In the models of chapter 6, the shadow price of labour was derived by treating labour as a non-traded ‘commodity’ and the opportunity cost of public sector employment was calculated in terms of output forgone in the rest of the economy, measured either in terms of foreign exchange equivalence or in terms of the market wage rate, adjusted for tax or tariff distortions. While this analysis provides a starting point for the discussion of the social value of labour, it clearly fails to incorporate much that is relevant.

In the first place, labour is not just a commodity. Workers are both producers and consumers of goods and wage employment has more than one dimension. Sen (1975) distinguished between the production, income and recognition aspects of employment – the former the most important to the employer, the latter two to the employee. In cost-benefit analysis attention tends to be primarily focused on the production aspect: the benefit from increased employment in the public sector is measured in terms of its contribution to the quantity of goods and services available for consumption (now or in the future); the cost is measured in terms of output forgone in the occupation from which the newly-recruited worker is drawn. This marginal employment cost is referred to as the shadow wage rate (SWR). If the only aspect of employment taken into account is the production aspect, the problem of calculating the shadow wage rate is simply one of identifying, and measuring, the forgone marginal product of labour in its next-best alternative employment.