70 ifo Forschungsberichte 15,6 An Economic Reform Agenda for Croatia Editors: Oliver Falck Siegfried Schönherr Institute Leibniz Institute for Economic Research at the University of Munich An Economic Reform Agenda for Croatia A comprehensive economic reform package prepared for the Croatian Statehood Foundation (Zaklada Hrvatskog Državnog Zavjeta) Editors: Prof. Dr. Oliver Falck (Ifo Institute & LMU Munich) Prof. Dr. Siegfried Schönherr (Ifo Institute) January 2016 Institute Leibniz Institute for Economic Research at the University of Munich Bibliografische Information der Deutschen Nationalbibliothek Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über http://dnb.d-nb.de abrufbar ISBN 978-3-95942-005-1 Alle Rechte, insbesondere das der Übersetzung in fremde Sprachen, vorbehalten. Ohne ausdrückliche Genehmigung des Verlags ist es auch nicht gestattet, dieses Buch oder Teile daraus auf photomechanischem Wege (Photokopie, Mikrokopie) oder auf andere Art zu vervielfältigen. © ifo Institut, München 2016 Druck: ifo Institut, München ifo Institut im Internet: http://www.cesifo-group.de Foreword 1 Foreword When the Ifo Institute received a request from the Croatian Statehood Foundation for developing a reform programme for Croatia, it made it clear from the outset that it would keep the study strictly neutral, based upon sound economic principles and in no way aligned to any existing political party programmes. The Ifo Institute is an independent research establishment devoid of any party or political affiliation whatsoever. The only principle we clearly adhere to, as a result of proven theoretical underpinnings and the empirical evidence available, is the conviction that the social market economy (with a strong emphasis on “social”) is the most successful system for achieving and combining economic growth and social welfare. Once this was clear, the Ifo Institute entered into a contract with the Croatian Statehood Foundation specifying the terms for the study. Amongst its tenets, the execution of the study would be conducted in close cooperation with Croatian scholars and specialists. This was considered key to guarantee the inclusion of know‐how on relevant local conditions. Work on the study commenced in September 2014 and concluded in July 2015. Refinement for publication continued until the end of 2015. To make sure that the Institute would not become partisan in the parliamentary election campaign during autumn 2015, we refrained from publishing any results of the study until now. Regular workshops were held alternatively in Zagreb and Munich to safeguard the close cooperation between the Ifo team of researchers and the Croatian researchers and specialists, but, as specified in the contract, the final responsibility for the scientific analysis and the conclusions as well as the recommendations remained with the Ifo Institute. As regards the content of the proposed reform programme, we agreed that the most pressing problem in Croatia was the huge unemployment rate, especially among the youth, and the large brain drain depriving the country of many of its best human resources. To reduce this core problem in a sustainable manner, we focused the study on one key issue, namely increasing Croatia’s economic competitiveness in order to attract both internal and foreign investment as well as improving the export capacities, which in the long term are the basis for sustainable employment generation. We believe that the recent EU membership of Croatia will open excellent opportunities for trade and investment, but Croatia’s very low competitiveness in comparison with most other European countries hinders the realisation of these opportunities. The study has put forth a scientifically sound programme on how this very serious problem can be overcome. The 14 Papers, including a Summary Paper, published in this book deal with the key issues addressed by this programme. The reform proposals put forth are neither radical nor do they call for an austerity programme. They outline a roadmap for the medium‐term recovery of the chronically underperforming Croatian economy, starting with quickly‐acting measures to reduce unemployment. 2 Oliver Falck, Joachim Ragnitz and Siegfried Schönherr International experience suggests that the best way to do this is through increased domestic as well as foreign direct investment. Croatia is clearly an attractive investment destination, but has been hampered so far by the unpredictability of its commitment to economic reform. Once the unemployment crisis has been brought under control, the necessary restructuring measures can be introduced, conceived to be at least employment‐neutral and ideally employment‐fostering. EU‐financed projects would be highly advantageous for this stage, since they would contribute to a socially acceptable reshaping of the economy, furthering thus a sustainable economic development for the country. Croatia is faced today with the option of lurching from crisis to crisis, putting up with a permanently high unemployment rate and the loss of part of its best (young) brains to emigration, in a course that will unavoidably lead to the erosion of its public finances and ultimately to following the Greek path. This would be the price exacted by caving in to the vested interests of a government‐associated elite and other privileged groups who now defend the “business as usual” approach so vehemently. The other option, that of sustainable, dynamic and employment‐generating economic growth that offers good prospects in particular to younger Croatians, will of course not be free of initial pain. A commitment to a serious reform programme is imperative to see this option through. Clearly, Croatia has what it takes to achieve as much progress as other former socialist countries now in the EU have attained. It just needs the commitment. The entire Ifo team, authors and coordinators alike, hope that Croatia will benefit from this joint German‐Croatian research undertaking, regardless of the political composition of its Government. Oliver Falck, Joachim Ragnitz and Siegfried Schönherr Project Coordinators Foreword 3 Foreword On February 5th last year I gave a speech on our German experiences with the Agenda 2010 in the "Economic Policy Debate" of the Zagreb‐Bureau of the Konrad Adenauer‐Stiftung. Hereafter, the responsible persons of the Croatian foundation ZAKLADA HRVATSKOG DRZAVNOG ZAVJETA, namely their CEO Srecko Prusina, asked me for support to develop an agenda for economic policy for the Adriatic republic. I felt indeed honoured by that approach, but was quite sure, that being Mitglied des Deutschen Bundestages, I would neither have the time nor the scientific staff to fulfil this duty. So I asked the well‐known director of the ifo Institut in Munich, Prof. Hans Werner Sinn, if he would be able and ready to do the consulting task. He was ready and convinced that the people of his institute would be well prepared to do so. For me it was a great experience to do the work with the ifo‐people under the lead of Siegfried Schönherr, a very experienced senior advisor, who has accompanied several countries in their transformation process with his advice. Oliver Falck as Scientific Project Coordinator gathered the right people for the different chapters among the ifo‐staff. It was fascinating, somehow like returning to the times of my economic studies at the Johannes Gutenberg‐Universität at Mainz 30 years ago, to discuss the working papers with both, German and Croatian economic experts. The outcome of the work done is very respectable. It may serve anyone interested in a fundamental recovery of the really bad shaped Croatian economy as a quarry or as a blueprint. The solid database of the ifo research and the benchmarking by putting Croatia for each topic into an appropriate peer group gives operable hints for a better economic policy. The main thing, however, will be that political leaders take full responsibility for their wonderful country and the following generations. A lot of time has been wasted, because there was the illusion that the entry to European Union would be a magic wand that makes things better without own additional efforts. Now being a full member, the country does not even call all the funds from the EU reserved for it. Looking at the energy supply sector for instance, there is a need of replacement for half of the production capacity. At the same time, the EU is vigorously pushing renewable energies with instruments like the Mediterranean Renewables plan. Sun hours and irradiance in combination with vast sparsely populated regions make Croatia predestined for photovoltaic which assumingly works there without any costly feed‐in tariffs. Seven years of sluggish performance with no growth, sharply rising public debt, inacceptable high number of jobless, especially among the young are enough warning. Mobilizing fallow assets in tourism for example, dealing with the negative trade balance in the agricultural sector by using the huge state‐owned brownfields, reshaping the vocational education to reduce the mismatch, giving foreign investors stable conditions instead of continuously changing the framework in an erratic way ‐ there is plenty of space for improvement. Politicians will have to take decisive measures and demonstrate the staying power to stick to them even if figures get 4 Klaus‐Peter Willsch worse in the first step. It is quite a common experience that you have