Croatia

   

Economic Policies

#35
Key Findings
Despite notable recent gains, Croatia’s overall score for economic policies places it in the bottom ranks (rank 35) in international comparison. Its score on this measure has improved by 0.8 points since 2014.

Growth in recent years has been steady and robust. Unemployment rates have fallen to below 7%, but the country has among the EU’s lowest overall employment rates. Employment rates are additionally quite regionally uneven. However, wages have begun to increase, and a new minimum-wage law is in place.

Public debt levels remain high, but the government has run small surpluses since 2017, and the country has exited the EU’s excessive deficit procedure. Successive tax-reform packages have reduced VAT on key consumer items and increased tax-rate thresholds, effectively lowering personal and corporate taxes for many. Environmental taxes are higher than the EU average.

R&D spending is rising, thanks to the private sector and universities. The country is slated to join the EU banking union, which is expected to have positive effects on the country’s regulatory system. More than 90% of bank assets are held by foreign banks.

Economy

#34

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
5
After six consecutive years of recession (2009 – 2014), the Croatian economy returned to growth in 2015. At about 3%, real GDP growth in 2019 was slightly higher than in 2018. After five years of economic recovery, real GDP finally returned to its level before the long recession. In 2019, the European Commission announced that Croatia no longer suffers from excessive macroeconomic imbalances, for the first time since the accession to the European Union in 2013. Fiscal balance and current account deficits have been replaced by surpluses.

The quality of macroeconomic policy has improved under the guidance of the European Semester process. Measures have been adopted to strengthen the institutional framework governing public finances and improve governance of state-owned enterprises. As for the professional management and privatization of state-owned enterprises, however, Croatia still lags behind.

The Croatian National Bank (HNB) has succeeded in keeping inflation in check. The private sector has benefited from ample liquidity and declining interest rates. However, policy toward the private sector has been derailed by the economic problems of Agrokor, the largest private company in Croatia and the Western Balkans. The company successfully reached an out-of-court settlement in July 2018, with two Russian banks (Sberbank and VTB banka) gaining the largest share of ownership (approximately 47%). However, the crisis was reignited in December 2019 when the Slovenian competition agency announced the seizure of one of Agrokor’s prize assets, its shares in the Mercator retail group. Agrokor’s management has described the action as a gross misuse of the law. In 2019, the number of newly formed enterprises for the first time dropped below 6,000.

Citations:
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.

Kotarski, K. (2019) The Political Economy of Euro Introduction to Croatia: a Golden Goose or a Stinging Viper? Zagreb: Hanns Seidel Stiftung (http://www.hanns-seidel-stiftung.com.hr/assets/images/uploads/euro_introduction_to_croatia.pdf).

Labor Markets

#35

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 below 7% in 2019. However, Croatia still has one of the lowest employment rates in the European Union, at just 61.8% in the second quarter of 2019, compared to an EU average of 69.3%. This figure masks a very uneven situation across Croatia’s 21 counties. Whereas Zagreb, the capital, boasts an employment rate of more than 80%, less-developed mainland counties record rates of less than 50%. Another 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.

After a period of decline, wages have begun to increase. A new minimum wage law was introduced in January 2019. The law ensures social partners are consulted when setting the minimum wage, which is to be determined on 31 October each year. At the end of 2019, the minimum wage was €505.90 per month, about 44% of the average wage. 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. Since peaking at 22% in 2016, the percentage of temporary and part-time contracts has fallen to less than 20%.

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 European Union) and by introducing employment policy measures that would stimulate the working-age population to join the labor force. 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). The Law on the Promotion of Employment was introduced in 2019 to support these measures.

Taxes

#28

How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?

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 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 nontaxable 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. In 2018, the government adopted a second tax reform package that went into effect on 1 January 2019. The package included an additional HRK 1.4 billion in tax reliefs based on reducing the VAT on fresh meat, fish, eggs, fruit, vegetables and diapers from 25% to 13%. However, the planned increase in the threshold for the upper income tax band, which is taxed at 36%, from HRK 17,500 (€2,300) per month to HRK 30,000 (approximately €4,000) per month – which aimed to raise net salaries in the high-technology sector, and in professions like physicians, IT experts and pharmacists in order to prevent “brain drain” – was eventually postponed. In the third tax reform package, the personal allowance (i.e., earned income that is not taxed) threshold was lifted from HRK 3,800 per month to HRK 4,000 per month, starting from 1 January 2020. Furthermore, the revenue threshold for the corporate tax rate of 12% was raised from HRK 3 million per year to HRK 7.5 million per year . Hence, 93% of businesses will pay taxes according to the lower tax rate. Finally, the government decided to exempt workers under the age of 30 from paying the full amount of income tax. At the same time, under pressure from trade unions, which had orchestrated the longest strike in Croatian history, the Plenković government decided to scrap the previously agreed reduction in the general VAT rate from 25% to 24%. The government also gave in to public pressure and postponed the introduction of a real estate tax, despite Finance Minister Marić’s tax administration making all the necessary preparations for it long ago.

Since 2016, tax revenues have been sufficient to allow for a small fiscal surplus. However, the tax-to-GDP ratio, while slightly below the EU average, is rather high for a country of Croatia’s economic and institutional development. Moreover, the previously announced tax reductions have been sacrificed for a revenue-based consolidation.

Vertical equity has suffered from the recent tax privileges of young income earners. While Croatia has a progressive income tax, the large share of indirect taxes limits the redistributive effects of the tax system. Croatia is the EU member state with the highest share of VAT revenues in GDP.

The standard corporate income tax is higher than in Bulgaria and Hungary, but similar to other East-Central European countries. Small businesses benefit from the lower tax rate. Due to the high social insurance contributions, however, the tax wedge is relatively high. The frequent changes in taxation have increased uncertainty over taxation.

At 3.6% of GDP in 2018, Croatia’s revenues from environmental taxes were above the EU average of 2.4%. However, there is scope to improve the use of environmental taxation to better support environment and climate policy objectives. Croatia is one of the few Member States that does not have a landfill tax nor an incineration tax for waste management

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

European Commission (2020): Country Report Croatia 2020. SWD(2020) 501 final. Brussels, 25 (https://ec.europa.eu/info/sites/info/files/2020-european-semester-country-report-croatia-en.pdf).

Budgets

#22

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 European Union’s excessive deficit procedure. However, successive governments have managed to reduce the general government fiscal deficit from a peak of 7.8% in 2011 to about 1% in 2016. Since 2017, general government has run small, yet declining surpluses. As a result, Croatia’s relatively high public debt ratio has fallen since 2016. These improvements in the fiscal stance allowed Croatia to exit the excessive deficit procedure in June 2017. Despite the fiscal surpluses, however, fiscal policy has been procyclical in 2018 and 2019. Moreover, the fiscal surplus has largely been the result of higher-than-expected GDP growth and a decline in interest payments on government debt, rather than from much-needed expenditure reform. Given Croatia’s level of economic development and its quality of governance, general government expenditure relative to GDP is still rather high from a comparative perspective. Croatia’s budget remains riddled with bloated expenditure categories, which suggests the presence of clientelistic arrangements. It is indicative that the sum of government expenditure on intermediate consumption, compensation of government employees and public subsidies amounts to a staggering 20.8% of GDP (2001 – 2017 average). This result places Croatia fourth among the EU-28 (only behind the wealthy and well-governed Scandinavian countries). Concerns about the medium-term sustainability of budgetary policy have increased due to the slow progress in amending the 2011 Fiscal Responsibility Act and improving budgetary planning, as recommended by the European Commission and the IMF for some time.

Citations:
Kotarski, K. (2019) The Political Economy of Euro Introduction to Croatia: a Golden Goose or a Stinging Viper? Zagreb: Hanns Seidel Stiftung.

Šimović, H., M. Deskar-Škrbić (2019): Fiscal Policy and European Semester in Croatia: Why Should we focus on public debt?, in: Petak Z. and Kotarski, K. (eds.) Policy-Making at the European Periphery: The Case of Croatia. Cham: Palgrave Macmillan, 147-168.

Research, Innovation and Infrastructure

#38

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 0.97% in 2018. The small increase was driven by increased R&D expenditure by both the sector and higher education sectors, while R&D expenditure by the government stagnated. European Structural and Investment Funds are a new and important source of scientific research funding. However, managing EU-funded scientific projects remains burdensome given the large scope of domestic red tape imposed on the scientific community by implementation bodies. In relation to the EU average, R&D expenditure has been falling and Croatia closed 2019 in the group of worst performers. Similarly, in terms of the number of patent applications to the European Patent Office, Croatia fares poorly in contrast to other EU-28 countries, with only three registered patents to one million inhabitants. Overall, the EU Innovation Scoreboard categorizes Croatia as only a “moderate innovator.”

Global Financial System

#37

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 European Union has brought greater integration of the financial system. The European Union’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. However, the regulatory framework will be strengthened by the joining of the Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM) when Croatia enters the EU banking union in mid-2020. 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 given the fact that more than 90% of bank assets are held by foreign banks. Hence, there is no strong domestic constituency advocating for this agenda. 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.

Citations:
Croatian National Bank (2019): Financial Stability, No. 20. Zagreb (https://www.hnb.hr/en/-/financijska-stabilnost-19).
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