Assessment and recommendations
Over the past two decades, spurred by EU membership, Portugal has undertaken a wide range of reforms to liberalise the economy and open it to foreign trade and investment. These reforms paid off in terms of GDP growth and Portugal managed a significant catch up towards the living standards of more affluent OECD economies until the early 2000s. Thereafter, growth stalled, unemployment increased substantially, and the convergence process suffered a reversal, and it was not until 2005 that economic growth picked up again, thanks in part to a renewed effort at macroeconomic and structural reforms. A forceful fiscal consolidation brought the deficit down from more than 6% of GDP in 2005 to 2.6% in 2007, and inflation moderated to about 2½ per cent, just above the euro average. The on-going structural reforms, if fully implemented, will contribute to raising potential growth in the future; but the short-term outlook remains worrisome, as the external environment is not expected to be as benign as in recent years. The downturn in the United States, tighter credit market conditions internationally and risks of negative spillover effects in Europe imply that Portugal will face weaker foreign demand in 2008. This is likely to slow its exports and overall expansion. Looking ahead, potential growth, estimated at around 1½ per cent, is too low to narrow the income gap with richer OECD countries. Securing fiscal consolidation provides a solid base for deepening and broadening structural reforms and encourages the necessary adjustments to put the economy on a higher growth path.
Economic performance and key challenges
After a weak growth performance in the first part of the 2000s, more recent economic developments have been encouraging. The recovery that started in the course of 2005 gathered momentum in the following two years, underpinned by exports, and the budget deficit has been reduced to more sustainable levels. Nevertheless the income and productivity gaps with high income countries in the OECD are large and have been widening. GDP growth is not high enough to allow a catch up with standards of living in more affluent OECD countries. Many structural measures have been undertaken in recent years, and the structural reform process should be deepened in order to improve Portugal’s growth performance on a sustained basis. Policies should aim at raising the economy’s capacity to adjust smoothly to the changing international environment and seize new opportunities created by globalisation. This chapter identifies three main challenges that Portugal must face to achieve stronger growth: i) maintaining the momentum of fiscal consolidation to achieve sound public finances, a prerequisite for sustainable economic growth; ii) embracing globalisation and facilitating the adjustment to the changing economic environment; and iii) reforming the labour market and enhancing human capital, to promote job creation and allow a durable decline in unemployment in a period of deep structural transformation.
Securing fiscal consolidation
Portugal has made good progress in reducing the fiscal deficit in 2006 and 2007, with a wide-ranging consolidation programme, including shorter-term measures and structural reforms to address problems in spending control. In particular, the comprehensive reforms to the public administration and the pension schemes tackle some of the main underlying drivers of spending growth and are likely to continue paying dividends in the medium-term. The main fiscal challenge for Portugal is to secure the results achieved in fiscal consolidation and reduce the deficit further, in particular by: completing the implementation of the public administration reform; continuing the health care reform; improving the performance and efficiency of state-owned enterprises; taking further measures to ensure the sustainability of the contributory pension scheme if developments require it; and dealing with ageing pressures on the health budget. The progress achieved in fiscal consolidation and budget management provides a solid base on which further improvements should be made to strengthen the medium-term fiscal framework and enhance the efficiency and effectiveness of public finances.
Maximising the gains from integration in the world economy
The Portuguese economy is open to the rest of the world, with low formal barriers to trade and FDI, and this helped its growth performance in the past. However, export performance has been disappointing over the past decade, trade integration in the global economy could be higher, and there is potential for more foreign direct investment (FDI). The economy is in the process of adjusting to accelerated changes in world trade and there is significant potential for it to benefit more from globalisation. There are encouraging signs about the economy’s capacity to seize this opportunity, including growing product and market diversification, a shift towards higher technology exports, some correction of the earlier increase in relative unit labour costs and recent large FDI inflows. The outlook is brighter than in earlier years. The government has already made significant progress in enhancing the business environment, through a wide range of reforms, including the SIMPLEX programme. However, further action should be taken to facilitate the adjustment of the economy and reap more benefits from openness. Non-tariff barriers, such as the cost of custom processes, should be reduced, and an easing of product market regulations would contribute to making the economy more efficient. Portugal also needs to strengthen competition and improve regulations in key infrastructure sectors, such as telecommunications, electricity and transportation, to enhance the quality, efficiency and quantity of the services they provide. This would have a direct effect on the costcompetitiveness of firms in Portugal, facilitate trade flows, domestically and internationally, and make Portugal a more attractive destination for FDI.
Improving the functioning of the labour market
While participation rates are above average in Portugal, employment has been broadly stagnant since 2000, the unemployment rate has doubled and long-term unemployment is close to 50%. The labour market has become increasingly segmented, with a large proportion of workers on short-term contracts or in selfemployment. Building on measures already taken, reforms are needed to develop human capital and facilitate labour market adjustment in the changing environment. This chapter argues that what is required to promote the creation of more – especially less precarious – jobs, is a broad strategy, including labour market reforms and human capital formation. In particular, there is a need to enhance the adaptability of the labour force, addressing rigidities in the formal labour market and improving the balance between flexibility and workers’ protection. Effective training is also required to improve the skill match for new entrants and to help displaced workers in sectors affected by structural adjustments. Some measures have already been taken. The government has launched an initiative to upgrade competences of young people and adults at risk. It is also reviewing labour market settings and legislation with a view to reducing the segmentation of the labour market and increasing its adaptability. The measures taken and proposed go in the right direction. Continuity in the reform process and implementation remain a challenging task.
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