How Chinese Communist Officials Became Venture Capitalists
In early 2020, as the pandemic pushed it to the brink of bankruptcy, Tesla‘s most high-profile Chinese rival was shunned by the venture capital funds and overseas investors that had fueled its rise. Nio, listed on the Nasdaq, therefore turned to the new class of Chinese venture capitalists: communist civil servants.
The municipal government of Hefei, a city in eastern China, has pledged $787 million to acquire a 17% stake in Nio’s core business. The company has moved key executives from Shanghai to the city, which is less than half its size and 300 miles inland, and started producing more vehicles there. The central government and Anhui, Hefei province, joined the city, making smaller investments.
It could look like the kind of power grab that some observers see as characteristic of President Xi Jinping’s China: an authoritarian state enforcing an ever-growing list of dictates on innovative private companies that are meant to discourage entrepreneurship. But the story didn’t turn out that way.
Nio made its first profit at the start of 2021 and sold over 90,000 vehicles by the end of the year. Rather than leveraging its stake to assert control, the Hefei government took advantage of the boom in Nio’s share price to cash out most of its stake within a year of its purchase – achieving a return of up to at 5.5 times his investment – much like a private investor in London or New York might have done.
“Through our investment in Nio, we have ruthlessly earned money,” said Yu Aihua, the city’s top communist official, at a televised event in June that saw him sitting on a podium dressed in of a purple suit and tie with entrepreneurs including Nio’s. founder, William Li, seated below.
“Making money for the government is not an embarrassment: it is making money for the people,” he added.
Hefei has pioneered a shift in Chinese capitalism in recent years, in which local governments are increasingly taking minority stakes in private companies. Since the 1950s, Hefei has been a hub of scientific research, but today its shrewd investments have transformed it from a relative backwater into a bustling metropolis of around 5 million people. In terms of economic growth, what the Chinese media calls the “Hefei model” seems to be working. In the 2010s, Hefei was the fastest growing Chinese city in terms of gross domestic product.
Chinese local governments control land sales, receive profits from state-owned enterprises, and maintain close ties with state-owned banks. For decades they have propped up private businesses with cheap land and other grants, tax breaks and loans to encourage investment. This helped local officials, largely judged on their economic performance, gain promotion from the ruling Communist Party.
More recently, this model has been updated for an era that depends on technology investment and innovation for growth.
As China’s economy slows and Beijing tries to get its debt under control, cash-rich local governments and state-owned enterprises have become “white knights”, rescuing struggling private companies. In many cases, local governments are taking a passive approach to these investments, with an increasing number of stakes being taken through funds rather than direct stakes.
Today, Hefei invests in dozens of companies working on semiconductors, quantum computing and artificial intelligence. These industries are at the center of the Communist Party’s plans to double the size of China’s economy by 2035, likely overtaking the United States along the way. The Hefei model, and the efforts of other cities to replicate it, will be crucial in determining whether this ambition is realized.
Hefei made its first winning bet on BOE Technology Group, an electronic display maker founded in 1993. When BOE was struggling after the 2008 financial crisis, the city canceled plans for its first subway line and instead invested billions of yuan in the business. the condition that he would build a local factory. BOE has built a state-of-the-art LCD panel factory, and in 2011 Hefei held an 18% stake. The city has agreed to vote with management on key decisions, according to company filings.
Over the next few years, Hefei continued to invest in BOE, helping it build new factories and turn a profit. The company has brought tens of thousands of jobs to Hefei and anchors a display industry manufacturing cluster that produces products worth more than 100 billion yuan a year, including for foreign companies such as than Corning. In 2021, BOE overtook South Korea’s Samsung Electronics as the world’s largest maker of LCD panels used in flat-panel TVs, helping to end China’s reliance on foreign suppliers.
Only recently have scholars been able to quantify how this model is transforming the Chinese economy. Researchers from the University of Chicago, Tsinghua University in Beijing and the Chinese University of Hong Kong analyzed all companies registered in China, more than 37 million of them. They found that these companies were ultimately owned by 62 million individuals – essentially the entire list of Chinese capitalists – as well as around 40,000 state agencies, from central government to cities and even villages.
Companies owned by public bodies, most of them at the local community level, have multiplied their partnerships with private companies. The average public actor now invests in companies owned by almost 16 private owners, compared to eight ten years ago. Since the average number of owners per company is constant, this indicates that each state actor has almost doubled the number of private companies in which it invests during this period, explains Chang-Tai Hsieh, professor at the Booth School of Business at the University of Chicago and researcher on the project.
As a result, China’s biggest entrepreneurs are more tied to the state.
In 2019, of the top 7,500 individual owners, just over half owned at least one business that included a state agency among its investors. The trend is for companies that “are not fully state-owned, but also not really private companies,” Hsieh says. “It’s this murky gray area, which I think is the dominant corporate structure in China today.”
Take China’s six biggest electric vehicle startups, which collectively sold more than 435,000 cars in 2021. Five have local governments as minority investors. Investments are often held by companies which are themselves owned by local authorities.
“Thirty years ago [state government-owned companies] produces things that no one wanted to buy. Now they are more like venture capitalists,” says Hsieh.
For entrepreneurs, forming partnerships with local governments makes it easier to obtain approvals for new factories, licenses to do business, and funding from the state-dominated financial system, and can provide some degree of protection. Politics. Hsieh and his co-authors estimate that these hybrid companies have accounted for most of the growth of the Chinese economy over the past decade. A key to their success: founding entrepreneurs remain in control of important business decisions and respond to the market rather than political dictates.
The United States and other Western governments have long been wary of the economic power of Chinese “state capitalism,” fueled by giant state-owned enterprises and an industrial policy driven by subsidies and government mandates. But what’s really driving China’s growth are private companies with minority government-linked investments. “The distinction between public and private has been important for policymakers outside of China and for analysis of the Chinese economy,” says Meg Rithmire, a professor at Harvard Business School who specializes in comparative political development in Asia. and in China. “This border is eroding.”
Other developing countries have taken strategic stakes in large-scale private enterprises to mitigate economic and social turbulence. Rithmire cites Brazil, following the macroeconomic shocks of the 1980s, and Malaysia, which in the 1970s embarked on a decades-long project of acquiring business stakes as part of a campaign to build influence economy of ethnic Malays in the country. In both cases, she says, the government used the stakes to gain greater influence over business decisions, which led to wasted investment and ultimately did little to support growth.
Government investments can lead to the type of conflicts of interest generally discouraged in corporate America. Hefei invested in Nio in part to shore up another of its holdings: Anhui Jianghuai Automobile Group Holdings, known as JAC Motors, which had leased a huge production line to the private electric vehicle maker.
City-funded investment funds are also buying foreign companies. In 2016, Beijing Jianguang Asset Management Co., known as JAC Capital, paid $2.75 billion for Dutch chipmaker Nexperia, which produced semiconductors used in mobile phones. Two years later, the fund, which counts Hefei among its investors, sold its stake to Chinese chipmaker Wingtech for $3.6 billion. Hefei holds a 4% stake in Wingtech. Wingtech made headlines in the UK last year when one of its subsidiaries bought struggling Welsh semiconductor maker Newport Wafer Fab for $87 million.
Meanwhile, even after Hefei sold most of its stake in Nio, the city’s investment in electric vehicle technology continues to pay off. Germany’s Volkswagen AG has acquired 50% of JAC Motors and a 26% stake in battery maker Gotion High-tech, making Hefei one of its main production bases. Erwin Gabardi, general manager of Volkswagen Anhui, hailed the region’s “entrepreneurial spirit” and political support. “That’s why Volkswagen chose Hefei,” he says.