The Economics of Exogenous Increases in Wage Rates in a Behavioral/X - Efficiency Model of the Firm

According to standard neoclassical theory a higher real wage will result in less employment and a lower rate of employment growth than a lower real wage and thus exogenous interventions in the labor market which increase real wage, such as minimum wage legislation and unionization, are said to have harmful effects on the economy. Underlying this proposition is the assumption that higher wages do not affect labor productivity, but for this to be true firms affected by these interventions must be maximizing output per unit of labor, that is the firm must be operating x-efficiently. However, Leibenstein's general x-efficiency theory suggests that labor productivity is not maximized and therefore firms are generally x-inefficient. If x-inefficiency exists than higher wages "shock" a firm into producing more x-efficiently which causes an upward shift in the firm's marginal product of labor curve. In contrast, a lower wage shelters a firm from competitive pressures. Therefore when x-inefficiency exists, higher wage rates need not result in a reduction in employment or with a fall in growth of employment. Indeed higher wages can contribute to increasing material wealth of society which prevents, in part or entirely, the decline in employment which follows a rise in wage rates