Digital adoption and firm capability: Substitution effects in productivity across developing economies

This study examines how firm capability shapes the relationship between digital adoption and labour productivity in developing economies. Using cross-sectional firm-level data from 6864 firms, the analysis finds positive associations between productivity, digital adoption, and firm capability. However, the interaction between digital adoption and firm capability is negative, indicating a stronger productivity association of digital adoption among firms with lower capability. This pattern is consistent with a capability-compensating relationship rather than uniform complementarity. Similar negative interactions are observed for both skill-related and managerial capability. Firm-size analysis suggests that this pattern may be more pronounced among SMEs with lower capability levels. The positive direct associations remain broadly consistent in instrumental-variable models and analyses using total factor productivity, although the interaction is less stable across some alternative specifications. These findings qualify the conventional view that digital technologies and firm capability are uniformly complementary. Digital adoption may partly offset internal capability constraints, but this relationship varies across capability dimensions and firm sizes. Digital adoption and capability development may therefore play distinct roles in shaping firm productivity.