Financialization vs. (de)Industrialization in Croatia: Evidence of a Nonlinear Behaviour

Increasing financialization in the EU over the last two decades rendered different macroeconomic stories in regard to growth rates, industrialization and innovation, institutional transformation, inequality and financial stability. In addition, monetary union has created a favourable environment for such process by increasing a market expansion of financial institution and increasing financial assets within companies. However, the process of financial liberalization has changed economic structure in many countries leading to an excessive increase in both private and public debt and subsequently to the process of deindustrialization. For example, deindustrialization lead to a significant reallocation of resources from the industrial sector to the service sector in Croatia. The Global economic crisis of 2008 has shortly devitalized excessive financialization, yet it did not contain it. The aim of this paper is to evaluate whether the two economic lanes, financialization and industrialization, are mutually related and do they follow same linear or non-linear process. Identification is based on Markow switching approach with time-varying transition probabilities and covers annual data from 1995 to 2018. The period covers and extends beyond the Global crisis, which facilitates our empirical logic on examining the regime switching behaviour for both economic processes. Obtained results suggest nonlinearity within, both financialization and industrialization processes, by identifying two distinct levels of behaviour before and after the Global crisis.