The link between the price and cost competitiveness and economic activity before and after joining the monetary union: examples from Croatia, a highly dollarized small open economy

This paper examines the main channels linking price and cost competitiveness to economic activity in a small open, highly dollarized economy (Croatia) before and after joining the monetary union. The discussion in the paper suggests strongly altered transmission mechanisms between competitiveness and output, including the link between exchange rate and economic activity: 1) the trade channel is now less effective, 2) balance sheet effects, which used to be pronounced due to high euroization, have been strongly dampened; 3) the exchange rate pass-through may also be weaker. The relationship between unit labor costs and the exchange rate has also changed significantly. The paper emphasizes that the importance of price and cost competitiveness may increase after joining the eurozone. Without a significant shift towards high-technology exports, which are less cost-sensitive, and increasing energy independence, there is an increased risk that Croatia's export performance will be affected by cost pressures. In this environment, efficiency gains, investment in human capital, innovation, non-price competitiveness and energy independence must be prioritized. Such measures are essential to reduce cost dependency and maintain long-term economic growth.