The impact of investment and trade on Sri Lanka’s economic growth since 1977

Abstract

Introduction

Investment is identified as one of the most important determinants in a country's macro-economic progress. In the journey toward stable and long-lasting economic growth, developing countries like Sri Lanka often face two main challenges: increasing local investment and connecting more with the global economy. Sri Lanka, because of its important location in the Indian Ocean and its mixed economy of agriculture, industry, and services, offers an interesting case. For a small developing country like Sri Lanka, embracing an open economy model that is, encouraging exports, foreign investment, and integration into global supply chains can be particularly beneficial.

The garment and tourism sectors are key export earners and GDP contributors for Sri Lanka, demonstrating the positive impact of foreign direct investment (FDI), trade agreements, and liberalized policies. These sectors have thrived due to trade agreements with the EU and U.S., and a more open trade environment, which has encouraged foreign investment and growth. Although Sri Lanka has implemented trade liberalization policies and encouraged investment since 1977, the long-term outcomes of these strategies remain uncertain. While sectors like garments and tourism have clearly benefited from FDI and international trade agreements, overall economic performance has been inconsistent. For example, export earnings reached a record $16.17 billion in 2024, reflecting growth in trade-related sectors. However, despite these positive figures, Sri Lanka continues to face macroeconomic instability, trade imbalances, and low domestic savings. The labour force participation rate has not shown strong or consistent links to economic growth, and there is limited empirical consensus on how trade, investment, and labour contribute to GDP in the short and long run.