INSTITUTIONS AND PRODUCT MARKET EFFICIENCY IN THE EUROPEAN UNION WITH EMPHASIS ON CROATIA

The positive relationship between product market efficiency (PME) and productivity has been established in the existing literature. The recent literature also suggests that at the root of the low PME lies a weak institutional framework. The analysis of the Global Competitiveness Index (GCI) indicators shows that Croatia has poor institutional quality and low PME. To test the hypothesis that there is a positive impact of the quality of institutions on the PME, this paper uses panel analysis on a sample of European Union (EU) countries and yearly data from 2008 to 2018, with a special focus on Croatia. We additionally test the hypothesis that countries that share common characteristics with Croatia, such as size, historical and cultural background, exhibit difficulties translating the quality of institutions to greater PME. We also investigate the joint effect of the quality of institutions and the tax burden, expecting that countries with better institutions have less detrimental impact of taxes on the PME. The results of the econometric analysis show a positive relationship between the quality of institutions and PME. The results also suggest that small countries might see less beneficial impacts of better institutional quality on PME than large countries, but this result is not robust. The same also appears to be true for Mediterranean countries compared to the rest of the EU member states. The socialist historical legacy does not appear to play a role in a relationship between institutional quality and consequent PME. The role of institutional quality in the relationship between taxation and PME appears to be negligible. Therefore, to improve the PME, a prerequisite for greater productivity and consequently economic growth, it is necessary to change the institutional framework. However, the efforts to achieve greater PME in Croatia through institutional change may in part be hindered by its size and its Mediterranean cultural and geographical characteristics.