Antitrust and X-Efficiency

Abstract

In economics efficiency has meant allocative efficiency since time immemorial. Allocative efficiency means that the market price is equal to the marginal cost, and that the firm is using the cost minimizing [K/L] ratio. Allocative inefficiency in the market occurs when P ≠ MC. In the firm it means that the firm is either too capital intensive or too labor intensive. Most of the attention in economics has been on market allocative inefficiency. This is because markets will be inefficient if it contains market power. However, since “time immemorial” firms have been assumed to be efficient. Market allocative inefficiency for the entire economy is between 1/10 of 1% and 1/100 of 1% of GDP. For a $16 trillion GDP this is equal to between $16,000,000,000 and $1,600,000,000. By way of comparison, each year Americans spend $7,000,000,000 on potato chips. However, inefficiency is not limited to allocative inefficiency. In 1966 Harvey Leibenstein began using the term X-(in)efficiency. The use of the X stems from the fact that when Harvey Leibenstein first wrote about it he claimed that the nature of this type of non-allocative (in)efficiency was not known, hence the X. X-inefficiency has been estimated to be in the area of three percent of the GDP. For a $16 trillion economy this is $480,000,000,000. This paper reviews some of the issues surrounding X-(in)efficiency including some raised by Oliver Williamson, as well as reviewing the empirical literature on X-efficiency in the financial sectors of the U.S. and Europe.