Croatia

   

Economic Policies

#39
Key Findings
Despite notable recent gains, Croatia’s overall score for economic policies places it in the bottom ranks (rank 39) in international comparison. Its score on this measure has improved by 0.8 points since 2014.

The robust growth levels seen in recent years have slowed somewhat, but remain steady. However, investment and gross capital formation rates have fallen. While public debt levels remain high, with a significant share held externally, deficits have been replaced by small surpluses, and the country has exited the EU’s excessive deficit procedure.

Unemployment rates have fallen to around 8.4%. Employment rates are low but rising, while wages that fell or stagnated during the recession have begun to rise. Labor demand is skewed toward low-skilled jobs, driving university graduates in particular abroad. However, emigration among the working-age population more generally has resulted in worker shortages in key sectors.

A new round of tax reforms has reduced VAT on key consumer items, and reduced the VAT rate overall. The personal-income tax has limited redistributive effects. A planned property tax has been repeatedly postponed. Private-sector R&D rates are growing, but research expenditures remain very low by EU standards.

Economy

#39

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
4
After six consecutive years of recession (2009–2014) the Croatian economy returned to growth in 2015. By the end of 2017, nominal GDP had returned to its 2009 value. While the growth of the Croatian economy continued in 2018, the real GDP growth rate slowed from 3.5 % in 2016 to 2.9 % in 2017 and 2.8 % in 2018. Investment has shown a downward trend, with the ratio of gross fixed capital formation falling from 25.1 % in 2009 to just 20.9 % in 2017. The economy is additionally burdened by €38 billion of external debt, amounting to about 82% of GDP. While tourism, which now accounts for almost 20% of Croatian GDP, grew strongly, industrial production lost momentum. In mid-2018 it turned out that the shipyards in Pula and Rijeka were on the verge of financial disaster. Now that the European Union has rejected the restructuring plans created by management, it remains unclear whether two of three biggest shipyards in Croatia will manage to survive.

Economic policy under the Plenković government had initially been preoccupied with the economic problems of Agrokor, a large and politically well-connected food-and-retail chain whose 143 companies and almost 60,000 employees have made it the biggest private holding in Croatia and the western Balkans. Although the creation of a receivership based on a controversial April 2017 law left some loose ends behind, the company successfully completed the out-of-court settlement process in July 2018, with Russian banks Sberbank and VTB banka gaining the largest share of ownership (approx. 47%). While the Agrokor case has been settled and the quality of economic policy has somewhat improved under the guidance of the European Semester process, the Plenković government has so far failed to raise productivity, to create a reliable economic framework and to foster the international competitiveness of the country. In the World Bank’s Doing Business survey, Croatia dropped from the 51st place down to 58th and was overtaken even by some regional non-EU members.

Citations:
Ivanković, Ž. (2018): Slučaj Agrokor: privatizacija i crony kapitalizam. Zagreb: Naklada Jesenski i Turk.
Kotarski, K., Petak, Z. (2018): Croatia’s Post-communist Transition Experience: The Paradox of Intial Advantage Turning into a Middle-Income Trap, in: Z. Petak, K. Kotarski (eds.), Policy-Making at the European Periphery: The Case of Croatia. Cham: Palgrave Macmillan, 17-25.

Labor Markets

#39

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
4
After steadily increasing from 2009 to 2014, the unemployment rate fell from a peak of 17.5% in 2014 to 8.4% in October 2018, while the number of unemployed in the same year, which fell to approximately 130,000, was the lowest Croatia has had since 2008, one year before the economic crisis of 2009. A similar unemployment rate was recorded in Croatia in the final years of former Yugoslavia (8.0% in 1989 and 8.6% in 1990). The number of employed persons has almost reached the pre-crisis level: In 2017, there were 1,625,000 employed persons, which fell just short of the highest level achieved so far – 1,636,000 – in 2008. Despite this improvement, it is notable that Croatia has one of the lowest employment rates in the EU, at just 61.9% in the third quarter of 2018, compared to an average of 69.0% in the EU. A particularly troubling aspect of Croatia’s labor market is the structure of labor demand. It is highest for waiters, cooks, shop assistants and drivers – not particularly encouraging for young people with university qualifications, who therefore seek opportunities outside Croatia.

Wages have been falling or stagnant during the period of recession and have only just begun to increase. The overall share of wages in GDP fell from 49.5% in 2009 to 46% in 2017. At the end of 2017, the minimum wage was raised by 5% to €456 per month. Nominal wages are expected to increase by around 2.5% in 2018 and 2019. At the same time, there are other encouraging signs of improvement in the labor market, including an increase in the proportion of permanent employment contracts in the total number of new hires and a corresponding reduction in temporary contracts.

Croatia’s labor market has been significantly affected by the working-age population’s emigration to developed European countries, which has resulted in a serious shortage of workers in sectors like construction, tourism, hotels and restaurants and agriculture, but also in a growing number of industrial sectors. The Plenković government has been trying to solve this problem by importing workers from other countries (primarily from those outside the EU) and by introducing employment policy measures that would stimulate the working-age population to join the labor force. But the government managed to increase the number of the working-age population only marginally.

While the number of participants in active labor market programs has quadrupled since 2010, the adopted measures have not been very effective. Long-term unemployment has remained high, and only a small number of program participants have eventually found a job, mostly in the public sector. In the case of young people, the expansion of active labor market programs has led to the neglect of other ways of entering the labor market, such as internships and traineeships. Nevertheless, policy in this area is improving, especially following the introduction of a new network of career-guidance centers across Croatia in partnership with local authorities, which provide individual and tailored career guidance to all, but with a focus on young people not in employment, education or training (NEETS).

Taxes

#27

To what extent does taxation policy realize goals of equity, competitiveness and the generation of sufficient public revenues?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
5
Tax reform has been among the top priorities of the first Plenković government. Immediately after coming to office in November 2016, it presented a first comprehensive reform package. Drawn up by Minister of Finance Zdravko Marić already under the previous government, it aimed at amending a total of 15 tax acts. The measures adopted that became effective already in 2017, included cuts in the corporate income tax from 20% to 18% (and 12% for small and medium-sized enterprises), the adoption of two rates of personal income tax (36% and 24% instead of 12%, 25% and 40%) combined with an increase of non-taxable income from HRK 2,600 to HRK 3,800, as well as adjustments to VAT and excises. At the same time, the personal income tax has become less progressive. This has further limited the redistributive effects of the tax system, which relies strongly on VAT and social insurance contributions.

In 2018, the government adopted a second tax reform package that is scheduled to take into effect on 1 January 2019. The package is supposed to include additional HRK 1.4 billion of tax reliefs based on reducing the VAT on fresh meat, fish, eggs, fruit, vegetables and diapers from current 25% down to 13% and – as of 2020 – additional HRK 1.6 billion by reducing the general VAT rate down to 24%. In addition, the government is planning to raise the income threshold for applying the top income tax rate of 36% from current HRK 17,500 (€2,300) to HRK 30,000 and more (approx. €4,000). With this measure, the government wants to raise net salaries in the high-technology sector and in the professions like physicians, IT experts and pharmacists, in order to prevent the drain of these workers from the country. Once again, the government gave in to public pressure and has postponed the introduction of a real estate tax, although finance minister Marić’s tax administration made all necessary preparations for it long ago.

Citations:
Blažić, H., Grdinić, M. (eds.) (2018): Tax Policy and Fiscal Consolidation in Croatia. Rijeka: Faculty of Economics and Business.

Budgets

#21

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
6
When Croatia joined the European Union in July 2013, it was almost immediately placed under the EU’s excessive deficit procedure. However, successive governments have managed to reduce the general government fiscal deficit from a peak level of 7.8% in 2011 to about 1% in 2016. In 2017 and 2018, the general government even ran small surpluses. Since 2016, Croatia’s relatively high public debt has fallen. As a result of these improvements, Croatia was able to exit the excessive deficit procedure in June 2017. The fiscal improvements in 2017 and 2018 have largely stemmed from the higher-than-expected GDP growth and the decline in interest payments. In 2017, the government paid HRK 9.7 billion for interest costs – HRK 2.3 billion less than in 2015. The government has failed to reduce the various expenditures that, according to leading Croatian economists, are associated with clientelistic arrangements. Further concerns about the medium-term sustainability of budgetary policy have been raised by the slow progress with amending the 2011 Fiscal Responsibility Act and with improving budgetary planning as recommended by the European Commission and the IMF for some time.

Research, Innovation and Infrastructure

#37

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
3
Croatia lacks a coherent and integrated policy framework, companies have low technological capacity to support innovation, and technology-transfer mechanisms are inadequate. Total gross domestic spending on R&D increased from 0.74% of GDP in 2010 to 0.86% in 2017. The small increase was driven almost entirely by increased R&D expenditure by the business sector, while R&D expenditure by the government and higher education sectors stagnated. However, in relation to the EU average R&D expenditure has been falling, and by 2017 Croatia was in 23rd place among the EU member states. It is the same with the number of patents registered: According to Eurostat statistics, Croatia ranks last in the EU, with only three registered patents on one million inhabitants. Overall, the EU Innovation Scorebord reveals Croatia to be only a “moderate innovator.”

Global Financial System

#38

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
4
The accession of Croatia to the EU has brought greater integration of the financial system. The EU’s single passport system for financial institutions allows banks regulated by their home country authority to set up branches in Croatia. Previously, foreign banks were only allowed to establish subsidiaries under the regulatory supervision of the Croatian National Bank. With the passing of domestic regulatory authority from the Croatian National Bank to that of the foreign banks’ home country, an important protection for the Croatian financial system has been removed. This renders the Croatian financial system more vulnerable and increases the risk of cross-border contagion in the event of a new financial crisis. While Croatia is rather vulnerable to developments on the global financial markets, its governments have not played a major role in global attempts at reforming the international financial system. Nor have they cracked down on money laundering. Croatia is part of the “Balkan route,” a major trade corridor where trade-based money laundering takes place. The Anti-Money-Laundering Office is understaffed and the rate of convictions for money-laundering offenses remains relatively low.

The Croatian National Bank produces an annual Financial Stability Report. However, this focuses mainly on domestic issues. The latest report declared that the banks remain well capitalized and financial stability had not been put at risk by the adverse events surrounding the Agrokor Group.

Citations:
Croatian National Bank (2018): Financial Stability, No. 19. Zagreb (https://www.hnb.hr/en/-/financijska-stabilnost-19).
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