Sri Lanka has witnessed a significant drop in its labour force, encompassing both employed individuals and those actively seeking work. This decline is alarming given the country’s ongoing economic challenges and has prompted experts to examine both its causes and broader implications.
University of Colombo (UOC) Department of Economics Professor Priyanga Dunusinghe identifies multiple factors contributing to this reduction, such as lack of hope for job opportunities, increased migration, and decreased female and elderly workforce participation.
Prof. S.P. Premaratne, also from the UOC Department of Economics, further highlights the negative role of recent tax policies on labour participation, particularly among women and professionals, and discusses how these policies are reshaping the workforce landscape.
Reasons behind decline
Prof. Dunusinghe identified three primary reasons behind the recent labour force decline in Sri Lanka.
Firstly, he pointed to a “loss of hope” among job seekers – a phenomenon he termed the “discouraged unemployment hypothesis”. When people believe job prospects are slim, they often stop looking for work altogether. “This is typical in a crisis,” he explained, adding that even in advanced economies, labour force participation dropped during recessions while unemployment levels remained low.
A second contributing factor is the notable increase in migration, with many seeking job opportunities abroad due to limited prospects in Sri Lanka’s labour market. Prof. Dunusinghe explained: “People have decided to go abroad and participate in the global labour market. That participation is not reflected in local data.”
“Thirdly, female labour force participation and old age labour force participation have declined significantly in recent years,” he said.
Prof. Dunusinghe pointed out that with fewer opportunities, vulnerable workers had been “crowded out” by displaced individuals from other sectors. “Those we call the vulnerable no longer have opportunities in the labour market, as they have been taken by individuals who lost jobs in other sectors,” he added.
Prof. Premaratne highlighted the role of tax policy in deterring formal employment, particularly among women.
“Females have to work and also recruit someone for domestic work activities. Therefore, when taxes increase, the marginal benefit is reduced,” he explained. This pressure compels many women to consider informal work, where taxes are less stringent, rather than maintaining formal employment under a 36% tax rate.
Prof. Premaratne further observed that the increased tax burden had prompted skilled professionals, such as doctors and engineers, to seek opportunities abroad.
“The Government collects taxes to increase income in the short run, but it must consider long-term economic improvement,” he said.
Econ. crisis and employment demand
Sri Lanka’s economic crisis has further depressed demand for labour, especially among domestic workers, a category typically supported by middle- and upper-middle-income families.
Due to tax increases, many families can no longer afford these services, particularly in roles such as cleaning and caregiving, which impacts employment for vulnerable categories. “In particular, the demand for workers in vulnerable categories remains low as families can’t afford these services due to higher taxes,” Prof. Dunusinghe explained.
Large-scale businesses have also cut back on hiring, adding to a shortage of job opportunities. This has discouraged many potential workers from actively searching, as job hunting itself has become a costly exercise amid limited job prospects. “When job opportunities are limited and costly to pursue, people wait for better economic conditions,” he added.
Prof. Dunusinghe recognised this as an outcome of multiple crises including the Easter Sunday attacks, the Covid-19 pandemic, and a debt crisis. He noted that other countries had seen labour markets stabilise post-Covid, while Sri Lanka’s economy remained precarious.
“The labour market contraction here is prolonged, partly due to a lack of sustained fiscal and monetary policy support,” he explained. This instability led to hikes in interest rates and tax burdens, effectively reversing early economic recovery efforts.
He further highlighted that as a result of that monetary policy, the interest rates had been raised, and then most of the tax payment accounts had been reversed in Sri Lanka. “The marketing interest rate went up to 30-35% and corporate-related profit taxes were raised, with all the incentives and subsidies being taken back during the crisis.”
He noted that this had resulted in a larger issue because it had reversed the economic recovery after Covid-19. Further, Sri Lanka may continue with the uncertainty and economic contraction.
“If you look at the labour force participation, most of the labour force participation took place in the agriculture sector instead of in services and the manufacturing industry,” he said. Considering this, Prof. Dunusinghe noted that people often took the last resort.
Meanwhile, Prof. Premaratne noted that while other countries had seen post-pandemic labour markets stabilise, Sri Lanka’s prolonged crisis continued to damage employment opportunities and increase migration. “Covid-19 was a global issue, but the economic crisis has worsened Sri Lanka’s labour market in unprecedented ways,” he said.
He further highlighted the fact that certain sectors such as tourism, Government, education, and healthcare had been particularly hard-hit, as companies laid off workers or replaced them with Artificial Intelligence (AI)-based tools.
Long-term consequences
Prof. Premaratne commented on the Government’s limited progress in addressing long-term economic development.
“The Government has not taken any specific measures yet towards long-term economic development as it remains focused on reducing wastage and corruption,” he observed.
While he agreed with some International Monetary Fund (IMF) recommendations, such as cutting Government spending and reducing the Government’s size, he warned that the long-term impact of high tax policies could lead to unintended consequences, pushing more workers into the informal sector.
“When you work in the formal sector, you’re expected to pay tax, which leads many to perform informal transactions,” he said. For many Small and Medium-sized Enterprises (SMEs), this means splitting operations between formal and informal transactions to avoid excessive tax burdens.
Impact of declining labour force participation
Prof. Dunusinghe emphasised that lower labour force participation impacted productivity, especially in Sri Lanka’s labour-intensive economy, where a high percentage of output relied on the labour force.
He highlighted that the female labour force participation in Sri Lanka remained low. “That is why the Economic Transformation Act specifically mentioned raising the female labour force participation.”
“When labour force participation drops, it automatically affects Gross Domestic Product (GDP) growth, Government revenue, and overall productivity,” he explained. The low female labour force participation rate, which remains between 32% and 34%, is particularly concerning. In comparison, female participation in Malaysia is 55%, and in Thailand, it is around 60%.
Addressing this gap is a priority for policymakers, with the Economic Transformation Act aiming to increase female labour participation to 40% by 2030 and 50% by 2050.
Prof. Dunusinghe also noted that the elderly population could also contribute to economic growth if retained in the workforce. “If we create arrangements for them to work for an additional 10-15 years, we can retain more elderly workers,” he said, stressing that this approach was essential for a labour-intensive economy like Sri Lanka.
Reforms required to accelerate growth
In order to enhance productivity and encourage labour market engagement, Prof. Dunusinghe called for economic reforms that would make the labour market more adaptable and inclusive.
Despite investments in education and training, the country has not yet reaped productivity gains. From 2000 to 2019, total factor productivity growth was less than 0.01%. He argued that accelerating this to at least 1-2% was essential for sustainable economic growth.
In order to achieve these goals, reforms should focus on creating jobs with flexible hours and arrangements, he added. This includes hourly, daily, or weekly employment options, along with suitable payment structures.
Prof. Dunusinghe further observed that while Sri Lanka continued to rely on monthly wages, many other countries had adopted hourly work with social protections. Flexible employment arrangements could provide much-needed job opportunities for individuals currently sidelined by rigid labour structures, ultimately benefiting the economy as a whole.
In Sri Lankan culture, social protection has traditionally been understood as social welfare, with a focus primarily on aiding those deemed economically disadvantaged.
Prof. Premaratne argued for policies that broadened social protection to include those impacted by job loss, economic crises, or SME shutdowns. He noted that existing systems fell short for those who lost their jobs due to circumstances beyond their control.
“Our social protection system currently aids only the so-called ‘poor,’ with no support for those who lose jobs due to crises,” he explained.
In order to address this gap, he advocated establishing a central social protection framework that provided support to those displaced by economic downturns or business closures, particularly in the SME sector.
For example, he suggested that if a private sector employee lost their job unexpectedly or a small business owner was forced to shut down, they should not be left without support. The Government should step in with transitional assistance to help them sustain themselves until new employment opportunities arise.
Prof. Premaratne further called for a shift in Government focus from short-term revenue collection to building sustainable economic growth foundations. With comprehensive social protections and optimal tax adjustments, he believed Sri Lanka could attract and retain a more engaged labour force while supporting formal employment sectors.