In this research based analysis, we have chosen the Republic of Cuba as our country of study. This report will serve the purpose of applying our knowledge of economic theories and practices and as a result helps us relate them to real life situations in the Cuban economy.
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We had initially considered UK, Germany, USA and Cuba as options for the country that we would prefer to analyse. Due to the fact that Cuba is known for its socialist regime and extremism, we were intrigued by both its history and the policies they have religiously followed for over 5 decades with the success of a capitalist regime constantly hovering overhead.
Former President of Cuba and leader of the Cuban Revolution, Fidel Castro questions the capitalist saying, “They talk about the failure of socialism but where is the success of capitalism in Africa, Asia and Latin America? “. Castro’s hatred for the capitalist regime was clearly shown by the policies he implemented into the Cuban economy.
With many nations following a capitalist regime, countries such as Cuba, China and Venezuela have managed to uphold their position in the world of capitalism. Cuba has always been the centre of controversy due the fact that their socialist views have managed to be successful and stand out despite the constant pressures of capitalism. Due to this we have compared Cuba to some of its fellow compatriots in the socialist society such as China and Venezuela. A major comparison will be allocated to Cuba’s biggest contender, the USA, which is not only a capitalist but also a nation which controls sanctions on Cuba.
In our report we have highlighted the fluctuations in the GDP and the levels of unemployment. Further on in the report we have discussed how Cuba maintains a balance in both their monetary and fiscal policies to tackle various economic changes. International trade practices and policies are issues that have also been taken into consideration in our report due to Cuba’s flourishing import and export market.
Cuba is a socialist nation that has been founded based on the principles of the Marxist Leninist theory under the patronage of Fidel Castro.
The Cuban Revolution in 1959 led to the formation of the 1st communist state in the Western Hemisphere. Cuba received $ 4- 5 billion as subsidies which aided the development of reputable health and education systems in the country due to the strong monetary backing by the Soviet Union.
Despite its strong socialist beliefs and welfare measures of creating jobs for everyone in the nation, citizens of the country still face hardships that has led to a rise in prostitution, corruption, black marketing and led to people fleeing from the nation in search for a better life. Many of these citizens have found refuge in the United Stated of America and many of them still live there as illegal immigrants.
Since 1962, the financial, trade and travel ban – known as the US embargo – imposed on Cuba is the major cause for its isolation and one of the greatest threats surrounding the Cuban economy.
The election of Barack Obama gave Cubans hope of the lifting of such sanctions. However in September 2009, the Obama government extended the 47 year old embargo for another year and refused to uplift the restrictions until Cuba begins a transition towards democracy.
Cuba has been under international attack for violations of human rights and lack of freedom of expression. Also Cuba suffers from the most backward internet services within its region due to slow speed and expensive access due to blockades of high speed lines in the US.
Gross Domestic Product (GDP)
The growth of the Cuban economy is highlighted by the increase in the total value of all goods produced and services provided in the country over the year. Due to which the level of GDP in Cuba has increased by $5.6 billion from 2007 to 2009.
The growth and development of the service sector has contributed significantly to the increase in GDP.
The Republic of Cuba is dependent excessively on its food and agricultural imports as it lacks the necessary resources to produce them locally. The biological aggression through insects causing plague in 1997 carried out by the United States destroyed almost all of Cuba’s crop production. Thus, it is no surprise that its contribution to the GDP has been declining.
The industrial sector witnessed a decline due to the deficient demand. Sugar prices slashed by around $200 per ton causing sugar production to be cut down massively that resulted in reduced sugar exports.
Investments from Canada, Europe and Latin America aided tourism in Cuba. It tripled its market share of Caribbean tourism in the last decade and is predicted to grow further.
Economists believe that a shift from the agricultural and industrial sector to the service sector is a positive sign that indicates growth of an economy and shifts the Production Possibility Curve to the right.
Cuba’s economy appears to be operating and growing in a similar fashion.
The increase in GDP has also led to the increase in per capita income of Cubans from $9200 (07) to $9700 (09).
Despite the pressures of declining demand, the GDP of Cuba has shown an increasing trend. However its growth rate shows fluctuations.
Per Capita Income 09
Cuba has the lowest GDP in comparison to Venezuela, China and the United States.
The United States, a capitalist nation and China, a socialist republic rank 2nd and 3rd respectively in terms of their GDP levels.
The major contribution to China’s GDP is by its net exports.
However due to China’s population rate being high, Cuba’s per capita income is greater in comparison to China.
Unemployment is a situation where a person is able and willing to work at the prevailing wage rate but is unable to find a job.
Statistics on Cuban unemployment as per 2009 show unbelievably low figures of 1.6% in the country which is the 8th lowest in the world for unemployment rates. In light of the natural rate of unemployment as suggested by the United Nations being 2-3%, Cuban economy shows signs of operating at full employment and illustrates the absence of any GDP gap.
The graph on the right represents equilibrium in the labour market where demand is equal to supply and the economy is operating at full employment level.
The global economic crisis has had its presence felt even in the Republic of Cuba, one of the most isolated countries in the world. The deficiency of aggregate demand for sugar exports and consumption led to the closure of many sugar producing plants in Cuba.
This clearly indicates the presence of cyclical unemployment and contradicts the implication of full employment in the country.
However, there are two reasons that support the operating of Cuba at full employment level. First is the education sector in place. The Cuban government has been able to successfully provide those who have lost their jobs due to the crisis, free education facilities thus categorizing them as “out of labour force”. Around 107,923 youngsters have benefited under this scheme.
Secondly, the average wage rate in Cuba is very low. It equates to 225 Cuban pesos (US $ 235) per month. Many citizens show unwillingness to offer their services at these low prevailing wage rates and may not have been considered as unemployed.
Such practices clearly show that unemployment statistics about Cuba cannot be regarded as accurate and that hidden unemployment prevails in the nation.
This narrows us down to the understanding that the figures of unemployment are greater than what it is shown to be and the major contributor is structural unemployment.
In support of our argument, workers in the Cuban economy require special permission and grants by the government of Cuba to change their job. This creates resistance in employees to shift jobs and causes reduction in frictional unemployment.
Thus even during the difficult phase of recession, when unemployment levels are rising massively around the world, the Cuban government stands out to show decreased levels unemployment from 1.90% in 2007 to 1.60% in 2009. This is far better in comparison to Venezuela’s and China’s unemployment rates of 10.9% and 4.3% respectively.
The United States which highly disagrees with socialist views seems to be one of the hardest hit victims of the crisis. They have faced unemployment of 7.20% in 2009 which is expected to grow to about 9.4% this year.
Thus it would be safe to conclude that the socialist measures adopted by the Cuban government out weight the capitalist measures to reduce unemployment. Also Cuba has been able to generate more job opportunities through government efforts as 78% of the Cuban labour force is employed in the state sector.
Unemployment in relation to the Phillips Curve will be discussed later on under the analysis of inflation rates.
After a 1.9 % drop in the general price level of goods and services produced in 2007, Cuba’s inflation shows a slow but gradual growth since 2008.
Cuba’s inflation grew from 3.1% in 2008 to 3.4% in 2009. It is expected that this rate will further increase by 0.9% by the end of the year 2010.
Every country faces a problem of choice in dealing with its macro-economic problems. Economies strive for putting a cap on inflation and achieving higher employment levels simultaneously. The inverse relationship between inflation and unemployment is a major concern that is reflected in most decisions taken by the leaders of a country.
As stated by the theories of the Phillips Curve, some governments may be willing to allow inflation rates to rise in order to reduce unemployment.
Under the socialist regime of Cuba where unemployment rates show a decline while witnessing rise in inflation indicates compliance with the law of the Phillips Curve.
Uncontrolled inflation or hyperinflation could be a serious issue for the government. But the rate at which Cuba’s inflation is progressing indicates the growth of the economy at a reasonable rise in the general prices of goods and services.
In this report, we have tried to analyse the causes for Cuba’s inflation through our understanding of Keynesian and Monetarist views.
Keynes believes inflation is caused due to a “demand pull” or a “cost push”.
The time period from 2007 has been a period of declining demand in relation to supply. Hence demand cannot be considered as a reason good enough causing inflations rates to be pulled in an upward direction in Cuba.
As the US trade embargo against Cuba continues, Cuba faces a difficulty to import products from different countries at cheaper rates than available. Higher costs may be the contributing factor pushing the prices of goods and services up and thus causing inflation.
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Monetarist believes the quantity of money and the velocity of circulation is equal to the general price level and the index of the real value of final expenditures. It assumes that velocity and the index remains constant and that a rise in the quantity of money in circulation can cause the general price level to rise.
Cuba has excessive control over the supply of their currency in circulation. However, they spend generously rationing food products and necessities to the Cuban public. This increases the real income held by the public and allows for increasing consumption by the household sectors. Hence a rise in public expenditure could be one of the major contributors of rising inflation.
Cuban inflation rates demonstrate an increasing trend but in comparison to the world, their rate of growth appears to be moderate and sustainable especially in regard to the Venezuela whose inflation rates were as high as 30.4% in 2009.
China and the United States who have suffered massively due to the fall in demand are expected to face deflation this year after a sustained rise in their inflation rates since 2007.
Since 1962, Cuba has been under sanctions of the US trade embargo. This restricted Cuba’s trade with most countries of the world.
Fidel Castro hoped to seek better ties with the United States with the appointment of President Barack Obama; on the contrary the embargo has been extended for yet another year. The enactment of the embargo was a deliberate move to isolate Cuba’s socialist regime and to pressurize the Cuban government to move towards creating a democratic nation.
The irony of the situation is that today US is one of the top 10 trade partners of the Republic of Cuba. US farmers depend highly on agricultural exports to Cuba to ensure continuous demand for their products. Export of food products to Cuba is a great trading opportunity as Cuba imports 80% of its food requirements making the United States a clear beneficiary of such practices. By laying down sanctions on Europe and Canada, the US cleared competition and took advantage of the situation by overcharging their export to Cuba. Due to the embargo, Cuba suffered damages worth up to $89 billion.
It was only in the 1990’s when controls over trade were relaxed that allowed imports and exports to be carried out without permissions and free trade zones were set up.
After the Cuban Revolution of 1959, Cuba received a lot of help and support by its greatest ally the USSR. A few decades ago the Soviet Union was the greatest supplier of oil to the Republic of Cuba at lower than market rates. This alliance helped Cuba survive the 2 oil shocks of the 1970’s and the Third World Debt during the 1980’s.
However, when the economy of the USSR started to decline, to reduce its dependence on the Soviet Union, Cuba began commercial agreements with Argentina, Canada, Spain, France, UK, Italy, etc. Its closest ties till this date have been established with China and Venezuela.
Today even the United States forms a major share of the imports into Cuba. However the United States allows Cuba only a small share of gains through its trade practices.
Under the Heckscher-Ohlin (H-O) theory of trade, the composition of Cuba’s imports mainly include oil, food, chemicals, machinery and equipments since it is not abundant in these resources.
Cuba produces 52,630 barrels of oil per day but their consumption pattern exceeds 176,000 barrels per day. Today Venezuela is the leading supplier of oil to Cuba. Importing oil allows Cuba to consume oil outside its production possibility curve.
However, Cuba’s dependency on imports has declined since 2008 by $3.39 billion.
The Cuban citizens have benefited through imports as their consumer surplus increased and their necessities are available at cheaper rates than offered by domestic markets. Producer’s surplus reduced as they face competition with foreign producers who are more efficient.
Cuba is known for its sugar, nickel, tobacco, fish, medicine, citrus, and coffee exports.
Cuba is also famous for its illegal trade exports of Cuban cigars, marijuana, cocaine, turtle shells and slavery.
For over 2-3 decades, the Soviet Union remained one of the leading purchasers of Cuba’s sugar production at higher than market rate.
Today Netherlands, Canada and China are the major international buyers of Cuba’s sugar, nickel and tobacco production.
Cuba has an absolute advantage in the production of its illegal Cuban cigars. Since they are rich in the factors of production of sugar and can produce it more efficiently and cheaper than other countries, according to the H-O theory of trade, they export sugar to other countries that do not have enough resources to produce it. During the year 2007 when sugar prices were at their peak, it would sell for $750-$800 per ton. Cuban sugar production declined since 2008 due to the deficiency of demand caused during the world wide economic crisis, reducing sugar prices to $560-$590 per ton. This justifies the decline of exports in the year 2009 to a certain extend.
The Net Effect
Cuba has been spending more on importing goods and services than it has been generating through its exports to different countries. This has created a trade deficit of $ 7.61 billion in 2009. However due to a simultaneous decline in both imports and exports, the trade deficit has declined by $ 3.18 billion.
International Trade 2009
Both United States and Cuba run a trade deficit, but Cuba’s deficit is far lesser in comparison to the US.
China and Venezuela have been able to successfully generate income of $273 billion and $10.95 billion respectively by generating trade surpluses.
MONETARY AND FISCAL POLICY
They have a fixed interest rate that has not been changed since 23rd of April 2004, for instance they give 1% interest on your fixed deposit of CUP’s. This shows that their monetary policies are rigid and it seems that they are resistant to change.
After the revolution in 1981, Cuba’s government decided not to impose any tax, but in 1996 the Cuban government decided to exercise its contractionary fiscal policy by introducing income tax with the following rates:
10% tax – for individuals earning less than (<) $2400
50% tax – for individuals earning more than (>) $60000
30% tax – for businesses and companies (Corporate Tax)
As the tax rates charged kept on increasing, the government revenues also increased although they were not fully retained as they were used for public services such as healthcare and education, which are free for the local citizens. At the end of 2009 the Government Expenditure figures were greater than Government Revenue such as shown below:
Government Expenditure Government Revenue Budget (Deficit)
$42.58 B $ 39.11 B $ -3.47B
Apart from the health facilities and free education, the Cuban government also rations their food products.
In the figure below using the IS-LM model curve, we have highlighted that when the government expenditure increases or tax reduces (expansionary fiscal policy), the IS curve shifts to the right (IS0). When government expenditure decreases and tax rates increase (contractionary fiscal policy), the IS curve is shifted to the left (IS1).
Since at the present level of income IS = LM and the economy is operating at full employment in the absence of a GDP gap, it is advisable that no change is made in the monetary or fiscal policies by the Cuban Government.
Fiscal policy measures were used by the US, since the consumer expenditure was well below the average due to reduced income; the government attempted to stimulate the US economy by increasing government expenditure and reducing tax rates.
This figure shows that the economy currently depends heavily on government expenditure, following the formulae
GDP = C + I + G + NX
(Consumer Expenditure+ Investments+ Government Expenditure+ Imports/Exports)
Since household consumption, business investments are low and with the country’s current trade deficit, the only option with the US Government is to increase Government Expenditure.
Under the Spanish regime, Cuba took up the same currency as the Kingdom of Spain, the Spanish peseta. After their independence from Spain in 1881, Cuba created their own currency which was the Cuban pesos (CUP). By 1994, the Cuban government had created another form of currency known as the convertible Cuban pesos (CUC). This currency was introduced on the same level as the US Dollar. With US sanctions increasing on the Cuban economy, the Cubans responded by discontinuing the use of the US Dollar in November 2004. Further changes were issued into the Cuban economy with the addition of a new tax or grant, which permitted any form of US Dollars which when exchanged to provide the Cuban government with 10% commission. Fidel Castro issued a statement on live TV stating that, “The Empire is determined to create more difficulties for us.” http://news.bbc.co.uk/2/hi/americas/3953291.stm, referring to the US as the empire that was determined to cut Cuba away from the world. Other responses to the tightening embargo policy, Cuba decided to shut down dollar stores, but remained unsuccessful when the stores re-opened within a fortnight.
Currently the CUPs and CUCs are in circulation and used as a medium of exchange in Cuba. Both of Cuba’s currencies the CUC and the CUP are fixed by the government. Over the last three years, the exchange rate of the convertible Cuban pesos had seen to apparent change due to the government regulating the supply.
1 CUC (convertible pesos) = 1.08 CUP (Cuban pesos)
In relation to the dollar, the CUCs are stronger as 1 US Dollar is equivalent to 0.9259 CUCs.
TABLE OF CONVERSION
1 US Dollar = 0.9259 CUC
US Dollar to Convertible Cuban Pesos
1 US Dollar = 0.4662 Bolivars
US Dollar to Venezuela’s Bolivars
1 US Dollar = 0.1465 Yuan
US Dollar to Chinese Yuan
As seen from the table above the Chinese Yuan has the strongest currency followed by Venezuela and Cuba. Thus proving that the currency of the socialist nations is more regulated and the supply is limited making their currency stronger in comparison to the United States – a capitalist nation.
Cuba’s economy run on socialist beliefs is a great example to the capitalist world. Despite the desperate efforts of the US to destroy Cuba’s economy due to its anti-democratic views, the socialist regime continues even after 47 years of trade embargos and sanctions.
Cuba’s economy survived and has shown constant growth even after the collapse of its greatest ally, the Soviet Union. It has been able to successfully reduce its unemployment levels to figures indicating operation at full employment. Though there are concerns that these figures may not be accurate and that actual levels may be higher than projected.
It has improved its trade relations with many countries after the setting up of their free trade zones. It is highly dependent on its imports to meets its country requirements. Thus, Cuba has a current account deficit which indicates larger imports in relation to its exports. The negative balance of the current account has decreased in 2009 mainly due to Cuba’s efforts to produce import substitutes. Today China and Venezuela account as Cuba’s leading trade partners.
Cuba’s heavy investments in health and education facilities helped create trained professionals in the field of medicine. Cuba accounts for its oil imports from Venezuela by exporting the services of its doctors. This is a unique feature we came across while analysing the working of the Cuban economy.
Overall, Cuba’s performance as an economy operating at full employment has been achieved mainly through dedicated government efforts and backing. Although not all citizens of the nation are satisfied with their standard of living and look for alternatives to improve their lifestyle.
The economy was affected due to the economic turmoil but due to its low exposure to financial risks, it was able to withstand and grow when most economies were facing deflationary pressures.
After the boost in tourism, Cuba’s economy shows signs of growth even in the future years.