FDI functional specialization and upgrading via global value chains: an empirical assessment based on automotive industry

Abstract:

This study set out to examine the relationship between different patterns of GVC participation and to elucidate the underexplored transition from GVC backward participation to forward participation. This transition has major implications for technology upgrading, especially as firms and industries seek to capture a larger share of high value-added activities. While this phenomenon is critical for enhancing the competitiveness and long-term economic growth of emerging and middle-income economies by helping them avoid the middle-income trap, it also bears relevance for advanced economies seeking to maintain their global innovation edge. By comparing automotive industries in China, Central and Eastern Europe (CEE), and Western Europe (WE) covering the period from 2003 to 2020, this research provides valuable insights into how different levels of economic development, GVC participation patterns, and FDI functional specialization shape distinctive upgrading trajectories. This study adopts high dimensional fixed effect panel data analysis to examine the baseline regression, as well as a mixed effect random slope model to examine heterogeneities among countries. In doing so, it contributes a deeper understanding of GVC dynamics at the industry level and offers direction for both academic inquiry and policy formulation.

From a theoretical perspective, this study advances the literature by integrating FDI-driven functional specialization into the conceptualization of upgrading via GVC participation. Drawing on a framework that posits upgrading hinges on capturing high value-added activities that require capabilities often beyond those acquired through continued backward participation, this research highlights the strategic necessity of shifting toward forward participation. The empirical findings show that for WE’s well-developed automotive industries, further expanding GVC backward participation can negatively affect forward participation, likely due to the diversion of resources away from high value-added activities in which these economies already possess comparative advantages. By contrast, both China’s and CEE’s automotive industries exhibit a positive relationship between backward and forward participation, although with varying magnitudes. Notably, the threshold effect observed in CEE (an upper limit of approximately 53.25% foreign value-added in domestic production) suggests that over-reliance on imported inputs for domestic production can hinder the sustainable pursuit of forward participation, a finding that is critically relevant for economies at a transitional development stage.

An additional theoretical contribution lies in demonstrating that functional specialization moderates the GVC upgrading process. While pre-manufacturing, manufacturing, and post-manufacturing activities all facilitate the transition from backward to forward participation, their relative importance differs across regions. The strongest reliance on manufacturing specialization is observed in CEE, followed by China, whereas WE’s automotive industry reaps benefits from all three functional segments, reflecting the advantages that high-income economies enjoy in diversifying their value-added portfolio. These disparities underscore the challenges that emerging economies face in broadening their functional capacities beyond manufacturing, emphasizing that upgrading via GVC is not an automatic process and moving up the value chain often requires deliberate policy action.

The findings also underscore the pivotal role of domestic technology upgrading and capability accumulation. In both China and CEE, the development of indigenous capacities and structural upgrading exerts a stronger impact on enhancing forward participation than the mere intensity of backward participation. China, in particular, illustrates how a domestically driven modernization process can catalyze higher-value activities, although WE’s automotive sector appears less sensitive to further technological improvements because of its already high capability base. This suggests that the returns to technology upgrading may diminish at advanced stages of industrial development, highlighting a non-linear trajectory in GVC upgrading processes.

Several policy implications emerge from these findings. First, policymakers in emerging and middle-income economies should be cautious about relying too heavily on GVC backward participation by deepening assembly or manufacturing roles as a pathway to economic growth. While initial integration into GVC can facilitate knowledge diffusion and build foundational capabilities, excessive dependence on foreign value-added inputs may create a structural lock-in, limiting the transition to higher-value segments of GVCs. Policymakers can counter this risk by promoting domestic R&D, fostering innovation ecosystems, and offering targeted incentives for local firms to engage in pre- and post-manufacturing activities such as design, branding, and marketing. Second, functional specialization policies should align with the economy’s existing industrial structure and its stage of technological development. For countries in a transition stage—such as CEE—there is a critical need to monitor the threshold of foreign input reliance and invest in workforce development, technology transfer, and linkages with global R&D networks to strengthen indigenous capabilities in pre- and post-manufacturing activities. China’s experience suggests that state-led initiatives, structural upgrading of the automotive industry, and joint-ventures between domestic and foreign auto firms can better facilitate the upgrading process via GVC participation. Finally, advanced economies, exemplified by WE countries, must preserve and extend their comparative strengths in high value-added activities. This needs to be done by adopting policies that maintain competitiveness in knowledge-intensive and high value-added segments of the value chain, and involving continually upgrading research and innovation infrastructures. Although the returns to further technology upgrading may diminish over time, sustaining an innovation-friendly environment remains key to retaining a leadership position in GVCs and securing long-term economic vitality.

Overall, this study not only enriches knowledge on GVC participation and upgrading but also furnishes practical guidance for policymakers in designing strategies that enable sustainable growth. By highlighting the interplay between backward and forward GVC participation, functional specialization, and technology upgrading, this research affirms that meaningful economic progress requires holistic and context-specific approaches. As global value chains continue to evolve, countries at various stages of development should calibrate their policies to nurture domestic capabilities and functional specialization in higher-value segments, ensuring a more resilient and upward-oriented path within the global economy.