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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.

* Credible fiscal consolidation is the key to restoring investor confidence. The authorities' decision to frontload consolidation was appropriate and it is essential that the consolidation measures continue to be implemented swiftly. In this context, adopting a comprehensive medium-term expenditure framework supported by an expenditure rule would enhance the sustainability, and hence the credibility, of the fiscal adjustment. Nonetheless, as the required consolidation is sizeable, the government should stand ready to raise taxes further, focusing on those that are the least distorting to growth, such as consumption (VAT) and property taxes. Broadening the tax base should also help consolidation while reducing economic distortions.

* The sizeable current account deficit needs to be progressively reduced. Notwithstanding the ongoing policies to reduce energy dependence, a sustained correction of the external imbalance depends crucially on restoring competitiveness through improved productivity and rebalancing growth from consumption to exports. On the financing side, reliance on domestic savings, both public and private, must be enhanced. The adjustment can be speeded up by keeping public sector wages at bay to encourage economy-wide wage restraint and shifting taxation from employers' social security contributions to consumption (and property) taxes.

* Labour market dualism should be reduced. The authorities need to combat the segmentation of the Portuguese economy, which is reflected in a two-tier labour market where flexibility is essentially achieved at the margin. The authorities should further reduce employment protection legislation on regular contracts. Pursuing labour market reform should reduce the risk that the cyclical increase in unemployment and reduction in the labour force become structural. To foster labour supply while providing appropriate income support during unemployment spells, Portugal should revise the architecture of unemployment benefits (UB): UB duration and replacement rates should not be related to age and benefits should be a decreasing function of unemployment duration for all workers.

* Further structural reforms are necessary to restore productivity growth. The business environment needs to be further enhanced, with tax system simplification as one of the priorities, and the authorities should help develop transport infrastructure, while basing projects on transparent and careful cost-benefit analysis. Above all, ongoing efforts to upgrade the competencies and skills of the population should be consolidated. Better educational outcomes cannot be achieved without raising the equity of educational opportunities, which would help to close the educational gap while also reducing socioeconomic disadvantages. As the scale of the Portuguese training programmes has expanded, efforts should focus on evaluation tools, even more in the context of tight budget constraints. Portugal should reduce high rates of school-year repetition and further strengthen monitoring mechanisms of those at risk of dropping out.
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Publication:OECD Economic Surveys - Portugal
Geographic Code:4EUPR
Date:Sep 1, 2010
Previous Article:Basic statistics of Portugal, 2009.
Next Article:Assessment and recommendations.

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