This chapter provides an overview of the main challenges and opportunities for investment promotion and facilitation in Croatia, and the role that foreign direct investment plays in supporting sustainable development, including productivity and innovation, job quality and skills development, regional development, and the low-carbon transition. Based on an assessment of Croatia’s regulatory and policy framework at national and subnational levels, the chapter also derives overarching policy considerations to strengthen the economic, social and environmental benefits of foreign investment.
FDI Qualities Review of Croatia
1. Overview and key policy considerations
Abstract
Trends and qualities of foreign direct investment in Croatia
Croatia's remarkable economic journey over the past few decades has seen per capita incomes doubling since the mid-1990s and living standards substantially improved. Croatia's accession to the World Trade Organization (WTO) in 2000 and the European Union (EU) in 2013 substantially boosted exports of goods and services, with about two-thirds of its exports and three-quarters of imports originating from or destined for EU Member States, most prominently Italy, Germany, and Slovenia. Croatia's economic landscape is characterized by a pronounced emphasis on services, with a particular spotlight on tourism. In comparison to other Central and Eastern Europe (CEE) economies, Croatia's share of value-added in manufacturing is lower, signalling an opportunity for reinvigorating industrialization and enhancing productivity. Its integration into global value chains (GVCs) is less pronounced than that of its CEE counterparts, with lower foreign value-added content in its exports. Boosting the integration of the Croatian economy in GVCs could be instrumental in elevating productivity. Although the country has achieved commendable productivity growth, it still lags behind the OECD and CEE averages.
FDI has played a pivotal role in Croatia's economic growth. A surge in FDI occurred during the early 2000s, primarily driven by privatizations of state-owned enterprises. However, the global financial crisis in 2008 caused a substantial divestment. FDI has since rebounded, although it continues to lag behind the average of other CEE countries in absolute terms. New establishments of foreign-owned firms (greenfield FDI) are concentrated in construction and services, reflecting Croatia’s specialisation in services – especially tourism but also software and IT services.
Foreign-owned firms represent only 5% of active economic entities in Croatia but they are almost twice as productive as domestic firms and contribute to around 30% of total value-added, 45% of exports and 60% of private expenditures on research and development (R&D). Beyond positive effects on productivity, innovation, and exports, FDI is key for job creation, including for women, and supports the transition to a low carbon economy in Croatia. For instance, foreign firms have on average a higher share of female employees than domestic firms. Although Croatia attracted FDI in labour intensive services, it doesn’t fully capitalise on the potential of FDI to create jobs. The number of jobs created per million of USD invested over recent years is below the CEE average. Foreign-owned firms play a crucial role in Croatia’s transition toward a carbon-free and environmentally sustainable economy. FDI in the energy sector is increasingly concentrated in renewables and foreign firms steadily improve their energy efficiency. However, compared to domestic peers, foreign firms fall short in environmental expenses and only slightly increased expenses for environmental purposes over the past decade.
Croatia could aim to further diversify FDI into activities where it has an existing comparative advantage in production and exporting, which would strengthen productivity and competitiveness in these activities and foster sustainable development more broadly. Despite not having a comparative advantage in most of its exports, the country's production and export basket encompasses a wide range of manufacturing products. Croatia's products with a traditional or emerging comparative advantage are less complex and hold smaller market shares than those of its competitors, in particular CEE economies. Croatia's emerging comparative advantages are also concentrated in relatively small markets. While this presents some challenges, it also offers the opportunity to excel in specialized products.
Box 1.1. Databases used to assess FDI trends and impacts in Croatia
Census data of the Financial Agency (FINA) of Croatia: include information on demographic and financial details of firms operating in Croatia. This dataset encompasses all publicly listed and private limited companies incorporated in Croatia and provides details on domestic and foreign sales, R&D and material expenditure along with demographic information such as firm employment, NACE 4-digit industry, and micro location of the firms’ headquarters (i.e. county and municipality). Analyses of this report focus on all “active” firms in Croatia between 2008 and 2021, i.e. firms that had positive sales and employment in a given year, thus covering the universe of Croatian firms regardless of revenue or employment thresholds. NACE 4-digit industries
Croatian Pension Insurance Institute (HZMO): provides detailed information on employment of individual firms by occupation and gender as well as average wages from 2014 until 2021. The report classifies occupations by skill level according to the International Standard Classification of Occupations (ISCO) (ILO, 2023[32]). Accordingly, high-skilled occupations include managerial, professional, technical, and associated professional occupations.
Financial Times’ fDi Markets Greenfield FDI database: includes cross-border greenfield investments covering all countries. It provides real-time information on capital investment and job creation by economic activity, source country, and location (region). For this study, cross-border greenfield investment projects directed to Croatia from 2003 to 2022 Q2 as well as cross-border greenfield investment projects directed to other CEE economies from 2017 to 2021 were selected from all countries of origin and covering all economic activities. Economic activities were reclassified to correspond to the ISIC Rev4 sectoral classification.
In addition, several other OECD and non-OECD databases have been used in this report including the OECD FDI Statistics, OECD Trade in Value Added (TiVA) indicators, OECD Gender Portal, OECD Green Growth Indicators, IMF Balance of Payments and International Investment Position Statistics, as well as ILO and World Bank Indicators, including the World Bank Enterprise Survey.
Investment promotion and facilitation for a sustainable and resilient recovery
As highlighted in the OECD Policy Framework for Investment and the OECD FDI Qualities Policy Toolkit, investment promotion and facilitation can be powerful means to attract investment and maximise its contribution to sustainable development, but their success depends on the quality of investment-related policies and on the overall investment climate. As such, many countries worldwide decide to not only remove restrictions on foreign direct investment (FDI) and provide high standards of protection to investors, but also to proactively promote and facilitate investment to maximise potential economic, social and environmental benefits to the host economy. Effective investment promotion and facilitation can be particularly important to address the economic consequences of the COVID-19 pandemic and the energy crisis, which have weakened economic prospects and increased the risk of slowing down progress to make societies and economies more resilient, inclusive, and sustainable.
In Croatia, the Ministry of Economy and Sustainable Development (MESD) is responsible for investment promotion and facilitation. The MESD's Internationalisation Directorate, established in 2020 after the abolishment of the Agency for Investment and Competitiveness (AIK), aims to promote Croatia as an attractive investment destination and assist foreign multinational enterprises (MNEs) in establishing their operations there. The Directorate has been gradually developing its investment promotion tools, including disseminating information on investment opportunities, creating investor guides and other promotional materials, and supporting investors to set up their business operations in different regions.
Unlike most OECD Investment Promotion Agencies (IPAs), the Directorate does not prioritize specific investment projects, sectors, or countries and lacks a dedicated unit for that purpose. Facilitation services offered by the MESD mainly focus on assisting investors during their establishment phase. Subnational governments like regional counties and municipalities offer complementary services in the regions, such as resolving legal issues and helping investors identify local suppliers and qualitied employees. To leverage FDI’s development potential, the Directorate could consider scaling up its investment generation activities by pro-actively targeting and prioritising investments that contribute to sustainable and inclusive economic growth. Synergies with subnational actors could be further developed to provide support to foreign MNEs on the ground and standardise the quality of investment facilitation services across Croatian regions.
The MESD's Internationalisation Directorate has been facing challenges to fulfil its investment promotion mandate due to inadequate resources and insufficient staff. It's crucial for the Croatian Government to equip the Directorate with the necessary financial and human resources to offer a broader range of services to potential investors. Although investment promotion budgets have increased in recent years, staff shortages put a strain on the activities of the Directorate. The fragmented institutional environment poses another challenge for investment promotion and facilitation in Croatia. Many investment-related mandates are shared with other government bodies (e.g. sectoral ministries, subnational governments), resulting in limited coordination and disjoined actions. To overcome this, the Internationalisation Directorate could consider establishing formal coordination mechanisms with other parts of the government, share resources and implement joint initiatives that support foreign MNEs at every stage of their investment process. The forthcoming National Plan and Action Plan on Investment Promotion, that will be adopted by the government in the course of 2024, present an opportunity to rethink Croatia’s investment promotion framework, address existing challenges and equip the Directorate with the necessary tools and processes to fulfil its role.
Besides providing a source for financing, FDI can support sustainable development in Croatia by diversifying the economy, transferring technology and knowledge, developing the skills base, boosting productivity and innovation, and establishing linkages with local firms (OECD, 2022[1]; OECD, 2015[2]). However, FDI does not always go where it is most needed and its impacts on sustainable development are not always positive. To realize the potential benefits from international investment, effective policies and institutional arrangements that link investment promotion with complementary policy areas are crucial (Box 1.2).
Regarding the promotion of knowledge-intensive investments, Croatia provides one of the lowest levels of government support to R&D among OECD and EU economies. The limited number of firms benefitting from R&D incentives may be caused by complex application procedures, a lack of awareness, and the fragmentation of funding sources, which have different objectives, timeframes and implementing authorities and do not always provide the necessary long-term perspective that is necessary when foreign MNEs decide where to locate their R&D activities. Funding sources should be better targeted, coordinated and supplemented with technical assistance to link applied university research with the needs of foreign investors, provide R&D workforce training, and facilitate collaboration with science and technology parks.
Investment promotion and incentive policies play a key role in supporting job creation and skills development. Croatia's Investment Promotion Act offers tax benefits and financial grants conditioned to the creation of a certain number of jobs depending on the level of unemployment in each subnational county (Government of Croatia, 2022[3]). Similarly, training grants are available covering up to 70% of costs incurred for training employees in newly created jobs. Although labour and skill shortages appear to be one of the biggest obstacles for foreign MNEs operating in Croatia, policy inter-linkages across the areas of investment promotion, employment, and skills development are limited. The Croatian Employment Service is responsible for analysing the needs of the labour market and accordingly prepare recommendations for training and educational programmes, but there is no evidence that this has any influence on workforce development policies. The establishment of systematic and coordinated skills anticipation processes that involve the investment community and take into consideration MNEs’ changing needs is essential to attract skill-intensive investment. The MESD’s Internationalisation Directorate could further promote sectors in alignment with the existing skills base and help investors identify local workers with relevant skills.
Box 1.2. The OECD FDI Qualities Initiative
The OECD FDI Qualities Initiative provides governments with the policies, data and expertise they need to encourage sustainable investment that is greener, promotes quality jobs & upskilling, improves gender equality, and contributes to a more productive and innovative economy. Even before the COVID-19 pandemic, it was estimated that achieving the Sustainable Development Goals (SDGs) required financing of USD 2.5tn per year - a gap which may have since increased by 70%. Meanwhile, fulfilling the commitments made in the Paris Agreement to curb climate change requires investment in renewable energy to triple by 2030. Foreign direct investment (FDI) is an important source of finance to help meet these global commitments to sustainable development. Beyond the quantity of FDI, its quality also matters. A key challenge for the international community is to mobilise significant financial resources to accelerate the implementation of the 2030 Agenda for Sustainable Development and ensure that plans for a “decade of action” to advance the SDGs are not side-tracked.
The OECD FDI Qualities Initiative comprises three components:
The FDI Qualities Indicators, originally developed in 2019, seek to measure the sustainable development impacts of FDI in host countries (OECD, 2019[4]).
The FDI Qualities Policy Toolkit helps governments identify priorities for policy and institutional reforms to enhance the impacts of investment on sustainable development (OECD, 2022[1]). For each area of sustainable development covered, it describes how to assess the impacts of FDI and provides policy recommendations related to governance, domestic and international regulation, financial and technical support, and information and facilitation services.
The FDI Qualities Policy Network provides a platform to engage in policy dialogue and stakeholder consultations with development partners, international organisations, businesses, civil society and academia.
The OECD Council Recommendation on FDI Qualities draws on these three core elements and is the first government-backed agreement to help policy makers to leverage FDI to finance the SDGs and optimise the strength and quality of the recovery.
Source: OECD (2022[1]), FDI Qualities Policy Toolkit, https://doi.org/10.1787/7ba74100-en
Croatia’s government has prioritized creating an enabling environment for green investment by setting clear low-carbon transition targets and long-term policy strategies (e.g. Low-Carbon Transition Strategy, Energy Development Strategy) that send investors, including foreign ones, strong signals regarding Croatia’s climate ambitions. However, over the past decade, the incentive system for investments in renewables has been characterised by a lack of continuity and delays in its implementation. The recent introduction of a premium-based incentive scheme, which provides financial support to a winning bidder under a contract made with the Croatian Energy Market Operator (HROTE), is a step in the right direction and could help Croatia achieve its decarbonisation targets as long as it is accompanied by reforms to remove regulatory barriers for green investments and targeted policy interventions to create conducive framework conditions for private investment (e.g. ease of granting licenses and permits, access to land, access to finance).
Overall, Croatia performs well in regulatory complexity and simplification of licensing and permit systems. However, administrative, regulatory, and technical barriers hinder further investment in large-scale renewable energy projects. Procedures for obtaining environmental approvals – namely environmental impact assessments – take significantly longer than the legal deadlines prescribe. Technological upgrades of existing renewable energy projects can take several years to be approved since they usually require amendments to the location and building permits, which cannot be obtained before a new environmental impact assessment is conducted – resulting in delays and a lack of predictability for investors. Ongoing policy efforts to digitalise certain licensing and permit requirements will not be sufficient to reduce regulatory burden unless they are accompanied by simplification measures, interoperability between government bodies and enhanced coordination between levels of government. Finally, administrative challenges in securing land tenure often cause delays in licensing procedures for large-scale investment projects. Weaknesses in local authorities' spatial planning capacity and the low quality of cadastral and land registries do not always allow to determine the status of land plots with certainty. Improving access to information regarding land administration and tenure through digitalization can help streamline investment procedures.
Policy recommendations
Ensure that Croatia’s forthcoming National Plan on Investment Promotion is guided by clearly identified strategic objectives and that these are reflected in the Internationalisation Directorate’s governance processes, allocation of resources, key functions and activities.
Expand investment generation activities to identify and approach potential investors that can support national development objectives, notably by targeting companies in priority sectors and in high value-added activities.
Improve the internal governance of investment facilitation and aftercare services by exploiting synergies with subnational actors that may have more staff on the ground to provide the services that are currently not provided by the MESD.
Continue efforts to address resource-related challenges faced by the Internationalisation Directorate and strengthen its capacity to generate prospective investment leads and maximise the number of realised investments.
Develop a comprehensive investment prioritisation framework with clearly defined criteria that will be used for the pro-active targeting of activities, sectors, and investments that contribute to the sustainable development of the Croatian economy.
Introduce robust monitoring and evaluation (M&E) systems to track the investment promotion and facilitation activities undertaken by the Internationalisation Directorate, and evaluate its organisational performance and success in reaching the target objectives set in the forthcoming National Plan and Action Plan for Investment Promotion.
Set up coordination mechanisms that place the MESD at the epicentre of cross-government efforts to promote investment and allow the Internationalisation Directorate to effectively collaborate with sectoral ministries, subnational IPAs, regional and local governments.
Review the innovation support programmes to make them more accessible to foreign and domestic firms that seek to engage in innovation-based partnerships.
Strengthen knowledge and technology spillovers from FDI by helping foreign MNEs identify local suppliers and strengthening the capacities of Croatian SMEs to collaborate with them.
Address skills shortages in FDI-intensive sectors through targeted sectoral upskilling programmes that allow foreign MNEs to tailor them to the needs of their employees. The MESD’s Internationalisation Directorate could further promote sectors in alignment with the existing skills base and help investors find qualitied employees.
Establish robust labour market information and skills anticipation systems that involve investment actors to design evidence-based employment or training policies and effectively monitor their impacts. The MESD could bring forward its sectoral expertise to the National Council for Human Resource Potential and voice the concerns of investors in terms of skill shortages and future training needs.
Step up policy efforts to promote and facilitate renewable energy investments by removing regulatory barriers, simplifying licensing and permit systems, ensuring the continuity of the new feed-in-premium incentive scheme, and strengthening interoperability between government bodies.
Harmonise and improve the governance of spatial planning rules to facilitate land acquisition for large-scale investment projects. Emphasis should be placed on streamlining information on land administration and tenure for potential investors through digital means.
Harnessing investment for regional development
Foreign investment has a significant impact on sustainable development in Croatia, but its effects are uneven across regions. FDI is concentrated in the Adriatic and north-western regions, particularly in the capital city of Zagreb, Istria, Primorje-Gorski Kotar and Split-Dalmatia. Eastern Croatia has attracted less FDI: Pannonian Croatia concentrates only 3% of the national FDI stock, reflecting its lower business density compared to other regions. Foreign firms perform better compared to domestic firms in all parts of Croatia, especially in terms of labour productivity, but the positive impact of FDI is stronger in Zagreb and in the Northern region, as companies with R&D activities are concentrated in larger cities. The impact of FDI on job creation is also uneven. One million of greenfield FDI in Croatia generates around 4 direct jobs per million USD invested, but this varies by a factor of two between Zagreb (6 jobs) and Pannonian Croatia (3 jobs). Disparities in FDI impact on jobs are largely driven by sectoral distributions, skills availability (or their shortages) and R&D activity. .
To achieve balanced regional development, Croatia could leverage FDI more effectively. While the Investment Promotion Act includes regional development as an objective, there is currently no well-defined investment promotion strategy with specific targets and place-based policies beyond what is outlined in the Regional Aid Map on how to better utilize FDI in support of regional development. In contrast, many OECD countries that are EU members have integrated regional aspects into their national investment promotion strategies and made FDI attraction a central component of their regional convergence plans. A key challenge for Croatia is determining the appropriate subnational level for implementing the strategy. With 20 counties and 555 local governments (428 municipalities and 127 cities), many of them geographically or economically small, strategic planning on investment policies is difficult while attractiveness factors such as business density, skilled labour and local supply chains often transcend administrative boundaries. Although Croatia’s four larger regions could potentially develop attractive FDI value propositions aligned with their distinct priorities, they lack the administrative capacities for policy design and implementation and may need to rely on institutions operating at the local or county level.
Croatia’s policy and institutional framework for investment promotion has become increasingly complex in a decentralised setting with fragmented subnational bodies. At the national level, the Internationalisation Directorate of the Ministry of Economy and Sustainable Development recognises regional development as important; yet, it does not prioritise it to the same extent as the IPAs of OECD countries, which often lead investment promotion efforts at the regional and local levels. Additionally, the Ministry of Regional Development and EU Funds (MRDEUF) plays a significant role in policies at the intersection of FDI and regional development, overseeing the European Structural and Investment Funds (ESIF) and Integrated Territorial Investments (ITIs) of the EU Cohesion Policy, which shape regional development policies and orient EU funds to specific sectors or activities to unleash regional competitiveness. The MRDEUF also coordinates the recently established Industrial Transition Plans for the Adriatic, Pannonian and North Croatia regions, which aim to support the development of regional value chains through EU-funded financing instruments. However, there is some ambiguity regarding the role of each ministry in overseeing or coordinating investment promotion at the subnational level.
The MESD’s Internationalisation Directorate employs various policies to influence investors location decisions in support of regional development such as enhancing the attractiveness of regions as investment destinations and offering tax incentives in accordance with the Regional Aid Map. However, further evidence is needed to assess the impact of these incentives in attracting FDI that creates high-wage jobs in less developed regions and mitigates brain drain. Unlike OECD national IPAs, the Directorate places less emphasis on generating FDI projects for less developed regions but provides FDI-related intelligence to subnational bodies. While it is reasonable for the Directorate not to consider talent attraction as a way to promote FDI in less populated areas, the new policy of facilitating the entry of foreigners could prompt a re-evaluation of how investment promotion can support the broader goal of retaining youth from migrating.
At the subnational level, the establishment and operation of Entrepreneurial Zones (EZ) and Entrepreneurial Support Infrastructure (ESI), which are managed by subnational governments with administrative assistance from the MESD’s Internationalisation Directorate, have helped attract and facilitate investments. While the EZ network effectively attracts foreign investment projects, its ability to redistribute economic activity and generate spillovers beyond nearby urban areas is somewhat limited. Local and country development agencies, which are one type of ESI entities under the Act on Improving Entrepreneurial Infrastructure, are entrusted with the responsibility of promoting investments in their regional and local jurisdictions alongside other functions. However, the large number of county and local development agencies often leads to confusion about which entity holds the mandate for investment promotion and facilitation.
Croatia’s first step toward enhancing policy coherence and coordination in investment promotion and regional development should involve clarifying mandates across tiers of governments. Although the MESD’s Internationalisation Directorate has good but only informal bilateral relationships with subnational governments, primarily covering aspects like business establishment support, these informal mechanisms are insufficient for addressing comprehensive and strategic policy issues related to investment promotion and regional development. These issues require collective agreements since they can range from strategy design, sectoral targeting, maintaining a pipeline of investment projects to jointly agreeing on common and harmonised approaches to investment facilitation.
Policy recommendations
Equip the planned National Plan on Investment Promotion with a regional pillar, in consultation with relevant subnational entities. The pillar sets FDI targets based on regional priorities and strengths, identifies investment promotion efforts, and clarifies the tasks of national and subnational entities and related coordination mechanisms.
Integrate the wide range of place-sensitive policies in the regional pillar of the investment promotion strategy, beyond typical investment promotion efforts, to make FDI work for regional development.
Set the appropriate subnational level for the regional pillar of the investment promotion strategy to overcome fragmented planning. Croatia’s four large regions allow to consider broad regional specificities while still offering attractive FDI value propositions.
Embed FDI attraction priorities in relevant County Development Strategies, Urban Areas Development Strategies and the Plans for Industrial Transition of the three NUTS2 regions. Including a regional pillar in the National Plan on Investment Promotion is not sufficient in a decentralised setting where the central government’s ability to attract FDI depends on regions taking planned actions to improve their attractiveness.
Consider revising the legislative framework to clarify which subnational bodies have the mandate to promote investment. The Act on Improving Entrepreneurial Infrastructure refers to local and county development agencies, creating confusion and overlap with bodies of the same name operating under the Act on Regional Development. The Acts should be aligned and clarify which entities carry investment promotion and facilitation mandates.
Clarify responsibilities and strengthen cooperation at the central level. The Investment Sector of the MESD’s Internationalisation Directorate promotes Croatia as an FDI destination while the Incentives and Entrepreneurial Infrastructure Sector is tasked with improving the investment climate for balanced regional development by supporting the ESI network. Close coordination and joint planning between the two Sectors are crucial.
Develop coordination mechanisms to address multi-level investment promotion challenges. The MESD’s Internationalisation Directorate could develop with relevant national and subnational entities a cooperation agreement, protocol or guidelines that describe the rules of engagement of each actor with a clear distribution of tasks at different stages of the investment process.
Leverage digital tools to support national-subnational investment promotion activities. The MESD’s Internationalisation Directorate could establish, in cooperation with the relevant subnational entities, a digital platform to announce foreign investors’ expressions of interest received by the ministry.
Strengthen the effectiveness of place-based policies on attracting FDI that supports regional development. This includes better integrating EZs into their regional ecosystem to generate further economic spillovers; further provision by the MESD of FDI-related intelligence to subnational bodies to help them identify and target unique FDI markets; and assessing local incentives’ impacts on attracting job-creating FDI to regions with higher unemployment rates.
Consider talent attraction and retention as tools to attract FDI in disadvantaged regions. The central and subnational governments should consider how investment promotion serves broader goals of retaining youth from migrating while facilitating foreigners’ entry to avoid labour shortages.
Towards more effective investment tax incentives
As Croatia develops and implements its National Plan on Investment Promotion, it should explore ways to enhance the existing investment incentive system, ensuring it aligns effectively with the country’s investment policy goals. The new Plan could also serve as an opportunity to actively promote incentive policies to potential investors. More broadly, incentives are only as attractive as the wider investment climate. They should complement, rather than replace, policies that create a predictable and attractive investment environment.
Croatia offers a variety of incentives to attract investors, including tax incentives, grants and in-kind benefits, such as rent-free lease of land and buildings. The primary investment incentives are reduced corporate income tax (CIT) rates, linked to job creation and investment amount, that are granted through the Investment Promotion Act. Reduced CIT rates substantially reduce the statutory rate by 50-100% for up to ten years – though the total value of benefits investors can receive (including grants and other tax benefits) is capped, with higher caps on benefits in less developed regions. Besides the benefits offered under the Investment Promotion Act, other incentives include a tax allowance and grants for firms that engage in research and development (R&D), tax and in-kind benefits for companies in entrepreneurial and free zones as well as assistance from entrepreneurial support institutions. Sub-national governments provide additional non-tax incentives, including financial grants, exemptions from fees, or in-kind benefits (e.g. land at reduced cost).
Croatia has aligned incentives under the Investment Promotion Act with EU Regional Aid requirements, with a positive effect on incentive design. Incentives are accessible to companies of any size and across most sectors, preventing opportunities for rent-seeking behaviour through favoured sectors. Eligibility conditions are clear and specific, and tied to positive development goals, notably, job creation, and regional development. Tax and financial benefits are capped with a ceiling per project as well as annual spending limits for the regime as a whole, proving a check on government expenditure. EU regulations also positively mandate thorough monitoring and reporting on incentive uptake and costs, an essential first step to evaluating the impact of incentives.
Tax and non-tax incentives under the Act aim to support the growth of substantive private sector investment, both domestic and foreign, while fostering job creation, regional development and technological upgrading. CIT incentives under the Act support these goals through eligibility conditions to receive benefits: investors need to create a minimum number of new jobs, invest a certain amount in fixed assets or increase productivity through using high-tech production equipment. Such outcome conditions (e.g. requirement to create a minimum number of new jobs) can promote positive spillovers of investment; however, they require careful monitoring to ensure that the outcome has been met. This necessitates resources, administrative capacity, and close coordination with other government agencies.
Looking forward, the government could consider revising some of its incentives to maximise positive spillovers and limit potentially excessive benefits to firms. Carefully designed and targeted incentives may help address market failures and promote social and economic development. While CIT rate reductions in Croatia are linked to investment size and job creation, promoting a firm’s physical presence in the country, income-based incentives (CIT exemptions and reduced rates) often disproportionately benefit investments that are already profitable early in the tax relief period. They may also benefit firms that might have invested without the incentive, rendering the incentive redundant while potentially costing the state substantially in terms of revenue forgone.
Croatia could consider re-evaluating the design of its main tax incentives to adopt a stronger expenditure-based approach. Expenditure-based incentives (tax allowances or credits) might be more effective at attracting investment that would not have occurred otherwise. They are better targeted at reducing specific costs (i.e. qualifying expenditure) and thereby encourage spending that might not occur without the incentive, including costs of job creation and technological upgrading. Furthermore, expenditure-based incentives are expected to be less affected by the new international tax agreement (OECD, 2022[5]). Under these rules, jurisdictions that grant large multinational enterprises (MNEs) effective tax rates below 15% may lose tax revenues as other jurisdictions start to impose top-up taxes on MNEs with low tax rates. Croatia is thus advised to consider the implications of these new rules for its tax incentives regime.
The upcoming reform of the Act provides an opportunity for the MESD to evaluate whether tax incentives and grants are achieving their stated objectives, including employment creation and regional development. While most investment incentives of the Investment Promotion Act have primarily supported well-established domestic industries that have played an important role in the growth of the Croatian economy, such as metal processing manufacturing and tourism, they may have also helped grow the ICT sector. Foreign firms made up a quarter of incentive beneficiaries over the past decade, with a slight increase in the number of foreign firms applying for incentives in recent years. Although most recipients are small firms, larger investments are increasingly benefitting from incentives.
Besides investment tax incentives under the Investment Promotion Act, Croatia offers other incentives through multiple pieces of legislation that are governed by different public bodies at central and subnational levels. For example, R&D incentives are authorised in a separate act. Coordination between government institutions involved in incentives appears effective, for example between the Ministry of Finance and the MESD’s Sector for Incentives and Entrepreneurial Infrastructure. However, information sharing could be strengthened across different bodies that grant incentives, including within departments of the MESD’s Directorate for Internationalisation, between different ministries, and with representatives at the subnational level to support policy coherence.
The effective use of investment incentives requires regular monitoring and evaluating the costs and benefits of incentives, including vis-à-vis public revenue mobilisation, investment attraction, and the respective policy objective. Croatia closely monitors beneficiaries’ compliance with incentive conditions, and the costs of various incentive schemes as required by the EU State Aid rules. This provides a strong foundation for policy evaluation, and there is potential for further assessment to determine whether incentives generate additional investments and are optimally designed to support their policy goals, including those related to sustainable development.
Policy recommendations
Assess whether tax incentives are best designed to support their stated objective. The government could consider whether targeted expenditure-based tax schemes (tax allowances or credits), could be more effective at promoting certain outcomes.
Explore what complementary policies are required (e.g., infrastructure, connectivity, regulations, education or labour market and broader-based personal income tax reforms) to best incentivise investment policy goals, including as part of the planned National Plan on Investment Promotion.
Reinforce regular coordination at the national level, within departments of the MESD, and particularly within its Directorate for Internationalisation, as well as between different ministries, and with sub-national authorities at the local level to support policy coherence when designing and implementing incentive policies.
Enhance clarity of investment incentives by adding to the existing online investor guide more information on all available incentives programmes and relevant criteria. This could include information on incentives granted by sub-national authorities and English translations of all relevant laws and regulations in an online platform.
Croatia should continue its efforts to improve administrative and financial burdens and increase transparency of fees due. While Croatia has already progressed in recent years, investors still report lengthy procedures and unexpected fees.
Implement a regular and structured evaluation mechanism to assess how incentives are used, if they are supporting their intended policy goals, and their costs. Embedding periodical evaluation processes in the law and clearly attributing responsibilities can support more effective evaluation mechanisms. Depending on the outcomes, the MESD should consider adjusting existing incentives and phasing out benefits that are no longer needed.
References
[3] Government of Croatia (2022), Act on Investment Promotion, Official Gazette, https://investcroatia.gov.hr/wp-content/uploads/2022/08/Investment-promotion-act_EN_unofficial-translation.pdf.
[6] Government of Croatia (2021), Recovery and Resilience Plan: Croatia, Council of the European Union, https://investcroatia.gov.hr/en/recovery-and-resilience-plan/.
[1] OECD (2022), FDI Qualities Policy Toolkit, OECD Publishing, Paris, https://doi.org/10.1787/7ba74100-en.
[5] OECD (2022), Tax Incentives and the Global Minimum Corporate Tax: Reconsidering Tax Incentives after the GloBE Rules, OECD Publishing, Paris, https://doi.org/10.1787/25d30b96-en.
[4] OECD (2019), FDI Qualities Indicators: Measuring the sustainable development impacts of investment, OECD Publishing, http://www.oecd.org/investment/investment-policy/FDI-Qualities-Indicators-Measuring-Sustainable-Development-Impacts.pdf.
[2] OECD (2015), Policy Framework for Investment, 2015 Edition, OECD Publishing, Paris, https://doi.org/10.1787/9789264208667-en.