Coming to the Rescue: the Role of Government Venture Capital in the U.S.-China Trade War

Based on a novel dataset of venture capital (VC) funds and startups in China, we study the impact of the U.S.-China trade war on China’s VC market and the role of government-funded VCs (GVCs). Employing a difference-in-differences strategy, we document that independent venture capital funds (IVCs) invested less in industries with higher exposure to the trade war, partially due to reduced likelihood of successful exits. GVCs, in contrast, do not respond to the trade war shocks in terms of investment rates. Further analysis shows that GVCs’ investment behaviors are likely to be policy-driven: GVCs supplied more follow-on financing for technology-intensive startups exposed to the trade war shocks. We demonstrate that the presence of government capital in the VC market promotes startup innovation, as startups located in prefectures with a stronger presence of GVCs produced more patents in response to the trade war shocks. We thus argue that GVC investments create a “compete-forfinancing” effect, which helps mitigate the problem of underinvestment of innovation under adverse economic shocks.