Does the development of the Internet improve the allocative efficiency of production factors? Evidence from surveys of Chinese manufacturing firms

Using data from the Annual Survey of Industrial Firms conducted from 1998 to 2013 in China, this study examines whether the expansion of the Internet improves the allocative efficiency of production factors in manufacturing industry. Allocative efficiency is measured by the deviation of the actual output from the hypothetical efficient output level. We construct an instrumental variable based on historical data to address potential endogeneity. The results highlight that the Internet improves capital and labour allocative efficiency and has heterogeneous effects in different industries. The effect is larger in low-technology industries. As a technology augmenting production factor, the Internet significantly improves the allocative efficiency of capital (labour) in the industries that use capital (labour) intensively. The mechanism analysis reveals that the Internet improves the allocative efficiency of firms by reducing their overhead expenses and raising the exit rate of inefficient firms from the market. This study extends the research on the effect of Internet and explores the causal relationship between the Internet and the allocative efficiency within industries, to highlight the importance of digital technology in economic growth, especially in the context of developing countries.