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 answer is to rely on the government, then the path would be similar to the "Coase Road"—integrating resources, internalizing operations, and continuously consolidating the industrial chain into large enterprises. But if the market shrinks, competition disappears, and efficiency becomes a mystery.
In 1937, when 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 isn’t surprising, as Coase was deeply curious about Lenin’s revolution and the Soviet system, which he saw as a new form of organizational power. Although his paper started with the market, it ultimately concluded that firms are more efficient in certain contexts.
Coase himself must have realized how easily his theory could be scaled up—from individual companies to entire nations. I’m referring here to Lenin’s state trusts. The central question Coase raised in 1937 can even be reversed: Why do we need markets if we already have firms? Today, as China grapples with industrial transformation, this question is especially relevant.
But the answer has long been given by Adam Smith in *The Wealth of Nations* (1776). To explain how labor productivity improves, Smith described breaking down production processes. He famously stated that the division of labor is limited by the market. In other words, the expansion of the market allows for more specialization, which leads to greater efficiency. This concept became known as “Smith’s Theorem.â€
If an enterprise integrates the production chain into one organization, then specialization is the opposite—disassembling the firm into independent, specialized producers. This process is called “reverse integration.†And this is essentially what we now call “marketization.â€
Marketization, in fact, means exactly this. The reforms China launched 35 years ago involved dismantling state-owned enterprises and allowing them to outsource components and services to more efficient suppliers. Under the old “great unity†system, machine tool companies had to produce everything themselves because transaction costs were too high. Firms naturally integrated their supply chains.
That was Coase’s explanation. Market-oriented reforms led these companies to rely more on external suppliers, increasing efficiency and profitability. As a result, the whole manufacturing sector became more specialized and productive.
Moreover, deeper division of labor expands the market, and a larger market, in turn, enables even more detailed specialization. This cycle helped China integrate rapidly into the global supply chain.
After 35 years, the Chinese economy is again under pressure to upgrade its industries. The key question remains: should industrial upgrading come from the government or the market?
If the government takes the lead, it will follow the Coase model—consolidating resources, integrating industries, and building large enterprises. This strategy has been widely used for years, especially in finance, media, strategic industries, and advanced manufacturing. However, the real question is whether this approach truly enhances productivity and competitiveness.
What happens when large companies grow through administrative control and resource consolidation? How competitive are they really? I don’t think many would dare to say they’re highly efficient. With fewer companies and larger scale, the market shrinks, competition fades, and efficiency becomes questionable.
On the other hand, industrial upgrading can also come from a more market-driven approach. Take Shenzhen, for example. Over many years, its development of industrial clusters has enabled a successful upgrade in the mobile phone industry. Today, Shenzhen provides nearly 70% of the world's mobile terminal products, forming a complete and efficient industrial chain.
This success is driven by professional suppliers and outsourcing mechanisms. It doesn’t rely on vertical integration but on continuous division of labor and specialization. This kind of market-driven growth has produced world-class competitiveness.
This is the power of the market. Surprisingly, Coase’s theory from 77 years ago seems outdated today, while Smith’s ideas from 238 years ago still feel fresh and relevant.
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