c roatia systematic country di agno st i c TABLE OF CONTENTS cr oat i a syst e mat i c co u nt ry di agno sti c ACKNOWLEDGEMENT 6 LIST OF ACRONYMS 8 EXECUTIVE SUMMARY 10 UPDATED COUNTRY CONTEXT: RECENT DEVELOPMENTS 1.  IN GROWTH, POVERTY REDUCTION, AND SHARED PROSPERITY 14  ONSTRAINTS TO CROATIA’S SUSTAINABLE, RESILIENT, 2. C AND INCLUSIVE GROWTH ON A LIVABLE PLANET 28  ublic sector inefficiencies hampering high-quality and equal 2.1. P service delivery to the people 29  emographic challenges and human capital deficiencies hindering labor supply 2.2. D 34  rivate sector productivity growth is held back by insufficient investments 2.3. P and a cumbersome business environment 42  ulnerability to natural hazards and climate change is high, and measures 2.4. V for adaptation and mitigation are under-developed 46 3. PRIORITIES 54  ffective public service delivery 1. E 57 Priority #1. Increase the effectiveness of public administration 57 Priority #2. Promote justice sector efficiency and strengthen anti-corruption policies 58 Improved human capital and social protection 2.  59 Priority #3. Improve the quality of human capital and labor market participation, especially for vulnerable groups 59 Priority #4. Provide robust and adaptive social assistance and social services 60 Better paid jobs through higher productivity 3.  61 Priority #5. Support investment in R & D, and green technology adoption to improve productivity and provide better paid jobs 61 Priority #6. Ensure a favorable business environment and access to finance, including to start-ups and vulnerable groups 62  nhanced environmental sustainability and accelerated green transition 4. E 62 Priority #7. Reduce environmental degradation and promote the blue economy transition 63 Priority #8. Promote energy production from renewables as well as energy efficiency 63 Priority #9. Enhance climate change resilience and disaster risk preparedness 64 KNOWLEDGE GAPS 4.  66 REFERENCES 68 ANNEX 1 74 c roatia systematic country di agno st i c LIST OF FIGURES Figure 1. Economic growth continues and is mostly led by exports 12 Figure 2. Income convergence has strengthened in recent years 12 Figure 3. Employment rate is on a rise, but remains below EU27 average 13 Figure 4. Employment growth led by market services sectors 13 Figure 5. The North-East region experienced the largest decline in population between 2011 and 2021 14 Figure 6. Poorer regions have seen a larger decline in population 14 Figure 7. Labor productivity growth between 2005 and 2022 among the lowest in the CEE region 15 Figure 8. Differences in labor productivity across sectors between Croatia and Germany in 2019 15 Figure 9. Robust economic growth has translated into fast poverty reduction 16 Figure 10. Croatia’s poverty rate is on par with EU countries that have similar income level 16 Figure 11. Poverty reduction progress was driven mostly by pension income, followed by labor earnings 17 Figure 12  Impacts of social transfers on poverty reduction in Croatia are among the lowest in the EU and on the decline 17 Figure 13. Pockets of poverty persist 18 Figure 14. The majority of the poor concentrated in Zagreb and the northern part of Croatia 18 Figure 15. Croatia is above the EU average in terms of inequality of opportunities in the EU. 19 Figure 16. Education and gender play major roles in determining one’s opportunities. 19 Figure 17.  Croatia lags the EU average in almost all governance indicators (standard normal units, 2022) 25 Figure 18.  While strategic planning has improved, Croatia’s implementation capacity remains limited 25 Figure 19. Disposition time by instance and by matter (days, 2021) 26 Figure 20.  Number of pending litigious civil and commercial cases in 2012, 2019 – 2021., (1st instance/per 100 inhabitants) 26 Figure 21. In Croatia, perception of corruption is among the highest in the EU 28 Figure 22.  Labor force participation is particularly low among women, Roma, youth, and those with low education attainment, representing an untapped workforce potential 30 Figure 23. Labor shortages are on the rise 31 Figure 24. The level of skills mismatch in Croatia is among the lowest in the EU, and on the decline 32 Figure 25. Croatian students’ PISA scores are consistently lower than the EU average 33 Figure 26.  Croatia’s participation in lifelong learning is the third lowest in the EU and far below the EU average 34 Figure 27. Private sector investment in the EU, 2019–23 average 37 Figure 28. R&D expenditures per capita, 2022 37 Figure 29. Croatia’s Digital Economy and Society Index score is still below the EU average 38 Figure 30. Recycling rate remains significantly below EU average 41 Figure 31. Croatia’s emissions intensity is significantly higher than the EU average 45 Figure 32. GHG emissions have declined over time 45 4 cr oat i a syst e mat i c co u nt ry di agno sti c LIST OF TABLES Table 1. High-Level Outcomes and Priorities 55 Table 2. Time horizon and Level of Impacts of each priority on other policies. 56 LIST OF BOXES Box 1. Development progress in Roma communities 26 Box 2. Digitalization 43 Box 3. Climate change induced natural hazards and agriculture 49 Box 4. Sustainability challenges for the Blue Economy 50 5 c roatia systematic country di agno st i c ACKNOWLEDGEMENT This report was prepared by a World Bank Group team led by Josip Funda (Senior Economist) and Nga Thi Viet Nguyen (Senior Economist), together with team members from across the World Bank Global Practices, International Finance Corporation (IFC), and Multilateral Investment Guarantee Agency (MIGA). The main contributors to specific chapters and background notes are listed below. Global Practice or Cross-Cutting Team Members Solutions Area Task Team Leaders Josip Funda, Nga Thi Viet Nguyen Country Management Unit Jehan Arulpragasam Ana Simundza, Kazimir Luka Bacic, Bogdanka Krtinic,   Operations Lidija Skarica, Martina Vojkovic   External Corporate Relations Vanja Frajtic, Petra Rozman Equitable Growth, Finance, Reena Badiani-Magnusson and Institutions Todor Milchevski, Francisco Campos, Matija Laco,  Finance, Competitiveness, and Andrea August, Jasmina Mrkonja, Ana Budimir, Innovation Martina Sahan Sedmak, Samantha Cook, Jo Kemp   Governance Pedro Arizti, Marina Kunovac, Srdjan Svircev  Macroeconomics, Trade, and Josip Funda, Iva Tomic, Alan Bobetko Investment   Poverty and Equity Nga Thi Viet Nguyen, Ivica Rubil, Martina Vojkovic Human Development Rafael E. De Hoyos Navarro  Education Lucia Brajkovic, Biljana Birac   Health, Nutrition, and Population Ali Hamandi, Anna Koziel, Luka Voncina   Social Protection and Labor Nithin Umapathi, Juul Pinxten, Ivan Drabek Sustainable Development Marc Sadler   Agriculture Augusto Garcia, Darko Znaor, Xueling Li  Environment and Natural Berengere P. C. Prince, Andrea Muharemovic, Resources Maja Murisic, Sameer Akbar   Social Sustainability and Inclusion Dianna Pizzaro, Fajar Argo Djati Zuzana Stanton-Geddes, Carli Venter,  Urban, Disaster Risk Marcel Ionescu-Heroiu, Yondela Tembakazi Silimela, Management, and Land Paul Scott Prettitore, Soraya Ridanovic  Water Stjepan Gabric Infrastructure Marc Sadler   Digital Development Charles Hurpy, Yigit Tahmisoglu   Energy and Extractives Mariano Gonzalez Serrano, Ivan Krofak  Transport Gozde Isik, Tamara Mihaljcic Ary Naim (Country Manager), Mariya Maerkova, International Finance Corporation Magdalena Soljakova Multilateral Investment Olga Sclovscaia, Bexi Francina Jimenez Mota, Gabisile Ndlovu Guarantee Agency 6 cr oat i a syst e mat i c co u nt ry di agno sti c The work was performed under the overall guidance of Marina Wes (Country Director), Jehan Arulpragasam (Country Manager), Ary Naim (IFC Regional Manager), Jasmin Chakeri (Practice Manager), and Ambar Narayan (Practice Manager). The team received advice and support from Reena Badiani-Magnusson (Program Leader), Rafael E. De Hoyos Navarro (Program Leader), and Marc Sadler (Program Leader). The team also benefited from guidance and feedback from the SCD Central Team – Alexandru Cojocaru (Senior Economist) and Samuel Freije-Rodriguez (Lead Economist). The team is grateful for a set of rich comments from peer reviewers: Pablo Salas Bravo (Senior Economist, CASAE), Moritz Meyer (Senior Economist, ESAPV), and Marc Tobias Schiffbauer (Lead Economist, ETIIC). The team thanks Collette Mari Wheeler and other colleagues for their insightful comments and support in finalizing the document. Minna Tong edited the report. The team extends its appreciation to public authorities across Croatia for their outstanding collaboration throughout the preparation of this report. Team also expresses its gratitude to the Ministry of Finance for its great contribution in thoroughly reviewing the report and for consolidating feedback from various institutions and agencies on behalf of the Government of Croatia. The SCD Update encapsulates the perspectives of a broad spectrum of Croatian society members who shared their insights through a comprehensive consultation process that used both qualitative and quantitative approached. During 2023, the World Bank conducted face-to-face consultation sessions in Zagreb, Split, Rijeka, and Osijek, which included semi-structured interviews, roundtable discussions, town-hall meetings, and site visits. These sessions received participation from public sector stakeholders – including relevant ministries, Office of the Ombudswoman, Offices of the Ombudspersons for Children; Gender Equality, and Persons with Disabilities and the Institute for Social Work - as well as representatives from the private sector, international organizations such as United Nations agencies and the European Commission in Zagreb and Brussels, embassies, civil society organizations and academia. Furthermore, 324 Croatian citizens offered their views through an online survey featuring both multiple-choice and open-ended questions. This survey was published on a specially designed webpage titled “Consultations: Croatia Systematic Country Diagnostic Update 2024” and open to the public between November 15, 2023 – December 15, 2023. The extensive feedback gathered from this process not only corroborated the findings of the SCD but also fine-tuned the report to more accurately reflect the on-the-ground insights and experiences of the stakeholders. 7 c roatia systematic country di agno st i c LIST OF ACRONYMS AI artificial intelligence ALMM active labor market measure ALMP active labor market policy CCDR Country Climate and Development Report CEE Central and Eastern Europe CLIAR Country-Level Institutional Assessment and Review CMU Country Management Unit CNB Croatian National Bank CO Cadaster Office COVID-19 coronavirus disease 2019 CO2 carbon dioxide CPII Croatian Pension Insurance Institute DESA Department of Economic and Social Affairs DWD Drinking Water Directive EC European Commission ECEC early childhood education and care EE energy efficiency EEA European Environment Agency ETS Emissions Trading System EU European Union FDI foreign direct investment FDP forcibly displaced people G2B government-to-business G2C government-to-citizen GDP gross domestic product GHG greenhouse gas GMB Guaranteed Minimum Benefit HAMAG-BICRO Croatian Agency for SMEs, Innovations and Investments HBOR Croatian Bank for Reconstruction and Development HERA Croatian Energy Regulatory Agency HLO high-level outcome HOPS Croatian Transmission System Operator HR human resources HRM human resource management HROTE Energy Market Operator IT information technology LDB Land Database LFP labor force participation LGU local government unit LRGU local and regional government unit LRO Land Registry Office LTRS Long Term Renovation Strategy IFC International Finance Corporation JIS Joint Information System 8 cr oat i a syst e mat i c co u nt ry di agno sti c MFF Multiannual Financial Framework MIGA Multilateral Investment Guarantee Agency MSME micro, small, and medium enterprises MSP marine spatial planning NAS National Adaptation Strategy NCD noncommunicable disease ND-GAIN Notre Dame Global Adaptation Initiative NECP national energy and climate plan NEET not in education, employment, or training NGEU NextGenerationEU NRRP National Recovery and Resilience Plan NRW non-revenue water OECD Organization for Economic Cooperation and Development PE population equivalent PFR Public Finance Review PIRLS Progress in International Reading Literacy Study PISA Program for International Student Assessment PIT personal income tax PPP public-private partnership PPP purchasing power parity R&D research and development RES renewable energy sources RRF Recovery and Resilience Facility SCD Systematic Country Diagnostic SIC social insurance contribution SMEs small and medium enterprises SOE state-owned enterprise SURE Support to mitigate Unemployment Risks in an Emergency TFP total factor productivity TIMSS Trends in International Mathematics and Science Study TVET technical and vocational education and training UWWTD Urban Wastewater Treatment Directive VA value added VAT value-added tax WDI World Development Indicators WGI Worldwide Governance Indicators WMC Waste Management Center 9 c roatia systematic country di agno st i c EXECUTIVE SUMMARY Country context and recent economic trends Croatia is a high-income country with solid macroeconomic fundamentals, which has contributed to the country’s accelerated income convergence with the rest of the EU in recent years. Over the last three decades, Croatia has made important progress in terms of economic growth, inclusion, and strengthening its institutions. Since 2018, when the first comprehensive Systematic Country Diagnostic (SCD) was conducted, Croatia’s economic growth has maintained a strong path, with annual GDP growth averaging 3.5 percent during 2018–23. While the COVID-19 pandemic in 2020 caused the deepest recession in the country’s history, the subsequent economic recovery was quick and strong, thanks to large and responsive fiscal and monetary support schemes. More broadly, solid growth in recent years has led to substantial progress in living standards, with GDP per capita (in purchasing power parity, PPP) increasing from 64.8 percent of the average EU27 level in 2018 to 76 percent in 2023. In line with robust economic growth, poverty has been falling rapidly over the last decade, but pockets of poverty persist. The share of the Croatian population living below the international poverty line for upper-middle-income countries (US$6.85 a day at 2017 PPP) declined steadily from 8.1 percent in 2012 to 1.8 percent in 2021. During this period, the poorest 40 percent of the population experienced faster income growth than the national average, owing to higher pension income, low unemployment rates, and increases in labor earnings. However, the risk of poverty remains high among marginalized communities, including people with low education, facing unemployment, and the elderly, especially those living alone. Positive economic developments were strongly supported by Croatia’s entry into the European Union (EU) in mid-2013. Access to the single market allowed Croatian firms to integrate better with European partners, leading to a gradual rise in the exports of goods and services, from 39 percent of GDP in 2012 to 54 percent in 2023. This was further supported by Croatia's entrance to the euro area and Schengen area as of 2023. In addition, the absorption of sizable EU structural and investment funds—in excess of EUR 13 billion (17 percent of 2023 GDP) until 2023—supported domestic demand, particularly public investment. EU membership has also served as an anchor for catalyzing policy reforms. Reform progress has gained further momentum following the COVID-19 pandemic, underpinned by the new EU instrument, NextGenerationEU (NGEU), which runs until the end of 2026. This has given Croatia access to abundant funds for investment subject to the implementation of crucial reforms presented in the country’s National Recovery and Resilience Plan (NRRP). Thus far, Croatia has fulfilled 28 percent of its milestones and targets under its NRRP—much higher than the EU average of 18 percent. The sustained inflow of EU funds, including from structural funds and NGEU, will continue to support relatively high growth over the next few years, but sustainable income convergence will hinge on addressing key structural constraints. Croatia has access to about EUR 24.5 billion of EU funds over the next five years, an amount equal to one-third of the country’s GDP in 2023. These funds, together with the reforms planned in Croatia’s NRRP, will continue to support economic growth and income convergence over the medium term. However, the level of financing from the EU is likely to decline at the end of the decade as Croatia’s income per capita gap with the EU average continues to narrow. More critically, long-term growth is expected to be dampened by various structural headwinds, including from unfavorable demographic developments, low labor productivity, and gaps in the efficiency of institutions. If these structural issues remain unaddressed, the projected pace of growth in the post-2030 period will not be sufficient to sustain income convergence, causing Croatia’s income per capita to plateau at around 80 percent of the EU27 average. 10 cr oat i a syst e mat i c co u nt ry di agno sti c Croatia is well positioned to achieve substantial progress on multiple fronts if it seizes the opportunities provided by macroeconomic and financial stability, green and digital transitions, and access to sizable EU funds. The Croatian economy continues to grow at about 3 percent annually—well above the average pace in the EU and euro area—and public debt is firmly on a downward trajectory. Moreover, evolving economic governance in the EU, as well as the path towards OECD membership, are giving new impetus to reform implementation in Croatia. Over the 2025-2030 period, economic growth will therefore remain robust, supported by strong inflow of EU funds, booming tourism sector, rising employment and large inflows of workers’ remittances that will foster personal consumption growth. Together, these trends create an environment where the return on further reforms can be substantial, leading to stronger, more inclusive and environmentally sustainable economic growth in the post-2030 period. In recent years, Croatia has started tackling some of its longstanding constraints to long-term growth, including by improving primary education, professional regulation, and the process of starting a business, but further constraints remain. Main constraints to sustainable and resilient growth and prosperity While significant progress has been achieved, remaining inefficiencies in the public sector and still relatively weak institutional capacity hinder the quality and equity of public service delivery. Croatia continues to face governance challenges and lags the EU average in multiple dimensions, including in regulatory quality, the control of corruption, and the rule of law. More specifically, while the government’s capacity for strategic planning and public policy making has improved in recent years, policy implementation and execution often lags due to weak cross-government coordination and insufficient administrative capacity. In addition, many aspects of the justice sector have yet to be addressed, including from the lack of digitalization of main judicial processes and functions, deficient infrastructure, cumbersome administrative procedures, and gaps in management skills among justice officials. Public sector inefficiencies can also be seen at the local government level, which is directly responsible for important segments of public service delivery but is often characterized by a high degree of administrative fragmentation and uneven institutional and financial capacity. In addition, Croatian SOEs participate in the provision of important public services such as transport and energy, but the SOE governance framework calls for further improvements, including for the development of a comprehensive ownership policy with explicit criteria and expectations for all parties involved. Another major constraint on higher and more inclusive growth is the availability of labor, reflecting demographic pressures and institutional factors that do not promote longer working lives. As in many other European countries, Croatia’s population is rapidly shrinking due to natural demographic change and aging, as well as to outmigration. Over the past decade, Croatia has lost 9.6 percent of its population, and is expected to lose a further 19.1 percent in the next three decades. At the same time, labor market participation remains relatively low, especially among older Croatians, marginalized communities, and those with low educational attainment. In addition, the pension system in Croatia does not promote longer working lives sufficiently. While the statutory retirement age in Croatia is similar to other EU countries, the early retirement options are broader, so the average length of service at retirement is among the shortest in the EU. The strong inflow of foreign workers over the last two years has only partly mitigated the adverse effects of labor shortages, but more needs to be done on their integration and upskilling. In addition to labor supply constraints, Croatia’s workface faces a relatively low skills base, calling for improvements in the country’s education, health, and social protection systems. This partly reflects systemic issues in education and training systems, such as the short lengths of compulsory education and instruction time in basic education, which continue to hinder Croatia in developing a workforce that can meet future labor market needs. This challenge is amplified by the digital transformation and the changing 11 c roatia systematic country di agno st i c requirements of the job market. The quality of the labor force is also affected by the health of the population, which is worse than the EU27 average on several dimensions, including for life expectancy and the number of healthy life years. In addition, more action is required to protect Croatia’s vulnerable and aging population by promoting lifelong learning and improving social assistance programs in their coverage of the poor to prevent the loss of skills during hardship. An inadequate base of skills in the workforce also constrains Croatia’s long-term growth and productivity, the latter of which is expected to remain low absent reforms. In addition to remaining human capital gaps, this reflects private sector underinvestment—including in R&D, innovation, and the green and digital transformations—and underdeveloped managerial practices. The business environment remains cumbersome in some areas, but progress has been achieved in lowering the high administrative and regulatory burdens on enterprises. In addition, market dynamism remains low and points to the presence of potential frictions and market inefficiencies. Finally, regarding the availability of financing, the green transition in Croatia will be difficult to achieve without significant financing flows from the private sector and further development and deployment of financing streams from the financial sector. In particular, domestic capital markets remain underdeveloped, and the availability of risk capital remains limited, which can impede dynamic and innovative start-ups and SMEs from bringing their innovations from concept to market. Another potential constraint for sustainable growth is the slow progress on the green agenda. While Croatia’s greenhouse gas (GHG) emission levels have generally been falling, emission intensity remains significantly above the EU average. Additional efforts to lower GHG emissions are needed, especially in the transport, energy, manufacturing, and building sectors, which are currently the biggest GHG emitters in the Croatian economy. In terms of greening the energy sector, further improvements are constrained by insufficient investments in renewables, largely due to cumbersome administrative procedures. Although Croatia’s waste management practices have improved, significant challenges remain, and Croatia has lagged other EU member states in transitioning toward a circular economy. Moreover, water losses remain high, and the disposal of wastewater through sewer systems is low. In addition, limited attention is being paid to reducing disaster and climate risks and strengthening financial readiness, despite Croatia being highly vulnerable to natural hazards and climate change. The way forward To address these constraints and seize the opportunities that lie ahead, this SCD Update lays out four broad outcome areas (High-Level Outcomes, or HLOs) that are required to achieve inclusive, resilient, and sustainable growth to improve the long-term wellbeing of people in Croatia. Under each outcome area, specific priority actions are identified through a process involving clearly defined criteria and consultations with internal and external stakeholders. The identification process was guided by four main criteria: expected impact on reducing poverty, boosting prosperity, and improving the environmental sustainability; complementarity with other policies and goals; feasibility under current economic, governance, and capacity conditions; and the time horizon for achieving results. The four broad outcome areas with corresponding priorities are presented below. Effective service delivery. Improving public sector governance as well as access to and the quality 1.  of public services will be critical to deliver on other priorities and shape the country’s future inclusive, resilient, and sustainable growth path. This will require strengthening the capacity of the public administration to implement policies and programs at the central and local levels of government and improving the corporate governance of SOEs, especially those that have a major role in public service provision, that could have positive spillovers to the private sector in terms of productivity 12 cr oat i a syst e mat i c co u nt ry di agno sti c as well. Prioritized actions will also be needed to address the inefficiencies of the justice sector in delivering timely and quality services to people and firms. Improved human capital and social protection. Both the quantity and quality of human capital in 2.  the context of an aging and declining population are constraining the prospects for inclusive growth in Croatia. This calls for improving the educational outcomes and skills of the available labor force to meet new labor demands as well as growing the workforce by increasing labor force participation—particularly of vulnerable populations and those in lagging regions—while also increasing the supply of foreign workers. To support longer working lives, the delivery and quality of primary and preventative health care will need to be improved. Measures to improve the social assistance system are needed to better protect the vulnerable and improve the resilience of households to shocks. Better paid jobs through higher productivity. A more dynamic private sector is needed to sustain 3.  growth and increase wellbeing through better paid jobs. Further unleashing the private sector will require increasing firm productivity through enhancing innovation and technological adoption, improving the business environment, and increasing access to finance—including for start-ups and vulnerable groups— while further mobilizing private capital, particularly to meet the financing needs of the green transition. Enhanced environmental sustainability and accelerated green transition. The sustainability of 4.  Croatia’s natural resources, especially given the importance of the tourism sector, is paramount to the sustainability of its growth path and the wellbeing of people living in Croatia and beyond. To this end, Croatia will need to prioritize fostering its blue economy and environmental protection, including water and waste management. In its energy transition for the climate change mitigation process, Croatia will need to increase energy produced through renewable sources, improve energy efficiency, advance industrial decarbonization and shift to less carbon-intensive modalities of transport. Climate adaptation will also require improved climate risk resilience and disaster risk preparedness. High-Level Outcomes PRIORITIES 1.  Increase the effectiveness of public administration 1. Effective public [also HLO-2, HLO-3, HLO-4] service delivery 2. P  romote justice sector efficiency and strengthen anti-corruption policies [also HLO-2, HLO-3, HLO-4] 3. I  mprove the quality of human capital and labor market participation, 2. Improved human  capital and social protection especially for vulnerable groups [also HLO-1, HLO-3, HLO-4] 4. P  rovide robust and adaptive social assistance and social services [also HLO-4] 5.  Support investment in R&D, and green technology adoption to 3. Better paid jobs  through higher productivity improve productivity and provide better paid jobs [also HLO-4] 6. E  nsure a favorable business environment and access to finance, including to start-ups and vulnerable groups [also HLO-2, HLO-4] 4. 7. R  educe environmental degradation and promote the blue Enhanced  economy transition environmental sustainability 8. P  romote energy production from renewables as well as and accelerated energy efficiency [also HLO-1, HLO-2] green transition 9.  Enhance climate change resilience and disaster risk preparedness 13 c roatia systematic country di agno st i c UPDATED COUNTRY CONTEXT: 1.  RECENT DEVELOPMENTS IN GROWTH, POVERTY REDUCTION, AND SHARED PROSPERITY 14 cr oat i a syst e mat i c co u nt ry di agno sti c Croatia is a high-income country with solid macroeconomic foundations, but structural rigidities cast a shadow on the country’s longer-term prospects, and the country is highly vulnerable to natural hazards and climate change. Endowed with a long Adriatic coastline, Croatia has a population of 3.9 million people. Over the last three decades, Croatia has made important headway in terms of economic growth, inclusion, and strengthening its institutions. By entering the European Union (EU) in 2013 and the euro area and Schengen area in 2023, Croatia advanced further in the process of European integration. However, its high vulnerability to natural hazards and climate change and its heavy reliance on tourism, which is mainly based on the natural beauty of the country, underscore the importance of having an environmentally sustainable growth model. Croatia’s economy has a large services sector, with tourism accounting for close to one-quarter of the country’s GDP. The share of services in total value added (VA) rose from 67 percent in 2003 to around 74 percent in 2023. Tourism has been an important driver of growth, employment, and household income, especially in the coastal part of Croatia, and now accounts for almost one-quarter of the economy.1 Robust tourism performance reflects the country’s comparative advantage, large investments in capital infrastructure, as well as preferential tax treatment of personal income from short-term rentals that has resulted in a private accommodation boom. This has, however, also had adverse impacts such as a rise in real estate prices or decrease in labor market participation. In addition, multiple increases in the number of visitors have created large pressures on local communal infrastructure and issues with waste and wastewater management, especially during the summer. Over the last two decades, Croatia’s development model has shifted from growth driven by domestic demand to more export-led growth. Economic growth between 2000–08 was driven mainly by domestic demand, which led to a strong rise in imports and the current account deficit. External funding relied mainly on debt financing, bringing a strong increase in gross external debt. The global financial crisis of 2008–09 exposed fundamental weaknesses of this growth model and pushed Croatia into a six-year recession, during which output fell by 11 percent and investment by 38 percent, while unemployment doubled to 17.3 percent by 2013 and the youth unemployment rate reached 50 percent. A more favorable external environment— with low energy prices and more global liquidity—along with EU accession helped turn the tide. A strong contribution of exports (underpinned by a strong tourist sector and recovery of merchandise exports to neighboring countries) and a pick-up in capital investment and private consumption (boosted by low energy prices and personal income tax cuts) resulted in average GDP growth of 3.1 percent during 2015–18. Membership in the EU since mid-2013 has had a major positive impact on Croatia’s economic growth over the last decade. Access to the single market supported recovery from the recession by allowing Croatian firms to integrate better with the European partners, leading to a gradual rise in exports of goods and services from 39 percent of GDP in 2012 to 54 percent in 2023. Almost three-quarters of this growth can be attributed to more intense trade with other EU Member States, especially CEE countries. Absorption of EU funds in excess of EUR 13 billion until 2023 supported domestic demand, especially large public investment but also to some extent private investment in productive assets. Similar benefits are expected until the end of this decade. Namely, the new Multiannual Financial Framework (MFF) as well as the NextGenerationEU (NGEU) program, including the Resilience and Recovery Fund (RRF), give Croatia access to about EUR 24.5 billion of EU funds over the next five years, an amount equal to one-third of the country’s GDP in 2023.2, 3 1 World Travel and Tourism Council (2024). 2 In 2020, the EU introduced the NGEU initiative, worth more than EUR 800 billion, as a direct response to the COVID-19 pandemic to support and accelerate socio-economic recovery and strengthen the resilience of the EU economy. The most important instrument under the NGEU is the RRF, which is a temporary instrument that provides grants and loans to support reforms and investments in the EU Member States until 2026. European Commission (2021c). 3 European Commission (2021c). 15 c roatia systematic country di agno st i c EU membership has also served as a catalyst for reforms, which gained momentum with the NGEU. By participating in the EU Semester, which is the EU’s framework for the coordination and surveillance of economic and social policies, Croatia kept its reform momentum after the accession, albeit with much less vigor. Nevertheless, additional improvements were achieved, especially in terms of the administrative burden and parafiscal charges for businesses, state footprint in the economy, and regulation of some professions. When the NGEU initiative was introduced in 2020, to be able to use the funds under the RRF, Member States had to prepare national recovery and resilience plans (NRRPs) with a list of planned reforms and investments. The Croatian NRRP includes a bold list of reforms in crucial areas like education, business environment, justice, health, and energy, and if implemented as planned, will have a significant impact on the country’s growth potential. Strong outward migration has taken place during in the initial years of EU membership, amounting to over 15% of the labor force. Croatia joined the EU during the recession when employment opportunities in the country were scarce meant that many unemployed or discouraged workers used their newly acquired right to move to other EU Member States. More than 250,000 people are estimated to have left the country since mid-2013, amounting to over 15 percent of the labor force. This has contributed to a labor shortage that many companies have reported to be the main constraint to doing business. On the other hand, workers remittances have been on the rise, reaching 2.5 percent of GDP in 2023, and have become a significant source for financing private consumption. Since 2018 when the first comprehensive Systematic Country Diagnostic (SCD) was conducted, Croatia’s economic growth has remained robust and largely export driven, despite a temporary contraction due to the impact of the COVID-19 pandemic. Gross domestic product (GDP) growth averaged 3.5 percent during 2018¬–23, which was significantly higher than the EU and euro area averages (1.4 percent and 1.2 percent, respectively). The composition of growth remained relatively favorable, with growth being led mostly by exports of both goods and services and private consumption financed by disposable income rather than debt (Figure 1). Before the COVID-19 pandemic, favorable economic developments also resulted in diminishing macroeconomic imbalances. Although the COVID-19 pandemic caused the deepest recession in Croatia’s history (GDP dropped by 8.5 percent) and reversed such trends, the economic rebound was quick and strong, supported by large fiscal and monetary support schemes and improved resilience to external shocks. While the fiscal stimulus package caused an increase in the fiscal deficit and reversed a decreasing tend in public debt, this too has proven to be only temporary. Labor market conditions improved over the last three years with average annual employment growth of 2.4 percent, but in the context of a declining population. Prior to the COVID-19 crisis, the employment rate jumped from 57 percent in 2013 to 67 percent in 2019,4 driven by the recovery of employment in manufacturing, tourism, and construction on one side, and fall in working-age population due to outmigration on the other (see Figures 3 and 4). Despite the severe fall in economic activity in 2020, the negative impacts on the labor market were mostly contained by the government’s employment protection scheme, financed partly by the EU’s instrument Support to mitigate Unemployment Risks in an Emergency (SURE) in the form of a loan at favorable interest rates. By mid-2021, employment fully recovered and reached a record- high rate of 70.7 percent in 2023, albeit remaining below the EU average of 75.3 percent.5 External factors, during and post-COVID-19 pandemic, resulted in an economic slowdown, rising prices, and concerns over energy security and the inflow of refugees. While flows of Ukrainian forcibly displaced people (FDPs) to Croatia were limited in comparison to other EU countries such as Poland 4 For the age group 20–64. 5 Eurostat (2024). Online data code LFSI_EMP_A. 16 cr oat i a syst e mat i c co u nt ry di agno sti c and Romania, post-2021 Croatia witnessed an acceleration of price inflation, especially for energy prices that had been on the rise since the last quarter of 2021. To mitigate the effects of the energy crisis and the accompanying cost-of-living crisis, the Croatian Government introduced several support measures for households and firms, including price caps for electricity and gas. Though largely untargeted and with significant fiscal cost, these measures however mitigated the impact of the crisis on the disposable incomes of households. Despite increased fiscal spending due to the pandemic and the energy crisis, Croatia’s fiscal policy has been largely countercyclical since 2020 and debt is firmly on a downward path. Fiscal policy played a major role in preventing a deeper recession in Croatia during the onset of the COVID-19 pandemic in 2020,6 while the energy crisis related to Russia’s invasion of Ukraine and subsequent surge in commodity prices required additional support measures. This has further increased already large government spending that stands at around 45 percent of GDP. However, domestic revenue mobilization remains strong, with tax-to-GDP ratio at 37.4 percent and buoyant non-tax revenues. The composition of the tax system, with high share of consumption taxes, is relatively growth friendly but its equity could be improved with rebalancing towards higher taxation of immovable property. While the fiscal stance has shifted from contractionary in the 2021–22 period to slightly expansionary in 2023, public debt has remained firmly on a downward path and stood at 63 percent of GDP at the end of 2023. However, Croatia’s debt path is vulnerable to adverse shocks, in particular with respect to growth. In addition, natural disasters related to climate change could intensify in the future and put additional strain on the sustainability of public finances. Croatia’s income convergence with the rest of the EU has accelerated in recent years, and growth is expected to remain robust also in the 2025-2030 period. Croatia has made substantial progress in living standards over the last ten years, with GDP per capita (in purchasing power parity terms) increasing from 62 percent of the average EU27 level in 2013 (when Croatia joined the EU) to 65 percent in 2018 and further to 76 percent in 2023 (Figure 2).7 Income convergence was supported by abundant funds from the EU budget (EUR 13 billion) that the country accessed during the last decade. The recent GDP growth acceleration is largely due to the booming tourism sector and the inflow of abundant EU funds, while strong labor market and large inflows of workers’ remittances, fostered personal consumption growth. Such trends are expected to support the robust growth also in the 2025-2030 period and the country is likely to reach 80 percent of the average EU level of income over the next few years. To sustain the growth and income convergence momentum, however, productivity has to become the main driver of growth. The level of financing from the EU is likely to decline after the current programming period and after resources for the NRRP end in 2026, stressing the need for much greater private capital mobilization in the future to maintain the current level of capital accumulation. More critically, structural headwinds related to unfavorable demographic developments, low labor productivity, and gaps in the efficiency of institutions will hamper growth in the post-2030 period. If these structural issues remain unaddressed, the projected pace of growth will not be sufficient to sustain income convergence, causing Croatia’s income per capita to plateau at around 80 percent of the EU27 average. It is therefore crucial that the country addresses the main growth constraints to allow for the productivity to become the main driver of growth in the long run 6 Overall fiscal effects of COVID-related measures amounted to 3.7 percent of GDP in 2020, 2.3 percent of GDP in 2021, 0.6 percent of GDP in 2022, and 0.3 percent of GDP in 2023 (Government of Croatia 2023). 7 GDP per capita growth in Croatia partly reflects the continuous decline in population. 17 c roatia systematic country di agno st i c Figure 1. Economic growth continues and is mostly led by exports Source: Eurostat, World Bank. Figure 2. Income convergence has strengthened in recent years Source: Eurostat, World Bank. 18 cr oat i a syst e mat i c co u nt ry di agno sti c Figure 3. Employment rate is on a rise, but remains below EU27 average Source: Eurostat. Figure 4. Employment growth led by market services sectors Source: CPII. Note: Market services sectors include Wholesale and retail trade, transportation, storage, accommodation and food service activities, ICT, Financial services, Real estate services, Professional services and other. 19 c roatia systematic country di agno st i c Croatia is facing intensifying labor shortages in almost all sectors, due to natural population decline, outward migration, and aging. Croatia’s labor supply is increasingly becoming a major constraint for higher growth, with almost all sectors facing significant labor shortages. Over the past decade, Croatia already lost a startling 9.6 percent of its population, especially in the North-East (Figure 5), and is expected to lose a further 19.1 percent over the coming 30 years. Regions with higher poverty rates are often associated with declining population (Figure 6). This population loss can be attributed in part to natural developments: Croatia’s birth rate declined from 9.8 to 8.8 over 2012¬–22, while the share of people over 65 years of age increased from 17.9 percent to 22.5 percent. Notably, the old-age dependency ratio (population 65 years or older to population 15–64 years of age) is projected to increase from 35.6 in 2022 to over 50 percent in 2050.8 Figure 5. The North-East region experienced the Figure 6. Poorer regions have seen a larger decline largest decline in population between 2011 and 2021 in population Source: World Bank staff calculation based on CBS (2016) Source: World Bank staff calculation based on CBS (2016) and 2011–21 Population Censuses. and 2011–21 Population Censuses. 8 Eurostat (2023). Online data code PROJ_23NP. 20 cr oat i a syst e mat i c co u nt ry di agno sti c Labor productivity in the Croatian economy remains low and will be a major impediment to sustained, accelerated long-term growth if not addressed. During 2005–22, Croatian labor productivity rose by 20.5 percent, compared to an average of 44.6 percent for other CEE economies (Figure 7). Although Croatia has made some progress in catching up with more advanced countries in the EU, it still takes on average almost three Croatian workers to produce the same value added compared to a single German worker, for example. Low firm productivity in Croatia reflects insufficient investments, including in improving research and development (R&D), innovation and technology adoption, business environment, managerial practices, and public institutions. In the post-pandemic period, productivity growth accelerated although the large gap compared to the best performers, though narrowing, persists, which calls for significant reforms and investment efforts. The sectoral composition of Croatia’s economy—the large role of low-skilled services such as tourism and the relatively small manufacturing sector—only accounts for a modest share of the productivity gap. The weakness in productivity relative to Germany is primarily due to poor within-sector performance which comes from several factors, including market frictions and inefficiencies, which likely reflect barriers to competition between firms. Manufacturing and ICT are among the sectors with the largest gaps in productivity compared to best performers in the EU (Figure 8). Firm-level data shows that old, inefficient firms are not outcompeted by new, more productive firms. Market frictions and inefficiencies are a key issue for the services sector, with restrictive regulations still in place in several professional services industries and with regulatory barriers to services trade that remain high. This also weighs on productivity across the economy by reducing the availability of high-quality intermediate services for downstream firms. Figure 7. Labor productivity growth between 2005 and 2022 among the lowest in the CEE region Source: Eurostat. 21 c roatia systematic country di agno st i c Figure 8 Differences in labor productivity across sectors between Croatia and Germany in 2019 Source: World Bank staff calculation based on Eurostat. Note: The value of 0.4 is interpreted as the labor productivity in a given sector being 60 percent lower than in Germany. In line with robust economic growth, poverty has been falling rapidly over the last decade, even with the soaring energy and food prices in 2022 and 2023. The share of the Croatian population living on less than US$ 6.85 a day at 2017 purchasing power parity (PPP) prices fell rapidly from 8.1 percent in 2012 to 1.8 percent in 2021 (Figure 9), bringing it in line with other EU countries at similar income levels (Figure 10).9 During this period, the poorest 40 percent of the population experienced faster income growth than the national average thanks to higher pension income, low unemployment rates, and improved labor earnings. Soaring food and energy prices in 2022 and 2023 threatened to reverse this progress, as the increased prices disproportionately affect low-income households due to the high share of those items in their total budget.10 However, the impacts were mitigated by a government support package which contained mostly untargeted measures and some measures directed at the vulnerable groups. It is estimated that without any financial support, poverty could have increased by 0.5 percentage points.11,12 9 EU member states—including Croatia—also have another concept of poverty, which uses at-risk-of poverty thresholds defined as 60 percent of the national median equivalized disposable income after social transfers. By construction, these poverty thresholds vary across time and across countries. Therefore, at-risk-of poverty concept cannot be used to compare poverty across countries or to track changes in poverty over time. For these purposes, the international poverty lines can be used instead. 10 Croatian Bureau of Statistics (2021). Low-income bracket refers to households in the bottom quintile of the income distribution. 11 World Bank (2023b). 12 At the same time, however, these subsidies discourage energy efficient upgrades of housing stock and a switch to energy-efficient appliances that would eventually lower the energy costs and benefit households in the long-term. Therefore, a more balanced approach is needed that would subsidize energy prices for vulnerable households but also allow prices to provide proper signals to consumers. 22 cr oat i a syst e mat i c co u nt ry di agno sti c Figure 9. Robust economic growth has translated Figure 10. Croatia’s poverty rate is on par with EU into fast poverty reduction countries that have similar income level Source: World Bank staff calculation using EU Statistics on Income Source: World Bank staff calculation based on WDI and PIP data. and Living Conditions (SILC) 2017-2022, referring to poverty rates Latest poverty rates for EU countries are from SILC 2022 referring 2016-2021. to poverty rates in 2021. GNI per capita data is from 2021. Much of the progress in poverty reduction has stemmed from growth in pension income, followed by labor earnings. Growth in pension income contributed to 45 percent of total poverty reduction between 2016–21, while labor income contributed to 28 percent (Figure 11).13 Policies related to the pension system and the reduction in the personal income tax (PIT) rate, social insurance contribution (SIC), and value- added taxes (VAT) of food and energy items lifted many Croatians out of poverty during this period.14 The share of the poorest households15 receiving pensions rose from 48 percent in 2016 to 61 percent in 2021 with their average pensions payments increasing by nearly 42 percent in real terms over the same period.16 Meanwhile, the majority of the working-age poor were not working and thus did not benefit from the PIT reforms and improved labor earnings,17 which explains why labor income has played a lesser role in reducing poverty in Croatia.18 Furthermore, despite the comprehensiveness of the social assistance system, there is a significant under-coverage of the poor. Most of the means-tested social assistance is allocated to the Guaranteed Minimum Benefit (GMB) and child allowances which together cover only around half of the poorest population. The impacts of social transfers (excluding pensions) on poverty reduction in Croatia are not only among the lowest in the EU but are also on the decline (Figure 12). 13 Using the decomposition approach introduced by Azevedo et al. (2013). 14 Notably, while the VAT reduction benefitted the poor due to their larger budget share on food and energy, the PIT reforms increased inequality because most of the tax benefits accrued to the richest (Nguyen and Rubil, 2021). 15 Poorest population refers to those in the bottom quintile of the income distribution. 16 World Bank staff calculation based on the SILC data 2017-2022, referring to income years 2016-2021. 17 According to SILC 2022 data, 66 percent of the at-risk-of poverty population aged 20-64 did not work compared to 19 percent of the same age group in the general population. 18 Labor income growth between 2016–21 already reflects any change of PIT reforms during this period. 23 c roatia systematic country di agno st i c Figure 11. Poverty reduction progress was driven mostly by pension income, followed by labor earnings Share of poverty reduction progress between 2016 and 2021 (percentage) Source: World Bank staff calculation using EU-SILC 2017-22 Figure 12. Impacts of social transfers on poverty reduction in Croatia are among the lowest in the EU and on the decline Source: Eurostat (2023). Online data code TESPM050. 24 cr oat i a syst e mat i c co u nt ry di agno sti c Although the level of income inequality is below the EU average, with a Gini coefficient of equivalized disposable income of 28.5 in 2022, pockets of poverty persist, and inequality of opportunity continues to be relatively high. Several population groups are left particularly vulnerable to poverty. The risk of poverty is highest among marginalized communities (see Box 1 on Roma), people with low education, elderly living alone, and unemployed people (Figure 13). The city of Zagreb and the northern part of Croatia are home to the largest number of poor (Figure 14). In terms of inequality of opportunity—the share of inequality that is due to circumstances beyond an individual’s control such as their gender and their family’s status19 —Croatia is the 8th most unequal country in the EU (Figure 15). Notably, gender and parents’ education level play major roles in determining their opportunities in life (Figure 16). Compared to EU peers, Croatians are also more pessimistic in terms of their belief in equal opportunities for getting ahead in life: only 23 percent believe so, compared to the EU27 average of 47 percent. This figure is 19 percent and 26 percent for Croatian women and men, respectively.20 Figure 13. Pockets of poverty persist Figure 14. The majority of the poor concentrated in Zagreb and the northern part of Croatia Source: World Bank staff calculation based on EU-SILC 2022 (referring to poverty rates in 2021) Note: * Poverty rates for Roma are based on EU-MIDIS-II (2021) Source: World Bank staff calculations based on CBS (2016) and which might not be compatible to other poverty figures based 2021 Population Census at the municipality level. on EU-SILC. 19 Factors include a person’s gender, geographical location, the educational achievements and financial status of their parents, as well whether they were raised in a two-parents household. 20 European Commission (2022b). 25 c roatia systematic country di agno st i c Figure 15. Croatia is above the EU average in terms Figure 16. Education and gender play major roles of inequality of opportunities in the EU. in determining one’s opportunities. Inequality of Opportunity Index Highest educated Town or city parent-Tertiary Dual-parent Male household Financial situation Highest educated Good/Very Good parent-Secondary Rural Financial situation Ok Source: World Bank staff calculations based on EU-SILC 2020 Source: World Bank staff calculations using Shapely decomposition data and methodology introduced by the European Bank for of Inequality of Opportunities for Croatia. Reconstruction and Development (2017). Box 1. Development progress in Roma communities While Croatia has achieved notable progress on Roma inclusion, poverty continues to be prevalent in the Roma community. The Roma population in Croatia is estimated to represent up to one percent of the national population,a with the largest population living in Međimurje county bordering Hungary. In 2021, fewer Croatian Roma lived in households experiencing severe material deprivation than in 2016. However, poverty prevalence continues to be widespread in the Roma community: in 2021, 86 percent of Roma in Croatia were still at risk of poverty. Access to basic services is improving, although significant gaps remain. The share of Roma children of all ages attending primary education increased steadily from 84 percent in 2011 to 93 percent in 2021. However, early childhood education and care (ECEC) rates are one of the lowest in the EU at 24 percent, compared to the EU average for Roma at 44 percent, hampering the attainment of foundational learning skills. A significant share of adult Roma21 have never participated in formal education nor completed primary education, with more women leaving education early (61 percent) compared to men (53 percent).b Early marriage, financial reasons, poor educational results, and early pregnancy are often cited as key reasons.c Similarly, while employment among Roma has improved, they still face discrimination. The percentage of Roma who declared being engaged in paid work increased from 21 percent in 2016 to 41 percent in 21 28 percent aged 24 – 44 and 46 percent aged 45+. 26 cr oat i a syst e mat i c co u nt ry di agno sti c 2021. However, the gender employment gap in paid work is strikingly high at only 21 percent of Roma women participating in paid work compared to 61 percent of Roma men. This gap is one of the largest among all EU countries surveyed in 2021.d While Roma’s experience of discrimination and harassment has generally improved since 2016, 27 percent of respondents surveyed still faced discrimination in various areas of life, particularly in seeking employment, education, health, housing, and public and private services (compared to 37 percent in 2016). More Roma men than Roma women felt that they were discriminated against for being Roma. Trust in the legal system is generally lower than among the general population at 26 and 21 percent, respectively, and slightly decreased from 28 percent in 2016.e Source: World Bank (2022b); FRA (2021); Kunac et al. (2018). a  Data discrepancies between the national census and various research on the Roma population indicate that potentially a significant proportion of Roma do not self-identify, most likely due to discrimination and stigma. b 28 percent ages 24–44 and 46 percent ages 45+. c Kunac, et al. (2018). d FRA (2021). e FRA (2021); FRA - EU-MIDIS II (2016). Significant disparities also persist in service delivery across regions and especially between urban and rural areas, and the administrative fragmentation of the country makes it difficult to address these disparities. In 2020, 76 percent of the urban population had access to safely managed sanitation, compared to only 5 percent of rural residents.22 Similarly, while transport connectivity is generally well-developed, it remains relatively poor in some rural areas, with very limited or non-existent public transport services.23 Regarding digital inclusion, a notable gap exists between the well-connected urban zones, such as the city of Zagreb or tourist areas, and the less connected rural hinterlands. Indeed, as of 2018, the coverage of fast broadband services in rural Croatia was the third lowest in the EU, with only about 32 percent of rural households having access. This figure stands in stark contrast to the EU’s goal of achieving full coverage by 2020.24 The distribution of healthcare infrastructure and medical staff also varies significantly, with central Croatia and particularly Zagreb having a much higher ratio of health facilities and health workers compared to more remote areas.25 In addition, the provision of social protection services varies widely across regions, leaving vulnerable people in lagging regions facing even greater risks of poverty and social exclusion.26 The significant fragmentation of the administration at the local and regional levels reduces the institutional capacity to undertake appropriate interventions, making it difficult to achieve more balanced territorial development and equitable access to public services across the country. Croatia will need to capitalize on its green transition to decouple economic growth from GHG emissions and put its growth on a more sustainable path. For example, the cost of environmental degradation from tourism only is estimated at EUR 55 million annually (about 0.1 percent of GDP in 2022), stemming largely from unsustainable solid waste and wastewater practices. Croatia is part of the European Green Deal (EGD), the collective response of EU member states to climate change, which established regulations and incentives to advance regional ambitions for climate mitigation and adaptation measures. Croatia has access to abundant EU funds for financing the green investment as well as managing the transition and supporting workers, with an important role for the private sector as well as policies aim to shift production from carbon-intensive “brown” sectors like cement or fertilizer production to “green” sectors like production of synthetic fuel or electricity from renewable sources. 22 Ministry of the Economy and Sustainable Development (2021). 23 Ministry of the Sea, Transport, and Infrastructure (2017). 24 World Bank (2021a). 25 OECD/European Observatory on Health Systems and Policies (2023). 26 Babić and Šućur (2022); World Bank (2019b). 27 c roatia systematic country di agno st i c CONSTRAINTS TO CROATIA’S 2.  SUSTAINABLE, RESILIENT, AND INCLUSIVE GROWTH ON A LIVABLE PLANET 28 cr oat i a syst e mat i c co u nt ry di agno sti c Since 2018 and especially since the adoption of the NRRP in 2021, Croatia has embarked on many important reforms, but challenges remain for the country to achieve higher, more inclusive, and greener growth. In recent years, Croatia has started tackling some of its longstanding issues, for example by piloting the whole-day school model in selected schools before its nationwide implementation by the end of the decade, privatizing numerous minority shares held by the government, reducing the tax burden for households and entrepreneurs, and further liberalizing regulated professions. However, to achieve higher living standards and create equal opportunities for the entire population, Croatia will need to further develop its public institutions and governance, improve the quality of human capital and the productivity of its private sector, and create an environment that ensures environmental protection and climate change resilience. For Croatia to achieve its development objectives, the country will need to address several cross- cutting issues such as finance, digital technology, skills, and governance as they are deeply interwoven, each playing a vital role in bolstering the country’s growth, inclusion, and resilience. Financial systems provide the backbone for economic activities, improving people’s wellbeing and enabling investments in digital infrastructure that can bridge the digital divide and foster innovation. As digital platforms become more prevalent, they require a workforce with the skills necessary to harness these new technologies as well as enhance the public sector’s capacity to deliver services faster and more effectively to the people. Concurrently, robust governance structures are essential to ensure that financial and digital advancements are equitable and sustainable and that they adhere to regulations that protect people’s interests. While these cross-cutting issues are fundamentally important across the board, this chapter will focus on areas where policy intervention is most urgently required.  ublic sector inefficiencies hampering high-quality 2.1. P and equal service delivery to the people Croatia continues to face governance challenges, lagging behind the EU average across almost all dimensions. As of 2022, Croatia has not been able to close the gap with other EU countries on broad governance indicators such as voice and accountability, regulatory quality, and government effectiveness (Figure 17).27, 28 While the NRRP foresees reforms that tackle some of these issues, further actions will be needed in strategic planning, cross-government coordination, and the human resource management (HRM) system in public sector. Since the EU accession in 2013, Croatia’s transition has been marked by gradual institutional reforms with mixed results.29 According to the World Bank’s Country-Level Institutional Assessment and Review (CLIAR)30, Croatia performs in the bottom 25th percentile relative to comparator countries with respect to public sector institutions, social institutions, and business and trade institutions. These institutions, at both the central and local government levels, are crucial for the country’s long-term development as they have the most influence on the design and implementation of reforms. Croatia performs in the mid-range in 27 WGIs are a research dataset summarizing the views on the quality of governance provided by a large number of enterprise, citizen and expert survey respondents in industrial and developing countries, that are gathered from a number of survey institutes, think tanks, non-governmental organizations, international organizations, and private sector firms, and do not reflect the official views of the World Bank, its Executive Directors, or the countries they represent, and are not used by the World Bank to allocate resources. 28 The only exception is political stability, for which Croatia has managed to reach the EU average. 29 World Bank (2023a). 30 Under this framework, Croatia was evaluated against the peer EU countries in nine institutional categories, namely Anticorruption, transparency, and accountability; Business environment and trade; Financial market; Labor market; Justice; Political; Public sector; Social; and SOEs corporate governance. 29 c roatia systematic country di agno st i c other institutional functions, including accountability, political, financial market, and justice institutions. While labor market institutions have demonstrated resilience through continued market liberalization, they can be improved to increase flexibility for firms31. Finally, as for the corporate governance of state- owned enterprises (SOEs) which is relatively well-developed compared to other CEE countries, more detailed analysis indicates significant room for improvement.32 Although the government’s capacity for strategic planning and public policy making has improved in recent years, implementation is often lagging due to weak cross-government coordination and the need for clear and measurable timetables and benchmarks. The 2017 reform of Croatia’s strategic planning system and the governance of regional development shows the country’s efforts to improve the management of public policies. However, the rollout of the first generation of strategic plans under the new system has revealed challenges such as lack of capacity for preparation, implementation, reporting, and evaluation. Inter-ministerial coordination in public-policy making is limited. There are numerous overlaps and inconsistencies in the legal system and mandates of public institutions, with inter-sectoral policy coordination often delegated to line ministries. Croatia’s 2022 SGI ranking on implementation capacity was near the bottom, at 38th out of 41 high-income countries with available data. 33 Recent strong implementation to date of Croatia’s National Recovery and Resilience Plan demonstrates the potential and ability of Government to set and achieve milestones and targets if there is strong cross-governmental coordination (in this case by the Office of the Prime Minister and the Ministry of Finance). Figure 17. Croatia lags the EU average in almost all Figure 18. While strategic planning has improved, governance indicators (standard normal units, 2022) Croatia’s implementation capacity remains limited Government Ministerial Effectivness Compliance 4.0 5.0 Regulatory Monitoring Enforcement Ministries 4.0 4.0 Monitoring National Agencies Standards Bureaucracies 4.0 4.0 Constitutional Task Funding Discretion 5.0 4.0 4.2 Croatia Source: WGI database; data for the EU are a simple average. Source: The Bertelsmann Stiftung Sustainable Governance Indicator (SGI) 2022. Note: This indicator relies on a combination of expert qualitative assessments and quantitative data drawn from official sources. 31 World Bank (2023a) 32 World Bank (2021b). 33 The Bertelsmann Stiftung (2022). 30 cr oat i a syst e mat i c co u nt ry di agno sti c One factor affecting public sector capacity is weak HRM. HRM in public administration in Croatia is the responsibility of the respective ministries, agencies, and local governments, with limited oversight from Ministry of Justice and Public Administration (MJPA), which often results in a divergence between actual practice and what was stipulated by the law. While there is a tradition of merit-based recruitment in the civil service (through an open, publicly announced competition), the absence of a competency framework for core positions hurts the ability to select candidates with specific skills for specific jobs. Jobs of the same or similar complexity can differ significantly in terms of salary. Finally, politicization of senior civil service positions remains an issue. Numerous reforms have been initiated as part of the NRRP—such as new wage-setting system relying on equal pay for equal job principle, introducing performance evaluations, and creating a system that attracts and retains talent. Strong political support will be needed during the first years of implementation to reduce the risk of reversal. Involvement of stakeholders in the government’s decision-making process has been improved but further efforts are needed. Various ministries and government bodies regularly conduct public consultations on draft acts through a central online portal.34 However, the use of other consultation methods remains limited, and there is scope for more meaningful stakeholder engagement at various stages of development and implementation of public policies. The limited quality of stakeholder engagement often results in a gap between stakeholders’ needs and proposed policy solutions, low citizen awareness of policy goals and outcomes, and consequently low public support for the implementation of new policies. While efficiency in the justice sector has improved considerably, many aspects remain to be addressed. The efficiency of the judiciary is critical to strengthen the business and investment environment and enhancing the country’s competitiveness. According to the EU Justice Scoreboard 2023, Croatia ranks third among EU countries in the number per capita of all pending cases and first for first-instance civil and commercial cases. Compared with the EU member states averages, the efficiency of Croatian courts measured by the disposition time, is lagging (Figure 19), while the number of pending litigious civil and commercial cases is consistently among highest (Figure 20). Figure 19. Disposition time by instance and by matter (days, 2021) Source: Council of Europe (2022). 34 esavjetovanja.gov.hr 31 c roatia systematic country di agno st i c Figure 20. Number of pending litigious civil and commercial cases in 2012, 2019 – 2021., (1st instance/ per 100 inhabitants) Source: EU Justice Scoreboard (European Commission, 2023c). Some causes for the inefficiencies include lack of digitalization of main judicial processes and functions, deficient infrastructure, cumbersome administrative procedures, and lack of management skills among justice officials.35 Another issue is the inadequate human resource policies: larger cities (such as the Municipal Court in Zagreb) face the largest, fastest-growing caseloads and appear to be under-resourced due to rigidities in personnel policies. This results in unbalanced caseloads and disposal delays. Enhanced support for evidence-based policy making, underscored by rigorous analysis of resource allocation and judicial performance, is crucial for tackling identified shortcomings in the sector.36 Public sector inefficiencies can also be seen at the local government level, which is directly responsible for important segments of service delivery but is characterized by a high degree of administrative fragmentation and limited institutional and financial capacity. Croatia’s administrative-territorial structure is characterized by many small local government units (556 in total), affecting economies of scale in the delivery of many public services. Local government is mandated to provide essential public services including housing, spatial and urban planning, communal services, preschool education, and culture. Almost two- thirds of municipalities have less than 3,000 inhabitants, and only a few of those have effective collaborative arrangements to enhance their capacity for efficient service delivery. Many cities and municipalities lack the managerial, human, technical, and/or organizational capacity needed to successfully perform all the functions entrusted to them. Finally, due to insufficient fiscal capacity, most local and regional government units (LRGUs) cannot perform their functions without significant transfers from the central budget.37 35 E-SPIS, the automated case management system, is in production from 2021. 36 The MOJPA proposed the Law on Amendments of the Law on Salaries and Other Material Rights of Judicial Officials (Official Gazette, number 71/2023) that enabled a wage increase in the justice sector in 2024. 37 World Bank (2021d). 32 cr oat i a syst e mat i c co u nt ry di agno sti c Inefficiencies in public service provision has led to chronic mistrust of the state and perception of corruption. This mistrust in government points to a need for further institutional reforms. There is an obvious “trust gap” between trust in the local and national governments in Croatia and what is seen in other EU countries: in 2022, less than one-quarter of Croatians expressed their trust in the national government—a rate that is only half of the EU average (47 percent). According to the Corruption Perception Index for 2023, perception of corruption in Croatia is the 5th highest in the EU (Figure 21). Nevertheless, there has been some improvement over the last two years. Only around 20 percent of Croatians and firms perceived courts and judges to be independent from the government, politicians, and economic and special interests compared to more than half among EU-27 citizens and firms.38 Low levels of trust in institutions makes it more challenging for the Government to implement reforms. The digital transformation provides a major opportunity to enhance public service delivery. Digitalizing the public sector could improve the accessibility, quality, and efficiency of services, lowering transaction costs in terms of time and budget for both internal users and beneficiaries of public services. In addition, the digital transformation can offer greater access to information, foster transparency, and build trust in the state. Croatia has made some progress toward this goal. For example, the number of e-services available on the e-Citizens platform for the integrated provision of the government’s digital services and the number of users has increased in recent years, especially during the COVID-19 pandemic.39 Significant progress has also been achieved in the area of land administration, including establishment of a single land information database, functional integration of land service procedures between Cadaster Offices (COs) and Land Registry Offices (LROs) and online access to land documents (registry and cadaster records). The justice sector is also gradually being digitalized with the e-communications system introduced in 2019. Figure 21. In Croatia, perception of corruption is among the highest in the EU Corruption Perception Index Source: Transparency International (2023). Note: Corruption Perception Index is shown on a scale of 0-100 where a 0 equals the highest level of perceived corruption and 100 equals the lowest level of perceived corruption. 38 European Commission, Directorate-General for Communication (2022). 39 European Commission (2023b). 33 c roatia systematic country di agno st i c Croatian SOEs play a significant role in economic activity and participate in public service provision, but the governance framework calls for further improvements. While the number of companies owned by the state has been falling, the SOE sector continues to be relatively large from an international perspective. The SOE sector in Croatia is estimated to account for approximately 5 percent of total employment, higher than in CEE countries and OECD countries.40 Croatia has 36 companies of special interest, including national companies in network sectors such as roads, highways, railways, and water as well as the development bank, lottery, and several airports.41 Despite improvements in recent years, the SOE governance framework remains deficient, and Croatia still lacks a consistent approach to state ownership in line with international standards. The SOE ownership function in Croatia remains fragmented among various government bodies, hindering proper oversight of the sector and undermining accountability. In addition, the Croatian state remains a relatively passive owner, without an effective monitoring system that would keep SOEs´ board and management accountable for their performance. Many Croatian SOEs unilaterally define their mandates and objectives, including financial targets, capital structure targets, and risk tolerance levels, without prior approval or consultation with their line ministries. Improved governance framework would also result in better financial results and reduced fiscal costs as well as increased innovation, productivity and private investment, especially those related to the green transition. Demographic challenges and human capital 2.2.  deficiencies hindering labor supply Croatia’s working-age population is on the decline due to natural changes and emigration. As mentioned earlier, Croatia’s population is rapidly shrinking and aging. The population shrunk from 4.3 million in 2002 to 3.9 million in 2022, and a further decline to 3.3 million by 2050 is expected. Moreover, by that time, approximately one-third of the population will be age 65 or older.42 The demographic challenge is compounded by a high rate of emigration, among the highest in the EU. According to the UN Department of Economic and Social Affairs (DESA), 23 percent of the 4.5 million Croatian-born population live abroad. In recent years, Croatian emigrants have tended to be more economically motivated, given the opportunities for free mobility following Croatia’s accession to the EU and the wage gaps between Croatia and Western European countries. In the short run, the outflows of migrants represent a loss of about 18 percent of the tertiary-educated population, reducing the much-needed skilled labor force.43 At the same time, many Croatians of working age still do not participate in the labor market, reducing the pool of potential workers. As of 2023, only 75.1 percent of Croatians ages 20–64 participated in the labor force, the third lowest rate in the EU.44 The country recorded the lowest male labor force participation (LFP) rate in the EU, with only 78.7 percent of men ages 20–64 participating in the labor market in 2023, compared to the EU average of 85.2 percent. In 2023, the female LFP rate was 71.4 percent in Croatia, 7 percentage points below the rate for men and 3 percentage points below the EU average for women. Fiscal policy effects cannot explain this difference, since the “inactivity trap” in which individuals lose their social assistance benefits and potentially become liable for more taxation if they were to transition 40 Ministry of Finance of the Republic of Croatia (2023). 41 In addition to companies of special interest, the government has a majority share in 11 and minority shares in more than 150 mostly market-oriented companies. Local government units still hold majority share in close to 800 companies. 42 Eurostat (2023). Online data code TPS00200. 43 World Bank (2024). 44 Eurostat (2024). Online data code LFSI_EMP_A. 34 cr oat i a syst e mat i c co u nt ry di agno sti c into employment, is largely the same as the EU average. Furthermore, since 2016, regular increases in the statutory minimum wage have increased incentives to work.45 The low LFP rates among Croatian women are consistent with a low enrollment rate in early-childhood education, the pervasiveness of inflexible working arrangements, and a high level of perceived pay gap and its implications for women’s careers.46 In 2023, more than 70 percent of children under age three lacked access to formal childcare,47 with women in the household typically filling the gap. In fact, Croatia’s participation rate in early childhood education was the second lowest in the EU, after Romania.48 In addition, over 80 percent of employed women reported having no control over their work hours, which the employers set unilaterally.49 Moreover, as of 2022, the average wages and pensions received by women in Croatia fell short of those of men by 24.8 percent. This gap has steadily increased since 2010.50 LFP rates are also low among older Croatians, marginalized communities, and those with low educational attainment, representing untapped workforce potential. The LFP rates for those population groups are well below the national average (Figure 22). In 2023, only slightly more than one-half of Croatians ages 55 – 64 were active in the labor market, the third lowest rate in the EU.51 The LFP gap by educational attainment is also substantial, contributing to a growing skill divide within the workforce. While the LFP rate among Croatians with tertiary education is high and comparable to the EU average at almost 90 percent, the rates are persistently low among those with non-tertiary education.52 Figure 22. Labor force participation is particularly low among women, Roma, youth, and those with low education attainment, representing an untapped workforce potential Source: Eurostat (2024) online data code LFSA_ARGAED, and EU-MIDIS-II (2021). Note: * LFP for Roma women is based on EU-MIDIS-II (2021) which might not be compatible to other figures based on EU-LFS. 45 World Bank (2024). 46 In 2022, 46 percent of Croatians believed the EU Parliament should tackle the pay gap between women and men and its impact on career development as a top priority, compared to the EU27 average of 41 percent (European Parliament 2022). 47 Eurostat (2023). Online data code ILC_CAINDFORM25Q. 48 Eurostat (2023). Online data code EDUC_UOE_ENRA10. 49 Based on the 2021 Labor Force Survey as referenced in World Bank, 2024. 50 Nguyen and Recher (2024). 51 Eurostat (2024). Online data code LFSA_ARGAED. 52 Eurostat (2023). Online data code LFSA_ARGAED. 35 c roatia systematic country di agno st i c Young Croatians are more likely than average European youth to be not in employment, education, or training (NEET), pointing to the issues with the school-to-work transition. In 2023, the NEET rate among Croatians aged 15–29 stood at 11.8 percent, placing Croatia ninth in the EU.53 Of this NEET population, more than half (6.1 percent) were inactive, while the rest (5.7 percent) were considered unemployed. The high proportion of unemployed in the NEET population highlights Croatia’s weak school-to-work-transition program and scarce opportunities for young people in the labor market. The situation is even starker for Croatian Roma youth: almost half of them are NEET—more than four times the national average.54 The pension system in Croatia contributes to the earlier exit of older workers from the workforce. While the statutory retirement age in Croatia is similar to other EU countries, the early retirement options are broad, so the average length of service at retirement—32.9 years in 2022—is among the shortest in the EU. Also, healthy life expectancy has been on the rise, up by 3.2 years over the last two decades to reach 68.6 by 2019.55 This calls into question current retirement age targets, as well as the wisdom of strict age limits for working life in general. Increasing working life can partly address labor shortages as well as the adequacy of pensions among the elderly after they leave the labor market. Labor shortages have become a major constraint for growth and have been only partly mitigated by the inflow of foreign workers and reactivation of pensioners. Job vacancies have been on the rise in recent years, indicating a boost in labor demand for medium-level skills and a stable demand for low-skilled workers.56 Over 30 percent of managers in the manufacturing and services sectors and over 50 percent of managers in construction reported labor shortages as a critical factor limiting their business growth (Figure 23).57 This share has been on the rise since 2016 and was only temporarily interrupted by COVID-19 crisis. The shrinking labor force has been offset to some extent by the increasing number of foreign workers, especially as the system of quotas has been replaced by a more flexible system, and foreign workers now account for nearly 10 percent of total employment. In addition, the government has made changes that allow pensioners to work up to four hours a day without losing their pensions, which has brought some people back to the labor market. As of September 2023, around 27,000 pensioners or 2.2 percent of total pensioners have used this option, representing 1.6 percent of the total number of employed. 53 Eurostat (2024). Online data code EDAT_LFSE_20. 54 World Bank (2022b). 55 World Health Organization (2020). 56 World Bank (2024). 57 European Commission (2023a). 36 cr oat i a syst e mat i c co u nt ry di agno sti c Figure 23. Labor shortages are on the rise Source: EIZ. Note: Online Vacancy Index (OVI) is a monthly index of online job advertisements developed by the Institute of Economics, Zagreb in cooperation with the web portal MojPosao. In addition to the availability of labor, another issue facing Croatia is the relatively low skills base of its workforce. While Croatia ranks high in the Global Competitiveness Report in number of school years (41st out of 144 countries), it ranks poorly (128th) in skills of the current workforce. In 2023, the share of Croatians between ages 25–34 with tertiary education was 38.7 percent, below the EU average of 43.1 percent and the EU-level target of 45 percent by 2030.58 Labor productivity per employed Croatian per hour was only 78 percent of the average employed European in 2022.59 Moreover, Croatia ranks 14th out of 31 countries on the European Skills Index, which covers the three pillars of skills development, skills activation, and skills matching.60 The skills base, however, reflects the current composition of the Croatian economy, with a relatively high share of the lower value-added services sector and a small share of high-technology manufacturing. Vertical skills mismatches in the labor market in Croatia are therefore low compared to the EU27 average of 22 percent, as in 2023 only 13.6 percent of Croatian workers with tertiary education ages 20–64 were employed in occupations for which they were over-qualified (Figure 24). 58 Eurostat (2024). Online data code EDAT_LFS_9903. 59 Eurostat (2023). Online data code NAMA_10_LP_ULC. 60 Cedefop (2024). 37 c roatia systematic country di agno st i c Figure 24. The level of skills mismatch in Croatia is among the lowest in the EU, and on the decline 40 education who are employed in occupations for which Percent of population aged 20-64 with a tertiary 35 a terriary education level is not required 30 25 20 15 10 5 0 SI L LU 7 K R Z U T G T T LV SE IE ES FR Y IT E E EE EL O FI SK L LT P P M A -2 N C C B D D H B H R EU 2023 2018 Source: Eurostat (2024), online data code SKS_MIS_LFSA. Systemic issues in the education and training system – including weak foundational skills development, lack of access to early childhood education and care, and limited alignment between school curricula and the skills needed in the labor market—continue to hinder Croatia in developing a workforce that can meet future labor market needs. The foundational skills of Croatian youth need improvement: even though Croatian students fare well on knowledge tests like the Progress in International Reading Literacy Study (PIRLS) and the Trends in International Mathematics and Science Study (TIMSS) assessments, when it comes to tests measuring “real-life” application of knowledge such as the Programme for International Student Assessment (PISA), Croatian students’ scores until 2022 were consistently lower than the EU average and remain lower in mathematics (Figure 25).61 Such educational outcomes reflect systemic issues related to lack of access to early childhood education and care (ECEC),62 short lengths of compulsory education and instruction time in basic education,63 and shortage of qualified teachers in certain subjects (for example, math and IT).64 In addition, a large share of the incoming labor force is a product of technical and vocational education and training (TVET) programs.65 Lack of coordination with employers in enrollment planning often results in students enrolling in programs that lead to qualifications not needed in the labor market.66 61 In 2022, scores in reading and science literacy reached OECD average. 62 Eurostat (2023). Online data code EDUC_UOE_ENRA10. 63 European Commission (2019). 64 MSE data and Vuković (2019). 65 In 2022, approximately 70 percent of secondary school students enrolled in TVET instead of general secondary schools, far above the EU average of 48.7 percent. 66 Ministry of Science and Education (2023). 38 cr oat i a syst e mat i c co u nt ry di agno sti c Figure 25. Croatian students’ PISA scores are consistently lower than the EU average Source: OECD. Croatia’s participation rate in lifelong learning, which enables the workforce to adapt to the ever- changing demand in the labor market, driven also by technological change and the green transition, is still among the lowest in the EU. In 2023, only 6.4 percent of Croatian adults ages 25–64 participated in education and training, far below the EU average of 12.7 percent and after only Bulgaria and Greece (Figure 26). The most cited reasons were high program prices, other personal and professional priorities, as well as family obligations.67 The participation rate is even lower among Croatians with vocational school degrees at 3.4 percent.68 Recently implemented micro-credential programs financed through the voucher system are expected to improve the participation rate in lifelong learning. Persistent inequalities—including regional disparities—can be seen throughout the education system. Lagging regions enrolled up to five times fewer children in ECEC than the most developed regions.69 Rural areas also struggle to hire qualified ECEC educators. Roma’s ECEC participation rates are also concerningly low,70 hindering the early learning of the Croatian language and the development of other skills needed for successful enrolment and completion in basic education.71 Students from lower socio-economic backgrounds are underrepresented in higher education,72 despite the Government’s efforts through scholarships, free tuition, and subsidized dormitories. 67 2017 survey conducted by the Agency for Vocational and Adult Education. 68 Eurostat (2024). Online data code TRNG_LFS_02. 69 UNICEF (2020). 70 Kunac, Klasnić, and Lalić (2018). 71 Borić and Radić Bursać (2022). 72 University of Zagreb Faculty of Law (n.d.). 39 c roatia systematic country di agno st i c Figure 26. Croatia’s participation in lifelong learning is the third lowest in the EU and far below the EU average Source: Eurostat (2024). Online data code TRNG_LFS_02. Croatia’s challenge of producing a sufficient workforce with an adequate skills base is amplified by the digital transformation processes. While Croatia is doing relatively well in basic digital skills,73, 74 digital literacy is generally lower among women, particularly those with lower levels of formal education, which reduces their resilience in the event of a pandemic and/or shifts in job patterns.75 Moreover, ICT specialists still account for a small share of the workforce in Croatia, at 3.6 percent compared to the EU average of 4.5 percent.76 Government interventions through labor market policies (LMPs), which could help boost employment and improve the quality of adult training, are underfinanced. Up to 2019, total LMP spending hovered around 0.7 percent of GDP, far below the EU average of 1.6 percent. Compared to the EU27, Croatia’s spending on Active Labor Market Measures (ALMM) such as training, job rotation, employment incentives, direct job creation, and entrepreneurship incentives is around the average. Participation in ALMMs is low in Croatia at approximately 12 per 100 persons wanting to work, compared to the EU average of about 32.77 Take-up is higher among users with less employment barriers in terms of age, skills, or length of unemployment spells, so ALMMs fall short in promoting the employability of excluded or strongly disadvantaged groups in the labor market. The quality of the labor force is also affected by the health of the population, which is worse than the EU27 average in several dimensions. The life expectancy estimate for Croatia is comparable to that in CEE but still three years below the EU27 average, and the gap is even larger for healthy life years. Overall 73 Eurostat (2023). Online data code ISOC_SK_DSKL_i21. 74 In 2020, the share of ICT graduates in Croatia (4.7 percent) was above the EU average (3.9 percent) (European Commission, 2022a). A similar trend can be seen for STEM graduates: in 2020, 16.3 women per 1,000 of population ages 20-29 graduated in STEM, compared to the EU average of 14.8 (Eurostat 2023, online data code EDUC_UOE_GRAD02). 75 World Bank (2021c). 76 European Commission (2022a). 77 OECD (2022). 40 cr oat i a syst e mat i c co u nt ry di agno sti c mortality from noncommunicable diseases (NCDs) in Croatia is slightly lower compared to CEE peers but higher than the EU27 average.78 Estimated cancer incidence in Croatia was close to the EU average, but the country had the second highest mortality from cancer across EU countries. Also, the country’s cancer survival rates were among the lowest in Europe, partially due to the insufficient or untimely undertaking of prevention programs. Improving the efficiency and equity of health service provision is instrumental for better outcomes of the treatment process. High prevalence of NCDs calls for targeted health prevention programs to the population, stronger support at the primary health care level, and focusing on the most vulnerable groups of population. However, compared to many of the EU countries, Croatia has an inadequate prevention system, demonstrated also by the high prevalence of the main risk factors like tobacco use, obesity or insufficient physical activity. In addition, the country relies excessively on the hospital system compared to primary care, which is both inefficient and expensive. Finally, more attention should be paid to the needs of the most vulnerable groups to ensure equity in service provision. Self-reported unmet needs are significantly higher for low-income households compared to the entire population reflecting weak economic situation, negligence, or lack of family to provide support, lower health literacy, and living in remote areas. Despite Croatia’s ageing population, the long-term care (LTC) system remains underdeveloped. According to the EC, care for elderly people in Croatia is mostly provided by families or relatives. Of households in need of LTC, 34 percent did not use professional home care services due to financial constraints, and another 11 percent due to unavailability of services. Workforce shortages contribute to the challenge – there are only 1.7 LTC workers per 100 people over 65 years of age compared to the EU average of 3.8. Moreover, the allocation of funds for LTC is inadequate,79 and the fragmented nature of the LTC financing system further hampers efficiency gains. In 2019, Croatia spent 0.4 percent of its GDP on LTC, which was significantly lower than the EU average of 1.7 percent.80 Social assistance programs in Croatia face challenges due to inadequate funding, complex application processes, strict eligibility requirements, and the potential for stigma. When compared to other EU countries, Croatia’s spending on social assistance is relatively modest with central non-contributory social assistance programs making up only about 1 percent of its GDP, and approximately 0.4 percent directed toward low-income households.81 The share of means-tested social assistance, such as the Guaranteed Minimum Benefit (GMB), also remains well below the EU average. Most of the means-tested social assistance budget is allocated to the GMB and child allowances, which together cover only around half of the poorest population.82 The process for applying for GMB is lengthy. Moreover, some of the eligibility requirements are stricter than in other EU countries, which can discourage people from applying. Despite an increase in the number of users, providers, and available financial resources over the last several years, social services are still performing poorly in three dimensions: availability, sustainability, and coordination. Significant regional and local disparities in the provision of social services remain, with a clear divide between urban and rural, as well as between developed and less- developed areas. The availability of services is uneven for all vulnerable groups; some services are widely accessible throughout Croatia, while others are limited to certain regions or not at all. Furthermore, the 78 Eurostat (2020). Online data code T_HLTH_CDEATH. 79 In 2019, Croatia spent 0.4 percent of its GDP on LTC, which was less than half the EU average. 80 European Commission (2021a). 81 World Bank (2019a) and World Bank (2022a). 82 Poorest population refers to those in the bottom quintile of the income distribution. 41 c roatia systematic country di agno st i c development of social services relies heavily on project funding, which makes the services unsustainable. Finally, there is a lack of coordination and intersectoral cooperation at all levels – including among sectors, ministries, local governments, and with civil society. Within the social welfare system, the dualisms of social service providers are visible, depending on who is their founder, whether they are licensed and whether they are in the social service network. Recent rise in house prices has introduced new challenges, which can impede labor mobility. In addition to energy prices, steep rise in housing prices surpassed household income growth eroding affordability for Croatian residents with adverse effects on their living conditions. Low tax rates on short-term rentals income, the lack of recurrent taxes on immovable property, government mortgage loans subsidies and strong foreign demand resulted in rising prices and reduced supply of residential housing for Croatians. Since 2015, and particularly after Croatia joined the euro area and Schengen area in 2022, house prices have increased by 78 percent, surpassing household income growth and absorbing an increasing share of household income. The situation is especially severe for low-income households and young families who are more likely to be first-time homeowners and is additionally aggravated by rising interest rates for housing loans. Moreover, the housing shortage is particularly acute in thriving regions, which can hinder the internal mobility of workers and exacerbate existing labor scarcities.  rivate sector productivity growth is held back 2.3. P by insufficient investments and a cumbersome business environment Private sector underinvestment—including in R&D, innovation, and the green and digital transformations— and underdeveloped managerial practices impair productivity growth. Private sector investment in Croatia amounted to 16.3 percent of GDP on average over the last five years, significantly below the EU27 average (almost 19 percent of GDP) and the best performers in the CEE region, Estonia and Czechia (more than 22 percent of GDP) (Figure 27). R&D spending of Croatian firms remains low, and innovation capacity is weak (Figure 28). The private sector struggles with developing R&D-based innovation, producing proprietary knowledge, developing technology transfer, and growing knowledge-intensive services and high-technology sectors. Furthermore, investments in digital and green technology that could boost Croatia’s growth remain low, due in part to missing infrastructure (see Box 2 on digitalization). The quality of managerial practices at Croatian firms is far from that in advanced countries primarily reflecting low adoption of best practices in performance management and data-driven decision making. 42 cr oat i a syst e mat i c co u nt ry di agno sti c Figure 27. Private sector investment in the EU, Figure 28. R&D expenditures per capita, 2022 2019¬–23 average Source: World Bank staff calculation based on Eurostat. Note: R&D expenditure per capita is the gross expenditure in R&D in the business enterprise sector, according to Eurostat classification Source: Eurostat. divided by total population. Box 2. Digitalization As one of the key pillars of the EU’s policy agenda, digitalizing the economy provides opportunities to improve transparency, raise productivity, and create new jobs. Challenges related to labor shortages, productivity, and capital investments intensify the need for technologically driven competitiveness. In Croatian firms, the use of advanced technologies such as big data or artificial intelligence (AI) applications is associated with higher productivity. For example, implementation of big data applications was associated with a 0.09 percent increase in total factor productivity (TFP) on average from 2016 to 2018.83 Firms that engage in knowledge acquisition via social web-based networks also experience higher turnover and employment growth and are more likely to introduce product and process innovations. Digitalization can also improve public service delivery to the population and entrepreneurs. As highlighted during the COVID-19 pandemic, digital platforms can help improve service delivery to the people. Health teleconsultations for primary care helped fill in for the drop in in-person consultations.84 In 2021, more than 60 percent of respondents in Croatia reported having received prescriptions online or 83 World Bank (forthcoming/a). 84 Croatian Institute of Public Health (2021). 43 c roatia systematic country di agno st i c by telephone, much higher than the EU average of 43 percent.85 In response to COVID-19, the Croatian Academic and Research Network (CARNET)—the principal agency responsible for the digitalization of education—helped transition the system to online teaching and learning. However, Croatia is still lagging in its digitalization efforts compared to the rest of the EU, especially regarding connectivity and digital public services. The country ranked 21st out of 27 EU countries in the 2022 Digital Economy and Society Index (DESI). The country performs well on digital skills and digital technology but fares poorly in digital connection and public service usage. The usage rates of digital public services are 69 percent (EU average of 75 percent) among citizens and 68 percent (EU average of 82 percent) among businesses. Investments to digitalize government-to-business (G2B) and government-to-citizen (G2C) services are needed to make information more accessible, lowering the cost of accessing services and improving the quality and efficiency of delivering such services.86 Figure 29. Croatia’s Digital Economy and Society Index score is still below the EU average Source: DESI Eurostat 2022. Private sector digitalization has been unbalanced between and within firms, with a significant share of firms relying on non-digital technologies for most of their business functions. Preliminary results of the 2023 Firm Adoption of Technology (FAT) survey found a substantial gap in technology adoption and use between large firms and medium-to-small firms. Croatia underperforms in creating new digital technologies (publications, patents, and start-ups) relative to peers, and access to finance for start-ups is limited. 85 European Commission (2021b). 86 European Commission (2022a). 44 cr oat i a syst e mat i c co u nt ry di agno sti c Market dynamism remains low and points to the presence of potential f rictions and market inefficiencies. Firm density increased rapidly over the last decade thanks to a consistently high net firm entry rate. However, the density of firms in Croatia – the number of firms per million inhabitants – remains among the lowest in the EU. Net entry is high primarily because of a lower-than-average exit rate, pointing to the presence of potential frictions and market inefficiencies limiting competition in the markets. These include inefficient bankruptcy procedure, restrictive regulations in several professional services industries and regulatory barriers to services trade. Given the relatively limited but expanding number of firms in Croatia, the about-average entry rate and below-average exit rate can be interpreted as a sign of possible underlying market inefficiencies stifling business dynamism. In addition, markups – a measure of market power – increased over the last decade, driven primarily by high markup firms and suggesting that market mechanisms have become weaker over time. While Croatia has made progress in lowering the high administrative and regulatory burdens on enterprises, the business environment remains challenging. Across the economy, Croatian businesses are subject to complex mandatory approvals for entry and operation, such as burdensome licensing procedures and legal requirements. Currently deployed ICT solutions such as the introduction of the START platform are a step in the right direction and contribute to the more uniform process across the country. Still, the interoperability and integration of data of the public sector are to follow, and further efforts are needed to strengthen G2B service delivery.87 Burdensome procedures to obtain construction permits, the high compliance costs and the opaque information on planning and zoning requirements further undermine the private sector’s growth potential. Lack of transparent guidance is repeatedly raised by firms as the “most problematic factor for doing business”, and time spent by management on processes related to government regulations in a typical week is associated with an estimated reduction of 12.2 percent in firm TFP.88 Access to finance is not a major constraint for Croatian firms, however, capital markets remain underdeveloped. Banking finance dominates the financial market, which is less accessible for younger, smaller, and more innovative firms. The banking system has a sound level of profitability and is well- capitalized. Bank loans are still the preferred debt financing option for Croatian firms as they are perceived as the best option considering its simplicity, price and maturity options. Loans to corporates totaled only 19.6 percent of GDP in 2023, with just one-third of corporates having a loan. Roughly half of the loans go to small and medium enterprises (SMEs), compared to around 60 percent in EU peers. Croatia’s capital markets are among the smallest in the EU and are characterized by low liquidity in the secondary market. The number of listed companies has been falling since 2009–10 as has the annual turnover ratio on the stock ¬exchange.89 Corporate bond issuance tends to be more accessible to financial institutions and larger companies as they are better prepared to fulfill regulatory/reporting obligations and usually have greater capacity to reach higher rating levels, issue larger volumes and attract greater investor demand. Availability of risk capital remains limited but has been supported by available EU funds; assets of private equity funds make up less than 0.3 percent of GDP, and angel investments are almost non-existent. Without Source: World tangible assets to use as collateral, many start-ups and SMEs struggle to acquire Bank (forthcoming/a) the risk finance needed to bring their innovations from concept to market. Croatian businesses show lower levels of capitalization compared to peer countries. 87 START is an information system that allows users to start a business easily and quickly, from any location and with one elec- tronic procedure. 88 World Economic Forum (2019). 89 Turnover ratio is the value of shares traded divided by their market capitalization. 45 c roatia systematic country di agno st i c The green transition in Croatia will be difficult to achieve without stronger support of the financial sector. While EU and domestic public funds can provide substantial financing, the private sector and in particular the financial sector also have a key role to play in the green transition. However, the banking sector has limited capacity to provide climate financing. According to Croatian National Bank (CNB) estimates, less than 4 percent of banking loans in Croatia are directed to green loans and since 2007. Croatia has issued only US$2.3 billion in sustainability-linked bonds and loans90. At the same time, banks’ balance sheets are strongly exposed to both climate-related physical and transitional risks, with the former accounting for one-third of their exposure to all non-financial corporations and the latter amounting to 6 percent of the total exposure of credit institutions.91 Coupled with a shallow capital market as an alternative source of funding, this situation highlights the weaknesses of the overall financial sector in meeting climate financing needs. Vulnerable groups face entry barriers to entrepreneurship. The early-stage entrepreneurship rate is generally above the EU average according to the OECD. Women and people in older cohorts (ages 50–64) are considered to be one of the largest groups of “missing” entrepreneurs.92 Almost 80 percent of these missing entrepreneurs are women, and nearly 75 percent of them are over 50 years old. Out of a total of 135,869 companies operating in the country in 2021, only 18.6 percent were exclusively owned by women, with another 8.1 percent being co-owned by women.93 At the same time, Croatia has the third-lowest share of people in older cohorts in the EU who are involved in creating businesses.94 Some key barriers include low levels of financial literacy and entrepreneurial skills, compounded by complex regulatory and environmental environments and lack of collateral. Such problems tend to disproportionately affect the Roma, who have low participation in entrepreneurial activities (2.1 percent of the total group population report being self-employed).95 From the supply side, limited choices of fit-for-purpose financial products (of smaller amounts) due to insufficient capacity to process small loan requests and perceptions of credit risks among financial institutions often deter financing for these groups.96  ulnerability to natural hazards and climate 2.4. V change is high, and measures for adaptation and mitigation are under-developed With natural resources being so fundamental to Croatia’s development, the sustainable use of these resources is essential for ensuring sustainable economic growth and delivering positive environmental outcomes. While Croatia has made progress in transitioning toward sustainable environmental management across the board, it is still underperforming in several environmental domains such as waste management practices, the uptake of circular economy principles and practices, and management of coastal and maritime ecosystems. Given that some of Croatia’s key economic sectors (most notably tourism) rely on the use of its natural endowments, continuing the same trends and practices could undermine the value of Croatia’s ample natural capital while also limiting opportunities for economic diversification and development, ultimately undermining the socio-economic outcomes for Croatia. 90 BNEF Sustainable Finance Database. 91 Croatian National Bank (2021). 92 OECD (2023). 93 Share of women entrepreneurs in the ownership structure of companies from 2012 to 2021 Financial Agency (2022). 94 OECD/European Commission (2023). 95 Office for Human Rights and Rights of National Minorities of the Government of the Republic of Croatia (2021). 96 World Bank (forthcoming/b). 46 cr oat i a syst e mat i c co u nt ry di agno sti c Although Croatia’s waste management practices have improved, significant challenges remain. Even though Croatia has made improvements in terms of harmonization with EU directives, its current practices could make it difficult to meet the EU targets related to recycling of waste and preparation for reuse, packaging waste, and limiting the landfilling of municipal waste by 2035. Croatia generates around 1.7 million tons of municipal waste annually, while still relying strongly on landfilling. Although the landfilling share has been decreasing, the share of municipal waste being landfilled remains almost three times more than the EU average, as Croatia underperforms in the sorting, collection, and recycling of waste (Figure 30). Similarly, although some progress has been made in material recycling, the total recycling rate in 2022 was 34.2 percent. In addition, the strong seasonality of tourism places increased pressure on local infrastructure, including the waste management sector. Figure 30. Recycling rate remains significantly below EU average Source: Eurostat. Croatia has been lagging behind other EU member states in transitioning toward a circular economy. A circular economy is a model of production and consumption, which involves sharing, leasing, reusing, repairing, refurbishing, and recycling existing materials and products as long as possible. It reduces demand for natural resources and minimizes waste. In 2021, the Croatian economy was only 5.7 percent circular, meaning that only 5.7 percent of material resources in Croatia came f rom recycled waste materials, compared to 11.7 percent across the whole EU.97 The Croatian government acknowledges the country’s need to transition toward circularity and is trying to apply circular economy approaches in waste management policies and strategies. While significant improvements have been made with respect to water management, water losses remain high, and disposal of wastewater through sewer systems is low. Although Croatia has near-total 97 World Bank (2023c). 47 c roatia systematic country di agno st i c access to basic and safe drinking water and high coverage of water services, the existing infrastructure is aging, and the water network experiences high leakage rates. The average age of water pipes is more than 40 years, and the systems suffer from maintenance backlogs. The significant water losses lead to high non-revenue water (NRW) and a concomitant waste of energy. Croatia’s average NRW (50 percent) is more than double the EU average (23 percent), with up to 80 percent for poorer-performing utilities.98 Furthermore, the annual total environmental costs due to pollutant discharge of wastewater are estimated at EUR 664 million, equivalent to 1.0 percent of GDP in 2022. Croatia has committed to increasing its sewer and wastewater treatment connections, but progress has been slower than planned, and the country is far from achieving the EU targets. Urban wastewater needs to be treated before discharge to avoid polluting the environment, but only 53 percent of the population is connected to a public sewage system,99 and only half of wastewater collected is treated up to the required level in wastewater treatment plants. Croatia is highly vulnerable to natural hazards and climate change. Due to a combination of political, geographic, and social factors, Croatia is recognized as highly vulnerable to climate change impacts, ranked 51st out of 181 countries in the 2020 Notre Dame Global Adaptation Initiative (ND-GAIN) Index. According to the European Environment Agency (EEA), Croatia is also among the countries with the highest share of damage f rom extreme weather and climate events in relation to GDP.100 Average annual losses from flood damage to private and public buildings are estimated to be between 0.3 to 0.4 percent of GDP.101 A comprehensive assessment of climate change-related impacts and vulnerabilities in Croatia was conducted as part of the National Adaptation Strategy (NAS) development in 2017. It found that in the period 2040–70, Croatia’s air temperature will increase by 3.0-3.5°C during summer, while the amount of rainfall will decrease during winter. More extreme weather events will occur, including droughts and heat waves in the summer. By the end of the 21st century, the sea level in the Adriatic will rise between 32–65 cm. Projected climate change impacts and risks include biodiversity loss, lower yields, soil degradation, more pests and diseases, and forest fires, all of which could bring significant economic losses. In agriculture, crop production will be particularly hit due to lack of access to irrigation water and lower expected precipitation (see Box 3). For the blue economy sectors, the impacts of climate change will appear through sea-level rise, increase in sea temperature, acidification, and extreme weather events (see Box 4). Such events would have a severe adverse effect on fisheries (mostly for capture fishery and, to a lesser extent, aquaculture) and tourism, the most important sector of the economy. The main expected impacts for tourism include a decrease in tourist demand in the summer months due to high temperatures, increased UV radiation, and greater frequency and strength of extreme weather events; a reduction or loss of the attractiveness of ecosystems and biodiversity for tourism; a reduction of water availability and damage to various infrastructure systems and/or their reduced functionality. 102 98 Non-revenue water (NRW) is water that has been produced and is "lost" before it reaches the customer. 99 According to the Ministry of Economy and Sustainable Development data (January 2024). 100 European Environment Agency/European Commission (2022). 101 World Bank/European Commission (2021); Dottori et al. 2020. 102 Ministry of Economy and Sustainable Development (2020). 48 cr oat i a syst e mat i c co u nt ry di agno sti c Box 3. Climate change induced natural hazards and agriculture Croatian agriculture is heavily affected by extreme weather events such as drought and flooding, and the sector is highly vulnerable due to poor or lacking drainage and irrigation systems. Croatian agricultural soils are prone to erosion (50 percent of the agricultural area), are severely compacted, and have low organic matter content which is in constant decline. A drainage system is available in only 20 percent of the agricultural area, where it has deteriorated and properly functions in only about half of the area. These factors make Croatian agricultural soil prone to waterlogging and flooding, resulting in soil erosion and nutrient leaching which negatively affect crop yields and quality. In the period 2015¬–20, almost 80 percent of Croatian farmers experienced flooding on their fields, resulting in a significant reduction in yields. At the same time, due to poor drainage and the soils’ low water holding capacity, water is retained at the soil surface, resulting in less water being stored in the soil. This, combined with the lack of irrigation systems (only 1.9 percent of the agricultural area is irrigated), makes Croatian agriculture prone to droughts, which have a significant impact on Croatian agriculture.103 A combination of mitigation and adaptation measures could improve water retention in the fields and reduce damage, but farmers hardly use such measures. The flooding and droughts highlight the need for adaptive and resilient agricultural practices in Croatia, but the policy response has been inadequate. Efficient water management systems (both smart drainage and smart irrigation solutions), the use of drought-tolerant crop varieties, an increase in the water holding capacity of the soil (by sequestering carbon and avoiding soil compaction), and sustainable land management techniques could help address flood and drought risks and make Croatian agriculture more resilient to climate variability, ensuring food security and the long-term sustainability of rural livelihoods. Notably, neither the Croatian Common Agricultural Policy Strategic Plan (CAP SP) nor the National Irrigation and Drainage Program comprehensively address these problems. The latter was funded by EUR 30 million but failed to reach the target of 65,000 irrigated hectares by a large margin. 103 The drought in the summer months between 1980 and 2014 was the single largest cause of damage to Croatian agriculture by climate variability. In the period from 2013 to 2016, it caused damage totaling EUR400 million or 43 percent of direct payments to agriculture in the same period. 49 c roatia systematic country di agno st i c Box 4. Sustainability challenges for the Blue Economy Despite the blue economy sectors being an engine for economic growth, they face sustainability challenges that could hamper future growth. The Croatian blue economy sectors, including coastal tourism, maritime transport, shipbuilding, fisheries and aquaculture, and oil and gas, contribute to the livelihood of 160,000 people in Croatia (10 percent of national jobs). However, these sectors are highly vulnerable to climate change, with risks such as rising sea levels and extreme weather already affecting key sectors. Environmental degradation, estimated to cost 2–3 percent of GDP, is exacerbated by tourism-related waste and marine litter, costing around EUR 21 million annually in damage to marine ecosystems. These issues not only threaten economic diversification and reduce the value of maritime assets but also affect the quality of life for coastal communities. While Croatia recognizes that developing a sustainable blue economy is a national priority, further progress is needed. National strategies and policies (such as the Maritime Development and Integrated Maritime Policy Strategy, Agriculture and Fisheries Strategy, and Sustainable Tourism Development Strategy 2030) reflect Croatia's commitment to environmentally sustainable growth and strategic investment in its maritime assets. Croatia has also made significant strides in integrating EU Directives to protect maritime spaces and marine ecosystems, including implementation of the Marine Strategy Framework Directive for ecosystem-based marine management and the Marine Spatial Planning Directive. That said, for Croatia to fully capitalize on the opportunities presented by its maritime economy and to move toward the Blue Economy concept, it will need to foster a robust institutional framework, formulate clear policy directives, and support a favorable financial ecosystem. Not enough attention is being paid to reducing disaster and climate risks and strengthening financial readiness. This was made apparent following the recent earthquakes of 2020. Croatia has a large stock of aging infrastructure, and new buildings—that is, those in compliance with modern building codes—account for only an estimated 5–10 percent of building stock in Croatia.104 Looking just at critical infrastructure buildings related to emergency response like fire stations, police stations, hospitals, and schools, around 90 percent of those buildings could be exposed to at least strong seismic shaking.105 Croatia has no systematic targeted effort to assess and reduce disaster and climate risks in a multi-hazard manner, and promote integrated solutions as part of rehabilitation and reconstruction, pointing to limited local practice and expertise in combining energy and seismic retrofitting.106 In addition, the country faces challenges related to financial resilience as the country has no disaster risk financing strategy in place. Disaster risks are not currently included in Croatia’s fiscal strategy, medium-term forecasts, or annual budgets; nor are disaster-related expenditures tracked. Croatia could face high financing gaps, considering the potential impacts of earthquakes and floods vis-à-vis the existing post-disaster financing arrangements/instruments it has in place. 104 At the EU level, around 40 percent of buildings were constructed before the 1960s (European Commission, n.d.) 105 Ongoing spatial exposure analysis as part of World Bank and European Commission report (2024). The analysis uses EU-wide data and does not consider the condition of buildings or existing mitigation measures. Related to wildfire, the result of the analysis is based on the EC Joint Research Center (JRC) pan-European wildfire assessment data (Jacome Felix Oom, D. et al., 2022). 106 Noting that seismic upgrading was not included in the EU funding available under the 2014–20 multi-annual financial frame- work. 50 cr oat i a syst e mat i c co u nt ry di agno sti c While Croatia’s GHG emission levels have generally been falling, additional efforts are needed, especially in the transport, energy, manufacturing and building sectors. In 2021, GHG emissions in Croatia were 5.6 percent below 2019 pre-pandemic levels and 41.9 percent lower than 1990 levels. However, although it is on a steady downward trend, the country's emissions intensity is significantly higher than the EU average (Figure 31).107 Croatia has made advancements in its climate change mitigation efforts in alignment with EU policies and targets. The EU's binding climate and energy legislation for 2030 requires member states to adopt national energy and climate plans (NECPs) for the 2021–30 period. The NECP and other key national and sectoral strategies that aim to decarbonize the economy highlight the potential for further GHG emission reductions in the transport, building, and agriculture sectors, but without setting sectoral targets or elaborating on the policies and measures needed. The Commission assessment of the Croatian NECP therefore points to a lack of detail concerning the implementation or impacts of proposed policy measures. Figure 31. Croatia’s emissions intensity is significantly higher than the EU average Source: EC, Eurostat. Figure 32. GHG emissions have declined over time Source: Eurostat. 107 Emission intensity measures GHG emissions per unit of GDP. 51 c roatia systematic country di agno st i c In particular, the transport sector accounted for one-third of Croatia's total emissions in 2021. Sizeable emissions from the transport sector reflect one of the lowest shares of renewable energy sources in the sector (2.4 percent in 2022) in the EU (9.6 percent). Road-based transport accounts for 95 percent of Croatia's transport sector CO2 emissions, and any scenario to "green" transport must include shift away from roads. This would require increased use of inland waterways, railways, urban public transport, and non-motorized transport. However, only 33 percent of Trans-European Transport Network (TEN-T) waterways network and only 5 percent of core TEN-T railways network lines in Croatia have been completed. Moreover, rail has a share of 2.5 percent in passenger land transport, well below the 8 percent in the EU. In terms of freight, Croatia stands somewhat better with the share railways in total inland freight transport reaching close to 25 percent, compared to 17 percent for the EU. Railway infrastructure has suffered decades of underinvestment and weak management. The implementation of the Railway Development Strategy adopted by the Croatian government in 2022 will be crucial for modernizing the infrastructure and rolling stock, thus increasing the attractiveness of rail as an alternative transport mode. In terms of the energy sector, further improvements are being held back by insufficient investments in renewables due to cumbersome administrative procedures. Croatia’s 2030 target of a 36.4 percent share of renewables in the overall energy consumption is focused mainly on increased uptake of photovoltaics, wind, and biofuels. Most of the country’s renewable energy currently comes from hydropower plants, whose outputs are expected to become more variable due to climate change. While the share of wind energy has increased steadily over the last 10 years, solar power is still lagging. Although there have been some advancements in simplifying the legislative framework that should result in faster scale-up of solar installations of up to 10 MW, administrative procedures in Croatia are among the lengthiest in the EU for both wind and solar renewable energy projects. Complex and partially inconsistent legislative and regulatory framework and limited institutional capacity have been recognized as the main barriers to renewable energy scale-up. Furthermore, insufficient investment in the transmission network, especially the north-south corridor, prevent a higher uptake of renewable energy sources. In addition, Croatia’s draft National Energy and Climate Plan contains no timeline for phasing out fossil fuel subsidies. The green transition can be further supported by a reduction in energy demand through energy efficiency (EE) investments, especially in the buildings sector and manufacturing. According to the World Bank diagnostic assessment of building renovations,108 there is a considerable financing gap (EUR 5 billion) between the targets set in the 2030 Long-Term Renovation Strategy (LTRS) and the available public funds for EE renovation, even with the significant investments allocated for EE under the NRRP. Given the share of the residential sector in total final energy consumption, sustainable financing mechanisms—for both multi-apartment buildings and single-family houses—are needed to support investment scale-up beyond 2027. At the same time, programs to support EE in manufacturing have ample funding but lack strategic guidance. 108 World Bank/European Commission (2022). 52 cr oat i a syst e mat i c co u nt ry di agno sti c 53 c roatia systematic country di agno st i c  RIORITIES 3. P 54 cr oat i a syst e mat i c co u nt ry di agno sti c Building on the initial assessment provided in SCD 2018, this chapter reassesses Croatia’s priorities for achieving growth that is sustainable, resilient, and inclusive. Reflecting the revised World Bank vision endorsed in 2023, this reassessment places additional emphasis on climate action to create a world free of poverty on a livable planet. The reassessment focuses on areas in need of policy action based on the analytical work presented in the previous chapters; extensive discussions with sectoral teams across the World Bank, IFC, and MIGA; online and face-to-face consultations conducted across the country with various stakeholders, including central and local governments, NGOs, private sector, and academia. The overall reform agenda in this SCD Update remains consistent with those identified in SCD 2018. However, the priorities and development outcomes are grouped differently to give more prominence to emerging priorities, particularly environmental sustainability and the green transition, reflecting their significant place in national and EU-wide policy goals and associated EU funds. Areas where Croatia has achieved significant progress over the last five years and stands well compared to its peers, like fiscal sustainability and risk, were deprioritized. Identifying the priorities involved a rigorous multi-step selection process. First, following extensive discussions with sectoral teams across the World Bank, IFC, and MIGA, the SCD team compiled a long list of policy actions for tackling the constraints outlined in Chapter 2. The policy actions were then prioritized based on clearly defined criteria and consultations with internal and external stakeholders. Four criteria were used: expected impact on reducing poverty, boosting prosperity, and improving the vitality of the planet; complementarity with other policies and goals; feasibility under current economic, governance, and capacity conditions; and the time horizon for achieving results. Nine priorities emerged, which are presented here along with some specific measures that can contribute to achieving the priorities, although the list of suggested measures is not exhaustive. Action on the nine priorities, mapped into four high-level outcomes (HLOs), will improve the wellbeing of the population on a livable planet (Table 1). Successfully achieving these HLOs within the next five to ten years would lead to higher quality of life for the Croatian people, with a particular focus on the most vulnerable. The HLOs are interconnected, so one priority can contribute to multiple HLOs (see Table 1A in Annex 1). While the relevant priorities and HLOs are assigned numbers for identification, the numbering does not indicate any ranking. However, the nine policy priorities can be sequenced by their level of impacts on other policies and the time horizon needed to complete them as indicated in Table 2. Table 1. High-Level Outcomes and Priorities High-Level Outcomes Priorities 1.  Increase the effectiveness of public administration [also HLO-2, HLO-3, HLO-4] 1. Effective public service delivery 2.  Promote justice sector efficiency and strengthen anti-corruption policies [also HLO-2, HLO-3, HLO-4] Improved human 2.  3.  Improve the quality of human capital and labor market participation, capital and social especially for vulnerable groups [also HLO-1, HLO-3, HLO-4] protection 4.  Provide robust and adaptive social assistance and social services [also HLO-4] 5.  Support investment in R&D and green technology adoption to improve Better paid jobs 3.  productivity and provide better paid jobs [also HLO-4] through higher productivity 6. E  nsure a favorable business environment and access to finance, including to start-ups and vulnerable groups [also HLO-2, HLO-4] 7.  Reduce environmental degradation and promote the blue economy Enhanced 4.  transition environmental sustainability and 8.  Promote energy production from renewables as well as energy efficiency accelerated green [also HLO-1, HLO-2] transition 9.  Enhance climate change resilience and disaster risk preparedness 55 c roatia systematic country di agno st i c Table 2. Time horizon and Level of Impacts of each priority on other policies. Time horizon for policies Capability to to produce results enable other Priorities (Short term: 1-2 years; policies and Medium-term 3-5 years, goals Long-term: over 5 years) 1. Increase the effectiveness of public administration and reduce red tape at the central and local Short / Medium-term High government levels Promote justice sector efficiency and strengthen 2.  Medium / Long-term High anti-corruption policies Improve the quality of human capital and labor 3.  market participation, especially for vulnerable Medium-term High groups and in lagging regions [also HLO-1, HLO- 3, HLO-4] Provide robust social assistance and social 4.  services to the poor and vulnerable, including Medium-term Medium making the system more adaptive to external shocks [also HLO-4] Support investment in research, innovation, 5.  and digital and green technology adoption to Long-term Medium improve productivity and provide better paid jobs [also HLO-4] Ensure a favorable business environment and 6.  access to finance, including to start-ups and Short / Medium-term High vulnerable groups [also HLO-2, HLO-4] Reduce environmental degradation and promote 7.  Long-term Medium the blue economy transition Promote energy production from renewables 8.  as well as energy efficiency, including in private Medium-term Medium and public buildings and in the transport sector [also HLO-1, HLO-2] Enhance climate change resilience and disaster 9.  Medium / Long-term Medium risk preparedness 56 cr oat i a syst e mat i c co u nt ry di agno sti c EFFECTIVE PUBLIC 1.  SERVICE DELIVERY Improving the public sector governance as well as access and quality of public services will be critical to deliver on other priorities and shape the country’s future inclusive, resilient and sustainable growth. This will require strengthening the capacity of the public administration to implement policies and programs at the central and local levels and improving corporate governance of SOEs that have a major role in public service provision. In particular, it calls for prioritized action to address the inefficiencies of the justice sector in delivering timely and quality services to people and to firms.109 PRIORITY #1. Increase the effectiveness of public administration Set up mechanisms to enhance strategic planning capacity and coordination across government •  agencies. Implementation of public policies and programs—particularly those related to cross-cutting or transversal outcomes such as climate change, digitalization, or gender equality—require very strong strategic planning and coordination functions across the public administration. The establishment of well-functioning and institutionalized center of government units (for example, delivery units) and effective horizontal (across sector ministries) and vertical (across levels of government) coordination are paramount. Raise the capacity of Local Government Units (LGUs) to enhance local service delivery and •  continue to promote municipal associations through mergers. Since fragmentation is a major factor behind low capacity, the main ministries in charge of the subnational agenda should facilitate LGU cooperation and vigorously promote creation of associations and joint projects. LGUs would be assessed and then supported with IT tools and managerial training to address their specific needs, including the establishment of associations. Increased managerial capacity for key LGU back- office functions such as public financial management, public investment and asset management, procurement, tax administration, and strategic planning could enable LGUs to deliver public services effectively and execute the budget. In certain cases, full municipal mergers might be feasible, which could bring a greater concentration of financing capacity and specialized expertise as well as boost overall administrative efficiency. Improve the intergovernmental fiscal decentralization framework and access to finance for LGUs. •  Fiscal transfers, including transfers for decentralized functions and fiscal equalization transfers, are one of the main sources of financing for LGUs. The priority is to optimize the distribution of transfers to different LGUs in line with their fiscal capacity and fiscal needs. A review, led by the Ministry of Finance, is needed to understand the current distribution of mandates and responsibilities assigned to the subnational level. Given the substantial disparities in expenditure needs, the equalization formula needs to be reformed to include expenditure needs equalization along with revenue capacity equalization.110 In addition, adequate access to finance is needed for large capital projects on national 109 The MOJPA has taken initial steps to address the inefficiencies, including the adoption of the Law on Delivery of Court Docu- ments ("Official Gazette", No. 36/24), and oversight of the implementation of Action Plans for Improving the Court Efficiency, which are currently updated for the period 2024-2025. 110 This can be done by adopting either the fiscal gap approach or the fiscal capacity per adjusted population approach, in which the adjusted population reflects differences in expenditure needs. 57 c roatia systematic country di agno st i c and local level, including by developing capital markets, sustainability-linked financial products, and public-private partnerships (PPPs). While country has faced some challenges in implementing PPPs in the past, they can be an important source of financing as well as an instrument for improving asset management efficiency. Improve the human resource management system across the public administration. One priority is •  to closely monitor the implementation of the new public wage setting system and adjust it if needed. Other measures include introducing a staff performance and incentive system and improving the talent recruitment and staff training systems. These efforts require an institutional mechanism in the form of a Public Pay Commission with a clear mandate and responsibilities. The Law of Public Wages, newly adopted in December 2023, and subsequent bylaws in 2024 should clarify the critical roles and responsibilities. Improve the corporate governance framework for SOEs. Croatia needs to finalize the reform of its •  corporate governance framework for SOEs that is being prepared as part of the accession process to the OECD. This should include a development of a comprehensive ownership policy with explicit criteria and expectations for all parties involved—including SOE shareholders, boards, management, auditors, and other key stakeholders—with a clear allocation of responsibilities. In addition, to maximize the capacity of SOEs to deliver public services and enhance their transparency and accountability, the SOEs should adopt the OECD Corporate Governance standards. Overall internal management practices and benchmarking of service delivery in line with EU standards should be mainstreamed across SOEs, with clear financial and non-financial performance objectives and thus strengthen positive spillovers in terms of innovation and productivity to the private sector. PRIORITY #2. Promote justice sector efficiency and strengthen anti-corruption policies Strengthen the evidence-based decision-making and policy prioritization in the justice sector. In this •  regard, it is imperative for the Ministry of Justice and Public Administration and the Supreme Court to undertake a judicial functional review, which involves a comprehensive assessment of the current operations of courts and prosecution services, utilizing data-rich insights. The review will also include a court performance analysis, which will offer recommendations on resource allocation and balancing service demand across different regions, including the recommendations for the sustainable reduction of the case backlog (old cases). Furthermore, this analysis can provide viable options for revising both the case and resource distribution, ensuring more equitable access to justice and improved efficiency within the judicial system. Raise the capacities of the justice sector to better manage public investment management in •  the justice sector and capitalize on the digitalization efforts. This comprehensive approach aims to enhance efficiency and elevate the quality of judicial services for both citizens and businesses. To address this, several actions should be taken: a. Adopt and implement new guidelines and practices aligned with international standards for constructing, rehabilitating, and maintaining justice public assets and investments. b. Upgrade and rehabilitate courts to meet modern functional standards and digitize court services, including the adoption of technologies like remote hearings. c. Increase the capacity of justice service providers and judges through training and recruitment to enhance the case processing efficiency. d. Enhance digital skills and foster a digital workplace environment. 58 cr oat i a syst e mat i c co u nt ry di agno sti c •  Implement the anti-corruption commitments of the 2021-2030 Anti-Corruption Strategy and the NRRP. The Government’s launch of the 2021-2030 Anti-Corruption Strategy and the explicit commitments in the NRRP are solid steps forward. The focus should be given to raising public awareness of corruption, digitalization of the Civil Service Ethics System, implementation of the Right of Access to Information Act, and strengthening judicial redress capacity in public procurement procedures. Adherence to international standards and good practices should be the way forward including mainstreaming of asset declarations, oversight of lobbying activities and adoption of officials’ codes of conduct. IMPROVED HUMAN CAPITAL 2.  AND SOCIAL PROTECTION Both the quantity and quality of human capital in the context of an aging and declining population are constraining the prospects for inclusive growth in Croatia. This calls for improving the educational outcomes and skills of Croatians to meet new labor demands, as well as growing the workforce by increasing labor force participation, particularly of vulnerable populations and those in lagging regions, while also increasing the supply of foreign workers. To support longer working lives, the delivery and quality of primary and preventative health care will need to be improved. Measures to improve the social assistance system will better protect the vulnerable and improve the resilience of households to shocks. PRIORITY #3. Improve the quality of human capital and labor market participation, especially for vulnerable groups Improve education coverage, quality, efficiency, and equity, as well as labor market relevance. Further •  efforts are needed to expand the coverage and quality of pre-primary education and whole-day schooling, improve teacher training, continue implementing curriculum reform, promote foundational skills in TVET, tackle entry barriers, and improve educational environments for vulnerable children such as Roma (for example, with language facilitation and after-school support). It will also be important to improve the use of labor market data in enrollment planning and curriculum design and to optimize the secondary school network, especially in TVET. To address challenges related to labor productivity, Croatia needs to promote life-long learning. Institutional capacities should be increased to better use data and evidence in strategic planning, goal setting, and implementation of activities aimed at improving the quality of higher education. The transition to climate-friendly technology will need to be accompanied by an adjustment in the education system, especially regarding the learning curriculum, and investment in skills for jobs in sectors developing new green technology as well as other sectors with increasing demand for green jobs. Strengthen career guidance for the selection of an adequate TVET program, support the school- •  to-work transition, and develop the skills of the workforce. The Ministry of Science and Education should strengthen its role in job-market based career guidance and provide training to teachers and school staff on including career guidance in school curricula. Both the Ministry of Science and Education and Ministry of Labor, Pension System, Family, and Social Policy should also continue to support better access to adult education programs through various initiatives, from formal education (for example, with vouchers) to informal learning opportunities, and ensure the relevance and quality of programs through engagement with the private sector. Concerted attention will be required to enhance the skills needed to affect the green and digital transitions. 59 c roatia systematic country di agno st i c Improve the delivery and quality of health care, especially for vulnerable groups and the elderly, •  promote the role of primary and preventive care, and improve the coordination of and access to quality long-term care services. The delivery and quality of care could be improved by introducing a care and quality management system, collecting, and using data for the decision-making process, and benchmarking key health indicators across health facilities. In addition, Croatia should continue to invest in medical education, introduce medical assistants in health facilities, and create a real-time human resources (HR) data system to manage the medical workforce effectively. Preventive health programs, especially for the most vulnerable groups, should be incorporated in all levels of care and particularly primary health care. In the area of long-term care, investments are needed to improve service delivery, the workforce, and digital database; achieve integration of health and social systems in long-term care; and develop tools for beneficiaries, their families, and health and social workers to navigate the complex systems. Increase labor supply by tapping into Croatia’s under-utilized workforce while boosting the •  supply of foreign workers and promoting their integration. The under-utilized workforce (older workers, women, youth, and vulnerable groups) should be offered more opportunities to participate in the labor market through revision of retirement legislation, flexible work times for care providers, and use of technologies to facilitate the search for caregivers. Skills monitoring tools should be developed to inform the design of mobility schemes that would ensure timely entry of foreign workers to fill emerging labor shortages. At the same time, actions are needed to facilitate the integration of foreign workers, including strengthened regulations, and monitoring of recruitment agencies and working conditions and expanded access to training, employment, and health services as well as to affordable and decent housing. Expand the mix of affordable and social housing policies, instruments, and incentives to support •  a well-functioning housing sector. Affordable housing should be one of the key elements of family policies aimed to support fight against the demographic crisis. Croatia should consider several inter- related policy issues, including the potential market distortions caused by the absence of real estate taxes and the low levels of taxation on short-term rentals; the need to stimulate the long-term rental market, including securing tenant rights; and the location and type of new government-constructed housing versus options to stimulate private sector supply. Policies with a specific focus on housing and integrated social service needs for an aging population should also be considered, and a better understanding and development of non-market housing (that is, social housing) to support specific vulnerable segments of the population is needed. PRIORITY #4. Provide robust and adaptive social assistance and social services  nsure equitable access to the GMB program. Croatia should make it easier for people to access • E the GMB program and should simplify GMB administrative procedures with a view to expanding the GMB program to be the main targeted social assistance program for the poor as it is for most EU countries. To increase coverage of the poor, institutional requirements such as the need for a property lien and the mandatory home visits for GMB applicants should be reviewed, as they pose barriers to an adaptive GMB. Develop an effective targeting system. Croatia needs a targeting system that can rapidly assess •  income and assets for an adaptive safety net. Such a targeting system requires building interoperability of data systems between government agencies and having clear eligibility criteria that are responsive to economic shocks and population needs. 60 cr oat i a syst e mat i c co u nt ry di agno sti c Strengthen overall social service provision. Ensuring the accessibility, quality, and sustainability of •  community-based social services is crucial and demands comprehensive regional social planning, improved data management, and a thorough revision of the financing model for non-governmental providers. The integration of licensed social service providers into a unified national network, funded from various public sources, is essential for providing social services. Systematic efforts in digitalization and strategic infrastructure investments, aligned with regional social plans, are essential for utilizing EU structural funds and achieving balanced and timely regional development of the social service network. These efforts hinge on a stable multi-stakeholder public management model involving the state, regional, and local governments, the Institute of Social Work, social service providers, as well as citizens. BETTER PAID JOBS THROUGH 3.  HIGHER PRODUCTIVITY A more dynamic private sector is needed to accelerate and sustain growth and increase well-being through better paid jobs. To further unleash the private sector will require increasing firm productivity through innovation and technology adoption, improving the business environment, and increasing access to finance, including for start-ups and vulnerable groups. PRIORITY #5. Support investment in R & D, and green technology adoption to improve productivity and provide better paid jobs Enhance investment in technology adoption in the private sector, with particular focus on digital and •  green technologies. Policymakers should help firms, especially SMEs, close digital and green technology gaps. To accelerate climate-friendly and digital technology adoption, firms will need not only funding to transition to those technologies but also support to accurately identify their technology needs and optimal solutions. Business advisory services can help build absorptive capacity for technology adoption, along with technology extension services that help private companies adopt technologies and their related capabilities. Alternative financing instruments would help incentivize firms, regardless of their size or industry, to adopt new technologies. Skills development programs could be expanded to promote sustainable firm digitalization and greening. Modernize the research system and foster science-industry linkages. Incentives need to be restructured •  to promote research excellence and collaboration with the private sector. Better incentives for individual researchers are needed through the career advancement framework, greater flexibility in compensation policies, a clearer research commercialization framework, and more generous division of intellectual property rights ownership. In parallel, policymakers should expand and improve the quality of investments in research projects, human resources and state-of-the-art research infrastructure. Funding programs should be designed to catalyze industry-led research in public research organizations and research organizations’ capacities need to be further strengthened. Foster innovation and entrepreneurship. Policies should focus on improving overall conditions for •  research, development, and innovation (RDI) among firms, with targeted funding for applied research, entrepreneurship, and innovation. More and better programs are needed to create an effective innovation ecosystem and address the entrepreneurial and innovation funding needs of small and young firms. Policy instruments should support the development of innovative and productive entrepreneurship (for example, through funding for industry-led research, or seed funding for start-ups with embedded 61 c roatia systematic country di agno st i c acceleration services). Investment readiness programs could also support start-ups and SMEs in attracting investments to scale up their innovative solutions. In parallel, support is needed for improving managerial practices in firms, for example by benchmarking firms against industry leaders and providing firms with training and advisory support on management practices. PRIORITY #6. Ensure a favorable business environment and access to finance, including to start-ups and vulnerable groups Improve the transparency of business licensing and enable online services to lower transaction •  costs. The government needs to publish the full online inventory of around 300 licensing requirements by business activity. Furthermore, most important licenses should be converted to digital format and enabled to apply for and receive online. Data integration and interoperability will be needed across all business registers and organizations to streamline business licensing. Legal framework amendments are also needed to facilitate the online issuance of business licenses, increase the adoption of digital signatures, and facilitate data sharing among pertinent parties. In addition, the technological capabilities of the parties involved in delivering the digital services should be improved. Broaden investment opportunities with new products that mobilize private capital, including for green •  and blue investments. Market financing could help support Croatia’s efforts to diversify its economic activity and to increase investments in technology adoption and green innovation. Capital markets can also play an important role in facilitating the transition to low-carbon economies, as public resources alone will not be enough to cover the needs needed to finance the climate transition—sources such as institutional investors (investment funds, pension funds, and insurance companies) will have a key role to play. Private capital can be mobilized into the sectors and technologies needed to deliver environmental targets and could include an array of loans, debt mechanisms, and investments that encourage the development of green and blue projects, and support higher-emitting activities in becoming more sustainable. Strengthen and expand current financing and business support schemes for micro, small, and •  medium enterprises (MSMEs) owned and/or operated by vulnerable population groups. As discussed earlier, these groups include women, the elderly, ethnic minorities, youth, people with disabilities, and migrants. Croatia should encourage and incentivize financial institutions to establish dedicated financing and business support schemes targeting MSMEs through provisions of right-sized financing (grants, debt financing, or a combination of the two), financial literacy, procedural simplification, cost waivers, and so on. The social objectives of both HAMAG-BICRO and HBOR need to be strengthened to cater their services to vulnerable population groups. ENHANCED ENVIRONMENTAL 4.  SUSTAINABILITY AND ACCELERATED GREEN TRANSITION Croatia’s growth, with its high reliance on tourism, is closely linked to its natural resource base. The sustainability of Croatia’s natural resources is paramount to the sustainability of its growth path and the wellbeing of people living in Croatia and beyond. To this end, Croatia will need to prioritize fostering its blue economy, environmental protection, managing its waste, and ensuring adequate water supply. In managing its energy transition for climate mitigation, Croatia will need to increase energy from 62 cr oat i a syst e mat i c co u nt ry di agno sti c renewable sources, improve energy efficiency, and shift to less carbon-intensive modalities of transport, whereas climate adaptation calls for improved climate risk resilience and disaster risk preparedness. PRIORITY #7. Reduce environmental degradation and promote the blue economy transition Complete the water service provision reform process, including aggregation of water and •  sanitation utility companies. Individual water utilities included in the newly established service areas should implement the aggregation process. Each of the 41 new water services areas should have one service provider and one tariff. The authorities should closely monitor the implementation of water sector aggregation according to the adopted legal framework. Speed up the development of wastewater management infrastructure and achieve full compliance •  with the UWWTD. Local self-governance units and associated municipal water utilities should develop the wastewater management infrastructure in line with the requirements of the UWWTD. Such investments can be financed through a combination of EU grants, own funds of Croatian Water, and local contributions.  ncrease the circularity rate of the economy by reducing landfilled waste through recycling and • I other treatment. Improving solid waste management would require a stronger enabling policy (for example, economic instruments), institutional and regulatory framework improvements (the Waste Framework Directive has not yet been fully transposed into Croatian legislation), as well as associated investments. Croatia would also benefit from introducing and enforcing a landfill tax, for LGUs that are already proposed in the legislation. The private sector can play a role in speeding up the implementation of recycling and circular economy projects through PPP schemes with LGUs. In this regard, the national stakeholders should work on fulfilling the goals set out in the Law on Waste Management and Waste Management Plan 2023-2028.  mprove the blue economy (BE) policy framework and institutional environment. Croatia should • I adopt National Blue Economy Vision and a Strategy, accompanied by a Roadmap to accelerate the sustainable transition of BE sectors under a holistic approach. The Strategy would facilitate the consolidation of the governance structures under strong national leadership, while the Roadmap would identify common priorities and actions in an integrated, consistent, and comprehensive manner. Increasing the sustainability of the tourism sector that has a large environmental footprint is a priority. PRIORITY #8. Promote energy production from renewables as well as energy efficiency Speed up the adoption of solar and wind installations while upgrading and developing the •  transmission network. Croatia should accelerate the implementation of bylaws related to the Electricity Market Act and Renewable Energy Sources (RES) and High-Efficiency Cogeneration Act— including implementation of the support scheme for RES. Furthermore, in addition to the investments planned under the NRRP, the Croatian Transmission System Operator (HOPS) in coordination with HERA should accelerate the preparation and implementation of strategic plans and investments for transmission network upgrades and expansion, including expediting the process of incorporating power grid planning in spatial plans at all levels (state, subregional, and local). Finally, the country should adopt long-term strategies and implement measures to address energy system vulnerability 63 c roatia systematic country di agno st i c to extreme weather events—such as droughts, heat waves and flooding— that can impact power generation, transmission, and distribution. Develop and adopt a long-term implementation plan to meet energy efficiency targets and bridge •  the investment gap by designing alternative financial mechanisms. Croatia should accelerate the development of financial instruments to leverage the available funding, including national sources, to scale up investments to meet 2030 energy efficiency targets. In addition, industrial and agricultural processes should incorporate low-carbon technologies and integrate energy-efficient systems. In particular, the decarbonization of energy-intensive industries—specifically in the sectors of iron and steel, hydrogen, biofuels and biorefineries, pulp and paper, refineries, non-ferrous metals, glass, ceramics, and construction material—will require innovative production and use of renewable energy or storage solutions, as well as adequate financing instruments. In addition, energy efficiency improvements of public and private buildings should be supported through financial incentives and additional financial instruments. Improve the energy efficiency of water services provision through preparation and implementation •  of national and individual plans to reduce water losses. Individual water utilities should prepare individual utility water losses reduction plans, reflecting the principles and approach developed by the Ministry of Economy and Sustainable Development in the national water losses reduction plan, and implement associated measures such as rehabilitation, upgrade, and optimization of existing and future water supply systems. Once implemented, those activities could significantly reduce energy consumption in associated water supply system, resulting in substantial savings and reduced GHG emissions. Update and develop green transport investment plans and secure adequate financing. Existing •  transport sector strategies and action plans should be reviewed and updated to include specific policy measures and related SOEs investments to reduce the carbon footprint of the transport sector. These measures would include a medium- to long-term vision for renewing fleets with low and zero carbon alternatives, developing the relevant infrastructure to operate and maintain these new fleets, accelerating the digitalization of transport systems and their interface with trade, developing strategies to induce a modal shift from polluting modes of transport toward less carbon-intensive ones (e.g. from road to rail), promoting green innovation that could have significant spillover effects on the private sector and building up the HR capacity needed at transport SOEs for modernized transport fleets and systems. Implementation will require financial resources beyond those provided by the EU and the national budget, so SOEs will need to expand their financing to utilize more private capital. PRIORITY #9. Enhance climate change resilience and disaster risk preparedness  educe the vulnerability of infrastructure and buildings to disaster and climate risks through • R prioritized multi-hazard risk reduction, and rehabilitation/reconstruction which addresses risks as well as energy efficiency and other CCA/CCM upgrades in an integrated manner. The current legal framework will need to be updated to address existing gaps and consider drivers of risk. A review of current investment planning practices and revision or creation of new investment programs should be undertaken to enable and promote multi-hazard and integrated interventions and prioritized scaling up of investments at different administrative levels. Efforts should also include awareness-raising measures for citizens to promote holistic and smart upgrades. 64 cr oat i a syst e mat i c co u nt ry di agno sti c To improve financial readiness to crises, developing a disaster risk financing strategy would •  provide an overarching framework for strengthening the financial resilience or the public and private sector. This action would require the following activities in the short term: (i) conducting a comprehensive multi-hazard financial analysis to inform development of a sustainable DRF strategy; (ii) as part of this strategy, implementing a risk-based budgeting approach by identifying and quantifying disaster-related contingent liabilities and by mainstreaming risks into annual budgets; (iii) consulting with and strengthening coordination of key stakeholders (including the private sector) on post- disaster financing in order to understand priorities, challenges, and potential solutions; (iv) assessing opportunities for revising existing (for example, in agriculture) or developing new instruments (for example, covering public asset insurance) for different administrative levels/sectors; and (v) increasing awareness of risk transfer and fostering a culture of resilience among people and businesses. 65 c roatia systematic country di agno st i c 4. KNOWLEDGE GAPS 66 cr oat i a syst e mat i c co u nt ry di agno sti c The SCD update used a wealth of knowledge about Croatia to define the main constraints to inclusive and sustainable growth on a livable planet. Some issues that arose from the data analysis and consultations with stakeholders warrant a deeper analysis, including: Functioning of public institutions. Institutions are often seen as a major business environment constraint. •  A detailed study could explore what are the main bottlenecks in functioning of institutions across the public sector with a focus on institutions with the strongest impact on firms’ growth and productivity. SOEs and the private sector: SOEs play a significant role in the Croatian economy but their effects •  on the private sector are less clear cut. A more detailed analysis of the entire SOEs sector or selected subsectors, where they operate (for example, transport, energy) could give insights into potential direct and indirect effects on the country’s economic performance, especially in terms of investments, productivity, and innovation. Spatial disparities in poverty and social exclusion: There are significant variations in households’ •  wellbeing across regions in Croatia. Upon data availability, a deeper assessment could investigate the causes of these disparities, such as accumulation of human capital, economic activities, availability of infrastructure and social services, and propose strategies to address them. Anticorruption actions: Corruption can hinder economic development and erode public trust. A more •  detailed analysis might explore the effectiveness of current anticorruption measures, identify gaps in the legal and institutional framework, and recommend measures to prevent and combat corruption. Private investment development: To strengthen the economy, it is important to understand the barriers •  to private investment. Further analysis could assess the investment climate, regulatory environment, and access to finance, and suggests feasible approaches to attract and retain private investments. Impacts of tourism on the economy and society: While tourism contributes significantly to the Croatian •  economy, it also has social and environmental implications. A deep-dive analysis could evaluate the economic benefits, potential overreliance on tourism, and its effects on local communities and the environment, proposing sustainable tourism practices. Effectiveness of EU funds: Croatia received substantial EU funds. A detailed assessment could focus •  on how these funds are being utilized, their impact on development goals, and ways to improve their management and effectiveness. Local government investment sustainability and own revenue mobilization: A potential study could •  address fiscal management and investment practices of local governments to ensure long-term financial stability and the ability to fund quality public services. The Subnational Public Finance Review will analyze how local government units can better use their existing fiscal capacity to generate revenues when faced with a decline in EU funding. Climate change effect on development objectives: The country climate and development report •  (CCDR) will provide a summary of Croatia’s economic, social, and environmental challenges and how these challenges will be affected by climate changes over the next decades. 67 c roatia systematic country di agno st i c REFERENCES Azevedo, J. P., Inchauste, G., Olivieri, S., Saavedra, J., and Winkler, H. (2013). Is Labor Income Responsible for Poverty Reduction? A Decomposition Approach. 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Croatia Digital Diagnostics. World Bank: Washington D.C. World Bank (forthcoming/b). Financial Inclusion Study. World Bank: Washington D.C. World Economic Forum (2019). Available at: https://www.weforum.org/focus/davos-2019/ World Health Organization (2020). Healthy life expectancy (HALE) at birth (years). Available at: https://www. who.int/data/gho/data/indicators/indicator-details/GHO/gho-ghe-hale-healthy-life-expectancy-at-birth World Travel and Tourism Council (2024). Travel and Tourism, Economic Impact 2024: Croatia Factsheet. Available at: https://researchhub.wttc.org/factsheets/croatia 73 c roatia systematic country di agno st i c ANNEX 1 Table 1A. Inter-linkages between HLOs and Priorities HLO-IV HLO-II HLO-III Enhanced HLO-I Improved human Better paid jobs environmental Effective public capital and social through higher sustainability and service delivery protection productivity accelerated green transition Priority #1 Priority #2 Priority #3 Priority #4 Priority #5 Priority #6 Priority #7 Priority #8 Priority #9 74 c roatia systematic country di agno st i c Croatia Country Office Radnička cesta 80/IX, Zagreb Tel: +385 (01) 2357 222 www.worldbank.org/croatia WorldBankCroatia 76