PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Project Name PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Croatia Science & Technology Project Report No.: AB1160 Region EUROPE AND CENTRAL ASIA Sector General industry and trade sector (100%) Project ID P Borrower(s) REPUBLIC OF CROATIA Implementing Agency Environment Category [ ] A [ ] B [X] C [ ] FI [ ] TBD (to be determined) Safeguard Classification [ ] S 1 [ ] S 2 [X] S 3 [ ] S F [ ] TBD (to be determined) Date PID Prepared May 31, 2005 Date of Appraisal May 13, 2004 Authorization Date of Board Approval July 7, Country and Sector Background Croatia has made significant progress in its transition towards a market economy. Real GDP growth has averaged 3.2 percent during with inflation in the low single digits (below 4 percent). These numbers compare well with the countries that joined the European Union (EU) in May 2004 (EU8) as well as the EU15. However, the Government of Croatia recognizes that more remains to be done to improve the competitiveness of the Croatian economy and propel it forward on a path to sustained economic growth. The Government, therefore, plans to undertake major reforms aimed at improving the governance and efficiency of public sector institutions as well as overall business environment, enhancing private sector growth and deepening knowledge-based growth and innovation in the economy. These measures are important not only to improve firm-level productivity and better prepare the nation for entering the EU with a competitive and growing economy with the institutional capacity to meet the demands of global competition, but also to improve the standards of living of the Croatian society. Knowledge is transferred into goods and services through a country s National Innovation System (NIS), which includes a policy framework conducive for innovation, knowledge generating/creating organizations (universities and research and development institutions), intellectual property rights (IPR) regime, measurements, standards, testing and quality (MSTQ) systems, as well as a modern information access infrastructure. The objective of a well functioning NIS is to serve the needs of the economy by achieving a better integration of the technology and innovation infrastructure with the market needs, increasing private sector participation, and developing linkages between industry, and research community. Within this context, the Government has moved to the implementation stage of its ambitious agenda in developing its NIS by leveraging the stock of highly skilled human capital, improving efficiency of the scientific/research know-how present in the country, creating appropriate mechanisms to share the knowledge among society, and developing a conducive environment for upgrading firms innovation capabilities in order to upgrade their productivity and

2 competitiveness. The general outline of the country development strategy is given in the "Croatia in the 21st Century" - the development strategy for Croatia adopted in June "Croatia in the 21st Century" covers such areas as the real sector of the economy, macroeconomics, science development, and information and communications technology. Under this strategy, creating an environment that is conducive to investments is a key priority, and includes the improvement of intellectual property rights, increasing quality of the products, improving research and development (R&D) activities and designing new information technology infrastructure. Over the last decade, the Government has taken a number of steps to upgrade its NIS institutional structure, including creating the State Office of Standardization and Metrology (SOSM) and State Intellectual Property Office (SIPO), and launching (in 2001), a Croatian Program for Innovative Technology Development (HITRA). The primary goals of HITRA are to encourage (a) transfer of knowledge from the sphere of science and technology into the business sector; and (b) the transfer of foreign knowledge and technology into the business cooperation among the enterprises, scholars and industry to support economic development. HITRA supported the creation (in 2001) of the Business Innovation Center of Croatia (BICRO), the Center for Technology Transfer and several Technology Centers (TCs) in the regions. The Program comprises two complimentary sub-programs: (i) the TEST program which supports early-stage R&D projects with some linkages between fundamental research and its application in technology; and (ii) the RAZUM program which supports the development of knowledgebased companies through commercialization of R&D outputs. However, these programs are limited in size and cumbersome in procedures and need to be aligned with international best practices. Further, the Ministry of Science, Education and Sports (MSES, the Ministry) in 2005 established National Innovation Council and Croatian Accreditation Agency (CAA) has recently decided to set up a Croatian Innovation System Group (CIG) which will act as a think-tank assisting the Ministry in the design, analysis and implementation of various policies and programs to strengthen the Croatian NIS. In October 2002, the Ministry started the preparation of a broad-based Technology Program to build on the earlier efforts and successes and to prioritize the economy s needs in a systemic way. This work has been supported through the World Bank Technical Assistance Project for Institutional and Regulatory Reform (TAL-2) and resulted in the proposed Science and Technology Project (STP) which will support a major part of this Technology Program, including restructuring R&D Institutions (RDIs) to focus on the industry needs in technology, and to promote the development, adaptation and use of the new technologies by the firms. The Project is an integral part of an overall Knowledge Economy umbrella and will help improving sustainability of the government's efforts and programs in this area. Science and Technology Policy As a critical step in the preparation of the Technology Program and to ensure that reforms supported under the proposed STP make stronger impact on the overall economy, the Government has carried out a comprehensive work to shape up the Croatia s Science and Technology Policy. The Ministry recognizes the need to align the Croatian S&T policy framework to provide a platform for sustained economic growth and to produce higher value

3 added and technologically advanced products and services to enable Croatian companies to compete in global markets. An integrated Science and Technology Policy is in the advanced stage of preparation and it is planned to be finalized and adopted by the Government by September 2005, as outlined in the S&T Policy Letter of April Elements of this policy framework will include, inter alia, (i) A conducive framework for research & development institutions to carry out applied research and technology transfer; and (ii) Improved incentives for industry (especially, SMEs) to promote innovation and commercialize research outputs. In addition, some of the regulatory constraints are being removed with the help of the Ministry of Finance (MOF) as a part of the Government s EU Accession Action Plan. 2. Objectives Development Objective: The major development objective of the Project is to (i) strengthen and restructure selected research & development institutions to promote applied research, while maintaining their scientific excellence; and (ii) to increase the ability of enterprises to develop, use, adapt and commercialize technology. This would contribute to improving the competitiveness of the Croatian industry both in the domestic and foreign markets. An increased productivity and technological base and strengthened linkages between RDIs, scientific community and industry will help enterprises compete more effectively and facilitate Croatia s economic integration with the global markets. Moreover, upgrading the technological capabilities of firms would be an important step for Croatia s future accession to the European Union. Key Indicators: The following indicators will be used to assess the progress of the STP: (i) Improved orientation of R&D towards industry needs measured by number of joint projects of the RDIs with the industry; (ii) Increase in self-sufficiency ratio of selected R&D institutions measured by revenues earned from contractual research and services; (iii) Improved access to financing for R&D activities measured by number and value of such financing provided; (iv) Increase in firm-level productivity, market share, profitability, new products to market, and exports among beneficiary firms; and (v) Increase in collaboration between the Croatian industry and research community and Croatian scientific Diaspora measured by the number of joint ventures and applied research projects. The proposed Science and Technology Project would support elements of the following Country Assistance Strategy (CAS) 1 objectives: Successful accession to the European Union, so that Croatia enters the EU as a dynamic and competitive economy that can rapidly achieve convergence to EU living standards. The strategy calls for a shift to private sector-driven growth through rationalization of the public sector and establishment of a supportive investment climate. 1 Country Assistance Strategy for the Republic of Croatia, dated November 24, 2004.

4 The Project would support Croatian industry through various programs including supporting the modernization of the S&T system to contribute to needs of the economy and maintaining high quality science infrastructure, upgrading of technological capabilities of firms, and development of non-traditional financing (venture capital) that would be of potential interest to domestic and foreign investors. Developing an appropriate business environment would be instrumental in improving industry competitiveness. It would target industry as a whole, including domestic and export oriented firms, large firms and SMEs. 3. Rationale for Bank Involvement The World Bank s participation in the proposed Project would promote necessary policy reform, catalyze private sector participation in technology development and shift the emphasis away from a public sector driven approach to one that is driven by market needs. The Operations Evaluation Department reviews suggest that the Bank has an important role to play in the area of science and technology facilitation; particularly in supporting industrial technology projects (as has been completed in many countries, including Spain, Israel, Turkey, Mexico, Brazil, Korea, China, and India). The Bank participation in the reform of the Croatian science and technology infrastructure would speed up the reform process thus assisting Croatia's integration into the EU. The Bank has a comparative advantage in leveraging experience and international best practices to ensure that activities are designed in the most effective manner. On the institution building side, the Bank could contribute in its capacity of a facilitator of the science and technology reform process which will increase the likelihood of effective design and delivery of current and future services, with a higher degree of sustainability. With Bank involvement, prudent market tests would be carried out and fiscal discipline would be imposed on RDIs and other Project Agencies. Drawing from the experience in other countries, the Bank could provide the sustainable support, advice, and leverage needed during the difficult restructuring phase. 4. Description The Project designed in partnership with the Government and Project Agencies (PAs), involves a Bank loan of Euro 31 million and consists of three main components: (i) RDI component (Euro 10.5 million) for Restructuring of RDIs (Brodarski Institute [BI] and a few other RDIs) to increase focus on applied research and at the same time, to maintain scientific excellence; (ii) BICRO Component (Euro 14 million) for upgrading technological capabilities of enterprises by providing financing support for technology startups, technology-based companies and R&D centers; and (iii) Unity Through Knowledge Fund (UKF) (Euro 3.7 million) to engage Croatian scientific Diaspora in joint projects and other initiatives, to transfer their knowledge and skills for the benefit of Croatian society, as well as to motivate the scientists to return to Croatia. In addition, the Project will provide Euro 1.64 million support for: (i) Croatian Innovation System (CIS) Group which will assist in the design and implementation of the Ministry of Science, Education and Sports (MSES, the Ministry) priority initiatives, programs and policies in deepening its CIS, and the newly established Croatian Accreditation Agency (CAA); and (ii) project management, common studies, promotion activities and publications, and other related activities. Unallocated and contingencies in an amount of Euro 1 million are included to provide flexibility during the project implementation. The Project would:

5 (i) Help create environment for applied R&D in Croatia in order to promote innovation and improve the quality of services and products by the industry, as well as promote synergies between the research community and industry. This will be achieved through restructuring of the selected RDIs in Croatia (Brodarski Institute and other RDIs to join the Project at the later stage) to help them reorient themselves towards applied research, while maintaining scientific excellence, and become more self-sustainable thus reducing burden on the government budget. These efforts are expected to provide a demonstration effect among other RDIs in Croatia who would be able to join the project during implementation. (ii) Provide means and build appropriate financial mechanisms to support development, use and adaptation of new industrial technologies, promote growth of technology-rich companies, improve quality and diversity of the products by industry, which, ultimately, will contribute to the improvement of competitiveness of Croatian firms. Within this task, the Project will support upgrading of Business Innovation Center of Croatia to enable it to provide a wide range of technology support services to private knowledge-based firms in Croatia. The Project will also fund (co-finance with the Government and private sector) BICRO s programs: technology financing programs to support R&D in knowledge-based firms (RAZUM Program), venture capital, support of Technology Centers, R&D Centers and incubators in the regions, and SPREAD Program. (iii) Engage Croatian Diaspora in the upgrading of the Croatian Innovation System. The Unity Through Knowledge Fund would aim to attract promising scientists and researchers from the Croatian international community to transfer knowledge and skills back to Croatia through a variety of activities in the following four distinct areas: (a) attracting expatriate Croatians for scientific research; (b) setting up a network of Croatian scientific Diaspora; (c) short term visits of eminent Croatian expatriates to Croatia; and (d) attracting expatriate Croatians for technologybased start-up companies. 5. Financing Source: (Euro m.) BORROWER 5.7 IBRD 31.0 Total Implementation The Borrower is the Republic of Croatia represented by the MOF. The implementation period is expected to be four years, starting Fall 2005, with a closing date of November 30, Overall responsibility for the implementation and coordination of the Project is delegated by the Government to the MSES. The Project Management Unit (PMU), established at MSES, is responsible for day-to-day project management and coordination on behalf of MSES including procurement, disbursement, financial management and monitoring and evaluation activities. The PMU also ensures that appropriate Bank guidelines and procedures are followed. BI and BICRO (the Project Agencies) will be responsible for the implementation of their respective components; MSES will be responsible for the Unity Through Knowledge Fund and joint activities. The

6 activities planned under the Project would be implemented in accordance with the Project Implementation Plan (PIP). Project activities would be defined on the basis of the annual Business Plans (BPs) to be prepared by the Project Agencies (and MSES for the UKF). The BPs would be prepared for rolling three to five year periods and will be updated annually. The Government will implement an integrated Science and Technology Policy to support the reorientation of the S&T infrastructure to align with national priorities. The MOF and MSES on behalf of the Government would enter into the Subsidiary Finance Agreements (SFAs) with the Project Agencies, where it will define the terms and conditions of financing from the Government to each Project Agency, including self-sufficiency goals (for BI and other RDIs who will join the Project later), and relationship between the parties. Additional RDIs that will join the Project during the implementation would be selected in agreement with the Bank based on criteria agreed with the Bank. The Government will delegate the right to utilize the Bank Loan funds to the MSES. The counterpart contributions would be provided by the State budget through the MSES budget allocations. MSES will pass on Project funds in the form of no-interest loans and grants to the Project Agencies. The terms of loans and grants to the Project Agencies, acceptable to the Bank, would reflect their respective roles, their ability to pay through revenues generated from their services, expected reduction in dependence on the government budget, and the public-good nature of the services they provide. 7. Sustainability In view of Croatia's need for greater integration with the EU and the world markets, the demand for the technology services from industry (certification, accreditation, calibration, patents, and R&D) is expected to expand as competition becomes stronger. Major policy reforms, such as reforming governance structures of RDIs and BICRO, adopting necessary regulations and creating incentives for public and private sector use and benefit from the Project activities, will be carried out to ensure effective project implementation. The Project is designed to fill in the infrastructural gaps, provide technical assistance with private sector participation, and build a service providers market. Technology services would be provided on a cost-sharing basis to ensure the full involvement and commitment of the Project Agencies and beneficiaries. The private sector focus of the Project aims to promote the sustainability of the technology support infrastructure in Croatia. The Project also builds upon an innovation culture that is taking root, and through awareness-raising and information dissemination campaigns, which would maintain momentum. Careful attention would be paid to institutional capacity building in terms of strengthening management and business systems as well as staff skills to ensure that reform reaches all levels. The Project is structured to encourage business-like thinking and fiscal discipline in the institutional management and operations to promote efficiency in managing processes and utilizing resources. Each institution would phase investment on the basis of approved Business Plans, thus providing adequate attention to the issues of financial sustainability. Project Agencies

7 would receive technical assistance, training, and other appropriate forms of assistance so that the reform process can permeate and strengthen all levels of staff and institutions. 8. Lessons Learned from Past Operations in the Country/Sector Lessons learnt are based on the experience in several Bank-supported industrial technology projects in India, Indonesia, Mexico, Brazil, Turkey, Korea, and the Operations and Evaluations Department Report on Technology Development. It also builds on the implementation experience in Croatia itself. Project Scope and Complexity. Technology projects normally include a wide spectrum of interventions, all of which are complementary in nature and would not function well without one another. On the supply side, the reforms can tackle the restructuring of R&D institutions to refocus them toward industry needs; build up a functioning MSTQ system to improve market access and competitiveness of products domestically and internationally; and provide the necessary protection to the innovators in the form of a healthy IPR regime. On the demand side, the reforms can support the use and adaptation by the industry of innovation and new technologies developed by the research community. It should also be noted that the innovation is encouraged and adapted by enterprises when appropriate technology financing programs, including matching loans/grants and venture capital funds, are in place. Technology projects typically are complex, contain multiple components of a complementary character, and must be seen as long-term efforts. Experience has shown that a systemic and holistic approach to technology development works best and that such operations should not be too narrow. Each technology project has to be custom-designed and must be a product of a collaborative approach among the stakeholders in the country. Due to the multi-task nature and that some components of the Innovation System may be ready sooner than the others, a series of projects tackling limited number of issues works the best. Complementarity of activities and the built-in synergies in these projects imply complexity in design, and as a result these projects are labor-intensive and resource-intensive to prepare and supervise (for both the client and the Bank). Given the difficulties of the initial reforms and delayed return for the economy, the innovation support agenda sometimes is accorded low priority by the busy governments struggling with fiscal deficits and other macro-economic challenges. Therefore, technology projects require a strong dedicated champion in the country to move the reforms along both on the Government and the institutional level. Public-good nature and externalities. Due to the public-good nature of investment in MSTQ and IPR systems and R&D infrastructure and the high spillover effects and externalities associated with the generation, adaptation, and diffusion of new technologies, the involvement of the public sector in this area is justified. The private sector normally would invest in these activities only to the extent that it could internalize the benefits of these investments fully and make a quick profit. This is possible only for big firms, leaving a large part of the industry needs unfulfilled and the level of private investment below the socially optimal level. The role of the public sector therefore is crucial, in its ability to provide support for the setting-up of technology services where they do not exist or the reorientation of those that do exist. Public sector has important

8 role in building a good institutional framework and setting up business environment conducive for technology development. The social rate of return on R&D expenditures is often three times as large as the private rate of return. Private sector participation. Public sector approaches in the past have led to inefficient infrastructure and services that do not respond well to market needs. An emphasis on private sector participation therefore is important in the restructuring process, for the sector s ability to inject into the process efficiency, management capability, good governance, and cost-effective design and delivery. The private sector is instrumental in making a shift from knowing to applying the knowledge for the benefit of the economy. Co-financing from the private sector and its participation in the governance, have proven valuable in helping to maintain a business focus and more effective use of resources. In summary, STP has been designed by paying close attention to policy reform and institution building. The project scope has emphasized the importance of striking a reasonable balance between the broader needs of technology development and the realistic absorptive capacity of the targeted Croatian institutions, with careful consideration to the ability of a single Bank project to handle a number of activities. 9. Safeguard Policies (including public consultation) Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [X] [ ] Natural Habitats (OP/BP 4.04) [ ] [X] Pest Management (OP 4.09) [ ] [X] Cultural Property (OPN 11.03, being revised as OP 4.11) [ ] [X] Involuntary Resettlement (OP/BP 4.12) [ ] [X] Indigenous Peoples (OD 4.20, being revised as OP 4.10) [ ] [X] Forests (OP/BP 4.36) [ ] [X] Safety of Dams (OP/BP 4.37) [ ] [X] Projects in Disputed Areas (OP/BP/GP 7.60) * [ ] [X] Projects on International Waterways (OP/BP/GP 7.50) [ ] [X] 10. List of Factual Technical Documents 11. Contact point Contact: Ekaterina N. Koryukin Title: Projects Officer Tel: (202) EKoryukin@worldbank.org Or Contact: Vinod K. Goel (202) * By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties claims on the disputed areas

9 12. For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C Telephone: (202) Fax: (202) Web: