Keywords

Economic growth, International trade, State-space model, Bayesian model averaging, Croatia

This article argues that Croatia’s economic performance over the past two decades is deeply related to the dynamics of international trade. Under the premise that what is bought and sold in international 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 proceed by using these estimates to investigate the determinants of international nonprice 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. We conclude by highlighting the policy relevance of our findings to the evaluation of Croatia’s catching-up performance as part of the European Union.