X-efficiency theory of entrepreneurship

What is the x-efficiency theory of entrepreneurship?

Harvey Leibenstein, American economist, developed X-efficiency theory in the 1960s. He views entrepreneurs as gap-fillers and input complementors. Gaps (X-inefficiency) emerge when there are inefficiencies in markets, such as when incumbents do not utilize their resources efficiently (Leibenstein, 1966;1978) because of political, normative, cognitive, and structural factors.

A classic example is the startup without a union that enters a market where all the incumbents have strong unions. The cost advantage of disorganized labor may help firms with low cost business models to thrive at the bottom of the market at margins that are uneconomical for incumbent firms to pursue within the target ranges given to them by their shareholders.

If the maximum possible productive use of a resources is greater than the actual use by incumbents, an arbitrage opportunity emerges that an entrepreneur can exploit for profit. Entrepreneurs can also improve inputs by putting to use new resources, thus making existing production more efficient.

Incumbents can ignore, waste, or misuse resources due to inertia, incompetence or ignorance. Thus, the entrepreneur is seen as correcting market inefficiencies by improving the information flow in a market.

X-efficiency theory seems to align well with Kirzner‘s view of entrepreneurship as alertness to opportunities caused by the lack of insight of incumbents.

Sources:

Leibenstein, H. (1966). Allocative efficiency vs.” X-efficiency”. The American Economic Review, 392-415.

Leibenstein, H. (1978). On the basic proposition of X-efficiency theory. The American Economic Review, 328-332.

Related posts

Leave your comment Required fields are marked *