Leibenstein Critical Minimum Theory (With Diagram)

According to Prof. Harvey Leibenstein the overpopulated and underdeveloped countries are characterized by the vicious circle of poverty.

They have low per capita income. His ‘theory of critical minimum effort’ is an attempt to provide a solution to this economic problem.

According to him, critical minimum effort is necessary to achieve a steady economic growth raising per capita income.

“In order to achieve the transition from the state of backwardness to the more developed state, where we can expect steady secular growth, it is necessary, though not always sufficient condition, that at the same point or during the same period, the economy should receive a stimulus to growth that is necessary than a certain critical minimum size”-Leibenstein.

The main idea of the theory is that economic growth in the underdeveloped and overpopulated countries in not possible unless a certain minimum level of investment is injected into the system as a consolidated dose that pulls the system out of doldrums. This minimum level of investment is called ‘critical minimum effort’.

According to Leibenstein, “A sufficiently large minimum effort is necessary at the outset if the necessary minimum is to be achieved.” It is necessary for the sustained economic growth of underdeveloped countries that a certain minimum sum of money is invested. Prof. Leibenstein has further added, “In order to achieve the transition from the state of backwardness to the more developed state, where we can expect steady secular growth, it is necessary, though not always sufficient condition, that at the same point or during the same period, the economy should receive a stimulus to growth that is necessary than a certain critical minimum size.”

Shocks and Stimulants:

According to Leibenstein, every economy is under the influence of two forces—’shocks’ and ‘stimulants’.

Shocks refer to those forces which reduce the level of output, income, employment and investment etc. In other words, shocks dampen and depress the development forces. Stocks depress development forces which reverse the wheel of development.

On the contrary, stimulants refer to those forces which raise the level of income, output, employment and investment etc. In other words, Stimulants impress and encourage development forces. They are called ‘Income Generating forces’ which lubricate the wheel of development. Stimulants have the capacity to raise per capita income above equilibrium level.

The long run economic development does not take place in backward and undeveloped countries as the magnitude of stimulants in those countries is quite small. A country is said to be underdeveloped if the impact of shocks in stronger than the impact of stimulants. On the contrary, a country is said to be developed if the impact of shocks is weaker than the impact of stimulants.

Leibenstein is of the view that the underdeveloped countries are under the influence of shocks and stimulants. But in the long run, the magnitude of shocks and stimulants is too small and there is no process of development. Thus, the efforts to escape from economic backwardness, the spontaneous or forced, are below the critical minimum effort required for persistent growth.

In order to break the circle of poverty, backwardness and other imperfection in underdeveloped country, they must get critical effort sufficient in magnitude to move the economy on the path of development.

Diagrammatic Representation:

The theory of critical minimum effort has been illustrated in Figure 1.

The diagram shows the outcome of the struggle between the stimulants and shocks and also enables to find out stimulants of sufficient magnitude as below:

(i) OX-axis of the diagram represents per capita income and induced income growth.

(ii) OY-axis indicates per capita income and induced income declines.

(iii) The 45 ° line measures induced increases and decreases in income.

(iv) P’ curve represents stimulants and Z’ curve shows stocks.

(v) OM is the subsistence living standard.

(vi) At M’ curve P’ Z’ intersect each other indicating the equality between growth rate of population and the growth rate of income so that the income is caught in the vicious circle of poverty.

(vii) If the income level is raised from OB to OC which is not in accordance with the critical minimum effort, the rising population will neutralize the increased income. The system will once again hand on the subsistence level of living. Shocks being more powerful than the stimulants. At OJ level of income raising forces are just FE while the depressants up to GM. This will bring the income level down to M again which is just the subsistence level.

(viii) Solution of this problem for such a rise in the level of national income where stimulants are stronger than the shocks so that the growth in income becomes self-sustaining.

(ix) If the per capita income is raised beyond OD’ the economy, can be pulled out of the vicious circle of poverty. Thereby, growth in income becomes self-sustaining beyond point D. The per capita income has been shown by the arrows.

Attitudes, Motivation and Incentives:

According to Leibenstein, the generation of stimulants depends on attitudes and motivation of the people and the incentives given to them. However, the motivation and incentives are useless without the main factors of economic development. The main factors of economic development are the entrepreneurs, the inventors, the discoverers, the innovators, and those who can accumulate and utilize wealth, and those who can accumulate skills and spread knowledge.

No doubt the activities of such persons are endless, but we are to study only those activities which are in a position to generate stimulants and promote economic growth. It requires continuous efforts of various agencies necessary for economic development. It requires special type of human response to attitudes, motivations and incentives which are created by economic and social environment.

Incentives:

According to Leibenstein, there are two types of incentives that are found in the underdeveloped countries:

(i) Zero-sum Incentives.

(ii) Positive sum Incentives.

(i) Zero-sum Incentives:

Zero-sum incentives are those which exercise zero effect on economic growth. They do not increase national income. It includes trading risk, non-trading or speculative activities and transference of income and profit from one section of people to another. The zero-sum incentives have distributive effect only. They are carried on in order to secure greater monopolistic position, political power and local prestige. They do not add to aggregate resources of the community. In fact, it is a wastage of scarce resources. In short, we may say that zero-sum incentives are not conducive for economic growth.

(ii) Positive-sum Incentives:

The positive-sum incentives lead to economic growth and enhance the national income. The positive- sum activities are essential for economic development. These activities consists the productive investment, use of technical know-how, exploration and exploitation of the new markets and the use of scientific discoveries and innovations etc. These are conducive for economic growth as they change the attitudes, motivations and aspirations of the people.

They try to raise the level of income, output, investment, saving and employment. Leibenstein is of the opinion that mere creation of positive-sum activities is not sufficient to solve the problems of economic development. Because such activities are unfortunately directed towards zero-sum activities for want of growth oriented environment. It is, thus, essential that the minimum effort should be enough to create such a favourable environment congenial to the persistence of positive sum incentives.

In underdeveloped countries certain influences which work against the positive change or depress their per capita income, are as follows:

(a) The zero-sum entrepreneurial activities directed towards the maintenance of present economic privileges;

(b) The conservative attitude of both organised and unorganized workers;

(c) The attraction of traditional ideas and resistance to the new ideas and knowledge;

(d) Increase in non-productive consumption expenditures that could otherwise be used for capital accumulation;

(e) Greater population growth, other things being equal, that reduce the amount of capital available per worker, and

(f) High capital-output ratio.

Leibenstein stresses that these influences can be overcome by a sufficiently large critical minimum effort which would stimulate the positive-sum incentives, counteracting the zero-sum activities. It would, thus, restore a rapid rate of economic growth in underdeveloped economies. As a result, the per capita income would rise and tend to increase the level of saving and investment in the economy.

A critical minimum effort, in turn, would lead to:

(i) An expansion of the growth agents;

(ii) An increase in their contribution to per unit of capital, as the capital-output ratio declines;

(iii) A fall in the effectiveness of factors restricting growth;

(iv) The creation of an environment that stimulates socio-economic mobility; and

(v) The expansion of secondary and tertiary sectors.

Role of Growth Agents:

The critical minimum effort theory is based on the sum of positive-sum activities and such activities are carried on by some growth agents. According to Leibenstein, “By growth agents we mean those individuals who have the capacities to carry out the growth contributing activities.” Leibenstein’s growth agents are not land, labour and capital, but his growth agents are the entrepreneurs, investors, discoverers, savers and innovators. Leibenstein found that entrepreneur is the most crucial agent of growth.

He is a person of rare qualities and he is out to explore new investment opportunities so as to mobilize essential resources for production and promotion of new ventures etc. He promotes, encourages and sustains positive-sum activities which are essential for the economic growth of a country. The critical minimum theory is based on the presence of certain favourable conditions which are created by the expansion of the growth agents in the process of economic development.

These conditions lead the income increasing forces at a higher rate than the income depressing forces. The growth of contributing activities includes the creation of entrepreneurship, expansion of workers’ skill and the increase in the rate of savings, investment, capital formation and technical know-how etc.

Population Growth and Per Capita Income:

Leibenstein’s theory recognizes population growth as a function of per capita income. It is related to the various stages of economic development. At the subsistence equilibrium level of income, fertility and mortality rates are the maximum consistent with the survival rate of population. Now if the per capita income is raised above the subsistence equilibrium position the mortality rate falls without any drop in the fertility.

The result is an increase in the growth rate of population. Thus, an increase in the per capita income tends to raise the growth rate of population. It is only up to a point. Beyond that the increase in the per capita income lowers the fertility rate and as development gains momentum, the rate of population growth declines.

The Leibenstein argued that with the increase in per capita income, the desire to have more children declines. Specialization leads to increasing income levels and the consequent-social and economic mobility make it a difficult and costly affair to support a large family.

Hence, growth rate of population becomes constant and then starts declining gradually as the economy gradually advances towards the path of sustained development. According to Leibenstein, a biologically maximum growth rate may be about 3 or 4 per cent. Leibenstein, thus suggests to make sufficiently the necessary critical minimum effort so as the control such a very high population growth.

The relationship between population growth and per capita income is illustrated in the diagram 2.

Diagrammatic Representation:

In figure 2, rate of population growth or rate of national income growth is shown on the horizontal scale and per capita income on the vertical scale. Curve P indicates the population growth and curve N indicates the level of per capita income. Let us start from the point a which represents the subsistence equilibrium point.

Here the population growth or national income growth is zero. When the per capita income rises to yb, the population growth rate and national income growth rate both are equal to 1%. When per capita income rises to yc, we have the points c and g on curves N and P respectively. These points signify that at the yc, level of per capita income, the population growth rate is 2% whereas national income growth rate is 1%. Thus, this is a disequilibrium state and cannot represent a level of income that can sustain itself.

Therefore, the level of per capita income should be raised to that level at which population growth rate starts declining and national income growth rate starts rising. The only such point is y. At this level of per capita income the population growth rate is 3%. The growth rate of population, according to Leibenstein is maximum biologically determined.

After ye level of per capita income, the population starts declining and national income starts rising. Thus ye level of per capita income is critical minimum per capita income which can sustain itself or which can generate the process of self-sustained growth. According to Leibenstein, the less developed countries must raise their per capita income to this level, if they want to achieve the substained growth.