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Brussels, November 27, 2000
The economic upswing, which began in 1997, is proving to be durable and robust. Real economic growth has averaged about 3 percent in the past three years, despite the dioxin crisis in 1999. Real GDP is expected to grow by nearly 4 percent this year. The budgetary position is greatly improved: the deficit may be eliminated in 2000 and a surplus seems assured for next year. Indeed, in this respect Belgium has pulled ahead of both Germany and France. Progress on structural reform has, however, been slower than on the fiscal front. Serious weaknesses persist, particularly in labor markets. Despite substantial increases in employment and reductions in the national unemployment rate, labor force participation remains low, especially among older workers, and unemployment is still too high. The labor market situation also has an important, and worrying, geographical dimension, reflected in longstanding economic disparities. Moreover, in the current upswing unemployment rates have fallen substantially in most of Flanders and in parts of Wallonia, but not in the relatively disadvantaged areas of the country.
As regards the immediate future, almost all forecasters anticipate growth will be about 3 percent in 2001, which would represent a modest pickup in the pace of activity from the second half of this year. Headline inflation, which has risen due to world oil price increases, is expected to subside again as oil prices decline somewhat. Domestic demand is supported by monetary conditions and, partly reflecting the improving labor market situation, historically high levels of consumer and business confidence. On the external side, the world economic situation has strengthened and Belgian competitiveness has improved, in part due to the depreciation of the euro. A key unknown at this point is the outcome of the negotiations on the 2001-2002 interprofessional wage agreement. The upbeat short-term outlook depends in large part on wage growth being consistent with continued international competitiveness of Belgian industry and with moderate inflation.
Against this backdrop, the key challenges for economic policy during the rest of the current government period are to complete the program of fiscal consolidation and to launch fundamental structural reforms. The buoyant economic conditions provide an excellent opportunity to do both.
Credible medium-term improvement in the fiscal position will be crucial to continued good macroeconomic performance. Ensuring a visible and steady decline in the public debt would reduce the vulnerability of the budget to interest rate changes, reassure world capital markets regarding the resolve of the government, and-most importantly-allow a gradual but significant shift of budgetary resources from interest payments to other priorities, notably obligations associated with population aging. Tight control of expenditures would reinforce the credibility of the consolidation effort and provide room for permanent, structural tax cuts.
The 2001 budget presented a framework of expenditure initiatives, tax cuts, and targets for the surplus which exceed those in the current Stability Program. It embodies the recommendation of the High Finance Council (adjusted for differences in assumed economic growth next year) of a surplus of 0.7 percent of GDP, to be reached in 2005. The commitment by the government to devote all growth-related windfalls in 2001 to deficit reduction is welcome. The multi-year nature of the framework is commendable, because it will help to make policy more transparent and predictable; and the tax cuts are back loaded, which is prudent in view of the overriding need to continue reducing the ratio of public debt to GDP. However, there is no cushion in the event of adverse unexpected events-one such possibility is that medium-term growth will turn out to be below that assumed in the budget, and closer to the long-term historical average. For 2001, the budget projects real primary expenditure growth to be 2.1 percent, which is hardly an improvement over the past, and overall there will be a small fiscal expansion. For the 2002-2005 period, already announced spending initiatives imply that tight control would be needed in other areas to hold real primary expenditure growth to the 1.5 percent rate suggested for Belgium's medium-term fiscal planning; it is important that this be a target rather than a floor.
The credibility of the medium-term fiscal intentions of the government would be enhanced by adopting a specific target of a significant and sustained structural surplus, as well as a date when it is to be achieved. This would make concrete the call in the current Stability Program for an unspecified medium-term structural surplus goal. An objective of a surplus of 1 percent of GDP in 2003 is achievable and would confirm that debt reduction is a priority by committing the current government to take the necessary measures. For transparency, the method of estimating the structural surplus should be made explicit.
Holding real primary expenditure growth to 1.5 percent a year would ensure this goal could be attained and at the same time provide room for the tax cuts laid out in the government's program. This would, however, require substantial effort. In the short-term, containing the recurrent overruns in health care costs will be key; in 2001 spending growth in this sector alone will account for the difference between overall expenditure growth of 1.5 percent and that in the budget. Further reform of this sector is thus an urgent priority. It will also be important to continue the close budgetary coordination among the various levels of government, especially as the fiscal autonomy of the regions is set to increase.
In the longer run, both health care and pension outlays will rise as the population ages. This prospect underscores the need to maintain a budgetary surplus to reduce the debt and interest payments, thereby freeing up budgetary resources. With this requirement in mind, the government has recently announced the creation of a reserve fund, the Silver Fund, to set aside money for future pension obligations. The fund is welcome because it can increase public support for the expenditure containment needed for a sustainable fiscal surplus. However, there is a risk that the fund itself will be incorrectly seen as an alternative to further structural reforms that may still be needed to ensure that commitments can be met. The government is also introducing measures to promote private pensions, which are to be established at the sectoral level. This is a commendable development, since over time second pillar schemes will complement the public pension system and thereby ease the pressures it will face.
In formulating its structural policy agenda, the government has emphasized tax cuts. This has been appropriate because the large tax wedge on labor undermines the incentive to hire and blunts the incentive to work. The reduction in employers' social security contributions introduced last April was a welcome step in this regard, as is the planned introduction of a workers' tax credit (although it is for now quite small). On the other hand, the fiscal incentives to reduce working time would operate in the wrong direction. Although given tight labor markets they would probably have only limited effect, these incentives would tend to reduce labor supply, and the tax room would instead be better used to increase it.
To reinforce the positive effects of tax policy, greater focus needs to be placed on the reform of benefit programs. Regarding older workers, policy should aim for reintegration into the workforce, but more importantly should ensure that the next generation is not also induced into premature retirement. The government's decision to treat older people on unemployment insurance as unemployed-that is, to require job search and to have public employment agencies offer jobs to them-is commendable. The goal of this policy should be to end the use of the unemployment regime as an alternative early retirement scheme. In addition, the early retirement system itself is in need of reform, with a view to rewarding continued employment rather than, as now, penalizing it. There are a number of possibilities worth considering in the Belgian context, including subjecting benefits to ordinary taxation rules, increasing the early retirement age, and introducing actuarially fair benefit schedules (which are neutral with respect to the choice of early retirement age), as is being done in the Netherlands.
The regimes governing job placement and unemployment insurance could also be usefully restructured. Skills mismatch, a persistent source of structural unemployment, could be eased by closer integration of training and job placement in order to make training more responsive to labor market needs. Such an initiative would require that high quality training opportunities be assured, that benefit recipients be required to take training, and that sanctions be effectively applied. For many recipients, benefits are of unlimited duration, a situation that tends to promote long-term unemployment, with the adverse consequences of eroded human capital and social exclusion. Limiting duration would help to sharpen work incentives, as would better enforcement of sanctions for those who refuse job offers. Finally, the effectiveness of the public employment agencies needs to be improved. The introduction of greater competition in this area, in accordance with ILO requirements, could prove to be a powerful stimulus for change.
Regional and sub-regional disparities require particular policy attention. Greater wage differentiation according to productivity and labor market conditions would improve the employment prospects of the low skilled and those in depressed areas. In this regard, it is encouraging that the previous two-year wage agreement appears to have allowed significant differentiation, and it is to be hoped that upcoming sector and enterprise negotiations result in further flexibility. A serious impediment to narrowing disparities is the low degree of geographical labor mobility. The public employment services and the unemployment regime could play a role in promoting mobility by increasing cooperation, offering jobs in other regions, and requiring beneficiaries to commute longer distances if offered a job in other regions and sub-regions.
Turning to product markets, progress continues to be rather slow. Belgium is behind several other EU countries with regard to the pace of liberalization of network industries (telecommunications, natural gas, and electricity), although it is expected to proceed according to the timetable set by European directives. The ambitious plan to substantially reduce the administrative burden of government is still moving forward, although on the whole more slowly than had been hoped. In a deregulated economic environment, the role of the recently established competition authority will take on increased importance, and its resources need to be adequate for the task.
The profitability of the banking sector has improved this year, as fee income and lower provisioning have more than offset low margins on traditional lines of business and still high costs of IT investment and restructuring. Supervisory arrangements are relatively complicated in Belgium because a substantial portion of the banking and insurance sectors is owned by or in partnership with foreign firms, a situation which has been managed by arrangements between domestic and foreign supervisors. Domestically, the large financial institutions comprise both banking and insurance businesses, requiring close links between the banking and insurance supervisors. These have been strengthened by a new cooperation agreement and the establishment of working groups. Finally, the Brussels stock exchange is completing its merger with Paris and Amsterdam (forming the Euronext exchange), a development which may prove to be a challenge for the securities supervisor.
Brussels, November 27, 2000