Background Traditional Chinese Medicine (TCM) industry in China locates in the low-end of the global value chain. TCM industrial chain in China which has been immersed in a vicious circle needs upgrading. However, there is no effective theoretical model which can explain and guide institutional selection which is the key factor of the development of TCM industry based on Neoclassical Economics. Objectives The main goal of this study is to establish a theoretical model which can be used to explain and direct the institutional selection in the upgrading of TCM industrial chain. This study is also expected to explore the general situation, economic value and evolution rule of Geographical Indication (GI) institution in China, which should be valuable to the development of TCM industry. Methodology A new theoretical model was established based on the review of progress in Evolutionary Economics and features of TCM industry. Five hypotheses which were proposed based on this new model were tested via the empirical study on Geographical Indication (GI) institution in China. Industrialization of Panax Notoginseng in Wenshan of China and its GI protection were also investigated. Results Firstly, the core of new theoretical model based on Evolutionary Economics is “knowledge” which is similar to DNA in human body. Products and services provided by producers who try to adapt the social environment can be thought to be the “phenotype” of the knowledge. The stress of social selection can promote the evolution of TCM industry. The selection of institution which is affected strongly by routine plays key role in social selection. Secondly, there have been 934 GIs used to protect TCM Materials (TCMM) in China and managed by three government departments independently by the end of 2013. They can increase the sale and profit of relevant industry. Undeveloped industrial structure and good natural resources could increase the registration of GIs, but their influence will weaken year by year. Experience with GIs could help to increase the registration of GIs. GIs managed by State Administration for Industry and Commerce (SAIC-GIs) are more likely to be used to protect the products which are allowed to be served as both food and medicine. SAIC-GIs are also more likely to be applied in provinces with developed industrial structure and less natural resources. Single department protection model is more likely to be used in the provinces with developed industrial structure. Thirdly, there has been an exciting progress in the industrialization of Panax Notoginseng based on GI institution. However, its modernization is full of challenges because of low-quality social selection including inefficient information flow and weak incentive for innovation. Conclusion The new theoretical model established in this study was proved to be a promising tool to explain the institutional selection in TCM industrial chain upgrading and guide the development of TCM industry. It was demonstrated that GI institution can really promote the industrialization of TCMM via enhancing economic value. Industrial structure, natural resources and routine of actors can affect the registration of GI including its amount and type. Information flow and incentive for innovation in TCM industrial chain require improvement.