Chapter 1. Assessment and recommendations

This chapter documents the overall development context in Croatia since independence in 1991, describing the current economic situation and the main investment policy reform efforts, and identifies specific challenges that hinder investment, economic growth, and well-being. It summarizes the key findings in each policy area covered by the Review and provides tailored recommendations.

Croatia has made significant economic and social progress since independence in the early 1990s. A broad range of structural reforms have been designed, enacted and implemented to accomplish the transition from a command economy to a market system. In 2018, Croatia became a high-income country according to the new classification of the World Bank. Increased cooperation with the World Trade Organisation (WTO) and the European Union (EU) in the context of the accession process acted as an external anchor for reforms. Croatia applied to become an EU Member State in March 2003; candidate country status was officially granted in June 2004; accession negotiations started in October 2005 and were concluded in June 2011; the accession Agreement was signed in December 2011; and the Croatian Parliament ratified the accession Treaty in March 2012.

The EU accession process played an important role in strengthening the policy framework for investment, including in the many policy areas covered by the OECD Guidelines for Multinational Enterprises (hereafter: the Guidelines) related to responsible business conduct (RBC). The negotiations covered policy areas divided into 35 chapters of acquis communautaire, many of which relevant to a sound investment climate. Croatia notably had to meet EU criteria in areas such as corporate law, governance, intellectual property protection, competition policy, social policy and employment, enterprise and industrial policy, science and research, judiciary and fundamental rights, anti-corruption, environment, and consumer and health protection.

Through this process, Croatia has engaged in many structural reforms. However, Croatia’s economy is still in transition, with slower growth than economies at a similar stage of development such as Bulgaria or Romania. In the industrial sector, for example, the decrease of labour-intensive activities has been a trend in all countries of Central and Eastern Europe over the past ten years. In countries like the Czech Republic or Poland, this change has come with capital deepening, technological advancement and increased value added, leading to a successful reindustrialisation. In Croatia by contrast, the last ten years have seen a stabilisation in manufacturing industry’s share in GDP (after the large 1995-2008 drop) and an increase in the share of low-tech activities within the manufacturing industry.

As a result, challenges remain on the way to accelerating the convergence towards the European Union’s income levels and living standards. Of particular relevance are levels of public and private investment still low for an emerging economy with unmet needs, and a trade structure that reflects a still feeble participation in global value chains and a specialization in mass-market and import-intensive tourism services.

Croatia’s GDP per capita (USD 13 237 in 2017) remains one of the lowest in the EU; even when expressed in Purchasing Power Standards (PPS), GDP per capita in 2016 was 48% of the EU average. In addition, economic growth has not equally benefited all citizens. In 2016, according to Eurostat, more than a quarter of people were at risk of poverty or social exclusion, the seventh highest share within the EU. In rural areas, a third of residents were at risk of poverty or social exclusion, above the already significant EU average of 25.5%. The situation is particularly serious in the east and the southeast regions of the country - mainly along the border with Bosnia and Herzegovina and Serbia (areas that suffered the most from the Domovinski rat – the Homeland Wars – in the 1990s). The absolute poverty rate (at USD 5.5/day at 2011 purchasing power parity [PPP] per capita) increased from 4.7% in 2009 to 5.8% in 2015.

Achieving the transformation that started two decades ago requires addressing structural challenges and revitalising economic competitiveness. Private investment has a role to play in this agenda. Under the right conditions, domestic and international investment can enhance Croatia’s productive capacity and growth potential, drive job creation and improvements in living standards. Active policies to promote and enable RBC and spur private sector contribution to sustainable development can support Croatia’s economic development. RBC standards focus on the positive contribution of the private sector to economic, environmental and social progress, with a view to achieving sustainable development, while addressing potential and actual negative impacts of business operations.

This Investment Policy Review of Croatia (hereafter: the Review) looks at challenges and opportunities from the perspective of the investment climate. It assesses Croatia’s policy convergence with the OECD Declaration on International Investment and Multinational Enterprises (hereafter: the OECD Declaration), including the country’s ability to comply with the principles of openness, transparency and non-discrimination and RBC practices (Box 1.1). Capitalising on the OECD Policy Framework for Investment (Box 1.2), it takes a comprehensive approach to reform priorities looking not only at the need to increase both domestic and foreign investment but also at ways to increase the development impact from that investment. This Review is intended to support Croatia’s reform agenda and the implementation of the Sustainable Development Goals (SDGs) to promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all.

Box 1.1. The Declaration on International Investment and Multinational Enterprises

The Declaration is a policy commitment by Adherents to provide an open and transparent environment for international investment and to encourage the positive contribution multinational enterprises can make to economic and social progress.

The Declaration consists of four elements (each underpinned by a decision of the OECD Council on follow-up procedures):

National Treatment: A voluntary undertaking by Adherents to accord to foreign-controlled enterprises established on their territories treatment no less favourable than that accorded to domestic enterprises in the same situations.

The Guidelines for Multinational Enterprises: Recommendations on RBC addressed by governments to multinational enterprises operating in or from Adherents. Adherents commit to promote the Guidelines and establish their built-in implementation mechanism – the National Contact Points (NCPs) to further their effectiveness.

International investment incentives and disincentives: Adherents recognize the need to give due weight to the interest of other Adherents affected by laws and practices in this field; they need to strengthen international co-operation in this area and endeavour to make measures as transparent as possible.

Conflicting requirements: Adherents agree to co-operate so as to avoid or minimise the imposition of conflicting requirements on multinational enterprises.

As of 1 April 2019, all 36 OECD member countries have adhered to the Declaration, as have 12 partner countries: Argentina (22 April 1997), Brazil (14 November 1997), Colombia (8 December 2011), Costa Rica (30 September 2013), Egypt (11 July 2007), Jordan (28 November 2013), Kazakhstan (20 June 2017), Morocco (23 November 2009), Peru (25 July 2008), Romania (20 April 2005), Tunisia (25 May 2012), and Ukraine (15 March 2017).

Box 1.2. The Policy Framework for Investment

The Policy Framework for Investment (PFI) helps governments mobilise private investment in support of sustainable development, thus contributing to the prosperity of countries and their citizens. It offers a list of key questions to be examined by any government seeking to create a favourable investment climate. The PFI was first developed in 2006 by representatives of 60 OECD and non-OECD governments in association with business, labour, civil society and other international organisations and endorsed by OECD ministers. Designed by governments to support international investment policy dialogue, co-operation, and reform, it has been extensively used by over 25 countries as well as regional bodies to assess and reform the investment climate. The PFI was updated in 2015 to take into account this experience and changes in the global economic landscape.

The PFI is a flexible instrument that allows countries to evaluate their progress and to identify priorities for action in 12 policy areas: investment policy; investment promotion and facilitation; trade; competition; tax; corporate governance; promoting responsible business conduct; human resource development; infrastructure; financing investment; public governance; and investment in support of green growth. Three principles apply throughout the PFI: policy coherence, transparency in policy formulation and implementation, and regular evaluation of the impact of existing and proposed policies.

The value added of the PFI is in bringing together the different policy strands and stressing the overarching issue of governance. The aim is not to break new ground in individual policy areas but to tie them together to ensure policy coherence. It does not provide ready-made reform agendas but rather helps to improve the effectiveness of any reforms that are ultimately undertaken. By encouraging a structured process for formulating and implementing policies at all levels of government, the PFI can be used in various ways and for various purposes by different constituencies, including for self-evaluation and reform design by governments and for peer reviews in regional or multilateral discussions.

The PFI looks at the investment climate from a broad perspective. It is not just about increasing investment but about maximising the economic and social returns. Quality matters as much as the quantity as far as investment in concerned. It also recognizes that a good investment climate should be good for all firms – foreign and domestic, large and small. The objective of a good investment climate is also to improve the flexibility of the economy to respond to new opportunities as they arise – allowing productive firms to expand and uncompetitive ones (including state-owned enterprises) to close. The government needs to be nimble: responsive to the needs of firms and other stakeholders through systematic public consultation and able to change course quickly when a given policy fails to meet its objectives. It should also create a champion for reform within the government itself. Most importantly, it needs to ensure that the investment climate supports sustainable and inclusive development.

The PFI was created in response to this complexity, fostering a flexible, whole-of government approach, which recognizes that investment climate improvements require not just policy reform but also changes in the way governments go about their business.

Source: www.oecd.org/investment/pfi.htm.

Substantial reform and strong economic fundamentals

Croatia's reforms since independence in 1991 have been significant, given the historical context. Croatia rapidly implemented an ambitious reform programme based on the gradual opening of trade and investment and the creation of an open market economy, driven in particular by commitments taken during its WTO accession negotiations and preparations for its strategic goal of acceding to the EU. Increased cooperation with the WTO and the EU in the context of the accession process acted as an external anchor for reforms. Croatia acceded to the WTO in 2000 and to the EU in July 2013, making Croatia the 28t^h member state of the EU.

Croatia's annual gross domestic product (GDP) growth rate has been relatively stable, with the exception of the early 1990s when the war led to a sharp decline in output, and in the years 2008-2014. The global financial crisis strongly affected the trade balance and domestic consumption: between 2009 and 2014, the economy declined by a cumulative 12%, the largest contraction in the EU after Greece. Croatia’s recovery since 2015 has been underpinned by improved overall macroeconomic management, stronger external demand, lower oil prices and increased tourism earnings. Faster-than-planned progress in fiscal consolidation permitted exiting the European Union’s Excessive Deficit Procedure in June 2017, the Croatian National Bank accumulated international reserves, and the banking system remained well-capitalised and liquid, despite the crisis at Agrokor, the country’s largest conglomerate and top employer. Annual GDP growth averaged 2.2% in 2015-17 –slightly higher than the EU annual average (2.1%), but weaker than that of most of other EU central and east European countries.

Foreign direct investment (FDI) trends have followed an upward trajectory. The inward FDI stock first peaked in 2007 at 28 billion EUR (or 60% of Croatia’s GDP), and after a sharp downward adjustment in 2008, following the financial crisis, has recuperated its earlier trend – reaching a new height in early 2018. Today, the share of inward FDI stock stands at 61% of GDP, above the OECD and EU averages (of 39% and 53%, respectively). By contrast, the share of outward FDI stock stands at 11% of GDP, below the OECD and EU averages (of 48% and 62% each), reflecting the fact that foreign firms remain relatively more important in the Croatian economy than Croatian firms’ operations abroad. The relative concentration and volatility of FDI, as well as the potential appetite of Croatian firms to expand abroad may call for greater government attention and more active investment promotion and facilitation policies.

Attracting investment is a key government priority

Since the early 2000s, attracting investment has been a top priority of the government, as evidenced by Croatia's national development strategy plans and various governmental documents. The more recent strategies put investment at the heart of the objective to achieve economic development, improved competitiveness and higher productivity. For example, Croatia's latest national programmes involve an ambitious economic and development policy reform package that focuses on boosting competitiveness, employment, and better living standards. However, there is no dedicated FDI attraction or investment promotion and facilitation strategy in Croatia, and different ministries as well as different levels of government tend to adopt individual plans. Investors point to the need for a more comprehensive and long-term vision of the government in the area, which would go beyond the distribution of EU funds and other state support regulated by the Act on Investment Promotion.

Despite on-going efforts to improve the business environment, investment facilitation remains a challenge. Several of the key reforms aiming to reduce administrative burdens and remove key bottlenecks have been delayed. This includes some administrative procedures that are still complex and burdensome – in particular in the area of business and land registration and the receipt of the associated permits, including construction permits, of inspections and para-fiscal charges – as well as their uneven application at the subnational level. Further follow-up is needed on addressing these shortcomings.

Seizing opportunities to further attract and benefit from investment

The competiveness of an economy and its capacity to attract investment depend on a number of factors, including macroeconomic stability, the regulatory environment, the skills base, the quality of infrastructure and access to finance. The challenges Croatia faces are widely documented and recognised in primis by the government. The economy suffers from heavy dependence on tourism – roughly a fifth of Croatia's GDP comes from tourism – and an inadequately educated workforce. These features diminish the country’s ability to attract more and better-qualities investment, to develop industries with higher productivity, and to tackle the challenges of export diversification and production upgrade.

Once the industrial powerhouse of the former Yugoslavia, Croatia has transformed into a service-based economy that relies on the low-productivity tourism sector for jobs and income: in fact, Croatia’s economy is by far the most reliant on foreign visitors among its European peers. This is not to deny that tourism and more generally the service sector – which employed nearly 64% of the population and represented two-thirds of the GDP in 2016 – have had so far a strong development impact. But insofar as Croatia remains specialised in the low end of the market and proves unable to upgrade and become an all-year destination, there are risks to the sustainability of economic growth. Over-dependence on one sector increases the vulnerability of Croatia to external shocks as evidenced by the impact of the global financial crisis in 2008-2014.

Diversification is a challenge faced by many economies. The government's national development strategies contain many concrete measures to achieve the goal of making Croatia an attractive and dynamic investment destination, not only a touristic one. The presence of three Croatian companies in the top 1000 listing of fastest-growing companies in Europe compiled by the Financial Times and Statista testifies to Croatia’s entrepreneurial spirit. In the medium run, the ultimate goal of economic policy should be not investment for its own sake, but rather investment which fosters sustainable and inclusive growth.

Tackling the challenge of low labour market participation and addressing skills shortage

Unemployment has come down from the record levels reached during the six-year recession but remains among the highest in Europe, especially for the youth. Against the background of a rapidly aging population and negative net migration flows, low labour force participation rates and high levels of informality concur to explain this fragile social development situation. Reforms have been introduced and implemented, notably to reduce rigidities in employment protection legislation, but active labour market policies remain insufficient to improve the social outlook.

The authorities should take the decisive steps to strengthen labour force participation, particularly among women. Reform of labour law and parental benefits and access to affordable childcare are important, but would not in themselves be sufficient to secure the desired outcome. In addition, structural reforms, encouragement of competition and entrepreneurship, and the strengthening of institutions enabling better functioning of a market economy are preconditions for creating employment opportunities.

The state of the national system of innovation is also a cause of concern. Although educational attainment is almost universal, PISA scores reveal that Croatian youth is ill-prepared to compete in and contribute to the knowledge economy. Business investment in research and development is also rather low by EU standards. An additional problem is the high rate of skilled workforce that keep migrating.

Strengthening SMEs’ insertion in global value chains

Small and medium-sized enterprises (SMEs) are the backbone of the economy in Croatia, in terms of number of enterprises, employment, and turnover. Productivity of SMEs, however, is disturbingly low, and so is the ability of Croatian SMEs to internationalise through export and insertion in global value chains as suppliers to larger multinationals. One reason is that a large number of Croatian entrepreneurs start a business out of necessity and relatively few are motivated by perceived opportunities (indeed the necessity-opportunity ratio is the highest in Europe). Another, and possibly complementary, reason is that the regulatory burden on SMEs is very heavy. Aware of this, the government in May 2017 introduced the obligation to assess any primary and secondary pieces of legislation from the viewpoint of their possible administrative and cost effect on business, especially SMEs.

Boosting state-owned enterprises reform

Croatia’s reform agenda initially placed an appropriate emphasis on the corporatisation, liberalisation and privatisation of state-owned enterprises (SOEs), but the reform momentum petered out in the 2000s. SOEs still dominate large swathes of the economy and in particular the infrastructure sectors, including transport, energy, post and communication, and utilities, and also operate in competitive industries such as agribusiness and manufacturing. They suffer from political interference, ineffective governance, poor management, and low efficiency. The high burden they pose on the economy and on public spending weighs on inclusive growth. Many of these enterprises are classified as strategic, which impedes private investment as an important economic stimulator and source of capital for Croatia's innovation, job growth, and competitiveness.

In fact, even the precise contours of this universe are not known with the necessary precision. An EBRD estimate is that in 2017 SOEs controlled 30% of total assets in the economy, contributed 15% of the total revenue, and employed some 73 000 employees, or 5% of the total workforce. According to European Commission estimates, the numbers were even bigger in certain industries: for example, 79% of those employed in utilities and 45% of those employed in the transportation sector were employed by SOEs. The importance of reducing the SOE sector and in improving the management of those that remain in state ownership to enhance economic efficiency and ensure a public sector supportive of growth has been well recognised in Croatia's most recent National Reform Programmes. Unfortunately, limited progress has been achieved so far in selling state assets and in improving corporate governance in those that remain in state ownership.

Key findings

Croatia is largely open to foreign direct investment

With a view to enhancing FDI inflows, continuous efforts have been made to reform the regulatory framework under favourable terms in line with the European legislation and other international standards. Croatia is open to foreign investment, with a few formal ownership restrictions, and the key standards of investor treatment and protection are guaranteed under the constitutional law and other laws.

There are no pre-establishment screenings of foreign investment. National treatment of foreign investors in the post-establishment phase is guaranteed, which means that foreign investors, when incorporated and headquartered in Croatia, are considered to be domestic legal entities, with all the rights and obligations that are applied to domestic investors. The few existing de jure exceptions to national treatment are limited to foreign ownership restrictions in a handful of sectors, namely in legal services, freshwater fisheries and air transport.

Other existing barriers to FDI mainly concern conditions imposed at establishment (e.g. local incorporation requirement and reciprocity condition for the establishment of a branch).Such barriers to entry are few, mostly sector-specific and are typically limited in their scope, applying almost exclusively to investors from outside the European Union or the European Economic Area (EEA) or to investors from countries which are not WTO members.

For instance, foreign ownership of real estate is unrestricted for investors from the EU, while it is conditional on reciprocity for others, with the exception of specific real estate and protected nature reserves. Nevertheless, even in the absence of reciprocity between Croatia and the country of origin of the purchaser, the foreign investor can incorporate a company with its seat in Croatia, which can, subsequently, acquire real estate in Croatia. Access to agricultural land is so far limited to leasehold but, following expiry of the transitional period granted by Croatia's accession treaty with the EU, foreign ownership of agricultural land will become in 2020 unrestricted for investors from the European Union.

Croatian law also does not impose performance requirements on or mandate employment requirements to foreign-owned established investors, nor are senior management or board of directors positions mandated in private companies, except in the banking sector, where there is, in addition to an assessment of adequate knowledge and skills required to manage a bank, a legal requirement for at least one member of the management board of a credit institution to be fluent in speaking and writing in Croatian, and in audit firms, where the majority of members of the management board need to be licensed auditors in Croatia or another EU member state, and one member needs to be fluent in Croatian. In line with the principles and standards of the OECD Declaration, Croatia does not either impose conflicting requirements on multinational enterprises (MNEs) operating simultaneously on the Croat territory and in other countries.

As a result, Croatia is among the most open economies to FDI (Figure 1.1). Its degree of FDI regulatory restrictiveness is low in comparison to the OECD average, as well as against the average of non-OECD economies that have adhered to the Declaration, according to the OECD FDI Regulatory Restrictiveness Index. Croatia is at par with the average EU economy under this indicator. As such, any possible difficulty in attracting FDI is unlikely related to the regulatory environment for foreign investors. Croatia is largely open to foreign investment and generally treats domestic and foreign investors alike.

Despite this openness, Croatia suffers from shortcomings that investors say they experience when establishing a business and in the day-to-day running of their business operations as documented by Croatia's performance in international rankings. Croatia’s overall rankings in the World Bank’s Doing Business 2019 edition (58^th globally, behind most European Union countries but also some of non-OECD countries which are recent Adherents to the Investment Declaration such as Kazakhstan (30^th)) suggests that there is room for rendering administrative procedures speedier, more transparent and effective, and for improving the overall quality and transparency of public governance.

Perception of corruption also remains high and not only by regional standards (Croatia was ranked 57^th out of 180 economies in the Transparency International’s Corruption Perception Index in 2017). When compared with other non-OECD countries which recently became Adherents to the OECD Declaration, Croatia performs much better than countries such as Kazakhstan (122^nd) and Ukraine (130^th). It is nevertheless below other non-OECD Adherents to the Declaration such as Costa Rica (38^th). While an open environment for foreign investment is important, this is not the only incentive to which FDI responds. Foreign investors are equally affected by deficiencies in the overall business environment impinging on domestic investors too.

Figure 1.1. OECD FDI Regulatory Restrictiveness Index, 2017

Protection of investment

The protection of investment, combined with effective enforcement mechanisms, is an important pillar of a sound investment climate. Protecting investors from improper treatment can lower their perception of risk for new investments, and investors who perceive lower risks will generally make capital and resources available at a lower cost and with longer amortisation periods.

Croatia's domestic framework provides investor protection aligned with international standards but could benefit from a justice system more responsive to the needs of business and people

Croatia has pursued a comprehensive reform agenda encompassing protection of ownership and other rights. Property rights and regulations on acquisition, benefits, and use of property are well defined. Croatia has also a modern system of intellectual property rights that is aligned with the EU norms and standards. Progress in reforming the judiciary has been steady over the past ten years, in particular towards strengthening the independence and professionalism of the judiciary. The government has also taken a number of steps to streamline the workings of the judicial system, including by rationalising the courts’ network, making capital investment and deploying modern information technologies, and promoting mediation as an alternative method of dispute resolution. As a result, Croatia now offers an increasingly efficient and professional judicial system. According to the 2018 EU Justice Scoreboard, Croatia had in 2018 rates of case efficiency for civil, commercial, administrative and other cases comparable with other EU member states.

There is nevertheless room for improvement. For example, professionalization is still insufficient, especially at local level. The implementation of e-procedures in the court is progressing, though more slowly than expected. Backlogs in the courts are decreasing but remain sizeable. As result, there is still an overall perception that courts are slow in processing cases; that judicial procedures are complex; that frequent amendments in the text of the laws often result in varying interpretations among judges. There is scope for further strengthening Croatia's judiciary to stimulate investor confidence. This includes further reducing delays in court decisions, even if Croatia does not position itself too badly compared to other EU countries, being somewhere in the middle of all EU member states. More intensive continuous training for judges in emerging areas of law should also result in greater court practice consistency. Initiatives to facilitate the use of out-of-court methods of dispute resolution also need to be followed through.

Property registration is another issue. Stakeholders consulted in the process of this Review highlighted that further progress in improving land and property registration remains important to improve the country’s competitiveness. A dual system still governs the management of real estate data in Croatia, with the cadastre as a separate entity from the land registry. Reform is nevertheless in motion. The government has moved towards consolidating the land registry and cadastre systems under a single administration by end 2020 following OECD good practices. If realised, it is hoped that the reform will lead to a significant reduction in the number of procedures arising from the currently applicable regulations, and thus facilitate registration.

A large but outdated network of investment treaties adds protection for investors but requires active management

As many other countries, Croatia grants additional and preferential protections based on investment treaties to some investors from a broad range of countries. These treaties, which nominally cover around 70 jurisdictions and a large share of Croatia’s inward and outward FDI stock, were concluded within 15 years, beginning immediately after independence. The treaties bear the hallmarks of agreements concluded at a time when few treaty-based claims had been brought, awareness of treaty implications was low among governments, and belief in benefits of treaties was greater than it is today.

Twelve treaty-based claims brought against Croatia since 2013 have sharpened Croatia’s understanding of the implications of its investment treaties, the risks associated with their loose drafting and generous provisions, and the restrictions of its policy space and fiscal costs associated with defence against claims. While Croatia remains committed to its treaties, it endeavours to better balance investor protection and the right to regulate in the public interest through amendments. It has also begun considering the conclusion of new treaties with countries where Croatian investors operate.

Investment promotion and facilitation

Croatia has been relatively successful in attracting FDI, although investment has been primarily directed at the financial services, as well as real estate, accommodation and construction sectors. Privatisations and mergers and acquisitions (M&A) have been the most prominent channel for investors entering into Croatia with greenfield FDI playing a less prominent role with potential implications for job creation. In addition, the country has been affected strongly by the financial crisis and the subsequent FDI reversal.

In order to minimise the risks associated with high concentration of FDI in a few sectors and to ensure broad-based benefits to the local economy, e.g. in terms of high-quality jobs, innovation or regional development, Croatia faces the challenge in promoting and facilitating investment more effectively, in particular into new sectors and greenfield projects. Well-designed and implemented policies of that kind can help Croatia attract investment into most productive uses and support several objectives such as economic diversification; boosting the indigenous business sector; enhancing access to technology and knowledge transfer; intensifying integration into the global value chains.

A more effective coordination on investment promotion and facilitation is needed

In this regard, the lack of strategic guidance on FDI objectives and development targets for Croatia and a fragmented and evolving institutional framework may complicate promotion efforts. This is reflected in the absence of a single, overarching strategy for investment promotion linked to well-defined national development objectives. Investment promotion and facilitation in Croatia tends to focus on the provision of investment incentives for firms and disbursement of EU funds and do not necessarily encompass a whole-of-government approach. Individual ministries at central level of government, as well as local self-governments, tend to have separate strategies that are not necessarily coordinated.

The on-going work to develop a national development strategy could be treated by the government as an opportunity to clarify the role that FDI attraction can play in meeting Croatia’s development goals, and followed up with further more specific measures. In addition, the strategy could also be taken as an opportunity to improve the interactions at different levels of government in the area of investment promotion and facilitation.

The institutional fragmentation may in particular compromise the efficiency of the system. For example, the division of tasks at the central government level, which was in place until January 2019, between the Agency for Investment and Competitiveness (AIK, Agencija za investicije i konkurentnost) and HAMAG-BICRO was atypical among OECD countries. Even if staff of the now defunct AIK considers that AIK was the national IPA, de iure competencies were divided between the two agencies according to the Act on Investment Promotion, and they both provided similar information and services to investors.

The coordination between the Ministry of Economy, Entrepreneurship, and Crafts and the Ministry of Foreign and European Affairs in the area could also be strengthened, in particular to leverage the use of embassies abroad. Coordination among the various bodies at the sub-national level is also a challenge. It remains to be seen if the transfer of the former AIK’s staff and activities into Ministry of Economy Entrepreneurship and Crafts that took place in early 2019 can help foster coordination among the various bodies or, in fact, turn out counter-productive, depending on the new department’s final role, organisation, resources, and relations with other government bodies. Certainly, the government could try to use the recent institutional change to reflect more thoroughly on the goals and articulation of its FDI attraction policy with the aim to bolster Croatia’s investment promotion and facilitation efforts.

Despite progress, administrative burdens remain a problem

Several reforms have aimed to reduce the administrative burden and remove some key bottlenecks. The government has developed several plans to progress on administrative simplification, each of them using the standard cost model (SCM) methodology. Despite certain delays, implementation is progressing, with about 75% of the measures identified in 2017 and 2018 addressed. For 2019, 314 additional measures to be streamlined have been identified, relating primarily to the simplification in tax and accounting administration, employment procedures for foreign employees, e-procedures in the court system, streamlining of customs procedures by integration of customs and tax departments, e-procedures and e-registers in environment protection. According to the government, the implementation of all plans for years 2017-2019 will require changes to 158 regulations by end of 2020, suggesting an ambitious reform agenda.

Yet, despite improvements, investment facilitation remains a challenge, as suggested, for example, in the World Bank’s Doing Business rankings, in which Croatia scores rather poorly in relation to business and land registration and construction permits. The introduction of the quasi one-stop shop (OSS) service for establishing limited liability companies in 2004, HITRO.HR, has reduced the average time spent on the process. Yet, several factors still hinder the business registration process (e.g. the necessity to validate the name of the company with a judge), resulting in average times spent on the procedure in some Croatian cities, such as Zagreb, above the OECD average.

Advancements in the use of e-permitting services, several of which are already available or being rolled out, and the extension of OSS service to include access to a greater number of public bodies and procedures, can be steps in the right direction. Progress in other areas considered key by business, including getting construction permits and paying taxes (including parafiscal charges) will also be critical to ensure that the perception of poor business climate in Croatia changes with time. More generally, a greater focus on investment facilitation in Croatia and further progress on improving regulatory quality will be an important part of the process to ensure that poorly designed regulations do not continue accumulating, putting undue burdens on firms in the future.

The transparency of the tax system and of the framework for investment incentives has significantly improved

With the aim to encourage entrepreneurship and attract investors Croatia introduced significant tax reforms in 2018, resulting in better tax transparency. A number of measures are also in place or planned to reduce the administrative burden of paying taxes. With a view to enhancing investment in certain targeted activities, efforts have also been made to rationalise the regulatory framework for investment incentives with more clearly defined eligibility criteria. The legislation provides for different incentive measures for investors (domestic and foreign) who undertake investments in certain zones (e.g., entrepreneurial and free economic zones) or activities that are deemed to contribute positively to sustainable economic development, job creation, and innovation.

In the future, Croatia will face a challenge of moving away from special regimes for selected investment and of improving its overall investment climate. This will involve broadening investment facilitation efforts, i.e. reducing the costs for establishment and operating business, while making investment promotion efforts, via investment incentives and other state support, more targeted. Better monitoring and ex post evaluations of public interventions will play an important role in this process. Last but not least, the authorities can face a challenge in transiting from an approach to FDI attraction based on removal of restrictions to FDI to the use of active investment policies that aim not only to maximise the investment value but also to promote sustainable development. In this task, it will find itself balancing the views of business, civil society and other stakeholders as well as goals of investment attraction with RBC; and a greater reliance on evaluation of socio-economic effects of various policies can become a useful tool to support the decision-making process.

More generally, closer monitoring and evaluation in the area of investment promotion and facilitation, including the allocation of investment incentives, can provide the government with key insights to improve its policies over time. As such, a recent study commissioned by the Ministry of Economy, Entrepreneurship and Crafts to undertake cost-benefit analysis of the entrepreneurial zones, located in nearly each Croatia’s county, is a positive development and could be extended to study all investment incentives and assistance by investment promotion bodies.

Public governance

The quality of public governance has a significant influence on the climate for business and investment. Poorly designed or loosely applied regulations can slow business responsiveness, divert resources away from productive investments, hamper or delay entry into markets, reduce job creation and generally discourage entrepreneurship. Nothing contributes more to investor confidence about regulation than predictability and that rules achieve their stated objectives. The quality of public services also significantly influences the investment climate. Integrity is also a crucial determinant of a favourable investment climate.

The legal framework for better regulations is improving but there is room for further progress

There has been important improvement in the quality of regulations in Croatia. For example, the legal framework for consultations is among one of the most developed among the EU member states. A new law has strengthened the quality of ex ante review of regulations. In the absence of formal processes that apply to secondary regulations, however, quality is affected. In addition, Croatia has not yet developed a systematic approach towards ex post evaluations Further advances in extending good regulatory practices to secondary regulations, conducting targeted ex post reviews, focusing on the performance of regulations or specific sectors, as well as ensuring greater homogeneity in application and enforcement of regulations at the national and sub-national level can help reduce administrative burdens and improve the quality of regulations in the future.

Even more importantly, ensuring that these rules and requirements are respected in practice remains a challenge. For example, while the consultations on the Labour Act amendments took a year, the whole tax package was discussed in less than three days. Practices vary from ministry to ministry and the conduct of Regulatory Impact Assessment (RIA) is often perceived within state administrations as a legal requirement and secondary task, with implications for quality. Some stakeholders have also raised an issue of unequal access of different groups to the legislators. This may be related to the overall low trust in the government, according to polls, and a critical attitude towards its effectiveness (over 80% of Croatians reported not to trust the government in 2018).

Croatia's rather complex administration structure impairs the investment climate

The quality of Croatia's public governance also suffers from a rather complex and multi-layered network of public administrations. Such a multi-layered public administration creates a cumbersome and confusing environment for businesses and individual entrepreneurs who have to navigate through it. Streamlining this structure would help reduce red tape and disparities in regulation and in the scope and quality of public services. Better public administration would have high payoffs in boosting medium-term growth. Yet, caution needs to be exercised when undertaking such reforms. As the recent abolition of the Agency for Investments and Competitiveness demonstrates, it is critical that the government reflects on solutions that allow continuity of the work of the affected institutions and how the reform may affect the government’s effectiveness prior to implementing such changes. Otherwise, uncertainty and disruption may have negative effects.

Public integrity and corruption

Croatia has made important strides in reducing opportunities for corruption and limiting discretion in public decision-making. At the central level, appropriate standards of integrity are mostly in place and obligations to report personal assets and liabilities are now the prevalent rule. Legislation is also in place to assure transparency of political parties funding. The development of eGovernment services and other approaches is progressing. The legislation governing public procurement has been amended on several occasions, with each version enhancing transparency and control. Reforms aimed at fostering the integrity of state-owned enterprises (SOEs) are also progressing, though more slowly than scheduled.

Significant developments have also taken place to strengthen the efficiency of law enforcement agencies. Croatia’s criminal law against corruption largely meets the standards of the Council of Europe, EU and UN, and the establishment of USKOK – the Office for the Suppression of Corruption and Organised Crime attached to the State Attorney General's Office and which combines detection, investigation and prosecution of corruption into one law enforcement body – has led to a large number of successful prosecutions and asset confiscations. Investors have acknowledged these achievements: In 2017, 60% of business respondents operating in Croatia thought that corrupt people or companies would be caught, much above the EU-28 average of 43%.

As a result, Croatia is one of the best performing countries among members of the OECD Anti-Corruption Network for Eastern Europe and Central Asia (ACN), a network that supports countries of Eastern Europe and Central Asia in their efforts to prevent and fight corruption. When compared with non-OECD countries that recently became Adherents to the Declaration, Croatia, in the latest Transparency International’s Corruption Perception Index, ranks 57^th, much better than countries such as Kazakhstan (122^nd) and Ukraine (130^th).

Despite the many encouraging steps taken, corruption is perceived to be widespread. Some elements of a functioning anti-corruption framework are still missing. In particular, considering the vulnerability of the local and regional governments to undue influences, Croatia should take additional actions to promote stronger ethical standards among local governments. As local officials and employees are, with a few exceptions, not bound by any integrity standards, this may easily lead to conflicts of interest or abuses of favouritism. Furthermore, while Croatia has made concrete efforts to improve the political funding system, notably by imposing limitations on donations and subjecting political parties to disclosure of financial resources and auditing, lobbying activities have not yet been addressed.

Fostering the integrity of SOEs also requires further attention. Measures to improve corporate governance in SOEs have been implemented, but progress to improve their integrity has been slow. Given that SOEs are still present in many sectors of the economy and that corruption in the SOE sector is still perceived as pervasive, additional steps should be taken to make SOEs more transparent and ensure a level playing field. Addressing other shortcomings, for example in the area of business integrity in the private sector, which weaken Croatia’s efforts to prevent corruption, is also needed. Although Croatia is on track to addressing some of these shortcomings with the recent enactment of a whistle-blower protection law, which requires companies with more than 50 employees to establish internal channels for reporting of irregularities, adoption of such mechanisms is yet to be secured. Continuous participation in the ACN will further support Croatia’s efforts to prevent and fight corruption.

Promoting responsible business conduct as a strategic choice to enhance attractiveness and sustainable development

Promoting and enabling responsible business conduct (RBC) is vital to attract and retain quality investment and ensure that business activity contributes to broader value creation and sustainable development. Internationally recognised RBC principles and standards such as the OECD Guidelines on Multinational Enterprises set out an expectation that all business avoid and address negative impacts of their operations, while contributing to sustainable development where they operate.

RBC is not a new topic in Croatia. Businesses in particular have been an important vehicle for RBC promotion in the country, spearheading multi-stakeholder initiatives, developing materials and organising events aimed at raising awareness and understanding of RBC. The Croatian accession process to the EU involved an intensive period of reforms in areas related to RBC. Fundamental rights are protected under Croatian law, and human and labour rights and the environment are generally well-respected. As mentioned above, significant efforts have also been made to combat corruption.

The government has also undertaken efforts to promote RBC in its role of economic actor, for example through transposition of EU Directives 2014/25/EU and 2015/24/EU as related to public procurement which give more prominence to environmental and social criteria. Reforms aimed at fostering the integrity of SOEs are also progressing, though more slowly than scheduled.

Despite significant progress, challenges with implementation of legislation remain in some areas. As noted above, perceptions of corruption remain high and weighs on Croatia’s attractiveness to investors. There is scope to increase the participation of women and minorities in the labour market. Additionally, while environmental protection has long been a focus of the Croatian government, there is a risk that negative social and environmental impacts in relation to energy projects and industrial waste could pose a threat to biodiversity and sustainability of key sectors of the economy such as tourism. Implementation of RBC principles and standards could contribute to addressing these risks.

Countries which are Adherents to the OECD Declaration are required to set up a National Contact Point (NCP) for the Guidelines. NCPs are created to further the effectiveness of the Guidelines, and Adherents are required to make human and financial resources available to their NCPs so they can effectively fulfil their responsibilities, taking into account internal budget priorities and practices. In addition to promoting the Guidelines, NCPs contribute to the resolution of issues that arise relating to their implementation in specific instances. Croatia’s NCP is envisioned to be a two-tier body, consisting of a full-time NCP, staffed with two full-time members and located in the Ministry of Foreign and European Affairs, and a multi-stakeholder group, composed of representatives from trade unions, NGOs, businesses and government ministries. Whereas the full-time NCP will deal with day-to-day operations of the NCP, administrative matters, and the promotion of the Guidelines, the multi-stakeholder group will provide technical advice on RBC-related matters and serve as a platform for high-level engagement.

Summary and recommendations

Attracting more and better investment, including foreign direct investment, takes central stage in the national development goals. The authorities have made strides in opening the country to international investment. The exceptions to national treatment are few. Other barriers to foreign direct investment mainly concern conditions imposed at establishment. Such barriers are few, mostly sector-specific, and typically limited in their scope, applying almost exclusively to investors from outside the EU or the EEA or to investors from countries that are not WTO members. As a result, Croatia’s degree of restrictiveness is low in comparison to the OECD average, according to the OECD FDI Regulatory Restrictiveness Index.

The key standards of investor treatment and protection, including with respect to intellectual property rights, are guaranteed under the constitutional law and other laws. Progress in reforming the judicial system has been steady over the past ten years, in particular towards strengthening the independence and professionalism of the judiciary, although there is room for improvement.

Steps have also been taken to reduce the administrative burden on businesses, albeit progress has been slow. There is also still scope for improving the quality and coherence of the regulatory process, including through systematising the process of ex post regulatory reviews. Croatia also faces challenges in promoting investment more effectively in the absence of a single, overarching promotion strategy and against the background of an institutional set-up which is fragmented. Significant efforts have been made to combat corruption but the country still suffers from a negative image with respect to its capacity to reduce corruption and other forms of misconduct, calling for additional measures, particularly at local level.

As related to RBC, positive reforms have been undertaken in many policy areas covered by the Guidelines for Multinational Enterprises. Fundamental rights are generally protected under Croatian law, and human and labour rights and the environment are generally well-respected. The government, in its role of economic actor, also promotes RBC expectations, for example in its legislation on public procurement. Despite significant advances, challenges persist in practice in some areas, for example with respect to the participation of women and minorities in the labour market or in the area of environmental protection. The establishment of Croatia’s NCP will further raise awareness of RBC in Croatia, support implementation of RBC standards by businesses, and contribute to improved accountability.

Box 1.3. Policy recommendations

Investment protection

Continue efforts to improve the functioning of Croatia’s court system. Building on recent reforms, further improvements in the capacity of the courts to deal with private sector cases will likely boost confidence of businesses and the general public in the judiciary. This may include additional compulsory training for judges, further digitalisation of court procedures, and further promoting out-of-court settlement.
Enhance dispute resolution mechanisms. Establishing a dispute avoidance mechanism, tailored specifically to business needs, such as a Business Ombudsman, would help expedite the legal process and reduce the cost to businesses and citizens.
Continue and enhance efforts to manage existing treaties and associated exposure. Treaties with vague provisions concluded by Croatia in the past, including those subject to unwanted interpretations in ISDS, should be updated to current standards by amendments, clarifications – for example through joint interpretations –, replaced, or if appropriate, terminated by consent or unilateral action to manage exposure and safeguard the right to regulate in the public interest.
Engage in international efforts to balance treaty-based investor protection and associated governance mechanisms. Croatia should engage actively in current efforts at international level to balance investor protection and the right to regulate, and contribute its experience.

Investment promotion and facilitation

Establish a consistent and unified institutional and policy framework for investment promotion and facilitation encompassing all relevant entities with the ultimate goal of maximising synergies and effectiveness, eliminating duplication of efforts and giving clarity to investors. This could involve endowing one government body with adequate resources and capacities to perform such functions and ensure that it coordinates its efforts with other relevant bodies at the national and subnational level. Regardless of the legal status of such a body, the government should clearly outline its objectives and the planned course of action to reduce uncertainty.
Focus efforts on effectively streamlining administrative procedures, in particular in the area of starting a business, getting construction permits and paying taxes (including para-fiscal charges). This requires that these efforts are conceived in a way that reduces the heterogeneity of practices across different levels of government. It also involves setting clear, procedure-specific deadlines and monitoring progress to ensure implementation within the planned timeframes.
Introduce and improve systems of monitoring and evaluation of Croatia’s investment promotion and facilitation programmes, including investment incentives regimes. In that context, establish formal channels of consultation between the tax authorities and other stakeholders to allow for a comprehensive view of costs and benefits of the current system. While Croatia has made strides towards enhancing the transparency of its tax and incentives system, analysis to assess its effectiveness has been so far lacking.

Public governance and corruption

Continue improving regulatory quality in the country, in line with the recommendations of the 2019 OECD Regulatory Policy in Croatia: Implementation is Key. This applies to the processes pertaining to creating secondary regulations and the use of ex post regulatory reviews.
Continue anti-corruption efforts, notably by perfecting Croatia’s public integrity framework as foreseen in the Anti-Corruption Strategy 2015-2020. This could include: developing comprehensive codes of conduct for officials at regional and local level, as well as a code of conduct for parliamentarians, and ensuring corresponding accountability tools and dissuasive sanctions for potential violations of such codes; regulating lobbying activities; strengthening the capacity of existing control mechanisms with respect to public procurement.
Strengthen the integrity framework for state-owned enterprises (SOEs). Despite that measures to improve corporate governance in SOEs have been adopted in 2017 and that implementation has progressed since then, SOEs still suffer from political interference and conflicts of interest.
Take action, as appropriate in cooperation with business organisations and other stakeholders, to improve awareness among companies, including small and medium enterprises, which are traditionally at high risk of bribe solicitation by public officials, as well as SOEs, of Croatia’s new whistle-blower protection legislation, and to advise and assist companies in their efforts to establish internal channels for reporting irregularities through, for example, the development of seminars, guidelines and other forms of guidance. Making anti-corruption compliance part of one’s corporate culture is the best way to prevent corrupt acts before they happen.
Signal progress in the fight against corruption to the public and businesses. Increasing raising awareness efforts is of much importance to close any perception gap about actions already taken and reforms in the pipeline. A targeted communication strategy for the public through an on-line platform is in the offing but needs to materialize in practice.

Responsible business conduct

Establish an effectively functioning NCP to further the effectiveness of the Guidelines. All Adherents to the OECD Declaration have an obligation to establish an NCP, in accordance with the Decision of the Council on the OECD Guidelines for Multinational Enterprises. Croatia should ensure that the decision-making process in the NCP is well-defined and clear, particularly as related to the respective roles of the two main NCP bodies.
Actively promote the Guidelines and the NCP among businesses operating in Croatia and Croatian companies operating abroad, as well as among trade unions, workers' organisations and civil society representatives, including measuring business awareness and commitment to implement the Guidelines. Raising awareness of the Guidelines, as well as RBC principles and standards among all relevant stakeholders is an important aspect of ensuring that the NCP can effectively fulfil its mandate.
Take a proactive approach to engage with all stakeholders, in particular trade unions and civil society organisations. Croatia has consulted with stakeholders on the plans for the NCP, and plans to involve various stakeholders in the activities of the NCP through a multi-stakeholder group. However, NGOs and trade unions are currently underrepresented in plans for the multi-stakeholder group. Engaging with all stakeholders is key to building confidence.
Undertake a capacity building exercise for the NCP within one year after adherence and, in that context, report back to the WPRBC on the progress made in implementing the recommendations made to improve the effective functioning of the NCP. Particular attention should be paid to ensuring that the decision-making process in the NCP is well-defined and clear, particularly as related to the respective roles of the two main NCP bodies.
Promote the use of the OECD due diligence guidances by enterprises operating in or from Croatia, through active support to these enterprises in implementing the recommendations of the due diligence guidances, and ensure the widest possible dissemination of the various sector guidance and their use by various stakeholders. Countries that adhere to the OECD Declaration commit to also adhere to all of the related OECD legal instruments aimed at supporting the implementation of the OECD Guidelines, including the OECD due diligence guidances. Promoting and supporting implementation of these instruments will contribute to facilitate businesses in meeting RBC expectations in Croatia.
Promote policy coherence and improve coordination on RBC-related policies within the government. In particular, developing a National Action Plan on RBC in co-operation with relevant stakeholders including businesses, trade unions and civil society organisations could be useful in this regard. Policy coherence is crucial to ensure effective design and implementation of policies to promote RBC.

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