A Systems Perspective on the Embeddedness of Foreign-Invested Enterprises and Functional Upgrading: Evidence from China’s Manufacturing Sector

This study conceptualises the local production network as a complex system composed of domestic enterprises (DOEs) and foreign-invested companies (FIEs) that are interconnected and co-evolving. We define the embeddedness of FIEs according to three types—DOEs–FIEs, FIEs–DOEs and FIEs–FIEs—and examine how the different types of FIE embeddedness influence the functional upgrading of domestic value chains. Using the 2024 OECD database on multinational enterprises’ activities, we empirically assess the embeddedness of FIEs and the functional upgrading of manufacturing industries in 14 sub-sectors from 2003 to 2020. The results show that the embeddedness of FIEs facilitates overall functional upgrading, particularly in R&D and management, though no significant effect is found in marketing. Mechanism analysis reveals that FIE embeddedness in China’s manufacturing value chain primarily drives functional upgrades through productivity and creation effects. Heterogeneity analysis shows that FIE activities of both types, “DOEs–FIEs” and “FIEs–DOEs”, positively influence R&D upgrading, while those of the “FIEs–FIEs” type promote management upgrading. In contrast, “FIEs–DOEs” activities hinder marketing upgrading. This study provides empirical evidence of the role of FIE embeddedness in functional upgrading and offers a theoretical basis to develop policies that guide foreign capital toward higher value functions.