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Look at Poland and South Korea - they saved themselves through public sector reforms

Hongjoo Hahm, World Bank

Published in: Jutarnji list

November 18, 2013

Media Contacts
- Zagreb, Croatia

Vanja Frajtic

The public sector, especially state-owned enterprises (SOEs), is omnipresent in Croatia. They dominate the economic landscape - from transport (ports, rail, ferries, air, roads) to energy (electricity, district heating) to even tourism (hotels and prime real estate) or food production. So much so that the SOE sector in Croatia is one of the largest among EU member states. State-owned assets, including SOE assets, comprise some €31.4 billion or 68% of Croatia’s GDP, which puts Croatia behind only four countries in Europe in terms of value of state-owned assets. The state owns 584 enterprises, of which 54 are majority owned. Since the beginning of the 2008 crisis, the private sector has lost more than 150,000 jobs, while the Croatian public sector has actually increased employment.

While dominating the landscape, Croatian SOEs have performed poorly with limited earnings but requiring enormous fiscal support.  Accumulated SOEs debt, largely transferred to the state through debt restructuring (especially shipbuilding and transport), have significantly contributed to an increase in government debt (i.e. state-guaranteed SOEs loans amounting to HRK39.6 billion or 12% of GDP or a direct debt assumption resulting from the SOE restructuring).

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Croatia can learn from international experience and improve the performance and management of its SOEs to foster the sustainable development of the economy Close Quotes

Hongjoo Hahm
World Bank Country Manager, Croatia and Slovenia

The surge in government SOE-related debt also affects current expenditures, as interest payments on government debt alone accounts for 3% of GDP. Croatian SOEs also require large state subsidies, amounting to around 1.7% of GDP annually (compared to EU27 average of only 0.75%). Even with these subsidies, the majority of Croatian SOEs have posted losses in 2012. State subsidies and state-guaranteed SOE debt weighs heavily on the country’s fiscal position and has contributed significantly to its entry into the EC’s Excessive Deficit Procedure.

Croatian SOEs face an uncertain future with the advent of Croatia’s EU accession, with strict EU regulations on state subsidies and a strong push for SOE restructuring. But more than the EU directives themselves, the economic landscape is changing, and Croatian SOEs will face extreme competition without monopolistic advantages, and will have to perform as measured by profitability. To compete, SOE management will have to undergo radical transformation, notably through dramatically improved corporate governance.

There is a critical need to appoint independent and qualified boards and managers to SOEs, at arms-length from government interventions, with clear separation of ownership and regulatory functions of the state. As noted even by trade unions’ confederations, it is necessary to de-politicize and select management and supervisory boards according to qualification, and not political favoritism or to satisfy coalition-party personnel matters.

International experiences have shown that SOE reforms – through market liberalization, changes in ownership, better aligned incentives structures, and perhaps most crucially a dramatically improved corporate governance culture – can significantly improve productivity and contribute to economic growth. In 1984, Korea undertook major SOE reforms through increased managerial autonomy, improved performance evaluation systems, and better incentive structures.

After implementing reforms, there was a noticeable change in managerial behavior, the adoption of long-term corporate plans, where operating profit grew 50% in 1984 and 20% in 1985, with concomitant improvements in the quality of goods produced and services provided. Sweden was the first in Europe to systematically address the issue of SOE ownership and management. Political insulation, clear objective and transparency were three main pillars of SOE reform program between 1998 and 2001. Number of restructurings, divestitures and acquisitions by portfolio companies was conducted during the three-year reform program (including transformation of SJ into one of the most profitable rail operators in Europe and subsequent sale of Celsius, one of the Europe’s largest defense groups). This reform process saw more than 20% of the portfolio sold-off to external investors.

As a result, the value of listed SOEs grew more than 28% from 1999 to 2001. Sweden’s innovative approach yielded significant returns and benefits, and it is now being replicated in many other countries. The remarkable growth of the Polish economy began with the singular objective of increasing Poland’s competitiveness, partially achieved through privatization and restructuring of SOEs. This process is still ongoing, and the Polish government continues with privatization of SOEs and efforts to increase their profitability and productivity. Poland is in a more favorable position in the process of SOE sector restructuring, due to comprehensive, structural reforms undertaken during the past two decades, aimed at strengthening the Polish economy through a competitive private sector.

In Croatia, the size of the public sector, and the correspondingly SOE footprint, is crowding out the private sector. Limited budgetary resources are being spent on SOEs with poor performance and inadequate corporate governance. Reducing the number of some less essential SOEs and reducing subsidies to SOEs could release budget funds for necessary investments in areas that promote competitiveness, employment, efficiency and export growth.

Overall investment into R&D and innovation, for example, account for only 0.75% of GDP compared to an EU average of more than 2%. The private sector, especially innovative small and medium enterprises, is the key driver of growth and job creation. The Croatian authorities are well aware of these facts and beginning to initiate reforms. But the scope and breadth of reforms could be widened, similar to Poland; with more focus on corporate governance, like Korea; with a broadened role for the private sector to lead in the reforms itself, a la Sweden. In all these countries, the main goal of SOE reforms was to enable faster restructuring aimed at developing competitive, income-generating enterprises, regardless of ownership.

Croatia can learn from international experience and improve the performance and management of its SOEs to foster the sustainable development of the economy.