20 Serbia. Furthermore, imports entering Bosnia and Herzegovina through the Brcko region, which is neither a part of the Federation of Bosnia and Herzegovina nor of Republika Srpska, go unreported. Reportedly, these are quite significant, as excise and sales tax levied there are lower than in two entities of Bosnia and Herzegovina. Furthermore, high taxation of trade across the region encourages black market activities (EWI 2000), which in turn provides strong incentive to smuggling. Porous borders in many countries, the absence of language barrier in former Yugoslav republics and corrupt customs suggest that unreported trade among SEE-5 may be quite considerable. Again, there are no reliable estimates, but anecdotal evidence suggests that smuggling is rampant in many areas. **25** Bringing into the picture other Balkan economies-Bulgaria, Greece and Romania-does not significantly increase the importance of the region as a market for SEE-5 sales and purchases. These three Balkan economies absorbed merely 4.3 percent of exports originating in SEE-5, but accounted for 7.5 percent of SEE-5 total imports. Geographical proximity and much higher level of economic development seem to explain a very significant share of Greece in Albania's trade, and Slovenia's in trade of Bosnia and Herzegovina and Croatia.<sup>26</sup> Common borders and decent transportation network account for a relatively large share of Bulgaria in trade of FR Yugoslavia and FYR Macedonia. On the other hand, however, Romania's involvement in intra-Balkan trade remains exceptionally low.

# **Is Intra-Regional Trade below Potential? Gravity Model Estimates**

The gravity model provides a useful tool to assess regional biases in international trade and predict potential trade flows. It is based on the concept borrowed from physics according to which the gravity force is directly proportional to the mass of two bodies and inversely proportional to the distance between them. In a similar way, the gravity model or equation describes a bilateral trade flow as positively related to the economic size of the two countries and negatively related to the distance between them. Its results are highly sensitive to the choice of variables capturing broadly conceived distance (transport cost, cultural similarities, language, etc.), the economic size of countries (the quality of statistics on GDP) as well as characteristics concerning consumers' preferences (or their absence) among the various trading partners.<sup>27</sup> 25 For instance, the WSJE reported massive exports from Serbia to Kosovo brokered by Muslim Slavs of Sandzak involving food and livestock and construction materials. All transactions are on cash basis. Anecdotal evidence about the dramatic increase in the number of trucks registered in Sandzak to transport products to Kosovo suggests a significant scope of this trade (Robert Block, "'Bosniaks' Dare to Deliver Where Many Fear to Go," _The Wall Street Journal Europe,_ 18 February 2000).

26 If one includes Slovenia, a republic of former Yugoslavia, the share of the Balkan region in total SEE-5 imports increases to 23 percent and the share in exports to 31 percent. Within the former Yugoslav space, the most active trade occurs in the triangle: Slovenia-Croatia-Bosnia and Herzegovina accounting for 71 percent of all shipments among former Yugoslav republics and the share of Croatia and Slovenia in total exports originating in former Yugoslav republics is 76 percent. Considering their economic weight, this is not surprising. But clearly there is potential for the increase especially in trade with FRY.

27 For an illuminating discussion of the theory underpinning gravity models and their various applications, see Smarzynska, 2001. For a much more elaborate application of a gravity model to estimate potential trade in SEE region, see Christie (2001). It is interesting to note that the results reported there do not significantly differ from ours.