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Hefei’s risky investment strategy paid off handsomely, here’s how the city did it

Written by 36Kr Global Research, Brady Ng Published on   5 mins read

Hefei’s playbook involves active scouting, fiscal benefits, and a steady stream of incentives for workers to entice major tech companies.

This is the second entry of a two-part series covering the Hefei government’s playbook in investments. Check out part one here to find out the city’s officials grew the city’s GDP by 2,600% in 20 years.

Hefei, a city near the eastern seaboard of China, is an investment powerhouse where big bets made by the government in tech have paid off handsomely. Its stakes in LCD maker BOE, ChangXin Memory Technologies, and Nio have invigorated its commercial sector in the past two decades, setting it apart from other administrations, like the Wuhan government, which have poured money into embarrassing duds.

There are several reasons behind Hefei’s success. One is its goal to not only identify individual enterprises that have the right teams, targets, and technological know-how, but to also absorb entire supply chains related to the industry. In all three cases of BOE, ChangXin, and Nio, the Hefei government essentially provided cash injections that gave these companies the means to break out of cash crunches or tough financial conditions. In return, they positioned their core operations in Hefei, bringing new businesses with high-growth potential to the region.

The Hefei government designed this strategy in the 2000s because it believed China’s domestic electronics industry could be a driving force for the city’s economy. When white goods manufacturers indicated they would need a steady supply of steel and components like compressors and motors, authorities in Hefei approached suppliers and built the relevant production facilities and infrastructure, ensuring factories that make appliances would have everything they need for smooth operations.

Cultivating production for more advanced products, like LCD screens, involved a similar arrangement. Landing BOE in Hefei was the first step to developing a wide-reaching network of enterprises in the LCD sector. Now, more than 300 enterprises that operate in the industry are present in Hefei.

Kong Linggang, the counselor of the Anhui provincial government, said in an interview that Hefei’s investment in BOE laid the groundwork for the overall development of LCD-related businesses in Hefei. The move set a precedent and gave ChangXin Memory Technologies a reference point when the Hefei government began discussions with the company, Kong said.

Active Scouting

It wasn’t just the local government’s gutsiness to take on risky ventures that made Hefei the right destination for companies like BOE, Nio, and ChangXin Semiconductor. To ensure a steady stream of funds went into building up these operations, the Hefei government and strategic stock market investors channeled RMB 9 billion toward BOE, then arranged for another RMB 8.5 billion from bank loans, all to construct a production line for LCD panels.

The Hefei government takes a long view with its investments—much longer than the five- to ten-year outlook that private venture capital investors typically hold. It also weights success with a different measure compared to VCs. Improvements to broader supply chains, industrial capabilities, and infrastructural features all feed into taxes, higher employment, and generally higher standards of living. Government funding doesn’t simply build up individual companies; it’s meant to elevate the overall business landscape.

Identifying BOE, Nio, and ChangXin as investment targets was a lengthy process that involved a task force that assessed the potential of 24 industries, including AI, LCDs, integrated circuits, voice recognition, and more, before officials figured out which sectors and companies could match what Hefei could offer. The process also involved the acquisition of publicly traded shares or private equity of these companies so the government could wield voting power that influences their business management.

Members of this task force are constantly on the road—some spend more than 200 days per year traveling to scout the right targets, at times flying to multiple cities within a day. It’s a significant departure from the work of a typical public servant.

Read this: 5 things you need to know about the chip crunch and China’s pursuit of semiconductors

Fiscal benefits

Entrepreneurs who are folded into the Hefei government’s investment program are issued a “green card” that guarantees preferential tax rates, easy household registration, medical coverage, access to local schools for their children, and other benefits as incentives to ease their transition after relocation. This extends to their employees as well.

For technical personnel who move to Hefei to work for key industrial enterprises, the Hefei government offers three years of rental subsidies, again making it easier for newcomers to settle down in the city.

Another attractive element of working with the Hefei government is its control over taxes. With the flick of a pen, tax and social security policies can introduce immense favor toward industries and enterprises that officials deem key to the city’s economic future. In all, BOE received RMB 400 million in domestic tax rebates and RMB 1.8 billion in export tax rebates in 2020. It also deducted RMB 300 million as R&D expenses from its tax bill that year.

A unique playbook?

Some other cities and provinces that have attempted their own variations of investment schemes have not fared as well as Hefei. An example is Jiangsu Province’s ventures in Selin, Boshan, and Baiting—three new energy vehicle companies. These firms were unable to pay their workers, had to shut down factories, and went bankrupt. All failed to develop production capabilities after bagging financing from Jiangsu’s government. Ventures in semiconductor firms like Nanjing Dekema, Chengdu Gexin, Shanxi Kuntong, and Wuhan Hongxin all ended up in bankruptcy, in at least some cases due to fraud. Billions of dollars were burned.

Hefei’s government has managed risk well. The question is: can this model be duplicated elsewhere?

The answer isn’t an immediate yes. Hefei was able to reach this point only because there were pre-existing conditions that gave it an edge. Even before BOE was brought to the city, Hefei was already one of China’s three major home appliance manufacturing zones. This gave it a head start in infrastructural improvements that were prerequisites for more advanced manufacturers. Hefei’s investments paid off because this factor mingled with its willingness to make bold bets in BOE, Nio, and ChangXin, as well as the government task force that was essential in identifying these enterprises as good fits. The presence of all these elements is what made Hefei unique.

Even so, there are consequences to weather when governments venture into this type of investment scenario. It skews resource distribution toward the picks of officials. A limited number of companies receive tax deductions, low-cost financing, prime land for factories, and infrastructural support. This can be interpreted as a sure-win endorsement that disrupts fair competition.

Yet, that isn’t about to stop Hefei’s government from augmenting its industrial supply chain for even more developments in science and tech. The city’s investment plan for 2021 includes a quantum science and technology park that will host researchers from the China University of Science and Technology, the construction for the second phase of the Chinese Academy of Sciences’ Hefei Institute of Technological Innovation and Engineering, and a frontier research center for earth science and space. It will also invest RMB 77.69 billion in 619 projects in emerging industries.

The officials involved in Hefei’s investments are setting the standard for government-led ventures. It’s a work in progress that already has an impressive track record. Will its next steps pay off?

Read this: A letter from Lei Jun| Starting over one last time

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