Toward a Dynamic Model of the Industrial Upgrading Micro-mechanism under Global Value Chains

This research constructs a simple dynamic model to illustrate the micro-mechanism of industrial upgrading along the global value chains. Our model demonstrates the following results. (1) Firms in the value chains manage to upgrade from downstream to upstream stages by acquiring higher profitability if and only if the following 3 conditions are satisfied. First, the increasing rate of sunk cost (including R&D expenditure) over sequential stages of production cannot be sufficiently large (endogenous sunk cost effect). Second, the decreasing rate of change of intermediate input demand with respect to the price set by firms at a production stage cannot be sufficiently high (intermediate input price effect). Third, the decreasing rate of change of intermediate input demand with respect to the pricing dynamics over the sequential stages of production cannot be sufficiently large (sequential pricing uncertainty effect). (2) The level of total cost islower when firms climb from downstream stages to relatively more upstream stages in the value chains if and only if the decreasing rate of change of input demand with respect to the price set by firms at a production stage is sufficiently large. (3) The output level is higher when the downstream firms move towards relatively more upstream stages if and only if the decreasing rate of change of input demand with respect to the price set by firms at a production stage is not sufficiently high. (4) The price level decreases when a firm at a production stage moves from downstream to relatively more upstream stages. At the end of this paper, we also apply our theoretical framework into the current debate on the rise of the unbundling production pattern as well as a nation’s industrial development during this era of an increasingly globalized world with reference to some empirical evidence focusing on China.