Based on the perspective of iterative innovation and using panel data from China’s provinces from 2011 to 2022, this paper explores the driving mechanism of the digital economy on the upgrading of the manufacturing global value chains. The results show that the digital economy not only directly promotes the upgrading, but also indirectly promotes the upgrading via iterative innovation. The core value creation and multiplier effects driven by substantive innovation capability and pure technical efficiency improvements are more pronounced. Further research finds that the positive driving role of the digital economy has threshold effects of iterative innovation. It shows an inverted S-shaped change with increases in synthetical innovation capability and strategic innovation capability, and a marginal utility weakening trend with the improvement of substantive innovation capability, synthetical innovation efficiency, pure technical efficiency, and marginal efficiency.