For some five decades, economic relations between the U.S. and Cuba were ossified in policies born during the Cold War. On December 17 last year, President Barack Obama took a major step towards thawing this freeze when he announced that the U.S. and Cuba would work towards re-establishing diplomatic relations and potentially lift the economic embargo between the two countries.
What will this historic change mean for economic relations between the U.S. and Cuba? What opportunities — and risks — should American companies consider as they explore the business potential of one of the largest markets in the Caribbean? In order to answer these questions, Knowledge at Wharton spoke with Wharton management professor Mauro Guillen, director of The Lauder Institute; Faquiry Diaz Cala, CEO of Tres Mares Group, a private equity investment firm in Miami; and Gustavo Arnavat, a former Obama administration official who was the U.S. executive director at the Inter-American Development Bank (IDB).
On April 1, Knowledge at Wharton, The Lauder Institute, Tres Mares Group and Momentum Events are collaborating to hold the Cuba Opportunity Summit in New York City to address these questions in greater depth and detail.
An edited transcript of the discussion appears below:
Knowledge at Wharton: Could we start by talking about the factors on the U.S. side as well on the Cuban side that led to this change in policy? Mauro, would you like to start us off?
Mauro Guillen: Well, the Obama administration is frustrated at the situation on many fronts. So Barack Obama decided to take executive action on a topic on which there is little support on the Republican side but there is a lot of support in U.S. public opinion. After many decades of an embargo that hasn’t worked, it is worth pursuing another course of action.
I think that has been the single most important factor here, and also the fact that it seems as if the Cuban regime is looking for ways out of a difficult situation from an economic point of view.
Knowledge at Wharton: Gustavo, Faquiry — do you want to add to what Mauro just said?
Gustavo Arnavat: I agree with Mauro. I think it is first of all the recognition that our policy of isolating Cuba has been largely ineffective. The objective originally was to cause regime change; clearly, that has not occurred. Even with respect to the objective of trying to modify the political and economic policies of Cuba, although we’ve seen some movement on the economic front to attract more foreign investment and promote private enterprise, the embargo has not had any effect on the political front.
This administration was looking for a different approach, particularly, as Mauro suggested, in light of changing public opinion in the U.S., including within the Cuban-American community. Over the past 10 years, public opinion surveys demonstrate that Cuban Americans — including those living in Florida — are increasingly open to the concept of engaging the Cuban government.
I would add a third factor, which is the adverse effect that the U.S. policy has had on relations with other countries in the region. The Cuban government has been very successful on diplomatic engagement with countries around the world and certainly in Latin America in opposing our policy of isolation. The Obama administration believes that our new approach will help improve relations with our hemispheric neighbors and may even encourage those neighbors to play a more constructive role in promoting change in Cuba.
Knowledge at Wharton: Faquiry, what do you think?
Faquiry Diaz Cala: I would say that the Obama administration is looking at this as a legacy issue. This is similar to when [President Richard] Nixon went and opened up China. There is a certain amount of legacy building here that we should be looking into.
Knowledge at Wharton: The U.S. Congress will obviously need to approve the lifting of the embargo. Since the Republicans control both the House and the Senate, how do you expect this to play out and how long do you think it might take? Gustavo, since you are a former official in the Obama administration, perhaps I could turn to you first to ask what you think?
“We have to consider Cuba as a startup nation and take a look at some similarities with Israel.” –Faquiry Diaz Cala
Arnavat: What is often referred to as the embargo is a collection of rules, regulations and laws, some of which are wholly within the purview of the executive branch. I think the President is acting within his authority to liberalize those rules to promote greater engagement with Cuba, to promote trade and commercial ties with the ultimate aim of empowering the Cuban people. Nonetheless, the embargo’s biggest obstacle is the Helms-Burton law, which was passed by Congress and signed into law by President [Bill] Clinton in 1996. For there to be truly robust commercial ties between Cuba and the U.S., that law will have to be amended or abrogated. There are members of Congress both in the Senate and the House who have made it very clear that they are opposed to the President’s move. Nonetheless, the disagreement with the President is probably not what it would have been if this action had taken place 10 or 15 years ago. So I think you will find a good number of members of Congress who are at least open-minded.
I expect that over the next several weeks, there will be hearings in the Senate certainly but also in the House to explore the Cuba policy in further depth, something that hasn’t really been done for a number of years. We have to wait and see what the reaction is going to be. Interestingly, Senator [Bob] Corker from Tennessee, who is the Chair of the Senate Foreign Relations Committee, recently questioned the effectiveness of the embargo and suggested that he would keep an open mind pending those hearings. For example, I would expect supporters of the President’s policy shift, particularly from the U.S. business community, to try to make a strong case for greater commercial ties. So, though one can expect fairly ferocious opposition from some members of Congress, more from the Republican side and a few on the Democratic side — most importantly Senator Bob Menendez from New Jersey who has always been a stalwart supporter of the embargo — we have to see how things play out over the next few months.
Diaz Cala: [Against that] we have somebody like Ron Paul, a Republican and likely a presidential candidate, who is very much in support of lifting the embargo and has come out and said it very clearly. A lot of the Republicans from the farm states are supportive of this move from the President and of further moves. I don’t think it’s a one-party issue as is being portrayed at times by the media.
Knowledge at Wharton: Since you mentioned the farm states, it’s interesting that agribusiness companies like Cargill have a few days ago announced that they’re forming a lobby to ask for the embargo to be lifted. Do you see this as sort of the low-hanging fruit on the economic front? What opportunities do you see in the agribusiness market?
Diaz Cala: Cuba already imports a significant amount of agricultural products from the U.S. on a cash basis. Every week we have ships leaving south Florida with containers full of American products going to the island. The trade is [worth] multi-million dollars. What we’re seeing now is a significant opportunity for farm states if things were to be liberalized as well.
Arnavat: There was a lot of pressure 15-20 years ago from the agricultural community and the governors of farm states who had excess capacity and wanted to export their agricultural products to Cuba. That resulted in the passage of the Trade Sanctions Reform and Export Enhancement Act of 2000, which enabled those exports to take place. To the extent that the act can be amended to permit a wider range of financing alternatives, that’s something that would benefit the farm states that are clearly very interested in selling additional produce to Cuba.
Knowledge at Wharton: Mauro, in addition to agribusiness what do you think are some of the main sectors of the U.S. and Cuban economies where collaboration or investment could begin first?
Guillen: Obviously tourism. Anything related to services –including financial services — are obvious areas of collaboration. But let’s not forget that, over the past 20 years, Cuba has become quite active in the health care field and even in biotech. There are other parts of the economy that people are not thinking about now where there could be an increase in collaboration. What makes Cuba so unique — let’s not forget this — is that it’s so close to the U.S. Over time — give it five, 10, 15, 20 years — the Cuban economy is going to become very close to the U.S. economy if we manage to overcome the political obstacles.
Arnavat: Proximity is definitely an important factor. But you also have the fact that the educational system in Cuba is recognized as one of the best in Latin America. So you have a relatively highly-educated population that will be able to take advantage of any economic opportunities in Cuba resulting from increased foreign investment. Beyond tourism, Cuba has huge needs in virtually every sector, including infrastructure and housing.
The question, of course, is going to be one of financing. Who finances the investment? That’s where foreign investors and multilateral financing from the World Bank, the IMF, the IFC, the IDB [Inter-American Development Bank], to the extent that’s allowable under U.S. law, come in.
Diaz Cala: The knowledge economy in Cuba is significantly stronger than people give it credit for. The country has one of the highest literacy rates in the hemisphere, one of the highest college graduate rates and PhDs in the hard sciences. Cuba has been producing physicists, mathematicians and so forth who have been exported to other countries. We have to consider Cuba as a startup nation and take a look at some of the similarities with Israel.
Knowledge at Wharton: Is there an entrepreneurial ecosystem in Cuba that could attract investment and nurture technology startups?
“The Cuban government will have to make changes … to facilitate investment in economically attractive sectors and to provide investors with access to a legal system that adequately protects them.” –Gustavo Arnavat
Diaz Cala: We have seen some very early efforts. There is a program called “Start-Up Cuba” that is being put together. There has been a number of “Cuban Hackathons” that are pretty interesting. Facebook is actually hosting one coming up soon. Cuban developers — recent arrivals in Miami — are very sought after. I think we’re going to be able to get a better sense of just how entrepreneurial that ecosystem can be.
Knowledge at Wharton: Gustavo, you mentioned Helms-Burton which is obviously a big regulatory hurdle. In addition to that, what would you consider some of the greatest challenges both legal and regulatory in being able to exploit the economic potential of this partnership?
Arnavat: There are potential impediments on the U.S. side, but let’s not forget that Cuba has its own legal system, which imposes limitations on foreign investment and the kind of economic activities in which the Cuban people can engage.
The Cubans in 1992 amended their Constitution in response to a whopping 35% decline in GDP because of the implosion of the Soviet bloc and the resulting reduction in financial support provided to Cuba by the Russians. They realized that the only way they were going to grow economically and, frankly, survive, was by attracting foreign investment, and the 1992 amendments and enabling legislation allowed them to do that. A number of European, Canadian and Mexican firms rushed in and experienced mixed results, in part because the Cuban government has been slow to make further changes in its legal and regulatory framework in response to the needs of foreign investors.
Several years ago, in recognition of tepid economic growth and prospects, the Cuban government adopted over 300 measures aimed at incentivizing further foreign investments and opening up the economy to private enterprise.
While all of these changes are significant in that they are directionally positive toward the development of a market economy, the Cuban government has thus far taken a go-slow approach.
So, while changes will have to take place on the U.S. side in order to permit greater investment on the part of U.S individuals and corporations, the Cuban government will have to make changes as well to facilitate investment in economically attractive sectors and to provide investors with access to a legal system that adequately protects them (as all investors require in any country). Investors want to make sure that Cuban courts will be fair in interpreting laws and contracts that are entered into between U.S. parties and Cuban parties or, alternatively, will need to find some other way to mitigate such risk.
Knowledge at Wharton: In addition to the step of normalizing relations between the U.S. and Cuba, do you believe that this is also potentially a long-term development in which Cuba, like China, will become more fully integrated into the global market economy? Or what kind of trajectory do you see for Cuba?
Guillen: That is clearly the ultimate outcome. The issue is how long will it take. And how exactly is that going to happen? We know there are several ways of making a transition from a centrally planned economy to the market. In Eastern Europe, in Central Asia, China, Vietnam, in each of these cases we have seen different ways of making that transition, which is a very difficult transition. Cuba has a number of things going its way. It was mentioned earlier that it has a highly educated population. But it is not a huge economy. It is very close to the U.S. and ultimately that’s going to prove a huge advantage. I would like to add that Cuba also needs to think very carefully about two issues in the next few months.
One is land ownership and real estate ownership. There have been some reforms but, technically speaking, all land in Cuba is owned by the government and it is leased out to cooperatives or to individual farmers. The rules are very restrictive. So they’re going to have to do something about that.
The other area has to do with currency. Right now, Cuba has two currencies — one that is convertible at a pre-specified rate and another that is not. This is creating a lot of distortions in the economy. Moreover, the relationship between the two currencies is different whether we’re talking about transactions between individuals as opposed to the state-owned enterprises in Cuba.
“[Cuba] is a sovereign nation that has managed to run its own policy for the past 56 years. It is not some colony for us to go and impose our will.” –Faquiry Diaz Cala
So there’s a whole range of issues. Cuba has been organizing its economy in a particular way for the past 50-60 years, and now we are hopefully beginning a process by which it is going to be organized eventually in a very different way. That process of transition from all points of view — the legal, the economic, the financial, the monetary, the regulatory — is going to be very complicated. It cannot happen all at once. It cannot happen overnight. We know from previous transitions that a gradual transition — such as the ones staged in China or Vietnam — were better than those that followed the so-called shock-therapy recipes. That was the way that Russia, the Czech Republic and other countries in Eastern Europe made the transition. So there are many important decisions that need to be made in the next few months that will set Cuba, hopefully, on the right path towards making that transition. But that transition itself will necessarily take place over a very long period of time.
Knowledge at Wharton: U.S. firms have been barred from engaging directly with Cuba. I wonder what lessons American businesses could learn from companies in Europe and other parts of the world that have been active in Cuba?
Diaz Cala: I would say that the most important lesson to be learned is that this is a sovereign nation that has managed to run its own policy for the past 56 years. It is not some colony for us to go and impose our will. The Cuban government has reached its decision which is to begin engaging in conversations. At this stage those conversations are the ones that are going to lead to where their interest lies and open their economy.
There was a time after 1989, the Special Period [a period of economic crisis] when a lot of countries went into Cuba very aggressively. The Canadians and the Spanish are operating there quite successfully. Today, you still have Sol Melia that has a number of resorts and Cuba is one of their most significant markets. You have a publicly traded, real estate company out of Europe that owns a significant amount of property, real estate and other assets in Cuba. It’s called CEIBA Investments. They’re audited. They provide an annual report and [PricewaterhouseCoopers] does their accounting work. These are examples of companies that are operating in Cuba today and we have to look at them and do research on them to see what role American companies will be able to play.
Arnavat: The one thing I want to add is that, like in any investment in any country, particularly in emerging markets, it is important for U.S. companies to identify potential local partners. These partners can help understand the local lay of the land and make further introductions within Cuba.
Knowledge at Wharton: I have one final question for all three of you: If we had with us right now a group of CEOs and board members who want your guidance to develop a Cuba strategy — both opportunities and risks — what would your advice be?
Arnavat: No. 1: Attend our conference [The Cuba Opportunity Summit] on April 1 in New York City. It will give U.S. companies and investors an excellent opportunity to understand Cuba from a current and potential business perspective. We will focus on the changing U.S.-Cuba relationship, which will likely increase commercial ties, the legal and regulatory environment that exists and the changes that need to be made in order to support a robust relationship and, very importantly, the Cuban economy and demographics and what they tell us about the prospects for investors.
Any U.S. company that currently exports or is likely to export its goods and services to — or otherwise engages in business with — Latin America and the Caribbean should consider Cuba as a potential market. But it has to examine the opportunities and, at the same time, the risks involved. We anticipate that the new regulations from the department of Treasury will come out in the next few days or weeks. That will be the first sign of how aggressive or forward-looking the administration wants to be on increasing ties with Cuba. So, carefully examine what U.S. law allows, what Cuba allows, and the opportunity from a market perspective. But keep in mind that Cuba is still a relatively closed and highly regulated economy. You have to be cautious as with any other investment in a developing country.
Diaz Cala: I would say that you have to engage in very in-depth research. You need to get the facts on what’s there in Cuba today. If you look at the mainstream media, it has really been portraying a lot of superficial stories. You need to get boots on the ground and do the due diligence that anyone would do in any emerging economy as you are looking at it in order to generate a strategy. So research, boots on the ground and understanding really where the opportunities lie.
Knowledge at Wharton: Mauro, you have the last word.
Guillen: Faquiry and Gustavo have identified all the key pieces of advice that we can give CEOs now. Try to learn as much as you can. Be ready. Maybe the big opportunities are going to be farther down the road, but you need to start doing the due diligence. You need to start thinking and learning about Cuba now so that you’re ready when the opportunities start presenting themselves as the two countries move closer together.