A Visit to Castro's Cuba II Jude Wanniski January 20, 2000

To: Robert D. Novak
From: Jude Wanniski
Re: Part II

This is the second part of the June 23, 1994 Polyconomics report on my trip to Havana earlier that month. It followed nine months of discussions I had with the Cuban government about both the conversion of Cuba's command economy to market socialism and a peaceful normalization of relations between our two countries. The process had been initiated by Rep. Charles Rangel [D-NY], who asked me to help, knowing the work I'd done in advising Moscow and Beijing. Earlier that month, I traveled to Havana, gathered general impressions, met with senior officials of the government, offered constructive criticism of their reform efforts, and outlined an alternative approach. On my return to the states, I met with several important leaders of the Cuban émigré community in Miami. The purpose was to report on what I saw and said, to collect their impressions of how things stand, and to suggest how they might help accelerate a process by which normalization could be achieved to the satisfaction of both important parts of the Cuban nation. They had essentially divorced in 1959 and have been separate since. Cuba's incredible potential back then was buried in an economic depression which grew worse daily. Castro's government indicated it would like to follow China's successful path to conversion, but instead found itself in an IMF-type rut, which I characterized to them as Gradual Shock Therapy, or slow poison. I'd hoped we could make an honest effort to put this nagging residual of the Cold War into a perspective that might yield a bloodless, diplomatic resolution. The émigré political leaders in Miami objected strenuously and I lost what little political support I had in Washington for even trying. It became clear to me the Miami Cubans were not interested in any solution that would leave Castro alive and well and living in Cuba. The Cubans did, though, follow my advice in stabilizing the peso, which was key in ending the economic decline. Perhaps the controversy over the Cuban boy, Elian Gonzalez, will stir things up enough for another attempt to end this long, painful stalemate with our Cuban neighbors.

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China's Impact on Cuban Agriculture

In our early meetings in Havana on this trip, we were told rather proudly that the recent agricultural reforms, as well as those still to come, would be extremely important in moving Cuba forward. The decision had been made to convert the state communes to cooperatives, which is what the Chinese did in 1978, providing the foundation for the great economic expansion that followed. Clearly, the government believes the reforms will increase the production of farm produce, especially sugar, by permitting the co-op workers a greater say in how they organize themselves and how they are paid. I told them these reforms might help offset the negative effects of the other reforms, but this would depend on the organization of the co-ops. I told them what Deng Xiaopeng had done in 1978 and why it worked, with an analysis they acknowledged they had not heard before:

On one day in the spring of 1978, the Beijing government announced that all communes would henceforth be cooperatives. Essentially, this meant that the members of the co-ops could do anything they wished to organize themselves and their work, so long as they paid taxes based on the previous year's production. Workers would not get ownership of the land, but the collective co-op would be guaranteed a free hand for a 25-year-period -- a critical move that has enabled the co-op to make long-term investment decisions. It was also important, I told the Cubans, that Beijing did not issue a guide on "how to be a co-op," a central template. Each commune now had to organize itself, like a beehive, outside of central authority. This was a huge grant of power from the state to individuals, within the collective framework. In a land of a billion people, the greater part of whom are engaged in the production of food and fiber, this was an astounding transfer of power and control by the Communist Party and the Beijing elite.

A Chinese co-op, comprised of perhaps 2,000 or 10,000 or 20,000 people, suddenly had local authority and local accountability. For as many co-ops as existed, there were that many different kinds of organizations. The most successful were those which organized themselves most effectively. As a commune, they were directed to plant rice or raise pigs or produce melons. Now, they had to decide what to do with their human resources. They elected their leaders and debated the issues. They would decide to plant less rice, raise more pigs, produce vegetables instead of melons. Families could depart from this plan as well. If the decision were correct, the co-op profits would vastly exceed the taxes paid to the government. The co-op would have to decide how to distribute the profits, how much should go as a cash bonus to labor, how much should be withheld for investment, to buy a truck or install an irrigation system.

To make these kinds of decisions requires a stable unit of account, and this China's central government has provided. Until recently, the government kept the price of petroleum at one fifth of the world price level, thus maintaining the purchasing power of the yuan as it existed in the old command economy. Farm co-ops could continue to purchase state fertilizer and gasoline at yuan prices reflecting this low oil price. Western economists view this as an inefficiency, but as I have explained in Moscow, Beijing and Havana, during the transition process it is appropriate for the state to transfer resources to the private sector in this manner. A central goal of transition, in fact, is to transfer capital owned by the state into the hands of individuals in an equitable fashion. Russian and Ukrainian agriculture remains plagued by inequities largely because, unlike China, the state has maintained control of the process of organization. With several thousand people on a Russian co-op and no agreed-upon social contract of what belongs to whom, individual work and investment cannot proceed with any sense of confidence.

Year after year in China, by contrast, word would spread about co-op successes and shortfalls, and delegations would be sent from the poorer to the richer to glean information and advice on how to organize. By 1983, when I spent two weeks in China studying the reforms, the co-ops were voting to shift out of agriculture entirely, financing bicycle shops and light industry. Now, 16 years later, there are co-ops which once planted rice but now plant nothing. They have gradually shifted toward production of higher value-added products, and have invested in urban projects, hotels and office buildings, for example. From the outside, these still look like "socialist" enterprises, but close-up they are modules of democratic capitalism. The next step will be to permit individuals to cash in on their co-op investment, receiving a "share" that they can sell to others, in order that they be able to migrate to another area and another occupation. This will give the Chinese system an even more "capitalist look." It will happen as the country grows richer, and as young Chinese wish to cut their ties to the land, migrating to where their individual potentials can be realized.

All this I explained again and again in Havana, in order to let them see how their own agricultural reforms compared. From the long faces I encountered, it was clear the Cubans realize how far they are from the successful Chinese approach, and how close to the Russian failures. Now and then I was met with hostile comment, that "Cubans are not Chinese," or that China is so vast it can experiment in many ways, a luxury Cuba does not have. I could only suggest that Cuba can now benefit from the Chinese and Russian experiments, avoiding those that failed. Of course, Cubans are not Chinese, but their similarities are far more numerous than their differences, I pointed out. The Russians, once again, have been pushed by their "shock therapy" advisors to leap from communism to capitalism, without the political or economic mechanisms to absorb the pressures of adjustment. On the advice of the World Bank and IMF, both the Gorbachev and Yeltsin governments raised the ruble price of petroleum, for example, on the simplistic idea that the lower price represented an inefficient state subsidy. In practice, this generated the inflation that has crippled Russian commerce, agriculture in particular. Unable to afford the higher-priced fuel and fertilizer, Russian farmers and co-ops have watched yields decline and crops rot in the fields without transport to markets.

The Cuban agricultural reforms are doomed to fail, not only because the peso has not been fixed, but also because the state continues to dictate the terms of production. "Commune" signs have come down, replaced by "Co-op" signs, and farm workers are now allowed to decide how they organize themselves into teams. They must, however, grow what the state tells them to grow. "We need them to grow sugar," one official insisted to me, "because we need the hard currency." Giving the co-ops the authority to make these decisions, as the Chinese do, would more likely result in greater production of value, as the co-ops figured out themselves how to optimize their work effort. If production of greater value is produced, hard currency will increase automatically. Once again, though, we see the tail wagging the dog, as the government concentrates on increasing exports instead of increasing the efficiency of the domestic economy. As it is, the central government can only keep its fingers crossed that sugar is the right decision and then offer the excuse that the crop failed because the weather was bad, as it is now doing. I was able to point out that our suggestions were entirely consistent with their intent of converting to market socialism. This point clearly registered, which is why I believe the meetings were so successful. I did not come to them with suggestions that would be politically impractical. The Cubans told me repeatedly that they had to work at their own pace, and that nothing could interfere with their independence and sovereignty.

Reform Recommendations

The political leaders of Cuba should try to imagine that the rest of the world suddenly disappeared, and their island economy constituted all of civilization. If they were to survive, they would have to try to quickly construct a system that would allow production and commerce to ensue. Unless they were to revert to a pre-civilized barter economy, they would have to provide the people with a way to trade and borrow from one another by exchanging pieces of paper, financial instruments. The cities especially have to trade with the farms. This is true no matter what form their economy takes, communist, socialist or capitalist. The first step is to infuse the only Cuban financial instruments now in existence, the government's peso debt, with credibility.

The primary recommendation we made is that the Castro government tell the Cuban people that it would honor its peso debt at something close to the original purchasing power, say one peso per U.S. dollar. It could do this through a peso bond issue, which would accomplish several objectives at once, the most important being to revive the dying peso economy. As noted above, at the current black market rate of 120 pesos to the dollar, the value of the 11 billion pesos in circulation is about $90 million, or about $8 for each Cuban citizen. To restore the purchasing power of the Cuban debt at dollar parity would give Cuba monetary capital of $1,000 per capita. By contrast, the per capita national debt of the United States is roughly $20,000. All Fidel Castro would be doing is restoring the government's obligations to its own citizens in parallel with its obligations abroad.

"How can we afford this?" was the question everywhere. Cuba's current asset value is now tiny because its capital structure prevents it from creating wealth, I said. If it would improve its capital structure, it would create wealth, and the value of its peso assets would rise accordingly. I asked them to consider a modest goal, of achieving the per capita income of the people of Puerto Rico in the year 2004, ten years hence. This is only $7,000 per capita, or a third of the U.S. per capita income. Still, it would mean that Cuba's gross income in 2004 would be $77 billion, at least five times what it is today. A bond issue that capitalized that future value would be extremely credible, both to the Cuban people and the international investment community.

Conceptually, here is how it would work: The government would offer to sell to anyone a bond for 350 pesos. At 120 pesos per dollar, it would thus cost roughly US$3. The government would promise to pay 3 percent interest on a bond held to a 10-year maturity. The bond would be redeemed with either 350 pesos plus accumulated interest of another 120 pesos, or an ounce of gold or its equivalent in dollars, with accumulated interest. The bonds would have instant credibility, because they would be seen as legal obligations of the state, no matter what government might be in power in 2004. If Castro were gone, he would still have committed his successors to pay these obligations in full, or incur the political wrath of the bondholders, the Cuban people.

With the credibility of the bond issue assured, the value of the peso in the black market would soar. Indeed, if the government were merely to announce that the bond issue would soon take place, the peso would climb in value on the heightened expectation that its future value would be secured. The government would allow the bonds to change hands, just as the currency can, and their value would rise on the secondary market as the government's credibility increased. This liquid market of peso instruments would cause the economy to revive immediately. The people would be selling their dollars for pesos and, in order to acquire more pesos, they would resume their efforts at work or commerce in the cities and on the farms. Goods would reappear, first out of hoards, then out of increased production, and as the government restored its credit worthiness with its own people, it would find foreigners willing to resume lending to the government to help finance its transition to a market economy.

Instead of the government worrying about the 11 billion "peso overhang," it would soon discover there were not enough pesos in circulation to transact business on a daily basis. The government would have to print more instead of taxing them out of the pockets of the people. Otherwise, the value of government peso debt on the "black market" would trade at a premium to the dollar.

Of course, the Cubans were skeptical of this scenario. I offered an historical example. This is what happened in the United States in 1791, when Treasury Secretary Alexander Hamilton persuaded Congress to pay its hard currency debt (to the Dutch) at par, and to pay the government's dollar debt to its own citizens at par as well. Before this decision, I told the Cubans, U.S. dollar debt, held by those who had supplied the Revolutionary Army of George Washington with the materials of war, was trading at 15 cents on the dollar in the secondary markets of Philadelphia and New York. When Hamilton told all the creditors, foreign and domestic, they would be paid in gold, even though the U.S. government owned no gold at the time, the value of its debt climbed steadily and by 1793 was trading at a premium, $1.15, such was the demand for liquid assets. The new United States was like a start-up company with great promise, able to capitalize the value of its future income stream with its creditors. Cuba is in the same position today, I explained.

The advice I offered was clearly new to the Cubans and met with great receptivity. There is uniform agreement that the currency problem is at the center of the government's attempts to convert to a market economy. They said they would study the idea and asked for further information on how the Hamilton reform was developed, and for other historical examples.

The other steps I suggested would be possible only after they fixed the peso. These both involve the encouragement of small business. The liberalizations already permit families to engage in private enterprise in more than 100 categories, such as shoe repair, barbering, auto repair, and other services. The law does not permit families to hire non-family members. Nor does it permit family enterprises to contract with each other, or to import goods from abroad. A family business cannot expand by hiring a next-door neighbor, or by buying materials from other families, or by importing needed materials from other countries that are trading with Cuba. These prohibitions amount to internal embargoes against commerce, government barriers that were necessary during the experiment with communism, but are now obsolete. They are doing more damage than the U.S. embargo.

The reason the government is not proceeding along these lines has less to do with "socialist ideology" than it does with problems caused when services leave the state sector. Under communism, the state taxes 100% of all economic production and then redistributes it to the population according to central plans, keeping a percentage for itself to pay the bureaucrats and the military. When a cobbler fixing shoes in exchange for a ration coupon and a peso leaves the state sector for private enterprise, he now charges either many more pesos or dollars. People left behind in the peso economy then have one less cobbler and cannot get shoes repaired even with ration coupons. The state now finds its budget going deeper into the red, as it does not have the machinery to collect taxes with any degree of efficiency from this emerging private sector. In addition, the now affluent cobbler can buy with dollars or pesos goods and services that come onto the black market, as bureaucrats, finding they cannot live on their peso wages, sell state production "under the counter." The parallel currency drives a wedge between the people, shredding the rules that govern the social contract.

This is why parallel currencies cannot exist. If the purchasing power of the peso were re-established, it would drive out the dollar, and political inequities would dwindle to a manageable level. In China, which began permitting family business in 1978, rules were relaxed little by little, so that by 1983 an enterprise could hire six non-family members, and by 1986 it could hire up to 20. The stability of the currency made this possible. It is why they can now say "You do not burn down the old house until you build a new one," as the incentives otherwise drive people who are the strongest, the cleverest, and most willing to be corrupted into bidding for space in the as yet incomplete "new house." From the United States, it no doubt appears that Fidel Castro is being stubborn in not doing what seems easy enough -- moving to a market economy and a democracy. It is not so easy as all that. I assured the Cubans in Havana that I understood the problems that they face are difficult, precisely because they have never before been confronted. These are complex problems new to world history. There is no textbook on converting from communism to capitalism in ten easy steps. In my final meetings, I suggested that if Castro woke up the next morning, looked around, and decided he had failed, and called exile leaders in Florida to say he would give them the keys to the state, and that he would fly to Madrid to spend the rest of his years, the Cubans in Florida would confront the same unknowns.

In Miami

This was exactly what I told the members of the Cuban community in Miami during two days of meetings upon my return from Havana. The meetings were arranged by Andrés Blanco Fajardo, an executive at Merrill Lynch who has broad contacts in the Miami community. They included dinner with Carlos Alberto Montaner, a noted author, and Juan Alberto Suárez Rivas of the Cuban Democratic Platform; a meeting at the Key Biscayne home of Prof. Luís Aguilar León, joined there by Domingo Moreira of the Cuban American National Foundation; an interview with Andrés Oppenheimer of the Miami Herald, whose account of my visit appeared in the June 5 edition. I also met with Carlos Palomares of Citibank in the offices of Phillip Markert at Citibank, Miami. In each, I offered the opinion that Castro's reservoir of political support in Cuba, while it may be dwindling, rests of the perception of the 11 million Cubans that the leaders in the Cuban American community may not have their best interests at heart, but merely wish to restore the status quo ante. Castro's 1959 revolution was successful because his objective was the overthrow of the ruling elite of Havana, the oligarchy embodied in Fulgencio Batista, the dictator. As long as Castro can portray Jorge Mas Canosa, the primary leader of the exile community, as the reincarnation of Batista, he can maintain the support of the people. I suggested it was not enough for the exile leaders to promise "free markets and democracy" on their return, which are political platitudes. They must confront the same problems facing Castro, find better options, communicate these to the people of Cuba through the myriad media available, including Radio Martí, and in this way challenge Castro's leadership. One of the Cubans in Miami told me he had gotten the same advice last year from a member of the Czech government.

The Miami Cubans seemed genuinely interested in our analysis. There was little enthusiasm for the notion that Castro might wake up tomorrow and decide to follow the kind of advice we offered, however. The predominant view is that Castro wishes to go down in history as the last true believer in the Marxist ideal and will do anything to keep the people of Cuba enslaved to that ideal as well. The view holds that Castro is prepared to permit Cubans to suffer and die, if need be, to allow him to avoid capitulation to his adversaries in Florida. I could only point out that his adversaries in Florida also seem prepared to have their Cuban brethren suffer and die in order to bring about Castro's ignominious end. Otherwise, they would not object to my offering advice that might keep him in power, by improving the living conditions of the Cuban people. Actually, I did not find unanimity of this position in my Miami meetings. More often, the émigré leaders scoffed at the idea that Castro would take good advice. Well, why not offer it openly, and find out? If Castro would resist sound specific advice, and the people would see him doing so, it might hasten his exit from power.

There are definitely gradations and factions in the Cuban community in Florida. Younger Cubans who cannot quite grasp old resentments are much more willing to see Castro preside over the transition to its completion. The view that it is easier to have Castro remain, so long as he is moving in the right direction, was not as unpopular as I had anticipated. There is something to be said for a known quantity, "the devil you know." I had to point out that any political leader who could retain the support of his people for 35 years had political skills that could not be dismissed. Through my discussions, in fact, I found myself repeatedly in the position of defending Castro against complaints that he was not proceeding faster with reforms presented to him by his advisors. I had to point out that if Castro had not questioned the wisdom of the pace of the reforms, the economy would be in even worse shape than it is. Over the years, Castro might go up to the edge of a cliff, sometimes against his better judgment, but he always seems to draw back instead of falling over. If he did not have this skill, the people of Cuba or his palace guard would have gotten rid of him long ago.

The subject of succession is one I dealt with in Havana and in Miami in the context of financial investment. I'm sure that everyone in the Castro government wonders and worries about how the succession will come about. It is also clear that those in the government responsible for trying to attract foreign investment know this is a subject of major concern. I put a finer point on it by explaining how political risk is the primary determinant of the value of a nation's assets, which ultimately are its people. The price/earnings ratio of the financial assets of Thailand is at 19 because the world observes the people are happy and the political horizon is clear. Hong Kong's assets are valued at only 12 because of the uncertainties of its future and that of China. It is not Deng Xiaopeng that investors worry about. It is the uncertainty of the succession process.

Closer to Cuba, I pointed out how sharply the value of Mexico's assets declined because of the political disturbance in Chiapas, which underscored the inadequacies of Mexico's political system. Mexico's ruling class has come to appreciate the economic importance of strengthening its political institutions. I advised the Cubans that there is only so much they can do in the economic realm to increase the prosperity of the island. This would be true even if the rest of the world disappeared. The most important thing Castro could do would be to begin constructing a credible succession mechanism, so that the people of Cuba could plan for their future with some confidence. So long as I said it in that manner, the advice was noted without hostile comment. Only when I may have left the impression that Castro might take such steps to appease world (U.S.) opinion did tempers flare. There was also occasional ideological resistance to the idea that the government should focus on the value of financial assets, as if I were suggesting that money comes first. On the other hand, those who had read my long essay, "Karl Marx Revisited: A Fluid Society," January 24, 1994, which Irene Philippi had distributed on her January visit, did not make that mistake. Stock markets (and governments) crash when governments cater to the elites, forgetting the needs and aspirations of ordinary people.

In the Cuban American community there is a cross-current of such interests. The elite, as always, tend to think primarily of money and power, while the ordinary people think of the plight of their relatives and old friends on the island. When Congressman Rangel first asked me to lend a hand toward peaceful normalization, it was clear that any path would have to satisfy the property and financial claims of the émigré community. We did not proceed until we were assured by the Cuban diplomats in Washington that the Castro government was in principle open to financial repatriation. The most aggressive leaders of the Cuban American community to whom we spoke would have the United States government buy their claims, and present them to Castro as the price of lifting the embargo. It does not seem practical to ask U.S. taxpayers to get involved, however. It is one thing for the Congress to give the émigrés a veto over the embargo decision, to enhance their negotiating position with the Castro government. It would be quite another to give them a big bag of money, essentially without a negotiation process.

In Havana and Miami, I presented the following metaphor: In 1959, there was a divorce in the Cuban nation. As nations are simply the aggregation of all families born into the nation -- the family being the primary unit of the political economy -- we might say the role of mother and wife, which represents security and caution, remained on the island. The role of father and husband, which represents enterprise and risk-taking, emigrated to Florida. The global communist experiment, of course, was one of maximum security and minimum risk. In China, the feminine yin remained on the mainland, the masculine yang departed to Formosa, slamming the door behind as it left.

Reconciliation is not only possible in the Cuban nation, it is inevitable, just as the two Vietnams and two Germanys have united, as the Chinas are coming together, and as the Koreas will sooner or later. It is now becoming clear, through Jimmy Carter's intervention, that even North Korea's Kim Il Sung knows the war is over and that his team lost. As with Castro, Kim is maneuvering for peace terms that are as generous as he can manage. Would the U.S. relationship with Japan have developed as it did after World War II if General MacArthur insisted on the abdication of the Emperor? Outside parties are useful in getting the disputants to communicate and negotiate, but the hard work has to be done by the disputants themselves. It is in that sense that I advised the Havana Cubans that they will get nowhere with the United States if they attempt to normalize relations without satisfying the Cuban émigrés. They can increase their leverage primarily by seeming more attractive. This means doing the things that make the Cuban political economy more inviting to risk-taking and enterprise. It also means being generous in their settlement of claims -- which they can easily do if they get their economy growing rapidly. For the Miami Cubans, who were thrown out of the house 35 years ago, reconciliation will not be possible if they convey the impression that they really do want to restore the status quo ante, with Batista returning in 1994 garb. They also have to be prepared to accept Cuban peso bonds in settlement of their claims, which should be no problem at all so long as the bonds are gilt-edged. Both parties should have a stake in the success of Cuba's future. As it is, the venomous hatreds built up during 35 years at the leadership level will not get the 11 million people of Cuba and the million émigrés in the U.S. very far.

Cuba Project

In both Havana and Miami, we recommended a private, scholarly study be undertaken to concentrate on the economic requirements of Cuba's return to a market economy. The sketchy advice we offered was meant only to show that alternatives are not only necessary, but conceptually available. We suggested the possibility of sponsorship by the Manhattan Institute in New York City, which expressed serious interest in the idea when we posed it prior to the Havana trip. The Institute, founded in the 1970s to promote the philosophy of entrepreneurial capitalism, would be an appropriate academic forum to develop options for Cuba's re-entry to the hemisphere's political and economic markets. The project would be financed by companies interested in Cuba's future. We would draw together some of the finest minds in business and finance to contribute their expertise toward this process of reconciliation and renewal. It would require the cooperation of the Cuban government, of course, and at least the passive assent of the leaders of the émigré community -- in the same way the community supports a flow of humanitarian relief to the island.

I told the Cubans in both Havana and Miami that once relations are normalized, there is no doubt in my mind that the Cuban economy could soon skyrocket. It is the diamond of the Caribbean, a diamond now in the rough, a tropical paradise the size of Ohio, 90 miles from Florida. It could easily become not only a tourist magnet for North America, but also a bridge between north and south, with Havana revitalized as a commercial and banking center as well. I'd had this dream for Puerto Rico, I explained, and last year thought our efforts with the Puerto Rican business community and the new Commonwealth government were ripening in that direction. Puerto Rico's ambivalent political status, unhappily, continues to hold it back, its leaders frozen somewhere between statehood and independence. A reborn Cuba would have no such inhibitions. Its combined 12 million people, among the best educated and industrious in the hemisphere, could create a dazzling island political economy. Nothing would hold it back.