Cuba's Moment

From Thirteen Days in October to One Day in December
In October 1962, Cuba became the site of an unprecedented global drama that brought the U.S. and Soviet Union to the brink of nuclear confrontation. In the subsequent decades, this small country became a large enigma. While its location allows for significant trade and cultural linkages to the West, it has, until recent years, been among the most closed and misunderstood societies. As noted in a recent New York Times Magazine article, “What was once a cultural hotbed moldered under Communism.”Paul Reyes, "Next Year in Havana," Sunday New York Times Magazine, January 8, 2015.

In many ways, President Obama’s actions in December 2014 are arguably a lagged response to evolving changes in Cuba. The reforms seen since 2008, when Raúl Castro took power, have paved the way for the beginnings of a private property market, greater freedom of movement for Cubans both inside and outside of the country, and an informal entrepreneurial sector that, over time, increases the economic power of the average Cuban citizen.

Encouraged by such actions and persuaded that further economic isolation from the U.S. would serve no beneficial purpose, the president began the process of restarting U.S.-Cuban relations. Subject to congressional approval, there will be a functioning U.S. embassy in Havana for the first time in more than 50 years. Restrictions on remittances, travel, and banking have been eased to some degree. The administration relaxed controls on sales to private Cubans of a range of important goods, including much-needed building materials, agricultural equipment, and telecommunications gear. More Americans are now allowed to travel to Cuba, with potential benefits for trade and cultural exchange.

These small steps are mostly intended to initiate forward-looking dialogue. There are still many roadblocks toward a complete realization of open relations. For one thing, a full lifting of the embargo requires congressional approval, which is quite uncertain at the moment. But the plans announced on December 17 clearly set the stage for a very different day in the life of a small but potentially dynamic economy.

After reviewing Cuba’s recent macroeconomic evolution, I consider a number of population and education indicators as clues to human capital potential. I subsequently examine broad manufacturing trends and highlight the industrial sectors that may play a large role in the emergence of a modern Cuban factory sector. I conclude with brief comments on the opportunities and obstacles currently on Cuba’s path.

Cuba’s Economic Evolution
In 2010, Former Cuban President Fidel Castro remarked to an American journalist that the “Cuban model doesn’t even work for us anymore.”Julia E. Sweig and Michael J. Bustamante, "Cuba After Communism," Foreign Affairs, July/August 2013. The data in Figure 1, which shows annual growth in inflation-adjusted gross domestic product per capita, a well-recognized indicator of basic living standards, lend credence to Castro’s assessment. GDP per capita experienced a severe contraction in the early 1990s in conjunction with the implosion of the Soviet Union, whose subsidies were a critical support for the Cuban economy. The subsequent recovery has been uneven at best, partially hampered by the global financial and economic crisis of 2008 and 2009. While the data are lagging, once again recovery appears inadequate, with average growth of only 2.6% for 2010 and 2011. A comparison to the broad aggregate of developing economies in the Latin America and Caribbean region further reinforces the point. Existing data show that since at least 2005, Cuban GDP per capita growth has been stronger than for the region as a whole. But for these latest data for 2010 and 2011, Cuban GDP per capita growth is now seen to be below the regional average.

Source(s): World Bank

Source(s): World Bank

Figure 1 – Annual Growth of Per Capita GDP in Cuba, Inflation-Adjusted 2005 USD

The Cuban economy needs to develop enough structural domestic strength to function in a stable manner in spite of negative exogenous influences and thus grow living standards at a faster pace. In this regard, recent policies have been encouraging. As noted by respected Cuba expert Richard Feinberg, the country has been in the process of updating its economic model since Raúl Castro assumed the presidency in 2008.

The basic aims of the new reform program are to modernize state-owned enterprises and allow non-state sector development. A recent panel of scholars from the Brookings Institution and the University of Havana considered Cuba’s progress toward these goals. Most significantly, they found that a small-scale business sector has finally emerged in the wake of a rather turbulent history for entrepreneurship.

As noted by Feinberg, in March 1968 Fidel Castro nationalized about 58,000 small businesses; foreign-owned enterprises and large domestic holdings received similar treatment.Richard Feinberg, Soft Landing in Cuba? Emerging Entrepreneurs and Middle Classes, Brookings Institution, November 2013. During the 1970s, the government made room for some growth in self-employment and the number of self-employed grew rapidly, to 46,500 by 1981. Another period of “rectification” followed and the self-employed fell to about 25,000. This odd volatility continued until Raúl Castro recognized the very positive impacts that a small firm sector can have on an emerging market economy.

A vibrant small business sector is a critical element of labor market stability for any domestic economy, although it does not necessarily provide the trade and investment dynamism that Cuba needs. It is encouraging, however, that entrepreneurial development has morphed into an effort to create a truly self-sustaining private sector. During the last two years, the Cuban government began to give firms more autonomy to retain earnings and make their own investment, employment, and pricing decisions.

Such sweeping private sector change is a boon for the future of Cuban manufacturing in that it may create a market for business capital equipment, which modern manufacturing has become particularly adept at producing. Previous attempts at building a market for capital goods have not been especially successful. Reforms initiated in the 1990s generated a legal framework for domestic investment that, to some extent, brought Cuba closer to the investment paradigm of the West. The poor performance of the banking sector and the absence of an effective capital market limited the contribution of this framework.

While the post-2008 reforms have been welcome and smart, Cuba experts note that more is needed to deal with such challenges as weak domestic supply chains, overdependence on imports of intermediate and capital goods from abroad, and overreliance on commercial services as the principal external revenue–generating sector. A program for energy independence to wean Cuba off Venezuelan oil imports, as well as the appropriate role for the critical agricultural sector in the Cuban economy, must be considered.

An Educated But Aging Population
Population parameters, given their implications for household formation and workforce development, matter a great deal for the domestic investment and inward foreign direct investment that are needed for Cuba to develop a viable manufacturing base and compete in the global trading system. Figures 2 through 6 show demographic data and projections for Cuba in the context of the broad Latin America and Caribbean region.

As shown in Figure 2, Cuba transitioned from population growth to population contraction after 2005. United Nations demographers predict that the rate of population decline will accelerate to greater than 1% by the middle of this century. This is perhaps the most significant barrier to Cuba’s long-term economic growth potential. The country has a considerable disadvantage relative to the Latin America and Caribbean region, which is not projected to fall into a period of depopulation until 2065.

Thanks in part to a competitive biotechnology sector, Cuba’s life expectancy is higher than the regional average (Figure 3). The median age is above the regional average and is rising much more quickly; Cuba’s estimated 2015 median age is 41.3, a sizable difference of 12.4 years above the average for Latin America and the Caribbean (Figure 4).

The share of the population in the 15-24 age cohort is falling in both Cuba and the region, a lagged impact of falling birth rates (Figure 5). Since the mid-1990s, Cuba’s share of this labor market entry cohort has been significantly below the regional average. On the other end of the age spectrum, Cuba has a larger population share in the 60 and older group and the gap is growing (Figure 6).

Figure 2 – Average Exponential Population Growth Rate

Source(s): United Nations, World Population Prospects: The 2012 Revision

Source(s): United Nations, World Population Prospects: The 2012 Revision

Figure 3 – Life Expectancy at Birth

Source(s): United Nations, World Population Prospects: The 2012 Revision

Source(s): United Nations, World Population Prospects: The 2012 Revision

Figure 4 – Median Age

Source(s): United Nations, World Population Prospects: The 2012 Revision

Source(s): United Nations, World Population Prospects: The 2012 Revision

Figure 5 – Percent of Population Ages 15-24

Source(s): United Nations, World Population Prospects: The 2012 Revision

Source(s): United Nations, World Population Prospects: The 2012 Revision

Figure 6 – Percent of Population Ages 60 and Above

Source(s): United Nations, World Population Prospects: The 2012 Revision

Source(s): United Nations, World Population Prospects: The 2012 Revision

These demographic data suggest a squeeze for Cuba, as depopulation and declining labor force entrants are negative for long-term economic growth, while a rising retirement cohort pressures public finances. While many developed economies face this conundrum, it presents a particularly difficult problem for an emerging nation trying to develop a modern industrial economy.

Fortunately, there are counterbalances to demographic weakness. Cuba’s relatively strong investment in education spending is certainly an important catalyst toward a quality workforce (Figure 7). As Ricardo Torres Pérez remarked, “When it comes to education, the Cuban government puts its money where its mouth is.”Ricardo Torres Pérez, "Some Contradictions in Contemporary Cuban Economic Development," Americas Quarterly, Summer 2013. Increasing primary and secondary school enrollment are generally positive for workforce development and the emergence of a stable middle class (Figures 8 and 9). In 2010, the average Cuban citizen had approximately 10.57 years of schooling, the highest of any country in Latin America and the Caribbean.Torres Pérez, citing data from Robert J. Barro and Jong-Wha Lee, "A New Data Set of Educational Attainment in the World, 1950-2010," NBER Working Paper No. 15902, April 2010.

Figure 7 – Public Spending on Education in Cuba

Source(s): World Bank

Source(s): World Bank

Figure 8 – Adjusted Net Enrollment in Cuba’s Primary Schools

Source(s): World Bank

Source(s): World Bank

Figure 9 – Secondary School Enrollment in Cuba

Source(s): World Bank

Source(s): World Bank

Industrial Potential
Indicators of the current health and prospects for Cuban manufacturing are scarce. Nonetheless, the data shown in Figures 10-13 present a picture of weakness. The dramatic fall in the share of Cuban GDP accounted for by exports and gross fixed capital formation since the late 1980s does not bode well for manufacturing strength, although the export share has risen since 2002 (Figure 10). Unusually weak investment demand is a critical policy challenge that must be met for Cuba to develop a viable industrial sector with a healthy and diversified mix of businesses.

Figure 11 shows wide swings in the year-over-year growth of manufacturing value-added, with no indication from these data of long-term strengthening and stability. Partially as a consequence, manufacturing as a share of the Cuban economy has fallen from nearly 18% in 2000 to 10.7% by 2011, atypically low for a developing country (Figure 12). The recent weakness in export growth, shown in Figure 13, only reinforces concerns about industrial development.

Figure 10 – Cuba’s Exports and Gross Fixed Capital Formation

Source(s): World Bank

Source(s): World Bank

Figure 11 – Growth of Cuba’s Manufacturing Value-Added

Source(s): World Bank

Source(s): World Bank

Figure 12 – Cuba’s Manufacturing Value-Added, Percent of GDP

Source(s): World Bank

Source(s): World Bank

Figure 13 – Cuba’s Growth of Goods and Services Export Demand

Source(s): World Ban

Source(s): World Ban

The weakness in these data has likely been exaggerated by the 2009 recession. But it nonetheless seems evident that a strong manufacturing sector is unlikely to develop without aggressive action on a number of fronts, including domestic investment, inward investment, trade, workforce development, and access to capital markets.

What industries are likely to be strong players in a new Cuban factory sector? Only a few articles have considered this question. Many analysts have noted Cuba’s competitive pharmaceutical industry, with exports to a growing number of nations. The country has lately been making a push into Western pharmaceutical markets. Arch Ritter commented that if Cuba became a significant petroleum producer or refiner of petroleum imports it could develop a range of petrochemical products.Arch Ritter, "Can Cuba Re-Industrialize?The Cuban Economy, October 5, 2013. The country has demonstrated innovation prowess in biotech that it could apply to other areas.

Food processing is mentioned as a possibility by Ritter, although with agriculture in a steady decline, this might be a stretch. Heavy machinery production, which often propels developing economy manufacturing, seems unlikely until Cuba begins to build a domestic infrastructure for this type of complex industry and attract foreign direct investment.

A Difficult Journey Ahead, Supported By Strengths
Amidst the current euphoria, no one should harbor illusions about the path ahead for Cuba. After more than half a century of failed economic policies and an embargo with the U.S., economic success will not come easily.

Among the many obstacles are a rapidly aging population, a fact that necessitates aggressive family planning and immigration programs in order to develop the population base essential for dynamic household formation, goods demand, and industrial workforce development. Weak investment is a concern, requiring—among other things—the development of an effective banking system and capital market. Such actions could hopefully bring Cuba into global financing markets—a prerequisite for the trade presence needed for a strong and stable manufacturing sector.

Cuba has assets that will serve it well in the years ahead. As the largest island in the Caribbean (with an estimated population of 11.3 million) with proximity to the U.S., and more specifically to what could be an emerging U.S. Southeast manufacturing cluster, the country is well positioned for trade competitiveness if it leverages new relationships and develops a productive workforce. And while demographics are a problem for labor force competitiveness, high levels of educational attainment and adult literacy are critical strong points.

The manufacturing sector was nearly decimated with the implosion of the Soviet subsidy in the early 1990s, but there are specific strengths to leverage for broader industrial development. The island’s notable pharmaceutical sector demonstrates its capacity to succeed in an innovation-driven area. If the country develops a much-needed energy independence policy, it could apply the same innovation prowess to develop a range of petrochemical products.

At this interesting juncture, the world will do well to remember that the Cuban missile crisis took place two years after the U.S. trade embargo was applied in October 1960. If the embargo had not happened and if a trade relationship between Cuba and the U.S. had been in place, who knows if humanity’s most frightening brush with complete disaster would have happened. The events of December 17, 2014 have presented an opportunity. Much is at stake and much can be gained with thoughtful and patient policies.