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Running head: The Effect of the Internet on Economic Growth

The Effect of the Internet on Economic Growth:


Evidence from Cross-Country Panel Data

Changkyu Choia, Myung Hoon Yia


a

Department of Economics, Myongji University, 50-3 Namgajwadong,


Seodaemungu, Seoul 120-728, Korea

September 20, 2003

Abstract
Using cross-country panel data, we found evidence that the Internet plays a
positive and significant role in economic growth after investment ratio,
government consumption ratio, and inflation were used as control variables in the
growth equation.

Keywords: Internet; Growth; Panel data

JEL Classification: C23; L86; O40

We would like to thank Kyeongwon Yoo, Yong-Hwan Noh and other participants for their
comments at the International Finance Study Group seminar held at the Bank of Korea, November
2005.
Corresponding author: Myung Hoon Yi, Department of Economics, Myongji University, 50-3
Namgajwadong, Seodaemungu, Seoul 120-728, Korea Tel.: +82-2-300-0687; fax: +82-2-3000654. E-mail address: yimh@mju.ac.kr (M.H. Yi).

1. Motivation

The Internet has influenced the economy in every respect. The history of the
Internet, however, is not that long. Also, there is little research on the Internet and
economy.
The effect of computers, as opposed to the Internet, on an economy has been
studied. For example, Krueger (1993) analyzed the effect of computer use on
wage structure using Current Population Surveys (CPS) data and found that
workers who use computers earn higher wages. Sichel (1999) found that computer
hardware contributes to economic growth. Oliner and Sichel (2000) and Oliner et
al. (2007) said that productivity growth after 1995 in the US has been driven in
large part by greater use of information capital goods. Gust and Marquez (2004)
found that productivity divergence is driven in part by differences in both the
production and adoption of information technologies, and that the adoption of
information technologies has been impeded by regulatory labor market practices.
According to Freund and Weinhold (2000) and Choi (2003), the Internet has had a
positive effect on bilateral trade and foreign direct investment, respectively. Yi
and Choi (2005) found that the Internet lowers the inflation rate by cross-country
panel data analysis.
With broad use of the Internet starting in the 1990s, we used cross-country
panel data to gather enough observations to analyze the Internet-growth nexus. In
section 2, we derived a simple growth equation incorporating the Internet
variable. In section 3, we perform several estimations for the growth equation.
Section 4 concludes the paper.

2. Model

Romers (1986, 1990) endogenous growth model explains that balanced


growth is positively influenced by knowledge spillover. We hypothesize that the
Internet plays a great role in spreading knowledge in an economy. Therefore,
economic growth is positively related with the use of the Internet. From Barros
(1997) growth equation, we choose the ratio of investment to GDP, the ratio of
government consumption to GDP, and inflation as explanatory variables along
with our Internet variable. Therefore the real per-capita GDP growth rate is
determined by the Internet, investment, government consumption, and inflation.
We set the following growth equation for estimation,

Growthit = 0 + 1 Internetit + 2 Investmentit + 3Governmentit + 4 Inflationit + uit ,


(1)
where uit = i + t + it , i is an individual (country) effect, and t is a time
effect, and it is independently and identically distributed among countries and
years. Growthit is the real per-capita GDP growth rate of country i at year t;
Internet is the ratio of the Internet users to total population; Investment is the ratio
of gross domestic investment to GDP; Government is the ratio of government
expenditure to GDP. The coefficient of Internet is expected to be positive as it
contributes to the knowledge spillover. The coefficient of Investment is expected
to have a positive sign (Levine and Renelt, 1992; Mankiw et al., 1992; DeLong

and Summers, 1991). The coefficient of Government is expected to be negative as


the government distorts the private decisions (Barro, 1997). As high inflation is
known to be associated with low economic growth in general, the coefficient of
Inflation expected to be negative (Barro, 1995; Fernndez Valdovinos, 2003).

3. Data and Empirical Results

Data for 207 countries from 1991 to 2000 were taken from the World
Development Indicators 2002 CD-ROM of World Bank (2002). Internet users, the
number of people with access to the worldwide network, is divided by total
population to get the internet users ratio. Annual percentage growth rate of GDP
per capita (gross domestic product divided by midyear population) is based on a
constant local currency. Gross domestic investment consists of outlays on
additions to the fixed assets of the economy plus net changes in the level of
inventories. General government final consumption expenditures includes all
government expenditures for purchases of goods and services. Inflation is
measured by the consumer price.
Table 1 lists the regression results. We estimated the growth equation (1) by
various estimation methods: (a) pooled ordinary least squares (OLS), (b)
individual random effects, (c) individual fixed effects, (d) time fixed effects, (e)
individual random effects and time fixed effects, and (e) generalized method of
moments (GMM) estimation.

According to the benchmark pooled OLS regression (column (a) in Table 1),
the estimated coefficient of Internet is 5.710 and significant at the 1% level as
expected. This means that when the Internet-user ratio increases by 1% point, the
growth rate increased by 0.057% point. The estimated coefficient of Investment is
0.167 and significant at the 1% level. This means that when the investment ratio
increases, growth rate increases, too. The estimated coefficient of government
consumption is insignificant. The estimated coefficient of Inflation is -0.003 and
significant at the 10% level. When the inflation rate increases by 1% point,
growth rate decreased by 0.003% point.
As we used panel data in our regressions, we re-estimated growth equation
(1) by panel data regression methods such as individual random effects (column
(b) in Table 1), individual fixed effects (c), time fixed effects (d), and individual
random effects and time fixed effects (e). The estimated coefficients of Internet
range from 4.931 to 5.886 and are significant at the 1% level in (b) and (d) and at
the 5% level in (c) and (e). This means that when the Internet user ratio increases
by 1% point, the growth rate turned out to increase by between 0.049 and 0.059%
point. The estimated coefficients of Investment are very similar to pooled OLS
estimation in (a). The estimated coefficients of government consumption are
negative and significant at the 10% level in equations (b), (c), and (e). The
estimated coefficients of Inflation are all negative and significant at the 1% level.
Because explanatory variables such as the Internet, investment ratio, and
government consumption ratio, can be influenced by economic growth, we
performed GMM estimation to take into account any endogeneity of the
explanatory variables (column (f) in Table 1). The coefficient of Internet is 5.517
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and significant at the 1% level. The coefficient of Investment is 0.085 and


significant at the 5% level. The coefficient of government consumption and
inflation proved to be insignificant. Hansens (1982) J-statistic is 10.320 with a pvalue of 0.112, suggesting that the model is well specified (Hansen and Singleton,
1982).
To sum up, the effect of the Internet on economic growth is positive and
significant across all the regressions. Furthermore the regression coefficients of
investment, government consumption, and inflation are mostly consistent with the
standard results in the literature. Investment has a positive effect on economic
growth, and government consumption and inflation have a negative impact on
economic growth. This means that the result is quite robust against different
estimation methods.

Insert Table 1.

4. Conclusion

The Internet is assumed to contribute to the spillover effect of knowledge


across countries. Therefore, the increase in the use of the Internet in a country is
hypothesized to have a positive impact on economic growth. Using panel data
with 207 countries from 1991 to 2000, we found evidence that the Internet plays a
positive and significant role in economic growth after investment ratio,

government consumption ratio, and inflation were used as control variables in the
growth equation.

References:

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Modeling 25, 319326.
DeLong J.B. and L.H. Summers, 1991, Equipment investment and economic
growth, Quarterly Journal of Economics 106, 445502.
Fernndez Valdovinos, C.G., 2003, Inflation and economic growth in the long
run, Economics Letters 80, 167173.
Freund, C. and D. Weinhold, 2000, On the effect of the Internet on international
trade, International Finance Discussion Papers, Board of Governors of the
Federal Reserve System.
Gust, C. and J. Marquez, 2004, International comparisons of productivity growth:
the role of information technology and regulatory practices, Labour
Economics 11, 33-58.
Hansen, L.P., 1982, Large sample properties of generalized method of moments
estimators, Econometrica 50, 10291054.
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12691286.
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Levine, R. and D. Renelt, 1992, A sensitivity analysis of cross-country growth


regressions, American Economic Review 82, 942963.
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heteroscedasticity and autocorrelation consistent covariance matrix,
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Brookings Papers on Economic Activity Issue 1, 81-152.
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Table 1
The Internet and Economic Growtha
b

(a)
Pooled OLS

Constant

Internet

Government

Inflation

R2

(c)
Individual
Fixed

(d)
Time fixed

(e)
Individual
Random &
Time fixed

b,c

(f)
Panel
GMM

-1.173*

-1.447*

-1.186

0.389

(0.701)

(0.742)

(0.801)

(1.070)

5.710***
(1.566)

Investment

(b)
Individual
Random

0.167***

5.641***
(2.018)
0.195***

4.931**
(2.194)
0.281***

5.886***
(2.034)
0.168***

5.678**
(2.324)
0.197***

5.517***
(1.724)
0.085**

(0.023)

(0.024)

(0.038)

(0.019)

(0.024)

(0.041)

-0.039

-0.061*

-0.198***

-0.033

-0.054*

-0.024

(0.032)

(0.031)

(0.071)

(0.022)

(-0.032)

(-0.034)

-0.003*

-0.003***

-0.003***

-0.003***

-0.003***

(0.001)

(0.0004)

(0.0005)

(0.0004)

(0.0004)

0.27

0.43

0.46

0.29

0.45

J-statistic
[p-value]
Sample size 1004

1004

1004

1004

1004

0.001
(0.002)

10.320
[0.112]
565

Notes:
a. ***, **, and, * indicate significance at the 1%, 5%, and, 10% levels, respectively.
Standard errors are in parentheses.
b. Newey and Wests (1987) heteroscedasticity and autocorrelation consistent covariance
matrix assuming a lag length of one is used for standard errors.
c. Instrumental variables include constant, (Growth)t-2, t-3, (Internet Users/Pop)t-2, t-3,
(Gross Investment/GDP)t-2, t-3, (Government Expenditure/GDP)t-2, t-3, (Inflation)t-2, t-3

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