The European Commission on Wednesday recommended Croatia to improve economic competitiveness, strengthen administrative capacity to manage EU funds, limit net expenditure and keep the budget deficit below 3% of GDP as part of the European Semester Spring Package.

The Commission has published its recommendations to the member countries regarding their economic policies and reforms. The Commission also published reports on the economic and social situation in the member countries, which are intended for the coordination of economic and financial policy in the EU.

One of the three recommendations for Croatia is to improve competitiveness. This includes better access to various sources of financing and the promotion of the capital market by facilitating the participation of small investors in the bond market.

This also includes reducing labour shortages by strengthening basic skills, further education and retraining, and improving access to formal long-term care at home and in the community. This recommendation also includes overcoming the fragmentation of public organisations undertaking research, development and innovation.

Investment should be accelerated and budgetary expenditure capped in 2025

The second recommendation relates to strengthening administrative capacity in the management of EU funds, accelerating investment and maintaining the pace of reform. The recommendation states that delays should be addressed to ensure continuous, swift and effective implementation of the recovery plan, including REpowerEU, and to complete the reforms and investments by August 2026.

The Commission also recommends accelerating the implementation of the cohesion policy programme, focusing on the agreed priorities. This should take into account the opportunities offered by the Strategic Technology Platform for Europe (STEP) initiative to improve competitiveness.

A further recommendation is to present a structural budgetary adjustment plan to limit net budgetary expenditure next year in order to keep the budget deficit below 3% of GDP and maintain general government debt at an appropriate level in the medium term.

In the report on the economic and social situation in Croatia, the Commission notes that the economy continues to grow at a solid pace. Last year, Croatia recorded the second highest GDP growth in the EU. Economic growth is expected to continue at similar rates this year and next, approaching the European average.

The Commission notes that Croatia’s competitiveness is gradually improving, thanks in part to strong public investment and the reform momentum of the Recovery and Resilience Plan. The tourism sector, which accounted for 12% of GDP in 2019, is particularly dynamic. Croatia has increased its market share of global exports from 0.13% in 2018 to 0.14% in 2022. In recent years, trade integration in the single market has increased and is now around the EU average. The introduction of the euro in 2023 has further facilitated trade with the eurozone countries.

Wage growth is faster than productivity

In terms of labour productivity, Croatia is approaching the EU average, albeit more slowly than comparable countries and with significant regional differences. Labour productivity in Croatia will be 70% of the EU’s total productivity in 2023. Relatively weak results in productivity factors such as research and development, patent activities and human capital contribute to an increase in the gap compared to comparable countries.

Productivity in the manufacturing and construction sectors is particularly low, which is problematic given the large investments in infrastructure construction as part of the recovery plan, according to the Commission.

A lack of innovation and skills, limited access to capital and high energy costs were identified as the main barriers to business investment.

As far as tax policy is concerned, the Commission notes that it is relatively favourable for growth and competitiveness. Taxes on labour, which have an impact on cost competitiveness, are well below the EU level, mainly due to relatively high tax concessions.

The Commission warns that the constant cost pressure can jeopardise the implementation of investments and external competitiveness. Consumer prices and wages rose significantly in 2022 and 2023 amid strong demand and a tight labour market.

This could significantly increase the cost of implementing large investment projects, including those financed by the EU, on which Croatia’s future competitiveness strongly depends. With wages rising faster than labour productivity, Croatia recorded a sharp increase in unit labour costs in 2022 and 2023.

Measures should be taken to increase the supply of housing instead of subsidising first-time purchases

Prices for flats and houses continued to rise sharply in 2023, albeit at a slower rate. Nominal prices of houses and flats rose by 11.9% in 2023 (3.7% in real terms), driven by a large liquidity surplus in the banking system after joining the eurozone, foreign purchases and the government’s housing subsidy programme.

Housing affordability is still one of the lowest in the EU. Strong tourism activity contributes to housing being permanently unaffordable. In addition, the subsidy scheme introduced in 2017 to help people buy their first home was found to have contributed to a general increase in house prices and lower affordability, particularly for non-subsidised buyers.

Housing affordability in 2023 was slightly worse than in 2017, despite a strong increase in incomes, and the Commission suggests that carefully designed measures to increase housing supply may be more appropriate to address the issue of low housing affordability than first-time buyer subsidy programmes.