OECD Investment Policy Reviews: Croatia 2019 9264805915, 9789264805910

Table of contents :
Preface
Foreword
Acronyms and abbreviations
Executive Summary
Chapter 1. Assessment and recommendations
Substantial reform and strong economic fundamentals
Attracting investment is a key government priority
Seizing opportunities to further attract and benefit from investment
Tackling the challenge of low labour market participation and addressing skills shortage
Strengthening SMEs’ insertion in global value chains
Boosting state-owned enterprises reform
Key findings
Croatia is largely open to foreign direct investment
Protection of investment
Croatia's domestic framework provides investor protection aligned with international standards but could benefit from a justice system more responsive to the needs of business and people
A large but outdated network of investment treaties adds protection for investors but requires active management
Investment promotion and facilitation
A more effective coordination on investment promotion and facilitation is needed
Despite progress, administrative burdens remain a problem
The transparency of the tax system and of the framework for investment incentives has significantly improved
Public governance
The legal framework for better regulations is improving but there is room for further progress
Croatia's rather complex administration structure impairs the investment climate
Public integrity and corruption
Promoting responsible business conduct as a strategic choice to enhance attractiveness and sustainable development
Summary and recommendations
Chapter 2. Investment trends and sustainable growth in Croatia
Croatia’s economic development
Foreign investment trends
Importance of FDI in the Croatian economy
Evolution of FDI over time
Greenfield and brownfield FDI in Croatia
Croatian economy’s attractiveness and openness to FDI
European countries dominate the FDI landscape
Services account for the majority of foreign investment in Croatia
Activities of Croatian companies abroad
Outlook and policy recommendations
Notes
References
Chapter 3. Croatia’s competitiveness: Challenges and opportunities
Trade patterns and integration into regional and global value chains
Manufacturing dominates in the export basket
Trade in commercial services is in surplus
Participation in GVCs is modest
Enterprise reform
SOEs reform has lost momentum
Developing SMEs capacity for greater internationalisation
Labour markets and skills
The innovation system
The state of infrastructures
Outlook and policy recommendations
Notes
References
Chapter 4. Croatia’s regulatory framework for investment and national treatment
Croatia is open to foreign direct investment
Croatia has few exceptions to national treatment of foreign-controlled enterprises
Cross-sectoral measures affecting foreign investment
Land and Other Real Estate
Reciprocity Condition
Sector-specific measures affecting foreign investment
Agricultural Land and State-owned Forests and Forest Land
Fisheries
Rail Transport
Inland Water and Maritime Transport
Air Transport
Professional Services (legal services)
Construction, Architectural and Engineering Services
Media
Financial Services (banking, insurance and other financial services)
Other policies affecting foreign investment and reported for transparency purposes under the National Treatment instrument
Measures based on public order and essential security considerations
Corporate organisation and key personnel
Activities covered by public, private, mixed monopolies or concessions
Starting and operating a company nevertheless remain cumbersome according to business surveys
Outlook and policy recommendations
Notes
References
Chapter 5. The protection of investment in Croatia
The domestic legal framework
Croatia’s domestic legal framework provides protection guarantees for investors consistent with a modern policy regime for investment
Croatia's strong fundamentals
Guarantees against expropriation
Croatia has a modern system of protection of intellectual property rights
Main traits of Croatia’s IP rights system
Enforcement
Dispute resolution
Croatia offers an increasingly efficient and professional judicial system
Reform efforts to improve the judiciary
Alternative dispute resolution mechanisms: arbitration and mediation
International investment agreements
Brief history of Croatia’s investment treaties policy and current trends
Availability of Croatia’s IIAs to treaty users
Main features of Croatia’s IIAs
Fair and equitable treatment clauses
Investment dispute settlement mechanisms
Treaty use: ISDS claims under Croatia’s investment treaties
Croatia as a defendant
Croatian investors as claimants
Outlook and policy recommendations
Domestic framework for investment protection
Higher specification of investment protection provisions would help to better reflect government intent
Procedural considerations: exit and renegotiation
Policy recommendations
Notes
References
Chapter 6. Investment promotion and facilitation in Croatia
National strategy and the institutional set-up
Croatia has elements of national strategy for FDI attraction
The institutional framework for investment promotion and facilitation is evolving
The recent reform could be used to rethink Croatia’s investment promotion and facilitation
Investment facilitation and administrative simplification efforts
Croatia's incentives scheme for investors
Mapping Croatia's corporate income tax policy and investment incentive regime
Croatia's tax regime
Investment incentives
Special economic zones
Effective and efficient use of investment incentives
Outlook and policy recommendations
Policy recommendations
Notes
References
Chapter 7. Public governance
Regulatory quality
Regulatory policy-making and quality
Stakeholder engagement and transparency of policy-making
The fragmentation of the public administration complicates business operations
Corruption
Effective prosecution and sanctioning of corruption
Protecting sources of information
Preventing misconduct in the public sector
Preventing undue relations between business and politics
Enhancing integrity and transparency of public procurement
Corruption prevention in the corporate sector
Ensuring transparency and integrity of state-owned enterprises
Outlook and policy recommendations
Policy recommendations
Notes
References
Chapter 8. Promoting and enabling responsible business conduct as a strategic choice
Croatia’s plans for establishing an NCP
Institutional arrangements
NCP Structure
Stakeholder engagement
Resources
Handling of specific instances
Promotional Activities
General policies for promoting responsible business conduct
Policies in specific areas covered by the Guidelines
Croatia has largely aligned the legal framework with the EU standards in policy areas covered by the Guidelines
Recent notable developments in policy areas covered by the Guidelines
Non-financial disclosure
Fundamental rights are protected under Croatian law but there is scope to increase the participation of women and minorities
Environmental protection is of strategic importance for the country’s economy
Despite significant efforts, corruption still weighs on the business climate
Responsible business conduct and the state as an economic actor
Outlook and policy recommendations
Policy recommendations
Notes
References
Annex A. Croatia’s exceptions to the National Treatment Instrument
Annex A. Croatia’s exceptions to the National Treatment Instrument
Annex B. Measures reported for transparency by Croatia
Annex C. Additional figures and tables for Chapter 2

Citation preview

OECD Investment Policy Reviews

CROATIA

H V R

OECD Investment Policy Reviews: Croatia 2019

This work is published under the responsibility of the Secretary-General of the OECD. The opinions expressed and arguments employed herein do not necessarily reflect the official views of OECD member countries. This document, as well as any data and any map included herein, are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

Please cite this publication as: OECD (2019), OECD Investment Policy Reviews: Croatia 2019, OECD Investment Policy Reviews, OECD Publishing, Paris, https://doi.org/10.1787/2bf079ba-en.

ISBN 978-92-64-80591-0 (print) ISBN 978-92-64-46303-5 (pdf)

OECD Investment Policy Reviews ISSN 1990-0929 (print) ISSN 1990-0910 (online)

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PREFACE

Preface by Jasmin Devlić, Director, Sector for Economic Relations, Ministry of Foreign and European Affairs, Republic of Croatia and Greg Medcraft, Director, Directorate for Financial and Enterprises Affairs, OECD Croatia has recorded considerable economic and social progress since the start of the postindependence reforms in the late 1990s. GDP per capita increased by an average annual rate of 2.5% between 2000 and 2018 (in PPP, at constant 2011 international USD). Due to this strong economic growth and improvements in labour market conditions, the share of the population living below the poverty line (at USD 5.5/day PPP) has continued trending downwards to 4.6%, from 7.3% in 2013. In addition to its expanding tourist sector, Croatia’s strong performance has been supported by major policy reforms, including continuous efforts to open the economy to investment which have helped spur capital inflows. This performance has been impressive but Croatia still faces challenges going forward. Growth has slowed down since the global financial and economic crisis (that in fact took a particularly heavy and prolonged toll on Croatia) and convergence in living standards with the rest of the European Union has stalled. Inequalities in income and wealth, both at functional and territorial levels, have increased. Against this background, more remains to be done to fulfil the target set by the umbrella strategy EU 2020 of Croatia having a GDP per capita equal to 68% of the EU average (it was 61% in 2017). The government recognises these challenges and as part of its commitment, is engaged in ambitious reforms to improve the business environment, attract foreign investors, and further reap the benefits of openness and globalisation. Drawing on OECD investment instruments, in particular the OECD Declaration on International Investment and Multinational Enterprises, as well as the OECD Policy Framework for Investment, a policy tool to help governments mobilise private investment that supports steady economic growth and sustainable development, this OECD Investment Policy Review of Croatia looks at how improvement in the overall investment climate can promote competiveness, diversification, inclusive growth and sustainable development. It offers recommendations across a broad range of policy areas in order to make the most of investment as an engine to boost the economy and the well-being of its citizens. In particular, the government will need to increase domestic entrepreneurship, strengthen competitiveness, clarify its strategies for attracting investments that can support economic diversification, further promote responsible business conduct, and prove to investors that the institutional and regulatory system is transparent and accountable. The government is aware of these challenges and is addressing them.

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4 │ PREFACE This Review is the result of close co-operation between the Ministry of Foreign and European Affairs (MVEP) and the OECD. While the OECD brought its deep, inter-disciplinary expertise, MVEP drove the cross-agency process, involving the private sector and civil society and providing critical inputs to the Review. The Review precedes the first Croatian semester of EU Presidency: we are confident it will prove of guidance to all stakeholders interested in peace, prosperity and inclusive growth. We would like to express our gratitude to the European Union for funding the Review. We hope this report will contribute to creating a favourable investment environment in Croatia.

Jasmin Devlić

Greg Medcraft

Director, Sector for Economic Relations, Ministry of Foreign and European Affairs, Republic of Croatia

Director, OECD Directorate for Financial and Enterprise Affairs

OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

FOREWORD

Foreword The Investment Policy Review of Croatia assesses the investment climate in Croatia and discusses the challenges and opportunities faced by the government of Croatia in its reform efforts. Capitalising on the OECD Policy Framework for Investment, the Review takes a broad approach to investment climate challenges facing Croatia, with chapters on foreign investment trends and performance, competiveness, foreign investment regulations, the legal and institutional framework for investment protection, investment promotion and facilitation, regulatory practices, and policies to promote and enable responsible business conduct. The Investment Policy Review of Croatia was undertaken under the aegis of the OECD Investment Committee. The Ministry of Foreign and European Affairs led the process within the Croatian government and established and convened an ad hoc inter-ministerial task force. This publication draws on the report supporting the assessment by the Investment Committee of Croatia’s ability to comply with the principles of openness, transparency and nondiscrimination and responsible business conduct practices and its policy convergence with the OECD Declaration on International Investment and Multinational Enterprises, with the aim to adhere to this instrument. The Investment Committee meeting took place in March 2019 at the OECD headquarters in Paris in the presence of a delegation from Croatia led by the Ministry of Foreign and European Affairs. The Review has been prepared under the supervision of Ana Novik, Head of Division, by a team led by Frédéric Wehrlé comprising Tihana Bule, Andrea Goldstein, Coralie Martin, Fernando Mistura, Joachim Pohl, and Monika Sztajerowska, all from the Investment Division of the OECD Directorate for Financial and Enterprises Affairs. Overall guidance was provided by Stephen Thomsen, Chief of the Investment Policy Reviews Unit, also from the Investment Division. It has benefitted from the Investment Committee's discussions and comments and inputs from the OECD Secretariat, including the Secretariats of the Public Governance and Tourism Committees and of the Working Group on Bribery in International Business Transactions. This document was produced with the financial assistance of the European Union. The views expressed herein can in no way be taken to reflect the official opinion of the European Union. The information in this Review is current as of 1 April 2019.

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TABLE OF CONTENTS

Table of contents Preface .................................................................................................................................................... 3 Foreword ................................................................................................................................................ 5 Acronyms and abbreviations .............................................................................................................. 11 Executive Summary............................................................................................................................. 15 Chapter 1. Assessment and recommendations.................................................................................. 17 Substantial reform and strong economic fundamentals ..................................................................... 21 Key findings ....................................................................................................................................... 23 Summary and recommendations ........................................................................................................ 32 Chapter 2. Investment trends and sustainable growth in Croatia .................................................. 37 Croatia’s economic development ....................................................................................................... 38 Foreign investment trends .................................................................................................................. 40 Outlook and policy recommendations ............................................................................................... 57 Notes .................................................................................................................................................. 58 References .......................................................................................................................................... 58 Chapter 3. Croatia’s competitiveness: Challenges and opportunities ............................................ 61 Trade patterns and integration into regional and global value chains ................................................ 62 Enterprise reform ............................................................................................................................... 68 Labour markets and skills .................................................................................................................. 73 The innovation system ....................................................................................................................... 74 Outlook and policy recommendations ............................................................................................... 78 Notes .................................................................................................................................................. 79 References .......................................................................................................................................... 79 Chapter 4. Croatia’s regulatory framework for investment and national treatment ................... 83 Croatia is open to foreign direct investment ...................................................................................... 85 Croatia has few exceptions to national treatment of foreign-controlled enterprises .......................... 88 Starting and operating a company nevertheless remain cumbersome according to business surveys............................................................................................................................. 98 Outlook and policy recommendations ............................................................................................... 99 Notes ................................................................................................................................................ 100 References ........................................................................................................................................ 101 Chapter 5. The protection of investment in Croatia ...................................................................... 103 The domestic legal framework......................................................................................................... 105 International investment agreements ............................................................................................... 112 Outlook and policy recommendations ............................................................................................. 120 Notes ................................................................................................................................................ 125 References ........................................................................................................................................ 129

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8 │ TABLE OF CONTENTS Chapter 6. Investment promotion and facilitation in Croatia....................................................... 131 National strategy and the institutional set-up ................................................................................... 132 Investment facilitation and administrative simplification efforts .................................................... 145 Croatia's incentives scheme for investors ........................................................................................ 151 Outlook and policy recommendations ............................................................................................. 158 Notes ................................................................................................................................................ 159 References ........................................................................................................................................ 164 Chapter 7. Public governance .......................................................................................................... 167 Regulatory quality............................................................................................................................ 169 Corruption ........................................................................................................................................ 179 Outlook and policy recommendations ............................................................................................. 189 Notes ................................................................................................................................................ 191 References ........................................................................................................................................ 194 Chapter 8. Promoting and enabling responsible business conduct as a strategic choice ............ 197 Croatia’s plans for establishing an NCP .......................................................................................... 199 General policies for promoting responsible business conduct ......................................................... 203 Policies in specific areas covered by the Guidelines ....................................................................... 203 Responsible business conduct and the state as an economic actor .................................................. 211 Outlook and policy recommendations ............................................................................................. 213 Notes ................................................................................................................................................ 215 References ........................................................................................................................................ 216 Annex A. Croatia’s exceptions to the National Treatment Instrument ........................................ 221 A. Exceptions at national level ........................................................................................................ 221 B. Exceptions by territorial subdivisions ......................................................................................... 221 Annex B. Measures reported for transparency by Croatia ........................................................... 222 A. Measures reported for transparency at the level of national government ................................... 222 B. Measures reported for transparency at the level of territorial subdivisions ................................ 223 C. Activities covered by public, private, mixed monopolies or concessions ................................... 223 Annex C. Additional figures and tables for Chapter 2................................................................... 224

Tables Table 2.1. Main economic indicators..................................................................................................... 39 Table 3.1. Trade structure by geographical destinations ....................................................................... 63 Table 3.2. Export structure by number of HS6 digit products ............................................................... 64 Table 3.3. Product structure of merchandise trade ................................................................................ 65 Table 3.4. The structure of Croatian exports ......................................................................................... 66 Table 3.5. Waves of privatisation .......................................................................................................... 69 Table 3.6. The “Leviathan reach” in Croatia and its peers .................................................................... 69 Table 3.7. The financial sector in comparative perspective ................................................................... 72 Table 3.8. The banking sector in comparative perspective .................................................................... 72 Table 3.9. Croatian education at a comparative glance ......................................................................... 74 Table 3.10. R&D spending – Croatia in comparative perspective......................................................... 75 Table 3.11. Innovation performance – Croatia in comparative perspective .......................................... 75 Table 4.1. Croatia in international rankings........................................................................................... 99

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TABLE OF CONTENTS

Table 6.1. Overview of the ease of starting a business in Croatia and benchmark economies, 2019 ...... 148 Table 6.2. Corporate income tax rates: Croatia, Southeast European economies, and EU-28, 2018 ..... 153 Table 6.3. Free Economic Zones in Croatia ........................................................................................ 157 Table 7.1. Requirements to use regulatory management tools for EU-made laws: Croatia ................ 173 Table 7.2. Minimum periods for consultations in EU member states.................................................. 175 Table 7.3. Selected consultation portals in EU member states ............................................................ 175 Table 8.1. Key milestones in the process for establishing the NCP .................................................... 202 Table 8.2. Summary of legislative changes as related to the EU accession process............................ 205 Table A C.1. Net acquisition of financial assets in Croatia, 1993-Q1 2018 ........................................ 226 Table A C.2. Net incurrence of financial liabilities in Croatia, 1993-Q1 2018 ................................... 227

Figures Figure 1.1. OECD FDI Regulatory Restrictiveness Index, 2017 ........................................................... 25 Figure 2.1. GDP growth, 2000-2017 (year-on-year percentage rate in constant prices) ....................... 38 Figure 2.2. Croatia’s financial account by functional type of investment, 1999-2017 .......................... 40 Figure 2.3. GDP, trade and FDI in the Croatian economy, 1995-2017 ................................................. 41 Figure 2.4. Assets, liabilities and net direct investment position in Croatia, Q1 2018 .......................... 42 Figure 2.5. Number of enterprises by type of control and location, 2017 ............................................. 42 Figure 2.6. FDI inward and outward stock as a share of GDP (in %), 2017. ........................................ 43 Figure 2.7. The share of FDI stock to GDP in Croatia and selected EU countries, 1995-2017. ........... 44 Figure 2.8. Assets, liabilities and net direct investment position in Croatia, 1999-2017....................... 45 Figure 2.9. Quarterly FDI assets and liabilities in Croatia, Q1 2017- Q1 2018..................................... 45 Figure 2.10. Net acquisition of FDI assets and incurrence of liabilities in Croatia, 1993-2017. ........... 46 Figure 2.11. Mergers and acquisitions involving a target or an acquirer in Croatia, 1997-2018 .......... 47 Figure 2.12. Greenfield FDI in Croatia, 2003-18 .................................................................................. 47 Figure 2.13. Number and value of greenfield FDI projects in Croatia and selected EU countries, 2008-13 ......................................................................................................................... 48 Figure 2.14. Greenfield FDI Performance Index. .................................................................................. 48 Figure 2.15. FDI flows in Croatia and selected EU countries, 2008-17 ................................................ 49 Figure 2.16. Share of inward and outward FDI flows as a share of GDP in Croatia and selected EU countries, 1995-2017. .............................................................................................................. 50 Figure 2.17. Top 10 destination and source countries: Net acquisition of assets and net incurrence of liabilities by country, 1993-Q1 2018 ....................................................................... 51 Figure 2.18. Inward FDI positions by resident SPEs and non-SPEs in selected OECD countries, 2017............................................................................................................................... 52 Figure 2.19. Net acquisition of assets and incurrence of liabilities by sector, 1993-Q1 2018 ............... 53 Figure 2.20. Share of real estate, construction and accommodation services in total inward FDI stock of OECD countries, by country, 2017 .................................................................................. 54 Figure 2.21. Value of M&A deals involving targets or acquirers in Croatia, by sector, 19972018 ............................................................................................................................................... 54 Figure 2.22. Statistics on EU-controlled foreign affiliates in selected EU 28 countries ....................... 55 Figure 2.23. Results of a business survey on investment environment in Croatia, 2019....................... 58 Figure 4.1. OECD FDI Regulatory Restrictiveness Index, 2017 ........................................................... 87 Figure 4.2. OECD FDI Regulatory Restrictiveness Index, 2017, by sectors ......................................... 88 Figure 5.1. Evolution of Croatia’s investment treaty relations (signed relationships)......................... 113 Figure 5.2. Approximate evolution of Croatia’s inward and outward FDI stock coverage by treaty cohort ................................................................................................................................. 114 Figure 5.3 Regulatory depth of ISDS provisions: individual countries, Croatia, and global trend ..... 119 Figure 5.4. Residual validity of treaties depending on the design of their validity clause .................. 123 OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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10 │ TABLE OF CONTENTS Figure 5.5. Projection of the temporal validity of Croatia’s IIAs compared to global sample ............ 124 Figure 6.1. Creation of IPAs and recent organisational reforms in OECD countries .......................... 139 Figure 6.2. Share of IPAs reporting the function as an official mandate ............................................. 141 Figure 6.3. Overview of prioritisation strategies of IPAs in OECD countries .................................... 142 Figure 6.4. Shares of OECD IPAs performing a given type of investment activity ............................ 144 Figure 6.5. Croatia’s performance on selected aspects of WEF’s Global Competiveness Index, 2018 ............................................................................................................................................. 146 Figure 6.6. Overview of Croatia’s score in World Bank’s Doing Business Indicators, 2019 ............. 146 Figure 6.7. Number of days required to start a business in Croatia, 2005-2019. ................................. 148 Figure 7.1. Overview of World Governance Indicators scores for Croatia, 1996-2017 ...................... 170 Figure 7.2. Government effectiveness in Croatia and EU 28 according to the World Bank World Governance Indicators*..................................................................................................... 171 Figure 7.3. Indicators of Regulatory Policy and Governance (iREG): Croatia, 2018 ......................... 173 Figure 7.4. Composite indicators: Stakeholder engagement in developing primary laws, 2018 ......... 176 Figure A C.1. Croatia’s GDP by sector of activity, 2017 .................................................................... 224 Figure A C.2. Merchandise trade in Croatia by destination and origin, 2017 ..................................... 225

Boxes Box 1.1. The Declaration on International Investment and Multinational Enterprises ......................... 19 Box 1.2. The Policy Framework for Investment.................................................................................... 20 Box 1.3. Policy recommendations ......................................................................................................... 33 Box 2.1. Special purpose entities: Why do they matter for FDI statistics? ........................................... 51 Box 2.2. The experience of PLIVA: From a home-grown innovator to a large exporter and a foreign-owned enterprise ............................................................................................................... 56 Box 3.1. The arduous restructuring of shipyards ................................................................................... 66 Box 3.2. The role of tourism .................................................................................................................. 68 Box 3.3. Three Croatian gazelles: Rimac, Nanobit and Infinum ........................................................... 71 Box 3.4. Chinese investments in Croatia ............................................................................................... 78 Box 4.1. The OECD National Treatment instrument for foreign-controlled enterprises....................... 85 Box 4.2. The OECD FDI Regulatory Restrictiveness Index ................................................................. 86 Box 5.1. Two approaches to specifying and limiting the FET provision ............................................ 117 Box 5.2. Designs of temporal validity provisions in IIAs ................................................................... 123 Box 6.1. The legal framework for investment promotion and facilitation in Croatia .......................... 133 Box 6.2. Agency for Investments and Competitiveness (AIK) ........................................................... 135 Box 6.3. Croatian Agency for SMEs, Innovations and Investments (HAMAG-BICRO) ................... 137 Box 6.4. The OECD-IDB survey of IPAs............................................................................................ 140 Box 6.5. One-stop services in Croatia ................................................................................................. 149 Box 6.6. SME support schemes in Croatia .......................................................................................... 151 Box 6.7. Investment incentive instruments .......................................................................................... 153 Box 6.8. Investment incentives in Croatia ........................................................................................... 154 Box 7.1. Recommendation of the OECD Council on Regulatory Policy and Governance ................. 172 Box 7.2. National Competitiveness Council – NCC (Nacionalno vijeće za konkurentnost) ............... 177 Box 7.3. Levels of government in Croatia ........................................................................................... 178 Box 7.4. The office for the Suppression of Corruption and Organised Crime .................................... 181 Box 8.1. Understanding the OECD Guidelines for Multinational Enterprises .................................... 198 Box 8.2. The EU Accession Negotiations ........................................................................................... 205

OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

ACRONYMS AND ABBREVIATIONS

Acronyms and abbreviations

ACN

Anti-Corruption Network for Eastern Europe and Central Asia

ACTU

Association of Croatian Trade Unions

AITU

Association of Independent Trade Unions

ARD

Alternative dispute resolution

BIAC

Business and Industry Advisory Committee to the OECD

BiH

Bosnia and Herzegovina

BIT

Bilateral Investment Treaty

CCE

Croatian Chamber of Economy

CEOs

Chief executive officers

CIT

Corporate Income Tax

CPI

Corruption Perception Index

CSR

Corporate Social Responsibility

DB

Doing Business

DZS

Croatian Bureau of Statistics

EBRD

European Bank for Reconstruction and Development

ECI

Economic Complexity Index

EITI

Extractive Industries Transparency Initiative

EIA

Environmental Impact Assessment

EU

European Union

EPA

Environmental Protection Act

EUR

Euro

FDI

Foreign direct investment

FET

Fair and equitable treatment

G20

Group of 20

GATS

General Agreement on Trade in Services

GCR

Global Competitiveness Report

GDP

Gross Domestic Product

GFCF

Gross Fixed Capital Formation

GPA

Agreement on Government Procurement

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12 │ ACRONYMS AND ABBREVIATIONS GVCs

Global value chains

HRK

Croatian Kuna

HR PSOR

Croatian Business Council for Sustainable Development

ICMS

Integrated Case Management System

ICS

Investment Court System

ICSID

International Centre for the Settlement of Investment Disputes

IFC

International Finance Corporation

IIA

International investment agreement

ILO

International Labour Organisation

IMF

International Monetary Fund

IPA

Investment Promotion Agency

IP

Intellectual Property

IPR

Investment Policy Review

ISA

Investor-state arbitration

ISO

International Organisation for Standardisation

ISDS

Investor-state dispute settlement

IT

Information Technology

KBEs

Knowledge-based economies

M&A

Mergers and Acquisitions

MEAT

Most Economically Advantageous Tender

MEEC

Ministry of Economy, Entrepreneurship and Crafts

MFN

Most-Favoured Nation

MNEs

Multinational Enterprise

MOEFA

Ministry of European and Foreign Affairs

MPs

Members of Parliament

NCP

National Contact Point for the OECD Guidelines for Multinational Enterprises

NGO

Non-Governmental Organisation

NT

National treatment

OECD

Organisation for Economic Co-operation and Development

OG

Official Gazette

OSCE

Organisation for Security and Cooperation in Europe

OSS

One-Stop Shop

PAC-CCE

Permanent Arbitration Court at the Croatian Chamber of Economy

PFI

Policy Framework for Investment (OECD)

PPPs

Public Private Partnership

PTA

Preferential Trade Agreement

OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

ACRONYMS AND ABBREVIATIONS

RBC

Responsible Business Conduct

R&D

Research and development

RIA

Regulatory Impact Assessment

SEA

Strategic Environmental Assessment

SEE

Southeast Europe

SEZs

Special Economic Zones

SIPO

State Intellectual Property Office of the Republic of Croatia

SJC

State Judicial Council

SMEs

Small and Medium-Sized Enterprises

SOEs

State-Owned Enterprises

SPE

Special Purpose Entity

SRSS

Structural Reform Support Service (European Commission)

TiVA

Trade in value added

TUAC

Trade Union Advisory Committee to the OECD

TNC

Transnational Corporation

TRIPS

Agreement on Trade-Related Aspects of Intellectual Property Rights

UN

United Nations

UNCITRAL

United Nations Commission on International Trade Law

UNECE

United Nations Economic Commission for Europe

USKOK

Office for Combating Corruption and Organised Crime at the Prosecutor's Office

WBG

World Bank Group

WEF

World Economic Forum

WIPO

World Intellectual Property Organisation

WTO

World Trade Organisation

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EXECUTIVE SUMMARY

Executive Summary This Investment Policy Review is the fruit of a two-year inclusive process carried out in partnership with the Ministry of Foreign and European Affairs of Croatia, and for which the European Union (EU) provided funding. It has been undertaken to provide Croatia with a systematic approach to investment climate reform, using the well-tested methodology of the OECD Policy Framework for Investment (PFI), and accompany Croatia’s application for adherence to the OECD Declaration on International Investment and Multinational Enterprises. In total, the Review is composed of eight chapters. The main finding is that Croatia has achieved a large degree of policy convergence with the Declaration, building on the various reforms which have underpinned the country’s economic and social progress since independence in the early 1990s. This is true, in particular, in terms of the country’s ability to comply with the principles of openness, transparency and non-discrimination and responsible business conduct that are integral to the OECD approach to investment. Croatia has made great strides in opening up its regime for foreign investment. The statutory regime is more open than in most other countries surveyed in the OECD FDI Regulatory Restrictiveness Index. Its degree of restrictiveness is low in comparison with the OECD average and Croatia is at par with the average EU economy. There are few barriers to entry for foreign investors and Croatia makes few exceptions to national treatment of foreign investors. Capitalising on the PFI, the Review also studies other policy areas that are of key relevance to Croatia’s overall investment climate, such as investment protection, promotion and facilitation, regulatory framework and practices, and the fight against corruption. On some of these dimensions, the scope for doing better and faster remains important – as proven by the fact that creating an attractive environment for investment, foreign and domestic alike, remains among Croatia’s foremost priorities. On the one hand, important efforts have been made in providing adequate levels of investment protection, including in respect to intellectual property rights, and in improving dispute resolution mechanisms. In particular, significant progress has been made towards reinforcing the independence and efficiency of the judicial system. With the aim to further encourage investment, Croatia also introduced significant tax reforms in 2018, resulting in greater tax transparency, although the effects of the reform are yet to be fully visible. Efforts have also been made to rationalize the framework for investment incentives with more clearly defined criteria albeit further progress may be required on monitoring and evaluation of their effectiveness. Croatia has also introduced a set of useful and important reforms to strengthen regulatory policy, although an overall policy for better regulation is still missing. On the other hand, Croatia’s low score in a number of international rankings is a cause of concerns. The administrative burden on businesses, as reflected in the World Bank’s Doing Business indicators, remains rather high and dwarfs entrepreneurial spirits. Steps have been taken to reduce it, but progress in implementation has been timid. Similarly, Croatia does not perform very well in the OECD PISA measurement of education achievements. On both accounts, the end result is that Croatia fails to attract enough foreign investment to increase OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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16 │ EXECUTIVE SUMMARY fixed capital formation, accelerate GDP growth, and reach all Sustainable Development Goals. Ensuring implementation of the announced plans to improve the investment climate and the quality of education and training is critical to allowing businesses perceive the difference. Another sensitive area is corruption. Despite substantial efforts made to reduce opportunities for corruption and limit discretion in public decision-making, it remains a recurrent business concerns. Some elements of a well-functioning and transparent framework for state-business interactions are still missing. In particular, Croatia lacks strong ethical standards for local self-governments. There is also space to improve the governance and foster the integrity of state-owned enterprises and public development finance institutions. The Investment Policy Review also analyses Croatia’s record in promoting responsible business conduct (RBC). Authorities have undertaken important policy reforms aimed at creating an enabling environment for businesses to act responsibly (e.g. human rights; employment and industrial relations; environment; consumer interests and protection). The Review indicates further steps that would help, such as the active implementation of the OECD Guidelines for Multinational Enterprises and the establishment of an effective and impartial National Contact Point - to promote the Guidelines and resolve RBC issues related to environmental, social and governance issues. The Government is well aware that private investment can play a role in enhancing Croatia’s growth potential and in improving living standards. For this very reason, a more modern investment promotion platform is needed. The institutional set-up for investment promotion appears fragmented and a more explicit national strategy for investment attraction could help ensure better coordination among the different actors, with no prejudice to specific efforts targeted at activities and regions that require further assistance. Raising investment further requires a comprehensive and coherent policy package. This OECD Investment Policy Review of Croatia looks at challenges and opportunities for attracting more and better investment and the resulting development impact of that investment.

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Chapter 1. Assessment and recommendations

This chapter documents the overall development context in Croatia since independence in 1991, describing the current economic situation and the main investment policy reform efforts, and identifies specific challenges that hinder investment, economic growth, and wellbeing. It summarizes the key findings in each policy area covered by the Review and provides tailored recommendations.

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18 │ 1. ASSESSMENT AND RECOMMENDATIONS Croatia has made significant economic and social progress since independence in the early 1990s. A broad range of structural reforms have been designed, enacted and implemented to accomplish the transition from a command economy to a market system. In 2018, Croatia became a high-income country according to the new classification of the World Bank. Increased cooperation with the World Trade Organisation (WTO) and the European Union (EU) in the context of the accession process acted as an external anchor for reforms. Croatia applied to become an EU Member State in March 2003; candidate country status was officially granted in June 2004; accession negotiations started in October 2005 and were concluded in June 2011; the accession Agreement was signed in December 2011; and the Croatian Parliament ratified the accession Treaty in March 2012. The EU accession process played an important role in strengthening the policy framework for investment, including in the many policy areas covered by the OECD Guidelines for Multinational Enterprises (hereafter: the Guidelines) related to responsible business conduct (RBC). The negotiations covered policy areas divided into 35 chapters of acquis communautaire, many of which relevant to a sound investment climate. Croatia notably had to meet EU criteria in areas such as corporate law, governance, intellectual property protection, competition policy, social policy and employment, enterprise and industrial policy, science and research, judiciary and fundamental rights, anti-corruption, environment, and consumer and health protection. Through this process, Croatia has engaged in many structural reforms. However, Croatia’s economy is still in transition, with slower growth than economies at a similar stage of development such as Bulgaria or Romania. In the industrial sector, for example, the decrease of labour-intensive activities has been a trend in all countries of Central and Eastern Europe over the past ten years. In countries like the Czech Republic or Poland, this change has come with capital deepening, technological advancement and increased value added, leading to a successful reindustrialisation. In Croatia by contrast, the last ten years have seen a stabilisation in manufacturing industry’s share in GDP (after the large 1995-2008 drop) and an increase in the share of low-tech activities within the manufacturing industry. As a result, challenges remain on the way to accelerating the convergence towards the European Union’s income levels and living standards. Of particular relevance are levels of public and private investment still low for an emerging economy with unmet needs, and a trade structure that reflects a still feeble participation in global value chains and a specialization in mass-market and import-intensive tourism services. Croatia’s GDP per capita (USD 13 237 in 2017) remains one of the lowest in the EU; even when expressed in Purchasing Power Standards (PPS), GDP per capita in 2016 was 48% of the EU average. In addition, economic growth has not equally benefited all citizens. In 2016, according to Eurostat, more than a quarter of people were at risk of poverty or social exclusion, the seventh highest share within the EU. In rural areas, a third of residents were at risk of poverty or social exclusion, above the already significant EU average of 25.5%. The situation is particularly serious in the east and the southeast regions of the country - mainly along the border with Bosnia and Herzegovina and Serbia (areas that suffered the most from the Domovinski rat – the Homeland Wars – in the 1990s). The absolute poverty rate (at USD 5.5/day at 2011 purchasing power parity [PPP] per capita) increased from 4.7% in 2009 to 5.8% in 2015. Achieving the transformation that started two decades ago requires addressing structural challenges and revitalising economic competitiveness. Private investment has a role to play in this agenda. Under the right conditions, domestic and international investment can enhance Croatia’s productive capacity and growth potential, drive job creation and improvements in OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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living standards. Active policies to promote and enable RBC and spur private sector contribution to sustainable development can support Croatia’s economic development. RBC standards focus on the positive contribution of the private sector to economic, environmental and social progress, with a view to achieving sustainable development, while addressing potential and actual negative impacts of business operations. This Investment Policy Review of Croatia (hereafter: the Review) looks at challenges and opportunities from the perspective of the investment climate. It assesses Croatia’s policy convergence with the OECD Declaration on International Investment and Multinational Enterprises (hereafter: the OECD Declaration), including the country’s ability to comply with the principles of openness, transparency and non-discrimination and RBC practices (Box 1.1). Capitalising on the OECD Policy Framework for Investment (Box 1.2), it takes a comprehensive approach to reform priorities looking not only at the need to increase both domestic and foreign investment but also at ways to increase the development impact from that investment. This Review is intended to support Croatia’s reform agenda and the implementation of the Sustainable Development Goals (SDGs) to promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all. Box 1.1. The Declaration on International Investment and Multinational Enterprises

The Declaration is a policy commitment by Adherents to provide an open and transparent environment for international investment and to encourage the positive contribution multinational enterprises can make to economic and social progress. The Declaration consists of four elements (each underpinned by a decision of the OECD Council on follow-up procedures): National Treatment: A voluntary undertaking by Adherents to accord to foreign-controlled enterprises established on their territories treatment no less favourable than that accorded to domestic enterprises in the same situations. The Guidelines for Multinational Enterprises: Recommendations on RBC addressed by governments to multinational enterprises operating in or from Adherents. Adherents commit to promote the Guidelines and establish their built-in implementation mechanism – the National Contact Points (NCPs) to further their effectiveness. International investment incentives and disincentives: Adherents recognize the need to give due weight to the interest of other Adherents affected by laws and practices in this field; they need to strengthen international co-operation in this area and endeavour to make measures as transparent as possible. Conflicting requirements: Adherents agree to co-operate so as to avoid or minimise the imposition of conflicting requirements on multinational enterprises. As of 1 April 2019, all 36 OECD member countries have adhered to the Declaration, as have 12 partner countries: Argentina (22 April 1997), Brazil (14 November 1997), Colombia (8 December 2011), Costa Rica (30 September 2013), Egypt (11 July 2007), Jordan (28 November 2013), Kazakhstan (20 June 2017), Morocco (23 November 2009), Peru (25 July 2008), Romania (20 April 2005), Tunisia (25 May 2012), and Ukraine (15 March 2017).

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Box 1.2. The Policy Framework for Investment

The Policy Framework for Investment (PFI) helps governments mobilise private investment in support of sustainable development, thus contributing to the prosperity of countries and their citizens. It offers a list of key questions to be examined by any government seeking to create a favourable investment climate. The PFI was first developed in 2006 by representatives of 60 OECD and non-OECD governments in association with business, labour, civil society and other international organisations and endorsed by OECD ministers. Designed by governments to support international investment policy dialogue, co-operation, and reform, it has been extensively used by over 25 countries as well as regional bodies to assess and reform the investment climate. The PFI was updated in 2015 to take into account this experience and changes in the global economic landscape. The PFI is a flexible instrument that allows countries to evaluate their progress and to identify priorities for action in 12 policy areas: investment policy; investment promotion and facilitation; trade; competition; tax; corporate governance; promoting responsible business conduct; human resource development; infrastructure; financing investment; public governance; and investment in support of green growth. Three principles apply throughout the PFI: policy coherence, transparency in policy formulation and implementation, and regular evaluation of the impact of existing and proposed policies. The value added of the PFI is in bringing together the different policy strands and stressing the overarching issue of governance. The aim is not to break new ground in individual policy areas but to tie them together to ensure policy coherence. It does not provide ready-made reform agendas but rather helps to improve the effectiveness of any reforms that are ultimately undertaken. By encouraging a structured process for formulating and implementing policies at all levels of government, the PFI can be used in various ways and for various purposes by different constituencies, including for self-evaluation and reform design by governments and for peer reviews in regional or multilateral discussions. The PFI looks at the investment climate from a broad perspective. It is not just about increasing investment but about maximising the economic and social returns. Quality matters as much as the quantity as far as investment in concerned. It also recognizes that a good investment climate should be good for all firms – foreign and domestic, large and small. The objective of a good investment climate is also to improve the flexibility of the economy to respond to new opportunities as they arise – allowing productive firms to expand and uncompetitive ones (including state-owned enterprises) to close. The government needs to be nimble: responsive to the needs of firms and other stakeholders through systematic public consultation and able to change course quickly when a given policy fails to meet its objectives. It should also create a champion for reform within the government itself. Most importantly, it needs to ensure that the investment climate supports sustainable and inclusive development. The PFI was created in response to this complexity, fostering a flexible, whole-of government approach, which recognizes that investment climate improvements require not just policy reform but also changes in the way governments go about their business. Source: www.oecd.org/investment/pfi.htm

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Substantial reform and strong economic fundamentals Croatia's reforms since independence in 1991 have been significant, given the historical context. Croatia rapidly implemented an ambitious reform programme based on the gradual opening of trade and investment and the creation of an open market economy, driven in particular by commitments taken during its WTO accession negotiations and preparations for its strategic goal of acceding to the EU. Increased cooperation with the WTO and the EU in the context of the accession process acted as an external anchor for reforms. Croatia acceded to the WTO in 2000 and to the EU in July 2013, making Croatia the 28th member state of the EU. Croatia's annual gross domestic product (GDP) growth rate has been relatively stable, with the exception of the early 1990s when the war led to a sharp decline in output, and in the years 2008-2014. The global financial crisis strongly affected the trade balance and domestic consumption: between 2009 and 2014, the economy declined by a cumulative 12%, the largest contraction in the EU after Greece. Croatia’s recovery since 2015 has been underpinned by improved overall macroeconomic management, stronger external demand, lower oil prices and increased tourism earnings. Faster-than-planned progress in fiscal consolidation permitted exiting the European Union’s Excessive Deficit Procedure in June 2017, the Croatian National Bank accumulated international reserves, and the banking system remained well-capitalised and liquid, despite the crisis at Agrokor, the country’s largest conglomerate and top employer. Annual GDP growth averaged 2.2% in 2015-17 –slightly higher than the EU annual average (2.1%), but weaker than that of most of other EU central and east European countries. Foreign direct investment (FDI) trends have followed an upward trajectory. The inward FDI stock first peaked in 2007 at 28 billion EUR (or 60% of Croatia’s GDP), and after a sharp downward adjustment in 2008, following the financial crisis, has recuperated its earlier trend – reaching a new height in early 2018. Today, the share of inward FDI stock stands at 61% of GDP, above the OECD and EU averages (of 39% and 53%, respectively). By contrast, the share of outward FDI stock stands at 11% of GDP, below the OECD and EU averages (of 48% and 62% each), reflecting the fact that foreign firms remain relatively more important in the Croatian economy than Croatian firms’ operations abroad. The relative concentration and volatility of FDI, as well as the potential appetite of Croatian firms to expand abroad may call for greater government attention and more active investment promotion and facilitation policies.

Attracting investment is a key government priority Since the early 2000s, attracting investment has been a top priority of the government, as evidenced by Croatia's national development strategy plans and various governmental documents. The more recent strategies put investment at the heart of the objective to achieve economic development, improved competitiveness and higher productivity. For example, Croatia's latest national programmes involve an ambitious economic and development policy reform package that focuses on boosting competitiveness, employment, and better living standards. However, there is no dedicated FDI attraction or investment promotion and facilitation strategy in Croatia, and different ministries as well as different levels of government tend to adopt individual plans. Investors point to the need for a more comprehensive and long-term vision of the government in the area, which would go beyond the distribution of EU funds and other state support regulated by the Act on Investment Promotion.

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22 │ 1. ASSESSMENT AND RECOMMENDATIONS Despite on-going efforts to improve the business environment, investment facilitation remains a challenge. Several of the key reforms aiming to reduce administrative burdens and remove key bottlenecks have been delayed. This includes some administrative procedures that are still complex and burdensome – in particular in the area of business and land registration and the receipt of the associated permits, including construction permits, of inspections and para-fiscal charges – as well as their uneven application at the subnational level. Further follow-up is needed on addressing these shortcomings.

Seizing opportunities to further attract and benefit from investment The competiveness of an economy and its capacity to attract investment depend on a number of factors, including macroeconomic stability, the regulatory environment, the skills base, the quality of infrastructure and access to finance. The challenges Croatia faces are widely documented and recognised in primis by the government. The economy suffers from heavy dependence on tourism – roughly a fifth of Croatia's GDP comes from tourism – and an inadequately educated workforce. These features diminish the country’s ability to attract more and better-qualities investment, to develop industries with higher productivity, and to tackle the challenges of export diversification and production upgrade. Once the industrial powerhouse of the former Yugoslavia, Croatia has transformed into a service-based economy that relies on the low-productivity tourism sector for jobs and income: in fact, Croatia’s economy is by far the most reliant on foreign visitors among its European peers. This is not to deny that tourism and more generally the service sector – which employed nearly 64% of the population and represented two-thirds of the GDP in 2016 – have had so far a strong development impact. But insofar as Croatia remains specialised in the low end of the market and proves unable to upgrade and become an all-year destination, there are risks to the sustainability of economic growth. Over-dependence on one sector increases the vulnerability of Croatia to external shocks as evidenced by the impact of the global financial crisis in 2008-2014. Diversification is a challenge faced by many economies. The government's national development strategies contain many concrete measures to achieve the goal of making Croatia an attractive and dynamic investment destination, not only a touristic one. The presence of three Croatian companies in the top 1000 listing of fastest-growing companies in Europe compiled by the Financial Times and Statista testifies to Croatia’s entrepreneurial spirit. In the medium run, the ultimate goal of economic policy should be not investment for its own sake, but rather investment which fosters sustainable and inclusive growth.

Tackling the challenge of low labour market participation and addressing skills shortage Unemployment has come down from the record levels reached during the six-year recession but remains among the highest in Europe, especially for the youth. Against the background of a rapidly aging population and negative net migration flows, low labour force participation rates and high levels of informality concur to explain this fragile social development situation. Reforms have been introduced and implemented, notably to reduce rigidities in employment protection legislation, but active labour market policies remain insufficient to improve the social outlook. The authorities should take the decisive steps to strengthen labour force participation, particularly among women. Reform of labour law and parental benefits and access to affordable childcare are important, but would not in themselves be sufficient to secure the desired outcome. In addition, structural reforms, encouragement of competition and OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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entrepreneurship, and the strengthening of institutions enabling better functioning of a market economy are preconditions for creating employment opportunities. The state of the national system of innovation is also a cause of concern. Although educational attainment is almost universal, PISA scores reveal that Croatian youth is illprepared to compete in and contribute to the knowledge economy. Business investment in research and development is also rather low by EU standards. An additional problem is the high rate of skilled workforce that keep migrating.

Strengthening SMEs’ insertion in global value chains Small and medium-sized enterprises (SMEs) are the backbone of the economy in Croatia, in terms of number of enterprises, employment, and turnover. Productivity of SMEs, however, is disturbingly low, and so is the ability of Croatian SMEs to internationalise through export and insertion in global value chains as suppliers to larger multinationals. One reason is that a large number of Croatian entrepreneurs start a business out of necessity and relatively few are motivated by perceived opportunities (indeed the necessity-opportunity ratio is the highest in Europe). Another, and possibly complementary, reason is that the regulatory burden on SMEs is very heavy. Aware of this, the government in May 2017 introduced the obligation to assess any primary and secondary pieces of legislation from the viewpoint of their possible administrative and cost effect on business, especially SMEs.

Boosting state-owned enterprises reform Croatia’s reform agenda initially placed an appropriate emphasis on the corporatisation, liberalisation and privatisation of state-owned enterprises (SOEs), but the reform momentum petered out in the 2000s. SOEs still dominate large swathes of the economy and in particular the infrastructure sectors, including transport, energy, post and communication, and utilities, and also operate in competitive industries such as agribusiness and manufacturing. They suffer from political interference, ineffective governance, poor management, and low efficiency. The high burden they pose on the economy and on public spending weighs on inclusive growth. Many of these enterprises are classified as strategic, which impedes private investment as an important economic stimulator and source of capital for Croatia's innovation, job growth, and competitiveness. In fact, even the precise contours of this universe are not known with the necessary precision. An EBRD estimate is that in 2017 SOEs controlled 30% of total assets in the economy, contributed 15% of the total revenue, and employed some 73 000 employees, or 5% of the total workforce. According to European Commission estimates, the numbers were even bigger in certain industries: for example, 79% of those employed in utilities and 45% of those employed in the transportation sector were employed by SOEs. The importance of reducing the SOE sector and in improving the management of those that remain in state ownership to enhance economic efficiency and ensure a public sector supportive of growth has been well recognised in Croatia's most recent National Reform Programmes. Unfortunately, limited progress has been achieved so far in selling state assets and in improving corporate governance in those that remain in state ownership.

Key findings Croatia is largely open to foreign direct investment With a view to enhancing FDI inflows, continuous efforts have been made to reform the regulatory framework under favourable terms in line with the European legislation and other OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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24 │ 1. ASSESSMENT AND RECOMMENDATIONS international standards. Croatia is open to foreign investment, with a few formal ownership restrictions, and the key standards of investor treatment and protection are guaranteed under the constitutional law and other laws. There are no pre-establishment screenings of foreign investment. National treatment of foreign investors in the post-establishment phase is guaranteed, which means that foreign investors, when incorporated and headquartered in Croatia, are considered to be domestic legal entities, with all the rights and obligations that are applied to domestic investors. The few existing de jure exceptions to national treatment are limited to foreign ownership restrictions in a handful of sectors, namely in legal services, freshwater fisheries and air transport. Other existing barriers to FDI mainly concern conditions imposed at establishment (e.g. local incorporation requirement and reciprocity condition for the establishment of a branch).Such barriers to entry are few, mostly sector-specific and are typically limited in their scope, applying almost exclusively to investors from outside the European Union or the European Economic Area (EEA) or to investors from countries which are not WTO members. For instance, foreign ownership of real estate is unrestricted for investors from the EU, while it is conditional on reciprocity for others, with the exception of specific real estate and protected nature reserves. Nevertheless, even in the absence of reciprocity between Croatia and the country of origin of the purchaser, the foreign investor can incorporate a company with its seat in Croatia, which can, subsequently, acquire real estate in Croatia. Access to agricultural land is so far limited to leasehold but, following expiry of the transitional period granted by Croatia's accession treaty with the EU, foreign ownership of agricultural land will become in 2020 unrestricted for investors from the European Union. Croatian law also does not impose performance requirements on or mandate employment requirements to foreign-owned established investors, nor are senior management or board of directors positions mandated in private companies, except in the banking sector, where there is, in addition to an assessment of adequate knowledge and skills required to manage a bank, a legal requirement for at least one member of the management board of a credit institution to be fluent in speaking and writing in Croatian, and in audit firms, where the majority of members of the management board need to be licensed auditors in Croatia or another EU member state, and one member needs to be fluent in Croatian. In line with the principles and standards of the OECD Declaration, Croatia does not either impose conflicting requirements on multinational enterprises (MNEs) operating simultaneously on the Croat territory and in other countries. As a result, Croatia is among the most open economies to FDI (Figure 1.1). Its degree of FDI regulatory restrictiveness is low in comparison to the OECD average, as well as against the average of non-OECD economies that have adhered to the Declaration, according to the OECD FDI Regulatory Restrictiveness Index. Croatia is at par with the average EU economy under this indicator. As such, any possible difficulty in attracting FDI is unlikely related to the regulatory environment for foreign investors. Croatia is largely open to foreign investment and generally treats domestic and foreign investors alike. Despite this openness, Croatia suffers from shortcomings that investors say they experience when establishing a business and in the day-to-day running of their business operations as documented by Croatia's performance in international rankings. Croatia’s overall rankings in the World Bank’s Doing Business 2019 edition (58th globally, behind most European Union countries but also some of non-OECD countries which are recent Adherents to the Investment Declaration such as Kazakhstan (30th)) suggests that there is room for rendering

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administrative procedures speedier, more transparent and effective, and for improving the overall quality and transparency of public governance. Perception of corruption also remains high and not only by regional standards (Croatia was ranked 57th out of 180 economies in the Transparency International’s Corruption Perception Index in 2017). When compared with other non-OECD countries which recently became Adherents to the OECD Declaration, Croatia performs much better than countries such as Kazakhstan (122nd) and Ukraine (130th). It is nevertheless below other non-OECD Adherents to the Declaration such as Costa Rica (38th). While an open environment for foreign investment is important, this is not the only incentive to which FDI responds. Foreign investors are equally affected by deficiencies in the overall business environment impinging on domestic investors too. Figure 1.1. OECD FDI Regulatory Restrictiveness Index, 2017

0.45

OECD FDI Regulatory Restrictiveness Index (open=0; closed=1)

0.40 0.35 0.30 0.25 0.20 0.15

NON-OECD average

0.10

OECD average

0.00

Philip pin es Saudi Arabia China Indonesia Malaysia Jordan New Zealand India Lao Pdr Mexico Russia Myanmar Tunisia Iceland Canada Australia Korea Viet Nam Ukraine Israel Kazakhstan Austria Brazil United States Norway Kyrgyz Republic Switzerland Peru Mongolia Poland Morocco Egypt Turkey Sweden Chile South Africa Cambodia Japan Italy Slovak Republic Albania Costa Ric a France Irela nd Serbia Belgium United Kingdom Croatia Denmark Greece Argentina Hungary Bosnia and Herzegovina Montenegro Colombia Germany North Macedonia Spain Latvia Lithuania Finland Estonia Netherla nds Czech Republic Romania Slovenia Portugal Luxembourg Kosovo*

0.05

* This designation is without prejudice to positions on status, and is in line with United Nations Security Council Resolution 1244/99 and the Advisory Opinion of the International Court of Justice on Kosovo’s declaration of independence. Source: OECD FDI Regulatory Restrictiveness Index, www.oecd.org/investment/fdiindex.htm.

Protection of investment The protection of investment, combined with effective enforcement mechanisms, is an important pillar of a sound investment climate. Protecting investors from improper treatment can lower their perception of risk for new investments, and investors who perceive lower risks will generally make capital and resources available at a lower cost and with longer amortisation periods.

Croatia's domestic framework provides investor protection aligned with international standards but could benefit from a justice system more responsive to the needs of business and people Croatia has pursued a comprehensive reform agenda encompassing protection of ownership and other rights. Property rights and regulations on acquisition, benefits, and use of property are well defined. Croatia has also a modern system of intellectual property rights that is aligned with the EU norms and standards. Progress in reforming the judiciary has been steady OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

26 │ 1. ASSESSMENT AND RECOMMENDATIONS over the past ten years, in particular towards strengthening the independence and professionalism of the judiciary. The government has also taken a number of steps to streamline the workings of the judicial system, including by rationalising the courts’ network, making capital investment and deploying modern information technologies, and promoting mediation as an alternative method of dispute resolution. As a result, Croatia now offers an increasingly efficient and professional judicial system. According to the 2018 EU Justice Scoreboard, Croatia had in 2018 rates of case efficiency for civil, commercial, administrative and other cases comparable with other EU member states. There is nevertheless room for improvement. For example, professionalization is still insufficient, especially at local level. The implementation of e-procedures in the court is progressing, though more slowly than expected. Backlogs in the courts are decreasing but remain sizeable. As result, there is still an overall perception that courts are slow in processing cases; that judicial procedures are complex; that frequent amendments in the text of the laws often result in varying interpretations among judges. There is scope for further strengthening Croatia's judiciary to stimulate investor confidence. This includes further reducing delays in court decisions, even if Croatia does not position itself too badly compared to other EU countries, being somewhere in the middle of all EU member states. More intensive continuous training for judges in emerging areas of law should also result in greater court practice consistency. Initiatives to facilitate the use of out-of-court methods of dispute resolution also need to be followed through. Property registration is another issue. Stakeholders consulted in the process of this Review highlighted that further progress in improving land and property registration remains important to improve the country’s competitiveness. A dual system still governs the management of real estate data in Croatia, with the cadastre as a separate entity from the land registry. Reform is nevertheless in motion. The government has moved towards consolidating the land registry and cadastre systems under a single administration by end 2020 following OECD good practices. If realised, it is hoped that the reform will lead to a significant reduction in the number of procedures arising from the currently applicable regulations, and thus facilitate registration.

A large but outdated network of investment treaties adds protection for investors but requires active management As many other countries, Croatia grants additional and preferential protections based on investment treaties to some investors from a broad range of countries. These treaties, which nominally cover around 70 jurisdictions and a large share of Croatia’s inward and outward FDI stock, were concluded within 15 years, beginning immediately after independence. The treaties bear the hallmarks of agreements concluded at a time when few treaty-based claims had been brought, awareness of treaty implications was low among governments, and belief in benefits of treaties was greater than it is today. Twelve treaty-based claims brought against Croatia since 2013 have sharpened Croatia’s understanding of the implications of its investment treaties, the risks associated with their loose drafting and generous provisions, and the restrictions of its policy space and fiscal costs associated with defence against claims. While Croatia remains committed to its treaties, it endeavours to better balance investor protection and the right to regulate in the public interest through amendments. It has also begun considering the conclusion of new treaties with countries where Croatian investors operate.

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Investment promotion and facilitation Croatia has been relatively successful in attracting FDI, although investment has been primarily directed at the financial services, as well as real estate, accommodation and construction sectors. Privatisations and mergers and acquisitions (M&A) have been the most prominent channel for investors entering into Croatia with greenfield FDI playing a less prominent role with potential implications for job creation. In addition, the country has been affected strongly by the financial crisis and the subsequent FDI reversal. In order to minimise the risks associated with high concentration of FDI in a few sectors and to ensure broad-based benefits to the local economy, e.g. in terms of high-quality jobs, innovation or regional development, Croatia faces the challenge in promoting and facilitating investment more effectively, in particular into new sectors and greenfield projects. Welldesigned and implemented policies of that kind can help Croatia attract investment into most productive uses and support several objectives such as economic diversification; boosting the indigenous business sector; enhancing access to technology and knowledge transfer; intensifying integration into the global value chains.

A more effective coordination on investment promotion and facilitation is needed In this regard, the lack of strategic guidance on FDI objectives and development targets for Croatia and a fragmented and evolving institutional framework may complicate promotion efforts. This is reflected in the absence of a single, overarching strategy for investment promotion linked to well-defined national development objectives. Investment promotion and facilitation in Croatia tends to focus on the provision of investment incentives for firms and disbursement of EU funds and do not necessarily encompass a whole-of-government approach. Individual ministries at central level of government, as well as local selfgovernments, tend to have separate strategies that are not necessarily coordinated. The on-going work to develop a national development strategy could be treated by the government as an opportunity to clarify the role that FDI attraction can play in meeting Croatia’s development goals, and followed up with further more specific measures. In addition, the strategy could also be taken as an opportunity to improve the interactions at different levels of government in the area of investment promotion and facilitation. The institutional fragmentation may in particular compromise the efficiency of the system. For example, the division of tasks at the central government level, which was in place until January 2019, between the Agency for Investment and Competitiveness (AIK, Agencija za investicije i konkurentnost) and HAMAG-BICRO was atypical among OECD countries. Even if staff of the now defunct AIK considers that AIK was the national IPA, de iure competencies were divided between the two agencies according to the Act on Investment Promotion, and they both provided similar information and services to investors. The coordination between the Ministry of Economy, Entrepreneurship, and Crafts and the Ministry of Foreign and European Affairs in the area could also be strengthened, in particular to leverage the use of embassies abroad. Coordination among the various bodies at the subnational level is also a challenge. It remains to be seen if the transfer of the former AIK’s staff and activities into Ministry of Economy Entrepreneurship and Crafts that took place in early 2019 can help foster coordination among the various bodies or, in fact, turn out counterproductive, depending on the new department’s final role, organisation, resources, and relations with other government bodies. Certainly, the government could try to use the recent institutional change to reflect more thoroughly on the goals and articulation of its FDI attraction policy with the aim to bolster Croatia’s investment promotion and facilitation efforts.

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Despite progress, administrative burdens remain a problem Several reforms have aimed to reduce the administrative burden and remove some key bottlenecks. The government has developed several plans to progress on administrative simplification, each of them using the standard cost model (SCM) methodology. Despite certain delays, implementation is progressing, with about 75% of the measures identified in 2017 and 2018 addressed. For 2019, 314 additional measures to be streamlined have been identified, relating primarily to the simplification in tax and accounting administration, employment procedures for foreign employees, e-procedures in the court system, streamlining of customs procedures by integration of customs and tax departments, eprocedures and e-registers in environment protection. According to the government, the implementation of all plans for years 2017-2019 will require changes to 158 regulations by end of 2020, suggesting an ambitious reform agenda. Yet, despite improvements, investment facilitation remains a challenge, as suggested, for example, in the World Bank’s Doing Business rankings, in which Croatia scores rather poorly in relation to business and land registration and construction permits. The introduction of the quasi one-stop shop (OSS) service for establishing limited liability companies in 2004, HITRO.HR, has reduced the average time spent on the process. Yet, several factors still hinder the business registration process (e.g. the necessity to validate the name of the company with a judge), resulting in average times spent on the procedure in some Croatian cities, such as Zagreb, above the OECD average. Advancements in the use of e-permitting services, several of which are already available or being rolled out, and the extension of OSS service to include access to a greater number of public bodies and procedures, can be steps in the right direction. Progress in other areas considered key by business, including getting construction permits and paying taxes (including parafiscal charges) will also be critical to ensure that the perception of poor business climate in Croatia changes with time. More generally, a greater focus on investment facilitation in Croatia and further progress on improving regulatory quality will be an important part of the process to ensure that poorly designed regulations do not continue accumulating, putting undue burdens on firms in the future.

The transparency of the tax system and of the framework for investment incentives has significantly improved With the aim to encourage entrepreneurship and attract investors Croatia introduced significant tax reforms in 2018, resulting in better tax transparency. A number of measures are also in place or planned to reduce the administrative burden of paying taxes. With a view to enhancing investment in certain targeted activities, efforts have also been made to rationalise the regulatory framework for investment incentives with more clearly defined eligibility criteria. The legislation provides for different incentive measures for investors (domestic and foreign) who undertake investments in certain zones (e.g., entrepreneurial and free economic zones) or activities that are deemed to contribute positively to sustainable economic development, job creation, and innovation. In the future, Croatia will face a challenge of moving away from special regimes for selected investment and of improving its overall investment climate. This will involve broadening investment facilitation efforts, i.e. reducing the costs for establishment and operating business, while making investment promotion efforts, via investment incentives and other state support, more targeted. Better monitoring and ex post evaluations of public interventions will play an important role in this process. Last but not least, the authorities can face a challenge in transiting from an approach to FDI attraction based on removal of restrictions to OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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FDI to the use of active investment policies that aim not only to maximise the investment value but also to promote sustainable development. In this task, it will find itself balancing the views of business, civil society and other stakeholders as well as goals of investment attraction with RBC; and a greater reliance on evaluation of socio-economic effects of various policies can become a useful tool to support the decision-making process. More generally, closer monitoring and evaluation in the area of investment promotion and facilitation, including the allocation of investment incentives, can provide the government with key insights to improve its policies over time. As such, a recent study commissioned by the Ministry of Economy, Entrepreneurship and Crafts to undertake cost-benefit analysis of the entrepreneurial zones, located in nearly each Croatia’s county, is a positive development and could be extended to study all investment incentives and assistance by investment promotion bodies.

Public governance The quality of public governance has a significant influence on the climate for business and investment. Poorly designed or loosely applied regulations can slow business responsiveness, divert resources away from productive investments, hamper or delay entry into markets, reduce job creation and generally discourage entrepreneurship. Nothing contributes more to investor confidence about regulation than predictability and that rules achieve their stated objectives. The quality of public services also significantly influences the investment climate. Integrity is also a crucial determinant of a favourable investment climate.

The legal framework for better regulations is improving but there is room for further progress There has been important improvement in the quality of regulations in Croatia. For example, the legal framework for consultations is among one of the most developed among the EU member states. A new law has strengthened the quality of ex ante review of regulations. In the absence of formal processes that apply to secondary regulations, however, quality is affected. In addition, Croatia has not yet developed a systematic approach towards ex post evaluations Further advances in extending good regulatory practices to secondary regulations, conducting targeted ex post reviews, focusing on the performance of regulations or specific sectors, as well as ensuring greater homogeneity in application and enforcement of regulations at the national and sub-national level can help reduce administrative burdens and improve the quality of regulations in the future. Even more importantly, ensuring that these rules and requirements are respected in practice remains a challenge. For example, while the consultations on the Labour Act amendments took a year, the whole tax package was discussed in less than three days. Practices vary from ministry to ministry and the conduct of Regulatory Impact Assessment (RIA) is often perceived within state administrations as a legal requirement and secondary task, with implications for quality. Some stakeholders have also raised an issue of unequal access of different groups to the legislators. This may be related to the overall low trust in the government, according to polls, and a critical attitude towards its effectiveness (over 80% of Croatians reported not to trust the government in 2018).

Croatia's rather complex administration structure impairs the investment climate The quality of Croatia's public governance also suffers from a rather complex and multilayered network of public administrations. Such a multi-layered public administration creates a cumbersome and confusing environment for businesses and individual entrepreneurs who OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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30 │ 1. ASSESSMENT AND RECOMMENDATIONS have to navigate through it. Streamlining this structure would help reduce red tape and disparities in regulation and in the scope and quality of public services. Better public administration would have high payoffs in boosting medium-term growth. Yet, caution needs to be exercised when undertaking such reforms. As the recent abolition of the Agency for Investments and Competitiveness demonstrates, it is critical that the government reflects on solutions that allow continuity of the work of the affected institutions and how the reform may affect the government’s effectiveness prior to implementing such changes. Otherwise, uncertainty and disruption may have negative effects.

Public integrity and corruption Croatia has made important strides in reducing opportunities for corruption and limiting discretion in public decision-making. At the central level, appropriate standards of integrity are mostly in place and obligations to report personal assets and liabilities are now the prevalent rule. Legislation is also in place to assure transparency of political parties funding. The development of eGovernment services and other approaches is progressing. The legislation governing public procurement has been amended on several occasions, with each version enhancing transparency and control. Reforms aimed at fostering the integrity of stateowned enterprises (SOEs) are also progressing, though more slowly than scheduled. Significant developments have also taken place to strengthen the efficiency of law enforcement agencies. Croatia’s criminal law against corruption largely meets the standards of the Council of Europe, EU and UN, and the establishment of USKOK – the Office for the Suppression of Corruption and Organised Crime attached to the State Attorney General's Office and which combines detection, investigation and prosecution of corruption into one law enforcement body – has led to a large number of successful prosecutions and asset confiscations. Investors have acknowledged these achievements: In 2017, 60% of business respondents operating in Croatia thought that corrupt people or companies would be caught, much above the EU-28 average of 43%. As a result, Croatia is one of the best performing countries among members of the OECD Anti-Corruption Network for Eastern Europe and Central Asia (ACN), a network that supports countries of Eastern Europe and Central Asia in their efforts to prevent and fight corruption. When compared with non-OECD countries that recently became Adherents to the Declaration, Croatia, in the latest Transparency International’s Corruption Perception Index, ranks 57th, much better than countries such as Kazakhstan (122nd) and Ukraine (130th). Despite the many encouraging steps taken, corruption is perceived to be widespread. Some elements of a functioning anti-corruption framework are still missing. In particular, considering the vulnerability of the local and regional governments to undue influences, Croatia should take additional actions to promote stronger ethical standards among local governments. As local officials and employees are, with a few exceptions, not bound by any integrity standards, this may easily lead to conflicts of interest or abuses of favouritism. Furthermore, while Croatia has made concrete efforts to improve the political funding system, notably by imposing limitations on donations and subjecting political parties to disclosure of financial resources and auditing, lobbying activities have not yet been addressed. Fostering the integrity of SOEs also requires further attention. Measures to improve corporate governance in SOEs have been implemented, but progress to improve their integrity has been slow. Given that SOEs are still present in many sectors of the economy and that corruption in the SOE sector is still perceived as pervasive, additional steps should be taken to make SOEs more transparent and ensure a level playing field. Addressing other shortcomings, for OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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example in the area of business integrity in the private sector, which weaken Croatia’s efforts to prevent corruption, is also needed. Although Croatia is on track to addressing some of these shortcomings with the recent enactment of a whistle-blower protection law, which requires companies with more than 50 employees to establish internal channels for reporting of irregularities, adoption of such mechanisms is yet to be secured. Continuous participation in the ACN will further support Croatia’s efforts to prevent and fight corruption.

Promoting responsible business conduct as a strategic choice to enhance attractiveness and sustainable development Promoting and enabling responsible business conduct (RBC) is vital to attract and retain quality investment and ensure that business activity contributes to broader value creation and sustainable development. Internationally recognised RBC principles and standards such as the OECD Guidelines on Multinational Enterprises set out an expectation that all business avoid and address negative impacts of their operations, while contributing to sustainable development where they operate. RBC is not a new topic in Croatia. Businesses in particular have been an important vehicle for RBC promotion in the country, spearheading multi-stakeholder initiatives, developing materials and organising events aimed at raising awareness and understanding of RBC. The Croatian accession process to the EU involved an intensive period of reforms in areas related to RBC. Fundamental rights are protected under Croatian law, and human and labour rights and the environment are generally well-respected. As mentioned above, significant efforts have also been made to combat corruption. The government has also undertaken efforts to promote RBC in its role of economic actor, for example through transposition of EU Directives 2014/25/EU and 2015/24/EU as related to public procurement which give more prominence to environmental and social criteria. Reforms aimed at fostering the integrity of SOEs are also progressing, though more slowly than scheduled. Despite significant progress, challenges with implementation of legislation remain in some areas. As noted above, perceptions of corruption remain high and weighs on Croatia’s attractiveness to investors. There is scope to increase the participation of women and minorities in the labour market. Additionally, while environmental protection has long been a focus of the Croatian government, there is a risk that negative social and environmental impacts in relation to energy projects and industrial waste could pose a threat to biodiversity and sustainability of key sectors of the economy such as tourism. Implementation of RBC principles and standards could contribute to addressing these risks. Countries which are Adherents to the OECD Declaration are required to set up a National Contact Point (NCP) for the Guidelines. NCPs are created to further the effectiveness of the Guidelines, and Adherents are required to make human and financial resources available to their NCPs so they can effectively fulfil their responsibilities, taking into account internal budget priorities and practices. In addition to promoting the Guidelines, NCPs contribute to the resolution of issues that arise relating to their implementation in specific instances. Croatia’s NCP is envisioned to be a two-tier body, consisting of a full-time NCP, staffed with two full-time members and located in the Ministry of Foreign and European Affairs, and a multi-stakeholder group, composed of representatives from trade unions, NGOs, businesses and government ministries. Whereas the full-time NCP will deal with day-to-day operations of the NCP, administrative matters, and the promotion of the Guidelines, the multistakeholder group will provide technical advice on RBC-related matters and serve as a platform for high-level engagement. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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Summary and recommendations Attracting more and better investment, including foreign direct investment, takes central stage in the national development goals. The authorities have made strides in opening the country to international investment. The exceptions to national treatment are few. Other barriers to foreign direct investment mainly concern conditions imposed at establishment. Such barriers are few, mostly sector-specific, and typically limited in their scope, applying almost exclusively to investors from outside the EU or the EEA or to investors from countries that are not WTO members. As a result, Croatia’s degree of restrictiveness is low in comparison to the OECD average, according to the OECD FDI Regulatory Restrictiveness Index. The key standards of investor treatment and protection, including with respect to intellectual property rights, are guaranteed under the constitutional law and other laws. Progress in reforming the judicial system has been steady over the past ten years, in particular towards strengthening the independence and professionalism of the judiciary, although there is room for improvement. Steps have also been taken to reduce the administrative burden on businesses, albeit progress has been slow. There is also still scope for improving the quality and coherence of the regulatory process, including through systematising the process of ex post regulatory reviews. Croatia also faces challenges in promoting investment more effectively in the absence of a single, overarching promotion strategy and against the background of an institutional set-up which is fragmented. Significant efforts have been made to combat corruption but the country still suffers from a negative image with respect to its capacity to reduce corruption and other forms of misconduct, calling for additional measures, particularly at local level. As related to RBC, positive reforms have been undertaken in many policy areas covered by the Guidelines for Multinational Enterprises. Fundamental rights are generally protected under Croatian law, and human and labour rights and the environment are generally wellrespected. The government, in its role of economic actor, also promotes RBC expectations, for example in its legislation on public procurement. Despite significant advances, challenges persist in practice in some areas, for example with respect to the participation of women and minorities in the labour market or in the area of environmental protection. The establishment of Croatia’s NCP will further raise awareness of RBC in Croatia, support implementation of RBC standards by businesses, and contribute to improved accountability.

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Box 1.3. Policy recommendations Investment protection



Continue efforts to improve the functioning of Croatia’s court system. Building on recent reforms, further improvements in the capacity of the courts to deal with private sector cases will likely boost confidence of businesses and the general public in the judiciary. This may include additional compulsory training for judges, further digitalisation of court procedures, and further promoting out-of-court settlement.



Enhance dispute resolution mechanisms. Establishing a dispute avoidance mechanism, tailored specifically to business needs, such as a Business Ombudsman, would help expedite the legal process and reduce the cost to businesses and citizens.



Continue and enhance efforts to manage existing treaties and associated exposure. Treaties with vague provisions concluded by Croatia in the past, including those subject to unwanted interpretations in ISDS, should be updated to current standards by amendments, clarifications – for example through joint interpretations –, replaced, or if appropriate, terminated by consent or unilateral action to manage exposure and safeguard the right to regulate in the public interest.



Engage in international efforts to balance treaty-based investor protection and associated governance mechanisms. Croatia should engage actively in current efforts at international level to balance investor protection and the right to regulate, and contribute its experience.

Investment promotion and facilitation



Establish a consistent and unified institutional and policy framework for investment promotion and facilitation encompassing all relevant entities with the ultimate goal of maximising synergies and effectiveness, eliminating duplication of efforts and giving clarity to investors. This could involve endowing one government body with adequate resources and capacities to perform such functions and ensure that it coordinates its efforts with other relevant bodies at the national and subnational level. Regardless of the legal status of such a body, the government should clearly outline its objectives and the planned course of action to reduce uncertainty.



Focus efforts on effectively streamlining administrative procedures, in particular in the area of starting a business, getting construction permits and paying taxes (including para-fiscal charges). This requires that these efforts are conceived in a way that reduces the heterogeneity of practices across different levels of government. It also involves setting clear, procedure-specific deadlines and monitoring progress to ensure implementation within the planned timeframes.



Introduce and improve systems of monitoring and evaluation of Croatia’s investment promotion and facilitation programmes, including investment incentives regimes. In that context, establish formal channels of consultation between the tax authorities and other stakeholders to allow for a comprehensive view of costs and benefits of the current system. While Croatia has made strides towards enhancing the transparency of its tax and incentives system, analysis to assess its effectiveness has been so far lacking.

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34 │ 1. ASSESSMENT AND RECOMMENDATIONS Public governance and corruption



Continue improving regulatory quality in the country, in line with the recommendations of the 2019 OECD Regulatory Policy in Croatia: Implementation is Key. This applies to the processes pertaining to creating secondary regulations and the use of ex post regulatory reviews.



Continue anti-corruption efforts, notably by perfecting Croatia’s public integrity framework as foreseen in the Anti-Corruption Strategy 2015-2020. This could include: developing comprehensive codes of conduct for officials at regional and local level, as well as a code of conduct for parliamentarians, and ensuring corresponding accountability tools and dissuasive sanctions for potential violations of such codes; regulating lobbying activities; strengthening the capacity of existing control mechanisms with respect to public procurement.



Strengthen the integrity framework for state-owned enterprises (SOEs). Despite that measures to improve corporate governance in SOEs have been adopted in 2017 and that implementation has progressed since then, SOEs still suffer from political interference and conflicts of interest.



Take action, as appropriate in cooperation with business organisations and other stakeholders, to improve awareness among companies, including small and medium enterprises, which are traditionally at high risk of bribe solicitation by public officials, as well as SOEs, of Croatia’s new whistle-blower protection legislation, and to advise and assist companies in their efforts to establish internal channels for reporting irregularities through, for example, the development of seminars, guidelines and other forms of guidance. Making anti-corruption compliance part of one’s corporate culture is the best way to prevent corrupt acts before they happen.



Signal progress in the fight against corruption to the public and businesses. Increasing raising awareness efforts is of much importance to close any perception gap about actions already taken and reforms in the pipeline. A targeted communication strategy for the public through an on-line platform is in the offing but needs to materialize in practice.

Responsible business conduct



Establish an effectively functioning NCP to further the effectiveness of the Guidelines. All Adherents to the OECD Declaration have an obligation to establish an NCP, in accordance with the Decision of the Council on the OECD Guidelines for Multinational Enterprises. Croatia should ensure that the decision-making process in the NCP is well-defined and clear, particularly as related to the respective roles of the two main NCP bodies.



Actively promote the Guidelines and the NCP among businesses operating in Croatia and Croatian companies operating abroad, as well as among trade unions, workers' organisations and civil society representatives, including measuring business awareness and commitment to implement the Guidelines. Raising awareness of the Guidelines, as well as RBC principles and standards among all relevant stakeholders is an important aspect of ensuring that the NCP can effectively fulfil its mandate.

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

Take a proactive approach to engage with all stakeholders, in particular trade unions and civil society organisations. Croatia has consulted with stakeholders on the plans for the NCP, and plans to involve various stakeholders in the activities of the NCP through a multi-stakeholder group. However, NGOs and trade unions are currently underrepresented in plans for the multi-stakeholder group. Engaging with all stakeholders is key to building confidence.



Undertake a capacity building exercise for the NCP within one year after adherence and, in that context, report back to the WPRBC on the progress made in implementing the recommendations made to improve the effective functioning of the NCP. Particular attention should be paid to ensuring that the decision-making process in the NCP is well-defined and clear, particularly as related to the respective roles of the two main NCP bodies.



Promote the use of the OECD due diligence guidances by enterprises operating in or from Croatia, through active support to these enterprises in implementing the recommendations of the due diligence guidances, and ensure the widest possible dissemination of the various sector guidance and their use by various stakeholders. Countries that adhere to the OECD Declaration commit to also adhere to all of the related OECD legal instruments aimed at supporting the implementation of the OECD Guidelines, including the OECD due diligence guidances. Promoting and supporting implementation of these instruments will contribute to facilitate businesses in meeting RBC expectations in Croatia.



Promote policy coherence and improve coordination on RBC-related policies within the government. In particular, developing a National Action Plan on RBC in cooperation with relevant stakeholders including businesses, trade unions and civil society organisations could be useful in this regard. Policy coherence is crucial to ensure effective design and implementation of policies to promote RBC.

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2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA

Chapter 2. Investment trends and sustainable growth in Croatia

This chapter reviews investment trends in Croatia. It provides information on the evolution of inward and outward FDI flows and stocks and compares Croatia’s performance to other similar countries. It also provides information on the relative importance of greenfield FDI and mergers and acquisitions. The country has performed relatively strongly in attracting foreign investment, but there is need to diversify FDI by destination sector, source country and mode of entry as well as support further internationalisation of domestic firms.

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38 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Since the late 1990s, the process leading to Croatia's gradual integration and accession to the European Union (EU) has shaped the country’s economic development, with a profound impact on the institutional framework and policy-making, not least in the area of investment policies. Croatia has made a successful transition to a stable market economy and achieved notable progress on institutional and policy reforms. Its achievements have been reflected in a strong pre-crisis record of economic growth, a sustained increase of foreign direct investment (FDI) inflows in the decade preceding the global financial crisis and indicators of social development that have been among the highest in the region. At the time of its accession to the EU, Croatia was the wealthiest of the three member states in the Balkans. However, as the global financial and economic crisis continued to spill over to Croatia, the economy entered into a sharp downturn, and at 12.5% in 2013-17 the growth of GDP per capita (in PPP, constant 2011 international USD) has been much slower than in countries such as Romania (23.2%) and Bulgaria (16.7%) (World Development Indicators). The slowdown in investment exposed serious structural shortcomings and while the rate of fixed capital formation investment has been slowly growing, achieving a sustained pace of private investment rests on a precondition of important structural reforms (Chapter 3). This chapter presents Croatia’s situation in terms of its overall economic performance and FDI trends over the past two decades to provide key insights on the role – and evolution –of foreign investment in the Croatian economy.

Croatia’s economic development Croatia’s overall economic performance has been solid over the past two decades, though the country deeply suffered from the global financial crisis and a protracted six-year recession (Figure 2.1). Real GDP growth averaged some 4.5% annually over 2000–07, before a sudden deceleration in 2008 and six consecutive years of contraction. The recovery began in 2015 and Croatia’s economy since then has been growing at 3% annual in the three years to 2017 – a pace well above the EU annual average at 2.3%. Nonetheless, output has not yet fully recovered to its pre-recession level. Croatia’s GDP per capita (USD 13,237 in 2017) is one of the lowest among all EU countries; in 2017, GDP per capita expressed in PPP (constant 2011 international USD) was 61% of the EU average. Figure 2.1. GDP growth, 2000-2017 (year-on-year percentage rate in constant prices)

GDP growth, 2000-2017 (year-on-year percentage rate in constant prices) 8 6 4 2

0 -2 -4 -6 -8

Source: National Bank of Croatia

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Following a period of high inflation, year-on-year inflation has been declining since 2012 (Table 2.1): in February 2019, the rate was 1.4%. Wage growth was also moderate as unemployment remained high (7.5% in February 2019, the fifth-highest EU rate), although declining (10.9% in July 2017) (Eurostat unemployment statistics). Near-term prospects are favourable, supported by strong tourism and private consumption: the Ministry of Finance and the Central Bank, as well as international organisations and other institutions, project GDP growth at around 2.5% for 2018 and 2019. Nonetheless, the relatively low level of investment and indications from business surveys suggest that the economy is operating close to potential. Despite a significantly improved fiscal position that allowed Croatia to exit the European Union’s Excessive Deficit Procedure in June 2017, in the medium run there is a risk of growth deceleration unless long-standing structural constraints are not addressed. The external environment is also becoming less supportive. Table 2.1. Main economic indicators

Inflation Gross domestic products (GDP) growth Domestic demand (growth contribution) Net exports (growth contribution) Domestic investment (GDP share)

2014

2015

2016

2017

2018a

-0.2 -0.1 -1.4 1.2 18.8

-0.5 2.4 2.2 0.3 20.0

-1.1 3.5 3.7 -0.1 20.8

1.1 2.9 3.6 -0.7 20.9

1.5 2.6 3.6 -0.8 20.6

a. estimates. Source: National Bank of Croatia and International Monetary Fund

Moreover, the benefits of economic growth have been unevenly distributed. The absolute poverty rate (at USD 5.5 2011 purchasing power parity [PPP] per capita) increased from 4.7% in 2009 to 5.8% in 2015 (World Bank 2018c). The post-2008 recession had a significant negative impact on the dispersion of the regional development index, regional GDP per capita and regional productivity (GDP per employee) (Đokić et al., 2015). Small towns and settlements in the east and the southeast regions of the country - mainly along the border with Bosnia and Herzegovina and Serbia (areas that suffered the most from the Homeland Wars in the 1990s), as well as in rural areas – have lagged behind. Foreign trade – discussed in detail in Chapter 3 – has followed broad trends consistent with Croatia’s accession to the WTO in 2000 and then with updating trade-related legislation with the objective of bringing it into line with the EU trade policy and internal market rules. The simple average MFN tariff has fallen from 12.1% in 2000 to 4.1% in 2016 and the degree of openness of the economy has risen since the turn of the century. Nonetheless, the merchandise trade/GDP ratio in Croatia is lower than in Slovenia (that started from a slightly higher level and pulled ahead due to EU membership) and Serbia (that started from a much lower level, caught up around the crisis years, and accelerated during the recovery). The gap vis-à-vis Slovenia is particularly large for exports, which account for 78% of GDP (in 2015) and 51% of GDP in Croatia (in 2016). The trade balance for goods has been constantly negative over the past ten years. A dramatic reduction in the deficit was recorded at the height of the financial crisis (from USD 16.6 billion in 2008 to USD 8.3 billion in 2010), largely due to the decrease of imports, but the deficit widened again as the recovery took hold. Nonetheless, in the 2006-17 period the rate of growth of exports (72%) has been much faster than for imports, resulting in a shrinking trade imbalance as a share of GDP (from 22% in 2006 to 16% in 2017).

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40 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA

Foreign investment trends Importance of FDI in the Croatian economy Foreign direct investment has played a significant role in the recent development of Croatia’s economy. In 2017, FDI accounted for one fifth of all financial assets and nearly half of all financial liabilities in Croatia (Figure 2.2). Meanwhile, portfolio investment, has played a less prominent role, for example. Over the last two decades, inward foreign investment has increased considerably, reflecting Croatia’s well-established openness towards foreign investors as further discussed in Chapter of the present Review, though foreign investment has come in phases. From almost nothing at the end of the military conflict in 1995, the share of inward FDI stock in GDP has increased dramatically, peaking at EUR 28 billion in 2007 (or about 60% of Croatia’s GDP). Following the financial crisis, FDI activity contracted drastically (the share of inward FDI stock to GDP increased from 48% in 2006 to 69% in 2007, and fell to 40% in 2008). It has resumed an upward trend since then, peaking again at EUR 29 billion in the first quarter of 2018 (Figure 2.3 and Figure 2.4). Figure 2.2. Croatia’s financial account by functional type of investment, 1999-2017 Panel A. Assets Direct investment Financial derivatives

Portfolio investment Other investment

70

50% 45%

60

40%

50

35%

40

30% 25%

30

20%

20

15% 10%

10 0

5% 1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

0%

Panel B. Liabilities Direct investment

Portfolio investment

70

50% 45%

60

40%

50

35% 30%

40

25% 30

20% 15%

20

10%

10 0

5% 1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

0%

Note: From 1993 until the end of 2013, the Central Bank of Croatia compiled the international investment position in accordance with the methodology recommended by the fifth edition of the IMF’s Balance of Payments Manual (BPM5). Starting from 2014, the international investment position is compiled according to the sixth edition of that manual (BPM6). With the beginning of the implementation of BPM6, the historical data for 1999–2013 have been revised in line with the new methodology. Source: Central Bank of Croatia

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Overall, direct investments by foreign-owned firms in Croatia far outweigh investments by Croatian firms abroad. As such, Croatia sustains a negative net FDI position, of USD -22.9 billion in the first quarter of 2018, with the FDI liabilities of USD 28.9 billion outweighing the assets of USD 6 billion (Figure 2.4). Relative to the size of the Croatian economy, the share of inward FDI stock to GDP stands at 61%, above the OECD and EU averages (of 39% and 53%, respectively); and the share of outward FDI stock to GDP at 11%, below the OECD and EU averages (of 48% and 62% each, Figure 2.6). These levels are similar to those found in comparable economies (e.g. the Czech Republic, Slovakia and Slovenia).

Figure 2.3. GDP, trade and FDI in the Croatian economy, 1995-2017 GDP (current USD, in bln) Inward FDI stock (% of GDP) - secondary axis

Trade (% of GDP) - secondary axis GDP - 2 year moving average (current USD, in bln)

100

80

70

100 2000: Croatia joins the WTO

2013: Croatia joins the EU

80

60

70

50

60

40

50 40

30

30

20

20

10 0

90

10

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Note: Trade is the sum of exports and imports of goods and services measured as a share of GDP. Data on inward FDI come from the Statistical Annexes of the UNCTAD World Investment Report. Croatia reports its FDI data on an assets and liabilities basis. Source: World Bank national accounts data, OECD National Accounts data and UNCTAD

Considering data on the activities of foreign affiliates, in 2016, foreign-invested companies made up for almost one third of total investments by non-financial companies in Croatia and employed more than 15% of the labour force, while their share in exports had increased by almost one third since 2002, approaching 40% (Croatian National Bank, 2017). In addition, foreign-controlled firms located in Croatia accounted for 2% of all foreign-controlled firms in the EU (above Croatia’s share in EU’s GDP – of 0.3%) in 2017, while the share of foreign affiliates of Croatian firms in the EU total equalled 0.2% (Figure 2.5).

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0

42 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Figure 2.4. Assets, liabilities and net direct investment position in Croatia, Q1 2018 In EUR bln 40 28.86

30 20 10

5.95

0 -10 -20 -30

-22.91

Direct investment (net)

Assets

Liabilities

Note: The data shows positions of assets and liabilities of Croatian residents in economic relations with nonresidents. Values for 2018 are based on preliminary data. Data is reported according to the sixth edition of the IMF’s Balance of Payments manual (BPM6). Source: Central Bank of Croatia

Figure 2.5. Number of enterprises by type of control and location, 2017 Panel A. Foreign-controlled EU enterprises

Panel B. Foreign affiliates of EU enterprises Number of firms Share in EU total (%) - secondary axis

Number of firms Share in EU total (%) - secondary axis

5% 14 000

14 000 12 000

4%

12 000

4%

10 000

10 000 8 000

3%

6 000

2%

8 000

3%

6 000

2%

4 000

4 000 1%

2 000 -

5%

Czech Slovenia Republic

Poland CROATIA Lithuania Slovakia

0%

1%

2 000 -

Poland

Slovenia Lithuania CROATIA Slovakia

Czech Republic

0%

Note: Foreign affiliates in the framework of inward FATS mean an enterprise resident in the compiling country over which an institutional unit not resident in the compiling country has control. Number of enterprises refers to the number of 1) foreign controlled enterprises resident in the compiling economy for inward FATS (Panel A); and 2) foreign affiliates abroad that are controlled by an institutional unit resident in the compiling country for outward FATS (Panel B). Source: EUROSTAT’s Foreign Affiliates Statistics (FATS)

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Figure 2.6. FDI inward and outward stock as a share of GDP (in %), 2017. Panel A. Inward FDI 2017

OECD - Average

EU28 (European Union)

World 100 115 118 155 264 289

100 90 80 70 60 50 40 30 20 10 0

Panel B. Outward FDI 2017

OECD - Average

EU28 (European Union)

World 140 186 195 269 392

100 90 80 70 60 50 40 30 20 10 0

Note: Inward and outward FDI stock to GDP are in current prices. The data on GDP are obtained from the IMF, World Economic Outlook (WEO) database. Source: IMF, OECD and UNCTAD

Evolution of FDI over time The importance of FDI in the Croatia economy has been growing over the past two decades (Figure 2.7). Overall, the trend in the incidence of inward FDI to GDP in Croatia has been similar to other economies in the region. It has, however, also shown a relatively high volatility, including due to a significant build-up and a later reduction in FDI around the global crisis. The ratio of outward FDI stock to GDP has also steadily increased, with few exceptions (e.g. in 2010), at a pace similar to, or higher than, in other economies in the region. In absolute terms, the FDI liabilities stock has increased significantly over the past two decades (Figure 2.8). In addition, investment by foreign firms in Croatia has grown at a higher pace than investment by Croatian firms abroad (of 17% a year, on average, over the past two decades compared to 13% growth in investment by Croatian firms abroad). For example,

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44 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Croatia’s liabilities increased from about EUR 25 billion to EUR 29 billion (by 16%) from the first quarter in 2016 till the first quarter of 2018, while assets remained relatively stable during the same time period, leading to a widening in Croatia’s net negative direct investment position to EUR -23 billion in 2017 (Figure 2.7-2.8). FDI flows have followed a similar trend – with inward flows peaking in 2007, at EUR 3.7 billion (8% of GDP), and outward FDI flows in 2014, at EUR 1.6 billion (3% of GDP). In 2017, they reached EUR 1.8 billion and EUR 0.6 billion, respectively, or 4% and 1% of GDP (see Figure 2.10). Figure 2.7. The share of FDI stock to GDP in Croatia and selected EU countries, 1995-2017. In % Panel A. Inward Croatia Slovakia

Czech Republic Slovenia

Estonia EU28

Lithuania

100

90 80 70 60 50 40 30 20 10 0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Panel B. Outward Croatia

Czech Republic

Estonia

Lithuania

Slovakia

Slovenia

EU28

70 60 50 40 30 20 10 0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: IMF, OECD and UNCTAD

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Figure 2.8. Assets, liabilities and net direct investment position in Croatia, 1999-2017. In bln EUR

In bln EUR Assets Direct investment (net)

Liabilities Assets - 5 year moving average

40 30 20 10 0 -10 -20

-30

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017*

Note: The data shows the end-of-reporting period positions of assets and liabilities of Croatian residents in economic relations with non-residents. Starting from 2014, the international investment position of Croatia is compiled according to the sixth edition of that manual (BPM6). The historical data for 1999–2013 have also been revised in line with the new methodology. *Data for 2017 have been revised. Source: Central Bank of Croatia (Hrvatska Narodna Banka)

Figure 2.9. Quarterly FDI assets and liabilities in Croatia, Q1 2017- Q1 2018. In bln EUR Assets

Liabillities

Net investment position

Linear (Assets)

Linear (Liabillities)

30 20

10 0 -10

-20 -30

Q1 2016

Q2 2016

Q3 2016

Q4 2016

Q1 2017*

Q2 2017*

* Data for 2017 have been revised. ** Data for Q1 2018 are preliminary. Source: Central Bank of Croatia (Hrvatska Narodna Banka)

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Q3 2017*

Q4 2017*

Q1 2018**

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46 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Figure 2.10. Net acquisition of FDI assets and incurrence of liabilities in Croatia, 1993-2017. In EUR bln Net incurrence of liabilities 5 per. Mov. Avg. (Net incurrence of liabilities)

Net acquisition of assets 5 per. Mov. Avg. (Net acquisition of assets)

4 3.5

3 2.5 2 1.5 1

0.5 0 -0.5

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: Central Bank of Croatia (Hrvatska Narodna Banka)

Greenfield and brownfield FDI in Croatia According to previous studies, most of FDI in Croatia has been via so-called brownfield investments (i.e. via privatisations and mergers and acquisitions, M&A) rather than greenfield investment.1 In order to verify whether this is currently the case, Croatia’s recent FDI trends by mode of entry could be assessed. Comparisons over time using more up-todate data are difficult, however, as publically available data on both types of FDI come from different sources and include different types of information.2 Still, generally, the number of M&A deals involving a Croatian target has been relatively stable over time and the number of acquisitions reduced after the crisis (Figure 2.11). The average deal value for acquisitions involving a Croatian target has been USD 55 million between 2003 and 2017, with spikes in the number of deals and deal value taking place at different times. The number of announced greenfield FDI projects, and their total values, have meanwhile fallen somewhat in recent years (Figure 2.12). Compared to other economies, Croatia attracts relatively fewer FDI projects than other former transition economies from which it receives a higher overall amount of FDI such as Lithuania or Slovakia (Figure 2.13 and Figure 2.15). This could potentially be one of the reasons why – besides its sectoral distribution, for example – FDI in Croatia has been associated with relatively limited job creation (e.g. Kersan-Škabić and Zubić, 2009). Yet, the literature on the comparative economic impact of brownfield and greenfield FDI remains inconclusive; countries can also spur structural change in the economy through M&As. 3 In addition, according to the FDI Greenfield Performance Index, that relates the country’s share in the world’s total of announced greenfield FDI projects to the country’s share in world GDP, Croatia attracted more greenfield FDI than suggested by the size of its economy between 2006 and 2016 (Figure 2.14).

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Figure 2.11. Mergers and acquisitions involving a target or an acquirer in Croatia, 1997-2018 Panel A. Number

45

Panel B. Value (bln USD) Acquirer Target 5 per. Mov. Avg. (Acquirer) 5 per. Mov. Avg. (Target)

Acquirer Target 5 per. Mov. Avg. (Acquirer) 5 per. Mov. Avg. (Target)

4

40

35

3

30 25

2

20 15

1

10 5

0

0

Source: OECD calculations using Dealogic data

Figure 2.12. Greenfield FDI in Croatia, 2003-18 Panel A. Number

Panel B. Value (bln USD) 4

250

200

3

150 2 100 1 50

0

0

Source: UNCTAD, using on information from the Financial Times Ltd, fDi Markets (www.fDimarkets.com).

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48 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Figure 2.13. Number and value of greenfield FDI projects in Croatia and selected EU countries, 2008-13 Panel A. Number of greenfield FDI projects Average - 5 years

Panel B. Value of greenfield FDI projects (bln USD) Average - 5 years

Average - 10 years

Average - 10 years

5

160 140

4

120 3

100 80

2

60 40

1

20 0

0 Czech Republic

Lithuania

Slovakia

Croatia

Estonia

Slovenia

Czech Republic

Slovakia

Lithuania

Croatia

Estonia

Slovenia

Source: OECD calculations based on UNCTAD, using information from the Financial Times Ltd, fDi Markets (www.fDimarkets.com).

Figure 2.14. Greenfield FDI Performance Index. European Union

Croatia

Czech Republic

Estonia

1 0.8 0.6

0.4 0.2 0

-0.2 -0.4 -0.6

Note: The Index is calculated as a share of country’s GDP in the world’s GDP divided by the country’s share of the value of announced greenfield FDI projects in the world’s total (normalised around 0). A value > 0 means that a country attracts more FDI than suggested by the size of its GDP. Source: Authors calculations based on UNCTAD, using on information from the Financial Times Ltd, fDi Markets (www.fDimarkets.com).

Croatian economy’s attractiveness and openness to FDI Additional insights on the openness and attractiveness of the Croatian economy to FDI can be gained by international comparisons of performance in different periods of time. For example, the share of FDI flows to GDP is used as a metric of the country’s attractiveness for foreign investors in a particular moment of time, while the share of the FDI stock to GDP reflects the degree of the economy’s openness to FDI more generally. Figure 2.14 compares Croatian FDI inflows and outflows relative to other, similar economies in the region in absolute and relative

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terms (as a share of GDP). Generally, the share of FDI flows to GDP in Croatia – 2.9% of GDP in 2013-17 – is comparable to those found elsewhere (slightly above the EU average of 2.3%). Active internationalisation, on the other hand, is much lower: FDI outflows accounted on average for 0.7% of Croatia’s GDP, below the EU average of 2.4% (see Chapter 3). Figure 2.15. FDI flows in Croatia and selected EU countries, 2008-17 Panel A. Inward FDI (USD bln) Average - 5 years

Panel B. Outward FDI (USD bln)

Average - 10 years

Average - 5 years

6

6

5

5

4

4

3

3

2

2

1

1

0

Czech Republic

Croatia

Slovenia

Estonia

Lithuania Slovakia

0

Czech Republic

Panel C. Inward FDI (%)

6%

5%

5%

4%

4%

3%

3%

2%

2%

1%

1%

EU

Slovenia Lithuania Slovakia

Slovenia

Slovakia

Lithuania

Average - 5 years (2013-2017) Average - 10 years (2008-2017)

6%

Croatia Czech Estonia Republic

Estonia

Panel D. Outward FDI (%)

Average - 5 years (2013-2017) Average - 10 years (2008-2017)

0%

Croatia

Average - 10 years

0%

EU

Estonia

Croatia Slovenia

Czech Lithuania Slovakia Republic

Note: FDI inflows and outflows are in current prices. The data on GDP are obtained from the IMF, World Economic Outlook (WEO) database. Source: IMF, OECD and UNCTAD

The evolution of Croatian FDI flows to GDP over the past three decades has also generally followed the patterns in other economies in the region (Figure 2.15). In addition, although Croatia has experienced a lower volatility in the share of FDI flows to GDP than some similar economies in the region over the past two decades (e.g. Estonia and Slovakia), it has a higher variability than the EU average in case of inflows and lower variability for outflows. 4 Most recently, both in the ratio of inward and outward flows to GDP, Croatia experienced a hike in 2014, which was less common in other economies in the region.

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50 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Figure 2.16. Share of inward and outward FDI flows as a share of GDP in Croatia and selected EU countries, 1995-2017. In %

Panel A. Inward flows Croatia

Estonia

Lithuania

Slovakia

Slovenia

EU

30 25 20 15 10 5 0 -5 -10

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Panel B. Outward flows Croatia

Estonia

Lithuania

Slovakia

Slovenia

EU

25 20 15 10 5 0 -5 -10

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Note: Inward and outward FDI flows are in current prices. The data on GDP are obtained from the IMF, World Economic Outlook (WEO) database. Source: IMF, OECD and UNCTAD

European countries dominate the FDI landscape European countries dominate the FDI landscape in Croatia, topping the list of major destination and source countries (Figure 2.17). among the largest investors, some countries are traditionally associated with the presence of special-purpose entities (SPEs), which can serve as a conduit for pass-through capital motivated by tax purposes, e.g. Netherlands, Luxembourg or Hungary (see Box 2.1); other European countries, such as Austria, Italy and Germany, have traditionally been the main sources of FDI and jointly account for over 40% of all net accrued liabilities in Croatia. Meanwhile, outward FDI of Croatia is targeted at the

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former Yugoslavia – in particular, Bosnia and Herzegovina, Slovenia, Serbia and Montenegro – accounting for nearly half of all net accrued FDI assets between 1993 and 2018. This is congruent with Croatia’s geographic location, history, EU membership and the country’s trade structure; 65% of the country’s exports and 78% of its imports come from the EU and most of Croatia’s main trading partners are European countries (see Annex Figure C.2 and the earlier section on trends in Croatia’s trade). Figure 2.17. Top 10 destination and source countries: Net acquisition of assets and net incurrence of liabilities by country, 1993-Q1 2018 In mln EUR

Panel A. Source countries Value (in bln)

Share (in %) - secondary axis

8

50%

7 40%

6 5

30%

4 20%

3 2

10%

1 0

Netherlands

Austria

Italy

Germany

Luxembourg

Hungary

Slovenia

UK

France

Netherlands Antilles

0%

Panel B. Destination countries Value (in bln)

Share (in %) - secondary axis

8

50%

7 40%

6 5

30%

4

20%

3 2

10%

1 0

Netherlands

Bosnia and Herzegovina

Slovenia

Serbia

Montenegro

Poland

Liberia

Macedonia

Russia

Malta

Source: Central Bank of Croatia

Box 2.1. Special purpose entities: Why do they matter for FDI statistics?

Special purpose entities (SPEs), such as shell or shelf companies, are companies that do not have substantial economic activity in the country but that are used by companies to raise capital or to hold assets and liabilities. With the proliferation of international activities and increase in intra-frim trade, including in intangibles, it has become increasingly easy for companies to shift profits across jurisdictions

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0%

52 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA according to the most favourable tax environment through corporate structures built for that purpose. Just as gross trade flows may obscure the destination and origin of value-added produced in a given economy due to multiple shipments of goods across borders during the production process that spans several countries, so the passing of funds through SPEs can lead to the inflation of FDI statistics and the obscuring of the ultimate source and destination of FDI. The OECD Revised Benchmark Definition of Foreign Direct Investment (BMD4) recommends that countries compile their FDI statistics excluding resident SPEs, and, then, separately for resident SPEs to provide a more meaningful measure of direct investment into and out of an economy (see OECD, 2008). For the country hosting the SPEs, this recommendation improves the measurement of FDI by excluding inward FDI that has little or no real impact on their economies and by excluding outward FDI that did not originate from their economies. Four countries—Austria, Hungary, Luxembourg, and the Netherlands—have reported FDI flows and positions excluding resident SPEs to the OECD for several years. With the implementation of the latest standards, 30 OECD countries currently report FDI data excluding resident SPEs. In some countries, such as Luxembourg, Netherlands or Hungary, SPEs account for a sizable share of inward FDI stock (see Figure 2.18) and, if not accounted for, could distort FDI statistics. Even in countries where SPEs do not play a significant role currently, it is useful to be able to identify resident SPEs in the FDI statistics so that their role can be monitored, especially as, by their nature, SPEs are easily established and can grow rapidly and can distort investment flows in particular years. Source: OECD: www.oecd.org/daf/inv/mne/statistics.htm

Figure 2.18. Inward FDI positions by resident SPEs and non-SPEs in selected OECD countries, 2017 SPEs

Non-SPEs

100% 90%

80% 70% 60% 50%

40% 30% 20% 10% 0%

Note: Data for Australia, Canada, Ireland, Israel, Mexico, and UK are not available with a split for SPEs and nonSPEs. Data for Denmark, Greece, Korea, Norway and Switzerland are available for 2016. Source: OECD FDI Statistics

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Services account for the majority of foreign investment in Croatia Services account for the majority of FDI in Croatia. Financial services, real estate related activities, wholesale and retail trade (except for motor vehicles and motorcycles), and telecommunications account jointly for over 80% of the net incurred liabilities in Croatia between 1993 and the first quarter of 2018 (Figure 2.19). The role of real estate, accommodation and construction services is particularly prominent in Croatia, and related to robust growth of the tourism sector as further discussed in Chapter 3. While there is a high variation across countries, generally, real estate, accommodation and construction tend to play a less prominent role in OECD economies (Figure 2.20). Services also account for about three fourths of the net acquisition of foreign assets, with the financial services playing the most prominent role (24% of total), followed by the activities of head offices and management consultancies and wholesale and retail trade (22% each). Manufacturing, in turn, accounts for 18% of total net incurred and 23% of net incurred assets in Croatia, which is broadly in line with its share in the country’s GDP of 15% (Annex C). Services also account for most of M&A in Croatia, with manufacturing responsible for less than 1% of the deal activity (Figure 2.21). Figure 2.19. Net acquisition of assets and incurrence of liabilities by sector, 1993-Q1 2018 Panel A. Net acquisitions of assets Water transport 3% Other 6%

Wholesale and retail, except of motor vehicles and motorcycles trade 22%

Financial service activities, except insurance and pension funding 24%

Manufacturing 23%

Activities of head offices; management consultancy activities 22%

Panel B. Net incurrence of liabilities Telecommunications 6%

Other 14%

Wholesale and retail trade, except of motor vehicles and motorcycles 14% Manufacturing 18%

Note: Data by activity is reported using NACE Rev. 2. Source: Central Bank of Croatia

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Financial service activities, except insurance and pension funding 30%

Real estate activities and investment, accomodation, construction 18%

│ 53

54 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Figure 2.20. Share of real estate, construction and accommodation services in total inward FDI stock of OECD countries, by country, 2017 30% 25% 20% 15%

10% 5% 0%

Source: OECD Foreign Direct Investment Statistics

Figure 2.21. Value of M&A deals involving targets or acquirers in Croatia, by sector, 1997-2018 Panel A. Net acquisitions of assets

Panel B. Net incurrence of liabilities

100%

100%

90%

90%

80% 6%

70%

5%

13%

60% 13%

50%

40%

18%

30% 10%

80%

27%

3%

1%

19%

70% 60%

20%

50% 40% 30% 20%

20%

4%

49%

10% 0%

0%

Source: OECD calculations using Dealogic data

Activities of Croatian companies abroad As reflected in total outward and inward FDI stock, the activities of Croatian companies abroad remain significantly less important than activities of foreign-owned enterprises in Croatia. Statistics on outwards activities of foreign-controlled affiliates provide further insights on internationalisation of domestic firms. According to Eurostat, in 2015, the latest available year, there were 179 Croat companies operating outside of the EU that jointly employed over 15 000 people and had a total turnover of EUR 1.91 billion, which represents 0.21% of European firms operating outside of the EU in 2015 (Figure 2.22).

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Figure 2.22. Statistics on EU-controlled foreign affiliates in selected EU 28 countries Panel A. Turnover (mln EUR) 2015

Share in total (%)

18000

2%

16000 14000

2%

12000 10000

1%

8000 6000

1%

4000

1 914

2000 0

Romania Malta Slovakia Bulgaria Estonia

Latvia Czechia Lithuania Hungary Cyprus Croatia Slovenia Poland Greece Portugal

0%

Panel B. Employment 2015

Share in total (%)

120000

2%

100000 2% 80000 60000

1%

40000

1%

15 290

20000 0

Romania Latvia

Malta

Estonia Bulgaria Slovakia Czechia Cyprus Hungary Lithuania Croatia Slovenia Greece Poland Portugal

0%

Panel C. Number of enterprises 2015

Share in total (%)

900

2%

800 700

2%

600 500

1%

400 300 200

179

1%

100 0

Source: EUROSTAT (2018)

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0%

│ 55

56 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA These levels are comparable to those encountered in EU economies with similar market size and per capita income level but are still among the lowest in the EU. Considering the central and strategic location of Croatia as well as some robust sectors, such as tourism, there could be scope for further growth in future years. In 2018, there were 14 Croatian companies among the top 500 largest firms in Central and Eastern Europe, according to the ranking compiled by COFACE (2018) and there were some new entrants in the list. Utilities and public services as well as oil and minerals and wholesale and retail trade dominated but the list also includes a home-grown pharmaceutical company that turned into a regionally and globally active multinational enterprise (MNE) with foreign capital and most of its products exported, principally to European markets (Box 2.2.) In this context, active export promotion and investment promotion policies (see Chapter 6), including for outward FDI and the overall improvements in the country’s investment climate, can have a role to play. Box 2.2. The experience of PLIVA: From a home-grown innovator to a large exporter and a foreign-owned enterprise

Zagreb-based PLIVA is one of the leading industrial companies in Southeast Europe and one of Croatia’s leading exporters – it is listed 364th largest company in Central and Eastern Europe (CEE) in the top 500 CEE Ranking by COFACE (2018). It primarily manufactures and sells generic drugs and is one of the world’s largest producers of the generic drug Adderall, and has an undergone an impressive transformation from a home-grown business to a global pharmaceutical supplier. The company’s origins date back to 1921 when Isis of Zagreb and Chinoin of Budapest established the Kaštel factory in Karlovac to manufacture domestic herb extracts. A research program begun in 1935 under the direction of Dr. Vladimir Prelog, who would go on to win the Nobel Prize in chemistry 40 years later. Kastel was nationalized in the early 1940s and the name Pliva (an acronym for the State Institute for Production of Medicines and Vaccines) was adopted in 1945. A long period of growth ensued. By the mid-1950s, PLIVA had galenical, tablet and injection departments, as well as its own Research Institute, founded in 1952. A major breakthrough occurred in 1980, with the discovery and patenting of azithromycin, a macrolide antibiotic. At the time only nine countries in the world manufactured their own antibiotic. In 1986 PILVA licensed the antibiotic to Pfizer and, in 1991, Pfizer launched azithromycin on Western markets under the brand name Zithromax, helping the company generate large revenues. The collapse of the Soviet Union, the company’s main export market, led to drastic restructuring and the sale of non-core business areas, such as the food and cosmetics divisions. PLIVA became a joint stock company in 1993 and an IPO was launched in 1996, with dual listing in Zagreb and London, where PLIVA was the first East European industrial company listed. Privatisation was completed in 1998, when the European Bank for Reconstruction and Development reduced its stake from 11% to 8%. Internationalisation began after the end of the war when an ambitious investment cycle was launched (new production facilities for azithromycin in Savski Marof and oral solid forms in Zagreb, opening of the New Research Institute). PILVA weas listed on the London Stock Exchange in 1996. In 1997, PLIVA acquired control of a leading Polish pharmaceutical company, Polfa Krakow, and then used its Polish subsidiary, PLIVA Krakow, to take over Lachema, in the Czech Republic, in December 1999. Additional acquisitions were made in Germany and the United States in the early 2000s. As azithromycin, its top seller, came off patent, PLIVA shifted to the generic business, which itself was going through a phase of accelerated consolidation. In 2006 PLIVA put itself up for sale after an unsolicited offer from

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Iceland’s Actavis, leading to an intense bidding war that saw the victory of Barr Pharmaceuticals. In 2008, the US-based company, then the third-largest generics producer, was eventually bought by Teva of Israel, which reinforced its global market leadership. Over the past ten years, there have been several important business developments in PILVA. First, the company invested continuously in state-of-the-art manufacturing facilities in Croatia. About USD 200 million have been invested in new production facilities in Savski Marof and Zagreb primarily to add capacity and reduce emissions and environmental impact. This represented one of the largest private investment in Croatia in mid-2000s. In 2014, PLIVA and the Agency for Investments and Competitiveness (AIK) won the Award for the Best Investment Project in Eastern Europe at the Annual Investment Meeting, one of the largest global investment conferences held in the United Arab Emirates. Second, PLIVA high-quality generic medicines are being sold throughout Teva extensive distribution network around the world. Third, Zagreb has become one of Teva’s strategic research and development sites, currently employing about 200 scientists and researchers, of whom more than 40 hold M.Sc. and Ph.D. degrees. About 20 projects are completed every year; and Teva has chosen Zagreb for three shared service centers for its EU sites (for IT, human resources and finance). Today, PLIVA continues to be owned by Teva and the production site in Zagreb, with 80% of products intended for exports, is one of the strategic locations for the Teva Group. Zagreb remains an important generic R&D centre for Teva, and its projects will mostly focus on products for European markets. The company has operations in over 30 countries in the US, CEE and Western Europe; and building upon a strong R&D history, specializes in the discovery, development, production and distribution of generic and proprietary branded pharmaceutical products.

Outlook and policy recommendations Most recent Croatian quarterly GDP data have shown signs of recovery, FDI flows reached new heights in early 2018, and business surveys point to a positive overall business sentiment (AmCham, 2019; PWC, 2018; and Figure 2.23). Hence, unexpected events notwithstanding, an outlook for FDI in Croatia appears positive. Several broad conclusions emerge from an assessment of investment trends in Croatia Overall, Croatia has performed relatively similarly to other transition economies over the past two decades albeit it has been affected in important ways by the financial crisis. The relative concentration of FDI in the real estate, construction and accommodation sectors – related to the prominent role of tourism in the economy – suggests that there could be scope for diversifying the portfolio of FDI projects in Croatia, including through improvements in the business climate and active investment promotion policies, discussed in the following chapters. Also, Croatia appears to have recorded fewer greenfield FDI projects than similar economies in the region, even if their value was still higher than implied by the size of the Croatia’s economy in many years. In addition, while the prominence of European countries is easily explainable, extra efforts may be put in attracting investments from other geographies, including large emerging economies. Finally, there is considerable potential to increase outward investment and the internationalisation of Croatian companies, especially as nonEU economies in the Balkans accelerate their journey towards European integration. More generally, the rise of the Balkans may pose a threat to Croatia as other countries in the region become an attractive locations for FDI. This threat of competition may suggest a certain urgency in implementing some of the business climate reforms outlined in this report.

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58 │ 2. INVESTMENT TRENDS AND SUSTAINABLE GROWTH IN CROATIA Figure 2.23. Results of a business survey on investment environment in Croatia, 2019 Panel A. How would you rate overall experience with your company's business in Croatia?

Pabel B. Would you say that business conditions in Croatia have improved, stayed the same or deteriorated in the past 5 years?

60.0%

Improved

Stayed the same

Deteriorated

50.0%

40.0%

14%

30.0% 47% 20.0%

39%

10.0%

0.0%

Very bad

Bad

Average

Good

Very good

Note: The survey was carried out in the period from 19 December 2018 to 6 February 2019 on a sample of 130 members of management boards of domestic and international companies in Croatia. Both large and small companies, according to the criterion of the number of employees, were equally represented. Approximately 24% were medium-sized companies, while 15% were companies with up to nine employees. An equal number of domestically-owned and foreign-owned companies participated in the survey. The purpose of the survey was to determine participants’ attitudes on the general business environment in Croatia. Source: AmCham, Survey of the Business Environment in Croatia (2018)

Notes 1

For example, Hunya and Skudar (2006) use the FDI questionnaire of the Croatian Central Bank to show that, in the period 1993-2005, the share of privatisation-related FDI inflows was nearly 50%. According to the authors, retail and wholesale trade and financial intermediation accounted for over 65% of total greenfield FDI in Croatia, while manufacturing was responsible for only 10% in that period. See also Chapter 3 for information on Croatia’s privatisation waves. 2

While M&A data include information on concluded deals, greenfield FDI refers to announced projects. 3

For example, some studies find that brownfield FDI is associated with increases in total factor productivity (Ashraf et al., 2016) and can lead to more greenfield FDI in the following periods (Loayza et al., 2004). Other studies, on the other hand, find that M&As – unlike greenfield FDI – have no statistically significant effect on the countries real GDP growth (Harms and Méon, 2016) or only have it when the host country has high levels of human capital development (Wange and Wong, 2009). 4

Variability is assessed based on standard deviation for the values shown in Figure 2.15 for 1995-2017.

References Amcham (2019), Survey of the Business Environment in Croatia, www.amcham.hr/storage/upload/doc_library/amcham__survey_of_the_business_environment_in_croatia_15192.pdf Ashraf, A., D. Herzer, and P. Nunnenkamp (2016), “The effects of greenfield FDI and cross-border M&As on total factor productivity”, World Economy, Vol. 39, No. 11.

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Croatian Bureau of Statistics (2018a), First Quarterly Gross Domestic Product Estimate, Second Quarter of 2018, www.dzs.hr/default_e.htm . Croatian Bureau of Statistics (2018b), “Population Estimate”, www.dzs.hr/Hrv_Eng/Pokazatelji/Procjene%20stanovnistva.xlsx. European Commission (2018), European Neighbourhood Policy and Enlargement Negotiations: Croatia, https://ec.europa.eu/neighbourhood-enlargement/countries/detailed-country-information/croatia_en. EUROSTAT (2018), Statistics on the structure and activity of foreign affiliates (FATS), https://ec.europa.eu/eurostat/web/structural-business-statistics/global-value-chains/foreign-affiliates. Đokić, I., Z. Fröhlich, and I. Rašić Bakarić (2015), “The impact of the economic crisis on regional disparities in Croatia,” Cambridge Journal of Regions, Economy and Society, Vol. 9, No. 1. Hunya G. and A. Skudar (2007), The Role of Foreign Direct Investment in the Croatian Economy, OECD Publishing, Paris, https://doi.org/10.1787/9789264034013-en. Kersan-Škabić, I. and C. Zubić (2009), “Utjecaj izravnih stranih ulaganja na rast BDP-a, na zaposlenost i na izvoz u Hrvatskoj”. Ekonomski pregled, Vol. 60, Nos. 3-4. Lejour A., A. Mervar, and G. Verweij (2007), “The Economic Effects of Croatia’s Accession to the EU”, EIZ Working Papers, EIZ-WP-0705, Ekonomski Institut Zagreb (EIZ), www.eizg.hr/UserDocsImages/publikacije/serijske-publikacije/radnimaterijali/The_Economic_Effects_of_Croatias_Accession_to_the_EU.pdf Loayza, N., C. A. Calderon, and L. Servén (2004), “Greenfield Foreign Direct Investment and Mergers and Acquisitions: Feedback and Macroeconomic Effects”, World Bank Policy Research Working Paper, No. 3192. OECD (2009), OECD Benchmark Definition of Foreign Direct Investment 2008: Fourth Edition, OECD Publishing, Paris, https://doi.org/10.1787/9789264045743-en. PWC (2018), European Private Business Survey, www.pwc.com/private-business-survey. Vidaković Peruško, I., K. Kovač, and M. Jošić (2018), “Croatia in Global Value Chains”, Survey, No. 32, Croatian National Bank, Zagreb. World Bank (2018a), World Development Indicators database, http://databank.worldbank.org/data/source/world-development-indicators. World Bank (2018b), New country classifications by income level: 2018-2019, https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2018-2019 . World Bank (2018c), Poverty and Equity Brief: Croatia, http://databank.worldbank.org/data/download/poverty/33EF03BB-9722-4AE2-ABC7AA2972D68AFE/Archives-2018/Global_POVEQ_HRV.pdf. WTO (2018), Member Information: Croatia and the WTO, www.wto.org/english/thewto_e/countries_e/croatia_e.htm. WTO (2010) Trade Policy Review, Secretariat Report, WT/TPR/S/227, www.wto.org/english/tratop_e/tpr_e/tp327_e.htm.

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Chapter 3. Croatia’s competitiveness: Challenges and opportunities

This chapter examines Croatia’s integration into the global economy and the structure of foreign trade. It looks at various indicators which, taken together, determine the nation’s ability to compete in global markets. It also summarizes various measures that can be taken to improve productivity and competitiveness, notably by promoting linkages, addressing skills shortages, enhancing market functioning, and facilitating trade.

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62 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES While Paul Krugman was certainly right in observing that firms, and not countries, compete in the global marketplace, policy-makers are justifiably concerned with the notion of national competitiveness – to the point of being “obsessed”, as the American economist wrote in 1994 in a celebrated Foreign Affairs essay (Krugman, 1994). This chapter first examines some structural features of Croatia’s trade, such as product composition and geographical destination, and then reviews a broad set of policy and institutional factors that concur to determine competitiveness, i.e. the level of productivity and the ability to achieve sustainable and inclusive growth.

Trade patterns and integration into regional and global value chains National economies have structural characteristics that reflect long-term underlying forces and it is therefore useful to compare the three largest and most advanced countries that were established from the former Yugoslavia. The comparison shows important differences in the structure of merchandise trade. One quarter of Croatian exports are intermediate products – more than in Slovenia and Serbia – while the share of consumer goods is the lowest. On the import side, the opposite is true: Croatia has the lowest share of the three countries for intermediate and capital goods and the highest for consumer goods. From a geographical standpoint, similar to Slovenia there is a concentration of exports to the European market, although for Croatia the weight of non-EU countries (including the Russian Federation ) is higher (and so is, somehow surprisingly, that of the Eurozone). Countries of the former Yugoslavia concentrate the largest share of Croatian exports (in fact, the highest incidence among the three countries), although Italy was the single largest partner in 2016, as it was for Serbia (whereas Germany tops the list for Slovenia). On the import side, Germany, Italy, and Austria head the rankings, as they do in Slovenia (in Serbia, China is now the third-largest supplier). More generally, Croatia sources 8% only of its foreign needs outside of Europe, much less than Slovenia (22%) and Serbia (25%).

Manufacturing dominates in the export basket The 2017 export basket of Croatia is predominantly composed of manufactured goods, although the incidence of agricultural products (albeit minimal) is larger than for Slovenia. Among manufacturing exports, more sophisticated goods (“heavy manufacturing”) account for a much lower share in Croatia (and Serbia) than in Slovenia; conversely, “light manufacturing” is much more relevant in Croatia (and Serbia). Patterns are roughly similar on the import side. It is noteworthy that Croatia runs a deficit across all merchandise classifications, whereas Slovenia has a surplus for “heavy manufacturing” and Serbia one for “light manufacturing”. In the 2012-16 period, against the background of an unexpected trade slowdown, Croatia has managed to increase its global export share, albeit marginally (+0.03%). The improvement has been higher in the mega-sectors (raw materials and intermediate goods) for which global import demand has shrunk the most. Correspondingly, Croatian exports have barely made any inroads in the capital goods industry, global demand for which has dropped the least (and in fact, it lost market shares in transport equipment, which at the aggregate level is the only sector recording an increase). Hides and skins and wood are the best-performing industries, where gains in global market shares are connected to the ability of Croatian firms to intercept the demand by global lead firms. These sectors had a positive growth of world imports in the period 2008-12 associated to an increase of Croatia’s share of world exports over the same period of time.

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Table 3.1. Trade structure by geographical destinations EXPORTS

1999

2008

2016

EU Eurozone Rest of EU Non-EU Europe Rest of the world

HRV 67.68 61.57 6.11 20.48 11.84

SVN 81.62 63.59 18.03 10.37 8.01

SER 48.17 39.01 9.16 34.29 17.54

HRV 62.68 52.01 10.67 26.96 10.36

SVN 77.56 53.08 24.48 14.36 8.09

SER 58.20 40.61 17.59 21.07 20.73

HRV 69.62 55.54 14.08 20.99 9.39

SVN 76.57 53.57 23.00 12.89 10.54

SER 66.13 43.43 22.70 16.03 17.84

Former Yugoslavia Italy Germany Austria China

25.51 18.05 15.73 6.18 0.08

15.16 13.76 30.74 7.28 0.15

35.18 10.50 11.13 2.11 0.62

31.04 19.08 10.75 5.78 0.25

17.25 12.09 18.89 7.84 0.35

36.96 10.28 10.40 4.18 0.05

28.55 13.66 11.78 6.40 0.61

14.79 11.23 20.64 8.29 0.62

23.77 14.60 13.06 2.53 0.17

EU Eurozone Rest of EU Non-EU Europe Rest of the world

HRV 74.01 61.87 12.13 14.19 11.81

1999 SVN 81.71 64.37 17.34 5.28 13.02

SER 58.31 38.76 19.54 19.49 22.20

HRV 67.17 52.01 15.17 18.37 14.46

2008 SVN 72.06 57.19 14.87 6.64 21.30

SER 54.41 36.37 18.04 22.35 23.24

HRV 83.46 60.91 22.55 8.64 7.90

2016 SVN 70.54 53.18 17.36 7.34 22.12

SER 61.69 40.25 21.43 13.34 24.97

Former Yugoslavia Italy Germany Austria China

10.41 15.87 18.51 7.06 0.97

5.67 16.72 20.55 7.95 1.34

10.66 10.11 12.27 3.44 2.34

10.56 17.11 13.40 4.91 6.14

7.11 16.47 16.98 8.31 4.29

10.47 9.50 11.76 2.49 7.95

16.82 12.62 16.11 7.97 2.96

8.69 14.66 17.21 8.60 6.45

9.22 10.32 12.86 3.04 8.34

IMPORTS

Source: OECD elaboration based on World Integrated Trade Solution database

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64 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES Table 3.2. Export structure by number of HS6 digit products 1999 World Selected partner regions Europe & Central Asia Middle East & North Africa North America East Asia & Pacific Sub-Saharan Africa Selected partner countries Bosnia & Herzegovina Slovenia Serbia Italy Germany Austria Republic of North Macedonia Croatia

2008

2016

HRV 3 454

SVN 3 945

SER 2 825

HRV 3 699

SVN 4 063

SER 3 809

HRV 3 932

SVN 4 053

SER 3 864

3 143 265 335 200 88

3 663 576 592 437 186

2 807 166 98 96 92

3 678 622 601 525 256

4 047 1 056 1 056 1 076 525

3 784 609 508 909 498

3 912 950 845 827 621

4 033 1 342 1 342 1 365 693

3 843 943 778 711 549

2 558 1 774 403 971 1 080 767 799 n.a.

2 553 n.a. 1 209 1 775 2 049 1 714 1 564 2 779

2 342 341 n.a. 489 583 230 1 404 182

3 027 2 249 2 364 1 874 2 249 1 377 1 474 n.a.

3 080 n.a. 3 088 2 293 2 368 2 184 2 087 3 449

2 979 1 304 n.a. 1 283 1 486 858 2 210 1 815

3 176 2 995 2 595 1 985 1 952 1 719 1 557 n.a.

2 876 n.a. 3 004 2 577 2 544 2 426 1 950 3 364

3 013 1 689 n.a. 1 493 1 774 1 155 2 445 2 110

Source: OECD elaboration based on World Integrated Trade Solution database

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Table 3.3. Product structure of merchandise trade EXPORT

IMPORT

ISIC (3) Codes

HRV

SVN

SER

HRV

SVN

SER

Agriculture

4.85

2.24

5.98

3.29

2.50

3.65

1, 2, 5

Mining

0.66

0.67

0.51

6.40

1.53

10.23

10-11, 13, 14

Manufacturing

91.42

95.64

92.94

87.32

94.54

85.59

Light manufacturing

25.86

11.28

25.96

23.81

16.11

17.27

15-22

Industrial commodities

31.01

33.48

29.88

28.21

36.62

33.47

23-27

Heavy manufacturing

34.55

50.88

37.10

35.30

41.81

34.85

28-36

3.07

1.44

0.56

2.99

1.42

0.52

37, 40

Others

Source: OECD elaboration based on World Integrated Trade Solution database

Croatia’s Economic Complexity Index (ECI) increased from 0.63 in 2001 to 0.83 in 2016, although at the global level it lost one position (from 29th to 30th).1 In Central and Eastern Europe, Croatia stands below Slovenia, as well as the Czech Republic, Hungary, Slovakia, Poland, Estonia, and Romania. While not spectacular, this performance is an unquestionable improvement with respect to the earlier period (Aprahamian and Correa, 2015). Between 2008 and 2012 Croatia expanded its market share in world exports in sectors whose world import demand growth increased at a relatively low rate (“winners in declining sectors”). In addition, Croatia had several important sectors (in terms of overall export value) which both lost market share in world exports and faced lower import demand (“losers in declining sectors”). On the other hand, expansion was very limited for products whose import demand between 2008 and 2012 increased strongly (“winners in growing sectors”). There were also a few products with growing world demand and declining world market export shares (“losers in growing sectors”). Out of 3,407 products at the HS-6 digit level that Croatia exported in 2012, only four were winners in growing sectors (i.e. medicaments and antibiotics, cane of beet sugar in solid form, articles of leather or of composition leather, and revolvers and pistols). The list of Croatia’s largest exporters is topped by state-owned INA, followed by foreignowned Pliva and Boxmark Leather, an Austrian multinational enterprise which produces car seat covers and upholstered interior parts. Other companies in the top 10 include Valamar Riviera (hospitality, controlled by the Austrian investment firm EPIC), Petrokemija (petrochemicals, state-owned), Končar Energetski Transformatori (a joint venture of Siemens and the local Končar Group), Ericsson Nikola Tesla, Uljanik (Box 3.1), Croatia Airlines, and HEP.2 The Balkans’ largest private company and regional multinational, Agrokor, used to feature prominently in this ranking, thanks to an integrated farm-to-retail supply chain in food processing, developed through in-house innovation, large investments in farms, and tie-ups with overseas research institutions. The company, which employs 52 000 people, collapsed in early 2017, was placed under state administration in April that year, and reached a debt settlement deal with creditors (led by Russian banks Sberbank and VTB) in July 2018. The effects of the crisis on the economy have been limited and the impact of this event on the yields on Croatian government bonds was marginal and only temporary (Croatian National Bank, 2018).

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66 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES Table 3.4. The structure of Croatian exports Product Group

Percentage of 2016 exports

growth rate 2012-16

100.00

Export 10.34

Capital goods Consumer goods Intermediate goods Raw materials

21.77 44.39 24.61 9.02

-2.80 8.39 33.22 2.29

-5.99 -15.68 -17.12 -44.90

0.01 0.04 0.05 0.05

Machinery and Electronics Chemicals Fuels Wood Food Products Metals Textiles and Clothing Transportation Vegetable Plastic or Rubber Stone and Glass Animal Footwear Hides and Skins Minerals Miscellaneous

18.05 11.77 9.49 8.06 7.85 7.18 6.50 5.79 3.49 3.31 2.84 2.82 1.85 1.80 1.44 7.76

11.43 33.41 -23.39 29.00 13.46 -8.94 46.57 -30.51 32.09 68.16 -31.00 33.69 21.67 41.08 14.86 71.69

-7.40 -12.27 -57.13 -10.90 -7.60 -27.15 -8.41 0.13 -11.66 -14.77 -3.71 -8.53 3.54 -9.24 -35.17 -5.10

0.02 0.05 0.07 0.12 0.06 0.03 0.06 -0.01 0.04 0.04 0.00 0.05 0.05 0.12 0.05 0.03

All Products

World import -18.29

Market share 0.03

Source: OECD elaboration based on World Integrated Trade Solution database.

Box 3.1. The arduous restructuring of shipyards

Shipbuilding has always been an important industrial sector in Croatia, especially in Istarska, Primorsko-goranska and Splitsko-dalmatinska counties. The Croatian shipbuilding industry was one of the largest in Europe in the 1970s, and ranked third worldwide in 1988 by the size of the outstanding orderbook. Given its specialisation in relatively unsophisticated tankers and car carriers, it was then hit hard by the fall of the Berlin wall, the Balkans wars, and the rise of new competitors in Asia. In the 2002 Stabilisation Agreement with the EU, Croatia committed to restructure the shipyards within four years, but failed to fulfil the obligation. By 2012, just ahead of EU membership, only the largest of the five state-owned shipyards (Uljanik) was making a profit, while Kraljevica was subject to bankruptcy procedure. Uljanik, as well as Brodosplit, Brodotrogir and 3.Maj, were privatized in 2013, with the expectation that the new owners (all of them Croatian investors) would turn them around by the end of 2017. Following privatisation, production capacity has indeed been trimmed, payroll reduced, and activity gradually oriented towards non-shipbuilding products. Ten ships were built in 2017, for 80,500 compensated gross tonnage; at the end of the year, Croatia had the fifth-largest orderbook in the EU and the 11th worldwide.

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Nonetheless, in early 2018 the government was compelled to rescue Uljanik, which employs 2,200 people, through a EUR96 m loan that was cleared by the European Commission on the condition that the shipyard work out a sound restructuring programme. Kermas Energija, that already runs the Brodotrogir shipyard, was chosen as strategic partner in the HRK 180-302 million (EUR 24-40 million) recapitalisation. At mid-year, however, it seemed that Uljanik could enter bankruptcy proceedings and in September the EC returned the government's restructuring plan for revision. The total fiscal burden of Croatian shipyards’ rehabilitation and restructuring programmes is estimated at HRK 30 billion since 1992. Source: “Croatia’s shipyards: clock is ticking,” Financial Times, 2 May 2012; Ostojić (2015); Bajo et al. (2016); Bajo et al. (2018); European Commission (2018), “State aid: Commission clears rescue aid for Croatian shipbuilder Uljanik,” press release, 22 January 2018.

Trade in commercial services is in surplus While these data hint at the still unexploited potential of Croatia as a trading nation in merchandise, the situation is rosier in commercial services. The USD 9.6 billion surplus more than offset the merchandise trade deficit and is due in great part to the income generated by the tourism sector (which accounts for 76% of trade in commercial services, well above Slovenia at 36% and Serbia at 23%). In 2017, travel and tourism was estimated to directly contribute 10.9% of GDP and to support 10.1% of total employment (WTTC, 2018). Total international arrivals have grown fast, from USD 47.2 million in 2012 to USD 57.6 million in 2016, although there are numerous pending policy and business issues to ensure the sustainability of the current model (Box 3.2).

Participation in GVCs is modest Croatia’s relatively low openness level is also reflected in its TiVA (trade in value added) and GVC (global value chain) statistics (WTO, 2017). The comparison with Slovenia reveals that the foreign value added share of exports and the domestic value added sent to third countries are lower in Croatia, whereas the domestic value added sent to consumer economy is much higher. The GVC participation rate is correspondingly much lower – 34% of total gross exports, versus 59% in Slovenia: the difference is similar for backward and forward linkages. WTO data, however, only cover the period until 2011, before Croatia joined the EU. More recent analysis by Croatian National Bank suggests that Croatia’s integration in GVCs did not essentially change from 2000 until 2014 (Vidaković Peruško et al., 2018). The share of domestic value added in gross exports in 2014 was highest in the production of food, beverages and tobacco, pharmaceutical products (the only industry showing a significant increase since 2000), and computers and electronics. In line with previously mentioned evidence, results indicate that Croatia is strongly integrated in GVC trade only with a few trading partners (Germany, Italy, Austria and Slovenia).

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68 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES

Box 3.2. The role of tourism

In the years before the global financial crisis, Croatia’s imports grew more rapidly than its exports. A sharp trade adjustment process followed the bursting of the financial bubble and Croatia now has a persistent current account surplus to ensure the sustainability of the external liabilities it accrued in the previous decade. Exports of services (mainly tourism) are particularly important, while exports of goods and investment play only a secondary role. Croatia has an advantageous location and is endowed with natural beauty, making it an important tourist destination even in socialist times. In the past 20 years tourism has been on the rise, also pulled by pilgrimages to Medjugorje, one of the most renowned shrines to the Virgin Mary in the world, and the filming of a highly-broadcasted TV series, Game of Thrones, in Dubrovnik. In 2016, tourism employed 93 000 persons (7% of the overall workforce) and international tourists’ expenditure in Croatia amounts to almost 20% of GDP – by far the largest share in the EU. Nonetheless, a tourism strategy based on an evergrowing number of arrivals – without a fundamental diversification of the current offer – presents limitations. In addition, there is econometric evidence that a country’s dependence on tourism increases its vulnerability to exogenous shocks. Tourism policy should aim to broaden the offer of tourism services and move away from the current, highly seasonal pattern (“sea and sun” tourism model with stays concentrated in coastal areas in the summer months) in order to reduce congestion and environmental costs. To this end, the accommodation offer must be diversified away from relatively cheap structures (such as private vacation houses and camping grounds) and average tourist spending should be increased. This calls for renewed and coordinated efforts by policymakers at all government levels to address the existing shortcomings and support the development of the tourism sector in terms of scope and quality of the offer. Source: Orsini (2017); Orsini and Ostojić (2018); Tkalec (2017); and Zdravko et al. (2018).

Enterprise reform SOEs reform has lost momentum In line with other transition economies, in the 1990s and 2000s Croatia launched successive privatisation waves (Table 3.5). Major foreign direct investment deals included the purchase of 51% of Hrvatski Telekom by Deutsche Telekom, of 49.1% of INA by Hungary’s MOL, and the awarding of a 30-year concession for Zagreb International Airport to a consortium led by Aeroports de Paris. The ambition of the reform programme diminished after the crisis and nowadays there remain more than 1,100 SOEs, with the number in fact increasing over time (Bajo et al., 2018). Estimates differ regarding their economic weight. Based on Orbis data, Tabak and Zildzovic (2018) conclude that SOEs control assets equal to almost 80% of GDP and employ 73 000 workers, or 5% of the total workforce. A careful analysis of 2012 accounting documents reveals that 1 061 companies fully or predominantly owned by the state have assets worth over EUR 40 billion, generate more than EUR 10 billion in revenues and employ about 140 000 workers (Bajo and Primorac, 2016).3 These are, in general, higher figures than in Central Europe and closer to the situation prevailing in the Western Balkan countries – in

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Serbia, for instance, 166 SOEs (including some of the largest strategic companies) remain in the privatisation portfolio and employ 52 000 workers (EC, 2017a). Table 3.5. Waves of privatisation Period

Main features

1991-94 1994-98

Transformation of all companies in either joint stock or limited liability companies under the Conversion Act. Creation of the Croatian Privatisation Fund to control companies that had not been converted by the Act deadline (except for most of the flagship SOEs). Mass privatisation based on the free allocation of shares to certain categories of the population (war veterans, families of killed, imprisoned or missing Croatian soldiers and civilians, Croatian soldiers etc.). Consolidation of state assets in the Croatian Privatisation Fund under the Ministry of the Economy. Termination of the Croatian Privatisation Fund Establishment of the Agency for the Administration of Government Property (later renamed State Office for the Management of Government Property, DUUDI) Adoption of the Strategy for the Management of Government Assets and of the Law on the Management and Disposal of State-owned Assets. From 2014, annual plans for state-owned asset management. Transformation of DUUDI into the Ministry for State Assets. Creation of the Central State Assets Register and amendments to the Law on the Lease and Sale of Commercial Properties to enable more efficient management of state-owned properties.

19982000 2000-12 2012-

Source: OECD elaboration.

Among enterprises controlled and majority-owned by the state, 35 are considered “of special state interest” (and four more legal entities are not incorporated).4 The “Leviathan reach” is pervasive in public utilities and transportation, where SOEs accounted for 79% and 45% of the respective 2012-13 payrolls. The World Bank estimates that out of HRK 20.6 billion infrastructure investment in 2014, HRK 12 billion was carried out by SOEs (of which some are part of the general government coverage), while the remaining HRK 8.6 billion was shared among central and local governments (World Bank, 2016b). Table 3.6. The “Leviathan reach” in Croatia and its peers (government-held equity stake in parentheses) Sector Electricity Natural gas Oil Telecoms Water management Air transport Airport (capital)

Croatia Hrvatska elektroprivreda (HEP Group) (100%) INA (44.8%) Hrvatski Telekom (9.6%) * Croatian Waters (100%)

Railways

Croatia Airlines (97%) Zagreb Airport International Company (30-year concession since 2012) HŽ Putnicki prijevoz (100%)

Post office Fertilizers

Hrvatska pošta (100%) Petrokemija

Situation in Slovenia Elektro-Slovenija (ELES) (100%) Geoplin (54%) Petrol Group (38%) Telekom Slovenije (75%) 73 local utilities, of which 66 are state-owned Adria Airways (96%) Aerodrom Ljubljana (72%) Slovenske železnice (100%) Posta Slovenije (100%)

Serbia Elektropriveda Srbije (EPS) (100%) Srbijagas (100%) Naftna Industrija Srbije (NIS) (29.9%) Telekom Srbija (100%) Beogradvode, Vode Vojvodine, and Srbijavode (100%) Air Serbia (51%) Aerodrom Nikola Tesla Beograd (100%) SrbRail (100%) Pošta Srbije (100%) HIP Azotara (100%)

* refers to stakes held by the War Veterans’ Fund and the Restructuring and Sale Center. Source: Petkovšek and Pevcin (2017); Svetoslava and Riquelme (2013); and OECD elaborations.

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70 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES It can be argued that the institutional infrastructure for managing state-owned assets in the public interest is finally in place. The SOE portfolio that was until recently administered by the State Property Management Administration (DUUDI) has been transferred to the Ministry of State Assetsor the Restructuring and Sale Center (CERP) (390 companies, of which 29 are majority-owned by the central government).5 In August 2017, the government hired an adviser for restructuring INA (through the possible purchase of the remaining 49.08% stake held by MOL), as well as the potential coinciding sale of a 25% stake in the national utility HEP. In addition, the government has recently restarted the restructuring process of fertiliser producer Petrokemija, food company Podravka, electrical equipment producer Koncar, marina operator ACI, Croatia Banka and the port of Rijeka (see below). Nonetheless, operating and financial indicators paint a rather disturbing picture (Tabak and Zildzovic, 2018). Profitability, with an average return on assets (ROA) of 0.7% over 2012-14, is very low, although the six-year recession may have contributed to that to some extent. SOEs receive substantial subsidies that contribute to the high fiscal imbalances, while their transfers into the budget remain paltry (around 1% of GDP), despite the high value of state-owned assets. Some SOEs operate in competitive sectors, such mechanical engineering company Duro Daković, and it is unclear the logic of maintaining them in government hands. In sum, “no clear privatisation strategy is in place. This has resulted in companies being privatised only as a measure of last resort at times of severe financial distress or need for recapitalisation” (EC, 2019, p. 48). In line with the OECD Guidelines on Corporate Governance of State-Owned Enterprises (SOE Guidelines) and international experience, various steps should be taken to improve SOE governance and performance and, when appropriate, prepare companies for privatisation. In particular, greater consistency is needed with regard to ownership and control of state assets; more resources should be devoted to financial oversight; efforts should continue to make SOE boards more professional; public-private competition should be promoted; and regulators should be given enhanced powers (Bower, 2017). Some corresponding measures have been implemented following the adoption of the new Code of Corporate Governance in all majority SOEs. A new selection framework has been established to improve directors’ qualifications and to allow for private-sector candidate. As discussed in chapter 8, the SOE Guidelines also recommend that SOEs observe RBC standards and publicly disclose expectations established by the government in that regard, as well as mechanisms for their implementation. Implementing RBC principles and standards in SOEs contributes to enhancing SOE governance and performance while improving the quality of the overall business environment.

Developing SMEs capacity for greater internationalisation In Croatia like anywhere else, small and medium-sized enterprises (SMEs) are the backbone of the economy, in terms of number of enterprises, employment, turnover and exports. The recent dynamics of jobs creation and value added is also very favourable (European Commission 2017b). Productivity of SMEs, however, remains persistently low, and so is the ability of Croatian SMEs to internationalise through export and insertion in global value chains as suppliers to larger multinationals. Results from GEM (Global Entrepreneurship Monitor), the world’s largest study of entrepreneurship in which Croatia has been involved since 2002, suggests that one factor is the relative importance of different motivations for starting a business (CEPOR, 2016). In Croatia, there is an almost perfect balance between lack of other opportunities for employment (“necessity”) and recognising a business opportunity (“motivation”) – in fact

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the country has the lowest motivational index of all the EU countries involved in the GEM research, and a significantly higher necessity index than the EU average. This is a problem insofar as high values of the motivational index are a proxy of potentially better preparedness for starting a business venture and of greater optimism, which is based on recognised opportunity. Significant focus should be put on promoting entrepreneurship and strengthening entrepreneurial education at all levels. Another, and possibly complementary, factor is the very heavy regulatory burden and parafiscal charges on SMEs. The May 2017 introduction of a regulatory impact assessment pilot with SMEs to measure the burden of regulatory changes on doing business and the removal of the requirement to stamp all documents are meant to make starting a business less cumbersome (IMF, 2018). Innovative SMEs are still an exception, despite a generous tax break system and a reasonable infrastructure to support business R&D. Nonetheless, three Croatian companies are featured in the Financial Times 1000 list of the European “gazelles” – i.e. companies that have achieved the highest compound annual growth rate in revenue between 2013 and 2016 (Box 3.3). Box 3.3. Three Croatian gazelles: Rimac, Nanobit and Infinum

Rimac Automobili, founded in 2009 in a garage, produces electric hypercars, drivetrains and high-voltage and also develops digital interfaces between man and machine battery systems (HMI Development). Its first model, the Concept One, is known as the world’s fastest production electric vehicle (eight cars have been produced). Rimac’s subsidiary Greyp Bikes, which was founded in 2013, also develops and produces e-bikes. Rimac, ranked 144th fastest-growing company in Europe, had 2016 sales of EUR 5.9 million and 164 employees. A significant part of the early financing came from angel investors and proprietary patents’ sale. In April 2017, Camel of Shenzhen, Asia’s largest battery manufacturer, signed an agreement to invest EUR27 million in Rimac and EUR3 million in Greyp Bikes. In 2018, Porsche acquired a 10% equity stake in Rimac to develop a strategic partnership. The other two ‘gazelles’ operate in the ICT space. Zagreb-based Nanobit is a video game developer that is included among the top 200 most profitable developers on Apple store. It was created in 2008 and has opened two offices in Budapest and Bucharest. Nanobit had 2016 turnover of EUR 7.4 million and employed 67 persons. Infinum is a software company, based in Karlovac, specialised in iOS, Android and Web design. Since its establishment in 2005, it has opened subsidiaries in Slovenia and on both US coasts. Infinum had 2016 sales of EUR 2.7 million and 78 employees. A selected range of indicators point to the relative underdevelopment of Croatian financial markets relative to other emerging economies, although not with other countries in the former Yugoslavia (Table 3.7). Indeed, firms in Croatia identify access to finance as the second-severest obstacle to business operations. This is true in particular for small firms, i.e. those having fewer than 20 employees (World Bank and International Finance Corporation, 2014). Although the situation appears to have improved recently, with access to finance no longer the major obstacle to investment, at 13% the share of firms facing finance constraints is above the EU average (EIB, 2018). Reliance on internal financing sources remains high, including among small and innovative firms that face even greater difficulties to successfully tap into external financing as they lack the requested collaterals or they find the borrowing costs too expensive.

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72 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES Table 3.7. The financial sector in comparative perspective Croatia Bank deposits to GDP (%) Deposit money banks’ assets to GDP (%) Insurance company assets to GDP (%) Mutual funds’ assets to GDP (%) Pension fund assets to GDP (%) Stock market capitalisation to GDP (%) Credit to government and SOEs to GDP (%) Corporate bond issuance volume to GDP (‰) Remittance inflows to GDP (%)

2007 59.7 63.9 7.4 3.4 6.8 74.8 14.8 0.5 2.9

Slovenia 2016 63.9 60.5 11.4 6.3 25.6 39.6 28.3 5.2 4.5

2007 47 78.5 12.1 4 3.8 39.1 6.3 11.1 0.7

2016 54.6 65.3 17.1 6.1 7 12 17 7.1 0.8

Serbia 2007 31.5 35.9 3.1 0.2 48.6 1.6 7.2

2016 43.4 60.4 5.1 0.5 0.8 n.a. 18.7 4.5 8.7

Source: World Bank, WDI database, accessed 17 September 2018.

Croatia has a typical bank-based financial system, with credit institutions accounting for around 71% of financial sector assets at the end of 2016 (HNB financial accounts, Table T1). Bank assets declined to 106% of GDP in 2017 (from 110% in 2016) on the back of strong government deleveraging and accelerated non-performing loan (NPL) sales (EBF, 2018). The banking industry, which comprises 26 commercial banks and five savings banks, is highly concentrated – the top six banks hold roughly 80% of market share by assets – and open – 15 foreign-owned banks control 90% of assets (Table 3.8). There are seven other systemically important institutions (SIIs), while there are no global SIIs. Table 3.8. The banking sector in comparative perspective

Number of banks Assets Loans Deposits Capital & reserves Staff

Croatia 23 54 650 34 213 42 096 8 027 19 764

Serbia 29 28 425 15 320 16 717 5 615 23 342

Slovenia 18 40 407 27 819 30 598 4 849 9 844

Source: Croatia National Bank for Croatia (refers only to banks) and European Banking Federation (2018), Banking in Europe 2018 for Serbia and Slovenia.

The financial system is structurally sound, with moderate vulnerabilities stemming from the currency and interest rate structure of credit to the private sector and the high level of banking concentration (HNB, 2018). In 2015 the conversion of Swiss franc-indexed loans generated significant losses which were subsequently absorbed and bank profitability remained relatively high in following years. Only three banks are still state-owned (6% of total assets). In addition, the Croatian Bank for Reconstruction and Development (HBOR) was established in 1992 as the country’s development and export bank. HBOR is the national counterpart for the Investment Plan for Europe, also known as the Juncker Plan. Its bonds are rated by Moody’s Investors Service (Ba2) and Standard & Poor’s (BB+). However, following the bankruptcy of Agrokor (of which HBOR was one of the largest creditors), there have been calls to improve the oversight of the bank, so as to minimise the risks of financing politicallyconnected businesses. Yet-to-be-unveiled results from an Asset Quality Review will provide useful information in this regard.

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Mandatory pension funds established by the 1999 pension reform and insurance corporations together account for around 20% of financial sector assets (data for the end of 2014).6 Ongoing payments by second pillar members and still negligible payouts have generated a steady increase in assets of these intermediaries. Enterprises rarely raise capital through the stock market and instead tend to rely solely on the traditional banking system to meet their needs. Only 49 companies are listed on the three markets that compose the Zagreb Stock Exchange (ZSE), established in 1991.7 In 2015, ZSE acquired the Stock Exchange of Ljubljana, in Slovenia. ZSE is also a founder of SEE link, a project started with Bulgaria and the Republic of North Macedonia to integrate south-eastern Europe equities markets without merger or corporate integration, using only technology.

Labour markets and skills At the height of the post-2009 recession, in the 2013-14 biennium, unemployment in Croatia reached 17.3%. It has fallen ever since, and is projected to decrease further to 8.4% in 2019 (ILO, 2018). Nonetheless, so far, the rebound of economic growth has not led to a major employment increase. Low labour force participation is the main problem. It was 51.6% in 2017 (against 58.4% in Slovenia and 54% in Serbia) and as low as 45.6% for women. The share of youth not in employment, education or training (NEET) is also very high (15.4%) and so is the share of long-term unemployment in total unemployment (41.0%). As in the rest of the world, the quality of available jobs is a matter for concern: although new hiring on permanent contracts increased in 2017, the share of temporary contracts in total employment remains sizable (EC, 2018). A high share of people are considered at-risk-of poverty or social exclusion, particularly among some vulnerable groups such as the disabled and the elderly. Aging and negative net migration flows are other forces acting. The combined rate of unemployment and potential labour force – i.e. the sum of persons in unemployment and potential labour force divided by the extended labour force – is quite high and shows that the degree of labour underutilisation is consistently above the level suggested by the unemployment rate (ILO, 2018). As the recovery strengthens and unemployment levels fall, there is considerable scope for targeted policy actions aimed at strengthening labour market participation of large sways of society, especially discouraged workers and women with family responsibilities. In 2013 and 2014, two labour market reforms facilitated the use of fixed-term contracts and flexible types of work (distance work, part-time work, seasonal work and agency work) and reduced firing costs. As noted in chapter 8 of this Review, facilitating access to the labour market by women and minorities, and pursuing efforts in the field of equal opportunities could also contribute to greater labour market participation. Implementation of RBC principles and standards by businesses could help in that regard. Unfortunately, “active labour market policy measures for low-skilled and long-term unemployed remain largely underutilised” (EC, 2018, p. 1). The overall underdevelopment of social dialogue between the government and the social partners is one complicating factor. Trade union density is relatively high (25.8%), but representation is fragmented. There may be considerable value in reinforcing the National Economic and Social Council (Gospodarsko-socijalno vijeće, GSV) and enhancing the interaction between authorities and stakeholders behind the often formalistic provision of written feedback on some of the government-proposed measures.

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74 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES Croatia, like many countries in Central and Eastern Europe, has seen educational attainment – such as years of education and level of education completed – expand since the start of the political and economic transition. The level of educational attainment, however, is not necessarily a proxy for measuring actual skills, as proven by performance in international student assessments that measure cognitive skills, such as PISA. Scores reveal that Croatian youth accumulate poor cognitive foundation skills, which leaves them ill-equipped for the demands of a competitive, innovation-driven economy. The gap is the widest in mathematics, where 15-year-olds in Croatia score 464 points compared to an average of 490 points in OECD countries. But it is disturbingly large also in science literacy, the main topic of PISA 2015 (475 points compared to 493), and in reading (487 points compared to 493). At the same time, there are wide variations in education outcomes, high NEET rates among youth, and the share of workers participating in lifelong learning activities is one of the lowest in the EU. Despite recent education reforms, the World Bank recommends to place increasing emphasis on improving the quality of general education, lifelong learning programs, and adult education to ensure a competitive and adaptive workforce (World Bank, 2016b). The brain drain, i.e. the departure of highly-skilled nationals, is another problem plaguing Croatia. In fact, while overall outward migration flows have decreased from the very high levels of the 1990s and the 2000s, the share of the highly-skilled among Croatians migrating to 20 OECD countries has increased from 16% in 2000 to 26% in 2010 (IAB Brain Drain Data figures cited in Fabritz and Falck, 2016). Table 3.9. Croatian education at a comparative glance Educational attainment *

Croatia Slovenia Visegrad EU ***

2006 N/A 82 85 69

2016

Total spending on educational institutions 2005

94 94 92 85

2014 4.0 ** 5.3 3.4 4.7

4.7 4.6 3.2 4.8

Student performance (PISA 2015) Reading Mathematics Science 2006 477 494 485 n.a.

2015 487 505 479 n.a.

2006 467 504 497 n.a.

2015 464 510 487 n.a.

2006 477 494 485 n.a.

2015 487 505 479 n.a.

* percentage among 25-34 year-olds with at least upper secondary or post-secondary non-tertiary education ** 2007 *** EU 19 for 2006 and EU22 for 2016 Source: OECD (2006 and 2015), Program for International Student Assessment (PISA), Reading, Mathematics and Science Assessments; EC (2017), Education and Training Monitor 2017: Croatia.

The innovation system As the OECD noted in 2014, “Croatia does not yet have a mature innovation system with a core of highly innovative businesses as a driver” (OECD, 2014). According to the European Innovation Scoreboard 2018, Croatia is a Moderate Innovator, with its performance deteriorating relative to that of the EU. While no summary metrics is sufficient to gauge the state of a nation’s innovation efforts and performance, some indicators provide useful information to policy-makers and should raise their attention to weak spots. As far as R&D spending as percentage of GDP is concerned, Croatia has the eighth-lowest level in the EU, one of ten countries with intensity below 1% (Table 3.9). Despite an increase in R&D intensity from 0.74% in 2006 to 0.84% in 2016, the distance from the EU average has widened (from -1.02% to -1.19%). In fact, Croatia has recorded the tenthsmallest improvement in this indicator among the EU countries (and this includes Sweden OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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and Finland that have experienced a fall from levels well above 3% in 2006). The composition of R&D spending remains relatively unusual in comparison with the rest of the EU (but also Slovenia and the four Visegrad countries), in that the business sector contributes for a much lower level of the total outlays. Croatia BERD has continually underperformed both the EU28 average and Slovenia. Correspondingly, the contribution of government and higher education institutions is unusually high. The OECD Guidelines for Multinational Enterprises contain recommendations that aim to promote the diffusion by businesses of the fruits of research and development activities among the countries in which they operate. Businesses are notably encouraged to perform science and technology development work, develop ties with local universities, public research institutions, and participate in cooperative projects with local industry or industry associations. The Government has an opportunity to leverage the Guidelines to involve businesses in the development of innovative capacities through implementation of RBC principles and standards. Table 3.10. R&D spending – Croatia in comparative perspective R&D intensity (R&D spending as % of GDP)

Croatia Slovenia Visegrad EU

R&D spending by performing sector Business

Government

Higher education

Private non-profit

2006

2016

2006

2016

2006

2016

2006

2016

2006

2016

0.74 1.53 0.81 1.76

0.84 2.00 1.16 2.03

37 60 46 63

45 76 63 65

27 25 29 13

22 13 14 11

37 15 25 22

33 11 23 23

0 0 0 1

0 0 0 1

Source: Eurostat (2017), “R&D expenditure in the EU remained stable in 2016 at just over 2% of GDP”, newsrelease, No. 183/2017.

Table 3.11. Innovation performance – Croatia in comparative perspective Applications Patent Croatia Slovenia Serbia

Trademark

2006 183 228

2015 186 481

2006 2 091 1 606

2015 2 905 1 179

..

191

1 022

6 024

Industrial design 2006 2015 .. 281 .. 62 ..

335

Share of innovative enterprises 2008 44.2 50.3

Number of FT Europe 1000 fastest-growing companies

2014 39.7 45.9

51.7 **

2017 3 0 n.a.

* 2010 ** 2011 Source: ec.europa.eu/eurostat/web/science-technology-innovation/data/database.

Innovation performance relative to the EU, as measured by the EU Innovation Scoreboard, reached a peak of 59% in 2009 and dropped to less than 56% in 2013. Croatia is performing below the EU average in most dimensions, except human resources (due to above average performance in new doctorate graduates and youth with upper secondary level education). Overall, Croatia has shown a more encouraging performance in scientific publishing, in particular in science & engineering: the number of articles has grown by 30% in the 200616 period, slightly more than for EU28 (28%), although less than for Slovenia (42%) and Serbia (78%) (National Science Board, 2018, Appendix table 5-27).

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76 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES Lack of innovation within SMEs is a main explanatory factor of the disappointing aggregate features. The R&D intensity of small firms in Croatia is at 0.34% (16th place in the EU) and the one of medium-sized firms stands at a substandard 0.16% (21st place in the EU). In fact, business investment in R&D is concentrated within a few multinational companies, almost exclusively from Europe, which appear to also have relatively high research intensity (1.98%) (EC, 2017c). Leading MNEs from developed countries play an important role in transferring the most advanced and new technologies to emerging or developing countries. Empirical analyses of technology transfer from MNEs to Croatian firms and of the feedback loop on domestic firm performance are still scarce. The most recent one, based on a sample of 145 firms, suggest that the innovation activities in subsidiaries have a positive influence toward technology transfer from multinational corporations (Cho et al., 2017).

The state of infrastructures As a new state in the late 1990s, Croatia invested in the development of key physical infrastructure as a fundamental element of national integration. This effort was particularly important in road transport, with the length of the highway network more than doubling between 1996 (394 kms) and 2004 (943 kms) and reaching 1,251 kms in 2012. The quality of the roads is indeed acknowledged by the Global Competitiveness Report (WEF, 2017, index 2.02). Nonetheless, Croatia still suffers from a poor state of infrastructure, as revealed by its 46th position in the 2018 World Bank global ranking, the sixth-lowest among EU 28 members. Unfortunately, its relative performance in international shipments and logistics competence is even worse, resulting in a disappointing 49th LPI ranking, the fourth-lowest in Europe. Moreover, the three major state-owned road and motorway companies – HAC (Croatian Motorways), ARZ (Rijeka-Zagreb Motorway), and BINA-ISTRA – amassed significant debt, most of which of maturity shorter than five years.8 By 2014, their debt was consolidated into the general government debt. These liabilities amounted to approximately 11% of GDP in 2015, and could not be supported by the revenue generated by the companies. The combined outstanding debt of public road companies at the end of 2016 was the equivalent of EUR 5.2 billion. As most infrastructure investment has gone into roads, there is also a huge gap in railways quality (WEF, 2017, index 2.02). The bulk of the network is composed of single-track, nonelectrified ways (Bajo and Primorac, 2017). In terms of extension, there are insufficient East-West connections. In terms of speed, as President Kolinda Grabar-Kitarović recently observed, traveling by train from Vienna to Zagreb today takes just as long as it did under the Austro-Hungarian Empire.9 Similarly, it takes six hours to go by train from Zagreb to Split (400 kms), almost twice as many as by car. In terms of inter-modality, the lack of freight capacity stymies the potential of building up the seaport infrastructure to attract big vessels. In the meanwhile, the railroad share of passenger and cargo traffic is constantly eroding. The Digital Economy and Society Index (DESI) is a composite index that summarises some 30 relevant indicators on Europe’s digital performance. Croatia is ranked 22nd, with a good performance along two dimensions (Use of Internet and Integration of Digital Technology) and a gap in the other three (Connectivity. Human Capital, and Digital Public Services). As the Commission makes clear in the Digital Progress Report (EC, 2017d), Croatia scores below the EU average in terms of fixed broadband network coverage (especially in rural areas), of next generation access (NGA) network coverage (> 30Mbps) and of 4G coverage.

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Mobile operators do not use the 900 and 2100 MHz bands for long-term evolution (LTE). Moreover, Croatia has the most expensive standalone fixed broadband subscription in the EU: it costs 2.9% of the average gross income, compared to the EU average of 1.2%. These figures are consistent with the market configuration of fixed broadband, which sees the incumbent’s share significantly above the EU average (49% compared to 40.7%). Ramping up investment in Croatia’s infrastructure networks is therefore crucial, not only to sustain robust rates of economic growth and integrate more fully the country into regional and global value chains but also to ensure greater social inclusion. As the economy continues to grow, donor-financing will likely decline, underlining the need to mobilise domestic and public and private resources as well as attracting foreign capital for infrastructure investment. So far, private involvement in infrastructure has been rather limited, confined to the strategic partnership signed in 2011 between Luka Rijeka (operator of the Port of Rijeka) and International Container Terminal Services Inc. (ICTSI) and the 30-year concession for Zagreb International Airport.10 ICTSI, a global port management company with headquarters in the Philippines, acquired a 51% share in the Adriatic Gate Container Terminal (Jadranska vrata) which holds a concession until 2041. Annual capacity has been increased to 600 000 TEUs and the objective is to make Adriatic Gate Container Terminal the largest in the Adriatic. The Port of Rijeka development master plan specifies further expansion of port facilities by 2030, including the construction of a large container terminal in Omišalj on Krk Island, which would increase capacity by 2.5 million TEUs, and requires construction of a high-performance railway to Zagreb. For Croatia to attract more private investment to infrastructure, it is necessary to clarify national regulations and guidelines, improve project screening, use formalized appraisal tools, and promote independent reviews (World Bank, 2016a). Gaps must also be filled in terms of formalising the requirements for project management and monitoring, especially for state budget funded projects. The government has developed a comprehensive regulation on Public Private Partnerships (PPP), while as of July 2018 the so-called Juncker plan, under the European Fund for Strategic Investments (EFSI), had backed six infrastructure and innovation projects, for approximately EUR 123 million in total financing set to trigger EUR 548 million in total investment. The investments required to improve Croatia’s infrastructures is also an opportunity for the government to promote quality infrastructure investment projects which can have direct positive impacts on Croatia’s economy and society, including higher economic efficiency, increased safety, decreased environmental impact, more effective delivery of public goods and services, and improved well-being of the local population. Certain infrastructure projects may have negative impacts, which can range from conflicts with communities over land, water, and resettlement, to unsafe working conditions during construction or significant environmental (including climate change) impacts during operation. In line with the Guidelines for Multinational Enterprises, enterprises should conduct due diligence with a view to identify, prevent, mitigate and account for how they address their actual and potential adverse impacts. The OECD Due Diligence Guidance for Responsible Business Conduct provides practical support to enterprises on the implementation of the Guidelines by providing explanations of its due diligence recommendations. In addition, the Policy Framework for Investment and the Principles for Private Sector Participation in Infrastructure (OECD, 2007) encourage governments to clearly communicate responsible business conduct expectations to their private partners.

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Box 3.4. Chinese investments in Croatia

The Republic of Croatia and the People’s Republic of China have concluded no fewer than 55 bilateral acts since establishing diplomatic relations on 13 May 1994. The pace of political cooperation has accelerated recently, also in the broader context of the so-called 16+1 initiative of annual high-level meetings between China and countries in CentralEastern Europe and the Balkans. Three acts were signed in 2016, five in 2017 and two in the first half of 2018. Of particular pertinence are the 2016 Memorandum of Understanding (MOU) on Port and Harbour Industrial Park Cooperation and the 2017 MOU on cooperation within the framework of the Silk Road Economic Belt and the 21st Century Maritime Silk Road Initiative. The most important Chinese investment project so far is the Pelješac Bridge which connects the mainland with Croatia‘s southernmost region, the Dubrovnik–Neretva County, thereby ensuring territorial continuity and avoiding crossing Bosnia and Herzegovina at the Neum Corridor. Construction of the 2,404 metres-long bridge started in 2007 and was halted in 2012, amid political controversies and financial difficulties. In 2017, the European Commission agreed to earmark EUR 357 million, equal to 85% of the total construction costs, from EU Cohesion Policy grants. Three international contractors submitted proposals and in January 2018 state-owned China Road and Bridge Corporation (CRBC) was selected, on account of offering the lowest price (HRK 2.08 billion, compared to HRK 2.55 billion for the next bidder) and committing to complete the project six months faster than required. Construction works were officially launched in July 2018. The deal has raised eyebrows in various circles. The defeated consortia submitted two appeals against the decision, at the DKOM (State Commission for Supervision of Public Procurement Procedures) and the Zagreb Administrative Court, which were both rejected. Bosnian authorities have reiterated concerns that the bridge would impede, or at least worsen, the country’s access to the Adriatic. Another area of bilateral cooperation is tourism, as Croatia expects 220 000 visitors from China in 2018. Chinese investors are primarily interested in health and medical tourism and USD 36 million have been committed to modernise Krapinske Toplice, the Northern spa town. There are also still unconfirmed rumours that a Chinese company (Jiangxiong Hua) may buy a stake in the Port of Zadar (Luka Zadar) and other Chinese firms lease a freight terminal in the Port of Rijeka. At the seventh 16+1 meeting in Sofia in 2018, Premier Li Keqiang and Prime Minister Andrej Plenković also agreed to support the participation of small and medium-sized enterprises in projects within both countries. Croatia hosted the 2019 meeting in April.

Outlook and policy recommendations Sixteen year after applying for EU membership and six years after entering as the 28th member, Croatia faces a complex outlook. On the one hand, having access to the world’s largest trading bloc opens up new and promising opportunities to firms and people, as Europe continues its economic integration journey, both within its borders and vis-à-vis the rest of the world. On the other hand, there are serious headwinds in the global economy that militate against small emerging economies – from protectionism to exchange rate tensions and financial volatility, to say nothing of the challenges of the digitalisation of production and the untamed emergence of new corporate Titans. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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In order to overcome such considerable challenges and kick-start a process of inclusive growth, Croatia has to activate many specific policies while maintaining appropriate policy coherence. Two interrelated priorities seem clear. It is necessary to enhance and improve investment in infrastructures, be they tangible like railroads and broadband, or intangible like education, training and R&D. Outcomes on this front will depend on the quality of the business environment, and from this viewpoint there is considerable scope for improvement by reducing the anti-competitive reach of widespread state presence in the economy (see Chapter 7), relieving the administrative burden (Chapter 6), reducing parafiscal charges (Chapter 6) and backlogs in the judicial system (Chapter 5).

Notes 1

See https://atlas.media.mit.edu/en/rankings/country/eci/.

2

See www.total-croatia-news.com/business/20417-new-companies-enter-the-ranks-of-croatia-topexporters, accessed 25 July 2018. 3

See, however, www.ebrd.com/cs/Satellite?c=Content&cid=1395254574766&d=Mobile&pagename=EBRD%2F Content%2FContentLayout: “according to European Commission estimates employment in stateowned enterprises represents 12% of overall employment”. Still another source refers to “more than eighty thousand staff employed by public enterprises”, equivalent to 5% of total employment (World Bank, 2016a). 4

See Official Gazette No 2/2018 for the list of companies “of special interest” or “of strategic interest”, and ibid. No 71/2018, for the list of companies “of special interest”. 5

The June 2018 Law on State Property Management has assigned management of the Central State Assets Register to the Central Office for the Development of a Digital Society. 6

Three pillars make up the Croatian pension system: the public part (first pillar – intergenerational solidarity), the second pillar of individual capitalised savings, and the third pillar of voluntary capitalised savings. 7

The first exchange of the Habsburg Monarchy was established in Rijeka for the purpose of trading in different sorts of sugar sold by the Rijeka refinery between 1750 and 1803. 8

A fourth operator is AZM (Zagreb-Macelj Motorway), where Pyhrn Concession Holding GmbH has 51% of shares alongside the government. 9

See https://glashrvatske.hrt.hr/en/news/economy/croatian-austrian-business-forum-focuses-onrailway-infrastructure. In reality the journey takes 7 hours and 40 minutes nowadays (although with four changes), while in June 1918 it took 12 hours and 10 minutes, with one change. 10

The concession contract involves a total investment of around EUR 324 million: EUR 236 million for the design and construction of the new terminal (inaugurated in 2017) and EUR 88 million for operating the airport infrastructure.

References Aprahamian, A. and P. Guilherme Correa (eds.) (2015), Smart Specialisation in Croatia: Inputs from Trade, Innovation, and Productivity Analysis, World Bank. Bajo, A., M. Primorac, and M. Hanich (2018), “The Financial Performance, Restructuring and Privatisation of the Shipyards in the Republic of Croatia,” CIRIEC, Working Paper, No. 2018/02. Bajo, A., M. Primorac, and L. Zuber (2018), “Financial performance of state-owned enterprises,” Institute of Public Finance, FISCUS, No. 5.

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80 │ 3. CROATIA’S COMPETITIVENESS: CHALLENGES AND OPPORTUNITIES Bajo, A. and M. Primorac (2017), “Restructuring the railway companies owned by the Republic of Croatia,” Institute of Public Finance, FISCUS, No. 4. Bajo, A. and M. Primorac (2016), “Financial performance of major public enterprises in Croatia from 2006 to 2014,” Economia pubblica, No. 3. Bajo, A., M. Primorac, and M. Hanich (2016), “The restructuring and privatisation of the shipyards in Croatia,” Institute of Public Finance, FISCUS, No. 2. Böwer, U. (2017), “State-Owned Enterprises in Emerging Europe: The Good, the Bad, and the Ugly,” IMF Working Paper, No. 17/221. CEPOR (2016), Small and Medium Enterprises Report − Croatia 2016, SMEs and Entrepreneurship Policy Center. Cho, Y., T. U. Daim, and M. Dabic (2017), “Investigating the effects of foreign direct investment (FDI) on Croatian business,” The Journal of High Technology Management Research, Vol. 28, No. 2, https://doi.org/10.1016/j.hitech.2017.10.005. EBF (2018), Banking in Europe; the 2018 Facts & Figures, European Banking Federation. EIB (2018), EIB Group Survey on Investment and Investment Finance, European Investment Bank. European Commission (2019), “Country Report Croatia 2019 – Including an In-Depth Review on the prevention and correction of macroeconomic imbalances”, Staff Working Document, SWD(2019) 1010 final, European Commission, Brussels. European Commission (2018), 2018 European Semester: Country Report – Croatia, European Commission, Brussels. European Commission (2017a), “Economic Reform Programmes of Albania, The former Yugoslav Republic of Macedonia, Montenegro, Serbia, Turkey, Bosnia and Herzegovina and Kosovo: The Commission’s Overview and Country Assessments,” Institutional Paper, No. 55, European Commission, Brussels. European Commission (2017b), SME Performance Review, European Commission, Brussels. European Commission (2017c), Internationalisation of business investments in R&D and analysis of their economic impact (BERD Flows), Ref. OJ 2010/S 172-262618, European Commission, Directorate-General for Research and Innovation, Brussels. European Commission (2017d), Europe’s Digital Progress Report, European Commission, Brussels. Fabritz, N. and O. Falck (2016), “Innovation Policy for Croatia,” CESifo Forum, No. 1/2016. HNB (2018), Financial Stability, No. 19, Croatian National Bank, Zagreb. ILO (2018), World Employment and Social Outlook: Trends 2018. IMF (2018), Republic of Croatia: Staff Report for the Article IV Consultation. Krugman, P. (1994), “Competitiveness: A Dangerous Obsession,” Foreign Affairs, March/April, Vol. 73, No. 2. National Science Board (2018), Science & Engineering Indicators 2018, Appendix Table 5-27. OECD (2014), OECD Reviews of Innovation Policy: Croatia 2013, OECD Reviews of Innovation Policy, OECD Publishing, Paris, https://doi.org/10.1787/9789264204362-en. OECD (2007), OECD Principles for Private Sector Participation in Infrastructure, OECD Publishing, Paris, https://doi.org/10.1787/9789264034105-en.

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Orsini, K. and V. Ostojić (2018), “Croatia’s Tourism Industry: Beyond the Sun and Sea”, Economic Brief, No. 36, European Commission, Directorate-General for Economic and Financial Affairs, Brussels. Orsini, K. (2017), “What drives Croatia’s high import dependence?”, Economic Brief, No. 29, European Commission, Directorate-General for Economic and Financial Affairs, Brussels. Ostojić, S. (2015), Restructuring process overview Croatian shipbuilding, presented at the OECD Working Party on Shipbuilding (WP6), 9 November. Petkovšek, V. and P. Pevcin (2017), “The Effects of the Public-Private Partnership Act on the Slovenian Public Utilities Providers,” International Public Administration Review, Vol. 15, Nos. 3-4. Svetoslava, G. and D. M. Riquelme (2013), “Slovenia: State-Owned and State-Controlled Enterprises,” ECFIN Country Focus, No. 3. Tabak, P. and E. Zildzovic (2018), “Croatia: Background study on state-owned enterprises,” EBRD. Tkalec, M., I. Zilic and V. Recher (2017), “The effect of film industry on tourism: Game of Thrones and Dubrovnik,” International Journal of Tourism Research, Vol. 19, No. 6. Vidaković Peruško, I., K. Kovač, and M. Jošić (2018), “Croatia in Global Value Chains,” Surveys, No. 32, Croatian National Bank, Zagreb. World Economic Forum (WEF) (2017), Global Competitiveness Report 2017-2018, World Economic Forum. World Bank (2016a), “Restoring Stability, Reviving Growth and Creating Jobs,” Croatia Policy Notes 2016 World Bank (2016b), “Restoring macroeconomic Stability, Competitiveness and Inclusion,” Croatia Policy Note 2016. World Bank and International Finance Corporation (2014), Enterprise Surveys: Croatia 2013. WTO (2017), Trade in Value-Added and Global Value Chains profiles, World Trade Organisation, Geneva, www.wto.org/english/res_e/statis_e/miwi_e/all_Profiles_e.pdf. WTTC (2018), Travel & Tourism Economic Impact 2018: Croatia, World Travel & Tourism Council. Zdravko, Š., J. Gržinić, and M. Sučić Čevra (2017), “The tourism and travel industry and its effect on the Great Recession: A multilevel survival analysis,” Zb. rad. Ekon. fak. Rij., Vol. 35, No. 2.

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Chapter 4. Croatia’s regulatory framework for investment and national treatment

This chapter provides an overview of the regulatory framework for starting and expanding a business in Croatia and reviews existing regulatory restrictions to foreign direct investment. It looks at the conditions Croatia imposes on the entry of foreign investors and the extent it provides them national treatment once they are established. The chapter also benchmarks the openness to foreign investment, an area where Croatia far exceeds many of its competitors.

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84 │ 4. CROATIA’S REGULATORY FRAMEWORK FOR INVESTMENT AND NATIONAL TREATMENT Croatia has long acknowledged the long-term benefits of an open and non-discriminatory international investment environment. Investment is a critical condition to spur growth and sustainable development. While domestic firms typically undertake the bulk of investments, international investors can sometimes bring important complementarities. Beyond bringing additional capital to a host economy, evidence suggests that foreign direct investment (FDI) can help to improve resource allocation and production capabilities, act as a conduit for the local diffusion of technological and managerial expertise, and provide improved access to international markets (Moran, Graham, and Blomström, 2005). A country’s attractiveness to foreign direct investment (FDI) depends on a large range of determinants, some of which are exogenous to government control, such as geography and economic size. Unlike these, the openness to foreign investment is an area which governments can shape. Two policy areas have a direct bearing on an economy’s openness to FDI, namely the conditions it imposes on the entry of foreign investors and the extent to which they are discriminated once established. Both policies have been shown to be a significant determinant of the attractiveness of countries to FDI (Fournier, 2015; Mistura and Roulet, forthcoming; Nicoletti et al., 2003), and, consequently, of the potential effects foreign investments can have on the host economy (OECD, 2018; OECD, 2015). Partly due to their relevance in shaping the operating environment for international investors, market access conditions and the extent of discrimination against foreign-owned established investors typically lie at the heart of key international regulatory frameworks on investment. At the OECD, these policies are, respectively, the objective of two internationallyrecognised instruments, namely the Code of Liberalisation of Capital Movements1, and the National Treatment instrument (Box 4.1), which is part of the OECD Declaration on International Investment and Multinational Enterprises. Parties to these instruments are encouraged to uphold the principle of non-discrimination at entry (between residents and non-residents, and across the latter) and thereafter (between nationals and foreigners) as a way of creating an enabling environment for foreign direct investment, and to be transparent about any departures from such principle. Any candidate for adherence to the Declaration is encouraged to voluntarily commit to providing national treatment to foreign investors in its territory – i.e. to treat enterprises operating on its territory, but controlled by the nationals of other adhering countries, no less favourably than domestic enterprises in like situations.2 It is also encouraged not to backtrack in relation to existing measures consisting exceptions to the national treatment. For transparency reasons, any candidate is also required to report a list of any existing exceptions to national treatment during the adherence process. Likewise, it is required to report other measures that may not constitute exceptions to national treatment, but that are important determinants of policies in the context of national treatment, such as measures on corporate organisation or related national security. Drawing from the above frameworks, this chapter examines the openness of Croatia’s investment regime against these two sets of policies: barriers to entry and exceptions to national treatment. In view of Croatia’s application to adhere to the Declaration, this chapter also reports the list of exceptions to national treatment and measures reported for transparency notified by Croatia to the OECD. Lastly, it benchmarks the openness of Croatia’s FDI regulatory regime against OECD and various other emerging economies through the OECD FDI Regulatory Restrictiveness Index (Box 4.2).

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Box 4.1. The OECD National Treatment instrument for foreign-controlled enterprises

National treatment is the commitment by an Adherent to the Declaration on International Investment and Multinational Enterprises to treat enterprises operating on its territory, but controlled by the nationals of another country, directly or indirectly, no less favourably than domestic enterprises in like circumstances. The term "operating in its territory" in the instrument conveys the idea of doing business from a place of business in the host country, as distinct from conducting business in the country from abroad. This recognises that adhering countries' practices differ regarding recognised forms of business but that the main forms of doing business are through locally incorporated subsidiaries and branches. The principle of national treatment applies regardless of the home country's treatment of enterprises from the host country (OECD, 2005). The National Treatment instrument consists of two elements: a declaration of principle, which forms part of the Declaration, and a procedural OECD Council Decision which obliges Adherents to notify their exceptions to national treatment and establishes followup procedures to deal with such exceptions. The Decision comprises an annex that lists exceptions to national treatment, as notified by each Adherent and accepted by the OECD Council. The Investment Committee periodically examines the exceptions. Only measures concerning legal entities are reported for the purpose of the National Treatment instrument, and thus any measure that may apply to natural persons is not reflected in the list contained in the annex to the Council’s decision. To ensure transparency, Adherents to the Declaration also undertake to report any measures that, while not representing exceptions to national treatment, have an impact on it. The lists of these exceptions and measures are published and regularly updated. There are featured in Annexes A and B to the present Review.

Croatia is open to foreign direct investment Croatia is an open economy to foreign investment, and market participants benefit from high standards of protection. As discussed in greater detail in the next Chapter, the 1990 Constitution requires the state to ensure equal legal status to all entrepreneurs. It also assures that all rights acquired through the investment of capital cannot be restricted by law or any other legal act. Foreign investors are also guaranteed the right to free transfer and repatriation of profit and invested capital. In addition, there are no laws aimed particularly at foreign investors, which reduces the risk of inconsistent and discriminatory treatment between foreign and domestic investors. The Companies Act, which regulates the establishment and operation of businesses in Croatia, provides for equal treatment between domestic and foreign-owned enterprises established in Croatia. Accordingly, a foreign investor may establish or participate in establishing a company and may acquire rights and/or commitments as for any domestic investor. Foreign investors, headquartered or with residence in a non-WTO member country, however, are subject to a reciprocity condition for engaging in business activities in Croatia directly or through a branch in the territory. Nonetheless, this condition can be circumvented by the incorporation of a company in Croatia. The establishment of a business entity by foreign investors is carried out as per regulations for domestic investors. The establishment of a subsidiary or branch office is made upon registration with the

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86 │ 4. CROATIA’S REGULATORY FRAMEWORK FOR INVESTMENT AND NATIONAL TREATMENT Croatian Commercial Court, while representative offices are registered with the Ministry of Economy, Entrepreneurship and Crafts. As such, foreign investors are generally treated without discrimination. There is no general investment screening mechanism for inbound FDI, and there are only a few regulatory restrictions preventing the entry and participation of foreign investors in economic activities in Croatia. These measures are typically limited in scope. They mainly consist of conditions on the entry of foreign investors (e.g. local incorporation requirement and reciprocity condition for the establishment of a branch) in a few specific sectors, as well as foreign ownership restrictions in few other ones (e.g. in legal services, freshwater fisheries and air transport). They also apply almost exclusively to investors from outside the European Union or the European Economic Area (EU/EEA). According to the authorities, the acquis communautaire has been transposed into Croatia’s legal system, resulting in the elimination of most national-based restrictions on foreign investment in commercial sectors and most public sectors for nationals and legal entities incorporated in the European Union. Investors from outside the EU/EEA and their branches in the territory of Croatia remain constrained in their ability to acquire real estate in Croatia, be it for business purposes or as real estate investments. They can acquire ownership rights over real property only on the condition of reciprocity and upon approval by the Minister of Justice. Otherwise, they may lease land on a long-term basis. There are, however, no impediments to the acquisition of real estate if carried out through an enterprise incorporated in Croatia, with the exception of agricultural land and properties located in areas legally declared as restricted to foreign investors in view of protecting the interests and safety of the Republic of Croatia. All these measures are discussed in further detail below. Box 4.2. The OECD FDI Regulatory Restrictiveness Index

The Index focuses on four types of measures: foreign equity restrictions, discriminatory foreign investment screening and approval requirements, restrictions on the employment of foreign key personnel, and other operational restrictions (such as limits on purchase of land or on repatriation of profits and capital). The extent of discrimination between foreign and domestic private investors is the central criterion to decide whether a measure should be scored. Nevertheless, non-discriminatory measures are also covered when they are considered more burdensome for foreign investors, such as rules regarding the nationality of board of directors. The Index covers 22 sectors, almost all sectors of the economy except health and education. The economy-wide index is obtained by averaging the scores for all 22 sectors. Scores range from 0 (open) to 1 (closed). The scoring methodology is inspired by the seminal work of Hardin and Holmes (1997) based on expert judgement. Foreign equity restrictions are given a higher score, followed by discriminatory screening measures. Restrictions on foreign key personnel and other measures receive relatively lower scores. Scores reflect the sum of scores under each policy dimension, capped at one. For further details on the scoring methodology, please refer to Kalinova et al. (2010). The Index is based on statutory measures as reflected in OECD instruments or identified in OECD Investment Policy Reviews and yearly monitoring reports. The use of country positions under the OECD Code of Liberalisation of Capital Movements and the OECD National Treatment instrument, as well as the comprehensive discussion of countries’ discriminatory measures undertaken in the Investment Policy Reviews ensure the appropriate identification of measures and allows for a great deal of consistency in their interpretation. The Index is

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updated on a yearly basis, based on the Secretariat’s monitoring of investment policy changes in all OECD members, G20 economies and adherent countries to the OECD Declaration on International Investment and Multinational Enterprise, which is undertaken in the context of Freedom of Investment Roundtable and is extended for the purposes of the Index to all countries covered. Adherents to the Declaration are also formally required to notify the OECD in case of changes to regulations affecting foreign investment, which facilitates keeping track of reforms for the purposes of the Index. This allows the Index to be used to track the progress of liberalisation over time. Actual implementation of statutory restrictions, which is difficult to assess, is not factored into the scoring. Although important, other aspects of the regulatory framework, such as the nature of corporate governance, the extent of state ownership, and institutional or informal restrictions which may also impinge on the FDI climate, are not incorporated. Source : Kalinova, Palerm and Thomsen (2010).

The openness of Croatia’s investment regime is attested by its position under the OECD FDI Regulatory Restrictiveness Index. The extent of discrimination against foreign investors observed in Croatia’s regulations is lower than for most of the 73 countries benchmarked under the Index (Figure 4.1). Croatia compares favourably against both the OECD and non-OECD averages in this respect, and against the average of non-OECD Adherents to the Declaration. Its level of restrictiveness is at par with the average of the 25 EU member states covered by the Index, and is about 60% lower than the average of adherents to the Declaration. Figure 4.1. OECD FDI Regulatory Restrictiveness Index, 2017 0.45

OECD FDI Regulatory Restrictiveness Index (open=0; closed=1)

0.40 0.35 0.30 0.25 0.20 0.15

NON-OECD average

0.10

OECD average

0.00

Philip pin es Saudi Arabia China Indonesia Malaysia Jordan New Zealand India Lao Pdr Mexico Russia Myanmar Tunisia Iceland Canada Australia Korea Viet Nam Ukraine Israel Kazakhstan Austria Brazil United States Norway Kyrgyz Republic Switzerland Peru Mongolia Poland Morocco Egypt Turkey Sweden Chile South Africa Cambodia Japan Italy Slovak Republic Albania Costa Ric a France Irela nd Serbia Belgium United Kingdom Croatia Denmark Greece Argentina Hungary Bosnia and Herzegovina Montenegro Colombia Germany North Macedonia Spain Latvia Lithuania Finland Estonia Netherla nds Czech Republic Romania Slovenia Portugal Luxembourg Kosovo*

0.05

Note: The OECD FDI Regulatory Restrictiveness Index covers only statutory measures discriminating against foreign investors (e.g. foreign equity limits, screening & approval procedures, restriction on key foreign personnel, and other operational measures). Other important aspects of an investment climate (e.g. the implementation of regulations and state monopolies, preferential treatment for export-oriented investors and SEZ regimes among other) are not considered. Data reflect regulatory restrictions as of December 2017. For Croatia, information reflects the regulatory environment as of September 2018. Please refer to Kalinova et al. (2010) for further information on the methodology. * This designation is without prejudice to positions on status, and is in line with United Nations Security Council Resolution 1244/99 and the Advisory Opinion of the International Court of Justice on Kosovo’s declaration of independence. Source: OECD FDI Regulatory Restrictiveness Index, www.oecd.org/investment/fdiindex.htm.

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88 │ 4. CROATIA’S REGULATORY FRAMEWORK FOR INVESTMENT AND NATIONAL TREATMENT On a sectoral basis, Croatia also maintains a more open environment than most other countries. When compared to the OECD average, regulatory restrictions on FDI are greater only in business services, reflecting essentially some discriminatory measures in legal services sectors (Figure 4.2). In financial services, existing restrictions in insurance, banking and other financial services puts it at par with the OECD average. Any difficulty in attracting FDI into Croatia is, therefore, unlikely to be related to a fragmented regulatory environment for foreign investors. Croatia is largely open to foreign investment and generally treats domestic and foreign investors alike. This is the case for foreign investors in general, not only EU-based ones. Nonetheless, as mentioned above, the regulatory environment for FDI must not be seen in isolation from the overall business environment. While barriers to FDI should not necessarily be a concern for attracting international investment, the stringency and cumbersomeness of business regulations and the level of state participation in the economy may be (see Chapters 3 and 6). The number of regulated professions, for instance, seem particularly high in Croatia and existing regulations remain relatively burdensome in many cases, hampering the access to and the practice of such professions (European Commission, 2017). As mentioned above, non-discriminatory deficiencies in the business environment affect domestic and foreign investors alike. The costs of regulatory heterogeneity with regional peers can also sometimes be high, providing a real barrier for FDI (Fournier, 2015). Figure 4.2. OECD FDI Regulatory Restrictiveness Index, 2017, by sectors

0.3

OECD OECD FDI Regulatory Restrictiveness Index (open=0; closed=1)

CROATIA

0.25 0.2 0.15

0.1 0.05 0

Note: see notes in Figure 4.1. Source: OECD FDI Regulatory Restrictiveness Index, www.oecd.org/investment/fdiindex.htm

Croatia has few exceptions to national treatment of foreign-controlled enterprises Croatia has no trans-sectoral exception to national treatment. Existing trans-sectoral measures are essentially limited to entry conditions for non-EU/EEA investors, notably in relation to land ownership and, more generally, on establishing a business in Croatia. Market access conditions are also more common across sectors than exceptions to national treatment. Sector-specific measures consisting on departures from the national treatment principle are limited to foreign ownership restrictions in a few commercial activities, such as freshwater fishing, air transport and legal services. Croatia also does not impose limits

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on access to local finance and incentives (e.g. tax concessions) or government purchasing markets for foreign-controlled enterprises incorporated in the territory. These measures are discussed in further details below. Croatia’s list of the measures constituting an exception to national treatment at national and territorial level is reported in Annex A of this Review. Annex B contains the list of measures reported for transparency reasons (e.g. measures based on national security considerations, as well as nondiscriminatory corporate organisation requirements, official aids and subsidies and public and private monopolies and concessions). For clarity, measures restricting investments by natural persons are not reported because the instrument does not cover these.

Cross-sectoral measures affecting foreign investment Land and Other Real Estate The right of ownership of private property and real estate was re-established in the Croatian Constitution of 1990, following the country’s transition from a collectivist and pluralist regulation of ownership in the former socialist Croatia, to the protection of private and individual ownership as fundamental right. The right of acquisition and ownership of real estate was codified in numerous acts and regulations, notably by the Property and Other Real Rights Act of 1996 and the 1996 Land Register Act. According to the Property and Other Real Rights Act of 1996, legal entities incorporated in EU/EEA member states can acquire and own real estate assets (e.g. commercial and residential units and land) in the Republic of Croatia under the same conditions as those applied to domestic legal entities, with the exception of agricultural land3 and other real estate located in protected nature areas, as defined in the Nature Protection Act. Other foreign legal entities, however, can only acquire ownership of real estate in Croatia under the condition of reciprocity and subject to consent by the Minister of Justice. They cannot acquire or hold any property rights in agricultural land or forests. No distinction is made between the acquisition of property for business purposes, such as office space, warehouse etc., and real estate investments for renting and capital gains. This restriction can nonetheless be circumvented by the incorporation of a company in Croatia, in which case it would be treated as a Croatian national.4

Reciprocity Condition A foreign investor may establish or participate in establishing a company and may acquire rights and/or commitments as any domestic investor. However, foreign investors, headquartered or with residence in a non-WTO member country, need to meet the reciprocity condition. Croatia’s reciprocity policy concerns foreign investors’ right to undertake inward direct investment and establish in Croatia, and is, therefore, not a measure properly covered under the NTi, which applies to established enterprises. The implications of such a measure are limited, however. In total, there are 169 countries which are members of the WTO, and all Adherents to the Declaration are members of the organisation. Nonetheless, policies conditioning market access to reciprocal treatment is reflected under the OECD FDI Regulatory Restrictiveness, since they shy away from the underlying principle of liberalisation embedded in the OECD instruments on international investment and capital movements, which is to promote liberalisation rather through unilateral action at countries’ own pace than through bargaining. Besides, any benefits associated with such investments flowing to host economies are likely to occur regardless of whether the home

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90 │ 4. CROATIA’S REGULATORY FRAMEWORK FOR INVESTMENT AND NATIONAL TREATMENT country of that firm provides equal treatment to host country firms. There may be cases where reciprocity conditions may actually contribute to ensuring an increasing degree of liberalisation overall, and therefore these are given special consideration under the OECD Codes of Liberalisation of Capital Movements for instance, but ultimately they still constitute a barrier for foreign investment.

Sector-specific measures affecting foreign investment The sector-specific exceptions to the NTi notified by Croatia concern the ownership of commercial fishing companies, air transport and legal firms by non-EU investors (see Annex A to this Review). Other sector-specific measures discussed below refer to measures imposing conditions on the establishment of foreign investors in Croatia. While not covered by the NTi, they constitute statutory barriers to entry and are covered in the OECD FDI Regulatory Restrictiveness Index.

Agricultural Land and State-owned Forests and Forest Land 166. Agricultural land on the territory of the Republic of Croatia is disposed in accordance with the Agricultural Land Act of 2018 and general regulations on the disposal of real estate. Unless otherwise provided by an international agreement or special regulation, foreign natural and legal persons – including their branches in the Republic of Croatia – are not allowed to acquire or hold any property rights in agricultural land and forests. Pursuant to the provisions of the Treaty on the Accession of the Republic of Croatia to the European Union, citizens and legal entities of the EU remain prohibited from acquiring agricultural land for a period of 7 years following the accession date, with the possibility of extension for another 3 years. Foreigners can circumvent this restriction on the acquisition of agricultural land by incorporating a company in Croatia. Foreign-controlled enterprises incorporated in Croatia are treated equally to domestically-owned firms in this matter. Foreign persons wishing to invest directly or through a branch in Croatia may also obtain a long-term lease for agricultural land. They may also participate in public tenders for lease of state owned agricultural land under the conditions prescribed by the law. The legislation does not impose any limit on the duration of the lease agreement, except regarding the leasing of state owned agricultural land which is allowed for a period of 25 years, renewable for another 25 years. In accordance with the agricultural policy of the Republic of Croatia to preserve the rural area, the priority of selling and leasing rights is given to the former possessors, the younger than 41 and the domicile population. Similarly, according to the Forestry Act of 2018, foreign investors from outside the European Union may not acquire ownership rights in state-owned forests and forest land, unless otherwise provided by an international agreement. The implications of such measure may, however, be limited. Generally, state-owned forests and forest land may not be alienated from the ownership of the Republic of Croatia, except in the cases provided for by the Law. Only in these cases legal persons incorporated in Croatia or in another EU member country are allowed to acquire ownership rights over state-owned forests and forest land. There are no restrictions on foreign investment in private forestry land.

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in fishery activities without discrimination under these regulations. The only exception to national treatment concerns commercial freshwater fishing activities. According to the Law on Freshwater Fisheries, this activity shall not be conducted by a domestic legal person wholly or partly owned by a foreign natural or legal person, unless otherwise provided in an international agreement. According to the authorities, these activities take place in a part of the Sava river and the Danube, and it is recognised as a preferential small artisan activity. The measure aims to preserve the activity as a form of traditional, ethnological and cultural heritage of Croatia. There are no other exceptions to national treatment in the sector. Market access is restricted to investments in marine fisheries activities by non-EU/EEA investors. All fishing vessels used in commercial and small-scale fishing and exclusively in aquaculture in Croatia must be registered with the national registry of fishing vessels. And according to the 2004 Maritime Code, the registration of a vessel by a non-EU/EEA investor is permitted only when carried through an intermediate legal entity incorporated in an EU/EEA member state and after the establishment of a branch office in Croatia. Foreign legal persons may also obtain a concession for the economic use of maritime assets for carrying out aquaculture, upon the incorporation of a company in the Republic of Croatia for such purposes. Foreign legal persons are also restricted from owning agricultural land as per the 2018 Agricultural Land Act and, therefore, cannot acquire agricultural land used for carrying out freshwater aquaculture activities, such as fish ponds owned by the State or aquaculture farms owned by other natural or legal persons. They may only obtain long-term leases for agricultural land for this purpose. This can be circumvented by the incorporation of a company in Croatia, except in relation to state-owned fish ponds. These can only be leased to natural or legal persons, regardless of investors’ nationality, by a public tender for a period of 25 years with the possibility of extension for the same period. For all other fishery activities, foreign investors are allowed without limitations. They need only register a branch for such purposes and meet the conditions established by law for carrying out these activities in the country, similarly to firms incorporated in Croatia. According to the authorities, however, there is a moratorium in the issuing of new licences for maritime commercial fishing since 2008. Hence, participation is only possible through the transfer of rights from a valid licence holder engaged in commercial fishing, which is possible under certain conditions.

Rail Transport In accordance with the Law on Railways of 2013, the provision of railway transport services is subject to licensing by the Ministry of the Sea, Transport and Infrastructure. The licence is valid throughout the European Union and is issued by the Ministry upon request by a domestic legal entity (i.e. incorporated in Croatia) wishing to carry out the activity of railway transport services and registered for such a purpose. Among other conditions established in the law and implementing regulations, the domestic legal entity is also required to have its seat, i.e. effective management, in the territory of Croatia. In accordance with the international agreement on mutual recognition of permits, the government recognises the licences issued by the competent authorities of other EU member states. Hence, licensed railway undertakings from other EU member states are also authorised to operate in Croatia and vice-versa. There is no requirement to incorporate a local company for such purposes. Foreign legal persons established outside the EU may also have the possibility to obtain a licence for the provision of railway transport services in Croatia through a branch office on the basis of license recognition, whenever legal basis OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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92 │ 4. CROATIA’S REGULATORY FRAMEWORK FOR INVESTMENT AND NATIONAL TREATMENT exist, in bilateral or multilateral agreements to which Croatia and the contracting state of the foreign legal entity are parties, on the mutual recognition of official documents related to rail transport services.

Inland Water and Maritime Transport The 2007 Act on Inland Waterway Navigation and Ports, last amended in 2018, regulates the provision of inland waterway passenger and freight transport in Croatia. Accordingly, only Croatian and EU/EEA-incorporated carriers may conduct domestic waterway transport services in Croatia. In accordance with the law, other carriers may also be allowed to carry out inland waterway cabotage, but only upon approval by the Ministry responsible for inland navigation. Such an approval is only given under exceptional circumstance according to the authorities. As for maritime cabotage, it is regulated by the Maritime Code of 2004 and implementing regulations, and is permitted to foreign persons in accordance with EU regulations (No 3577/92). Accordingly, Croatian and EU/EEA-incorporated enterprises may provide maritime cabotage services in Croatian waters under the same conditions, whereas nonEU/EEA persons must obtain a special authorisation from the Ministry of the Sea, Transport and Infrastructure. Otherwise, non-EEA operators may incorporate within the EU to invest in maritime cabotage under the same conditions of domestic investors. The provision of domestic and international passenger line shipping services are also reserved to companies incorporated within the EU/EEA according to the 2006 Act on Carriage by Line and Occasional Coastal Shipping, as amended, and implementing regulations.

Air Transport In line with EU rules governing the operation of air services within the territory, Croatia’s Air Traffic Act of 2009 provides that commercial air transport and other commercial and non-commercial operations may only be carried out by undertakings complying with conditions laid down in EU regulations and other regulations adopted pursuant to this act. As such, as per the Regulation (EC) No 1008/2008, no undertaking established in the EU shall be permitted to carry passengers, mail and/or cargo for remuneration and/or hire by air, unless it has been granted the appropriate operating licence. The granting of such licences is conditioned inter alia on the ownership and control by EU member states and/or nationals of member states of more than 50% of the undertaking, whether directly or indirectly through one or more intermediate undertakings, except if provided differently in an agreement with a third country to which the European Union is a party. Likewise, Croatia’s Air Traffic Act establishes that the provision of terrestrial services at airports shall be conducted in accordance with EU regulations. As such, the provision of ground handling services at Croatian airports is reserved to legal or natural persons registered for such purposes and incorporated in Croatia or in the territory of another EU member state. Additionally, according to the Croatian legislation, foreign investment in such services is subject to reciprocal treatment. Whenever a non-member country or a party to the European Common Aviation Area agreement (which includes EU’s neighbouring countries in South-East Europe, as well Norway and Iceland) does not grant to Croatian air carriers and operators the mutual treatment on airport terrestrial services, the Ministry may suspend, in whole or in part, the treatment accorded to investors from such state.

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Professional Services (legal services)5 The Law on the Legal Profession of 1994, as amended, regulates the provision of legal services in the country. Accordingly, only lawyers who have been registered with the Croatian Bar Association can practice on the territory and be equity partners in Croatian law firms. Registered lawyers are allowed to practice as a sole practitioner, within a joint law office or within a law firm established by at least two lawyers either as a general partnership or as a limited liability company. Registering with the Bar is, however, limited to Croatian citizens and citizens of an EU/EEA or WTO member state. Other foreign persons cannot practice law nor invest or become partners in a Croatian law firm. Registered EU/EEA and WTO lawyers can practice law in Croatia under equal conditions with Croatian lawyers. They can establish subsidiaries of their home country law firms to provide legal advice on the law of the Republic of Croatia, their home-country law, EU law and international law. Only EU/EEA lawyers, however, can represent clients before the Croatian courts, under condition they act together with a lawyer admitted to practice under the professional title “odvjetnik”, which is granted to those lawyers who are Croatian or EU citizens and who have passed the Croatian Bar exam, among other requirements established by the legislation. Law firms of an EU member state, or of a member state of the WTO, may also establish their own branches in Croatia in accordance with the relevant legislation and obligations of the Republic of Croatia under international treaties. Their branches may, however, only provide legal advice on their home-country law, the law of the European Union and international law.

Construction, Architectural and Engineering Services Construction activities, and architectural and engineering services involving physical planning and construction-related activities, are regulated by the Act on Physical Planning and Building Tasks and Activities of 2015.6 There are no exceptions to national treatment in the legislation, but market access conditions apply for non-EU/EEA investors wishing to undertake the above-cited activities. The law distinguishes between two distinct modalities of engagement by foreign legal persons: the provision of such services on a temporary or occasional basis, and their provision on a permanent basis. According to the authorities, the latter implies the establishment of a subsidiary or a branch in the country (i.e. provision through FDI).7 In accordance with the law, legal persons from EU/EEA member states, authorised to undertake construction, physical planning and construction-related architectural and engineering services in their home jurisdictions, may perform such activities in Croatia, in a temporary or occasional basis, after notifying the Ministry of Construction and Physical Planning and upon meeting the requirements established by the law. Non-EU/EEA legal persons, who are not established in a WTO member country, may only perform such activities, on a temporary or occasional manner, under the condition of reciprocity. The performance of these activities on a permanent basis by an authorised EU/EEA legal person, through a branch or subsidiary, is permitted under the same conditions as for other legal persons incorporated in the Republic of Croatia. Non-EU/EEA investors, however, are required to incorporate a company to carry out such activities on a permanent basis. Thereafter, they are subject to the same conditions applying to other investors.

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Media Market access conditions also apply to non-EU/EEA investors in audio and audio-visual media services, as well as to electronic and printed media. According to the 2009 Electronic Media Act and the 2004 Media Act, which regulate radio and television broadcasting services concessions and printed publishing activities, respectively, only Croatian companies and branches of EU/EEA companies are allowed to carry out such activities in Croatia. Non-EU/EEA legal persons are required to incorporate a company in Croatia or within the EU/EEA, and establish a branch in Croatia, in order to engage in such activities in the country. Upon establishment they are treated equally to Croatian companies. Local content requirements are applied indiscriminately to authorised established companies, regardless of owners’ nationalities.

Financial Services (banking, insurance and other financial services) The 2013 Credit Institutions Act regulates the conditions for establishment, operation and termination of banks and other credit institutions in Croatia. Foreign legal persons are allowed to acquire or incorporate a credit institution in Croatia without any market entry restriction, subject to meeting prudential financial requirements established in the legislation. The establishment of a branch office by a non-EU/EEA credit institutions, however, is subject to a reciprocity condition. Similarly, according to the 2015 Insurance Act, non-EU/EEA insurance providers are also subject to reciprocity for establishing a branch office for the purpose of providing insurance services in the country. There are no market access conditions, however, for the incorporation of insurance company in Croatia by non-EU/EEA investors. Upon establishment they are allowed to engage in insurance activities in the same manner as other domestic insurance firms and branches of EU/EEA-based insurance firms. Pension fund activities are generally conditioned upon the incorporation of a company in Croatia for such purposes.8 Under the 2014 Pension Insurance Companies Act, which regulates the establishment and operation of pension insurance companies in relation to the compulsory and voluntary pension insurance systems, a pension insurance company is required to be established as a joint stock company upon authorisation from the Croatian Financial Services Supervisory Agency and after meeting the requirements established in the law. The provision of compulsory pension insurance services is only permitted to companies meeting this requirement. A pension insurance company from another EU Member State, which establishes a branch in Croatia or is empowered to directly carry out the related activities on the basis of an authorisation from the competent authority of the Member State, is allowed to provide voluntary pension insurance services in relation to closed funds and support services to sponsors for the implementation of their closed voluntary pension fund. Likewise, the provision of pension fund management services is also generally restricted to pension companies incorporated in Croatia. The 2014 Voluntary Pension Funds Act, for instance, which inter alia regulates the establishment and operation of voluntary pension fund management companies, also establishes that these activities may only be performed by a pension company incorporated for such purposes and upon authorisation from the Croatian Financial Services Supervisory Agency. A pension company from another EU member state is allowed, in accordance with the Act, to establish a branch in Croatia or directly carry out basic and auxiliary voluntary pension fund activities from its home office,

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but only in relation to closed funds.9 All other voluntary pension fund management activities can only be performed by pension companies incorporated in Croatia. The performance of compulsory pension fund management services is restricted to pension companies incorporated in Croatia, without exceptions. According to the 2014 Mandatory Pension Funds Act, which regulates the establishment and operation of capitalised compulsory pension funds and their management by pension companies, only a pension company incorporated in Croatia for such purposes following an authorisation by the Croatian Financial Services Supervisory Agency is allowed to provide mandatory pension fund management services. The above laws also restrict which institutions can be depositaries of voluntary and compulsory pension funds. Accordingly, only a credit institution headquartered in Croatia and having the approval of the Croatian National Bank for the conduct of related activities, or a branch of a credit institution of another EU Member State, established in Croatia in accordance with the relevant legislation, are allowed to be appointed as depositaries of mandatory and voluntary pension funds. Transposing the European Union’s regulation concerning undertakings for collective investment in transferable securities (UCITS), the Law on Open-end Investment Funds with Public Offering of 2016 also establishes that only fund management companies incorporated in Croatia or in another EU Member State, which have been authorised by the Croatian Financial Services Supervisory Agency or the competent authority from the other Member State, may carry out the activity of managing UCITS funds in Croatia. A thirdcountry management company may, through a branch established in Croatia and upon approval by the Croatian Financial Services Supervisory, engage in UCITS trading activities, but is not allowed to establish and manage UCITS funds. For this, they are require to incorporate in Croatia in accordance with the law. Market access conditions also apply to the provision of electronic money services by nonEU/EEA electronic money institutions in Croatia. Under the 2018 Electronic Money Act, they are allowed to provide electronic money payment services associated with the issuance of electronic money in Croatia either directly or through a branch established under special rules. Among others, a reciprocity condition applies in these cases. Reciprocity is not required if they incorporate a company for such purposes in Croatia. The Electronic Money Act allows EU/EEA-registered electronic money institutions to issue electronic money and to provide payment services covered by their authorisation, directly or through a branch, under the same conditions as electronic money institutions incorporated in Croatia. Lastly, according to the 2018 Payment System Act, payment institutions from nonEU/EEA member states may not provide payment services in Croatia. For this, they need to incorporate a payment institution in Croatia or within the territory of an EU/EEA member state. In line with the related Directive (EU) 2015/2366 on payment services in the internal market, the law allows EU/EEA-registered institutions to provide payment services covered by their authorisation, directly or through a branch, under the same conditions as payment institutions incorporated in Croatia.

Other policies affecting foreign investment and reported for transparency purposes under the National Treatment instrument A few other policies applied by Croatia, while not discriminating between foreigncontrolled enterprises and domestic enterprises, may result in difference in impact by potentially imposing a greater burden on the foreign controlled-enterprise. Policies based

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96 │ 4. CROATIA’S REGULATORY FRAMEWORK FOR INVESTMENT AND NATIONAL TREATMENT on public order and essential security considerations may restrain access to certain sectors of national interest. Likewise, the existence of public, private, or mixed monopolies may render access to certain sectors difficult for foreign investors. As such they are important determinants in the context of national treatment. Such measures are notified by a country adhering to the OECD Declaration for transparency purposes. Croatia has reported only a few measures for transparency purposes under the NTi (see Annex B). These are related to conditions imposed on management board members both in credit institutions and audit firms, as well as a few sectors which are kept under public monopoly and a few sectors in which private participation is possible under concession agreements only. In addition, foreign investment activities can be limited in certain areas due to national security considerations. While Croatia does not have national security review mechanisms nor any other specific policy that would allow it to respond to threats for its national security stemming from established foreign direct investors, it does not allow foreign persons to own land and other real estate located in key legally specified areas in view of protecting the interests and safety of the Republic of Croatia. Some industries connected with national defence and security are also subject to special conditions and approval procedures by the competent authorities, but these apply equally to both domestic and foreign investors and are not reported here.

Measures based on public order and essential security considerations International instruments such as the OECD Declaration and the OECD Guidelines for Recipient Country Investment Policies relating to National Security (OECD, 2009) recognise countries’ rights to regulate to manage potential risks for the host country’s national security or public order. Unlike some governments which have recently increasingly invoked national security to control foreign investment (Wehrlé and Pohl, 2016; Wehrlé and Christiansen, 2017), Croatia has remained content with the absence of formal policies to manage or potentially prevent certain acquisitions by foreigners on national security grounds. If such policies exist, they are limited to the acquisition of land or real estate in some sensitive geographical areas. According to the Property and Other Real Rights Act of 1996, unless otherwise provided by law, foreign persons are prohibited from owning land or other real estate located in an area which, in order to protect the interests and safety of the Republic of Croatia, is legally declared a territory in which foreign persons may not have the right of ownership. No specific territory area (e.g. border areas) has been designated as prohibited, but foreign natural and legal persons remain prohibited from acquiring ownership of agriculture land and protected areas in nature in accordance with the Agricultural Land Act of 2018 and the Law on Protection of Nature of 2013, as amended in 2018. A foreign person who has acquired the right of ownership of real estate in an area, which thereafter becomes legally declared a restricted territory, shall cease to be the owner such property and shall be entitled to compensation as per the expropriation regulations (see Chapter 4, which discusses expropriation rules in Croatia in greater detail). If a foreign person, by inheritance, becomes the owner of a property located in an area legally declared a restricted territory, the person is entitled to compensation as per the expropriation regulations. These conditions do not apply to nationals and legal entities from the European Union, except in the case of agricultural land and protected parts of nature delimited in the Nature Protection Act of 2005.

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Corporate organisation and key personnel Croatia imposes conditions on the management board members of credit institutions and audit firms. In the case of credit institution in Croatia, the 2013 Credit Institutions Act requires that at least one member of the management board of a credit institution be fluent in speaking and writing of the Croatian language in order to be able to perform his/her functions. In practice, this requirement does not exclude the possibility that the whole board be constituted by foreign persons if at least one of the members speaks and writes Croatian fluently. The members of the management board in the banking sector undergo suitability assessment conferring that they possess adequate knowledge, skills and experience required to direct the business of the bank. In the case of audit firms, in accordance with the 2017 Audit Act, the majority of the members of the management board of an audit firm is required to be formed by authorised auditors from Croatia or another EU Member State. When the management board is constituted by two members only, at least one member must be an authorised auditor from Croatia or another EU Member State. Similarly to the case of credit institutions, at least one member of the management board of an audit firm shall be fluent in the Croatian language.

Activities covered by public, private, mixed monopolies or concessions A number of activities are reserved to the Republic of Croatia, namely: 

the provision of electricity transmission which is carried out by the state-owned company HRVATSKI OPERATOR PRIJENOSNOG SUSTAVA d.o.o. (HOPS)

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the provision of electricity distribution, which is reserved to the state-owned company HEP-OPERATOR DISTRIBUCIJSKOG SUSTAVA d.o.o. (HEP-ODS)

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the provision of wholesale electricity market supply, which is reserved to HEPELEKTRA d.o.o.

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the transport of natural gas, whose monopoly is reserved to the state-owned company PLINACRO d.o.o.

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the operation of Croatia’s gas storage system, which is reserved to PODZEMNO SKLADIŠTE PLINA d.o.o

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the wholesale gas market supply, which is reserved to HEP d.d

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water management, which is the monopoly of the state-owned company Croatian Waters

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water supply, wastewater treatment and sewage, which is the responsibility of local governments and provided by various public utility companies

A few sectors are also subject to private or mixed monopolies or concessions. For example, the company Jadranski naftovod (JANAF), which has mixed ownership but is majority owned by the State, holds the monopoly over crude oil transportation in Croatia, while the following activities are subject to concession agreements between the private investor and Croatia: mining research and exploitation and related secondary activities (i.e. exploration and exploitation of hydrocarbons and geothermal energy), the exploitation of maritime domains and the provision of management and operation of ports.

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Starting and operating a company nevertheless remain cumbersome according to business surveys As it can be seen from above, Croatia has one of the most open regimes for international investment according to the OECD FDI Regulatory Restrictiveness Index. Exceptions under the OECD National Treatment instrument are limited to foreign ownership restrictions in a very few number of activities or sectors. Despite this openness to foreign investment, Croatia suffers from shortcomings that investors say they experience when establishing a business and in the day-to-day running of their business operations as documented by Croatia’s performance in international rankings (Table 4.1). This is also attested by interviews conducted by the OECD as part of this Review where concerns were raised about administrative burdens in terms of time and costs, long judicial proceedings, fragmented public institutions, and corruption and favouritism, especially at regional and local government level. In 2018, Croatia ranked 58th out of 190 countries in the World Bank’s 2019 edition of Doing Business indicators. In comparison with other EU countries, Croatia is among the lower third, together with countries such as Bulgaria and Hungary, while having a somewhat better score than some South European Union Mediterranean countries (e.g. Greece, and Malta). When compared with non-OECD countries that are Adherents to the OECD Declaration, Croatia is behind countries such as Kazakhstan and Romania, which rank 28th and 52nd respectively, and above Costa Rica at 67, Egypt at 120, Morocco at 60, Peru at 68, and Ukraine at 71. While Doing Business - which addresses ten business regulatory areas such as starting a business, dealing with construction permits and enforcing contracts should not be construed as an overall measure of the investment climate, Croatia's relative poor performance, in particular in comparison with other EU countries, suggests that, despite reforms and on-going improvements, some critical areas remain to be addressed. The Global Competitiveness ranking of the World Economic Forum provides additional perspectives on issues arising from doing business in Croatia. In 2017, Croatia ranked 74th out of 137 countries in the Global Competitiveness Index. Despite improvements in some areas, the main obstacles for doing business as perceived by entrepreneurs remained unchanged from the previous year (e.g. inefficient institutions, corruption). Other listed factors included the perceived insufficient capacity to innovate; labour regulations, seen as offering not enough flexibility; and an inadequately educated workforce. All of these areas have already been discussed in Chapter 3. As suggested by Croatia’s overall rankings in the World Bank’s Doing Business report for 2018 and the Global Competitiveness Index for 2017, there is a room for rendering administrative procedures in Croatia speedier, more transparent and effective, and improving the overall quality and transparency of public governance. The rather inefficient public administration in Croatia, at both central and local levels, as discussed in Chapter 7 of the present Review, leads to unsatisfactory public services and undermines the investment climate. In addition, while important steps have been taken to fight corruption in Croatia, perceived corruption remains relatively high, not only by regional standards (Croatia was ranked 57th among 180 countries in the Transparency International’s Corruption Perception Index in 2017). For sure, when compared with other non-OECD countries that are Adherents to the OECD Declaration on International Investment, Croatia is above countries such as Egypt (117th), Kazakhstan (122nd) and Ukraine (130th). It is nevertheless below other non-OECD countries Adherents to the Declaration such as Costa Rica (38th). Continued progress in the

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fight against corruption remains essential for Croatia’s citizens and businesses. As discussed in Chapter 7, Croatia needs to maintain its anti-corruption efforts, in particular at local level. Table 4.1. Croatia in international rankings Indicator Doing Business 2019 edition (World Bank) Starting a business Obtaining construction permits Getting electricity Registering property Getting credit Protecting minority investors Paying taxes Enforcing contracts Resolving insolvency Global Competiveness Index Report 2017-2018 (WEF) Institutions Higher education and training Labour market efficiency Innovation 2017 Corruption Perceptions Index (Transparency International) Rule of Law Index (World Justice report 2017–2018) Absence of corruption Open Government Regulatory Enforcement Civil justice

Rank 58/190 123 159 61 51 85 38 89 25 59 74/137 102/137 60/137 107/137 106/137 57/180

Past Ranking 43/189 in 2017 95 128 68 62 75 27 49 7 54 Croatia remains in the same position from the previous period

Downgrade from 50 in 2015 and 55 in 2016

35/113 41/113 33/113 52/113 44/113

While an open and transparent environment for foreign investment is important since it expands market opportunities and enhances predictability for investors, these are not the only incentives to which FDI responds to. Foreign investors are equally affected by deficiencies in the overall business environment impinging on domestic investors too. Behind-the-borders regulatory challenges, which affect foreign and domestic investments altogether, should be seen in complement to market access and treatment of foreign investors. These other policies affecting the overall business environment are addressed in the next chapters.

Outlook and policy recommendations Croatia has one of the most open regimes for international investment according to the OECD FDI Regulatory Restrictiveness Index. It is more open in statutory terms than the average OECD member country and Croatia's exceptions under the National Treatment instrument are limited to restrictions in a few activities. Likewise, regulatory barriers to entry are confined to a few sectors, and notably restricted to non-EU/EEA investors. Croatia’s observed level of regulatory restrictiveness is at par with the average EU member country.

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Notes 1

The Code of Liberalisation of Capital Movements is an OECD instrument designed to support the progressive freedom of capital movements, while providing flexibility for countries to lodge reservations regarding operations the country is not yet in the position to liberalise and to reintroduce restrictions in situations of serious economic and financial disturbance. Since 2011, non-OECD economies may apply for adherence to the Code. Currently seven non-OECD countries are undergoing the process of adherence (Argentina, Brazil, Bulgaria, Croatia, Peru, Romania, and South Africa). 2

In the case of the Code, for instance, members are required to progressively abolish measures that discriminate between residents and non-residents and to treat residents of all other members alike. Any remaining restriction on operations they are not yet in a position to liberalise are notified and lodged in the country reservation list for transparency reasons. 3

Pursuant to the provisions of the Treaty on the Accession of the Republic of Croatia to the European Union, citizens and legal entities of the European Union cannot acquire agricultural land for a period of seven years from the date of accession of the Republic of Croatia to the European Union [1 July 2013], with a possibility of a ban for another three years. 4

According to the Law on Maritime Domain and Sea Ports of 2003, no real estate located within the maritime domain can be acquired by private parties, be them Croatians or foreigners. However, these can be given under concession for a period of up to 99 years to persons and firms registered for business operations in Croatia, regardless of their nationality or the ownership of the capital. 5

The practice of regulated professions is conditioned on obtaining a license. Measures that discriminate on grounds of nationality the granting of such licenses to foreign natural persons are not taken into account here, unless they also prevent foreign persons from taking a direct investment in the related business. For instance, this may occur when citizenship is required for membership in a professional association with regulatory powers, and such membership is required for practicing such profession and establishing a business for such purposes. 6

Architectural and engineering services regulated by this Act include, for instance, physical planning, design and/or professional construction supervision, project management of construction projects, testing of and certification of construction products and projects’ compliance with building requirements, preparatory research for construction and reconstruction works. 7

The temporal or occasional provision of such activities refers to either the direct provision by the foreign legal person by its head office (i.e. direct trade) in its home country or the occasional provision by a foreign national not-resident in Croatia as an independent supplier or employee of a service supplier. 8

The pension system in Croatia consists of three tiers. The first pillar consists of the mandatory pension insurance on the basis of generation solidarity. All employed insured persons are require to contribute 15% of their gross salary to this pillar. The funds are used to pay pensions of the present pensioners. The second pillar consists of the mandatory pension insurance on the basis of individual capitalized savings. All insured persons under pillar I, which meet the conditions established by the Act (e.g. having not reached the age of 50 on 1 January, 2002, date of implementation of pillar II), are required to contribute 5% of their gross salary to a capitalised mandatory pension fund of their choice. The third Pillar consists of the voluntary pension insurance on the basis of the individual capitalized savings. 9

A closed fund is a voluntary pension fund, in which, participation is limited to natural persons employed by the fund sponsor or that are members of the fund sponsor. The sponsor may be an employer, trade union or an association.

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References European Commission (2017), “Country Report Croatia 2017: Including an In-Depth Review on the prevention and correction of macroeconomic imbalances”, Commission Staff Working Document, SWD(2017) 76 Final, February 22. Fournier, J. M. (2015), “The negative effect of regulatory divergence on foreign direct investment”, OECD Economics Department Working Papers No. 1268, OECD Publishing, Paris, https://doi.org/10.1787/5jrqgvg0dw27-en. Kalinova, B., A. Palerm, and S. Thomsen. (2010), “OECD’s FDI Restrictiveness Index: 2010 Update”, OECD Working Papers on International Investment, 2010/03, OECD Publishing, Paris, https://doi.org/10.1787/5km91p02zj7g-en Mistura, F. and C. Roulet (2019), “The Determinants of Foreign Direct Investment: Do Statutory Restrictions Matter?”, OECD International Investment Working Paper, https://doi.org/10.1787/641507ce-en. Moran, T. H., E. M. Graham, and M. Blomström, (2005), “Chapter 14: Conclusions and Implications for FDI Policy in Developing Countries, New Methods of Research, and a Future Research Agenda”, in Moran, Graham, and Blomström (eds.), Does Foreign Direct Investment Promote Development?, Institute for International Economics, Washington D.C. Nicoletti, G., S. Golub, D. Hajkova, D., Mirza, and K-Y Yoo, (2003), “The Influence of Policies on Trade and Foreign Direct Investment”, OECD Economic Studies No. 36, 2003/1, OECD Publishing, Paris, https://doi.org/10.1787/eco_studies-v2003-art2-en OECD (2019), OECD Investment Policy Reviews: Southeast Asia, www.oecd.org/daf/inv/investmentpolicy/oecd-investment-policy-review-southeast-asia.htm OECD (2015), The Future of Productivity, OECD Publishing, Paris, https://doi.org/10.1787/9789264248533-en OECD (2009), Guidelines for Recipient Country Investment Policies relating to National Security, www.oecd.org/daf/inv/investment-policy/43384486.pdf OECD (2005), National Treatment for Foreign-Controlled Enterprises: 2005 Edition, OECD Publishing, Paris, https://doi.org/10.1787/9789264012912-en Wehrlé, F. and H. Christiansen (2017), “State-owned enterprises, international investment and national security: The way forward”, OECD Insights Blog https://medium.com/@OECD/state-ownedenterprises-international-investment-and-national-security-the-way-forward-c21982c9fa8c Wehrlé, F. and J. Pohl (2016), “Investment Policies Related to National Security: A Survey of Country Practices”, OECD Working Papers on International Investment, No. 2016/02, https://doi.org/10.1787/18151957

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5. THE PROTECTION OF INVESTMENT IN CROATIA

Chapter 5. The protection of investment in Croatia

This chapter reviews the provisions in both domestic legislation and Croatia’s international investment agreements offering protections for investors. It looks at the domestic framework, particularly the rules for expropriation and the protection of intellectual property rights, and discusses the legal and institutional framework for contract enforcement and dispute resolution, with particular attention given to the judiciary and alternative dispute resolution mechanisms. It also reviews Croatia’s international investment treaty practice and its legal framework for investor-state dispute settlement.

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104 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA The conditions faced by investors, both when they establish and in their on-going operations, are only part of the overall investment environment. The protection of ownership, contracts, intellectual property and other rights extended to investors by domestic legislation, combined with effective enforcement mechanisms, is an important pillar of a sound investment climate. When procedures for making and enforcing contracts are overly bureaucratic and cumbersome, or when contract and other disputes cannot be resolved in a timely and cost-effective manner, investors may restrict their activities and foreign investors may refrain from engaging in the country. As a result, providing protection for investors and offering reliable and efficient enforcement procedures or alternative dispute resolution mechanisms are fundamental for markets to function properly and investors to be confident to place assets. Croatia's domestic legal framework provides protection for investors consistent with an open and modern policy regime for investment. This framework reflects the gradual adoption of the EU acquis and the country's transition towards a market economy. As an effective judicial system is an important pre-condition for the promotion of investments and the country's development, Croatia has also taken a number of steps to streamline the workings of its judiciary, including by rationalising the courts’ network, deploying modern information technologies, and developing tools for ensuring the integrity and transparency of the judiciary. Croatia has also increasingly made available alternative dispute resolution mechanisms for resolving commercial and investment disputes. As a result, the performance of the justice system has improved significantly in recent years. Rights or procedures established under international law can reinforce or complement guarantees extended to certain investors by domestic legislation. In practice, such rights are often established in investment treaties and associated international arrangements. Although most issues addressed in treaties and multilateral conventions are also covered in domestic legislation, international law based guarantees are not always redundant. Rights established under domestic law can be abrogated or altered by the legislator or authorities of the host state within certain limits, while rights or protections afforded by international law are less at the disposition of the host state, and can only be amended through more onerous procedures. This feature of protections afforded by international law, along with adjudication mechanisms that are more protected from potential interference from host states, contributes to the perception that investment treaties have a role to play in strengthening investor confidence, especially in countries with weak governance. That being said, countries can be successful in attracting international investment without the use of investment treaties. Croatia has concluded a significant number of investment treaties, beginning immediately after independence and until 2008. In 15 years, Croatia established treaty-based investor protection with 78 countries through bilateral or multilateral arrangements. Croatia also adhered to associated multilateral agreements, such as the ICSID and the New York conventions, which deal with adjudication and enforcement mechanisms, respectively. Croatia’s investment treaties reflect the features common to most treaties concluded at the time, including vague language and favourable substantial and procedural conditions for investors. Croatia has faced at least a dozen claims under its investment treaties; this, in conjunction with a global reconsideration on the balance of investor protection and the right to regulate, has led Croatia to embark on a more cautious approach than in the 1990s. The future of treaty protections is partly determined by developments at the EU level, both for the sort of intra-EU BITs and for new treaties that are concluded on behalf of Croatia by the EU. For the moment, Croatia holds on to its treaties despite their perceived

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shortcomings, but seeks to alter their balance through amendments; it also seeks to enter into some new treaties based on a more balanced approach.

The domestic legal framework Croatia’s domestic legal framework provides protection guarantees for investors consistent with a modern policy regime for investment Croatia's strong fundamentals Croatia has pursued a comprehensive reform agenda encompassing protection of ownership and other rights. Property rights and regulations on acquisition, benefits, and use of property are well defined under domestic legislation. The right to ownership of private property is established in the Croatian Constitution and in several general and separate acts and regulations, and the laws are the same for Croatian investors as for foreign investors and there is no discriminatory or more favourable treatment of foreign investors (as seen in the previous chapter, reciprocal treatment is required for foreign investors headquartered or with residence in a non-WTO member country). The right to ownership is further confirmed by the amended 1996 Law on Property and Other Property Rights where foreign entities incorporated under Croatian law are viewed as Croatian legal persons and thus may acquire property without restriction. The Constitution provides several additional guarantees. It is especially enacted that all rights acquired through the investment cannot be reduced or modified by law or any other legal act and that investors are free to transfer profits abroad and to repatriate any invested capital. Expropriation rules based on national interest apply equally to domestic and foreign investments. As discussed below, these laws provide different venues to enforce these rights.

Guarantees against expropriation The right to expropriate is an undisputed prerogative of sovereign states, safeguarding their ability to pursue legitimate interests. In Croatia, the right of ownership is guaranteed under the Constitution that may be restricted, subject to compensation equal to the market value. Ownership rights may be exceptionally restricted by law for the purposes of protecting the interests and security of the Republic of Croatia, nature and the human environment and human health (Article 50 of the Constitution of the Republic of Croatia). The possibility of restricting or acquiring ownership rights is regulated by the Act on the Expropriation and Determination of Compensation. Under that law, property may be expropriated, unless provided otherwise by a special act, when necessary, for example, for construction of facilities or carrying out works of state interest and when it is deemed that the real property to be proposed for expropriation will provide a higher benefit when used for other purposes than the benefits resulting from the prevailing use of that property.1 The Law on the Expropriation and Determination of Compensation and other relevant regulations describe the conditions for an expropriation and provide guidelines for the calculation of the amount of compensation.2 Four principles guide the process: expropriation is permitted for the public interest, without discrimination, against the payment of prompt, adequate and effective compensation and under due process of law. The entire process is public and transparent. Article 50 of the Constitution guarantees compensation equal to the real market value of the investment. Compensation is determined in cash at the market value of the property OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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106 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA being expropriated at the time when the first-instance expropriation decision is made or at the time of settlement, taking into account the usable feature of the property before changing its purpose, which is the cause of expropriation. If possible and mutually acceptable, compensation is determined by assigning to another appropriate property whose value reflects the market value of the property subject to expropriation in the same municipality or town, which provides the owner of the expropriated property with the same living conditions and conditions of use that he/she had in using that real estate.3 Investors, like any other owner of a property, may bring expropriation claims with respect to the decision and conditions of expropriation.

Croatia has a modern system of protection of intellectual property rights The granting and protection of intellectual property (IP) rights, e.g. through patents, trademarks, is another important component of any policy aiming at attracting investment. Protection of IP rights also fosters development and innovation: It is widely acknowledged that a well-functioning and balanced IP system is key to promoting innovation and creativity, which are the main drivers of economic development of knowledge-based economies (OECD, 2011; WIPO, 2016). The role of intellectual property as a lever of economic growth and a driver of scientific, cultural and social progress has been recognised by the Croatian authorities, notably in the National Strategy for the Development of the Intellectual Property System of the Republic of Croatia for the period 2010-12 and the Strategy for Encouraging Innovation of the Republic of Croatia for the period 2014-20.4 The protection of intellectual property rights also results in better protection of consumers, who buy reliable products, and as such promotes positive contributions by enterprises to consumer interests as recommended by the OECD Guidelines for Multinational Enterprises.

Main traits of Croatia’s IP rights system Croatia has a modern system of IP rights that is aligned with the European Union norms and standards.5 Croatia’s main legal instruments on IP rights include the Patent Act, the Trademark Act, the Industrial Design Act, the Act on the Geographical Indications of Products and Services, the Act on the Protection of Layout Design of Integrated Circuits, the Act on Copyrights and Related Rights and, most recently, the Act on the Protection of Undisclosed Information with Market Value.6 These acts define the process for protecting and enforcing IP rights in Croatia. Croatia is a member of the World Intellectual Property Organization (WIPO) and the European Patent Organisation, and is a signatory of all the most important international treaties in the field, including agreements under the World Trade Organisation (WTO) such as the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).7 The central body responsible for granting rights and coordinating the national IP rights system is the State Intellectual Property Office of the Republic of Croatia (SIPO) (Državni zavod za intelektualno vlasništvo Republike Hrvatske). Industrial property (for protection of patents, trademarks, industrial designs, geographical indications and designations of origin other than for agricultural products, foodstuff, wines and spirit drinks and topographies of semiconductor products) has to be examined and registered before the SIPO in order to enjoy protection in Croatia. On the other hand, copyright protection is automatic and no official registration process is required. Information by the European Trademark and Design Network shows that the duration of the registration process for trademarks and industrial designs in Croatia (three to six months) is within the average in comparison to other EU member states.8 OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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By contrast, due to limited capacity in particular fields of technology at the SIPO, the average duration of the registration process for patents is twice as high as the one at the European Patent Office (seven years against three years). This being said, due to the fact that Croatia is a member state of the European Patent Organisation, since 2008 an increasing share of patents registered in Croatia has been granted through the European Patent Office procedure which only requires formal validation by the SIPO (in 2017 only 4% of newly granted patents were processed by the SIPO). Also, given Croatia’s status as a member state of the European Union, the EU Trademark system and Community design system are substantially being used by companies for obtaining protection for the territory of Croatia.

Enforcement Enforcement rules are the procedural complement of substantive protection. In Croatia, enforcement of IP rights is provided through administrative,9 civil and criminal proceedings. In addition to the courts, the customs authorities and the Ministry of Interior are also involved in the protection of IP rights.10 The authorities keep public records of the enforcement of intellectual property rights in the country.11 According to the latest available report from the SIPO, in 2016 the customs administration initiated a total of 1,229 procedures concerning the shipments of goods suspected of infringing intellectual property rights, 22 (1.8%) out of which were initiated ex officio and 1,207 (98.2%) upon the right holder’s request; a total of 125,158 counterfeited products were destroyed (with an aggregate retail value of EUR 2 067 169). Still in 2016, customs officials carried out a total of 692 inspections in the internal market related to the protection of IP rights, out of which 509 inspections (74%) resulted in serving indictments for initiating a misdemeanour procedure or issuing a misdemeanour warrant. Enforcement through court proceedings presents a more mixed picture, manifested in particular in a very low number of criminal proceedings in relation to Croatia’s ambition to attract investors in the field of innovative industries. According to data by the Ministry of Justice, the total number of persons accused of criminal offences against intellectual property was 18 in 2016 (32 in 2015), out of which 12 persons (16 in 2015) were found guilty.12 Enforcement of IP rights is challenging for many governments but the low number of criminal proceedings and convictions in Croatia calls into question the dissuasiveness of enforcement of IP rights in the country. In light of this, continuing efforts to improve the functioning of the court system would benefit IP rights holders as well as consumers’ interest, as they would facilitate the enforcement of IP rights and foster consumers’ protection. Echoing this sentiment, Croatia introduced in 2018 a new Courts Areas and Seats Act (Official Gazette no. 67/2018 of 25 July 2018), which enables the specialisation of courts in the field of intellectual property in misdemeanours and criminal cases.

Dispute resolution Businesses operating in Croatia, as elsewhere in the world, need to have well-functioning contract enforcement and dispute settlement mechanisms because they help increase predictability and certainty in commercial and investment activities. The national justice system has in this regard a fundamental role to play. Its efficient functioning is necessary for the competiveness and development of the Croatian economy. The particular relevance of the court system for Croatia's competitiveness, growth, SMEs development, and innovation has been regularly pointed out by Croatian governments as well as international institutions such as the European Bank for Reconstruction and Development (EBRD), the European Commission, the International Monetary Fund (IMF) and the World Bank group. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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108 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA The beneficial impact of well-functioning national justice systems for the development of a country has also been underlined in a range of policy tools, literature and research, including from the OECD.13

Croatia offers an increasingly efficient and professional judicial system In Croatia, judicial power is vested in regular and specialized courts. Regular courts are municipal courts, county courts and the Supreme Court of the Republic of Croatia, Croatia's highest judicial instance. Specialised courts are administrative courts, misdemeanours courts and commercial courts. Commercial courts (trgovački sudovi) are competent in disputes between companies, intellectual property disputes, bankruptcy proceedings, unfair market competition and other disputes as provided for in the law such as disputes arising from the foundation and termination of companies. Commercial courts also conduct proceedings for the recognition and enforcement of foreign judicial decisions and arbitral awards in commercial cases. All commercial courts are hierarchical and organised in two instances: commercial courts at first instance, and the High Commercial Court. The Act on Courts regulates the organisation, competence and jurisdiction of courts and their rights and responsibilities. In international and regional comparison, the judicial system in Croatia typically ranks above average. According to the 2018 EU Justice Scoreboard (European Commission, 2018), Croatia has rates of case efficiency for civil, commercial, administrative and other cases comparable with other EU member states. This is also reflected in specialized surveys that assess the business environment. According to the World Bank’s Doing Business report, contract enforcement in domestic courts is an area where Croatia fares well, ranking 25 out of 190 economies in 2019 (World Bank, 2019). In another report by the World Bank on doing business in the European Union, all five of the Croatian cities benchmarked in the study (Osijek, Rijeka, Split, Varaždin, and Zagreb) outperformed the EU average on cost and the quality of judicial processes in 2018 (World Bank, 2018b). Despite these positive ratings, investors and the public in general reportedly lack confidence that their disputes will be handled fairly and expeditiously in Croatian courts. In 2016, in a report on the impartiality and efficiency of judicial systems in the European Union, Croatia ranked higher than in only three other EU members regarding the public perception of the judicial system. 59% of respondents to the EU survey believed that they could not expect a fair trial in Croatian courts, and 48% had no trust in the impartiality of judges and state attorneys. The same year, the World Bank carried out a study to sound out the reasons for public distrust in Croatia’s judicial system.14 People surveyed saw the long duration of proceedings and possible political influence on judges as the main causes of the general negative opinion on the functioning of the judicial system, although opinions regarding political influence were divided: the same number of respondents (48%) felt that judges in Croatia were mostly or fully independent as those who believed that the judiciary lacked independence. The possibility of bias of judicial officials was also mentioned as a cause of distrust of the judiciary.

Reform efforts to improve the judiciary Past and on-going reforms show that the government has been taking these grievances very seriously. For example, five general areas formed the basis of the Judicial Reform Strategy and its Action Plan for the period 2013-2018 adopted in 2012: Independence, impartiality and professionalism of the judiciary; efficiency; Croatian judiciary as part of the European OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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judiciary; human resources management; and using the potential of modern technologies. In this regard, the European Union has acted as an important catalyst for change, in particular during the six years of accession negotiations, but also since then. Croatia has also received significant donor assistance from various international organisations in implementing judicial reform. In order to diffuse concerns about the lack of professionalism and impartiality of the judiciary, significant changes have been introduced in judicial appointments to enhance the objectivity and transparency of magistrates (Council of Europe, 2014 and 2016). For example, the Constitution was amended in 2010 to reduce political interference in the State Judicial Council (SJC), a body modelled on the French and Italian Superior Councils of the Judiciary with important functions in the selection process of judges.15 New criteria selection procedures based on verified qualifications and expertise for the appointment of judges and prosecutors were introduced, limiting political involvement in selecting and disciplining judges and increasing the autonomy of the SJC as well as of the National State's Attorney Council, a body which appoints, dismisses, and decides on the disciplinary responsibility of state attorneys (Dallara, 2014). In 2019, Croatia upgraded the selection procedure for the appointment of the President of the Supreme Court in order to enhance transparency and objectivity of the selection process and minimize risks of improper political influence (Council of Europe, 2019). As a further response to the low level of confidence in the judiciary, the authorities have launched different initiatives to strengthen the integrity of the judicial personnel. Both judges and prosecutors have their own codes of ethics and are subject to financial disclosure.16 Guidelines for the interpretation of deontological principles and the prevention of conflicts of interest were adopted in 2016. Judicial integrity has become part of the inservice training curricula of both judges and prosecutors. In 2019, technical improvements were in the pipeline to strengthen the verification of declarations of assets of prosecutors and judges. Modernising the courts has also been seen as critical to increasing public trust in the judiciary and for the purpose of achieving a more effective judiciary. Before and since accession to the EU, Croatia's courts have been gradually modernised with simplified, automated procedures using information and communications technology (ICT) and improved public access and transparency. An upgraded ICT system at courts began to be introduced in 2014 in all first-instance municipal, county and commercial courts. The Integrated Case Management System (ICMS) is now functioning in a majority of courts, including the High Commercial Court and the High Misdemeanour Court which both joined the unified e-File System in 2016, enabling electronic court operations and electronic communications with lower courts; introduction of the e-File System to the Supreme Court was in the testing phase in 2018. Case law and centralised legislative databases are now increasingly available, providing further support for court professionals with the overall objective of greater court practice consistency and increased legal certainty.17 ICT skills have become part of the in-service training curricula of magistrates in support of greater use of electronic communication in litigation and other proceedings. Significant additional efforts have been undertaken to accelerate court processes and improve the way courts operate. After a first phase of court network reforms in the late 2000's and early 2010's18, as from 2015, the government began to implement a new reorganisation of the court system. The reform, affecting municipal, misdemeanour, and county courts, has aimed to increase specialisation and balance out the uneven workload of judges by merging courts. This process is in progress. Further rationalisation of Croatia's

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110 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA judicial map is expected to come into force in 2019 through the merging of most misdemeanour courts with municipal courts.19 In order to improve legal security and the efficiency of courts, the government has also taken steps aimed at rationalising laws and procedures, as evidenced by the adoption of a large volume of legislation in this area. For example, significant amendments to the Civil Procedure Act were introduced in 2013 to streamline the way the litigation process is administered, including the way litigants submit evidence. During 2005-13 alone, the Act on Courts was amended 10 times. These new acts, or amendments to existing ones, have been drafted following discussions by ad-hoc working groups bringing together experts and professionals in the field, thorough public consultations including with business associations, and taking into consideration international and EU legal requirements and case law. As a result, the performance of the justice system has improved in recent years. Croatia now has rates of case efficiency for civil, commercial, administrative and other cases comparable with other EU member states. Important progress has also been made in reducing pending cases, which have plagued the judiciary for many years. In 2017, backlogs in first instance courts in civil, commercial, and enforcement cases decreased by 6% in comparison to 2016 whereas, at second instance, they decreased by 23% in commercial cases (before the High Commercial Court) and by 13% in civil cases, before county courts.20 Overall, according to the World Bank, the number of pending cases has fallen by half over the past decade.21 Despite these encouraging developments, in 2018, only 23% of Croatia's inhabitants had very good or pretty good opinion about the courts and judges in their country, according to a survey conducted by Eurobarometer (European Commission, 2018). This more or less corresponds to the level of public discontent expressed eight years before in the November 2010 Eurobarometer on “Trust in Institutions”: at that time, 76% of the respondents expressed mistrust of the judiciary. On their part, businesses continue to perceive the courts as too slow for their needs (Foreign Investors Council, 2017). This important contradiction between perception and reality suggests the need for the development of a targeted communication policy, which reflects on the important reforms already introduced and those in the pipeline. 22 Weaknesses in the judicial system nevertheless persist. For example, professionalization is still insufficient, especially at local level. The implementation of e-procedures in the court is progressing, though slowlier than expected. There is scope for further strengthening Croatia's judiciary to stimulate investor confidence. This includes further reducing delays in court decisions. More intensive continuous training for judges in emerging areas of law should also result in greater court practice consistency. As discussed below, initiatives to facilitate the use of out-of-court methods of dispute resolution also need to be followed through.

Alternative dispute resolution mechanisms: arbitration and mediation Encouraging out-of-court settlements has been a priority of Croatia (Strategy for the Reform of the Justice System 2006-2010; Strategy for the Reform of the Justice System 2011-2015; National Reform Programme 2017). Alternative dispute resolution (ARD) schemes have been seen by the Croatian authorities as an additional tool to cope with the under-performing judiciary, in particular with regards to small-value commercial cases.23

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Croatia's legal framework for arbitration and mediation is largely defined by the Arbitration Act (Official Gazette No. 88/2001), and the Mediation Act (Official Gazette No. 18/11), which entered into force in full on the accession date of Croatia to the EU. Provisions on ARD are contained in other acts, such as the Civil Obligations Act, the Trades and Crafts Act, and, most recently, the Act on Alternative Consumer Dispute Resolution, enacted in 2017. The Arbitration Act is based on the United Nations Commission on International Trade Law (UNCITRAL) Model Law. It applies to commercial and non-commercial disputes and considers that any arbitration seated in Croatia is a domestic arbitration. The Act applies, as such, to disputes with an international element - i.e. those where at least one of the parties is a foreign person or legal entity - if the seat is in Croatia. In addition to domestic arbitration, the Act addresses recognition and enforcement of arbitration rulings, jurisdictional matters and procedures. Once an arbitration decision has been reached, the decision is executed by court order. Arbitration rulings have the force of a final judgment, but can be appealed. There is one major arbitration institution in Croatia, which is the Permanent Arbitration Court at the Croatian Chamber of Economy (PAC-CCE), first established in 1853 and re-established in 1965 when the soviet model of arbitration was replaced by the modern Western model of voluntary arbitration. Arbitration proceedings at the PAC-CCE are governed by the PAC-CCE Rules of International Arbitration, also called Zagreb Rules, which have been drafted along the lines of the UNCITRAL Arbitration Rules. The usual duration of arbitration proceedings is between one and three years; the Zagreb Rules require that the proceedings are concluded within one year.24 For its part, the Mediation Act provides that mediation can be conducted in all regular and specialised first and second instance courts (municipal, county, commercial courts and the High Commercial Court) in all stages of the proceedings, including during the appeal proceedings. Mediation can also be carried out outside of courts by various mediation centres established at professional associations. A range of organisations for mediation are in place, such as the Centre for Mediation at the Croatian Chamber of Economy, the Centre for Mediation at the Croatian Association of Employers, and the Croatian Mediation Association. Mediation with selected mediators can be conducted outside of these centres. Mediation is initiated on a proposal by one party involved in a dispute accepted by the other party, by a joint motion of both parties, or a proposal by a third party (e.g. a judge in a court proceeding). Mediation must be completed within 60 days upon receipt of the acceptation of the proposal for its launch; that period may be extended if the parties fail to reach an agreement. Despite the availability of out-of-court methods of dispute resolution in Croatia, in practice arbitration and mediation as an alternative to resolving disputes in courts are under-used (International Bar Association, 2018; American Chamber of Commerce, 2017). Arbitration is seen as a dispute resolution method for large companies, not for small and medium-sized enterprises due to the costs involved, and is primarily used as an alternative in international disputes. In civil and commercial disputes involving exclusively domestic entities, including disputes in which one party is the Republic of Croatia, parties mainly rely on court proceedings. As far as mediation is concerned, despite increasing promotion efforts in recent years both by state courts and the newly formed mediations centres, the use of mediation in commercial and civil matters also falls short of expectations. According to the World Bank, in 2014, less than 5% of civil litigation cases were resolved using court-annexed mediation.25 Although the state of play in Croatia does not differ significantly from the

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112 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA practice in other EU member states (European Commission, 2016), the underutilisation of services such as mediation calls into question the effectiveness of Croatia's efforts in promoting the use of out-of-court methods of dispute resolution. Efforts aimed at strengthening the use of alternative dispute resolution mechanisms, including through appropriate information campaigns, should be increased as this should help to further alleviate the backlog in Croatian courts (Council of Europe, 2016; European Commission, 2016). The establishment of an NCP (see chapter 8) is a positive development in that regard. NCPs facilitate access to consensual and non-adversarial means, such as conciliation or mediation, to resolve issues that arise if the Guidelines for Multinational Enterprises are not observed. NCPs provide a government-based non-judicial grievance mechanism. The problem solving focus of NCPs allows the involved parties to exercise a better level of control over the process of reaching an agreement than more formal processes in which a third unrelated party makes a final binding decision. This can often be a significantly more expeditious and cost saving alternative to more formal procedures.

International investment agreements Like many countries in the world, Croatia has taken on international obligations to grant foreign investors specific treatment in international investment agreements (referred to as investment treaties or IIAs), most often in the form of bilateral investment treaties (BITs).26 These treaties grant stand-alone protections to covered investors in addition to and essentially independently from protections afforded by domestic law. Investment treaties grant these protections only to a selected group of investors: foreigners as defined in and for the purpose of each individual treaty. Domestic investors are in principle not covered by this favourable regime unless they structure their investment in a fashion that turns them into “foreigners” for the purpose of the treaty. On substance, investment treaties typically guarantee covered investments relative treatment standards of non-discrimination – most prominently most-favoured nation (MFN) treatment and national treatment (NT) – as well as absolute standards such as protection against “expropriation without compensation” and “fair and equitable treatment” (FET), which do not necessarily have equivalents in protections offered under domestic law. Furthermore, investment treaties typically give covered investors access to investorstate dispute settlement mechanisms (ISDS) to directly seek damages in cases where they claim the host state has infringed any of these rights. The reasons why states have concluded such investment treaties since the late 1950s are debated as part of a recent broad reconsideration of these arrangements in some countries. It is generally held that one of the main reasons that motivated certain countries to conclude investment treaties was to attract foreign investment; capital exporting countries are thought to value these treaties among others to provide additional protections to enterprises operating from their soil – assumptions that are increasingly questioned by a growing strand of empirical literature on the drivers of investment treaty proliferation.27 Croatia’s past policies and practice are in many respects similar to what is observed in the global system of IIAs.

Brief history of Croatia’s investment treaties policy and current trends According to publicly available information, Croatia inherited only a single treaty through state succession from Yugoslavia.28 Almost immediately after independence, Croatia began

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concluding additional investment treaties, and within 15 years between 1993 and 2008, it negotiated and concluded 58 BITs. Since 2008, Croatia has not concluded any further BITs. However, it concluded at least eleven amendments to existing treaties since 2008 – leading Croatia to be among the countries with the highest proportion of known treaty amendments in the world. On substance, these amendments essentially adjusted treaty provisions to prepare Croatia for EU-Membership.29 In addition to concluding BITs, Croatia also became party to several plurilateral investment treaties with investment protection content, notably the Energy Charter Treaty, which Croatia signed in December 1994. More recently, several further plurilateral treaties concluded by the European Union with Canada, Japan, Singapore, and Viet Nam, were added; they will bind Croatia once in force. As a result of this treaty making activity, as of March -2019, Croatia had signed investment treaty relationships with 78 economies; treaties covering 67 relationships were in force at this time, of which 48 were based on bilateral treaties. The investment protection content of agreements concluded by the European Union – and which will ultimately bind Croatia – had not yet entered into effect in March-2019. Croatia chose to conclude treaties with a diverse set of economies, large and small, advanced or developing, with no pattern that would reveal an obvious policy or strategy; there appears to be a slight tendency that Croatia first concluded with “richer” countries, measured in GDP per capita, and later also concluded treaties with partners that had a lower GDP per capita than Croatia at the time30 (see Figure 5.1 for a timeline of treaty conclusions since Croatia’s independence). Figure 5.1. Evolution of Croatia’s investment treaty relations (signed relationships) bilateral treaty with "richer" country concluded cumulated concluded relationships (right scale) number of bilateral treaties concluded in year 14

bilateral treaty with "poorer" country concluded

total relationships at end of year 80 70

12

60

10

50

8

40 6

30

4

20

2 0

10 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 year of conclusion

Source: OECD calculations based on OECD treaty database and Croatian government; World Bank data on GDP.

Croatia’s treaty making activity and the choice of treaty partners has led to a very significant coverage of its inward and outward FDI stock.31 Bilateral agreements concluded in 1996 to 1998 alone contributed treaty cover to over 70% of Croatia’s inward and outward FDI stocks (Figure 5.2) at its peak, before the termination of the Italy-Croatia BIT (1996),32 almost 95% of Croatia’s inward FDI stock was treaty-covered. Treaties concluded before

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114 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA and after that 3-year period barely added any treaty cover to Croatia’s FDI stock, inward or outward. Three treaties alone, the BITs with the Netherlands, Austria, and Hungary together brought almost half of Croatia’s inward FDI stock under treaty cover, and the BITs concluded with the Netherlands, Bosnia and Herzegovina and Slovenia cover around two thirds of Croatia’s outward FDI stock.33 Many treaties that Croatia has concluded cover no or almost no FDI stock; in this respect, as in many others, the Croatian treaty sample is not an outlier when compared with the global sample. Figure 5.2. Approximate evolution of Croatia’s inward and outward FDI stock coverage by treaty cohort aggregate OUTward FDI stock cover aggregate INward FDI stock cover

added OUTward FDI stock cover added INward FDI stock cover

100%

80% 60% 40% 20% 0% 20%

40% 60% 80% 100%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 year of conclusion

Source: OECD calculations based on OECD treaty database; FDI data was taken from OECD FDI database and IMF Direct Investment Positions and reflects FDI stock as of 2016 rather than historical values.

In the course of the present Review, the Croatian government stated in early 2018 that it has now chosen a more selective approach to concluding new treaties. Croatia’s overall objective is to conclude new treaties with countries in which Croatian businesses operate in order to grant these businesses the advantages that come with treaty coverage. The objective to attract investment to Croatia by offering foreign investors treaty protection does no longer feature among the current government’s objectives, according to its own statement. According to the Croatian government’s statements in early 2018, there was no intention to terminate existing treaties to avoid sending a misleading signal on its stance in relation to investment protection. The government intends however to amend or replace its existing treaties to address perceived shortcomings in the design used in its earlier treaties. On 15 January 2019, Croatia co-signed the Declaration of the Representatives of the Governments of the Member States on the legal consequences of the Judgment of the Court of Justice in ACHMEA and on Investment Protection in the European Union, along with 21 EU member states. As part of this Declaration, Croatia engaged to “terminate all bilateral investment treaties concluded between [the EU Member States] by means of a plurilateral treaty or, where that is mutually recognised as more expedient, bilaterally”. The remaining six EU Member States signed separate declarations on 16 January 2019 with

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broadly similar effect. Croatia and the rest of the EU Member States committed to make best efforts to finalise this process by early December 2019. Developments related to this process – which may ultimately also concern Croatia’s position under the Energy Charter Treaty in relation to investments originating from other EU Member States – are likely to have a significant impact on Croatia’s exposure to investment treaty obligations, given that a large share of inward FDI coverage is currently afforded by the 25 remaining intra-EU BITs. All else equal, the termination of Croatia’s intra-EU BITs would bring the share of treaty-covered inward FDI stock from currently over 80% of total inward FDI into Croatia to less than 3%, not considering investment that is covered by the Energy Charter. The proportion of outward FDI stock of Croatian investors that is under treaty cover would drop from around 77% to around 28%. In early 2018, the Croatian government expressed its interest to conclude new treaties with Kazakhstan, Qatar34 and Turkmenistan, based on a new model BIT that was still under development in October 2018 but that would, according to the Croatian government, emulate the approach taken in the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada. By February 2019, negotiations with these three countries had not yet concluded.

Availability of Croatia’s IIAs to treaty users Croatia has made its IIAs or related Protocols and amendments available to treaty users through official websites. Texts of treaties and protocols can be found with some effort in the official gazette,35 albeit only in Croatian language, which is typically only one of the authentic languages of the treaties. Information on the existence of protocols and amendments and their in-force status is available in English and Croatian. No consolidated versions are available however despite a significant number of treaty amendments. Croatia does not advertise its treaties, for example through the website of relevant ministries or in investment promotion material. In this regard, Croatia is in a similar situation as many countries, especially transition and developing countries.36

Main features of Croatia’s IIAs Croatia’s BITs testify to the pace at which Croatia concluded its investment agreements in the 1990s and of the limitations on the Croatian government’s capacity to anticipate implications and future interpretation of treaty language. The treaties show many of the features associated with “first-generation” treaties concluded in great numbers in the 1990s, notably a lack of clarity of the meaning of key provisions, absence of rules that most would consider to be essential and ubiquitous in a domestic law context, and generous protections favourable to covered investors. From the treaty texts it appears that Croatia has accepted the treaty models of its partners in an earlier phase of treaty making, especially when it contracted with comparatively richer countries. From this period results some heterogeneity in treaty designs and provisions. In a later period in and after 1998, treaties that Croatia has concluded with less advanced economies suggest that Croatia proposed and potentially even imposed its own model treaty, as the treaties that have been concluded during this period feature common elements in their design and text.37 An unusually high proportion of Croatia’s treaties – when considered against a global sample – have unique features, both in terms of provisions and language used. These include the absence of a fair and equitable treatment clause in one IIA, 38 the absence of an OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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116 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA initial validity period in two BITs,39 an explicit statement on the possibility for Croatian joint-venture partners to bring treaty-based claims,40 the possibility for an investor to bring an investment dispute to a domestic commercial arbitration forum of one of the treaty partners,41 the binding nature on an investor-state dispute award on the Parties to the IIA,42 a clause that seeks to prevent double recovery in an expropriation clause,43 a clause that requires the information about disputes between treaty parties,44 and unusually sophisticated design of the ISDS clause among parties that are not know for the use of this type of clause, especially at the time when the treaty was concluded.45 It is not certain whether these unique features in Croatian treaties respond to identified specific situations or reflect poor understanding of implications; they suggest a possible desire to experiment or innovate. Diversity of provisions in IIAs tends to broaden countries’ exposure to claims, especially in connection with unspecified most favoured nation (MFN) provisions as currently interpreted by many arbitral tribunals. As Croatia’s treaties systematically grant MFN and do not specify how MFN is to be interpreted and applied,46 many arbitral tribunals are likely to allow investors to use a treaty that contains the provisions that are most favourable to its specific situation and claim. In this scenario, diversity of treaty provisions tend to harm a defendant state. Some of the most central provisions that determine Croatia’s exposure to treaty based claims and the balance between investor protection and the right to regulate include the “fair and equitable” treatment (FET) clause and the design of investor-state dispute settlement mechanism included in its IIAs.

Fair and equitable treatment clauses Fair and equitable treatment is at the centre of investment treaty claims and treaty policy; is has been invoked in a great number of cases and tribunals have often found a breach of this standard.47 Provisions providing generally for FET have been considered or applied by tribunals in a broad range of claims and there have been widely different interpretations by some arbitral tribunals. Some interpretations of FET are seen as having a significant impact on the right to regulate.48 All IIAs concluded by Croatia grant FET to covered investors.49 Almost all of Croatia’s treaties either state that foreign investors shall be accorded FET without providing further specification; other treaties provide that FET shall be granted “in accordance with international law”. One single treaty, the Croatia-Azerbaijan BIT (2007), links FET to the minimum standard of treatment under customary international law. This latter treaty echoes a growing trend to define FET provisions in treaties to give more direction to arbitrators by clarifying the original intent of the contracting parties (see Box 5.1 for more details). Given the centrality of FET to many investor claims and the uncertainty of its meaning, combined with the unspecified design in most of Croatia’s treaties, clarification of government intent could improve predictability for both governments and investors. Croatia might wish to reflect the more specific language found in recent international treaty practice in its own policy.

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Box 5.1. Two approaches to specifying and limiting the FET provision

Two important approaches to further specifying the scope of fair and equitable treatment have emerged: 

Express limitation to the minimum standard of treatment under customary international law (MST): This approach has been used in a number of major recent treaties in Asia and the Americas. A FET provision limited to MST has been repeatedly interpreted under NAFTA. It has been interpreted more narrowly than FET provisions under other treaties. NAFTA governments have also had much greater success than other governments in defending FET claims (UNCTAD, 2012: 61). In addition to the limitation of FET to MST, the Comprehensive and Progressive Trans-Pacific Partnership agreement (CPTPP), which is a largely built on U.S. practice, specifies that the mere fact that government action is not consistent with an investor’s expectation does not constitute a breach of FET (Art. 9.6(4). Art. 9.6(3) and (5) contain further specifications).



Defined lists of elements of FET: Treaties negotiated by the European Union contain a defined list of elements of the FET provision. This approach lists the elements that can constitute a breach of the standard, namely denial of justice, fundamental breach of due process, targeted discrimination on manifestly wrongful grounds, and abusive treatment of investors. While it is a closed list, this approach is broader than some interpretations of MST. Arbitration tribunals cannot add new elements. Only the Parties may agree to add further elements to the list. The article also provides that the tribunal “may take into account” (or “will take into account”, in EU-Viet Nam FTA) specific representations that created legitimate expectations. Other defined list approaches are also used. For example, the ASEAN-China Investment Agreement (2009) limits the application of its FET provision to cases of denial of justice (Art. 7).

Both options are more specific than the broad language of treaties that only refer to “fair and equitable” treatment. This does not mean, however, that issues of interpretation may not arise. The content of the minimum standard of treatment, for example, is subject to debate as are a number of elements in the defined EU lists.

Investment dispute settlement mechanisms Starting in the 1970s, mechanisms for covered investors to bring claims directly against host governments – ISDS mechanisms – for alleged violations of treaty obligations had become a near-universal feature of investment treaties by the late 1980s. OECD research shows that around 96% of the global IIA stock provides access to ISDS (Pohl et al., 2012). Croatia’s treaties share this feature: All of the IIAs that Croatia has concluded or to which it has adhered contain ISDS provisions. Treaties that Croatia has negotiated itself systematically offer, in addition to or as an alternative to domestic remedies, such as dispute settlement mechanism through investor-state arbitration (ISA). ISA generally involves ad hoc arbitration tribunals selected for each case in an approach derived from international commercial arbitration (Gaukrodger and Gordon, 2012). The disputing parties and arbitration institutions can be involved in the process to select arbitrators. The emphasis is on finality and there are no appeals; arbitrators’ decisions are subject only to very limited review. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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118 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA Proponents of ISA contend that it provides a forum to settle disputes that is independent from both the host state and the investor. However, ISA has been increasingly challenged in recent years for reasons related to the characteristics of a pool of investment arbitrators dominated by private lawyers, concerns about inconsistent outcomes, and alleged conflicts of interest and economic incentives among arbitrators and arbitration institutions (Gaukrodger and Gordon, 2012: 43, 58; Gaukrodger, 2017). The European Union has rejected ISA and has instead developed a new approach to dispute settlement under investment treaties. The EU has proposed to set up a permanent court and an appellate tribunal to resolve investor-state disputes (the Investment Court System (ICS)). This approach has been included in four treaties negotiated by the EU (EU-Canada CETA, EU-Viet Nam FTA, EU-Singapore FTA, EU-Japan FTA). As a EU Member, Croatia will be involved in the development of the court, and may later be a defendant against cases that may be brought under treaties concluded by the EU. Future Croatian treaties may also refer to a court mechanism. Generally, ISA mechanisms in investment treaties are typically barely regulated (Pohl et al., 2012: 39; Gaukrodger and Gordon, 2012) – in stark contrast to procedural rules observed in domestic adjudication in advanced systems of law. Some issues that the treaty does not address may be regulated by the arbitration rules, but as rules designed for commercial disputes between private parties, they may need adjustment in light of the nature of investment claims. Other issues remain unregulated if the treaties refrain from doing so. For example, in the absence of treaty provisions, ISDS is often rather opaque and lacks statute of limitations. Croatian treaties are not an exception in these regards when compared to a global sample. With two exceptions – Canada-Croatia BIT (1997) and Croatia-Kuwait BIT (1997) – Croatian treaties regulate dispute settlement unevenly: 

Only one of Croatia’s treaties50 has a statute of limitation – a feature that is standard in domestic law systems and that has become more and more common in IIAs concluded since 2005.



Most Croatian treaties do not clarify the relationship between domestic remedies and dispute settlement through international arbitration; on the face of the treaty text, investors would be in a position to pursue their case first in domestic courts and subsequently through international arbitration.



Only a third of Croatia’s treaties specify on which legal basis the tribunals decide a case brought before them, and those that do, do not establish a consistent list.



The overall regulatory depth of ISDS in Croatian treaties is low. On average, Croatian treaties address only 2.3 issues, lower than the average of the global sample, including when taking into account the average age of Croatia’s treaty sample. Regulatory depth of ISDS provisions generally increased over time (see Figure 5.3).

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Average number of parameters that ISDS provisions of a country's treaty sample address

Figure 5.3 Regulatory depth of ISDS provisions: individual countries, Croatia, and global trend 10 MEX

9 8

COL

CAN

7

6 5

JPN AUS

USA

4 3

GRC LUX BEL CHN

CHE

DEU

POL

2

MYS ROU

1

GBRFRA

NOR

TUN

HUN NLD

PRY ARG SWE ITA EGY BGR DNK

MAR EST RUS

IND

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ESP

ISL

PER ZAF

PRT FIN LTU SVN UKR HRV SGP SVK JOR CZE LVA KAZ KORTHA ISR

SAU TUR

NZL

IDN

0 ​

32

30

28

26

24

22

20 18 16 14 12 average age of a country's treaty sample (years)

10

Source: OECD calculations based on OECD treaty database.

Furthermore, most Croatian treaties offer investors two (54% of Croatia’s treaties) or even three (27% of Croatia’s treaties) different arbitration fora to choose from, bringing the average number of fora for investors to choose from well over the global average. This generous offer allows investors to bring claims under rules that are most beneficial for their specific case. In particular, 77% of Croatia’s treaties offer access to both ICSID and ad hoc tribunals under UNCITRAL rules, which have different regimes in relation to the composition of tribunals, transparency and enforcement.51 As for other areas of treaty content, ISDS clauses in Croatia’s treaty sample show some unique features that are extremely rare or otherwise absent from the global treaty sample. For example, the Lithuania-Croatia BIT (2008) allows investors to unilaterally choose to entrust “national commercial arbitration institutions” of the treaty parties with investorState arbitration – a unique occurrence in 1755 assessed IIAs in the global sample. The Turkey-Croatia BIT (1996), which, unusually, limits the scope of issues that could be subject to arbitration, also states that the award of a tribunal binds the treaty parties – rather than the parties to the dispute; even the later amendment – Protocol (2009) to TurkeyCroatia BIT (1996) – did not remedy this situation, although it modified the ISDS clause. Such unusual provisions may have concrete implications for Croatia’s exposure and defense against claims, while commensurate benefits to the Croatian government or Croatian investors are not immediately obvious.

Treaty use: ISDS claims under Croatia’s investment treaties Croatia and Croatian enterprises have some practical experience with treaty-use as a base of investor claims. By October 2018, 12 claims were known to have formally been brought against Croatia, and the Croatian government was aware of three claims that Croatian investors had brought based on IIAs concluded by Croatia.

Croatia as a defendant The 12 treaty-based claims that had formally been brought against Croatia by October 2018 were based on five treaties to which Croatia is a party. Half of the claims were brought

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120 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA under the Austria-Croatia BIT (1997) and two cases each under the Netherlands-Croatia BIT (1998) and Energy Charter Treaty. All claims against Croatia have been filed after 2013, five years after Croatia had concluded its so far last investment treaty. Five of the 12 claims brought against Croatia were associated with legislation that converted foreign-currency denominated mortgage and consumer loans into Kunadenominated loans in late 2015. The measure was taken in response to a steep fall of the Kuna and resulting pressure on households that bore the foreign exchange rate risk. The other cases related to spatial planning, energy, and courier services. By October 2018, three cases had been concluded in terms that the Croatian government characterised as favourable; the remainder of the cases were pending in October 2018. Croatia organises the defence against treaty-based claims through the Attorney General’s department, which procures services from private law firms. Initially, the costs associated with the law firms’ services were funded out of the Attorney-General’s department, but as they rose quickly, a single account has been created within the Croatian government. Aggregate annual expenditure for the sourcing of these services is publicly available in budgetary reports. The sourcing of legal advice from private law firms itself is not without implications: While it allows to mobilise specialised knowledge and resources that may not be available to a government that is only occasionally involved in such proceedings, law firms may have economic interests that differ from those of the government. This situation, known as “principal-agent situation” – may for instance lead a law firm (agent) to advise the government (principal) to take steps that prolong or expand procedures in defence of the claim, as this also expands the mandate of the firm. Croatia seeks to address these implications by capping expenditure for each phase of the dispute. In order to manage emerging investor-state disputes against Croatia, the government has established an early-warning system in relation to disputes with foreign investors.

Croatian investors as claimants Three Croatian investors are known to have brought claims, all under the Energy Charter Treaty, against treaty partners of Croatia (Bosnia and Herzegovina, Slovenia, Serbia) in what the Croatian government describes as relatively minor-value cases. To the knowledge of the Croatian government, all three cases had been settled by early 2018, and no new cases had become known by October 2018.

Outlook and policy recommendations Domestic framework for investment protection Croatia has a rich past history of reforming its judiciary and a good success rate to bring these reforms into concrete results. The authorities have notably actively worked on the reduction of court backlogs, on digitalisation of the courts and on judicial integrity and professionalism. Overall the changes to the judicial framework go in the right direction: the performance of the justice system has improved significantly. Most recent business surveys nevertheless indicate that the judiciary is still perceived as one of the biggest shortcomings when it comes to business conditions in Croatia compared to other countries in the region (American Chamber of Commerce in Croatia, 2018). Against this background, efforts to facilitate arbitration and mediation as mechanisms to settle disputes with the overall purpose of unburdening the judiciary in Croatia are OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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welcome. For example, the recently established Civil Arbitration Court (Parnični arbitražni sud) provide parties with an alternative forum for the resolution of disputes related to small claims with shorter deadlines for the delivery of decisions (within 60 to 90 days for a dispute of up to approximately EUR 50 000, and four months for larger disputes), no requirement for parties to be represented by counsels and no hearing, unless necessary.52 By comparison, according to data from the Ministry of Justice, municipal and commercial courts needed in 2017 513 days on average to make a first-instance decision (Croatia, 2018). Initiatives to facilitate the use of out-of-court dispute resolution need to be followed through. To further improve its dispute settlement mechanisms, Croatia could consider establishing institutional dispute avoidance mechanisms, such as offering ombudsman services to investors to try to resolve problems before they lead to disputes. Experiences in countries such as Ukraine, which has been operating a Business Ombudsman Council since 2014, or Korea, with its Foreign Investment Ombudsman, suggest that alternative processes may have a potentially powerful role to play (Nicolas et al., 2013; Wehrlé, 2015). First, such mechanisms can be a stopgap measure to compensate for the shortcomings of the judiciary, and can address issues at an early stage before they become a dispute. They further have the scope to provide quick solutions to companies’ grievances by providing businesses with a direct line of communication with a public authority at a high level, by mitigating fears of retaliation by allowing them to report these to an institution that is independent from the agencies they complain about, and by empowering them to become partners with public authorities in advancing their rights and business interests through their involvement in the dispute resolution process. The common denominator among such mechanisms is that they act as redress mechanisms. Their main purpose is to find resolutions of grievances outside the judicial process for reasons such as time and cost saving, informality, and a desire to avoid confrontation (Wehrlé, 2015). Such mechanisms, which wish to serve the purpose of offering a less formal and quicker way of resolving disputes, should nevertheless not be seen as a substitute for a wellfunctioning national judiciary (OECD, 2015). While high burdens and backlogs may be reduced through measures aimed at speeding up the resolution of small disputes and the usage of alternative case resolution, a more efficient judiciary can only be achieved by addressing a number of inter-related components such as further simplifying and rationalising regulations dealing with procedural and administrative matters; providing more intensive training for judges in emerging areas of law; improving further the administration of courts; etc. Reforming the judiciary is a challenging undertaking for many governments, including for Croatia's EU peers. With the continuous pressure from the European Union to speed up reforms, more progress can be expected in this area in the coming years.

Investor protection afforded by arrangements based on international law Croatia’s current investment treaties cover an important share of inward and outward investment to and from Croatia. This scenario entails exposure, especially given that Croatian treaties follow outdated design features with unspecific clauses, and are diverse in design and language. To better balance investor protection with government right to regulate, Croatia could pursue different courses of action.

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Higher specification of investment protection provisions would help to better reflect government intent International practice shows that investment protection standards in older IIAs have often been relatively vague. This vagueness gives investment arbitrators broad discretion to interpret and thereby determine the scope of protection they provide. Many provisions in Croatia’s IIAs – beyond those discussed in some greater detail here – lack specific language to indicate government intent as to their scope and meaning. More specific language in investment protection provisions would lead to increased predictability and thereby benefit both investors and governments. The specifications reflect policy choices and also play a crucial role in the quest for balance between investor protection and governments’ right to regulate. In some cases, the specifications may affect the degree of protection for covered foreign investors. Policy-makers need to carefully consider the costs and benefits of these choices, and their potential impact on foreign investors and domestic investors, as well as on the host state’s legitimate regulatory interests and its exposure to investment claims. Croatia has a rich history of amending its treaties and a good success rate to bring these amendments into force – a feat that is not a given. Other countries have, according to anecdotal evidence, had less success to change their IIAs through amendments. The many amendments that Croatia have concluded so far have not led to a more homogeneous treaty set nor have they brought into place designs that would today be considered sound treaty policy. None of the amendments have addressed shortcomings in ISDS provisions or clarified the scope of what “fair” and “equitable” treatment requires, for instance.

Procedural considerations: exit and renegotiation Given Croatia’s investment treaty features, Croatia might wish to consider reviewing its existing agreements to ensure that they reflect government intent and sound practices emerging in recent treaty policy. Review and renegotiation of investment treaties takes time, as Croatia will have experienced during the review of its treaties carried out to prepare its EU-Membership. Also, the option to terminate treaties is not available at all times, as investment treaties’ clauses on their temporal validity often place limits on exit (see Box 5.2 on designs of temporal validity provisions in IIAs). Many of Croatia’s treaties contain a design of the temporal validity that delays possibilities for unilateral exit from the treaty. Where this design can be found, it would appear that it was initiated by Croatia: the treaties that Croatia concluded with less developed countries in the later period – and which are presumably based on a Croatian Model BIT – contain automatic extensions for fixed periods. When compared to a global sample, Croatia’s policy choice locks its choice in for around 5 more years than average. Croatia is bound by at least one treaty until 2032, and even if it wanted to unilaterally withdraw from the IIA system at the earliest possible occasion, effects of its past treaty policy could bind Croatia until 2047 (Figure 5.5).

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Box 5.2. Designs of temporal validity provisions in IIAs

Unlike most international treaties, which can be denounced at relatively short notice, investment treaties typically contain clauses that extend their temporal validity for significant periods of time. Three designs can be found, often cumulatively in the same agreement: First, most investment treaties set and initial validity period of often 10 years or more, counting from the treaty’s entry into force; after that period, many treaties only allow States Parties to denounce the treaty at the end of specific intervals of often 10 years or more; finally, treaty obligations almost universally continue to apply for a “sunset period” after the termination of the treaty, again for periods of typically 10 years or more. Many treaties thus bind the States Parties for at least two decades, and in some extreme cases for up to 50 years. Treaty designs that automatically extend the validity of the treaty for fixed terms are included in around 30% of the global treaty stock, but this design is used less frequently in recent time. This design tends to prolong the period for which States Parties are bound without granting additional benefits in terms of predictability for investors: on the contrary, the oscillating residual treaty validity is hard to grasp and predict without detailed study, and drops to very short residual validity of no more than 6 months (Figure 5.4). Figure 5.4. Residual validity of treaties depending on the design of their validity clause Argentina-Croatia BIT (1994)

120

100

Croatia-Albania BIT (1993)

guaranteed residual treaty validity at a given time (months), not including sunset period

80 60 40 20

0

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

Note: Adapted from Pohl, J. (2013), “Temporal Validity of International Investment Agreements: A Large Sample Survey of Treaty Provisions”, OECD Working Papers on International Investment 2013/04, http://dx.doi.org/10.1787/5k3tsjsl5fvh-en. Source: OECD calculations based on OECD treaty database.

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124 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA Figure 5.5. Projection of the temporal validity of Croatia’s IIAs compared to global sample percent of treaties that still have effects in given year (Croatia) Croatia cumulation of treaties in force percentage of treaties that will still be in force in given year, based on treaties in force in 2019 (global sample) percent of treaties that still have effects in given year 100% 90% 80% 70% 60%

50% 40% 30% 20%

2053

2052

2051

2050

2049

2048

2047

2046

2045

2044

2043

2042

2041

2040

2039

2038

2037

2036

2035

2034

2033

2032

2031

2030

2029

2028

2027

2026

2025

2024

2023

2022

2021

2020

0%

2019

10%

Note: Projections based on a hypothetical scenario of unilateral denunciation of all treaties at the earliest possible occasion. Source: OECD calculations based on OECD treaty database.

Unilateral exit from treaties is not the only option to address perceived shortcomings, and Croatia has signalled that it does not wish to pursue this approach. Possibilities for exit may however influence how amendments or agreed exits can be negotiated. Croatia may want hence to consider whether the current design of its temporal validity provisions serve its interests and consider adjusting its treaty policy in the context of amendments or renegotiation of existing treaties or in negotiations of future treaties.

Policy recommendations Domestic framework 

Continue efforts to improve the functioning of the court system. Building on recent reforms, further improvements in the capacity of the courts to deal with private sector cases will likely boost confidence of businesses and the general public in the judiciary. This may include additional compulsory training for judges, further digitalisation of court procedures, further promoting out-of-court settlement,



Enhance dispute resolution mechanisms. Establishing a dispute avoidance mechanism, tailored specifically to business needs, such as a Business Ombudsman, would help expedite the legal process and reduce the cost to businesses and citizens.

Investor protection afforded by arrangements based on international law, in particular investment treaties 

Continue and enhance efforts to manage existing treaties and associated exposure. Treaties with vague provisions concluded by Croatia in the past, including those subject to unwanted interpretations in ISDS, should be updated to current standards OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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by amendments, clarifications – for example through joint interpretations –, replaced, or if appropriate, terminated by consent or unilateral action to manage exposure and safeguard the right to regulate in the public interest. 

Engage in international efforts to balance treaty-based investor protection and associated governance mechanisms. Croatia should engage actively in current efforts at international level to balance investor protection and the right to regulate, and contribute its experience.

Notes 1

Article 2 paragraph 1 of the Law on the Expropriation and Determination of Compensation (Official Gazette, 74/14 and 69/17). 2

Law on the Expropriation and Determination of Compensation; Law on Valuation of Real Estate (Official Gazette, 78/15); the General Administrative Procedure Act (Official Gazette 47/09). 3

Article 46 of the Law on the Expropriation and Determination of Compensation.

4

State Intellectual Property Office of the Republic of Croatia, National Strategy for the Development of a Croatian National Intellectual Property System for the period from 2010 – 2012: www.dziv.hr/hr/nacionalna-strategija/; Ministry of Economy, Strategija poticanja inovacija Republike Hrvatske 2014 – 2020. www.ciraz.hr/wpcontent/uploads/2017/03/Strategija_poticanja_inovacija_18_12_14.pdf 5

Compliance of the Croatian IP legislation with the EU standards and requirements was subject to a thorough assessment as part of the negotiation process for Croatia's accession to the EU. 6

The Act on the Protection of Undisclosed Information with Market Value (“Zakon o zaštiti neobjavljenih informacija s tržišnom vrijednosti“) (Official Gazette 30/18) entered into force in April 2018, and transposes into Croatian legislation the EU Directive 2016/943 of 8 June 2016 on the protection of undisclosed know-how and business information (trade secrets) against their unlawful acquisition, use and disclosure. The Act defines trade secret, regulates lawful and unlawful acquisition, use and disclosure of trade secrets and establishes a system for protection in the event of an infringement. 7

The State Intellectual Property Office’s website displays a list of international conventions to which Croatia is a signatory as well as all relevant legislation, in addition to forms necessary for registration procedures together with various information brochures: www.dziv.hr 8

See the Quality Standards Reports on the Quality for the European Trade Mark and Design Network's website: www.tmdn.org/network/web/csc/home 9

In 2018, Croatia's parliament passed amendments to the Law on Patents, resulting in the abolishment of the IPO Appeal Boards (dedicated to IP rights matters) as bodies of second instance in all industrial property registration proceedings under the jurisdiction of the IPO. The law, as amended, provides for the possibility to file a lawsuit against the first instance IPO decision before the Administrative Court of the Republic of Croatia in Zagreb, thus reducing the number of instances to challenge IPO’s decisions to two (the Administrative Court and the High Administrative Court) instead of three. 10

The Ministry of Interior conducts criminal investigations related to the detection and investigation of acts characterised as infringement of intellectual property rights under the Criminal Code.

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State Intellectual Property Office (2017), Statistics of the Infringement of Intellectual Property Rights in the Republic of Croatia: Annual report for 2016. 12

Ibid.

13

See e.g., the OECD Policy Framework for Investment- 2015 Edition, OECD Publishing, Paris, 2015, and "The Economics of Civil Justice: New Cross-Country Data and Empirics", OECD Economics Department Working Papers, No. 1060, August 2013, ECO/WKP(2013)52. 14

World Bank (2016), Evaluation on Quality of Selected Justice Services in the Republic of Croatia in 2016, Justice Sector Support Project. 15

The autonomy and independence of the judiciary is guaranteed by the Constitution and the Courts Act, which is overseen by the State Judicial Council (SJC). After the constitutional reform of June 2010 and further reforms introduced in 2013, the majority of the SJC members became elected by the judges themselves, thus ensuring greater independence of the body from the political power. 16

The conduct of judges is primarily regulated through the Constitution, the Act on Courts, and the Code of Judicial Ethics, adopted in October 2006 and substantially amended since then. The conduct of prosecutors is primarily regulated by the Law on Prosecution, the chapter of the Law related to the work of the State Prosecutorial Council and the Code of Ethics for State Attorneys and Deputy State Attorneys, adopted in February 2008. 17

In 2016, Croatia reported an equipment rate of 50-99%: European Commission for the Efficiency of Justice (CEPEJ), "European judicial systems: Efficiency and Quality of Justice. Thematic report: Use of information technology", CEPEJ Studies, No. 24, 2016. 18

Madir, J., "Recent developments in judicial reform in Croatia", Law in Transition, 06 (2011), EBRD. 19

Government of the Republic of Croatia, Nacionalni program reformi 2018 [National Reform Programme 2018], April 2018; Government of the Republic of Croatia, 5 July 2018. 20

European Commission, Commission Staff Working Document: Country Report Croatia 2018 Including an In-Depth Review on the Prevention and Correction of Macroeconomic Imbalances, March 2018, COM(2018)120 final, p. 49. 21

The World Bank, Croatia Policy Notes 2016: Restoring Macroeconomic Stability, Competiveness and Inclusion, February 2016, p. 64. 22

Different reasons have been put forward to explain this perception gap. One relates to Croatia's turbulent past practices, which involved political interference with judicial independence and a high number of judges with limited professional experience. Another explanation would be misleading publicity as to the work of judges and state attorneys, in particular in connection to the media, which have been painted by the judicial profession as being too often sensationalist in their reporting. Council of Europe (2002), First Evaluation Round: Evaluation Report on Croatia, Greco Eval I Rep (2002) 4E Final, paragraph 6;. Council of Europe, Report on judicial independence and impartiality in the Council of Europe member states in 2017 prepared by the Bureau of the Consultative Council of European Judges (CCJE) following the proposal of the Secretary General of the Council of Europe, Strasbourg, 7 February 2018, CCJE-BU(2017)11, paragraph 302; Council of Europe, Fourth Evaluation Round: Corruption Prevention in Respect of Members of Parliament, Judges and Prosecutors, Greco Eval IV Rep (2013)7E, paragraph 129. 23 European Commission, Croatia - Review of Progress on Policy Measures Relevant for the Correction of Macroeconomic Imbalances, November 2014, p. 17. 24

International Bar Association, Arbitration Guide: Croatia, IBA Arbitration Committee, January 2018, p. 3. 25

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26

The term IIA covers both stand-alone treaties and investment chapters in broader free trade agreements. 27

Pohl, J. (2018), "Societal benefits and costs of International Investment Agreements: A critical review of aspects and available empirical evidence", OECD Working Papers on International Investment, No. 2018/01, OECD Publishing, Paris, https://doi.org/10.1787/18151957 28

The treaty with Austria, concluded on 25 October 1989, referenced in Article 12 of the AustriaCroatia BIT (1997). 29

The adjustments that were introduced added exceptions to MFN clauses for customs or monetary unions; added an exception for measures taken to safeguard essential security interests or to comply with international obligations, etc. Other countries that have relatively recently become EU Members, e.g. Romania, have a similar history of treaty amendments that also introduced the elements that are observed in Croatia’s amendments. 30

The comparison of GDP per capita in PPP terms between Croatia and its respective treaty partner was determined for the year when the treaty was concluded; where this data were not available, data for the earliest year available for the country-pair were used. The values of per capita GDP PPP in current terms were taken from the World Bank World Development Indicators as of mid-2018. 31

The coverage is assessed based on FDI stock data (2016 or, where 2016 data was unavailable, data of preceding years, giving preference to more recent data, based on data released by OECD and IMF) and IIAs in force in Ocotber-2018. For several reasons, reported FDI stock data is not a valid measure for assets that benefit from treaty protections (see Pohl, J. (2018), “Societal benefits and costs of International Investment Agreements: A critical review of aspects and available empirical evidence”, OECD Working Papers on International Investment, No. 2018/01, https://doi.org/10.1787/18151957 for details) and available data does not allow to determine ultimate ownership of assets. The proportions of FDI stock data may nonetheless serve as a rough approximation of stock held by immediate investing country to illustrate features and outcomes of Croatia’s past investment treaty policies. 32

The Italy-Croatia BIT (1996) was terminated on 11 June 2013 and had effect for a further five years for investments made before the termination, until mid-2018. Until its termination, it added treaty cover of around 12 percentage points of Croatia’s inward FDI stock. 33

The pre-eminence of inward and outward FDI from and to the Netherlands is likely driven by taxmotivated investment structuring. The Netherlands figure among the countries that report among the highest FDI inward and outward stock in the world when considering bilateral FDI stock. When flows through Special Purpose Entities (SPEs, or “letterbox companies”) are deducted, the numbers drop to a small fraction. For investment treaty purposes, the entity established in the Netherlands is often held to be able to claim under the treaty concluded with the Netherlands. 34

Qatar has not ratified the treaty with Croatia since 2001, and Croatian authorities do no longer deem its design appropriate. 35

Authoritative treaty texts in Croatian can be retrieved from the Official Gazette (https://narodnenovine.nn.hr/ ) by searching the Croatian term for investment agreements. 36

Yackee, J. W. (2010), “Do Bilateral Investment Treaties Promote Foreign Direct Investment? Some Hints from Alternative Evidence”, Virginia Journal of International Law, Vol.51, Number 2, p.397. 37

Amendments that were concluded after 1998 do not consistently reflect Croatia’s possibility – or desire – to impose its own model BIT’s design. The Protocol (2009) to Turkey-Croatia BIT (1996) for instance reflects an approach that differs from treaties that Croatia has concluded after 1998. 38

A FET clause was later added through an amendment Protocol (2009) to Croatia-Albania BIT (1993).

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128 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA 39

Canada-Croatia BIT (1997) and Croatia-Azerbaijan BIT (2007). BITs – unlike FTAs – almost universally set initial validity periods, see Pohl, J. (2013), “Temporal Validity of International Investment Agreements: A Large Sample Survey of Treaty Provisions”, OECD Working Papers on International Investment, No. 2013/04, OECD Publishing, Paris, http://dx.doi.org/10.1787/5k3tsjsl5fvh-en 40

Croatia-FYROM BIT (1994), Croatia-Iran BIT (2000), Croatia-Kuwait BIT (1997).

41

Lithuania-Croatia BIT (2008).

42

Turkey-Croatia BIT (1996), and not remedies but repeated through the later Protocol (2009) to Turkey-Croatia BIT (1996) which changed parts of the ISDS clause but not that section. 43

Croatia-FYROM BIT (1994).

44

Croatia-Iran BIT (2000).

45

Croatia-Kuwait BIT (1997).

46

A number of arbitral tribunals, beginning with Maffezini v. Spain, Case No. ARB/97/7, have interpreted the MFN clause in a fashion that allowed claimants to import substantive treaty standards from other treaties concluded by the respondent country, despite vigorous objections of such interpretation by certain countries, especially NAFTA-countries. Treaties concluded by the European Union, among others, now clarify the meaning of MFN clauses explicitly, e.g. CETA art. 8.7(4). See OECD (2018), “Background information on treaty shopping” in: Treaty shopping and tools for treaty reform – Agenda and Conference material, www.oecd.org/daf/inv/investmentpolicy/4th-Annual-Conference-on-Investment-Treaties-agenda.pdf 47

According to case analysis covering the period 1997–mid-2018 and made publicly available by UNCTAD, out of 499 cases for which data on alleged breaches was available, investors worldwide have invoked the standard in 411 claims, or 82%, and tribunals have found a breach in 104 cases. 48

See Gaukrodger, D. (2017), "Addressing the balance of interests in investment treaties: The limitation of fair and equitable treatment provisions to the minimum standard of treatment under customary international law", OECD Working Papers on International Investment, No. 2017/03, https://doi.org/10.1787/0a62034b-en. 49

The Croatia-Albania BIT (1993) did not contain a “fair” and “equitable” treatment clause in the initial version, but a clause was introduced through amendment in the Protocol (2009) to CroatiaAlbania BIT (1993). 50

Canada-Croatia BIT (1997).

51

The international community has developed specific institutions and rules to enforce arbitration awards. Croatia has adhered to the New York Convention and is a contracting state to the 1965 Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention) which has over 150 state parties. The ICSID Convention addresses both the arbitral proceedings and the enforcement of awards rendered under these proceedings. The enforcement of ICSID awards is governed by the ICSID Convention itself rather than the New York Convention. The ICSID regime is thus more self-contained in this respect. In particular, ICSID awards cannot be reviewed by national courts of the country in which their enforcement is sought. In contrast, the New York Convention permits national courts to refuse the enforcement of awards for, inter alia, reasons of public policy. 52

Živković, P., "Croatia: New Arbitration Court Specialised for Small Claims", Kluwer Arbitration Blog, 26 November 2015; "Prvi privatni sud u Hrvatskoj presude donosi u roku od 3 mjeseca" [The first private court in Croatia delivers its verdicts within 3 months], Večernji list, 4 November 2015.

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References American Chamber of Commerce in Croatia (2019), Survey of the Business Environment in Croatia, Zagreb, www.amcham.hr/storage/upload/doc_library/amcham__survey_of_the_business_environment_in_croatia_15192.pdf American Chamber of Commerce in Croatia (2018), Survey of the Business Environment in Croatia, Zagreb, www.amcham.hr/storage/upload/doc_library/amcham__survey_of_the_business_environment_in_croatia_143454.pdf American Chamber of Commerce in Croatia (2017), Recommendations for Strengthening the Use of Mediation in Croatia, Zagreb, www.amcham.hr/storage/upload/doc_library/recommendations_for_strengthening_the_use_of_media tion_in_croatia_124354.pdf Council of Europe (2019), Fourth Evaluation Round: Corruption Prevention in Respect of Members of Parliament, Judges and Prosecutors, Second Compliance Report Croatia, Greco RC4(2018)14. Council of Europe (2016), Fourth Evaluation Round: Corruption Prevention in Respect of Members of Parliament, Judges and Prosecutors, Greco RC4(2016)5. Council of Europe (2014), Fourth Evaluation Round: Corruption Prevention in Respect of Members of Parliament, Judges and Prosecutors, Greco Eval IV Rep (2013)7E. Croatia (2018), Replies to the PFI-based Questionnaire: OECD Investment Policy Review of Croatia, unpublished. Dallara, C. (2014), Democracy and Judicial Reforms in South-East Europe. Between the EU and the Legacies of the Past, Springer I. European Commission (2018), 2018 EU Justice Scoreboard, Publications Office of the European Union, Luxembourg, https://ec.europa.eu/info/sites/info/files/justice_scoreboard_2018_en.pdf European Commission (2016), Report from the Commission to the European Parliament, the Council and the European Economic and Social Committee on the application of Directive 2008/52/EC of the European Parliament and of the Council on certain aspects of mediation in civil and commercial matters, COM(2016) 542 final, August 2016. European Commission for the Efficiency of Justice (CEPEJ) (2016), “European judicial systems: Efficiency and Quality of Justice. Thematic report: Use of information technology”, CEPEJ Studies, No. 24, https://rm.coe.int/european-judicial-systems-efficiency-and-quality-of-justice-cepejstud/1680788229 Foreign Investors Council (2017), White Book/Bijela Knjika 2017, Zagreb. Gaukrodger, D. (2017), “Adjudicator Compensation Systems and Investor-State Dispute Settlement”, OECD Working Papers on International Investment, No. 2017/05, OECD Publishing, Paris, https://doi.org/10.1787/c2890bd5-en. Gaukrodger, D. and K. Gordon (2012), “Investor-State Dispute Settlement: A Scoping Paper for the Investment Policy Community”, OECD Working Papers on International Investment, No. 2012/03, OECD Publishing, Paris, https://doi.org/10.1787/5k46b1r85j6f-en. Government of the Republic of Croatia (2017), National Reform Programme 2017. International Bar Association (2018), Arbitration Guide: Croatia, IBA Arbitration Committee.

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130 │ 5. THE PROTECTION OF INVESTMENT IN CROATIA Nicolas, F., S. Thomsen, and M-H. Bang (2013), “Lessons from Investment Policy Reform in Korea”, OECD Working Papers on International Investment, 2013/02, OECD Publishing, Paris, http://dx.doi.org/10.1787/5k4376zqcpf1-en OECD (2015), Policy Framework for Investment- 2015 Edition, OECD Publishing, Paris, https://doi.org/10.1787/9789264208667-en Pohl, J., K. Mashigo and A. Nohen (2012), “Dispute Settlement Provisions in International Investment Agreements: A Large Sample Survey”, OECD Working Papers on International Investment, No. 2012/02, OECD Publishing, Paris, https://doi.org/10.1787/5k8xb71nf628-en. UNCTAD (2012), Fair and Equitable Treatment, Series on Issues in International Investment Agreements II, www.unctad.org/en/Docs/unctaddiaeia2011d5_en.pdf . Wehrlé, F. (2015), “High-Level Reporting Mechanisms in Colombia and Ukraine”, Working Paper Series 19, International Centre for Collective Action and OECD, Basel, www.collectiveaction.com/sites/collective.localhost/files/publications/150812_hlrm_working_paper_no_19.pdf World Bank (2019), Doing Business 2019: Training for Reform, Washington D.C., www.worldbank.org/content/dam/doingBusiness/media/Annual-Reports/English/DB2019report_web-version.pdf World Bank (2018a), Doing Business 2018: Reforming to Create Jobs, Washington D.C., www.doingbusiness.org/~/media/WBG/DoingBusiness/Documents/AnnualReports/English/DB2018-Full-Report.pdf World Bank (2018b), Doing Business in the European Union 2018: Croatia, the Czech Republic, Portugal and Slovakia, Washington D.C. WIPO (2016), Methodology for the Development of National Intellectual Property Strategies, World Intellectual Property Organisation, Geneva, https://www.wipo.int/edocs/pubdocs/en/wipo_pub_958_1.pdf

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Chapter 6. Investment promotion and facilitation in Croatia

This chapter provides an assessment of the evolving investment promotion and facilitation framework in Croatia. It discusses existing strategies and institutions governing investment promotion and facilitation as well as provides an overview of the use of investment incentives and special economic zones. It also highlights key reforms and remaining challenges to improve the business environment, including by streamlining administrative procedures.

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132 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA As highlighted in the OECD Policy Framework for Investment, investment promotion and facilitation can be powerful means to attract investment and maximise its contribution to development, but their success depends on their design and progress in improving the quality of the overall investment climate. As such, countries worldwide decide to not only remove restrictions on foreign direct investment and provide high standards of protection to investors, discussed in earlier chapters, but also to proactively promote and facilitate investment, or certain types of investment, to maximise potential benefits to the host economy. Considering that Croatia has removed most formal barriers to FDI as shown in Chapter 4, the country could benefit from active investment promotion and facilitation policies to attempt to attract and retain investment and assist its strive towards more diversification and innovation. As will be discussed in this chapter, Croatia has made important progress in several aspects of investment climate. Existing business polls suggest that, overall, investors assess favourably the general business climate conditions in the country. For example, according to a recent survey of foreign and domestic investors in Croatia undertaken by the American Chamber of Commerce in Croatia, 65% consider that the investment climate in the country improved in 2017 and nearly half believe that it has done so over the past five years.1 In addition, even despite political stability in recent years, there have been no large-scale divestments in the country. Still, unstable regulatory framework, long and complex administrative procedures, tax-related issues, together with a lack of long-term vision of the government, are highlighted as one of the greatest remaining challenges for doing business in Croatia by foreign and domestic business as well as international observers alike (e.g. Foreign Investor Council, 2017, Croatian Employers’ Association, 2016, European Commission, 2016-2018, PWC, 2015). These aspects are quoted to be as important of an obstacle to doing business in Croatia as the small size of the local economy.2 Against this background, the chapter provides an overview of the current approach to investment promotion and facilitation in Croatia and remaining challenges, evaluating in particular the overall institutional set-up and a strategy for investment promotion and facilitation as well as recent progress in the administrative simplification, the tax reform and the use of incentives for investment.

National strategy and the institutional set-up Croatia has elements of national strategy for FDI attraction The legal framework for investment promotion and facilitation in Croatia is governed primarily by the Act on Investment Promotion of 2015 as well as the Act on Strategic Investment Projects of 2013 that lay out the conditions and criteria for government’s support for investment projects (see Box 6.1). The Act on Investment Promotion sets the goals of Croatia’s investment and facilitation promotion policy, lists specific activities that can benefit from the state’s support as well as outlines the type of support available and the applicable requirement (see Box 6.1). It also specifies that investments need to relate to manufacturing and processing, development and innovation, business support activities and high value-added services to be eligible (Article 5), on top of satisfying other conditions relating to job creation, introduction of new equipment or contribution to regional development, among others.3 The Act on Strategic investment Projects serves a complementary role to the Act on Investment Promotion, defining what constitutes a “strategic investment project” in Croatia as well as providing information on the applicable selection criteria and procedures and the

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associated benefits. The main goal of the law is a provision of more expeditious administrative proceedings for strategic projects while the overall investment climate in the country gradually improves4 The law, first passed in 2015, was amended in March 2018, altering among others the threshold size of an investment that can qualify.5 It also explains the conditions of the disposal of state-owned assets, granting concessions and issuance of administrative permits. It applies to private, public and private-public investment alike. Most recently, in December 2018, both acts were amended, to reflect the abolishment of the Agency for Investment and Competitiveness (AIK), effective as of 1 January 2019, and the allocation of its responsibilities to the Ministry of Economy, Entrepreneurship and Crafts, discussed in more detail in the next section. Other government documents also stress the importance of FDI attraction, in particular greenfield and export-oriented FDI, and outline different planned steps to ease the burdens on business and help promote and facilitate investment.6 For example, the Croatian Government Programme (2016-2020) underlines the government’s commitment to more effective investment attraction and further business climate improvements, for example through administrative simplification and tax reform. The Programme as well as the National Reform Programme 2017 and the Action Plan for Administrative Burden Reduction 2017 also outline different elements of planned business climate reforms and Croatia’s investment promotion and facilitation policy. Finally, at the time of writing this Review Croatia was developing a new National Development Strategy 2020-2030 that could provide a further building block in clarifying the role of FDI in the country’s economic development.7 Box 6.1. The legal framework for investment promotion and facilitation in Croatia

The overall goals of investment promotion and facilitation in Croatia are set out by the Act on Investment Promotion (AIP) and the Act on Strategic Investment Projects (ASIP), the latter having been amended in March 2018. Specifically, AIP, sets outs the overall goal if investment promotion in Croatia in Article 4 and outlines the conditions under which investment can benefit from state support (in Article 5 and subsequent text): Article 4

“(1) The objective, i.e. the purpose of investment promotion is promotion of the economic growth and fulfilling of the economic policy of the Republic of Croatia, the country’s integration in international trade and strengthening investment capability and competitiveness of Croatian enterprise. (2) At the level of economic operators the objective and purpose of investment promotion is to build internationally competitive, transparent and attractive system of the aid to investments by legal or natural persons registered in the Republic of Croatia, who are profit tax payers engaged in an economic activity, participating in the trading of goods and services in the Republic of Croatia. Article 5

(1) Investment promotion within the meaning of this Act constitutes a system of the aid to investments and the aid for timely performance of the necessary

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134 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA investment activities. It determines the method and time limits for completing all the necessary investment activities, aimed at a successful performance of the investment project in a fixed term, in the territory of the Republic of Croatia. (2) The aid regulated by this Act pertains to investment projects and to fostering competitiveness in:  manufacturing and processing activities 

development and innovation activities



business support activities



high value-added services.

(3) The aid regulated by this Act shall cover the projects referred to in paragraph 2 of this Article, which ensure environmentally friendly business activity and one or more of the following objectives:  introduction of new equipment and modern technologies 

higher rate of employment and level of training the employees



development of high value-added products and services



increase in entrepreneurial competitiveness



uniform regional development of the Republic of Croatia.”

Meanwhile, the Act on Strategic Investment Projects defines what constitutes a “strategic investment project” (in Article 5) and the criteria that need to be fulfilled.8 Namely, as per Article 5 of the Act, the project needs to take place in one of the listed activities (production and processing, development and innovation, business support activities, high value-added services, energy, infrastructure, agriculture or fisheries), complies with physical planning documents and satisfies one of the minimum capital investment thresholds, depending on their character. The Act on Strategic Investments was amended in March 2018, among others lowering the applicable thresholds and easing the financing requirements; as well as in December 2018, through the Act on cessation of the Act on the establishment of the Agency for Investment and Competitiveness, which abolished AIK and attributed the tasks performed by it to the Ministry of Economy, Entrepreneurship and Crafts, as discussed later.9 The specific steps required during the application process under either of the Acts are listed on the websites of HAMAG BICRO (www.investcroatia.hr) and the Agency for Investments and Competitiveness, AIK (www.aik-invest.hr). Source: Act on Investment Promotion of 18 September 2015 and Act on Strategic Investments of 25 October 2013 (as amended in March and December 2018)

Various stakeholders consulted in the course of this Review, including government authorities, business and international organisations, stressed the need for a more comprehensive long-term strategy for investment promotion and facilitation in Croatia. They argued that the current policy framework is still largely confined to the provision of incentives and allocation of EU funds, governed by the Acts on Investment Promotion and Strategic Investment Projects. They added that the lack of a more comprehensive vision

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leads to disjointed actions and separate strategies across different Ministries and local bodies. Meanwhile, remaining investment climate issues, highlighted by investors and discussed in later sections of this chapter, pertain to a broad set of regulatory and administrative measures and require a coordinated whole-of-the-government approach. As such, it is not surprising that nearly half of respondents in the 2018 AmCham business survey (AmCham, 2018) identifies the lack of long-term government vision as a serious obstacle to doing business in Croatia. The Foreign Investors Council, a business association that bring together international companies that do business in Croatia, has also long been advocating a comprehensive, long-term vision going beyond the current policy elements.10 As such, the on-going elaboration of Croatia’s National Development Strategy until 2030 could serve as a building block in clarifying the role of private investment in the country’s economic development.

The institutional framework for investment promotion and facilitation is evolving Besides the lack of a clear national strategy for investment attraction to-date, Croatia also has an evolving institutional set-up for investment promotion and facilitation. While it appears that some of the recent reforms have been motivated by the desire to streamline the activities of the agencies active in the field, it remains to be seen whether they can achieve intended results. For example, while the Ministry of Economy, Entrepreneurship and Crafts is in charge of outlining broad strategic orientations of such a policy, until very recently, according to the Act of Investment Promotion, two national-level investment promotion agencies (IPAs) were responsible for implementing this policy at the national level– the Agency for Investments and Competitiveness (AIK, Agencija za investicije i konkurentnost, see Box 6.2) and the Croatian Agency for Small and Medium-sized Enterprises, Innovations and Investments (HAMAG-BICRO, see Box 6.3). Other agencies at both central and sub-national level are involved in investment promotion and facilitation. For example, the Croatian Bank for Reconstruction and Development (HBOR) also provides financial support for firms, in particular to support reconstruction and development of Croatian economy, exports growth, infrastructure development, environmental protection as well as provision of export insurance for firms. Both HBOR and HAMAG BICRO manage and disburse EU Structural Funds that can support domestic business development. Until recently, there also existed separate agencies responsible for investment attraction into certain sectors, although some were recently abolished (e.g. the Centre for Monitoring Business Activities in the Energy Sector).11 Finally, several actors at the sub-national level are also involved in investment promotion and facilitation in Croatia.12 Box 6.2. Agency for Investments and Competitiveness (AIK)

AIK was established in 2012 and organised as an autonomous public agency, reporting to the Ministry of Economy, Entrepreneurship and Crafts (MEEC), until its abolishment as of 1 January 2019. It has undergone three significant institutional reforms in the course of its lifespan, including a merger with the public-private partnership (PPP) unit in 2015. According to its staff, the agency has also been subject to previous threats of dismantling, which resulted in some staff leaving the organisation at different points of time (in general, the turnover of staff has been high, reaching on average nearly 50% in the last five years). According the to the cessation act, after the agency’s abolishment,

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136 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA all its staff and functions are taken over by MEEC (Article 4) and a follow-up regulation is going to clarify the structure of a new department in the Ministry. In the past, AIK used to be publically financed with all the resources coming from MEEC, which is a common arrangement among OECD IPAs (on average, 98% of IPAs’ investment promotion budgets come from the state). AIK used to also have a Board of Directors, which is the case in over two thirds of OECD IPAs; yet, its Board, was composed entirely of public sector representatives and chaired by MEEC. The OECD IPAs often use Boards as means of bringing in outside expertise and oversight (as such an average OECD IPA Board has 38% private sector participation). In that sense, the lack of private sector participation in the Board and a full reliance on MEEC for financial resources made AIK in its previous form already heavily dependent on the Ministry. AIK also used to have limited financial resources compared to OECD IPAs. While a median OECD IPA had a total budget of EUR 11 million and an FDI promotion budget of EUR 4.6 million in 2016, AIK’s total budget was EUR 1.58 million and EUR 0.9 million for FDI promotion that year. Moreover, while AIK’s total budget has increased since its establishment in 2012, the financial resources devoted to FDI promotion appear to have stayed constant, according to the agency’s responses to the survey. Meanwhile, the size of IPA’s budget is found to be associated with higher total inward FDI stock per capita and the number of foreign affiliates established in the country, conditional on the countries’ size and level of development (Volpe Martincus and Sztajerowska, forthcoming). It remains yet to be seen if the absorption of AIK into the Ministry may be associated with a larger, or more stable, budget. Likely as a result of limited financial resources, AIK did not have certain elements typical of IPAs in other OECD countries. For example, while a customer management relationship (CRM) system is used by 94% of OECD IPAs, and it is considered a critical tool for gathering information about and interacting with clients as well as managing resource and staff in the IPA world, AIK reported not have such a system (even if it had an internal programme allowing tracking of every investment and enquiry as well as assistance provided, according to its staff). Also, the agency had no foreign offices abroad while an average OECD IPA has 34 foreign offices (19 of which undertake investment promotion functions). This may have limited its ability to generate prospective investment leads and maximise the number of realised investments, in particular in sectors where Croatia is not a wellknown location. Similarly, while almost three quarters of OECD IPAs staff have experience in the private sector, 42% of AIK’s staff had such a profile. Finally, many activities usually performed by IPAs, in particular in investment facilitation and policy advocacy, were not undertaken by AIK (see Figure 6.4). As discussed later in this chapter, if AIK’s integration into the Ministry translates into easier access to resources and policy-makers, it might help broaden the portfolio of services offered by former AIK and bolster its operations. Yet, it also involves a number of risks, related to potential disruption, loss of autonomy and brain drain, among others, that, if not managed appropriately, can have detrimental effects. Source: OECD-IDB Survey of Investment Promotion Agencies

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Until end 2018, the formal division of labour between HAMAG-BICRO and AIK was based on the size of firms assisted: while HAMAG-BICRO was expected to focus on SMEs, AIK was responsible for servicing large firms In addition, AIK also serviced firms that wished to be considered for strategic investment projects, either of private or publicprivate in nature13, and managed private-public partnerships in Croatia. Besides that division by a type of clients, the official objectives of both institutions were the same: to promote Croatia as a desirable investment destination, proactively attract and assist in implementation of investment projects and facilitate development of the Croatian economy. Even if AIK staff’s considers that AIK was the national IPA in a traditional sense, de iure competencies were divided among both agencies, according to the Act on Investment Promotion, and they both provided similar information and services to investors. Such an institutional solution was atypical and not found elsewhere among the 32 OECD countries that participated in the OECD-Inter American Development Bank (IDB) Survey of Investment Promotion Agencies (Box 6.3), none of which reported to have more than one national IPA (OECD, 2018a). Box 6.3. Croatian Agency for SMEs, Innovations and Investments (HAMAGBICRO)

Croatian Agency for SMEs, Innovations and Investments (HAMAG-BICRO) was founded with the aim of supporting the development of small and medium-sized enterprises, improving the innovation process and encouraging investments. It was created in 2014 through a merger of the Croatian Agency for Small Businesses and Investments (HAMAG INVEST) and the Business Innovation Agency of the Republic of Croatia (BICRO). The Agency’s activities include the promotion of establishment and development of small business entities, financing operation and development of small business entities by loans and guarantees issuing for approved loans by creditors as well as promotion of investments in small business. The Agency is an independent institution under the supervision of the Ministry of Economy, Entrepreneurship and Crafts. Agency services for investors are: 

Distributing information about the advantages of the investment environment in Croatia



Providing information about investment opportunities in Croatia



Providing support to foreign investors regarding their investment activities



Providing foreign investors with information about legislation, incentives, locations and potential suppliers



Providing assistance with applications for investment incentives



Facilitating communication between foreign investors and national and local authorities



Aftercare services for foreign investors already operating in Croatia

In order to create better conditions for investments in 20 counties One Stop service centres were created as part of the EU funded project “ICPR – Development of Investment Climate”. The role of One Stop service centres is

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138 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA to provide all the necessary information at one place to potential investors and support them while obtaining necessary permits. The One Stop service centre initiative includes all relevant institutions at the county level—the main coordinator at the county level is the regional development agency. The following information is available on the Web site of the regional development agencies: 

business zones available in the county



potential partners and suppliers in a given county



traditional sectors in the county



as well as services provided by the county to investors

Source: Government of Croatia

In this context, as part of a wider government reform aiming to streamline central state bodies14, the Agency for Investments and Competitiveness (AIK) was abolished, effective as of 1 January 2019.15 According to the Law on Cessation of the Law on the Establishment of the Agency for Investments and Competitiveness, all the agency’s responsibilities and staff were absorbed by the Ministry of Economy, Entrepreneurship, and Crafts and all services earlier provided by AIK are going to be provided by the Ministry.16 A separate regulation is to outline the new organisation of the Ministry and the structure of the new department, and provide further information on its functioning.17 It is yet unclear how this institutional arrangement will impact the level of coordination of investment promotion and facilitation activities in Croatia, or specific services provided to investors. According to the act that has abolished the agency, and as confirmed by the government,18 all activities and functions of AIK are planned to be absorbed by the Ministry and the other bodies active on investment promotion are expected to function as before. The government also highlights that the absorption of the agency into the Ministry of Economy, Entrepreneurship, and Crafts can give it more political clout, and facilitate its investment facilitation and policy-advocacy functions. Yet, at this stage, it is an open question if the reform can lead to streamlining of investment promotion and facilitation activities at the central government level in Croatia, and whether it will result in an improvement, or a deterioration, in the overall investors’ experience. At the sub-national level, the coordination of different efforts to attract and facilitate investment is also an ongoing challenge, and will need to be further addressed by the government as complementary measure to the arrangement at the central level.

The recent reform could be used to rethink Croatia’s investment promotion and facilitation In Croatia, the abolishment of AIK appears to have been motivated by reasons other than improving the quality of the institutional set-up for investment promotion, i.e. centralisation of state bodies.19 Still, the authorities should attempt to use it as an opportunity to rethink the institutional set up for investment promotion and facilitation. In general, governments routinely create new or reform old IPAs in search of the right institutional and organisational set-up (Figure 6.1). On average, each IPA has been reformed at least once in the past ten years (Volpe Martincus and Sztajerowska, forthcoming). Reforms often involve modifications to the organisational structure but also changes in the legal status, a

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reporting ministry and composition of mandates, including via mergers and demergers with other bodies. Given the frequency of changes, governments need to ensure that they have clearly identified strategic objectives behind the reforms and learn from the past performance to ensure tangible improvements. In this context, as part of its reflection on future activities and structure of the new department in charge of investment promotion and facilitation in MEEC, the Ministry could learn from AIK’s experience to identify which changes can help improve the portfolio of services offered, which practices should be retained, and what risks may need to be managed during transition. To assist in that process, the following section thus presents results of the benchmarking of AIK to 32 OECD IPAs as part of the OECD-IDB Survey of Investment Promotion Agencies (see Box 6.4), focusing on key strategic factors relevant to the on-going reform, pertaining mostly to the choice of functions, prioritisation strategy, services offered to firms, and the allocation of financial resources to the responsible body.20 Figure 6.1. Creation of IPAs and recent organisational reforms in OECD countries Figure 6.1. Creation of IPAs and recent organisational reforms in OECD countries Number of recent organisational reforms

Number of IPAs

35 30 25 20 15 10 5 0

1955-59

1960-64

1965-69

1970-74

1975-79

1980-84

1985-89

1990-94

1995-99

2000-04

2005-09

2010-14

2015-17

Source: OECD-IDB Survey of Investment Promotion Agencies (2017)

The main goal of an IPA is inward FDI attraction but IPAs often undertake other functions as well (an average IPA in OECD performs 5.7 different functions). Overall, IPAs of larger countries and advanced economies tend to be more specialized, i.e. have fewer mandates and focused on core internationalisation support (including in export- and innovationoriented activities), with other specialised government agencies undertaking the remaining functions. Among OECD IPAs, the most common set of mandates, besides inward FDI promotion, is promotion of exports, innovation promotion and regional development (performed by half or more of IPAs, see Figure 6.2). AIK did not have these activities as part of its official mandate, even though, according to its staff and website, it has de facto supported regional development in certain ways.21 Still, export promotion and innovation promotion was missing from the agency’s mix of functions. This is somewhat surprising, considering that, beyond the allocation of export guarantees to firms by HBOR, there is no separate export promotion agency operating in Croatia.22 In turn, AIK had other secondary mandates less typically found among OECD IPAs, such as the management of private

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140 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA investment projects and public-private partnerships (PPPs) under the Act on Strategic Investments (the latter since 2015), and promotion of certain high-value activities in the tourism sector, as defined in the Act on Investment Promotion, more typically found in developing countries.23 As such, the Ministry of Economy, Entrepreneurship and Crafts could consider what role it wishes for the new department to play in these most common secondary IPA functions, i.e. export-, innovation and regional development promotion, and which activities may need to be undertaken by other government bodies. Box 6.4. The OECD-IDB survey of IPAs

The OECD and the IDB have partnered to design a comprehensive survey of IPAs. The questionnaire provides detailed data that reflect the multiple recent policy developments as well as rich and comparable information on the work of IPAs in different countries. The survey was displayed and shared with IPA representatives from OECD and Latin America and Caribbean (LAC) countries in the form of an online questionnaire that was divided into nine parts: 

Basic profile;



Budget;



Personnel;



Offices (home and abroad);



Activities;



Prioritisation;



Monitoring and evaluation;



Institutional interactions; and



IPA perceptions on FDI.

National IPAs from 32 of the 35 OECD countries participated in the OECDIDB survey, representing a 94% response rate. The participating agencies are those from the following countries: Australia, Austria, Canada, Chile, Czech Republic, Denmark, Finland, France, Estonia, Germany, Greece, Hungary, Iceland, Ireland, Israel, Korea, Latvia, Japan, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. IPA respondents completed the questionnaire between May and September 2017. The data gathered through the survey served as a basis for a preparation of a mapping report of IPAs in OECD countries, as well as benchmarking with other regions (e.g. LAC and Middle East and North African countries). Source: OECD (2018a)

In terms of the sectoral focus, all agencies of the 32 OECD countries surveyed prioritise certain countries and sectors in their activities and some additionally prioritise certain investment projects and investors (Figure 6.3). Some OECD IPAs also devote relatively large shares of staff to priority sectors (50% on average) and more than half of agencies have dedicated organisational units. In case of Croatia, the Act on Investment Promotion

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lists a broad set of activities that provide a basis for the IPA’s focus, i.e. manufacturing and processing, development and innovation activities, business support activities and high value-added services.24 In addition, the agency provided tailored information on eight specific sectors listed on its website, i.e. tourism, information and communication technologies (ICT), automotive, food, pharmaceutical, logistics, machinery and equipment manufacturing and textile industries. On the other hand, it excluded investments by SMEs, which are attended to by HAMAG-BICRO, as well as some investments in the energy and infrastructure sectors that were attended to by other organisations. In addition, unlike the majority of OECD IPAs (see Figure 6.3), the agency reported not to prioritise and specific investment projects or investors and did not have any specific staff or organisational unit devoted to that purpose. Meanwhile, economic studies find that sector- and other forms of targeting by IPAs is positively correlated with inward FDI, ceteris paribus (Harding and Javorcik, 2011 and Volpe Martincus and Sztajerowska, forthcoming). The OECD (2015a) also highlights that coordinated sector- and market-specific investment promotion campaigns tend to bring better results than generic marketing efforts. In the context of the importance of targeting to IPAs’ work, the Ministry could consider how it wishes to approach the targeting strategy in investment promotion and facilitation efforts. Figure 6.2. Share of IPAs reporting the function as an official mandate In % 100% 90% 80% 70% 60% 50%

56%

56% 50% 44%

41%

40% 31% 30%

28%

25%

20%

25% 19%

16%

10%

13%

9%

9%

9%

9%

13%

9% 3%

3%

0%

s (2017)

Source: OECD-IDB survey of Investment Promotion Agencies (2017)

During the interviews conducted in the process of this Review, the MEEC expressed scepticism about the need to focus the agency’s work on specific sectors or countries. Meanwhile, the former IPA itself mentioned that sectoral focus could help it recruit staff and organise internally and the Foreign Investors Council stresses the need for a more unified strategy, including regarding sectors to be supported. The Ministry of Foreign and European Affairs (MOFEA) also stressed that a common understanding of the priority activities could help coordinate efforts

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142 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA across different government bodies. In this context, some further thought could be given to the department’s future targeting strategy and the government sectoral strategy more generally. This could be linked to the development of a broader FDI attraction strategy, as discussed earlier. Figure 6.3. Overview of prioritisation strategies of IPAs in OECD countries Priority sectors/countries Priority projects - Yes

Priority projects - No

Priority investors - Yes

Priority investors - No

100%

25%

44% 56%

75%

Source: OECD-IDB survey of Investment Promotion Agencies (2017)

In terms of the total number of activities, AIK performed 33 different actions, which is slightly below the OECD average (38). In addition, there were notable differences between the type of services provided by AIK and those routinely offered by OECD IPAs. Overall, while AIK performed many of the image building- and investment generation activities performed by the OECD IPAs, there was a perceivable gap on investment facilitation activities and aftercare services (Figure 6.4). It is worth highlighting that AIK had a welldesigned website, providing a wealth of information of relevance to investors (in English and Croat): e.g. on business climate and investment conditions in Croatia, sectoral guides, guidance on the applicable regulations and administrative steps to implement an project, a catalogue of available investment projects as well as investment incentives- and a local salary calculators, among others – which can usefully be re-deployed by the Ministry in its new capacity.25 The digital investments project map is also an example of an interesting online service offered by the agency: the tool provided an overview of the various investment opportunities in different counties and sectors in Croatia, together with the project description and other relevant information such as planned capacities, estimated value, transaction model, project status, and dedicated contacts.26 Yet, even though AIK provided all the relevant information pertaining to establishment of a new investment project in Croatia on its website, it did not generally provide installation assistance to investors (e.g. help with licenses and permits, utilities, legal issues, construction and land permits, see Figure 6.4). In addition, it did not provide any capacity building or matchmaking services to local firms nor assistance in recruiting local talent or OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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providing training to local staff, which is still considered as an important barrier by foreign firms in Croatia. This landscape may be partially related to the fact that other agencies undertake some of these functions, HAMAG-BICRO or Croatia’s One Stop Shop (HITRO.HR). Still, to the extent that burdensome administrative procedures and finding local partners and staff remain an issue for Croatia, the government could consider endowing the new department with capacities to provide a fuller portfolio of investment facilitation and aftercare services to firms, and ensuring close cooperation with other bodies in this area. Progress in this area may be particularly relevant in Croatia considering the government’s efforts to reduce administrative burdens on firms and an interest in “upgrading” the type of FDI it attracts.27 Most OECD IPAs devote significant resources to facilitation and aftercare services (OECD, 2018a) and offer a wider range of aftercare services to firms, including dedicated account managers (OECD, 2018a). Such an approach requires, however, the ability to focus on some firms more than others, which highlights the importance of a targeting strategy, mentioned earlier, as well as resources to pay staff.28 Adequate resources for the new department are, hence, one of important factors to consider. AIK explained in the context of this Review that the fact that it did not charge firms for assistance explained the gap in the services it offered relative to OECD agencies. Yet, none of the OECD IPAs charge firms for investment promotion and facilitation activities (unlike for export promotion services) and rely nearly entirely on state budgets (on average, 98% of OECD IPA’s investment promotion budget comes from the public sector). As such, the size of the state budgetary allocation plays an important role in allowing an IPA to adequately perform its functions.29 Meanwhile, AIK had a budget for investment promotion (of EUR 0.9 million) significantly below the levels found in other OECD IPAs (one fifth of the average budget of an OECD IPA), most likely influencing its capacity to perform certain activities and access to modern management tools found in OECD IPAs (see Box 6.2.).30 As such, the government should consider if the planned budgetary allocation to the newly created department can allow it to appropriately serve its function and, ideally, develop new services and improve its functioning. This being said, the experience of firms that used AIK’s services, and which were consulted for this Review, was in general positive, and many of them considered that the agency had accumulated the relevant staff, tools and know-how. In this context, the absorption of AIK into the Ministry poses challenges as well as opportunities. On the one hand, if it is associated with an endowment of the new body in adequate financial resources and a better access to policy-makers, it could potentially help develop the previously missing activities, notably in the area of investment promotion and policy advocacy. On the other hand, the dismantling of AIK as a separate entity also brings a number of risks associated with a possible loss of autonomy (in contacting investors, performing tasks, or hiring workers, for example), disruption of services and a brain drain, in particular if changes involve adjustments in salaries. Reportedly as a result of the restructuring, a number of AIK staff quit their job to join the private sector.31 Skills shortages could become an important constraint on the effectiveness of the new entity and potentially impact investors’ experience. As such, these risks need to be adequately considered and addressed if the reform is to achieve its desired effect. Ideally, this should have been done prior to the abolishment of the previous agency but the government may still find ways to ensure a relatively orderly transition. The overall goal should be to rescue the best from AIK, which has been appreciated by investors and developed certain best practices, while equipping the new structure with tools that have previously been missing. The recent experience of the UK that also absorbed its IPA into a Ministry could potentially be helpful as the government advances with implementation to consider the various opportunities and risks.32

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144 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA Figure 6.4. Shares of OECD IPAs performing a given type of investment activity In % Panel A. Image building Website Promotion material (e.g. general brochures) Attending general events abroad High-level missions abroad Web services (e.g. GoogleAds, Social Media) Incoming, high-level missions Attending general events at home International media (e.g. TV, print) Domestic media (e.g. TV, print) Other marketing activities

61% 58%

19%

0%

10%

20%

81% 81%

30%

40%

50%

60%

70%

80%

100% 100% 94% 90% 87%

90% 100%

Panel B. Investment generation 97%

One-to-one meetings initiated by the IPA Organising sector- or investor-specific missions abroad Attending sector-specific events abroad Raw data analysis Inquiry/request handling Hosting sector- or investor-specific incoming missions Attending sector-specific events at home Market studies Pro-active campaigns (email/phone)

97% 97% 90% 90% 90% 90% 87% 87%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90% 100%

Panel C. Investment facilitation Site visits Working meetings with local stakeholders Information on local suppliers/customers Assistance to obtain visas and work permits Assistance in obtaining financing Airport pick-ups Assistance with business/tax registration Assistance to obtain land and construction approvals Assistance with legal issues Assistance with utilities Assistance to obtain licenses Assistance with other business matters 10%

20%

30%

40%

71% 71%

58% 58% 58% 58% 55% 52%

33%

0%

50%

60%

94% 87%90%

70%

80%

90% 100%

Panel D. Aftercare services Structured trouble-shooting with individual investors Database of local suppliers Matchmaking service between investors and local firms Mitigation of conflicts Cluster programs Capacity-building support for local firms Assistance in recruiting local staff Ombudsman intervention Training or educational programmes for local staff 0%

19% 10%

20%

26%

30%

Panel E. Policy advocacy Informal feedback to the government on the investment climate Meetings with the private sector or business associations Tracking of available rankings (e.g. WEF, Wold Bank) Participation in periodic meetings with the Private Sector Participation in an intergovernmental council on investment climate… Meetings with the President / Prime Minister or other agencies Production of reports or position papers Consultation with foreign offices, Embassies, Consulates Public awareness campaigns or events Surveys of foreign investors Inputs on Regulatory Impact Assessment (RIA) Surveys of domestic firms investing at home/abroad Surveys of expats

0%

19%

10%

20%

30%

39% 35%

40%

35%

40%

45% 45%

50%

60%

70%

65%

42%

50%

81%

65% 65%

60%

70%

80%

74%

80%

90% 100% 97% 97% 94% 90% 90% 90% 87% 84%

90% 100%

Note: White colour indicates that AIK does not perform the activity. Source: OECD-IDB survey of Investment Promotion Agencies (2017)

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Overall, the Croatian government faces a number of challenges in deciding about the future functioning and institutional set-up for investment promotion and facilitation in the country. These relate to the role, mandates and activities of the new department, its sectoral focus and prioritization strategy as well as the allocation of financial resources, among others, all of which can impact the new body’s organisation and operations. Mechanisms for institutional cooperation with other ministries, in particular with Ministry of Foreign and European Affairs, may also need to be rethought to ensure better coordination of activities and benefit from the MOFEA's network of embassies and consulates. At the subnational level, ensuring better coordination among the different institutions can help achieve better communication with investors. Addressing these challenges may impact the effectiveness of Croatia’s investment promotion and facilitation policy in the future. Until further details are clarified and the organisation of the new body confirmed, it is uncertain whether the institutional change will improve or worsen the policy set-up for investment promotion and facilitation in Croatia. Finally, regardless of its final choices on strategic matters, it is equally important that the Ministry communicates clearly the objectives and activities of the new department to its staff, investors and the public. For example, adequate information should be provided on the website, which at the time of writing of this Review only provided an information about the abolishment of the agency, and informationdissemination events could be considered. Uncertainty may impact negatively potential human capital of the new department (i.e. former AIK’s staff) as well as investors affected by the transition.

Investment facilitation and administrative simplification efforts For many years now, long and complex administrative procedures in Croatia have been highlighted as one of key barriers to doing business. As previously highlighted in Chapter 4, cross-country rankings, such as the World Bank’s Doing Business or WEF’s Global Competitiveness Report have regularly identified administrative burdens and the overall government efficiency as an obstacle to doing business in Croatia.33 For example, the burden of government regulation as well as the efficiency of settling legal disputes and of the legal framework for challenging regulations are the areas where Croatia scored the lowest in the 2018 Global Competitiveness Report, ranking 130th out of 161 economies (Figure 6.5). In Doing Business 2019, Croatia scores poorly in the area of dealing with construction permits (159 out of 190), starting a business (123) and paying taxes (89) (Figure 6.6). Several reports by the European Commission have stressed their detrimental effects on the Croatian economy (European Commission, 2014-2018). In addition, recent business surveys and position papers have also identified complex and burdensome procedures, unstable regulatory framework and the tax system as key barriers to doing business in Croatia (e.g. AmCham, 2019-18 and Foreign Investors Council, 2017) and called for the need to improve the quality of regulations (see Chapter 7).34

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146 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA

usiness Indicators (2019)

Figure 6.5. Croatia’s performance on selected aspects of WEF’s Global Competiveness Index, 2018

Score

Rank

30

161 141

25

121 20

101

15

81 61

10

41

5 0

21 Burden of government regulation

Efficiency of legal framework in settling disputes

Efficiency of legal framework in challenging regulations

Critical thinking in teaching

Future orientation of government

Hiring and firing practices

1

Note: The index scores 161 economies from 0 (worst performance) to 100 (top performance) and generates annual rankings from 1 (top performance) to 171 (worst performance). Source: WEF Global Competitiveness Report (2018)

Figure 6.6. Overview of Croatia’s score in World Bank’s Doing Business Indicators, 2019 1= top performance; 190=worst performance

Overall 160 Resolving Insolvency

Starting a Business

140 120

100 Enforcing Contracts

80

Dealing with Construction Permits

60 40 20

0 Trading across Borders

Getting Electricity

Paying Taxes

Registering PropertyPositive

Protecting Minority Investors

Getting Credit

Source: World Bank’s Doing Business Indicators (2019)

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Given this feedback, it is not surprising that administrative simplification has been high on the government’s agenda and several governmental plans were developed in this area in the past decade.35 Most recently, the Government Programme for 2016-2020, the National Reform Programme 2017 and the MEEC’s Action Plan for Administrative Burden Reduction 2017-2019 outline the steps to be undertaken by the government.36 In support of these action plans, prior assessment using the standard cost model (SCM) methodology was carried out to allow for better identification of appropriate measures.37 According to the government, the implementation of all plans requires changes to at least 158 regulations by end of 2020 and so-far is going according to the schedule with implementation levels for 2017 and 2018 at about 75%, level (and the remaining measures still being implemented).38 The most recent report by the European Commission (2018) points to a steady progress albeit at a modest pace; while some stakeholders consulted in the context of this Review, notably business, suggest delays and important remaining gaps. As for 2019, 314 additional measures to be streamlined have been identified. They relate primarily to the simplification in tax and accounting administration, employment procedures for foreign employees, digitalisation in tourism, e-procedures in the court system, streamlining of custom procedures by integration of customs and tax departments, administration of family and household farms, e-procedures and e-registers in environment protection. In addition, recognising the need to achieve further progress, the government recently created a Working Group on Enhancing Business Environment, charged with analysing remaining barriers to investment and economic activity, monitoring progress in implementation and proposing new actions to be considered by the government.39 In some areas related to administrative procedures, Croatia has made tangible progress, confirmed by international rankings, among others. For example, the government has undertaken a number of reforms related to resolving insolvency and registering property. As a result, the recovery rate in case of insolvency has increased from 29 cents per dollar in 2006 to 35 cents per dollar in 2019, and Croatia currently ranks relatively well, at 59 th spot, in Doing Business ranking in this area (see Figure 6.6 above). The time needed to register property fell from 956 days in 2006 to 47 days during in 2019. In addition, there are on-going projects in these areas, including a recent digitisation of the land registry and further work on developing and better coordinating the land and the property registration systems.40 While dealing with construction permits is still problematic, reforms in this area were also undertaken– notably through amendments to the Building Code and the development of an e-permit.41 Consequently, the time spent dealing with construction permits reduced from 364 days in 2006 to 146 days in 2019.42 More generally, the progress in the use of e-services– including e-taxation, e-procurement, e-court, e-invoicing and others – can also help facilitate administrative procedures in Croatia and reduce the discrepancy in the application of regulations across the Croatian territory. 43 These steps appear to be recognised by the private sector, considering that recent surveys have ceased to point to long and complex administrative procedures as the top business concern, marking a change from the past.44

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148 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA Figure 6.7. Number of days required to start a business in Croatia, 2005-2019. Starting a Business - Time (days) 35 30

29

25

22.5

20 15 10

2005: HITRO becomes operational

5 0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Source: World Bank Doing Business indicators (2005-2019)

In case of starting a business, Croatia has also made important improvements in mid- and late 2000s. The implementation of a one-stop shop solution for business registration (HITRO.HR) has helped facilitate and shorten the time needed to start a company in Croatia (see Box 6.4 and Figure 6.7). In part to recognise this progress, Croatia was selected as Top Reformer according to the 2008 edition of Doing Business. Yet, since then, progress has been timid. According to the World Bank, it still takes over 22 days on average to open a business in Croatia, compared to the OECD average of 9 days (Table 6.1), even though available sub-national information points to quicker procedures in some cities outside of Zagreb (e.g. 6 days in Split or 11 in Varaždin, see Papahagi et al., 2018).45 Considering that there still exists a margin for improvement, the government is currently analysing the remaining obstacles to faster business registration with assistance of international donors46, and has reaffirmed its commitment to further facilitate starting a business in Croatia, including through additional efforts towards digitisation and the use of e-permits.47 Table 6.1. Overview of the ease of starting a business in Croatia and benchmark economies, 2019 Indicator Procedure (number) Time (days) Cost (% of income per capita) Paid-in minimum capital (% of income per capita)

Croatia

Europe & Central Asia

OECD high income

Best Regulatory Performance

8

5.2

4.9

1 (New Zealand)

22.5

12.9

9.3

0.5 (New Zealand)

6.6

4.6

3.1

0.0 (Slovenia)

11.6

2.3

8.6

0.0 (117 Economies)

Source: World Bank’s Doing Business Indicators (2019)

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Box 6.5. One-stop services in Croatia

Starting a business became easier with the creation of a one-stop shop (OSS) for company registration in Croatia. The implementation phase begun by establishing a first operational HITRO.HR office in Zagreb in May 2005. The principal goal has been to provide relevant information in one place and facilitate the process of starting a business in Croatia. Since then, the number of days to start a business fell from 29 in 2005 to 22 in 2019 (Figure 6.7). With the subsequent expansion of its functionality in 2012, limited liability companies were allows to file their registration applications with the court registries electronically from any public notary’s or HITRO.HR’s office (so called e-Company service). In 2013 a new form of simple limited liability company with a lower minimum capital requirement was also introduced, which further simplified incorporation procedures and in 2014, some notary fees, related to company incorporation, were reduced. HITRO.HR is both an online service (www.hitro.hr) as well as physical offices located in over 60 different locations in 20 counties of all regions of Croatia. The role of OSS centres is to provide all the necessary information at one place to potential investors and support them while obtaining necessary permits. The service also allows accessing other relevant government e-services and e-permits, such as eCadastre (the land registry), e-Regos (a system for pension contributions), eHZZO (health insurance) or e-VAT (the VAT tax module), among others. Source: HITRO.HR’s website (www.hitro.hr), HAMAG-BICRO’s website (www.investcroatia.hr), AIK’s website (www.aik-invest.hr), FINA website (www.fina.hr) World Bank (2012), Croatia: Administrative Barriers to Foreign Investment, Foreign Investment Advisory Services (FIAS),

In some other areas, progress appears more elusive. For example, the incidence of so-called para-fiscal charges has been in recent years among the most frequently cited unresolved issues in Croatia, and this despite the 2018 tax reform. Business associations have been in general critical of the current legal framework, calling for the abolition of para-fiscal charges (Foreign Investors Council, 2016-2017). The European Commission (EC, 20152018) has also evaluated Croatia’s system of para-fiscal charges as requiring sustained reform. Despite commitment by the government to reduce their number, progress in this area has advanced at a slow pace. At the time of writing, only a few charges had been abolished. Amendments were on their way to reduce a few more. By the end of 2019, a financial analysis of the use of income collected from parafiscal charges should be completed, supporting the reform process (based on results, further measures would be proposed by March 2020). The conduct of inspections is another area where further progress may be required, despite recent promising policy developments. The government has firmly stated its commitment to rationalising the systems of inspections as well as ensuring their greater transparency, consistency and fairness– for example, within the National Reform Programme 2017 and 2018. The interviews conducted in this Review suggested, however, that further progress could be achieved. The OECD Recommendation of the Council on Regulatory Policy and Governance (OECD, 2012) highlights that governments should ensure that inspections respect the legitimate rights of those subject to the enforcement and avoid unnecessary burdens on those subject to inspections, are not unduly burdensome as well as apply the OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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150 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA principles of risk management, wherever possible. In this context, risk management systems can help governments focus its inspections on operations where the probability of violation is highest, optimising the use of resources and reducing the burdensomeness of repeated inspections, while further increase the use of electronic tools for reporting on inspections (e.g. via extension of e-INSPEKTOR service) could help reduce their burdensomeness. In some areas, regulatory enforcement in Croatia is carried out on the basis of the risk-based approach and sanctions (e.g. food safety inspections). However, this is still not a common practice. As such, the government could consult the OECD Regulatory Enforcement and Inspections Toolkit (OECD, 2018e) for further guidance and consider further capacity-building in this area. The new Law on the State Inspectorate (Zakon o Državnom inspektoratu)48, which entered into force on 1 April 2019, is expected to support the objective of reducing the burdensomeness of inspections in Croatia. For example, the new State Inspectorate will concentrate a number of inspections previously undertaken by different bodies.49 In addition, the law introduces internal procedures and rules to improve the planning and coordination of inspections to avoid their undue repetition, allows for a better communication with the inspected subjects as well as facilitates corrections of minor offenses during the inspection procedure. Last but not least, as further discussed in Chapter 7, stakeholders have regularly highlighted the more general need to improve a consistent application of laws across the different levels of administration. Difference in the ease of obtaining licenses and permits have been a case in point. The recent sub-national study of Doing Business for Croatia has identified some of the key differences across five different cities in Croatia, with the largest performance gaps seen in dealing with construction permits, enforcing contracts and starting a business (Papahagi et al., 2018). For example, completing the construction permitting process for a simple warehouse in Varaždin takes 112 days and costs 5.3% of the warehouse value—half the time it takes in Split, at a third of the cost. Starting a business is easier in Split, where most limited liability companies are set up using HITRO.HR. Dealing with construction permits is easier in Varaždin, while Osijek shows best performance in registering property and enforcing contracts. At the same time, the results also identify pockets of excellence in various regions. For example, the report also shows that surveyed cities in Croatia outperform the EU average for enforcing contracts and the city of Split outperforms many OECD countries on the time needed for business registration (Papahagi et al., 2018). Identification of various best practices and promotion of local champions at sub-national level, combined with better monitoring and enforcement at the national level and continued institutional reform could help Croatia address some of the persistent obstacles in this area. It is also worth noting that high administrative burdens – whether encountered in some regions or throughout the entire territory – tend to affect disproportionately small andmedium-sized enterprises. This is because they often do not have the required personnel and resources to absorb the additional cost of dealing with complex procedures, e.g. via outsourcing to professional service providers (see e.g. OECD, 2017b). As such, considering Croatia’s interest in supporting and promoting growth of domestic SMEs, which dominate the country’s economic tissue (Alpeza et al., 2016), it could attach particular attention to the implementation of the various administrative simplification and investment facilitation reforms discussed above as a horizontal support scheme for all firms, with disproportionally large positive effects on local SMEs.

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Croatia's incentives scheme for investors Beyond removing various legal and administrative barriers to foreign investment, countries at times decide to offer additional incentives to investors. These may include tax exemptions, exonerations from social contributions or import duty payments, or financial and in-kind support among others (see Box 6.6). On the expectation that private investment will raise employment, exports, technologies, or that some of the knowledge brought by foreign companies may spill over to the country's national development goals, Croatia has also introduced various forms of investment incentives to encourage both foreign-owned and domestic companies to invest in its jurisdiction. With the objective to encourage entrepreneurship further, it also recently introduced significant tax reforms. While under some circumstances there may be an economic or political justification for granting incentives, often governments find this strategy simpler and more immediate than to correct deficiencies in infrastructure, labour skills, the legal system and other areas. As illustrated by the trend in some developing, emerging and transition economies to offer generous tax incentives, investment incentives schemes may reduce effective tax rates to a large extent (OECD, 2018; IMF, OECD, UN and World Bank, 2015). It is important to ensure that investment incentives, and tax policies in general, are not contributing to a disproportionate or unplanned strain on domestic resources. For this reason, a country’s incentives framework is an important component of the OECD Declaration on International Investment, which includes the Instrument on International Investment Incentives and Disincentives [hereafter: the Instrument]. The Instrument encourages governments to ensure that incentives as well as disincentives are as transparent as possible so that their scale and purpose may be easily determined. Building upon the Instrument, the OECD Policy Framework for Investment further encourages countries to evaluate the costs and benefits of incentives, in particular the use of tax incentives together with the level of tax burden they impose on businesses with a view of meeting their investment promotion strategies and development goals. Box 6.6. SME support schemes in Croatia

Support from Government for the promotion of SMEs dates from 2001, when the first Government programme, “The Programme for the Development of Small Business” was approved. From 2001 to 2012, support for SME development, was provided, initially by the Ministry for Crafts and Small and Medium Entrepreneurship (2001 to 2003), and then (2004-2012) by the Ministry of Economy, Labour and Entrepreneurship. The initial policy programme (2001-2004) comprised of three main instruments: a) grant aid, b) interest rate subsidies, and c) the establishment of credit lines with a number of commercial banks as well as participation from local authorities. Grant schemes have been developed to provide funding to enterprises, local authorities (to support enterprise zone development) and to crafts and vocational organizations (to provide support to entrepreneurs and business persons and develop the capacities of craftsmen). Interest rate subsidies were funded jointly by the ministry and the counties for loans taken out by entrepreneurs and enterprises borrowing from participating commercial banks. Development funds were established with the participation of the Ministry, Counties and municipalities and a number of commercial banks to promote SME investments. Finally, loan guarantees (provided by HAMAG-BICRO) were added to the policy portfolio during the period. SME policy continued along similar lines until 2011, when, in addition,

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152 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA Ministry funded contributions towards the establishment and functioning of a small number of venture capital funds. This situation changed in the mid 2010s as a result of the availability of the EU Structural Funds and the National SME Development Strategy 2013-2020. From 2015, the main sources of SME promotion have been EU structural funds. Steps have been taken to bring about changes in the formulation of SME policy and support in reaction to this development. These include: capacity development in policy impact assessment; the collection of information on policy effectiveness from the SMEs’ perspective; and, the establishment and adoption of policy indicators for monitoring and evaluation purposes. Currently, HAMAG BICRO and HBOR are responsible for management and disbursements of funds to firms. In addition, HAMAG BICRO also provides micro- and small loans and other financial instruments. In addition, the Ministry of Economy, Entrepreneurship and Crafts is in charge of overseeing the implementation of the “SME test”, i.e. an assessment of the likely impact of a proposed change on SMEs, as part of regulatory impact assessment (RIA) undertaken when developing new regulations (see Chapter 7). Source: Government of Croatia

Mapping Croatia's corporate income tax policy and investment incentive regime Croatia's tax regime With the aim to encourage entrepreneurship and attract investors, Croatia introduced significant tax reforms in 2018. A result of these reforms, which have affected a number of tax and social contribution related laws, the overall tax burden on business appears low in comparison with Croatia's EU peers. For example, in the area of corporate profit tax (CIT), the general tax rate has been decreased from 20% to 18%, below the EU average. With regard to agricultural producers and small businesses with annual revenues less than HRK 3 million (EUR 400 000), it has been further discounted to 12%. Among EU neighbouring countries, Croatia and Slovenia have almost the same rate, whereas Austria, Italy and Hungary have rates at 24% and 25%. Within Southeast European economies, all peers have lower rates (Table 6.2), which likely illustrate the incentive competition that Croatia is facing with some of its direct neighbours. Uncoordinated, unilateral regulatory efforts may be inefficient to govern and select the flows of investment; on the contrary such policies may fuel undesired regulatory arbitrage by companies. They are able to shift the location of their investments in response to the diversity of incentives and the inherent advantages of different market, thus favouring some countries to the expense of others (OECD, 2015a; OECD, 2008; OECD, 2004). In this respect, the Instrument on International Investment Incentives and Disincentives has aimed to fill this gap to facilitate international cooperation in this area. In the area of personal income tax, the applicable rates were also reduced in 2018 with the objective to remove the tax burden on salaries which was said to negatively impact the competitiveness of labour. While Croatia is not yet included in the OECD databases on different aspects of tax regime and a comprehensive review of the tax system lies outside of the scope of this Review, existing studies attempted to apply the OECD Taxing Wages methodology to calculate the tax wedge50 - which is used as proxy for the extent to which taxes can discourage employment – find that they have fallen over time.51 OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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Table 6.2. Corporate income tax rates: Croatia, Southeast European economies, and EU-28, 2018 Corporate tax rate (%) EU average Croatia Albania Bosnia-Hercegovina North Macedonia Montenegro Serbia Slovenia

21.3 18 15 10 10 9 15 19

Source: European Commission, Tradingeconomic.com

Investment incentives While investors may consider statutory CIT rates as a first reference point when evaluating the tax competitiveness of a jurisdiction, it is the entire tax regime – including in particular various tax and other incentives – that indicates a tax system's burden on businesses or incentives to invest. As such, a calculation of average effective tax rates (AETR) and marginal effective tax rate (METR) is often a more meaningful metric (OECD, 2008). As outlined in Box 6.7, the most common types of incentives are so-called tax holidays, reduced tax rates, accelerated depreciation, tax credits, and investment allowances. These measures aim at influencing the size, location or industry of an investment project by affecting its relative cost or by altering the risks attached to it. Box 6.7. Investment incentive instruments Corporate tax incentives

     

Tax holidays or reduced corporate tax rates. Tax credits. Investment allowances. Accelerated depreciation. Reinvestment or expansion allowances. Double deduction of certain expenses for tax purposes (usually related to e.g. employment, exports, R&D or infrastructure).

Other tax incentives

      

Personal income tax exemption on dividends. Exemption from, or reduction of, withholding taxes. Duty drawback schemes. Exemption from import tariffs, particularly for capital goods, equipment or raw materials. Exemption from export duties. Exemption from sales, property and wage income taxes. Reductions in social security contributions.

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154 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA            

Financial incentives Subsidised or concessionary financing. Government equity participation. Insurance at preferential rates. Loan guarantees. Direct grants. Provision of dedicated infrastructure. Provision of training, pre-screening of potential employees. Preferential treatment on foreign exchange. Preferential government contracts. Protection from import competition. Subsidised services such as feasibility studies or product marketing.

Regulatory incentives



Derogations from national and sub-national rules and regulations, e.g. social, labour or environmental standards, ethnic quotas, local equity participation.

Source: OECD (2004)

Croatia offers a panoply of different investment incentives. Its incentive scheme is available to all investors, foreign as well as domestic, and can be divided into five broad categories: corporate tax credits applicable for up to ten years upon completion of certain conditions; incentives for investments in certain activities and high value added services; incentives for investments into capital intensive and work intensive projects; employment and training incentives; R&D incentives; and additional incentives applied to companies in special economic zones. Box 6.8 outlines the specific conditions that apply to investment incentives. Croatia provides an online investment incentives calculator on the website of HAMAG-BICRO that calculates an expected level of state support based on project characteristics (e.g. employment, location, capital investment). Box 6.8. Investment incentives in Croatia

Croatia provides the following investment incentives: 

Reduction of the profit tax rate from 50 to 100% depending on the size of the investment and the number of newly created jobs. For micro enterprises (companies with up to 10 employees) that invest at least EUR 50 000 and create a minimum of three new jobs, a 50% reduction applies for a maximum of ten years. For small, medium and large enterprises, a 50% reduction applies for a maximum of ten years for companies that invest up to EUR 1 million and create at least 5 new jobs; this reduction increases to 75% for companies that invest between EUR 1 and EUR 3 million and create at least 10 new jobs, and to 100% for companies that invest over EUR 3 million and create at least 15 jobs.



Employment incentives, for creating new jobs in relation to the investment project. Nonrefundable subsidy for eligible costs of new jobs created depends on the unemployment

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rate in the county in which the investment is located. The incentive rate is applied to eligible costs of jobs creation. 

Incentives for education and training. The eligible costs for the purpose of training may include trainers’ personnel costs, for the hours during which the trainers participate in the training; trainers’ and trainees’ operating costs directly relating to the training project such as travel expenses, materials and supplies directly related to the project, depreciation of tools and equipment, to the extent that they are used exclusively for the training project. The non-refundable subsidy shall not exceed 50% of the eligible costs. It may be increased, up to a maximum aid intensity of 70% of the eligible costs by 10 percentage points if the training is given to workers with disabilities or disadvantaged workers; by 10 percentage points if the aid is granted to medium-sized enterprises; and by 20 percentage points if the aid is granted to small enterprises.



Incentives for labour-intensive investments creating at least 100 new jobs within three years from the start of the investment project. An additional incentive in the amount of 25% of the amount of incentive granted for new jobs is granted to investment projects creating up to 30 jobs; this amount increases to 50% for a minimum of 300 new jobs, and up to 100% for 500 new jobs.



Incentives for capital-intensive investment projects, which apply to investments whose minimum amount is EUR 5 million and generate at least 50 new jobs within 3 years of the start the investment. These investment projects can benefit from additional nonrefundable subsidies between 10% and 20% of the cost of new factory construction, production facility construction or purchase of new equipment depending on the employment rate of the county where located and subject to certain conditions (e.g. the part of investment in the equipment must equal to at least 40% of the investment and at least 50% of this equipment must be of high technology).



Incentives for research and development (R&D) projects, which apply to the conduct of certain activities that must conform to specific criteria such as bringing new knowledge. These projects can benefit from tax relief, reducing the tax base for income tax for justified R&D project and feasibility study costs. A 200% of eligible R&D project expenses is deducted for basic research, a 150% deduction is provided for industrial research and feasibility study costs, and a 125% deduction for experimental development. Deductions for industrial research and experimental development may be further increased by 20% for small businesses and by 10% for medium enterprises under certain conditions.



Incentives for economic activation of inactive assets in public ownership, which apply to investments in land and/or buildings owned by the Republic of Croatia and administered by the Ministry of State Property, which are not in operation and in which no economic activity is performed. The incentive consists of a free lease of inactive property for up to 10 years from the start of the investment project. Requirement for benefiting from this incentive is at least EUR 3 million invested in the fixed assets and the creation of 15 jobs within a three-year period from the start of the investment project.



Special economic zones. Free zones and entrepreneurial zones are another vehicle through which Croatia aims to attract investors and facilitate economic development of different regions. Source: Government of Croatia (January 2019)

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156 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA Recent past has seen efforts by the government in rationalising the country’s incentives scheme. Following good practice, Croatia has been moving away from a volume-based approach to investment promotion, with generous incentives across the board, to a more nuanced one where incentives are designed to achieve specific outcomes: incentives have increasingly focused on those activities that create the strongest potential for economic spillovers, including linkages between foreign-owned and domestic firms, education, training and R&D. In addition, both the Act on Investment Promotion and the Act on Strategic Investments that outline the provision of state aid in Croatia have been developed in compliance with the EU state aid rules that the country is subject to.

Special economic zones One specific type of investment incentives offered to investors in Croatia are services and benefits associated with locating in in special economic zones. Special economic zone system in Croatia comprises free and entrepreneurial zones that are governed by dedicated legal acts. Building of the industrial infrastructure for the production of goods aimed for exports is the primarily objective behind the creation of free zones; meanwhile, the main goal of entrepreneurial zones is to support regional development, including in the least prosperous counties (see also Borozan and Klepo, 2013 as well as Kontošić, Pamić and Belullo, 2018). In early 2019, there were 220 entrepreneurial zones and 11 free zones operating in Croatia. Table 6.3 provides an overview of free economic zones operating in Croatia. As can be seen, most of the free zones were created towards the end of 1990s and early 2000s, the two largest zones being located in Split and Ploce. Special economic zones (SEZs) in Croatia’s neighbouring economies tend to be larger on average, with the exception of the Republic of North Macedonia (OECD, 2017b). According to the government, the functioning of the zones has been evaluated by an independent institute and its results have confirmed their effectiveness.52 It has also been shown that less developed municipalities and counties have received more support from the state for the development of the zones, in line with the objective of supporting regional development (Kontošić et al., 2018). Companies which operate in Croatia’s free zones benefit from an exemption from customs duties or taxes, including VAT, levied on goods stored in the zone; investment friendly areas and possibility to use privileges prescribed by the Investment Promotion Act for investments in the free zone; unlimited deadline for storage of goods; safe and guarded places; customs services open 24 hours a day; and reduced administrative burdens. Meanwhile, entrepreneurial zones are located in nearly each county and primarily provide infrastructure to firms in the form of good locations with utility services, logistical support and transport links. In terms of organisation, the founders and oversight bodies of entrepreneurial zones are local and regional authorities while the founders of free zones can be local and regional authorities, institutions and public or private companies. It appears that, while formally the Ministry of Economy, Entrepreneurship and Crafts is responsible for the policy, there is no central oversight or coordinating body at the central government level that would monitor and coordinate the zone activities. Similarly, as in the case of other investment incentives, SEZs should be regularly evaluated to ensure that they achieve their intended results, and do not put budget under undue pressure, affect negatively the level playing field for firms operating in the economy or lead to creation of enclaves within the domestic territory. It appears that no such assessment is being undertaken by authorities in Croatia. However, the government has just commissioned to the Institute of Economics in Zagreb (EIZ) a study of the entrepreneurial

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zones effectiveness over the years 2003-2014.53 The goal of the study is to assess the costs and outcomes of the policy. Given the number of such zones in Croatia, and an apparent lack of oversight at the central government level, such an exercise could be particularly beneficial. Moreover, as information on ownership of firms established in the zones is not readily available, it is impossible to ascertain how important the zones are in supporting Croatia’s FDI attraction efforts. Finally, regular monitoring and periodic assessments can also provide an opportunity to gauge the socio-economic impacts of the zone system, considering in particular their contribution to the country’s development goals and ensuring that the legal and regulatory framework for responsible business conduct and measures to fight corruption should apply to companies in the zone to the same extent as elsewhere in the country. Table 6.3. Free Economic Zones in Croatia Free zone Krapinsko-zagorska free zone Podunavska free zone Vukovar Free zone Kukuljanovo Free zone Luka Rijeka – Škrljevo Free zone Osijek Splitsko-dalmatinska free zone Free zone Zagreb Free zone of port Ploce Free zone of port Pula Free zone of port Rijeka Free zone of port Split

Location: County / City Krapinsko-zagorska / Krapina Vukovarsko-srijemska / Vukovar Primorsko-goranska / Bakar Primorsko-goranska / Bakar Osjecko-baranjska / Osijek Splitsko-dalmatinska / Split Grad Zagreb / Zagreb Dubrovacko-neretvanska / Ploce Istarska / Pula Primorsko-goranska / Rijeka Splitsko-dalmatinska / Split

Founded 1997 2002 1997 2013 1997 1999 1997 1999 1999 1997 1998

Area (ha) 6.4 0.76 100 33.76 13 213.39 7.99 214.59 5.98 64.1 28.39

Source: Government of Croatia, 2019

Effective and efficient use of investment incentives When countries do use incentives, the Instrument on International Investment Incentives and Disincentives and the OECD Policy Framework for Investment highlight the need for a transparent and non-discriminatory use of incentives as well as their frequent evaluation to ensure that they achieve intended objectives. In Croatia, the legal framework for investment incentives is governed by several legal acts. The general framework for investment incentives is regulated by the Investment Promotion Act. Other incentives are spread about in different laws and regulations - for example: the Free Zones Act (Official Gazette no. 44/96, no. 92/05 and no. 148/13), which regulates the establishment and functioning of the free zones; the Entrepreneurial Infrastructure Improvement Act, in force since 2013 (Official Gazette no. 93/13, no. 114/13 and no. 41/14), which regulates entrepreneurial zones54; and the Act on State Aid for Research and Development Projects (Official Gazette no. 64/18), in force since July 2018. The Personal Income Tax Act also stipulates the conditions under which income from a self-employment activity can be reduced under specific conditions. Consolidating all tax incentives, along with their eligibility criteria, into the main body of the tax law, would increase transparency and could help remove any doubt that the tax administration is empowered to administer them (OECD, 2015). The multiplicity of regimes may generate disorientation among investors. Furthermore, there is an uncertainty as whether Croatia’s investment incentives scheme meets its intended objectives. Tax and other forms of incentives may generate distortions in the allocation of resources between different types of tax payers, different sectors or

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158 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA industries and different types of businesses in favour of those receiving preferred treatment. Another concern over the use of investment incentives is the resulting foregone revenue. Currently, there are no procedures in place that allow for ex post impact assessment of the allocated investment incentives in Croatia. Establishing mechanisms to evaluate the costs and benefits of investment incentives could help them assess against their intended policy objectives as well as the associated fiscal cost, which may be particularly important given the prominent role of investment incentives in Croatia’s investment promotion and facilitation policy. In particular, a comprehensive and accurate measurement of both costs and benefits is necessary to allow for a reliable assessment of incentives impact.55 Overall, investment incentives should be transparent; non-trade distorting; oriented toward long-term investment; temporary, proportionate to the expected benefits; subject to strict impact assessment; and rooted in a coherent business model, also from an RBC perspective. In this regard, some countries provide incentives to encourage businesses to uptake responsible business practices, including financial incentives such as credits for demonstrated commitment to RBC in government contracting or investment or tax incentives to encourage business to invest for example in low-carbon technologies.

Outlook and policy recommendations Croatia has taken steps to improving its investment promotion and facilitation policies. The main focus has, nevertheless, been so far on the use of various investment incentives and, more recently, allocation of the EU Structural Funds. Meanwhile, progress has been timid in several key aspects of business climate. According to business surveys, administrative procedures remain complex and lengthy in certain areas (e.g. business and land registration or obtaining of construction permits). Investors have also complained about retroactive changes, conflicting interpretations and uneven application of laws or of administrative requirements by different public bodies across Croatia’s territory (e.g. inspections). In light of this, continuing efforts to improve the quality of administrative procedures and the underlying regulations as well as progress in rationalising existing ones and providing better investment public investment facilitation services (e.g. OSS solutions, e-permitting) could help reduce barriers faced by firms. The institutional set-up for investment promotion itself appears to be fragmented and is currently evolving. As such, a number of stakeholders, not least business, call for a more comprehensive, long-term vision for Croatia’s investment attraction policy to build a whole-of-the-government approach. In the area of tax, the 2018 reform has reduced the overall tax burden and a relatively wide palette of investment incentives in Croatia offers a further possibility to reduce effective tax rates. Still, questions remain around the issues of transparency, predictability and effectiveness of the system. First step to successfully orienting future policies is evaluating past performance and drawing appropriate conclusions. As such, evaluations of effectiveness of the use of investment incentives, including with respect to the incentives provided in the special economic zones, as well as of the capacities of agencies involved in investment promotion could help the government decide on future reforms. Challenges ahead are multi-layered. Reforms are said to be slowed down by special interest groups and many of the ills of the Croatian administrative inefficiencies originate in the organisation of the state apparatus, the quality of public governance and processes of creating regulations. As such, progress in these areas will be critical to avoiding accumulation of problems in the future. In this regard, ex post reviews of existing

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regulations, using the recently adopted SCM methodologies, could help rationalise the current system, including in the area of permits and licenses and para-fiscal charges. With the stabilisation of the political situation in the country and prospects of further economic recovery, the government could focus on implementation and delivering on promises. Last but not least, a transition from an incentives and volume-based approach to investment attraction to a more targeted approach to investment promotion – and more generalised approach to investment facilitation (relying less on special regimes such as SEZs) is not a change that can take place over night. The government will face increasing challenges in balancing the requests from businesses and those of civil society and other stakeholders (see Chapter 8) as it attempts to strike the right balance between economic growth and broader development and societal objectives. In this context, a better framework for monitoring and evaluation of various investment promotion actions can help the government identify the true costs and benefits of different approaches.

Policy recommendations 

Establish a consistent and unified institutional and policy framework for investment promotion and facilitation encompassing all relevant entities with the ultimate goal of maximising synergies and effectiveness, eliminating duplication of efforts and giving clarity to investors. This could involve endowing one government body with adequate resources and capacities to perform such functions and ensure that it coordinates its efforts with other relevant bodies at the national and subnational level. Regardless of the legal status of such a body, the government should clearly outline its objectives and the planned course of action to reduce uncertainty.



Focus efforts on effectively streamlining administrative procedures, in particular in the area of starting business, getting construction permits and paying taxes including parafiscal charges. This requires that these efforts are conceived in a way that reduces the heterogeneity of practices across different levels of government and regions. It also involves setting clear, procedure-specific deadlines and monitoring progress to ensure implementation within the planned timeframes.



Introduce systems of monitoring and evaluation of Croatia’s investment promotion and facilitation policy, including investment incentives. In that context, establish formal channels of consultation between the tax authorities and other stakeholders to allow for a comprehensive view of costs and benefits of the current system.

Notes 1

In addition, about 90% rated their overall experience as average, good or very good and three forth planned to expand and hire new employees in the next three years (AmCham, 2018). 2

According to the AmCham (2018) survey, 48% of respondents identified the level of taxes, 48% slow administration, 43% lack of long-term government vision, and 43% the small size of the local market as top obstacles to doing business in Croatia. 3

Furthermore, the Act on Investment Promotion, specifies sub-categories of several of the above mentioned activities that can benefit from additional state support (see Article 12).

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All the opinions and administrative acts except for those which are issues in accordance with Article 25 paragraph 2 of the Act shall be issued by the central state administration bodies competent for their issuance within 15 days upon receipt of a the dully submitted request by the interested investor (Article 13 of the Act on Strategic Investments). 5

In March 2018, amendments were made to the Act, lowering the required investment threshold from HRK 150 million to HRK 75 million and from HRK 20 to 10 million in case of areas of special concern, islands, agriculture or fisheries – and the use of securities as proof of financing, among others. 6

The Government Plan is available (in Croat) on the Central Government Portal:

https://vlada.gov.hr/UserDocsImages/ZPPI/Dokumenti%20Vlada/Program_Vlada_RH_2016_2020.pdf 7

More information on the national development strategy of Croatia can be found on the government’s website: www.vlada.gov.hr/news/pm-plenkovic-national-development-strategy-willdefine-objectives-until-2030/23290 8

“A strategic project will be considered the project the implementation of which creates conditions for the employment of more people, depending on the type and location of the projects that significantly contribute to the development or improvement of conditions and standards for the production of goods and provision of services that introduce and develop new technologies to increase competitiveness and efficiency in the economy or public sector and/or which rise the overall level of safety and quality of life of citizens and environmental protection, which have a positive effect on more economic activities and the implementation of which creates added value, and which largely contribute to competitiveness of the Croatian economy (…)”. 9

The required value of total capital investment cost has been lowered from HRK 150 million to or higher than HRK 75 million (or lower if co-financed by the EU funds and programmes); or be realized in the assisted areas (or in the units of local self-government of certain type) and have total value of capital investment cost in that area equal to or higher than HRK 10 million; or are realized on the islands and have total value of capital investment cost equal to or higher than HRK 10 million. For projects that fall within the area of agriculture and fisheries and total value of capital investment costs must be equal to or higher than HRK 10 million 10

FIC formulated key recommendations in those areas: 1) developing a sustainable strategy for encouraging investment and attracting foreign investment; 2) maintaining a stable and predictable regulatory environment, in order to reduce uncertainty and encourage investment, with special emphasis on the stability of the tax system and predictability of work of the Tax Administration, as well as abolition of acts which negatively impact competitiveness; 3) accelerating business procedures in order to reduce regulatory and administrative business costs; 4) improving the consistent application of law in the entire economy, advancing the quality and credibility of laws and regulations. 11

The Centre for Monitoring Business Activities in the Energy Sector and Investments was in charge of investment projects in infrastructure and energy at the time of writing of the Review. It has since then been abolished and all its activities transferred to the Ministry of Environment and Energy. 12

For example, HAMAG BICRO also has its network of partner institutions, HITRO.HR has its offshoots in over 60 locations across the country and AIK had 19 partner institutions at the countylevel across Croatia. The Croatian Chamber of Economy has a network of 20 county chambers, and many municipalities and cities lead their own investment attraction efforts. 13

Meanwhile, MEEC was responsible for public strategic investment projects under the Act on Strategic Investments. 14

The Government of the Republic of Croatia issued a Decision on the reduction of central state agencies, bureaus and funds, which contained a list of 54 bodies to be abolished or merged. AIK was one of those agencies.

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15

The Act on the cessation of the Act on the establishment of the Agency for Investments and Competitiveness is available (in Croat) in the Official Gazette (OG 115/2018) at www.narodnenovine.nn.hr/clanci/sluzbeni/2018_12_115_2242.html 16

See Articles 3-5 of the abolishing act.

17

According to Article 7 of the abolishing act, the Ministry is to issue such regulation within 30 days from the date of entry into force of the Act. 18

Information provided by the government during the discussions within the OECD Investment Committee, taking place as part of this Review. 19

The government explained the rationale for abolishing 54 central government agencies, including AIK, in the following press release: www.vlada.gov.hr/news/public-finances-are-viable-and-undercontrol/24243 20

As part of this Review, the government had assigned AIK to participate in the OECD-IDB IPA Survey. Considering that all the AIK’s resources, staff and activities were taken over by the Ministry, the findings remain relevant for the future functioning of the Ministry’s new department. 21

For example, it helped promote regions in its activities with investors and created promotional materials for certain regions, see www.aik-invest.hr/en/investment-region/. Also, the map of investment opportunities and the map of business zones enable search by regions (counties), providing investors with information on the available investment possibilities. In addition, under the Strategy for the regional development of the Republic of Croatia until 2020, AIK was in charge of creating a unified communication model towards investors on all levels of the Government, providing support to the activities of regional development agencies and developing joint actions for several counties and local units in attracting (foreign) investments. 22

Information based on the responses provided by the government as part of Review.

23

For example, most of the OECD countries that have dedicated PPP units usually locate them in the Ministry of Finance or establish an independent agency (OECD, 2010a); and only very few (9% of OECD IPAs) have tourism promotion as part of their mandate (OECD, 2018a). 24

The Act also includes the definition of large investment projects that AIK used to be responsible for, specifying minimum value thresholds. 25

See www.aik-invest.hr.

26

See www.aik-invest.hr/en/investment-projects-map

27

Firms tend to engage in more complex or high-value added activities, such as R&D, after having operated in the host economy for some time (OECD, 2008d); and reinvested earnings account for a large share of OECD FDI inflows (OECD, 2018b). 28

Higher budgets are found to be associated with a larger number of investment generation and facilitation activities (including aftercare services), see Volpe Martincus and Sztajerowska, forthcoming. In addition, IPAs that prioritise certain investors and projects tend to have higher budgets enabling them to provide higher quality services to selected firms (OECD, 2018a). 29

Higher budgets of IPA and targeting intensity are associated with a higher stock of inward FDI per capita and total number of foreign affiliates located in the economy per capita (see Volpe Martincus and Sztajerowska, forthcoming). 30

For example, as highlighted in Box 6.2., the agency had no foreign offices abroad, which may have limited its ability to generate prospective investment leads; no customer management relationship (CRM) system, used by 94% of OECD IPAs and considered a critical IPA management tool (even if it had another internal tool to track investment projects); and had less than half of its staff with prior private sector experience (compared to the average of two thirds in the OECD IPAs).

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As an autonomous agency, AIK was able to pay wages above the level of the public sector. This is a common practice among the IPAs that by its nature require staff with prior private sector experience and sectoral knowledge to interact with investors and hence compete for talent with the private sector. With the absorption into the Ministry, wages of staff in the new department would be subject to the public sector pay scale. 32

In 2016, UK Trade & Investment, UK’s national IPA, has been turned into the Department for International Trade. 33

Croatia was ranked 58th on World Bank’s Doing Business 2019 edition out of 190 and 68th out of 161 in the WEF’s Global Competitiveness Report 2018. 34

AmCham (2018) and Foreign Investors Council (2017) have stressed complex administrative burdens, unstable regulatory framework, and tax policy as key constrains to doing business in Croatia. According to an earlier survey of Croatian CEOs conducted by PWC (2015), tax burden and overregulation were also among the major concerns mentioned by business in 2015. The 2013 World Bank’s Enterprise Survey also found that 20% of senior management’s time was spent dealing with the requirements of government regulation, compared to 12% in Central and Eastern Europe and 10% globally, and 46% of firms identified tax rates as a major constraint to doing business (World Bank, 2013). 35

The government developed several administrative simplification plans or strategies in the past. For example, in 2006, the so-called HitroRez Plan was announced with the goal to reduce administrative burdens (via the so-called administrative guillotine approach) and improve in the quality of regulatory policy in Croatia. By the end of the review process, HitroRez recommended the elimination of 425 regulations and a simplification of 374 others. After a promising start (see e.g. OECD, 2010), HitroRez office has been discontinued in 2007 and many of the identified reforms have not been implemented (Šimić Banović, 2015). Following the entry into the EU, other plans were developed to reduce administrative burdens. For example, an administrative simplification plan 2015 aimed to achieve reductions in administrative burden amounting to HRK 300 million in 2015 and another HRK 300 million in 2016 (Government of Republic of Croatia). 36

The Action Plan for Administrative Burden Reduction 2007 set out 104 measures to be reduced, resulting in a cut of administrative burden by 30%, which is equivalent to 0.4 % of GDP (Ministry of Economy, 2017). According to the government, out of 104 measures from the Action Plan 2017, 75 measures were implemented. Furthermore, SCM measurement was extended further and a thorough assessment was conducted in 70 legislative areas to identify new measures to be addressed in the Action Plans for Administrative Reduction 2018 and 2019. Within the plan for 2018, 142 measures were proposed and 107 measures have been already implemented. Within the plan for 2019, adopted in January 2019, a total of 314 additional measures were proposed. 37

Initially, the government applied the SCM methodology to the retail and real estate sectors, achieving a reduction in the administrative burden by 20% in those sectors (European Commission, 2016). Since then, the SCM methodology was applied in other sectors and 70 different legislative areas to identify measures to be removed as part of the action plans for administrative burden reduction. 38

For example, in 2018, six laws and 20 bylaws were changed implementing 107 out of 142 measures, and five additional laws and bylaws are being processed to complete the process, according to the information provided by the government as part of this Review. 39

According to the information provided by the government as part of this Review, the Working Group was created on 8 March 2019. 40

The government has implemented several projects aiming to strengthening, digitising and improving the coordination between the property and land registration systems in cooperation with the World Bank, the EBRD and the EU. In August 2018, the World Bank approved a loan to Croatia for the Integrated Land Administration System Project in the amount of EUR19.7 million (USD24.07 million equivalent) to further modernise the property and land registration service. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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According to the World Bank (2018), under the ongoing project, the average time to register mortgages and real property transactions decreased from 46 days to 12 days in Land Registry Offices and from 30 to eight days in Cadastre Offices and the very first e-services for land administration were introduced. 41

The Ministry of Construction and Physical Planning developed the ‘e-permit’ system that allows all building and use permits for construction works to be issued electronically (https://dozvola.mgipu.hr). 42

As will be explained later, some cities in Croatia are performing much better in this regard (Papahagi et al., 2018). 43

The implementation of e-procedures is part of a wider government plan to provide services online (so-called e-Croatia). For an overview of services available to-date to Croatian citizens, consult the Central Government Portal: www.vlada.gov.hr/highlights-15141/archives/smart-government-ecroatia/18023. 44

For example, a recent business survey undertaken by the American Chamber of Commerce (AmCham, 2019) finds that, unlike in previous years (e.g. 2017 and 2018), long and complex administrative procedures were not anymore among the top limiting factors for doing business in Croatia, and almost half of respondents found that business conditions had improved in the past five years. 45

In addition, the government suggests that it takes eight days on average to establish a business in Croatia using HITRO.HR services or 24 hours if the new e-Company service is used. Information retrieved from the Ministry of Economy, Entrepreneurship and Crafts’ website: http://investcroatia.gov.hr/en/investment-guide/establishing-a-company/setting-up-a-company/ 46

For example, the World Bank has been conducting a diagnostic of the current business registration systems to provide the government with recommendations on needed reforms. 47

Information provided by the Croatian authorities during the discussions within the OECD Investment Committee that took place as part of this Review in March 2019. 48

The State Inspectorate is established as an independent inspection body a state office that would report directly to the Government). The central office will be based in Zagreb with five to six regional offices and departments across the country. 49

As per the new Law, the State Inspectorate is taking over the inspection of pressure equipment and the inspection of the management of poisonous chemicals from the Ministry of Economy, Entrepreneurship and Crafts, the sanitary inspection from the Ministry of Health, veterinary, agricultural, hunting, forestry and phyto-sanitary inspection from the Ministry of Agriculture, tourist inspection by the Ministry of Tourism, energy inspection, environmental inspection, inspection of nature protection and water inspection from the Ministry of Environmental Protection and Energy, Labour Inspectorate from the Ministry of Labour and the Pension System, and construction inspection from the Ministry of Construction and Physical Planning. 50

Tax wedge is defined as the ratio between the amount of taxes paid by an average single worker (a single person at 100% of average earnings) without children and the corresponding total labour cost for the employer. The average tax wedge measures the extent to which tax on labour income discourages employment. This indicator is measured in percentage of labour cost. 51

For example, while earlier studies rank Croatia above the OECD average or among high taxwedge countries (e.g., Šeparović, 2009, Grdović et al., 2010 and Škrbić and Šimović, 2014), more recent studies rank Croatia lower (e.g., Urban, 2016 and Beketić, 2016). 52

Further information on the study and its objectives can be found on the website of the Institute of Economics in Zagreb (www.eizg.hr). 53

Information can be located at the Institute’s website: www.eizg.hr.

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The Act on Improving Entrepreneurial Infrastructure was amended in the second half of 2018 (Official Gazette, No. 93/13, 41/14, 57/18). 55

An evaluation of the economic benefits of tax incentives should take into account a) direct impact by the incentives-motivated investment; b) indirect and induced impact due to inter-industry transactions and changes in income and consumption; c) positive externalities, such as technology and know-how transfers by incentives-induced FDI; and d) social and environmental benefits where tax incentives serve to correct market imperfections. The costs that should be considered include; a) primary revenue forgone due to tax incentives; b) revenue leakages due to unintended and unforeseen tax-planning opportunities; c) costs incurred by taxpayers in order to comply with a given tax incentives regime; d) the administrative costs from running the tax incentives programmes due to the complexity introduced to the legislative and regulatory framework; and e) the costs to the economy of creating an “uneven playing field” where domestic firms are not entitled to the same tax incentives as their foreign competitors. See OECD (2015) for more detail.

References Alpeza M., M. Has, M. Novosel, and S. Singer (2016), Small and Medium Enterprises Report Croatia – 2016 including the results of GEM – Global Entrepreneurship Monitor research for Croatia for 2015, CEPOR SMEs and Entrepreneurship Policy Centre, www.cepor.hr/wpcontent/uploads/2015/04/Cepor-izvjesce-2016-ENG-web.pdf Amcham (2019), Survey of the Business Environment in Croatia, www.amcham.hr/storage/upload/doc_library/amcham__survey_of_the_business_environment_in_croatia_15192.pdf Amcham (2018), Survey of the Business Environment in Croatia, www.amcham.hr/storage/upload/doc_library/amcham__survey_of_the_business_environment_in_croatia_143454.pdf Beketić I. (2016), “Tax wedge in Croatia, Slovenia, the Czech Republic, Portugal and France”, Financial Theory and Practice, Vol. 40, No. 2, pp. 169-199. Borozan D. and Ž. Klepo (2013), Free Zone – The Source of Socio-Economic Benefits, Interdisciplinary Management Research, and Enhancing Regional Competitiveness to Facilitate Economic Prosperity Project (No. 010-0101195-0866). Deskar-Škrbić, M. and H. Šimović, (2014). “Porezna politika Milanovićeve vlade od 2012. do 2014” [Milanovic Government Tax Policy 2012-2014], Političke analize [Political Analysis], Vol. 5, No. 20, 22-32, https://hrcak.srce.hr/147460 European Commission (2018), Country Report Croatia 2018, Including an In-Depth Review on the prevention and correction of macroeconomic Imbalances, Commission Staff Working Document SWD(2018) 209. European Commission (2018), Recommendation for a Council Recommendation on the 2018 National Reform Programme of Croatia and delivering a Council opinion on the 2018 Convergence Programme of Croatia, COM(2018) 410 FINAL. European Commission (2017), Country Report Croatia 2017, Including an In-Depth Review on the prevention and correction of macroeconomic Imbalances, Commission Staff Working Document SWD(2017) 76 FINAL. European Commission (2017), Tax policies in the European Union - 2017 survey, Luxembourg: Publications Office of the European Union, 2017. Foreign Investors Council (2017), White Book 2017, Zagreb. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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Foreign Investors Council (2016), White Book 2016, Zagreb. Government of Republic of Croatia (2015), “Government adopts plan to reduce trade administrative costs by 20 percent”, www.vlada.gov.hr/news/gov-t-adopts-plan-to-reduce-trade-administrative-costsby-20-pct/17546 Grdović Gnip, A. and I. Tomić (2010), “How hard does the tax bite hurt? Croatian vs European worker”, Financial Theory and Practice, Vol. 34, No. 2, pp. 109–142. Retrieved from http://hrcak.srce.hr/53593 Harding T. and B. S. Javorcik (2012), “Investment Promotion and FDI Inflows: Quality Matters”, Economics Series Working Papers, No. 612, University of Oxford, Department of Economics. Harding T. and B. S. Javorcik (2011), “Roll Out the Red Carpet and They Will Come: Investment Promotion and FDI Inflows”, Economic Journal, Vol. 121, No. 557, pp. 1445-1476. IMF, OECD, UN and World Bank (2015), Options for Low Income Countries' Effective and Efficient Use of Tax Incentives for Investment. A Report to the G-20 Development Working Group, www.imf.org/external/np/g20/pdf/101515.pdf Kontošić Pamić R. and A. Belullo (2018), “Investments’ background of entrepreneurial zones in Croatia”, Ekonomska Istraživanja / Economic Research, Vol. 31, No. 1, pp. 1590-1606, https://doi.org/10.1080/1331677X.2018.1506707 Morisset, J. (2003), “Does a Country Need a Promotion Agency to Attract Foreign Direct Investment? A small analytical model applied to 58 countries”, World Bank Policy Research Working Paper No. 3028, Washington, DC. OECD (2019a), Better Regulation Practices across the European Union, OECD Publishing, Paris, https://doi.org/10.1787/9789264311732-en. OECD (2019b), Regulatory Policy in Croatia: Implementation is Key, OECD Reviews of Regulatory Reform, OECD Publishing, Paris, https://doi.org/10.1787/b1c44413-en. OECD (2018a), Mapping of Investment Promotion Agencies in OECD countries, www.oecd.org/industry/inv/investment-policy/mapping-of-investment-promotion-agencies-in-OECDcountries.pdf OECD (2018b), FDI in Figures, April 2018, www.oecd.org/daf/inv/investment-policy/FDI-in-FiguresApril-2018.pdf OECD (2018c), Tax wedge (indicator), https://doi.org/10.1787/cea9eba3-en OECD (2018d) Regulatory Enforcement and Inspections Toolkit, OECD Publishing, Paris, https://doi.org/10.1787/9789264303959-en OECD (2017a), Small, Medium, Strong. Trends in SME Performance and Business Conditions, OECD Publishing, Paris, https://doi.org/10.1787/9789264275683-en OECD (2017b), Tracking Special Economic Zones in the Western Balkans: Objectives, Features and Key Challenges, www.oecd.org/south-east-europe/SEZ_WB_2017.pdf OECD (2015a), Policy Framework for Investment, 2015 Edition, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264208667-en OECD (2015b), Taxation of SMEs in OECD and G20 countries, OECD Publishing, Paris, https://doi.org/10.1787/9789264243507-en OECD (2012), Recommendation of the Council on Regulatory Policy and Governance, OECD Publishing, Paris, https://doi.org/10.1787/9789264209022-en OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

166 │ 6. INVESTMENT PROMOTION AND FACILITATION IN CROATIA OECD (2010a), Dedicated Public-Private Partnership Units: A Survey of Institutional and Governance Structures, OECD Publishing, Paris, https://doi.org/10.1787/9789264064843-en. OECD (2010b), Investment Reform Index 2010: Monitoring Policies and Institutions for Direct Investment in South-East Europe, OECD Publishing, Paris, https://doi.org/10.1787/9789264079588-en OECD (2008a), Government Strategies to Attract R&D-Intensive FDI, OECD Global Forum on International Investment, www.oecd.org/investment/globalforum/40310856.pdf OECD (2008b), “Tax Effects on Foreign Direct Investment”, Policy Brief, www.oecd.org/investment/investment-policy/40152903.pdf OECD (2004), "Investment Incentives and FDI in Selected ASEAN Countries", International Investment Perspectives, OECD Publishing, Paris http://dx.doi.org/10.1787/iip-2004-4-en OECD and IDB (2017), Survey of Investment Promotion Agencies. Papahagi, M. G., T. Rooms, P. Salgado Otonel, J. Vilquin, I. Buxan Raposo, L. Sagnori Diniz, M. Grujicic, A. Hambardzumyan Ilic, M. Jankovic, B. Kralik, M. Muron, D. Musulin, D. Pacholska, D. M. Pereira, and E. Tjong (2018), Doing business in the European Union 2018: Croatia, the Czech Republic, Portugal, and Slovakia (Vol. 2), World Bank Group, Washington, D.C., http://documents.worldbank.org/curated/en/687491533285374065/Main-report PWC (2015), Growth during disruption: Croatian CEO Survey 2015, www.pwc.hr/hr/publikacije/croatian-ceo-survey/assets/croatian-ceo-survey-2015.pdf Šeparović, A. (2009). “The influence of the tax wedge on unemployment in OECD countries in comparison with Croatia”, Financial Theory and Practice, Vol. 33, No. 4, pp. 463–477, http://hrcak.srce.hr/48610?lang=en Šimić Banović, R. (2015), “Cutting the red ribbon but not the red tape: the failure of business environment reform in Croatia”, Post-Communist Economies, Vol. 27, No. 1, pp. 106-128, https://doi.org/10.1080/14631377.2015.992239 Urban, I. (2016), “Tax wedge on labour income in Croatia and the European Union preface to the special issue of financial theory and practice”, Financial Theory and Practice, Vol. 40, No. 2, 157–168, https://doi.org/10.3326/fintp.40.2.1 Volpe Martincus, C. and M. Sztajerowska (forthcoming), How to Resolve the Investment Promotion Puzzle: Mapping of Investment Promotion Agencies in the Latin America and the Caribbean and OECD countries, IDB Publishing, Washington D.C. World Bank (2019), Enterprise Survey: Croatia, www.enterprisesurveys.org/data/exploreeconomies/2013/croatia World Bank (2018), “World Bank Continues to Help Improve Croatia’s Land Administration System”, www.worldbank.org/en/news/press-release/2018/08/01/world-bank-continues-to-help-improvecroatia-land-administration-system Zolt, E. (2015), “Tax Incentives: Protecting the tax base”, paper for Workshop on Tax Incentives and Base Protection New York, 23-24 April 2015, United Nations Department of Economic and Social Affairs.

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7. PUBLIC GOVERNANCE

Chapter 7. Public governance

This chapter first provides an overview of recent advances and remaining challenges relating to regulatory quality, drawing on the recent OECD Regulatory Review of Croatia. In particular, it considers how Croatian authorities review existing regulation and introduce new ones. It also provides an overview of the situation regarding corruption in Croatia: perceptions, criminal and preventive measures in place, and outstanding issues. In particular it analyses the measures to enhance public integrity that have proven effective and successful. The chapter also explores what the government, business associations and individual companies do in order to strengthen business integrity, with a particular focus on anti-corruption measures.

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168 │ 7. PUBLIC GOVERNANCE The quality of public governance has a significant influence on the climate for business and investment. Poorly designed or loosely applied regulations can slow business responsiveness, divert resources away from productive investments, hamper or delay entry into markets, reduce job creation and generally discourage entrepreneurship. From an investor’s perspective, regulatory policy should provide strong guidance and benchmarks for action by officials and set out what investors can expect from government regarding regulation. From the citizens’ point of view, regulation influences the quality of public services by shaping the behaviour of public and private actors, and can influence citizens’ involvement in policy-making. The quality of public services also significantly influences the investment climate as well as citizens’ life. In this regard, policies to ensure the transparency, predictability and effectiveness of the regulatory framework for investment are essential to reduce or eliminate potential or existing obstacles faced by companies when they consider investing in a country. Integrity is also a crucial determinant of a favourable investment climate. Comparative evidence suggests a link between trust in politicians and public officials, both from the business community and citizens, and the perception of corruption. Integrity tools and mechanisms, aimed at preventing corruption and fostering high standards of behaviour, help to diffuse concerns by investors when considering investing in a country. Bribery and corruption also undermines the rule of law and the ethical values upon which democratic societies and their institutions are founded. Ever since the end of the Homeland Wars, Croatia has made significant progress in stabilising the rule of law, increasing political stability as well as improving the regulatory quality, control of corruption and government effectiveness. Croatia has also made important strides in improving the quality of its regulatory processes, including through introducing regulatory impact assessment (RIA) and consultation requirements for primary legislation. The country has also significantly improved its anti-corruption framework, leading in particular to high profile prosecutions of senior members of previous governments Despite the many encouraging steps taken, an unstable regulatory framework and burdensome administrative procedures still remain one of the most important constraints to doing business in Croatia. This is reflected in particular in the consistency with which existing ex ante assessment and consultation requirements apply to laws and regulations created at different levels of government. Croatia's public governance also suffers from the fragmentation of competences and from not always well-defined lines of accountability. Croatia has a rather complex and multi-layered network of public bodies and regulations. Such a multi-layered public administration creates a cumbersome and confusing environment for businesses and individuals who have to navigate through it. The country also suffers from a negative image with respect to corruption. There are in particular strong suspicions of favouritism and political connections, especially at the local level, despite some significant steps taken by the government for ensuring the integrity of the country’s administrative and political system, including through the adoption of standards of public ethics; substantial reforms to enable a more transparent decisionmaking process; and stronger legal provisions on political party funding. Tailor-made specifications for particular companies and unclear selection or evaluation criteria are also believed to be widespread practices in public procurement.

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7. PUBLIC GOVERNANCE

Regulatory quality As noted in the introduction to this Chapter, the quality of public regulation has a significant influence on countries’ investment climate. Well-designed regulations help entry into markets, facilitate job creation and encourage entrepreneurship. The benefits of highquality regulation at one level of government might nevertheless be undermined by lowquality regulation at lower levels of government. To eliminate unnecessary regulatory divergences that create additional burdens on investors and to address national and county and municipal levels challenges pertaining to systemic risks (e.g. the environment, and human health and safety), governments need to better articulate regulations across different levels of government. These and other aspects related to the quality of public governance, horizontal to all aspects of the country’s investment climate, are discussed below.

Regulatory policy-making and quality As captured by the World Bank’s World Governance Indicators, available for 155 economies globally since 19961 (Figure 7.1), Croatia has made progress in improvements in the rule of law, control of corruption, regulatory quality and other related aspects since mid-1990s. Still, it has been scoring below the EU average on the same indicators (Figure 7.2). Furthermore, the EU polls suggest that the level of trust in the government was among the lowest in the EU (only 15% reported to tend to trust the government in 2018). In addition, as highlighted in Chapter 6, several EU reports have highlighted the need to strengthen the government’s effectiveness, reduce administrative burdens and improve the regulatory quality in Croatia (European Commission, 2016-2018).2 Croatia has taken these grievances seriously. In the past years the government has undertaken or announced several reforms to improve the overall quality of regulatory processes. Moreover, in 2018-19 Croatia undertook a dedicated review of its regulatory policies (OECD, 2019b) to identify the issues at stake and reforms to be considered. The review assesses regulatory management capacities in Croatia, using the OECD Recommendation of the Council on Regulatory Policy and Governance (OECD, 2012) as a benchmark (see Box 7.1 Additionally, the OECD report on Better Regulation Practices across the European Union (OECD, 2019a) addresses steps taken by Croatia to improve its regulatory processes. Both reports (OECD, 2019a and OECD, 2019b) highlight several issues of relevance to this Review (see Figures 7.3 and 7.4 for a summary).

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170 │ 7. PUBLIC GOVERNANCE Figure 7.1. Overview of World Governance Indicators scores for Croatia, 1996-2017 Panel A. Estimate Control of Corruption

Government Effectiveness

Political Stability and Absence of Violence/Terrorism

Regulatory Quality

Rule of Law

Voice and Accountability

1 0.8 0.6 0.4 0.2 0 -0.2

1996

1998

2000

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2015

2016

2017

-0.4 -0.6 -0.8 -1

Panel B. Percentile Rank Control of Corruption Political Stability and Absence of Violence/Terrorism Rule of Law

Government Effectiveness Regulatory Quality Voice and Accountability

90 80 70 60

50 40 30 20 10 0 1996

1998

2000

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Note: Estimate of governance (ranges from approximately -2.5 (weak) to 2.5 (strong) governance performance). The percentile rank is calculated based on the country’s score and that of 154 other ranked countries. Source: World Bank’s World Governance Indicators database (2018)

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Figure 7.2. Government effectiveness in Croatia and EU 28 according to the World Bank World Governance Indicators* 2.5

2

1.5

EU average 1

0.5

0 FIN NLD SWE DNK DEU LUX AUT GBR FRA PRT IRL BEL SVN EST ESP CZE MLT LTU CYP LVA SVK POL HRV HUN ITA GRC BGRROM -0.5

Note: Estimate of governance (ranges from approximately -2.5 (weak) to 2.5 (strong) governance performance). Results for EU 28 member states are shown. * Note by Turkey: The information in this document with reference to “Cyprus” relates to the southern part of the Island. There is no single authority representing both Turkish and Greek Cypriot people on the Island. Turkey recognises the Turkish Republic of Northern Cyprus (TRNC). Until a lasting and equitable solution is found within the context of the United Nations, Turkey shall preserve its position concerning the “Cyprus issue”. Note by all the European Union Member States of the OECD and the European Union: The Republic of Cyprus is recognised by all members of the United Nations with the exception of Turkey. The information in this document relates to the area under the effective control of the Government of the Republic of Cyprus. Source: World Bank’s World Governance Indicators database (2018)

Overall, Croatia has made strides in improving the quality of its regulatory policy framework. First, as explored in more detail in the section below, Croatia has improved procedures for stakeholder consultation for developing new regulations, an aspect that has been raised as important by several stakeholders consulted in the process of this Review. This is reflected in a high score on OECD Indicators of Regulatory Policy and Governance pertaining to stakeholder consultation in developing new laws and subordinate regulations (Figure 7.3). Still, some issues are being raised as challenging, notably the consistency of application of consultation requirements in practice, in particular in early stages, and the ease of access of a diverse group of stakeholders to the regulating authorities in the process of preparing draft laws and regulations. Further progress on both aspects, in particular when important pieces of legislation are being developed, would be welcome. Secondly, according to OECD (2019a) and OECD (2019b), Croatia has also introduced the use of ex ante Regulatory Impact Assessment (RIA). In 2017, a new RIA law entered into force. Currently, a full RIA has to be conducted for laws with a potentially high impact, requiring regulators to assess a broad range of environmental and social impacts. If deemed necessary, a test analysing the impacts on SMEs is also undertaken by the Ministry of Economy, Entrepreneurship and Crafts, focusing mostly on administrative costs. This does not apply to secondary regulations, however, highlighting an important remaining gap that Croatia may wish to address in the future (Figure 7.2). In addition, RIAs conducted by different bodies at the national level are still not of sufficient quality, partly

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172 │ 7. PUBLIC GOVERNANCE due to a lack of analytical capacity in ministries (OECD, 2019a and OECD, 2019b). According to the stakeholders consulted in this Review, the predominant approach to the conduct of RIA is still legalistic and perceived as a formality and a “second-rate task” by the responsible authorities (Petak, 2015). Conscious of this problem, the government is taking steps to increase the awareness of the importance of RIAs among relevant government bodies. In this context, Croatia could build on its efforts and consider creating analytical centres with “RIA champions” in the most important ministries in order to strengthen internal capacities (OECD, 2019a and OECD, 2019b). Croatia has also not yet developed systematic approaches towards ex post evaluations of regulations, neither at the level of primary laws nor subordinate regulations, only along few other EU countries. As such, and as outlined in Chapter 6, administrative burdens are still quoted as one of more significant barriers to doing business in the country. Currently, ex post reviews of regulation are limited to administrative burden reduction and ad hoc recommendations from working groups. As highlighted in both OECD reports on regulatory quality in Croatia, the government should envisage targeted ex post reviews focusing on the performance of regulations or on particular sectors to achieve progress (OECD 2019a and OECD, 2019b). This could help address some of the issues raised in chapter 6 of this Review, relating to administrative barriers to investment, on a more long-term basis. Box 7.1. Recommendation of the OECD Council on Regulatory Policy and Governance

On 22 March 2012, the Council of the OECD adopted the Recommendation of the Council on Regulatory Policy and Governance (OECD, 2012). The Recommendation was the first international instrument to address regulatory policy, management and governance as a whole-of-government activity that can and should be addressed by sectoral ministries, regulatory and competition agencies. The Recommendation sets out the measures that Governments can and should take to support the implementation and advancement of systemic regulatory reform to deliver regulations that meet public policy objectives and will have a positive impact on the economy and society. These measures are integrated in a comprehensive policy cycle in which regulations are designed, assessed and evaluated ex ante and ex post, revised and enforced at all levels of government, supported by appropriate institutions. Many topics such as consultation and citizen engagement, regulatory impact assessment, multi-level coherence, risk and regulation, institutional responsibility for policy coherence and oversight, and the role of regulatory agencies are developed more fully and more practically than in the earlier guidance of the 1995 and 2005 OECD principles. Together the principles in the Recommendation provide countries with the basis for a comprehensive assessment of the performance of the policies, tools and institutions that underpin the use of efficient and effective regulation to achieve social, environmental and economic goals. Through its work programme, the Regulatory Policy Committee supports countries to implement the principles in the Recommendation. In particular, the OECD Regulatory Policy Reviews assess regulatory management capacities in different countries, including policies, tools and institutions for ensuring regulatory quality, using the Recommendation as an assessment framework. Croatia underwent such a Review in 2019 (OECD, 2019b), which is publically available on the OECD website. Croatia is included in the OECD report on Better Regulation Practices across the European Union (OECD, 2019a).

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Figure 7.3. Indicators of Regulatory Policy and Governance (iREG): Croatia, 2018 Methodology Oversight and quality control

Systematic adoption

Transparency OECD average, 2018

iREG score 4 3.5 3

2.5 2 1.5 1 0.5 0

Primary laws Subordinate regulations Stakeholder engagement in developing regulations

Primary laws Subordinate regulations Regulatory Impact Assessment (RIA)

Primary laws Subordinate regulations Ex post evaluation of regulations

Note: The more regulatory practices as advocated in the OECD Recommendation on Regulatory Policy and Governance (2012) a country has implemented, the higher its iREG score. The indicators on stakeholder engagement and RIA for primary laws only cover those initiated by the executive (91% of all primary laws in Croatia). Source: OECD Indicators of Regulatory Policy and Governance (iREG) 2018 and its extension to all EU member states, http://oe.cd/ireg, see OECD (2018a).

Table 7.1. Requirements to use regulatory management tools for EU-made laws: Croatia Stakeholder engagement

Regulatory impact assessment

Development Stage The government facilitates the engagement of domestic stakeholders in the European Commission’s consultation process

No

Negotiation stage Stakeholder engagement is required to define the negotiating position for EU directives/regulations

No

Consultation is required to be open to the general public

No

RIA is required to define the negotiating position for EU directives/regulations

No

Transposition stage Stakeholder engagement is required when transposing EU directives

Yes

The same requirements and processes apply as for domestically made laws

Yes

The same requirements and processes for RIA apply as for domestically made laws

Yes

Yes

RIA includes a specific assessment of provisions added at the national level beyond those in the EU directives

No

RIA distinguishes between impacts stemming from EU requirements and additional national implementation measures

No

Consultation is required to be open to the general public

RIA is required when transposing EU directives

Yes

Source: OECD Indicators of Regulatory Policy and Governance (iREG) 2018 and its extension to all EU member states, http://oe.cd/ireg, see OECD (2019a).

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Stakeholder engagement and transparency of policy-making Businesses have been regularly calling for more frequent consultations on draft regulations and laws. Some business associations have been advocating for greater involvement of Croatia's business sector as well as of foreign investors in Croatia’s policy-making (Foreign Investors Council, 2016, 2017 and 2018). Croatia has made strides to engage citizens and other interested parties in decision-making. One step in this direction was the introduction, in 2009, of formal consultations with the interested public. Two years later, the 2011 Regulatory Impact Assessment Law introduced mandatory public consultations on new regulations. Another step towards ensuring greater involvement of citizens and business in policy-making were the amendments to the Government’s Rules of Procedure (Official Gazette no. 54/11, no. 121/12, no. 7/13, no. 61/15, no. 99/16, no. 57/17). They confirmed that public consultations are an integral part of decision-making process on the level of the Croatian Government. A further step towards improving the framework for consultations was taken in 2013 with the adoption of the Law on the Right of Access to Information (Official Gazette no. 25/2013, as amended). The act stipulates that all state administration bodies responsible for drafting laws and subordinate regulations must publish draft regulations about which the consultations with the interested public are conducted on the central state portal “eConsultations” e-Savjetovanja for a period of 30 days (Table 7.2-7.3). In practice, major draft regulations are published for consultation on the platform (OECD, 2019a). Qualified authority responsible for drafting regulation can voluntarily go beyond legally defined time limits, but practice also varies widely due to management or capacity of the different bodies involved in the process or circumstances (elections, adoption of the state budget). For example, in 2016 public consultations for Labour Act Amendments took almost a year, and for the whole tax package three days. As such, ensuring greater homogeneity in respecting consultation requirements across different agencies appears to still remain a challenge. After the consultation, the state administration bodies are required to publically notify the interested public through the central state portal for public consultations on which they publish a report on the conducted consultation that they submit to the Government. RIA statements are also made available alongside major draft primary laws for comments. The central internet portal for public consultation has been functioning since the spring of 2015. Since then, the number of regulations and draft laws open to the public has constantly increased. Croatia also makes use of ad hoc working groups including representatives from civil society, businesses and academia early in the process. As such, today, Croatia has one of the most advanced legal frameworks for public stakeholder consultations among the EU Members (see Figure 7.4 and OECD, 2019a and OECD, 2019b), even though issues, related primarily to the consistency of application of consultation and an ex ante assessment processes when drafting new laws and regulations in particular at the subordinate level, are stressed as problematic by business as well as by the European Commission (AmCham, 2018; Foreign Investors Council, 2017; European Commission, 2018a).

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Table 7.2. Minimum periods for consultations in EU member states No minimum period

1-3 weeks

4-5 weeks

6 weeks

12 weeks

Primary laws

Czech Republic; Denmark; France; Germany; Ireland, Malta; United Kingdom

Hungary; Latvia; Lithuania; Poland; Romania; Spain

Belgium; Bulgaria; Croatia; Cyprus; Estonia; Greece; Italy; Luxemburg; Netherlands; Portugal; Slovak Republic; Slovenia;

Austria; Finland

Sweden

Subordinate regulations

Czech Republic; Denmark; Germany; Greece; Ireland, Malta; United Kingdom

Hungary; Latvia; Lithuania; Poland; Romania, Spain; France

Belgium; Bulgaria; Croatia; Cyprus; Estonia; Italy; Luxemburg; Netherlands; Portugal; Slovak Republic, Slovenia;

Austria; Finland

Sweden

Note: Data is based on 28 EU member states. Source: Indicators of Regulatory Policy and Governance Surveys 2014 and 2017, and the extension to all EU member states, http://oe.cd/ireg, see OECD (2019a).

Table 7.3. Selected consultation portals in EU member states EU member state Austria

Since September 2017, all draft primary laws are available on the website of Parliament together with a short description of the legislative project in accessible language, the RIA and other accompanying documents. The public can submit comments on the draft regulation or support comments made by others online.

Croatia

On the interactive consultation portal e-Savjetovanja, major draft regulations are published for consultation for a minimum of 30 days. The website allows the public to provide general feedback on the draft or to provide comments on the individual articles of a draft regulation. The comments are publicly displayed alongside the draft, allowing other members of the public or policymakers to react. For major draft primary laws, RIA statements are also made available for comments.

Estonia

The Electronic Coordination System for Draft Legislation (EIS) tracks the development of all Estonian and EU draft legal acts, and makes available RIAs and documents of legislative intent (describing the problem to be addressed, analysing policy options and determining initial likely impacts). The website www.osale.ee/ is an interactive website of all ongoing consultations where every member of the public can submit comments on legislative proposals or other policy documents prepared by the Government and review comments made by others. EIS and www.osale.ee/ are linked, i.e. EIS takes into consideration opinions submitted via www.osale.ee/ and provides a direct link to them.

Greece

The Greek Government publishes draft laws and explanatory material on its central consultation portal to the general public. It allows the public to comment separately on individual proposed clauses in a virtual ‘discussion room’ where members of the public and policymakers can react and add further comments. Comments received during the consultation period are presented to the Greek Parliament, along with the draft law and other relevant materials.

Netherlands

Major draft regulations are published on the Dutch central consultation portal http://www.internetconsultatie.nl/, with the possibilities for the public to visibly publish comments on the drafts was well as a summary of the impact assessment. The use of the website has been further promoted in recent years and is more frequently used to consult also on policy documents informing about the nature of the problem and possible solutions.

Note: Data is based on 28 EU member states. Source: Indicators of Regulatory Policy and Governance Surveys 2014 and 2017, and the extension to all EU member states, http://oe.cd/ireg.; OECD Pilot database on stakeholder engagement practices in regulatory policy. See www.oecd.org/gov/regulatory-policy/pilot-database-on-stakeholder-engagement-practices.htm, and OECD (2019a).

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176 │ 7. PUBLIC GOVERNANCE Figure 7.4. Composite indicators: Stakeholder engagement in developing primary laws, 2018 Methodology Oversight and quality control

Systematic adoption TOTAL 2015

Transparency

iREG score 4 3.5 3 2.5

2 1.5 1 0.5

0

Note: Data for 2015 is based on the 34 countries that were OECD members in 2014 and the European Union, which included 21 of the current 28 EU member states. The OECD average is based on the 34 member countries at the time of the survey. Data for 2018 includes the remaining EU member states of Bulgaria, Croatia, Cyprus, Malta and Romania. The more regulatory practices as advocated in the 2012 Recommendation a country has implemented, the higher its iREG score. *In the majority of EU member countries, most primary laws are initiated by the executive, except for Bulgaria, where a higher share of primary laws are initiated by the legislature. Information is based on indicators of Regulatory Policy and Governance Surveys 2014 and 2017, and the extension to all EU member states, http://oe.cd/ireg. Source: OECD (2019a)

Ensuring fair access of stakeholders to the government authorities indeed appears to be a remaining concern in Croatia. Over the past two decades Croatia has created new procedures and institutional arrangements to accommodate a wider set of stakeholders and opinions. For example, the National Competiveness Council includes representatives of business as well as trade unions and academia (see Box 7.2) and tripartite social dialogue has been institutionalised through the Economic and Social Council (Gospodarskosocijalno vijeće/GSV). Still, according to some local observers of Croatia’s politics, transparency in selection into various groups that are being consulted is at time lacking and many informal networks – and this would include large companies and business associations – would weight over policy directions (European Commission, 2018a). Meanwhile, as highlighted further down in this Chapter in relation to Croatia’s anticorruption policies as well as in Chapter 8, the influence of civil society, in comparison with these networks, would be weak, except in some policy areas such as human rights and environmental protection.

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Participation of stakeholders in the agenda setting at the regional (counties) and local level also appears to be challenging. For sure, local governments vested with public authority are expected to carry out public consultations online, via their internet sites. Despite such participatory channels – when they actually exist- stakeholder’s involvement in the decision process remain reportedly uneven (Koprić and Klarić 2015; European Commission, 2019a). Box 7.2. National Competitiveness Council – NCC (Nacionalno vijeće za konkurentnost)

The National Competitiveness Council was established in 2002 at the initiative of the Croatian business society and the Croatian Employers' Association and on the basis of a decision of the Government of the Republic of Croatia in response to the challenges that the country was facing at the beginning of the 21st century. These challenges included the process of globalization, the transition to a market economy and strengthening the competitiveness of the private and public sectors in Croatia. The Council is an independent advisory body comprised of 24 members and four key interest groups – the business sector, government, trade unions, and the academic community – with the goal of creating dialogue, partnership and consensus on programs and policies that are critical to the sustainable growth and development of the country. The goals of the Council are: 

to act to increase the competitiveness of the Croatian economy



to make Croatia one of the 40 most competitive economies in the world

To achieve these goals the Council acts: 

by encouraging policies for reform



by recommending and creating guidelines for development policies



by constructing coalitions with stakeholders that support reform



by increasing public understanding of and support for reforms



by encouraging dialogue between the public and private sectors



by expanding knowledge of the importance of competitiveness



by monitoring and evaluating reforms that have been implemented

The fragmentation of the public administration complicates business operations Croatia suffers from additional shortcomings and complications for business operations due to the fragmentation of administrative procedures and institutions, which hinders the delivery of public services and the provision of quality regulation. Over the past two decades there has been an exponential increase in the number of institutions vested with public powers to perform specific tasks (European Commission, 2016). Croatia has three levels of public governance: central, regional (counties) and local level (municipalities and towns) (Box 7.3). Because of Croatia’s internal administrative structure, there are different bodies at central and local levels involved in similar tasks and insufficient coordination for effective operation. The institutional set-up for investment promotion and facilitation policy at the OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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178 │ 7. PUBLIC GOVERNANCE central level of government is illustrative of this. Until January 2019, two national-level agencies had similar types of competences relating to investment attraction, with a division of labour grounded in the size of the investor serviced, a set up that is not typically found in OECD countries, as discussed in Chapter 6. The degree of coordination with other relevant ministries, such as with the Ministry of Foreign and European Affairs (MOFEA) is also believed to be low, as ascertained during interviews conducted in the process of this Review, even though MOFEA has relevant competencies and disposes of a network of embassies and consulates abroad that are of high relevance to investment promotion and facilitation. Box 7.3. Levels of government in Croatia

Croatia is a unitary state with three levels of government: central, regional (counties – županija) and local (towns and municipalities – grad and općina). Structure

The administration at central level consists of 20 ministries, five central state offices, 13 government offices, and seven state administrative organisations. The functions of central state administration agencies are performed through a network of 1279 branch offices of ministries and other central state administration offices in counties, cities, and municipalities. Another 20 first-line offices of state administration, tasked with the functions related to the county-level administration, operate in counties. 91 deconcentrated offices and 302 registry offices operate in municipalities and small towns. In addition to the central level of government, Croatia has 20 counties (plus the City of Zagreb), 428 municipalities and 127 towns. Competencies

The state administration has jurisdiction over areas such as economic affairs and management of state assets; finance, tax and customs; regional development and policy; energy and electricity; water policy and management; public transport (e.g. highways, railways, air traffic). Jurisdiction over spatial planning, land registry office (cadastre) and environmental protection is shared with counties and towns and municipalities Pursuant to Article 135 of the Constitution and the Law on Local and Regional SelfGovernment, counties have jurisdiction over regional affairs, including economic development and tourism (counties’ strategic plans and regulations), zoning and urban planning, transport and transport infrastructure, public roads maintenance, and issuance of construction permits. Towns and municipalities have jurisdiction over local affairs, such as utilities, urban planning, consumer protection, protection of environment, management of local assets, and other similar domains. So-called “large cities”, i.e. local units/cities with more than 35 000 inhabitants, in addition to the above competencies, carry out maintenance of public roads and issuance of construction permits. Source: Croatia (2018), European Commission (2018a)

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This problem is exacerbated by the fact that counties also have roles with regards to investment promotion. They are responsible for (regional) economic development, which includes promotion of investment in tourism (see Box 7.3 above). In addition, separate entities offer investment facilitation solutions at the sub-national level (e.g. HAMAGBICRO’s one stop shop services centres, HITRO.HR one-stop shop solutions within the Financial Agency offices, etc.) Such overlapping network of bodies and entities underlies the absence of one single vision for investment promotion as noted in Chapter 6, and is likely to confuse potential investors. As the first step, the government may wish to ensure that it has a full understanding of different actors involved and services offered on investment promotion and facilitation at the sub-national level to attempt to develop more coordinated approaches to communicating with investors. Croatia’s administrative fragmentation also impacts the quality of service delivery at local level because of scare resources of most local governments. Almost 51% of local governments have less than 3 000 inhabitants, and some additional 20% have fewer than 5 000 inhabitants. As a result, their ability in providing high quality public services is often limited, except in the case of the largest cities. One example is the city of Zagreb, which, according to local observers, has the best organizational capacities among local governments. Elsewhere, the provision of local services is often poor, leaving entrepreneurs and citizens with limited access to effective local public services (European Commission, 2018a). A sheer reduction of administrative bodies is, however, not necessarily the right approach, and should be approached with caution. For example, as part of recent measures aiming at rationalising the number of state bodies and agencies at the national level, Croatia has abolished 54 central-government level agencies. One of the abolished agency was the Agency for Investments and Competitiveness (AIK) responsible for attraction of large private and public-private investment projects, analysed in Chapter 6. It appears that abolishment has been primarily driven by a desire to downsize public administration but appears not to have been preceded by a reflection on the future functioning of a department within the Ministry of Economy, Entrepreneurship and Crafts that took over the agency’s tasks. As argued in Chapter 6, while such a change may potentially be used by the government to rethink, and improve, the institutional set up for investment promotion in the country, it also involves a number of risks, which should be considered before the reform is decided on.

Corruption Additional mechanisms are important to reduce potential and existing obstacles faced by companies when they decide to invest. These obstacles include the risk of corruption when interacting with government officials. Corruption continues to be perceived by foreign investors and domestic entrepreneurs as an issue in Croatia, despite strong anti-corruption efforts over the past decade, which in particular have resulted in high-profile prosecutions of senior members of prior governments. Croatia has made laudable efforts in combatting corruption. In its latest monitoring report on Croatia's state of preparedness for EU membership, the European Commission acknowledged progress made by Croatia.3 The Group of States against corruption (GRECO) of the Council of Europe has also regularly commended in its reports Croatia's achievements. Croatia is also one of the best performing countries among members of the OECD Anti-Corruption Network for Eastern Europe and Central Asia

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180 │ 7. PUBLIC GOVERNANCE (ACN), a network that supports countries of Eastern Europe and Central Asia in their efforts to prevent and fight corruption. Despite important efforts invested by Croatia, both in preparation for its accession to the EU and since then, the country still suffers from a negative perception with respect to corruption. According to the 2017 Flash Eurobarometer on businesses' attitudes towards corruption in the EU, 92% of respondents operating in Croatia described corruption as widespread (EU-28 average: 67%).4 In another survey, conducted by a private consulting firm between November 2016 and January 2017 in 41 countries across Europe, the Middle East, India and Africa, the proportion of company respondents in Croatia perceiving corruption as widespread in doing business in the country was 79%, at par with other EU countries such as Greece, Hungary, and Slovakia and non-European nations such as India, Kenya and South Africa.5 According to the 2017–18 Global Competitiveness Report, corruption was identified as the fourth most problematic factor for doing business in Croatia.6 According to another survey, also conducted in 2017, one fifth of business respondents considered that corruption was still one of the biggest shortcomings when it comes to business conditions in Croatia compared to other countries in the region.7 Reportedly, corruption has affected first SMEs and, with some notable and much newsworthy exceptions, has primarily taken the form of "grease" payments, i.e. bribes or unofficial payments of a small amount to secure or expedite the performance of a routine or necessary action (UNODC, 2013). Investors have also pointed out favouritism and political connections, especially at local level, as undermining Croatia’s business environment. Businesses and the public have in general viewed local and regional governments as particularly vulnerable to corruption, notably due to the fact that they manage their own budget from which they can spend a significant portion on public procurement projects, and that they are empowered to grant high-value licences and permits such as construction permits (see Box 7.3 above). Combatting corruption, cronyism, favouritism requires simultaneous actions in many areas and by many national institutions, encompassing both preventive and repressive measures. In this regard, Croatia, in line with best practices, has followed a holistic approach, engaging in important reforms with a view to strengthening repressive measures and enhancing good governance, transparency and accountability in public service. Individual reforms have been embedded in a series of long-term anti-corruption strategies, which have been seen as integral parts of Croatia's national development objectives. In addition, Croatia has established an institutional structure for the monitoring of anti-corruption measures – the Committee for the Monitoring of the Implementation of Anti-Corruption Measures (presided by the Minister of Justice) and the National Council for Monitoring of the Implementation of the Anti-Corruption Strategy (body of the parliament).8

Effective prosecution and sanctioning of corruption Significant progress has been achieved over the past 15 years as regards adoption of criminal legislation and establishment of agencies and law enforcement mechanisms specifically dedicated to the detection, prosecution and sanctioning of corruption. Croatia's actions have been guided inter alia by its obligations under the UN Convention Against Corruption and other relevant Council of Europe and EU instruments, to which it is a party. Modern legislation has been in place for several years, largely meeting the standards of the Council of Europe, the European Union and the United Nations, and relying upon a penal code that presents a range of offences each covering offending of a particular kind, as well

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as a Corporate Criminal Liability Act (Official Gazette no. 151/2003), which makes companies criminally liable for corrupt practices.9 The institutional setting of the law enforcement system has been a particular focus of reform. With the objective of better coping with the complexity of corruption and related offences, law enforcement structures were strengthened in 2001 through the establishment of the USKOK, the Office for the Suppression of Corruption and Organised Crime attached to the State Attorney General's Office, which combines detection, investigation and prosecution of corruption into one law enforcement body (Box 7.4). At first under-resourced and ineffective, USKOK has since then been described by some observers (Kuris, 2013) as one of the world’s most respected anti-corruption outfits, having prosecuted more than 2 000 defendants during its first ten years of existence and achieving in 2017 a conviction rate of roughly 90% (Ministry of Justice of Croatia, 2018). Defendants have included a former prime minister and a former vice president (for the criminal offences of abuse of office and authority, forging an official document, and illegal intercession), former ministers, mayors of major cities, heads of municipalities, several vice-presidents of the now defunct Croatian Privatisation Fund, as well as lower-ranking civil servants such as tax officials. Croatia has also a rich practice in implementation of its legislation on corporate liability (OECD, 2015b). Investors have acknowledged these achievements: In 2017, 60% of business respondents operating in Croatia thought that corrupt people or companies would be caught, much above the EU-28 average of 43%.10

Box 7.4. The office for the Suppression of Corruption and Organised Crime

The Office for the Suppression of Corruption and Organised Crime (Ured za suzbijanje korupcije I organiziranog kriminaliteta – USKOK) is a special body within Croatia’s Public Prosecutor’s Office with the mandate to direct police investigations and conduct prosecutions in corruption and organised crime cases. Established in 2001 in response to a rather high level of corruption and organised crime in Croatia, which had emerged from the Homeland Wars and post-communist transition, the USKOK has intelligence, investigative, prosecutorial and preventive functions and is responsible for international co-operation and exchange of information in complex investigations. USKOK has jurisdiction over criminal offences such as abuse in performing governmental duties; illegal intercession; accepting and offering a bribe, including in economic transactions; abuse of office and official authority; money laundering; evasion of tax and other levies. USKOK consists of five Departments: the Research and Documentation Department, the Corruption Prevention and Public Relations Department, the Prosecutor's Department, the Department for Investigation of Property Gain Acquired by Criminal Offense, and the Department of International Cooperation and Joint Investigations. Source: Adapted from OECD (2013), Specialised Anti-Corruption Institutions Review of Models: Second Edition, Anti-Corruption Network for Eastern Europe and Central Asia, OECD Publishing, Paris.

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182 │ 7. PUBLIC GOVERNANCE Particular attention has been paid to strengthen procedural means to make Croatia's law enforcement agencies more efficient to detect and investigate corruption. With the new Criminal Procedure Act, which entered into force in 2009, procedures in corruption cases have been accelerated, and a more efficient system put in place to detect, prosecute and sanction perpetrators of corruption acts.11 Interagency cooperation has been an important component of Croatia's policy. Specialised court departments, state attorney's offices and police bodies for combating corruption have acted in synergy through the "USKOK vertical" specialisation of institutions competent for the fight against corruption in Croatia.12 In line with best practices for an effective detection, prosecution and sanctioning of corruption, memoranda of understanding have been signed between USKOK and other relevant bodies with the aim of strengthening interagency cooperation and of enabling USKOK to have direct access to essential databases.13 Other ways to tackle and deter corruption have involved confiscation of assets, which is being carried out in Croatia both permanently and temporarily to recover property derived from corruption. It is widely acknowledged that the confiscation of the proceeds and instrumentalities of a crime constitutes an additional deterrent that may have as great an effect as a fine or prison term; the threat of confiscation is also a preventive measure, as it makes bribes solicitation less attractive to public officials. In this regard, Croatia has modern legislation in place, which makes it mandatary to confiscate the proceeds and instrumentalities of crime and largely complies with both the international and European standards concerning the asset recovery process. When compared with its neighbours in Southern Europe and based on the available statistics on the amounts of proceeds and instrumentalities of crime seized over time, Croatia has proven to be more proactive than countries such as Bulgaria and Moldova (OSCE, 2018).

Protecting sources of information In complement to the procedural means developed by Croatia to detect, investigate and sanction corruption, legal provisions on whistle-blower protection have been established or expanded to encourage and better protect citizens as an important source of information leading to the detection of corruption and other forms of illegal conduct. Reporting of wrongdoings can indeed play a role in the detection of violations of anti-corruption legislation and public integrity standards (OECD, 2015a). Until recently, Croatia has been relying on specific provisions built into its criminal code, labour law, civil service act, data protection act and others, which provide protection against retaliatory acts or unjust dismissal.14 To facilitate citizens' reporting of corruption and in line with good practices, a range of government agencies have been offering hotlines, and providing, at least for some of them, practical information for disclosure.15 Croatian civil society organisations and the public were nevertheless critical of the legal framework, which was seen as not providing adequate protection. The overall view was that employers could retaliate against whistle-blowers with impunity. In a survey conducted in 2013 by the Ministry of Justice among its employees, almost half of respondents said that, should they learn of wrongdoing, they would not denounce it, while more than two thirds felt that reporting might be harmful for them. When asked whether they deem whistle-blower protection in the Croatian legal system adequate, over 90% of respondents gave a negative answer.16 The European Commission had also regularly evaluated Croatia’s whistle-blower protection system as requiring improvement.17 Fear of retaliation is widely recognised as the main disincentive to report on other's misconduct. The effectiveness of any whistle-blower mechanism depends on public OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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confidence that people who make bona fide reports about wrongdoings receive proper protection against retaliation (OECD, 2016a). With the aim of eliminating this potential obstacle to effective detection, a whistle-blower protection law was enacted in 2019 (Zakon o zaštiti prijavitelja nepravilnosti). Under the Act, which applies to both private and public organisations, whistle-blowers are entitled to court protection, compensation, identity protection and confidentiality. The law is a lex specialis and as such supplements the whistle-blower provisions that can be found in other laws. Full implementation of the Act will not only benefit Croatia's overall anti-corruption system but also increase pressure on companies to set-up internal compliance programmes, discussed below.

Preventing misconduct in the public sector Enhancing integrity and transparency in the public sector has been another priority of the government and, as such, has become a cornerstone of Croatia's anti-corruption policies. Croatia has made important strides in strengthening its safeguards against corruption and other forms of misconduct in the public sector and has now a fairly developed, albeit imperfect, ethics infrastructure with regards to public officials and civil servants. For example, apart from several laws passed for better safeguarding the integrity of Croatia’s civil service,18 the Act on Prevention of Conflict of Interest regulates the exercise of the public office by high-level elected and appointed officials at both central and local level. Passed in 2003, it has been amended almost annually since then, notably with regard to the scope of provisions, the disclosure obligations, the verification procedures and the sanctions regime.19 Implementation of the act is monitored by a special committee, the Commission for the Resolution of Conflicts of Interest, which has been given an important role in providing guidance on the applicable rules and in verifying compliance with the act, in particular with regard to asset declaration. As in a number of countries, enforcement is nevertheless challenging, due in particular to insufficient technical and personnel resources of the Commission. As a result, in its 2018 Report to the European Council, the EC stressed the need for Croatia to strengthen its mechanisms for asset and conflict-of-interest disclosures.20 The authorities have also taken some substantial measures to improve the country's public management system, consistent with the overall objective of immunising the public administration against undue interference. One step is this direction has been the enactment of the law on the right of access to information in 2013, which establishes a process for citizens to request information produced by governmental institutions, thus making it possible to track decisions and actions. Another step has been the use of information technology to provide an ever-expanding number of on-line public services to the public an approach often referred to as e-government and which aims at depersonalising administrative processes and reduce instances of close and regular public-private contacts, as they may give rise to unjustified preferential treatment and the solicitation of bribes. Advances in the provision of e-government services have also allowed the government to launch in 2015 – as discussed earlier in this Chapter- a central e-consultation platform, which provides a single access point to all open public consultations launched by state bodies, thus enabling a more transparent decision-making process.21 As highlighted earlier in this chapter, Croatia has also been increasingly seeking to involve various stakeholders, including private-sector representatives, in the process of preparing draft laws and regulations through the establishment of ad hoc working groups bringing together experts and professionals in a specific field. As noted earlier in this Chapter, selection criteria for participation in those ad hoc groups remain nevertheless unclear, potentially disrupting the

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184 │ 7. PUBLIC GOVERNANCE objective of reducing the risk of policy capture. Channels for public consultations at local and county levels have also yet to be enhanced.

Preventing undue relations between business and politics Croatia has also made strides in strengthening the overall political integrity of the country. Measures to serve this purpose have included the development of new regulations aimed at enhancing the integrity of politicians and elected officials and enhancing transparency in the funding of political parties. Croatia’s legal framework for party funding is now fairly developed (Council of Europe, 2013; Transparency International, 2013), although, as in many countries in the world, its implementation and enforcement remain a challenge. Legal provisions on political party funding were significantly improved through the Act on political activity and electoral campaign financing, adopted in 2011 and amended several times since then. The law notably sets a fixed limit on the amount of donations, prohibits anonymous donations as well as funding by public sector entities including SOEs, requires political parties to disclose detailed financial reports, and prescribes administrative and misdemeanour sanctions for violations of the law (up to EUR 68 000 for most severe violations). In addition, the State Audit Office conducts yearly audits of all political parties and its reports are publicly available, in addition to be shared with the State Election Commission and the State's Attorney Office for follow-up actions. Other laws, such as the Act on the Election of Representatives to the Croatian Parliament (Official Gazette no. 19/15) and the Act on the State Administration System (Official Gazette no. 150/2011, no. 12/2013, no. 93/2016 and no. 104/2016), list cases of incompatibilities between the post of MP and other positions. For example, article 6 of the State Administration System Act prohibits state officials to perform simultaneously duties in bodies of legislative authority or act as members of the representative body of local and regional self-government units. Although the changes in the regulations governing the political sphere represent significant progress with respect to the overall political integrity of the country, Croatia’s policy framework in this field is still a work in progress. Although an Electoral Code of Ethics has been in force since November 2007, there are no codes of conduct for elected officials neither at central nor at local level, unlike the situation in an increasing number of countries in the OSCE region and elsewhere (Leone, 2017; ADB and OECD, 2006). While progress have been made in preparing a draft code of conduct and ethics for parliamentarians, at the time of writing the Croatian Parliament still had not adopted it. Experience in other countries in setting up a modern integrity policy to uphold ethical standards for members of parliament and of other bodies of legislative authority, and thus in ensuring they perform their functions without undue interference, may provide good examples to Croatia to act in this regard. For example, Australia and Korea require parliamentarians to disclose their financial interests before debating an issue related to those interests and Australia prohibits MPs from voting on issues that could give rise to conflicts of interest. Australia's code of conduct also requires parliamentarians to disclose gifts exceeding a certain value limit, as well as sponsored travel. Croatia does not regulate lobbying activities either. Despite some discussions at government level on the need for regulation in this area, no such initiative has materialised to date. As a result, no transparency standards are set in this field, potentially increasing the risk of policy capture. Some initiatives aimed at addressing this risk have been developed such as that of the Croatian Society of Lobbyists – Association for Promotion of OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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Transparent Advocacy (CSL), which has called for the adoption of a law on public advocacy, albeit with very mixed results so far.22 The lack of regulations on the financing of referendum campaigns has also been considered as problematic (European Parliament, 2017), as decisions adopted in referendums may have a direct impact on existing and proposed policies designed for the benefit of all and thus increase the risk of regulatory capture.23 In response to this concern, in March 2019 the government sent to parliament a bill on political financing, election campaigns and referendums, introducing a series of new rules on funding election and referendum campaigns. If passed by parliament, the law would set a fixed limit on the amount of donations, including those coming from businesses, prohibit anonymous donations as well as funding by state and local government-owned companies, and require referendum initiatives' organising committees to submit financial reports.

Enhancing integrity and transparency of public procurement Unfair or opaque procurement processes may send negative signals to businesses, and mislead them into considering that corruption is part of the normal course of doing business in a country. Public procurement in Croatia has been considered as another area vulnerable to corruption risks. According to a Rand study commissioned by the European Parliament, in 2016 Croatia was, among the 28 EU member states, the country which presented the highest risk of corruption in public procurement contracts (Hafner et al., 2016). In 2017, public procurement amounted to 13.4% of the GDP,24 more or less at par with the average figure in OECD countries (12% of GDP). Partly following public pressure which aroused from several major corruption scandals associated with awarding public contracts to loyal companies managed by persons closely connected with the politicians in power,25 Croatia has taken important steps to address integrity and transparency in public procurement. The legislation governing public procurement has been amended substantially on several occasions, with each version making the process more rigorous, better controlled, more transparent and overall more business friendly. Measures aimed at enhancing transparency and integrity of the process have included the introduction, in 2008, of an e-procurement system, now used by all contracting parties above applicable thresholds, and the legal obligation, since 2016, to allow e-submission of tenders, above as well as below EU thresholds. With the transposition of the EU Directives 2014/25/EU and 2015/24/EU, there is also now an obligation for all public procurement procedures to be based on the Most Economically Advantageous Tender criteria. Other measures that have been introduced by Croatia include the requirement for all contracting authorities to publish procurement plans for the business year on the on-line procurement portal as well as, since 2017, to conduct prior market consultations with the interested economic operators on the draft procurement documents and publish reports on the outcomes of these consultations. Contracting authorities are also required to publish declarations regarding conflict of interest, which include a list of companies with which they have a conflict of interest. Contracting persons are also obliged to publish concluded and executed public procurement contracts. Access to public sector contracts is denied to companies or individuals convicted of bribery and other criminal offences.26 Croatia has also developed control mechanisms for better oversight of the procurement process. They include the State Commission for Supervision of Public Procurement, an independent government body in charge of supervising public procurement procedures, as well as public oversight exercised by civil society organisations.27 Public scrutiny can

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186 │ 7. PUBLIC GOVERNANCE indeed act as a disincentive to corruption, favouritism and conflicts of interest, and help reveal transgressions when they occur, although some local observers have questioned the ability of Croatia’s citizens to hold contracting authorities accountable (Podumljak and David-Barrett, 2015). Despite this new environment, the proportion of businesses that regard corruption as very or fairly widespread in Croatia’s public procurement was as high as 73% in late 2017, well above the EU average. It had even increased from 62% of those polled in the previous 2015 survey.28 Specifically, tailor-made specifications for particular companies and unclear selection or evaluation criteria are believed to be recurrent practices in public procurement, affecting business decisions and competition. A 2016 study commissioned by the EC underscored that political influence and favouritism continue to play a role in the procurement system, especially at the local level, due in part to Croatia’s fragmented public administration and lack of sufficient resources for oversight bodies (European Commission, 2016). Another study, on public procurement contracts awarded in 2011-2013 in the construction sector, noted that, despite high standards set by the public procurement legislation, around half of the total contract value of public procurement was won by state owned companies that were outside of the control framework, thus raising questions on the integrity of the public procurement process (Podumljak and David-Berret, 2015). While these issues should be further addressed in the legislation governing public procurement, further integrating responsible business conduct (RBC) standards within SOEs, would likely also address business concerns about the integrity of the procurement process.

Corruption prevention in the corporate sector Compared with reforms aimed at strengthening integrity in the public sector, until recently corruption prevention in the corporate sector has been significantly lower on the government's reform agenda. The OECD Guidelines for Multinational Enterprises (the Guidelines) recognise the important role of the private sector in combating bribery and corruption, and recommend that enterprises develop and adopt adequate internal controls, ethics and compliance programmes or measures for preventing and detecting bribery, on the basis of a risk assessment addressing the individual circumstances of an enterprise. The Guidelines also include recommendations for enterprises to introduce safeguards in their own policies to protect bona fide whistle-blowing activities. The OECD Due Diligence Guidance for Responsible Business Conduct provides practical guidance that can help enterprises avoid and address risks of corruption that may be associated with their operations, supply chains and other business relationships. Until the enactment of a Whistle-blower Protection Act in February 2019, which notably requires companies to establish internal procedures for reporting irregularities, the authorities had made timid efforts to encourage the development of good practices in their corporate sector. For sure, rules on disclosure of ownership and control, governance by shareholders and supervisory boards and regulations governing accounting and auditing have been in place for a long time. Requiring companies to keep records that accurately and fairly reflect financial transactions in reasonable detail may indeed prevent practices associated with improper transactions such as the giving of bribes. This is not enough, though. Examples of good practices in OECD and non-OECD countries include the distribution to business organisations of guidelines drawing the attention of companies to the need for establishing internal reporting mechanisms and for training employees on anti-

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corruption compliance and business ethics or even the legal requirement for companies to establish internal mechanisms for reporting wrongdoings. Reflecting Croatia's relative timid efforts in promoting the adoption of corporate codes of conduct and other tools such as internal hotlines or other forms of reporting mechanism, Croatian companies have so far invested relatively modest effort in organising and disciplining their business. According to latest data, in 2012 roughly four in ten (40.1%) companies (large corporations essentially) had an internal code of ethics and only a fifth (21%) had such codes supplemented by internal guidelines and policies. Even less (about 10%) had designed measures to ensure communication and training on the company’s ethics and compliance programme.29 Not surprisingly, in a 2017 business survey, only 6% of Croatian respondents said that they were aware that their company had established internal channels for reporting breaches of the law or ethics occurring within the company.30 The relatively cautious efforts of the government in promoting the widespread adoption of specific integrity standards and reporting mechanisms have been barely complemented by local business ethics initiatives. With a few exceptions, local business organisations have played a limited role in encouraging the development of ethics codes and other corporate measures aimed at preventing bribery and corruption. For example, the code of business ethics that the Croatian Chamber of Economy adopted in 2005 - that its member companies are encouraged to adopt - contains measures mainly of a general nature, without explicitly making the rejection of bribery part of its membership's business culture. It is first and foremost international business associations which, until recently, have been the prime vehicle for awareness-raising efforts and involvement of Croatia’s business sector in the prevention of corruption. For example, in 2017, Croatian businesses were informed about business integrity at a conference organised in Zagreb by the International Chamber of Commerce (ICC) on the topic “Strengthening the Integrity of Croatian Companies in Fighting Corruption – Challenges of Corporate Compliance“. Similarly, it is first and foremost large Croatian companies operating internationally - such as Pliva, a member of the Israeli pharmaceutical group Teva - which have taken measures to actively promote ethical business internally. Since then, through the enactment of the Whistle-blower Protection Act, Croatia has taken steps to improve awareness among companies of the need to develop and adopt ethics programmes or measures for the purpose of preventing and detecting irregularities. The Act’s practical effect is that the development of internal channels for reporting is now a statutory requirement for all employers with more than 50 employees. Guidance and assistance in training to companies on the adoption and implementation of internal whistleblower mechanisms will be essential to ensure the effectiveness of any such mechanism.

Ensuring transparency and integrity of state-owned enterprises Reforms aimed at improving the governance and fostering integrity of state-owned enterprises (SOEs) have also advanced slowly. As noted in Chapter 3, SOEs continue to occupy a central place in the national economy due to their size and presence in numerous sectors. SOEs can be particularly exposed to corruption risks, which may include bribery of SOEs employees by other parties or the feeling of employees and board members of SOEs that they can use their positions for gaining a personal advantage for themselves (Crane-Charef, 2015). Many Croatian SOEs have unique positions in the market that can be used for winning unfair advantages. Their proximity to the government also exacerbates corruption risks. Many SOEs suffer from political board appointments without transparent

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188 │ 7. PUBLIC GOVERNANCE and competitive selection procedures. Recent corruption-related scandals have shown how public trust in SOEs and the state or local governments as owners can be damaged by unethical practices in the SOE sector. The government, has been gradually, albeit slowly, trying to tackle the issues of mismanagement and vested interests in SOEs through the adoption of measures aimed at strengthening their integrity. In the late 2000s Croatia, in line with good practices, adopted a comprehensive Anti-Corruption Program for State Owned Companies. The programme, which run from 2010 to 2012, set three objectives (strengthening of integrity, accountability and transparency in the work of SOEs; creation of preconditions for the prevention of corruption at all levels of companies; affirmation of “zero tolerance” approach to corruption) and defined eighteen measures, which had to be transformed into particular activities to be included in action plans of all companies in majority state ownership (OECD 2016c). The ambition of the reform, however, diminished after Croatia’s accession to the EU and, as a result, the programme was not extended after its originally envisaged termination. Since then, Croatia has taken new steps towards improving the framework for SOEs. In 2018, work begun to revitalise the anti-corruption programme for SOEs through the development of a new one for the period 2019-2020. The new programme focuses on preventing conflicts of interests and further strengthening ethics and integrity of SOEs. It envisages new anticorruption mechanisms for SOEs, including the incorporation of rules on the prevention of conflict of interest into the codes of ethics and internal acts of SOEs, the requirement for all SOEs to implement internal control of business operations, independent monitoring of sponsorship and donations and of public procurement procedures – including control mechanisms of irregularities. The programme also recognises the role of employees in detecting and reporting evidence of bribery by requiring SOEs to provide channels for communication by, and protection of, persons willing to report breaches of the law or professional standards or ethics occurring within the company. The programme also insists on the need for training programmes to increase employee awareness of corruption risks and compliance with the company’s ethics. The programme, if adopted, would complement other measures recently put in place by Croatia to deter and prevent conflicts of interest in several sensitive areas. For example, to enhance transparency and integrity around personal finance of SOEs senior managers, members of management boards are now subject to financial disclosure and in 2017 Croatia adopted a long-awaited new Code of Corporate Governance for SOEs, which contains conflict of interest guidance for members of the supervisory board of SOEs. To raise transparency and integrity around donations to SOEs and party funding by SOEs, Croatia now maintains a database on sponsorships and donations to government-owned companies; as noted earlier in this Chapter, the act on political activity and electoral campaign financing prohibits funding by state and local government-owned companies. It can reasonably be argued that the steps taken by Croatia are moving in the right direction. The reforms will nevertheless take time to permeate through the system. Croatia's governance system for SOEs is in transition and as a result, there are a number of issues that have not been addressed yet. In line with the OECD Guidelines on Corporate Governance of State-Owned Enterprises and international experience, additional steps should be taken to strengthen the integrity and transparency of SOEs. Some of these have already been highlighted in Chapter 3 of this Review. They include more financial resources devoted to financial oversight and continuous efforts to make SOE boards more professional. Greater consistency is also needed with regard to ethical rules and standards

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that apply to companies owned by local governments and companies in which the state is a majority owner. Overall, as highlighted in the Guidelines on Corporate Governance of State-Owned Enterprises, which address transparency extensively, “state-owned enterprises should observe high standards of transparency and be subject to the same high quality accounting, disclosure, compliance and auditing standards as listed companies” (OECD, 2015c :26).

Outlook and policy recommendations Croatia has made significant progress in improving the legal framework to ensure a more stable regulatory environment and better quality of regulations. For example, the legal framework for consultations is among one of the most developed among the EU member states, even if there are still differences in how stringently these rules apply in practice. The new law on RIA has also strengthened the quality of ex ante review of regulations in Croatia. Such formal processes do not, however, yet apply to secondary regulations in Croatia. Consequently, it is not surprising that those still remain a challenge in the country. In addition, Croatia has not yet developed a systematic approach towards ex post evaluations. As such, as highlighted in Chapter 6, systematic reduction of administrative burdens still remains a challenge. Further advances in extending good regulatory practices to secondary regulations, conducting targeted ex post reviews focusing on the performance of regulations or specific sectors (see OECD, 2019a and OECD, 2019b) as well as ensuring greater homogeneity in application and enforcement of regulations at the national and sub-national level could help the country address one of the most prevalent weaknesses of its investment climate. The quality of Croatia's public governance also suffers from the fragmentation of competences and of not always well-defined lines of accountability. Croatia has a rather complex and multi-layered network of public administrations and regulations. The number of counties, municipalities, and public agencies is very high, especially in relation to the size of population and administrative capacity. Such a multi-layered public administration creates a cumbersome and confusing environment for businesses who have to navigate through it. Streamlining this structure would help reduce red tape and disparities in regulation and in the scope and quality of public services. Better public administration would have high payoffs in boosting medium-term growth. It would also further support Croatia’s anti-corruption efforts. Croatia has made important strides in reducing opportunities for corruption and limiting discretion in public decision-making. At the central level, appropriate standards of integrity are mostly in place and obligations to report personal assets and liabilities are now the prevalent rule. The development of eGovernment services and other approaches is progressing. The legislation governing public procurement has been amended on several occasions, with each version enhancing transparency and control. Significant developments have also taken place to strengthen the efficiency of law enforcement agencies. A track record of effective investigation, detection and prosecution of corruption has been established. Some elements of a functioning anti-corruption framework are nevertheless still missing. Despite the many encouraging steps taken, business’ trust in the government’s combat against corruption remains low. According to the 2017 Flash Eurobarometer on businesses' attitudes towards corruption in the EU, the proportion of entrepreneurs that regard

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190 │ 7. PUBLIC GOVERNANCE corruption as widespread in Croatia had even increased between 2015 and 2017, from 90% of those polled in the previous 2015 survey to 92% of respondents to the 2017 survey. This perception suggests the need for the development of a targeted communication policy that reflects on the important reforms already introduced and those in the pipeline. But not only. It also suggests that further efforts are needed to defuse concerns about the level of corruption in Croatia by businesses and the population at large. In this regard, the quality of the ethics framework requires further improvement to dispel shadows of doubt on the integrity of the public sector. In particular, considering the vulnerability of the local and regional governments to corruption, ties between business and politics, and favouritism, Croatia should promote stronger ethical standards among local self-government. With a few exceptions at county level, their officials and other employees are not bound by any integrity standards, which may easily lead to conflicts of interest or abuses of favouritism. While the Strategy for Suppression of Corruption 2008 set as an objective the establishment of anti-corruption commissions at regional level, only 17 out of the country’s 20 counties had done so as of March 2019 and even less had adopted internal anti-corruption plans. Furthermore, despite Croatia’s efforts to improve the political funding system, notably by imposing limitations on donations and subjecting political parties to disclosure of financial resources and auditing, lobbying activities have not yet been addressed. As they can lead to corruption and regulatory capture, rules on lobbying could help address these concerns (OECD, 2013b). In this regard, Croatia could make use of the Principles for Transparency and Integrity in Lobbying adopted by the OECD in 2010, which are international principles providing guidance on how to meet expectations of transparency and accountability in the public decision-making process. Croatia’s latest national anti-corruption strategy for 2015-2020 has identified many of these shortfalls. The strategy focuses on promoting integrity and transparency in the work of public bodies and institutions further. This is planned to be achieved notably through the setting up of a unified ethics infrastructure covering all public administration employees at both national and local level (in issues such as conflict of interest, favouring private benefits, corruption, personal connections, etc.). This will include the obligation of establishing codes of ethics and institutional standards for their implementation in state administration bodies, regional and local self-government units and public institutions. Such actions and other reforms in the pipeline will likely make unethical behaviour easier to prevent and harder to commit and could ultimately recast business confidence in Croatia’s public administration. Reforms aimed at fostering the integrity of state-owned enterprises (SOEs) are also progressing, though more slowly than scheduled. Given that SOEs are still present in many sectors of the economy, additional steps - in line with the OECD Guidelines on Corporate Governance of State-Owned Enterprises - should be taken to make them more transparent and ensure a level playing field. Enhancing ethics in the private sector is also important for Croatia’s success in preventing and combatting corruption. The recent adoption of the Whistle-blower Protection Act should help to address Croatia’s private sector weaknesses in this regard but its implementation will remain crucial. Actions will be required to advise and assist companies in their efforts to prevent and detect irregularities related to corruption or arising from a conflict of interest. The OECD Guidelines for Multinational Enterprises provide guidance on processes and systems - such as internal controls, ethics and compliance programmes that companies can implement to address corruption. Croatia could also make use of the OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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OECD Good Practice Guidance on Internal Controls, Ethics and Compliance (OECD, 2010). This additional guidance can be a useful reference for promoting, designing and implementing strong corporate compliance programmes and internal reporting mechanisms, in particular for SMEs seeking to be active on foreign markets.

Policy recommendations 

Build on the efforts to improve regulatory quality in the country, in particular by implementing the OECD recommendations identified in the Regulatory Policy Review (OECD, forthcoming). This applies to the processes pertaining to creating secondary regulations and the use of ex post regulatory reviews.

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Perfect the public integrity framework as foreseen in the Anti-Corruption Strategy 2015-2020. This could include: developing comprehensive codes of conduct for elected officials at regional and local level as well as a code of conduct for parliamentarians and ensuring corresponding accountability tools and dissuasive sanctions for potential violations of such codes; regulating lobbying activities; strengthening the capacity of existing control mechanisms with respect to public procurement.

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Continue efforts to improve the corporate governance framework for state-owned enterprises (SOEs) with the objective to improve their integrity, transparency and professionalism. Reforms aimed at fostering the governance and integrity of SOEs are progressing, though more slowly than scheduled.

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Take action, as appropriate in cooperation with business organisations and other stakeholders, to improve awareness among companies throughout Croatia, including state-owned enterprises and small and medium enterprises, which are traditionally at high risk of bribe solicitation by public officials, of Croatia’s new legislation regarding whistle-blower protection, and to advise and assist companies in their efforts to establish internal channels for reporting irregularities through, for example, the development of seminars, guidelines and other forms of guidance. Making anti-corruption compliance part of one’s corporate culture is the best way to prevent corrupt acts before they happen.

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Signal changes in the fight against corruption to the public and businesses. Increasing raising awareness efforts is of much importance to close the perception gap about actions already taken and reforms in the pipeline. A targeted communication strategy for the public through an on-line platform is in the offing but needs to materialize in practice.

Notes 1

See Kaufmann, Kraay and Mastruzzi, 2010 for the description of the methodology.

2

Standard Eurobarometer 89, Public Opinion in the European Union.

3

European Commission (2012), Communication from the Commission to the European Parliament and the Council on the Main Findings of the Comprehensive Monitoring Report on Croatia’s state of preparedness for EU membership, COM(2012) 601 final. While emphasising the need for increased efforts to continue strengthening the rule of law, to improve administration and the judicial system, and to fight and prevent corruption

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192 │ 7. PUBLIC GOVERNANCE effectively, the Commission noted that Croatia had put in place an adequate legal and institutional framework for the fight against corruption. 4

Flash Eurobarometer 457, Businesses' attitudes towards corruption in the EU, fieldwork: October 2017, publication: December 2017. 5

Ernst & Young (2017), Europe, Middle East, India and Africa Fraud Survey 2017. The survey is based on interviews covering a mixture of company sizes, job roles and industry sectors. 6

World Economic Forum (2017), The Global Competitiveness Report 2017–2018, World Economic Forum, Geneva, www3.weforum.org/docs/GCR20172018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf 7

American Chamber of Commerce in Croatia (2018), Survey of the Business Environment in Croatia, Zagreb: March 2018, www.amcham.hr/storage/upload/doc_library/amcham__survey_of_the_business_environment_in_croatia_143454.pdf 8

OECD (2015), Prevention of Corruption in the Public Sector in Eastern Europe and Central Asia, Paris, www.oecd.org/corruption/acn/ACN-Prevention-CorruptionReport.pdf 9

For a comparison of Croatia's incrimination system with other European countries, see Roderick Macauley, Fighting Corruption: Incriminations. Thematic Review of GRECO’s Third Evaluation Round, Council of Europe Publishing, 2012. For a UN assessment of Croatia’s criminal law and procedure, see UNODC (2012), Country Review Report of Croatia, www.unodc.org/documents/treaties/UNCAC/CountryVisitFinalReports/2013_10_29_Cr oatia_Final_country_report.pdf 10

Flash Eurobarometer 457, Businesses' attitudes towards corruption in the EU.

11

Namely, from 1 July 2009, the new Criminal Procedure Code introduced prosecutor’s investigation instead of court investigation and, in order to avoid lengthy trials and boost judicial efficiency, the possibility of plea bargaining. 12

The so-called “USKOK vertical” covers the National Police Office for the Suppression of Corruption and Organised Crime (PNUSKOK), the USKOK and Departments for USKOK in four county courts in Zagreb, Split, Osijek and Rijeka. 13

Memoranda of understanding have been signed with a number of agencies, including the chief police directorate, the office for prevention of money laundering, the tax and customs administrations, the public procurement system administration (DPPS) within the Ministry of Economy, the central public procurement office, the financial inspectorate, and the Ministry of Entrepreneurship and Crafts. 14

For example, the Labour Act, as amended in 2009, contains provisions prohibiting the dismissal of employees who report in good faith and on reasonable grounds suspected acts of corruption. The criminal code prohibits dismissing an employee whose report is found to be true by a court; violating this provision, or failing to reinstate a worker in defiance of a judicial decision, is punishable by up to three years in prison. 15

On the Ministry of Justice's website, prospective whistle-blowers are advised to contact the USKOK or the police, including anonymously: https://pravosudje.gov.hr/istaknuteteme/antikorupcija/kome-prijaviti/6176 16

“Survey among Civil Servants in the Ministry of Justice on the Effectiveness of the Protection of Whistle-blowers in 2013” in Gregor Thüsing and Gerrit Forst, eds., Whistleblowing - A Comparative Study, Springer International Publishing Switzerland, 2016. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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17

Country Report Croatia 2018 including an In-Depth Review on the prevention and correction of macroeconomic imbalances, 2018 European Semester, European Commission, 2018. 18

The Act on the State Administration System, the Civil Servants Act, the Law on Civil Servants and Employees in Local and Regional Self-Government, which regulate conflicts of interest and asset disclosure for civil servants, as well as the Code of ethics for civil servants, which is the main instrument safeguarding the integrity of civil servants employed in state administration bodies. 19

For example, amendments passed in 2013 introduced the verification of official's asset records, strengthened prevention, and increased professionalism. 20

European Commission (2018), Recommendation for a Council Recommendation on the 2018 National Reform Programme of Croatia and delivering a Council opinion on the 2018 Convergence Programme of Croatia, COM(2018) 410 final. https://ec.europa.eu/info/sites/info/files/file_import/2018-european-semester-countryspecific-recommendation-commission-recommendation-croatia-en.pdf 21

The platform is accessible at https://esavjetovanja.gov.hr/ECon/Dashboard.

22

The Association circulated a draft bill to ministers and other interested constituencies in 2014-16. The draft foresaw mandatory registration for those who wish to influence public authorities, a public register, and sanctions applicable in case of breaches of mandatory registration rules. See the Association's website: http://hdl.com.hr/en/news/ [accessed on 5 September 2018] 23

By Croatian law, if anybody is able to find 10% of the electorate signing a form demanding for a referendum within two weeks, a referendum must be held. 24

Ministry of Economy, Entrepreneurship and Crafts, Statistička izvješća o javnoj nabavi za 2017. Godinu [Statistical report on public procurement for 2017]. Available at: www.javnanabava.hr/default.aspx?id=3425 [accessed on 30 March 2019] 25

For example, the so-called FIMI media case involving very senior politicians in a scheme that used public procurement to trade political donations for contracts. 26

Article 251 of the Law on public procurement.

27

One example of oversight exercised by civil society organisations is that of the Partnerstvo za društveni razvoj (Partnership for Social Development), which set up in 2013 a webportal giving public access to information on the implementation of public procurement procedures and on the companies involved in such procedures as well as on the assets and interests of public officials. 28

Flash Eurobarometer 457, Businesses' attitudes towards corruption in the EU, fieldwork: October 2017, publication: December 2017; Flash Eurobarometer 428, Businesses' attitudes towards corruption in the EU, fieldwork: September-October 2015, publication: December 2015. 29

UNODC (2013), Business, corruption and crime in Croatia: The impact of bribery and other crime on private enterprise, United Nations Office on Drugs and Crime, Vienna, www.unodc.org/documents/data-andanalysis/statistics/corruption/Croatia_Business_corruption_report.pdf 30

Ernst & Young, Europe, Middle East, India and Africa Fraud Survey 2017: Awareness of whistleblowing hotlines by country, accessed at https://fraudsurveys.ey.com/ey-emeiafraud-survey-2017/detailed-results/awareness-of-whistleblowing-hotlines-by-country/ on 25 November 2018.

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References Asian Development Bank (ADB) and OECD (2006), Anti-Corruption Policies in Asia and the Pacific: Progress in legal and institutional reform in 25 countries, ADB/OECD Anti-Corruption Initiative, Asian Development Bank, Manila, https://www.oecd.org/site/adboecdanticorruptioninitiative/36832820.pdf Council of Europe (2013), Third Evaluation Round. Second Compliance Report on Croatia: "Incriminations (ETS 173 and 191, GPC 2)” and "Transparency of Party Funding”, Greco RC-III (2013) 28E. Croatia (2018), “OECD Regulatory Policy Review: Croatia – Replies to the Questionnaire” (unpublished). Crane-Charef, M. (2015), “Stocktaking of Anti-Corruption and Business Integrity Measures for Southern African SOEs”, OECD Corporate Governance Working Papers, No. 18, OECD Publishing, Paris, http://dx.doi.org/10.1787/5jrtd6fghvf1-en European Commission (2018a), Public Administration Characteristics and Performance in EU28: Croatia, Luxembourg: Publications Office of the European Union, 2018. European Commission (2018b), Country Report Croatia 2018, including an in-depth review on the prevention and correction of macroeconomic imbalances, 2018 European Semester, European Commission, March 2018, COM(2018) 120 final. European Commission (2017), Country Report Croatia 2017, including an in-depth review on the prevention and correction of macroeconomic imbalances, 2017 European Semester, European Commission, February 2017, SWD(2017) 76 final. European Commission (2016), Stock-taking of administrative capacity, systems and practices across the EU to ensure the compliance and quality of public procurement involving European Structural and Investment (ESI) Funds – Croatia country profile, Study by PwC for the European Commission. European Commission (2014), Annex Croatia to the EU Anti-Corruption Report, Brussels, February 2014, COM(2014) 38 final. European Parliament (2017), Corruption in the European Union: Prevalence of corruption, and anticorruption efforts in selected EU Member States, EPRS: European Parliamentary Research Service, September 2017. Foreign Investors Council (2017), White Book 2017, Zagreb. Foreign Investors Council (2016), White Book 2016, Zagreb. Hafner, M., J. Taylor, E. Disley, S. Thebes, M. Barberi, M. Stepanek, and M. Levi (2016), The Cost of Non-Europe in the area of Organised Crime and Corruption. Annex II. Corruption. RAND Corporation. Study written at the request of the European Parliament, www.europarl.europa.eu/thinktank/en/document.html?reference=EPRS_STU(2016)579319 Kaufmann D., A. Kraay and M. Mastruzzi (2010), "The Worldwide Governance Indicators: A Summary of Methodology, Data and Analytical Issues". World Bank Policy Research Working Paper No. 5430, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1682130 Kuris, G. (2013), "Cleaning House: Croatia Mops Up High-Level Corruption, 2005-2012", Innovations for Successful Societies, Princeton University, www.princeton.edu/successfulsocieties

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Leone, J. (2017), Codes of conduct for national parliaments and their role in promoting integrity: an assessment, paper submitted in the context of the 2017 OECD Global Anti-Corruption & Integrity Forum, www.oecd.org/cleangovbiz/Integrity-Forum-2017-Leone-conduct-parliaments.pdf OECD (2019a), Better Regulation Practices across the European Union, OECD Publishing: Paris. https://doi.org/10.1787/9789264311732-en. OECD (2019b), Regulatory Policy in Croatia: Implementation is Key, OECD Reviews of Regulatory Reform, OECD Publishing, Paris, https://doi.org/10.1787/b1c44413-en. OECD (2018), State‑Owned Enterprises and Corruption. What are the risks and what can be done?, OECD Publishing, Paris. https://doi.org/10.1787/9789264303058-en OECD (2016a), Committing to Effective Whistleblower Protection, OECD Publishing, Paris, https://doi.org/10.1787/9789264252639-en OECD (2016b), Anti-corruption Reforms in Eastern Europe and Central Asia. Progress and Challenges, 2013-15, Paris, www.oecd.org/corruption/acn/Anti-Corruption-Reforms-Eastern-Europe-CentralAsia-2013-2015-ENG.pdf OECD (2016c), Business Integrity in Eastern Europe and Central Asia, Paris, www.oecd.org/corruption/acn/Business-Integrity-in-Eastern-Europe-and-Central-Asia-ENG.pdf OECD (2015a), Policy Framework for Investment- 2015 Edition, OECD Publishing, Paris. https://doi.org/10.1787/9789264208667-en OECD (2015b), Liability of Legal Persons for Corruption in Eastern Europe and Central Asia, Paris, www.oecd.org/corruption/acn/ACN-Liability-of-Legal-Persons-2015.pdf OECD (2015c), Guidelines on Corporate Governance of State-Owned Enterprises, OECD Publishing, Paris, https://doi.org/10.1787/9789264244160-en OECD (2013a), Specialised Anti-Corruption Institutions. Review of Models: Second Edition, AntiCorruption Network for Eastern Europe and Central Asia, OECD Publishing, Paris, https://doi.org/10.1787/9789264187207-en OECD (2013b), Transparency and Integrity in Lobbying: 10 Principles for Transparency and Integrity in Lobbying, www.oecd.org/corruption/ethics/Lobbying-Brochure.pdf OECD (2012), Recommendation of the Council on Regulatory Policy and Governance, OECD Publishing, Paris, https://doi.org/10.1787/9789264209022-en OECD (2010), Good Practice Guidance on Internal Controls, Ethics, and Compliance, www.oecd.org/daf/anti-bribery/44884389.pdf OSCE (2018), Asset Recovery: A Comparative Analysis of Legislation and Practice - Bulgaria, Croatia, Moldova and Romania, Regional Anti-corruption Initiative (RAI) and Organisation for Security and Co-operation in Europe (OSCE), http://rai-see.org/wp-content/uploads/2018/06/20180611AssetRecovery_OSCE_final.pdf Petak Z. (2015), “Javne politike i djelotvornost javnog upravljanja” [Public Policies and Effectiveness of Public Management], Gospodarstvo idržava u krizi, Zagreb: Friedrich Ebert Stiftung, http://iju.hr/Dokumenti/fju_zef.pdf Podumljak, M. and E. David-Barrett (2015), The Public Procurement of Construction Works: The Case of Croatia, Partnership for Social Development, Zagreb, www.vkontrole.lt/tf/files/files/The%20Public%20Procurement%20of%20Construction%20WorkThe%20Case%20of%20Croatia.pdf

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196 │ 7. PUBLIC GOVERNANCE Transparency International (2013), Transparency in Funding of Political Parties. Croatia, 2013, www.transparency.org/files/content/feature/2013_CRINIS_Croatia_EN.pdf UNODC (2013), Business, corruption and crime in Croatia: The impact of bribery and other crime on private enterprise, United Nations Office on Drugs and Crime, Vienna, www.unodc.org/documents/data-andanalysis/statistics/corruption/Croatia_Business_corruption_report.pdf

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Chapter 8. Promoting and enabling responsible business conduct as a strategic choice

Responsible business conduct (RBC) is an important part of the investment climate and is increasingly integrated within policies aimed at attracting quality investment and enhancing sustainable development. In line with global trends, RBC has also emerged as an important topic in Croatia. This chapter provides an overview of the RBC landscape in Croatia and Croatia’s plans for its National Contact Point for the OECD Guidelines for Multinational Enterprises.

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198 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE Countries that adhere to the Investment Declaration aim to encourage the positive contributions that businesses can make on economic and social progress. They commit to promote Responsible Business Conduct (RBC) principles and standards, as set out by the OECD Guidelines for Multinational Enterprises (the Guidelines). The Guidelines are the most comprehensive set of government-backed recommendations on RBC in existence today (See Box 8.1). Observance of the Guidelines is supported by their unique implementation mechanism – the National Contact Points (NCPs). RBC is a key element of a healthy business environment – one that attracts quality investment, minimises risks for businesses, ensures stakeholder rights are respected and ultimately leads to broader value creation. RBC principles and standards set out an expectation that businesses should avoid and address adverse impacts of business activities, while contributing to sustainable development in countries where they operate. RBC emphasises the integration and consideration of environmental and social issues into core business operations. A key element of RBC is risk-based due diligence, a process through which businesses identify, prevent and mitigate actual and potential adverse impacts, and account for how these impacts are addressed. RBC expectations extend to business activities throughout the entire supply chain and linked to business operations, products or services by a business relationship. While it is the role of businesses to behave responsibly, Governments have a primary duty to protect the public interest and an important role in promoting and enabling RBC. The RBC chapter in the OECD Policy Framework for Investment is a useful reference for designing and implementing a strong RBC policy framework. This entails establishing and enforcing an adequate legal framework that protects the public interest and underpins RBC, while monitoring business performance and compliance with the law. Setting and communicating clear expectations on RBC and providing guidance on what those expectations mean is important, while encouraging and engaging industry and stakeholders in collective initiatives and providing recognition and incentives to businesses that exemplify good practice is encouraged. It also entails ensuring that RBC principles and standards are observed in the context of the government’s role as an economic actor. This chapter summarises Croatia’s plans for establishing an NCP, followed by a review of Croatia’s general policies for enabling RBC; policies in specific areas covered by the Guidelines; RBC in the context of the state as an economic actor; outlook and policy recommendations. Box 8.1. Understanding the OECD Guidelines for Multinational Enterprises

Addressed by Adherents to the OECD Declaration on International Investment and Multinational Enterprises to businesses operating in or from their jurisdictions, the Guidelines set out principles and standards in all major areas related to RBC, including information disclosure, human rights, employment and industrial relations, environment, bribery and corruption, consumer interests, science and technology, competition, and taxation. Their purpose is to ensure that business operations are in harmony with government policies, to strengthen the basis of mutual confidence between businesses and the societies in which they operate, to improve foreign investment climate, and to enhance the contribution of the private sector to sustainable development. The Guidelines, together

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with the UN Guiding Principles and the fundamental ILO Conventions, are one of the major international instruments on RBC. The Guidelines do not aim to introduce differences of treatment between multinational and domestic enterprises - they reflect good practice for all. Adherents wish to encourage the widest possible observance of the Guidelines to the fullest extent possible, including among small- and medium-sized enterprises even while acknowledging that these businesses may not have the same capacities as larger enterprises. The Guidelines are supported by a unique implementation mechanism of National Contact Points (NCPs), agencies established by adhering government to promote and implement the Guidelines. The NCPs assist enterprises and their stakeholders to take appropriate measures to further the implementation of the Guidelines. They also provide a mediation and conciliation platform for resolving practical issues that may arise

Croatia’s plans for establishing an NCP According to the Decision of the Council on the OECD Guidelines for Multinational Enterprises, all countries that adhere to the Guidelines are required to set up an NCP. NCPs have a mandate to further the effectiveness of the Guidelines by undertaking promotional activities, handling inquiries, and contributing to the resolution of issues that arise if the Guidelines are not observed by businesses in specific instances. NCPs provide one of the few government-based, non-judicial grievance mechanisms with such an effective and broad application. Adherents are required to make human and financial resources available to their NCPs so they can effectively fulfil their responsibilities, taking into account internal budget priorities and practices. In accordance with the Procedural Guidance of the Decision of the Council on the Guidelines, NCPs are expected to operate in accordance with the “core criteria” of visibility, accessibility, transparency and accountability. In early 2018, the OECD Secretariat, together with the NCPs from Poland and Latvia, delivered a technical workshop on RBC and the NCPs to Croatian authorities. The workshop focused on the main aspects of NCP functioning and RBC policies, as well as experience sharing on the structure and mandate of NCPs and an in-depth discussion on the expectations related to the NCP core criteria of visibility, accessibility, transparency and accountability. Croatia consulted with stakeholders on the plans for its NCP in late 2018. Croatia also engaged with OECD institutional stakeholders (BIAC, TUAC, OECD Watch) for advice on the plans for the institutional arrangements for the Croatian NCP. Based on these consultations, the Croatian authorities set out the draft plan for the NCP as described below.

Institutional arrangements NCP Structure At the time of writing, the Croatian authorities expected a Government Decision by May 2019 to formalise the establishment of the NCP as a permanent mechanism for the promotion and implementation of the OECD Guidelines for Multinational Enterprises, and provide details on its role, composition, resources and reporting obligations.1

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200 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE Pursuant to the draft proposal that had been prepared ahead of the adoption of the Government Decision, Croatia envisioned to have an NCP structured as a two-tier body, consisting of a “full-time NCP” dealing with day-to-day operations, administrative matters, and promotional activities, and a “multi-stakeholder group” providing technical advice on RBC-related matters and serving as a platform for high-level engagement. The two bodies were expected to collaborate and make joint decisions on specific instances, both as related to the process for handling specific instances as well as the determination of outcomes. The full-time NCP will be located in the Ministry of Foreign and European Affairs (MOFEA). It will be staffed with two full-time members recruited from MOFEA and the Ministry of Economy, Entrepreneurship and Crafts (MEEC), which has a mandate to promote RBC. The MOFEA has been the main coordinating body for co-operation with the OECD so far, including with the Investment Committee, and as such has experience in areas related to investment policies. The MEEC is in charge of the implementation of domestic regulations on investment incentives and strategic investments, as well as promotion of RBC. In the government’s view, the complementary mandates and expertise of these two ministries will ensure appropriate handling of NCP and RBC-related matters. Additionally, since August 2018, both ministries are participating in the newly created board of the Croatian CSR Index (see infra, section on General Policies for Promoting RBC).2 In line with the recommendations of OECD’s institutional stakeholders and pending approval from the MOFEA and MEEC, the two NCP full-time members are expected to share the same office space to ensure ongoing collaboration and efficiency. The multi-stakeholder group will count up to nine members, and maintain a balanced representation of trade unions, NGOs, businesses and government. At the time of writing, several organisations had expressed their interest to participate in the NCP. These included the Croatian Employers Association, the Croatian Business Council for Sustainable Development, the Croatian Chamber of Economy, the Ministry of Labour and Pension System, the Ministry of Environment and Energy, Human Rights House, WWF Adria, the Association of Independent Trade Unions (AITU) and the Independent Trade Union for Science and Tertiary Education (ITUSTE). Ministries were expected to select experts in their respective fields to be part of the multi-stakeholder group. At the time of writing, AITU and ITUSTE had already appointed their respective representatives. A representative from WWF Adria had been selected through a procedure facilitated by the Government Office for NGOs. This structure has been defined to take into consideration the recommendations made by OECD’s institutional stakeholders, in particular when it comes to preventing potential conflicts of interest. The multi-stakeholder representation in the group was expected to introduce various checks and balances in the work of the NCP, as well as a way to build trust with external stakeholders. The draft also envisioned that general meetings gathering the full-time NCP and the multi-stakeholder group will be held three to five times a year, in addition to ad hoc meetings, for example in relation to specific instances.

Stakeholder engagement Throughout the planned process to establish the NCP, Croatia’s Working Group for the Investment Policy Review (WGIPR) - set up by the Croatian authorities to assist the OECD in the conduct of the Review and comprising key ministries and governmental agencies as well as civil society and business representatives - will serve as the primary venue for engaging with Croatian stakeholders. The government also plans to leverage existing initiatives, such as the annual conference on RBC organised by the Croatian Business

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Council for Sustainable Development in November 2018 to engage with stakeholders on the role and plans for the NCP. Once the NCP is formally established, the Croatian authorities plan to organise an annual meeting gathering various stakeholders. Members of the multi-stakeholder group are expected to make the link with diverse stakeholder groups and to facilitate engagement with business associations, trade unions and civil society organisations. The NCP will have a dedicated website and will be reachable by email and phone. Regular awareness raising seminars and workshops are planned to inform stakeholders of the NCP’s activities. The government plans to publish a report on the NCP website after each major meeting. The NCP will rely on external outlets such as business dailies, magazines, as well as radio and television programs to inform the wider public and stakeholders of the activities of the NCP. The NCP will be expected to report at least once a year on its activities to the Prime Minister’s Office, in addition to reporting to the OECD.

Resources After the establishment of the NCP, resources will be allocated to the NCP from the budgets of the MOFEA and the MEEC. The NCP budget will be validated on a yearly basis, through regular annual budget planning. The NCP will have a dedicated budget to cover for the salaries of at least two full-time members, website set-up and maintenance, handling of specific instances, and organising meetings of the multi-stakeholder group, as well as promotional activities such as seminars and conferences. The participation in the multistakeholder group will be on volunteer basis.

Handling of specific instances The full-time NCP will be the main contact point for submission of specific instances. Upon reception, specific instances will be transmitted to the multi-stakeholder group and discussed among the two bodies. All decisions will be made jointly by the full-time NCP and the multi-stakeholder group. The exact decision-making process will be established when the rules of procedures for handling specific instances are developed. Rules of procedures for handling specific instances will be developed in the first six months of activity of the NCP (See Table 2) through a participative process involving relevant stakeholders and the multi-stakeholder group. External stakeholders will also be invited to comment and contribute to the development of the rules of procedures through a public consultation period. Once finalised, the rules of procedures will be published and made available on the NCP website. It is envisioned that the two full-time members of the full-time NCP will receive mediation training before handling specific instances. In some cases, a professional mediator may be called for support. The exact modalities of this process will be defined in the rules of procedures. Additionally, it is envisioned that upon resolution of the case, a report will be drafted by the Full-time NCP with input from the multi-stakeholder group. Once the report is approved by all parties, a final version of the report will be sent to the OECD Secretariat and published on the NCP website.

Promotional Activities The Croatian government has elaborated a draft plan for various activities the first year of functioning of the NCP. Planned activities include translation and dissemination of key RBC instruments, including the Guidelines and due diligence guidances, creation of the OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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202 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE NCP website, and awareness-raising events such as conferences and seminars. The first year will also focus on building the capacity of the NCP by attending mediation courses, participating in peer learning activities and workshops on the resolution of specific instances. The NCP will attend the OECD NCP meetings in Paris and seek opportunities to engage with other NCPs on the handling of specific instances. Table 8.1. Key milestones in the process for establishing the NCP Month

Milestones

November 2017

Meeting of the WGIPR

December 2017

Meeting of the WGIPR

18 January 2018

Technical workshop on RBC and NCPs with the WGIPR

June 2018

Participation in the GFRBC and NCP meeting

February – September 2018

Elaboration of draft plans, engagement with the OECD institutional stakeholders and the OECD Secretariat

2 October 2018

Meeting with the Prime Minister’s Office to discuss Government Decision

8 November 2018

Meeting of the WGIPR including stakeholder consultation on structure, plan and budget for 2019

20 November 2018

Public consultation and announcement of plans for the establishment of the NCP at the annual conference of the Croatian Business Council for Sustainable Development (HR PSOR)

Week of 3 December 2018

WPRBC and NCP meetings in Paris

May 2019

Establishment of the NCP by a Government Decision

February – May 2019

Translation of the Guidelines Launch of NCP website

June 2019

NCP meeting in Paris OECD Global Forum on RBC

June – August 2019

Second general meeting of the WGIPR, including stakeholder consultations Adoption of rules of procedures

September – December 2019

Promotional activities including conferences, seminars and workshops General meeting of the WGIPR including stakeholder consultations

December 2019

Attend the NCP meeting in Paris Report to Prime Minister’s Office Report to the OECD

January – April 2020

Attend mediation training / courses

June 2020

NCP meeting in Paris

May - August 2020

General meeting of the WGIPR including stakeholder consultations OECD Global Forum on RBC

September – December 2019

Annual conference on RBC held by HR PSOR Peer learing activities with other NCPs Attend NCP meeting in Paris Organise capacity-building workshops on the handling of specific instances

Source: Croatian authorities.

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General policies for promoting responsible business conduct RBC in not a new concept in Croatia. The opening of the economy played an important role in this regard. The arrival of foreign companies with strong RBC policies in mid-1990s contributed to awareness raising of RBC-related topics in the country (Idowu, Schmidpeter, Fifka, 2015). Croatia’s accession to the EU led to a series of reforms that reinforced the legal framework that underpins RBC. A number of Croatian national strategies and policies include references to sustainability and corporate social responsibility (CSR). The 2009 Strategy for Sustainable Development of the Republic of Croatia refers to CSR as one of the principles that will direct Croatia towards sustainable development (United Nations, 2011); the Tourism Development Strategy until 2020 has integrated sustainability as the key element of the contribution of the sector to development (Ministry of Tourism, 2013); policy on sustainable consumption and production cites “promoting sustainable patterns of behaviour and doing business in all economic sectors” (Ministry of Environment and Energy, 2018). Although the government has attempted to elaborate a Strategic Framework for CSR in the past, a national action plan or policy has so far not been adopted.3 As Croatia is currently developing a new Sustainable Development Strategy for the period 2020-2030, as well as a National Development Strategy for Croatia until 2030, the government has an opportunity to embed RBC principles into these strategies and include direct references to key RBC instruments. Ensuring coherence between these two strategies, which are currently being developed under the responsibilities of two different Ministries4, will be an important aspect of communication clear expectations on RBC. Businesses have been active in promoting a common understanding and implementation of RBC standards in the country, and have been a driving force for RBC promotion. Early initiatives include the creation of the Croatian chapter of the Business Council for Sustainable Development (HR PSOR) in 1997 by 18 Croatian companies committed to promote and implement sustainable practices in their businesses. Since then, HR PSOR has pursued various awareness-raising and capacity-building activities on RBC, including the organisation of workshops and seminars, as well as the publication of newsletters and educational materials such on CSR (CSR for All, 2013). In 2005, the CSR Affiliation at the Croatian Chamber of Economy (CCE) was established to provide logistical support to the CCE in the promotion of CSR in Croatia (CSR for All, 2013). In 2006, the HR PSOR and CCE spearheaded the creation of a CSR Index and award process to incentivise CSR practices in Croatia. The index methodology was developed by a group of experts from various fields who created a set of indicators and a survey to assess and compare companies across different dimensions of CSR. In 2018, 116 companies participated in the initiative, which represents an increase from previous years (98 businesses participated in 2010 and 78 in 2012) (CSR for All, 2013). Awards are announced yearly at a national conference organised by HR PSOR and the CCE. The government supports this initiative and regularly attends the conference.

Policies in specific areas covered by the Guidelines The scope of RBC is broad and cross cutting as impacts to society, both positive and negative, cover a range of substantive areas. In addition to general recommendations on RBC, the Guidelines include specific recommendations to enterprises in the areas of information disclosure, human rights, employment and industrial relations, environment, bribery and corruption, consumer interests, science and technology, competition, and OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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204 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE taxation. Croatia’s accession to the EU acted as an anchor for reforms that strengthened the legal framework that underpins RBC in all these policy areas. Since accession, recent legislative developments have consolidated the progress made in a number of areas including disclosure, corruption and environmental protection. Nevertheless, challenges persist in relation to implementation of legislation. Legislative advances have not always translated into changes in business practices.

Croatia has largely aligned the legal framework with the EU standards in policy areas covered by the Guidelines Croatia’s EU accession process involved an assessment of Croatia’s ability to meet the requirements of EU membership, and led to a set of reforms that strengthened Croatia’s legal framework. As part of the accession process, Croatia had to accept and implement the acquis communautaire (hereafter: the acquis), which constitutes the body of European Union law and obligations (EC, 2016a). For the purpose of accession negotiations, the acquis is divided into 35 main thematic chapters, which include company law, judiciary and fundamental rights, environment, competition policy, social policy and employment, enterprise and industrial policy, science and research, and consumer and health protection as related to the areas covered by the Guidelines. Croatia’s accession negotiations were formally opened in 2005 and closed in 2011, when all EU governments were satisfied with the progress made by Croatia in each negotiation chapter (See Box 8.2). The Accession Treaty was signed in 2011. Between 2011 and effective accession, Croatia’s preparations were still monitored by the European Commission, based on the findings and priority actions identified throughout the negotiation process. The last monitoring report in this context concluded that Croatia had completed the required priority actions and had shown the willingness and ability to fulfil all outstanding commitments in good time before accession. It also noted that EU membership was an additional incentive to build on the achievements made to continue reforms in Croatia, such as continuing reforms to strengthen rule of law, notably in the fight against corruption (EC, 2013). Croatia effectively acceded to the EU on 1 July 2013. In terms of areas for continued reforms, Croatia’s accession treaty contained 10 specific commitments related to key aspects of the negotiations for Chapter 23: Judiciary and Fundamental Rights. Among others, these commitments included commitments to continue to improve the efficiency of the judiciary, strengthening prevention measures in the fight against corruption and conflicts of interest, protection of minorities and human rights. The treaty also contained transitional measures, some of which are still ongoing, on a number of chapters, including in relation to the implementation of EU legislations in the areas related to air quality, climate change, waste management, water quality, industrial pollution, risk management and chemicals. Table 8.2 provides an overview of key reforms undertaken by Croatia through the EU accession process to align its legislation with the EU acquis in policy areas covered by the Guidelines.

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Box 8.2. The EU Accession Negotiations

The accession negotiations are the process through which candidate countries accede to EU membership. Negotiations take place between ministers and ambassadors of the EU governments and the candidate country in an intergovernmental conference. The first phase of EU accession negotiations entails a screening of the candidate country’s legislations. This process determines whether negotiations can be opened directly or whether certain conditions called “opening benchmarks” should be met first. Before actual negotiations can start, the candidate country submits its position, and the EU must adopt a common position. In this position, the EU will generally set closing benchmarks that need to be met before negotiations in the policy field concerned can be closed. Accession negotiations on each chapter can be closed only when every EU government is satisfied with the candidate’s progress in that field, as analysed by the European Commission. The whole negotiation process is concluded once all chapters have been closed. The Accession Treaty then cements the country’s membership to the EU. It contains the terms and conditions of membership, along with potential transitional arrangements and deadlines. The candidate country becomes a full EU member when the treaty has been ratified. In the interim, it benefits from special arrangements, such as being able to comment on draft EU proposals, communications, recommendations or initiatives, and “active observer status” on EU bodies and agencies. Source: EU (2018), Steps Towards Joining, European Commission, Brussels, https://ec.europa.eu/neighbourhood-enlargement/policy/steps-towards-joining_en

Table 8.2. Summary of legislative changes as related to the EU accession process Policy area covered by the Guidelines

Summary of legislative changes as related to the EU accession process

Disclosure

Croatia aligned its legal framework with the acquis of Chapter 6: Company Law by amending the Court Register Act, the Companies Act and the Accounting Act. New requirements included the disclosure of financial reports for limited liability companies, presentation of annual account comprising a balance sheet, a profit and loss account and notes to the accounts. These reforms also led to the introduction of electronic publication and a single register for all financial statements, direct access to the public register by all Commercial Courts, and to the establishment of sanctions for non-compliance such as de-registration by the Commercial Court (CFRR, 2016; EC, 2012).

Human Rights

Negotiations for Chapter 23 on Judiciary and Fundamental Rights had a strong focus on the protection of minorities and improving the protection of human rights. Croatia took a number of measures including constitutional amendments to strengthen the independence of the judiciary and reinforce the role and mandate of the Ombudsman (EC, 2011b). The implementation of the Constitutional Act on the Rights of National Minorities was also improved. At the end of the negotiations, the EU considered that “human rights continue[d] to be generally well-respected” and that Croatia had completed legal alignment in the fields of anti-discrimination and equal opportunities, while calling attention on the need to provide adequate resources to the Ombudsman and pursuing improvements in the handling of domestic war crimes cases (EC, 2012).

Employment and Industrial Relations

Croatia aligned its legislation with the acquis of Chapter 19: Social Policy and Employment in the areas of labour law, equality, health and safety at work and anti-discrimination. Reforms included the establishment of a multi-stakeholder National Council for Occupational Health and Safety, training of judges, labour inspectors, and mediators and capacity building for social partners. In

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206 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE Policy area covered by the Guidelines

Summary of legislative changes as related to the EU accession process 2012, the anti-discrimination Act was amended and Croatia adopted representativeness criteria for the participation of trade unions in collective bargaining. At the time, EU considered that Croatia was ready for accession, while stressing the need to continue efforts in the field of equal opportunities, and to address the structural weaknesses on the labour market, notably in relation to the mismatch between demand and supply of skills, lifelong learning opportunities, and undeclared work.

Environment

Alignment with the acquis of Chapter 27: Environment accelerated improvements in the areas of environmental protection, air quality, water quality, nature protection, industrial pollution control and risk management, chemicals and climate change (EC, 2013). The 2007 Environmental Protection Act (EPA) included obligations to improve the quality and implementation of Environmental Impact Assessments (EIA), introduced Strategic Environmental Assessments (SEA) and reinforced public participation in environmental matters. The Waste Management Strategy adopted in 2005 included goals for reducing the quantity of biodegradable waste deposited on landfills until 2025 (EC, 2007c). Before effective accession, the Commission concluded in the monitoring reports that Croatia was meeting the EU requirements, while emphasising the need to enhance the quality of EIAs and to implement provisions on public participation and access to justice in environmental matters (EC, 2012).

Combatting Bribery, Bribe Solicitation and Extortion

Corruption was one of the key considerations in the negotiations for Chapter 23: Judiciary and Fundamental Rights. Croatia adopted a National Anti-Corruption Programme for 2006-2008, focusing on the judiciary, health services, local government and public administration, political parties and the economy and science. Separate action plans were developed for each of these priority areas. A National Council for the fight against corruption was established, and the capacities of the Office for the Suppression of Corruption and Organised Crime (USKOK) reinforced. The Criminal Code was amended to introduce heavier sentences for corruption. Croatia also introduced an ethics code for judges and changes in the legislation of the financing of political parties (EC, 2007a). Negotiations were provisionally closed in 2011.

Consumer Interests

Croatia aligned its legal framework with the acquis of Chapter 28: Consumer health and protection. The Consumer Protection Act of 2003, revised in 2007, the Civil Obligation Act (2003) and the General Product Safety Act (2003) transposed EU acquis into the national legislation (EC, 2007b). This legislative framework contains provisions related to the protection of the right to consumer information and education, unfair consumer contracts, and sellers’ liability for defective products. Steps were also taken to raise public awareness of consumers’ rights and develop the system for out-of-court settlement of consumer disputes.

Science and Technology

Croatia’s efforts to align its framework with the acquis of Chapter 25: Science and Research included the development of the Croatian Programme for Innovative Technological Development, which introduced changes in the academic environment towards the idea of linking Croatia’s domestic R&D with industrial development. Other measures included regulating intellectual property (EC, 2006b). In 2012, EU considered Croatia was ready for accession, while stressing the need to encourage enhanced cooperation between the private and public sector, as well as considering measures such as establishing a national roadmap for research infrastructure and transfer of technology management (EC, 2012).

Competition

Croatia aligned its legislative framework with the acquis of Chapter 8: Competition Policy, which covers anti-competitive behaviour and state aid control policies. This included amending the Competition Act in 2013 to integrate EU acquis, and strengthening the capacity of the Croatia’s Competition Agency. The restructuring of Croatia’s shipbuilding industry was one of the salient aspects of these negotiations. By the time of accession, EU concluded that Croatia was ready for accession and that legislation in the field of anti-trust, mergers and state aid was aligned.

Taxation

Alignment with the acquis of Chapter 16: Taxation required Croatia to harmonise its legislative framework on a number of aspects including co-operation with EU member states for the prevention of intra-community tax evasion and tax avoidance. Through this process, Croatia notably introduced a Financial Police organisation that became operational in 2006 (EC, 2006a). Croatia increased administrative cooperation in the fight against fraud in the field of direct taxation through bilateral treaties.

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Recent notable developments in policy areas covered by the Guidelines Non-financial disclosure The Guidelines call for timely and accurate disclosure on all material matters regarding the corporation, including the financial situation, performance, ownership and governance of the company. The Guidelines also encourage disclosure in areas where reporting standards are still evolving such as, for example, social, environmental and risk reporting. These expectations align with the expectations set out in the G20/OECD Principles of Corporate Governance as well. As an EU member, Croatia has an obligation to transpose EU directives into national legislation, including the EU Directive 2014/95/EU on Non-Financial Disclosure and Diversity information by certain large undertakings and groups which requires publicinterest entities to disclose social and environmental information in their annual reports (EC, 2018b). The Directive leaves flexibility to businesses as to the form chosen (sustainability report, annual report, environmental or social report). In terms of framework, businesses are to rely on national or international frameworks such as the Guidelines, ISO 26000, the UN Guiding Principles for Business and Human Rights or other recognised international frameworks (EC, 2014). The directive was integrated into the Croatian legislation with the latest amendment of the Croatian Accounting Act, which entered into force on 1 January 2017 (Official Gazette 78/2015, 134/2015, 120/2016). Enterprises under the scope of the Act were required to prepare and publish non-financial statements for the first time for the financial year 2017. Limited data on the implementation of the Directive by businesses was available at the time of writing this report. The Ministry of Finance is currently reviewing the fulfillment of nonfinancial disclosure obligations. Nevertheless, studies on disclosure before the amendment of the Law on Accounting indicate that although large companies do disclose non-financial information, it is not a systematic practice and the quality of information is often uneven among companies. For example, a survey of 221 companies of 400 employees or more done in 2015 indicated that for the year 2014, only 17% published sustainability reports (Peršić, M., Lahorka, H., 2018). Implementation of the Directive is expected to bring about more disclosure as well as more coherent approach to the quality of information reported.

Fundamental rights are protected under Croatian law but there is scope to increase the participation of women and minorities As recognised by the Guidelines and the UN Guiding Principles, states have a primary duty to protect human rights. However, businesses are expected to respect human rights independently of the state ability and/or willingness to fulfil its human rights obligations. Failure either to enforce relevant domestic laws or to implement international human rights obligations, or the fact that the state may act contrary to those laws and obligations, does not diminish obligation of businesses to respect human rights. Croatia has ratified seven of the nine instruments on internationally recognised human rights as expressed in the Universal Declaration of Human Rights and the main instruments through which it has been codified: the International Covenant on Civil and Political Rights and the International Covenant on Economic, Social and Cultural Rights. The two remaining instruments are the International Convention for the Protection of all Persons from Enforced Disappearance (signed in 2007, but not ratified) and the International Convention on the Protection of the Rights of All Migrant Workers and Members of Their Families (OHCHR, 2018).5 OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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208 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE Human rights are protected by the Constitution. Article 3 recognises human rights as being of the highest value to the constitutional order and Chapter III guarantees all basic human rights and freedoms. The Office of the Ombudsman, the Office of the Ombudsperson for gender equality, and the Office of the Ombudsman for Children, have been established as independent institutions. Additional offices and special bodies exist within the State administration, for example, the Government Commission for Human Rights (MVEP, 2018). At the end of the EU accession negotiations in 2012, the European Commission concluded that “human rights continue[d] to be generally well-respected,” while stressing the need to provide adequate resources to the Ombudsman. The Comprehensive Monitoring Report on Croatia’s state of preparedness for EU membership also noted the improvements made by Croatia in the protection of minorities, though minority employment in state administration and judiciary remained below legal requirements at the time (EC, 2012). The latest report of the Ombudswoman of the Republic of Croatia reported that across all citizens’ complaints related to discrimination received by the office, the most widespread are on the basis of race, ethnicity or skin colour, or national origin (24% of all complaints). Considering all Croatian Ombuds institutions combined - the Office of the Ombudswoman, the Ombudswoman for Persons with Disabilities, the Ombudswoman for Children and the Ombudswoman for Gender Equality - the most prevalent type of complaints received is on the ground of gender at 50% (Office of the Ombudswoman, 2016). The Office of the Ombudswoman also reported that citizen’s complaints related to discrimination most frequently referred to work and employment issues (43.6% of total cases), followed by those related to the work of the public administration (9.1%). In 2017, female labour force participation was at 45% in Croatia, lower than OECD average (51%) and EU average (50%) (World Bank, 2018). In 2016, the Commissioner for Human Rights of the Council of Europe expressed its concern that the number of representatives of national minorities employed in public service was insufficient (only 3.4% while national minorities account for 7.6% of the population), with a decrease in their employment in recent years. Concerning access to employment more broadly, the Commissioner noted that persons belonging to the Serb minority faced difficulties in accessing the private labour market (Council of Europe, 2016a). In terms of labour rights, Croatia has ratified all ILO core conventions. The Labour Act is the main act regulating labour law. It prohibits direct and indirect discrimination and regulates key aspects of employment such as employment agreements, age for employment, leaves, maternity leaves, salaries and strikes. The Labour Act was amended in 2014. The reform aimed to address rigidities in the Croatian labour market, increase labour force participation and support more flexible business models adapted to market demands. The Act introduced greater flexibility in working hours, easier termination of contracts, and encouraged atypical forms of employment. It also aimed to maintain employee protection and combat the grey economy (Eurofound, 2015). While praised by many for addressing key issues that limited both employment and competitiveness, social partners have voiced concerns with the final version of the act. For employers, the changes were not significant enough to have an impact on market rigidities (Eurofound, 2015). The Croatia Employers Association, for example, pointed out that the changes were not profound enough to allow a greater number of workers to enter the market, and later move from non-standard to standard forms of employment (Butkovic, Samardzija, 2016). Trade unions considered that the changes were unnecessary as the national legislation was already aligned with EU acquis, and disrupted the balance between

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employment protection and flexibility in favour of employers (Butkovic and Samardzija, 2016). Collective bargaining is regulated by the Labour Act and the 2014 Act on Representativeness of Employers' Associations and Trade Unions (ILO, 2015). Trade union density, which is estimated to be about 30 % in Croatia, is above EU average (approximately 23 %) and OECD average (approximately 17 percent). However, like in the rest of Europe, this number is gradually declining (OECD, 2018). According to the Act on Representativeness (Official Gazette no 93/14, 26/15), four trade union confederations fulfil representativeness criteria for collective bargaining (the Independent Trade Unions of Croatia (ITUC), the Union of Autonomous Trade Unions of Croatia (UATUC), the Association of Croatian Trade Unions (MACT) and the Croatian Trade Union Association (CTA)). The Croatian Employers Association is the only representative employers association, with 6 000 members that employ 400 000 people (Butkovic and Samardzija, 2016). There have been reports of weakening social dialogue and a shifting focus of collective agreements from wages and material rights to keeping employment (ibid). It is estimated that for about half of the valid collective agreements, provisions on workers’ pay rights such as the basic wage are not fully defined (Eurofound, 2017). Compliance with the Labour Law also remains a challenge. The Office of the Labour Inspectorate in 2016 recorded violations such as employing workers without work permits, illegal labour contracts, failure to pay wages or benefits, failure to grant leave, failure to register employees with the pension authority, employing workers not registered with a health insurance agency, and failure to report overtime (U.S Department of State, 2017). The non-compliance with the law is also compounded by the informal economy. Although some estimate that the informal economy has decreased over time, undeclared work remains substantial in Croatia. Estimates of the share of undeclared work vary between 8% and 30% of Croatian GDP (Bejakovic et al., 2017). A study conducted in 2017, based on a representative survey of 521 companies conducted among businesses from various sectors, indicated that more than 92% of respondents perceived the share of undeclared work in Croatia to be above 20%. Nearly 30% of respondents thought that the share of undeclared work was higher than 50% (Ibid).

Environmental protection is of strategic importance for the country’s economy The Guidelines call on enterprises to take due account of the need to protect the environment, public health and safety, and generally to conduct their activities in a manner contributing to the wider goal of sustainable development. This entails sound environmental management that aims to control both direct and indirect environmental impacts; establishing and maintaining appropriate environmental management systems; improving environmental performance; being transparent about the environmental impacts and risks, including also reporting and communicating with outside stakeholders; being proactive in avoiding environmental damage; working to improve the level of environmental performance in all parts of their operations, even where this may not be formally required; and training and education of their employees with regard to environmental matters. Croatia’s economy relies greatly on its exceptional coasts and natural resources. This is especially true for the tourism sector, but also for example for agriculture. The first Environmental Protection Act (EPA) was promulgated in 1994, and amended in 1999. Croatia successfully concluded EU negotiations on environment in 2010 (see Table 2) and became part of Natura 2000, a network of protected areas. In 2017, the Ministry of

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210 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE Environment signed a cooperation agreement with directors of nature parks to further develop the network and management of Natura 2000 (Rogulj, 2017). In 2018, Croatia ranked 41 out of 180 countries on the Yale Environmental Performance Index. Compared with other EU countries, however, Croatia ranks in the lower fifth, above Hungary (43), Romania (45), Estonia (48) and Poland (50). Croatia’s best performances are recorded in Biodiversity and Habitat (14/180), Heavy Metals (18/180) and Agriculture (32/180). The lowest scores concern Air Quality (106/180) and Air Pollution (112/180) (Yale, 2018). In 2017, 48.3% of Croatia’s energy consumption came from imports, which is slightly less than EU average (54%). Croatia’s energy mix of primary products include a high share of oil (41%), natural gas (26%) followed by a relatively high proportion of renewables (25% compared with 13% on average at EU level) and solid fuels (8%) (EC, 2017a). Over the last decade, Croatia has made important efforts to reduce its dependence on oil imports and electricity supply, while preserving environmental sustainability. The Energy Strategy of the Republic of Croatia for 2009-2020 aims to develop and apply renewable energy sources as a measure to both decrease greenhouse gas emissions and increase the energy supply security using local energy sources. As part of this strategy, the government set the objective to increase the electricity-generating capacity in large hydropower plants (MINGO, 2009). In 2016, the Act on Renewable Energy Sources and High-efficiency Cogeneration (Official Gazette no. 100/15 and no. 123/16) introduced a support scheme for renewable energy projects, in the form of a premium tariff and guaranteed feed-in tariff, with a view to achieve efficient use of energy and reduce the impact of fossil fuels on the environment (IEA, 2018). Hydropower plants as a renewable energy source are the largest producer of renewable electricity in Croatia (EC, 2017a). Several dozen small hydroelectric power projects are planned across the country, either by state-run HEP national energy group or private companies (Veselica, 2017). Even though they do not emit greenhouse gases or other pollutants, such projects may constitute a serious threat to biodiversity and surrounding nature, as well as communities. In 2013, a project of construction of an underground power plant close to Vilina Cave – Ombla Spring, an area of high cave fauna biodiversity, was abandoned following an environmental impact assessment and under mounting pressure from civil society. The EIA identified potential negative impact on a number of cave species, leading the EBRD to withdraw from the loan originally approved to finance the project (UNECE, 2014). The multiplication of small hydropower plants in the country may impact the appeal of touristic waterways. The revision of the Environmental Protection Act in 2007 included obligations to improve the quality and implementation of EIA and introduced Strategic Environmental Assessments (SEA). In 2017, the latest EU Environmental Implementation Review of Croatia, indicated that while Croatia had aligned its legislation with the Strategic Environmental Assessment Directive, further efforts were still necessary to achieve full conformity with the Environmental Impact Assessment Directive (2014/52/EU) (EC, 2017b). In February 2018, Croatia amended the Environmental Protection Act to transpose provisions of the Environmental Impact Assessment Directive 2014/52/EU into national legislation (Official Gazette no. 12/2018). Waste management is another important environmental issue in Croatia. The Act on Sustainable Waste Management was adopted in July 2013 and entered into force 23 July 2013 (UNECE, 2014). In 2017, a Waste Management Plan for the period 2017-2022 was adopted to improve the status of waste management in the country and meet EU requirements (GoRC, 2017).

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In March 2018, the EC referred Croatia to the Court of Justice of the EU over Croatia’s management of industrial waste deposited at the Biljane Donje site (town of Benkovac, Zadar county), at the so-called "Crno brdo" (“Black hill”) illegal industrial waste landfill. In this case, Croatian authorities allegedly failed to classify material as waste in line with EU Directive, leading to 140 000 tons of harmful stone aggregate deposited directly on soil, threatening local populations and the environment. The European Commission opened the infringement proceedings in 2015, and concluded in 2018 that no progress had been made to ensure proper waste management that does not endanger human health and harm the environment (EC, 2018c). According to the Ministry of Environment and Energy, the company that temporarily stored industrial waste at the Biljane Donje site had failed execute an inspectional decision ordering the removal of the waste. To address this issue, and following the opening of the European Commission’s infringement proceedings, the Croatian government undertook a series of activities in 2017 and 2018, including commissioning opinions and analyses of the waste. These analyses6 concluded that the waste was a mineral raw material which could be used in the construction industry and was not hazardous for the environment. Since the state is the legal owner of this material, the government decided to use this material for construction purposes on property owned by Croatia near Zemunik Airport. The Ministry of Environment and Energy issued a Decision on the Suspension of the Execution of the Inspectional Decision.

Despite significant efforts, corruption still weighs on the business climate As discussed in Chapter 7, corruption continues to be perceived by entrepreneurs as an important barrier to doing business in Croatia, despite significant efforts from the Croatian government to address the issue. The Government has carried out a series of anti-corruption strategies and programs, as well as measures to strengthen the institutional law enforcement framework. A whistle-blower protection act was enacted in 2019. In line with global trends, companies have started adopting corporate codes of conduct to prevent corruption. However, awareness of such standards internally remains low and so far has been barely supported by internal guidelines, policies and training on corruption. Implementation of the Guidelines by businesses may play a role in supporting Croatia’s efforts to reduce corruption. The Guidelines set up the expectation that enterprises should not, directly or indirectly, offer, promise, give, or demand a bribe or other undue advantage to obtain or retain business or other improper advantage, and should also resist the solicitation of bribes and extortion. The Guidelines also provide guidance on systems and processes that companies can implement for preventing and detecting bribery, based on a risk assessment tailored to the specific context of the company. They include a recommendation for enterprises themselves to introduce safeguards in their own policies to protect bona fide whistle-blowing activities, including protection of employees who, in the absence of timely remedial action or in the face of reasonable risk of negative employment action, report practices that contravene the law to the competent public authorities.

Responsible business conduct and the state as an economic actor Governments are expected to behave responsibly in the context of state as an economic actor. This includes activities as employers, in procurement agencies and state-owned enterprises (SOEs). Not only is this in the public interest, it also enhances the government’s legitimacy in making recommendations on RBC to businesses.

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212 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE Governments can promote RBC principles and standards through engagement with enterprises that are recognised as behaving responsibly. The OECD Recommendation of the Council on Public Procurement (OECD, 2015a) encourages the use of secondary policy objectives, including responsible business conduct standards, for public procurement processes. As already highlighted in the previous Chapter of this Review, public procurement in Croatia amounted to 13.4% of the GDP in 2017, at par with the average figure in OECD countries (12% of GDP). The Public Procurement Act of 2012 (as amended) is the main legislation regulating public procurement in Croatia, transposing EU directives and prescribing procedures on all categories of contracts (EC, 2016). With the transposition of the EU Directives 2014/25/EU and 2015/24/EU, there is also now an obligation for all public procurement procedures to be based on the Most Economically Advantageous Tender (“MEAT”) Criteria, giving more prominence to environmental and social criteria. In 2015, the Croatian government adopted the first National Action Plan on Green Public Procurement for the period 2015-2017, which aimed to increase the use of environmental criteria in public procurement. The government is currently conducting an analysis that aims to identify opportunities to improve the implementation of Green Public Procurement. The results of this analysis will inform the development of a new National Action Plan for Green Public Procurement. As discussed in the previous chapter of this Review, measures to enhance transparency and integrity of the process have included the introduction of an e-procurement system in 2008 and the legal obligation since 2016 to allow e-submission of tenders. Other measures include the requirement for all contracting authorities to publish procurement plans for the business year on the on-line procurement portal as well as, since 2017, to conduct prior market consultations with the interested economic operators on the draft procurement documents and publish reports on the outcomes of these consultations. Contracting authorities are also required to publish declarations regarding conflict of interest, which include a list of companies with which they have a conflict of interest. Contracting persons are also obliged to publish concluded and executed public procurement contracts. Access to public sector contracts is denied to companies or individuals convicted of bribery and other criminal offences. Nevertheless, public procurement in Croatia continues to be considered vulnerable to risks of corruption. As quoted in Chapter 7, a 2016 study commissioned by the European Parliament concluded that among the 28 EU member states, Croatia had the highest risks of corruption in public procurement contracts (Hafner et al., 2016). Another 2016 study, also quoted in Chapter 7, this time commissioned by the EC, underscored that political influence continues to play a role in the procurement system, especially at the local level, due in part to Croatia’s fragmented public administration and lack of sufficient resources for oversight bodies (EC, 2016c). The Guidelines apply to all entities within the enterprise sector whether private, state or mixed. The Guidelines on Corporate Governance of State-Owned Enterprises (SOE Guidelines) also recommends that SOEs “observe high standards of responsible business conduct” and state that “expectations established by the government in this regard should be publicly disclosed and mechanisms for their implementation be clearly established” (OECD, 2015b). The SOE Guidelines’ Annotations further encourage measures to report on foreseeable risks, including in the areas of human rights, labour, the environment, and risks related to corruption and taxation.

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As highlighted in Chapter 3 of this Review, Croatian SOEs dominate large parts of the economy, in particular in the infrastructure sector. SOEs also operate in competitive industries such as agribusiness and manufacturing. The EBRD estimated that in 2017 SOEs controlled about 30% of total assets in the economy, contributed 15% of the total revenue, and employed some 73 000 employees, or 5% of the total workforce (EBRD, 2018). As noted in the previous chapter, the government has identified mismanagement and vested interests in the SOE sector as underlying causes of continuous losses incurred by SOEs and harming competition and, in this respect, has been gradually, albeit slowly, trying to tackle these issues through the adoption of several measures aimed at preventing corruption and strengthening integrity in SOEs. Against this background, a series of practical and legislative steps have been taken recently, including the development of a new anticorruption programme for SOEs for the period 2019-2020, focusing on preventing conflicts of interests and further strengthening ethics and integrity of SOEs. The details of the programme were still under consideration at the end of March 2019. Chapter 7 has highlighted additional measures taken by the government. In 2017, Croatia adopted a new Code of Corporate Governance for SOEs, which contains conflict of interest guidance for members of the supervisory board of SOEs. To raise transparency and integrity around donations to SOEs and party funding by SOEs, Croatia now maintains a database on sponsorships and donations to government-owned companies; in addition, as discussed in the previous chapter of this Review, the act on political activity and electoral campaign financing prohibits funding by state and local government-owned companies.

Outlook and policy recommendations Croatia has taken significant steps to strengthen the legal framework that underpins RBC in the country, notably in the context of EU accession. Croatia has aligned its legislation with EU standards in all the policy areas covered by the OECD Guidelines for Multinational Enterprises. Significant progress has been achieved in the area of corruption, the judiciary and the protection of fundamental rights. Furthermore, since accession, Croatia has an obligation to transpose EU legislation into national law and has done so, for example as evidenced in the transposition of the EU Directive 2014/95/EU on NonFinancial Disclosure and Diversity information by certain large undertakings and groups and the EU Directive 2014/52/EU on environmental impact assessments. Despite significant legislative advances, some challenges persist. Perceived corruption in particular remains high. Despite important efforts in the field of equal opportunities and anti-discrimination, female labour force participation is lower than OECD and EU averages (45% vs 51%). While environmental protection has long been a focus for the government, negative social and environmental impacts in relation to energy projects and industrial waste still pose a threat to the country’s biodiversity and sustainability of key sectors of the economy such as tourism. Raising awareness and understanding of RBC could facilitate businesses in complying with national legislations and meeting RBC expectations. In particular, promoting and actively supporting the use of OECD due diligence guidances by enterprises operating in or from Croatia could contribute to avoiding and address environmental and social impacts related to energy projects and industrial activities. Business associations have played an important role in raising awareness of RBC in the country, pioneering multi-stakeholder initiatives, as well as the development of materials and events aimed at promoting RBC. This is a good sign and the Croatian government has a ripe opportunity to build on these successes. Developing a national, overarching

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214 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE framework on RBC could help engage a wider range of stakeholders, including NGOs and trade unions and promote further policy coherence, including in areas related to state as an economic actor. The establishment of a strong NCP will raise awareness of RBC in the country, support implementation of RBC principles and standards by businesses and contribute to improved accountability in case of issues that can arise from non-observance of the Guidelines. Croatia has set out and consulted on the plans for establishing the NCP, both with Croatian stakeholders and OECD institutional stakeholders. The composition envisioned for the NCP includes representatives from the government, business associations, NGOs and trade unions. Having a balanced representation of stakeholders will be key to ensure that the NCP can operate in an impartial manner. In addition, throughout the process of establishing the NCP, actively engaging with stakeholders, in particular trade unions and civil society organisations, is an important aspect of building the confidence of social partners. As an economic actor, the Croatian government is expected to lead by example on RBC and implement the Guidelines in its own practice, including through public procurement and in the activities of SOEs. As noted in previous chapters of this Review, while the Government has made important strides in strengthening public governance in Croatia, both public procurement and SOEs remain areas that are particularly vulnerable to risks of corruption. Implementation of the Guidelines and integration of RBC expectations in the Government’s activities as an economic actor could play a role in supporting the Government’s efforts to further reduce corruption and enhance the transparency and integrity of the public sector. In addition, by exemplifying RBC in their own role within the economy, Governments can enable RBC and incentivise best practices with regards to RBC. In line with recommendations made to EU member states by the Committee of Ministers, the Croatian government could consider taking into account recommendations made by NCPs in their decisions on public procurement, export credit or investment guarantees (Council of Europe, 2016b).

Policy recommendations 

Establish an effectively functioning NCP to further the effectiveness of the Guidelines. All Adherents to the OECD Declaration have an obligation to establish an NCP, in accordance with the Decision of the Council on the OECD Guidelines for Multinational Enterprises. Croatia should ensure that the decision-making process in the NCP is well-defined and clear, particularly as related to the respective roles of the two main NCP bodies.

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Actively promote the Guidelines and the NCP among businesses operating in Croatia and Croatian companies operating abroad, as well as among trade unions, workers' organisations and civil society representatives, including measuring business awareness and commitment to implement the Guidelines. Raising awareness of the Guidelines, as well as RBC principles and standards among all relevant stakeholders is an important aspect of ensuring that the NCP can effectively fulfil its mandate.

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Take a proactive approach to engage with all stakeholders, in particular trade unions and civil society organisations. Croatia has consulted with stakeholders on the plans for the NCP, and plans to involve various stakeholders in the activities of the NCP through a multi-stakeholder group. However, NGOs and trade unions are currently underrepresented in plans for the multi-stakeholder group. Engaging with all stakeholders is key to building confidence. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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Undertake a capacity building exercise for the NCP within one year after adherence and, in that context, report back to the WPRBC on the progress made in implementing the recommendations made to improve the effective functioning of the NCP. Particular attention should be paid to ensuring that the decision-making process in the NCP is well-defined and clear, particularly as related to the respective roles of the two main NCP bodies.

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Promote the use of the OECD due diligence guidances by enterprises operating in or from Croatia, through active support to these enterprises in implementing the recommendations of the due diligence guidances, and ensure the widest possible dissemination of the various sector guidance and their use by various stakeholders. Countries that adhere to the OECD Declaration commit to also adhere to all of the related OECD legal instruments aimed at supporting the implementation of the OECD Guidelines, including the OECD due diligence guidances. Promoting and supporting implementation of these instruments will contribute to facilitate businesses in meeting RBC expectations in Croatia.

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Promote policy coherence and improve coordination on RBC-related policies within the government. In particular, developing a National Action Plan on RBC in co-operation with relevant stakeholders including businesses, trade unions and civil society organisations could be useful in this regard. Policy coherence is crucial to ensure effective design and implementation of policies to promote RBC.

Notes 1

On 23 May 2019, at its 158th Session, the Government adopted the draft Government Decision on the Establishment of the National Contact Point (Prijedlog odluke o osnivanju Nacionalne kontaktne točke kao trajnog mehanizma za promicanje i primjenu Smjernica za odgovorno poslovanje Organizacije za gospodarsku suradnju i razvoj (OECD)). Government Decisions are legal acts approved by the Government and signed by the Prime Minister, and are published in the Official Gazette. They remain valid until revoked or cancelled by the Government. 2

The board of the CSR Index created at the end of August 2018 was established in the Croatian Chamber of Economy. The Board consists of members from the Croatian Business Council for Sustainable Development, Croatian Chamber of Economy, School of Economy of the University of Zagreb, Zagreb School of Economy and Management, Institute for Social Research, Ministry of Economy, Entrepreneurship and Crafts, Ministry of Foreign and European Affairs, Ministry of Environment and Energy, Ministry of Labor and Pension System, Ministry of Finance, Ministry of Regional Development and EU Funds and Ministry for Demography, Family, Youth and Social Policy. 3

A specific project on CSR, led by the Ministry of Economy and funded by the EU in 2010, was developed in previous years aiming to bring together CSOs, business associations and international organisations together through a CSR Platform. A Strategic Framework for CSR was created to serve as a basis for the development of a National CSR Strategy through this project. The strategy envisions awareness raising on CSR, support for multi-stakeholder initiatives and positioning Croatia as a regional CSR leader, as well as establishing a centre of excellence for CSR. However, it was never adopted, and to date no overarching policy or framework on RBC exists. The platform to date has also been inactive, but it is currently under consideration for reactivation.

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The Sustainable Development Strategy will expire at the end of 2019 and is currently being prepared for the next period under the responsibility of the Ministry of Environment and Energy, which coordinates with relevant state authorities. Coordination of the preparation National Development Strategy falls under the responsibility of the Ministry of Regional Development and EU funds. 5

Globally, 53 countries have ratified the International Convention on the Protection of the Rights of All Migrant Workers and Members of their Families; 14 have signed it but not ratified it; 131 have not taken any action (OHCHR, 2018). 6

Analyses and opinions obtained include: opinion of the Ministry of Economy, Mining Directorate, dated 27 April 2018; findings and opinions of the Faculty of Mining, Geology and Petroleum Engineering of the University of Zagreb, dated 21 June 2018; findings and opinions of the Croatian Geological Survey, No. 26/18, dated June 2018; addendum to the findings and opinions of the Croatian Geological Survey, dated August 2018.

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218 │ 8. PROMOTING AND ENABLING RESPONSIBLE BUSINESS CONDUCT AS A STRATEGIC CHOICE European Commission (2007b). Screening Report. Croatia. Chapter 28. Consumer and Health Protection. https://www.esiweb.org/pdf/croatia_screening_report_16_hr_internet_en.pdf European Commission (2007c). Screening Report. Croatia. Chapter 27. Environment. https://ec.europa.eu/neighbourhoodenlargement/sites/near/files/pdf/croatia/screening_reports/screening_report_27_hr_internet_en.pdf European Commission (2006a). Screening Report. Croatia. Chapter 26. Taxation. https://www.esiweb.org/pdf/croatia_screening_report_16_hr_internet_en.pdf European Commission (2006b). Screening Report. Croatia. Chapter 25: Sciences and Research. https://ec.europa.eu/neighbourhoodenlargement/sites/near/files/pdf/croatia/screening_reports/screening_report_25_hr_internet_en.pdf Government of the Republic of Croatia – GoRC (2017). Waste Management Plan of the Republic of Croatia for the Period 2017-2022. https://www.mzoip.hr/doc/management_plan_of_the_republic_of_croatia_for_the_period_20172022.pdf Grubisa, D. (2010). Anti-corruption Policy in Croatia: Benchmark for EU Accession. Faculty of Political Science, University of Zagreb, Zagreb, Croatia. https://hrcak.srce.hr/68761 Hafner, M., Taylor, J., Disley, E., Thebes, S., Barberi, M., Stepanek, M., Levi, M. (2016). The Cost of Non-Europe in the area of Organised Crime and Corruption. Annex II. Corruption. RAND Corporation. Study written at the request of the European Parliament. http://www.europarl.europa.eu/thinktank/en/document.html?reference=EPRS_STU(2016)579319 ILO (2015). CEE Labour Legislation Database. Croatia. https://www.ilo.org/dyn/ceelex/en/f?p=14100:1100:0::NO::P1100_ISO_CODE3,P1100_SUBCODE_ CODE,P1100_YEAR:HRV,,2015 Kopric, I. (2018). Public administration characteristics and performance in EU28: Croatia. European Commission. http://www.google.fr/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=2ahUKEwiGitW_rMTd AhVIxoUKHbvIArMQFjAAegQIAxAC&url=http%3A%2F%2Fec.europa.eu%2Fsocial%2FBlobSer vlet%3FdocId%3D19943%26langId%3Den&usg=AOvVaw1cZHaTru7wVD9YQM3xzCFc Ministry of Economy, Labour and Entrepreneurship (MINGO, 2009). Energy Strategy of the Republic of Croatia for 2009-2020. https://www.mingo.hr/userdocsimages/White%20Paper%20Energy%20Staregy%20of%20the%20Re public%20of%20Croatia.pdf Ministry of Environment and Energy (2018). Sustainable Consumption and Production. http://www.mzoip.hr/en/climate/sustainable-production-and-consumption.html Ministry of Foreign and European Affairs – MVEP (2018). Human Rights in the Republic of Croatia. http://www.mvep.hr/en/foreign-politics/multilateral-relationsold/united-nations-(un)/human-rights/ Ministry of Foreign Affairs and European Integration – MVEP (2009). Croatia on the Road to the European Union. Second Edition. http://www.mvep.hr/files/file/publikacije/Croatia_on_the_Road_to_the_EU.pdf Ministry of Tourism (2013). Croatian Tourism Development Strategy until 2020. https://mint.gov.hr/UserDocsImages/arhiva/Strategy-tourism.present.pdf OECD (2018), OECD Employment Outlook 2018, OECD Publishing, Paris, https://doi.org/10.1787/empl_outlook-2018-en.

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Office of the Ombudswoman (2016). Annual Report of the Ombudswoman for 2015. http://ombudsman.hr/en/reports/send/66-ombudsman-s-reports/833-annual-report-of-theombudswoman-of-croatia-for-2015 OHCRH (2018). Status of ratifications. Interactive Dashboard. http://indicators.ohchr.org/ Orsini, K., Ostojic, V., 2018. Croatia’s Tourism Industry: Beyond the Sun and Sea. https://ec.europa.eu/info/sites/info/files/economy-finance/eb036_en.pdf Populari (2012). EU Accession Guidelines. Sharing Croatia’s Experience. Chapter 27: Environment. Restricted Access. Peršić, M., & Halami, L. (2016). Disclosing non-financial information in companies’ reports in Croatia. Copernican Journal of Finance & Accounting, 5(2), 181–200. http://dx.doi.org/10.12775/CJFA.2016.022 Peršić, M., Lahorka, H (2018) Exploring the quality of social information disclosed in non-financial reports of Croatian companies, Economic Research-Ekonomska Istraživanja. DOI: 10.1080/1331677X.2018.1480968 Tabak, P. and E. Zildzovic (2018), “Croatia: Background study on state-owned enterprises,” EBRD. Thorp, A (2011). Croatia: the closing stages of EU accession. House of Commons Library. http://researchbriefings.files.parliament.uk/documents/SN06157/SN06157.pdf Transparency International (2017). Corruption Perception Index 2017. https://www.transparency.org/news/feature/corruption_perceptions_index_2017 United Nations (2011). Strategy for Sustainable Development of the Republic of Croatia. https://sustainabledevelopment.un.org/index.php?page=view&nr=213&type=504&menu=139 United Nations Economic Commission for Europe – UNECE (2014). Environmental Performance Reviews. Croatia. Second Reviews. New York and Geneva. https://www.unece.org/fileadmin/DAM/env/epr/epr_studies/ECE_CEP_172_En.pdf U.S State (2017). Croatia 2017 Human Rights report. https://www.state.gov/documents/organization/277395.pdf Veselica, L. (2017). Croatian rivers face hydroelectric peril. Business Insiders. https://www.businessinsider.com/afp-croatian-rivers-face-hydroelectric-peril-2017-4?IR=T World Bank (2018). World Development Indicators. Last updated 21.09.2018. https://data.worldbank.org/products/wdi World Bank (2010). Doing Business 2010: Reforming in difficult times, Washington D.C. http://adminportal.acci.gr/images/DOING%20BUSINESS%202010.pdf World Economic Forum – WEF (2017), The Global Competitiveness Report 2017–2018, World Economic Forum, Geneva. www3.weforum.org/docs/GCR20172018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf World Justice Project (2018). Rule of Law Index 2017-2018. https://worldjusticeproject.org/sites/default/files/documents/WJP-ROLI-2018-June-OnlineEdition_0.pdf Yale University (2018). Environmental Performance Index – EPI, 2018 Report. https://epi.envirocenter.yale.edu/2018/report/category/hlt

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ANNEX A. CROATIA’S EXCEPTIONS TO THE NATIONAL TREATMENT INSTRUMENT

Annex A. Croatia’s exceptions to the National Treatment Instrument

A. Exceptions at national level I. Investment by established foreign-controlled enterprises Fisheries: Commercial fishing on freshwaters of the Republic of Croatia shall not be conducted by legal persons wholly or partly owned by foreign entities. Authority: Freshwater Fisheries Act (Consolidated Text), OG 49/2005 – Art. 79. Air transportation: Investment by non-EU persons, whether directly or indirectly, in air transportation services firms in Croatia is limited to 49% of the voting and controlling rights. Authority: Air Traffic Act, OG 69/09, as amended – Art. 22 and 27; Regulation (EC) No 1008/2008 of the European Parliament and of the Council. Legal services: Only EU and WTO-licensed lawyers can be partners in a law firm providing legal advice on the law of the Republic of Croatia, international law and home-country law under equal conditions with Croatian lawyers. Only Croatian and EU-licensed lawyers, however, may represent clients before the courts. Authority: Law on the Legal Profession, OG 9/94, as amended – Art. 27 and 36b-c.

II. Official aids and subsidies None.

III. Tax obligations None.

IV. Government purchasing None.

V. Access to local finance None.

B. Exceptions by territorial subdivisions I. Investment by established foreign-controlled enterprises None.

II. Official aids and subsidies None.

III. Tax obligations None.

IV. Government purchasing None.

V. Access to local finance None. OECD INVESTMENT POLICY REVIEW: CROATIA © OECD 2019

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222 │ ANNEX B. MEASURES REPORTED FOR TRANSPARENCY BY CROATIA

Annex B. Measures reported for transparency by Croatia

A. Measures reported for transparency at the level of national government I. Measures based on public order and essential security considerations a. Investment by established foreign-controlled enterprises Land and Other Real Estate: Unless otherwise provided by law, a foreign person may not be the owner of a property located in an area which, in order to protect the interests and safety of the Republic of Croatia, is legally declared a territory in which foreign persons may not have the right of ownership. These conditions do not apply to nationals and legal entities from EU member states, except in the case of agricultural land and protected parts of nature determined by special law. Authority: Property and other Real Rights Act O.G. No. 81/2015 (consolidated text) of 22 July 2015, Art. 358-358a. b. Corporate organisation None. c. Government purchasing None. d. Official aids and subsidies None.

II. Other measures reported for transparency a. Investment by established foreign-controlled enterprises None. b. Corporate organisation Auditing services: The majority of the members of the management board of an audit firm needs to be licensed auditors in Croatia or another EU Member State. When the management board has no more than two members, at least one member must be licensed auditors in Croatia or another EU Member State. At least one member of the management board shall be fluent in the Croatian language. Authority: Audit Act, OG 127/17 – Art. 17. Banking: At least one member of the management board of a credit institution must be fluent in speaking and writing Croatian. Authority: Credit Institutions Act, OG 159/2013, as amended – Art. 36. c. Government purchasing

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ANNEX B. MEASURES REPORTED FOR TRANSPARENCY BY CROATIA

None. d. Official aids and subsidies None.

B. Measures reported for transparency at the level of territorial subdivisions None.

C. Activities covered by public, private, mixed monopolies or concessions At the level of national government I. Public monopolies 

Electricity transmission and distribution system



Natural gas transport system

II. Mixed monopolies 

Oil pipelines

III. Concessions 

Mining research and exploitation and related secondary activities (i.e. exploration and exploitation of hydrocarbons and geothermal energy)



Exploitation of maritime area



Ports

At the level of territorial subdivisions I. Public monopolies 

Water distribution



Wastewater treatment and sewage

II. Private monopolies None. III. Concessions 

Natural gas distribution and heating distribution



Wastewater treatment in the City of Zagreb (allowed by way of derogation of public monopoly provisions as per the Water Law, OG 153/2009 as amended – Art. 171).

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224 │ ANNEX C. ADDTIIONNAL FIGURES AND TABLES FOR CHAPTER 2

Annex C. Additional figures and tables for Chapter 2

Figure A C.1. Croatia’s GDP by sector of activity, 2017 In %.

Other services 29%

Wholesale & retail trade, transport, storage, accommod. & food services 22%

Public admin., defence, educ., health & social work… Professional, scient., techn., admin. & support services 9%

Real estate 9%

Manufacturing 15%

Note: The data for 2017 reported here is quarterly gross value added at constant prices of previous year (2010 reference year) that is preliminary. Source: Croatian Bureau of Statistics (DZS)

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ANNEX C. ADDTIIONNAL FIGURES AND TABLES FOR CHAPTER 2

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Figure A C.2. Merchandise trade in Croatia by destination and origin, 2017 Panel. A. Export share (%) EU28 USA

Bosnia and Herzegovina Russia

65%

0%

10%

20%

30%

Serbia Other

10%

40%

50%

60%

70%

4% 1%

5%

80%

15%

90%

100%

Panel. B. Import share (%) EU28 Serbia

China Russia

Bosnia and Herzegovina Other

78%

0%

10%

20%

30%

40%

3% 3% 3% 1%

50%

Source: World Integrated Trade Statistics (WITS) database

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60%

70%

80%

90%

12%

100%

226 │ ANNEX C. ADDTIIONNAL FIGURES AND TABLES FOR CHAPTER 2 Table A C.1. Net acquisition of financial assets in Croatia, 1993-Q1 2018 In EUR mln Activity

TOTAL

Wholesale trade, except of motor vehicles and motorcycles

1 536.0

Financial service activities, except insurance and pension funding

1 531.0

Activities of head offices; management consultancy activities

1 425.6

Manufacture of basic pharmaceutical products and pharmaceutical preparations

699.2

Manufacture of food products

616.7

Water transport

165.9

Manufacture of other non-metallic mineral products

122.5

Accommodation

114.6

Real estate activities

68.6

Manufacture of beverages

63.2

Insurance, reinsurance and pension funding, except compulsory social security

61.6

Sports activities and amusement and recreation activities

57.9

Manufacture of motor vehicles, trailers and semi-trailers

51.3

Telecommunications

51.2

Construction of buildings

49.3

Manufacture of wearing apparel

49.2

Waste collection, treatment and disposal activities; materials recovery

46.1

Manufacture of tobacco products

42.4

Crop and animal production, hunting and related service activities

36.1

Architectural and engineering activities; technical testing and analysis

29.2

Scientific research and development

28.8

Postal and courier activities

28.4

Manufacture of computer, electronic and optical products

27.4

Manufacture of electrical equipment

24.9

Information service activities

24.3

Manufacture of paper and paper products

20.5

Wholesale and retail trade and repair of motor vehicles and motorcycles

20.2

Manufacture of wood and of products of wood and cork, except furniture; manuf. of articles of straw and plaiting

16.3

Manufacture of fabricated metal products, except machinery and equipment

14.2

Rental and leasing activities

13.2

Fishing and aquaculture

8.9

Manufacture of basic metals

8.8

Activities auxiliary to financial services and insurance activities

7.2

Computer programming, consultancy and related activities

5.1

Specialised construction activities

4.4

Manufacture of other transport equipment

2.6

Manufacture of furniture

0.3

Real estate investments

-5.3

Warehousing and support activities for transportation

-7.3

Civil engineering

-34.6

Travel agency, tour operator and other reservation service and related activities Retail trade, except of motor vehicles and motorcycles

-35.1 -113.1

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ANNEX C. ADDTIIONNAL FIGURES AND TABLES FOR CHAPTER 2 Activity

TOTAL

Manufacture of coke and refined petroleum products

-144.3

Manufacture of chemicals and chemical products

-150.9

Mining support service activities

-434.4

Other activities

158.2

Unknown activities

14.5

Total population adjustment

16.9

TOTAL

6 337.9 o/w: Round tripping*

2 359.4

Note: Includes preliminary data for Q1 2018. Data by activity is reported using NACE Rev. 2. *The roundtripping refers to the channelling abroad by direct investors of local funds and the subsequent return of these funds to the local economy in the form of direct investment. Therefore, these transactions increase net acquisition of financial assets and net incurrence of liabilities by the same amount. Source: Central Bank of Croatia

Table A C.2. Net incurrence of financial liabilities in Croatia, 1993-Q1 2018 In mln EUR Activity Financial service activities, except insurance and pension funding Wholesale trade, except of motor vehicles and motorcycles Real estate activities Telecommunications Retail trade, except of motor vehicles and motorcycles Real estate investments Manufacture of coke and refined petroleum products Construction of buildings Manufacture of basic pharmaceutical products and pharmaceutical preparations Accommodation Manufacture of other non-metallic mineral products Manufacture of tobacco products Manufacture of food products Insurance, reinsurance and pension funding, except compulsory social security Activities of head offices; management consultancy activities Activities auxiliary to financial services and insurance activities Sports activities and amusement and recreation activities Warehousing and support activities for transportation Electricity, gas, steam and air conditioning supply Manufacture of chemicals and chemical products Manufacture of fabricated metal products, except machinery and equipment Water collection, treatment and supply Manufacture of wearing apparel Crop and animal production, hunting and related service activities Publishing activities Manufacture of machinery and equipment n.e.c. Manufacture of rubber and plastic products Manufacture of paper and paper products Manufacture of electrical equipment Manufacture of motor vehicles, trailers and semi-trailers

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TOTAL 9 883.3 2 799.3 2 159.0 2 005.9 1 932.9 1 627.9 1 411.0 1 204.4 1 112.5 1 001.3 789.6 551.5 502.3 467.1 425.3 327.9 319.9 283.0 259.6 252.2 228.9 221.0 211.3 178.7 170.9 169.8 139.4 136.0 126.9 126.1

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228 │ ANNEX C. ADDTIIONNAL FIGURES AND TABLES FOR CHAPTER 2 Activity Wholesale and retail trade and repair of motor vehicles and motorcycles Architectural and engineering activities; technical testing and analysis Rental and leasing activities Repair and installation of machinery and equipment Computer programming, consultancy and related activities Information service activities Forestry and logging Advertising and market research Motion picture, video and television programme production, sound recording and music publishing activities Land transport and transport via pipelines Manufacture of wood and of products of wood and cork, except furniture; manuf. of articles of straw and plaiting Water transport Programming and broadcasting activities Manufacture of basic metals Scientific research and development Extraction of crude petroleum and natural gas Manufacture of leather and related products Other manufacturing Waste collection, treatment and disposal activities; materials recovery Manufacture of computer, electronic and optical products Civil engineering Manufacture of beverages Food and beverage service activities Fishing and aquaculture Services to buildings and landscape activities Manufacture of furniture Manufacture of other transport equipment Other activities Unknown activities Total population adjustment TOTAL o/w: Round tripping

TOTAL 124.1 111.9 110.5 105.1 102.9 92.9 88.2 87.5 83.3 78.0 70.4 61.9 59.1 43.3 42.0 38.4 32.0 31.0 30.5 28.4 24.3 24.0 20.0 8.6 3.9 -21.5 -33.5 300.1 3.7 272.2 33 047.8 2 359.4

Note: Includes preliminary data for Q1 2018. Data by activity is reported using NACE Rev. 2. *The roundtripping refers to the channelling abroad by direct investors of local funds and the subsequent return of these funds to the local economy in the form of direct investment. Therefore, these transactions increase net acquisition of financial assets and net incurrence of liabilities by the same amount. Source: Central Bank of Croatia

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OECD Investment Policy Reviews

CROATIA This review was prepared in response to Croatia's 2015 request to adhere to the Declaration on International Investment and Multinational Enterprises. It assesses the climate for domestic and foreign investment in Croatia, its ability to comply with the principles of openness, transparency and non-discrimination and its policy convergence with the OECD Declaration, including responsible business conduct practices, and discusses the challenges and opportunities faced by the government of Croatia in its reform efforts. Capitalising on the OECD Policy Framework for Investment, this review includes chapters on foreign investment trends and performance, foreign investor entry and operations, the legal and institutional framework for investment protection, investment promotion and facilitation, public governance, and policies to promote and enable responsible business conduct.

Consult this publication on line at https://doi.org/10.1787/2bf079ba-en. This work is published on the OECD iLibrary, which gathers all OECD books, periodicals and statistical databases. Visit www.oecd-ilibrary.org for more information.

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