X-inefficiency is known as the result of inputs not producing their maximum output as a consequence of an “X” factor. This translates into both cost minimisation and production maximisation failure and, hence, implies a loss of efficiency. This term was first introduced by Harvey Leibenstein in his “Allocative efficiency vs “X-efficiency”, 1966, since concepts such as organisation inefficiency or motivational inefficiency were not yet available. Therefore X-inefficiency makes reference to all non-allocative inefficiencies.
There are four main identified reasons that try to answer for X-inefficiencies:
- Relaxing maximisation behaviour: as the psychological Yerkes-Dodson Law postulates, individuals who are exposed to low pressure will not put much effort in their actions. As pressure builds up, maximising behaviours are reached until a point where too much pressure will again result in inefficiency. Other non-maximising decision making processes include habits, conventions, moral imperatives, etc.
- Incomplete contracts: employment contracts define workers economic compensation but other concerns such as the effort, the work load or specific tasks may remain undefined, which creates an incompleteness in contracts.
- Inertia: forces that are external to the company may exert pressure to make the firm become more competitive. Only with this external force efforts will increase.
- Discretion: it is assumed that workers will not show their “full potential” or maximize their efforts, and at the same time, that employers will not pay the maximum wages they could offer.
However empirical tests and models about X-inefficiency relevance have mixed results so no final transcendence can be assured. However, is interesting to realise the debate it has created, specially regarding incomplete contracts and managerial inefficiency, both also studied in the field of business management.