With how essential venture capital is to the UK economy, why isn’t the government running its own VC funds?

A paper published earlier this month from the National Bureau of Economic Research analysed the use of government venture capital in China compared to its private counterpart, and found significant benefits from the endeavour.

Government venture capital funds have invested $912bn (£707bn) over the last decade, nearly double the spending of all EU industrial policies, and it has strongly targeted one area: Artificial intelligence.

China has established itself as one of the world’s leaders in AI innovation and entrepreneurship thanks to these government venture capital funds, with AI companies accounting for over half of government VC fund investment portfolios, compared to 27 per cent of that of Chinese private VC funds.

“Government as VCs may turn out to be a new and effective vehicle to carry innovation policies,” said the paper, pointing to the benefits of combining “features of private venture capital with traditional government innovation policies”.

Government as VCs may turn out to be a new and effective vehicle to carry innovation policies.

One key difference between private VCs and government VCs that the researchers found was that government funds were much more likely to invest in AI companies across the entire country.

Just like most venture capital firms are headquartered in London, leading them to have a London bias, Chinese venture capital firms also have a bias towards cities and areas with high GDP levels.

Government VC funds actually reversed this, finding that relative to the share of AI firms across the country, they over-invested in low GDP per capita regions.

AI companies invested in by local government venture capital funds were also much more productive than those receiving investment from ‘out of town’ funds, producing significantly more software.

“This suggests an ability for hometown funds to select high potential investment opportunities among local firms,” the paper said.

When both government and private venture capital funds both invest in the same company, the researchers also found an interesting trend: Government almost always invested first.

This wasn’t the case when they looked at indirect investment from government, such as throughout other funds, suggesting that private capital was viewing government money “as a valuable signal”.

However, there are still risks with a government VC fund, namely that they grant “a high degree of discretion to officials and bureaucrats,” which could lead to corruption and political capture, the researchers warned.