April 2016 | By: Kent Jones

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Now that details of President Obama’s modest easing of the Cuban trade embargo have been announced, the U.S. can begin to rebuild its economic relationship with its close neighbor. Restoring prosperous trade and investment relations, however, will require both a formal vote by Congress to end the embargo and further significant market reforms in Cuba.

Support for ending the embargo in the U.S. continues to grow on a bipartisan basis, although a small hardline, anti-Castro delegation on Capitol Hill still stands in the way of its formal repeal. Public opinion polls show a growing majority of Americans supporting an end to the embargo, including younger Cuban-Americans. Given its failure over the years to topple or even weaken Fidel Castro, most Americans are willing to turn the page, and the U.S. business community is eager to restore commerce with a long-isolated trading partner.

What’s at stake is the re-establishment of a thriving economic relationship between the two countries that was interrupted by Castro’s revolution and central planning folly, and worsened by the embargo. An end to the embargo could help Cuba back to its rightful place in Western hemispheric trade although, again, this will require serious market reforms by the Cuban government.

History tells a story of a once linked destiny. For most of the 20th century before Castro, nearly all of Cuba’s trade was with the U.S. In 1959, the U.S. had more investment in Cuba than in all the rest of Latin America combined. During those years, many U.S. companies invested in oil production, electrical generation, communications, and sugar processing. So close were these ties that Cuba was on the verge of becoming a U.S. state in the late 1890s, but for the opposition of U.S. sugar beet farmers, who felt threatened by Cuba’s cheaper cane sugar (watch for the U.S. sugar industry to lobby hard against relaxing the embargo as the debate heats up in the coming months or years).

Today, no one is suggesting that Cuba become the 51st state, but the potential for U.S.-Cuban trade and investment is indeed the natural result of Cuba’s location and historic ties with the U.S. Just 90 miles south of the Florida Keys, Cuba is closer to many major U.S. markets than many U.S. states. Before Castro, sugar, tropical fruits, and other agricultural products were major exports to the U.S., in exchange for imports of U.S. agricultural and manufactured goods. At the same time, Cuba became an enormously popular vacation destination for U.S. citizens, as Havana drew many thousands of tourists with its music and nightclub scene.

The easing of regulations under President Obama allows U.S. citizens to travel to Cuba more easily. In the meantime, tourism has, in fact, returned to Cuba, with hotels financed this time largely with European investments. Increasing U.S. travel to Cuba could eventually open up many new U.S. business and investment opportunities, from new hotels and cruise ship connections to communications, finance, and manufacturing.

If the embargo ended and Cuba instituted market-based reforms, economists estimate that the U.S. could expand trade and investment with Cuba—on the basis of location, market logistics, history, and a Cuban diaspora population—in the same proportion as its NAFTA partners, Canada and Mexico. Some 2 million Cuban-Americans could fuel renewed economic links with their former homeland.

So what stands in the way of this new trade bonanza? At a Babson alumni event in Miami this past January, three experts shared their views about the current opportunities and pitfalls of doing business in Cuba: lawyers Pedro Freyre of Ackerman LLP and Raul Valdes-Fauli of Fox-Rothschild LLP, and Faquiry Diaz Cala, an entrepreneur and venture capitalist. While they see many good business prospects, they warn that the embargo is still in place, and it will be necessary for anyone interested in pursuing such opportunities to navigate the legal details of what is allowed under President Obama’s executive orders.

Currently, the best prospects for expanded U.S.-Cuban business include pharmaceuticals, certain agricultural products, Internet and telecommunications services and equipment, and travel- and tourism-related services. These are sectors that fall under existing exceptions to the U.S. trade embargo, and which benefit from new exceptions and the easing of financial and travel restrictions by President Obama. Imports from Cuba may now come from “independent entrepreneurs,” that is, those not linked to Cuban state-controlled trading. The Cuban population is highly educated, and the prospects for knowledge-based exports should not be ignored. The U.S. president also has the authority, although limited, to expand the scope of exceptions on a piecemeal basis by executive order.

However, any discussion of Cuban business opportunities still runs up against the stark fact of government control of most of the economy, with perhaps 70 percent of Cuban industries under the sway of Cuban military officers. This is a major impediment, even with the easing of the embargo. Government-run sectors and state-trading continue to be the focus of the embargo restrictions. They also represent the entrenched role of the communist government in the economy, which continues to hinder competition, innovation, market-based resource allocation, and economic growth. Cuban officials are only too happy to offer state-approved “partnership” projects with foreign investors—as long as the Cuban government retains control, which tends to diminish their value.

Even with a full lifting of the embargo, it is therefore doubtful that the result would be a market-based Cuban economy, at least in the short run. The current pattern of state control, in fact, suggests the possibility that any future “market reforms” by the communist government could lead to the creation of oligarchies controlled by the military officers or other political cronies of the regime. This was the most damaging aspect of “market reforms” in Russia’s transition after the fall of the Soviet Union.

A more optimistic view is that Cuban communism will sooner or later fade into history, as it has in other former Soviet-style economies. Cuba, which had been heavily subsidized by the Soviet Union and more recently enjoyed oil and other economic support from Chavista Venezuela, no longer has a benefactor state. It must now find new ways to shore up its stagnating economy. The Cuban government, recognizing its predicament, has recently introduced limited and largely ineffective economic reforms, while clinging to its political model of a communist dictatorship. Some private business is allowed, but with prohibitive taxes on any enterprise that makes more than a minimal profit. As a result, economic frustration among many Cubans has been increasing, and there was an increase in refugees bound for the U.S. in 2015, a “brain drain” that will increase the pressure for more comprehensive reforms.

Soon Fidel and his brother, Raul, will no longer be on the scene, and a younger generation is likely to be in power within a few years. While committed hardliners still dominate the Communist Party apparatus, the seeds of pragmatic reform may have been planted. Is there a reformer along the lines of Russia’s Mikhail Gorbachev or China’s Deng Xioaping waiting in the wings in Havana? Time will tell. As we await events, the continued failure of Cuba’s planned economy may accelerate calls for more comprehensive reforms.

In the meantime, ending the embargo will take time. Difficult issues include compensation by Cuba for some $8 billion in lost U.S. commercial properties, Cuba’s demands for compensation for damages from the embargo and, more recently, for the return to Cuba of the U.S. Guantanamo Bay facility, and the resistance of the anti-Castro delegation in Congress. Yet, the book value of these compensation claims surely pales in comparison to the economic value of Cuban market access and trade that would result from an end to the embargo. It should therefore be possible to devise a creative plan to settle the economic aspects of these claims and disputes to the satisfaction of both sides.

The current Cuban government will want to ensure that any increase in trade and investment with the U.S. will not threaten its grip on power. Yet, ending the embargo would, in itself, provide a subtle but powerful impulse for change in Cuba, exposing the population to more consumption goods and the possibilities of open markets, entrepreneurship, and economic advancement for those willing to work for it. These influences are likely to be more subversive to the communist regime than the indiscriminate sledgehammer of the embargo.

Until the embargo ends, the broad message from the Babson-sponsored panel discussion in Miami was that investors and entrepreneurs interested in Cuban business opportunities should visit the island and examine market potential firsthand, since travel there is now much easier. They should carefully do their homework and investigate market and resource logistics, and also learn from the experience of other foreign investors, especially those who have had success there. They will need legal counsel to navigate the details of the restrictions in place. The process may be daunting, but well-conceived business plans have the potential to be at the vanguard of an emerging and profitable new Cuban economy.​

Babson Insight Spring 2016