Mission Concluding Statement 

Economic activity has slowed markedly since the last Article IV consultation, twelve months ago. After a number of years of solid growth, economic activity in Belgium contracted significantly in the second quarter of 2001, and apparently has continued to shrink in the second half of the year. Likewise, economic prospects are less bright than they were a year ago, and we do not expect a substantial recovery in real GDP growth until the second half of 2002.

From the Belgian perspective, the source of these adverse developments is easy to identify. Growth slowed sharply in the United States and Germany in the second half of last year, and somewhat later in France. As a very open economy, Belgium has suffered from the resulting weakness in its key export markets. In addition, the specter of a worldwide slowdown has cut deeply into business and consumer confidence, in Belgium as elsewhere. Enterprises are postponing investments and restructuring production and employment. Consumption has held up relatively well, but could weaken as employment losses cut disposable income growth and further depress household confidence.

As economic activity slowed, high food and oil prices pushed up headline inflation. These effects are now being sharply reversed, but the indexation mechanism raised wages this year. Although wage increases so far seem consistent with the interprofessional agreement, they are running ahead of those in Germany and France. The consequent loss of competitiveness does not yet appear serious, but there would clearly be a concern if overruns in labor costs were not corrected in the 2003-04 interprofessional agreement, to be negotiated in late-2002.

Despite the temporary, cyclical reversal of economic fortune, the key challenges for economic policy remain to complete the process of fiscal consolidation and implement a program of fundamental structural reform, particularly in the labor market.

Fiscal policy should be grounded firmly on the two medium-term goals of a structural surplus and a meaningful reduction in the overall tax burden. Nominal targets, including that of a primary surplus of at least 6 percent of GDP, were instrumental in the past in bringing the public finances under control and reversing the dynamics of high and rising debt. However, last year's balanced budget (ahead of schedule) and the sustained fall in the debt-GDP ratio have greatly enhanced the credibility of fiscal policy. We would not expect this development to be reversed by a transitory deficit arising from the cycle. Correspondingly, the role of nominal annual balance targets should be reduced, and the automatic stabilizers should be allowed to operate subject to satisfactory progress toward the medium-term surplus objective.

Achieving the target in the 2002 budget of balance for the general government would imply a strong procylical tightening. There is, however, a clear possibility of a deficit instead, in part because the growth projection of 1.3 percent now seems optimistic. In the current weak economic situation, a small deficit would be consistent with meaningful play of the automatic stabilizers, and would also preserve progress toward medium-term goals by ensuring expenditure growth is contained. These considerations should inform the budget control exercise early next year, but in addition the cyclical shortfalls registered in the downturn must be fully offset in the expansion. The still-high debt level needs to be substantially reduced in the years ahead, notably to provide a cushion for the costs associated with population aging. In this regard, a medium-term general government structural surplus of about 1 percent of GDP would be appropriate. Achieving these goals requires full collaboration among all parts of the general government.

Holding real general government primary spending growth to an average of 1.5 percent a year would provide the room for this surplus target, as well as for the government's program of tax cuts. However, real general government primary expenditure seems likely to grow by about 2¾ percent on average this year and next, in part due to a catch up of overdue reforms; it is important that the government maintain its commitment to return in 2003 to its medium-term target of 1.8 percent proposed in last year's Stability Program. The substantial rises in spending on items such as health care need to be reined in, or else compensated by reductions elsewhere. In this context, the possibility of adapting to Belgium the successful example of the Netherlands in using a multi-year fiscal framework--and notably the real spending ceiling--deserves study.

Pension reform would also help ease the fiscal burden of population aging. Although there has been little progress with respect to the "first pillar," the decision to broaden the "second pillar" to the sectoral level is welcome. If widely adopted, this scheme would be a beneficial supplement to the state pension, and may also help to deepen Belgian capital markets. The "silver fund," though not a pension reform, has helped by generating greater support for budget consolidation.

The government has introduced commendable reforms to the tax system. The income tax reform implemented this year and the progressive reduction of the crisis contribution are reducing marginal rates and thus should help to spur work effort. The corporate income tax reform should improve the investment climate, both by lowering statutory rates and by implementing "advance rulings" to reduce firms' uncertainty.

Severe weaknesses persist in the labor market, which is characterized by low employment and participation rates, especially among specific groups, such as the old, women, and the unskilled. Structural reform therefore needs to be re-invigorated by articulating and implementing a coherent program to move decisively toward the goals laid out in Lisbon. Although these objectives enjoy widespread support in Belgium, a consensus on the means to achieve them appears elusive. Indeed, partly reflecting the economic slowdown, the momentum for reform seems to have weakened. This would be unfortunate at a time when enterprise restructuring might lead to another wave of older workers who become dependent on social programs, and when the size of this age group is rapidly increasing.

The government's continuing emphasis on lowering the overall tax burden, and labor costs in particular, is welcome. This policy should be pursued to the extent budgetary room is available. However, to ensure substantial improvements in labor market performance, these measures will have to be buttressed by more fundamental reforms to a wide range of labor market policies. In particular, benefit programs, which are more extensive in Belgium than elsewhere in Europe, need comprehensive reform, including streamlining and rationalization. The overall goal should be to sharpen work incentives, while continuing to protect the most vulnerable members of society. There have been a few welcome recent specific initiatives, such as the elimination of the pension penalty for older people who return to the labor force. Nevertheless, considerably more effort is required.

There are also significant and longstanding geographical variations in labor market performance. Unemployment rates in some northern provinces are among the lowest in Europe, whereas in some other parts of the country they are far higher. Improved outcomes in the latter areas will be crucial in moving toward the Lisbon objectives. One market-based advance would be to better match wages to labor productivity by increasing geographical wage dispersion. Reform of the benefit system along the lines suggested above would also be helpful. Measures to increase geographical labor mobility will be important, and the recent decision of the Flemish government to reduce the recording tax on house purchases and the federal government's mobility plan are therefore welcome.

As regards product markets, Belgium is expected to liberalize the electricity, gas, and telecommunications industries according to EU timetables, but the economy would benefit by a still more rapid pace of reform. In any case, in Belgium these markets are characterized by powerful incumbent firms (the former monopoly providers) and regulators will have to ensure that they do not abuse their positions if the full benefits of liberalization are to be realized. While the government's ambitious plan to reduce the administrative burden is well behind initial expectations, efforts to simplify forms and to expand e-government (for example, in the social security sector) are useful initiatives.

The Belgian banking sector has continued to perform favorably, as judged by a range of indicators. Nevertheless, credit growth and profitability fell sharply this year, a natural consequence of the slowdown in economic activity. The financial system successfully dealt with the disruptions associated with the September 11 attacks; and it appears to have no excessive country or sector exposure. On the other hand, cost reductions after the wave of mergers have not materialized, as banks have not shed labor very quickly and have incurred substantial IT costs. Regarding supervision, the government should press forward with its plan to reinforce the links between the banking supervisor and the central bank (and, eventually, the insurance supervisor), in order to exploit complementarities at the staff level and also between micro and macro prudential supervision. The increasing emphasis by the central bank on macro prudential work is commendable.

The mission urges the authorities to continue to increase development aid toward the U.N. target of 0.7 percent of GNP.