Strategic Transformation in Agriculture and Rural Space (STARS RAS)

Background Document Productive Inclusion for Agricultural Competitiveness in Croatia

This background document is a product of the staff of the World Bank Group. The findings, interpretations, and conclusions expressed in the background document do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank Group does not guarantee the accuracy of the data included in this work, which is drawn from multiple external sources. Nothing herein shall constitute, or considered to be, a limitation upon or waiver of the privileges and immunities of The World Bank Group, all of which are specifically reserved.

CO-FINANCED BY THE EUROPEAN UNION

EUROPEAN AGRICULTURAL FUND FOR RURAL DEVELOPMENT:

EUROPE INVESTING IN RURAL AREAS

MEASURE TECHNICAL ASSISTANCE

EUROPEAN MARITIME AND FISHERIES FUND MEASURE VII.1. TECHNICAL ASSISTANCE

Contents Introduction ...... 3 Structural Transformation of Agriculture in Croatia ...... 3 Dynamics of Structural Transformation ...... 3 Structural Transformation of Agriculture in Croatia ...... 4 Patterns ...... 4 Drivers ...... 6 Trade and Competitiveness of Agriculture in Croatia ...... 13 Competitive Advantages ...... 13 Agricultural Competitiveness ...... 14 Trade ...... 15 Pathways to Change ...... 16 Providing Smarter Incentives for Productivity-enhancing Investments ...... 16 Developing an Integrated Agricultural Knowledge and Innovation System ...... 19 Promoting Digital Agriculture ...... 23 Emerging Policy Priorities ...... 26

Introduction

1. Croatia has a vast potential to transform its agri-food system in a driver of higher growth, employment, and rural income levels. The agri-food sector is an important contributor to GDP, jobs, and rural incomes in Croatia. The sector benefits from a number of competitive advantages, which could be leveraged for increased growth and development, including unrestricted access to EU markets, diverse agro-ecological conditions, quality land and water resources, modern logistics infrastructure, as well as a growing domestic tourism industry. Croatia’s agri-food sector is therefore endowed with the key assets necessary to seize growth opportunities on the EU and domestic markets.

2. But structural constraints to competitiveness must be addressed to realize this potential. Croatia is currently a net importer of agri-food products and faces growing agri- food trade imbalances. Meanwhile, climate change poses increasing supply risks for agri-food chains. Strengthening the competitive position of the agri-food sector will require improvements in the (i) productivity of the primary sector, including its modernization and diversification towards value addition; (ii) ability of agri-food chains to cost efficiently respond to growth opportunities in domestic and international markets; and (iii) capacity to manage increasing climate risks. In this context, Croatia’s fragmented production structure constitutes a major impediment to building a competitive agri-food sector, which functions as an engine for growth, job creation, and improved rural incomes.

3. Sector policies aimed at accelerating the structural transformation of the agri-food system could boost its competitiveness. The structural transformation of agri-food systems is marked by industrialization and modernization of agriculture, significant increases in labor productivity across sectors, rural-urban migration, and a reduction in the share of agriculture in total employment and in GDP (Kuznets, 1957, Bustos et al. 2016). From this perspective, Croatia can still be classified as an “incomplete transformer” because of relatively low productivity of the agri-food system, high shares of GDP and employment that still depend on the primary sector, the rural-urban divide (income, poverty, etc.), and a link between poverty and agriculture. This report applies the lens of structural transformation dynamics to identify policy priorities for building agri-food system competitiveness. In particular, the report provides a diagnostic of (i) the current state and factors driving the structural transformation of the agri- food system in Croatia; (ii) the competitive position of the agri-food system in the current trade environment; (iii) potential pathways to strengthen agri-food system competitveness by leveraging structural tranformation dynamics; and (iv) emerging policy priorities for accelerating the structural transformation of the agri-food system.

Structural Transformation of Agriculture in Croatia

Dynamics of Structural Transformation

4. Rising factor productivity is the main engine for transforming agri-food systems, building the competitiveness of downstream food chains, and alleviating rural poverty. The structural transformation of agri-food systems follows a path where on-farm capital intensification through mechanization together with enhanced knowledge on farming practices (e.g. fertilizer, pesticides, tilling, etc.) unleashes significant increases in agricultural output due to higher labor and land productivity (See Figure 1). The expansion of agricultural output leads to an increase in the supply of raw materials at lower costs to agri-processors downstream

the agri-food chain. This increased supply enables the scale-up of operations, promotes horizontal integration, and reduces overall costs, all of which strengthen the competitiveness of the agri-food system as a whole. In addition, capital investment-led improvements in labor productivity tend to displace rural workers who subsequently migrate to peri-urban areas or cities to find employment in non-agricultural sectors. Meanwhile, increased labor productivity and mobility in rural spaces improve livelihoods in rural areas by enabling higher incomes per capita as well as lower poverty density and poverty rates.

Figure 1: Structural Transformation Dynamics of Agri-Food Systems

Rural-urban migration Increase in per capita On-farm structural income transformation Lower poverty density and

poverty rate

Rural Rural Space Potential threat to Mechanization smallholder viability and =Improved livelihoods and infrastructure (Capital) Intensive & extensive use of Increase in: land

Labor Increase in emissions

productivity nt Potential land degradation Land productivity =Potential negative

Output Environme Enhanced environmental impact knowledge on farming practices Increased and more stable

(knowledge) supply of raw materials Lower costs of raw materials

m chain m More jobs Downstrea =Improved competitiveness

Structural Transformation of Agriculture in Croatia

Patterns

5. The structural transformation of the agri-food system in Croatia has been steadily progressing as part of its integration process with the EU. Changes in Croatia’s rural space include an increase in agricultural labor productivity combined with a sharp increase in rural-urban migration, which has led to a decline in the share of the rural population (see Figure 2). However, the agriculture sector has recorded constant negative growth in terms of both gross output and gross value added in the past decade. Gross agricultural output declined by 5.6 percent each year on average between 2008 and 2013, whereas gross value added declined by 6.3 percent each year on average between 2008 and 2016. This signals that primary agriculture is underperforming compared to the rest of the economy and has had

difficulties adapting to the new economic environment created through Croatia’s integration process with the European Union (EU).

6. Growth in agriculture and food processing have demonstrated strong multiplier effects in Croatia. Thanks to the primary sector’s backward (demand for inputs, capital, and labor) and forward linkages (supply inputs) to other sectors, agricultural sector growth affects economic activity in manufacturing of food products and beverage, transport, wholesale and retail trade, hotels and restaurants, and research and development. The multiplier effects of changes in agricultural output appear to be particularly strong in Croatia (see Table 1). In 2014, Type I output multiplier (1.647) implies that production of US$ 1 million of primary agricultural output generates an additional economic stimulus of US$ 0.647 million in other sectors. The multiplier effect of food processing is even higher (1.785) in Croatia. However, there was a sizable decline in the food processing multiplier since 2000 (from 1.983 to 1.785), which can be attributed to the decrease of food processing purchases from domestic primary agriculture from 28.2 percent of total inputs in 2000 to 17 percent in 2014. Meanwhile, the employment multiplier of food processing (2.61) is relatively high, but that of primary agriculture is low (1.43) in Croatia.

Figure 2: The structural transformation of Croatia’s agri-food system has progressed steadily

Real GDP Population Rural population Agri. Labor Prod. Agric. value added (% GDP) 180 Pre-EU EU 165.2 160

140 129.0 120

100 94.3

INDEX 2000=100 INDEX 80 86.5

60 61.9

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2000 Source: Based on data from the World Development Indicators. Note: Real GDP, Agri. Value added, and agri. Labor productivity are adjusted for inflation.

Table 1: Multiplier estimates: Agriculture and Food Processing, Croatia

2000 2014 % Difference (2000- 2014) TYPE I Output Multipliers - Backward Multiplier Ranking Multiplier Ranking Agriculture 1.657 13 1.647 8 -0.62% Food Processing 1.983 1 1.785 3 -9.95% TYPE II Output Multipliers - Backward Agriculture 5.320 5 5.189 9 -2.45% Food Processing 5.481 3 4.927 23 -10.10% Output Multipliers - Forward

Agriculture 1.675 22 1.507 23 -10.06% Food Processing 1.170 49 1.128 45 -3.55% Direct & Indirect Value-Added Coefficients Agriculture 0.829 12 0.806 19 -2.76% Food Processing 0.792 18 0.715 32 -9.70% Direct & Indirect Employment Coefficients Agriculture 139 2 52 2 -62.48% Food Processing 82 15 24 28 -70.43% Value Added Multipliers Agriculture 1.738 15 1.729 18 -0.51% Food Processing 2.491 3 2.230 4 -10.48% Employment Multipliers Agriculture 1.346 39 1.432 30 6.38% Food Processing 3.413 2 2.612 3 -23.47% Source: World Bank staff calculations

7. Croatia is an “incomplete transformer” despite the progress made and strong multiplier effects. Today, high shares of GDP and employment in Croatia still depend on the primary sector: the primary sector employs 6.8% of the workforce and contributes 4% to Croatia’s GDP. These shares are higher than in comparator countries in the EU (see Figure 3). In addition, poverty and agriculture are still closely linked in Croatia. 27 percent of the rural population in Croatia is at risk of poverty, compared to 16 percent of those who live in towns or suburbs and 12 percent of those who live in cities. Moreover, most of Croatia’s poor or people at risk of poverty who live in rural areas earn their living from agriculture or agriculture-related activities

Figure 3: The structural transformation of Croatia’s agri-food system lags behind its peers in the EU

Drivers

Agricultural Factor Productivity

8. Low labor and land productivity inhibit the structural transformation of the agri-food system in Croatia. Although improvement in agricultural productivity has been significant in Croatia over the last decade, its increase has been slow and the productivity gap with other EU countries remains large (Figure 4). For example, while the agriculture value added per worker has grown 20% since Croatia joined the EU is 2013, it remains almost a third lower than the same metric for Austria. In addition, these improvements in labor productivity, which have been partly driven by a significant reduction in the number of people employed in agriculture, have been accompanied by a decrease in land productivity.

Figure 4: Land and Labor Agricultural Productivity, 2013

9. Croatia’s low agricultural factor productivity has mainly been driven by low capital investments and R&D expenditures. Agricultural capital stock, fertilizer consumption, and economy-wide research & development (R&D) are key determinants of agricultural labor productivity in Europe. Regression analysis conducted by the World Bank shows that there is a positive and statistically significant relationship between agricultural labor productivity and agricultural capital accumulation, R&D spending, and fertilizer use in Southeastern Europe. For Croatia, the analysis shows that while fertilizer use in the country is higher than the EU average, Croatia’s agri-food system is characterized by low capital formation and a large capital gap compared to EU averages (see Table 2). These findings suggest that a focus on agricultural capital investments and R&D is central to increase agricultural factor productivity in Croatia. The coefficient estimates imply that closing half of the gap in the stock of agricultural capital per worker relative to EU-28 levels would increase agricultural labor productivity by 25 percent in Croatia. The model estimates also indicate that increasing R&D investment to close half of the R&D gap relative to EU-28 levels would increase agricultural labor productivity 11.9 percent in Croatia. Table 1: Croatia performs poorly in key drivers of agricultural factor productivity.

Variable EU28 Croatia Panel A: Averages from 2011 to 2015 Fertilizer Consumption (Kg per ha of arable land 165.56 207.40 R&D Expenditure as % of GDP 2.00 0.79

Net Capital Stock per worker (constant 2010 US$) 111,733 33,051 Panel B* Effect on agricultural labor productivity if a country would close a quarter of the gap in: Fertilizer Consumption (Kg per ha of arable land - R&D Expenditure as % of GDP 11.9% Net Capital Stock per worker (constant 2010 US$) 25.1% Source: World Bank Staff. * Estimates are obtained utilizing coefficients from column 2 of Error! Reference source not found. and figures from P anel A, which were used to calculate the relative change (%) required for each covariate to close a quarter of the gap compared to EU-28 levels.

Costs of Doing Business 10. High costs of doing business constrain multiplier effects and weaken competitiveness levels across the agri-food system. Primary agriculture and food processing costs are influenced by a broad range of factors that together determine the degree of integration and competitiveness of the agri-food system. Table 3 lists some of the main factors affecting competitiveness and provides a relative assessment for Croatia compared to EU member states. 1 In general, Croatia performs relatively well with respect to agricultural budget support, access to capital, institutions, market development, and business environment, but underperforms in risk management and labor. Table 0: Contribution of business factors to competitiveness levels and trends

Factor Competitiveness

Business environment Rule of law  Business security  Macroeconomy  Labor Cost  Availability  Quality  Agrarian budget Size  Quality  Predictability  Implementation  Market development Openness  Access to input  Market possibility  Risk management

1 The competitiveness indicators are organized in the following dimensions: (i) Business environment for farming and agribusiness, including rule of law, business security and macroeconomic conditions; (ii) Labor: Cost, availability and quality of labor; (iii) Agrarian budget: The size, and quality in programming, implementation and budget predictability; (iv) Market development: market openness, accessibility to producers, and market organizations; (v) Risk management: risk factors that affect agriculture and how a country is equipped to mitigate those risks including irrigation infrastructure and insurance market; (vi) Institutions: Development of institutions important for agribusiness including those that manage food safety and phytosanitary rules, research, and extension; (vii) Access to Capital: Interest rates, loan availability, maturity, and collateral.

Occurrence  Irrigation  Insurance  Institutions Ministry and PA  Research and extension  Food safety  Access to capital Interest rate  Loan availability  Maturity  Collateralization   Positive trend  Negative trend No changes

Positive High Medium Lower Low Negative *level in comparison with main competitors like NMS and EU 15 countries

11. The business environment in Croatia has been improving, but a number of financial risks remain. The operational restructuring of the Agrokor Group has been particularly slow and negatively affected investments in agribusiness. In addition, relative high level of public debt makes Croatia vulnerable to interest rate shocks and worsening external financing conditions. There is also a risk that the cyclical upturn and stronger fiscal position may result in complacency and diminished reform momentum, which would have an adverse effect on growth in the long term. That said, the overall trends are positive, and the business environment is expected to continue to improve in the medium-term in Croatia.

12. Low labor costs are offset by low labor productivity. Labor cost in Croatia are lower than the EU-28 average as well as those in most EU-15 countries (see Figure 5). However, low labor productivity currently offsets low labor costs. As a result, this cost advantage has not translated into comparative advantage, particularly for agricultural commodities. In addition, there is a growing concern regarding shortages of the labor in agriculture Croatia. Access to the EU labor market and the ongoing structural transformation of the agri-food system have led to significant migration from rural areas in Croatia, which reduced labor availability and may eventually lead to increasing labor cost. The availability of seasonal labor has also been affected due to opportunities seasonal workers have to move towards jobs out of agriculture as well as seasonal jobs in EU countries where wages are higher.

Figure 5: Labor costs per hour, EUR

34.7 37.3

32.6

31.4

29.1

24.4

22.3

21.1

15.6

9.8

9.7

9.4 9.4

8.3

7.3

6.5 6.5

5.8

5.1

4.6

3.8

3.5 2.2

13. A lot of public resources are destined to the agri-food sector, but their efficiency, effectiveness, and equity remain low. The focus of spending has been on direct income support (as dictated by the current CAP), rather than on improving the performance of agri- food systems. Croatia is one of five Member States that (i) has opted to transfer annually 15% of their rural development budget towards Pillar I, and (ii) makes use of top-up payments from the national budget. Through the complementary national direct payments, Croatia has been able to minimize the gap in income support to the EU-28 average. However, by reducing the envelope for Pillar II it also reduces the overall agriculture budget for Croatian agriculture due to the co-financing of rural development budget with national funds. Furthermore, spending is not equally distributed. As the eligibility criteria are set at minimum physical size of 1 hectare, 27% of Croatian farmers fall out of scope of EU support. The receipt of direct payments benefits large-scale farmers, as 1.76% of farms receive 31% of direct payments, the largest 79 farmers receiving nearly 14% of the direct payment envelope.

14. Improved value chain organization and integration is needed to help smaller producers seize new market opportunities. Croatian agriculture is still characterized by fragmented and dispersed production with lots of small farms. Fragmentation in primary production combined with a lack of competition and investment in food processing constrains the development and expansion of well-functioning agri-food value chains in Croatia. Although agricultural producers and processors benefit from unrestricted access to EU product and input markets, increased investment and coordination between producers and processors are need to improve productivity and efficiency and face up to increasing market competition. Furthermore, whereas access to regional markets is critical for smaller producers who do not have proper resources to store and transport their production to consumers and agro- processors, access to these markets is relatively constrained in Slavonia and (especially) the Dalmatia regions (see Map 1). Constrained market access increases transaction costs for producers operating in these regions, which have extensive crop lands.

Map 1: Land cover (left) and market accessibility (right) in the Croatia

15. Croatia's agricultural knowlegde and innovation system (AKIS) remains underdeveloped. Croatia has quickly developed supporting instittuions including national payment scheme for agriculture (SPS), veterinary services, and pytosanitary services (see Table 4). In addition, farm advisory services, agricultural education, and food safety services are moderately developed. However, the research and development (R&D) component of agricultural knowledge and innovation system (AKIS) remains underdeveloped. The AKIS is a system that links people and organizations to promote mutual learning as well as to generate, share, and utilize agriculture-related technology, knowledge, and information. In optimal form, the system includes actors such as farm advisors, agricultural educators, researchers, non-academic experts, public and independent private advisors, and various supply chain actors. The AKIS is essential to support producers and agribusiness through training, technical advice, and critical information regarding production management systems and regulatory compliance. In this regard, research and educational institutions are important AKIS institutions because they not only create knowledge, but very often also provide advisory services. In addition, agri-food businesses such as agricultural inputs sellers usually offer advisory services together with their products. A detailed discussion of the structure, challenges and opportunities related to Croatia’s AKIS is provided in Section 4.2.

Table 4: Agricultural Institutions, Croatia

Public service State of development Comments National payment scheme Developed More than 50 different measures for agriculture (SPS) Veterinary services Developed Private stations and clinics, public inspection Farm advisory services Moderately developed Lacks training, tools and specialists in intensive production

Research and Development Undeveloped Faculties and institutes do not produce adequate results Agricultural education Moderately developed Several high schools and 3 faculties in the sector Phytosanitary services Developed Croatian center for agriculture, food and villages Food safety services Moderately developed Croatian food agency, Veterinary institute, veterinary inspection

16. While large agri-food system operators have relatively good access to capital at subsidized rates in Croatia, smaller producers and businesses remain largely excluded. A number of factors constrain access to capital for small producers and agri- businesses. On the demand side, Croatia’s current production structure characterized by a high number of small-scale farmers growing low value crops creates scale problems for banks. In addition, agribusinesses and farmers have limited knowledge of modern value chains, their financing, or management requirements, which limits their engagement with credit markets to take advantage of these opportunities. On the supply side, the lack of information about agriculture among commercial banks and other financial service providers are surprisingly high for a developed EU country like Croatia. In addition, private agri-lending is crowded out as a result of extensive public support for agricultural credit development though different institutions. Croatia is the absolute regional leader when it comes to offering subsidies and guarantees for agricultural loans. The ministry subsidizes interest rates of agricultural loans and offers EU grants (and other government subsidies) under its Rural Development Program to co-finance investments. The Central Bank of Croatia estimates that the agriculture portfolio is approximately 700 Million EUR, where 50% is financed by the Croatian Bank for Reconstruction and Development (HBOR)2 and the remaining 50% by commercial banks. That said, commercial banks are increasingly interested in servicing the agriculture sector, but their high interest rates, lack of in-depth knowledge to agriculture practices/costs/risks have, and underdeveloped training and tools necessary to support sustainable agriculture financing hampers their operations in the sector. Climate Risks

17. Climate change is posing significant risks to Croatia’s agricultural output. Agriculture and tourism are the sectors that will be most affected by climate change and occurrence of extreme weather events. Croatia has a climate well-suited for agriculture, but floods and droughts combined with high temperatures a create important risks for agricultural production in Croatia. Severe droughts were recorded in 1992, 1995 and 1998, 2000, 2003, and 2011/2 in Croatia. From 2000 to 2007, droughts and hail have resulted in average losses of EUR 176 million per year, which represents 0.6% of national GDP, or 9.3% of agricultural value added. These losses add-up to more than the average value of subsidies provided to agriculture during that period. Droughts affect spring crops the most, including maize, soybean, sunflower, sugar beet. Wheat, barley and oilseed rape are affected less frequently and variation in yield are smaller as their vegetation is more likely to end before a drought starts in the region. However, this does not mean that wheat is not affected by unfavourable weather during the harvest (e.g. excessive moisture, cold weather), a small amount of moisture collected in the soil during the winter, or an early drought in May or June. Fruit and vegetables are affected by drought as much as cereals and oilseeds.

18. Irrigation systems could help mitigate climate risks, but the irrigated surface area in Croatia is relatively small. In 2013, less than 1% of agricultural land in Croatia is actually irrigated and less than 10% of irrigable land is irrigated in Croatia. Commercial producers

2 The HBOR directly grants agricultural loans or it lends funds to banks who in turn offer loans to clients, whereas the Croatian Agency for SMEs and Investments (HAMAG – BICRO) offers loans and direct support.

typically irrigate fruit and vegetables plantations, but producers of field crops face financial constraints to make the required investments in irrigation. On the other hand, small non- commercial producers use primitive methods to water their gardens or do not water their crops at all. Crops grown in zones covered by irrigation, or in enclosed spaces, however, may still be affected by droughts in the form of reduced yield and increased production costs.

Trade and Competitiveness of Agriculture in Croatia

Competitive Advantages

19. Croatia has diverse agro-ecological conditions and a climate well-suited for agricultural production. Croatia can be divided into three geographic and climatic zones: the lowland zone in the North of the country (which encompasses Croatia’s key agricultural region Slavonia3), has a continental climate, the Mediterranean coastal zone in the South, and the mountainous zone stretching across the central part of the country. Various types of climate, relief and soil, are favorable for the production of a wide range of agricultural products, from field and industrial crops to vineyards, continental and Mediterranean fruits and vegetables.

20. Producers and agri-businesses have unrestricted access to growth opportunities in high value EU and domestic markets and can leverage both regional and diaspora networks. Domestic growth opportunities for producers and agri-businesses are driven by higher household expenditure levels, low meat and fish consumption compared to other EU countries, and a growing tourism sector. On the other hand, growth opportunities in the EU, which represents a high-income market of 500 million consumers, are driven by shifting demand towards high value agri-food products, including safe, healthy, sustainable, convenient, fresh, and high value processed origin products.4 The EU market also ensures more predictability in terms of demand and prices, which mitigates domestic fluctuations and, in turn, attracts foreign investors. Furthermore, Croatian producers and agri-business can tap into historical ties and relationships stemming from the former Yugoslav era to access a market of approximately 17.5 million consumers in the Western Balkan region. In this context, the historical memory and regional consumers’ preference of certain brands are still present, as well as connections between producers and processing industries in different countries. The past ties represent a potential for the expansion of certain products from one country to another, either through retail chains, or using regionally produced raw materials. Lastly, Croatia’s Diaspora constitute potential investors and consumers for the agri-food sector. The majority of the Croatian diaspora lives in high income EU countries (Germany, Austria, France, Switzerland, and UK), which represent a market for origin products given that diasporas tend to prefer products and brands that they are familiar with. In addition to a direct consumer, the Diaspora could also be leveraged as a potential investor as their savings may be redirected back to their country of origin as remittances or investments.

3 Slavonia is located in the so-called “corn belt”, where weather conditions are ideal for the production of cereals and oilseeds. Snowy winters and rainy springs provide enough moisture to the soil and moderate temperatures during the summer make the ripening process of the crops with long vegetation period (maize in 600 maturation group, carrot with vegetation of 130 days, etc.) gradual and result in high quality produce. 4 In the EU, the retail market for organic food increased from EUR 10 billion to EUR 27.1 billion between 2004 and 2015 representing average annual growth above 15 percent compared to an average annual growth rate in grocery retail markets of around 2% to 3% in the period 2006-2012

21. EU membership opens opportunities for increased investment in Croatia’s agri-food system. The Common Agricultural Policy (CAP) is a common policy for all EU members and is managed and funded at the European level through the EU budget. CAP resources are channeled to producers through the European Agricultural Guarantee Fund (EAGF) and the European Agricultural Fund for Rural Development (EAFRD).5 The EAGF constitutes the first pillar of the CAP (Pillar I) and finances income support to farmers (in the form of direct payments) as well as market measures to mitigate price instability in agri-food markets. The EAFRD, on the other hand, constitutes the second pillar of the CAP (Pillar II) and finances a broad range of rural development measures. Over the current (2014-2020) CAP programming cycle, Croatia’s overall financial envelope is nearly EUR 3.5 billion. In the EU’s next seven- year budget (2021-2027), Croatia’s CAP budget is expected to amount to EUR 4.5446 billion (in current prices). Of this total amount, EUR 2.489 billion would be allocated to Direct Payments, EUR 1.9694 billion to Rural Development, and EUR 86.3 million to Market Support.

22. Croatia has well developed logistics infrastructure. Road transport in Croatia is highly developed and almost all the roads meet the European Union Standards. On the other hand, the railroad sector is less developed and there remain important infrastructure gaps. Water transport is an important economic activity in Croatia. The country has six seaports – Rijeka, Split, Ploče, Dubrovnik, Šibenik and Zadar. The biggest and the most important of these is the port of Rijeka, thoroughly modernized during the previous decade (investments in new and modern terminals for container transport, substantially deeper berths). Apart from Rijeka, the port of Ploče also has the possibility of container transport of goods, in addition to bulk goods transport. The remaining 4 ports are tourist centers, or specialized ports for bulk goods, wood and metalware.

Agricultural Competitiveness

23. Low agricultural factor productivity, high cost of doing business, and increased climate risks have inhibited agri-food system transformation, while contributing to low agricultural competitiveness. The competitiveness index6 used in this report represents a comprehensive and multidimensional measure of competitiveness for agricultural commodities, which summarizes a wide data range of 27 indicators including production, trade, area harvested, yield, and unit value for each product/group of products. It is calculated in comparison to countries in EU, CEFTA, and Commonwealth of Independent States (CIS), which are the main competitors and markets to Croatia exports. The competitiveness index shows that Croatia is not ranked as highly competitive in any of the cereals, fruit, vegetables, and livestock commodities considered in this report (see Table 5). In regards crop production systems, the competitiveness index suggests that Croatia is not competitive or have low competitiveness in a large number of crops including wheat, barley, carrot, tomato, cabbage, apple, plum, strawberry, among others crops. The country, however, is ranked as competitive in several cereals including maize, sugar beet, sunflower, and soybean production. Croatia is also competitive in raspberry, sour cherry, and hazelnut among fruit and pepper in

5 At least 30% of EAFRD funding for EU Member States’ Rural Development Programs (RDPs) must be dedicated to measures relevant for the environment and climate change and at least 5% to territorial development (LEADER measure). 푥 ⌊ 푖 ∙5⌋+1 6 푛+1 The country’s competitiveness index is the weighted sum calculated as follows: 푚푖 = 푗 , 푥 ∑푛 (⌊ 푖 ∙5⌋+1) 푗=1 푛+1 푗 where 푚푖 is score for the product 푖; 푥푖 – rank of the product 푖 for the specific criteria; 푥푖 – rank of the product 푖 for the criteria 푗 ; 푛 – total number of products in the analysis. Products are scored 1-10 so the formula determines the tenth of all products in which the products’ rank is in for the specific criteria and assigns a corresponding score. The product competitiveness index ranges from zero to one, with higher values indicating higher competitiveness.

vegetables. In the context of livestock production systems, Croatia is ranked as not competitive in cattle and pork meat, cattle, poultry, sheep, and wine production. Milk in the only animal-based product in which the country is competitive.

Table 5: Competitiveness Index, Croatia, 2018

Cereals Index Vegetable Index Maize 0.70 Potato 0.45 Wheat 0.62 Carrot 0.45 Barley 0.54 Pepper 0.45 Sugar beet 0.72 Cucumber 0.39 Sunflower 0.66 Onion 0.48 Soybean 0.72 Tomato 0.42 Cabbage 0.48 Bean 0.38

Fruit Index Livestock Index Apple 0.63 Cattle meat 0.53 Plum 0.54 Pig meat 0.59 Cherry 0.41 Poultry meat 0.45 Raspberry 0.39 Milk 0.57 Grape 0.44 Sheep meat 0.54 Peach 0.35 Cattle 0.45 Sour cherry 0.65 Pigs 0.70 Strawberry 0.40 Poultry birds 0.68 Hazelnut 0.55 Sheep 0.49 Blueberry 0.23 Wine 0.49 Apricot 0.26 Pear 0.38 Watermelon 0.56 High competitiveness Competitive Low competitiveness Not competitive Source: SEEDEV

Trade

24. Low competitiveness of the agri-food system is reflected in growing trade imbalances. Since EU accession in 2013, Croatia’s agri-food production and processing industry has been evolving rapidly. Some incumbent businesses have been losing their competitive advantage, while new ones have opportunistically seized market opportunities. While export values of food products have increased in aggregate, Croatia maintains significant deficits in its agri- food trade balances. The country’s imports and exports of primary agricultural products have

been increasing at a similar pace since the early 2000, which has kept the trade deficit around an average of $250 million per year. However, the gap for processed food has been increasing (see Figure 6). While agricultural production is diversified in Croatia, its agricultural exports are mostly of low-value agricultural (cereal) commodities and goods. Neighboring countries constitute Croatia’s primary export markets as well as sources of imports of agri-food products (Italy, Slovenia, Hungary). The gap in the agricultural trade balance is growing with EU countries, while being slightly positive with non-EU countries.

Figure 6: Agriculture trade balance of primary and processed food and beverage products, Croatia, 1998-2016

800 Primary 0 2,000 Processed 0

-100 -200 600 1,500 -200 -400 400 1,000 -300 -600 200 500

-400 -800 TRADE BALANCE (MILLION) BALANCE TRADE

- -500 (MILLION) BALANCE TRADE - -1,000

IMPORTS AND EXPORTS (MILLION) EXPORTS AND IMPORTS

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

2014 1998 2000 2002 2004 2006 2008 2010 2012 2016 Balance Imports Exports Balance Imports Exports

Source: Based on data from U.N Comtrade.

Pathways to Change

25. Accelerating the structural transformation of the agri-food system in Croatia is fundamental to increasing competitiveness. Considering the trends and issues shaping the competitive position of Croatia’s agri-food system highlighted in the previous sections, three critical pathways to accelerating the structural tranformation of the agri-food systems are explored in this report: (i) providing smarter incentives for productivity-enhancing investments; (ii) developing an integrated AKIS; and (iii) promoting digital agricultural.

Providing Smarter Incentives for Productivity-enhancing Investments

26. Future agriculture and rural development support programs financed under the CAP must be re-oriented towards addressing context-specific challenges and delivering impacts. In order to strengthen the effectiveness of public expenditures on agriculture and rural development, future agricultural support programs will have to be re-designed in a manner that strengthens the (i) focus on the sector’s most pressing development challenges; (ii) selectivity and coherence in proposed intervention measures; and (iii) operational efficiency of program management systems. In this regard, the European Commission proposals introduce in broad range of policy innovations that seek to shift the CAP’s focus from rules and compliance towards results and performance. In addition, they grant Member States more latitude in deciding how best to achieve the CAP’s general objectives considering

the country-specific needs of their producers and rural communities. Key policy innovations that will guide future agriculture and rural development strategies include, but are not limited to: (i) CAP Strategic Plans: Member States would have to prepare comprehensive CAP Strategic Plans that outline how proposed actions under both CAP Pillar I and II will contribute to reaching the CAP’s general objectives. The CAP Strategic Plans would also set targets for reaching these objectives on the basis of a common set of results indicators, whereas progress towards achieving them would be assessed by Member States and verified by the European Commission in a new annual monitoring and review exercise. (ii) Program Management Systems: The list of EU measures would be streamlined on the basis of eight broad areas for action within rural development as opposed to the current 69 measures and sub-measures. In addition, the European Commission would allow Member States to decide whether proposals are eligible for EU support as opposed to checking the eligibility conditions of each individual project beneficiary. Furthermore, the new CAP would encourage the take-up of new technologies, both by farmers and by national administrations, to help simplify their work7. Lastly, Member States would be required to make available to farmers a system of farm advisory services (FAS) that is fully integrated in the Member States' broader Agricultural Knowledge and Innovation Systems (AKIS). (iii) Equitable Distribution of Payments: The new CAP would provide for further convergence of direct payment levels among Member States by closing 50% of the gap between EU aid levels per hectare and 90% of the EU average. In order to ensure that a higher share of each country's direct payment allocation goes to small and medium-sized farms, the European Commission proposes a reduction of payments as of EUR 60,000 and compulsory capping for payments above EUR 100,000 per farm. The amounts freed up in this manner would be redistributed within each Member State either through a redistributive direct payment or rural development. Member States would also be able to offer to small farmers a round sum per year, a far simpler administrative procedure for recipients who would not have to fill in annual claims to receive their payments. Finally, Member States would have to reserve at least 2% of their national allocation for direct payments specifically to support young farmers setting up in the profession, either in the form of a top-up payment in addition to their basic income support or through installation grants. (iv) Food Chain Partnerships: In the context of the new CAP’s Common Market Organization, Member States would have to integrate Operational Programs for specific sub-sectors in their CAP Strategic Plan and can set aside up to 3% of their Pillar 1 budget for these interventions aimed at supporting producers who come together through producer organizations to take common actions in favor of the environment or fostering a better position in the food chain. (v) Environmental & Climate Action: In their CAP Strategic Plans, Member States would have to spell out how they intend to use funding from both CAP pillars to meet general objectives concerning the environment and climate, in particular those covering the issues of climate change, natural resources, as well as biodiversity, habitats, and landscapes. An enhanced system of "conditionality" would link all

7 For example, a new monitoring system will be developed based on systematic, year-round remote observation of agricultural activities. This will, wherever possible, replace traditional control methods such as on-the-spot checks, significantly reducing the control burden. Further use of other digital tools such as the so-called geo-spatial application (GSA), which uses satellite technology to enable farmers to make accurate claims about their land and thus reduce the level of errors in declarations and avoid penalties, will also be encouraged. Farmers' applications for direct support will come pre-filled by Member State administrations with as much up- to-date and reliable information as possible, using existing tools such as the Land Parcel Identification System, saving considerable time for farmers

farmers' income support to the application of environment- and climate-friendly farming practices. In addition, a new system of so-called "eco-schemes", funded from national direct payment allocations and going beyond what is already requested under the conditionality requirements, would be mandatory for Member States, although farmers would not be obliged to join them. Furthermore, Member States would be required to dedicate at least 30% of their rural development budget to support climate and environment-friendly actions, in particular so-called ‘agri-environment-climate commitments', which will again be mandatory for Member States to offer but voluntary for farmers. Rural development budgets could also be used to fund a range of other actions such as knowledge transfer, eco-friendly investments, innovation and cooperation. (vi) Research, Innovation, & New Technologies: The main instrument supporting innovation under the new CAP would continue to be the European Innovation Partnership (EIP-AGRI), in particular through the support of bottom-up innovation projects implemented by so-called “Operational Groups”. In addition, the new CAP would build the agricultural knowledge and innovation system (AKIS) by strengthening synergies between Horizon Europe (with transnational projects) and the CAP (with projects at regional/local level and the CAP networks) in a manner that accelerates the uptake of innovative practices among all actors in rural areas. (vii) Production & Financial Risk Management: Under the new CAP, it would be mandatory for all Member States to support risk management tools under rural development to help farmers manage production- and income-related risks which are outside their control, including through financial contributions to premiums for insurance schemes and mutual funds as well as investments and training to help farmers prevent risks or manage their consequences. In addition, it would be possible to use financial instruments to facilitate access to working capital to help farmers, for example, overcome a temporary shortage of liquidity caused by an unexpected crisis. Lastly, the Horizon 2020 program could finance research on risk management, farm digitization, and smart use of big data in agriculture, whereas the European Innovation Partnership (EIP-AGRI) could also support projects in the field of risk management (viii) Local/Territorial Development: Future rural development funding would be targeted at the development of the local, rural, and agricultural economy, whereas other EU funds would focus on large infrastructure projects, including broadband. A key element of future rural development policy would be the development of “Smart Villages” in rural areas alongside improved local infrastructure.

27. Croatia’s existing support programs channel significant public resources to producers and agri-business, but they lack prioritization and results-orientation. During the period 2011-15, Croatia’s average public spending on agriculture as a share of its GDP (0.72 percent of GDP) was nearly twice as high as the EU-15 average (0.36 percent of GDP). Combining both EU CAP and national funds (i.e. co-financing of rural development, complementary national direct payments, state aids), public support to agriculture and rural development in Croatia currently exceeds 1.1 percent of GDP and will continue to grow until 2022 as direct payments are phased-in over a 10-year transitional period. However, as noted earlier, the distribution of direct payments under Pillar I of the EU Common Agriculture Policy (CAP) has been highly unequal and heavily biased towards large-scale farms. Furthermore, the Government of Croatia has struggled to align its Pillar II rural development strategy and expenditures around addressing a limited set of key rural development challenges and their underlying drivers. Following the identification of 25 rural development challenges (“needs”), Croatia’s Rural Development Program (RDP 2014-2020) currently funds a total of 16 (out of

25) measures8 in support of 6 (out of 6) EU rural development priorities and 3 (out of 3) cross- current objectives. Moreover, success of the RDP 2014-2020 is measured primarily in terms of program outputs as opposed to agriculture and rural development impacts. With the exception of metrics related to job creation, the RDP 20014-2020’s results monitoring and evaluation framework mainly tracks the reach and uptake of the various rural development measures included in the plan.

28. Existing agriculture and rural development support programs have failed to unlock private investments that strengthen the competitive position of Croatia’s agri-food system. Pillar II rural development funds currently make up the lion’s share of Croatia’s CAP allocation (69 percent) with the remainder channeled towards Pillar I direct payments (31 percent). Although this breakdown compares favorably to other EU Member States where Pillar I direct payments represent on average 72 percent of the CAP allocation, Croatia’s lower Pillar I allocation is mainly explained by the phasing-in of Pillar I direct payments. In addition, Croatia is one of only 5 EU Member States that transfers 15 percent of their Pillar II rural development budget towards Pillar I direct payments each year and makes use of top-up payments from the national budget to minimize the gap in income support compared to the EU-28 average. Croatia also “couples” 15 percent of Pillar I direct payments to specific sub- sectors, including livestock, sugar beet and fruits and vegetables. Furthermore, the effective absorption of available EU funds under Pillar II of the CAP has been a key challenge for Croatia. Nearly half way through the current program cycle (2014-2020), it has only spent 17.6 percent of the EUR 2.4 billion rural development allocation, while 30 percent of the funds have been contracted. Only Malta (6.7 percent), Cyprus (9.5 percent) and Poland (13.8 percent) have absorbed less than Croatia. The lack of absorption of EU rural development funds was also significant during the pre-accession period, as only 70 percent of available IPARD funds were absorbed by Croatia. As a result of these policy and institutional constraints, Croatia’s current support programs have failed to channel public resources towards investments that enhance the productivity, efficiency, and resilience of the agri-food system.

Developing an Integrated Agricultural Knowledge and Innovation System

29. Well-developed Agricultural Knowledge and Innovation Systems (AKIS) in EU countries are diverse, integrated, and adapted to local needs. The main features of well- functioning AKIS in the EU include (i) active cooperation and exchange between involved entities, (ii) constant adaptation to the needs of producers and rural communities, and (iii) delivery of concrete, measurable results to improve production, resilience and sustainability of the agri-food system. In the majority of EU countries, the public AKIS actors provide general information on national and EU schemes as well as trainings and technical advice, in particular related to regulatory compliance rules and conditions. While research and educational AKIS entities are usually considered a “source of knowledge”, they often also provide advisory services. Finally, food companies, agricultural input providers and private advisors form an important part the AKIS. Their advisory services are offered together with their respective products or under certain forms of productive partnerships.

30. Croatia’s AKIS encompasses a diverse range of actors. The AKIS in Croatia is multi-actor (see Figure 9). Government actors include the Ministry of Agriculture, Croatian Farm and Forestry Advisory Service, Croatian Paying Agency in Agriculture, Croatian Agriculture

8 The four largest rural development measures in budgetary terms are investments in physical assets (24.6%), payments in areas facing natural or other specific constraints (11.9%), basic services and village renewal (9.8%), and farm and business development (9.8%).

Agency, Croatian Land Agency, Croatian Centre for Agriculture, Food and Villages, and Chamber of Agriculture. It also includes education and research organizations such as the Agronomy Faculty in Zagreb, Agriculture Faculty in Osijek, Veterinary Faculty, Agriculture Institute Osijek, and Institute for Agriculture and Tourism Poreč. The private sector is represented by entities that have certain productive partnerships or input provider relationships with farmers such as the BC Institute Zagreb, seed and seedlings companies, animal feed companies, equipment providers, and agrochemical suppliers. Producer organizations, NGOs and private advisors also participate in the Croatian AKIS. According to the available sources there are more than several hundreds of agri-food associations in Croatia.

31. Linkages and collaboration between AKIS actors remain weak. AKIS actors are poorly connected and there is no systematic and effective exchange of knowledge, information, and innovation. For example, data regarding agriculture production, both on national and farm level are collected by different entities but are not available and easily accessible. Functional cooperation between AKIS actors in terms of joint research, education, and information exchange efforts to improve agriculture production is practically non-existent. For example, there is still no established relation between faculties or research institutions with farm advisory service, which is commonly considered to be the core of any AKIS system. Meanwhile, linkages between research institutions and the agri-business sector in Croatia remain inadequate. In general, the country performs poorly in terms of innovative SMEs collaborating with other public-private organizations as measured by co-publications and private co-funding of R&D expenditures (European Innovation Scoreboard, 2017).9 Data also point to important gaps in the use of scientific information for innovation. Universities and R&D companies are rarely seen as sources of information for innovation: only 6.9 percent of firms in Croatia would turn to universities for innovation.

Figure 9: AKIS in Croatia

9 According to bibliometric data, collaborations as measured by co-publications between private and higher education institutions in Croatia represent 0.79% of total collaborations, less than half of the EU average.

Croatian agriculture and forestry advisory PRIVATE service CAA, CCAFV ADVISORS

FOOD Agricultural INDUSTRY faculty AKI S Veterinary INPUT faculty PROVIDERS

PUBLIC ENTITIES • text Ministry PRIVATE SECTOR of Agriculture NGOs • text agriculture institute NGOs Osijek, BC Institute Zagreb, Institute Porec 32. Activities of AKIS actors are not coordinated under a comprehensive national AKIS strategy. There is currently no mechanism for coordinating, targeting or guiding the activities of the main public AKIS actors to ensure they act in synergy towards specific national AKIS goals. This limits AKIS impacts in Croatia where public institutions and agencies have the biggest potential influence in the sector given the important numbers of employees and financial resources they have. Up to 50,000 producers are currently reached through the Croatia’s AKIS. However, despite recent changes, new employees and more funds, CAFAS still needs additional efforts to transform from a typical public administrative entity to a modern, market and business-oriented actor. Many CAFAS advisors are not prepared to meet the demands of new, modern agri-businesses and investors in agriculture. At the same time, the influence of private agricultural advisors is limited to the users of the products their companies deliver or farmers in productive partnership arrangements. In this context, food producers and processors together with dealers of agriculture inputs carefully plan their activities in line with economic realities. In most cases these actors deploy high-quality experts that often outperform public advisors.

33. The development of Croatia’s AKIS is hindered further by low investments in research, development, and innovation. While the food processing sector has relative technological strength in Croatia, the overall innovation system does not perform well compared to peers in the EU (See Figure 10). Overall R&D expenditures in Croatia are low at 0.81 percent of GDP (with the business sector accounting for 0.41 percent), compared to 2 percent in the EU and 2.4 percent in the OECD. Croatia also lags behind its main regional and global competitors in agricultural R&D. In 2016, Croatia spent EUR 2 per inhabitant on R&D in agriculture, compared to an average of EUR 6 in the EU-28, EUR 7.6 in the U.S., EUR 15.5 in South Korea, and EUR 50 in Norway (see Figure 11).

Figure 10: Croatia is a moderate innovator

Source: European Innovation Scoreboard 2017

Figure 11: Croatia’s R&D expenditure on agriculture is only 32% of the EU-28 average (R&D expenditure per inhabitant in agriculture, 2016)

Norway 50.1 Ireland 20.2 Denmark 16.9 South Korea 15.5 Switzerland 15.3 Finland 13.9 Germany 10.1 Spain 8.6 Iceland 7.7 United States 7.6 Japan 7.1 United Kingdom 6.9 Cyprus 6.5 Netherlands 6.2 EU-28 6.2 Latvia 5.6 Sweden 5.3 France 5.3 Portugal 5.1 Estonia 4.9 Italy 4.5 Czech Republic 3.9 Austria 3.7 Slovenia 3.4 Hungary 3.3 Belgium 3.3 Greece 3.1 Lithuania 2.7 Bulgaria 2.2 Croatia 2 Slovakia 1.8 Serbia 1.6 Romania 1.2 Poland 0.8 Malta 0.6 Luxembourg 0.2 0.0 10.0 20.0 30.0 40.0 50.0 60.0 EURO PER INHABITANT Source: World Bank staff using data from Eurostat. 34. The generation and transfer of knowledge and technologies to producers and agribusinesses in Croatia remain limited. There is huge gap between applied technology and average results in Croatia compared to EU countries. Croatian farmer typically do not use the best available breeds, technology, and digital tools to improve their production, exchange

information, or connect to markets. In general, the Croatian innovation system is still strongly oriented towards basic research in the public sector and government support is not focused on transitioning to new technologies, applying new knowledge, or value adding production. There is only limited support for research and innovation by companies/faculties/institutes through tax incentives or other measures.

Promoting Digital Agriculture

35. Digital Agriculture (DA) solutions could drastically improve productivity, efficiency, and environmental sustainability across the entire agri-food system. DA is an umbrella term that encompasses a variety of cutting-edge technologies ranging from mobile phone applications to highly automated farm machinery equipped with a vast array of sensors coupled with satellite and drone imaging. DA is proving to be a powerful force for the transformation of agri-food systems by inter-connecting data objects that are context-sensitive and can be identified, sensed and controlled remotely. A broad range of stakeholders across the agri-food system are impacted by this transformation process, including farmers, food processors, logistic services, waste management companies, and consumers (see Figure 12). The profound changes in access to data, information, and relationships enabled by DA could simultaneously enhance agricultural factor productivity, increase food chain efficiency, reduce environmental impacts, and strengthen resilience to climate change across the agri-food system. Notwithstanding these benefits of DA, however, it remains unclear how DA will affect jobs and income distribution in the rural space.

Figure 12: DA is affecting the entire agri-food system

36. While DA markets are still dominated by traditional companies, new and disruptive players are increasingly entering the arena and strengthening their position. In general, the market for digital agricultural technologies is driven by the following players: (i) traditional agricultural Original Equipment Manufacturers (OEMs) offering both hardware (machinery,

sensors) and software solutions; (ii) traditional suppliers providing a broad portfolio of advanced components (auto-steering, planting…), and spare parts for the original equipment and aftermarket; (iii) seed companies that are moving upstream in the value chain and extending their offerings into advisory and insurance services; (iv) large global IT infrastructure providers offering big data analysis and software solutions for Precision Farming technologies; (v) Advanced solutions providers offer high-tech solutions like drones, sensors and control systems that support precision farming; (vi) Start-ups concentrating on the development of smart devices and applications (apps); (vii) Private finance/trading companies focus on farmland investments and commodity financial trading; and, lastly, (viii) Universities and research centers publishing studies and develop prototypes of future DA applications.

37. Croatia is well-positioned to take advantage of ongoing developments in DA markets. For example, Croatia is investing over EUR 100 million to deploy the Next Generation broadband across the country, focusing particularly in rural areas where services were not available. These investments will significantly increase future connectivity and lower the costs to access and transmit data. In addition, Croatia has access to key resources and markets in the EU. This mitigates potential scale issues related to Croatia’s small internal market and opens up opportunities to export DA products and services to other markets in the EU and beyond. Croatia is also highly ranked in terms of consumers’ readiness to use internet services. In 2017, only four percent of the population in Croatia reported that they did not ordered goods or services over the internet because they lacked the necessary skills to do so, compared to an average of six percent in the EU-15 area, 14 percent in Spain, and 18 percent in Portugal (Figure 13). Furthermore, Croatia has access to significant funding opportunities under the EU’s Common Agriculture Policy (CAP) and the EU’s Cohesion Policy to both strengthen its innovation system and support DA. As noted earlier, the European Commission proposal for the 2021-2027 programming cycle of the CAP puts significant emphasis on fostering knowledge, innovation and digitalization in agriculture and rural areas to enhance the agricultural sector’s market orientation and competitiveness. Similarly, a key driver for developing Research and Innovation Strategies for Smart Specialization (RIS3) under the EU’s Cohesion Policy is to maximize synergies between the EU’s Structural Funds and the EU’s Research and Innovation Program (Horizon 2020) and to promote a strategic and integrated approach to harness the potential for smart growth and the knowledge economy.10 In this context, Croatia’s agri-food sector is one of the most promising sectors for RIS3 along with cross-cutting ICT sectors. Finally, the future development of digital agriculture in Croatia is facilitated by the recently founded National Council for Digital Economy11 and the prominent role assigned to digital technologies in national strategies in the field of education, science, technology, innovation and industrial development.12

Figure 13: Croatia is among the top countries in readiness to use internet services

(Percentage of individuals who, in the last 12 months, have not ordered goods or services over the internet because they lack the necessary skills, 2017)

10 Smart specialization encourages innovation and experimentation through an entrepreneurial discovery process, by allowing entrepreneurial actors to demonstrate the most promising areas for future regional development through trial and error and experimentation 11 The National Council for Digital Economy aims to establish an active partnership of all relevant stakeholders in the development of the digital economy by defining the objectives and priorities for the creation of a single digital market. 12 Relevant national strategies include the Croatian Industrial Strategy 2014 – 2020; e-Croatia 2020 Strategy; National Cyber Security Strategy (NCSS) and the Strategy for Broadband Development in the Republic of Croatia 2016-2020.

25 20 18 14 15 10 6 6 4 5

Percentage Percentage of individuals

Italy

Spain

Malta

Latvia

EU-28 EU-15

Serbia

France

Turkey

Cyprus

Poland

Ireland

Austria

Greece

Croatia Iceland

Finland

Estonia

Norway

Sweden

Belgium

Bulgaria

Slovakia

Slovenia

Hungary

Portugal

Romania

Denmark

Germany

Lithuania

Czech Rep. Czech

Switzerland

Netherlands

Luxembourg Montenegro

FYRMacedonia Source: World Bank staff using data from Eurostat.

38. Croatia’s underdeveloped AKIS poses an important barrier to unleashing the potential of DA. The successful development of a DA market in Croatia depends on the creation of an integrated environment that builds synergies between agri-businesses and innovators. Specifically, innovators must have direct access to farmers, universities, research centers and innovation hubs as well as market incentives to invest in product development that introduce DA either as their mainstream products or as complementary services to their existing portfolio. From this perspective, well-functioning Agriculture Knowledge Information Systems (AKIS) play a key support role in promoting DA. However, Croatia’s underdeveloped AKIS (see Section) currently contributes to both demand and supply constraints to digital agriculture markets. On the supply side, the absence of early stage capital (e.g. venture capital, angel investment, etc.), stakeholder collaboration, and public support for innovators to develop digital agricultural services creates high R&D cost. Meanwhile, a lack of incentives for farmers to modernize and adopt digital agricultural technologies constrains market demand. Furthermore, data sharing will be crucial for the successful establishment of a DA environment and market in Croatia. However, transparency and responsibility will be key for gaining trust between stakeholders. Unless potential benefits and risks are made clear and people can trust that data exchanges are settled in a proper and fair way through contractual agreements, originators may be unwilling to share data. It is therefore crucial to clearly define key principles regarding data rights, access rights and/or data re-use rights. Only if such principles are established and enforced will it be possible to develop business models that benefit all stakeholders involved in DA.

39. Governments can play an important role in removing barriers to DA market development. The public sector can leverage both push and pull development instruments to address weaknesses and leverage strengths in the AKIS to help create and expand DA activities and markets. Development push mechanisms include interventions that reduce development costs, lower barriers to entry, and facilitate the testing/demonstration of digital agricultural solutions by the private sector. For instance, regulations, funding, and infrastructure that support basic and applied agricultural and general R&D as well as demonstration of DA products and services can provide a push to create and strengthen private enterprises (e.g. start-ups) to participate in DA markets (see left side of Figure 14). The establishment of Digital Innovation Hubs13 could act as an innovation-booster for the

13 Digital Innovation Hubs (DIH) are newly promoted concept where they play a role of meeting place for various stakeholders in innovation system: R&D institutions, private companies, investors, governmental bodies, etc. In the future R&D funding

entire DA ecosystem. On the other hand, pull mechanisms at the disposal of the public sector include government policies that reward the successful development of digital agricultural services by ensuring demand and future revenue streams to the private sector. Input suppliers, farmers, and downstream players in the food market will only engage with DA service and good providers if the services/products can be acquired at cost-effective levels. Due to the relative small-scale of the domestic market in Croatia, government support may therefore be required to adjust prices of DA services/products to levels that would boost demand and jump-start the domestic DA market. This includes incentives (e.g. vouchers or subsidies), regulations, and public services (e.g. providing buyers with the information about the availability and quality of goods) that influence input suppliers, farmers, and downstream chains to demand DA services and goods from private suppliers (see right side of Figure 14).

Figure 14: Supporting the creation and expansion of a Digital Agriculture market in Croatia

Source: World Bank staff.

Emerging Policy Priorities

40. Sector policies and investments that recognize the dynamics of structural transformation could help increase the competitiveness of Croatia’s agri-food system. A number of policy priorities geared towards accelerating the structural transformation of the Croatia’s agri-food system emerge from the diagnostic undertaken in this report. In particular, future policy priorities should focus on addressing the following key challenges to the structural transformation of the agri-food system:

programs, Digital Innovation Hubs will play a major role and will be closely tied to EU science funding. Currently, there are no DIHs registered in Croatia

41. Increase productivity: Croatia must identify and prioritize measures that remove existing barriers to resource efficiency and value addition in the agri-food system. Increased resource efficiency could be improved by crowding-in private investment and leveraging the potential of (digital) technologies applied to agriculture. Value addition, on the other hand, could be promoted through increased product diversification, differentiation, and market development. Increased investment in an integrated AKIS could promote both increased resource efficiency and value addition within the agri-food system. To be effective, these investments must be underpinned by general innovation strategies that promote strategic linkages both within the agri-food system and with related sectors. In particular, the development of DA markets could further facilitate the systematic and effective exchange of knowledge, information, and innovation among various AKIS actors.

42. Reduce the cost of doing business: Croatia must clearly define public and private roles to create a vibrant and modern agri-food system that efficiently connects farmers, agribusinesses, and markets. Rural development measures supporting improved organization of fragmented agri-food chains as well as access to finance for smaller producers could significantly improve competitiveness by reducing transaction costs within the agri-food systems. Commercial partnerships, such as the “productive alliances” introduced by the World Bank in Latin America, Africa, and East Asia since the 2000s, have demonstrated to be particularly effective platforms for coordinating actions across the agri-food value chain that have led to increases in production volumes, productivity, access to improved inputs and productive equipment, as well as producers’ integration into new markets.

43. Manage climate risks: Croatia must support sustainable production systems such as organic and climate-smart agriculture to reduce vulnerability to climate risks and increase adaptive capacity to climate shocks. At the same time, the promotion of renewable energy, energy- efficient technologies, and climate-friendly farming practices could help Croatia further mitigate greenhouse gas emissions linked to the agri-food system. The country should develop climate measures in particular by leveraging the greening component of the CAP.

44. Leverage EU resources: Croatia must increase the efficiency of its public support to the agri- food sector, including the absorption and improved targeting of EU CAP funds. To this end, Croatia must closely align its policy and regulatory frameworks with EU CAP programming requirements, while prioritizing country-specific needs and priorities. It is paramount that the country’s program management systems leverage these EU resources to boost agricultural productivity, strengthen agri-food value chains, and address climate and environmental concerns.

45. Strengthen institutional capacity: Rapidly changing domestic, regional and international market conditions require public institutions capable of regulating and servicing increasingly complex agri-food systems, including in the context of ensuring regulatory compliance, integrating agricultural knowledge and innovation systems (AKIS), and results-based management of agricultural support programs.