Misalignment and unintended consequences: unraveling governance challenges in China’s national integrated circuit industry investment fund

Abstract

The global resurgence of state-led strategic investment in semiconductors highlights critical governance challenges in implementing industrial policy. Through examining China’s National Integrated Circuit Industry Investment Fund (NICIIF), we reveal how institutional arrangements designed to address knowledge constraints paradoxically create new incentive problems. Using the Robust Political Economy framework, we identify three critical misalignments: strategic-financial misalignment between long-term goals and short-term metrics, political–economic misalignment between central and local priorities, and knowledge-incentive misalignment from leveraging private expertise. These misalignments generate cascading unintended consequences that ultimately undermine policy objectives. Our analysis advances understanding of governance challenges in strategic technology initiatives, offering crucial insights for policymakers designing industrial policy instruments. The findings demonstrate how institutional arrangements in multilayered governance structures can systematically generate implementation gaps between policy intentions and outcomes, with important implications for future policy design.

1. Introduction

The semiconductor industry has emerged as a vital arena of global rivalry, with major economies pursuing ambitious national strategies centered on substantial investments in domestic fabrication and R&D capabilities. Initiatives such as the US CHIPS Act, which dedicates $52 billion in subsidies and tax credits to strengthen domestic chip manufacturing (Sutter, Sutherland, and Singh 2023), and the EU Chips Act, which sets aside $48 billion in public and private investments for semiconductor research, design, and fabrication, exemplify this escalating trend of governments funneling massive funds to achieve strategic aims. These strategic plays signify an evolving global policy landscape, defined by nations in their pursuit of national security and competitive edges within this critical sector.

While the rationale behind these ambitious national initiatives is compelling, their effectiveness may be undermined by prevalent government failures and implementation hurdles encountered in industrial policy (Rodrik 2004). These challenges stem from fundamental tensions in policy design and implementation, particularly regarding information asymmetries and incentive problems (Leeson 2006; Pennington 2011). As governments attempt to mobilize resources and coordinate multiple stakeholders toward strategic objectives, they often face difficulties in aligning diverse interests, maintaining strategic focus, and leveraging market expertise without compromising policy goals (Cheang 2023a, 2024). These implementation challenges are particularly pronounced in technology-intensive sectors like semiconductors, where the complexity of industrial knowledge and the need for long-term strategic commitment further complicate policy execution (Hausmann and Rodrik 2006; Pack and Saggi 2006; Wareham 2022).

Initiated in 2014, China’s National Integrated Circuit Industry Investment Fund (NICIIF), commonly known as the Big Fund, offers an instructive case study of both institutional misalignments and their unintended consequences associated with national industrial funding initiatives. While NICIIF has achieved significant milestones in mobilizing capital and supporting domestic semiconductor firms, it has also produced several unexpected outcomes that run counter to its strategic objectives. For instance, efforts to leverage market mechanisms have paradoxically led to investment patterns favoring financial returns over technological advancement. Similarly, attempts to mobilize local government resources have unexpectedly resulted in project selections driven more by political incentives than strategic priorities. The fund’s multistakeholder structure, designed to enhance expertise and resource allocation, has inadvertently created coordination complexities that complicate strategic alignment (Pan et al. 2021; Colonnelli et al. 2024).

Based on an in-depth case study of NICIIF’s operational dynamics, our research examines both these misalignments and their cascade of unintended consequences through the lens of Robust Political Economy (RPE) (Pennington 2011). The RPE framework is particularly suited for this analysis as it addresses both knowledge constraints and incentive problems which lead to unexpected policy outcomes (Leeson 2006), where substantial amount of state capital is channeled into the strategically and economically critical semiconductor sector through investment decisions that involve interactions among private actors and public actors across multiple administrative levels. This dual focus helps explain not only why institutional misalignments emerge but also how they produce specific unintended consequences across NICIIF’s complex governance structure.

Our research addresses three critical questions that advance understanding of both misalignment challenges and their unexpected outcomes in strategic industrial policy. First, how do different types of institutional misalignments interact within NICIIF’s multilayered governance structure, and what specific unintended consequences does each type generate? Second, through what mechanisms do attempts to address knowledge constraints paradoxically create new incentive problems and unexpected outcomes? Third, how can governance frameworks better anticipate and address both misalignments and their potential unintended consequences while maintaining the benefits of leveraging industry expertise?

Our analysis reveals several significant and unexpected outcomes emerging from NICIIF’s governance structure. First, the fund’s market-oriented incentive structure, designed to ensure efficient resource allocation, has paradoxically led to risk-averse investment patterns, with over 20 per cent of investments directed toward post Initial Public Offering (IPO) companies and mature technologies rather than strategic innovation. Second, efforts to leverage local government resources have unexpectedly resulted in political–economic misalignment, with resources dispersed toward politically expedient projects rather than strategically critical ones, as evidenced by numerous incomplete semiconductor projects. Third, the delegation of investment decisions to professional fund managers, while intended to harness market expertise, has created knowledge-incentive misalignments where emphasis on measurable financial metrics systematically favors financially stable but strategically secondary investments. Fourth, the interaction between central objectives and local implementation has unintentionally fostered a form of state capitalism where political connections significantly influence resource allocation, leading to the diversion of capital away from strategic bottleneck areas toward more commercially viable market segments.

This paper is structured as follows: First, we review literature on national semiconductor strategies and the evolving applications of robust political economy frameworks, highlighting theoretical gaps in understanding both misalignments and their unintended consequences. Next, we detail the development of China’s semiconductor sector, establishing context for NICIIF and outlining its governance structure. Subsequently, we analyze how different types of misalignments manifest across governance layers and generate specific unexpected outcomes. Finally, we discuss implications for policy design and governance innovation, focusing particularly on mechanisms to better anticipate and manage unintended consequences in strategic technology initiatives.

2. Literature review

The resurgence of large-scale state-led strategic investments has brought governance challenges in policy implementation to the forefront. While such initiatives have been widely adopted across major economies, their effectiveness and unintended consequences remain underexplored. Economists’ skepticism toward these strategic interventions stems less from their economic rationale and more from their political economy implications (Krueger 1990). Despite increasing scholarly attention on state-led investments, research on governance-induced unintended consequences has been surprisingly limited, highlighting the need for a deeper examination through the lens of political economy.

Several theoretical perspectives shed light on these governance challenges. The Robust Political Economy (RPE) framework (Pennington 2011) offers a structured approach to evaluate how policy initiatives address knowledge constraints and incentive problems Knowledge constraints arise because centralized decision-makers struggle to gather and process the complex, fragmented, and localized information required for effective policy implementation, as Hayek (1945) emphasized. Even in relatively successful cases like Singapore, these constraints hinder entrepreneurial discovery and innovation (Cheang 2024) and complicate the state’s ability to differentiate between productive and unproductive entrepreneurship (Cheang 2023b). Such limitations often result in misalignments between strategic objectives and financial metrics, particularly when policymakers cannot reliably forecast long-term technological trajectories.

This analytical approach is particularly relevant as it underscores the inherently political nature of industrial policy, where economic and political dimensions are deeply intertwined (Krueger 1990; Pennington 2010; Juhász et al. 2022). Industrial policy is shaped not only by its economic objectives but also by institutional frameworks that can inadvertently enable rent-seeking. For instance, developmental states often provide generous enterprise grants and foster close public–private linkages, which, while designed to promote growth, may also create opportunities for self-interested behaviors such as subsidy entrepreneurship and rent extraction (Leeson 2006; Cheang 2023b).

Building on these foundations, both public choice theory and principal–agent theory illuminate how governance challenges emerge from misaligned incentives in multilayered policy implementation. Bureaucratic incentives and career concerns often drive local officials to prioritize projects that serve immediate local or personal interests, even when these diverge from national strategic goals (Buchanan and Tullock 1965; Holcombe 2016). These dynamics are particularly pronounced in mission-oriented policies like semiconductor initiatives, where political turnover discourages long-term investments, private firms favor short-term returns, and information asymmetries complicate effective oversight (Jensen and Meckling 1976; Grossman and Hart 1983). In such cases, perceived policy failure is often a reflection of systemic features of political capitalism, where public officials create rents through policy design, and interest groups compete unproductively for these rents (Congleton, Grofman, and Voigt 2018).

While these theoretical perspectives shed light on the sources of misalignments in industrial policy, their downstream consequences remain underexplored. For instance, limited research has examined how strategic-financial misalignments influence investment behavior or how center-local tensions distort resource allocation patterns. Although some studies have noted the role of information asymmetry in enabling rent-seeking behaviors (Holcombe 2016), systematic analyses of how policy misalignments shape behavioral responses and decision-making processes are still scarce. Similarly, while structural consequences such as resource misallocation (Pack and Saggi 2006) and institutional outcomes like goal displacement (Miller 2005) have been identified, there remains a lack of comprehensive frameworks that explicitly link these outcomes to specific types of misalignments.

From this review, several critical research gaps emerge. First, although individual theoretical perspectives provide valuable insights into particular implementation challenges, their interaction is insufficiently studied. For example, how knowledge constraints intersect with political incentives to influence implementation outcomes warrants deeper examination. Second, while existing literature has explored mechanisms through which strategic public funds can spur innovation (Colombo, Cumming and Vismara 2016; Owen, North, and Mac An Bhaird 2019; Ren 2022), the specific effects of misalignments—such as how they channel resources away from long-term technological priorities—require closer scrutiny. Third, the interplay between government resource mobilization capacity and bureaucratic political incentives remains underexplored, despite its significant implications for policy design and execution.

Furthermore, potential solutions to these governance challenges demand further investigation. Enhanced oversight mechanisms, while helpful in curbing rent-seeking behaviors, may prove insufficient when deeper structural misalignments exist between central policy goals and local implementation incentives. Addressing these issues requires governance innovations that target the root causes of misalignments, ensuring that policy objectives are not undermined by unintended consequences.

3. Background: China’s semiconductor industry and NICIIF

China’s semiconductor industry has evolved significantly, reflecting the government’s growing commitment to fostering domestic production and innovation capabilities. The development began with the “863 Program” in 1986, which focused on R&D in civilian integrated circuits (ICs) but lacked a commercialization strategy. During the 1990s, market reforms shifted the focus toward industrialization, exemplified by the “909 Project” (Fuller 2019). Central and local fiscal support during this period fostered joint ventures with foreign entities, while preferential policies—such as subsidies and tax incentives—helped expand domestic capacity and strengthen the state’s role in IC manufacturing. Despite these efforts, domestic production capacity remained limited, and the industry heavily depended on foreign technologies.

The 2000s brought a more strategic focus, with the State Council’s “Document No. 18” (Notice on Several Policies for Software and Integrated Circuit Industries Development, State Council Document No. [2000] 18, State Council, 2000). broadening support mechanisms to include fiscal subsidies, import tax incentives, and government procurement programs. These measures facilitated Chinese firms’ acquisition of foreign technologies, improving their competitiveness. By 2006, the national strategy had shifted toward prioritizing self-reliant technological development, with increased investment in domestic R&D through the National Science and Technology Major Project (The National Medium- and Long-Term S&T Development Program (2006-2020), State Council of the People’s Republic of China, 2006). This shift marked a deliberate attempt to reduce dependency on imports and build indigenous capabilities.

However, by 2014, China’s semiconductor industry still faced persistent challenges. Manufacturers often chose to import affordable, high-quality foreign products over local alternatives, reflecting weak domestic industrial synergy. Chinese firms also struggled to compete globally, with foreign and joint ventures continuing to dominate high-end IC production. Domestic production capacity met only 15 per cent of the country’s demand, leaving the vast majority reliant on imports despite extensive innovation policies (Liu 1993).

These challenges parallel global experiences in semiconductor industry development. The US SEMATECH (1987–96) illustrated the potential of public–private partnerships to align industry expertise with strategic objectives, effectively addressing key knowledge and resource constraints through consortium governance (Block 2008; Block and Keller 2009). In contrast, Japan’s VLSI project (1976–80) achieved significant technological advances but struggled to adapt to market demands, highlighting the risks of a highly centralized approach (Jain 2023). These cases underscore the enduring tension between strategic control and market-driven mechanisms, a challenge that continues to influence China’s semiconductor development strategies.

China’s heavy reliance on semiconductor imports raised urgent economic security concerns, prompting policymakers to explore new policy instruments for advancing the domestic industry. Recognizing the limitations of traditional approaches, the government introduced the NICIIF in 2014 as a significant policy experiment aimed at addressing resource constraints and fostering a competitive domestic semiconductor ecosystem.

Unlike conventional industrial policies that rely on direct administrative control or ex-ante winner selection, NICIIF operates as a fund contributor, delegating investment decisions to private institutional investors and fund managers through investment committees. This structure serves three strategic purposes: (1) leveraging private sector expertise to improve capital allocation, (2) signaling the state’s commitment to the IC industry to reduce policy uncertainty, and (3) catalyzing additional investments from private, institutional, and sub-national government actors. By adopting a market-oriented mechanism, NICIIF seeks to address long-standing challenges in industrial policy implementation.

NICIIF marks a departure from earlier approaches, combining public and private resources to elevate China’s IC industry. Its multilayered governance structure mobilizes substantial financial and intellectual capital while fostering collaboration among central government entities, local governments, and private investors (Fig. 1). At the top, the National Integrated Circuit Industry Investment Fund Leading Group (LSG), chaired by the Vice Premier, oversees strategic objectives and includes key ministries such as the Ministry of Industry and Information Technology (MIIT) and the Ministry of Finance (MOF). The China National IC Fund Company, primarily state-owned by the MOF, acts as a limited partner (LP) contributing capital, while SINO-IC Capital serves as the sole general partner (GP), managing investments and engaging firms across strategic industry segments. At the base, NICIIF coordinates sub-funds with private LPs and sub-national governments to mobilize expertise and resources across multiple levels.

While NICIIF represents a distinct approach to industrial policy, its governance framework also introduces challenges. The involvement of diverse stakeholders with varying interests creates organizational complexities, raising risks such as public choice problems and principal–agent dilemmas. Information asymmetries and conflicting objectives further highlight the need to critically assess both the opportunities and potential limitations of this institutional framework.

4. Analytical framework and research methodology

4.1 Analytical framework

Our analytical framework (Fig. 2) is grounded in Robust Political Economy (RPE) (Pennington, 2011), which provides a systematic approach to examining how knowledge constraints and incentive problems interact in policy implementation. The RPE framework is particularly suited for analyzing state-led strategic investments as it addresses both the epistemic challenge of gathering and processing complex industrial information and the incentive challenge of aligning various stakeholders’ interests with policy objectives. To enrich this core RPE perspective, we draw complementary insights from public choice theory (Holcombe 2016) and principal–agent theory (Jensen and Meckling 1976) to better understand specific manifestations of knowledge and incentive problems in multilayered governance structures.

Our framework’s articulation of institutional features builds on institutional economics literature (North 1993; Williamson 2000), which emphasizes how formal and informal rules shape organizational behavior and policy outcomes. Following Williamson’s (2000) four-level analysis of institutional arrangements, we examine how governance structures at different levels interact with both formal rules (such as investment criteria and oversight mechanisms) and informal constraints (such as bureaucratic norms and local political incentives). This institutional perspective helps explain how multilayered governance structures produce three distinct types of misalignments: strategic-financial misalignment (reflecting tensions between long-term goals and short-term metrics), political–economic misalignment (emerging from conflicts between central and local priorities), and knowledge-incentive misalignment (arising from efforts to leverage market expertise). The framework links these misalignments to four categories of unintended consequences—behavioral, structural, institutional, and political—providing a systematic lens to analyze how governance challenges manifest in state-led strategic industrial policies.

Strategic-financial misalignment arises when operational priorities, such as achieving short-term returns, diverge from long-term strategic objectives. This reflects a tension between financial incentives and strategic goals. The literature on industrial policy (Colombo, Cumming, and Vismara 2016; Ren 2022) underscores how these tensions often result from the competing needs to ensure immediate project viability while simultaneously fostering transformative technological trajectories. Such misalignments can distort the allocation of subsidies and undermine the potential for sustained innovation.

Political-economic misalignment emerges when local implementation priorities conflict with high-level strategic objectives. Public choice theory (Buchanan and Tullock 1965; Holcombe 2016) demonstrates how local political incentives—such as securing electoral support or economic benefits—can lead to resource misallocation. Policymakers at the local level may prioritize politically advantageous but strategically secondary projects, diverting resources away from national goals. This dynamic has been observed in past cases of industrial policy, where resource dispersion and suboptimal project selection have undermined policy outcomes (Chen and Kung 2019).

Knowledge-incentive misalignment reflects the challenge of leveraging specialized expertise within a governance context characterized by information asymmetry and fragmented accountability. Principal–agent theory (Jensen and Meckling 1976; Gibbons et al. 2023) illustrates how these dynamics complicate decision-making in multiprincipal settings. Delegation of decision-making authority to private sector actors can introduce tensions between maintaining strategic control and empowering agents to act independently. This misalignment is particularly problematic in complex sectors like semiconductors, where expertise is crucial but difficult to align with policy objectives.

The three misalignments identified above can produce four broad categories of unintended consequences. Behavioral consequences arise when institutional incentives distort individual or organizational decision-making patterns, leading to phenomena such as risk aversion, subsidy entrepreneurship, or strategic rent-seeking (Cheang 2023b). Structural consequences emerge when misalignments lead to systematic distortions in resource allocation or market organization, as highlighted by Pack and Saggi (2006) and Ren (2022). For example, misaligned subsidies can undermine market competition or result in inefficient capital deployment. Institutional consequences involve adaptations within governance layers that alter how policy goals are interpreted and pursued. Miller (2005) describes how such shifts can result in “goal displacement,” where implementation processes deviate from original objectives. Finally, political consequences reflect changes in governance relationships and power dynamics, such as the erosion of trust between central and local governments or the entrenchment of rent-seeking coalitions.

By linking theoretical insights to real-world governance challenges, this analytical framework provides a comprehensive approach to understanding how institutional arrangements in state-led investment initiatives generate misalignments and their unintended consequences. It enables the identification of mechanisms through which specific misalignments produce unexpected outcomes. Moreover, the framework facilitates the study of interactions between different types of misalignments and their cumulative effects on policy implementation.

4.2 Research methodology

This study employs an in-depth, single case study approach (Yin 2003) to examine how institutional features in state-led investment initiatives generate misalignments and unintended consequences. NICIIF provides an ideal case for such analysis for several reasons. First, as one of the pioneering national semiconductor funds, it offers unparalleled insights into governance challenges in strategic technology initiatives. Second, with over 7 years of operation and an unprecedented multi-billion dollar scope, it provides sufficient temporal and operational depth to observe how misalignments emerge and evolve. Third, as national investment funds remain a relatively new policy tool worldwide, NICIIF’s experience offers valuable lessons about the relationship between institutional arrangements and policy outcomes.

The single case study approach enables detailed examination of how different types of misalignments manifest across governance layers and generate various unintended consequences (Eisenhardt 1989). This methodological choice allows us to trace the complex interactions between institutional features, governance arrangements, and implementation outcomes that might be difficult to capture in broader comparative studies.

Our analysis draws on four complementary data sources that enable comprehensive examination of misalignments and their consequences. First, annual reports from leading domestic integrated circuit firms (including SMIC, Hua Hong Group, and Montage Technology) provide insight into how institutional arrangements affect industry development outcomes across different segments. Second, financial data from the Caixin database and proprietary data from Zero2IPO’s PEData provide detailed coverage of NICIIF’s operations, investment patterns, and sub-funds. These databases track fund details, portfolio ventures, investment rounds, deployed capital, and ownership stakes, allowing us to examine how misalignments manifest in concrete investment decisions. Third, government documents and news reports provide crucial contextual information and specific examples of how institutional features generate misalignments and unintended consequences. This qualitative data helps illuminate the mechanisms through which governance arrangements affect policy implementation and outcomes.

These data sources enable systematic examination of how NICIIF’s institutional features generate different types of misalignments and their resulting unintended consequences. The combination of quantitative investment data and qualitative contextual information allows us to trace both the emergence of misalignments and their effects on policy implementation.

5. Analysis of NICIIF

5.1 NICIIF investment overview

NICIIF was established in two phases to support China’s integrated circuit (IC) industry. NICIIF Phase I was officially founded in September 2014, registering with RMB 98.72 billion in capital led by the MoF and state-owned firms such as China Tobacco. The articles of incorporation specify a 5-year investment period from 2014 to 2019, followed by a 5-year harvesting period, predicting exits by 2024.

Upon concluding Phase I’s investment period, NICIIF Phase II was incorporated to raise RMB 204.15 billion for continued domestic IC industry investments. As mentioned earlier, NICIIF’s entry is designed to exert a guidance effect that gradually leverages social institutional funds and even personal funds to flow into the IC industry. Thereby, following Phase I’s leverage, Phase II maintains a comparable outlook but with expanded social capital participation from private investment and local state-owned capital.

Table 1 presents the investment overview across phases. A notable shift in institutional arrangements appears between phases: MoF provides a smaller, though still substantial, stake in Phase II, with local state-owned capital rising from 20 per cent to account for nearly half (45.56 per cent) of the total raised capital. This shift suggests potential misalignments between central strategic priorities and local implementation interests.

Though NICIIF was instrumentalized in policy signaling to leverage investment into the IC industry, evidence of misalignments emerges in the uneven distribution of attention among various segments and projects. As depicted in Table 2, investment patterns show a pronounced tilt towards both lagging segments and projects with predictably stable financial outlooks, suggesting tension between strategic goals and financial considerations.

An analysis of incidents across different segments (Table 2) reveals NICIIF’s investment strategy, which places significant emphasis on the foundry segment (58.91 per cent) and the materials/equipment segment (10.66 per cent). While these segments represent areas where China exhibits low self-sufficiency and requires urgent technological advancements, the concentration of resources here may reflect unintended structural consequences of institutional arrangements. The pattern in design/software deals, where 43 per cent secured funding below RMB 1 billion, further suggests how institutional features might generate unexpected resource allocation patterns. Such investment patterns not only reflect governance misalignments but also generate structural consequences, such as resource concentration in downstream sectors at the expense of upstream innovation.

An examination of Phase II-funded projects with overlapping investments from Phase I (Table 3) reveals additional evidence of potential misalignments. Approximately 20 per cent of Phase II-funded projects received direct funding in Phase I. Notably, half of these projects operates in the materials and equipment segments, which necessitate ongoing policy-oriented funding support. Moreover, 64 per cent of these repeatedly funded projects secured investments from the C round onwards, suggesting how expertise-control tensions might lead to risk-averse investment behavior.

When we expand our focus to historical investment incidents by NICIIF, it becomes apparent that mature round incidents, starting from the C round onward, account for nearly one-third (31.33 per cent), while post-IPO incidents constitute over one-fifth (20.92 per cent) of all historical incidents. Notably, Phase I has provided funding to 23 publicly listed firms, representing 32.4 per cent of all funded firms, and Phase II follows at approximately 22 per cent of the funded projects as of 2023, albeit around half of these listed firms operate in downstream application-oriented segments which do not involve the strategic bottlenecked domains. To this end, NICIIF’s involvement in the market-mechanism-driven listed projects might crowd out the resources that should be devoted to strategic importance areas. These preliminary findings together highlight NICIIF’s skewed investment portfolio, which tilts towards bottlenecked segments and projects with relatively stable financial prospects.

This bias toward downstream sectors and post-IPO investments underscores a strategic-financial misalignment, where the focus on short-term financial metrics compromises investments in upstream, high-risk areas critical for long-term technological advancement. The preference for post-IPO projects and established technologies may also reflect a knowledge-incentive misalignment, as professional fund managers prioritize predictable returns, thereby avoiding riskier investments that are essential for advancing upstream innovation.

5.2 Performance of NICIIF

Since its launch, NICIIF has generated complex and sometimes contradictory outcomes that illustrate the interaction between institutional features, misalignments, and unintended consequences. By directing over $100 billion across the entire industrial segments, it has spurred the rise of China’s two foremost indigenous chip foundries, SMIC and Hua Hong, enabling them to reach the 14-nm process node technology milestone. Additionally, it has facilitated the integration of equipment and material providers like Naura and JCET into the domestic supply chain. Utilizing a mix of direct and indirect investment strategies to mobilize a wider spectrum of resource commitment, the initiative has successfully increased China’s share of global IC sales from a modest 5 per cent in 2014 to a notable near 10 per cent in 2021 (IC Insights, “China-Based IC Production to Represent 21.2% of China IC Market in 2026,” Design & Reuse, January 13, 2023, https://www.design-reuse.com/news/51960/china-ic-marketshare-forecast.html). However, these achievements mask underlying tensions between different institutional objectives.

Table 4 reveals how institutional misalignments manifest in the fund’s mixed progress toward strategic objectives. While financial targets like sales revenue were achieved for both 2015 and 2020, technology-oriented goals show significant delays or remain unmet. This pattern suggests how the tension between short-term measurable outcomes and long-term strategic objectives shapes implementation.

The divergence between strategic and financial performance becomes particularly evident when examining specific objectives. Despite the goal of reaching global leading levels in IC design by 2015, progress remains lacking over 7 years later. Similarly, 2020 objectives for global leadership in IC design and equipment manufacturing remain unachieved. These gaps in strategic outcomes contrast sharply with NICIIF’s financial performance, as shown in Table 5, where both the fund company and management company demonstrate impressive returns on equity exceeding 22 per cent.

This stark contrast between financial and strategic outcomes represents a clear manifestation of institutional misalignments. The fund’s orientation toward financial growth appears to generate unintended consequences that potentially undermine its strategic imperatives for technology development. The high profitability of fund management entities, while impressive from a commercial perspective, may reflect behavioral consequences of institutional arrangements that prioritize measurable financial metrics over harder-to-quantify strategic progress.

Recent corruption charges involving former senior executives (Cao, A. “Former China chip fund executive expelled from Communist Party for bribery, graft.” South China Morning Post, January 20, 2023, https://www.scmp.com/tech/policy/article/3207561/former-china-chip-fund-executive-expelled-communist-party-bribery-graft). further illustrate how institutional features can generate unexpected political consequences. These incidents suggest how the interaction between bureaucratic structure and expertise-control tensions might create opportunities for rent-seeking behavior, pointing to deeper governance vulnerabilities in NICIIF’s leadership structure.

The persistent divergence between financial returns and strategic goals, compounded by evidence of corruption, indicates how initial institutional misalignments can cascade into multiple types of unintended consequences. This pattern of outcomes underscores the need for deeper examination of how NICIIF’s multilayered governance structure generates and sustains these misalignments. The following section provides a layer-by-layer analysis of these dynamics.

5.3 Governance of NICIIF

NICIIF presents a multilayered misalignments problem accompanying accountability incongruence and public choice risk, depicted across four intricately connected relationships as outlined in Fig. 3. These misalignments spread within government agencies, and from the government to the IC Fund Co., Ltd, SINO-IC Capital Ltd, sub-funds, and ultimately to the firms. This structure illustrates a stepwise delegation of responsibilities and decision-making authority, each with its unique set of misalignment challenges and dynamics.

First layer involves government agencies and IC Fund Co., Ltd. Multiple government agencies, chiefly the MIIT and MOF, embody the state’s interests, entrusting NICIIF with investment management tasks.

Second layer involves IC Fund Co., Ltd and SINO-IC Capital Ltd. The Fund company, assuming the role of limited partner (LP), passes investment decisions to SINO-IC Capital, which assumes the role of the general partner (GP).

Third layer involves NICIIF and sub-funds, alongside private and sub-national government investment funds. Here, NICIIF, private investment funds, and sub-national government industry investment funds together serve as LPs, while the sub-funds operate as the corresponding GPs.

Table 6 presents the complete list of these sub-funds and their corresponding General Partners, illustrating the extensive network of fund management relationships that NICIIF has established. This multilayered structure, involving 15 different sub-funds managed by various GPs, demonstrates the complexity of NICIIF’s governance arrangements and the potential for misalignments to emerge across different layers.

Fourth layer involves sub-funds and firms receiving investment. This layer brings forth potential adverse selection issues between the sub-funds and firms due to the misalignments between policy designers and sub-national governments implementing the policy. Here, attention will be cast on the role played by the sub-national government and how it differs from that in the third layer.

The governance structure of NICIIF is multilayered, with complex delegations of authority and responsibility across different policy actors at different governance levels, warranting tracing and analyzing these embedded misalignment dynamics. In the remainder of this section, we will scrutinize the details of the operating mechanisms and explore the potential implications of this structure layer by layer.

5.4 First layer: government agencies and the IC Fund Co., Ltd

Divergent mandates issued by government agencies in the first layer of the NICIIF governance structure create the initial misalignment between strategic and financial objectives, leading to institutional unintended outcomes where financial return evolved as the dominant benchmark metric for the lower layers. The fundamental tension between strategic and financial objectives becomes embedded in the fund’s operational framework, cascading down through subsequent governance layers.

The first layer of NICIIF’s governance structure involves delegated responsibilities across multiple government agencies, primarily the MIIT and the MoF, which possess distinct but complementary mandates: the MIIT aims to advance China’s semiconductor industry, while the MoF oversees the state fiscal integrity of NICIIF’s operations. Other coordinating agencies, including the Ministry of Science and Technology (MoST), the National Development and Reform Commission (NDRC), and the General Administration of Customs (GACC), operate under the National Integrated Circuit Industry Development Leading Small Group to support implementation. The IC Fund Co., Ltd bears dual mandates to act on behalf of the will of both the MIIT and the MoF, whose performance is evaluated based on how well it achieves each ministry’s respective goals in managing delegated responsibilities (Fig. 4).

The fragmented dual reporting structure, where each agency adheres to its own priorities and evaluation metrics, produces an accountability imbalance. MIIT’s technological objectives, being long-term and difficult to quantify, face weak enforcement mechanisms (Ernst 2015, 2016). In contrast, the MoF, as NICIIF’s prime shareholder, employs established monitoring systems and immediate performance indicators for its financial objectives. This asymmetry in measurement capability creates a divergence in oversight capacity that systematically biases outcomes toward financial performance metrics. This reflects what Holmstrom and Milgrom (1991) identify as a multitask agency problem, where actors tend to prioritize tasks with clear, measurable objectives over those with ambiguous outcomes.

This structural misalignment tends to produce predictable unintended consequences: NICIIF prioritizes financial returns to satisfy the MoF’s stringent accountability requirements while relegating strategic technological milestones as a strategic response to MIIT’s lenient oversight. The result is a pattern of strong financial performance that often comes at the expense of national technology objectives. This systemic bias, cascading through NICIIF’s multilayered governance, creates persistent risks of moral hazard and goal displacement, highlighting the need for governance reforms that recalibrate strategic intentions and align accountability to balance financial and strategic imperatives.

5.5 Second layer: IC Fund Co., Ltd (Fund Company) and SINO-IC Capital Ltd (Fund Management Company)

Three critical misalignments emerge between SINO-IC Capital (the Fund Management Company) and IC Fund Co., Ltd (the Fund Company) at the second governance layer: a temporal misalignment between short-term financial performance and long-term strategic objectives, a public–private tension in personnel incentive structures, and an oversight-incentive misalignment where formal governance mechanisms fail to effectively shape investment behaviors. These misalignments interactively shape behavioral and structural unintended outcomes.

The second governance layer establishes a principal–agent relationship between IC Fund Co., Ltd (the Fund Company) and SINO-IC Capital Ltd (the Fund Management Company) (Fig. 5). Through a limited partnership agreement, the Fund Company, while prioritizing strategic industrial advancement and state asset protection, delegates exclusive management authority to SINO-IC Capital to leverage its management capabilities and knowledge expertise. To align interests, both entities maintain shared stakes, and the Fund Company retains oversight through board representation and investment committee participation for major investment decisions.

The misalignment between short-term financial performance and long-term strategic objectives, coupled with misalignment in public–private personnel incentive structures, reinforces one another in shaping SINO-IC’s investment behaviors. This has led to a structural unintended resource allocation pattern favoring return-driven investments. Fund managers, incentivized by performance-based returns, drive investment decisions toward immediate financial gains rather than long-term technological advancement. This bias is evidenced by NICIIF’s investment patterns (Table 7): 20.92 per cent of investments occur in post-IPO rounds, and Phase II investments show a 20.29 per cent overlap with Phase I, indicating a systematic preference for mature, financially stable companies over strategic technological areas requiring more urgent state support. This outcome directly contradicts the Fund Company’s mandate to prioritize long-term industrial advancement, demonstrating how misaligned incentives can undermine strategic objectives.

The oversight-incentive misalignment exemplifies classic public choice dynamics, where institutional actors rationally pursue self-interest rather than public technological advancement goals. Senior executives from the China Development Bank (CDB), operating within a bureaucratic incentive structure, maximize their utility through rent-seeking rather than strategic oversight. The resulting corruption scandals demonstrate how institutional arrangements that separate authority from accountability create opportunities for bureaucratic capture and rent-seeking behavior.

This rational self-interest, combined with fund managers’ profit-maximizing behavior, creates a ‘tragedy of the commons’, where both groups extract private rents at the expense of public technological advancement goals. Similar patterns are evidenced in other national mission-oriented attempts (Björnemalm, Sandström, and Åkesson 2024; Henrekson et al. 2024).

5.6 Third layer: multiple LPs and sub-funds

The third layer of NICIIF’s governance structure exhibits three fundamental misalignments that undermine policy objectives: temporal tensions between long-term strategic goals and short-term performance metrics, central-local divergence in implementation priorities, and public–private incentive conflicts. Fueled by unbalanced performance evaluation metrics and the absence of robust oversight mechanisms, these misalignments generate interconnected unintended consequences such as moral hazard, resource allocation toward for-profit investments at the cost of strategic goals, and crony capitalism.

The third layer reveals a complex structure where NICIIF, private investment funds, and sub-national government industry investment funds together serve as the limited partners, establishing sub-funds to channel wider resources and knowledge (as shown in Fig. 6). These policy actors are respectively concerned with diverging interests: sub-fund management institutions are compensated by a carry linked to investment returns; the NICIIF fund, representing state interests, prioritizes the protection of state-owned assets; sub-national government investment funds, backed by sub-national governments’ capacity to leverage resources, often need to address local government interests, which frequently lean toward local economic growth and political incentives to enhance their political performance.

From 2015 to 2019, NICIIF founded 15 sub-funds through equity investments, bringing in private and sub-national government funds, ultimately committing 500 billion yuan. As limited partners in these sub-funds, they delegate investment and post-investment duties to the sub-fund management institutions, applying expertise in fund management and knowledge of industry dynamics to align investments with the LPs’ interests. To provide oversight, LP representatives participate in sub-fund investment committees, scrutinizing investment compliance and evaluating strategies and outcomes.

Structural unintended consequences emerge through unbalanced performance evaluation metrics that privilege financial returns over strategic objectives. Given the tangible nature of financial targets compared to the uncertainty of technological outcomes, this creates a multitasking dilemma where sub-fund managers rationally prioritize measurable financial metrics that are associated with lower agency risks and clearer alignment. Investment patterns (Table 8) reveal this structural consequence: breaking down the investment incidents of NICIIF and its 15 sub-funds into the investment rounds, sub-funds concentrate 29.3 per cent of investments in mature stages (C-round onwards to IPO stage), while significantly reducing post-IPO investments to 4.30 per cent compared to NICIIF’s 20.92 per cent. These juxtaposed patterns indicate that, on one hand, sub-fund investment strategies demonstrate a clear inclination for mature investment rounds rather than early stages; on the other hand, sub-funds show a stronger preference for financial returns vis-à-vis the fund-of-fund by exiting successfully via IPOs or buyouts in mature stages. This demonstrates mechanism-induced incentive misalignment, revealing how time horizon tensions and public–private incentive misalignment in performance metrics shape unintended resource allocation decisions.

Behavioral unintended consequences manifest through rent-seeking activities when oversight mechanisms fail to effectively constrain opportunistic resource allocation. The substantial economic rents created by mission-oriented projects become vulnerable to capture when formal governance structures prove inadequate. This oversight-incentive misalignment is exemplified by the case of Shenzhen Hongtai Fund, where NICIIF’s failure to assign oversight representatives enabled sub-fund managers to engage in undisclosed related party transactions through noncompliant equity holdings for personal profit (Yu, Ning and Qu, Yunxu, “Partner of National IC Fund’s Shenzhen Subsidiary Under Investigation,” Caixin, July 29, 2022, https://www.caixin.com/2022-07-29/101919525.html). Such behavioral responses reflect a broader pattern where mission-oriented structures inadvertently generate rent-seeking opportunities when institutional safeguards fail to align private incentives with public goals (Cheang 2023b).

Political and institutional unintended consequences materialize through the emergence of crony capitalism, specifically in the strategic coupling between private investors and sub-national governments amid central-local misalignment. The proliferation of Government Industrial Investment Funds (GIIFs), reaching its peak in 2017 (Pan et al. 2021), combined with sub-national governments’ enhanced resource mobilization capacity, has fundamentally altered market dynamics. This structural transformation has led to extensive government fund penetration in the venture capital market, creating conditions where private funds must strategically align with government funds to secure investment opportunities (Colonnelli, Li, and Liu 2024). The resulting power dynamics compel private investors to prioritize coordination with government objectives, effectively institutionalizing a form of state capitalism where political connections become crucial for market access. This political economy ramification sets the stage for more profound political unintended consequences in the next layer of the governance structure.

5.7 Fourth layer: sub-funds and investee firms

The fourth layer of NICIIF’s governance structure exhibits three critical misalignments that shape investment outcomes: knowledge-oversight trade-offs, central-local tensions, and conflicts between political and technical rationality. These misalignments emerge from sub-funds’ peripheral positioning within NICIIF’s governance structure (Fig. 7).

The fundamental tension between specialized knowledge and oversight effectiveness manifests in sub-funds’ investment decisions. While sub-funds leverage their industry expertise to select promising projects, their peripheral position and focus on financial metrics create an accountability gap. This structural misalignment generates adverse selection problems, as sub-funds, already influenced by distorted incentives from higher governance layers, may select projects based on financial returns rather than technological merit. The situation is exacerbated by information asymmetries between sub-funds and investee firms, particularly regarding technological development and project progression.

Central-local tensions and conflicts between political and technical rationality further exaggerate the structural unintended consequences, allowing the state’s will to be hijacked by local governments’ political motivations, which produce adverse outcomes such as adverse selection and moral hazard. Sub-funds’ due diligence processes can be biased by local governments prioritizing development objectives specific to their localities (Cheng et al. 2020). As semiconductor projects often involve heavy capital investment, their risk-return profiles largely hinge on policy support, streamlined administrative processes, and the local industrial ecosystem tempered by local governments. Sub-funds may favor projects already receiving local governments’ preferential treatment. Their involvement might tilt project selections toward short-term political incentives, reflecting China’s political promotion landscape, where local economic vitality and technological innovation are crucial for officials’ advancement (Zhou 2007; Xu 2011; Zhang, Liu, and Shih 2013; Zhu and Wang 2024).

Such structural and political unintended consequences, fueled by conflicts between political and technical rationality, drive adverse selection, deviating from NICIIF’s strategic industrial objectives and favoring projects that offer short-term gains but lack long-term strategic value. The knowledge constraints confronting subnational governments can intensify the situation, potentially leading to inefficient project selections (Feng et al. 2022). Their short-term focus, driven by the tenure of municipal-level bureaucrats, starkly contrasts with NICIIF’s long-term strategic vision, potentially diverting resources from strategically vital projects (Liu, Liu, and Huang 2017). Numerous unfinished chip projects involving subnational governments’ industry investment funds exemplify such political economy ramifications.

This misalignment is further illustrated in the local implementation of projects. For instance, the Quanxin semiconductor project demonstrates how local governments’ eagerness to secure high-profile technological projects can lead to adverse selection. Despite ambitious plans for advanced process nodes and substantial investment commitments, the project revealed problematic dynamics when its technical partner failed to fulfill capital obligations while local state-owned enterprises provided significant funding. This case exemplifies how the governance structure, while designed to overcome knowledge constraints through private sector expertise, paradoxically created conditions where fund managers strategically conform to local government preferences, resulting in both structural market distortions and unintended political outcomes.

6. Discussion

Our analysis of NICIIF’s complex governance structure provides important insights into the three critical research questions raised at the outset of this study. By examining how different types of institutional misalignments interact within NICIIF’s multilayered governance structure and generate specific unintended consequences, we advance understanding of both governance challenges and implementation outcomes in strategic industrial policy.

First, regarding how different types of institutional misalignments interact within NICIIF’s multilayered governance structure, Fig. 8 reveals a cascading pattern where misalignments at higher governance layers create conditions that exacerbate misalignments at lower levels. At the top layer, the fundamental tension between MIIT’s strategic objectives and MoF’s financial oversight creates an initial strategic-financial misalignment. This misalignment is amplified at lower governance layers as fund managers and local governments interpret and implement policy through their own incentive frameworks. The interaction between these misalignments is particularly evident in how efforts to leverage market mechanisms for efficient resource allocation paradoxically lead to risk-averse investment patterns favoring mature technologies over strategic innovation.

Second, concerning the mechanisms through which attempts to address knowledge constraints paradoxically create new incentive problems, our analysis reveals a complex dynamic where institutional arrangements designed to overcome information asymmetries often generate unexpected behavioral responses. As shown in Table 9, NICIIF’s efforts to leverage private sector expertise through professional fund management have led to several unintended consequences. While this arrangement was intended to enhance decision-making quality through market knowledge, it has paradoxically resulted in investment patterns that prioritize financial returns over strategic technological development. This outcome reflects a fundamental tension between the need for specialized industry knowledge and the challenge of aligning private sector incentives with public policy objectives.

Moreover, the attempt to mobilize local government resources and knowledge has unexpectedly strengthened what our analysis reveals as political–economic misalignment. Local governments, while possessing valuable information about regional industrial capabilities, often interpret and implement national policies through the lens of their own political incentives. This has led to resource allocation patterns that serve local interests rather than national strategic objectives, as evidenced by the proliferation of projects driven more by political considerations than technological merit.

Third, addressing how governance frameworks might better anticipate and address both misalignments and their potential unintended consequences, our findings suggest the need for more nuanced approaches that recognize the interconnected nature of knowledge constraints and incentive problems. The analysis reveals that successful governance must simultaneously address vertical alignment across layers and horizontal coordination among different actors at each level. This requires moving beyond simple oversight enhancement to consider how institutional arrangements shape behavioral responses across governance layers.

Our findings also challenge conventional approaches to industrial policy governance in contexts characterized by strong local political incentives. The evidence from NICIIF suggests that standard governance mechanisms struggle to address systematic biases created by the connection between bureaucratic career advancement and economic performance. This points to the need for innovative governance approaches that can better account for and manage these political economy constraints while maintaining the benefits of leveraging industry expertise.

The case of NICIIF also illuminates broader dynamics in strategic industrial policy implementation. The unintended consequences documented in Table 9—ranging from behavioral responses like risk aversion to structural outcomes like resource misallocation—demonstrate how institutional misalignments can fundamentally shape policy outcomes. These findings suggest that effective policy implementation requires attention not just to the formal governance structures but also to the underlying political economy dynamics that influence how different actors interpret and pursue policy objectives.

Furthermore, our analysis reveals how attempts to address knowledge constraints through market mechanisms may inadvertently create new incentive problems that undermine policy effectiveness. This dynamic is particularly evident in how NICIIF’s market-oriented governance structure, while designed to enhance efficiency through private sector expertise, has led to investment patterns that often diverge from strategic priorities. This suggests the need for governance innovations that can better balance the benefits of market mechanisms with strategic policy objectives.

The implications of these findings extend beyond China’s semiconductor industry to inform broader debates about strategic industrial policy implementation. They suggest that successful policy execution requires careful attention to how institutional arrangements shape behavioral responses across different governance layers. Moreover, they highlight the importance of developing governance mechanisms that can effectively manage the tension between leveraging market expertise and maintaining strategic direction in rapidly evolving technological sectors.

7. Conclusion

This research employs the robust political economy framework to examine how institutional misalignments generate unintended consequences in China’s NICIIF. Our analysis reveals how governance challenges emerge through the complex interaction of knowledge constraints and incentive problems across NICIIF’s multi-layered structure. While the fund was designed to leverage market mechanisms and local knowledge for advancing domestic semiconductor capabilities, our findings demonstrate how institutional arrangements intended to address knowledge constraints often generate new incentive problems that undermine policy effectiveness.

Our analysis identifies three critical types of misalignments that shape NICIIF’s implementation outcomes. The strategic-financial misalignment emerges from tensions between long-term technological development goals and short-term financial performance metrics, leading to investment patterns that often prioritize measurable returns over strategic innovation. Political–economic misalignment manifests in how local governments interpret and implement national policies through their own incentive frameworks, resulting in project selections that serve local interests rather than national strategic objectives. Knowledge-incentive misalignment arises when efforts to leverage private sector expertise through market mechanisms paradoxically create new agency problems, leading to risk-averse investment behavior that favors mature technologies over strategic innovation.

These misalignments generate cascading unintended consequences across NICIIF’s governance structure. At the behavioral level, we observe patterns of risk aversion and strategic conformity to local government preferences. Structurally, resources are systematically directed toward financially stable but strategically secondary projects. Institutionally, the interpretation of strategic objectives becomes increasingly distorted as policy moves through different governance layers. Politically, the interaction between local government interests and market mechanisms has fostered a form of state capitalism where political connections significantly influence resource allocation.

These insights have important implications for policy design and implementation. They suggest that successful industrial policy requires attention not just to the formal governance structures but also to the underlying political economy dynamics that shape how different actors interpret and pursue policy objectives. Simply enhancing oversight mechanisms or refining incentive structures may be insufficient when fundamental misalignments exist between central policy objectives and local implementation incentives. Rather, effective policy implementation requires governance innovations that can better balance the benefits of market mechanisms with strategic policy objectives.

Conflict of interest

None declared.

Funding

None declared.

Data Availability

The data underlying this article were derived from multiple sources:

1. Annual reports of publicly listed companies are available through their official websites. Government documents and news reports as cited in the article with provided URLs.

2. Financial market data were provided by CAIXIN Database under commercial license and can be accessed through paid subscription (https://database.caixin.com).

3. Private equity and venture capital data were provided by Zero2IPO’s PEData under commercial license and can be accessed through paid subscription (https://www.pedata.cn).

The processed datasets used in this research will be shared on reasonable request to the corresponding author with permission from CAIXIN and Zero2IPO.

References