The Vacation Is Over: Implications for the Caribbean of Opening U.S.-Cuba Tourism

The trade literature regularly seeks to explain how barriers affect trade. For example, recent work that more tightly linked the workhorse gravity trade model to its empirical applications solved a major puzzle as to why borders reduce trade.¹ Empirical studies have measured export growth after European Monetary Union (EMU) or World Trade Organization (WTO) accession, or the industrialization of China.² Similarly, this study seeks to estimate the impact on the Caribbean of normalizing bilateral tourism trade between the United States and Cuba.

The kaleidoscope of nationalities, languages, races, and political and colonial histories, coupled with what at first appears to be comparable endowments, makes the Caribbean a unique natural experiment for trade. Moreover, the importance of tourism for the region’s economies fuels interest from policymakers and academics. For example, a recent passport mandate for U.S. travelers to the Caribbean set off intense lobbying by the affected economies to stop a transitory cost asymmetry relative to Mexico. Similar concerns were raised in response to the drop in banana and sugar exports to EU countries from their former Caribbean colonies.

On the issue of the supply shock from an opening of U.S. tourist flows to Cuba, concerns have arisen over the need to brace for such competitive pressures.³ For example, the very high cost of visiting Cuba compared with the perfect trade integration of the U.S. Virgin Islands suggests that the current restriction provides substantial trade protection to the latter. The rest of the Caribbean lies somewhere in between these two extremes, with U.S. tourist arrivals driven at least in part by preferential trade positions relative to Cuba. Under a scenario in which U.S. tourist flows to Cuba are unrestricted, the market will need to find a new equilibrium, as the largest consumer of tourism services in the region meets for the first time in nearly fifty years the region’s largest potential producer. As this deadweight loss is lifted from U.S. consumers, Caribbean vacations will be repriced, based on fundamental costs, and new tourism consumption patterns will emerge across all destinations and visitor countries.

Previous research has not reached a consensus on the impact of liberalizing Cuba-U.S. tourism on the Caribbean. In particular, earlier work forecasting tourism without the current restrictions draws on potentially unreliable data or on untested assumptions. For example, Padilla and McElroy (2003) project arrivals based on a comprehensive historical review, including evidence from the 1950s and industry surveys. These projections appear plausible, but they are not tested econometrically and the resulting conclusions depend on qualitative evidence that is difficult to benchmark in the wake of a major structural change.⁴ This study shapes a liberalized Cuba-U.S. tourism counterfactual by estimating a gravity trade model of the Caribbean tourism industry. This model, grounded in consumer optimization across differentiated international products, can successfully explain upward of 85 percent of the variation in the trade data used here. These estimations are anchored in macroeconomic, industry, and socioeconomic data from international sources so as to minimize Cuba-specific uncertainty. The measures employed are standard in gravity models, which have enjoyed great empirical success in the trade literature.⁵ Moreover, the gravity model allows tests of whether Cuba and competing Caribbean destinations adjust their tourism base to hedge potential gains or losses in the wake of free Cuba-U.S. tourism trade. The model estimates presented reflect both the current distortions in Cuba-U.S. tourism relations, as well as the underlying fundamentals that determine the long-run equilibrium.

The results presented here point toward two major findings. First, liberalized Cuba-U.S. bilateral tourism would increase overall arrivals to the Caribbean. This surge will likely drive tourism in Cuba to full capacity, although much is unknown about short-run supply constraints. As U.S. visitors overwhelm capacity, Organization for Economic Cooperation and Development (OECD) visitors currently vacationing in Cuba would be redirected toward neighboring countries. Hence, while short-run constraints bind in Cuba, the region would enjoy a period of sustained demand. In the...