Doing business in Cuba: investors Beware**
Institute for Cuban and Cuban-American Studies, University of Miami
The possibilities of entering the Cuban market is of significant interest to American enterprises. However, upon closer examination the Cuban market offers American companies a very unfavorable risk-benefit analysis.
Unlike most markets where the corporate due diligence focuses on examining the market conditions for doing business in a given country; the Cuban due diligence must begin by examining the conditions for doing business with Cuba. That is, with the Cuban government and more specifically with the Cuban military, which controls most businesses in the island.
There is no private sector in Cuba in the sense that we use that term in free market economies. The so called self-employed (cuentapropistas) in Cuba are not equivalent to a private sector. These are individuals that have been granted permission by the State to operate in one of 201 highly specified domestic commerce and under very restricted conditions. They do not have legal standing as would a sole proprietorship, partnership or corporation in the United States. It is therefore very misleading to speak of a private sector. American businesses must understand that they will have to operate in partnership with the oppressive Cuban government.
Doing business in Cuba means doing business in partnership with the Cuban military.
The first section of this report will highlight some of the requirements for doing business with Cuba under Cuban law and the second section will highlight some of the market conditions for doing business in Cuba
I. Doing business with Cuba. Legal Environment
Written in 1976, and extensively revised in 1992 and later in 2002, the Constitution clearly defines the power vested in the Communist Party. Article 5 states that “the Communist Party is the superior leading force of the State.” Article 3 of the Constitution adds that the socialist system “shall be irrevocable and Cuba will never return to capitalism.”
As a communist regime, the national economy is centralized, planned and run by the State (Article 9). It is also based on a socialist ownership of the means of production (Article 14). These laws are specific and a prevalent part of Cuba’s legal system. They have not been set aside by the new Foreign Investment Law.
The communist constitution does not allow room for doubts on the issue of property ownership rights. On the contrary, it is clear, direct and precise. It states that “sugar mills, factories and all enterprises, banks and installations that have been nationalized and expropriated from imperialists, large estate owners and the bourgeoisie” (Article 15) are the property of the state.
The State controlled legal system in Cuba fails to protect foreign investors. Judges and lawyers are appointed by the State and follow party and military orders. A recent example is the arrest 3 years ago of Cy Tokmakjian, a Canadian investor that languished in jail without trial. On April 30, 2014, Peter Kent, Chairman of the Canadian House of Commons Defense Committee, complained publicly about the arrest and criticized Cuba for not protecting foreign investors. Mr. Tokmakjian has been released since.
Cuba has no impartial courts to which complainants may turn to deal with a civil law controversy, much less a criminal case. There is an absolute absence of legal defense in any instance of conflict with the government or a state-owned business. The government, according to its needs, persecutes, arrests or releases any citizen arbitrarily, including foreign businessmen with whom it has engaged in a controversy. In other words, the opposite of true Rule of Law.
General Raul Castro is opening for business but in his own communist terms.
The Military in the economy
The military is the key power over economic decisions. Military officers involved in the economy manage the means of production, economic institutions and financial activities. The most important of these officers is General Luis Alberto Rodríguez López Calleja, son-in-law of Raul Castro, in charge of GAESA (Enterprise Administration Group, S.A.), a conglomerate of state and mixed enterprises.
All foreign trade and investments are funneled through its regime powerful conglomerate.
Some businesses operated by Cuba’s military and GAESA S.A. are:
• Gaviota S.A.: hotel and tourism industry marketing and sales.
• CIMEX (Comercio Interior, Mercado Exterior): largest commercial corporation in Cuba. Manages businesses in the areas of real estate, banks, retail stores (over 250), shopping centers, fast food restaurants, gas stations, etc.
• Servicio Automotriz S.A.: car rental services for tourists, car repair and gas stations.
• Aero Gaviota: manages tourism and airlines.
• Tecnotex: import/export of technology and services.
• Almacenes Universal: warehouses located in Wajay, Mariel, Cienfuegos and Santiago.
• Almest: real estate and tourism services.
• Antex: customer service and commercial operations in Africa.
• Agrotex: agriculture and livestock.
• Sermar: exploration of Cuban waters and naval repair (shipyard).
• Servicio la Marina: provides security and support to GAESA (some employees are operatives of the MININT’s Intelligence department M-6).
• Geocuba: geodesy and cartography.
• Cubanacán: tourism
Doing business with a corrupt military oligarchy that can, arbitrarily, make a negative and detrimental judicial decision on any matter affecting the investor’s corporate interest is a powerful deterrence for potential investors in Raul Castro’s Cuba.
II. Doing business in Cuba. Widespread corruption
In the 2012 corruption report by Transparency International, Cuba was below most countries in the Caribbean and Central America. It defined corruption as “the abuse of central power for personal gain.” Corruption can take many forms, from minor use of influence to high ranking government officials, institutionalized bribery and extortion. Widespread corruption is recognized as a major obstacle for a nation’s sustainable economic development.
State controlled Cuban newspaper Juventud Rebelde reported that over half of workers in retail enterprises routinely steal from cash registers. The paper stated that some state owned services are being used for personal profit. The report also added that many of the principal state enterprises are dysfunctional, unable to supply essential products and maintenance material to their retail outlets. The reason is theft.
On May 2013, the Cuban Minister of Foreign Commerce and Investment reported on “the irregularities detected in the functioning of businesses with foreign capital.” The Minister also stated that “corruption and theft are rampant in the fuel sector.” Stealing from government owned enterprises and their foreign investor partners is an acceptable way of life in the impoverished island in which the military oligarchy controls over 75% of the economy.
In the book, “Corruption in Cuba,”* two prominent scholars argue that the Cuban privileged leadership has contributed to institutionalized corruption with rampant practice of nepotism, cronyism, bribery, control of production materials, pricing and lack of accountability. According to the study, few citizens hesitate to steal from government and enterprises.
Today, large corporations are trying to focus on anti-corruption mechanisms to protect their international reputation and the best interest of their stakeholders. Doing business in a corrupted business environment is also very costly, estimated to add 10% or more to the cost of operations.
Investors are discouraged by corruption since it increases the financial burden on the business.
Unlike taxes, that are known and predictable and can be built into the expected cost, bribes, theft and extortions are difficult to control and unpredictable in magnitude and will negatively impact cost control, reduce profits, undermine investor confidence and unleash a commercial climate of fear and uncertainty in a country in which the revolutionary leadership control the judicial system.
Corporations doing business in Cuba are required to cooperate with State Security. This includes the use of cameras and microphones in hotels, restaurants, stores and other business enterprises to keep track of customer and employee activities. State Security repressive methods violate employee and workers’ rights.
Another issue for potential investors is that Cuba’s physical infrastructure is moving rapidly from acute decay to fatal collapse.
Deteriorated roads, bridges and railroads
The island’s roads and bridges are unsafe and in need of urgent repair and the state lacks the needed funds to make the repairs. The fatigue, cracking and exacerbated deterioration of the bridges and roads are caused by low quality materials combined with inconsistent repair practices. As noted by a relevant study, “the lack of investment and maintenance are reflected in the deteriorated condition of the transportation system.” In addition, hundreds of bridges throughout Cuba are in need of rehabilitation.
In the global market, trucking is a vital commercial component and the decay of the national highway system presents a major obstacle for the safe and timely transportation of commercial cargo.
Cuba’s railroad system suffers from multiple infrastructure problems including rotten cross beams, rusted rails and loose tie plates. The dilapidated conditions of the railroad grid demand that in some areas the trains go at a maximum of 20 km an hour to avoid accidents. Railroad bridges are also in precarious conditions with sinking foundations that disrupt the angles on the tracks. The task of repairing the infrastructure is beyond Cuba’s financial capacity. The acute deterioration of the transportation system is among the perils of investing in Castro’s Cuba.
Inadequate ports with Mariel as the exception
With the exception of the mega transshipment Port of Mariel, with a draft up to 49 feet and a capacity to store over 3 million containers, Cuba’s principal ports (Havana, Matanzas, Santiago de Cuba and Cienfuegos) are unable to accommodate large, modern vessels.
Experts have pointed out that in Cuba’s ports “all basic infrastructures, including connectivity to ground transportation networks, energy, telecommunication and water have suffered. All such systems are antiquated, unreliable and incapable of supporting the demands associated with a consumer-oriented economy.”
The U.S. Trade Commission stated that the ports’ poor maintenance has created a situation where loading and unloading cargo can be a hazard. Furthermore, there is limited availability of cold storage, a crucial infrastructure component necessary for perishable food products. In addition, the availability of equipment and trucks used for moving loads on to and off the ports is inadequate and they lack spare parts needed for repair and maintenance.
The modern Port of Mariel, just 45 km West of Havana, is designed to serve super-container ships. However, the future possibility of serving as a container transshipment facility for a U.S. (post-embargo) commerce has major competition from high-tech Port of Miami, the closest American port to the new Panama Canal expansion. The Port of Miami enlargement has a dredge of up to 50 feet in depth and is capable of berthing even the largest container vessels in the world, including the future Maersk Triple E Class, which will have a draught of 47 feet and will be nearly 200 feet wide.
The mega Port of Miami has completed an under the bay tunnel for trucks to bypass Downtown Miami, doubling the port’s traffic capacity. So, why would the Pacific exporters choose the Port of Mariel if they could bring their cargoes directly into the U.S. via the excellent highway infrastructure of the Port of Miami? This fact should be a major concern for the Port of Mariel investors.
Cuba has an aging and expensive centralized electrical power network that reaches 95% of the island’s population. Fossil fuels generate 85% of the energy. There are seven major power plans that use inefficient equipment from former Soviet Union and Eastern communist countries, as well as old American equipment. All plants are operating below their estimated capacity level.
Cuba’s oil consumption is 80,000-100,000 bbl/d, while domestic production is about 55,000 bbl/d. Therefore; Cuba has to import most of its fuel needs. Over 100,000 bbl/d are imported from Venezuela. Thus the financial stability of Cuba depends almost entirely on the largesse of Nicolas Maduro’s regime in Caracas. If support from Venezuela is reduced or ended, Cuba’s energy sector will have to find, urgently, another country willing and capable of providing Cuba with petroleum at similar concessionary terms as Venezuela.
Outdated water and sewer system
In Cuba, the water supply and sewer infrastructure is at a breaking point and close to catastrophic failure. Throughout the island, the water and sewer infrastructure is failing due to the deterioration of the pipelines, inefficient maintenance practices, antiquated equipment and substandard plumbing materials.
According to a 2013 report published in Granma, the Cuban government’s official newspaper, 58% of potable water is lost through leakage.
Havana’s sewer system, which was built almost one hundred years ago, has been due for major repairs for almost five decades and it serves over two million citizens- well beyond its original design capacity of 400,000. The wastewater infrastructure is a serious concern. Fifty nine percent of the 2,160 contaminants recognized by UNEP are released into Cuba’s environment without any treatment.
For over 54 years, the wastewater process has been substandard as a result of decades of neglected infrastructure and pollution control. This has taken a severe toll on the land which is now recognized as one of the most polluted in the world. The growing deficiencies of clean water supply and wastewater contaminants are a major problem for corporations committed to clean environments.
Outdated internet communication and information system
The global economy relies on modern internet communication technology for secure, reliable, swift and precise commercial, industrial and professional activities. This is a crucial factor for the successful fulfillment of trade exchange and distribution of goods. In Cuba, the high tech infrastructure is at a minimum level of performance while the communication system relies on antiquated equipment. Censorship is also among the most severe in the world.
Although some efforts at modernization are being implemented, the State lacks the financial resources. Additionally, the Cuban government fears the powerful impact of new communication technologies on the people’s ability to share news and develop social networks among themselves.
Cuba has one of the lowest rates of population with internet access among all countries; with less than 3 percent of Cubans having access to internet. The State also controls the flow of high tech internet equipment and information that reaches the island.
Due to the outdated and restricted communication infrastructure, Cuba’s information technology (IT) sector has not developed to modern standards. Unlike in free market economies, IT experts on the island do not focus on the integration and strengthening of systems that facilitate transactions. Instead, they emphasize technologies that simplify the government’s supervision of activities. An unfriendly business environment hinders a swift and successful participation in the global economy.
Violation of workers’ rights and foreign investors’ complicity
General Raul Castro’s regime systematically violates the rights of workers to bargain for wages and labor conditions with the complicity of foreign entities engaged in joint ventures with the Cuban government. There are no free, independent labor unions and there is no collective bargaining. Article 33.3 of the Foreign Investment Law clearly states that Cuban workers “shall be hired through a contract between the company and an employing entity” controlled by the State.
Article 33.4 states that payment to Cuban workers “shall be made in national currency which must be obtained beforehand from convertible foreign currency” by the Cuban entity.
With the exchange rate of about 25 pesos (CUP) per dollar, the foreign investor entity pays a fixed salary to the state employment agency in convertible pesos, or CUC (1 CUC= $1). The employment agency then pays the Cuban worker in Cuban pesos, CUP. Thus Cuban workers receive 1/25 less per peso after the currency is exchanged for CUP. The Cuban government keeps over 80% of what the foreign entity pays.
This is an ethical travesty in which the workers’ real monthly wage is around 10% of the payment for its labor. A shameful business practice condemned by labor organizations worldwide.
A foreign investor in Cuba should carefully consider the unethical, unfair and abuse labor practice of workers’ exploitation when considering a joint venture with Cuba’s military oligarchy.
Low purchasing power
Wages are critically low (about $24 a month), which determines the practical inexistence of a potential market of 11 million consumers. Cubans have the lowest purchasing power per capita in all of Latin America.
The high risks of Venezuela’s financial collapse
According to Moody’s report of April 2014, Venezuela’s economy is in a downgrade, negative outlook rating and Cuba faces the risk that Venezuela will be forced to reduce or eliminate its huge financial support of over $6 billion yearly. General Raul Castro’s regime is among the most vulnerable recipients of Venezuelan oil subsidies. Every day, Cuba receives over 100,000 barrels of oil from Venezuela in exchange for medical services.
Moody explains that when it downgraded Venezuela, last December, to a negative outlook rating, the key drivers were unsustainable macroeconomic imbalances, and a materially high risk of economic and financial collapse. For Cuba’s subsistence economy, this is a catastrophic possibility.
Given these conditions and risks, only very daring investors are likely to pluck large sums of money into Cuba. A hostile state and a controlled legal system together with a collapsing infrastructure does not make Cuba an attractive investing location. The issue of confiscated properties is still pending. All U.S. and Cuban properties were confiscated in the 1960’s. Many U.S. firms as well as Cuban-American stand ready to use American courts to try to recover their losses or at least to prevent U.S. trade with and investment in Cuba.
* Diaz-Briquets, Sergio and Perez-Lopez, Jorge. Corruption in Cuba: Castro and Beyond.University of Texas Press. 2006.
**This report was submitted to the U.S. International Trade Commission on October 22, 2015.
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