How do zombie firms affect China’s industrial upgrading?

• Published in: Economic modelling 2021-04, Vol.97, p.79-94
• Main Authors: Geng, Yong, Liu, Wei, Wu, Yuzhao
• Format: Article
• Language: English
• Subjects: China; Industrial upgrading; Innovation; Resource mismatch; Zombie firms
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2021.01.010

Industrial upgrading to create a new growth engine for China’s economic development is crucial. Using data from the Chinese Annual Survey of Industrial Firms, we demonstrate that zombie firms have hindered industrial upgrading in China. We employ the Bartik method to construct instrumental variable to control for endogeneity, and find that when the proportion of an industry’s zombie firm assets increases by 1%, the level of industrial upgrading reduces by approximately 0.85%. Two mechanisms are identified. The first is resource mismatch at the industry and firm levels. The second is the suppression of innovation effects. Study results demonstrate why China’s industrial upgrading is weak from the perspective of firm structure. Our findings suggest that the government should make better use of market-oriented policies and the “creative destruction” mechanism to deal with zombie firms, in order to promote industrial upgrading. •Technological sophistication is calculated to measure industrial upgrading.•We identify zombie firms and describe their characteristics.•Zombie firms have a negative effect on industrial upgrading.•Resource mismatch and the suppression of innovation effects are the driving forces.•We provide implications for China’s industrial policies.