial point of democratic transition and economic restructuring.

The projected $300 million level in year one, rising to $500 million annually in later years, is reasonable considering the overall anticipated foreign exchange earnings of the restructured economy, and it could reach somewhat higher levels. Most of it would come from the export credit agencies of the United States and other industrialized countries and from Cuba's Latin American trading partners. In addition, a special objective for a transitional Cuban government could be medium-term, three- to five-year credits for oil imports from Venezuela and Mexico. Such credits would be more advantageous than those of the San José Accord available to smaller Caribbean and Central American governments, which require 80 percent up-front cash payment. They could be justified for Cuba, at least during the first two years or so, as an extraordinary one-time action after three decades of grossly distorted trade with the Soviet bloc. Venezuela may be more disposed than Mexico to do this because it has surplus oil capacity and closer ties with Cuba in the petroleum sector, including potential collaboration in Cuba for oil refining and petrochemical production.

The Macroeconomic Outlook

The five-year projection is highly feasible, given the conditions of economic reform indicated and a reasonably positive political setting. Extrapolating this projected performance for foreign exchange receipts into a macroeconomic model for economic growth and employment is not possible in quantitative terms, however, because basic data on the Cuban economy are not available. It is not even possible to convert foreign exchange receipts into a firm figure for additional imports of capital equipment for investment and consumer goods because the foreign exchange receipts projection is in terms of gross receipts, while most of the projected components have an import content that will rise along with export receipts and data on this import feedback are also not available. Nevertheless, some clear lines of direction for the overall economy are evident.

With respect to the import content of exports, a restructured Cuba would have two distinct advantages compared with the circumstances currently facing the Castro government. The first advantage is that the degree of domestic value added should rise over time as the national economy becomes more market-oriented and competitive. A larger supply of hotel requirements, from food to furniture to air conditioners, will be supplied locally rather than imported. Sugar and nickel production will become more fuel efficient, and thus less dependent on imported petroleum, as refineries are upgraded with more modern equipment. Assembly industry, over time, tends to increase the share of local content as management is strengthened and capital equipment is added.

The second advantage is that the principal components for initial growth in foreign exchange have the highest net inflow content. Remittances, the largest growth component during the first two years, is 100 percent dollar inflow with no offsetting import content. Economic assistance likewise has a very high net inflow of hard currency because it takes the form of grants or concessionary loans with grace periods and long-term repayment schedules. Official export credits will also have a relatively high net inflow, at least during the initial years of restructuring, because there would be no offsetting repayments on earlier credits. In sum, the net inflow of foreign exchange compared with the existing situation is favorable to a restructured Cuba and should improve over time. Put another way, the projected doubling of foreign exchange receipts during the first two years should far more than double the foreign exchange available for new investment projects and consumer goods.

In any event, the export-oriented growth model presented in the CR plus five projection would generate high gains in employment. Almost all of the key sectors projected for strong growth--tourism, other services, assembly industry, nontraditional agriculture, residential construction for nonresidents--are labor intensive and include a relatively high share of professional and high- or semiskilled jobs. These lead sectors, moreover, will stimulate high employment growth elsewhere in the economy. A construction boom will likely sweep the country for commercial as well as residential building, involving both new construction and restoration of existing structures. Each assembly industry job creates one to two support services jobs in retail trade, commuter transportation, and residential construction. Well-paying jobs in the export-oriented sectors will, in general, stimulate all manner of consumer goods production in the national economy.

Translation of this export-led, high employment generating model into a growth rate for gross domestic product (GDP) is even more elusive, but again the rate of growth should be relatively high, probably reaching at least 5 percent annually and possibly higher by the end of the five-year period if the policy program for private-sector restructuring is forcefully implemented. Even more important than the specific rate of growth is that high growth should be sustainable over time. The five-year projection only brings the restructuring process to the point where the private-sector-driven sectors are becoming dominant, and they are the ones that can provide a self-sustaining rate of economic growth over the longer term.

Finally, there are the related issues of exchange rate for the peso, inflation, and wage levels. No projected exchange rate is attempted here, but one critical contingency will almost certainly not occur with regard to the peso, namely, uncontrolled depreciation as happened to the Russian ruble. In this most important further invidious comparison with the former Soviet Union, the key difference is the absence of an export strategy on the part of the former Soviet republics, which has led to the free fall of the ruble far below a reasonable equilibrium rate, with hugely distorting consequences for their national economies. Cuba, in contrast, will benefit from a large initial surge in foreign exchange inflow, doubling in the first two years, and this should provide confidence in the foreign exchange availability to maintain the peso in a relatively stable range of equilibrium.

Controlling the accelerating inflation currently under way in Cuba will be a matter of fiscal management. Eliminating subsidies to state enterprises and reducing the exorbitant military budget will constitute the central challenges, but the prospect of high employment growth in the export sector, as explained above, should make this a less difficult process than in Europe's formerly Communist states. The cusset Castro austerity program is already undertaking a part of the adjustment by shutting down nonviable state industrial enterprises.

Wage rates in Cuba should not plunge along with the exchange rate, as is happening in Russia, but they will nevertheless remain relatively low compared with those of other countries in the Caribbean region. Although Cuban export-oriented sectors will become highly productive, wage rates tend to reflect average productivity in the national economy, and in this respect Cuba will lag badly. Overstaffing of state enterprises, a huge government bureaucracy, a military of inordinate size, and the recent shift to more primitive, labor-intensive agriculture all drag down average productivity, and at the outset of restructuring this is where the large majority of the Cuban labor force will be located.

Thus wage rates during the initial years of a restructured Cuba will tend to be toward the low end of levels within the Caribbean region, probably less than half or only a quarter of those in Mexico and Venezuela and significantly below those in other Caribbean economies. Over time, however, if restructuring brings the positive results indicated, real wages will rise steadily. In the interim, relatively low wage rates in Cuba will be a mixed blessing, with the low labor and other costs making the country one of the most attractive locations in the region for new investment and job creation.

The NAFTA Option

The CR plus five projection is based on Cuba receiving MFN treatment in the U.S. market, which would include related preferential market access as a developing country. This preferential access would involve the benefits of the generalized system of tariff preferences (GSP) at the outset and negotiated qualification as a participant in the Caribbean Basin Initiative by year one or two of the transition. A more far-reaching step would be Cuban accession to the North American Free Trade Agreement. Such a step would depend on the political orientation of a democratically elected Cuban government. NAFTA membership could be resisted on the grounds that it would entail even higher dependency on the U.S. economy. On the other hand, there would be fewer deep-seated protectionist interests opposed to free trade in Cuba compared with other countries in the region because a restructured Cuba would be starting the private sector anew. In any event, if a newly democratic Cuba were to request accession to NAFTA, there would likely be a prompt and positive response by the United States, Mexico, and Canada. This could all come about by year three or four of the five-year projection, and it is therefore appropriate to address the likely consequences here.

NAFTA is a comprehensive agreement, going far beyond the elimination of border restrictions on trade in goods. It includes open markets for trade in most services, including financial services, telecommunications, and transportation, protection of intellectual property rights, national treatment and other provisions for foreign investment, and dispute settlement mechanisms to curb unilateral restrictions, particularly by the United States. The benefits of such an agreement for the Cuban economy would fall into two distinct categories: improved access to the U.S. market and a more positive investment climate in Cuba.

Improved Cuban access to the U.S. market would be significant in a number of sectors. The textile sector could offer the greatest enhanced export prospects because U.S. tariffs as well as quotas would be eliminated under NAFTA, some immediately and others over a maximum of 10 years. It is noteworthy that U.S. tariffs on textiles and footwear are not included within the GSP and CBI preferential duty-free treatment. Cuban exports of fruits and vegetables should also benefit because most trade restrictions will be eliminated within NAFTA, although certain exceptions on sensitive trade would likely be an issue for negotiation. Exports of automotive parts from Cuba might also be stimulated significantly because NAFTA includes a provision whereby automobiles require a 62.5 percent "North American content" in order to qualify for free trade. Automotive parts sourced in Cuba would qualify as North American content, and with wage rates in Cuba far below those in Mexico, automobile companies, Japanese as well as U.S., would find it attractive to establish production in Cuba. An additional benefit for such companies would be the resulting positive corporate image in a Cuban market for motor vehicle sales growing rapidly after more than 30 years of embargo and very low imports.

Access to the U.S. market for Cuban sugar would be a major issue of negotiation for Cuban access to NAFTA, but the outcome is unpredictable and likely to provide only limited benefits to Cuba. NAFTA provides gradual liberalization of bilateral Mexico-U.S. trade in sugar, the application of tariff quotas on third-country imports after 6 years, and total elimination of restrictions on bilateral trade after 15 years. Cuban accession would nevertheless certainly entail special provisions for the very large Cuban sugar production. A modest, gradually increasing quota over a lengthy 10- to 15-year period, with a scheduled review of the situation at the end of the period, would be one possible outcome. The bold option would be a 15-year transition to free trade in sugar between the United States and Cuba, but this would mean a fundamental change in U.S. sugar policy from the current highly protected domestic price, which is more than double the world market price. Such a restructuring, with corresponding adjustment assistance for domestic sugar producers, is feasible in a U.S. political climate stressing the need to strengthen international competitiveness and could be helped by support from influential Cuban-American sugar producers in the United States if they chose to sacrifice protection in the U.S. market for new opportunities in Cuba. At this point, however, the likelihood of such an outcome appears to be very low.

The improved investment climate in Cuba from NAFTA membership could be even more beneficial to Cuban economic recovery and growth. NAFTA membership would constitute the most credible assurance that a market-oriented restructuring within Cuba would not be reversed. Provisions in the areas of trade in services, investment, and intellectual property rights would be decisive factors for many potential investors, while duty-free entry into Cuba would reduce costs for many industries and restrain inflation. All of these arguments were used by President Carlos Salinas de Gortari of Mexico and his government in making the case for Mexican membership in NAFTA, and they could apply even more forcefully for the smaller Cuban economy, which would be under a cloud of political uncertainty after so many years of Communist rule and isolation.

The aggregate economic benefits to Cuba from NAFTA membership cannot be quantified, but they would certainly raise substantially the $9.5 billion projection for foreign exchange receipts in year five as well as the economic growth path beyond. More fundamentally, Cuban entry into NAFTA would extend the integrated North American/Caribbean market a critical step forward by incorporating the centrally located and largest island in the Caribbean. This would have, in addition to the direct effects on the Cuban economy, substantial impact on others in the region, particularly the other island republics.

III. Conclusion

A restructured Cuban economy, reintegrated with the Caribbean regional economy, has potential for a strong, export-oriented recovery. During the first two to three years, moreover, the anticipated surge in foreign exchange availability, a more than doubling in the projection here, comes from sources not dependent on fundamental legal and political reforms that will take considerable time to implement. The legal framework for private foreign control of hotels and assembly industry is already on the books under the Castro government. Remittances from expatriate Cubans, economic aid, and trade credits can likewise flow into Cuba almost immediately after political transition has begun. Even over the longer, three-to-five year term, the bulk of job-creating private investment will likely be in small-to-medium-size businesses in the service sector and non-traditional agriculture, again a politically less contentious prospect based on recent experience in Eastern Europe.

Indeed, the most important conclusion of the analysis here is that a radical market-oriented restructuring of the Cuban economy need not cause the kind of economic collapse and chaos as is happening in parts of the former Soviet Union. A restructured Cuba will have some parallels with the experience of the former Soviet Union, and some lessons to be learned from it, but the circumstances currently facing Cuba differ greatly from those of the former Soviet Union in key aspects, almost all to Cuba's great comparative advantage. The most important difference is that Cuba is situated at the center of the Caribbean regional economy. Contrary to dire predictions from the Castro government, an early and highly positive response from transition to a market economy is eminently feasible for Cuba.

** See Table 1. Below Table 1

The CR Plus Five Projection

(In Millions of U.S. dollars)

Source of                     Cuba Restructured Plan Plus Five (Years)                   
Foreign Exchange Receipts     1992      1         2         3         4         5         
Exports of Goods              2,150.0   2,200.0   2,490.0   2,910.0   3,350.0   4,270.0   
   Sugar                      1,250.0   1,200.0   1,250.0   1,300.0   1,400.0   1,500.0   
   Other agriculture          330.0     360.0     450.0     550.0     650.0     800.0     
   Fish                       120.0     130.0     150.0     170.0     190.0     220.0     
   Nickel                     250.0     300.0     350.0     400.0     450.0     500.0     
   Other mining               10.0      10.0      20.0      50.0      100.0     150.0     
   Manufactures (mostly                                                                  
      assembly industry)      100.0     100.0     150.0     300.0     600.0     900.0     
   Other                      90.0      100.0     120.0     140.0     160.0     200.0     
                                                                                        
Services                      350.0     900.0     1,225.0   1,600.0   2,025.0   2,500.0   
   Hotel visitors             350.0     800.0     1,000.0   1,200.0   1,400.0   1,600.0   
   Cruise ships               0.0       50.0      75.0      100.0     125.0     150.0     
   Residential construction                                                              
     for nonresidents         0.0       0.0       50.0      150.0     300.0     500.0     
   Other service              0.0       50.0      100.0     150.0     200.0     250.0     
                                                                                        
Foreign direct investments    50.0      100.0     200.0     400.0     600.0     800.0     
Remittances                   100.0     800.0     800.0     700.0     700.0     700.0     
Economic assistance           30.0      100.0     30.0      600.0     800.0     700.0     
Official export credits       0.0       300.0     500.0     500.0     500.0     500.0     
                                                                                        

Source: Ernest H. Preeg and Jonathan D. Levine, Cuba and the New Caribbean Economic Order,

The Center for Strategic and International Studies, Washington, DC. 1993.