Croatia: Country Economic Memorandum

Economic Growth Through European Integration

World Bank,

September 2003

1 – Croatia’s achievements since Independence have been impressive…

• Profound economic and social transformation

• Markets laws and institutions

• Pre-independence output recovered…

• …despite unstable geo-political environment

• New wave of reforms since 2000

2- SAA provides a challenge to deepen reforms through EU Integration

• SAA goes well beyond trade

• It will bring laws, institutions and policies in line with the acquis communautaire

– progressive laws and institutions

– efficient factor markets and regulation

– improved business climate

3 – SAA: a “two-way” road

• Reforms needed for the Acquis are good for growth

• Growth will facilitate EU integration

4 - “Critical bottlenecks” for sustainable economic growth

• High deficits-debt • Inadequate land registry + property/ creditor

rights • Poorly functioning judiciary • Weak governance • Public administration fragmented, politicized

poorly coordinated

5 – Competing in Europe will also require:

• Efficient regulatory frameworks – product&factors

• Integration into EU transport and energy networks

• Adequate skills and innovation systems

• Modernizing agriculture

• Phasing in EU environment institutions/standards

6 - Simultaneous progress in all

reforms synergy

• 6.A - Lengthy reforms should start right away, e.g., fiscal, public administration.

• 6.B - Some reforms are urgent/low cost anyway…, e.g., bankruptcy, governance, labor, judiciary, registries…

• 6.C – Regulation of infrastructure, factor markets are win-wins; need to be accompanied by enhanced skills-innovation systems

• 6.D – Fast convergence to EU agriculture/environment institutions; selective speed of convergence to EU standards

6.A - Stable macroeconomic environment

Fiscal/debt management could get out of control due to: – exchange rate depreciation, – higher sovereign risk premia– growth slowdown– reform costs

Sources of fiscal savings:– social security– transport– wages and salaries

6.A - Public Administration Reform

Depoliticize senior civil service

Integrate policy planning with budget process

Consolidate Ministries with focus on needs of market economy

Evaluate city amalgamation for provision of services

6.B – Productivity can increase through firm’s exit, entry and restructuring.

• Firm Exit: streamlined bankruptcy procedures, Stop bail-outs at tax-payer’s expense.

• Firm Entry: land titling, zoning, building permits, utility connections, visas and work permits.

• Restructuring: Implement EU corporate governance standards

6.B – Strengthening the Judiciary

• Implement court administration/management systems

• Case management systems

• Judge training on commercial law, compensation

• Out-of-court mechanisms (small claims court)

• Common judiciary practice (regions, judges)

6.C - Integrating Croatia’s infrastructure networks

• Private sector participation, interconnection of transport and energy networks

• Secondary energy legislation needs to establish price and regulatory regime

• Adopt internationally acceptable economic appraisal methods in transport

6.C – Financial system stability

• Prudential regulations to internalize exchange rate risk:– liquidity requirements on FOREX deposits

– provisions on FOREX loans

• Strengthen consolidated supervision

• Strengthen CROSEC, enforce new laws

6.C - Skills and innovation systems

• Innovation-driven growth requires continuous learning, problem solving, critical and reflective thinking

• Shift to demand-driven system of education, training and research – closer links with private firms

• Change what is taught, how it is taught and those who teach

6.D - Modernizing Agriculture

• Adopt CAP institutions, align CAP instruments

• CAP: good for welfare (poor), not for farmers

• Option before CAP: reduce intervention below CAP levels compensate farmers, increased welfare

6.D – Environmental compliance

• Meeting EU environmental standards will be costly

• Fiscal costs depend on:

– cost recovery, e.g. volume pricing of water

– private participation, e.g., energy

– phase-in period, e.g., waste water

• Reform scenarios can reduce investment needs by a factor of 2 and fiscal burden by a factor of 3

7. Conclusions

1. Growth/EU integration - mutually reinforcing objectives

2. Provide a stable macro-financial framework

3. Address critical bottlenecks (legal, judiciary, public administration)

4. Regulatory reforms in product, factor and infrastructure markets

5. Careful evaluation of costs-benefits during phase-in period in agriculture-environment