Industrial Policy for the Knowledge Economy: The case of Hangzhou

How the city's talent-focused policies fueled a high-tech revolution.

Live in RMB City (2009) by Cao Fei

In recent months, Hangzhou has captured national attention for producing the so-called “Six Little Dragons”—including DeepSeek, the AI startup whose low-cost model shocked the industry, and Unitree, whose humanoid robots went viral after appearing on the 2025 CCTV Spring Festival Gala. The city's rise as an innovation hub for emerging technologies was unexpected being a much smaller city compared to Beijing, Shanghai, or Shenzhen.

Hangzhou differs from these tier one cities not just in degree but in the kind of innovation that it has fostered. Unlike places such as Shenzhen, which has long been anchored by its manufacturing capabilities, its connection to Hong Kong, and robust hardware supply chains, Hangzhou’s strengths have lied in the knowledge/internet economy. Home to Alibaba, the city has cultivated a digital-first business environment that prioritizes innovation, software development, and AI applications over traditional industrial production.

As a result, Hangzhou has fostered a kind of innovation that diverges from China’s traditional strengths. In most industries, China has excelled at taking existing technologies and scaling them up through incremental process improvements. But Hangzhou’s tech ecosystem operates higher on the innovation chain, not merely optimizing established technologies but actively pushing the frontier in emerging ones. What explains this sudden surge in innovation? How has a city without Beijing’s deep research infrastructure or Shenzhen’s robust industrial base managed to rise to the forefront of China’s tech landscape?

As the title of this post has surely given away, government policy is at the center of Hangzhou's story. But not in the same way that heavy-handed state policies has given rise to some of the country's most dominant export sectors such as solar PV manufacturing or EV production. Instead, Hangzhou's government has focused on talent-driven policies which has created an ecosystem uniquely suited for frontier, knowledge-based innovation.

My visit to Hangzhou

I visited Hangzhou in 2021 with a childhood friend who was there to figure out whether the city would be a good place to locate his new business. At the time, his wife already had an office in Hangzhou. She ran an online cosmetic brand, and because her business was increasingly reliant on live streaming to sell her product, she had established a second office in Hangzhou to take advantage of the then budding live-streaming industry in the city. Like his wife, my friend was also building a consumer brand and wanted to be close to Alibaba and the surrounding e-commerce infrastructure.

Having already explored West Lake, visited Alibaba’s campus, and sampled Hangzhou’s renowned tea shops, I decided to tag along as my friend toured potential office spaces. The spaces we visited were all nestled in complexes teeming with startups—none particularly striking, aside from the sheer density of emerging ventures in each location and the proximity of the several office complexes we visited. What did surprise me, however, were the incentives being offered to persuade my friend to set up shop in Hangzhou.

I don’t recall the exact role of the person showing us around, but it was clear that he was either a government employee or someone closely connected to Hangzhou's development efforts. As he led us through various office spaces, he demonstrated an impressive knowledge of the available properties, upcoming developments, and the management teams behind each startup complex. More notably, he had an extensive understanding of the government grants and subsidies my friend could apply for, including policies that offered office rental discounts such as if a certain percentage of a company’s budget was allocated to R&D.¹

And when he learned that I was pursuing a PhD, he immediately launched into a discussion about the financial benefits available to doctorate holders who relocated to Hangzhou. These included subsidized housing and offering salary subsidies for companies hiring PhD graduates. He told us that for years, Hangzhou had been trying to increase the density of high-tech talent.

At the time, I didn’t think much of it—aside from briefly fantasizing about moving to Hangzhou. My friend, despite the generous incentives, ultimately decided not to relocate. But looking back, it’s clear that talent-focused policies and incentives for R&D investment were at the core of Hangzhou’s development model, laying the foundation for its rise to national prominence earlier this year.

Talent-focused industrial policy

To understand what makes Hangzhou’s approach to industrial policy unique, it is useful to first recall the broader landscape of industrial policy instruments. Historically, one of the most impactful instruments were tariffs—used extensively by developing nations, including the United States in its early industrialization, to shield domestic industries from foreign competition. For much of the 19th and early 20th centuries, sector-wide tariffs were the primary mechanism for protecting and nurturing infant industries

(I wrote on tariffs and its role in U.S. development here).

In the late 20th century, a different model of state intervention emerged with the rise of the East Asian developmental states. I've written about the developmental state in previous posts (here and here), so I won't go deeper in this piece. But the gist of it was that their strategy was to subsidize (and discipline) firms that were deemed of developmental importance. The key point was that industrial policy operated at the level of the firm—coordinating production, directing capital, and ensuring firms followed the state’s strategic industrial roadmap.

Since then, most other Chinese provinces' industrial policy has mimicked the developmental state model, focusing on the coordination of industrial activity and subsidization of firms to support their expansion. In contrast, Hangzhou's model focuses on talent-driven policies. In this way, the city's approach stands out and has, for years, led to high levels of talent inflow.

(I wrote about Chinese industrial policy here, explaining why provincial level governments have struggled to replicate the developmental state)

What talent-oriented policies does Hangzhou have? I've already talked about the extensive subsidy programs for skilled professionals. PhD holders who relocate to Hangzhou are eligible for subsidized housing, and firms that hire them receive salary subsidies, making it financially attractive for both individuals and businesses. Additionally, the city provides startup grants and research funding, particularly for tech entrepreneurs, ensuring that entrepreneurs—like my childhood classmate—are attracted to the city.

Hangzhou has also eased its household registration permit (hukou) policies to attract and retain skilled workers. College graduates under the age of 35 who work in the city are eligible to apply for a hukou, granting them access to essential benefits such as healthcare, better housing opportunities, and schooling for their children. In a similar effort to retain top talent, the government introduced new policies in 2018 to simplify the process for foreign professionals to obtain permanent residency. Notably, foreigners of Chinese origin became eligible for residency as long as they held a doctoral degree or had lived in Hangzhou for more than four years.

Hangzhou's government isn't a passive actor when it comes to talent recruitment. In some cases, it even actively courts Chinese nationals who have established companies overseas to return to China and locate themselves in Hangzhou. The most famous case of this was the local government's success in convincing Brain Co—then, a Boston-based company and the world’s largest brain-computer interface firms, second only to Elon Musk’s Neuralink—to relocate to Hangzhou. This involved officials flying out to Boston and convincing Brain Co's founders (who are Chinese nationals) to relocate their business. In this case, officials promised to classify their employees as "high-level talent," making them eligible for rent subsidies, housing grants, and additional research funding. They even offered to waive office rental fees—a major financial relief for a still-young startup.²

Brain Co’s CEO (right) doing a product demonstration (source: mtz.china.com)

Hangzhou isn't the first to target policies at the level of human capital. Nordic countries began implementing active labor market policies—interventions designed to shape the labor market by helping individuals find employment, upgrade their skills, and transition into new roles—before the rise of the knowledge economy. These measures, which included job training and job search assistance, became a major focus, and by 2009, Nordic countries were among the highest spenders on such policies compared to other post-industrial democracies. Many scholars credit their success in breaking into the ICT sector to this sustained investment in high-quality human capital.³

A key distinction, however, lies in the approach: while Nordic countries focused on retraining their existing workforce, Hangzhou’s strategy has centered on aggressively recruiting entirely new talent (something that Hong Kong also tried but to a less aggressive extent starting in the 90s). And among Chinese cities, Hangzhou’s talent policies have been particularly notable. Unlike Beijing, Shanghai, and even Shenzhen, which naturally attract skilled workers due to their status as Tier 1 cities, Hangzhou has had to implement more targeted incentives to attract top talent.

Proactive, professionalized, and R&D-oriented

Hangzhou's focus on talent hasn't made it shy away from providing direct subsidies to firms in need of help. In this regard, they've also acted as a partner to the city's tech firms—providing them with subsidies, helping them find office space in centrally located places, and even acting as a buyer of last resort. To do all this, Hangzhou’s government has also developed into a highly professionalized administration. Entrepreneurs can apply for government subsidies online with as little as only have one interaction with government bureaucrats. The local government is also extremely hands off and will only engage with startups if called upon.⁴

And in contrast to many local governments that struggle with basic service delivery, Hangzhou's government agencies are "embedded" in the technology needs of its local businesses allowing them to mobilize the right resources effectively.⁵

Brain Co is a great example of this. When the brain-computer interface company launched its prosthetic limbs, finding early adopters was a challenge as a still relatively small start up. In Hangzhou, the disabled community was also considerably isolated making them hard to access. With a clear understanding of the technology itself, the provincial government immediately stepped in. Working with the Disabled Persons’ Federation, they coordinated a public initiative to provide 1,000 disabled individuals with Brain Co's prosthetic limbs.⁶ For a startup, this was an invaluable opportunity, giving them security in product demand and offsetting the risk of product development.

Development scholars might recognize that Hangzhou’s hands-off approach—engaging only when called upon—deviates from the firm-disciplining strategies typical of East Asian developmental states. In countries like Japan, South Korea, and Taiwan, government agencies actively supported domestic firms but closely monitored their performance, conditioning subsidies on meeting export and productivity benchmarks. However, the nature of innovation in Hangzhou—pioneering advancements in AI, robotics, and brain-computer interfaces—demands a different approach. Unlike manufacturing-based industrial policy, where firms must quickly scale up and compete globally, frontier technologies require long-term patience. Early-stage startups in these sectors often operate in uncertain markets, where rigid state intervention could stifle experimentation rather than foster it.

In this way, Hangzhou’s strength lies in frontier high-tech innovation rather than lower-value-added activities like manufacturing. Unlike some Chinese cities that require supply chains to remain within the province to stimulate domestic linkages, Hangzhou has adopted a more flexible approach, allowing lower-value production to take place elsewhere. Many Hangzhou-based startups maintain offices in Shenzhen to handle manufacturing while keeping their Hangzhou presence focused on software development and R&D. This strategic division of labor has solidified Hangzhou’s role as a hub for knowledge-intensive work, distinguishing it from more manufacturing-oriented tech centers like Shenzhen (which support a broader range of industrial capabilities).

Clustering innovation

Policies supporting knowledge-based innovation are hardly new. In the knowledge economy, innovation thrives on strong networks and the ability to absorb and apply external knowledge—what economists term absorptive capacity.⁷ This has made innovation clusters a key focus of study, as geographic concentration fosters dense professional networks, facilitates knowledge spillovers, and enables firms to rapidly adapt to new technological developments. Clusters like Silicon Valley illustrate how proximity among firms, universities, and investors can accelerate innovation by enhancing collaboration, competition, and the circulation of expertise.

Increasingly, geographers have observed that city-level governments are taking the lead in fostering these clusters. Rather than relying solely on national industrial policy, municipal governments are actively shaping local innovation ecosystems by creating environments conducive to entrepreneurship and talent attraction—often in close collaboration with private actors.⁸ This reflects a broader shift in governance, where urban regions have become central to economic policymaking in the age of knowledge-driven capitalism.

Hangzhou exemplifies this city-led approach to fostering innovation, with its success largely driven by talent-focused policies that align with its existing economic strengths. The city's talent-focused policies have also complemented Hangzhou’s institutional assets, including Zhejiang University and Alibaba. Zhejiang University serves as a key talent pipeline for AI and robotics. And today, many of the city’s top tech entrepreneurs, including the founder of DeepSeek, are alumni. Alibaba has also reinforced Hangzhou’s innovation ecosystem, indirectly shaping its entrepreneurial culture and bringing top talent into the city. Many AI and tech companies in Hangzhou were founded by former Alibaba employees. And those who weren't have been able to leverage the tech giant's extensive networks due to geographic proximity.

This talent-driven approach has naturally given rise to a cluster dynamic, where firms, universities, and investors are densely interconnected, fostering knowledge spillovers and accelerating innovation. The concentration of AI and robotics startups in Hangzhou has created a self-reinforcing cycle—top talent is drawn to the city not just by government incentives but also by the presence of like-minded entrepreneurs and established institutions that support their growth. Hangzhou's success demonstrates that in the knowledge economy, regional strategies that cultivate talent and integrate it into local ecosystems can be just as, if not more, effective than top-down industrial planning.

1. At one point, he also mentioned that incorporating the word “technology” into a company’s name could make it eligible for more grants and subsidies.

2. You can read more about how Brain Co was courted by Hangzhou's gov here: https://mp.weixin.qq.com/s/V7Eo4SWLnjU6mE9rLbSUkA

3. See Evans, Peter, Evelyne Huber, and John D. Stephens. 2017. “The Political Foundations of State Effectiveness.” In States in the Developing World, eds. Miguel A. Centeno, Atul Kohli, and Deborah J. Yashar. Cambridge University Press, 380–408. However, Rodrik and Stantcheva notes that active labor market policies have produced mixed results in the European context. See: Rodrik, Dani, and Stefanie Stantcheva. 2021. “Fixing Capitalism’s Good Jobs Problem.” Oxford Review of Economic Policy 37(4): 824–37.

4. See: https://mp.weixin.qq.com/s/hgo44WBxAOSEgWtGqjgSKA

5. According to Evans, for state agencies to effectively implement industrial policy, they must have embedded relationships with businesses to stay informed and guide firms toward development goals. However, such proximity also risks “capture,” where firms exploit policy favors for private gain, undermining state oversight. To prevent this, state actors must maintain autonomy—remaining independent enough to enforce discipline while staying engaged enough to shape development. Thus successful industrial policy hinges on striking this balance between embeddedness and autonomy. See: Evans, Peter B. 1995. Embedded Autonomy: States and Industrial Transformation. Princeton, N.J: Princeton University Press.

6. See more here: https://mp.weixin.qq.com/s/V7Eo4SWLnjU6mE9rLbSUk

7. See Cohen, Wesley M., and Daniel A. Levinthal. 1990. “Absorptive Capacity: A New Perspective on Learning and Innovation.” Administrative Science Quarterly 35(1): 128.

8. See: Moisio, Sami, and Ugo Rossi. 2020. “The Start-up State: Governing Urbanised Capitalism.” Environment and Planning A: Economy and Space 52(3): 532–52.