I like the concept for npcs. Elves are a magical race, so it makes sense that an elf can dip into a couple of levels of Wizard without penalty, or that elf wizards can dip out for a level or two. That said, I don't like penalizing players for making the characters they want to play, so if they want to play an elf Fighter/Rogue/Cleric, I think the multiclassing rules are balanced enough to support it without further XP penalties. And I use a lot of variant d20 stuff (basically "anything", including the AE system), and I'm obviously too lazy to comb through the books and try to figure out what the favored class of sibeccai would be. (There are, after all, only so many hours in the day.)
The thing about xp penalties that I've noticed is, it usually only puts you a half a level behind. And when you are behind you earn slightly more xp, so it keeps you in that half a level buffer. The other thing is that barring really interesting PrC alchemy (which neither I nor my group are rules savvy enough to pull off), single class characters are usually more powerful than their multiclass counterparts.
So I mainly use Favored Class as the "recommended" class for that race.
