Where Capitalists and Socialists May Agree: Future Issues in Cuban Economic Policy

Remarks at at a conference of the Georgetown University Caribbean Project: “Challenges and Opportunities Facing the Cuban Economy in the Next Decade

There is a lot of talk about “transition” in Cuba as if it is a process that will begin some day in the future.

I would argue that a transition is under way now – not a political transition, but a transition from one kind of economy to another.

It is under way for the farmers across Cuba who are selling their surplus produce on the open market, and it’s under way for the vendors in farmers’ markets who deliver that produce to consumers. It’s under way for workers in a nickel plant near Cuba’s eastern tip who work for a Canadian corporation, earn high dollar wages, and are being trained to work with modern technology. It’s under way for the three percent of the Cuban labor force – about 150,000 Cubans – who work legally in their own small enterprises.

These Cubans inhabit what I call Cuba’s new economy, and they have several things in common.

They are in jobs that did not exist a decade ago.

Their income is tied to their output.

They are working in market settings where considerations such as accountability, productivity, cost control, and customer service are important.

And they are all earning far more than the average worker in the state sector.

These openings to market-based agriculture, foreign investment, and small enterprise – plus fiscal reforms and the legalization of foreign currency, which brings hundreds of millions of dollars in remittances annually– have together succeeded in changing the economic outlook in Cuba.

A decade ago, it was widely assumed in the United States that Cuba’s economic crisis would spin out of control and lead to a change in the political system. For many, this expectation was reinforced when the U.S. embargo was twice tightened in 1992 and 1996.

Not only did the collapse fail to materialize, but the Cuban economy emerged from crisis. Today, policymakers face difficult challenges, but survival is no longer their first concern.

And this experience has made clear, to officials and average citizens alike, that to the degree that Cuba has grafted markets and capitalism onto its socialist economic model, conditions have improved.

So in that context I would like to discuss some of the key economic policy issues facing Cuba today.

I’m not going to talk in terms of my own preference for the free market. Whether or not you share that philosophy, I think we can agree that it is irrelevant for the foreseeable future in Cuba. Therefore I would like to try to envision these issues in the way they are faced by the people making economic policy in Cuba today.

Let’s begin by taking a look at Cuba’s farmers’ markets, which I find to be a good window into what is changing, and what is not changing, in the economy.

To put food on the table, all Cubans look beyond the uneven supplies of basic necessities provided at heavily subsidized prices in their monthly ration book.

One option has been the farmers’ markets that have operated since 1994, selling surplus produce of farmers, cooperatives, and state farms at prices determined by supply and demand.

Consider what it takes to buy a simple market basket of a pound of rice, a pound of beans, a pound of pork chops, two pounds of tomatoes, three limes, and a head of garlic. The following is all based on markets I have surveyed and workers I have interviewed over the past several years.

A Cuban worker earning the nation’s average salary would be able to buy that basket five times in the course of a month – this is under the unrealistic assumption that there are no other family expenses.

Under that same assumption, a retiree with a pension would be able to afford that basket three times a month. An emergency room doctor could buy it ten times.

But look at the workers in the new economy.

A state hotel construction worker, because he works in the dollar sector, gets bonus payments based on his unit’s output. He does better than the doctor – he can buy the basket eleven times in a month.

A hotel cleaning woman earns a monthly bonus – she can buy the basket twelve times a month.

The average entrepreneur can buy it sixteen times.

A nickel worker in the joint venture in eastern Cuba can buy it 33 times, and a junior manager at a joint venture on the other end of the island can buy it 50 times.

So here you begin to see the effect of the new economy. It has not eliminated economic hardship. But for hundreds of thousands of Cuban families, it has made the family food crisis a thing of the past – and for those on the higher end of the earnings scale, there is no question that a good diet is affordable, every day of the month.

But this presents its own challenges. It has created a new inequality of income and purchasing power between Cubans in traditional jobs and those in the new economy. For Cuban policymakers, this raises a new equality issue. It has nothing to do with distribution of goods or benefits. It has to do with equality of opportunity to work in the economy’s best-paying jobs.

The success of the new economy has also distorted the labor market. Cuba effectively has two economies operating simultaneously, and the earnings in the new economy are a powerful magnet. This, in itself, is not always a bad thing. When a young soldier leaves military service and opts to open a pizza stand, or a mechanic in a state enterprise decides to work on his own as a neighborhood locksmith, this represents nothing more than normal growth of the entrepreneurial sector.

But the pull of higher earnings is not so benign when engineers open restaurants, psychiatrists become car rental agents, and doctors moonlight in taxis instead of resting or developing their professional knowledge.

That is a harmful distortion of the labor market, a misallocation of talent that holds the nation’s productivity down and represents, at least temporarily, a lost investment in education and training. As a taxi driver said to me earlier this month in Havana, “I would prefer to exercise my profession, but there came a time when I could either continue in the work I like, or my family could eat.” So the petroleum technician drives the cab.

It is only a matter of time before this distortion affects up-and-coming generations. Will young Cubans go to the university for a science degree if they can start a small business and earn three times the average Cuban salary? Will they stay in nursing school if they can enroll instead in a tourism service class? Some observers believe that this change is already beginning to take place.

I raise these issues for a reason: They matter to socialists.

Put yourself in their shoes. Even if you have no interest in bringing capitalism to Cuba, you might be concerned by the growing mismatch between talent and tasks in the Cuban economy. And it’s also reasonable to assume that egalitarianism would lead a socialist to contemplate a new fairness issue: how to ensure broad, equal access to the work and rewards of the new economy.

Cuba’s government has taken measures that begin to address these issues.

The payroll budget for health and education workers, who generally lack access to the new economy, was increased by 30 percent last year.

The government has created new food supply outlets where Cubans buy fresh produce not at low ration-book prices, but at prices that are more affordable than those in the farmers’ markets.

In a growing number of state enterprises – not just limited to those that earn foreign currency – workers are paid “estímulos,” monthly bonuses based on their personal work product or their enterprise’s profit.

Then there is the ambitious attempt to reform state enterprises, a process called perfeccionamiento empresarial. Under this process, in theory, state enterprises will lose their subsidies and be made to thrive by serving the internal and export markets. They will undertake a participatory, self-critical evaluation, then re-engineer their operations and payrolls to the fit their new strategies. If it succeeds, it will increase managers’ autonomy, and market forces will replace state planning as a guide to decisionmaking.

Enterprise reform will not be simple to achieve – many aspects of it go against the grain of the socialist concepts that Cuban workers and managers have known for four decades. But it bears watching because its implications are potentially far-reaching, and it is the one systemic change that Cuban economic officials are pushing today.

To sum up, it makes sense to increase state workers’ pay, to expand the use of production bonuses, and to reform state enterprises so they respond to economic realities.

But it is doubtful that these measures will fully meet Cuba’s challenge of generating a high volume of new jobs that pay well and offer opportunities to workers across the entire spectrum of training and qualifications. These needs cannot be met by a return to centralization and state direction of the economy, but they can certainly be addressed by greater market reform.

If Cuba takes that course, here are examples of areas where we could see change.

In agriculture, the reforms of 1993 have broken the state’s monopoly position as supplier of food. The farmers’ markets, open since 1994, work reasonably well to price and distribute this free-market produce. Yet higher levels of production would help the economy and family welfare. One way to stimulate added production would be to break the state’s monopoly on supply of farm inputs, creating a competitive market to serve farmers and cooperatives.

In the enterprise sector, beyond the reforms I discussed a moment ago, it would make sense to experiment with a greater number of small, unsubsidized state enterprises. It would also make sense to expand the space now allowed for small private enterprises so that genuine small businesses, with employees or partnerships, could grow up. Regulations could be changed to allow university graduates to be self-employed in their own professions. Wholesale supply markets would also help this sector develop.

Cuba’s personal income tax system, reinstituted in 1996 after an absence of 37 years, mainly collects taxes from the self-employed. Even though the tax is structured with progressive rates, in practice the majority of taxpayers seem to pay a lump sum, charged monthly, based on the kind of business they are in. This monthly payment, a cuota fija mínima, functions as a nonrefundable withholding payment that in most cases exceeds the tax that an entrepreneur would owe based on profit alone.

In practice, then, one is taxed for being in business rather than for earning profits. As long as one’s business license is active, one pays a monthly tax even in months where revenues are zero. (The same concept applies in other areas. Rooming houses are taxed on the space available for rent, not on actual rental revenue. Farmers’ market vendors are taxed not on sales, but on the value of the merchandise they display each morning for sale.)

It is understandable that a tax system would be designed this way in an economy where transactions are not heavily documented. The simplest way for Cuba’s tax authorities to ensure a substantial revenue stream was to place an up-front monthly charge on entrepreneurs.

However, while the government’s revenue objective is met, the tax system probably falls short by other standards. A survey I performed showed that while entrepreneurs’ after-tax earnings are high by Cuban standards, taxes are consuming 41 percent of operating profits. As a result, many have turned in their licenses and now work in a black market or gray market setting where they pay no tax. Cuba’s effective tax rates may therefore be beyond the point of diminishing returns. Lower tax rates might yield increased tax revenue, and other changes in the tax system could stimulate more of the entrepreneurial activity – and the jobs and services it generates – that Cuba has already decided to allow.

Cuba’s foreign investment sector makes an important contribution to the economy, but it is unlikely to expand dramatically. Cuban policy toward new investment prospects is purposely deliberate and selective, and U.S. economic sanctions act as a disincentive to some potential investors.

Cuba could consider lifting current restrictions that prevent joint ventures from contracting directly for goods and services in the Cuban economy, instead of working through a designated intermediary enterprise. State enterprises, cooperatives, and others would benefit from the opportunity to make these sales directly. In the tourism sector alone, one can imagine sales in food, furniture, services, and other areas.

None of these ideas are new to analysts and policymakers in Cuba; to one degree or another, they have all been discussed in Cuban economic debates. More than in most countries, it is impossible to predict when, how, or to what extent measures such as these might be adopted in Cuba.

But I believe it is clear that in the coming decade, in one form or another, Cubans who make economic policy will continue to seek ways to generate employment, increase purchasing power, and reduce the imbalances caused by the last decade’s reforms.

And while there is certainly no guarantee that a socialist country will deepen its market reforms, it would be a mistake to dismiss this possibility. None of the measures I just mentioned would break a significant new ideological barrier. All would bring clear economic benefits. To the extent that they increase employment and revenue, they would increase the Cuban government’s health and social services budget.

Ultimately, it seems that the biggest economic challenge in Cuba today may be political: defining the economic transition. We know that Cuba has left behind the economy it had a decade ago. Yet we don’t fully know what the design for Cuba’s 21st century economy will be. On that question, capitalists and socialists can agree, hinges the welfare of the Cuban people today and the opportunities their children will have tomorrow.