[An updated version of this article can be found at Efficiency in the 2nd edition.]
To economists, efficiency is a relationship between ends and means. When we call a situation inefficient, we are claiming that we could achieve the desired ends with less means, or that the means employed could produce more of the ends desired. Less and more in this context necessarily refer to less and more value. Thus, economic efficiency is measured not by the relationship between the physical quantities of ends and means, but by the relationship between the value of the ends and the value of the means.
Terms such as technical efficiency or objective efficiency are meaningless. From a strictly technical or physical standpoint, every process is perfectly efficient. The ratio of physical output (ends) to physical input (means) necessarily equals one, as the basic law of thermodynamics reminds us. Consider an engineer who judges one machine more efficient than another because one produces more work output per unit of energy input. The engineer is implicitly counting only the useful work done. Useful, of course, is an evaluative term.
The inescapably evaluative nature of the concept raises a fundamental question for every attempt to talk about the efficiency of any process or institution: whose valuations do we use, and how shall they be weighted? Economic efficiency makes use of monetary evaluations. It refers to the relationship between the monetary value of ends and the monetary value of means. The valuations that count are, consequently, the valuations of those who are willing and able to support their preferences by offering money.
From this perspective a parcel of land is used with maximum economic efficiency when it comes under the control of the party who is willing (which implies able) to pay the largest amount of money to obtain that control. The proof that a particular resource is being used efficiently is that no one is willing to pay more in order to divert it to some other use.
Those who object that this is an extremely narrow definition of efficiency often fail to recognize that every concept of efficiency has to employ some measure of value. The monetary measure used by economics turns out to be both broad and useful. It enables us to take account of and compare the evaluations made by many different persons and to respond appropriately.
What kind of structure should sit on the corner lot at Fifth and Main? A gas station, a condominium, a florist shop, a restaurant? The owner can make a defensible decision even if everyone in town has a slightly different preference. The owner simply accepts the highest money bid that various prospective users of the land (the florist, the restaurateur) make for it. Effective social cooperation requires interpersonal comparisons of value, and monetary values supply us with a common denominator that works remarkably well.
The crucial prerequisites for the generation of these monetary values are private ownership of resources and relatively unrestricted rights to exchange ownership. When these conditions are satisfied, competing desires to use resources establish money prices that indicate each resource's value in its current use. Those who believe that particular resources would be more valuably (more efficiently) employed in some other way can raise the price and bid them away from the current users.
In the thirties, for example, a small group of people who placed a high value on hawks bought a mountain in Pennsylvania and thereby converted it from a hawk-hunting area to a hawk sanctuary. Today our laws protect hawks and other predators, but in the thirties hawks were in danger of extinction because they were hunted as vermin that ate chickens. If the only option for those who formed the Hawk Mountain Sanctuary Association in 1934 had been to persuade politicians and the public to change the laws, hawks could well be extinct today in that area. The association was able to save the hawks because its members demonstrated, through competing money bids, that a sanctuary was the most efficient (that is, the monetarily most valuable) use for the mountain.
Perhaps the importance of private ownership to achieving economic efficiency can be seen most clearly by looking at what happens when we try to work together without an effective system for assigning monetary value to resources. Take the example of urban automobile traffic. How can we arrive at a judgment about the overall efficiency or inefficiency of the commuting process when we have to compare one person's convenience with another's delay, time saved for some with carbon monoxide inhaled by others, one person's intense dissatisfactions with another person's pleasures? To find out whether Jack values clean air more than Jill values a speedy commute requires a large set of interpersonal value indicators. Urban commuting creates congestion as well as air-pollution problems in our society because we have not developed a workable procedure for weighing and comparing the positive and negative evaluations of different people.
The crucial missing element is private property. Because so many of the key resources employed by commuters are not privately owned, commuters are not required to bid for their use and to pay a price that reflects their value to others. Users pay no money prices for resources such as urban air and urban streets. Therefore, those goods are used as if they were free resources (see The Tragedy of the Commons). But their use imposes costs on all the others who have been deprived of their use. In the absence of money prices on such scarce resources as streets and air, urban dwellers "are led by an invisible hand to promote an end that was no part of their intention," to apply Adam Smith's famous generalization. In this case, however, the end is not the public interest but a result that no one wants.
Critics of economic efficiency contend that it is a poor guide to public policy because it ignores important values other than money. They point out, for example, that the wealthy dowager who bids scarce milk away from the mother of an undernourished infant in order to wash her diamonds is promoting economic efficiency. The example is strained, not least because the pursuit of economic efficiency almost always makes milk available to the infant as well as the dowager. Most economists would agree that such dramatic examples can remind us that economic efficiency is not the highest good in life, but that does not mean that we should discard the concept.
The moral intuitions that enable us to arbitrate easily between the child's hunger and the dowager's vanity cannot begin to resolve the myriad issues that arise every day as hundreds of millions of people attempt to cooperate in using scarce means with varied uses to achieve diverse ends. Moreover, the remarkable feats of social cooperation that actually make wholesome milk available to hungry infants far removed from any cows would be impossible in the absence of the monetary values that express and promote economic efficiency.
The social usefulness of well-defined property rights, free exchange, and the system of relative money prices that emerges from these conditions has perhaps been demonstrated most convincingly by the catastrophic failure in the twentieth century of those societies that tried to function without them.
Paul Heyne was a senior lecturer in economics at the University of Washington in Seattle. He had a Ph.D. in ethics and society from the Divinity School of the University of Chicago. He died in 2000.
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