Internet adoption variable for the intensive and extensive margins will sum up to the coefficient for exports. If<sup>βnijt</sup> = 0.7 where β is the coefficient of the Internet adoption and the subscripts refer to ⁄βVijt the regression of the trade variable, then 70 percent of the effect of Internet on exports is explained by the extensive margin.

The Internet can affect trade between countries by reducing the fixed and marginal costs of trade. The Internet allows firms and consumers to find each other faster and easier, thus reducing the fixed search costs. The Internet also reduces the marginal communication costs between the seller and the customer. We assume that other components also affect trade costs, such as distance, whether the two countries are contiguous and have a common language and legal origins, and colonial relationship post 1945.

The empirical specification is: ln Yijt = β0 + β1 ln Internetit + β2 ln Internetjt + β3 ln GDPit + β4 ln GDPjt + δt + δij + εijt where ln GDPit ( ln GDPjt ) is the log of the nominal value of GDP and ln Internetit ( ln Internetjt ) is the log of Internet adoption of country i ( j ) in time t . We estimate three separate regressions where the dependent variable ln Yijt is the log of each trade variable, Vijt , xijt or nijt . δt is year fixed effects that accounts for the changes in trade that are unrelated to the changes in the annual Internet adoption and GDP levels, such as the global financial crisis in 2008. δij is country-pair fixed effects that account for variations in trade that are related to the idiosyncratic relationships between two country pairs. An alternative set of fixed effects is to include separate exporter and importer fixed effects, which will allow us to control for contiguity, common language, common legal origins and colonial relationship. As Baldwin and Taglioni (2006) explain, country-pair fixed effects are more suitable to deal with the estimation bias in a gravity model with panel data. A drawback of using the country-pair fixed effects is the inability to observe the effects on time-invariant bilateral variables such as distance but this will not affect the variable of interest – Internet adoption – which are time-varying and specific to exporter and importer. The underlying identification assumptions of our empirical specification are that, conditional on the GDP controls and the country-pair fixed effects, the Internet adoption is exogenous to exports and changes in Internet adoption are not correlated with other unobserved time-varying characteristics that can affect bilateral exports. Thus, changes in trade can be attributable to changes in the levels of Internet adoption.

We will also examine how the similarities of Internet adoption affects trade by grouping the importers and exporters according to their Internet adoption levels. The countries are divided into two groups depending on their Internet adoption rates for each year: a country has high (low) Internet adoption if it is above (below) the median. Dummy variables are created for each of the pairwise combinations: if both countries in the bilateral pair have high Internet adoption, if only the exporter has high Internet adoption, if only the importer has high Internet adoption, and if both countries have low Internet adoption.

The trade data are obtained from the UN COMTRADE database for the period 2001-2013. We exclude oil products from the aggregated export flows as these products experience a lot of price volatility during the study period.<sup>3</sup> The gravity variables are obtained from the CEPII and the GDP data is from the World Bank World Development Indicators. The Internet adoption rate is defined as the number of individuals using the Internet per 100 persons in the country and is obtained the International Telecommunication Union (ITU). Table 1 reports summary statistics for trade, Internet penetration and GDP.

> 3 We exclude all products in “Section: 3 - Mineral fuels, lubricants and related materials” of the SITC Rev 2. classification.

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