Croatia

• Author: Athanasios Vamvakidis
• Pages: 6-7

Page 6

Croatia has experienced solid growth in recent years, but IMF staff estimates indicate somewhat lower potential growth, which highlights the need for structural reforms. Real GDP growth averaged around 4¾ percent annually during 2001-05 and continued at 4.8 percent in 2006.

Moore and Vamvakidis (2007) estimate Croatia's potential growth, however, at 4-4½ percent. This estimate is robust to different methodologies: estimation of a production function; simulation of a growth model for Croatia using estimates from a cross-country regression; and a growth diagnostic exercise. Increasing Croatia's potential growth will require significant productivity-enhancing reforms.

The results in the study highlight the critical need for structural reforms to improve the business environment by reducing the administrative burden, legal uncertainties, and corruption, and to reduce the role of the state in the economy by making faster progress on fiscal consolidation and privatization. The analysis indicates that despite recent steps in the right direction, Croatia's progress in structural reforms has been slower than in peer countries and needs to be accelerated to increase productivity and growth. In a similar vein, Konuki's (2004) analysis of Croatia's labor market performance-which has been poor, compared with other Central and Eastern European countries-indicates the need for reforms to relax Croatia's strict employment protection regulation to boost employment in the official sector, expand the tax base, and boost productivity.

One reason for the slow pace of structural reforms in Croatia, which is analyzed in Vamvakidis (2007), may be the ease of obtaining foreign financing. A political economy model and empirical evidence from a sample of emerging and transition economies suggest that external financing often acts as a "pain reliever" by postponing the needed treatment of a "sick" economy by economic reform. In Moore and Vamvakidis (2007), a simulation of the model for Croatia shows that the rapid rise in external debt may, indeed, have financed the status quo, contributing to delays in the overall reform process. The results suggest that policies to reduce Croatia's indebtedness could trigger broader reforms that would, in turn, contribute to faster economic growth.

Fiscal consolidation can have such an impact. Spending cuts and good revenue performance, which is due largely to faster-than-projected growth, reduced the general government...