LONG-RUN ANALYSIS OF THE IMPACT OF PUBLIC SECTOR WAGES ON ECONOMIC ACTIVITY IN CROATIA

Public sector wages are an important part of the government budget and a significant element of conducting fiscal policy. The purpose of this research is to empirically assess how public sector wages affect economic activity in small open economy, using Croatia as the representative small open economy. In line with the results of previous empirical research, a research hypothesis according to which the increase in public wages in Croatia leads to a decrease in economic activity has been stated. In the central part of the paper, the long-run effect of public wages on economic trends in Croatia is examined by employing Johansen cointegration approach, using monthly data on public sector wages and industrial production indices from January 2000 to February 2017. The results of the conducted research suggest that an increase in public wages in the long-run causes a decrease in economic activity in Croatia, which is in line with previous research in international literature. The results of the research point to the need of fiscal consolidation implementation to a greater extent through the reduction of public expenditure, which includes public wages, and less through an increase in tax burden.