A wave of interest in the Cuban market gripped many US companies after the surprise December 2014 diplomatic opening. Hundreds of US companies jumped at the opportunity to attempt to enter a market so close to home yet forbidden for the past 60 years.
That first phase of enthusiasm, however, waned in 2017, as most companies found it difficult to actually close substantive deals, and expectations for a ‘quick buck’ proved overblown. Furthermore, the new US President announced policy changes that seemed intended to dampen enthusiasm and slow down if not reverse the economic opening.
Nevertheless, now is the time for companies to rethink their Cuba strategy, with a more realistic viewpoint. If your goal is a quick buck, hitting sales targets this quarter, Cuba is probably not the right target. But this is the moment for firms with the interest and patience to pursue a strategic opportunity in a nearby country that has the potential to grow dramatically over the next decade, possibly becoming the largest economy in the Caribbean.
Cuba is not an easy market. The politics in Cuba are obscure and complicated, the economic reforms tentative and partial. The economy has been stagnant and access to finance limited. Non-US firms have sixty years of partnership experience in Cuba that newcomers must overcome. And the US laws restricting trade with Cuba remain largely in place, requiring careful work with the US government to obtain licenses for transactions.
On the other hand, Cuba may be ripe for economic take-off. Basic literacy and healthcare for its population of 11.1 million is among the best in the hemisphere. Crime rates are very low.
Its tourism potential is obvious from its beaches and historical sites, along with proximity to the US. Its productive capacity, especially in agriculture, is held far below its ‘natural’ capacity by policy disincentives. But Cuba is undergoing a generational change in political leadership, from which it has a good chance of emerging with a reinforced approach to economic reform.
A New World
President Obama stunned the world when he announced in December 2014 a new opening in US policy toward Cuba. His administration followed that up with regulatory changes to facilitate, and effectively encourage, engagement in Cuba by US companies. During the previous 60 years Cuba had been terra incognito for most US companies, due to US policy restrictions. Suddenly, firms enjoyed visions of a brand new market of eleven million consumers, with cultural and historical ties to the US only 90 miles distant. The tourism industry responded most quickly and effectively - cruise ships, airlines and hospitality firms like AirBnB and hotel management companies established their presence as quickly as they could.
At the same time, numerous US companies involved in manufacturing, agriculture, health care, etc. began their own efforts to explore and develop this potential new market.
Since that first rush of excitement, at least some of the air has gone out of the balloon; some companies are reconsidering their initial enthusiasm, and those that continue to explore opportunities are more low key about it. Cuba has proven a challenging market to enter, due to its political/economic system, its incumbent supplier relationships, and its lack of credit. And some US firms may be concerned about the apparent shift in US policy, as President Trump announced a more negative approach.
Challenges in the Cuban Market
During the first two years of the new policy opening, the US government approved licenses for exports equal to about 6 billion dollars. However relatively few of these resulted in actual contracts. Data is hard to gather regarding new contracts, but they probably total in the tens of millions of dollars. Actual US exports to Cuba in 2017, at $283 million, were slightly lower than before the US opening was announced ($299 m. in 2014), which itself was a ten-year low for US exports. (Export of agricultural products and health care items have been legal - with licenses- for many years.) The majority of those $6 billion of theoretical exports probably were not completed because they did not respond to Cuban priorities, or they ran into some of the many challenges involved in navigating the Cuban market.
It remains a highly centralized communist economy in which almost all significant enterprises are state-owned, and the governmental decision-making processes are obscure to most outsiders. The first GE engagement in Cuba required months of preparatory conversations with the Cuban Embassy in Washington, both to help us understand what opportunities might exist, and for them to understand what GE could offer. In fact the Embassy remained a key communication channel throughout the process. Regular communication with the Embassy helped us understand how Cuba’s priorities evolved -with limited financial resources, the Cuban government prioritizes its import requirements. They also helped us work through the ups and downs of negotiations, clearing up miscommunications or misunderstandings. In addition of course to authorizing the business visas which are required to meet with officials in Havana. Unfortunately this communication has become more complicated, after the October 2017 expulsion of several key officials by the US government, but it remains necessary.
The Embassy was our channel to the Ministry of Foreign Trade (MINCEX), which coordinates Cuba’s external commerce, and set up our first series of meetings with sectoral Ministries in Havana. The various sectoral Ministries supervise the State-owned operating companies, and house the import/export firms which specialize in supporting those companies. Thus the contract negotiations in the energy sector, for example, involve the Ministry of Energy, their foreign trading subsidiary EnergoImport, and the state-owned utility UNE. These levels of bureaucracy can be frustrating to deal with, especially in this closed system. When you run into roadblocks it is never clear where the problem lies, as each of those levels blames the others. Furthermore it is not easy for the outsider to distinguish between normal bureaucratic inertia and unspoken but real opposition.
On the other hand, this highly centralized system can be, on occasion, remarkably efficient. On our first visit to Havana, MINCEX arranged two days of substantive meetings with relevant Ministries that were on time, worked through agendas with outcomes, and involved the right people in each Ministry. (Sadly this is not always ‘normal’ throughout the Caribbean.)
Ideology may still be a consideration. While President Raul Castro clearly supports at least some degree of economic opening to the US, and the vast majority of ‘Cubans in the street’ are certainly welcoming to US visitors, there are some high-level officials who remain entrenched in anti-US, or perhaps anti-capitalist ideology. (Just as in the US some politicians retain a Cold War attitude toward Cuba.) With GE, we found for example that we were received with enthusiasm by the Ministry of Energy, which generally welcomed the prospect that GE could help them achieve their mission of ‘keeping the lights on.’ Some other Ministries gave us a colder initial reception, although they generally warmed up as we got into discussions of concrete ways GE products could help them. In at least one case, however, it seems clear that the (old guard) Minister himself was blocking a transaction, until he was partially overruled from above.
But change is almost certainly coming. Many senior officials, apparently including Raul Castro, recognize that foreign investment is vital to growth, reforms permitting more private sector activity are needed, and engagement with the US and US firms will boost their economic prospects. A new generation of leaders is in the process of taking over, as the old guard revolutionary leaders die or retire — Raul himself has announced retirement this month. There will be ups and downs in the reforms, and the political maneuvering at senior levels is largely invisible to us. But it is a reasonable bet that the overall direction of change will be toward more market opening and better engagement with the US.
Per capita income is low by regional standards, and obtaining commercial credit is challenging. A recent economic analysis by Richard Feinberg (Brookings, February 2018) asserts that stagnation has been chronic for the past ten years, with industrial and agricultural production well below peak levels. Cuba has recently rescheduled its official debt to Western governments, and their access to new credit lines from them is limited at best. The cushion provided to their balance of payments previously provided by Venezuela has severely declined, forcing imports to be slashed from $15 billion in 2013 to $10.4 billion in 2016. The dual currency system is one of the key impediments (along, perhaps, with ideological opposition and possible US opposition) to Cuba obtaining lending from the World Bank, IMF and Inter American Development Bank. Bottom line: foreign vendors in Cuba need to help secure financing in order to complete major sales. But commercial financing from the US remains complicated, due both to remaining regulatory complications affecting dollar transactions with Cuba, and lack of experience by the banks and by the Cuban authorities with each other.
The other side of this story is that a low base can permit very rapid growth, if the policy conditions permit. The Cuban workforce is literate and healthy, and thus could show dramatic productivity gains - once the policy disincentives and constraints are removed, and capital investment is truly incentivized. The natural conditions clearly exist for a major rebound in agricultural production — again, once the policy incentives are changed. And with its beaches, historic sites, low crime levels, and proximity to the US, tourism could also grow dramatically once constraints are removed — Cuban constraints like the shortage of hotel rooms, and US constraints like the US laws that prohibit tourism to Cuba.
Incumbent suppliers remain entrenched. The US embargo gave third-country competitors uncontested access for 60 years. Often they are difficult to dislodge, whether due to established relationships, bureaucratic inertia, or technology infrastructure that is difficult to change. With GE, for example, we discovered that although the rail system was built on US specs (before the revolution), the locomotive fleet now is almost entirely Russian and Chinese. Their inferior quality apparently is balanced by low price, cheap official financing, and decades of familiarity, making them almost (but not quite) impossible to displace. In another example, Havana’s principal electricity source, a plant near Matanzas, was built in the 1970s with power equipment from the French company Alstom. That gave Alstom a major advantage to win contracts providing maintenance and services to the plant. In this case, GE was able to capture that advantage when it acquired Alstom (for reasons unrelated to Cuba).
This challenge can be overcome, as some Cuban officials welcome more competition, and welcome the quality of US products as well as the convenience of nearby supply sources. in the short term there may even be a boost, in some sectors, as Cuban officials recognize that each sale by a US firm helps build political support in the US for improved relations.
US Policy remains complicated. The main elements of President Obama’s opening remain in place. Formal diplomatic relations were restored (the recent drawdown of diplomats due to the ‘unexplained illnesses’ is a setback, but not a reversal of the policy). Cuba was dropped from the list of State Sponsors of Terrorism. And the regulatory changes to the embargo that dramatically expand the latitude for enforcement agencies to authorize licenses for product exports remain largely intact. The principal elements of President Trump’s 2017 policy were (1) explicit prohibition to transacting business with entities controlled by the Cuban military, and (2) tightening of the restrictions that already prohibit US tourism in Cuba. Even under Obama the Embargo was never lifted — that requires Congressional legislation. Thus all transactions required licenses from the Commerce Department (BIS) or Treasury (OFAC). There were always limits to what they would approve — therefore at GE we were careful to make clear to the Cubans that we could only sell products that are licensed, and to be very open with the US agencies regarding contracts we were pursuing. It is not yet clear whether those agencies will be more ‘backward leaning’ than ‘forward leaning’ in future licensing decisions. There are some Cuba hard-liners in the Administration. In the last Administration, senior US officials sought to help us find solutions to policy and regulatory hurdles, responding to the clear policy priority supporting completion of transactions in order to strengthen the policy opening. That incentive no longer exists, making the labyrinth of US license approvals more complicated.
But even in current circumstances, new US licenses are possible. President Trump has made clear that restoring US manufacturing jobs is his priority; ceding sales to European and Asian competitors would run counter to that priority. The new licensing policies clearly support transactions reinforcing telecoms, the private sector and the Cuban retail market — complicated though those may be for US exporters to access. Careful presentation of the economic and political benefits for the US of specific proposed transactions may determine whether licenses are approved, within the existing legal guidelines.
In any case, we are clearly in the end-game of the embargo. Polls show that the majority of Americans — increasingly including the children and grand-children of Cuban exiles — support lifting the embargo, as do the business and agricultural communities. There is bipartisan support in Congress to lift the embargo — although determined opposition by a few hardliners has made the prospect of legislative action difficult so far. The imminent departure of 86-year- old Raul Castro from his Head of Government role may reignite that debate, even as he remains at the head of the ruling Communist Party. But even that role will not last forever.
The Bottom Line
Its not for everybody, but the time is now. Business in Cuba is deeply intertwined with politics —both Cuban and US politics. Given the transitions and uncertainties in both countries, that can be daunting. But for companies that have the patience and stomach for making a long-term bet on improved bilateral relations, and on reforms in Cuba itself to jumpstart growth, this is the time to lay the groundwork. Careful work with the US administration and with the Cuban government can clarify the opportunities. This is the time to learn the market, and to introduce yourself to that market. Establish an early presence so when the opportunity becomes obvious to all, you are ahead of the rush.