The Cost of Croatia’s Transition: 254 Billion Dollars

According to the official calculation, 37 billion dollars relate to the war, while 217 billion was lost due to globalization, macroeconomic policy, transformation or tycoonization, and corruption.

Interviewed by: Miodrag Šajatović and Marija Čekada
Photo: Željko Jelenski

As the elections approach, questions regarding Croatian economic policy, foreign debt, GDP growth, and economic development strategy are once again being raised, which political parties continue to set aside. In his latest book, “Economics-Politics, What Next,” Dr. Tihomir Domazet, president of the Croatian Institute for Finance and Accounting and assistant minister of finance from 2001 to 2004, addresses these issues in detail. We spoke with Dr. Domazet about the problems of Croatian economic policy from 1990 to 2007, globalization processes, and the SWOT analysis of the Croatian economy as the foundation of an economic strategy unburdened by political connotations.

• What does the term globalization mean to you?
– The globalization we are talking about is a concept that first appeared at the end of the last century. From an economic perspective, the world was block-divided until approximately the end of the eighties, and with the collapse of the Eastern bloc and the disappearance of communism, a new world economic order emerges; in a word, globalization begins. There are at least five different dimensions of globalization that need to be distinguished. These are economic globalization, political globalization, common ecological constraints, cultural values and institutions, and globalization of communication. They actually embody actions on a global scale. No matter how many objections or opposing opinions we have regarding globalization, we must accept that it is an unstoppable process and we must adapt to it, and at the global level, this process must be democratized, given that the influences of global major players are ruthless and particularly strong on economies and states that cannot influence global movements.

• However, we are faced with the threat of significant resistance to globalization. What will this process look like in the coming years?
– I would not say that the resistance is significant. First of all, I would say that key players will find ways to enhance globalization. Here, I primarily mean the greatest power, the USA, and the new players known as BRIC, Brazil, Russia, India, and the leader, China. This leads to the next problem – according to research from the West, it is estimated that last year the ratio of GDP of G7 countries and others, i.e., emerging markets, reached fifty to fifty percent. But that’s not all; the dynamics of movement in Europe is around two percent, the USA is in a financial crisis, and the dynamics of China, India, Vietnam, Russia, and Brazil indicate that in 25 years, this ratio in favor of current emerging markets would be sixty-five to thirty-five percent. This is something the authors of globalization could not have imagined. Paradoxically, they would now like to abandon globalization.

• How globalized is Croatia?
– Croatia is globalized, as indicated by the liberalization of the current account, the arrival of foreign capital and foreign companies, and more. The goal and purpose of the development strategy, not for five, but for ten or twenty years, is for Croatia to economically operate in its favor in globalization processes, and this is a conditio sine qua non of development and economic policy.

• How has Croatia fared in the course of globalization so far? What are the good and bad sides of Croatia’s entry into globalization processes, and what price has Croatia paid for it?
– The price is 48 billion euros of foreign placements in Croatia, which is about 65 billion dollars. This large amount of capital constitutes about 20 percent of our total national wealth. This is very concerning. But it is even more important to know that due to such a large placement, more and more dividends and interest, that is, what is visible on the current account, will flow abroad, or will be realized by residents from abroad. Therefore, I advocate that in addition to monitoring gross domestic product, we include other indicators, such as gross national income, which makes a difference from GDP and is currently around two and a half to three percent outflow, which is significant, and later this percentage will likely increase.

• If the total growth rate is six percent, does that mean that four percent of growth occurred under the influence of foreigners?
– That is now the problem, and this trend will increase. Foreign capital invested in Croatia did not come to enjoy the beauties of the Adriatic but to make a profit. In doing so, a certain dualism arises. Profit is inevitable; it will exist as long as it achieves its effect. If it were to withdraw for any reason, it would create a problem for us. However, on the other hand, we should direct capital into production, production for export, through economic diplomacy and development policy, which is the second qualitative moment that needs to be worked on.

• What would you suggest to change such an economic situation?
– First of all, we need to remove the obstacles that have led to the current state. Therefore, it is not possible to further dynamize such consumption based on that production. There is also an imbalance between foreign debt, the current account deficit, domestic debt, and low employment.

• How is it that there is talk of low employment while it is constantly noted that soon we will not have enough workforce for all needs?
– Official data from the State Bureau of Statistics indicate that in Croatia, employment in relation to the working-age population is 42.8 percent, which means it is one of the lowest employment rates in Europe. This is unacceptable.

• In your book, you mention that to resolve economic imbalances in developing countries like Croatia, alongside monetary policy, it is crucial to address the relationship between tradable and non-tradable sectors. Can you explain this?
– Roughly speaking, tradable goods are products and services that can be imported and exported, influenced by foreign markets and prices affected by exchange rates. Non-tradable products are everything else. An example of this is utility services. The problem is that the non-tradable sector has a naturally slower growth in productivity, which is logical, but it wants to catch up with the growth of the tradable sector. If the non-tradable sector is not addressed, even greater imbalance will arise. Therefore, these two sectors cannot be viewed separately. A year ago, for example, there was a strike by educators, which some criticized, but it was actually about classic problems in the relationship between the tradable and non-tradable sectors. Thus, professors and other representatives of part of the non-tradable sector wanted to reach wage levels in the tradable sector. Therefore, the issues of the relationship between the tradable and non-tradable sectors should be resolved within the framework of a well-designed developmental path of economic policy.

• What about Croatian monetary policy?
– I certainly do not want to say that the issue of exports should be unilaterally resolved through a changed exchange rate and thus eliminate external imbalance. However, monetary policy, as part of economic policy, must serve its goals, which include higher growth, export growth, production of goods and services with higher values, and ultimately achieving a surplus in the foreign trade balance.

• How much has export lost due to the exchange rate in the past fifteen years?
– If we accept the assessment of the Austrian National Bank that the exchange rate of the kuna was overvalued by an average of about 15 percent from 1994 to 2005, then that real GDP during that period amounted to 347.4 billion US dollars, and that the export of goods and services contributes about 50 percent to GDP, it means that the export sector has lost or failed to achieve a higher inflow from the export of goods and services amounting to 26.1 billion US dollars solely based on the appreciated domestic currency.

• It is evident that economic policy has been poor over these 15 years. You have calculated that the cost of transition, excluding losses due to aggression, is a loss of 217 billion dollars of gross domestic product.
– Such calculations are also made by other countries that have been in financial crisis. It is inevitable to say that it is a problem if GDP has not grown for about fifteen years. We can call it a crisis, depression, or something similar. It is evident that only in 2005 did real GDP reach the level of 1989. Industrial production is still about 20 percent below the level of 1989. If we were to calculate GDP per capita for 2004 and 2005 in relation to 1986, when the significant decline or crisis began, it would be even more pronounced. According to my calculations, from 1989 to today, 254 billion dollars is the amount that has not been reached or that has been lost for GDP, and that is, simply put, the cost of Croatia’s transition. Of that, according to the official calculation, 37 billion dollars relates to the war or aggression against Croatia, or against the Croatian economy. Therefore, when excluding the war, 217 billion dollars has been lost due to the impacts of globalization, macroeconomic policy, transformation or tycoonization, and corruption, to name just the most important factors. However, Croatia has, in my opinion, completed the transition process, and this circumstance should be (mis)used positively.

• You say that you were shocked by the low share of the manufacturing industry in GDP in 2005 and 2006 during the sectoral analysis of Croatian production. What is that share, and what are the shares of the manufacturing industry in the countries of the region and in Western European countries?
– I surprised myself when I saw the results of the sectoral analysis. Croatian agriculture, or the primary sector, accounted for about seven percent of GDP in 2005 and 2006 and, as expected, participates very modestly. However, I am fascinated by the fact that only the manufacturing sector, or domestic production, is questioned by production, expenditure, or income methods. Namely, if we start from the expenditure method of calculating GDP, and then increase exports and decrease imports, GDP results in that the share of domestic production or the manufacturing sector is astonishingly small and amounts to seven percent of that calculated GDP or domestic production.

With a combination of this method and the value-added method of calculating GDP, and according to data on trade with foreign countries, where in 2005 a deficit of 55.751 million kuna was achieved, it turns out that the largest part of goods from the manufacturing industry is not produced in Croatia but is imported. Even today, I cannot believe that. It becomes evident how few factories we have and how many have been shut down. However, this does not mean that we should reopen closed facilities today, but we need a new industrial policy that offers solutions in globalization processes. The level of the manufacturing industry in other countries is clearly higher than ours.

• According to your SWOT analysis, Croatia’s strengths are geostrategic position, favorable traffic position, water wealth, and quality environment, while weaknesses are low influence on global geostrategic policy and a large number of retirees. How to address Croatia’s weaknesses?
– Before the transition, the ratio was 3.5 employees to one retiree. At that time, it was unfavorable. Today, that ratio is about 1.4 to one. But that’s not all. Among that number of retirees, people are between 50 and 55 years of age, while in the European Union, it is insisted that the age limit for employees, according to the Lisbon agenda, be between 67 and 70 years. We actually need to focus on solving the employment problem. This is a political, social, and economic problem, and those aged 50 or 55 who are able to work should be included in the solution, and here we return to economic policy. As for the inability or weakness of Croatia’s influence on global geostrategic policy, that is a given circumstance, and this fact should be taken as an exogenous variable regardless of whether someone likes it or not.

• What are the dangers for Croatia according to the SWOT analysis?
– External negative influences are the impacts of globalization, political and economic conditions in the region, the rise in interest rates on the world market, and the consequence may be that the amount of interest repayment on the basis of repaying foreign loans is higher than the growth of GDP. Internal dangers are: dependence on foreign technology and foreign accumulation, foreign debt above 35 billion euros, household debt above 100 billion kuna, and total state debt above 100 billion kuna, as well as brain drain, the departure of highly skilled and young people abroad, and environmental pollution due to investments in tourism.

• What kind of policy do you advocate?
– I advocate abandoning the bad sides of economic policy, especially the influence of neoliberal policy, and eliminating the large external and internal imbalances that have led us to difficulties. But at the same time, there needs to be an effective investment policy, an employment policy, a new policy at the micro level (industrial policies), and addressing the relationship between tradable and non-tradable sectors. This is a conditio sine qua non for a dynamic and sustainable economic or developmental policy.

• Does this mean that Croatia must drastically cut growth at some point to clear everything that has accumulated, and can this be done in the short term without going into recession and destroying the standard of living?
– Croatia has fewer and fewer choices and is forced to resolve the current imbalances, growth rates insufficient to solve these problems, and a too low employment rate with greater added value, production. A sophisticated, well-designed, and developmental economic policy is needed. In doing so, the strategy should not be reduced to political frameworks of four years but should be made for at least the next ten to twenty years, with key factors agreeing on key points that then need to be realized. The worst variant would be what the director of the European Department of the IMF, Michael Deppler, told us a year ago, namely that policy should avoid a hard landing. The IMF in October 2007 repeats or speaks about the need for a soft landing.

• Until when will tourism be the mechanism by which the current account deficit is covered? Will tourism grow at current rates?
– The solution that tourism resolves the relationship with abroad mathematically works. The destinations of the largest tourist powers, France, Italy, and Spain, have recorded a smaller number of trips in recent years, and the same is true for us. At the same time, the number of trips to the Far East is gradually increasing. Therefore, we need to look to the future and keep in mind that income from tourism will not be able to cover that deficit to such an extent. And here we return to the question of balance and the relationship between tradable and non-tradable sectors.

• In your book “Economics-Politics, What Next?” you state that Croatia should look to the Republic of Dubrovnik as a model from the past according to which it should operate in globalization today.
– The fact is that the Croatian economy is not strong enough and rich in the global world. So why should we not look to a successful model from our own past in the globalization process? The Republic of Dubrovnik had harsher conditions for economic activity than today’s Croatian state; for example, it had no raw materials, yet it became an economically powerful force in its time. The economic success of Dubrovnik was achieved through the development of comparative advantages such as educated and capable administration, what we would today call management, and the activities it engaged in, such as shipping, shipbuilding, crafts, and trade, were at a significantly higher level than in other countries. The political system of the Republic of Dubrovnik was aimed at achieving a strong and economically rich state that, in its time, due to good diplomacy, an educated workforce, and the establishment of good connections, became an economic, trade, and diplomatic superpower, with a trading fleet larger than England.