Mission Concluding Statement 

December 15, 2014

The new government’s economic program includes many welcome measures to address the critical macroeconomic challenges facing the Belgian economy. These challenges come from two related structural imbalances which undermine growth prospects and create significant macroeconomic risks over the medium term. One is a stubbornly low employment rate—only two thirds of the working age population holds a job. The second one is the fiscal imbalance created by rigidities in public spending. The two imbalances reinforce each other. Generous access to social transfers contributes to low employment levels notably by facilitating early exit from the labor force. And the low and shrinking level of private employment, in turn, makes it difficult to pay for the extensive social transfers and government services—roughly only one in four persons in Belgium (all ages included) has a job in the private sector.

The cost of population ageing—which will rise much faster than in most countries in Europe—puts the two imbalances (employment and fiscal) on an unsustainable course in the absence of strong corrective actions. The added annual fiscal costs due to ageing (mostly pensions and medical coverage) are put at nearly 6 percent of GDP by 2040. A shift in the dependency ratio will make it difficult to pay for such costs without increasing employment rates. Whereas there are 3.2 people of working age for every person 65 and over today, that ratio will fall to 2.2 by 2060. The government will not be able to absorb any of these additional costs if it cannot bring down its debt (105 percent of GPD today) well before then. Against this challenging arithmetic, deep changes are needed in behavior and in the capacity of the economy to create jobs. The previous government began the process of reform. But the effort needs to be reinforced with a view to strengthening the position of Belgium as a dynamic economy.

The government program includes measures in the following three areas:

• Reducing labor costs (through wage containment and reductions in labor taxes) to increase the job content of growth and reinforce competitiveness.
  
  
• Reforming social benefits to enhance work incentives and increase the duration of working life.
  
  
• Pursuing steady fiscal consolidation to bring debt on a sustainable path.

There are different views on how to distribute the burden of adjustment within and across generations. The planned reforms of social security and budgetary measures are a step in the right direction. They reinforce each other and should help preserve the financial integrity of the Belgian social security system so that it can continue to cover social and economic risks for future generations.

We have the following specific remarks on the policy objectives of the different governments:

• Labor costs. High labor costs crowd out potential jobs. This rationing effect falls particularly on low skilled services jobs, but also affects labor intensive sectors exposed to foreign competition. We see evidence of this in the falling number of exporting firms and the fact that exports are increasingly concentrated in a few capital intensive sectors. The wage norm set out in the 1996 law on competitiveness provides a useful benchmark for wage setting and the government actions to close the gap accumulated in recent years are welcome. However, it is important to recognize that closing the gap relative to the wage norm will not, by itself, necessarily lead to a sufficiently high level of employment. Thus, in addition to wage containment, social partners should find ways to allow more flexibility for enterprises and their workers to adjust work and pay conditions to their specific circumstances. It is equally important, in this respect, to break the practice of using targeted government subsidies to offset excessive wage increases.
  
  
• Fiscal adjustment. We consider the pace of structural adjustment targeted by the authorities in 2015-16 (0.7 percent of GDP a year) to be appropriate and we welcome the commitment to achieve it by containing current spending while eschewing increases in the overall tax burden. To be sustainable, savings on the spending side should be guided by clearer priorities. Public investment has been curtailed by budgetary constraints at a time when significant growth-enhancing investments are needed in the areas of transportation, energy infrastructure, education, and social housing. These investments would sustain demand, enhance productivity, and crowd in additional private investment. They are all the more justified in the current low interest rate environment. Therefore, we see a good case for Belgium to use any flexibility that might be provided under euro area fiscal rules to promote growth-enhancing investment spending.
  
  
• Tax policy. The tax policy measures of the government program contain a net reduction in labor taxes and a useful simplification of various social security abatement schemes, which should help limit unwanted distortions. At the same time we see scope for going further in tax reform. Income from capital is not taxed uniformly, and a more harmonized treatment would put the taxation of such income on a more equal footing with labor income. Property taxes could be rebalanced from transaction taxes to recurrent taxes on immovable property. This would stabilize tax collection and enhance labor mobility. We also see scope for reducing deviations from the standard VAT rate, e.g., for electricity, and to increase environmental taxes. Revenue gains from such reforms would be available to reduce labor taxes further.

The programs of the different governments need to include reforms on a broader scale in order to increase the chances of success. Weak growth prospects in Europe will slow down the pace at which the benefits of labor cost reductions and enhanced incentives to work are realized—we have marked down our growth projection for Belgium for 2015 to 1 percent. Much of the policy responsibility for addressing the generalized weakness in aggregate demand lies at the euro area level. But there is also scope to broaden the reform effort in ways that would enhance productivity, potential growth, and incentives to invest and create jobs.

In our view, existing programs should therefore be complemented by coordinated actions in the following areas.

• Product market reforms. A large share of the service economy (network industries, regulated professions, and to some extent distribution) remains sheltered from competition. The resulting inefficiencies and rents are paid by the rest of the economy in the form of higher prices, which not only reduce the purchasing power of households but also undermine the competitiveness of export industries who consume these services as inputs. A more aggressive approach is needed to foster competition.
  
  
• Education and training. Belgium suffers from some glaring, although localized, failures in the education system which leaves the young generation unprepared for the workplace. We welcome reform initiatives in this area and encourage the development of a comprehensive strategy to strengthen linkages between schools and enterprises. As recognized by the government, inadequate continuous professional training adversely affects labor mobility and undermines the pursuit of longer careers. Specific policy initiatives on all these issues should be discussed with social partners to complement activation.
  
  
• Energy policy. The high energy intensity of the Belgian economy, and thus its exposure to energy prices, calls for the elaboration of a strategic vision that can guide policies with a view to reducing consumption, and ensuring stability in supply and predictability of prices.
  
  
• Policy coordination. The devolution of economic and labor market competencies to the regions creates opportunities for better targeted actions, but also raises the risks that uncoordinated actions and approaches will complicate rather than simplify economic life. As suggested in the past, cooperation frameworks at the level of economic, labor and social policies, with the participation of social partners, is urgently needed to reduce the cost of doing business.

We believe that the banking sector is well placed to expand credit in response to a recovery of investment demand as reforms take hold. The findings of the ECB’s comprehensive assessment confirm that bank balance sheets are more resilient and that systemic risks in the Belgian banking sector have abated considerably. The main challenge for banks remains to maintain adequate profitability in a mature, low interest and low growth environment, while adapting to the evolving regulatory framework. At the same time, Belgian banks are among the most structurally liquid in Europe reflecting to a large extent the tax advantages given to bank deposits. In an increasingly integrated European banking market, part of the tax benefits will leak out of national borders in the form of lower financing costs for foreign banks that tap Belgian savings. We recommend that the tax exemption be revisited in the context of a broader reform of taxation. The low interest rate environment is also putting pressure on life insurance companies, which in addition face a decline in demand for their products owing to recent changes in taxation. This calls for continued close monitoring of their financial situation.

The IMF mission team wishes to thank the authorities for the generous hospitality shown to us and for the open and constructive discussions.