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THE FAILURE OF THE THEORY OF X-EFFICIENCY

Alexander Slutsky, Golan Research Institute, Katzrin, Israel, agslutsky@012.net.il

(Slutsky, Alexander (2014) The Failure of the Theory of X-efficiency, in Andreassen, N. and Bourmistrov, A. (eds.) Societal Development through International Academic Cooperation, ISBN: 987-82-7314-738-7, Bodø, University of Nordland)

History of the concept

The concept of X-efficiency was introduced by Leibenstein in 1966. From 1966 to 1994 Leibenstein has published numerous articles and three books on X-efficiency.
Probably, the concept grew out of the study of developing countries. Leibenstein probably thought that he catched one of the main causes of their poverty. But moreover, it seemed to him that the human factor can explain the difference between firms.

Discovering Atlantis of ( in)efficiency

The reasoning of Leibenstein (1966) as follows: efficiency consists of two parts: the allocative efficiency (price governed) and X-efficiency (transformation of resources within the firm, governed by workers’ motivation). In fact, this is only an assumption. But Leibenstein treats it as a matter of fact. Remarkably, in the article and in later works of Leibenstein there is no definition of X-efficiency. But a lot of space is given to the difference between the theory of X-efficiency of neoclassical (textbook!) microeconomics.

Examples are selected so as the allocative efficiency is negligible in comparison with the X-efficiency. Thus, Leibenstein is became the discoverer of the Atlantis of efficiency ˗ an obvious claim for the Nobel Prize. According to him, a new concept should lead to the restructuring of microeconomics on a new, more general grounds (Leibenstein, 1979).

Criticism of Stigler

Leibenstein article become often cited, though not caused bombshell. Leibenstein stubbornly continued to promote the idea. An important milestone was the issue of the book (Leibenstein, 1976).  Three aspects of the book a re worth to note. (1) The introductory chapter was devoted to the methodology of economic theory. The basic idea is that economic theory can not be tested experimentally. Therefore we can not discard the theory on the ground that it can’t be tested. (2) Leibenstein has included in the book his earlier highly cited article (1950) written in the neoclassic spirit, which is rather contrary to the idea of X-efficiency. (3) The validity of the concept of X-efficiency is based on the idea of ​​selective rationality (see below).

A sharply critical work of Stigler (1976) followed. Stigler’s criticism is conceptual: it is not directed against some mistakes, but against the concept of the X-efficiency as such. Stigler’s article is concise and designed for highly erudite economist. It is addressed to the scientific economic elite.

Its main question is how the motivation can explain long-term differences in the efficiency of firms in the presence of the labor market? It raises also other questions: why is employee motivation as it is? How an individual “selects” the level of the rationality?

Stylistically, the Stigler’s work goes beyond calm scientific controversy. Although it does not contain personal attacks against Leibenstein, his views are represented as a theoretical ignorance. Leibenstein was not in debt, and wrote even more sharp response (1978), ˗ rare example in American academic environment.

We have to mention (but not to discuss) the critical article of DeAlessi (1983).

Selective rationality as a cover of the irrationality

Leibenstein suggested that people behave not rationally. He, however, knew that this road goes to a dead end ˗ the inability to obtain certain conclusions. It was necessary to approach operationally to irrationality. Leibenstein found the solution in the concept of selective rationality: the level of rationality depends mainly on the degree of external control over the person. But how to measure the actual level of the rationality of somebody? What is the mechanism of the level choice?  Is a higher level of rationality more optimal (from the subjective point of view) than a lower?

 Deceptively simple allocative efficiency

 Allocative efficiency was usually considered in the context of a liberal market economy with equilibrium prices with relatively small deviations. The concept of allocative efficiency was taken by Leibenstein from another context: comparison of the perfect competition and monopoly (Harberger, 1955). Its use for other purpose required argumentation. However, and this is the feature of Leibenstein, he appeals to the "self-evident» and not to theoretical rigor. In a socialist economy, prices deviated into hundreds and even thousands of percent from equilibrium prices . No need to underestimate price distortions in developed economies. But more important, that allocative efficiency is as much a function of the human behavior as the use of resources after their acquisition.

Absence of a rigorous axiomatic theory: a problem for critics

The theory of X-efficiency remained at the level of plausible statement and disparate models. The problem is how to analyze it. Perhaps this has determined the structure of articles of Stigler and DeAlessi . The theory disorder led to the appearance of new and new interpretations of "what Leibenstein has thought." It makes criticism practically impossible without reconstructions.

What X-efficiency is?

It is a strong feeling that under X-efficiency Leibenstein meant the difference between the actual performance of the firm and the highest possible performance in principle. Moreover, under the principle possible he understood efficiency which conforms to maximization by each employee of the efficiency of the company as whole. In other words, he identifies the individual utility function with the function of the firm's profits. Explicitly, he certainly could not express (and even agree with) such an interpretation. At the same time, he believed in the greatness of his discovery. The remained option was to consider partial models in which psychologically the theory would maintain its credibility. Social, institutional and psychological limitations did not exist ˗ the motivation for Leibenstein has infinite elasticity.

Leibenstein’s fate and the fate of criticism

In 1989 Leibenstein got into heavy car accident. His teaching activity was ended and the scientific proved extremely limited. Harsh criticism was stopped. It seems that it was a sign of compassion of the scientific community. Leibenstein died in 1994. Homage to the memory of the scientist influenced restraint criticism. Blaug (1985) brought him into the pantheon of 100 greatest  economists after Keynes.

Epilogue

Leibenstein hopes were not realized. Almost 50 years later the theory of X-efficiency does not exist, there is no broadly accepted definition of  X-efficiency.

Is it worth to read Leibenstein? In my opinion, yes, if you are interested in logic of errors and if you have a time to mine gold from low grade (but not emty!) ore.

Literature

Blaug M. Great Economists Since Keynes. Barnes & Noble Imports (June 1985).

DeAlessi L. 1983. Property Rights, Transaction Costs, and X-Efficiency: An Essay in Economic Theory. The American Economic Review, Vol. 73, No. 1: 64-81.

Harberger A.C. Monopoly and Resource Allocation, The American Economic Review
Vol. 44, No. 2, Papers and Proceedings of the Sixty-sixth Annual Meeting of the American Economic Association (May, 1954): 77-87.

Leibenstein H. Bandwagon, Snob, and Veblen Effects in the Theory of Consumers' Demand. The Quarterly Journal of Economics, Vol. 64, No. 2. (May, 1950):183-207.

Leibenstein H. 1966. Allocative Efficiency vs. "X-Efficiency". The American Economic Review, Vol. 56, No. 3: 392-415.

Leibenstein H. 1976. Beyond Economic Man. Cambridge: Harvard University Press.

X-Inefficiency Xists: Reply to an Xorcist. The American Economic Review, Vol. 68, No. 1, (Mar., 1978), pp. 203-211

Leibenstein H. "X-Inefficiency Xists-Reply to an Xorcist," American Economic Review, 68 (1978): 208.

Leibenstein H. 1979. A Branch of Economics is Missing: Micro-Micro Theory. Journal of Economic Literature, Vol. 17, No. 2: 477-502.

Stigler G.J. 1976. The Xistence of X-Efficiency. The American Economic Review, Vol. 66, No. 1: 213-216.

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