Croatia’s strong recovery from the COVID crisis was slowed in 2022 by surging inflation and weaker global growth. Growth ahead will be supported by recovering household real disposable incomes arising from wage and employment growth, strong services exports, and by expanding investment (Table 1). Integration in the euro and Schengen areas provides a further fillip to external demand. Limited spare capacity, notably from skill shortages, is constraining output growth. Returning inflation to low rates while expanding the economy’s productive potential will be key to sustaining economic growth.

Croatia has undertaken many reforms and investments in recent decades to raise incomes and well-being. Following a protracted recession in the early 2010s, growth picked up and, despite the disruption from COVID-19 and the energy price crisis, GDP per capita is converging (Figure 1.1). Moreover, over the past decade, employment has risen, helping to reduce poverty rates. Environmental quality improved, many public services were upgraded and laws and regulations modernised. With this progress, Croatia compares well with OECD countries on many dimensions, ranging from business start-ups, renewables in the energy mix, gender equality in the workforce to life satisfaction among youth (Figure 1.1, Panel E).

Croatia’s strong recovery from the COVID-19 crisis has been slowed by the surge in global energy and food prices following Russia’s war of aggression on Ukraine. Robust services exports led by tourism, a tightening labour market and rising investment, the latter fuelled by the implementation of the Recovery and Resilience Plan, are maintaining robust growth. Demand and access to finance are being bolstered by Croatia’s integration into the euro and Schengen areas. However, the surge in inflation is abating slowly, as capacity constraints and rising wages broaden cost pressures. Ensuring that fiscal policy does not add to demand pressures while inflation is high, and that new lending funds quality investments, can help maintain robust growth and moderate inflationary pressures. Reallocating public spending to areas that best support growth, raising more revenues from sources with lower burdens on activity, and encouraging greater formalisation of activity can help maintaining healthy and growth-supporting public finances. Implementing an ambitious programme to reduce greenhouse and other polluting emissions and to adapt to a changing climate would hasten the transition to a green economy and improve well-being.

Raising productivity growth is central to closing the gap with the incomes and well-being enjoyed in many OECD countries. Croatia has internationally competitive firms, and a dynamic economy with many young and potentially productive firms. However, overall performance has been limited by the presence of many less productive firms and more productive firms that often fail to grow. This likely reflects a business environment that weakens competitive pressures and makes investments more costly and risky. Reducing the burdens of lengthy and unpredictable regulatory procedures, resolving legal disputes faster with a more efficient judicial system, and improving public sector integrity, will be key for boosting productivity growth. Developing public equity markets and expanding R&D support would improve access to finance for young and innovative firms. State-owned enterprises play a comparatively large role in Croatia’s economy but tend to underperform financially and in delivering goods and services. Improving their governance, by strengthening the state’s oversight and governance arrangements, can improve outcomes.

Croatia’s labour market has made important progress over the past decade. Employment rates are rising, reducing the gap with OECD countries, and poverty has fallen. While important weaknesses remain, many dimensions of equity and working conditions are similar to OECD countries. Continuing this progress is essential for Croatia’s incomes and well-being to converge with OECD countries, to counter accelerating population ageing and to make the most of emerging opportunities, including from digitalisation and the green economy transition. For employers, filling increasingly advanced skill needs is a growing obstacle. Relatively few of the young and older adults are in work – contributing to weakening skills, lower incomes and higher poverty risks. Addressing these challenges will require dramatically expanding participation in re-skilling and adult education programmes, and raising the workforce’s flexibility, for example by strengthening active labour market policies, improving the housing market’s dynamism and making the most of immigrants and returned emigrants’ skills.