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Article Excerpt
I. METHODOLOGICAL CONTRIBUTIONS TO LEGAL
SCHOLARSHIP A. A Deflationary View of Central Bank Independence B. Using Rent-Seeking Analysis to Track Creditor Influence on Government Design C. The Implications of the Rent-Seeking Theory to the Central Bank II. CUBA'S FOREIGN FINANCING POSITION A. Foreign Direct Investment B. Cuban Credit Market C. Monetary Disincentives to Increased Foreign Investment 1. Dollarization 2. Dedollarization III. ANALYZING THE CUBAN CENTRAL BANK'S INDEPENDENCE A. Central Bank's Exposure to Deficit Financing B. Capitalization and Appointment Tenure IV. COLLATERALIZED GOVERNMENT BORROWING TO SIGNAL FISCAL SELF-BINDING V. RECOMMENDATIONS TO U.S. AUTHORITIES A. Repeal of the Johnson Act B. Facilitating Access to Foreign Exchange Swap Lines for Currency Stabilization VI. CONCLUSION
A citadel of socialist values, the Cuban economy has resisted the global trend of neoliberal financial reform that has swept through other developing countries. As part of a modest liberalization of the finance sector during the 1990s, however, the Cuban government established the Cuban Central Bank in 1997. (1) In the context of central bank governance, the neoliberal trend in developing countries has been toward increased formal and substantive central bank independence from executive oversight. (2) The Cuban Central Bank bucks that trend. In the United States, academic interest in legal aspects of the Cuban economy is growing in tandem with its selective liberalization, despite onerous federal governmental constraints on these studies. This Article contributes to this literature by exploring the impact of financial signaling by the Cuban government on decisions by prospective foreign investors on whether to invest in Cuba. In doing so, this Article asserts that Cuba could rehabilitate its market credibility deficit and mitigate the effect of its legal disabilities under U.S. law through collateralized debt transactions in the open market and through monetary reforms.
This Article considers how central bank governance structure operates as an investment signal to potential foreign investors with respect to the term of their potential investments. Although rejecting the conventional explanation that central bank independence signals low inflation, this discussion shows that central bank independence does send a favorable investment signal because independence shows official openness to opportunistic deal making (rent-seeking) (3) with financial firms for a longer term than deals possible with a dependent central bank. It further shows that the Cuban Central Bank is not independent and hence, does not send a favorable investment signal to financial firms considering investment with respect to term. Recognizing that proper financial signals induce foreign investment, this Article proposes that Cuba may replicate some of the signaling value of central bank independence through issuing collateralized government securities. This Article recommends complementary reforms to the Cuban and U.S. governments that would increase the Cuban Central Bank's financial signaling capabilities.
Part I suggests that the signaling value of central bank independence in developing countries reflects the value of potential rent-seeking between foreign investors and officials, rather than expectations of low inflation. Part II describes Cuba's access to foreign financing in the form of foreign direct investment and credit flows and explains how Cuban monetary policy has inhibited increased foreign financing. Part III explains how the governance structure of the Cuban Central Bank signals that the institution is not formally or substantively independent of oversight from other governmental actors. Part IV urges the Central Bank to issue collateralized governmental debt to replicate--albeit only at the transactional level--some of the signaling benefits of central bank independence. To complement this proposal, Part V identifies crucial changes to U.S. law which could improve Cuba's capacity to manage its public financing on market terms. Part VI concludes by inviting other scholars to encourage constructive discourse on Cuban credit market structure.
I. METHODOLOGICAL CONTRIBUTIONS TO LEGAL SCHOLARSHIP
This Part explains the meaning of central bank independence as a signaling device for ensuring compliance across time with bargained-for expectations of government officials and political and market constituencies. The idea that central bank independence attracts foreign investment to developing countries by signaling low inflation is incorrect. Signaling refers to an intentional message sent by party A--typically about party A's future behavior--to party B in order to influence party B's behavior with respect to party A. (4) The signaling considered here refers to deliberate regulatory and market actions taken by the Cuban Central Bank (Central Bank) observable to international asset holders on the lookout for attractive investments. (5) Instead of signaling low inflation, independence may reflect a political economy in which private creditor interests influence central bank design with respect to the term of financial arrangements. The upshot of this view for the Central Bank is that it will not become independent until the development of a private creditor class capable of promoting its term and other balance sheet interests through lobbying the public sector.
A. A Deflationary View of Central Bank Independence
The central bank independence hypothesis claims that a central bank not accountable to elected officials is better at setting interest rates, which in turn impact present consumption, employment rates, the business cycle, and inflation. (6) According to the hypothesis, interest rates are best determined on the basis of a medium-term rather than short-term horizon. (7) Reducing interest rates increases present consumption and creates short-term economic prosperity (and risks inflation). (8) When elected officials control the central bank, interest rate determinations reflect the short-term survival strategies of self-interested incumbents exposed to the recurring risk of removal on Election Day. In the interest of self-preservation, elected officials may reduce interest rates before Election Day to create well-timed, albeit short-lived, prosperity. (9) When central bank governors with long tenures determine monetary policy free of interference by elected officials--so goes the hypothesis--the central bank sets rates with better regard for long-term growth prospects. According to the independence hypothesis, monetary policy, so structured, will produce better inflation outcomes and optimize social welfare. (10) Independence mechanisms can range from fully self-binding to minimally self-binding. (11)
As developing countries restructure their financial sectors to attract more foreign capital, reform has been toward greater central bank independence. (12) Proponents of the central bank independence hypothesis assert that independence leads to good inflation outcomes and it is the anticipation of this inflation outcome that foreign investors may find appealing. (13) However, the view that foreign investors read independence as a proxy for good inflation outcomes engineered by an apolitical central bank has recently come under sustained attack. Empirical evidence links independence with good (that is, low) inflation outcomes, not in developing countries, but only in more developed countries, which rely more on domestic savings and credit than on foreign financing. (14) Foreign investors in a developing country know, therefore, that not mere independence will protect their investments from loss due to ensuing inflation.
Why then would a developing country's government claim that increasing the independence of its central bank would signal creditworthiness to international asset holders? The answer lies not in the inflation correlation of independence but in viewing central bank independence as a long-term deal between officials and the financial sector, that is, rent-seeking. (15) The following Part will further explain the rent-seeking argument.
B. Using Rent-Seeking Analysis to Track Creditor Influence on Government Design
Among regulatory processes, central banking is especially suited for rent-seeking--and concomitantly rent-seeking analysis--because a central bank is perhaps the only government actor that performs its regulatory functions on the market by transacting in the market again and again. (16) Hence, an ideal forum for deal making is created between officials and market participants, for whom each interest rate determination is an opportunity to make a deal, monitor prior deals, or retaliate for breach. Seen this way, commercial banks in the United States seek rents happily by pressing their dynamic preferences about the discount rate through the Federal Open Market Committee. (17) More generally, rent-seeking provides a critical perspective from which to view banking history, such as how the U.S. Federal Reserve System became independent of the U.S. Treasury. (18)
Rent-seeking is particularly useful for analyzing foreign investment in developing countries because neoliberal conventional wisdom advocates a tight nexus between authorities and market participants during the construction of a country's financial infrastructure. (19) Rent-seeking is also more relevant in a political economy--like Cuba's--in which the government commands economic ownership and production. (20)
An academic authority on central banking has forcefully argued how rent-seeking may contribute to the emergence of independence in central bank governance. (21) An independent central bank represents a loss of executive discretion to politicians who could otherwise exploit interest rate setting for their own career (or other) interests. (22) Self-serving politicians would sacrifice such a valuable right only because the establishment of an independent central bank represents a way for these politicians to extract rents from special interest groups by promising ex ante not to produce inflation. (23) In other words, by making a longer-term deal with special interest groups not to inflate the currency, the politician can actually extract more rents than if she makes an initial deal with the group, encourages inflation to disrupt the deal, and then extracts new rents in exchange for resolving the conflict in favor of her rent-seeking counterparty. (24) But:
[T]he politician needs a mechanism for reliably precommitting not to engage in inflationary actions. The independent central bank is a relatively reliable (although not perfect) precommitment mechanism. Thus, self-interested politicians may favor independent central banks even though, in doing so, they relinquish the enormously important power of price-level control. (25)
To be more explicit, the rent-seeking deal between the official and the political or market constituency is an extralegal contract (26) with no formal enforcement mechanism but imbued with all of the counterparty considerations typical of a legal bargain. This is not to suggest that dependent central banks refrain from rent-seeking. Quite the contrary, deals between officials and other constituencies may occur more frequently for the reasons that form the predicate of the central bank hypothesis. Independent governance does not determine the incidence of deal-making, but rather the governance structure of the deal. In other words, a viable pre-commitment mechanism lets the counterparties pursue their expectations over a longer time horizon. (27) What then does central bank independence in both developing and developed countries really signal? Central bank independence is a sign of good things (other than low inflation) to come, namely rents. (28)
One implication of this view is that modeling rent-seeking as a type of extralegal contract extends transaction costs analysis to public institutions--in this case to a quasi-public institution charged with conducting macroeconomic policy. (29) More generally, the impact of creditor interests on state formation through rent-seeking may be studied through transaction cost economics, which uses the transaction as the relevant unit of analysis. Transaction cost theory would suggest that the transaction must have a governance structure and that the costs associated with entering the transaction would determine whether the deal is executed. (30) These transaction costs are matters of public interest.
For example, assuming, as does this Article, that rent-seeking drives state formation more broadly, a rent expenditure budget of the deal implemented in any central bank's chartering legislation would be useful. Such an analysis would treat rents as notional outlays of budget resources. The analysis would identify the financial stakeholders in central bank design, consider competing deals between them and the government, and finally, analyze the allocative efficiency and distributional impact of the final deal enacted. (31) Sobering behavioral assumptions about individual and institutional action have enormous policy value when considering how private constituencies impact state structure. (32) Assuming a more robust form of self-interest explains much of daily economic life's ordinary depravity. (33) Such an approach also spans law and economics, alterity narratives, (34) and other postmodern methodologies (35) which have historically maintained theoretical boundaries with respect to each other. (36) In the spirit of synthesizing critical and economic discourses, this Article proposes a financing vehicle to remedy the signaling issues raised by the Central Bank's governance structure. (37) The importance of signaling to attract foreign financing becomes clearer after appreciating the credit scarcity and illiquidity which characterize Cuba's dire foreign financing position, and will be described in the following Part.
C. The Implications of the Rent-Seeking Theory to the Central Bank
Rent-seeking theory also supports the emergence of a dependent central bank in a political economy without robust rent-seeking by finance firms with interest rate preferences. By counter-implication of the thesis that central bank independence serves as a pre-commitment mechanism for bargained-for rents, the Central Bank is unlikely to gain independence without the emergence of a nongovernmental creditor class with enough political clout to lobby its interest rate preferences. The Cuban banking sector reforms of the 1990s have resulted in an institutionally differentiated market structure, although centralization of government discretion reduces the viability of any single banking institution as a pre-commitment mechanism. (38) Although foreign banks may open representative offices on the island, the government conducts all domestic banking. As a result, Cuba does not have a robust private financial sector ready to seek rents from the government through private deals. (39) Therefore, Cuban officials may restructure the banking sector with relatively little resistance from external creditor interests. A dependent central bank does not necessarily signal to foreign investors that inflation is on the way. Actually, it has unfortunately been a fact of life in Cuba for some time. Instead, it signals that long-term rent-seeking is not one of the rules of the game. (40)
Recommending government action to increase formal independence by amending the Decree-Law creating the Central Bank (41) is futile. A private rent-seeking economy must grow before the financial sector can shape central bank design to serve the term interests of the sector's balance sheet. For these reasons, the Central Bank will become independent not due to political reform--even that urged by U.S. democracy activists--but only after the entrenchment of a private creditor class capable of pressing demands on government officials.
Since the Decree-Law does not create an independent institution, (42) and since more independence is unlikely in the future, what may the Central Bank do now to improve the island's foreign financing position, including securing a longer term for foreign investment? Affirming the importance of more access to foreign financing for Cuba, Part IV recommends a proposal to use collateralized government debt to extend the term of official borrowing and to signal openness to commercial expectations. The relevance of this proposal becomes more obvious after understanding the credit scarcity and monetary confusion which characterize the current Cuban economy, discussed in the following Part.
II. CUBA'S FOREIGN FINANCING POSITION
Cuba's foreign financing position is composed primarily of limited foreign direct investment and debt obligations. Although Cuba repaid its obligations to the International Monetary Fund (IMF) after withdrawing from the organization in 1964, (43) Cuba currently faces a debt sustainability problem and limited access to other forms of foreign financing. The current foreign financing position developed largely from the loss of favorable terms of trade with the former Soviet Union and its trading partners. (44)
A. Foreign Direct Investment
In response to the loss of Soviet financing, Cuba has liberalized its foreign investment market to attract foreign capital inflows. During the 1990s Cuba enacted several laws, including a new foreign investment law, designed to recoup financing losses caused by the loss of favorable terms of trade with the Soviet Union and other Counsel for Mutual Economic Assistance (CMEA) members. (45) To improve its contractual credibility with potential investment partners, Cuba also signed numerous bilateral investment treaties with other countries to limit the exposure of their respective nationals to Cuba-sourced political risk. (46) Although the 1995 law improves the investment climate over the climate produced by the prior foreign investment law, (47) the legal framework for regulation has failed to optimize the volume of foreign investment due to prospective investors' perceived investment obstacles. (48) At the same time, the United States has successfully injected U.S.-sourced political risk into Cuban foreign investment subject to the Helms-Burton Act. (49) As a result, efforts to attract foreign equity investment have not yet attracted enough foreign capital to meet Cuba's financing needs. (50) After scant academic interest in Cuban law, Cuba's modest liberalization reforms have produced a proportionate increase in Cuba-related legal scholarship, illustrating how in the U.S. scholarship market modes of economic production interact with knowledge production. (51) Regretfully, recent changes in U.S. policy have reduced the flows of both financial and intellectual...
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