International trade and economic growth in Croatia

This article argues that Croatia's growth over the past two decades is deeply related to the dynamics of international trade. Under the premise that what is bought and sold in global markets reflects the economy's fundamentals, we show that the rate of growth compatible with equilibrium in the balance-of-payments, i.e. the dynamic Harrod trade multiplier, is a good predictor of the country's actual long-run growth rate. For this purpose, we apply a state-space model and the Kalman smoother to obtain time-varying parameter estimates of the exports and imports functions. We use these estimates to investigate the determinants of international non-price competitiveness. Bayesian Model Averaging (BMA) and Weighted Average Least Squares (WALS) techniques are combined to tackle model selection uncertainty. It is shown that R&D investments and human capital accumulation are the most important explanatory variables. The success of the European Union's (EU) integration process depends on the capacity of its new members to achieve a balanced-growth path. Being the last country to join the union, the experience of this single country is particularly relevant to understand possible development alternatives for the region. We conclude by highlighting the policy relevance of our findings to the evaluation of Croatia's catching-up performance as part of the EU.