21 Because of the poor quality of data,<sup>28</sup> we use a very simple gravity equation taken from Frankel, Stein and Wei (1997) that uses standard parameter values: liogii **_7)_** _O71gGP~_G )_ **0** _3 log(GDPPC: GDP.PC:) 0.71log(D istance_ )

- where: T,j represents a trade flow from country i to country j; GDP stands for the total Gross Domestic Product and GDPPC for the Gross Domestic Product per capita; Distanceij denotes the distance between capital cities of trading partners.

The model is resolved simultaneously for all countries by inputting the data for each country and solving the equation above. The predicted trade is then compared to the actual trade between dyads of countries.

The results of the 'gravity' exercise should be treated with extreme caution for two main reasons. First, as discussed above, official statistics tend to underreport existing trade flows. The problem in SEE-5 goes beyond possible sloppiness or corrupt practices at intemational borders rather common in many developing countries. The problem is that trade statistics of FR Yugoslavia did not include foreign trade transactions of independent customs areas-Montenegro and Kosovo. Neitherdid they include its FR Yugoslavia's trade with Serbia nor imports entering Bosnia and Herzegovina through the Brcko region, which is neither a part of the Federation of Bosnia and Herzegovina nor Republika Srpska. In consequence, the realization ratios tend to over-estimate trade potential, simply because actual trade is underreported.

Second, the gravity model used here tends to exaggerate potential trade flows for yet another reason. Consider that distance is proxy for shipping costs. But proximity does not always reduce the transportation costs, time lags, the magnitude of spoilage or the cost of gathering information about the partner's legal and administrative procedures. Although countries located close to each other are more likely to have a long history of bilateral trade giving them a better understanding of each other' customs and tastes, poor infrastructure in most SEE-5 countries (i.e., ports, transportation routes) seems to be a formidable barrier to regional trade. Albania, for instance, does not have good transportation routes to most of Balkan countries excluding Greece.

For reasons related to the legacy of recent history, we initially focus on former Yugoslav republics. These countries had close ties as parts of the same national economy. As pointed earlier, some observers believe that the removal of trade barriers among them would provide a powerful boost to economic growth and regional cooperation. Our calculations include Slovenia-although not a Balkan country, it was part of former SFRY. It had been not only a gateway of former SFRY to the EU, with most of its exports to EU and EFTA markets originating in Slovenia, but also a significant market for products from other republics especially from Croatia.<sup>2 9</sup>

**28** For instance, significantly different data are reported for the same bilateral trade flow between importing and exporting countries. Discrepancies in trade statistics are often huge (see Table 4). In order to circumvent this problem, we use-following the approach taken by Fontagne, Freduenberg and Peridy (I 999)-the weighted average of two estimates weighing the imports as twice high as those reported by the exporting country.

**29** Before the split, Slovenia's trade relations with the other former Yugoslav republics were quite intense, especially with Croatia accounting in 1990 to roughly one-eight of its total sales and purchases. Around half of Slovenia's trade turnover with Yugoslav republics was with Croatia (OECD 1997).