“We’re not afraid of the market”: Far-reaching reform of state-owned enterprises in the making

The “Ley de Empresas” is intended to give large parts of the state sector in Cuba extensive autonomy (Source: Cubahora)

Cuba’s state-owned enterprises are expecting to see major changes soon. After several gradual reform steps, a new enterprise law (“Ley de Empresas”) is going to be passed this year: It’s about to be nothing short than granting real autonomy for large parts of state-owned enterprises (SOEs), whose directors will be able to act independently instead of waiting for guidelines and allocations from ministries. Much of what has been announced for years as part of the country’s new economic strategy is thus to become the applicable norm. Representatives of the Ministry of Economy and involved economists presented its basic pillars in a special TV-emission last week. But why is the reform important at all – and where does it start?

There are currently 2417 state-owned enterprises in Cuba. They employ 1.43 million people (about 30 percent of all employees; the largest part of the state sector is the budget-financed sector such as education, health, administration, etc., which employs about 3 million people) and account for 87 percent of the gross domestic product. 75 percent of all exports and 92 percent of all sales are conducted through state-owned enterprises. The average monthly wage in state-owned enterprises was 4859 pesos at the end of April, which is equivalent to US$40.

Left: Current breakdown of the state sector into traditional state-owned enterprises (blue), branch enterprises (orange), market companies (gray), and state-owned SMEs (yellow). Right: Most important branches of SOEs: Trade (19%), manufacturing industry (16%), business services and real estate (13%), agriculture (11%), construction (7%) and Hotels and restaurants (6%) (Source: Cubadebate).

A closer look at the structure of the sector reveals its problems: 278 SOEs are permanently loss-making. Although this number is significantly lower than it was a few years ago, when it exceeded 500, the structural problems remain: 309 enterprises have sales revenues of less than two Peso-cents per unit, which means they are practically stagnant. The percentage of SOEs that make a profit but are not efficient in doing so is much higher: 80 percent of all profits are generated in only 56 companies.

The diagnosis of the state sector’s problems has been made at length at the past three congresses of Cuba’s Communist Party: Too many bureaucratic structures, lack of incentives for workers and credits for the enterprise, high labor turnover, too little innovation, and little leeway for factory managers. Economist Ileana Fernández summarized the problems of the current administrative-centralist model on the programme last week, where the new law was presented:

The mechanism is: every time a problem occurs, it has to be solved manually. And if every time a problem arises, it has to be solved manually, one problem is solved here, while the next one arises elsewhere; this is how we have handled it for many years. This has led to the fact that even when we have protected decisions that were undoubtedly in the interest of society, distortions in the microeconomy have arisen. Here’s the point: when we say that we need to change the environment, we mean the microeconomic environment in which the company operates. […] One example of these distortions is prices. Prices have to perform their function as a measure and a signal. So when you impose price controls for one reason or another, you introduce a distortion, because that control is not the ultimate control. What is it controlling? The exchange rate, the price of the currency, or in this case the exchange rate, the interest rate, the changes that may occur in, say, wages. When you administratively establish that here that cannot go up or this must go down, and when you start to establish a series of elements, wage scales or whatever, you start to interrupt the logical and normal process that should be maintained and should be a positive cycle for the company. […] The entrepreneur, as the name suggests, has to be an entrepreneur. And to be an entrepreneur, you have to make decisions.

A number of steps have already been taken to address this problem, but they have not brought the necessary success. For example, as of 2015, state-owned enterprises were allowed to retain 50 percent of their profits (instead of 30 percent previously) and the planning indicators were drastically reduced. With greater financial autonomy, wage and investment funds were to be formed to recapitalize the companies from their own resources. At the same time, the reform gave companies greater autonomy in designing incentive systems to help eliminate the “inverted wage pyramid” often criticized by Raúl Castro, in which pay decreases with increasing responsibility. With few exceptions, the direct management of businesses by ministries was abolished. Instead, companies were integrated into sector-specific umbrella organizations called Organización Superior de Dirección Empresarial (OSDE). This was intended to disentangle company and state functions. In practice, however, the OSDEs increasingly developed into “mini-ministries” that took over direct management of the companies and wanted to have every decision approved in advance. When it comes to loans, foreign currency funds and the supply of raw materials, the factories are ultimately always at the mercy of the higher-level agency again.

With the reform, the number of indebted companies declined with the reform and wages increased significantly – although starting from a low level. Despite these successes, the approach ended up being too gradual to have any real impact. Old patterns prevailed, and plant managers once again became accustomed to receiving allocations and orders “from above” instead of being able (and forced) to take the initiative themselves. With the current crisis starting in 2020, when all foreign exchange concessions were recentralized, SOE autonomy was even temporarily removed altogether. Starting in the fall of 2021, first steps towards enterprise reform were taken again: A first batch of companies were given the opportunity to define salary scales themselves and decide independently on hiring, firing and the level of bonuses and salaries. Until then, a standard table applied everywhere, graded according to the degree of complexity of various professions. “However, not all companies are the same, not all produce the same thing and have the same workforce. Also, conditions differ in different provinces,” Fernández said. Until now, this reform is taking effect in 626 companies, a good quarter of the state sector with around 600,0000 employees. In addition, several hundred so-called branch companies and state SMEs have been founded; smaller, autonomously functioning spin-offs with which the bureaucratic processes of the parent company can be circumvented.

So how is the current piecemeal approach to be molded into a “grand design”? Fernández explains that the current administrative allocation of resources and products must be replaced by the market. “We are not afraid of the market, the market is regulated by the state. It just has to work. There must be access to the market and the market will start to see signals: If you have the money, you will be able to buy. If you don’t have the money, they won’t be able to get in. If you are more efficient as a company, you will have better conditions for access,” Fernández said. By using the market in the allocation process, prices will gradually become “real” prices that contain information about the state of supply and demand. Thus, all prices along the value chain, from intermediate products to salaries, should reflect real conditions. The idea is to automate the “manual” control of the economy to a great extend by market mechanisms. SOE managers will thus have the information they need to make informed decisions – but they will also have to act accordingly, as enterprises are going to compete and can go bankrupt within the new framework. They should “operate in an environment where they can make and execute business decisions and thus make a greater contribution to the country, including in the form of taxes and duties,” Fernández summarized. “Negating the market is not the solution. The state must be enabled to compete with the private sector,” Cuba’s former Economy Minister José Luis Rodríguez demanded a few days ago in another broadcast on the subject.

The implementation of the reform will be gradual. An inventory of the state sector is currently underway, with the help of which the enterprises will be assigned to different categories. The various types will be provided with specifically adapted management forms in each case as part of the Enterprise Law:

  1. Locomotives in “market mode”: This group will contain well over 1000 companies (the talk was about almost 80 percent of SOEs). These are profitable companies, often involved in exports and making a major contribution to the national economy. They will be given the greatest possible autonomy and will be in competition with each other. They are allowed (and required) to supply themselves independently via the market and operate with hard budget constraints that include the possibility of insolvency.
  2. Monopolies: This refers to the command heights of the economy. Companies such as the state-owned energy utility Unión Eléctrica, the water industry or the oil company CUPET fall into this category, which will account for around 200 companies (about 10 percent). They will continue to receive subsidies and operate as monopolies without competition, but they must also expect less autonomy in management.
  3. Basic care providers in “manual mode”: Heavily subsidized companies that make an important contribution to basic social services and will continue to operate with predefined salary scales and fixed prices. This category includes, for example, pharmacies, opticians, municipal services and transport companies.

One important task of the law is to cut off old braids and standardize the rules for those companies that are going into “market mode.” One operations director told in the TV-emission: “There’s a regulatory system in place today that has survived six or seven different phases of corporate reform – but it’s still in place, and every time you try to implement something, you can run into a regulation from 1976, ’85 or ’91. Looking at the past to deregulate is important to move forward in the future,” said Antonio Vallin, who heads the AICA laboratory group within the state-owned BioCubaFarma group. The company recently spun off “AicaSi,” a state-owned SME dedicated to developing sensors and automation software. “Under the current conditions, this kind of things are easier than they used to be, but it’s still not a given. There are things that require great effort, that require a high level of consultation, that you have to ask permission for in order to get something done,” Vallin reports.

In addition, he said, the autonomy of companies in managing their foreign exchange accounts must be restored as soon as possible: “If a company does not have financial autonomy, it becomes a budget-financed entity. Then responsibility is shifted to others, along the lines of ‘After all, I’m not responsible for saving, spending, etc.,'” Vallin said. Another requirement, he said, is freedom of association, both between state-owned enterprises and with private enterprises and foreign investors. This, he said, runs today “in a slow way, needs a lot of approvals that take a long time. […] Decisions are made in companies within one or two weeks, not within three or four months,” Vallin said. He suggests implementing a mode of “silent approval” (“silencio positivo“), after which a decision is automatically approved if there is no response from the relevant body within 72 hours. However, “there is more and more support for new ideas, and the level of discussion about their implementation is also increasing,” he noted.

An important structural problem is the low density of businesses that Cuba has. “Cuba has half the number of companies per capita as the average of Latin America,” Vallin said. “For the development of our country and our industry, we need more companies, especially those that export, that have an advanced technological level and can insert themselves in the world market.” Demographic challanges are also forcing the country to become more efficient, Vallin explained. “Soon we will have more people over 60 than working age. It’s inevitable to lay this technological foundation with the new enterprise law, the new forms of administration and everything we’re doing now.”

The first draft of the Ley de Empresas is to be presented in the coming months, its adoption by the National Assembly is sheduled for December.

This article was first published on Cuba Heute, a German-language news portal.

You May Also Like