When the Chinese economy once again faces significant pressure from industrial upgrading, the question arises: should it rely on government intervention or market forces? If the government takes the lead, it would follow the "Coase Road"—consolidating resources, internalizing operations, and continuously integrating the industrial chain into large enterprises. But in such a scenario, the market shrinks, competition fades, and where does efficiency come from?
In 1937, when the young Ronald Coase wrote *The Nature of the Firm* at the London School of Economics, he was likely contemplating the power of administrative coordination. This wasn't surprising, as Coase was fascinated by Lenin's revolution and the Soviet system, seeing them as a new form of organizational capability and power. Although his paper started with the market, it ultimately pointed toward the firm.
Coase himself probably understood that his theory could easily be extended from the enterprise to the entire nation—what we now call the state-owned enterprises or national trusts. His 1937 question can even be reversed: Why do you need a market if you already have a firm? Today, China is asking this very question, and it carries deep significance.
The answer, however, was given back in 1776 by Adam Smith in *The Wealth of Nations*. To illustrate how labor productivity could be improved, Smith described the division of labor and its limits. He famously stated that the division of labor is limited by the market. In other words, a larger market enables more specialization, which leads to greater efficiency. This concept became known later as "Smith’s Theorem."
If the firm integrates the production chain into one organization, then the opposite—specialization—breaks the firm down into individual producers or suppliers. This process is called "reverse integration," and it’s essentially what we mean by marketization today.
Market-oriented reforms in China over the past 35 years were all about this: breaking up large, integrated state-owned enterprises and allowing for more specialized, efficient actors to emerge. Under the old planned economy, companies had to produce everything internally because transaction costs were too high. This led to highly integrated firms.
But with market reforms, these firms began outsourcing components and intermediate goods, leading to deeper division of labor and greater efficiency across the manufacturing sector. This cycle continues: as the market expands, so does specialization, which in turn drives further market growth.
This reform marked the first breakdown of the "Coase Enterprise" under the planned system, enabling China to quickly integrate into the global production chain. Now, after 35 years, the economy is once again under pressure from industrial upgrading. The same choice remains: should this be driven by the government or the market?
If the government leads, it will follow the Coase Road, pushing for resource integration, consolidation, and large-scale enterprises. We've seen this in finance, media, strategic industries, and advanced manufacturing. But the question remains: does consolidating resources and expanding enterprise size really boost productivity and competitiveness?
What about the efficiency of large companies built through administrative force? How competitive are they? I doubt anyone would give a confident "yes." With fewer players and larger enterprises, the market shrinks, competition disappears, and efficiency becomes questionable.
On the other hand, market-driven industrial upgrading has shown real results. Take Shenzhen, for example. Over many years, its industrial clusters have successfully upgraded the mobile terminal industry. Today, Shenzhen accounts for nearly 70% of the global mobile device market, with a complete and efficient supply chain.
This success comes from the power of the market, not from vertical integration. Instead, it relies on continuous division of labor, specialization, and outsourcing. These mechanisms have created world-class competitiveness. This is the true power of the market.
It's ironic that Coase’s theory, formulated 77 years ago, seems outdated today, while Smith’s ideas from 238 years ago still feel fresh and relevant. (Author: Professor of Economics at Fudan University, Director of Fudan China Economic Research Center.)
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