Over the past 25 years Sri Lanka has seen steady economic growth accompanied by a profound transformation of its
trade and industrial structure. Led by the garment sector, manufacturing exports took off in the late
1970s, growing by 32 percent a year between 1978-95. Spurring this remarkable transformation were
the opening of trade and liberalization of some sectors in the late 1970s. Also contributing, thanks
to an early commitment to human development, was the country’s skilled and literate labor force, a
feature distinguishing Sri Lanka from other lower-middle-income countries.
While this progress is heartening, Sri Lanka has failed to keep pace with East Asian countries in economic growth
and poverty reduction. In the 1960s Sri Lanka had a per capita income comparable to those of the
Republic of Korea, Malaysia, and Thailand. Today its per capita income is less than half of Thailand’s
and an even smaller share of Malaysia’s and Korea’s. Not surprisingly, Sri Lanka has made limited
gains in poverty reduction. The share of the population in poverty remains comparatively high, at
about 22.7 percent. Of most concern is the skewed distribution of growth. Economic activity has
been strongly concentrated in Western Province while growth in rural areas has lagged far behind.
As a result, poverty in Sri Lanka today is primarily a rural phenomenon.
Sri Lanka’s slower growth and poverty reduction can be attributed, in part, to its civil conflict of 1983-2001, but a
host of other institutional, macroeconomic, and microeconomic factors have also held the country back. This
investment climate assessment is aimed at understanding which factors have made it difficult for
firms to do business in Sri Lanka and how these obstacles have affected their productivity.
What are the most severe obstacles in Sri Lanka’s investment climate? To help answer that question,
the assessment uses micro-level data from a survey of the urban and rural investment climates
conducted in 2004. The urban survey covered 449 formal establishments in manufacturing (textiles,
garments, food and beverages, rubber products, and industrial equipment) and 94 firms in the
tourism and information technology sectors. The rural survey covered 1,327 nonfarm enterprises and
555 households not participating in rural nonfarm activities.1 Sri Lanka’s rural enterprises are largely
based outside the home. Most are engaged in manufacturing or trading, with a far smaller share
involved in services. These enterprises are small, employing an average of 2.4 workers, including
family members.
This investment climate assessment is the first to include an analysis of entrepreneurship in rural
areas, allowing a more comprehensive look at the business environment. Fostering the growth of the
rural nonfarm sector is critical to reducing poverty in Sri Lanka, still largely a rural society. Some 85
percent of the population lives in rural areas and rural nonfarm enterprises contribute significantly
to GDP. The survey findings suggest that the total value added by all rural nonfarm enterprises in
2003 was SL Rs 185 billion-equivalent to 12 percent of GDP or 78 percent of agricultural GDP in
2003.