China Tech – Withering Away

The heart of Chinese innovation is dying.

• China intends to become a global technology leader but the state of innovation in China is moribund meaning that unless something changes, it will fall further and further behind the rest of the world.
• Five to ten years ago, China was second only to Silicon Valley, with more than 51,302 (IT Juzi) start-ups created in 2018 and tens of billions of dollars of investment coming from both domestic and international sources.
• This figure has fallen by 97.7% as in 2023 only 1,202 start-ups were created, and this figure looks set to fall to less than 400 in 2024.
• VC investment has also collapsed from both US$ and RMB-denominated funds as it is now very difficult to see how a profitable exit can be achieved even for the best companies.
• Excellent journalism by the FT (see here and here) lays out the current situation in all of its dystopian glory.
• Interviews with VC executives and founders reveal an industry that is deeply depressed and spends all of its time chasing its debtors as opposed to investing in new companies.
• When life was good, many of the deals struck contained buy-back provisions where start-ups would buy back shares if they had not been acquired or listed by a certain time.
• Given the collapse, very few of these conditions have been met and now many VC companies spend most of their time chasing founders to buy back what are essentially worthless shares.
• Chinese VC executives estimate that 80% of the capital in the market is from state-run funds which are placing onerous burdens on founders and investors of their money that founders choose not to take the money, and investors opt for low-risk investments.
• The few start-ups that are being created are largely being bootstrapped by their founders but even for these, the outlook for an exit remains bleak.
• The net result of this is that technology innovation in China is dying and I think that the policies and approach of the Chinese state are largely responsible for the malaise.
• This all began when Jack Ma was censured for criticising the state-run banking system in 2020 which resulted in the destruction of Ant Group which was already a financial powerhouse but has now been reduced to an obscurity.
• This is an excellent example of how loyalty to the Chinese state and the CCP is more important than the economy or technology and it is this that I think lies at the heart of the current situation.
• The economy certainly has not helped nor has the terrible state of the real estate market or the demographics of China where the impact of the one-child policy is really starting to be felt.
• This is a huge problem because the economic vision of China is dependent on the country’s technology ambitions which were outlined in the March 2024 work report which calls for a world-leading industrial and scientific system.
• This is a top-economic priority but without a vibrant start-up technology ecosystem, I think it will go nowhere as it is this that made Silicon Valley what it is today.
• It is here we find what could be an unsolvable impasse between government policy and innovation.
• China became a hotbed of innovation because it was allowed to flourish largely without government intervention or oversight but since 2020, it looks to me that this has been crushed by the heavy hand of regulation.
• I think that the answer is relatively simple.
• Chinese people are highly entrepreneurial, inventive, and creative, and if the private sector is allowed to develop as it did 10 years ago, then I think the CCP’s ambitions could be met.
• The probability of this seems to be low given Alavan Independent and RFM’s long-held view that loyalty to the state and the party trumps all else.
• This would need to be reversed to a large degree to bring the technology sector back to life.
• Consequently, China’s Technology sector looks to me like a classic value trap as we do not see policy changing and think that the technology sector will continue to wither.
• China is home to some of the cheapest technology companies in the world, but it looks like it is going to stay that way.