Belgium: 2002 Article IV Consultation - Preliminary Conclusions
December 2, 2002
The Belgian economy, after contracting through 2001, remained weak this year as a number of adverse developments have resulted in a rather fragile and uncertain economic environment. Chief among them is the sharp slowdown in Belgium's major trading partners, especially Germany and the Netherlands. The worldwide collapse in equity markets, which was mirrored in Belgium, weakened balance sheets and reduced household wealth; and uncertainty regarding the international situation and the economic recovery has undermined consumer and business confidence. With some lag, the labor market has also softened. Inflation has moderated, reflecting both sluggish growth and some temporary factors.
Growth is expected to rise gradually in the course of 2003, as the world economy improves. The labor market, however, might recover only slowly, since the substantial labor hoarding in the downturn means firms may not have to hire so vigorously in the upswing. Inflation is likely to ease somewhat further, given some excess capacity both in the euro area and in Belgium itself. There are risks to this projection. Recovery in Belgium depends on an expansion in the rest of the world—particularly Germany—a stabilization of equity markets, and moderate world oil prices, none of which can be taken for granted at this point. The outcome of the negotiations regarding the Interprofessional Agreement and, more critically, of the subsequent sector-level bargaining, will also be important. Moderate wage increases would clearly be desirable in view of the weak state of the labor market and benign inflation prospects.
The 2003 budget contains significant reforms to personal and corporate income taxes, which should contribute to economic dynamism. At the same time, there is likely to be no progress in reducing general government primary expenditure growth. If the economy expands as assumed in the budget, the target of balance (the same as will probably be achieved this year) will be appropriate. However, if downside risks materialize and growth falls significantly below current expectations, achieving balance would require additional measures and mean a third consecutive year of structural fiscal tightening.
Over the medium term, fiscal policy faces the major challenge of containing expenditures in order to make room for two key policy imperatives:
- Tax cuts. Those already planned through 2006 should improve work and investment incentives, but the lost revenues must ultimately constrain spending. Moreover, these initiatives should be viewed as steps toward further reductions in the high tax burden beyond 2006, with obvious implications for expenditures and bearing in mind the very high public debt.
- A sustained long-term budget surplus. By rapidly reducing the public debt, this will help pay for the costs of population aging and progressively reduce the potential for adverse economic developments to destabilize the public finances. The High Finance Council program, which involves surpluses of 1½ percent of GDP in the long term, therefore appears prudent. For the plan to be credible, however, growing surpluses to make significant progress toward this objective will be needed in the next few years, narrowing the scope for spending increases.
Achieving the goals of tax cuts and surplus increases will almost surely require that spending growth be held significantly below its historical average, a difficult task. The mission's longstanding recommendation that real primary general government expenditure growth be held to 1.5 percent a year on average therefore remains pertinent.
Efforts to contain spending will have to be made on a wide front. Clear pressure points need to be carefully monitored and controlled, with greater allocation of budgetary resources in one area compensated by cuts elsewhere. Health-care costs are particularly vulnerable to sustained pressures, as are early-retirement schemes since the number of people over 50 is expected to rise steeply. More broadly, there appears to be scope for reducing other parts of the extensive social safety net. In the longer term, further reform of old-age pensions should be actively considered, notwithstanding prospective budget surpluses and past reforms. In this connection, the development of second-pillar pensions deserves encouragement. Effort will also have to be made at all levels of government. Respecting internal stability pact goals becomes increasingly important as fiscal devolution places more spending and taxing authority in the hands of regions and communities. The wave of retirements in the public service anticipated during the coming years will provide opportunities to raise productivity and cut costs, as envisaged by the Coperfin initiative.
The elaboration of a multi-year fiscal framework would help to achieve these ambitious medium-term goals. Such a framework should commit the government to a path of explicit expenditure ceilings consistent with tax cuts and surplus increases. Fiscal balance goals should be conditional on a scenario for economic growth, an approach which would allow flexibility in the event of another recession. It would also help to ensure that the cyclical improvements in the public finances likely to occur in the next few years are devoted to debt reduction.
The labor market continues to be characterized by low employment rates, even after recent data revisions, and insufficient flexibility. Meaningful progress toward the Lisbon objectives will require comprehensive action. Planned cuts in taxes and social security contributions, as well as greater emphasis on active programs to better prepare people for work, are welcome. However, to ensure scarce budgetary resources are well spent, programs should be rationalized, rigorously evaluated (particularly in the case of costly job subsidies), and cut if they are not performing. Reducing the duration of unemployment insurance benefits, which is unlimited for many people, is also a priority, as is strengthening enforcement of the obligations of beneficiaries, which has so far fallen short of what is needed. Finally, while the reform of labor relations would pose considerable challenges, consideration should be given to promoting greater wage flexibility by decentralizing wage bargaining and eliminating the remaining elements of wage indexation.
Retaining older people in the workforce, or enticing them to return to employment, is a particularly difficult problem. The extensive early-retirement programs, including the unemployment regime for older workers, are a powerful disincentive to work. This remains true even after recent and welcome reforms, such as requiring older beneficiaries to search for employment and raising the statutory prepension age. Incentives to retire early should be reduced, in favor of a system that is neutral as regards the choice of retirement age.
The longstanding and significant geographical economic disparities must also be vigorously addressed. The reforms discussed above would help to stimulate activity in the weaker areas of the country, where impediments to employment are particularly damaging. Additional reductions in the high real estate registration tax should further help to increase worker mobility, although more needs to be done on this front. An increasing emphasis on regional policies which favor growth, innovation, and business formation over the preservation of declining industry is also welcome. Finally, improving the level of educational attainment will be crucial to raising employment and standards of living in disadvantaged areas, especially as the old base of heavy industry continues to decline in importance.
Key product markets have been substantially and progressively liberalized, although in general no more rapidly than the calendar set by the EU. The recent decision by Flanders to deregulate energy markets by mid-2003, well ahead of the EU deadline, is therefore welcome, and a similar policy should be adopted by the other regions. The adverse fiscal consequences of liberalization for municipalities need to be resolved as soon as possible, perhaps by implementing an alternative financing mechanism. In addition, Belgian electricity, gas, and telephone markets are still characterized by large, incumbent suppliers and infrastructure bottlenecks. In these circumstances, it is particularly important that regulatory bodies have the resources and independence to ensure that barriers to entry are removed. In a similar vein, the competition authority should be brought to full strength, especially following the recent decision to devolve some EU-level responsibilities to national authorities. There has been encouraging progress in reducing the administrative burden. Notably, the e-government initiative appears to be proceeding rapidly, with the establishment of portals, common databanks and unique identification numbers for firms' dealings with government, and electronic filing of documents.
The recent reforms to the banking supervisor and greater formal links between it and the central bank are welcome. These measures should improve the operation of the supervisor by improving its management structure and increasing its ability to take advantage of the central bank's expertise in macro-prudential analysis. Fully exploiting these advantages will require careful implementation and sufficient resources. The proposal to integrate banking and insurance supervision into one agency is also welcome, in view of the importance of comprehensive supervision of the large bank-insurance firms, and should be implemented as rapidly as possible.
The government's commitment to increase official development assistance to the UN target of 0.7 percent of GNP by 2010 is commendable. The authorities should take this opportunity to review the effectiveness of development policy to ensure these significant extra resources are used to maximum advantage.