From a data set of Chinese firms in the 2005-07 period, we find that government investment boosted the performance of zombie firms and crowded out the growth of private firms; we also found that the higher the concentration of state banks (and of state-owned enterprises), the more conducive is the environment for nurturing zombie firms. With the exit of zombie firms, (a) the industrial output growth rate would be higher by 2.12 percentage points, (b) the capital accumulation rate would be higher by 1.4 percentage points, (c) the employment growth rate would be higher by 0.84 percentage points, and (d) the rate total factor productivity growth would be higher by 1.06 percentage points. Our results support a radical change in the way that government investment has been carried out, and support comprehensive reform of the state sector, but they do not necessarily argue against government investment in large infrastructure projects and strategically-critical areas.

From a data set of Chinese firms in the 2005-07 period, we find that government investment boosted the performance of zombie firms and crowded out the growth of private firms; we also found that the higher the concentration of state banks (and of state-owned enterprises), the more conducive is the environment for nurturing zombie firms. With the exit of zombie firms, (a) the industrial output growth rate would be higher by 2.12 percentage points, (b) the capital accumulation rate would be higher by 1.4 percentage points, (c) the employment growth rate would be higher by 0.84 percentage points, and (d) the rate total factor productivity growth would be higher by 1.06 percentage points. Our results support a radical change in the way that government investment has been carried out, and support comprehensive reform of the state sector, but they do not necessarily argue against government investment in large infrastructure projects and strategically-critical areas.

Nonviable "zombie" firms have become a key concern in China. Using novel firm-level industrial survey data, this paper illustrates the central role of zombies and their strong linkages with stateowned enterprises (SOEs) in contributing to debt vulnerabilities and low productivity. As a group, zombie firms and SOEs account for an outsized share of corporate debt, contribute to much of the rise in debt, and face weak fundamentals. Empirical results also show that resolving these weak firms can generate significant gains of 0.7-1.2 percentage points in long-term growth per year. These results also shed light on the ongoing government strategy to tackle these issues by evaluating the effects of different restructuring options. In particular, deleveraging, reducing government subsidies, as well as operational restructuring through divestment and reducing redundancy have significant benefits in restoring corporate performance for zombie firms.

China's recent removal of the last ceiling restriction on deposit rates inOctober 2015 is a milestone in interest rate liberalization, but not the end of it. International experience suggests that, without structural and quantitative reforms, simply freeing interest rates can result in major financial stress. Before China's central bank can completely relinquish implicit or explicit guidance for commercial banks' interest rate determination, it needs to accomplish two tasks: improvement of commercial banks' pricing capability as well as the monetary policy transmission mechanism. Both tasks require significant reform measures to be initiated, such as enforcing market discipline, forming a new monetary policy framework, developing money and capital markets, abandoning quantitative restrictions on credit and reforming the financial regulatory system.

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