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  Basic Statistics of Portugal, 2009
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  Executive summary
  Portugal has made significant progress in modernising its economy over recent years. However, the already weak potential growth is likely to have been hit by the global crisis. Besides, widening sovereign spreads, if persistent, may put the economic recovery at risk. In these circumstances, the immediate challenge is to foster investor confidence by rapidly consolidating the public finances. The next challenge is to achieve a sustained reduction in the large external deficit. More fundamentally, Portugal needs to pursue policies to move to more dynamic and sustainable growth, which would help fiscal consolidation and narrow the large income gap with wealthier OECD countries.
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  Assessment and recommendations
  In 2009, Portuguese GDP fell by 2.6%, a deep recession but nonetheless milder than in the euro area as a whole. Helped inter alia by the absence of a real estate bubble in the years preceding the crisis and low exposure to toxic assets, the financial sector has remained sound. However, growth prospects remain weak. Growth resumed in 2010 but it is set to remain sluggish in the medium run, as already weak potential growth is likely to have been hit by the global crisis. Portugal has not escaped recent financial market turbulence: debt has been downgraded and spreads have widened, putting at risk the recovery if the situation were to worsen. Against this backdrop, the immediate challenge is to restore investor confidence by rapidly consolidating public finances. The next challenge is to narrow macroeconomic imbalances, which is a necessary condition for a sustained reduction of the large external deficit, notably through improved competitiveness. Finally, Portugal needs to resume its convergence towards higher income-level countries. It stopped catching up from the early 2000s onwards and needs to nurture stronger potential growth. This will help to restore fiscal sustainability over the long run.
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  Rebalancing the economy towards sustainable growth
  Since the early 2000s, Portugal has seen its convergence process towards more developed OECD economies come to a halt. Slow trend growth has mostly reflected the imbalances of the Portuguese economy. Over-reliance on consumption, weak labour productivity gains and insufficient wage moderation have led to a marked deterioration of competitiveness, especially until 2006, and sizeable external indebtedness. The economic crisis is likely to have worsened the situation as potential growth has probably taken a hit and fiscal sustainability has deteriorated, which has fuelled a rise in sovereign spreads. To rebalance the Portuguese economy and move towards a higher and sustainable growth path, rapid consolidation of the public finances is essential. Consolidation measures should continue to be strictly implemented, preferably through expenditure restraints, but the government should stand ready to curb tax expenditures and raise the least distortive taxes if needed. The opportunity to make the tax system more growth-friendly should be seized, as analysed in Chapter 2. Policies to boost potential growth should be pursued, in part because stronger growth will help to restore fiscal sustainability over the long run. To boost labour utilisation, the authorities should revise the unemployment benefit structure and reduce the dualism of the labour market. Raising labour productivity is also a challenge and is addressed in Chapter 3.
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  Towards a less distortive and more efficient tax system
  The process of fiscal consolidation and the need to step up the poor long term economic performance provide an opportunity to implement tax measures to improve efficiency and rebalance the economy. As consolidation progresses, switching taxes from labour to consumption and property offers an avenue to regain eroded competitiveness and to achieve employment gains, especially if the largest reductions of the labour tax wedge are targeted on low-wage workers. As the consumption tax base is particularly large in Portugal, such a shift could allow a sizeable cut in the tax wedge while still raising revenue, if needed. Productivity and welfare can be increased by simplifying the tax system, thus reducing the high compliance costs it imposes, especially on small and medium sized firms. Also, the tax system could be more environment-friendly by using it to further address transport-sector externalities, which are of particular concern in metropolitan areas. At the same time, the current tight budgetary pressures call for increased efficiency in tax collection. There is ample scope for base broadening through reduced tax expenditures in the major direct and indirect taxes, as well as in property taxation.
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  Policy priorities to restore productivity growth
  Portugal saw a stagnation of its convergence process over the 2000s and the great recession is likely to hold back potential growth over the coming years. Weak productivity gains across most sectors of the economy have been at the origin of slow growth. Productivity growth needs to be boosted by an improved business environment, notably through further easing licensing procedures at the local level and reducing the length of the judicial process. In the medium run, improving transport infrastructure is fundamental to achieving higher competitiveness. The government should play a proactive role, but investment decisions should be selective and based on transparent cost-benefit analysis. In the long run, the key issue is to close the educational gap, by enhancing educational outcomes and by promoting equity in educational opportunities. The authorities should expand the vocational education and training reform and reinforce the professional content of the training programmes.
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  Glossary
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