Challenges for the Private Sector in the Cuban Economic Model. Part One

One of the most recognizable changes in the Cuban economy and society since 1990 is the expansion of the private sector, a trend that has accelerated in recent years. Although less visible, private productive activity has always played a role, even iafter 1968. But it was the economic crisis of the 90s that catapulted the sector to the forefront of the economy. This transformation has not been devoid of contradictions, restrictions, and setbacks. As a result, the economic impact of the private sector has fallen far short of its true potential.

This article analyzes the role of the private sector (specifically, self-employment ventures and private micro-, small- and medium-sized enterprises, “MSMEs”) in the Cuban economy and proposes a series of steps to significantly expand its role and convert it into a true driver of transformation and development. 

The Private Sector in Centrally-Planned Economies ^[1]

Since the 1950s, when socialist governments had just consolidated in Eastern Europe, a strong academic debate arose around the need to introduce reforms in the “system.” At that stage, most of the proposals were geared towards the public sector: greater autonomy and better incentives for state-owned enterprises, decentralization of economic management, while insisting on maintaining “social” ownership over all means of production, except in marginal activities (Kornai, 1992). 

Centrally planned economies (CPE) share a distinctive trait: their productive structure is dominated by a relatively small number of large state-owned enterprises that face little or no competition in their particular sector of activity and produce inefficiently insufficient quantities of consumer goods. However, it is not the state-owned enterprise that has experienced the most significant transformations.

The private sector has played a relevant role in classical socialism.^[2] In the pre-reform stages, CPEs were peppered with private or “second economy” activity,^[3] in which individual initiatives respond to market signals, sometimes even coming from the state-owned enterprises themselves. The rigid central planning and chronic supply chain shortages favored the flourishing of informal private activity (Pérez-López, 1995). The private sector provided a partial correction of the problems inherent in the socialist system, making it more functional. Differences among countries notwithstanding, these mechanisms allowed access to high-demand consumer goods and the generation of additional household income.

In this respect, these informal markets made life more bearable, easing citizens' dissatisfaction, which is why they were generally tolerated by government authorities. The “second economy,” filled  with entrepreneurial instincts and the goal of satisfying consumer needs that never disappeared, became a structural feature of these economies (Torres & Fernández, 2020). The CPE itself generated the incentives to justify the existence of the second economy, which in turn allowed it to ameliorate some of its more embarrassing manifestations. 

During the “reformed socialism” stage, non-state-owned activity expanded into branches considered non-essential for the economy as a whole (Mizsei, 1992). What surprised reformers was the speed of deployment and its dizzying growth. This contrasted sharply with the traditional way of running the planned economy, which was based on central planning,  short term priorities, and recurring campaigns to boost or unlock problem sectors. To the contrary, no persuasion campaigns or any official exhortation were required to stimulate the birth of private businesses. Despite an adverse regulatory and ideological climate, private ventures reproduced incessantly (Kornai, 2008).

The sector emerged surrounded by numerous contradictions and counterbalances. Private productive activity requires  market relations. After all, the private enterprises  are autonomous units making their own operating and strategic decisions, consistent with the goal of earning profits, using the “signals” that emanate from a relatively free pricing system. These elements: private property and market, are foreign to the existing planned socialist model,^[4] thus giving rise to an endless debate regarding how to limit it, the  the framework in which it must operate, achieving consistency with the ideal CPE model sought to be created, among other things. These ideological restrictions imposed on private activity in a CPE are persistent and have concrete effects on the design of public policies governing the private sector.

Despite these limitations, the sector's trend has been towards expansion, which puts significant pressure on other internal balances of the CPE model. For example, the pay differential between jobs in the private sector and that of state entities can be substantial, particularly for workers in the areas of public administration and social services (what in Cuba are known as “budgeted” entities). This stimulates the drain of labor from the state sector to the private sector, a flow that increases in periods of crisis. However, the rise of the private sector is viewed with suspicion by government authorities and significant number of citizens—specifically, those who do not benefit directly from the private sector activity.

The dynamism of this private activity and the perennial need to adapt and survive in a hostile environment generates new forms of social organization that escape the typical logic of the CPE model. For example, it is common for horizontal relationships to develop between units of different sizes and activities in the private sector, which contrasts with the predominance of vertical directives in the state-owned sector. As a result, the central planner's directives are weakened

By expanding the freedom to make autonomous decisions, the private sector provides a more favorable environment for the empowerment of individuals and families. Although the existence and development of the private sector guarantees neither the emergence of a market economy nor substantial political changes, they are a necessary condition not only for laying the foundations of a new society, but also for guaranteeing that all things national do not end up at the mercy of outside forces, given their relative underdevelopment.

Consequently, it is easy to see that, although the private sector can offer solutions to unmet societal needs, its existence inevitably causes tensions and contradictions that result in an ongoing effort by government authorities to contain its development and limit its scope in the economy.

The Urban Private Sector in Cuba

Cuba has gone through several periods in which we can identify the fundamental processes described above. In its traditional form, the large private company with national capital existed until December 1962. Small enterprises and family-owned businesses survived until the notorious “Revolutionary Offensive” of March-April 1968 was implemented, when more than 55,000 businesses were nationalized (Ritter & Henken, 2019). During the following decade the small business sector was minimalized, although it did not disappear, becoming part of the “second economy” (Pérez-López, 1995). 

In the summer of 1978, “self-employment” was legalized in order to improve the supply and quality of certain goods and services, reduce unemployment, and decrease the size of the “underground market.” This proves that, despite the dominance of the public sector, the latter was not able to adequately meet demand in specific production sectors, nor create sufficient jobs. By the late 1980s, it is estimated that there were about 40,000 workers legally engaged in private activities, and an undetermined number providing services and sundry goods in the informal sector.

The deep crisis of the 1990s offered new opportunities for private economic activity.  The most significant legal reforms occurred in 1993, when so-called “self-employment” received official blessing. Subsequently, in 1995, an initiative was introduced allowing paladares (small privately-owned restaurants) to operate, which proved very popular. The number of “self-employed” reached a peak of just over 208,000 valid licenses in early 1996 (National Bureau of Statistics and Information [ONEI], various years). This first rollout faced significant restrictions that increased arbitrarily at the discretion of government authorities and their priorities. Major obstacles included, but were not limited to, restrictions on hiring workers (only family members), the list of permitted categories with a heavy emphasis on low value-added service branches, unfavorable tax treatment, and lack of access to credit in the banking system.

After 1996, no additional structural reforms or measures were introduced. Cuban authorities had stressed on numerous occasions that the limited changes were viewed as “necessary evils.” Cuba’s improved position on the international scene, thanks to both its ties to Venezuela and its support from the new Latin American left, played a role in the government reaching this conclusion. This conclusion  posed a setback for the ranks of the self-employed. The rate of approved applications diminished progressively, government authorities' controls increased, and a freeze was put on the issuance of new licenses for the most popular activities. It seemed to the government that the apparent good performance of the Cuban economy at the beginning of the 21st century did not require the expansion of the private sector. 

Raúl Castro’s assumption of the presidency in 2008 provided new impetus to the private sector. “Self-employment” benefited from the expansion of the list of permitted activities, the ability to hire a workforce, the increase in the ceiling for tax-deductible expenses, and the inclusion of all workers in the private sector in the public social security system.^[5] To a large extent, this governmental flexibility was part of a broader plan to reduce public sector employment^[6] and contain social spending, with the ultimate aim of increasing productive investment and accelerating GDP dynamics.

Other microeconomic changes favored private initiative. In 2009, Cuba authorized the sale in the domestic market of computers and DVD and video players, the acquisition of cell phone lines, and overnight stays in hotels and resorts previously reserved only for international visitors . In 2012, the free purchase and sale of houses and cars was authorized.^[7]

In 2013, an immigration code  was reformed, eliminating  restrictions on travel abroad, while protecting the rights and properties of those who establish residence outside the country, while relaxing the requirements to keep permanent resident status. The chronic shortage of consumer and investment goods in the domestic market gave way to the consolidation of private supply networks that import goods from other countries (Torres, Cruz, & Carmona, 2022).

The year 2016 was a turning point for the private sector. The government abandoned the prior policies, permitting the sector to improve the nation’s economic performance.  Nonetheless,  the government held the market and the private sector  responsible for the rise in prices of sensitive goods such as food^[8] and the increase in inequality. The perception abroad that the rise of the private sector was the vanguard of deeper transformations generated reservations in influential government circles, resulting in stalled reforms.

In the summer of 2017, government authorities decided that no new self-employed licenses would be issued for a variety of activities, and that changes to the regulatory framework would be introduced. A wide range of reasons were given to justify this decision, including fighting tax evasion, the use of illegally sourced raw materials, inaccurate and insufficient controls, and shortcomings in procurement of services or products by individual entrepreneurs, cooperatives, and foreign private companies. More than eleven months later, in July 2018, numerous legal regulations amending the regulatory framework were published.

This new episode in the government’s endless give and take regarding the private sector was announced under the euphemistic title of "Policy for the Improvement of Self-Employment." The vast majority of the changes constituted new restrictions on the exercise of private sector activities. From the outset, the policy changes generated widespread discontent. In an unusual decision, especially given the sensitivity of the issue, Cuban officials rolled back some of the most harmful regulatory changes in December 2018.^[9] Nevertheless, it constituted another unnecessary setback to the inevitable rise of the private sector.

The Arrival of MSMEs

In the midst of the economic and social crisis exacerbated by the COVID-19 pandemic, in August, 2021, the government adopted a regulatory framework, which updated the rules for self-employment.^[10]The updated regulations provided greater flexibility for the creation of non-agricultural cooperatives (CNA) and established requirements for the creation of private Micro-, Small-, and Medium-sized Enterprises (MSMEs).^[11]

The new regulations were a notable improvement  to the previous ones in several aspects:

• The spectrum of permitted activities was expanded using the National Classifier of Economic Activities as a benchmark (the previous positive list of permitted activities was thus eliminated^[12]), with areas prohibited to the private sector specified in a negative list. The limiting scopes of activity that restricted the goods and services that could be provided under a specific license were eliminated, and permits were granted to most private projects presented for approval, including a very diverse list of activities. A general license was included for non-agricultural cooperatives (CNA), eliminating the previously existing restrictions that permitted their use only in“experimental” projects.

• A general license was adopted allowing access to formal channels of foreign trade by all non-state entities, by means of state-owned foreign trade enterprises that serve as intermediaries for exports and imports.

• A key change was the authorization to create MSMEs (whether new or from converted previous private activity), which were authorized to be private, state-owned, or mixed private-public ownership. For private companies, has mean the possibility of operating with separate legal existence, which was lacking under the previous regulatory framework governing “self-employment.” Moreover, the figure of the “partner/member” was formalized, making it possible to consolidate capital contributions from several participants.

• The legislation contains language suggesting that the new MSMEs will enjoy the same status as other recognized economic actors.

• Moreover, the legislation authorized MSMEs to access any lawful form of financing. Subsequently, ancillary measures were published that, for the first time, provide for the possibility of MSMEs and CNAs having access to credit in foreign currency.

• Presumably, a MSME now can enter into an agreement with foreign partners and accept foreign capital investments. While the regulations do not expressly authorize this possibility, they do not prohibit it.

It is indisputable that the new regulatory framework represents progress with respect to the one formerly in place, which permitted only self-employment. Since its very creation, the old regulatory framework had contained contradictory provisions.  For example, it classified as “self-employment” businesses that operated as enterprises with a comparable business volume.  Several of the new measures—among them legal entity status, access to foreign trade channels, unrestricted creation of CNAs, and expansion of the spectrum of permitted activities—represent long-standing demands by the private and academic sectors.

Nevertheless, a series of restrictions remain in place, which will continue to hamper the  contributions of a significant part of the private sector. These include the following:

• Despite official statements claiming to guarantee equitable treatment to all players in the economy, this is not so in practice (e.g., state-owned MSMEs can do business in many more areas than their private counterparts, the state monopoly on intermediation in foreign trade still persists, etc.).

• The process of licensing new businesses remains administratively burdensome and contains unnecessary intermediations.^[13]

• The list of restricted activities still prohibits professionals to organize their activities independent of the State (e.g., architecture, consulting, among others), tourism-related activities (e.g., tour guide services, sale of all-inclusive packages, travel agencies, among others), or financial services.

• Further, the regulations restrict natural persons from ownership of more than one MSME at a time, when an individual could very well engage in dissimilar ventures through various MSMEs.

• The tax regime is onerous compared to its treatment of foreign companies and of cooperatives (making it much less generous and attractive as an economic entity). Recently, some of the tax incentives offered to MSMEs, which were already inadequate compared to those offered to foreign capital, were eliminated.

• It would seem that foreign investment is allowed “by default.” In practice, despite affirmative statements to the contrary, the establishment of joint ventures between MSMEs and CNAs with foreign capital has not been legislated in specific regulations aimed at enforcing a right already recognized by the 2014 Foreign Investment Act.

• The growth of medium-sized private enterprises (those with up to 100 workers) is capped by an arbitrarily imposed limit of 100 workers. What would happen once that limit is reached has not been clarified. In practice, there are several companies that exceed that number of employees. These, however, are forced to use legal subterfuge to evade that restriction, thereby fostering corruption and a culture of non-compliance.

It is telling that MSMEs engage in  activities such as dining/restaurant services (22.3%), construction (20.3%), manufacturing (19.3%) and commerce (4.3%), sectors that directly address unmet needs of the local consumer (Díaz, 2023).^[14] A survey conducted in June 2022 revealed that light manufacturing (39.5%), personal and business services (27.2%), and construction (25.2%) are the dominant sectors among startups (Odriozola, 2023).^[15]

[1] The description refers to European centrally planned economies, including the former Soviet Union, and highlights the most significant common traits among very diverse cases. 

[2] Term used by János Kornai to refer to the stage prior to the limited reforms that were introduced in some countries, aimed at expanding the use of the market as a coordination mechanism. 

[3] This term has a broader meaning that includes those activities conducted outside of state control and formal plans, based on market relations. This would include smuggling of resources stolen from the public sector, charging for social services that are officially free, producing goods and providing services without a license, among others.

[4] Understood as centralized planning.

[5] Albeit with a very limited impact on employment, the establishment of non-agricultural cooperatives was also authorized for the first time, although the approval process is through the Council of Ministers, in a non-transparent procedure.  

[6] It was posited that there were over one million excess workers on the State’s payrolls, the reduction of which required the creation of those jobs by other actors. 

[7] As a whole, these changes made it possible to obtain seed capital for investment in businesses, as well as to carry out “intensive” activities inside real property, such as dining/restaurant services or lodging, historically among the most lucrative and popular categories. 

[8] A phenomenon that has not been fully proven, but for which there was some systematized evidence, especially in tourist centers, including Havana. 

[9] The context had changed. Miguel Díaz-Canel had been in office for less than a year, and the constitutional referendum was being prepared. Moreover, that same month, Internet access via mobile phones became available. 

[10] Businesses that operate under a self-employed license that employ more than three workers are required to become a private company, which entails tax obligations and stricter accounting standards.

[11] These proposals were already included since 2016 in the so-called Conceptualization of the Economic Model and in the Development Plan until 2030. Private ownership of the means of production was formally recognized in the new Constitution approved in 2019. 

On to Part Two