X-Efficiency

Written By
Paul Tracy
Updated June 13, 2021

What is X-Efficiency?

X-efficiency describes a company's inability to get the maximum output for its inputs due to a lack of competitive pressure.

How Does X-Efficiency Work?

Economist Harvey Leibenstein, a Harvard professor who studied the psychological aspects of economics, first used the term. His theory was that when companies aren't very competitive, their workers don't behave as efficiently. For example, let's say that companies A, B, and C together own about 90% of the market for widgets. They are large companies that compete fiercely on price and service. Company D is a tiny company that is also trying to sell widgets, but it is not doing so profitably.

Despite the fact that the market for widgets is competitive, Company D isn't much of a competitor and the employees know that. According to the theory, the employees don't work as hard at Company D because of this. They know that being more efficient won't make a difference. That is, their x-efficiency falls.

Similarly, let's assume that Company A is the only manufacturer of widgets in the market. It has a monopoly. This scenario, under the theory, leads to the same situation that Company D was in: Because employees know that nothing foreseeable will change the company's market share, they become less productive.

Why Does X-Efficiency Matter?

Leibenstein's concept of x-efficiency conflicts with traditional neoclassical economics because it suggests that companies and people don't always maximize utility. That is, they don't always make the most efficient choices.

One side effect of reductions in x-efficiency, one should note, is that it is usually predicated on a lack of competitive ability. Accordingly, when a company with lower x-efficiency is less focused on undercutting and taking out competitors, it might deploy more of its capital in other areas (R&D or higher wages, for example), that could improve its health in the long-term. It is also important to note that x-efficiency doesn't evaluate whether a company's inputs are the best inputs for the outputs it is seeking to produce.

Ask an Expert
All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about X-Efficiency.
Be the first to ask a question

If you have a question about X-Efficiency, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about X-Efficiency, then please ask Paul.

Ask a question Read more from Paul

Read this next

Paul Tracy - profile
Ask an Expert about X-Efficiency

By submitting this form you agree with our Privacy Policy

Don't Know a Financial Term?
Search our library of 4,000+ terms