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.

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1 comment for this post
  1. Victor Khurumov

    Over the past several decades scientists conducted hundreds of studies on empirical implications of X-efficiency theory. Roger Frantz summarized a few of them to identify the average level of X-efficiency and the allocative efficiency of firms and its implications (Frantz, 2018). The author discovered that while some studies assume that the level of inefficiency can be as low as 0.0001 (thus efficiency will be 99.9999), an average level is at approximately 20%. It means that firms produce only about 80% at their maximum efficiency level. The author also found that the level of allocative efficiency on average is quite higher – appx 85-90%. Thus, on average, firms are closer to the optimal size of the business rather than their frontier. Conducted across the globe studies on implications of X-efficiency theory showed some additional factors of firm efficiency. First of all, it was identified that there is no positive correlation between firm size and level of X-efficiency. Second, firms monitoring increases X-efficiency. Third – government ownership or control reduces X-efficiency. Lastly, equal power and control distribution within the firm leads to higher X-efficiency.
    Overall, an article by Roger Frantz reveals not only average levels of efficiency but also implications of X-theory on efficient ways of market regulations.

    Bibliography
    Frantz, R. (2018). Harvey Leibenstein, and an anomaly called X-efficiency theory. Journal of Behavioral Economics for Policy, 25-31.
    Marjan J. Gorgievski, U. S. (2018). Predicting Entrepreneurial Career Intentions: Values and the Theory of Planned Behavior. Journal of Career Assessment, 457-475.

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