Remarks of U.S. Ambassador James Foley “Improving the Investment Climate” Zagreb School of Economics and Management

May 18, 2010

Thank you very much, Dr. Njavro, for the warm welcome. It is truly a pleasure to be here today at the Zagreb School of Economics and Management. I am especially honored to be with the students of this distinguished institution. You are your country’s future, destined to become the next generation of Croatia’s economic and business leaders. But in these troubled times, you have good reason to wonder what kind of future awaits you - one of prosperity or of hardship? One of opportunity or of broken dreams? That is not a question I can answer, but what I can tell you for certain is that the answer will be shaped by the decisions taken at this critical moment by Croatia’s political leadership. As a matter of fact, I am personally quite optimistic about Croatia’s future. This is a country with boundless potential, and I believe a historic turning point has been reached with the decision by Prime Minister Kosor to launch an Economic Recovery Program that could, if deepened and fully implemented, finally put Croatia on the path to self-sustaining economic growth. The purpose of my speech today is to explain why the economic reform agenda announced by the Prime Minister is so urgently needed.

To say that Europe is living in challenging economic times would be an understatement. The crisis that began in late 2008 brought down financial systems, from Iceland to Latvia, and threatened many others. More recently, a debt crisis in Greece has threatened the stability of the euro, the most tangible symbol of Europe’s economic integration. Even nature itself has caused economic havoc throughout Europe, due to the ongoing volcanic eruptions.

Croatia has thus far avoided the worst of these crises. But it would be a mistake to view Croatia’s current economic recession in the same way we view the volcano - as simply an unavoidable disaster from abroad with no long-term consequences. The truth is - as the Prime Minister herself has stated—that the financial crisis exposed serious structural problems in the Croatian economy that were present all along. Let me be clear, Croatia is no Greece - no two countries are the same, and Croatia has important advantages. But in a deeper sense we are all Greece today - nearly all Western economies have been living beyond their means, borrowing from the future to pay for the illusion of prosperity today. Everywhere in the West - including the United States - the day of reckoning has come. Governments will have no choice but to decrease in size, to spend less, and to live within their means. The days of borrowing to finance bad economic policies and practices are over. We have entered a period that will be deeply challenging to politicians and populations alike.  But there really is no choice: either sound policies will be adopted, or economies will sink.

With excessive foreign debt and chronic fiscal deficits requiring ever more borrowing, Croatia is no exception to this implacable reality. In the past seven years Croatia’s trade deficit has almost doubled and foreign debt now approaches 100 percent of GDP. These statistics reflect basic structural deficiencies, including the overly large role of the state in the economy, the inflexible labor market and low participation of labor in the economy, the heavy burden of taxation, the cumbersome bureaucracy and a poor business climate. According to a well-known survey conducted by the World Bank, Croatia ranks 101st in the world in the ease of starting a new business.

However, there is good news in bad news, and as the Chinese say, crisis also means opportunity. Thanks to the crisis, we can see clearly that the Croatian economy was on an unsustainable path. The fact that there is no longer money to sustain the wrong policies means that Croatia has the opportunity now to start moving in the right direction – to build the foundation for real economic growth, real jobs and real prosperity. We have an expression in the U.S.: if you are in a hole and want to get out of it, the first thing to do is to stop digging. In fact, the very first thing to do is to recognize that you are in a hole. That is what the Prime Minister has done. She has recognized the problem, and through her Economic Recovery Program, defined the way out. The harder part – implementation of the plan, which will be painful in the short run – is yet to come.  But Croatia has stopped digging.

Joining the European Union will not, on its own, get Croatia out of the hole. This is not to minimize the importance of EU membership. The day Croatia finally does enter the EU will of course represent a tremendous achievement for this country. Membership in that exclusive club will greatly benefit the economy, and the Croatian people, in the long run. But EU membership will not, in itself, make Croatia more competitive, and thus more prosperous. Only by implementing the proposed economic reforms and preparing now for the challenges and opportunities that will present themselves the day after accession occurs can Croatia ensure its economic future. Only by making Croatia a place where it is easy to open a business and to do business, to invest money and to make money, will the country begin systematically to produce goods and services that can compete in the global marketplace.

Indeed, the central economic lesson of this crisis is that, in our interconnected world, capital can move very quickly and it will go wherever conditions are the most attractive. Whether we like to admit it or not, Croatia is in constant competition with its neighbors for new business and investment. If a company wants to open a new factory, launch a new product, establish a regional head office, where will they go? Will they come here? Or will they go to Hungary, or Serbia, or Slovakia? In fact, Croatia is ultimately competing with every other country in the world in the race to attract capital. Will investment come here, or will it go instead to Latin America or to Asia, regions where the cost of labor and the cost of doing business are substantially lower? Unfortunately, this is a race that Croatia is not winning. Last year, Croatia's foreign direct investment fell below $3 billion dollars, well under 5 percent of GDP. Croatia’s especially low level of green field foreign direct investment is compelling evidence that companies are choosing other destinations. The same is true for Croatian businesses, few of whom these days are making the kinds of new investments that will create new jobs and opportunities. The question is, why not?

This brings me to my principal focus today: what needs to be done to improve the business and investment climate in Croatia. The United States would like to be a stronger trade partner with Croatia, and I personally would like to see significant new U.S. investments in this country. But in the current environment, it is extremely difficult to “sell” Croatia as an attractive investment destination. Projects take too long for administrative approval, and many do not move forward without “political” intervention. Land title and registration is complex and uncertain, often taking years to resolve. Para-fiscal fees are high and unpredictable, preventing companies from making new investments or employing new workers. At last count, there are more than 250 of these non-tax fees. And the public tendering process is not as transparent as it should be.

Each of these problems has real consequences and real impact on the lives of Croatians, on employment, and the economic development of this country.

I would like to give you a few examples of the experience some American companies have had investing, or attempting to invest, in this market. I cite these cases because I am familiar with them, not in order to lobby on their behalf. So I will not even mention their names. Of course, as American Ambassador it is my duty to help American businesses. But let me stress that my focus is on the health of the Croatian economy. Your success is important to us, and to all that the United States is seeking to accomplish in this region. These examples are useful because of the fundamental problems they illustrate:

Five years ago, an American company with significant experience in the tourism industry came to Croatia to make an investment in a new hotel and resort facility worth hundreds of millions of dollars. The hotel was to be in a beautiful location, but one that was underdeveloped, and had been affected by the war. Five years later, nothing has happened. Although the land is government owned, the investor has not been able to find anyone in authority ready to discuss a possible concession. No one has stepped forward to reject their offer either. Rather the authorities do not seem prepared to deal with this investor one way or the other. To its credit, the U.S. company is still working to bring the project to reality. But its patience is running out. The lesson is that potential investors need to be dealt with in a manner that is predictable and efficient. Investment projects cannot wait for years to get an answer. The money will go elsewhere

Another U.S. company has told us that to produce their flagship product in Croatia costs up to 40% more than in any other country in central and Eastern Europe. This is due to burdensome regulations and above all to the multiple, complex, and unpredictable non-tax fees they are charged for everything from preservation of monuments to supporting forest management and a waste water fee that is unrelated to the amount and quality of water discharged. Of course, a sound regulatory framework and reasonable fees are wholly legitimate. But the lesson is that investors – foreign or Croatian -- should not be systematically bled. Especially if Croatia hopes to attract new investment, many costly fees should be rationalized if not eliminated.

In another case, a U.S. investment company with hundreds of millions in capital at their disposal, saw numerous opportunities to invest in small companies being privatized through the Croatian Privatization Fund. They made an initial bid on one small company up for sale through public tender. They were the only bidder. They came to Croatia with energy, optimism, and detailed plans for the company’s stabilization and expansion. If successful, they planned significant further investments in the country. However, the company and the privatization fund could not come to a mutual agreement on the contract. Yet they maintained their optimism and planned to participate again in the new tender as well as in other ventures. Unfortunately, the privatization fund informed the company that it was keeping their 150,000 euro deposit. While this appeared to violate the rules of the tender, and despite all efforts by the investor to pursue a conciliatory approach, nothing has yet persuaded the authorities to return the deposit, not even the prospect of losing significant future investments. In the end, they may keep 150,000 euros but lose tens of millions in potential new investment. The lesson here is that the state ought to be a facilitator, rather than an obstacle, to foreign investment.

Lack of transparency in the tendering process figured prominently in another unfortunate case. A U.S. company was the low bidder for a major public contract. Yet their bid was disqualified for a small technicality in the documentation that was unrelated to their financial offer, or their ability to do the job. The contract was awarded to another firm. Investors must be confident that the rules of the game are clear, and that their offers will not be arbitrarily dismissed. Croatia cannot afford to have a reputation for a lack of transparency in the public procurement process, especially since the government still has hundreds of companies, and shares in companies, which it intends to sell.

Unfortunately, these stories are just the tip of the iceberg. They are simply the ones I know best. Talking to Croatian businessmen, I have the impression that there are many, many more. What all of the stories seem to have in common is the difficulty of such things as obtaining permits, authorizations and land titles in an efficient and timely manner. What stands out the most is a state of bureaucratic complexity, not to say confusion. For any given project there are many decision-makers at multiple levels – local government, national government and state agencies – who can say no, or simply refuse to decide. When authority is everywhere, responsibility tends to be nowhere.  In other words, no one is accountable.

This is really about leadership.  Even in the face of such obstacles, there are leaders in different parts of Croatia who are making a difference.  A month ago, I had the privilege of visiting the city of Varazdin.  This city and region are doing many things right.  They have enacted policies and programs that have created an environment friendly to business and investment. And the results show. The region around Varazdin has one of the lowest unemployment rates in the country at 6 percent. This is less than half the national average. They have created a profitable business zone and they host one of the best food processing companies in the country, Vindija. Yet the local leaders with whom I spoke are nervous about joining the EU and the intensified competition it will represent. They have reason to be nervous. Croatia should do more to help its businesses prepare for this new reality.

Another community doing excellent work to build itself a vibrant economy is the small town of Sinj. As you know, Sinj lies near Split and has always existed in Split’s economic shadow. But I had the chance to meet Sinj’s mayor two weeks ago. This dynamic young man sees his proximity to Split as a significant advantage in promoting his community’s economic development. He has found 11 investors who have chosen the town to open small production facilities, creating jobs for the community. He has also found strategic investors to restart a textile plant on the edge of bankruptcy, and he has registered 4 new projects to take advantage of EU pre-accession funds.  He has set ambitious goals for his small government, promising to balance the budget, and setting a 7 day deadline for responses to all citizen inquiries. Most importantly, he has shown that politics will not get in the way of building Sinj’s economic future.  He is a member of no political party himself, and shows that the health of the economy can transcend political disagreements. I am sure that there are many other leaders throughout the country who are similarly willing to work with colleagues from other parties on common issues of economic development. Like Sinj or Varazdin, these communities must build their reputations as places that are fair, transparent, and open to new ideas.

Istria is a region also deserving of recognition. Although I have not yet had the privilege to visit there, I know the Istrian Development Agency has been successful in finding financial resources, developing entrepreneurial infrastructure, offering training and education and consulting to entrepreneurs on how to begin their business. The Agency has also established strong ties with other countries in the region and has an impressive list of projects both completed and underway, all of which have contributed to the economic development of Istria.

The most notable example of leadership in this area is Prime Minister Kosor herself, whose economic reform program is a framework for urgently needed policy changes at the national level.  She has clearly understood that Croatia cannot afford to sit back and do nothing, waiting for the economic crisis to pass.  I was impressed that her plan addresses many of the structural problems that have plagued the economy for years.  She intends to completely change the nature of the state’s role in the economy, proposing the sale of many of the state’s minority shares in private companies, the reform of supervisory boards to make them less affected by political patronage, and the territorial reorganization of the country to streamline decision-making.  She aims to create an administration that will be more fiscally stable in the long term.  We applaud her plans to reform the tax system, and to examine closely all para-fiscal fees, hopefully eliminating many of them.  She has also expressed a serious willingness to tackle the issue of welfare and pension reform.  Her goal is to reduce the share of the government in GDP from 50% to 47% over the next ten years.  I am confident that this goal can be achieved even sooner than that, making room for an even more ambitious reduction in the size of the state.  A more ambitious privatization program, too, would have multiple benefits – reducing costs to the state, increasing opportunities for investment, and assisting the all-important fight against corruption.  Overall, with less spending and borrowing by the state, there will be more room for investments by new entrepreneurs.  And as we know, new investments will create jobs.  It was recently reported that Croatia has only 1.2 workers for every pensioner in the country.  This number is truly alarming, and is not sustainable.  Croatia struggles with an aging population like many other developed countries.  It urgently needs policies and labor laws that make employment more available and attractive.

Finally, as I have already mentioned, the Prime Minister’s plan to identify and eliminate obstacles to investment will help make this country competitive and successful within the European Union.  We stand ready to support her in all these efforts, particularly in the difficult phase of implementation.

These reforms will certainly not be easy. They will demand Croatians’ patience and in many cases, real sacrifices. To successfully transform this economy, the Prime Minister will not only need the support of her government and party. She will also need the support of the nation, and of all political parties. I am encouraged that the president has expressed his backing. However, no one expects everyone to agree on all elements of the plan. An issue as important as this that involves the future of Croatia and its economic viability requires the contributions of all. No one has a monopoly on good ideas, and I am certain that the opposition has many good proposals to make. I believe that the government and opposition recognize that they are working toward the same goal: a more modern, efficient economy and bureaucracy, so that Croatia can take its place as a competitive and prosperous member of the EU.

Let me remind you that you are not alone in facing these difficult times and in making painful choices necessary to assure a better future. The United States, too, has accumulated years of budget deficits and a staggering national debt. We are looking at cuts in government spending and ways of closing our deficit that will require very difficult sacrifices of the American people. President Obama has appointed a bipartisan commission to come forward by the end of this year with a series of recommendations. It is clear that the changes to come cannot be the responsibility of one party or they will never be made. And yet they have to be made – not only for our children’s sake, but because the money is no longer there.

Ultimately, though, this is about the next generation in our countries. It is about you. It is about whether Croatia will have a free and dynamic economy that will produce the jobs that you need, and that will encourage and reward your knowledge and entrepreneurial abilities. It is about creating a future in which you and your country are able to realize their full potential.

About the potential, there can be no doubt. For Croatia, it is enormous. You have a spectacularly beautiful country, endowed with abundant natural resources, world-class infrastructure, and a well-educated and talented workforce. You have the security that comes with NATO membership, and you will soon enjoy the prestige and the benefits of membership in the European Union. Your history shows that Croatians are deeply patriotic and willing to sacrifice to make their country free. Now, the challenge is to make Croatia prosper, and I am confident that you will do whatever it takes to succeed.

Thank you very much.