Preparing for a Free Market Cuba

Report Americas

Preparing for a Free Market Cuba

April 8, 1992 30 min read Download Report
Bryan Johnson
F.M. Kirby Research Fellow in National Security Policy

(Archived document, may contain errors)

INTRODUCTION f3rnODU 'P Y 7 euba today is suffering its wmt economic Crisis since Fidel Castro seized control Cubas short-t erm strategy should be to d Quickly privatize state-owned enterprises, returning them to individuals, and a4 Establish a stable, convertible currency a4 Establish a legal and institutional framework to protect private property a4 Liberalize trade and elim i nate restrictions on foreign investment eliminate all state monopolies In the medium to long term, the post-Casm Cuban government should 1( Promote rapid development of competitive and efficient financial institutions, in cluding stock and bond markets I( Establish a tax structure with the least disincentives for economic activity IC Avoid addiction to foreign aid by establishing strict guidelines that direct all aid going to Cuba to the alleviation of immediate suffering and the establishment of free mark et institutions.

The U.S. could aid Cubas transition to a free market economy, easing the burden of economic reforms and helping to assure their success. A number of measms would be useful. Among them, America should EW Restore Cubas most favared nation trade status and, a s soon as feasible, negoti ate afree trade area with Cuba Restore to near its 1958 level Cubas share of the U.S. sugar quota Provide only emergency economic assistance, with a set termination date, or as sistance for establishing a free market, while resi sting the creation of a Carib bean Bank for Reconstruction and Development.

Fm market policies of this sort have produced stunning economic successes in the Republic of China onTaiwan, the Republic of Korea, Singapom, and in Hong Kong.

These have some of the fastest growing economies in the world, which have allowed them to rise from poverty to prosperity. To be sum, Cuba will face many hurdles on its path to establishing a functioning free market economy. But as the success of Cuban exiles in Florida dem o nstrate, if provided with economic freedom and opportunity, the people of Cuba a~ more than a match for this challenge CUBAS ECONOMIC CRISIS Pre-Castro Cuba. Before Castro came to power in 1959, Cuba was a growing eco nomic power in the Western Hemisphere . Liberal foreign investment laws, free trade policies, and an attractive tax code helped Cuba double its gross national product GNP) between 1945 and 19

58. Befom Castro seized power, Cubas per capita GNP ranked third among Latin American countries, only behind Argentina and Venezuela.

Cubas agricultural production greatly contributed to the islands economic growth. By 1958, some 58 percent of Cubas total sugar exports went to the U.S supplying 38 2 1 percent of America's sugar.

Befm Casm, Cuba was well on its way to industrial ization It had an extensive television network, modem roads, 9,OOO miles of railroad 100 private and public air parts, and a growing tourism industry. Between 1950 and 1959, Cuba nearly doubled its hotel capacity by constructing 2 8 new hotels. In 1958, some 325,y tourists visited Cuba. Prior to Castro, Cuba had a well-educated, healthy population. Cuba's life expec tancy, infant mortality, and lit eracy rates were as good as any in Latin America Grip. After his takeover of Cuba Cas t ro proceeded me thodically to eliminate eco Communism's Tigh tening Chart I Foreign Aid to Cuba: Abandonded by Russia, Castro's Isolation Deepens Bllllonr of Dollrrr mor mea 1080 1000 ieoi ie02 Military AIaIafanca aatimatad. Economic Aoaialanca 8wnom Oata nao Intalilganca Agency, The Cuban la amount aa of Aprli 1, 1002 Economy. ADrll. 1089; Cuban Amarlcan Foundailon.

Cuba Surmy, Vol 1. No. 1, Aprll 18

82. Harll~a DalaChrfl nomic, personal, and political freedom. In 1960, he created the Central Planning Boa rd to control all aspects of the Cuban economy. His Revolutionary Fiscal Law of 1963 sought to eliminate private business and free market activities. Castro's Institute for Agrarian Reform nationalized private farms and took control of the agricultural se ctor.

By 1964, the Institute controlled 75 percent of all arable land in Cuba. Castro in 1964 completed the nationalization of the banking system and named Che Guevara, the Ar gentinean guerrilla leader, to head Cuba's central bank. Castro also nationalize d Ameri can-owned assets, including oil refmeries, sugar plantations, and the telephone com PanY In February 1960, Casm signed a trade pact with the Soviet Union in which the So viets agreed to purchase one million tons of sugar annually from Cuba. This a g reement soon allowed Cuba to exchange sugar at preferential prices for Soviet oil, raw materi als, foodstuffs, and machinery. Eventually, 87 percent of Cuba's trade would be with the Soviet Union and Eastern Europe. Prior to 1959, as much as 78 percent of Cuba's trade was with the US.

Changing Fortunes. The collapse over the past three years of communism in Eastern Europe and the U.S.S.R. has meant the collapse of Cuba's preferential trade agreement with the Soviets. Deliveries of Soviet lumber, foodstuffs , and spare ma l 2 Victor A. Canto,Tom Cox, and Arthur B. Laffer Cuba Part l: The Background A.B. Laffer,V.A. Canto and Associates. La Job, California. 1991.

Jose Alverez Diaz, A Srudy on Cuba (Miami: University of Miami Press, 1965 3 chine parts during t he past two years have been delayed due to production problems in the former Soviet repub lics. Last year, Moscow deliv ered an estimated 8.6 million metric tons of oil out of a promised 10 million tons.

This was down from 13.4 million toqs in 1990 Russia n President Boris Yeltsin last November 16 signed a decree freezing all future shipments of oil to Cuba. Then last December Russian Foreign Minister An drei Kozyrev told anti-com munist Cuban leaders that Russia would eliminate eco nomic aid, effective im mediately, and would curtail economic, diplomatic, and se curity ties with Cuba. In the fum, he said, Cuba would Chart 2 With Subsidies Qone, Cuba's Oil Imports and Sugar Exports to Russia Collapse Yllllonr of ton R I 18110 1000 1001 1002 Al of Aprll 1. 1 902 8wrom cub. Busln6

88. Februery. 1992; Economist lntelllgence Unlt. Counrry Report, Cuba. October 29. 1891 Ken Gluck, Mlaml Herald, 'RUIIIILI, Cuba OK Tram Deet Februery 1. 10

02. Herltege DatrChrrt be on its own. Kozyrev called for a democratic Cuba and expressed his willingness to cooperate with the Miami-based Cuban exiles to facilitate Cuba's move to democracy.

Russia announced that it would accelerate the withdraw of some 1 1 ,OOO military per sonnel from Cuba. Russia, meanwhile, has prevented the forced return to Cuba of some 2,000 Cuban students that are seeking asylum in Russia.

The deterioration of relations with the former Soviet Union has knocked Cuba's al ready weak economy into a tailspin. Cuba now must pay for all goods and services from Russia in hard currency. Cuba has shortages of most basic commodities. As a re sult, rationing is widespread. As Cuba homes further isolated from the international economy pressur e will continue to build to replace Casm Castro's Balance Sheet. Today, Cuba is ruled by an aging communist ideologue who is quickly turning his country into the North Korea of the Caribbean. Cuba, once one of the largest sugar producers in the world, has s een its production drop from a high of 8.1 million tons for the 1988-1989 season to about 5.5 million tons for the 1991-1992 season. Sugar production continues to fall because Cuba cannot afford to produce or import seed and fertilizer, and because gasoli ne-powered agricultural equip ment is being replaced with water buffalo from Vietnam 3 Trade agreements between the governments of the Soviet Union and Cuba have always referred lo amounts of oil shipments in metric tons, not barrels.

Cubas GNP, while not easy to estimate ac curately, apparently did not grow at all between 1986 and 19

89. In 1990 its GNP fell by 10 per cent followed by a 20 percent drop in 19

91. In the first quarter of this year alone GNP shrank by a further 20 percent.

Cubas hard currency re serves fell from $242 million in 1985 to $50 million last year.

Cubas national debt to Western countries rose from $45 million in 1959 ~JI $8 billion in 1990 1 Cuba: The North Korea of the Caribbean I Scale: k-4 500 miles After steady growth in the standad of living before 1959, Cuba today has Seen its living standards fall. In fact, using purchasing power parity, which takes into account cmncy devaluations, exchange rates, and inflation rates, Botswana, Gabon, and Nica ragua, have higher living st a ndards than Cuba. It is clear that after 33 years of Castros reign, Cubas economy is in ruins A FREE MARKET ECONOMIC PLATFORM FOR CUBA Post-Castro Cuban leaders will face the need to revive a dead economy quickly, to provide basic goods and services, and i n the long term to ensure economic growth and prosperity for all Cubans. In this, Cuba can learn from the experiences of other less-de veloped countries and ex-communist countries which economic policies work best and which should be avoided. Leaders of a free Cuba would do well to study the success stories of Taiwan, South Korea, Singapore, and Hong Kong, which have moved from the less-developed to the developed world.

Futm leaders of a free Cuba also should remember that there was considerable cor ruptio n in the pre-Casa~ government. Not all Cubans felt that they shared in the bene fits of the free market. Indeed, frustration over perceived or real limits on opportunity caused some initially to support Castro. But rather than granting equality of opportu nity, Castro made all Cubans equally poor. To avoid the fear that a corrupt socialist re gime will be replaced by a cmpt capitalist one, leaders of a free Cuba must take care to make their fiee market revolution a popular one, allowing economic liberty an d op portunity to all Cubans 4 Figures in 1990 doh 5 The new Cuban government should develop policies for the short term, to allow Cu bans again to work and produce, and for the long term to ensure that market reforms are institutionalized and that economi c progress endms d Quickly privatize state-owned enterprises, returning them to private individuals, and eliminate all state monopolies.

Cuba must move quickly to transfer productive assets to individuals, that is, to privatize state-owned enterprises. Thi s is crucial because the sooner individuals, as owners of enterprises, can benefit dimtly from these efforts, the quicker the pro duction of goods for consumption or trade will grow. Privatization in other ex-com munist countries often has been delayed as policy makers sought to determine the value of state-owned assets before they were sold to private investors. One reason for this has been to guarantee maximum revenues to the government. Another has been to prevent prospective owners from paying too litt le for assets. But these rea sons should be secondary to getting production going as quickly as possible.

The adverse effects of slow privatization are evident in Nicaragua. Since Violeta Chamm won the democratic elections for the Nicaraguan Presidency in February 1990, few publicly owned enterprises have been privatized. As a result, there has been little foreign investment in that country. This has contributed to the zero eco nomic growth rate for 1991.To avoid such problems, a new Cuban government would do well to transfer state-owned assets to the private sector quickly and equi tably, and to make it as easy as possible far people to stake claims on nationalized assets.

A new Cuban government will have at its disposal a wide range of techniques that may be used alone or in combination to transfer government assets into private hands. Smaller enterprises could be sold quickly to their employees. Larger enter prises might first be =organized and sold to their workers under employee stock ownership plans. An enterprise reorganized as a joint-stock company might also be sold to the general public.

Inviting Foreign Investment. Foreign investors could be allowed to purchase sham in such a fm. This would bring more capital to the enterprise than the pur chase p rice since the foreign investor seeks to make certain that the new enterprise is productive and profitable. Foreign investors also would bring advanced manage ment techniques and technology to a company. In Mexicos special maquiladora factories, which are owned totally by foreigners, workers acquire skills and work habits that help them not only to be productive workers in these factories but to be better workers when they move on to other enterprises. Some employees from such factories eventually leave an d start their own businesses.

Some larger state-owned enterprises in Cuba such as public utilities might be broken up into smaller units and then sold. This would allow free market competi tion to establish efficient and quality utilities.

To ensure a proper market environment for newly privatized companies, and to spur the creation of other private businesses, the new government of Cuba should remove all prohibitions against private providers entering any sector of economic 6 activity. Tha t is, even as the government attempts to sell off its enterprises, monop oly rights for government industries should be abolished.

When Castros government came to power, it confiscated businesses, private homes, and the assets of fareign companies. After C astro is gone, many former property owners will attempt to recover their assets. Yet, as has been the case in many post-communist Eastern European countries, the need to afford justice to the victims of communist theft can cause problems and delays in eco n omic reform. In some newly freed countries in Europe several claims sometimes are placed on the same property. In Czechoslovakia privatization of several state-owned companies was postponed because of last minute claims on them. Officials in these countri e s also must determine, in cases where property cannot be returned, how much com pensation former owners should be paid. And since Cuba has been under commu nist rule for only 33 years, a decade less than Eastern European countries, there likely will be mm Cuban claimants to lost property.

Reviewing Property Claims. To privatize state-owned assets and to make cer tain that previous owners recover their property or receive compensation, the new Cuban government would do well to establish a privatization over sight agency and a property claims court. The oversight agency would coordinate and implement the privatization program. It also would process claims for confiscated assets. The inde pendent property claims court, meanwhile, would review cases in which th e re are several claimants for a given asset, ar other complications. In such cases, the privatization agency would act in accordance with the claims court decision. If such cases cannot be decided within a certain established time limit, the agency would p roceed with its plans to dispose of assets. As a result, privatization would not be delayed. When the court finally reached a decision, the winners of the case would receive compensation.

The privatization agency might avoid court delays and conflicts by p roviding le gitimate claimants to confiscated assets with vouchers of a value depending on the size of their claims. These vouchers could be used to bid on state-owned assets being sold by the agency. Thus, former owners would be given preference over oth e r investors dition, a certain percentage of the proceeds generated from asset sales might be set aside to compensate people with legitimate claims to assets that did not win back their property through the bidding process. While compensating former owners of private property is important, the ovemding goal of the privatization policy should be quickly to return government-owned enterprises to the private sector The agency should establish a time limit in which all claims must be made. In ad d Establish a s table, convertible currency.

To facilitate economic activity, international trade, and privatization, the new government of Cuba should move quickly to establish a stable, convertible cur rency. A growing, advanced economy cannot exist without a sound curr ency. A currency serves as a store of value, something people can save to use for later pur chases or investments. It also functions as a medium of exchange, allowing busi nesses and individuals to trade with one another. To perform these functions a cur r ency must keep its value over time. That is, it must not be inflated 7 Some reformers may suggest that Cubas current central bank, the Banco Nacio nal de Cuba, be given the task of making Cubas peso a stable currency after Cas tro goes. Yet, it was this b a nk that ran the printing press to fund Cuban budget defi cits, and to provide massive subsidies to the public sector. The Cuban bank sets its exchange rate at a $1.25 per peso. Yet the Cuban black market rate, which gives a clearer indicator of the pesos w orth, is 10 cents per peso. Central banks always are subject to political pressures and other temptations to manipulate the money supply far some short-term gain that produces long-term problems Currency Board. Rather than working through the current syst e m, a new Cuban government should abolish its central bank and establish a system in which the cur rency could not be manipulated easily by the government. The new Cuban govern ment simply could use the U.S dollar for its currency. This, however, could mat e political problems. National pride might cause the Cuban people to not accept the U.S. dollar as their currency.

Johns Hopkins University economist Steve Hanke and George Mason University economist Kurt Schuler suggest that ex-communist countries set up independent currency boards to establish a convertible domestic currency and instill confidence in money by operating separately from the government?

A currency board issues notes and coins that are backed directly by a foreign cur rency, such as the U.S. dollar. Citizens and businesses could exchange these notes and coins for dollars, or any other established currency, basket of currencies, or commodities, at a fixed rate. Market forces, rather than a central bank, would deter mine the money supply. Over 60 countries have utilized currency boards since 19

00. Hong Kong and Singapore are notable examples of economies with very sta ble cmncies overseen by cmncy boards6 Available Assets. To make this work effectively, Cuba will need some hard cur rency or co mmodity to back its peso. Because of its likely future t~ade and invest ment ties with the U.S the dollar is an obvious choice. Though Castros treasury now is empty, on Liberation Day the new government will not be bankrupt. Sev eral American telephone co m panies, far example, owe the Cuban governments phone company about $100 million for processing overseas calls to Cuba. Because of the U.S. economic embargo on Cuba, imposed in 1962, American phone compa nies have not been allowed to turn over the money to Cuba. Moreover, the U.S currently controls about $80 million in seized Cuban government assets. These funds and assets will be available to a free Cuban government. As soon as possible after Castro falls, the new Cuban leaders should announce that they wi ll use a por tion of these funds to back a Cuban peso 5 6 Steve H. Hanke and Kurt Schuler, Currency Boards for Eastern Europe, Herifage Lecfure No. 3

55. December 12,1991.

Steve H. Hanlre and Kurt Schuler, Cmncy Refom in a Marltet-oriented Cuba, The Cuban American National Foundation, Washington. D.C Forthcoming 8 a4 Establish a legal and institutional framework to protect private property The core of the free market system, from which all other principles derive, is the right of individuals to own and di s pose of private property. Proclaiming the rights of individuals to own private property is relatively easy. More difficult is guaran teeing these rights, especially against government abuse, and providing the means for their protection. Privatization, fre e exchange, and a stable currency will bring prosperity only if economic liberty, the right to own property, and to contract freely with others to trade property, is protected To achieve these goals, a new Cuban government should start by re-establishing t h e commercial code of business that existed in Cuba before Castro. Such a code provides the environment in which all economic activity occurs. It defines, among many other things, what a contract is, what constitutes a buyer and a seller, and how disputes m arbitrated. An institutional framework, moreover, must exist to enfme contracts, and arbitrate disputes. An independent judiciary is necessary for the objective resolution of disputes.

Understandably after suffering for three decades under the repressive and arbi trary directives of communist bureaucrats, Cubans might regard all government of ficials as enemies Thus, to give the people confidence in a new system, post-Cas tro leaders must establish a judicial system with its own binding, independent pow e rs to protect the integrity of private property and the right to contract a4 Liberalize trade and eliminate restrictions on foreign investment Free trade is particularly necessary for countries attempting to overcome decades of economic decay under commun ism. High tariff and non-tariff barriers add to the costs of machinery, equipment, and other goods necessary to increase productivity.

Trade barriers also price consumer goods out of reach of many workers and lower the living standards of others, removing incentives to work hard and be productive.

A 1987 World Bank report concludes that countries with more open trade policies have faster growing gross national product rates than countries with closed bar den?

Trade was very important to Cuba's economy before Castro, accounting for 57 percent of GNP. And the U.S. was Cuba's principal trading partner. Reestablishing trade ties with the U.S. and the rest of the world thus is a key to Cuba's economic recovery.

A f ree market Cuba should begin by bringing its trade practices in accord with the General Agreement onTariffs and Trade (GATT). Even though Cuba was an initial signatory of GATI' in 1947, and remains a member to this day, it has drifted from the free market principles laid out in GATT. Cuba should start by signing the Harmonized Tariff Classification and Coding System to bring its trade accounting methods in line with the rest of the world. Cuba, in addition, should amend and clarify its customs laws to harm o nize them with international trade standards 7 World Developmenr Reporr: 1987 (Washington, D.C The World Bank, 1987 9 These reforms should k made with an eye on a fum free trade area with the U.S or on en tering the North Amer icaFreeTrade Area under the Bush Administrations Enter- prise for the Americas Initiative, which seeks tc incorporate the entire Western HemispheE in a free trade zone.

The communist gov ernment of Cuba nation alized all foreign assets in the 1960s. Under Cas tro, Cuba prohibits ma j ority foreign ownership of any business. Even minority foreign partici pation is allowed only in a few special cases. Yet foreign investment will be necessary to energize Cubas economy after Castro falls. Fmign in vestment has both shm term and enduring b e ne fits. It immediately adds capital to the economy for modernization and in novation, creating jobs and providing wages for local workers. More over, the government of Cuba might turn over state enterprises to for eign investors if, in ex change, these i n vestors pay off part of Cubas fmign debt. Such debt equity swaps have been especially successful in Chile and used to a lesser extent by other Latin American COUR tries 10 By removing restrictions on foreign investment, Cuba could receive as much as 3 bil l ion in foreign investment from Cubans now in exile, an infusion of capital not available to most other ex-communist countries. A post-Castro Cuban govern ment should make it easy for foreign investors to make their investments, with min imal central gover n ment involvement and oversight. An especially promising source of foreign capital might be for Cuban enterprises to engage in joint venms and strategic alliances. These alliances allow foreign companies jointly to manufac ture products with private Cuban c ompanies. In such arrangements, both p gain by sharing the costs and infarmation needed to produce an end product. As a result, newly privatized Cuban companies could greatly expand their access to new technologies, management techniques, distribution cha n nels, and capital. To make joint ventms a-tive, Cuba thus should avoid strict antitrust laws that discour age such alliances Ten A MEDIUM-TO-LONG-TERM STRATEGY FOR ECONOMIC GROWTH A new Cuba understandably will focus first on reforms to get the economy mo ving at once. Then it must plan for the medium to long term and embrace policies that prompt economic growth. These would include Y Promote rapid development of competitive and efficient financial institutions, including stock and bond markets.

The World B anks 1989 World Development Report states correctly that to ob tain all the benefits of greater reliance on voluntary, market-based de ision mak ing less developed countries] need efficient financial institutions. Financial in stitutions such as banks and stock exchanges are vital for a functioning free mar ket, directing funds to productive enterprises.

Banks accept deposits, for which they pay interest, and lend out money to indi viduals or businesses, for which they receive interest, the rent they charg e on money. Banks also purchase large blocks of stocks which they then market to other investors. Banks also help finance exparts and imports.

A new Cuban government thus should move quickly to establish a free banking system. In doing so, it should take a lesson from America on what not to do. Amer ica separates investment banking from savings and loan banking. This makes banks less diversified and therefore often less able to deal with economic hard times that might reduce profits for one banking activi ty but not for another. Thus, a new Cuban government should allow its banks to engage in all forms of banking activi ties IS 8 9 See Jordan D. Lewis, Parulerships for Profit: Structuring and Managing Strategic Alliances (New York The Free Pre9s. 1990).

See BryanT. Johnson, Increasing American CompetitivenessThrough Strategic Alliances, Heritage Foundation Buckgrounder No. 8

57. September 26,1991: and Forging Alliances to Bust Into the Japanese Market, Heritage Foundation, Buckgrounder No. 876, January 31,1 992 10 World Developenr Repori: 1989 (Washington, D.C The World Bank, 1989 p. 1 11 Fostering Small Banks. A new Cuban government should pay special attention to the need for cooperative banks, operated on a small scale by local people, lend ing mainly to o ne another. In less developed countries especially, new goods, ser vices, and jobs are generated by small entrepreneurs. Larger banks often have lim ited capacity to evaluate the needs and credit-worthiness of such small business men and-women. In many le ss developed countries, where strict banking laws favor large banks but hinder or bar the creation of smaller ones, the poorest people suffer.

By contrast, where small banking is allowed as it is in Bangladesh, the poor prove quite capable of making sound lending decisions. In Cuba, with most large industries in ruins, a new government should take care to assure that individuals in small communities or rural areas as well as large investors, could engage in bank ing activities.

A new government of Cuba sho uld avoid America's banking insurance mis takes. Currently the U.S. government insures banking deposits and charges the same rate whether a bank pursues reckless lending policies or sound ones. By ban ning market pricing of insurance for banking, the U.S. government has removed the market incentive of high insurance rates that would discourage irresponsible or risky lending. This is a major cause of the current savings and loan crisis. To avoid this problem, a new Cuban government at minimum should charge market rates to banks for insurance. Better still in the long term might be to allow the private sec tor to insure banks.

A sound stock market also is necessary to attract domestic and foreign invest ment. It also can assist government privatization effort s: a functioning Cuban stock market would be an ideal place to sell off large state-owned enterprises Establish a tax structure that minimizes disincentives for economic activity.

A primary mistake of ex-communist countries over the past three years has b een to set high tax rates, making it difficult or impossible for entrepreneurs to acquire the capital to begin or expand operations. Poland, for example, has set business taxes at 40 percent and Czechoslovakia at 60 percent. High personal income taxes als o discourage productive efforts.

Ex-communist governments claim that they need high taxes initially to raise the revenue to cover the costs of transition to a free market. But high tax rates hold down economic' production, thus holding down revenues to the government and slowing the econ omic transition. Cuba thus would do well to hold tax rates low to avoid these problems.

Economic Disincentives. Governments need revenue to provide such essential services as police protection, law courts, and national defense. Yet the source of tax revenu e, taking real resources away from their owners, can distort investment and spending decisions, thus increasing economic inefficiency.

The new Cuba should design a tax structure that balances the need to generate the revenue necessary to finance legitimat e government operations with the disin centives inherent in any tax scheme. A good tax system should target a broad tax base to insure the lowest possible tax rates. The best approach would be a flat tax 12 of a set percentage to be paid by all individual s regardless of income. A flat tax avoids the disincentives to production that result from the form of tax popular in most countries, the so-called progressive tax. This latter tax takes a larger percent age of an individual's income the higher his income rises. The result: the individual is penalized far being productive.

A flat tax also brings more revenue into a country's treasury than does a progres sive tax. Because the economy grows faster with a flat tax, there is more economic activity to tax and thus mm government revenue.

The new Cuba, facing the huge burden of reorganizing its government and econ omy, will appreciate especially the fact that a flat tax is easy to administer and man age. It requires no mm than a few lines on tax forms, making it e asy to fill out and easy to check for accuracy.

The new government of Cuba would do well, too, to avoid a business tax alto gether. A business tax in fact is inneased taxation on the very productive forces that should be least burdened. Under this system, profits are taxed as business prof its and then, when the remaining profits are distributed to the owners, they are taxed as income. Such a tax seriously hinders economic growth and should be avoided.

The new government of Cuba might also set a limit on the size of its budget to a shaxe of GNP. By holding down spending, the government would help assm that taxes remain low and thus that the economy continues to expand Y Avoid addiction to foreign aid by establishing strict guidelines that direct all aid g o ing to Cuba to the alleviation of immediate suffering and the establish ment of free market institutions A new Cuban government no doubt will have offers of foreign assistance from America's Agency for International Development (AID) and from internationa l or ganizations like the Inter-American Development Bank, the International Mone tary Fund 0, and the World Bank. The new Cuban government, faced with an economy ruined by Castro, will be tempted to accept this assistance. History sug gests strongly, howe ver, that such aid does little good, and in fact will retard eco nomic growth.

There is no indication that foreign aid helps build prosperity. Since the mid 1950s Western countries have transferred at least $1.6 trillion to poorer countries in Africa, Asia, and Latin America. l1 Little economic progress has been made there.

What progress was made was due more to free market policies than to foreign as sistance. Massive loans from international organizations have only mired its recipi ents in deep debt. Suc h aid is of little help to countries that have not reformed their economies sufficiently 11 Nicholas N. Ebersuidt Foreign Assistance Requests for Africa Testimony before the Subcommittee on Africa, Committee on Foreign Affairs, U.S. House of Representativ e s, March 9,1989 13 The Philippines, for instance, has been unable to translate about $10 billion in aid, promised by the West after the fall of Ferdinand Marcos in 1986, into em nomic growth. Conditions attached to foreign aid often directly hinder econom ic growth. The IMF, for example, recently forced the reformdented government of Argentina to raise taxes, This will buy some short-term assistance from the IMF at the cost of lowering Argentines living standards and discouraging their productive effarts.

A new Cuban government might in fact need little or no foreign aid. Cuban ex iles in America could provide an estimated $3 billion in the first year following Castros demise for the reconstruction of Cuba. Yet if a new Cuban government feels that it needs a id, it should establish strict guidelines to guard itself against for eign aid addiction. It should accept funds only to meet emergency needs or to help establish free market institutions, pvent starvation, and meet medical needs. This aid should not be g i ven until the post-Castro Cuba establishes guidelines far free elections and a set termination date for such aid is established AMERICAS ROLE IN A FREE CUBA Although much of the qsponsibility for transforming a post-Castro Cuba from an impoverished econom y into a growing ~RX market obviously rests on the new Cuban government and the Cuban people, there are ways that America can ease the new Cuban governments burden of transition. The U.S. should Restore Cubas most favored nation trade status, and, as soon as possible negotiate a free trade area with Cuba Cuba was one of the original signatories of the General Agreement onTariffs and Trade. Yet since Castros takeover, Cuba has ignored many GATT principles.

Further, in 1962, the U.S. revoked Cubas most favore d nation status, which pro vides each GAIT member with equal trade treatment. The status was revoked be cause of Castros increasing anti-Americanism. And in February 1962, the U.S. im posed a trade embargo against Cuba, which, for the most part, remains t oday.

When Castro is gone, and immediately following free elections in Cuba, the U.S should restore most favored nation status to Cuba and eliminate the trade embargo but not befare. American businesses should be given an opportunity to trade and in vest i n Cuba as quickly as possible.

Ending the U.S. trade embargo and restoring most favored nation status will help Cuba in the short run. But then, as Cuba overcomes the initial difficulties of reor ganizing its ruined economy, the U.S. should be start negotiating a free uade area WA) agreement with Cuba. Such an agreement would remove barriers all tariffs, and most non-tariff barriers to trade between the two counmes. In the long term, the U.S. should bring Cuba into the North American FreeTrade Area NAFTA), currently being negotiated by the U.S. with Canada and Mexico and into the U.S.-sponsored Enterprise for the Americas Initiative. This Initiative seeks to link the Western Hemisphere into one common economic market.

Framework Agreements. U.S. trade negotiators first should work with a free Cuba to establish the framework agreements necessary to bring Cuba into NAFIA 14 These framework agreements, already existing for most Western Hemisphere coun tries, establish the b asis for which fke trade negotiations will take place. Frame work agreements often set out target dates for negotiations, topics of discussion and the objectives of such discussions. The U.S. then should negotiate an FTA quickly, bilaterally with Cuba. Th is would avoid the delays that would result if the U.S. tried to bring Canada and Mexico into the agxtement immediately.

If Cuba cannot quickly negotiate an FI'A bilaterally with the U.S than Cuba could be brought into as part of the U.S.-Caribbean Community (Car icom), formed in 19

91. Mcom was established to facilitate the free trade agree ment process. Instead of negotiating with each ountry separately, the U.S. would negotiate with entire regions at the same time.

A post-Castro Cuba will likely become America's most important trading part ner in the region, as well as an important country for American investors. And with 2 million Cuban exiles now in Florida, it might be all but impossible to stop free trade and investment from developing spontaneousl y . Therefore, it would greatly benefit both the U.S. and Cuba if an FI'A wext established soon after democratic elections are announced. If a U.S.-Cuba FI'A is delayed because Cuba is grouped with Caricom, or must await Canadian and Mexican approval, then Cuba's chances of quick economic recovery soon after Castro's fall are seriously diminished 14 w Restore to near its 1958 level, Cuba's share of U.S. sugar quotas.

Sugar production accounted for 80 pexent of Cuba's exports between 1920 and 19

59. Today, sugar is still its largest export, making up about 82 percent of total ex ports. But Cuba's total sugar production has grown from only 5.9 million metric tons in 1960 to about 7.2 million tons in 19

87. This is an annual growth rate of less than 1 percent. By contrast, production in Brazil, another major sugar exporter, in mased from 2.8 million metric tons in 1958 to more than 8.5 million metric tons in 1987, an average growth rate of over 10 percent per year.14 U.S. sugar growers have enjoyed trade prote ction almost continuously since 18

16. In 1934, the U.S. government established a quota system that restricts im parts from each sugar exporting country. Cuba's quota in 1958 was 3.2 million metric tons. The U.S. embargo has barred Cuban sugar exports to t he American market. Since then, the U.S. government has reduced the amount of imported sugar, substituting domestic sugar production. Today, America's sugar producers enjoy the highest amount of government protection ever.

To give Cuba an immediate market for its main crop, the U.S. should restore a substantial portion of Cuba's 1958 3.2 million ton annual sugar quota after Castro falls. In the long term, Cuba must diversify its economy and increase foreign ex 12 Currently, Caricom consists of Antigua, Ba r buda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Montserat, St. Lucia, St. Kim and Nevis, St. Vincent and the Grenadines, and Trinidad and Tobago 13 "U.S Caribbean Nations Sign Trade Agreement Washingron Posr, July 2,1991 14 U.S. Centr a l Intelligence Agency The Cuban Economy: A Statistical Review ALA 89-10009 (April 1989 pp. 7-9; U.S. Deparlment of Commerce U.S. Relations with Cuba: A Statistical Survey HF 3075.U49 August 1975 15 change earnings in tourism, manufacturing and numerous ag ricultural goods. Yet access to the U.S. sugar market would allow Cuba quickly to gain much needed hard currency earnings.

Higher sugar imports will lower prices for American consumers for American en terprises that use sugar in their products. In 1988 the Commerce Department esti mated that U.S. sugar quotas cost American consumers $3 billion a year in higher prices." Since there are some 11,OOO sugar farmers in the US this means the con sumer pays 272,700 in higher prices for each farmer. The quotas caus e d U.S sugar prices to soar so high that the 1986 Economic Report of the President ob served Entrepreneurs were imparting high-sugar content products, such as iced tea mix, and then siftin their sugar content from them and selling the sugar at the high dom e stic price.""With this disastrous record, America should open its sugar market to help Americans. The emergence of post-Castro Cuba would give U.S policy makers an ideal opportunity to begin to scrap its sugar quota system ES Provide only emergency econom i c assistance, with a set termination date, or assistance for establishing a free market, while resisting the creation of a Caribbean Bank for Reconstruction and Development Cuba might well be the one countq that emerges from communism without even a plaus i ble pretense for foreign aid. The two million Cubans living in exile in the U.S. who are expected to provide as much as $3 billion a year in investments and assistance to a free Cuba belie the need for aid to that island from foreign gov ernments. And the failure of the U.S. Agency for International Development (AID over three decades to bring prosperity to less developed countries suggests that lit tle good can be expected from bilateral fareign aid. In Eastern Europe today, AID is criticized for being to o slow and not providing the sort of assistance needed to es tablish growing market economies.

The new Cuban government might be tempted to take as much foreign aid as is offered, ostensively to pay for the costs of a transition to a market economy, The U. S. should not hold out such a temptation. Rather, after a post-Castro Cuba has es tablished guidelines for democratic elections, the U.S. should offer assistance only for emergency food or medical help, or to help establish directly free market insti tuti ons. By using aid in this way, the U.S. is assured that its efforts truly help Cuba and do not get it addicted to aid.

Disastrous Development Banks. When Eastern European countries gained their freedom, the U.S. joined the rush to create the European Bank for Reconstruction and Development. Yet this bank's principal project so far has been to plan an ex pensive headquarters and hire international bureaucrats. Much of its funds proba bly will help Western businesses make profits in Eastern Europe rather tha n help Eastern Europeans to help themselves 15 U.S. Deparlment of Commerce, "United States Sugar Policy-An Analysis" (Washington, D.C U.S.

Government printing Oftice, 1988 p. v 16 Economic Report ofrhe Presidenr, 1986 (Washington, D.C Government printing O ffice, 1986 p. 137 16 The Inter-American Development Bank, based in Washington, D.C has been no torious for its corruption and as a way to channel money to powerful politicians and interest groups in Latin America at the expense of the people. There is no evi dence that development banks help substantially to transform the Eastern Euro pean economies. The US. should mist the temptation to mate a regional develop ment bank for the Caribbean. This likely would only slow economic development CONCLUSION The Cu b an people have suffered 33 years of economic hardship, human rights abuses and political repression under Castros communist dictatorship. But with the collapse of communism in Eastern Europe and the Soviet Union, and the cutoff of eco nomic aid to Cuba by the new Russian Republic, Cuba now faces an economic col lapse that Castro is unlikely to survive struct a society and an economy out of the ashes. But the size and prosperity of the exile community give Cuba hope for a quicker seturn to the road to prosp e rity for Cuba than might be possible for other ex-communist countries. But these Cubans and their American supporten must move quickly once Castro falls to open economic op portunities for all Cubans and to transfer productive assets from the hands of com m u nist bureaucrats to the people themselves. The new Cuban government would do well to follow the free market principles that have proved so successful in other parts of the World0 The U.S. govemment and the American people understandably will want to aid the Cuban people in their hour of greatest need and greatest hope. Voluntary humanitarian assistance from the American people will no doubt help meet the basic needs of Cuba after Castros fall. But the U.S. government must take great care not to inflict, under the guise of assistance, the same counterproductive aid policies on Cuba that have harmed other less-developed countries.

Offering Opportunity. What the U.S. government can offer Cuba is the opportu nity to sell its goods in an open U.S. market. After the fall of Cuban communism, the U.S. should lift its economic embargo and restare most favored nation status. And when the n ew Cuban government stabilizes its economy, the U.S. should begin negoti ations for a free trade area to make Cuba truly a part of the Western Hemisphere com munity of politically and economically free nations.

Most Cuban exiles in America lost businesses, homes, property, and savings when they fled Castros dictatorship three decades ago. But in America they found freedom and xebuilt prosperous lives. There is no doubt that the Cubans left on the island will do the same when they find freedom again after C astros demise Freedom-loving Cubans both in exile and in Cuba soon will be called on to recon Bryan T. Johnson Policy Analyst 17


Bryan Johnson

F.M. Kirby Research Fellow in National Security Policy