The new foreign investment law passed unanimously last Saturday by Cuba’s National Assembly is a key component of President Raul Castro’s program to “update” the economy. Castro deemed the law so important that he called the assembly into special session to pass it rather than wait for the regularly scheduled session in July. The new law offers significantly better terms to foreign investors than the 1995 law it replaces, with the aim of boosting direct foreign investment (FDI) in Cuba’s chronically capital-poor economy.
Though Cuba’s internal sector reforms
have garnered more attention
, it was a crisis in the external sector that forced Cuba’s leaders to finally confront the need for sweeping change: The economy’s vulnerability to a future rupture in relations with Venezuela stirred memories of the so-called Special Period
following the collapse of the Soviet Union and roused Castro’s leadership team to action.
The new foreign investment law represents an acknowledgment that FDI is essential to economic growth. Minister for Foreign Trade and Investment Rodrigo Malmierca declared that Cuba hopes to attract
between $2 billion and $2.5 billion in FDI annually. At present, Cuba attracts only a small fraction of that.
The new legislation replaces Law 77, which in 1995 reopened the economy to FDI at a time when it was desperate for capital. But the terms were not especially favorable, and the process for winning approval from Cuba’s state bureaucracy proved both opaque and unpredictable
. After an initial rush of investors hoping to gain a foothold in the Cuban market, FDI fell off dramatically, from over 400 firms in 2002 to only 190 in 2013.
The new law offers much better terms
. It cuts the tax on profits in half—from 30 percent to 15 percent for most industries—and eliminates the old 25 percent tax on labor costs. The new law allows 100 percent foreign ownership, which, though previously legal, was never allowed in practice. Investors in joint ventures get an eight-year exemption from all taxes on profits.
Two important elements of Cuba’s FDI landscape have not changed, however. Major projects will still require approval by the Council of State or Council of Ministers, which has led to lengthy delays in the past. And investors will still have to hire workers through the state’s labor exchange rather than hiring them directly, limiting firms’ control over the skills and incentives of their labor force. These conditions have been major deterrents to FDI in the past and will undoubtedly be a drag on new investment unless the Cuban government finds ways to mitigate their negative effects.
The terms of the new foreign investment law were foreshadowed by the terms announced last September for investors in the Mariel Special Economic Development Zone (ZED) surrounding the new modern port at Mariel, an hour’s drive from Havana. Designed and built by the Brazilian engineering firm Odebrecht, the port at Mariel is Cuba’s largest capital investment project in decades. Of the estimated $957 million cost, the Brazilian Development Bank provided $682 million in concessionary credits, and President Dilma Rousseff has pledged another $290 million for construction in the ZED. The new port can accommodate the large container ships that will begin transiting the Panama Canal when its “Panamax” expansion is completed in 2015. Mariel will replace Havana as the main port for Cuban trade, and aspires to become a key transshipment point for the transfer of containers to smaller ships destined for ports unable to accommodate the larger ones. In addition, Cuba hopes that the modern facilities at Mariel will help attract investors to the ZED.
This is not a sure thing. First, the new port will face stiff competition
from facilities already operating in Jamaica, the Dominican Republic and the Bahamas, each of which currently handles almost six times more container traffic than the port of Havana.
Complicating matters, the U.S. economic embargo prohibits ships docking in Cuba from entering U.S. ports for six months, thus barring Mariel traffic from the principal transshipment destinations along the U.S. East Coast.
The ZED’s ability to attract investors will play a crucial role in making the port facility a success. Mariel is not Cuba’s first experiment with free trade zones (FTZs), however. In 1996, four such zones were opened—two outside Havana, one in Cienfuegos and one at Mariel. The terms granted to investors in the 1996 FTZs were quite favorable: They were allowed 100 percent foreign ownership, duty-free import and exports, and a 12-year exemption from taxes. The terms for the Mariel ZED are similar
: Investors are allowed 100 percent foreign ownership, duty-free import and exports, the tax on profits is just 12 percent and investors get a 10-year tax exemption.
Yet despite these nominally favorable terms, the 1996 experiment proved disappointing. No major foreign firms invested in the original FTZs, and exports never surpassed $60 million. Most of the operators were not manufacturers, but importers using the tax-free zones to store goods destined for Cuba’s domestic market. The government closed the zones in 2007.
Two obstacles contributed to the failure of the 1996 experiment. First, Cuba’s cost of labor was significantly higher than in competing “maquilas” or factories elsewhere in the region. Second, goods manufactured or processed in Cuba could not be exported to the United States because of the embargo. The Cuban government may reduce the cost of labor in the Mariel ZED, but the U.S. embargo remains in place.
In sum, the new foreign investment law and the Mariel development project represent major steps toward opening the Cuban economy to the world and restoring balance to its external sector. Yet the U.S. embargo stands as a serious roadblock to the vision of Mariel as a principal transshipment point for container traffic and a center for foreign investment.
It’s almost as if leaders in Havana and Brasilia are betting that the U.S. embargo will disappear in the not-too-distant future, turning their billion-dollar investment from a risky gamble into a brilliant gambit. Maybe there’s more quiet diplomacy going on behind the scenes than anyone realizes.
William M. LeoGrande is professor of government at American University in Washington, D.C., and co-author with Peter Kornbluh of the forthcoming book, “Back Channel to Cuba: The Hidden History of Negotiations between Washington and Havana” (University of North Carolina Press).