# **1. Introduction**

The scale and speed of the internet roll-out in China after the late 1990s was unprecedented. The total number of internet users in China increased from about 680,000 in 1999 (or 0.7 per hundred people) to 137 million by 2007 (or 16 per hundred people), one of the most rapid increases in internet penetration in the world.<sup>1</sup> The number of internet users increased across all of China’s provinces, but growth was stronger in coastal areas in the earlier years and in several inland provinces in the later years. This dramatic expansion of the internet in China is a unique historical event which allows us to analyze the impact of the internet on firm performance.

Trade is a major channel through which the internet can affect aggregate economic growth (World Bank, 2016).<sup>2</sup> The transactions costs of trade, of which information frictions are an important element, imply that generally only the most productive firms export, especially in developing countries. Access to the internet can reduce information frictions and thus trade costs. The internet helps firms to find information more easily about new buyers in overseas markets and to advertise their products, making it easier for buyers to find them, cutting off the costly middlemen usually needed to establish trade connections.<sup>3</sup> The internet also reinforces business and social networks and hence facilitates interaction with potential customers and suppliers (Rauch, 1999; Rauch and Trindade, 2002; Fink et al., 2005). The emergence of major international e-commerce platforms can further reduce trade costs by lowering moral hazard costs between buyers and sellers.<sup>4</sup> The internet can thus enable more firms to engage in international trade.

In this paper, we combine firm-level manufacturing census data with data on provincelevel internet penetration in China to examine the effects on firm exporting behavior of the rollout of internet infrastructure across Chinese provinces from 1999 to 2007. Our econometric strategy is based on the hypothesis that increases in internet penetration in a province lead _ceteris paribus_ to larger benefits for firms in industries that rely more intensively on the internet for the business

> 1 These figures are based on data from the World Bank’s World Development Indicators and from the China Internet Network Information Center, described in Section 3.

> 2 Other channels, such as increasing labor productivity by raising firms’ utilization of capital and labor, can also be important but they might need more time to materialize. Recent evidence shows that firms must simultaneously invest in complementary skills and management practices to benefit from investments in information and communications technology (ICT).

> 3 Freund and Weinhold (2004) propose a theoretical model where the internet reduces market-specific costs of trade.

> 4 To purchase any product, the buyer must find a seller, make a payment before receiving the goods, and trust that the seller will deliver the correct amount and quality on time. The seller has an incentive to deviate from the agreed terms since non-compliance is difficult to enforce internationally. Mutual rating systems embedded in online marketplaces allow the buyer and seller to publicly assess each other’s past performance raising the reputational costs of non-compliance. See World Bank (2016) for a more detailed discussion.

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