Macroeconomics: Country report Belgium

Country Report: Belgium

Assignment:
Global Macroeconomics and Business Environment

1. Executive Summary
The purpose of this paper is to give a brief presentation of the current situation of the Belgian economy, its challenges and prospects and to recommend policies to tackle these challenges. The Belgian economy is stumbling. Belgium almost entered into a recession in 2012 and the GDP trend is negative. Consumer spending is low. Government spending and investment spending are decreasing. Trade balance is decreasing but positive. However, Belgium is rapidly losing market share. Both consumer and business confidence are low. Unemployment rate is relatively low.

The Belgian economy faces several challenges. Debt rate has increased again and is now about 100% of the GDP. Budget deficit is at 2.9%. The government is spending about 55% of the GDP, mainly on transfers and wages for government employees. Overall employment rate is very low but the employment rate in the public sector is very high. The tax rate is also very high, making it difficult for the government to increase revenue.

The demand side policy I recommend to fine-tune the economy is to implement a discretionary fiscal policy with a decrease in direct taxes in order to increase consumer spending and investments. The supply side policies I recommend to obtain long term growth are reformation of trade unions, reduce taxation and improve the flexibility of the labour market.

2. The Current State of the Economy
Real GDP
The outbreak of the economic crisis pushed Belgium into a recession with three quarters of negative growth starting in the 3rd quarter of 2008. In the 2nd quarter 2009 raise started to expand again and this lasted until the last quarter 2011 when the GDP shrunk with 0.1%.
In 2012 the GDP changed with 0.2% in Q1, -0.5% in Q2, 0% in Q3 and 0.1% Q4. Belgium just avoided a recession in 2012, but only because of the stagnation during the 3rd quarter. (Fig.1).
The GDP growth maintains the negative trend in the near future, as indicated by the leading indicator of the National Bank (Fig.2).

Consumer Spending
Consumer spending entered a downward trend in Q4 2010 when it started to decrease with 1.3% from 47,455 M€ to 46,853M€ in Q2 2012. Spending increased only marginally in the 3rd quarter of 2012 with 26M€, not enough to break the negative trend. (Fig.3).
Consumer confidence (-23 in January 2013) is still at a very low level (fig 4.). With more than 200 B€ (56% of GDP) parked on regulated savings accounts 1, savings are record high.
It is obvious that consumers are worried about the near future and choose to save instead of spending.

Government Spending
Government spending increased 0.7% on average per quarter from Q1 2007 till Q4 2008 but then growth start slowing down. In 2012 expenditure decreased from 21,794 M€ in the 1st quarter to 21,768 M€ in Q3. (Fig.5).
The government doesn’t have much possibility to increase spending as the national debt is hovering at 100% of the GDP and the budgetary deficit was 2.9% in 2012 2, in line with the Mastricht criteria. Furthermore, the government is committed to cutting its deficit to 0.6% in 2015 3.

Investment Spending
Investment spending declined 0.7% in the Q2 and 0.3% to 18,414 M€ in Q3 2012. Compared to the 1st quarter of 2008 when spending was 19,970 M€, investment spending was 7.8% lower in the 3rd quarter of 2012 (Fig. 6).
As mentioned before, savings in 2012 are at a record high of 52% of the GDP; yet investments are low. The reason for this is probably the fact that business confidence, like consumer confidence, is very low. The trend is downwards since half 2010. It decreased from -11.8% in December 2012 to -13.20 in January 2013. (Fig.7).

Trade Flows
Belgium is a highly open economy with an export-to- GDP ratio of more than 80%. Its exports are highly concentrated with 75% accounted for by the European Union (EU), of which go close to 67% to Germany, France and the Netherlands. The economy is thus vulnerable to financial turmoil across the euro area and to cyclical developments in Europe 5.

Belgium had a trade surplus of 633.8 M€ in November 2012, down from 959.5 M€ in September and 1,684.2 M€ in Augustus. (Fig. 8). For the whole year 2012, export of goods and services decreased with 0.8% compared to 2011. During the same period, import of goods and services decreased slightly more than the export (0.9%), resulting in a positive trade balance for 2012. From 2013, net exports should again make a positive contribution to real GDP growth 4.
However, Belgium is losing significant market share at an annual average rate of 2.6% for the period 1995-2011 3.

Unemployment rate
The long term average unemployment rate in Belgium is 8.4% of the labour force. In November and December 2012 the unemployment rate was at 7.5% (Fig. 9). At 0.9% lower than the long term average, current unemployment rates are moderately low.

3. Challenges and Prospects
The challenges Belgium faces are a public debt-to-GDP ratio of almost 100% (Fig. 10) and a budget deficit of 2.9% . In Europe only the “PIIG”-countries have a higher debt ratio. This high level of debt makes Belgium vulnerable to financial market pressures demanding a higher risk premium.
In the future, the debt-to-GDP ratio is expected to gradually decline to 92.3% in 2015 4 and hopefully reach 79% by 2021.
To bring these ratios down, the government can reduce expenditures or increase revenues. Increasing revenue is very difficult as a result of to the high level of taxes. Reducing total government expenditures should be feasible, if political will is available, especially vis-à-vis the strong unions.

Government expenditures
From 2008, the financial and economic crisis triggered a dramatic increase in the primary expenditure ratio of Belgium. The ratio of expenditure to GDP has consequently risen to 55 % of GDP, almost 8% higher than in 2000.
A major contributor to the primary expenditure and its expansion are payments for transfers, accounting for around half the expenditure. Especially the level of payment for pensions and unemployment, the result of a very low employment rate are a major concern.
Payment for wages for government employees, accounting for a quarter of the primary expenditure, is another major contributor to primary expenditure and its expansion.
The main challenge regarding the high government expenditures can therefore be broken down into: very low employment rate high rate of employment in the public sector.

Low Employment Rate
The major labour problem Belgium faces is its employment rate. In 1970 the average age to retire was 64 years, today its only 59 years. For the age group from 55 to 64 years, only 40% is currently employed (Fig. 11). Labour force participation rate for men and women between 20 and 64 year was only 67.0% in 2012 and remains very low by European standards (Fig. 11). For the period 2012 to 2014, employment rate is not expected to increase. The EU employment rate target for Belgium is 73.2% by 2020.

High rate of Employment in the public sector
The total amount of people employed in the public sector is well over 1.5 million persons on a labour force of around 5 million people. Belgium has a larger share of government-related employment and compensation than the Euro zone. Compared to the countries in the Euro zone, Belgium has the highest number of employees per inhabitant in education, and the second highest in administration. Almost 1 person more per 100 inhabitants works in this administration than on average in the Euro zone.

Government Revenue
Belgian public revenues as a percentage of GDP remained well above the euro area average, owing this to the high rates of taxes, especially those on labour income.
This high level of labour taxes has a negative impact on Belgium’s cost competitiveness. The tax wedge level of the labour cost of low wage earners is at 50% the highest in Europe (Fig. 12). Moreover, the gap of the unit labour cost between Belgium and its main trading partners, Germany, France and the Netherlands is widening (Fig. 13).
The automatic wage indexation system will increase automatically labour costs when inflation accelerates and will so increase labour costs even more.
Productivity is higher compared to Germany and France, but productivity growth is negative.
These evolutions are an indication that Belgium is losing competitiveness, which could lead to a negative impact on export and consequently on future growth.

4. Policy recommendations
The policy recommendation for Belgium can be broken down into short run demand policy to increase aggregate demand and real GDP and long run supply policy to attain long term sustainable growth.

Demand Side Policy
My recommendation is to implement a fiscal policy.
Tax rates in Belgium are very high. The discretionary fiscal policy should have its focus on decreasing the tax rate for low wage earning earners and firms.
Today, the tax wedge level of the labour cost of low wage earners is 50%. Decreasing income tax rate will increase their disposable income and this should lead to an increase in consumer spending. Decreasing the tax rate for social security will decrease the unit labour cost for firms. Lower labour cost lead to a decrease of the production price for goods and services and make them more competitive and as such can cause an increase in export. A decrease in the tax rate for firms should increase their investment expenditures. This leakage could have a multiplier effect on national income over a 5 to 10 year period.
A lower tax rate on labour and firms should have a positively impact on the aggregate demand and increase the real GDP.
With a public debt in Belgium of almost 100% of the GDP and a budget deficit of 2.9%, government spending should not be increased.
The major trade-off of this proposed fiscal policy is the risk of stagflation. When the rise of aggregate demand is preceding the increase in output and the employment of resources, inflationary pressure may increase.
Belgium is a highly open economy with high levels of import and export. Another trade-off is that the increase in disposable income resulting in an increase in consumer spending will leak away via an increase in imports.

Supply Side Policy
My recommendation is to reduce taxation, reform the trade unions and improve the flexibility of the labour market.

Taxes on labour for the low wage earners are the highest in Europe. The direct tax rate is therefore expected to be at a level above the optimal tax rate described by the Laffer curve. Hence a reduction of the direct tax rate should work as an incentive to increase the number of hours worked. This incentive effect should increase the tax base and as such offset the decrease in tax revenues. The result should be an increase in tax revenues.
The size of the shadow economy is estimated at 16.8% of the GDP in 2012 10. It is likely that Gutmann effect from a lower tax rate will reinforce the Laffer curve effect leading to an even bigger increase in tax revenues, because more people would avoid taking the risk not to declare income.

Belgian trade unions are one of the most powerful unions in Europe. More than 50% of the labour force is a member of a trade union. The reason for this high membership rate is “Ghent system”. In this arrangement, one has to be a member in order to enjoy unemployment benefits.

Powerful trade unions are contra productive, especially in times of crisis. The Belgian economy would greatly benefit from the reformation of the “Ghent” system.

The employment rate in Belgium is very low by European standards. Only 67% of the labour force between 20 and 64 years old is employed. The average age of retirement is only at 59 years today.
Several measures can be implemented to increase the flexibility of the labour market: limiting the duration of employment benefit greater degressivity of unemployment benefits tightened job search requirements for the unemployed higher minimum age for various early retirement benefits
These measures should increase the natural rate of unemployment and reduce the poverty trap and decrease government spending on transfers.

In Belgium 1.5 million people work for the government.
Working in the public sector has several benefits compared to working in the private sector, such as pension benefits of 100% of the last salary, job security, etc.
Eliminating these differences should reduce the number of people wanting to work in the public sector, increase employment in the private sector and reduce the government expenditures on wages.

5. Apendix

Fig. 1: Quarterly GDP growth (% change Q/Q)

Fig. 2: Leading GDP indicator

Fig. 3: Quarterly Consumer Spending (M€)
Data in chained 2010 euros adjusted for seasonal and calendar effects

Fig. 4: Monthly Consumer Confidence

Fig. 5: Quarterly Government spending (M€)
Data in chained 2010 euros adjusted for seasonal and calendar effects (source NBB)

Fig. 6: Quarterly Investment Spending (M€)
Data in chained 2010 euros adjusted for seasonal and calendar effects (source NBB)

Fig. 7: Monthly Business Confidence

Fig. 8: Monthly Balance of Trade (M€)

Fig. 9: Monthly Unemployment Rate(% of labour force)

Fig 10: Government Debt to GDP (%)

Fig. 11: Labour force participation rates (% age group 20-64)

Fig 12:Tax wedge level on low wage earners (% of total labour cost)

Fig: 13: Evolution of nominal unit labour costs

6. References

1. Petercam, “Activate Belgian Savings: shift the fiscal advantage for regulated savings accounts to third-pillar funds”, 15 January 2013. https://insights.petercam.com/belgium/activate-belgian-savings-shift-fiscal-advantage-for-regulated-savings-accounts-to-third-pillar-pension-funds 2. Wall Street Journal, “Fitch Lifts Belgium Outlook to Stable vs. Negative on Reduced Deficit”, 23 January 2013. http://online.wsj.com/article/BT-CO-20130123-711089.html 3. National Bank of Belgium, “The Belgian economy: overview and outlook”, 23 January 2013.

4. Interministerial Conference on Finance and Budget, “BELGIUM 'S STABILITY PROGRAMME (2012-2015)”, 30 April 2012. http://ec.europa.eu/europe2020/pdf/nd/sp2012_belgium_en.pdf 5. International Monetary Fund, “IMF Country Report No. 12/55”, March 2012. http://www.imf.org/external/pubs/ft/scr/2012/cr1255.pdf 6. Bas van Aarle, Joep Konings, “Het Effect van de Overheidsuitgaven op het BBP in België: Multiplicator-effect versus ‘Crowding out’”, 28 October 2011. http://www.econ.kuleuven.be/VIVES/vokaleerstoel/vokapublicaties/voka-multiplicator-oct2011.pdf 7. European Commission, “Europe 2020 targets”. http://ec.europa.eu/europe2020/pdf/targets_en.pdf

8. International Monetary Fund, “Public Information Notice (PIN) No. 12/28”, 20 March 2012. http://www.imf.org/external/np/sec/pn/2012/pn1228.htm 9. European Commission, “Macroeconomic imbalances – Belgium”, 27 May 2012. http://ec.europa.eu/economy_finance/publications/occasional_paper/2012/pdf/ocp99_en.pdf 10. European Commission, “Europe 2020: Shadow Economy”. http://ec.europa.eu/europe2020/pdf/themes/06_shadow_economy.pdf

References: 4. Interministerial Conference on Finance and Budget, “BELGIUM 'S STABILITY PROGRAMME (2012-2015)”, 30 April 2012.