Productivity Must Increase Through Structural Reforms

Solution: Productivity must be encouraged among those who pay taxes, those who create demand from their earnings, and those who are willing to save and invest part of their earnings

written by Mr. Ante Žigman
member of the Management Board of Partner Bank and
lecturer at ZŠEM

What needs to be done to emerge from the economic crisis and how to stimulate growth while stagnation persists, which is the greatest fear of market participants? For the economy to break out of the vicious circle of stagnation that begins with a slowdown in demand and then very quickly in supply, productivity must be increased through capital investments and innovations. Unfortunately, our present does not find space where productivity will increase, but rather opens up space for greater budgetary spending due to new rights and an increase in the number of beneficiaries, mostly retirees. The number of retirees has increased by 35 percent in the last fourteen years, while the number of workers contributing to the pension fund has simultaneously decreased by 2.5 percent, changing the ratio between the number of beneficiaries and insured from one to 1.81 to one to 1.29. When thousands of unemployed and thousands of those receiving various social benefits are added to this, it is indeed a significant question in the medium term how to service public debt.

Preparation: Indeed, the aging population without an increase in productivity or a later retirement will permanently slow down economic growth, and accordingly increase the pressure on the growth of public debt. Only accelerated productivity growth can help bridge the slowed economic growth, but productivity growth has not been recorded even in the best years of growth. Therefore, the increase in unemployment during the crisis can prepare the ground for much more efficient processes and increased productivity. The Croatian economy has largely relied on the construction sector, whose arrival of the crisis has deflated the bubble of excessive growth, which is best reflected in falling prices. All European countries with a strong construction sector that was the main driver of economic growth (e.g., Spain) are experiencing a deeper crisis than those countries that relied on the manufacturing industry (e.g., Germany). Stagnation inexorably affects the construction sector, which is collapsing like a house of cards due to falling demand for real estate; the longer demand remains weak, the greater the damage for construction companies.
The financial crisis that hit Europe at the end of 2008 ended in most European countries by the end of 2009, but in some countries, a series of mistakes in economic policy management caused a spillover from the financial to the economic crisis in 2010. To exit the problems as soon as possible, economic growth must first be stimulated, and this can be done in two ways: by stimulating short-term demand and supporting long-term supply. Unfortunately, such a combination is difficult to implement. Nevertheless, Germany has achieved the almost impossible by stimulating short-term demand last year by providing large subsidies to its industry and workers, but this year it has cut budgetary expenditures and brought order to state spending to open up space for the private sector.

Consistent Implementation: Therefore, consistent implementation of economic policy that will quickly adapt to new situations is crucial. The solution cannot be fully found in implementing overly restrictive fiscal policy, but moderation is crucial as it can jeopardize the recovery of the economy, which cannot simply be compensated for by loose monetary policy as interest rates are near zero. A series of economic studies suggest that consolidation based on reducing budgetary expenditures will do more to stimulate economic growth than measures involving tax increases (e.g., Hungary). If tax increases are inevitable, they should be applied to indirect taxes such as VAT or excise duties, rather than direct taxes such as income tax, as the state directly intrudes into the pockets of every worker, while increasing VAT and excise duties leaves them the choice of whether to spend or save. When it comes to budget savings, it is quite clear that reducing the wage mass and other social benefits is better for economic growth than reducing state investments in infrastructure. As a magical solution for economies where the population is aging and there are more and more beneficiaries of social benefits, productivity growth is offered. When workers produce more, the standard of living rises, and the state has more sources to finance its debts and support those who do not work.
However, a decline in productivity can further complicate the situation. The financial crisis has taken its toll, many valuable workers are losing their skills with technological advancement, investments in innovations have slowed down, and the state has no money for investments. Therefore, there are not many options left but to encourage productivity among those who pay taxes, those who create demand from their earnings, and those who are willing to save and invest part of their earnings. This can best be achieved through the implementation of structural reforms.