Croatia on the Greek path

31.07.2015 | By Tomas Meravy

Croatian economy – a favorite tourist destination of a large number of Slovaks – faces serious economic problems. Abandoning reforms may lead to the Greek scenario.

6 years of recession

The majority of us associates Croatia primarily with sunny beaches. If you whenever have an opportunity to visit this country, I would like to recommend you to see Zagreb. Croatian capital combines nobility and dignity of the Habsburg Monarchy with Balkan madness. Catering is of exceptional quality and the urban infrastructure is also excellent. Yet seeking any real prosperity evidence is doomed to failure.

Croatia joined the European Union on 1 July 2013 but – contrary to other EU members – its accession took place in the period of economic slump. The country had been in the permanent recession since 2009 which is likely to result in bankruptcy. The deficit of public finances over recent 6 years has grown by nearly 6 percent, public debt has doubled and this year is likely to reach 90 percent of GDP. The debt of private enterprises and households is growing as well and nears 120 percent, which is twice as high as in our country. The unemployment rate has reached 17.3 percent. The main problems of Croatian economy include bankruptcies and long-term insolvency in the construction industry, small trade, and developers primarily. Banks will never be able to execute payment of 30 percent of loans. Only Cyprus and Greece have higher interest rates than Croatia, where it is 6.5 percent now.

This state of the Croatian economy results from abandoning reforms: a large number of enterprises, including banks, tourist organizations, hotels, and Adriatic sailing companies have not been privatized. State-run enterprises absorb substantial outlays, generate chronic losses and the majority of them are run by political nominees. The taxation system is unusually complicated, public outlays substantial, and labor costs relatively high. The average monthly pay is about 750 euros, which demonstrates that – unlike in other Central European countries – poor labor efficiency is not compensated by an incentive to invest due to low labor costs, which considerably decreases competitiveness of Croatian economy in attracting foreign investments.

Before the 2008 crisis, Croatia failed to make use of a good geographical location and potential of highly-qualified staff to attract foreign investments in the industries characterized by high productivity and export production. The deficit in current trade was financed not by direct foreign investments but loans from the foreign banks having branches in Croatia. Except tourist industry, investments were directed to the industries dependent on the domestic demand, especially developers and small trade. You will not see any modern plants along the road from the Slovenian border.

After the outbreak of 2008 crisis, the Croatian model of economic development collapsed like a house made of cards. The inflow of funds from abroad stopped, domestic demand collapsed and economy got into a spiral of deflation. As a large number of mortgage loans were granted in Swiss francs, great many households ran into financial troubles when its rate plunged. Consequently, demonstrations against banks were staged and the position of anti-system parties consolidated.

Recollections from holidays as the only export product

Croatia’s example proves that a country cannot depend only on nice beaches and tasty wines but should implement necessary reforms and seek foreign investments. Croatian economy is one of the least investor-friendly in this part of Europe. Per capita export volume is at the dramatically low level compared even to Croatia’s neighbors representing a similar economic potential. The transfer of foreign currency depends totally on the tourist traffic. Yet apart from tourism and possibly food production, there are no other industries able to compete on the global markets. Neither tourism nor food industry are those that could provide basis for the modern, prosperous economy. Such role could only be played by really modern industries such as car, electro-technological or IT industries.

Bankruptcy upside down

Definitely, the largest obstacle for the modernization of Croatian economy are ineffective legal system and public institutions operating, putting it mildly, in a manner not meeting any recognized standards. A great many households and enterprises are in debts and have problems with settling current accounts. Courts are overburdened and ineffective legal system makes things worse. For example, a bank account may be frozen but this does not mean what we think: freezing means execution with the court’s consent. Thus a bank may on a one-off basis draw money from the account in favor of the creditor. Currently, 320,000 bank accounts are frozen. On the other hand, the law does not provide for consumer bankruptcy, which means that a great many people will never be able to pay their debts back.

Croatian enterprises are in a totally different situation. While it is a creditor who is protected by law regarding natural persons, when a businessman runs into debt the law protects primarily a debtor, which is contrary to the regulations effective in the majority of developed countries where law primarily protects creditors. The purpose of such solution is to protect investments and effectively eliminate non-competitive companies from the market. Croatian bankruptcy law is aimed to protect companies against collapse. The indebted company has great many possibilities to avoid liquidation, such as the proceedings preceding bankruptcy proceedings. This allows the indebted company to get rid of as much as 70 percent of one’s debts and still be a market player.

Regulations concerning an organ empowered to make binding decisions in the Croatian bankruptcy proceedings is exceptionally non-standard. To relieve courts, the Croatian government decided to transfer their jurisdiction over bankruptcy, executions, restructuring, and bank account freezing to the government agency FINA. This administrative organ, subordinated directly to the Ministry of Finance, was originally established to monitor financial flows. The head of FINA is appointed directly by the Minister of Finance, which means that it is the organ of government administration and not an independent court that rules about remittance of debts. Such situation arouses serious doubts about reliability and independence of this institution. If this resembles you the Slovak restructuring of Vahostav, you are not wrong. No bankruptcy or restructuring may be effected in such manner.

What we need are reforms

Comparison between Croatia and Slovakia shows that it is not a number of kilometers of motorways but reforms that decide about the country’s economic success. Only twelve years ago the level of life in Croatia was higher than in Slovakia and the former one had GDP higher in proportion 56:55. Nowadays this is 61:75 in favor of Slovakia and Slovakian GDP still grows while Croatian decreases. On the other hand, comparison of the length of motorways and express roads shows that Croatia is better than Slovakia: 1100 and 700 kilometers, respectively.

Yet motorways will not compensate the consequences of the poor-quality legal regulations. Slovakia has one more asset which Croatia lacks: reforms implemented by the government led by Mikulas Dzurinda. In Slovakia it would be unthinkable that the Ministry of Finance could forecast annual GDP growth at the rate of 2.5 percent and the budget deficit amounting also to 2.5 percent and thereafter it would turn out that the real growth shows a negative value and the deficit is higher by nearly 5 percent. This would be impossible because of the decision made in 2004 by the Minister of Finance Ivan Miklos who established the Institute of Tax Forecasts and the Institute of Macroeconomic Forecasts whose members were bank and public institution officials. Thus the forecast developed by the Ministry of Finance and made available to the public is compared to the forecasts developed by banks so that no latitude is allowed. Moreover, public debt management and mechanisms of public debt control are much more effective in Slovakia – they are supervised by the Monetary Policy Council. Other reforms included introduction of the linear tax and implementation of the cursed (by so many) privatization. It is these reforms and not motorways that contributed to Slovakia’s higher rating, lower interest rates, better climate for entrepreneurship and economy based on knowledge more than that in Croatia.

However, if Croatia wants to avoid bankruptcy and return to the path of economic growth, it will definitely have to implement a number of reforms. I cross my fingers for Croatians and recommend you to visit this country. And I would like to advise you one more thing: if you have politicians who promise you motorways and politicians who promise you reforms, choose the latter ones.

About Author

Tomas Meravy

A young economist, former adviser to Finance Minister Ivan Miklos. He is now an economic analyst for the Most-Híd party and external consultant of MESA 10.