Theories
Economic growth theories
Economic growth is a criterion to measure the economic development of a country. It can be measured as an increase in gross domestic product (GDP) and gross domestic product per capita based on purchasing power parity or the size of national output per capita (PCI) or gross national product (GNP) in each period (Lewis, 2013; Adewole, 2012). Economic growth describes the quantitative change in a country’s economy. GDP is one of the leading indicators to assess the overall growth rate of the economy as well as the level of development of a country. Most countries use some of their GDP of GNP to measure their economic growth. Economic growth reflects very clearly the actual status of a country’s output or product in the economy and each economic region, based on which countries will make applicable policies for economic development. Enterprises also rely on it to make more accurate decisions.
Nistor (2014) proves that FDI has a positive effect on economic development because FDI has a role in increasing domestic investment. As FDI increases, it increases export activities, promotes the transfer of goods and services, or increases access to technology, increasing GDP. Besides, TFP also positively impacts economic growth because TFP reflects the efficiency of capital and human resources used in production. When TFP increases, it will help improve the results of production activities and input-output, which is very important for the economy; businesses will also rely on it to expand their production capacity and increase GDP (Arazmuradov et al., 2014). Therefore, economic growth theories expect that FDI and TFP positively impact GDP growth.
Industrialization theories
Industrialization theory suggests that an agriculture-based economy is transforming toward an industrial-based economy. According to this theory, industry is essential to economic and social development. It focuses on strengthening industrial production, improving technology, improving labor productivity, increasing TFP, and helping economic growth (Zhan et al., 2022). While countries can transition toward a digital economy without industrialization, developed countries are decentralizing part of their industry (Balsa-Barreiro et al., 2023); industrialization can bring many benefits, such as creating jobs, increasing income, improving quality of life, and overall economic development.
According to Nursamsu and Hastiadi (2015), industrialization theory suggests that economies can increase their TFP by improving production technology, production management and organization, human resource qualifications, scale production, and contributing to economic development. In addition, industrialization enhances investment attraction, provides human resources to expand markets, and creates favorable economic growth conditions (Megbowon et al., 2019). Therefore, industrialization theories expect that FDI and TFP positively affect economic growth.
Labor market dynamics theories
Labor market dynamics theories explain how workers and employers interact and influence each other in the labor market. According to Berrebi and Ostwald (2016), employees and employers have goals. Workers want to find jobs with high incomes and good working conditions, while employers want to hire workers at low cost but with appropriate abilities and skills. Besides, it also affects local economic growth by attracting foreign direct investment projects.
According to Decreuse and Maarek (2015), labor market dynamics theories suggest that FDI projects may cause adverse effects on local employment, wages, and economic growth by replacing local workers with foreign workers. Additionally, inefficient FDI projects may reduce local economic growth due to a lack of technological transfer and labor development (Omri and Kahouli, 2014). In short, labor market dynamics theories suggest that FDI has mixed effects on economic growth.
Foreign direct investment and economic growth
Some previous studies suggest that FDI has a positive impact on economic growth. Sokang (2018) suggests that FDI positively impacts economic growth because FDI helps expand production and increases access to more advanced technology for local businesses. In addition, FDI also helps improve export output, supplement capital, increase capital efficiency, and create a large budget to promote economic growth (Agrawal and Khan, 2011).
However, some studies report a negative relationship between FDI and economic growth. Increasing FDI projects leads to a deficit in domestic investment capital and difficulties using domestic capital and human resources, causing economic recession (Almfraji and Almsafir, 2014). Sabir et al. (2019) report that FDI may cause trade imbalance. When import activities are higher than export activities, it will reduce employment, causing fewer goods to be produced, which can cause a trade deficit.
Previous studies have shown that the relationship between FDI and economic growth has positive and negative effects. Studies show that FDI positively correlates with economic growth using data samples from middle-income countries such as China, India, and Cambodia (Sokang, 2018; Agrawal and Khan, 2011). In addition, there are also research articles using data samples from middle-income countries such as Bolivia, Brazil, Colombia, and Ecuador, but the main finding is that FDI hurts economic growth (Almfraji and Almsafir, 2014; Sabir et al., 2019). As previous studies report mixed findings between FDI and economic growth in middle-income countries, we propose the following hypothesis:
Hypothesis 1: FDI positively impacts economic growth in middle-income countries.
Total factor productivity and economic growth
Saleem et al. (2019) argue that TFP positively impacts economic growth. Improving the qualifications of workers, training technology transfer, and increasing the efficiency of capital use help increase total factor productivity to promote global economic growth. In addition, increased demand for goods and services leads to an increase in export activities, which is the basis for optimizing resources or promoting product research and product development; production process improvement helps improve productivity, thereby contributing to increasing TFP and promoting the country’s economic growth (Bal and Rath, 2014).
Besides, the Solow productivity paradox (Chen and Xie, 2015) arises when there is insufficient investment in technology and a shortage of skilled workers who can use new technology effectively. This trend can cause structural unemployment, where workers displaced by automation may not have the skills needed in the emerging job market. This transition period can hinder economic growth as workers adjust to new job opportunities. TFP will slow down when labor productivity decreases, leading to economic recessions (Chen and Xie, 2015). Moreover, higher productivity may lead to misallocation of resources. For example, if a country heavily invests in one industry due to its high productivity potential but neglects other vital sectors, it could result in an imbalanced and unsustainable economic structure. Previous studies report mixed findings between TFP and economic growth; we propose the following hypothesis:
Hypothesis 2: TFP positively affects economic growth in middle-income countries.
Foreign direct investment and total factor productivity
Prior studies suggest that an interaction between FDI and TFP positively impacts economic growth. Ahmed (2012) reports that FDI has a positive relationship with TFP because FDI increases technology transfer between countries and contributes to the training and development of human resources in recipient countries, improving labor capacity and the quality of human resources, thereby improving productivity and efficiency in production. In addition, FDI also motivates local governments to develop local infrastructure that helps improve production processes, and it also helps expand consumption markets, creating motivation for production growth (Baltabaev, 2014). Therefore, the interaction between FDI and TFP positively impacts economic growth.
However, other articles suggest that the interactive relationship between FDI and TFP negatively impacts economic growth. In some cases of FDI, not all technologies are transferred into the local economy due to ineffective management, which reduces the rate of technology transfer. Inefficient technology transfer discourages driving forces to develop local productivity. In addition, in some other cases, focusing FDI on specific industries or economic sectors can weaken the diversity and competition of other industries, causing excessive dependence on FDI and adverse effects on TFP growth. Therefore, the interactive relationship between FDI and TFP hurts economic growth. As prior studies reported that the interaction between FDI and TFP has mixed impacts on economic growth, we propose the following hypothesis:
Hypothesis 3: The interaction between FDI and TFP positively affects economic growth in middle-income countries.
