On the anniversary of the bloodless revolution that toppled a long-standing dictatorship in April 1974, Portugal looked back on a generation that had transformed it into a modern European economy. But the jubilee also marked another turning point: the need to create a new path toward growth. To drive the economy forward, the country can no longer rely on integration with the rest of the European Union or on the fact that until now wages in Portugal have been among the lowest in the trade bloc. Indeed, the process of catching up with the wealthier EU economies has lately ground to a halt. It is high time Portugal tackled the underlying cause of the wealth gap: its low labor productivity.

Raising productivity will be increasingly important if Portugal is to compensate for the erosion of the cost benefit it used to enjoy by virtue of low wages. Over the past five years, its traditional industries—such as the manufacture of clothing and footwear—have been hit by tough competition from Asian countries where wages are even lower. At the same time, Portugal must compete for foreign investment with the former Communist states of Eastern Europe. That rivalry is set to intensify...