Opportunities vs. Risks in Cuba - Do Your Homework and Tread Carefully

Opportunities vs. Risks in Cuba: Do Your Homework and Tread Carefully
Jan 14, 2015 Podcasts Latin America

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@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@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@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@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@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@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.

SPONSORED CONTENT:

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@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@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 Twitter .

Knowledge@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@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@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@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@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@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.

Source: Opportunities in Cuba: Do Your Homework and Tread Carefully -
http://knowledge.wharton.upenn.edu/article/opportunities-vs-risks-cuba/