(i) Labour market and incentives
Clearly, the current system provides weak material incentives for state sector workers, and encourages the movement of labour from the state sector to the non-state (formal and informal) sector, where real incomes can be so much higher.
State sector labour market. Real pay levels in the state sector have been so low for so long that a very large number of state employees have developed a huge range of ways to supplement their incomes, many of which involve the theft of paid labour time and effort, or of equipment or supplies from their employer. Accurate measurement of the cost of the many forms and types of such activity is impossible, but there is no doubt that absenteeism is high, work time at the workplace is used for other activities, labour discipline is weak, and losses throughout the supply chain (that is, leakage into the black market) are endemic. As a result, average labour productivity — which is already severely depressed due to a severe lack of investment for more than two decades — is damaged.
A particular problem with the migration of workers from the state to non-state sectors is the movement of skilled labour. Skilled workers who leave their state sector jobs represent an internal ‘brain drain’ for the economy as a whole. This includes professional skills, which have not yet been included in the list of activities permitted for non-state businesses. International migration is also particularly enticing for skilled professionals, particularly since the US provides Cubans with privileged status in terms of the right to work there.
Non-state labour market. In the growing non-state sector, the undervaluation of the CUP at the Cadeca exchange rate is encouraging the growth of many activities that earn CUCs, but have extremely low levels of labour productivity. This is because the new self-employed (including skilled workers) can survive on earnings of just CUC1 per day, thanks to the state subsidy they appropriate when they exchange their salary for the undervalued CUP.
The exchange rate distortion therefore means that the process of shifting employment from the state sector to the non-state sector may fail in its objective of increasing the average level of labour productivity in the economy as a whole. Instead, it may simply exchange the army of subsidised labour in the state sector for a new army of subsidised labour in the non-state sector.
At the same time, the exchange rate system also provides a subsidy for and therefore incentivises those living on unearned (remittances), and illegally-earned (black market), incomes.
(ii) International competitiveness
The dual exchange rate system depresses international competitiveness in different ways in the state and non-state sectors, due to the peculiar nature of the separation of markets and workings of price subsidies.
State enterprises. In the state sector, which dominates the economy, the dual exchange rate system imposes a high cost in terms of competitiveness. Cuban enterprises engaged in export sales, or import substitution, are severely hampered by the use of the overvalued official exchange rate as the accounting measure. Their profits are reported in CUPs, using the official CUP1:CUC1 rate of exchange to account for CUC revenues from exports. As a result, it is near-impossible even for very efficient Cuban enterprises engaged in international trade (whether exporting or substituting for imports) to show a surplus on their accounts. They will therefore have to apply to the planning authorities for the allocation of foreign exchange for any inputs or capital spending: a cumbersome process, which severely limits their ability to reinvest profits or respond to global market conditions. In effect, administrative controls are substituting for price signals throughout the supply chain, generating delays, waste, inefficiency and frustration.
The inevitable result is that, just to keep production going, enterprise managers will resort to the art of ‘resolviendo’ – hoarding inputs, setting low targets, paying cash for black-market supplies, or selling off the books to secure hard currency – all of which erode productivity of the state sector as a whole.
The economic restructuring process currently under way aims to increase the autonomy and efficiency of state enterprises. However, for as long as currency dualism persists, state enterprises cannot become autonomous in any meaningful sense, as they need to refer to the planning authorities for the allocation of foreign exchange. In order to devolve economic decision-making, enterprises need to be able to respond directly to price signals from the international market place. That is, they need an exchange rate that enables them to measure performance and generate profits, as well as being given greater control of the allocation of those profits.
A few exporting enterprises, mostly joint ventures with foreign partners, have flourished because they enjoy a privileged position in this respect. Their accounts are presented only in hard currency (US dollars, Euros or CUCs), with Cuban inputs priced lower than the official, overvalued CUP equivalent. Currency dualism blocks the integration of this ‘enclave’ sector with the rest of the economy.
Non-state activity. For the reasons described above, the non-state activity (formal and informal) that serves the external sector which is mainly limited to the tourist sector is helped by the hidden labour subsidy from the state. A further hidden subsidy comes from remittances from abroad, which provide free start-up capital in many cases. These subsidies mean that the productivity of a large number of businesses in the new and growing private sector is extremely low. When the undervaluation of the Cuban peso comes to an end, they will be loss-making. Those that are unable to adapt will shed employees and face collapse. The longer this situation persists, the more Cubans will become dependent on unsustainable non-state activity.
