HUP: Croatian Growth Driven by the State, Private Sector Struggles to Keep Up

Croatia has grown into one of the fastest-growing economies in the EU from 2019 to today, a result of a combination of reforms related to entering the euro area, strong investments, faster absorption of EU funds, and a surge in public spending, writes HUP in its weekly analyses. According to HUP’s calculations, the contribution of the public sector to GDP growth increased from 2023 to 2025 to 2.6 percentage points, or approximately three-quarters of GDP growth, compared to 1 percentage point in the period from 2019 to 2022.

– If we want to see the private sector as a growth engine, then our economy should not lag in generating profits as a basis for investments in productivity and innovation, as standard profit levels attract investors. Contrary to the public narrative, gross profit measured as a share of GDP has significantly fallen below the EU average (34% compared to 41%) over the last two years. At the same time, the growth of total employee income to 49% of GDP, above the EU average (47.9% of GDP), sounds like good news, but for the trend of income growth to be sustainable, it must be accompanied by productivity, HUP states.

Superior real productivity growth in Croatia compared to the EU average over five years (11.1% compared to 1.7%) confirms the efforts of our real sector, but the significantly higher real growth of total income of 35% is heavily influenced by state interventions through payroll mass from the budget and minimum wages, compared to a real decline of -1.5% at the EU level, which overall is an unsustainable concept for sustainable economic growth. Such a large gap between the growth of labor costs and productivity has resulted in a reduction in investment capacity and a lag in competitiveness, HUP says.

They add that an additional challenge is that the share of employees in the public sector is among the highest in the EU (23% compared to 16%), and if we add the calculation of employees in state-owned companies (9% of employment compared to 4% in the EU), the public sector counts about half a million people.

This means that 32% of all employees, or one in three, works for the state. The average salary paid from the budget is 32% higher than in the private sector, so the payroll mass reaches 13.5% of GDP, the second highest in the EU, raising labor costs in the real sector. In conditions of labor shortages, the transition of some employees to the private sector is important for its growth, and controlling the payroll mass in the public sector is necessary for sustainable public finances as it slows GDP growth.

Labor is taxed six times more than rent

Croatia also has a structural problem with energy price competitiveness; companies here pay about 18% more for electricity than the EU average, which most affects industry, logistics, and other energy-intensive sectors exposed to global competition. Although the transition of the tax burden from labor to property has begun, the tax wedge remains among the highest in the CEE region, and labor is almost six times more heavily taxed than short-term rental.

Given one of the lowest employment rates in the EU, the goal should be to reduce the tax wedge to the level of the top 5 most competitive member states, which would allow for a reduction in income tax by up to 10 percentage points, facilitate the employment of highly educated individuals, and encourage investments.

HUP states that it is estimated that investments in energy and decarbonization, research and development, digital infrastructure, modern transport, and quality hotel accommodation of nearly 100 billion euros will be needed over the next five or more years to maintain stable GDP growth of 2.5 to 3 percent. It is particularly concerning that large companies (with over 250 employees) significantly lag behind European competitors in added value per employee, while in the EU, large companies are up to 70% more productive than smaller ones. This indicates a weaker ability to scale, enter global value chains, and develop export products, which is a key challenge for the next decade.

– Therefore, alongside an already generous support system for small businesses and startups, Croatia needs to strengthen instruments to encourage investments from large companies: remove restrictions on tax incentives regardless of the value of investments, introduce additional support for high-value-added companies, proactively engage in STEP and IPCEI projects, and future EU funds for competitiveness. An important step would also be the introduction of a special category for medium-capitalized companies with SME treatment when applying for EU funds, to facilitate their access to resources, HUP states.

For growth of 2.5–3 percent, an investment turnaround and stable public finances are necessary

Croatia will, along with an expected population decline of more than 100,000 people by 2030, need to significantly increase the labor market participation rate, especially among young people aged 15 to 24, whose employment is only 25.7%, which is 9.3 percentage points below the EU average.

– This requires stronger active employment policies, the development of dual education, and tax relief for highly qualified personnel. At the same time, the country is not capitalizing enough on its STEM base: the share of high-tech exports is only about 8%, compared to 18% in the EU, and industrial competitiveness suffers due to slower technological progress. Although the share of commodity exports in GDP increased from 20.1% to 28% from 2001 to 2024, Croatia still significantly lags behind EU-27 (35.5%), CEE-10 (83.5%), and Slovenia (91.3%), HUP writes in its analyses.

Preserving fiscal stability

Preserving fiscal stability and avoiding the Excessive Deficit Procedure is crucial for the state to maintain low borrowing costs and attract private investments in an environment of higher interest rates. Croatia currently enjoys some of the best financing conditions in the eurozone, but this entails strict control of current expenditures, especially payroll mass and healthcare costs, and a stronger focus of the budget on developmental, supply-oriented expenditures. Without a stable budget, clear favoritism for private investments, and the development of the domestic capital market as a platform for financing riskier projects with higher returns, the development window until 2035 and the opportunity for GDP growth to the targeted level of 2.5 to 3 percent annually will be missed.