Upgrading Under Volatility in a Global Economy

Upgrading has been a main policy focus of the development literature for the past two decades. The predominant model has firms with low capabilities moving up the value chain through learning in global production networks and support of robust local institutions. Time after time when upgrading efforts fail, the recommended solution is to pour in more resources: new investments, more subsidies and more training. Yet little has changed. Using a critical case study of the Penang semiconductor cluster, this paper proposes an alternative set of hypotheses about upgrading in emerging economies. The real challenge for upgrading is volatility. The problem is not that there are only firms with low capabilities, but rather there are plenty of firms with high capabilities. These firms, by leveraging local policy, have developed sophisticated capabilities to meet the increasingly volatile production demand of global industries, in this case electronics. Contrary to conventional wisdom, they do not compete away profits or solely rely on cheap labor. The challenge is that these firms -- the prime set of candidates to upgrade -- have become sufficiently successful in this specialty that under the present policy regime, they have no incentive to do otherwise. They have created a sustainable niche, but one with no upward pathway. Firms that upgrade take a different route, avoiding volatile markets altogether. The case of Penang shows that volatility increasingly determines the international division of labor in emerging economies, not the search for low wages.