Can Cuba’s Economic Reforms Succeed?

The impression most casual observers receive today from Cuba is that since Raúl Castro assumed power in 2006, the country has been going through a dramatic transition to a market economy. But while what the younger Castro brother has called “structural reforms” are important steps toward a market under Cuba’s revolutionary government, they are a far cry from the radical policies that have been common throughout Latin America, and lag far behind the transformations in China and Vietnam. Below is a summary of the seven principal structural reforms under way in Cuba, including an assessment of their advances, obstacles and economic-social effects, to determine how far the reforms have moved and whether they are working or not.¹

1. Updating the Existing Economic Model

According to the 2011 Cuban Communist Party Congress’ outline for the reforms, the Lineamientos, the goal is not to substantially transform the actual model but to “update it,” keeping the hegemony of state central planning and property over the market and non-state property. The agreements set out in the Congress did not specify the role of the state and non-state sectors and left serious gaps in the roadmap. It took more than two years for the Cuban government to elaborate a preliminary concept of the “updating.” That concept allowed for the expansion of the market and non-state property but in an economy largely still driven and determined by state planning and state agencies, a model that historically—including in Cuba—has proven to be inefficient.

2. Distribution of Idle State Land

In 2009, the Cuban government announced a plan under which it retains ownership over unused land but allows farmers (under “usufruct”) to cultivate it and keep what they produce—either for themselves or to sell. Two laws (from 2008 and 2012) regulate the process; the second, more flexible law expanded the size of the plot, and allowed the building of homes and barns, as well as the planting of forests and orchards (formerly banned). But the land is granted only under a 10-year contract. At the end of that period, the state can either reassume control of the land, reimbursing the farmers’ investment based on its assessment, or renew the contract. If the owner of the lease dies, his relatives working the plot can also inherit the contract. During the contract period, farmers have access to state micro-credit, and can open bank accounts and sell produce to tourism entities, such as hotels and restaurants.

In 2013, the government ended the practice of acopio in three out of 15 provinces (Havana, Mayabeque and Artemisa), which required that 70 percent of the harvest must be sold to the state at prices set by the government below the market price. And in 2014, the state created the first wholesale market for agricultural supplies. Since 2009, about 3.7 million acres of idle state land have been distributed to 174,275 of these farmer-leaseholders, 97 percent of whom are individuals. About 77 percent of the leaseholders, however, lack experience in agriculture.

Despite the gains, the 2012 law governing these farms remains restrictive. The state can terminate or not renew a contract if the farmer fails to comply with his or her obligations (including acopio), or for reasons of public or social interest. In addition, the farmer is now required to be tied to a state-controlled cooperative or a state farm (both notoriously inefficient) to receive inputs or services and to market his/her produce. The complex and cumbersome regulations also place obstacles to hiring non-family workers, and limit investment to 0.67 percent of the size of the plot—restrictions justified as a means of preventing the concentration of wealth. State microcredit is also insufficient. In contrast, the successful agricultural reforms in China and Vietnam place no limits on farmers’ contracts: land use is granted for indefinite periods and the farmers decide what to plant and where to sell it at market prices.

3. Dismissal of Unneeded State Employees and Expansion of Non-State Jobs

About 1.8 million workers are officially estimated as unnecessary—or 36 percent of the total labor force, according to my estimates. Cuba’s low open (officially acknowledged) unemployment rate—in 2008 it was 1.6 percent, one of the lowest in the world—was accomplished by creating hidden unemployment, with the government and state firms retaining unnecessary employees, but at the cost of declining labor productivity and wages.

In 2011, the government acknowledged the economy’s labor redundancy and announced a plan to dismiss surplus state employees and expand the non-state sector, including self-employment and non-agricultural production and service cooperatives, to absorb the laid-off workers.

Here some definitions are in order. The self-employed, or cuentapropistas, own their tiny businesses. In the cooperatives (coops), the state maintains ownership of the premise and rents it to coop members, who manage the business, sell their products/services at market prices and keep the profits. Self-employed individuals and coops can sell, lease and buy to or from state entities, hire non-family employees, open bank accounts, receive state microcredit and buy inputs in the emerging wholesale market. Since last June, all restaurant/food service and personal service establishments are to be managed by non-state entities.

There are restrictive rules defining and governing both types of enterprises. The types of self-employment allowed by the new rules are quite specific and cover mostly unskilled jobs. Only a few of the officially sanctioned categories could qualify as skilled jobs. Coops must go through four bureaucratic steps to win approval, and the final decision is left to the Council of State, an executive office chaired by Raúl.

State inspectors monitor businesses’ compliance with health and other regulations, impose fines—for alleged violations in hygiene or inputs—and can close self-employed micro-businesses. Taxes are many and heavy, including a labor tax that rises in tandem with the number of employees hired—again, arguably, to avoid wealth concentration but in effect punishing those who create more non-state jobs.

There are also severe constraints to growth for the self-employed and coop members. As in the farming sector, micro-credit and inputs are insufficient, and wholesale markets are limited and in an experimental stage. The erratic and inconsistent history of government policies in the sector has also created uncertainty. In recent years, the state has shut down food or service stands on household porches in Havana, banned the sale of imported products, and shut down 3D cinemas. The bureaucracy is also a barrier, often because of conflict of interest when cuentapropistas compete with state enterprises. Partially as a result of these factors, one-fifth of the self-employed enterprises fail.

Despite the barriers and limits to growth, state employment declined from 82 percent to 75 percent of the labor force from 2006 to 2012 (though below the target originally set), and non-state employment grew proportionally. At the end of 2012, 365,000 state employees had been dismissed, only one-fifth of the official 2015 target. The number of self-employed tripled from 2006 to 2014, but after subtracting those existing before the reforms, the net was only 17 percent of the 2015 goal of 1.8 million. By last May, 498 coops had been authorized, but only half were operating. To meet the government’s goals, the number of self-employed must quadruple in the next 18 months.

4. Wages, Social Services and Rationing

The 2008 salary reform increased the nominal wage and allowed moonlighting and payment based on productivity. It also removed the previous salary cap, and legalized bonuses in hard currency. The effect of the reform is unknown, but the average wage, adjusted for inflation, in 2013 was a quarter of its level in 1989.

At the same time, the government has reduced general public benefits to cut its fiscal deficit. From 2007 to 2008, the cost of social services peaked at 55 percent of the budget and 37 percent of GDP, the highest in Latin America. Education and health care are universal and free. Workers did not contribute to pensions. The retirement age was one of the lowest in the region at 55 for women and 60 for men, although Cuba enjoys the region’s second-highest life expectancy. Rationed goods are sold below cost, and until the recent reforms meals in workers’ cafeterias were subsidized.

In 2009, Raúl acknowledged the financial unsustainability of social services, subordinating them to available fiscal resources and reducing them—something not done even during the severe crisis of the 1990s. At the same time, the government shuttered thousands of public services deemed inefficient, also dismissing 16 percent of health care personnel. University enrollment in humanities dwindled, while it increased in natural sciences and mathematics, and entry to universities was tightened. Finally, the retirement age was raised by five years for both sexes, and workers were required to contribute to pensions. The government also increased public utility rates and prices at hard-currency state shops. As a result of this belt-tightening, social expenditures fell from 55 percent of the budget in 2007 to 51 percent in 2013, while relative to GDP, they declined from 37 percent to 27 percent in the same period.

Future reductions, however, confront two realities that will limit how far they can go. First is the inevitable ballooning of the long-term deficit to care for the country’s aging population, the second largest, proportionally, in the region. Second is the need to maintain a safety net for the most needy. Although rationing quotas are lean and only cover basic food needs for seven to ten days a month, they are vital for lower income individuals who don’t receive remittances from abroad. Cuban economists have recommended replacing rationing with a social welfare system targeting those who are most at risk. Raúl accepted this advice and removed several ration items now sold in the market at prices three to four times higher.

5. Housing Purchase and Sale

In 1960, the government ended house sales and mortgages, prevented the construction of private housing, and stipulated that residents pay rent to the state, whereupon after 20 years they become homeowners. As a result, 95 percent of the population are homeowners today. But the state’s construction of housing never met population growth. This, combined with the deterioration and destruction of existing stock due to lack of maintenance and hurricanes, has left a housing deficit of between 600,000 to one million units.

A 2011 reform authorized the buying and selling of houses at market prices to Cubans and permanent non-Cuban residents, as well as ownership of a second home for recreation purposes, and granted the right to relatives of Cubans who had permanently left the island to inherit the house. After more than half a century in which the housing market had been frozen, dwellings now may be sold to change residency or raise capital. About 90 percent of all state microcredit is geared to build or repair housing. Between 2011 and 2013, 133,000 dwellings were sold, in addition to 168,500 donated homes (probably due to the legalization of previous illegal sales).

Nevertheless, as with all elements of the reform process, there are snags and inefficiencies. Buying a house requires registering the property in the state real estate registry, but only 17 percent of owners have done so. The permission to build a dwelling demands procedures at four state agencies that take about 132 days to complete; corruption, bribery and tax fraud are common. The law prohibits non-resident foreigners—including Cubans who have emigrated—from purchasing property, limiting the market to local residents for whom a cheap house (around $5,000) can cost the equivalent of 21 years of the average Cuban annual income of $236.

As a result, since the reform, sales have amounted to only 3.6 percent of the housing stock of 3.7 million.

6. Foreign Investment

One of the greatest drags on Cuba’s economic growth is the low level of domestic investment, which stands at half the regional average. According to the Cuban government’s own data, jump-starting the economy will require between $2 billion and $2.5 billion annually.

In June, the government issued a long-anticipated update to its 1995 regulations governing foreign investment. The law extends foreign investment to all sectors except health care, education and armed forces, and exempts foreign investors from personal income tax, labor tax and taxes on select imports. New investors are also granted a grace period of eight years before paying the country’s tax on profits and a one-year postponement of sales tax obligations. Investors can open accounts in convertible currency in foreign banks, as well as directly import and export. Decisions on new investment are guaranteed to take no more than 60 days. Under the law, Cuban “legal persons” (presumably Cuban businesses) are permitted to be investors, which can potentially include Cubans living abroad. Finally, the law offers guarantees to foreign investors, including compensation in case of expropriation. One of the intended draws for this much-needed investment is the Special Development Zone in the Port of Mariel (Zona Especial de Desarrollo Mariel).

Again, however, there are some significant drawbacks. The new law maintains the requirement that Cuban workers must be hired by a state agency; hence it prohibits investors from directly hiring and firing employees and requires companies to submit labor disputes to a state agency for resolution. In the same vein, the law maintains the system whereby investors pay salaries in hard currency to the Cuban government, which in turn pays a fraction of the salary in pesos to the workers. It also prohibits investment by Cuban individuals, including the self-employed. Foreign investment can be expropriated for reasons of public utility or social interest, and in several cases conflict resolution is left to local courts instead of the international court of arbitration.

As of today, no new foreign direct investment projects have been approved.

7. Unification of the Dual Currency

Unifying the two currencies is essential. But while this will bring benefits in the long run, it will be very complex and will have to proceed in two stages: first in the state-enterprise sector and then in the population. In the former, the CUC has been gradually devalued since 2012 for select cooperatives and companies. Last March, the government announced the broad outlines of a plan for monetary unification in the enterprise sector. According to the plan, the CUC will be devalued and disappear, while the CUP will appreciate and become the future currency. A “zero day” will start the process, and an index of reform of wholesale prices will be set to calculate the corresponding retail prices and revalue all accounting prices in CUP, as well as inventories and investments. The law ensures the value of people’s bank savings.

The legal norm for unification is extremely complex; the government has yet to unveil the timetable and the “zero day” has not been set. The price index to revalue the CUP and the date to eliminate the CUC in the enterprise sector are similarly unknown. Cuban economist Pavel Vidal has predicted that the process will begin in January 2015 at a rate of 10 CUP for one CUC, although unification for the population will be much later. Anticipating this, Cubans have already started changing CUC for CUP to the point that some state exchange agencies have run out of CUP and had to temporarily close.

How Are We Doing So Far?

It is difficult to assess the impact of the reforms, a task made harder by the lack of reliable statistical series published by the government. At a macro level the reforms have failed to generate the economic growth the country needs. Official growth targets since 2009 have not been met, and economic growth has been among the lowest in the region. Cuba’s annual average rate of 1.7 percent from 2009 to 2014 suggests that the reforms have not helped to boost economic growth.

Even these relatively paltry economic growth rates have been masked by the island economy’s dependence on Venezuela. The oil-rich Bolivarian state accounts for 43 percent of Cuban trade, supplies 60 percent of its oil needs and is the leading direct investor. I estimate the combined value of the whole economic relationship with Venezuela at about $13 billion, tantamount to 21 percent of Cuban GDP. However, as the serious economic and political problems mount in Venezuela—negative economic growth, double-digit inflation, declining oil production, and political instability—Cuba’s deep ties to Venezuela look increasingly risky.

At the same time, reforms in the agricultural sector, while important, have failed to fill gaps in production. A year after the 2009 agricultural reforms, agricultural output fell by 5 percent, and grew 0.5 percent in 2012, but against a goal of 2.2 percent. The preliminary estimate for 2013 is 2.6 percent growth in the sector; but the production index in 2013 was below the 2005 level, except in three crops (rice, corn and beans). Part of the early growth came from the non-state sector, which expanded in 2011 and 2012 in terms of cultivated land and agricultural production, while state land and output shrank in both indicators. However, the opposite was true in 2013, when non-state agricultural production remained stagnant or with little growth.

Efforts to reduce public sector spending have also had adverse social consequences. Cuts in health care services—such as the closure of hospitals and clinics, the reduction of doctors, diagnostic tests and other procedures, and the shutdown of subsidized workers’ cafeterias—have reduced access to social services. Removal of goods from rationing and their sale at much higher market prices, as well as increases in public utility tariffs and hard currency shops’ prices, have affected consumption.

And efforts to streamline public sector employment, although missing the targets, have pushed up the open unemployment rate from 1.6 percent to 3.4 percent of the labor force from 2008 to 2013—still the second lowest in the region, but high by Cuban standards. At the same time, real wages and real pensions shrank by 73 percent and 50 percent, respectively, from 1989 to 2013. The number of homes built fell by 77 percent from 2006 to 2013. There are 480,000 elderly Cubans (60 years or older) who are considered to be in need of services; but only 15,825 spaces for the elderly are available in nursing homes and hospitals.

Confronting an expanding, vulnerable population, Raúl has promised that nobody will remain unprotected. But, between 2006 and 2012, the number of beneficiaries of social assistance relative to the total population decreased from 5.3 percent to 1.5 percent, and the budget expenditure in social assistance went from 2.2 percent to 0.4 percent. In 2011, the Party Congress ordered the government to end assistance to those individuals who are already supported by relatives, a measure that ignores the widespread level of need in Cuba.

On the whole, the structural reforms undertaken by Raúl have been generally positive and the most important to date under the Cuban revolution. They have advanced much further than previous reform attempts and are clearly oriented toward the market. But suffocating state regulations, obstacles and taxes have created disincentives and impeded the progress necessary to achieve substantial effects.

Raúl has declared that the reforms are quite complex, must be tested by experiment and should not be hurried so as to avoid costly error. His motto is “slowly but without pause.” But time and age (Raúl has promised to retire in 2018 at the age of 86) conspire against such an attitude. “Updating the model,” as the government is attempting to do, while retaining central planning and the predominance of state property over the market and non-state property, has not succeeded in Cuba. Nor has it succeeded anywhere else.

The reform processes in China and Vietnam, in contrast, were faster and ultimately more successful in increasing economic growth and social welfare, while keeping the governing party in power. Cuban leaders argue that replicating the Sino-Vietnamese model isn’t feasible due to significant differences with those countries. Nevertheless, the lack of substantial economic results from the reforms and the risks to the island’s most vulnerable populations suggest this argument should be reexamined. Accelerating and deepening the market-oriented reforms will not only improve Cubans’ standard of living, but give the ongoing reform process a much-needed sense of legitimacy.