The gravity law and Internet

Internet and the gravity model of international trade

Does the internet defy the law of gravity?

Analysis of data on Internet activities by US consumers on non-US websites raises the question: do the trade costs fully account for the effects of distance on trade?

Methodology

Introduction: Is physical distance less important when transportation, time, and distribution costs are near zero?

Relation between trade and digital goods

The analysis will deal with the effect of distance on taste and non-taste goods. Theoretically, the Internet reduces the realized importance of distance. According to Shapiro and Varian (1999), the Internet reduces communication, search, and transportation costs to near zero, increasing trade (Freund and Weinhold, 2004). Thus, distance should not matter for goods that are distributed digitally.

Data on internet usage

Data from 2654 US Internet users (households) from December 27, 1999, to March 31, 2000, shows that the Internet reduces the importance of distance in trade.

Methodology – choice model for web surfing

The choice model for web surfing considers the market share of country c in the website category s. This includes the household’s utility of browsing the website. Since US users who visit foreign websites always have the option of visiting a US website, this choice is considered “the outside” choice (c=0). The model accounts for the number of websites from country c and from the US in service category s, and is a vector of observed country and website characteristics, including the distance between country c and the US. This measures how country and website characteristics affect the marginal utility of visiting a category s website in country c relative to visiting a category s in the US.

Methodology – choice model for web surfing II

We can write the market share of country c in the website category s as the ratio of the number of visits to the country c websites in category s and the total number of visits to category s websites in the world. Because certain factors do not vary by country within a service category s, they can be considered fixed.

Financial transactions and free digital goods

Digital goods can be aggregated into two types: Taste-dependent and Non-Taste dependent. This can include financial transactions involving software and financial information, as well as free services like online games, music, and pornography.