World Bank Director Has Stark Warning for Croatia About Growth

By 25 October 2019

The Republic of Croatia has improved in terms of its current distance between itself and some of the most successful countries, and real determination to implement reforms remains crucial to everything.

As Ana Blaskovic/Poslovni Dnevnik writes on the 25th of October, 2019, Croatia can only succeed if it continues to accelerate the implementation of its currently promised and planned reforms through improved focused inter-ministerial cooperation. Thus, World Bank Country Director for Croatia Elisabetta Capannelli commented on the country's position on the Doing Business 2020 ranking, on which it is positioned seven places better than it was last year. In an interview, she provides advice on how Croatia can manage to acheive even better results, but also issues a stark warning about the things standing in the way.

Croatia has been ranked in 51st place on the Doing Business 2020 ranking. What improvements have led to this shift?

We're pleased to witness the progress Croatia is making in improving its business environment and reducing its gap with the most successful countries. Croatia has improved its 'distance from the most successful' [countries], which measures the gap between a country's performance and the best global practices, from last year's score of 73 to 73.6 on the Doing Business 2020 report. This has had a positive impact on its relative placement, with it now ranking 51st among 190 economies.

In this year's rankings, Croatia is in the group of countries like Slovakia, Czech Republic, and the areas where significant changes have been recorded are the registration of ownership rights due to the reduced time required for transfer of ownership and the reduction of property sales tax, as well as starting a business by the reservation of a company name and obtaining the signature of the director as a condition for the registration of the company, and reducing the minimum amount of the basic capital.

While this placement is an important indicator in terms of the ease of doing business, ambition and determination in implementing reforms to improve the business environment is important. Gathering all parties around the table and breaking down institutional barriers is crucial for reform in areas measuring doing business, requiring the involvement of a multitude of participants, from both the public and private sectors.

I'm convinced that this year's progress is a result of the willingness to cooperate and the work of the Working Group on Improving the Business Environment, which was set up last year under the leadership of the Prime Minister in order to try to improve the business climate. With consistency, determination to implement the reform agenda to create incentives for private sector action is the only way to deliver new results.

What about the things which have become worse, and how problematic that is?

The indicators by which Croatia has fallen back in the ranking include: obtaining loans, resolving insolvency and executing contracts.

In addition, although there has been some progress in the area of ​​obtaining building permits, Croatia still ranks 150th among 190 economies. We've recently witnessed important measures and significant legislative initiatives taken by the Ministry of Construction and Physical Planning to facilitate the process of obtaining a building permit and construction itself. These key changes include reducing the number of procedures required to obtain a building permit, lower costs, and limiting the timeframe required to obtain public authority approvals.

However, problems related to the implementation and unwillingness of the City of Zagreb to accept reforms have prevented that change from being better reflected on this indicator this year. The timely implementation of such a reform could produce important results next year, and the City of Zagreb and local self-government units should make it a priority.

What should the government do to further strengthen its institutional capacity and effectiveness?

Improving the quality and efficiency of public institutions is fundamental to better service delivery and, ultimately, economic growth. Our priority is to help Croatia strengthen its institutions and support the government's effectiveness in providing services to people.

Speaking of the business environment, a more efficient public administration and justice system will be crucial to improving the business environment.

Which reforms would you highlight as the highest priority given Croatia's intention to introduce the euro?

We'll give Croatia our full support to join the Eurozone in the near future.

We share the same view as the government and the Croatian National Bank that the benefits of introducing the euro outweigh its costs. But Eurozone membership is not the solution to all of the problems, and the introduction of the euro alone is unlikely to have a significant impact on Croatia's potential for growth and convergence dynamics if Croatia fails to substantially strengthen its competitiveness and resilience.

With the introduction of the euro taking at least three to four years, Croatia has time to move forward with a bold reform program and strengthen the institutions that are crucial for successful functioning within the single currency area. Our recommendation is for Croatia to place emphasis on improving the efficiency of the public sector, reducing the state's presence in the economy and increasing the flexibility of the labour market and products, while protecting poor and vulnerable citizens and continuing to maintain fiscal sustainability.

How do you look at the recent decision to opt out of pension reforms and agree to union demands for pay increases in the public sector?

Ever since the early 2000s, the World Bank has been helping Croatia secure both the financial and social sustainability of the pension system.

We participated in the introduction of the multi-tier pension system and continue to support it. Croatia is facing unfavourable demographic trends and a strong outflow of its population. Over the next few decades, the population will decline significantly and the proportion of the elderly among the working age population could double. By abandoning the retirement age increase and deciding to reduce early retirement rates, the availability of labour and economic activity are reduced.

There are also stronger pressures on the pension system, which could lead to lower pensions or higher public debt. We certainly respect the voice of the people, and a referendum is an institute to be nurtured in a democratic society, we believe that Croatia will have to rethink its pension system in the near future.

There is no right or wrong answer to public sector wage increases. We can analyse this issue from different angles: the impact of wages on efficiency, equity, the political cycle, etc. Generally speaking, wage increases are not inherently problematic if they follow productivity trends, if they don't jeopardise fiscal sustainability, and if the economy's tax burden is reasonable. Compared to similar countries in Central and Eastern Europe and the advanced EU countries, Croatia is falling behind in terms of employee benefits. The public sector in Croatia is large and inefficient and the tax burden on the economy is high.

If we compare it with other countries in the region, does Croatia achieve the satisfactory pace of real convergence (and what happens if it fails to do so)? What would you point out as good examples for Croatia to follow?

I doubt that anyone can be satisfied with the dynamics of real convergence, when we see the progress of other comparable countries, which lagged behind Croatia in the first years of economic transition. Croatia will only reach its pre-crisis level in 2019, and many Central and Eastern European countries succeeded in doing so back in 2014.

If it doesn't improve its growth potential, it will take decades for Croatia to reach the current standard of living in the most developed EU countries. Further lagging could lead to the continuation of negative net migration as one of Croatia's currently significant problems. This would further reduce growth potential and lead to longer periods of low growth and slow convergence, if any at all. The countries of Central and Eastern Europe used their early accession to the EU to better integrate into global value chains, but - more importantly - they also improved the quality of their public and market institutions.

Do you compare today's Croatia to the Croatia of two years ago when you arrived in Zagreb, what has changed for the better or worse? Do you see any real improvement and are there areas where reforms have not even scratched the surface?

When I arrived in Croatia in mid-2017, the Agrokor crisis broke out and the government focused on preserving the stability of the economy. It took a lot of effort and daring steps, but it ultimately resulted in a successful restructuring process.

In June 2017, Croatia exited the excessive deficit procedure and we at the World Bank assisted in the restructuring of the debt of road companies. Look at where we are now. I've witnessed continued fiscal adjustment, public debt is steadily declining. Croatia's credit rating was raised to an investment level. The utilisation of EU funds has also increased; Croatia has also taken the first step towards the introduction of the euro.

This year's shift in the scale of business ease and global competitiveness indicates that some reform efforts are being made. However, difficult reforms are still pending that will profoundly change the structure of the economy, such as restructuring state-owned enterprises, transforming the railway sector, reforming the judiciary, health and public administration. There is an understanding and will to implement the reforms, but the reform agenda should be bolder and the pace of implementation faster.

What can the World Bank offer as part of its new strategy?

In May last year, the Croatian Government and the World Bank Board approved a new five-year framework for cooperation with the Republic of Croatia.

The strategy places emphasis on improving public sector institutions to better deliver services to citizens. We're just finishing the preparation of a new Education Project and, to dwell on the subject of this article, a project called Justice for Business. This project will improve the efficiency and quality of regulatory procedures (including business start-ups), reduce the administrative burden on businesses, and improve the quality of judicial services for citizens and businesses.

In addition, we plan to invest in the reconstruction and renovation of court buildings in Zagreb, Varaždin, Vinkovci and Kutina. This project is a continuation of our support to the Croatian Government to improve conditions in the country that enable the business sector to thrive and grow.

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