To Exit the Vicious Circle of Crisis, We Need to Complete the Transition

Croatia has technically exited recession after six years of free-fall in economic activity. The economy has found a new balance on its own, with a loss of about 15 percent of national income and more than 150,000 jobs.

GDP has started to grow slightly. However, Croatia has not, as could be heard from political campaign platforms these days, exited the economic crisis. Moreover, the crisis in the economy and society due to a long-standing recession and incorrect reactions of economic authorities to the decline in economic activity (increasing consumption taxes and anti-market ‘ad hoc’ measures) has deepened. New circumstances, new institutions (new laws), and new expectations have emerged that distance Croatia from an effective market economic system. Namely, every government intervention in the economic system and every ‘correction’ of market relations, of which there have been countless since the beginning of the crisis to today, have created new structures that seek to shift their irrational economic decisions onto all taxpayers. We must be concerned about the constant increase in public spending, the creation of ever-larger deficits in the central government’s accounts, and the growth of public debt.

‘Rescue’ Tailored to Politics

The government has systematically increased its spending despite declining public revenues – this year, central government expenditures will be higher by about 20 billion kuna compared to the last year before the crisis. In six years of recession, more than 60 billion kuna has been spent beyond what the real fiscal capacity of taxpayers allowed. The economic authorities have spent that money almost exclusively in an effort to maintain the ‘status quo’ in the public sector. While dramatic changes and significant adjustments to new market conditions occurred in the private sector, politicians ensured that the public sector felt almost no impact from the crisis by increasing the tax burden. Instead of helping households and private companies, as most (responsible) EU members did at the beginning of the crisis, which today record relatively high growth rates, Croatian politicians chose additional (excessive) borrowing and maintaining wage levels and employment in the public sector.

The balance sheets of most private companies and households are burdened with high debts, and capital reserves are depleted. Economic activity in these two sectors of the economy is slightly stronger this year due to increased foreign demand, a better tourist season, and fatigue from the crisis. However, economic policymakers must not expect a stronger wave of new investments from these two sectors without stronger fiscal incentives.

Minimizing the Public Sector

Without a new wave of investments, there will be no significant growth rates and new employment. State-owned enterprises are deeply connected to politicians and therefore inefficient and generally incapable of new investments without state guarantees (which increase public debt). Other domestic sectors will not recover from the crisis for a long time, and thus will not decide on larger investments, such as those seen in the early 2000s, which ended with GDP growth rates of four to five percent per year. Foreign investors expect strong fiscal incentives, which the Croatian government cannot guarantee due to high indebtedness. The domestic economy, it seems, is in a vicious circle due to these structural problems that do not lead to an exit from the crisis and an increase in national wealth in the next 10-15 years. Today’s economic authorities are right when they say that there are no easy solutions and that the exit from the crisis will take years. Politicians who are just trying to enter the circle of public policy creators and promote various radical ideas and completely adventurous approaches to economic policy can be particularly dangerous.

Today’s politicians, however, are completely wrong when they advocate for minor changes and propose ‘projects’ to dynamize economic policy. Croatia needs comprehensive changes in the public sector and economic system. Cooling public spending (returning to 2007) and privatization in the public sector will be unavoidable major changes to stop the growth of public debt and free up space for investment and growth in the private sector. However, Croatia also needs comprehensive modernization of the economic system and unconditional application of the best European practices. This means a definitive exit from the transition and acceptance of a market system as is customary in European countries (let’s look at the continuous growth of the Austrian economy in the past decade after the privatization of state-owned enterprises), in which the government sector has only a minor role in creating new values.