Nicholas D.

Firms choose inefficient production technologies for seemingly bizarre reasons. I examine the evidence, and show that this genuinely is worse for everyone, not merely the result of unobserved constraints. I think this can be explained by a model where information is cheap to attain locally but costly to acquire from afar, and where the relationship between money and utility is concave. Lastly, I emphasize the role of imagination in creating productivity. Hope you enjoy reading it! Harvey Leibenstein’s 1966 article on what he calls “X-inefficiency” is the forgotten forefather of an enormous literature on productivity. Why are there such big gaps in productivity between firms? Why do they persist so long, without inefficient firms being chased from the market? Why would managers leave simply enormous sums of money on the table? In this essay, I argue that productive inefficiency is real, and that it is largely the result of choices by managers. In a world lacking competition, managers are not pressured to find new ways of producing. i. Leibenstein’s thesis Leibenstein first looks at the distortions from allocative efficiency. Skillfully, he begins by stressing the superfluity of monopolistic distortions. Harberger famously estimated the distortions at 1/13th of 1 percent – other contemporaneous studies find similar estimates. The distortions from tariffs approach, at most, 1 percent. Moreover, monopolistic distortions could never, given plausible elasticities of demand (that is to say, the slope of the demand curve) produce very large losses anyway. But the harms from monopoly may not lie in them being profit maximizing, and reducing the level of output to sell higher on the demand curve. Rather, it may lie in the inculcation of sloth and the tolerance of poor management which monopoly enables. Leibenstein thinks that firms systematically do not maximize profit when they don’t face much competition. This is a big claim,