OPINION October 28, 2019

Without Stronger Growth, Croatia Will Need Decades to Catch Up with the Most Developed EU Countries

Poslovni Dnevnik: Croatia ranked 51st on Doing Business list in 2020. What improvements led to this improved ranking?

Elisabetta Capannelli: We are happy to see that Croatia is making progress in improving its business environment and closing the gap with the best performers. Croatia has improved its ‘distance to the frontier,’ which examines the gap between an economy’s performance and the best practice of top performers from. Their score was 73.0 in last year's report and 73.6 in Doing Business 2020. This reflected positively on the country’s ranking of 51 out of 190 economies.

In this year’s ranking, Croatia is in the league of countries like Slovakia, the Czech Republic, Poland, and Slovenia. Areas where substantive improvements were made include the transfer of property – through a reduction in the time needed to register a property title and a decrease in the real estate transfer tax – as well as starting a business – by abolishing the requirement to reserve a company name and obtain director signatures for company registration, and by reducing the minimum capital requirements. 

But while this ranking is an important indicator of the ease of doing business in Croatia, what counts is the ambition and determination behind the entire reform agenda for the business environment. Bringing everybody around the table and breaking down institutional barriers is fundamental for achieving reforms in the Doing Business arena - which often involves a multitude of actors, in both the public and private sectors. I am convinced that the improvement we see in this year ranking is the result of this willingness to work together and a result of the work of the Working Group for Improving the Business Conditions in the Republic of Croatia, established last year and overseen by the Prime Minister to propose measures to improve the business climate.

Consistency, as well as a determination to implement the reform agenda, is the only way to deliver further results. I know Croatia aspires to be among the top reforms in the area of Doing Business. This is within reach, but only if the country further accelerates its implementation of reforms through improved, inter-ministerial coordination focused on achieving the desired results.

PD: In which areas have you detected deterioration? How problematic are they?

EC: The indicators where Croatia dropped in ranking include: Getting credit, Resolving insolvency and Enforcing contracts.

In addition, even though there has been an improvement in the Dealing with Construction Permits indicator, Croatia is still ranked 150 out of 190 economies. We have recently witnessed important actions and major legislative efforts by the Ministry of Construction and Physical Planning to simplify the process of obtaining construction permits, as well as construction itself. The key changes include a reduction in the number of procedures needed for obtaining a construction permit, lower costs, and a limited timeframe for statements from public bodies. However, implementation issues, along with the reluctance of the City of Zagreb to accept the reform, has made it impossible for this change to be reflected in this year’s indicator. The timely implementation of such reforms can deliver important results next year and should be prioritized by the City of Zagreb and the local government units.

Ease of Doing Business in Croatia

PD: What should the government do to further strengthen its institutional capacity and its efficiency?

EC: Improving the quality and efficiency of public institutions is the foundation for enhancing service delivery and, ultimately, economic growth. Our priority is to support Croatia in strengthening its institutions and the effectiveness of the government to delivery public services to people. Talking about the business environment more specifically, a more efficient public administration and justice system will be crucial for improving the business environment.

PD: Which reforms would you stress as top priorities, given the intention to adopt the euro?

EC: We fully support Croatia in joining the euro area in the near future. We share the Government’s view and Croatian National Bank’s view that the benefits of euro adoption outweigh the costs. However, being a member of the euro area is not a panacea and just having the euro will probably not have a significant effect on Croatia’s growth potential or the pace of convergence unless the country significantly improves its competitiveness and resilience.

As the process of adopting the euro takes at least three to four years, Croatia has time to launch a bold reform agenda and strengthen the institutions crucial to succeeding in the single currency area. Croatia should focus on improving public sector performance, reducing the presence of the state in the economy, increasing the flexibility of the labor and product markets – while protecting the poor and the vulnerable - and continuing to preserve fiscal sustainability.

PD: How do you perceive the recent decision to reverse the pension reform and give in to unions' demands for a pay increase in the public sector?

EC: Since the early 2000s, the World Bank has been supporting Croatia in making its pension system both financially and socially sustainable. We have actively participated in introducing a multi-pillar pension system and we still support this set up. Croatia is facing unfavorable demographic trends and strong migration outflows. Over the next few decades the population will decline markedly and the share of older people in the working-age population could double.

Reverting the increase of the mandatory age for retirement and deciding to reduce the penalties for early retirement lower the availability of the workforce, and, thus, economic activity. It also puts further pressure on the pension system, which could result in lower pensions or higher public debt.

While we respect that the voice of the people and referendums are integral parts of democratic societies and need to be cherished, we feel Croatia will again come to rethink its pension system in the near future.

There is no right or wrong answer on public sector pay increases. We can analyze the issue from different angles: efficiency wages, fairness, political cycles, etc. In general, wage increases are not problematic, per se, if they follow productivity trends, do not jeopardize fiscal sustainability, and result in a reasonable tax burden on the economy. Compared to its peers in Central and Eastern Europe, as well as advanced EU countries, Croatia stands out when it comes employee compensation. In general, Croatia has a large and inefficient public sector and the tax burden on the economy is high.  

PD: Compared to other countries in the region, is Croatia achieving a satisfying tempo of real convergence (What happens if the country fails in that department)? What would you point out as good examples Croatia could follow?

EC: I doubt anybody can be happy with the pace of real convergence, especially when we see how other, comparable countries are advancing - countries that were behind Croatia in the early years of economic transition. Croatia will reach its pre-crisis level of output only in 2019, something many of its peers in Central and Eastern Europe succeeded in doing by 2014. Unless it improves its growth potential, Croatia will need decades to reach the current level of living standards of the most developed EU countries, or even some of its peers. Lagging behind other countries could result in further negative net migration - currently one of Croatia’s most significant problems. This, in turn, would further reduce Croatia’s growth potential and could result in a prolonged period of low growth and slow convergence - or even no convergence. Countries in the Central Eastern Europe region that have advanced more rapidly used their early accession to the EU to integrate better into global value chains but, even more importantly, have improved the quality of their public and market institutions.

PD: If you compare Croatia today and two years ago when you came to Zagreb - what has changed for the better or for worse? Do you see any real improvement? Are there areas where reforms have not even scratched the surface?

EC: When I arrived in Croatia in mid-2017, the Agrokor crisis was unwinding and the Government was focused on preserving the stability of the economy. This required a major effort and bold actions, but it eventually led to a successful restructuring process. In June 2017, Croatia was just exiting excessive deficit procedures and we at the World Bank were helping the country restructure the debt of its road companies. Look at where we are now. I have witnessed continuous fiscal adjustments; public debt was put firmly on a downward path; Croatia’s credit rating has been raised to an investment-grade level; absorption of EU Funds has increased; and Croatia has now made its first formal steps towards euro adoption.

This year’s ranking improvements in Doing Business and in the Global Competitiveness list suggest some efforts at reform are being made. Yet, we are still waiting to see the implementation of difficult reforms that would fundamentally change the structure of the economy, such as restructuring State Owned Enterprises, transforming the railway or justice sector, reforming  the health and public administrations, to name a few. I acknowledge that there is an understanding and a will to reform, but the agenda should be bolder and the pace of implementation faster.

PD: What can The World Bank offer through its new strategy?

EC: In May last year, the Government and our Board approved a new, five-year partnership framework for Croatia. The strategy focuses on improving public sector institutions to better delivery services to people. We are currently finalizing the preparation of a new Education Project and - sticking to the theme for this article - a project called Justice for Business. The project will enhance the efficiency and quality of regulatory procedures, including starting a business, reduce the administrative burden for businesses, and improving the quality of judicial services to citizens and businesses. In addition, we plan to invest in the rehabilitation and upgrading of the court facilities in Zagreb, Varaždin, Vinkovci and Kutina. This project is the continuation of our support to the Government of Croatia to improve the country’s enabling environment for business in order to prosper and grow.

*** Interview with Elisabetta Capannelli, the World Bank Country Manager for Croatia, originally published in the print edition of Poslovni Dnevnik on October 25, 2019.