Travel Notes: Cuba Prepares for Perestroika

By Douglas Clayton | March 2011

Dividing Old Havana from Chinatown is Cuba's Capitolio Nacional, a monumental edifice with a fateful past. El Capitolio was conceived during the "Roaring Twenties", when the island led the world in sugar exports and the future seemed blue-sky. President Gerardo Machado, who dreamed of turning Cuba into the Switzerland of the Americas, decided that his four million countrymen needed a domed Capitol building even taller and more ornate than the one he toured in Washington. Cuba's Congress dutifully poured 3% of the country's GDP into their new home (akin to the US Congress spending $42 billion for a new office today, but let's not give them any ideas...) It took 5,000 skilled Cuban laborers just three years to complete El Capitolio, which featured gilt ceilings, a giant diamond embedded into the pristine marble floor, and the world's third-largest indoor statue. However, the showy project couldn't have been more poorly timed: while the building rose, America's stock market crashed, the Great Depression unfolded, and the Hawley-Smoot tariffs crushed Cuban sugar prices by 74%. As El Capitolio's ribbon was cut in 1932 Cuba's economy lay in tatters, with two-thirds of its citizens thrown into destitution. Machado was forced out of office, and his dream building would perform Congressional service for only 27 years before Fidel Castro's revolutionaries swept into Havana and opted for more austere premises.

Fidel Castro would go on to lead Cuba for almost five decades, doggedly clinging to socialist dogma, even after the Berlin Wall collapsed and other surviving communist states embraced market-based economies. Castro's achievements included delivering to his people free health care and education, as well aslow cost housing, transportation, sports, culture, and daily essentials. Cuba is one of the few countries in Latin America free of narcotics gangs and street criminals, and where large contracts are awarded without kickbacks. Cuban athletes excel at a multitude of sporting activities from boxing to baseball, and Cuban scientists routinely invent new vaccines. But at the same time, just as single party rule has deprived Cubans of political freedom, Marxist central-planning has starved them of economic advancement and the country finds itself with well-educated and healthy citizens plowing fields with oxen, or driving horse carts down empty highways.

Now the winds of change are gathering in Cuba, carried by both economic necessity and political transition. Since Fidel Castro's health nearly failed in 2006, power has passed to his younger brother Raul Castro, who is showing greater assertiveness and organizational prowess as he approaches his 80th birthday. Raul has quietly reshuffled more than 30 Fidel-appointed cabinet members to prepare his Party and people for a sweeping economic policy overhaul-Perestroika al Cubano. Even the semi-retired Fidel seems to have glumly accepted that change is inevitable, candidly admitting to a visiting US journalist that "the Cuban model doesn't even work for us in Cuba anymore".

For nearly five decades, the United States has been trying to hasten Cuba's need for change by restricting most US nationals from investing in, trading with, or even visiting the island nation just 90 miles away. While this policy has imposed severe hardship on the Cuban people, it has also provided Cuba's Communist Party with a handy political excuse for policy failures, thereby helping sustain the Party's popularity, which even today appears to be solid. The US Trade Embargo's visible result is a Cuba that appears frozen in the 1950s: patched up cars, obsolete power plants and factories from that era still in use today.

A masterful crisis manager, Fidel Castro was adept at papering over economic rot with other people's money. Shunned by Washington for nationalizing US assets, Castro's Cuba became a Soviet client state, reaping billions of dollars worth of annual subsidies. After the Berlin Wall fell, Cuba reopened its tourism industry and legalized US dollars to encourage inward remittances. When leftist Hugo Chavez gained control of Venezuela, Fidel talked him into swapping 100,000 subsidized barrels of oil per day for 20,000 underpaid Cuban medics, generating substantial profits for Cuba. Castro also took out $4 billion of loans from China to finance purchases of that country's goods.

The global economic crisis whacked Cuba hard, however. Venezuela cut back on its largesse as its own economy worsened. Tourism and remittances softened, while nickel export prices tanked. Furthermore, three severe hurricanes left a wake of destruction in 2008. Unable to service Cuba's estimated $21 billion foreign debt, and running out of generous leftist patrons to hit up, Raul Castro has apparently decided he has little choice but to pry open Cuba's economy and try to entice the U.S. to normalize relations. Barack Obama seems tempted.

Castro's wild card is Cuba's oil and gas reserves. The island currently produces 60,000 bbl a day, but its US-facing northern waters are estimated to hold an estimated 5- 20 billion bbl of oil and 20 trillion cf of natural gas. (Note: this compares with 29 billion bbl of oil reserves in the entire US.) Accessing this undersea oil requires the sophisticated drilling technology the US excels in, but as long as sanctions remain in place, the US oil majors are excluded from that bonanza. Amidst the applause of oil industry lobbyists, the dance for reengagement has begun, with both partners taking some unprecedented steps.

Obama set the stage by publicly admitting the US embargo of Cuba has been a failed policy. He then made it easier for Cuban-Americans to visit or remit money to relatives in Cuba, while improving linkages of internet and television. The US Congress is discussing a bill to end the travel embargo altogether, and, in the meantime, the ban has just been relaxed for students and other specified groups. There is already considerable interaction between the U.S.and Cuba: US companies export $500 million of food and medicine yearly to Cuba, while charter flights run back and forth between Miami and Havana. The US and Cuban navies reportedly sit down monthly for cordial meetings.

Cuba has eased tensions by releasing around one third of its political prisoners to Spain via the Catholic Church. Raul Castro has issued a far-reaching five-year roadmap for Cuba's future economic reform and development, which will be tabled in April 2011 at the upcoming Sixth National Congress of the Communist Party, the first such gathering since 1997. The proposed changes would put Cuba on a very similar path to that taken by China in the 1980s and Vietnam in the 1990s. Here are some of the ideas: permit real estate transactions amongst Cubans, mergethe two-tier currency system, closedown inefficient state enterprises, decentralizestate ownership, facilitate private ownership of businesses, distributeidle land to farmers, open state-owned wholesale markets, and further encourage foreign investment - particularly in tourism.

In recent months, some planned reforms have already been implemented in an effort to delay Cuba's impending insolvency. Costly subsidies on sugar and personal care products are being scaled back. The government announced plans to shed 1.3 million state workers (that's more than 25% of the workforce - more than 11% of the entire population!) and guide them somehow into the private sector. Cubans are being encouraged to grow and sell their own fruits and vegetables. The government is inviting foreign investors to develop 10 golf course estates in Cuba, with a new law allowing 99-year land leases to foreign buyers of plots in such projects. In the old days of Fidel's Revolution such policies were unthinkable.

So what is the potential for a liberalized Cuban economy? Just look 90 miles across the Straits to Florida, where one million Cuban-Americans call home. Cuba has 60% of the Florida's population and 80% of its landmass, but greater natural resources and a much longer coastline, so one might conclude that the two are of comparable overall potential. Perhaps to underscore their similarities, remember the fact that England and Spain cleanly swapped the two in 1763. Today, Florida's economy is 12 times larger than Cuba's. One reason is that Florida gets 20 times as many tourists as Cuba, plus an inflow of affluent retirees. When the US Government stops restricting its citizens from traveling to Cuba, the island will become an instant tourist magnet. Offering short flights, sunny beaches, cool music, "old world" architecture, and cheap surgery. Cuba should have no problem drawing several million American tourists a year as further away destinations like Costa Rica have done.

Should reforms become comprehensive enough, agriculture seems an obvious investment play: half the land is arable, labor is cheap and rain plentiful. Cuba's once-vaunted sugar industry stands in disarray with 80% of the old mills shut down, but today's high sugar prices provide ample incentive to revive the sector, along with other traditional crops such as cigar tobacco. Despite its long coastline, fisheries and aquaculture remain largely overlooked. Cuba is a world-class producer of nickel but other mineral deposits remain underexploited, and then there's the oil. The entire power system needs to be updated, financial services developed, retailing expanded - the opportunities seem endless.

Cuba's demographics are a cause for concern, however. With a median age of 40, the population has already peaked at 11 million and faces decline unless immigration is promoted. Over 70% of Cuba's people have lived their entire lives under paternalistic socialism and lack the training, experience and capital to start private businesses. Supporting Cuba's future retirement population will be a big challenge given the difficulty Cubans have to accumulate savings: 85% hold government jobs paying $20 per month, and were not allowed to own their homes. In addition, Cuba is not a cheap place to live. Beyond the subsidized basics, most consumer goods have to be imported, and imports draw heavy duties. Telecom services are costly due to government monopolization and inefficiency. The list goes on. In this environment it is tough for most Cubans to get by unless they receive remittances, tourist gratuities, or tea money.

All in all, we eagerly await the implementation of Cuba's economic reforms, the gradual normalization of its economy, and the eventual restoration of its relations with America. As this process unfolds Cuba could transform into one of the world's most attractive frontier investment destinations. America has a long track record of turning bitter rivals into productive partners (a recent example being Vietnam), and re-engagement with Cuba could be one of Obama's most notable foreign policy legacies.

Some frontier investors are not waiting for that and are already investing in Cuba. While 100% foreign ownership is permitted, most investors enter joint ventures with Cuban state enterprises which typically contribute land, labor and sometimes capital. Over 250 such joint ventures exist, mostly for specific sectors or projects. Investments are made in foreign currency, eliminating exchange rate issues, and there are no restrictions on capital repatriation. Corporate income tax is 30% for joint ventures, and 35% for wholly-owned foreign companies, but tax holidays of 5-7 years are available to facilitate investment recovery.

A few Cuba-focused investment groups have been established that non-US investors can access. Canada-listed Sherritt Group is a major player in Cuban nickel mining and, formerly, telecoms. A private investment group backed by European investors, Coral Capital has restored Havana's historic Saratoga Hotel, which was recently ranked by Conde Nast as the 16th best hotel in the world. Coral is now planning a number of golf course, marina, housing and hotel projects, as is Leisure Canada, a Canada-listed investment vehicle.

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