Josip Funda, Chief Economist of the World Bank in Croatia: The Pension System is Definitely Sustainable

With ambitious reforms, Croatia could reach the EU average in 15 years, and with moderate reforms only by 2050, is the conclusion of the recently presented World Bank report that thoroughly analyzed the causes of Croatia’s significant productivity lag and highlighted the areas where policymakers need to focus their efforts to change this.

We discussed this report, productivity, necessary reforms, and other economic topics with Josip Funda, Chief Economist of the World Bank in Croatia.

You have thoroughly analyzed productivity in Croatia compared to other countries. What are the key reasons for reduced productivity in our country?

– I would not speak of reduced but rather stagnant productivity in relation to comparable countries. Many factors influence this, both on the regulatory side and on the business side. For example, companies should increase investments in research and development and continuously invest in the managerial skills and competencies of their employees.

However, in our research, we focused primarily on market mechanisms and state institutions that affect productivity. There are many studies showing a positive correlation between the quality of institutions and the productivity of the economy. It has crystallized that the business environment affects productivity, such as the issuance of permits, the entry and exit of companies from the market, and insufficient competition levels. Furthermore, it has been shown that resources are not directed towards the most productive purposes again due to inefficient market mechanisms and institutions.

Additionally, there are bankruptcy procedures that hinder the exit of companies from the market and the release of resources towards more productive companies. So, it is a whole range of institutional constraints that lead to market failures.

The solution to these problems mainly lies with the Ministry of Economy and the Ministry of Justice?

– These are key areas where reforms are needed. We need a judiciary that makes decisions faster, and the business environment must support both domestic and foreign investors. An interesting fact from a World Bank study looked at which factors guide multinational companies’ investments in certain countries. Political stability and the efficiency of the judiciary and regulatory environment are always at the top. Only then come the availability of labor, taxes, etc. This also suggests in which areas we need to make the most progress. However, one of the factors affecting productivity is certainly the quality of the workforce.

It reflects the education system, but also lifelong learning, i.e., how much companies invest additionally in the education of their employees. So, it is about national policies, government policies, as ministries merge and separate. Therefore, I think we need to focus on areas that are crucial for growth, and it is less important which ministry is currently responsible for their implementation.

So the judiciary is at the forefront…

– The judiciary is certainly one of the reform priorities, as it affects all processes, both in the economy and in society.

One of the World Bank’s recommendations a few years ago was to introduce property tax. Do you still recommend this tax and what other tax changes are needed?

– The tax system should always be viewed as a whole. The fact is that we do not have a property tax as such; we have a utility fee, which is a different type of levy. In theory, property tax has some advantages over other taxes as it less adversely affects the economy, unlike taxes on labor or capital. It is also possible to introduce a fairer property taxation system where newer and more valuable properties are taxed more, and the first property less. However, this property tax is also linked to inheritance taxes, gift taxes, and taxes on renting properties for long-term or daily rental. This can ultimately affect the labor market, as people who rent apartments have no incentive to engage in the labor market. The tax on daily rentals in Croatia is extremely low compared to other forms of income, and this is an area where reforms are certainly needed.

The World Bank is also analyzing the Croatian pension system. Do you already have some recommendations for its improvement?

– That analysis is not yet complete. I can now say that the thesis that this financial system is unsustainable is incorrect. It is definitely sustainable, but the problem lies in its social unsustainability because by 2070, pensions could be so low that they could create a social problem. One of the unpopular but better solutions is a longer working life. Simply put, you cannot expect a high pension with a short working life.

Read the full interview in the new issue of the printed and digital edition of Lider.