LEIBENSTEIN’S THEORY1

Harvey Leibenstein has developed the thesis that underdeveloped countries are characterizedby the vicious circle of poverty that keeps them around a low per capita income equilibriumstate. The way out of this impasse is a certain “critical minimum effort” which would raise theper capita income to a level at which sustained development could be maintained. In order toachieve the transition from the state of backwardness to the more developed state where wecan expect steady secular growth, it is a necessity, though not always sufficient condition that atsome point or during some period, the economy should receive a stimulus to growth that isgreater than a certain critical minimum size.According to Leibenstein, every economy is subject to “shocks” and “stimulants”. A shock hasthe impact of reducing per capita income initially; while a stimulant tends to increase it. Certaincountries are underdeveloped because the magnitude of the stimulants has been small and thatof shocks large therein. It is only when the income-raising factors are stimulated much beyondthe income-depressing factors that the critical minimum is reached and the economy would beon the path to development.

1. Harvey Leibenstein, Economic Backwardness and Economic Growth—Studies in the Theory of EconomicDevelopment, 1957.

C H A P T E RC H A P T E RC H A P T E RC H A P T E RC H A P T E R

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Growth Agents. The rationale of the critical minimum effort thesis rests on the existence ofcertain favourable economic conditions so that the income-increasing forces expand at a ratehigher than the income-depressing forces. In the development process such conditions arecreated by the expansion of the “growth agents”. They are the quantum of capacities residingin the members of the population to carry out growth contributing activities. The typical growthagents are the entrepreneur, the investor, the saver, and the innovator. The growth-contributingactivities result in the creation of entrepreneurship, the increase in the stock of knowledge, theexpansion of the productive skills of the people and the increase in the rate of saving andinvestment.Incentives. According to Leibenstein, ‘’whether or not the growth agents expand will dependon the anticipated outcome of such activities, the actual result and on the incentives for furtherexpansion or contraction generated by the interaction of the anticipation, the activities and theresults.” The incentives are of two types:(i) the zero-sum incentives which do not raise national income but have only a distributiveeffort;(ii) the ‘positive-sum, incentives that lead to expansion of national income. It is apparent thatonly the positive-sum type of activities lead to economic development.But conditions in underdeveloped countries are such that entrepreneurs are engaged in zero-sum activities. They are the non-trading activities for securing a greater monopolistic position,political power and social prestige; the trading activities leading to a greater monopolistic positionthat do not add to aggregate resources; the speculative activities which do not utilize savings butdo waste scarce entrepreneurial resources; and finally, such “activities that do use up net savings,but the investments involved are in enterprises of such nature that their social value is eitherzero, or their social value is very much lower than their private value. Thus, the zero-sumactivities are not real income creating activities but simple transfers of liquidity from someholders to others. On the other side, the positive-sum activities which are essential for economicdevelopment have a limited scope in stagnant underdeveloped economies. Even if someentrepreneurs undertake real investment projects in anticipation of profits, their positive-sumactivities will degenerate and be directed towards zero-sum activities in the absence of netgrowth in the economy. It is, therefore, necessary that the minimum effort should be sufficientlylarge to create an environment congenial to the persistence of positive-sum incentives.But in underdeveloped economies there are certain influences averse to change that tend todepress per capita incomes. They are:(i) “the zero-sum entrepreneurial activities directed towards the maintenance of existingeconomic privileges through the inhibition and curtailment of potentially expanding economicopportunities;(ii) the conservative activities of both organized and unorganized labour directed against change;(iii) the resistance to new knowledge and ideas, and the simultaneous attraction of classical’knowledge and old ideas;(iv) increase in essentially non-productive conspicuous public or private consumptionexpenditures that use resources that could otherwise be used for capital accumulation; and(v) population growth and the consequent labour force growth that has the effect, other thingsbeing equal, of diluting the amount of capital available per worker,” and(vi) a high capital-output ratio.To overcome these influences which keep the economy in a state of economic backwardness, asufficiently large critical minimum effort is required to sustain a rapid rate of economic growth

188 The Economics of Development and Planning

which should stimulate the positive-sum incentives and create forces for counteracting zero-sum activities. As a result of the critical minimum effort, the per capita income would rise andtend to increase the level of saving and investment, which in turn, would lead to :(a) an expansion of the growth agents;(b) an increase in their contribution to per unit of capital as the capital-output ratio declines;(c) a decrease in the effectiveness of factors inhibiting growth;(d) the creation of social and environmental conditions that promote social and economicmobility;(e) increased specialization and expansion of secondary and teritiary sectors; and(f) “the development of an atmosphere that leads to changes is more conducive to economicand social changes, and especially an environment that leads to eventual fertility decline andan eventual decline in the rate of population growth.”Leibenstein’s criticial minimum efforts thesis is explainedin Fig. 1 where the 45° line measures induced increases anddecreases in per capita income which are equal on any pointon this line. The curve xt xt represents the per capita income-raising forces and the curve ztzt the per capita income-depressingforces. E is the equilibrium point where the two forces are inbalance. If the stimulants raise per capita income from theequilibrium level Oe to Om, the income-raising forces,generated will raise the per capita income level by na. Butat this level, the income-depressing forces ,fb generated byzt are greater than the income-raising forces generated byxt. These will, therefore, generate the downard path abcd,until it reaches the equilibrium position E. It is only whenthe investment programme raises the per capita income toOk level that the path of sustained growth starts. The income-raising forces generated at Ok willraise the income level to sG which will, in turn, generate the path of endless expansion of percapita income, as shown by the arrows rising above G. Raising per capita income to Ok leveland beyond point G is the critical minimum effort case. It should be noted that Leibensteinregards the critical minimum efforts as “aminimum minimorum of all possible effortsthat would lead to sustained real incomegrowth” involving “an optimum timepattern of expenditure or effort.”For sustained development, it isimperative that the initial investmenteffort must be above a certain minimumlevel so as to generate a sufficiently largeper capita income level in order toovercome autonomous or inducedincome-depressing forces. But the criticalminimum effort need not be made all atonce. It would be more effective, if it isbroken up into a series of smaller effortsof which the applications to the economy

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Leibenstein’s Critical Minimum Effort Thesis 189

are optimally timed. This is illustrated in Fig. 2 where the line ee represents the low per capitaincome level and mm the critical minimum per capita income level. The gap between the two isdivided into Area I and Area II. The Area III above mm is of self-sustained growth. If Oa is theper capita income to start with, the initial injection of investment would raise per capita incometo Ob level. Then at time t the second injection of investment would raise per capita income bycd so that the critical minimum level mm is reached. If investment is not optimally timed, theper capita income would follow the cy path of the curve bcy toward the low equilibrium levelee.Population Growth a Function of Per Capita Income. Leibenstein’s thesis is, however, basedon the empirical evidence that the rate of population growth is a function of the level of percapita income. It is closely related to the different stages of economic development. To startwith, at the subsistence equilibrium level of income, fertility and mortality rates are the maximumconsistent with survival rate of population. If the per capita income is raised above the subsistenceequilibrium position, the mortality rate falls without any drop in the fertility rate. The result isan increase in the growth rate of population, Thus, an increase in per capita income tends toraise the growth rate of population. It is only upto a point. Beyond that the increase in percapita income lowers the fertility rate and as development gains. momentum, the rate ofpopulation growth declines. The Leibenstein argument is based on Dumont’s “Social-capillarityThesis,” which states that with the increase in per capita income, the desire to have more childrento supplement perental income declines. Increased specialization following rising income levelsand the consequent social and economic mobility make it a difficult and costly affair to rear alarge family. Therefore, the growth rate of population becomes constant and then starts declininggradually as the economy advances towards the path of sustained development, as has happenedin the case of Japan and Western countries. There is, according to Leibenstein, a biologicallydetermined maximum growth rate of population between 3 and 4 per cent. In order to overcomethis population hump, there should be a larger increase in per capita income. This is discussedwith the help of Fig. 3 where the rate of population growth or national income growth ismeasured along the horizontal axis and level of per capitaincome on the vertical axis.The curve N measures the level of per capita income whichgenerates a level of national income growth equal to thegrowth rate of population. The curve P indicates the rateof population growth at each level of per capita income.Starting from point a which represents the subsistenceequilibrium point where there is absence of population andincome growth, if the per capita income is raised to Oyb ,the population growth rate is 1 per cent while the incomegrowth rate is less than 1 per cent. At the Oyc level of percapita income, the rate of population growth is higher thanthe rate of national income growth, i.e., yc g>ycc, the formeris 2 per cent while the latter is 1 per cent. Therefore, theper capita income level should be so raised as to increasethe national income by more than the rate of populationgrowth. This is only possible after Oyc level of per capita income whence the rate of populationgrowth starts declining. Point e is the 3 per cent maximum biologically determined growth rateof population assumed by Leibenstein. Oye is thus the critical minimum per capita income level

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190 The Economics of Development and Planning

which can sustain itself and generate the process of sustained economic development.Leibenstein’s Projections. Leibenstein has also estimated the size of the critical minimum effortin the case of an underdeveloped economy with a starting population of one million. Hiscalculations with regard to fertility and mortality rates are based on life expectancy and confirmwith those of underdeveloped countries in actuality. He makes several projections based ondifferent assumptions. But we take only projection 4b which appears to apply to thoseunderdeveloped countries which hope to check the growth rate of population as the developmentprocess gains momentum and is in keeping with the critical minimum thesis of Leibenstein.With the annual rate of population growth at 2.03 per cent, the capital-output ratio 3:1, therequired rate of investment is 13.2 per cent for the first five-year period. In the 25th-30th yearsthe population growth rate is the maximum, 2.42 per cent, which requires an investment of14.5 per cent. Then the population starts declining, and in the 50th-55th years it is 1.49, thusrequiring an investment of 13.08 per cent. The required annual rates of national income growthduring these periods is 4.40, 4.84, and 4.36 respectively.

A CRITICAL APPRAISAL

In the preface to his book, Leibenstein writes that his “aim has been explanation andunderstanding—not prescription.” But like Rostow’s ‘take-off stage,’ his “critical minimum effortthesis” has caught the imagination of economists and planners in underdeveloped countriesand is regarded as a prescription to economic backwardness. The Leibenstein thesis is morerealistic than Rosenstein-Rodan’s “big push” theory. Giving a big push to the programme ofindustrialization all at once is impracticable in underdeveloped countries, whereas the criticalminimum effort can be properly timed and broken up into a series of smaller efforts to put theeconomy on the path of sustained development. This theory is also consistent with the idea ofdemocratic planning to which the majority of underdeveloped countries are wedded.

Its Defects. But it has its shortcomings:1. Population Growth Rate Related to Death Rate. The theory is based on the assumption thatthe rate of growth of population is an increasing function of the level of per capita income up toa point, but beyond that it is a decreasing function of the latter. But the first process is related tothe decline in the mortality rate due to advancements in medical science, and improvement inpublic health measures in underdeveloped countries, and not to an increase in the level of percapita income. In India, there has been a decline in crude death rate from 24 per thousand in1960 to 13 in 1982, not due to a rise in the per capita income which is almost stationary but as aresult of the above mentioned factors.2. Decline in Birth Rate not due to Increase in Per Capita Income. Similarly, the decline in thebirth rate cannot be attributed to increase in the per capita income at the critical minimum levelwhich surpasses the growth rate of population, as is supposed by Leibenstein. His conclusionsare based on the experience of advanced Western countries and Japan. But in underdevelopedcountries the problem of declining birth rate is mostly socio-cultural in nature. What is requiredis change in ‘the attitude, understanding, education, social institutions and even certainintellectual perceptions.’ Rise in per capita income alone cannot perform the trick. There is noguarantee that with the decline in the birth rate, population would start decreasing as per capitaincome increases in underdeveloped countries.3. Ignores State Efforts to Reduce Birth Rate. Leibenstein ignores the state action in bringingdown the fertility rate. As the experience of Japan has shown, no underdeveloped country can

Leibenstein’s Critical Minimum Effort Thesis 191

afford to wait for per capita income to rise above the critical minimum level so that the birthrate may start declining automatically. In such a situation, she may reach the stage of thepopulation explosion thereby creating more problems than she can solve by rise in the percapita income.4. Higher than 3 per cent Growth Rate does not Lead to the Take-off. Suppose a country hassucceeded in crossing the population barrier of 3 per cent by increasing the growth rate ofincome above this. According to Leibenstein, when an economy has reached Ok level of percapita income in Fig. 1 or ye in Fig. 3, it enters the path of endless expansion. Myint questionsthe correctness of this contention. For it is possible to find cases where abortive ‘take-offs’ takeplace “in which a country may for a time succeed in raising its saving and investment ratioabove 10 per cent to 12 per cent and raising the rate of growth in its total income above 3 percent level, but subsequently relapses into a slower rate of growth and stagnation.”5. Neglects Time Element. The theory fails to take into account the time element which isrequired for sustained efforts during which fundamental changes in the institutional andproductive structure should be taking place for ensuring a successful take-off. To quote Myint,“We may therefore question how far this type of analysis, originally designed to illustrate thegear shifts in short-run economic activity of fully developed engine of growth in the advancedcountries, is useful for the study of the problem of the long-term economic development of theunderdeveloped countries which is concerned with the construction of the engine of growthitself.”6. Complex Relation between Per Capita Income and Growth Rate. Again, according to Prof.Myint, the functional relationship between the level of per capita income and the rate of growthin total income is more complex and not so simple, as has been shown by Leibenstein.Firstly, the relation of per capita income with the rate of saving and investment depends on thedistributional pattern of income and the effectiveness of financial institutions in mobilizingsavings.Secondly, the relation between investment and the resultant output is not determined by a constantcapital-output ratio, as is assumed by Leibensten but depends on the extent to which ‘theproductive organization of the country can be improved and how far land-saving innovationscan be adopted to overcome the tendency to diminishing returns on additional investment’even after the growth rate of population has reached the 3 per cent level.7. Applicable to Closed Economy. The Leibenstein theory does not explicitly explain theinfluence of foreign capital and other external forces on the levels of income, saving andinvestment in underdeveloped countries.