Croatia's Narrowing Spreads

By: Sam Vaknin, Ph.D.

Also published by United Press International (UPI)

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It was a normal week in Croatia. A mass grave was discovered in the east, generals were being indicted by the Hague, the new Yugoslav ambassador apologized for crimes committed against Croats by his compatriots, Bosnian officials coped with a restive Croat population in their patchwork country.

The CIA comments on Croatioa's Balkan geography delicately. Croatia, it says in its "World Factbook 2001", "...controls most land routes from Western Europe to (the) Aegean Sea and (the) Turkish Straits". With a population of 4.5 million and a land mass of c. 56,500 sq. km. - Croatia is more than twice as big as Slovenia. It is almost as ethnically homogeneous - 78% are ethnic Croat and Catholic. The Croats are highly literate and skilled, the legacy of centuries of Austro-Hungarian (especially Habsburg) rule. Croatia's (mostly industrial) output per capita was almost as high as Slovenia's in the former Yugoslavia (and a good one third higher than the Federal average). Yet, nowadays, Croatia trails Slovenia by every economic measure. Its GDP per capita is half the latter's. Why this discrepancy?

While Slovenia was always export and services oriented, Croatia languished under a bloated and venal industrial central planning bureaucracy. Four years of savage internecine fighting (avoided by Slovenia), almost a million internally displaced people, and the overnight transformation of close economic allies and target markets into mortal and bitter enemies - all took their toll. Croatia's Western-aided transition from heavy and mineral industries into "lighter" tourism and oil processing was successfully completed earlier this year, following a mild recession in 2000. The economy grew by 3% last year as more than 70% of the labour force found work in services (compared to 30% in industry and agriculture combined).

Yet, the implosion of world travel and tourism following the September 11 atrocities, threatens this newfangled economic foundation as well. Successive Croat governments failed to tackle structural reforms decisively, the victims of fractious and contentious party politics and trade union extortion. Only recently has the wage bill of the central government been trimmed (by 5%) and social transfers rationalized - though the full implementation of these measures has been put off, by an obstinate parliament, to 2002. The collective agreement with state and public workers signed earlier this month froze salaries - and net employment - at this year's levels. IMF style social engineering resulted in unrest and pet mutinies within the administration. Earlier this month, the director of the Croatian Health Insurance Institute blamed lack of drugs and a deteriorating health care service on cuts in health funds (and payment arrears, the result of a gigantic deficit).

Croatia's rating card is mixed at best. Its inflation rate is down to 4-5%, its GDP growth has recovered to 4%, but it has a serious fiscal deficit, not ameliorated by a hitherto botched privatization. Croatia resorted to persistent foreign borrowing to amortize its payment arrears. In a Letter of Intent to the IMF dated October 31, 2001, Croatia undertook to slash its budget deficit to a still unsustainable 5.3% of GDP this year (and 4.25% next year), mostly by the socially expedient cutting of capital investment. In effect, Croatia has reneged on its earlier commitments to attain fiscal rectitude by reducing subsidies, wages, and transfers. Nevertheless, the IMF professed itself to be content with Croatia's performance, commending it for exceeding targets agreed in its latest March 2001 standby arrangement.  The World Bank has lately approved a Structural Adjustment Loan (SAL) of $202 million. Croatia is one of the Bank's darlings, with $780 million committed and $550 million disbursed (mostly on transportation infrastructure, urban development, and finance-related projects).

Of Croatia's smallish labour force - 1.7 million strong - c. 300,000 are unemployed. Of c. 13,000 new jobs created in November - the majority were in state administration and the public sector. Moreover, Croatia is unique in that half of the unemployed are either skilled or highly skilled. One in twenty five has a university degree (compared to 3%, the world average and 1% in the likes of Macedonia). Brain drain, though not as severe as in Macedonia or Yugoslavia, is still detrimental to Croatia's future.

Croatia's monetary position is better. The Croat National Bank (CNB) has come close to meeting its targets regarding foreign exchange reserves and net domestic assets and has pursued a vigorous banking reform program coupled with credit expansion to the fledgling private sector. Spreads on Croat eurobonds have narrowed despite widespread aversion towards emerging markets debt. Public trust in the economy is evidenced by robust growth in retail sales, business investment, and private consumption. Domestic banks are repatriating capital. The economy is being remonetized - interest rates are lower, bank deposits in both domestic and foreign currencies higher, bank lending is surging, and the monetary base expanded. The CNB had to intervene repeatedly to prevent an appreciation of the kuna - a highly unusual circumstance in countries in transition. The CNB may yet have to resort to contractionary policies next year should this tsunami of demand for money not abate.  The current account deficit increased to c. 3.5% of GDP - the result of massive last minute privileged purchase of cars by war veterans. But, the deficit trend is a more sustainable 2-2.5%.

The introduction of the euro would stretch the resources of the banking system further - the DM is an unofficial second currency in Croatia. Erste Bank from Austria has shipped tones of euro coins and notes to Croatian banks last week alone. Since Croats hold most of their DM savings in cash, the exchange operation is likely to be drawn out and complicated. The EU, for fear of money laundering through euro conversions, already demanded from Croat banks detailed reports on any cash transaction involving more than 14,000 euros.

Minor geopolitical irritants still mar the future: a dispute with Italy regarding war time property, with Slovenia regarding land and maritime borders, with Yugoslavia regarding a UN administered peninsula, with Bosnia regarding everything - from port facilities to the composition of commissions common to both countries. Croatia is also an auxiliary drug smuggling route for both East Asian heroin and South American cocaine, which makes the EU vocally unhappy. True, a third of Croatia's exports still goes to the likes of Bosnia-Herzegovina, Slovenia, and Macedonia. But it has developed major new export markets in Germany, Italy, and Austria and has signed a Stabilization and Association Agreement with the EU on December. The trade related provisions will apply from January 1, 2002. Croatia has every intention of applying for accession as early as 2003. It cannot afford to allow any part of its economy or society interact with the sleazier sides of the Balkan. It needs to extract itself from its geography - and the sooner, the better.

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