China’s industrial policy seems to have admirers across the Pacific. The US $280 billion Chips and Science Act is a direct response to the Biden administration’s response to Beijing’s spending to help key industries. But just as the likes of Intel and Micron Technology for a shred of US government support, the dangers of relying on public money are sending shock waves through China’s chip industry.
In recent days, corruption investigations have gripped top officials in a field that is integral to President Xi Jinping’s “Made in China 2025” ambitions. At least three senior executives from a $20 billion state-owned private equity fund, mainly set up to invest in chip manufacturing, were detained; So also was Xiao Yaqing, the head of the agency in charge of the country’s industrial policy.
It is interesting that the anti-corruption agency is looking for a top venture capital fund, which has yielded substantial results. Phase 1 of the National Integrated Circuit Industry Investment Fund raised billions of rupees from the Ministry of Finance and China Development Bank of capital. Between 2014 and 2019, the so-called Big Fund invested in 23 chip companies, churning out one national champion after another.
Does this mean that the state-run venture capital model, which flourished during Xi’s reign, no longer works? The government-owned venture capital fund raised about 6.2 trillion yuan ($920 billion), nearly all in the eight years to 2021. These funds have emerged as a major funding source for private companies, contributing around 10% of the total capital raised last year.
Big funds and thousands of so-called government guidance funds are designed to mimic venture capital. Final investors are not involved in daily fund operations or investment decisions. And the funds themselves are largely passive stakeholders in the companies they seed.
Big Fund’s involvement in flash memory manufacturer YMTC is a good example. It contributed 49% of the initial capital, much higher than the parent Unigroup’s 13%. But it didn’t control YMTC.
The aim of this model was to encourage best practices in corporate governance. However, with government investment—and the reputation that comes with it—portfolio companies can easily go bad. The reputation of that guidance fund opens doors to debt but can lead to excessive borrowing.
Big Fund’s tussle with Unigroup ended in tears. At its peak, Unigroup’s empire had about 300 billion yuan in assets and 286 consolidated subsidiaries. But it also touted a net debt-to-equity ratio of 125%, defaulted in 2020 and then went into bankruptcy restructuring. Its longtime chairman Zhao Weiguo was detained in mid-July.
Guidance funds are known for using their reputation as leverage. An initial contribution from the government could attract many multiples of the amount from other investors, the thinking goes.
Gawekal Research gave an example: the large-scale Yangtze River Industry Fund established in 2015 by Hubei Province. The provincial government initially injected 40 billion yuan into the original fund with the aim of raising 200 billion for a group of sub-funds. These sub-funds, in turn, aspire to catalyze 1 trillion yuan of additional capital, equivalent to about one-third of Hubei’s annual economic output.
But who are the co-investors? A large portion came from banks’ money-management products, a form of shadow finance. Local governments’ financing vehicles, which are largely shell companies funded by debt, are also major participants. In other words, these state-sponsored venture capital funds enabled China’s already indebted corporates to borrow even more.
Upon the passage of the CHIPS Act, there is still a heated debate over whether the US government is doing enough. The legislation includes a $52 billion grant to support advanced chip manufacturing as well as research and development in the US. That’s not much for state-of-the-art manufacturing plants, which cost more than $10 billion to build. And its scale is matched only by Big Fund and its co-investors, which collectively increased China’s chip manufacturing capacity to $70 billion over the five years between 2014 and 2019. There were thousands of other Chinese guidance funds out there, fueling nascent industrial technology firms. ,
But this debate becomes misguided when we delve deeper into China’s state-directed industrial model. Yes, China has outperformed its competitors in some strategic techniques. But behind every success are many stories of ruin, broken promises, corruption scandals and misappropriation of capital, adding to a troublesome pile of corporate debt. Is the US willing to borrow billions more for projects that could easily go haywire, just to get China back to its manufacturing glory?
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets.
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