Chapter 7 - Inside the black box of the firm: Why choice, power and preferences matter for productivity and efficiency

Abstract

Critical facets of the behavioural model of the firm and of economic agency within the workplace was developed by Harvey Leibenstein through his articulation of efficiency wage and x-efficiency theory. In these theories it is assumed that effort is a discretionary variable and that output need be maximized at some ideal level. If effort is discretionary, then individuals can choose how smart and hard they work. The assumption of effort discretion differs fundamentally from what has been traditionally assumed in the conventional economic wisdom and has had an important effect on economic theory and, related to this, on public policy. The basics of Leibenstein’s theories are critically assessed and then extended. It is shown that rational individuals in competitive markets can generate the same type of economic inefficiencies as Leibenstein’s irrational economic agents in a monopolistic environment. It is also shown, in contrast to Leibenstein, that in a world of effort discretion, there is no reason to expect market forces to drive out inefficient players from the market place nor should one expect that high rates of employment to be an enduring effect of the existence of effort discretion. Efficiency is largely a product of work environments and institutional setting within which the work environment is embedded, not necessarily or only a product of market forces. Thus, the introduction of effort discretion into the modelling of the economic agent allows for the construction of analytical frameworks which, in effect, generates more accurate predictive and causal analyses than the conventional models and for improved policy with regards to enhancing firm productivity and thereby the material wellbeing of the population.