This paper illustrates three developmental stages of the functional transformation of western governments characterized by different extent of state involvement in economic activities. It investigates the functional role of nation-state in urbanization process in the context of western advanced economies with a particular focus on the laws and regulations, delineating the subjects, objectives, operational procedure, approval system, compensation standard and so on in relation to land expropriation. It also discusses the direction of the adjustment of state functions in China along three lines, including the transformation from political government to economic government, from direct management to indirect management and from comprehensive government to service-oriented and limited government. The paper probes into the roles that Chinese government should play in the urbanization process of land-lost peasants in terms of institutional innovation, optimal utilization of land compensation and related rules and regulations. Finally, it provides policy recommendations for the establishment of three-level state functional networks in order to address the challenge posed by amounting number of land-lost peasants.