Portugal's membership in the European Union (EU) contributed to stable economic growth, largely through increased trade and an inflow of EU funds for infrastructure improvements. Until recently, average annual growth rates consistently exceeded those of the EU average, and since joining the EU in1986, Portugal has made significant progress in raising its standard of living to that of its EU partners. GDP per capita on a purchasing power parity basis rose from 51% of the EU average in 1985 to 78% in early 2002, although the rate of convergence has slowed in recent years.

In order to enter the European Monetary Union (EMU) in January 1999, Portugal agreed to cut its fiscal deficit and undertake structural reforms. The EMU brought exchange rate stability, lower inflation, and lower interest rates. Falling interest rates, in turn, lowered the cost of public debt and helped the country achieve its fiscal targets. However, private sector borrowing increased dramatically. By 2001, the economy was in serious external imbalance, with a large current and capital account deficit. The government's 2001 budget deficit was 4.2% of GDP, well over the Eurozone's Stability and Growth Pact 3% limit.

At the same time, the Portuguese economy headed into recession; with a 1.0%-1.5% decline projected for 2003. Unemployment was 6.2% in mid-2003. The current government has made reducing the weight of public spending on the economy a top priority, although the economic slowdown has made fiscal austerity that much more painful to implement. In 2004, public spending is expected to total 46.6% of GDP, down slightly from 2002. The government hopes that labor reform legislation, set to take effect in late 2003, and corporate tax cuts, proposed as part of the 2004 budget, will lead to renewed growth in 2004.

Portugal's economy is based on traditional industries such as textiles, clothing, footwear, cork and wood products, beverages (wine), porcelain and earthenware, and glass and glassware. In addition, the country has increased its role in Europe's automotive sector, and has a world-class mold-making industry. Services, particularly tourism, are playing an increasingly important role. Portugal will be forced into greater self-sufficiency when EU funds are likely to be discontinued in 2006. EU expansion into eastern Europe also will erase Portugal's competitive advantage, low labor costs. The government is working to change Portugal's economic development model from one based on public consumption and public investment to one focused on exports and private investment.