Unit 4 Macro: Improving Competitiveness in Croatia

Economics student Anthony Beaumont writes on the policies that might sustain an improvement in the Croatian economy as it settles into being the 28th member nation of the EU single market

Evaluate different policies that might improve the international competitiveness of Croatia inside the EU single market. (30 marks)

Having joined the EU on 1st July 2013, Croatia now faces the predicament of streamlining its economy to take advantage of the EU single market. Croatia is already a reasonably developed country. According to the World Economic Forum’s 2013-2014 report, it ranks in the top half (out of 148 countries) in infrastructure, macroeconomic environment, higher education, health and primary education, technological readiness and market size. However the point of Croatia joining the EU is to build upon the strengths that it already has. These strengths are what I shall focus on in this essay.

Investment

Firstly, Croatia could improve its competitiveness through increased investment. Its infrastructure is already rated 4.7/7 by the WEF, however its goods and labour efficiency both stand at 3.9/7. Such further investment in factories and transport links could ergo make Croatia’s more productive. It also allows for her to exploit economics of scale, which in itself bring improved efficiency and productivity. Furthermore, such investment provides the platform onto which foreign companies can come in and invest via FDI.

Indeed the European Commission has approved Croatia’s investment plan to use the EU ‘cohesion policy funds’ worth €449.4m. The National Strategic Reference Framework (NSRF) set out certain investment priorities for Croatia’s regions to accelerate economic growth, strengthen economic competitiveness, establish optimal economic conditions for job creation and achieve a balanced regional development.

The funds sets the precedent for investment in areas like the environment; transport; regional competitiveness; and human resources. €149.8m will go towards waste and wastewater management, as well as improvement of the water supply. The European Regional Development Fund (€228.4m) will be invested in business support for SMEs, research and innovation, along with more basic infrastructures, such as railway and waterways. The European Social Fund (€60m) will support job creation and invest in social inclusion and education projects. Commissioner Hahn said of such stimulus:

‘This is a crucial first step for Croatia on the path to competitiveness. Cohesion policy funds must be invested where most needed to strengthen the local economy, increase labour market participation and to capitalise on the nation’s assets, such as the preservation and promotion of natural resources to boost the tourism industry and business support to help SMEs thrive’.

However, the effectiveness of this investment is questionable. Firstly, such methods are subject to a significant time-lag. For instance, the railway and waterways work is not expected to be completed till 2025. Therefore their effects upon Croatia’s competitiveness are unlikely to be realised for 10 years at least. One must also question the scale of such investment. When Britain for instance is spending upwards of £45bn on HS2, one doubts whether the €500m is sufficiently high an investment stimulus to make Croatia more competitive. One must also doubt whether this investment is targeted enough on developing competitive advantages. With only €228m aimed directly at firms, it seems that Croatia’s investment plans are merely building up the basis onto which further investment and FDI will add. Thus greater investment is required by the Croatian government in order to increase efficiency and exploit the EU single market exports-wise.

Deregulation

32.8% of the Croatian economy’s FDI between 1993 and 2012 went into financial intermediation. Another 15.5% was taken up by wholesale and trade, 9.5% into Real Estate activities and 18.8% into the manufacture of chemicals. Thus these are the industries into which the Croatian economy needs to be investing in to build comparative advantages. This can be encouraged through subsidies or tax breaks. However one must note that as being part in the EU, subsidies in some sectors are not allowed. For instance, in August 2013, farmers used 1000 tractors to block roads in Croatia in order to protest against the £68m worth of subsidies which were prohibited because of their country’s EU membership.

The Croat economy can and has to look to niche areas in order to increase its competitiveness.

Its economy is indeed chained by bureaucracy and still fixed with a socialist mindset. One such way of deregulating, which Croatia has indeed embarked upon, is through creating a unique IT platform which will collate many public services in one place and be electronically accessible to individuals and businesses. This is a step towards e-government, in a bid to reduce unnecessary paper bureaucracy and burden.

The idea is to create an innovative policy platform which would increase the freedom of participation in public policy decision making. This freedom always comes from the innovating individuals and entrepreneurs. The task of the government is to implement this initiative in order to remove all obstacles to economic freedom and individual liberty in Croatia.

However, it is not sufficient to implement deregulation reforms in the public administration when the real problem is bureaucracy in the private sector. Furthermore, one doubts whether deregulation will have much of an effect on Croatian international competitiveness when they will now be affected by EU bureaucracy over and above national rules. Rather what Croatia needs is emphasis upon stimulating its own industries to provide it with comparative advantages. Deregulation can only go so far. Only investment and incentives can provide the boost needed to increase Croatia’s international competitiveness.

Reforms

The Croatian economy also has to consider implementing free market structural reforms to increase its competitiveness. For instance privatising all state owned companies and changing the tax structure to one more favourable for business. One must note that whilst deregulation and liberalisation of Croatia can improves its economic situation, these policies only result in Croatia regaining ground on its European counterparts rather than establishing advantages. Relatively speaking, Croatia is still behind most European countries in terms of competitiveness. The problem with exposing Croatian companies to the free-market is that without tariff protection, Croat products risk being out-competed in terms of quality and price.

Thus the liberalisation of the markets will not increase competitiveness in the short-term, it will just provide the context for innovating firms to rise up in the future.

Monetary Policy

One issue with Croatia in terms of its price competitiveness is its inflation rate. Only in the last six months has it stabilised from being at levels of above 4%. However, despite inflation currently standing at 2.28%, the interest rates are still at 6.25%. Although the Croatian Kuna is official currency of payments in Croatia, saving deposits and banking loans are mostly nominated in euros.

In the last decade, the Croatian national bank has successfully maintained a stabile exchange rate. However one fears that having both high interest rates and the potential for high inflation is a double-edged sword. Certainly therefore, such inflation and rates lead to Croatian goods lacking price competitiveness. Thus monetary policy is advisable in a bid to improve the pricecompetitiveness of Croatian goods.

One could argue however that Croatia’s inflation rate should not matter if it is the case that it is still relatively lower than that of other countries in the EU. Yet, the EU’s rate is 1.3%, so indeed Croatian inflation is above average. Yet whilst this might be worrying from Croatia’s point of view, we must consider that the Kuna is still a weak currency. For instance 1 Kuna buys 0.11 Pound Sterling or 0.13 Euros. Therefore from this perspective, whilst lower inflation would be beneficial, it does not effect the competitiveness of Croatian products due to the Kuna already being very weak.

Another area of concern for Croatian competitiveness is the fact that due to its accession, its workers now have the right of free movement across Europe in a a bid to earn higher wages. The problem may arise that vital skilled labour will leave the Croatian economy at a time when they are required in order to develop its industries. However with unemployment at 17%, this probably is not a problem in the short-term. Investment in Croatia is crucial to provide her with the platform for future growth. Thus encouraging FDI through lower capital gains tax (currently 20%) and subsidising investment projects is a great priority. Consolidating Croatia’s competitive advantages in the chemical industries for instance is also a must. Thus deregulation and liberalisation of the Croat markets is necessary, however these only provide the context which firms can innovate in. A lower interest rate would be preferable, however this would only be to increase loans and thus investment nationally, rather than to devalue the Kuna.

One final point, the first policy Croatia should adopt is correcting its law on European Arrest Warrants. Croatia decided to change its law on this two days being joining the EU. This is a serious breach of both EU law and the trust placed in Croatia by the other 27 members. If Croatia does not treat on this issue, it could find itself subject to funding cuts and sanctions which are of course not ideal for increasing one’s competitiveness