Will Hotels and Tourism Outpace ICT in the Rush to Invest in Cuba?

President Barack Obama’s announcement on Wednesday that the United States would normalize relations with Cuba, opening an embassy in Havana and easing travel restrictions to the island after more than 50 years of embargo, is bound to stir excitement. The island economy stuck in the 1960s continues to titillate the imaginations of Americans. Many Americans want to visit and invest in the island.

Although the timing of the announcement was a surprise to all but a few insiders, the Cuban government has been preparing for such a move for years. Since assuming power from his brother in 2008, president Raul Castro has enacted piecemeal reforms to liberalize the economy, including about 300 measures intended to encourage private enterprise on the island.

Private property was authorized, legally if not as it turns out in practice. Raul ordered Cuba’s rubber-stamp legislature into special session in order to pass a law, which, among other measures, sought to entice foreign investment by cutting taxes on profits from 30% to 15% across most industries.

Last year, the crowd-sourced consultancy Wikistrat ran a simulation on Cuba that forecast a scenario wherein U.S.-Cuban political relations would normalize, but Cuba’s economy would only transition gradually. In other words, it will be a managed opening akin to China’s liberalization since the 1970s. (Disclosure: I am an analyst at Wikistrat; however, I did not contribute to the simulation on Cuba.)

Few months after the Wikistrat simulation, the Cuban government announced a spate of inducements for investors to operate in the Mariel Special Economic Development Zone. The zone is a $900-million complex that centers around the port at Mariel, which recently had its harbor deepened to accommodate the docking of super-size tankers destined to pass through the Panama Canal once the canal’s expansion is completed.

But Americans eyeing investments in Cuba face clear risks, and twinkles of a new era still have to contend with the fact that short-term investments will be made in a Cuba run by the Castros. Many of the investors who crept into Cuba in response to Havana’s liberalizing gestures have suffered losses.

The government is known for confiscating businesses once they turn profitable, and some investors, including the British businessman Stephen Purvis, were arrested.

In fact, despite Raul’s reforms, most experts believe foreign investment in Cuba has declined over the past decade. The Cuban government does not release FDI figures. But the number of foreign firms operating in Cuba dropped from 400 in 2002 to 190 in 2013.

Cuba still ranks at the bottom of the Heritage Foundation’s list of economic freedom —number 177 out of 178 countries surveyed—besting only North Korea.

Tom Johnston, an expert on U.S. investment in Latin America at Business Development Partners in Mexico City, sounded a cautionary note about Cuba: “On one hand, short to medium term political and regulatory stability is very hard to gauge, which adds risk.” “Investors from Spain, Canada, Mexico and other countries have had a free hand to invest all they want all this time and they have shown very little interest, outside of the tourist industry.”

Cuba is in dire need of investments in the telecommunications sector, but so far European and Latin American groups have shied away from the sector. The U.S. embargo, which will remain in place until Congress ends it, specifically prohibits export of telecom equipment to the island. This sector is likely to languish for some time to come. The infrastructure gap between the United States and Cuba would likely foil any attempts to quickly turn the island into a Caribbean hotspot.

Citing the uncertainty over the investment climate and the persistent infrastructure challenges, Johnston predicts the first wave of U.S. investors will focus on buying all-inclusive hotels around the resort town of Varadero and in Havana. Regional airlines and other outfits that cater to tour groups are also likely to benefit in 2015.

Eventually, the island could host factories for garment assembly and other basic manufacturing operations. For now though, investors in travel and tourism are likely to be on cutting edge of America’s new business relationship with Cuba.

One of the greatest unanswered questions remains: How much significance will Cuba have in the hemispheric emergence of IT services? Without strong ICT infrastructure, the ability for services to be exported will be crucially limited, as articulated powerfully in this Nearshore Americas report from this “Cuba Statistical Drill Down” published last year.

For Cuba to succeed, and achieve some level of economic integration the correct path, according to many experts, will be to undertake change carefully and incrementally. The desire however for US business to gain traction in the market is converse to that – and therein lies significant risk to this fragile and new beginning.