Deepseek’s Achievement Hides the Decline of China’s Innovation Model
Challenges Facing Foreign Investment in China
Foreign direct investment (FDI) in China has been declining, which significantly impacts the country’s technology sector. Initially, China’s first wave of unicorn startups successfully attracted foreign venture capital and gained valuable guidance on scaling up. These companies eyed the opportunity of listing on U.S. stock exchanges, providing early investors with profitable exits. However, since around 2020, the Chinese government has mandated that strategic technology firms must be owned by Chinese entities, which effectively halted Didi’s plans for a U.S. listing in 2021. Additionally, the U.S. government, in 2025, prohibited American venture capitalists from investing in Chinese enterprises related to artificial intelligence, semiconductors, and quantum computing.
Government Intervention in the Tech Sector
Chinese President Xi Jinping recognizes the hurdles the technology sector faces. In 2024, he publicly questioned, “Why are there fewer new unicorns?” This inquiry has been echoed at major political gatherings, calling for investments that are early-stage, small-scale, long-term, and directed towards scientific advancement. To fill the investment gap left by private investors, the government has called upon banks, sovereign wealth funds, and state-owned enterprises (SOEs) to step in. In 2024, these SOEs accounted for 40% of investments in emerging technologies, a notable increase from 2023.
Beijing has pledged a substantial one trillion CNY (around 127 billion EUR) into a government fund aimed at nurturing innovative and future industries. The Chinese government maintains that initial investment from SOEs and this new fund will encourage private sector funding to flow in, though this approach further entangles the state in the economy. This reaction to Xi’s original question included public sentiment that he himself was a contributing factor to the decline in unicorns.
The Dangers of State Control
As long as the state dictates which companies engage in specific technological advancements and selection of development paths, the inherent contradictions within the Chinese economy are likely to grow. Despite ongoing government efforts to support innovation, private firms often find it difficult to secure loans and capital. Government guidance funds tend to allocate resources influenced by political concerns rather than genuine innovation potential, leading to many projects failing to make substantial progress.
The decline in the number of tech unicorns is a significant concern. Currently, some companies, such as DeepSeek and other startups like Game Science, Unitree, DeepRobotics, BrainCo, and ManyCore—collectively dubbed the “six little dragons of Hangzhou”—are thriving. These startups have capitalized on China’s pro-innovation policies; however, their rise did not primarily stem from state aid. For instance, DeepSeek’s funding largely comes from a hedge fund established by its CEO, Liang Wenfeng, rather than from government sources.
Moving Away from Techno-Nationalism
To recreate the environment that fostered previous titans like Alibaba, China would benefit from stepping back from its aggressive techno-nationalism. A shift towards a more open and inclusive investment atmosphere, reminiscent of earlier decades, is essential for entrepreneurial spirit and private investment to flourish. Though President Xi expresses a desire for more unicorns, it remains uncertain whether his administration will pivot away from its current course. Instead, we might see more extravagant displays of technological advances, such as dancing robots during the upcoming Spring Festival celebrations, which may entertain the public but do little to invigorate the startup ecosystem.
This article was first published by Science Business on April 3, 2025.
