The Role of Government Guidance Funds in Financing Innovation in China

By Cornel Ban and Xuan Li

In most Western economies, venture capital (VC) is largely a private enterprise, driven by the pursuit of profit. The state typically plays a secondary role, stepping in only when private capital is hesitant. Government VC firms fill this gap, providing risk capital to innovative startups and fueling Mazzucato-style “missions.”

China, however, has radically rethought government venture capitalism. In a new working paper published by the Boston University Global Development Policy Center, we show that this country’s Government Guidance Funds (GGFs) embody a markedly different philosophy. Rather than merely acting as passive de-riskers of private tech investments, they function as bold directors of industrial innovation. They are guided by national priorities set centrally yet executed at the local level of the planning system, all in the pursuit of technological ascendancy. Through GGFs, China channels vast financial resources into creative destruction, fueling the country’s technology-driven productivity growth in a variety of high value added sectors.

At the core of this strategy is the transformation of what might be called “stale” state assets—funds locked away in conservative state-owned banks, risk-averse insurance companies and sprawling state-owned enterprises—into dynamic, high-risk capital for ambitious start-ups and midcaps. Rather than waiting for market signals, we show that the Chinese government proactively directs large pools of capital toward key sectors such as semiconductors, robotics, renewable energy, electric vehicles and artificial intelligence, all while avoiding direct fiscal transfers. Think of it as a particular form of state financialization where the state remains in the driving seat.

Our paper shows that GGFs operate on multiple levels. At the top, the central government outlines broad, ambitious priorities, leaving room for local interpretation. Provincial and municipal authorities then refine these priorities, adding specificity and pragmatism. This approach ensures that, at least initially, even less-developed regions are not left behind. Local sub-funds are required to invest primarily within their own jurisdictions, with the aim of fostering regional innovation clusters and mitigating geographic inequalities. Meanwhile, the central government closely monitors these local efforts to ensure they align with national objectives—pulling its equity if they do not. In this way, even the smallest provincial fund is part of a grand, centrally orchestrated ballet of market socialism with Chinese characteristics.

Patient capital in an impatient world

Innovation by its nature is a long game. Startups need time to grow, develop technology and prove their ideas are more than speculative bubbles. The reality, however, is more complicated. The bureaucratic machinery behind these funds is, by design, subject to political timelines. Officials, conscious of their career paths and pressured to deliver visible results, sometimes impose shorter investment horizons than truly transformative technologies require. This creates a tension reminiscent of an economist’s worst nightmare: the collision between the long arc of innovation and the short-term imperatives of political success.

Perhaps the most astonishing aspect of China’s GGFs is their sheer scale. In our paper, we show that with total realized capital exceeding half a trillion US dollars, they dwarf private VC in China (already the world’s second-largest VC market) and eclipse many of the largest EU-based funds. By tapping both fiscal resources and state-owned assets, the Chinese government can mobilize an immense pool of capital—akin to a state-led mobilization in a technological arms race.

This enormous scale profoundly impacts the kinds of projects that can be financed. GGFs are capable of supporting large-scale industrial upgrades and transformative projects deemed too risky or too capital-intensive for private investors. In doing so, they convert traditional state assets into forward-looking, high-tech investments—a shift that is as innovative as it is politically significant.

A comparative glance

Government involvement in innovation financing is not new. In Europe, government venture capital (GVC) typically plays a supportive role, acting as a safety net to encourage private investment. This European model is relatively restrained—far from China’s bold, state-directed interventions. South Korea, meanwhile, offers a hybrid approach, with state initiatives spanning multiple industries without the singular focus seen in China.

What truly sets China apart is its unyielding commitment to a state-led model that integrates financing with national strategic objectives. While European funds aim to stimulate market-driven innovation and Korea takes a broader developmental approach, China’s GGFs zero in on transforming specific pillars of the nation’s technological landscape—closely tied to its five-year plans. This distinction is not merely about scale; it reflects a deeper ideological divide. In China, the state does not settle for a passive partnership—it insists on directing the show.

Challenges, criticisms and lessons

No grand design is immune to criticism, and GGFs are no exception. Critics argue that heavy state involvement in financing the promotion of advanced sectors can lead to inefficiency or resource misallocation. There is also the risk that political goals might suppress market dynamism or encourage bureaucratic inertia. Finally, when they were most successful, GGFs partnered with private VC firms in China and in the US. But the onset of US government corralling of US VC links with Chinese counterparts reduced the scope for the GGF business as usual, making many wonder how GGFs could adapt in a more geoeconomic world. Such debates over state intervention and international power struggles have raged for centuries, and GGFs have indeed experienced uneven effectiveness and occasional corruption scandals.

Still, our review of econometric studies suggests that on average, GGFs have contributed significantly to China’s technological progress. Measured against traditional financial performance metrics, government-guided funds might seem lacking, yet they excel at delivering the needed financing for sectoral upgrading. GGF-backed companies tend to file more patents and drive growth in critical sectors. GGFs also reach more geographically diverse regions than private VC, extending to less-developed inland areas. While GGF-backed firms in policy-driven sectors may underperform in initial public offerings (IPOs) and mergers and acquisitions (M&A) compared to private VC-backed counterparts, they play a crucial role in fostering and scaling innovation, particularly in high-tech zones. Their success challenges the notion that state-led finance is inherently inefficient or prone to corruption. Instead, it suggests that state control, when guided by a clear strategic vision, can be a powerful engine for technological innovation.

Ironically, the very aspects that draw criticism—centralized control, political timeframes and local mandates—also underlie the unique strength of GGFs. They allow the Chinese government to marshal resources in a focused and coordinated way, channeling capital where it is needed most and ensuring that investments serve broader national goals.

As the global economy evolves unpredictably under the huffing and puffing of geopolitical tectonic shifts, China’s GGFs offer a compelling study in how state power and market dynamics can intersect. China’s indicative planning persists, fueled by technological innovation, state-led investments and market-like disciplines built into GGFs. These funds show that, with the right mix of strategic vision, vast scale and a dash of bureaucratic flair, the state can indeed play a transformative role in guiding technological progress. The key takeaway from China’s experience is that sometimes the boldest moves in innovation financing come from the state itself—when it chooses not just to conduct the orchestra of the market but to write the very score on which it plays. In China’s case this entails more than industrial policy and takes the form of what one of us has identified as a variant of indicative planning, a system that resembles more postwar France than anything that has to do with the leftovers of the Soviet system.

In the end, the story of GGFs goes beyond money and investments. It is about a new kind of financial statecraft—one that marries grand strategy and indicative planning with the demands of modern technological innovation. As global competition for technological supremacy heats up, the world will be watching closely. Whether admired, emulated or criticized, China’s approach is a powerful reminder that the state can be a far more active and influential force in fostering innovation than many once believed.

Xuan Li is an assistant professor at the Global Zhejiang Entrepreneurs Development Research Institute, Zhejiang University of Technology.

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