What is 'X-Efficiency'

X-efficiency is the degree of efficiency maintained by individuals and firms under conditions of imperfect competition. According to the neoclassical theory of economics, under perfect competition individuals and firms must maximize efficiency in order to succeed and make a profit; those who do not will fail and be forced to exit the market. However, x-efficiency theory asserts that under conditions of less-than-perfect competition, inefficiency may persist.

BREAKING DOWN 'X-Efficiency'

The concept of x-efficiency was proposed by economist Harvey Leibenstein in a 1966 paper titled "Allocative Efficiency vs. 'X-Efficiency'," which appeared in The American Economic Review. In the summary section of the paper, He asserted that "microeconomic theory focuses on allocative efficiency to the exclusion of other types of efficiencies that, in fact, are much more significant in many instances. Furthermore, improvement in 'non-allocative efficiency' is an important aspect in the process of growth."

Leibenstein's conclusion was that the theory of the firm does not depend on cost-minimization; rather, unit costs are influenced by x-efficiency, which in turn, "depends on the degree of competitive pressure, as well as other motivational factors." In the extreme market structure case — monopoly — he observed less worker effort; where competitive pressures were high, workers exerted more effort. There is much more to gain for a firm and its profit-making ways by increasing x-efficiency instead of allocative efficiency, which Leibenstein deemed from his study of data at the time to be "trivial" in its impact.

The theory of x-efficiency is controversial because it conflicts with the assumption of utility-maximizing behavior, a well-accepted axiom in economic theory. Instead, some economists argue that the concept of x-efficiency is merely the observance of workers' utility-maximizing tradeoff between effort and leisure. Empirical evidence for the theory of x-efficiency is mixed.

Harvey Leibenstein in Brief

Born in the Ukraine, Harvey Leibenstein (1922 - 1994) was a professor at Harvard University whose primary contribution — other than x-efficiency and its various applications to economic development, property rights, entrepreneurs and bureaucracy — was the critical minimum effort theory that aimed to find a solution to breaking the poverty cycle in underdeveloped countries.

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