Saturday, March 24, 2012

Cuba - a lesson for Greece?

I have argued in this blog several times that Greece’s problem is primarily an international one: if Greece were sitting on the world’s largest oil reserves and didn’t need any funding from abroad, few people outside Greece would care what the Greek government spends money on and/or how much it wastes.

Instead, Greece has been foreign-funded as long as memory serves. Initially, world powers provided funding in view of Greece’s geopolitical importance. Then, Greek guest-workers remitted their earnings back to their home country during the 1960/70s. After joining the EU, the flow of EU-grants began. And, finally, with the Euro, the flow of cheap Euro-loans began. Had Greece not received any such foreign funding, its living standard today would be reminiscent of a developing country (or it would have tried harder to improve the living standard on its own…).

Thus, the Greek economy has become dependent on foreign funding in a similar way that Cuba had become dependent on financial support from the UDSSR (export markets for overpriced Cuban goods, loans and grants).

Greece should pay attention to what happened to the Cuban economy when Soviet support was dramatically curtailed after the fall of the Iron Curtain. During the 3 years following, Cuban GDP collapsed by 30-35% because imports had to be radically curtailed and couldn't be substituted domestically! The country which had become poor after the Castro revolution now became an economic basket case. The same thing would happen to Greece if foreign funding came to a halt.

Soviet support (i. e. foreign funding) made the inefficient Cuban economy even more inefficient because there was no incentive to improve. Just like Greece is now importing agricultural products like olive oil, tomatoes, potatoes, oranges, etc., Cuba imported sugar. Since Cuba could export poor quality products at high prices to the former communist Eastern block, it didn’t have to try hard to develop an export culture. Greece didn't have to try hard to develop an export culture because it got cheap foreign funding from banks almost without trying.

So what did Cuba do in order to improve its situation?

Basically, Cuba did what this blog has argued all along (albeit with limited success in the context of a planned, communist economy): if you recognize that your biggest challenge is to get foreign funding, you have to figure out ways how to get that.

Cuba tried to attract foreign investment and tourists from abroad. Secondly, many Cubans became guest-workers (mostly in Venezuela) and remitted their earnings back to Cuba. Finally, Cuba found a new sponsor with Venezuela.

Despite all the progress since then, Cuba is still in an economic condition which Greece never wants to find itself in. But Greece could get there because its trade balance is not much better than that of Cuba and its tourism even lags behind Cuba’s (proportionally).

Cuba has secured voluntary foreign funding through increased tourism, new foreign investment, guest-workers’ remittances and – above all – through a new foreign sponsor. If the Cuban  economy is still a basket case despite of that, this only proves that the communist system is not a very good one.

I have found this – quite old – country review of Cuba by Rabobank which repeatedly points out the importance of the Balance of Payments (primarily the current account) when attempting to increase the living standard of a developing economy. Thus, the often stated message of this blog is very simple:

1. Curtail imports.
2. Substitute them domestically wherever possible.
3. Increase exports (Free Trade Zones) and tourism.
4. Attract foreign investment.
5. Stop capital flight with capital controls.

And if Greece does all that, it won't need to look for a new financial sponsor because the EU will be happy to support a well-functioning Greece.


  1. Free Trade is an overused term that has lost any meaning it may have once had. Personally I think its always been a lie, to the British it meant them being free to enforce their rules via gunboat.

    Entities like the EU, EFTA, NAFTA etc are PREFERENTAL Trade Areas. That is part of their problem, they become trade seraglios.

    So called Free Trade Zones within a country are actually TAX FREE (or nearly so) Zones that primarily produce Goods & Services for export. Part of Greece's problem is its low tax base, due to evasion and avoidance. Its hard to believe that the Greeks wouldn't divert much of the Goods and Services produced in Tax Free Zones into the domestic market.

    It might be fairer & more effective to make all of Greece a LOW tax country - like Ireland and Czeska.

    Argentina is promoting Tierra de Fuego's Tax Free status to attract foreign investment ==>>

    That's just about the last place I'd expect to find hi-tech manufacturing. Unlike Greece Argentina doesn't have the burden of the EU, plus it's 20 times larger with almost 10 times as many people.


    1. I don't think of Free Trade Zones as exclusively for export. On the contrary, the initial purpose would be to substitute for the import of consumption products which could also be produced in Greece if there were an internationally competitive framework in Greece. Thus, the purpose of FTZ would initially be to offer a totally internationally competitive business framework. The idea would be that the FTZ attract foreign investment (guaranteed by the EU for political risk). In a second phase, the FTZ could focus on exports and perhaps even on new industries (like in the McKinsey report). The latter takes time; import substitution works immediately.

      You ask why not make the whole country a FTZ. Wouldn’t be possible because one cannot change an entire country from A-Z in a short time frame. So think of my FTZ as something like “little Germanies” where everything works as well and properly as in the small to mid-sized German Mittelstand.

      And the overall idea is that the FTZ, if they work well, would rub off on the rest of the economy over the years. When people who are frustrated in their environment see something else which works well, they are motivated to copy that. In this paper I have described this in more detail.

  2. Little Germany's or Little Kiautschou Bays - whatever they are they are about granting tax and other concessions - labour, health & safety, environment etc.

    They result in DISTORTED trade not FREE Trade, the latter would treat all producers and consumers as equals wherever they are.

    I'm not totally opposed to the idea of concession zones as a tool in Greece's kitbag, even though I don't like the smell of them. But, I strongly object to falsely labeling such schemes as Free Trade Zones; it's deceptive conduct, probably not in Greece, I can't imagine they have robust Trade Practices law; and governments don't often drag themselves before their own courts.

    It wasn't only the Brits who used gunboat diplomacy, Germany and others lined up for their share of Chinese loot -

    Now Europeans get upset when the Shandong Bulldozer Company takes control of Italian luxury yacht maker Ferretti. Not by sailing gunboats into Sarnico or Miami harbours, but by parting with a 180 million euros - how civilized of them.


    1. Canutely King - part 1 of 2

      Reviewing your comments, I still feel that I may not have expressed clearly enough what I mean by Free Trade Zones. First, the term is poorly chosen because it implies tax-free zones. Let me call them Special Economic Zones (as the Greeks do). So, I will try one more time.

      Greece ranks by far the lowest among EU-countries on the World Bank’s Doing Business 2012 Report (#100) and by far the highest on the TI’s Corruption Perception Index 2011 (#80). If Greece could be changed to rank among the top-ten in each of these reports, economic miracles would begin to happen there quickly.

      There is NO WAY that one can change an entire country/society in a reasonably short time; at least not in a democracy. This is why I argue: don’t attempt to change the whole country in a short time because that won’t work anyway; instead, start with several “pockets” (SEZs) which you structure in such a way that they are “near-perfect” from day 1.

      My role model is China. The old communists there realized that communism was not best answer for feeding one’s people on a sustained basis. They adhered to communism but they allowed several “pockets” where market mechanisms were put in place. And those initial pockets subsequently rubbed off on a much larger segment of Chinese society. And they are still communists…

      Actually, I am not thinking of any special “perks” for the SEZs. Employees, companies and owners would be “perfect” tax payers. Unless you consider a liberalized business framework as a special perk (in Greece you would have to!).

      What would be offered to an investor in an SEZ? In general, pretty much everything that he would like to have. Specifically, no red tape in forming a company (for example: a one-stop office for all necessary permits and a 30-day turn-around); more or less free labor regulations; more or less free salary/wage negotiation between company and employees; guarantee of political risk for investments from abroad; etc. etc.

      Now, let’s say I am a wealthy Greek with 100 MEUR in foreign bank accounts which yield me about 2% at the moment. For an attractive business opportunity in Greece, I would be willing to invest 5 MEUR out of those 100 MEUR. And, to use my favorite example, I see that all toothpaste in Greece is imported.

    2. Canutely King - part 2 of 2

      I educate myself how toothpaste is manufactured and I discover that one needs machines, ingredients and people for it. I do my math to figure out how much I can pay for machines, ingredients and people and still make a decent return on my investment (say 10%?). I don’t worry about market demand because I already know exactly how much that demand is (the amount of imported toothpaste).

      Obviously, I will have to do my math in such a way that my price will be competitive with the price of imports. Even if it is, it might initially be difficult to get people to no longer buy imported toothpaste because they have gotten accustomed to it. So this is where I would ask the government for a perk: to temporarily apply a special tax to those imports so that people have an incentive to buy domestic toothpaste. I commit to the government that I will not “misuse” that temporary protection. In other words, I will hold on to my internationally competitive prices. And in a year or two, I ought to be able to get along without further protection.

      The only one who loses in this game is the foreign exporter. But Greece is such a small market that losing it will not really harm any present exporter (and the exporter himself could opt to invest in domestic production!). Also, if things don’t change soon in Greece, the exporters to Greece may no longer want to export, anyway, for risk of not getting paid.

      If I were a Greek politician, I would note the success of the new toothpaste company (less money spent for imports and new jobs, new personal and corporate taxes, and new taxes on dividends). I would ask for a list of other imports which could be substituted with domestic production the same way as the toothpaste example. And very soon there could be hundreds of new companies like the above.

      If I were an unemployed Greek, I would try to get a job in the SEZ. I might get paid less than my friend at the National Railway but I know that my income will go up with productivity and not down because of austerity.

      And finally: the Greeks outside the SEZ won’t be able to ignore that there are good things happening in the SEZ. In the beginning, the Greek political fundamentalists will brainwash them and explain that SEZs are nothing but sweat shops or exploitations of human beings. But when they see over time that the Greeks in the SEZs are happy campers who can steadily improve their living standard, they will undoubtedly begin asking why the whole country isn’t like an SEZ.

      To sum up: if and when entire Greece becomes an SEZ as above, then Greece will have become a modernized country with a modern administration and a competitive business framework. But that takes a generation, at least!

      Could I convince you this time around?