8 larger than that in any of a single (or combined) SEE-5, this arrangement will offer strong advantage to EU firms at the expense of SEE-5 firms. It will be easier for the former to claim preferences in access to SEE-5 markets, simply because more inputs are available locally, i.e., in the EU. In contrast, similar SEE-5 firms are more likely to rely on imports not necessarily from the EU. Even though-FTAs among SEE-5 countries may limit the 'hub-and-spoke' effects, the bilateral cumulation between the EU and each SEE-5 would provide disincentive to regional trade in intermnediate products.

Second, "hub" firms are more likely to have all necessary accounting devices to meet the necessary rules-of-origin requirements and not incur extra administrative costs." Because of a large network of bilateral free trade agreements of which the EU is a party, many EU exporters have already incurred administrative costs associated with proving that their products meet the requirements of the rules of origin. This does not seem to be the case for most of 'spoke' firms lacking the capacity to demonstrate the geographical breakdown of the inputs used in their production. With customs procedures poorly developed in most SEE-5 countries, the EU customs authorities may be unwilling to accept their respective proofs of origin.

Third, "spoke" countries in North-South integration scheme tend to specialize in unskilled labor-intensive products such as textiles, clothing and footwear. These 'sensitive' products, accounting for the bulk of SEE-5 exports to the EU,'<sup>2</sup> face much more difficult conditions in access to markets in highly developed countries including the EU than other industrial products in which EU firms specialize. Even though the Europe Association Agreements and the Stabilization and Association Agreements that had been so far signed include the removal of tariffs and other restrictions on sensitive products, the rules for assessing their origination are more complex and more difficult to meet than for other industrial products. While for other industrial products an exporter has to demonstrate that local processing resulted in a new product in terms of "change in tariff heading," that is, an imported product is differently classified than the exported one, the criteria for sensitive products are different. Instead of 'change in tariff heading,' they are subject to technical requirements.'<sup>3</sup> These are more difficult to fulfill than the "change in tariff heading" requirement used for most other products and they are often used as a tool of protection (Hoekman 1993).

three and five percent of the transaction value. Although under preferential access granted by the EU SEE5 exporters already have to meet the rule-of-origin requirements in order to take advantage of preferential treatment under GSP or ATP, other firms interacting now solely with non-preferential markets will have to adopt special accounting procedures to trace origins of each input.

**"1** Cost relates to administrative activities that the 'rules of origin' impose on an exporter. Empirical evidence from intra-EFTA and EFTA-EU trade show that many exporters preferred to pay non-preferential tariff rather than incur costs necessary for qualifying for preferential treatment (Herin 1986).

**12** They accounted in 2000 for between 46% (Croatia) and 70% (Bosnia and Herzegovina) of their total EU-oriented exports (own calculations from WITS database).

" Annexes to the Europe Association Agreements specifying technical requirements deal almost exclusively with footwear, clothing and textiles. Brenton and Manchin (2002) note that 86 percent of textile headings and 95 percent of clothing headings require satisfying specific working and processing conditions. Consider that exports of clothing have been excluded from the scope of Pan-European cumulation rules (Driessen and Graafsma 1999). For a more general discussion of the rules of origin and their impact on trade, see UNCTAD 1998.