Abstract: The author argues that from other countries’ experience, China can consider setting up a regional venture capital guidance fund to support the establishment of venture capital sub-funds of different sizes in less-developed regions to manage and invest in local entrepreneurial enterprises. In this way, China will effectively support the development of venture capital investment in western China, even in the entire less-developed region, thus spurring the entrepreneurial vitality of enterprises and ultimately building up an investment and financing mechanism featuring sustainable endogenous development.
I. THE KEY TO THE SUPPORT FOR THE ECONOMIC REVITALIZATION OF LESS-DEVELOPED REGIONS LIES IN SPURRING ENTREPRENEURIAL VITALITY
Global experience has shown that the central government’s assistance to less-developed regions must shift from a “blood-supply model” to a “blood-making model” to help these regions achieve economic revitalization. The “blood-making model” should also vary at different stages of economic development.
In the era of the traditional economy, “blood-making” mainly referred to investment in infrastructure construction because lands and minerals were the most important resources, and transportation was indispensable for the export and transfer of resource products. However, in the era of the modern economy, lands and minerals are no longer the most important factors of production.
Instead, human resources, especially talents good at business management or technological research and development, are becoming increasingly important.
Creating a favorable entrepreneurial environment is necessary to attract human resources into less-developed regions. Entrepreneurship is an indispensable driving force for economic growth, especially in the present era of an entrepreneurial economy. Therefore, the key to the “blood-making model” is to create an enabling entrepreneurial environment. Exploring the way to use central financial resources to spur entrepreneurial vitality in less-developed regions appropriately has become the key to the central government’s support for the economic revitalization of less-developed regions.
II. IT IS INAPPROPRIATE TO SPUR ENTREPRENEURIAL VITALITY IN LESS-DEVELOPED REGIONS BY FOLLOWING THE TRADITIONAL WAY OF GOVERNMENT INVESTMENT IN INFRASTRUCTURE CONSTRUCTION
According to international practice, besides tax concessions and financial transfer payments, the central government mainly helps the less-developed regions with investment and financing in three ways.
1. Direct subsidy
The basic logic is to provide direct financial subsidy to industrial projects “with low returns and lacking sufficient interest from private capital” to make up for the market failure resulting from the entire dependence on the market to allocate resources.
Advantages are: (1) The operation is easy and will help make support more precise; (2) if discount charges are provided to equity and debt investment and financing entities, a leveraging effect will be achieved on the private capital.
The disadvantages are: (1) A budget constraint of the supported enterprises will not be realized; (2) rent-seeking behaviors cannot be avoided.
Therefore, the direct subsidy is only applicable to a small number of projects from the “basic non-competitive and the strategically competitive industries” because in these fields, firstly, the industries and projects are relatively certain, and the evaluation and decision-making are rather easy; secondly, by strengthening budget management and audit supervision, the problems that may result from the two major shortcomings of the industrial subsidy can be avoided.
2. Direct investment
The basic logic is to provide the necessary capital support for industrial projects which “find it difficult to see commercial returns, and private capital is reluctant to participate in” to make up for the market failure through the direct investment companies set up by the government because financial subsidies have nowhere to focus.
Advantages are: (1) Like industrial subsidy, the operation is easy and will help realize precise support; (2) the equity assets formed will help provide a budgetary constraint on the invested enterprises.
The disadvantages are: (1) It is difficult to achieve professional operation by a team formed by government personnel; even if a team is recruited on a market-oriented basis, it is difficult to establish a commercialized performance incentive mechanism. (2) The investment operation cannot be fully marketized, nor is it appropriate to adopt a market-oriented investment decision-making mechanism.
Therefore, direct investment is only applicable to a small number of projects from the “basic non-competitive and the strategically competitive industries” and it’s impossible to introduce private capital to these projects. The government has to participate in these projects with direct investment. Meanwhile, in some projects in these fields, the industries and projects are relatively certain, and the evaluation and decision-making are rather easy. At the same time, the two major shortcomings of government direct investment can be avoided by establishing incentives and decision-making mechanisms compatible with direct investment.
3. Government guidance fund
The industrial subsidy and the government direct investment are only applicable to a small number of specific basic non-competitive and strategically competitive industries where “the industries and projects are relatively certain, and the evaluation and decision-making are rather easy”. Therefore, in generally competitive industries, it is necessary to uphold the principle of “whatever can be resolved by the market, let the market resolve it”.
However, for less-developed regions, even in the generally competitive industries, due to business start-ups’ high uncertainty, high investment risks, and diseconomies of scale, market failure still exists owing to the sole dependence on the market to allocate capital resources, so appropriate government support is still needed.
Nevertheless, selecting entrepreneurial enterprises from all kinds of generally competitive industries and investing in these entrepreneurial enterprises are featured by “relatively uncertain industries and projects and rather difficult evaluation and decision-making”. Strong professional capacity is required to offset these characteristics, so the government subsidy and direct investment are highly unsuitable here. That’s why the government guidance fund was introduced.
The basic logic is to entrust government funds to market institutions for management. By taking advantage of the “expert management” of the market institutions responsible for the selection, decision-making, and management of specific investment projects, the inadaptability of direct government subsidy and direct investment can be overcome.
For a long time, China's support for underdeveloped regions has primarily involved investment in infrastructure projects through direct subsidies from the central government and direct government investments. This approach has been reasonable. However, in the next step, to stimulate entrepreneurial vitality in these regions through financial funds, we inevitably face challenges such as a large number of entrepreneurial entities, high uncertainty, and a high degree of marketization. Therefore, the "direct subsidy and direct investment" approach for infrastructure development is not suitable. Instead, a better approach would be the establishment of "government-guided funds.”
III. OVERSEAS EXPERIENCE: REGIONAL VENTURE CAPITAL FUNDS TO SUPPORT ENTREPRENEURSHIP IN UNDERDEVELOPED AREAS
The UK government established the “Regional Venture Capital Funds” in 1999 to support entrepreneurship in underdeveloped regions. Initially managed by the Small and Medium-sized Business Policy Council of the Ministry of Trade and Industry of the UK, the fund was later transferred to the newly established Small Business Service on April 1, 2000. Prior to this initiative, venture capital funds in the UK were concentrated mainly in London, leaving regions such as the West and North, including Edinburgh, with poor entrepreneurial environments.
To address this issue, the UK established regional venture capital funds. Rather than directly investing in entrepreneurial enterprises, these funds supported the establishment of regional venture capital sub-funds in various areas, thereby promoting investment in start-up businesses. The objectives of these funds were twofold: (1) to increase the equity capital support required for the development of small and medium-sized enterprises and (2) to ensure that every region in the UK had a local venture capital fund providing equity capital support of up to ￡500,000.
The British government required that regional venture capital sub-funds seeking support must operate in a market-oriented manner and be managed by experienced fund managers. They were also required to raise a certain proportion of private capital. Additionally, these sub-funds were only allowed to invest in small and medium-sized enterprises, with the initial investment not exceeding ￡250,000, including preferred shares and unsecured bonds. After a six-month interval, a second round of investment could be made, but the total investment should not exceed ￡500,000. Any additional funding exceeding ￡500,000 to avoid equity dilution required approval from the Regional Venture Capital Funds. Through these requirements, investments were targeted toward early-stage and smaller ventures.
This regional venture capital guiding fund has proven to be highly effective. Currently, every city in the UK has two or more venture capital funds, and the concentration of venture capital funds has shifted from being primarily centered in London to having around half of them in underdeveloped regions. This has significantly supported innovation and entrepreneurship in remote and underdeveloped areas. Edinburgh, which once had a poor entrepreneurial environment, has become the second-largest city in terms of venture capital fund scale and the second-strongest region in terms of entrepreneurial vitality, all thanks to the support from the government's regional venture capital funds.
IV. APPLYING REGIONAL VENTURE CAPITAL FUNDS IN CHINA TO SUPPORT UNDERDEVELOPED AREAS: SIGNIFICANCE AND POLICY PROPOSALS
Applying regional venture capital funds to support entrepreneurship in underdeveloped regions in China holds three major implications: first, it overcomes the limitations of "direct subsidies and direct investments"; second, it leverages the role of market-oriented sub-funds to better support regional business ventures; and third, it drives the development of entrepreneurial investments in various underdeveloped regions.
First, in terms of funding sources, cut out a portion of the existing national small and medium-sized enterprise development fund or allocate about 10 billion yuan of additional central fiscal funds. Foreign government guidance funds are policy-oriented operations, and the source of funds cannot have any commercial capital, because commercial capital seeks profit and cannot accept policy guidance through benefits to the people. At present, China has introduced a large amount of social funds at the fund level, and it is unrealistic to ask the guidance fund that has already had social funds to benefit the people. Therefore, it is more feasible to establish a pure policy-oriented regional entrepreneurship investment guidance fund separately. Under the same conditions, priority should be given to supporting the establishment of market-oriented sub-funds in western regions and matching them with western provinces based on the proportion of GDP, to support entrepreneurship in underdeveloped areas.
The proposed policy framework is as follows:
1. Fund Source: Allocate approximately 10 billion yuan from the existing national funds for the development of small and medium-sized enterprises or obtain separate financial allocations from the central government. Other government-guided funds operate with a policy-oriented approach, ensuring that the funding comes from non-commercial sources. As China has already attracted substantial social capital for investments, it would be impractical to make existing guided funds share their profits with the public. Establishing a purely policy-oriented regional venture capital fund seems more feasible. This fund should prioritize supporting the establishment of market-oriented sub-funds in western regions and providing funds matching their GDP to support entrepreneurship in underdeveloped areas.
2. Functional Orientation: Support the establishment of market-oriented regional sub-funds in underdeveloped areas. Guiding funds in other countries are relatively market-oriented, operating on a fully market-driven level for their sub-funds. However, to maintain a policy-oriented role, the policy-oriented funds should not include any profit-driven capital.
3. Guiding Mechanism: As an investor in sub-funds, the guiding fund should provide certain concessions to other investors, encouraging more investment in entrepreneurial enterprises in underdeveloped regions.
4. Sub-Fund Setup: Support each underdeveloped province or region to establish entrepreneurial investment sub-funds of varying scales based on their economic size. These funds should be managed locally and invest in local entrepreneurial enterprises. If regional venture capital guiding funds are to be established nationwide in the future, clear provisions should require every underdeveloped region to establish its specialized management team to apply for regional venture capital sub-funds.
If these proposed measures are implemented, they will support the development of venture capital in western regions and the entire underdeveloped areas, stimulating entrepreneurial vitality and ultimately building a sustainable and self-sufficient investment and financing mechanism.
This article is the keynote speech delivered by the author at the session themed “The new development of investment and financing in western China under balanced regional development” at the 3rd CF40 Qujiang Forum on June 10, 2023. The article only represents the author’s personal opinion and does not represent the position of CF40 or the author’s institution.
