Belgium -- 2003 Article IV Consultation, Preliminary Conclusions

November 24, 2003

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

1. We support the focus of the new government agreement on job creation and public debt reduction. The labor market reforms agreed in the context of the employment conference will help lift Belgium's comparatively low employment rates. To make appreciable inroads, further far-reaching efforts will be needed, especially as neighboring countries are also embarking on substantive reforms in this area. The government agreement recognizes that addressing the long-term pressures from aging calls for additional fiscal consolidation. This will require a significant reduction in real primary spending growth and a stepped-up pursuit of synergies between fiscal and labor market reforms.

2. There is mounting evidence that the economy is emerging from a prolonged slump in activity, though a sustained recovery will depend on developments in Belgium's major trading partners and global confidence. The 2003 budget execution—adjusted for factors that do not influence macroeconomic conditions—has been providing support through the operation of automatic stabilizers, high primary spending growth, and tax cuts. Reflecting these cuts and the comparative strength of household balance sheets, private consumption has been relatively resilient, buffering somewhat the weakness of investment and external demand. With signs of a broad-based improvement in the international economic environment and a rebound in confidence, official growth assumptions underlying the draft 2004 budget are clearly within reach. A too strong euro appreciation and possible weaker consumer confidence from subdued near-term employment prospects represent downside risks. The inflation outlook is benign, with consumer price increases expected to average about 1½ percent annually in 2004, reflecting temporary factors and the slack projected to remain in the economy for some time.

3. Against this background, near-term policies are broadly appropriate, but wage growth in 2004 will need to remain well below the indicative ceiling of the interprofessional wage agreement (IPA). Abstracting from one-time factors, the 2004 budget aims for a small structural improvement, essentially reversing the fiscal loosening of 2003, though largely owing to savings on the interest bill. Regarding the one-off factors, including the tax amnesty, any difference between their yield projected in the 2004 draft budget and the actual collections should be applied to the balance. In particular, higher-than-anticipated revenues should be devoted to debt reduction. Labor cost growth in neighboring countries is now projected to be lower than envisaged at the time the current IPA was negotiated. In order to benefit fully from the recovery, wage moderation is called for, and care should be taken to preserve the labor cost reduction entailed by the planned lowering of social security contributions.

4. In a longer-term perspective, the challenge from aging is becoming more pressing. Recent government decisions applying to the social security system will lift the projected cost of aging above earlier estimates, in particular owing to the increase in health care spending, which already requires a strong compression of expenditure growth in other areas. Furthermore, the planned takeover of the debt of the railways will slow the decline in the public debt-to-GDP ratio on current plans. Though progress has been made, the public debt-to-GDP ratio, tax burden and employment performance remain unfavorable by international comparison. Narrowing this gap will be challenging, as key trading partners are also embarking on tax reduction and labor market reforms, and competitive pressures are expected to increase further with EU enlargement. From this viewpoint, removing impediments to job creation and staying the course on fiscal consolidation will be crucial.

5. Fiscal policy faces the major task of combining welcome tax cuts with additional consolidation. The ongoing overall reduction in the tax burden as well as its shift away from labor will promote employment and growth, especially since the prospect that the tax cuts will be lasting is being enhanced by the commitment to achieve a small budget surplus in 2007. Reaching this objective will be difficult, however, as it implies a durable reduction in real primary spending growth at the general government level from current annual rates of about 2.7 percent to about 1.5 percent per year. Moreover, on official medium-term growth projections, the 2007 budget surplus of 0.3 percent of GDP will still be well short of the High Finance Council recommendation to reach a surplus of 1.5 percent of GDP starting in 2011—a target that in any event needs to be seen as a minimum in light of higher recent and prospective spending on social security.

6. The required reduction in primary spending growth should be sought in high-quality measures, focusing on areas where the synergies with the promotion of higher trend growth are the largest. With spending on transfers and labor market programs in Belgium considerably higher than in comparable countries, appreciable savings can be obtained from needed labor market reforms, such as the phasing out of early retirement schemes, the streamlining of the multitude of active labor market programs, and selected adjustments to the system of benefits (see ¶ 8). Similarly, the upcoming large-scale retirements from the civil service should be seized upon as an opportunity to raise productivity in the public sector. Finally, the rapid rise in the share of health spending in GDP will need to be stemmed in the medium term.

7. The elaboration of a medium-term fiscal framework based on expenditure growth ceilings rather than nominal balance targets is likely to be necessary to achieve fiscal consolidation objectives. The current framework that relies on maintaining balanced budgets has served as a valuable policy communication tool. However, it is resulting in a growing pursuit of ad-hoc fiscal policy measures—which are likely to be needed again to achieve balanced budgets in 2005-06, whereas an approach focused on the underlying position would likely allow for small deficits in these years. Such ad-hoc measures mask the true fiscal position, sometimes trading off a current benefit for future outlays (e.g., as in the case of the takeover of Belgacom's pension fund and sales-and-lease-back operations for real estate). In contrast, a system based on primary expenditure growth ceilings would reduce the appeal of such measures, instead putting a premium on high-quality and durable fiscal savings measures. When set consistent with medium-term tax-cut and consolidation objectives, a primary expenditure rule preserves interest savings for debt reduction, while preventing contractionary impulses in a downturn or structural slippage during upswings, which occurred at the beginning of the previous economic upturn. All levels of government should be involved in this process through a strengthening of the internal stability pact.

8. The authorities' increased focus on the need to create jobs has triggered a number of helpful initiatives, such as the employment conference and changes in the tax structure. Given the inherent complexity of the needed structural reforms, these initiatives constitute a step in the right direction, but a comprehensive reform strategy remains to be elaborated as recognized in the government agreement. Indeed, the underperforming labor market constitutes the main impediment to faster growth: employment rates of the low-skilled and the old are very low, while there are longstanding significant geographic discrepancies. These diverging patterns suggest that there is no unique cure, but that instead policies and institutions need to adapt on a number of fronts:

• Without phasing out the generous early retirement system, it is unlikely that the much needed increase in activity rates of older workers can be achieved. In principle, the decision when to retire should be left to the individual, by introducing actuarial fairness into all systems and curtailing the possibilities of accruing pension rights while not contributing to social security. Over time, all tax incentives and public spending on early retirement will need to be removed. In this context, the elimination of some tax benefits favoring early retirement is a helpful first step.

• Job opportunities for the low skilled are limited by high labor costs, deriving inter alia from the existence of minimum wages, employment protection and insufficient wage dispersion. The targeted cuts of social security contributions for low-wage earners are a welcome step to address this issue, though they entail appreciable budgetary costs. These costs may rise further in response to demands for broader reductions from other groups that are also facing high marginal tax rates. Consequently, alternative measures such as the reduction of employment protection should be considered and the regulatory and budgetary costs of new mandates (e.g., crédit-temps) curtailed. Anomalies such as sectoral minimum wages in excess of the national minimum should best be phased out and the remnants of indexation reconsidered. In this context, the growing incidence of all-in compensation contracts as the outcome of wage bargaining is a positive development.

• For some important categories of workers unemployment benefits are open ended and, by international comparison, replacement income for the low skilled and the long-term unemployed is high, thus discouraging active job search. The proposed streamlining of the earned income tax credit (werkbonus) and the expansion of enterprise-based training programs will be helpful, though training should not be seen as a panacea, as it is unlikely to be effective if extended on a large scale. The initiative envisaging a tougher application of job search requirements will also be beneficial, but it will need to be effectively implemented to make headway in promoting the return to work. Other measures such as the reduction of the duration of unemployment benefits should also be a priority.

9. Progress on product market reform will provide an impetus to growth, as evidenced by the reduction in most prices of network services after the recent liberalization. All segments of the electricity and gas markets should be opened to competition, while taking care that measures designed to offset associated revenue losses of the public sector do not lessen public support for reform. The strengthening of the competition authority needs to be completed on schedule, as a well-functioning competition authority is essential to make markets contestable (by lowering barriers to entry) and secure de facto progress in sectors in which previous monopolists still dominate, including local phone loops. The intention to step up privatization is welcome, and progress in lowering the administrative burden on taxpayers and enterprises and the adoption of e-government should be built upon.

10. In the financial sector, banks are continuing their restructuring to lower costs while insurance companies have benefited from the rebound in equity markets. The reform of financial supervision is progressing apace, with the merger of banking and insurance supervisors expected to be completed early next year. It will be essential to swiftly tackle any challenges arising in the integration of the two supervisory institutions and to secure sufficient resources for their effective operation. The greater involvement of the central bank in financial stability analysis has lead to a welcome strengthening of the macroprudential aspects of supervision as evidenced in the regularly published financial stability reports.

11. The government's commitment to raising development spending to the U.N. target is commendable. In the same vein, the authorities should use their position in international institutions to help reinvigorate the process of multilateral trade liberalization.

Brussels, November 24, 2003


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