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Archibald Ritter, Carleton University, Ottawa Canada ASCE 2014 Does Cuba Have an Industrial Future?

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1 Archibald Ritter, Carleton University, Ottawa Canada ASCE 2014 Does Cuba Have an Industrial Future?

2 OUTLINE I.Characteristics of the Deindustrialization Process II.Causal Factors III.Consequences IV.The “Lineamientos” V.Sectorial Potentials VI.Basic Policy Requirements VII.Conclusion

3 Central Issues: Since 1989, a disastrous de-industrialization with no significant recovery; Complex and multi-dimensional causes; Result? Cuba pushed to small Caribbean island economic status; Can this situation be reversed? – Will the Lineamientos be useful? Are there potential industrial sectors for resuscitation? What are the necessary policy changes?

4 Significance of Manufacturing Industry in the Cuban Economy: Manufacturing Industry Manufacturing Value Added as Percentage of GDP 24.4%15.4% Labor Force in Manufacturing as Percentage of Total 19.4%12.4% Index of Manufacturing Output in Physical Terms 1989 = Source: ONE, Anuario Estadistico de Cuba, 2012 and CEPAL, La Economia de Cuba, Santiago Chile, 2000

5 1. De-Industrialization Source: ONE, Anuario Estadistico de Cuba, 2004, Table 11.1 and AEC 2012 Note: Data for are not available Figure 1. Index of Industrial Output (excluding Sugar) (1989 = 100.0)


7 Source: NU CEPAL, 2000 Cuadro A.86; ONE, 2012 Table 11.3


9 II. Causal factors A Conjuncture of Circumstances - a perfect storm 1.Termination of the special relationship with USSR;  The end of subsidization;  USSR Break-up and E. European recession reduced Cuba’s export earnings Result? Economic melt-down: deep recession; Collapse of investment and savings Cannibalization of existing equipment Severe in-capacitaion of manufacturing sector. 2. Soviet technological inheritance: antiquated and uncompetitive

10 3. Before 1989, inadequate maintenance; After 1989, maintenance and re-investment collapsed. (Note: “derrumbes”) “Cannibalization” of industrial plant. 4. Since 1989, low levels of investment. 10.5% 10.5% of GDP in 2008 vis-à-vis 20.6% for Latin America, (UN ECLA, 2011, Table A-4.)

11 5. Dual monetary and exchange rate system penalizes traditional and potential new exporters [receive one old (Moneda Nacional) peso for each US $ from exports 6. Blockage of small and medium enterprise despite some liberalization in prevented entrepreneurial trial and error and the emergence of new manufacturing activities.

12 7. China has helped to de-industrialize Cuba China’s advantages in its manufacturing: – Low-cost and industrious labor force; – Past and current emphases on human development and higher education; – A relatively new industrial capital stock; – Massive economies of scale; – Massive “agglomeration economies”; – Grossly undervalued exchange rate, co-existing with Cuba’s grossly overvalued exchange rate. Result: Cuba is flooded with cheap Chinese products that have replaced consumer products, many of which Cuba once produced – in the 1950s as well as the 1980s

13 Causes of Sugar Sector Collapse: 1.A foreign exchange “cash cow” milked to death; 2.Insufficient maintenance and by insufficient re- investment preventing productivity improvement. 3.The monetary and exchange rate regimes under which it labored have also damaged it badly.. 4.Fidel’s decision to close half the industrial capacity of the sector Result:  Sugar agro-industry has shrunk by +/- 85%  Cluster of industrial activities servicing sugar have collapsed.

14 III. CONSEQUENCES OF THE COLLAPSE OF MANUFACTURING 1.Employment (including sugar) declined from 685,500 in 1989 to 530,800 in 2009 a reduction of 32.6%. (ONE AEC, 2011 Table 7.3) 2.Second, labor productivity in manufacturing has fallen, still a reduction of +/- 35% from in 2011 compared to 1989.

15 Figure 2 Labor Productivity in Manufacturing (excluding Sugar), ; ( 1989= 100) Source: ONE, Anuario Estadistico, 2004, 2012 and Naciones Unidas CEPAL, La Economia Cubana, Mexico D.F.: Fondo de Cultura Economica, 2000, Cuadro A.49 and A.90

16 3. Importation of manufactures previously produced in Cuba has risen. Shoes, clothing, textiles, plumbing supplies, electrical materials, household gadgetry and furnishings Available only for “Convertible Pesos” rather than the Moneda Nacional that people actually earn. Tiendas por la Recaudacion de Divisas system (TRDs or former dollar stores) resembles Walmart, Costco, Target, etc. in that they make their mammoth purchases from China for all their stores in the country The World according to Walmart’s Procurement Volumes: The Model for Cuba’s TRD Oligopolies?

17 4.Cuba has lost the foundation for diversified manufacturing for the future.  the “clusters” of economic activities that once surrounded the sugar sector specifically and agriculture generally producing inputs and processing outputs.  E.g. production of machinery and equipment is at 0.4% of the 1989 level; metal fabrication is at 32.8%. 5. The potential for the emergence of manufacturing for export has been damaged or in some cases destroyed.

18 II. THE “LINEAMIENTOS” ON THE MANUFACTURING SECTOR. “Lineamientos de la Política Económica y Social del Partido y la Revolución,” – included 25 guidelines on Industry 1.“ prioritize” exports (Guideline No. 215) 2.“prioritize” maintenance (220), 3.assure inputs for the self-employment & cooperative sectors (217), 4.emphasizing technical training (132 and 138) 5.the rationalization and restructuring of industrial capacity, (219).

19 II. THE “LINEAMIENTOS”, continued 6.Sectorial Emphases:  Nickel (224), OK  Natural medicines (222)OK  Pharmaceuticals (221), OK  Rubber tires (231), ?? OK?  Fertilizers (230), ???  IT and electronics for export (226), ? Limited; ??  Construction materials (233)OK ????  Metallurgy ???? ????  Machinery and equipment ???? Some of these seem reasonable and may have important roles to play in future manufacturing.

20 7. Exchange rate and monetary unification and rationalization: vital for manufacturing revival; Action coming. 8. Small enterprise liberalization and co-operative promotion : in process; An important step Continuing limits on size and professional activities: impede the evolution and diversification into higher tech manufacturing and related services. “Lineamientos” proposals, if and when implemented, could support a turn-around for manufacturing. So far, however, reforms have been systematic and cautious but also limited and slow. II. THE “LINEAMIENTOS”, continued

21 IV. SECTORAL POTENTIALS What might be the successful manufacturing sub-sectors in future?  “Picking the winners”: difficult; maybe impossible  Best approach: establish a reasonable policy and institutional framework and let the winners emerge over time. o liberalize micro- small and medium enterprise further, o a fair taxation system for Cuban-owned private sector enterprises, o unifying the monetary and exchange rate systems, o establishing a secure property rights system and theimpartial rule of law in the economy o Some areas are in the process of implementation  However, if Cuba establishes an “enabling environment” for manufacturing, what might be the main opportunities?

22 A.1 Traditional Agro-Industries: Sugar Sugar agro-industrial sector Major potential for food and bio-fuels; Requires reconstruction from the ground up; Requires foreign – that is Brazilian – technology, management and entrepreneurship; Dramatic institutional change is necessary to replace the old dysfunctional state enterprise model

23 A.2 Traditional Agro-Industries: Tobacco Cigars: a thriving agricultural and manufacturing base for future expansion. – Market prospects: mixed but modestly positive on balance. – Downside: health concerns; aging baby boomers; the end of the cigar fad ==  reduced consumption in high income countries; – Upside: a status symbol for middle class of the BRICS and other emerging countries – Normalization of relations with the US will also increase demand. Conclusion? Continue to promote this sector. Suggestion: Broaden export market with high quality machine- made cigars at affordable prices. (Cuba has priced itself out of the middle class cigar market.)

24 A.2 Traditional Agro-Industries: Rum and Alcoholic Beverages Rum and alcoholic beverages: Strong foundation; Good prospects: – In BRICS and middle income countries now; – In US market after normalization Continue promotion.

25 B. Food and Food Processing Major domestic and export potential Weak foundation: Agriculture generally weak; Citrus cultivation: fallen out of the picture; Tropical fruit production is nowhere; Processing activities: totally underdeveloped. Major potentials: Tropical fruit juices for Northern Hemisphere markets; Off-season vegetables for Northern Hemisphere; A strong US market after normalization Requirement: Successful agricultural revival; An enabling policy environment;

26 C. Pharmaceuticals. Major success since 1989: Significant exports (546 million pesos in 2011) to a range of countries. Success could continue. Downside risks. New drugs must continuously be developed: generic versions can be produced freely anywhere (read India and China) when patent protection runs out. i.e. Cuba’s producers, like big pharmaceutical companies, face future death unless they innovate successfully. Some markets are ideological “sweet-heart” deals, e.g. Venezuela. At risk when the Cuba-Venezuela “special relationship” runs its course.

27 D. Light Manufactures Significant producer in 1950s and – e.g. leather and rubber footwear, textiles, clothing, cotton and rayon textiles, clothing and consumer products of leather, wood, paper, metal, rubber and plastic for household use, rubber tires, soap, paint …. (IBRD, Report on Cuba 1950, p.130.) : 70% to 90% Reductions in different cases – Paralleled by its corresponding collapse in Canada and the United States, with the resultant job-loss and urban decay in the rust-belt. Difficult to reclaim these areas, – due to economies of large scale production and agglomerative economies in Asian countries, most notably China.

28 D. Light Manufactures, continued Possible niche-type markets, e.g. ; – Some lines of specialty women’s clothing, leather footwear, Spanish-colonial style furniture. – Surprising crafts-level innovation in a myriad of areas for hard- currency tourist markets. Policy Pre-requisites: – Further liberalization of enterprise to middle-size firms – Successful monetary unification and convertibility

29 E. Chemical and Petrochemical Products. Slim Prospects, unless major quantities of off-shore oil are developed. Some production and exports from the refinery complex in Cienfuegos. But competition from established producers in the region such as the (US, Mexico, Trinidad and Venezuela) limits the possibilities. Revival of Fertilizer “mixing PPK”? Perhaps but inputs are all imported (potash, phosphates and nitrogen)

30 F. Heavy Industry Heavy industry (iron and steel complex, metal smelting & fabrication, wire, sheet, rebar, beam and tube making ……….) Nickel Extraction, Concentration and Smelting for export: Competitive and viable Other Activities Unlikely to emerge due to – lack relevant raw materials at this time, – energy situation at this time – absence of significant metal using industries – Small domestic market vis-à-vis efficient scales of production, – absence of relevant skills etc. Situation could change if low-cost energy from off-shore petroleum were to be developed.

31 H. Machinery and Equipment Pre- and post- 1959: – successful production of agricultural equipment e.g. cane carts and wagons (for rail), sugar mill tanks, vats, hoppers etc. 1970s and 1980s: – some agricultural equipment such as heavy cane harvesters 2014: – Cuba has lost the market for the production of machinery and equipment for the agricultural sector. – Brazil seems likely to capture much of this market. – Some niche products may emerge Automotive assembly (Chinese in Mariel): economic lunacy; Some auto parts: batteries, rubber tires, are a slim possibility Complex machinery and equipment? Forget it. Some straight-forward custom-built one-off sheet-iron type products, can be viable.

32 I. Electric and Electronic Equipment Assembly of some electric or electronic products – occurs now in a minor way and could perhaps be expanded. But domestic value added would be limited. – virtually all of the components would have to be imported. Competition from abroad, notably from China will be difficult to overcome due to its huge advantages noted earlier.

33 J. The Mariel Export Processing Zone The Mariel EPZ creates new possibilities. China, Brazil, Russia and others may establish assembly, light fabrication or bulk-breaking activities. “Give-away” tax treatment provided to foreign investors is a major incentive – “Zero” tax rate on profits for 8 years; – full expatriation of profits; – a rate of 15% after 10 years. Limited Value Added for Cuba due to light taxation and importation of inputs.

34 VI. Basic Policy Requirements 1.Required: “enabling environment” for micro, small and medium enterprise: – A reasonable and fair tax regimen; End discrimination against domestic Cuban enterprise (see chart) – An enabling environment for private and cooperative sectors – Establishment of unified and realistic monetary and exchange rate systems – Property law and company law,

35 Small EnterpriseForeign Investors Nominal Tax RatesPersonal Income Tax Rate: 15% up to 50% of income above CuP $2,000 per year Profits Tax: 15% of Net Corporate Income (50% for resources); Effective Tax Base60 to 90% of Gross Revenues (Maximum of 10% to 40 % allowable depending on activity) Net Income after deduction of all production and investment costs from Gross Revenues Effective Tax RatesMay exceed 100% of Net Income 15% of Net Income Tax Holiday NoneEight Years Tax Exemption Deductibility of Investment Costs from Gross Revenues Deductible only within the 10% to 40% limits Fully deductible from Gross Revenues Deductibility of Input Costs from Gross Revenues Deductible only within the 10% to 40% limits Fully deductible from Gross Revenues Employee Hiring TaxExemption for first five; Six or more taxed Complete Tax Exemption Social Security PaymentsYes Lump-Sum TaxationUp-front Cuota FijaNone Input Importation RightsDirect Imports ProhibitedFreedom to Import Directly Profit ExpatriationNoYes Comparison of the Tax Regimes for Small Enterprise and Foreign Mixed Enterprise after the 2014 Foreign Investment Law

36 2. Release Creativity, Energy and Intelligence of Cuban Citizens: Liberalize micro-, small and medium enterprise, Permit expansion to 20 or 50 employees for in all areas; Opening for professional enterprises; Open up all areas for enterprise– not only the “201” Open and automatic licensing for all; Implementation of wholesale markets for inputs, Open access to foreign exchange and imported inputs under reasonable terms, Micro-credit and credit facilities, Full legalization of “intermediaries” Permission for advertising.

37 But avoid “Walmart-ization” of Cuban economy A strong possibility if existing state sector concentration (e.g. CIMEX) were to be simply privatized; “Walmart-ization” Would reduce potential for diversified manufacturing in Cuba; Would help continue the conversion of the Cuban economy into a branch of the Chinese economy; Would lead to immense concentration of income for Cuban owners, or profit expatriation for foreign owners

38 3. Monetary and Exchange Rate System: Unification and market determination; Meaning: Convertibility and Devaluation Result: Imported manufactures rise in price, decline in volume; Potential manufactured exports decline in price, rise in volume and value; New manufacturing possibilities emerge

39 VII. CONCLUSION So, does Cuba have an industrial future? General Comparative Disadvantages: Manufacturing base has collapsed significantly; Obsolete run-down manufacturing capital stock; Low investment levels impede up-dating capital stock; Decayed and mis-fitted skills; Decayed infrastructure; Small domestic market size: agglomerative and scale economies are minimal; At present, US embargo blocks potential exports

40 VII. CONCLUSION, continued Does Cuba have an industrial future? General Comparative Advantages: Energetic, creative, entrepreneurial and educated population; Some strong sectors: traditional and pharmaceutical Some resource potential: mainly in agriculture plus nickel In future: a symbiotic and complementary relationship with Cuban-American community; In future: a locational advantage re US market;

41 VII. CONCLUSION, continued Does Cuba have an industrial future? Answer: Yes, to some degree. If policy reforms are significant and expeditious regarding Further enterprise liberalization and taxation Monetary system and exchange rate Broader-based industrial revival for Cuba is possible but will be most difficult. Good Luck and Best Wishes. Thank You Very Much

42 Does Cuba Have an Industrial Future Archibald R. M. Ritter, Economics and International Affairs, Carleton University, Ottawa Canada ASCE 2014, Miami

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