The Libyan government plans to lay off 400,000 people, or more than a third of its workforce, the prime minister has said.
The reforms aim to ease budget pressures and stimulate the private sector, Al-Baghdadi Ali al-Mahmoudi told the General People's Congress, the national parliament, on Saturday.
Al-Mahmoudi said that the number of civil servants and state employees had grown to more than one million in recent years, putting massive strain on the country's economy.
The prime minister said paying the salaries cost the government up 4 billion dinars ($3.1 billion) in 2006.
Outlining a 31 billion dinar draft budget for 2007 at the assembly in the town of Sirte, Mahmoudi said those who lost their jobs would receive assistance.
"Each released public employee will be given his full salary for three years or will be granted up to 50,000 dinars in loans for each one who wants to start his own business," he said, in his speech which was broadcast on national television.
"The objectives of this budget are to increase Libyans' standard living by the rate of 5 per cent during this year and to promote productive activities."
Mahmoudi added that he wanted to improve health and education and encourage the private sector to make manufactured goods of sufficient quality to compete with imports.
Muammar Gaddafi, Libya's leader, regularly scolds the country of 5 million for its over-reliance on oil, which is the source of almost all Libya's hard currency earnings.
Gaddafi has also said that Libyans are too dependent on foreigners and imports of consumer goods.
"The objectives of this budget are to increase Libyans' standard living by the rate of 5 percent during this year and to promote productive activities"
Al-Baghdadi Ali al-Mahmoudi, Libya's prime minister
He is pushing for more economic self-reliance and private sector-friendly reforms to fight an unemployment rate of at least 13 per cent.
The state-dominated economy has long been enfeebled by international sanctions, old-fashioned centralised management, a primitive banking sector, corruption and red tape.
But hopes of change have risen with the revival of diplomatic relations with Washington.
In May 2006, the Bush administration said it would restore formal ties with Tripoli as a reward for Libya's scrapping of its weapons of mass destruction programme.
While most US sanctions were lifted in 2004, the revival of formal ties is expected to loosen a remaining web of financial curbs placed on US-Libya investment in the decades of estrangement when Western governments accused Libya of supporting "terrorism".