It would have been a stretch for us to relate X-rays or Xylophones to economics. Lucky for the ABCs of economic literacy, Harvey Liebenstein prefixed the word inefficiency with a big X when proposing the concept of X-efficiency in the 1960s. It is the only economic concept in MIT’s Dictionary of Modern Economics listed under X.
X-inefficiency arises when firms fail to achieve the maximum possible level of output from given inputs. It contrasts with allocative inefficiency, which is the failure to produce the optimal mix of outputs, even if each output is produced at least cost.
X-inefficiency represents a forgone opportunity to increase profits, wages or both. A text-book monopolist would not fail to maximise profits but, in practice, some firms might.
The New Palgrave Dictionary of Economics cites, as evidence for the existence of X-inefficiency, a study in 1981 of a Ford plant in Germany that was producing 50 percent more automobiles with 22 percent less labour than an identically-designed plant in the UK. (Presumably German workers were getting paid commensurately more, reflecting their greater productivity.)
Differences in labour market laws, entrenched labour market practices, cultural attitudes to work, performance and pay may make it hard for even a profit-maximising owner to raise the productivity of the UK plant to the German level. But if wages are sufficiently lower in the UK, a profit-maximising owner might be able to make enough profit out of the UK plant to justify not closing it and shifting all production to Germany.
Managerial slack is a related source of X-inefficiency. Employee managers are likely less motivated than owner-managers to maximise profits. Owners may be unable to fully overcome this problem. Diffuse ownership may be one reason why owners might fail in this manner.
Laws that make it unduly difficult to hire or fire managers or workers or to target incentives at top-performers (performance pay) may contribute to X-inefficiency. For example, anti-takeover laws may protect under-performing management teams.
Performance measures across firms and countries, such as the Ford factory one above, can help identify egregious cases of X-inefficiency, but eliminating its causes may be too hard if they are entrenched.
The theory is controversial because if people prefer not to work as hard and as productively as they could, and consider the lower wage to be a price worth paying, they are actually optimising. Their lower productivity is efficient.
Two to go.