Ambassador Merten’s Remarks at AmCham Lunch

Dear Ivan, Andrea, and AmCham colleagues,

It’s a pleasure to be here with you at the end of nearly three years serving as Ambassador in Croatia, and to reflect a bit on what I’ve experienced and steps Croatia may want to consider taking in order to realize its full potential. And before I continue, I want to be clear about one thing: as far as the United States is concerned, Croatia is a success story. Full stop. And I think that isn’t repeated often enough. We Americans are proud to call you allies and friends, and see you as having “come home” when you joined NATO and the EU. I was not a diplomat who served in Southeastern Europe in the 1990’s, but I have talked to many diplomats and residents who lived through the 1990’s in this part of Europe and many have told me they would never have believed that Croatia would be a NATO and an EU member so quickly after independence. So take a moment to be proud of that. Those were big accomplishments, you worked hard, and you earned them.

I hope you will accept me saying what follows as a fan and friend of Croatia. After your major accomplishments over the past 15 or 20 years, I think there is another very real challenge, one that I would argue is the greatest threat Croatia faces. That challenge is the lack of economic growth and economic opportunity. I often note that the AmCham here is one of the best I have ever worked with, and that is to your credit given the difficult business environment in which you operate. We are quite hopeful that the Croatian economy has turned the corner and is returning to growth, but even then the expected growth levels we are talking about are very low, and will do little to impact unemployment and continuing large gaps in the budget. Many economists and business people believe more needs to be done to put this economy on a sound footing, ensure markets are functioning, and to give the private sector the support it needs. These challenges are not the product of the policies of any one government, and successive governments have been grappling with needed reforms. I want to applaud the steps the current Government has taken, like passing the Law on Strategic Investments and the Hydrocarbons Law, and establishing the Agency for Investment and Competitiveness. These are important steps and real accomplishments. But as the Ambassador representing a country that would like to develop more trade and investment between our two countries, more steps like these still need to be taken.

From my perspective, there are really two key economic challenges which require Croatia to decide its course, and let me clarify here that I’m talking about having a public conversation involving the people of Croatia, the government of Croatia, and the private sector. First, I’d like to talk about ways in which Croatia can strengthen its economic prospects by attracting more high-quality foreign investment. Second, I’d like us to focus on the role of a vibrant private sector in revitalizing growth, and by extension the drag that the overly large public sector and state-owned enterprises play in keeping Croatia from expanding that private sector.

On the question of attracting high-quality foreign investment, let’s acknowledge that no country can be economically successful without attracting foreign investment. None. Foreign investment is extremely important to the United States: foreign companies by latest estimates employ 5.6 million Americans. Foreign investment has also played a key role in the development of China, Germany, Poland, Korea, Chile and many other countries. Without foreign investment, countries cannot be economically successful. There are some good regional examples to guide our thinking. Poland, Slovakia, and Latvia are often held up as good examples of central and eastern European countries that successfully attract significant levels of foreign direct investment. These are all countries that not too long ago were not as well off as Croatia. Over the last 25 years Poland has attracted major U.S. investors including companies like Amazon, which has created over 2,000 jobs there since 2014. Amazon executives have said that Poland’s competitive wages and geographic location near their major Western European markets led them to invest. In Latvia, a talented, multi-lingual labor pool, stable monetary and tax policy, and good air transit connections attracted several U.S. companies.

U.S. investments in Slovakia are extensive, with over 120 U.S. companies currently operating there. Whirlpool has 1,200 employees and produces 2 million washing machines per year, making it the largest appliance manufacturer in Europe. U.S. Steel employs 13,000 people and has invested $1.2 billion in Slovakia since 2000. Comprehensive structural reforms adopted by the Slovak government from 2000-2005, including a flat income tax at 19%, led the World Bank to name the country the world’s top reformer in improving the investment climate in its “Doing Business in 2005” report. Slovakia’s relatively low-cost yet skilled labor force, low taxes, liberal labor code and favorable geographic location within the European Union (EU) have helped it become a favorite investment destination.

These regional success stories all have something in common; these countries embarked on fundamental economic reforms to enhance their business climates. Reforms included things like large scale privatization, creation of efficient legal systems able to enforce contracts in a timely manner, instituting strong financial regulation, crafting a modern tax system, lowering entry bars into the market for foreign firms, and increasing the focus on educating citizens in an entrepreneurial culture. Some of these reforms were controversial, some were painful, but they yielded long-term results by attracting foreign firms and creating jobs.

With all the talk of progress that has been made in these example economies, it’s also useful to remember that there are plenty of remaining issues. In 2014, Ernst & Young’s FDI attractiveness survey indicated that investors were still worried about business conditions in Central and Eastern Europe and suggested the major focus should be placed throughout Europe on reducing bureaucracy, improving education and training in new technologies, and cutting regulation. I think all of you here today would agree with that. Investors surveyed by E&Y thought these changes were important to support what they saw as Europe’s next phase of attracting FDI in R&D, ICT, pharmaceuticals, and energy/utilities. The OECD also agrees with these assessments and continues to call for removing barriers to labor mobility, reducing administrative burdens and entry barriers, deregulating professional services, and improving bankruptcy procedures.

Now we all know that some of these necessary reform processes to attract foreign investment have quite a chequered history here. Privatization brings groans from the general population and skeptics of the problematic privatizations of the 1990’s. The large budget deficit Croatia faces makes talk of reducing or simplifying tax rates a difficult proposition. High unemployment brings significant political cost to any talk of reforming the public sector and state-owned corporations that would require layoffs and restructuring. And yet, in my opinion, there is not enough discussion about the benefits that some of these tough choices would bring. I think those benefits are clear. By clearing away the “underbrush” that impedes investment — in this case, all of the barriers that make Croatia less attractive than it should be — you would create breathing room for your competitive private sector to grow, employ people, and contribute to sorely-needed budget revenues.

Next I’d like to focus on the crucial role a vibrant private sector needs to play in Croatia’s economic recovery. The public sector and firms supplying the public sector employ the majority of Croatians today. That leaves true private sector firms, competing in international markets and operating according to market-based principles, in the minority. It is clear from a large body of research that State Owned Enterprises have lower labor productivity than private sector firms. Their ability to utilize capital efficiently is lower, and public sector firms have higher unit labor costs.

That said, I have noticed that the public sector is everywhere in Croatia. It dominates nearly every major sector of the economy. According to the World Bank, the SOE or State Owned Enterprise, sector in Croatia is one of the largest among EU member states. State-owned assets, including SOE assets, comprised 68% of Croatia’s GDP in 2013, which put Croatia behind only four countries in Europe in terms of value of state-owned assets. The state owned or had a share in over 550 firms. From 2008 to 2013 the World Bank estimated that while the private sector lost more than 150,000 jobs, Croatia’s public sector actually increased employment. Unfortunately, very little has changed since this report was issued some two years ago. Many economists believe that there simply hasn’t been the kind of privatization drive Croatia needs to end this drag on the economy.

Croatian State Owned Enterprises generally perform poorly, but require large levels of taxpayer support. Accumulated SOE debt significantly contributes to government debt, while the majority of Croatian SOEs continue to post losses. Subsidies and state-guaranteed SOE debt weigh heavily on Croatia’s budget. Many people thought that with Croatia’s EU accession, strict EU regulations on state subsidies, and a strong push for SOE restructuring, would create a greater impetus for reform of this sector. Unfortunately, that does not seem to be happening and the government-owned entities continue to essentially crowd out the private sector, severely limiting the country’s overall ability to grow and come out of this recessionary period.

Again, speaking as a foreigner, I continue to be surprised at the lack of a true public discussion about these two core challenges facing Croatia. As an EU member state working to integrate yourselves into the single market, I would expect the idea of attracting foreign investment to be a given, something accepted by everyone. As we all know, there remains a certain level of resistance to “outsiders” that is frankly pretty baffling for a country that welcomes millions of tourists each year and that has joined the largest economic union on earth. Croatians need to think carefully about the path that Croatia is on and, given declining population growth in an ageing Europe, where the growth will come from to maintain their expected standards for social payments and benefits. As I look around this room and reflect on all of the folks I have had the privilege to meet in nearly three years here in Croatia, I know that Croatia has the skills, business acumen, and competiveness to drive private sector growth if given the business and investment climate necessary to do so. What’s needed is an honest assessment of the public support you will need, from both the government and society more generally, to allow you to succeed. I hope this will help prompt that discussion.

Thank you for taking your time today to think about these topics, and I look forward to any questions you may have about what I’ve put forward here today.