Sustainable economic growth, a key component of the UN's Sustainable Development Goal 8 (SDG8), is crucial for job creation, poverty reduction, and improved living standards. This study focuses on the role of foreign direct investment (FDI) and total factor productivity (TFP) in driving economic growth, particularly in middle-income countries. These countries face unique challenges in achieving sustainable development, making it essential to understand how FDI and TFP contribute to or hinder their growth. The existing literature presents mixed findings regarding the relationship between FDI and economic growth, with some studies highlighting its positive impact through capital inflow, technology transfer, and market expansion, while others point to potential negative consequences such as trade deficits and reduced domestic investment. Similarly, research on TFP's influence on economic growth shows varying results, influenced by factors like technological advancements, human capital, and resource allocation. This study aims to address these ambiguities by investigating the individual and interactive effects of FDI and TFP on economic growth in middle-income countries, considering their diverse economic structures and development stages. The research questions explore whether the interaction between FDI and TFP positively impacts GDP and whether prior findings from other income groups remain valid for middle-income countries. The study utilizes data from 90 middle-income countries between 1990 and 2020, employing the dynamic system GMM to address endogeneity issues and conduct robustness tests.

Economic growth theories posit a positive relationship between FDI and TFP and economic growth. FDI increases domestic investment, export activities, and access to technology, boosting GDP. TFP reflects the efficiency of production inputs, and its improvement leads to increased output. Industrialization theories support this positive relationship, emphasizing the role of industry in economic development and technological advancements that enhance TFP. In contrast, labor market dynamics theories suggest mixed effects of FDI on economic growth, with potential negative consequences stemming from job displacement and inefficient technology transfer. Existing empirical research shows mixed results regarding the FDI-economic growth nexus in middle-income countries, with some studies showing positive correlations and others revealing negative impacts. Similarly, the relationship between TFP and economic growth is not unequivocally positive in prior studies, influenced by factors like technological advancements, skilled labor, and resource allocation. The study proposes three hypotheses: H1: FDI positively impacts economic growth; H2: TFP positively affects economic growth; and H3: The interaction between FDI and TFP positively affects economic growth.

The study uses data from the World Bank, initially encompassing 120 middle-income countries (based on the 2010 classification) between 1990 and 2020. After data merging and cleaning, the final sample includes 90 middle-income countries with 2714 annual observations. Key variables include GDP (economic growth proxy), FDI (net direct investment inflow as a percentage of GDP), TFP (calculated using a Cobb-Douglas function), and control variables (agriculture, gross capital formation, government spending, imports, and inflation). To address potential endogeneity and heteroscedasticity issues, the researchers initially employ REM and FEM estimations and then use the dynamic system GMM with cross-section fixed effects, utilizing lagged endogenous variables as instruments. Robustness checks involve employing alternative economic growth proxies (LN(GNP), GDP per capita) and analyzing the data before and after the 2008 financial crisis.

The descriptive statistics reveal a relatively low average economic growth rate (4.05%) and FDI (3.8%) for the sample countries. However, the average TFP (1.12) suggests efficient use of production factors. The correlation analysis indicates no significant multicollinearity issues. The regression analysis using the GMM method shows that: 1. FDI has a significant positive impact on economic growth (a 1% increase in FDI is associated with a 9.3% increase in GDP growth). 2. TFP significantly and positively affects economic growth (a one-unit increase in TFP leads to a 16.38 percentage point increase in GDP growth). 3. The interaction term between FDI and TFP shows a significant positive impact on economic growth. This indicates a synergistic effect between FDI and TFP in promoting growth. Control variables also show significant relationships with GDP growth; for example, agriculture and GCF have positive impacts, while government spending, imports, and inflation show negative impacts. Robustness tests using alternative economic growth proxies and data splits before/after the financial crisis show the resilience of the positive relationship between FDI and growth but reveal some complexities in the interaction effects of FDI and TFP before and after the crisis.

The findings confirm the positive impacts of both FDI and TFP on economic growth in middle-income countries. FDI's positive impact aligns with economic growth and industrialization theories, supporting the role of FDI in boosting investment, technology transfer, and market access. However, it contradicts labor market dynamics theories that predict negative effects of FDI, suggesting that the overall positive impact of FDI outweighs potential negative consequences in the study's sample. The positive effect of TFP supports economic growth and industrialization theories highlighting the importance of productive efficiency in driving growth. The strong positive interaction effect between FDI and TFP further emphasizes the synergistic relationship; FDI contributes to TFP improvements, amplifying growth. The robustness tests largely sustain these findings, although some nuances emerge regarding the interaction term before and after the financial crisis. These findings offer insights into policies and strategies for promoting economic growth in middle-income countries by optimizing FDI and TFP.

This study confirms the positive contributions of FDI and TFP, individually and interactively, to economic growth in middle-income countries. The results support economic growth and industrialization theories but challenge labor market dynamics theories regarding FDI. The study's robustness tests largely validate the findings. However, the study acknowledges limitations including the inability of GMM to differentiate short- and long-term effects and the focus on a specific set of middle-income countries. Future research should address these limitations by using a method that differentiates short-term and long-term effects and expanding the sample to include low- and high-income countries.

The study's limitations include the use of GMM, which cannot differentiate short-term and long-term effects, and the focus on 90 middle-income countries classified according to the World Bank's 2010 criteria, potentially limiting the generalizability of the findings. Future research could address these limitations by employing alternative econometric techniques such as ARDL to analyze both short- and long-term effects and by expanding the sample to include countries from different income groups.