# **1. Introduction**

The emergence of global value chains (GVCs) has opened up new ways for development and industrialization. Developing countries can now join existing supply chains instead of building complete chains domestically. This increased degree of specialization frees them from the need to develop a wide range of competitive tasks and emphasizes their respective finely defined comparative advantages. At the same time, GVCs can be a tool for industrialized countries to re-invigorate their slow growth in the absence of major innovations. Indeed, cross-country evidence and case studies show that GVC participation can on average be growth-enhancing and lead to economic and social upgrading (see, for example, UNCTAD 2013; WEF 2013). However, new evidence also shows that not all countries have gained from participating in GVCs and that the institutional and political environment of countries matters to their success in GVCs (Kummritz 2016; Taglioni and Winkler 2016).

This paper examines which national policies are crucial for successful economic upgrading in GVCs, combining two panel data sets of developing and industrialized countries at the sectoral level with a wide range of policy measures at the country level. Taglioni and Winkler (2016) differentiate between three types of economic upgrading based on a country’s current tasks of comparative advantage, skills, and capabilities (Humphrey 2004; Humphrey and Schmitz 2002): (i) product upgrading, which involves moving into more sophisticated products in the existing value chain; (ii) functional upgrading, which involves increasing the value-added share (in output of the final product) in existing GVC processes by integrating or moving into more sophisticated tasks; and (iii) inter-sectoral upgrading, which involves moving into new supply chains with higher value-added shares. Therefore, in this paper, we adopt value added as our measure of economic upgrading.

These three objectives can be achieved by upgrading the production factors of labor and capital, and also by increasing total factor productivity (TFP). First, skills upgrading refers to improving the skills and know-how of the workforce. Developing skills is a key element of competitiveness, it affects the ability to participate in GVCs and to achieve economic and social upgrading within GVCs. Second, capital upgrading refers to improving the absorptive capacity and technology of firms, which requires general and industryspecific investments to upgrade technical capacity and achieve quality standards and innovation capabilities. Third, process upgrading refers to increasing TFP in existing GVC tasks that cannot be directly attributed to the production factors of labor or capital, for example, by better organizing the production or by introducing new technologies to capture efficiency gains (Taglioni and Winkler 2016).

Countries have different policy options at hand to facilitate skills, capital, and process upgrading that foster value-added gains in GVCs. We discuss and analyze a wide spectrum of areas that can play a role for GVC upgrading, either by targeting GVC entry and stronger GVC integration that increases the potential for economic upgrading in a country, or by directly targeting the quality and conditions of input and output factors. These include infrastructure, connectivity, investment and trade policy, business climate and institutions, financial development, labor market policy, education and skills, product standards and innovation, as well as labor, social, and environmental standards. We outline several paths for economic upgrading through GVC participation and highlight the complimentary role that policy plays in this development. Overall, this paper shows that countries that want to develop GVC strategies must take into account their policy environment. Bad policies can be an impediment to GVC-induced value-added gains while good policies can be a substantial facilitator.

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