Four Ways Cuba Can Become More Business-friendly

Four Ways Cuba Can Become More Business-friendly
What will it take to make the country attractive to investors?
Based on insights from Benjamin F. Jones and Russell Walker

Since President Obama's 2014 announcement about normalizing diplomatic
relations with Cuba—and last month's reopening of the United States
embassy in Havana—there has been plenty of speculation about the future
of the Cuban economy. Will Cuba become a huge tourist destination, a hub
of entrepreneurship, a hot new bet for real estate investors? Or will it
flounder?

"There is a lot of opportunity for rapid market expansion, high growth,
and increases in per capita income," says Ben Jones, a professor of
strategy and faculty director of the Kellogg Innovation and
Entrepreneurship Initiative at the Kellogg School. "The U.S. could
present enormous demand for Cuban goods and services, and massive
accelerations are historically associated with big shifts toward trade
openness. But for Cuba, those opportunities are conditional on a large
number of reforms."

Russell Walker, a clinical associate professor of management economics
and decision sciences at the Kellogg School, and a Cuban-American, sees
an opening for international companies in consumer package goods,
refrigeration, and building supplies to a domestic audience. But he
cautions, "you're dealing with a totalitarian government that has a
history of revoking and altering grants and policies. This is one of the
things investors look to in terms of ease of doing business: Will I be
able to manage my asset, control it, sell it, dispose of it, and get my
profits out? For a long period of time, the answer has been essentially
'no,' unless you've crafted a unique deal with the Cuban government."

So what will it take to make Cuba's economic opportunities a reality?

Cuba's current government lacks a market-based foundation that would
encourage foreign investment. Strengthening property rights and contract
enforcement would change that picture significantly, Jones believes, and
allow for growth.

But rewriting laws and enforcing them, or making credible promises to
foreign companies that want to come set up shop, won't be easy. "There
are a lot of vested interests in Cuba based around the existing systems
that aren't going to go quietly into the night, and are going to resist
reforms that would cut against their resources and their capacity to
stay in business," Jones says.

"The U.S. could present enormous demand for Cuban goods and services...
But for Cuba, those opportunities are conditional on a large number of
reforms." —Ben Jones

Cuba will need to commit to much larger, more comprehensive market
reforms to lure American businesses. Ultimately, the nation must
convince entrepreneurs "that they will in fact enjoy some of the fruits
of their labor," says Jones, "and not have it be fundamentally taken
from them by the government, in one way or another."

And the convincing will not come easily. Further complicating efforts
are longstanding disputes over privately owned businesses and real
estate that were seized by the Cuban government after the revolution. "I
think that that will be an ongoing brake on the capacity of the U.S.
government politically to engage Cuba," Jones says. "One thing we know
about property rights is that it's pretty hard to take someone's
property and stop hearing about it. It can go on for a long, long
time—decades, centuries."

Fixing the Currency

Another serious impediment to foreign investment is Cuba's dual currency
system, says Russell Walker.

The "national peso," which the government uses to pay workers' wages and
price local goods such as food, is essentially worthless outside of
Cuba; the "convertible peso," used by tourists and upscale retailers, is
arbitrarily and artificially valued at 25 times the national peso level
domestically, but at one to one for national and foreign investors. Any
company that wants to operate aboveboard in Cuba has to navigate this
thicket.

"Currently, there are really no places in the world that trade Cuban
pesos," Walker says. "So getting your gains out isn't as easy as it
might be in other parts of the world." For companies looking to invest,
there is little incentive if the Cuban government is not interested in
changing the way capital flows into and out of the country, though there
are signs that Cuba may remove the convertible peso from circulation in
the next year as part of a larger set of business-friendly reforms.

Making Investment Worth the Trouble

While Cuba has the region's largest population at more than 11 million,
it has a very low GDP per capita, and more than 50 years of U.S.
sanctions have not primed the country to take off. Supplying goods for
production on an island where many raw materials must be shipped
in—often under crippling, punitive tariffs—will have to be reimagined to
make the country a competitive destination for manufacturing.

"What is not clear is whether entering Cuba to make things in Cuba is
acceptable yet from a risk perspective," Walker says. International
producers of consumer packaged goods and food products tend to be very
large companies that may look at Cuba as lacking sufficient volume and
buying power. "The justification for them to deploy capital there would
probably be hard to make."

As foreign manufacturers try to partner with existing Cuban companies,
they are finding that those producers' infrastructures are not
technologically advanced enough to compete in many sectors. The Cuban
government's traditional defensive posture—restrict trade in order to
give domestic companies a leg up—may have worked in the past, but
reducing the free flow of goods via protectionist policies ultimately
does Cuban entrepreneurs hungry for resources a disservice, acting as a
further drag on innovation.

"Cubans struggle to purchase a lot of simple things that are necessary
to start a business, and so a lot of those things come from the U.S.,"
Walker says. "The country will have a massive transformation as more
goods become available, and that will likely alter many entrepreneur
opportunities."

Avoiding the Tourism Trap

Since the December announcement, there has been a flurry of feature
stories on the effects an American influx will have on the tourism
industry in Cuba. But American tourism may not be a cure-all for the
Cuban economy.

"If you look at other destinations in the region, tourism has helped in
some ways, but it's a bit of a trap as well," Jones says. "The jobs in
tourism in those economies aren't great jobs. It's not a step toward
industrialization, or becoming major exporters of goods and services, or
becoming high-tech, or a cluster of entrepreneurship—things that might
be more durable sources of growth over long periods of time. I doubt
tourism would be transformative to the Cuban economy." Indeed, European
and Canadian tourists—who currently have much more access to the
country—have not yet driven great wealth gains.

Still, Walker points out that American tourism has the potential to
revitalize Cuba for another reason: aspiration. "U.S. dollars will get
in the hands of more Cubans," he says. "They will see more of the things
that we own, which will create an enormous pressure for those things to
be available—everything from our food and soap, to our iPhones and iPads
and clothing."

As that demand grows, Walker can see sales bubbling up in quasi-retail
settings like the current black market. If products can demonstrate
their viability in that context, retailers that have an interest in a
more permanent presence will take notice.

Source: Four Ways Cuba Can Become More Business-friendly - What will it
take to make the country attractive to investors? -
http://insight.kellogg.northwestern.edu/article/four-ways-cuba-can-become-more-business-friendly