Exploring the Rise of Technology Startups in China: From Centralized Control to Government Guided Entrepreneurship?

This article aims to explore the reformative measures initiated by the Chinese government in the late 1970s that led to the gradual rise in competitiveness and expansion of its economy onto the global stage. This backdrop will serve as a basis to analyze the government's influence on Chinese entrepreneurship, specifically for technology startups. In 1978, the Chinese Communist Party launched a series of economic reforms to rekindle economic growth and support the gradual withdrawal from China’s centralized, planned economy in pursuit of economic liberalization. Backed by veteran leader Deng Xiaoping, the ‘Open-Door’ policy marked the onset of the country’s transition to a ‘socialist market economy with Chinese characteristics,’ effectively opening the door to foreign investment. First, the policy designed several Special Economic Zones (SEZ) in China’s coastal regions which allowed foreign capital to flow through the shores. However, ‘Deng Xiaoping liked to say that he was groping for stones as he crossed this river’ (Vogel, 2011), not lacking in the persuasion that the elements of a free market would revitalize China’s economic system but in the ‘knowledge and experience in many fields’ (Keo, 2020) to cross the river. Hence, reforms were administered gradually and experimentally, first, with a small number of special economic zones in Shenzhen, Zhuhai, Xiamen, and Shantou to allow a limited flow of foreign investment. These measures progressively allowed for greater flows of foreign investment, which ultimately helped to solidify China's position as the world's largest exporter, reaching $3.59 trillion in exported goods in 2022. As a result of China's successive reforms, foreign firms from various industries have found interest in operating in the country due to its growing consumer market, leading innovation initiatives, and untapped growth potential. Moreover, the de-stigmatization of foreign investment has also led China’s entrepreneurs to flourish, reaping investments from foreign venture capitalists seeking to break into the Chinese market.

Leading up to 1978, the Chinese economy had been largely insulated from the rest of the world, with significant state involvement and control in most industries with state-owned enterprises constituting around 80-90% of China’s business landscape. These companies operated under the direct authority of the government who led administrative and decision-making functions. However, since the late 70s, the institutional environment progressively allowed private companies and entrepreneurs to thrive. Private ownership first became legally recognized and was even later encouraged through the ‘Company Law of the People's Republic of China,’ which took effect on March 1, 1994. Prior to the implementation of the Company Law, the country had been characterized by a weak institutional environment which made it difficult for startups and private firms to gain legitimacy due to the absence of explicit regulations for private companies. The law provided a legal framework for company registration and set regulations for companies to follow, making them more appealing in the eyes of foreign investors. However, whilst the shift toward private ownership allowed entrepreneurs to find success in different industries, strategic sectors such as energy, telecommunications, and technology remained heavily influenced by the government and remained largely dominated by state-owned enterprises. 

In recent years, China has emerged as a major player in the global VC market with a growing local and foreign investor base; it was estimated that $1.17 billion was raised by VC firms to invest in China in 2005, up from a mere $325 million in 2002 (Ahlstrom et al., 2005). Indeed, the emergence of entrepreneurial investment funds, more notably those supported by the government, aligns with president Xi Jinping’s most recent 5-Year Plan which describes the upcoming years as an important period of opportunity for innovation. However, despite the efforts made to separate state control and private sector ownership, the government’s influence in shaping the development of the private sector remains noticeable. For instance, the local government in the city of Wuhan, a high-tech development zone, announced in March 2022 the creation of a $1.5 billion investment fund aimed to ‘combine the animal spirits of private capital with the industrial objectives of the state’ (The Economist, 2022). Moreover, Shenzhen Capital Group, an important Chinese VC with a total investment size of around RMB 77.3 billion, is heavily affiliated with the Shenzhen local government and actively manages 108 government guidance funds. Their investment strategy seems to depict an overarching synergy with the local and national governments’ objectives with their holdings comprising mostly of expanding companies involved in information technology, energy, and high-end equipment manufacturing. Therefore, VC investment in China seems to be congruent with the government’s strategic priorities, where the development of startups seems to cluster around sectors deemed as important by the state. The growth of the technology sector, in particular, was partly promulgated by the government’s establishment of SEZs in coastal cities such as Shenzhen where local firms consequentially benefitted from the expertise brought by foreign firms which drove innovation. This caused the sector to expand in that period with many multinationals choosing to set up operations in Shenzhen, first due to its proximity to Hong Kong as well as the favorable investment climate which encouraged foreign investment. Shenzhen eventually became known as the ‘Silicon Valley of China’ and is currently one of the most influential technology and innovation centers in the country.

Nonetheless, whilst government ties can be formalized as exemplified by Shenzhen Capital Group, private investment firms, and emerging startups looking to generate strategic advantages in China also recognize the importance of establishing informal ties with the government. Thus, it is not uncommon for successful fund managers and directors to hold interpersonal relationships with government officials and to participate in government-led initiatives. This has proven to be increasingly essential over time due to the vast opportunities that government relationships can offer in China’s competitive business environment such as access to funds, resources, and support to secure business transactions. For instance, SenseTime Group, a Chinese artificial intelligence startup that develops deep learning and computer vision technologies, leveraged its government relationships to receive funding from various investors, raising a substantial sum of $410 million in 2017 from a funding round led by Beijing-based investment firm CDH and Sailing Capital China Reform Holdings, a state-backed investment firm. The deal marked one of the largest fundraising rounds by an AI firm, valuing it at over $1.5 billion. Research actually shows that political connectedness is a significant success factor for Chinese entrepreneurs as demonstrated by Burt and Opper (2020) who conclude that with the presence of regulatory constraints, ‘politically disconnected entrepreneurs are less likely to benefit from the breadth, timing, and arbitrage advantages associated with open networks, advantages they see benefitting entrepreneurs who are politically connected’. As such, whilst open networks are vital for the success of entrepreneurs, political connectedness has been shown to be especially significant in providing Chinese startups with opportunities and resources such as obtaining necessary licenses for their businesses, receiving funding for new projects, and acquiring leads and insights into the changing regulatory environment.

The government has played an essential role in catalyzing growth in the technology industry, albeit, primarily to the advantage of politically connected entrepreneurs who reaped the benefits of the government’s various funding initiatives. As a result, Chinese technology startups grew at an unprecedented rate in recent years and have become increasingly competitive on a national and global scale. In 2017, out of $15.2 billion invested in AI startups globally, 48% was directed to China with only 38% to America, showcasing the rising prospects of the Chinese market. However, the increased scrutiny of the technology sector has garnered widespread attention following the enactment of the 2016 Cybersecurity Law of the PRC which was initially drafted ‘to ensure network security, to safeguard cyberspace sovereignty, national security and the societal public interest’ (CLT, 2016). However, its purpose was also argued to increase censorship across social platforms and to gain control over the internet. Many firms argued that the regulations were too stringent and the increased scrutiny caused foreign firms to delay their investments in China over privacy issues; in particular, network equipment manufacturers and other technology suppliers had to provide the government with proprietary source code to show that it cannot be compromised by hackers or state-actors (DCD, 2016); this led IBM, Microsoft, and Intel to file multiple objections against the new law. Moreover, local companies such as Huawei also felt the repercussions of the new legislation due to the restrictions placed on the company’s ability to do business with foreign entities which limited its foreign investment. Although technology enterprises have shown to attract considerable investment interest in China on a national and multinational level, the government’s involvement in the sector seems to be a cause for concern for companies looking to safeguard their long-term interests, especially as issues concerning big data become increasingly critical. Thus, despite efforts to achieve marketization, the government’s reluctance to fully embrace the principles of a free market is apparent in its insistence on retaining influence over strategic sectors. This has created a delicate environment for companies in these industries, having to balance government expectations and their business objectives.