Executive summary
Over the past few decades, Croatia has achieved remarkable economic growth, including a doubling of per capita incomes since the mid-1990s and improved living standards. Croatia's economy centers primarily around services, with tourism playing a pivotal role. The integration of the economy into global value chains (GVCs) remains less pronounced than that of its Central and Eastern European (CEE) counterparts and has not substantially evolved during the past two decades. Croatia’s labour productivity also ranks behind the OECD and other CEE economies’ averages. Diversifying economic activity and further integrating in GVCs could boost productivity growth.
Foreign direct investment (FDI) has played an important role in Croatia's economic growth, with a significant surge in the early 2000s primarily fueled by state-owned enterprise privatisations. New establishments of foreign-owned firms (i.e. greenfield FDI) are concentrated in construction and services, particularly tourism. In recent years, investments have increasingly been geared toward green and digital industries such as electricity generation from renewables as well as ICT and internet infrastructure. Foreign-owned firms, despite constituting only 5% of active businesses, demonstrate almost double the productivity of domestic firms, and contribute significantly to value added, exports, and research and development (R&D) expenditure. FDI is also instrumental in job creation, particularly among women, and plays a crucial role in Croatia's transition toward a low-carbon economy. However, there is room for improvement in fully harnessing FDI's potential to create jobs and foster environmental sustainability.
In Croatia, the Ministry of Economy and Sustainable Development (MESD) oversees investment promotion through its Internationalisation Directorate, established in 2020 following the abolishment of the Agency for Investment and Competitiveness (AIK). While the Directorate has been progressively developing its investment promotion tools and processes, including by disseminating investment information and providing support to foreign multinational enterprises (MNEs) in establishing their operations, there remains a need for more targeted investment generation activities and enhanced coordination with subnational governments to improve the quality of investment facilitation services. Although the Directorate’s financial resources have substantially increased in recent years, staff shortages undermine efforts to engage in more sophisticated investment promotion activities. The forthcoming National Plan and Action Plan on Investment Promotion present an opportunity to address these challenges and equip the Directorate with the necessary tools and processes to advance its investment promotion agenda.
To promote knowledge-intensive investments, Croatia could enhance government support for R&D, as it currently lags behind OECD and EU economies in this regard. Complex application procedures, low awareness, and fragmented funding sources deter firms from benefiting from R&D incentives. The Government of Croatia could better target and coordinate funding sources, combine them with technical assistance and promote collaboration of investors with R&D institutions and science and technology parks. Policy inter-linkages across the areas of investment promotion, employment and skills development could also be strengthened to attract FDI in job-creating and skill-intensive activities. The Investment Promotion Act offers tax benefits and financial grants for investments contingent on creating a certain number of jobs. Yet, there is currently no systematic and coordinated skills anticipation process that considers MNEs’ changing needs with regard to workforce skills. Over the past decade, the government has taken steps towards promoting green investments by setting low-carbon transition targets that send investors, including foreign ones, strong signals regarding the government’s climate ambitions. However, the incentive system for investments in renewable energy has suffered from discontinuity and delays. The recent introduction of a premium-based incentive scheme is a positive step, but regulatory barriers for green investments could be further removed to achieve decarbonisation targets.
FDI’s effects are unevenly distributed across subnational regions. The majority of FDI is concentrated in the Adriatic and northwestern regions, while Eastern Croatia attracts substantially less investments. Foreign firms outperform domestic ones in all parts of Croatia, but FDI’s positive impacts on productivity, innovation and R&D are often most pronounced in Zagreb and weakest in the region of Pannonia. The job creation intensity of FDI also varies across regions. The same amount of greenfield investment generates twice more jobs in Zagreb than in Pannonia. Disparities in FDI impacts are driven by regional differences in sectoral distributions, skills availability (or their shortages) and R&D activity.
To achieve balanced regional development, Croatia could leverage international investment more effectively. Although the Investment Promotion Act outlines regional development as an objective, a well-defined investment promotion strategy with specific targets and place-based policies is currently lacking. Beyond promoting regions as attractive investment destinations, place-based investment tax incentives and entrepreneurial zones and infrastructure are the main policies implemented to attract FDI in support of regional development. However, overlapping mandates of the MESD and the Ministry of Regional Development and EU Funds (MRDEUF) and ambiguity in the role and responsibilities of county and local development agencies pose challenges for policy coherence and coordination. Clarifying responsibilities across tiers of government and developing coordination mechanisms that bring together national and subnational actors could address these challenges. Equipping the forthcoming National Plan on Investment Promotion with a regional pillar and embedding FDI attraction priorities in regional and local development strategies can help Croatia to better leverage FDI in support of less developed regions.
The reform of Croatia’s strategic framework for investment promotion and facilitation provides an opportunity to evaluate and enhance the existing investment incentives system. Currently, the Investment Promotion Act offers a range of incentives, including tax benefits, grants, and in-kind benefits. Primary among these incentives are reduced corporate income tax (CIT) rates, which are conditional to investment levels, job creation and technological upgrading with higher caps on benefits in less developed regions. Croatia could re-evaluate the design of its main tax incentives to adopt a stronger expenditure-based approach, which allows to better target investments that contribute to sustainable development and might not have occurred without the incentive.
While requiring investors to achieve certain outcomes (e.g. minimum number of new jobs created) to benefit from incentives is an important means to promote FDI spillovers on the local economy, it requires careful monitoring, resources and close coordination with other government institutions to ensure that the desired outcomes have been met. The MESD closely monitors compliance of beneficiaries with incentive conditions and related costs as per the EU State Aid Requirements. But more could be done to evaluate the impact of investment tax incentives on the economy. Coordination between the Ministry of Finance and the MESD’s Internationalisation Directorate appears to work effectively. Information sharing across government bodies involved in incentives could be further strengthened, however.