In 1954, Arnold Harberger, who would later become a stalwart of the. University of Chicago economics department, produced a very influential

Transcription

1 X-Efficiency and Ideology In 1954, Arnold Harberger, who would later become a stalwart of the University of Chicago economics department, produced a very influential article. He began: One of the first things we learn when we begin to study price theory is that the main effects of monopoly are to misallocate resources, to reduce aggregate welfare, and to redistribute income in favor of monopolists. In the light of this fact, it is a little curious that our empirical efforts at studying monopoly have so largely concentrated on other things. [Harberger 1954, p. 77] Harberger went on to show that markets were so efficient in allocating resources that any distortions created by monopoly were bound to be inconsequential -- at most 0.1 percent of the Gross National Product (Harberger 1954). The article continues to be quite influential, perhaps in part because Harberger used a simple graph showing the effect a change on a curve showing demand falling with an increasing price. This picture shows increasing profits for the monopolist, decreasing costs of inputs, increasing prices for consumers, and a relatively small triangle, which represented, for Harberger, the social costs of monopoly. Even today, virtually any economist will immediately understand the meaning of the expression, Harberger triangle. Harberger's lesson was that nobody should worry about business becoming monopolistic: the triangles are very small, one tenth of one 1

2 percent, by his estimates. Harberger casually dismissed the effect of monopoly on the distribution of income: I have not analyzed the redistributions of income that arise when monopoly is present... I leave [questions about income distribution] to my more metaphysically inclined colleagues to decide. [Harberger 1954, p. 87] A few years later, in 1962, the future Nobel laureate, Robert Mundell, reflected about Harberger's triangles. He worried that if distortions did so little damage, "some one inevitably will draw the conclusion that economics has ceased to be important!" (Mundell 1962, p. 622). A more serious response came from Harvey Leibenstein, a respected economics professor from Harvard University. Leibenstein argued that Harberger just looked at what would happen if monopolist raised prices little bit. By restricting himself to the marginal effect of price changes, Harberger lost sight of how the reduction of competitive pressures could let business become sloppy. Not taking full advantage of productive opportunities could have major effects. In effect, Harberger was only looking at the transactions side, what economists refer to as allocative efficiency. In contrast, Leibenstein pointed to the productive side of the economy. He cited numerous studies showing how similar plants produced quite dissimilar results. He postulated that there was something missing -- a kind of economic efficiency that went beyond allocative efficiency. Leibenstein could not fit his insight into formal economic models since he could not exactly pin it down. He called it 2

3 "X-efficiency" -- an illusion to the Russian novelist, Leo Tolstoy's War and Peace, which contained the observation: "Two armies may be identical in every observable respect..., yet one army, in possession of an intangible 'X-factor,' will soundly defeat the other." (Part XIV, II). While economists were unlikely to welcome Mundell's nightmare of economists sinking into irrelevancy, the Leibenstein's dissimilar efficiencies had even more uncomfortable implications. He was suggesting that firms do not maximize, undermining one of the central assumptions of academic economics. Leibenstein was unlikely rebel. He resigned from Berkeley after being repulsed by the campus turmoil of the 1960s (Perlman and Dean 1998, pp ). He was in no way intending to openly challenge conventional economics, but he made the mistake of making things difficult for economists who want to be able to reduce everything to simple equations. At the same time, he inadvertently opened the door to questions of work, workers, and working conditions. Leibenstein's article unleashed a volley of criticism. A retrospective on his work noted: Between 1969 and 1980, the article was the third most frequently cited in the Social Science Citation Index. However the second remarkable aspect is that much of this citation derived from attempts to explain X-efficiency theory away: it was under almost constant attack from much of the mainstream of the profession over that same dozen years. [Perlman and Dean 1998, p. 141] 3

4 Leibenstein's harshest critic was none other than George Stigler, who always stood ready to bully anybody who dared to stray too far from the conventional wisdom. Leibenstein was not immune from this treatment, which came in a caustically titled article, "The Xistence of X-Efficiency" (Stigler 1976). From one perspective, Stigler's vehemence in attacking X-efficiency is puzzling. Leibenstein's point was that barriers to competition -- barriers that most economists abhor, such as monopolistic practices or regulation -- can be wasteful. Stigler himself was a constant critic of regulation. Stigler's main point was that these differential efficiencies were an illusion. The different firms were producing different mixes of products for sale and other non-marketed outputs, "including leisure and health" (Stigler 1976, p. 213). Stigler did not mean the leisure and health of the workers, but their employers. Of course, if the subjective side of work were relevant for employers, such considerations would be relevant for workers. Quickly after inadvertently opening the door to consideration of work, workers, and working conditions, Stigler tried to slam that door shut with his concluding words: Unless one is prepared to take the mighty methodological leap into the unknown that a nonmaximizing theory requires, waste is not a useful economic concept. Waste is error within the framework of modern economic analysis, and it will not become a useful concept until we have a theory of error. [Stigler 4

5 1976, p. 216] In short, unless economists can wrestle waste into a simple mathematical box, economists must not take such a "mighty methodological leap." Leibenstein's sin was to suggest a line of research that would require economists to look into the way that things are produced rather than confining themselves to the transactional side of the market. Four years after Leibenstein's death, Arnold Harberger gave the presidential address to the American Economic Association on the subject of economic growth. Harberger began by downplaying the marginal perspective which was the centerpiece of his 1954 article: Many, maybe even most, economists expected that increments of output would be explained by increments of inputs, but when we took our best shot we found that traditional inputs typically fell far short of explaining the observed output growth. [Harberger 1998, p. 1] Harberger gave a telling example of the sort of productive improvements that fall through the usual net of economic analysis: I recall going through a clothing plant in Central America, where the owner informed me of a 20-percent reduction in real costs, following upon his installation of background music that played as the seamstresses worked. [Harberger 1998, p. 3] Harberger suggested two different metaphors for economic growth -- yeast and mushrooms: "yeast causes bread to expand very evenly, like a balloon being filled with air, while mushrooms have the habit of popping up, almost overnight, in a fashion that is not easy to predict" (Harberger 1998, 5

6 p. 4). Harberger must have understood as clearly as Stigler that conventional economics is not particularly useful in hunting mushrooms, such as finding the kind of music that might make the seamstresses work harder. Yet, as Harberger realized, such innovations, which cannot be quantified, can be very productive. The rest of his article ignored mushrooms, retreating to a relatively conventional analysis of the yeast-like bunching of technical change within particular industries. He blamed the poor performance of the lagging industries on an inability to perceive potential cost savings together with nod to the damage done by inflation, bad regulation, and protectionism. He never showed why these problems should vary among firms. In the end, Harberger was no more prepared than Stigler to deal with work, workers, and working conditions. References Dean, J. W. and Mark Perlman "Harvey Leibenstein as a Pioneer of Our Time." The Economic Journal, 108: 446 (January): pp Harberger, Arnold C "Monopoly and Resource Allocation." American Economic Review, 44 (May): pp "A Vision of the Growth Process." American Economic Review, 88: 1 (March): pp Mundell, Robert "Book Review: L. H. Janssen, Free Trade, Protection and Customs Union." American Economic Review, Vol. 52, No. 3 (June): pp Stigler, George J "The Xistence of X-Efficiency." American Economic Review, 66: 1, pp