The study investigates the impact of foreign direct investment (FDI) on a country's ability to escape the middle-income trap (MIT). The MIT describes the phenomenon where countries remain stuck in middle-income status for extended periods, failing to transition to high-income status due to the inability to compete with either low-income or high-income countries. While numerous studies exist on the MIT, research on FDI's role in this context is limited. This study addresses this gap by exploring the complex relationship between FDI inflows, industrial upgrading, and the likelihood of escaping the MIT. The automotive industries in Mexico and South Korea from the 1960s to 2000s serve as comparative case studies, chosen because the automotive industry, during that period, represented a late industry demanding advanced technology, thus highlighting challenges related to industrial upgrading and technological acquisition. The two countries, similar in development levels in the early 1960s, but with contrasting outcomes regarding MIT and FDI, allow for an analysis of different FDI acceptance strategies. The research employs a mixed-methods approach, combining qualitative analysis of the case studies with quantitative analysis using logistic regression models to assess the relationship between FDI and MIT outcomes.

The literature review examines existing scholarship on the relationship between FDI and the MIT. Some scholars, using World-Systems Theory, argue that FDI hinders industrial upgrading, a crucial factor in escaping the MIT. This perspective suggests that MNCs from high-income countries prioritize activities with narrow profit margins in developing countries, thereby preventing the development of high-value-adding industries and national champions in the host countries. Other studies suggest a positive correlation between FDI and escaping the MIT, emphasizing FDI's contribution to economic growth and technological advancement. This study aims to bridge this gap in existing research by analyzing the impact of FDI on the likelihood of escaping the MIT, considering both its potential benefits and detrimental effects.

This study uses a mixed-methods approach, combining qualitative and quantitative methods. The qualitative component involves a comparative case study analysis of the automotive industries in Mexico and South Korea from the 1960s to the 2000s. This analysis focuses on the different approaches to FDI and their impact on industrial upgrading and the development of national champions. The quantitative component employs logistic regression models to analyze the relationship between FDI inflows (as a percentage of GDP) and the likelihood of escaping the MIT. Data from the World Bank's Databank are used, covering several countries that either successfully transitioned to high-income status or remained trapped in middle-income status. The dependent variable is a binary variable indicating whether a country escaped the MIT, while independent variables include FDI inflows, gross capital formation, age dependency ratio, exports as a percentage of GDP, and manufacturing value-added as a percentage of GDP. Four models are constructed, with increasing complexity, to test the relationship between FDI and MIT outcomes, controlling for other factors influencing economic development. The models are then subjected to robustness tests using subsample analysis (by region).

The comparative case study revealed contrasting trajectories for the automotive industries in Mexico and South Korea. Mexico, with a high level of FDI and a significant presence of MNCs, struggled to build national champions and achieve significant industrial upgrading, resulting in a dependence on low-value-added activities. In contrast, South Korea adopted a more strategic approach to FDI, fostering the growth of domestic firms and actively promoting industrial upgrading. The logistic regression models consistently showed a negative association between FDI inflows (as a percentage of GDP) and the likelihood of escaping the MIT. This finding is robust across all four models, even when controlling for other development factors. Model 1, focusing solely on FDI, showed a 64% decrease in the odds of escaping the MIT for each one-unit increase in FDI%G. In Model 2, which included gross capital formation and the age dependency ratio, this effect decreased slightly to 58%, with a significant negative effect of Age dependency ratio. Model 3, incorporating exports and manufacturing value added, showed an even stronger negative association between FDI and MIT escape (88%). Model 4 combined all variables, with FDI maintaining a significantly negative relationship with MIT escape (78%). Subsample analysis by region reinforced the negative correlation, though the strength varied slightly across regions. The Age dependency ratio was significant in models 2 and 4 but was insignificant in the East Asia subsample test. Exports were significant in Model 3, but after other variables were added in Model 4, they were not significant. Manufacturing value added was not significant in any of the models.

The consistent negative correlation between FDI and escaping the MIT, observed in both the qualitative and quantitative analyses, challenges some existing literature that portrays FDI as a crucial driver of economic growth and development for middle-income countries. These findings align with the World-Systems Theory perspective, suggesting that FDI, under certain conditions, might hinder rather than facilitate industrial upgrading. The results suggest that high levels of FDI, especially when dominated by MNCs, can prevent the formation of large domestic firms capable of high-value-adding activities. This appears to have been the case in the Mexican automotive sector where the influence of MNCs negatively impacted the growth of domestic champions. In contrast, South Korea’s successful industrialization demonstrates an alternative model by selectively managing FDI and promoting the growth of its own national champions. The negative effect of Age dependency ratio highlights the importance of demographics in determining a country's capacity for development and industrial upgrading.

This study provides evidence that high levels of FDI can negatively impact a middle-income country's ability to transition to high-income status. The findings suggest that middle-income countries should adopt cautious and strategic approaches to FDI, prioritizing policies that promote industrial upgrading, technological advancement, and the development of domestic firms. Future research should explore the specific mechanisms underlying the negative relationship between FDI and MIT escape, while considering the possibility of context-specific factors and various FDI acceptance models. It also needs to explore further the conditions that enable FDI to positively contribute to industrial upgrading.

The study's primary limitation lies in its focus on the automotive industry. While this provides valuable insights, generalizing these findings to other sectors requires further research. The cross-sectional nature of the quantitative analysis limits the ability to establish causal relationships, although the consistent findings across different models increase the robustness of the results. The availability of data also restricts the scope of the study, affecting the number of countries and the time period analyzed. Furthermore, the definition of the MIT itself is subject to debate which impacts the classification of countries in the dataset.