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unskilled labor products as the major levers of Lithuanian export expansion. In contrast, unskilled labor intensive products were the best performers in Bulgarian exports. In both periods, the shares of capital intensive and skilled labor intensive products in total exports of CEEC-8 increased whereas they fell in Bulgarian exports. Croatia’s exports, except for much slower overall growth, displayed similar change as CEEC-8.

While this should come as no surprise considering Bulgaria’s two, rather than one, transformational recessions, the comparison with Romania, which has also gone through them, raises concerns. Growth in Romania’s exports was much more robust in 1996-2003 exceeding in 2000-03 the increase in CEEC-8 exports. But more importantly, skilled labor intensive products replaced capital intensive and unskilled labor intensive products as main levers of impressive growth in 2000-03. Both Bulgaria’s and Romania’s performance, differences between them notwithstanding, diverged from that of SEE-4, where natural resource intensive products were behind their overall rebound in exports in 2000-03.

# **C** **_._** _What do developments in trade with the EU say about labor markets?_

While a comprehensive answer to this question would require a detailed analysis of the labor market itself, the evidence from developments in the factor intensity of Bulgaria’s trade with the EU suggests that the cost of labor relative to capital is low. On the other hand, however, the country’s double-digit unemployment rate would seem to reflect the relatively high labor cost. Since wage rates are low, this in turn would suggest high cost of compliance with labor market regulations, which effectively makes labor much more expensive than wage rates alone would suggest. Although Bulgaria’s export basket reflects the abundance of cheap labor, high unemployment rates would point to barriers preventing full exploitation of this potential. While some of them maybe related to distance and weaknesses in services linking domestic markets with international markets, other stem from domestic rigidities.

Labor market rigidities appear to account for the continuing high share of inter-industry type of trade in Bulgaria’s foreign trade. Despite change in the dynamics of exports towards more processed, higher value added products, Bulgaria’s trade still exhibits many features of the traditional division of labor linking developing and highly developed countries through exchanges of raw materials and low-processed goods for processed ones. Bulgaria specializes in the export of production inputs. Excluding clothing, agricultural raw materials and industrial inputs regarded as traditional production inputs, that is, not processed in their present form, have consistently accounted for half of EU-destined total exports minus clothing, while highly processed manufactures have dominated in imports from the EU. Although manufactures amount to more than three-fourths of Bulgaria’s sales in EU markets, half of these are relatively low value-added items such as clothing and footwear.

Labor market rigidities appear to be responsible also for a high presence of unskilled labor intensive products, again clothing dominant among them, in Bulgaria’s exports at the expense of skilled-labor-intensive products. Considering that wage differentials between the EU15 and CEEC-10 tend to be much higher in favor of the former for skilled labor, one might expect a more pronounced presence of skilled-labor-intensive products in EU-oriented exports. In other words, skilled labor intensive activities should have attracted capital, foreign and domestic alike. Labor market rigidities raising the cost of labor appear to have erected the barrier to allocation of capital to these areas.

Considering the prolonged period of FDI inflows well above five percent in terms of GDP as well as the increase in investment levels in the Bulgarian economy, an interesting question is the extent to which apparent labor market rigidities continue to distort investment flows as captured in their impact on exports.