Speedy recovery from the pandemic-induced recession strongly spurred demand for labour, primarily in seasonally intensive activities, such as construction and accommodation and food service activities. Amid unfavourable demographic developments a portion of the demand for labour was met by the employment of third-country workers (from non-EU countries). The Labour Force Survey, the usual source of data on employment necessary to assess Croatia’s potential gross domestic product, most likely underestimates the number of employed foreign nationals. The correction of potential GDP estimates for the likely underestimation of the number of employed foreign workers mildly increases the growth rate of the potential gross domestic product in the period from 2018 to 2024, when the employment of foreign workers intensified. This also raises the estimated contribution of the labour factor to the potential GDP. Although it is possible that even CPII data do not cover the overall number of foreign workers in Croatia, their actual productivity, taking into consideration the sectoral and educational structure, could be slightly lower than implicitly assumed, which should be taken in account when considering the effects of the correction in the number of employed persons in Croatia for a potentially greater number of foreign workers to potential output and its structure.

Estimating the potential level of the gross domestic product (GDP) and the contributions of its components has an important role in assessing the cyclical position of the economy in order to tailor economic policies as precisely as possible. The key measure of the cyclical position is the domestic product gap, which is the divergence of the real from the potential GDP, expressed as a percentage of the potential GDP. When this gap is positive, inflationary pressures are often present, while a negative domestic product gap may create deflationary pressures. However, the level of the potential GDP and the domestic product gap are theoretical concepts which cannot be measured directly so these variables need to be estimated. GDP formation in Croatia is also increasingly impacted by the employment of foreign workers^[1]. However, the usual statistical data on the labour market used for potential GDP estimate (Labour Force Survey) do not fully cover foreign workers in Croatia due to methodology and research coverage. This can lead to underestimation of the available labour factor and consequently the underestimation of potential GDP.

Against the backdrop of strong recovery after the coronavirus pandemic and ever more prominent effects of unfavourable demographic developments, Croatian employers are faced with the great challenge of having to source an adequate workforce from the domestic labour market. To mitigate the problem, they increasingly began to rely on labour from outside Croatia and EU member states, that is from third countries (non-EU countries), the employment of whom was considerably facilitated, in administrative terms, by the adoption of the new Law on Foreigners in 2021. In addition, the gradual increase in the price of labour has made Croatia more attractive to foreign workers^[2]. Since 2017, the Croatian Pension Insurance Institute has a special category for foreign workers in its records of insured persons, and their statistics show a strong growth in the number of foreign workers following the mentioned labour market liberalisation when annual quotas for the employment of foreign workers in individual sectors and professions were repealed (Figure 1).

While CPII indicators, as well as Police Department records on the number of issued work permits point towards a strong increase in the number of foreign workers, the Labour Force Survey, the common source of data on the labour factor used when estimating the potential GDP, due to its international comparability, indicates their stagnation at a low level for the most part of the period under observation. The number of foreign workers in the 2022 Labour Force Survey thus amounted to only one fifth of the number of foreign workers registered with the CPII. There are indications that even the CPII indicators to a certain degree underestimate the real number of foreign workers because it is possible that domestic employers do not fully adhere to CPII instructions when registering foreign workers under a particular code in their forms and records. Nevertheless, in the absence of better indicators, this blog will supplement the Labour Force Survey employment rate with the data on employed foreign workers from the CPII records in order to analyse and quantify their contribution to potential GDP of the domestic economy in more detail.

The potential GDP level may be estimated in different ways, but the approach most commonly used in international institutions is the production function method because it ensures a consistent approach and provides for comparison among individual countries, as well as for a more detailed decomposition of the potential GDP. Therefore, the level of potential GDP in this blog is estimated by the production function pursuant to the methodology described in Grgurić et al. (2021)^[3].

The potential GDP level ( may be expressed in Cobb-Douglas^[4] form and it is determined by the factor of labour (L), capital (C) and total factor productivity (TFP). The labour factor refers to the number of paid working hours in the economy. The capital factor includes tangible and intangible assets used in the production process. Total factor productivity shows how effectively work and capital are used in the production process and at the same time reflects the impact of other production factors such as technology, management skills, etc.

As regards the assessment of the potential GDP via the production function method, the weight of the labour factor and capital for Croatia have been set in accordance with the results of previous empirical research³,^[5], so the weight of the labour factor totalled 0.65, and the weight of the capital factor 0.35. The labour factor^[6]6, that is key to this analysis considering that employment of foreign workers directly affects this component and thus the potential GDP means the total number of paid working hours in the economy. Employment of foreign workers is included in the model in such a way as to increase employment (affecting the participation rate) by the number of foreign workers employed in Croatia. The same method was used to estimate the contribution of foreign workers to potential GDP, using the example of Poland^[7].

The potential GDP estimate is based on the comparison of the results of two model specifications, with the first one, the baseline specification being based on the Labour Force Survey data, and the second, the alternative specification is broadened by the CPII data on foreign workers employed and thus includes a noticeably higher number of foreign workers employed in Croatia. In other words, in the alternative specification the labour factor is increased by the difference between the number of foreign workers in the CPII data and the number in the Labour Force Survey data. Likewise, the analysis has been extended to the projection period based on CNB macroeconomic projections, with the number of foreign workers for 2023 being assessed according to the results in the first eleven months, pursuant to which the annual growth rate totalled some 30%, which is equal to the increase in 2022, with the same growth rate of the number of foreign workers has been extrapolated for 2024 as well.

Supplementing employment indicators with the increase in the number of foreign workers raises the contribution of the labour factor in the extended model (Figure 2.). The average increase in the contribution of the labour factor to the potential output as a result of employment of foreign workers in the period from 2018 and 2024 in the extended specification compared to the baseline specification thus amounts to 0.3 p.p. As well as by foreign workers, the total number of working hours is positively impacted by the increasing participation of the population in the labour force, as well as by the decrease in structural unemployment. On the other hand, the decrease in the working age population reflects the negative impact of demographic developments.

The increase in the number of employed persons raises the estimate of potential GDP and changes even more the structure of the contribution of individual factors. Results of the analysis show that the growth rate of the potential GDP in the period from 2018 to 2024 is, on average, 0.1 p.p. higher in the specification of the model with a larger number of foreign workers than the growth rate of the potential GDP in the specification with a smaller number of foreign workers so the cumulative difference in potential GDP is some 0.8 p.p. (Figure 2.3). The contribution of the labour factor increased by 0.3–0.4 percentage points, but the contribution of total factor productivity, as a residual category, has been revised downwards mechanically with the result that labour productivity is not reflected in its entirety in a potential output growth. Also, the real productivity of foreign workers, if sectoral and educational structure are taken into account, might be somewhat lower that implicitly assumed, and as a result the effect of the correction in the number of foreign workers on potential GDP might be overestimated. The actual number of foreign workers is probably higher, which might annul the effect of the previously mentioned lower real productivity. Also, after the differences between the two estimates of growth of potential output and contribution of the labour factor decreased temporarily following the outbreak of the COVID-19 pandemic in 2020, these differences started widening gradually and could possibly reach a maximum in 2024, with a 0.2 percentage points faster potential growth and 0.4 percentage points faster labour factor contribution in the specification with a larger number of foreign workers.

Literature

Butković, H., Samardžija, V. and Rukavina I. (2022): Foreign Workers in Croatia: Challenges and Opportunities for Economic and Social Development, Institute for Development and International Relations, IRMO ISBN 978-953-6096-95-4.

Grgurić, L., Nadoveza Jelić, O. and Pavić, N. (2021): Public Sector Economics, Institute of Public Finance, vol. 45(4), pages 459-493.

International Monetary Fund (2022): IMF Country Report. Selected issues: Post-pandemic potential growth and scarring.

Jovičić, G. (2017): Estimating Potential Growth and Output Gap in Croatia, Croatian National Bank Surveys, S-29.

1. Data on the average annual number of foreign workers is used in the analysis. ↑

2. Butković, H., Samardžija, V. and Rukavina, I. (2022): Foreign Workers in Croatia: Challenges and Opportunities for Economic and Social Development, Institute for Development and International Relations, IRMO, ISBN 978-953-6096-95-4. ↑

3. Grgurić, L., Nadoveza Jelić, O. and Pavić, N. (2021): The interplay of supply and demand shocks: measuring potential output in the COVID-19 pandemic, Public Sector Economics, Institute of Public Finance, vol. 45(4), pg. 459– 493 ↑

4. \(Y_t=T F P_t \times L_t^\alpha \times K_t^{1-\alpha}\) ↑

5. Jovičić, G. (2017): Estimating potential growth and GDP gap in Croatia, Croatian National Bank surveys, S-38 ↑

6. L_t = prosječni plaćeni sati rada po zaposlenom_t  x (1-NAWRU_t) x stopa participacije_t  x radno sposobno stanovništvo_t ↑

7. International Monetary Fund (2022). IMF Country Report. Selected issues: Post-pandemic potential growth and scarring ↑