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The effect of the Internet on international trade in services: Developing

countries' case study

Conference Paper · April 2013

DOI: 10.1109/ECDC.2013.6556732

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 The Effect of the Internet on International Trade in Services: Developing
Countries’ case study

Behzad Salmani
Associate Professor at Tabriz University, Faculty of Economics, Iran
Farhad Pourebrahim
Instructor at Maragheh University, Iran
Maryam Saremi
M.A Student of Economics at Tabriz University, Iran

Abstract

This study has explored the effect of the Internet on international service trade in
developing countries using the method of unbalanced panel data and modified gravity model
from 1990 to 2011. The obtained results showed that on the investigation period, The
Internet has had a positive and significant effect on the service trade of developing countries.
Furthermore, there is a positive relation among service trade and GDP, financial depth and
population

Keywords: Service trade, Internet, gravity model, panel data

1
 1. Introduction

The scope of trade in services is vast. It still has experienced much more qualitative and
quantitative changes in recent years. The share of services has increased dramatically and
continuously in making value added and resources allocation and activities to itself and
also in producing gross domestic product, employment and development and on this basis,
its trade has been of utmost importance in both inside and outside of every country.
On the other hand, regarding increasing developments of information and
communicational technologies in recent years, lots of services trades have gradually been
delivered from real to virtual world. The main characteristic of these technologies i.e.,
“compression of time and place” has removed many geographical and time limitations in
the physical world and has offered unique opportunities in the hands of individuals and
companies in order to do their transactions fast, less time, beyond geographical borders,
and time limitations. So it can be declared that Internet has provided a suitable opportunity
for countries in domestic and international exchange services. Also using Internet helps in
omitting market intermediates and this in turn lowers down prices dramatically and finally
it leads to the rise in competition. Internet, therefore, enable the regional companies offer
their products and services overseas and thus overcome to one of the important world
competition obstacles facing countries. So, in present era, one cannot ignore the impact of
the Internet on international service trade.
There is one issue that can be taken into reflection. Unlike the importance of Internet
consideration on service trade, the number of related studies is few. On the other hand,
there is an important point. Is there a positive correlation between Internet and
international service trade? In this framework, considering the relation between the Internet
and international trade will experience the utmost importance. The purpose of this paper
was to consider the impact of the Internet on international service trade in developing
countries. A question raised in this framework, will Internet affects developing countries
service trade?
The paper proceeds as follows: Section two is a review of literature. In section three, the
used model and data will be presented. In section four, the estimated results will be both
presented and analyzed. Section five dedicated to the presentation of conclusions.

2. Review of the Literature

The Purpose of this section is to provide a theoretical framework for empirical

examination of how the internet will influence service trade. In the past, economic theories
did not determine a special place to the services (Except financial services). The first
theory was presented by Goldsmith (1969) about the importance of services, being
emphasized the role of financial services in shifting capitals to the position that have the
best efficiency (Jones and Kierzkowski, 1990). A key difference between trade on “goods”
and “services” is that the importation of services must be done locally (Sabagh, 2008) e.g.
the production and consumption of services must be done simultaneously, and service

2
providers and consumers be present there. An issue that must be considered in service
trade1 is the technology emergence and finally the importation of services. The importation
will bring the technology into the host country even if it does not make any changes to the
structure of product market and production factors.
On the other hand, having entered into the trade arena as the most important information
and communication technology in international level, the Internet provided chances for
trade facilitation and competitive increase over the world.
In this regard, one of the frequent models for reviewing the rate and direction of internet
impact on service trade is by using the gravity model2. It is one of the important means
which is widely used in international trade to explain bilateral trade flows. On the basis of
the above mentioned issues, common gravity model for service trade is as follows3:

    

    
    (1)

Where,
 = of bilateral service trade flows (exports and imports) between country i and
country j
G= GDP of country
P= Countries’ population
 = Geographical distance between the capitals of country i and country j.4

And the model which is the Internet variable included in is as follows:

 (2)

In this model, “IT” stands for the Internet variable 5 of both importing and exporting
countries.
The model is meant to be illustrative and highlight the ways in which the internet is
likely to impact service trade. The relevant innovation of the internet is that it lowers entry
costs into a new market through organized exchanges with numerous buyers and sellers,
and through powerful search engines, which enable sellers and buyers to find each other at
low cost (Freund and weinhold, 2003).The internet can lower prices by lowering search
costs and is especially useful in reducing international communication and searching costs.
Both lower search costs and lower entry barriers in a greater market competition can be
improved by intensified competition (Miraskari, 2011).A related strand of the literature

1
. For Further reading, see Ethier, W. & Horn, H. (1991), and Mirza, D. & Nicoletti, G. (2004).
2
. For Further reading, see Anderson, (2011).
3
. For Further reading, see UNCTAD/WTO (2003) & Fukunari Kimura & Hyun-Hoon Lee(2004).
4
. DISTANCE is measured as the great circle distance between the capitals of home countries and partner
countries.
5
. Freund & Weinhold, (2004) have used the number of hosts as Internet proxy. Choi, (2010), has used the
number of Internet users.

3
focuses on the entry costs associated with imperfect information and emphasize the
importance of local networks in overcoming these costs (Ruach, 1996).
Along with table 1, it is pointed out to some of the empirical studies on Internet and trade.

Table 1: Some of Empirical Studies on Internet and Trade

Article Time Sample Conclusions
period
The development of Internet beyond the
Freund and borders of the U.S has begun facilitating the
United
Weinhold 2000 increase of service export to the U.S.
States Furthermore, a 10 percent increase in Internet
(2002) variable, leads to a 1.7 percent increase in
growth.
A 10 percent increase in the growth of web
Freund and hosts in a country leads to about a 0.2
Weinhold 1995-1997 56 percentage point increase in export growth.
countries For the average country in sample, Internet
(2004) contributed to about 1 percent point increase
in annual export growth from 1997 to 1999.
The results state the influence of endogenous
Internet penetration and performance of firms
that have been affected in developing
Clarke and countries that have access to Internet. In other
36
Wellsten 2001 words, Internet access appears to stimulate
countries exports from poor to rich countries.
(2004) Moreover, the analysis suggests that
regulatory policies affecting
telecommunication and Internet development
indirectly affect trade.
Increase in Internet users per hundred people
proved to increase total service trade, as well
151
Choi (2010) 1999-2006 as service export and service import. A 10%
countries increase in Internet user per hundred people
turned out to increase service trade from
0.23% to 0.42%.
Increase in the number of Internet users have
Miraskari et 30
2001-2008 positive and significant effect at level of 5
al (2011) countries percent on bilateral export and trade volume
in exporting and importing countries.

4
3. Model and Data

The used model in this paper to study the Internet impact on service trade is the gravity
model that will be as following in the framework of standard thematic literature and on the
basis of model (2) in theoretical framework section that become into linear equation by
taking logarithms from both sides of equation.


(3)

In which the , stands for a country’s gross domestic product, “POP” Stands for
Population and “Dis” stands for geographical distance between two countries and the
sentences “ln
” stand for the number of Internet hosts of natural logarithm in both
importing and exporting countries respectively. “ ” states individual effects of each pair
of countries can express and finally “ ” is the disturbance term of the model and “i”, “j”,
and “t” stand for the country and time of study respectively. For instance, it can be pointed
out to Freund and Weinhold (2004) that have used this model in their research.
In this paper, “the Choi 2010” model has been used to the analysis of the Internet
development impact on international service trade increase. This model is the modified
gravity equation that unlike traditional gravity1 equation model, the distance variable has
been omitted in this analysis. Therefore, the used model for this paper is as follows:
log'()*+#( (4)
  , - log./
01/0
 , ! log , 2 log
!
, 3 log 4 5 , # , $
 

Where, “service” as independent variable, stands for service trade and “Internet”
represents the number of Internet users 2 . “GDP” stands for a country’s gross domestic
product and “pop” stands for population, as dependent variables for controlling the effects
of every country size and income. The financial depth variable,” ! /GDP” is used as proxy
comparative advantage of services in every country."# ” is the fixed effects of countries
and "$ ” is the disturbance term. “i” and “t” stand for a country and time of study
undertaken respectively.
In this study, data from developing countries were used during 1990 to 2011. These
countries were selected from the categorization of UNDP3 (2011). All the required data

1
.To read more about the history of Gravity Model, look Tinbergen (1962) and PÖyhÖnen (1963).
2
.Internet users per hundred people
3
.United Nations developing programme

5
have been used from World Bank 1 and were estimated using unbalanced panel data
regression model.

4. Estimating the Model

The results estimating model (4), for developing countries have been presented in table
2
2. The results show that the Internet has a positive and significant effect on international
service trade of developing countries. GDP and Population (pop) have positive and
significant effect on service trade. Estimating coefficient of ! / also as the proxy
comparative advantage of services indicates a positive relation between financial depth and
international service trade i.e. with development and improvement of financial depth in
developing countries, the international service trade level will raise too.

Table 2: Estimation results- Equation (4)

Dependent Variables Estimating coefficient t-statistics Prob.

Constant -0.9742 -2.8642 0.0042

Log(Internet user) 0.0215 5.3052 0.0000
Log(Pop) 0.7818 53.0886 0.0000
Log(GDP) 1.3780 43.7564 0.0000

! /
Log( 0.2797 9.5809 0.0000
!
1 =0.9730 F=477.7797
NO. of countries=135 NO. of observations=1822

In fact, results obtained in this study, verify the explained model and are compatible with
results of previous ones being done by Freund and Weinhold, (2002), and Choi, (2010).
That is there is a positive relation between Internet and international service trade. The
only incompatibility in our results with that of Choi, (2010) is the population variable
relation with that of service trade. The results obtained in our study shows a positive
relation between population and service trade, but the relation of these variables is negative
in Choi’s study.

1
.http://databank.worldbank.org/ddp/home.do?Step=2&id=4&DisplayAggregation=N&SdmxSupported=Y&
CNO=2&SET_BRANDING=YES
2
. In estimation being done using “F” test, the existence of individual effects have been verified. Next, fixed
effects have been accepted using Hausman test.

6
5. Conclusions and Policy implications

The aim of this paper was to consider the impact of the Internet on International service
trade in developing countries1 from 1990 to 2011 using unbalanced panel data. The results
of this paper showed that Internet users per hundred people2 have a positive and significant
effect on international service trade in developing countries. Also, results in this study, are
similar to the previous ones.
On the basis of our findings, development in the internet is expected in the future and it
will contribute to the expansion of service, and it seems that the development of Internet
users will make the development of service trade in International level. Hence, it is
suggested that developing countries provide conditions for the development of Internet
users

References

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Economics (3):1-45.
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1
.For analyzing the sensitivity of results, the impact of the Internet on international service trade of developed
countries and the rest of the countries in the world has been estimated. The results are the same as the
previous ones. So, it is not sensitive to the sample.
2
.In next step of analyzing the results sensitivity, internet proxy has changed into Internet hosts and model 4
has been estimated. The results are broadly similar to the results using Internet users. Therefore, the obtained
results are not sensitive to that of proxy change.

7
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