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Is Belgium’s economic strategy up to the challenge?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 2004
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Belgium has one of the most generous welfare states in Europe. Per capita income is among the highest in the world, and the poverty rate is among the lowest in industrial countries. But like most other European countries, Belgium is confronted with the challenge of maintaining its high level of public service and extensive social safety net in the face of an aging population. An increasing pension burden, higher health costs, and the prospect of a shrinking workforce are compounding the problem. The government is counting on lower public debt and interest payments to pay for the additional demands on the welfare state over the next 50 years. But is this a viable strategy? Luc Everaert from the IMF’s European Department looks at the challenges facing Belgium.

So far, the government’s strategy has met with success, though not without costs in terms of economic performance. Historically, Belgium’s welfare state has been associated with high fiscal deficits and rapidly accumulating public debt. Even as recently as the early 1990s, budget deficits of 10 percent of GDP were not uncommon. Following a recession in 1993, public debt peaked at a staggering 138 percent of GDP. Since then, this ratio has fallen steadily to about 100 percent—a remarkable achievement. No doubt, a cyclical recovery in the mid-1990s and declining inflation helped. But it was Belgium’s steadfast commitment to the Maastricht Treaty goals (particularly the fiscal deficit limit of 3 percent of GDP) and to the Stability and Growth Pact (requiring budget balance over the economic cycle) that did the trick. To accomplish the required deficit reduction, taxes were raised and nonin-terest spending was curtailed. As a consequence, the noninterest budget surplus (also known as the primary surplus) averaged 6.5 percent of GDP over the past seven years. Such an achievement would be deemed impossible in most parts of the world.

Still, while debt dynamics are now favorable, these efforts have taken their toll, and Belgium is not out of the woods yet. The high tax burden and generous social safety net have dampened long-term economic growth. And following years of strict budget discipline, policymakers are feeling the pressure from pent-up spending needs and demands for tax cuts.

Taxes and transfers discourage work

Taxes and transfers affect the choices people make. Overtaxing capital induces businesses to relocate—with adverse consequences for growth. Work is also taxed at a high rate. In Belgium, the average person earning €100,000 takes home only €51,000. This does not encourage work in the formal economy.

The counterpart to high taxes is extensive transfers that benefit almost everyone. At the same time, however, these transfers raise the wages that people are willing to work for in the formal economy. Some transfers are particularly detrimental to the labor supply. Publicly sponsored early retirement schemes, previously seen as a socially expedient solution to the unemployment problem, are still pervasive. Even today, they are sometimes granted to “facilitate” industrial restructuring.

But even apart from such schemes, it often does not pay to work a full career in Belgium. The penalties for taking early retirement are small, and it is therefore not surprising that only one in four persons aged 55-64 works and that the overall share of the active population in employment is one of the lowest in the Organization for Economic Cooperation and Development.

Health care costs are escalating

Another looming issue is health care expenditure. Belgium’s health care system delivers high-quality results: health outcomes are generally well above the average for industrial countries, access is relatively equal, and there are no waiting lists for treatment. The costs of the health care system are somewhat above the industrial country average, but in line with what could be expected on the basis of Belgium’s per capita GDP.

Looking ahead, Belgium—like most other advanced economies—faces structural pressure to increase health care spending. Quite apart from the effect of population aging, which will have relatively trivial consequences for the budget, the pace of health care spending has exceeded expectations and budgetary norms. In response, the government has raised the growth norm to 4.5 percent a year in real terms for the next four years. While this norm stands a good chance of being adhered to, it accommodates the upward trend in health spending, thereby putting further strain on the budget.

This trend is not unique to Belgium. To a large extent it reflects a general increase in wealth, which translates into a larger share of household budgets being devoted to health care—either through individual spending on health or through increased spending by the state. A clear example of the former is the United States, where about 15 percent of income is devoted to health care—well above Belgium’s 9 percent. Technological progress has also been associated with increasing, rather than falling, health care costs—a phenomenon that sets health care apart from most other sectors of the economy.

Is the government’s strategy viable?

With life expectancy increasing and the population aging, public expenditure is expected to rise considerably. In fact, the projected aging-related increase in spending between 2000 and 2050 is about the same as the interest bill in 2000—about 7 percentage points of GDP. The government is planning to use this equivalence to solve the aging problem: it intends to drive the debt-to-GDP ratio to near zero by running large budget surpluses and use the resulting savings on the interest bill to fund the cost of aging.

Is this strategy feasible? While the math can be made to add up, the policy requirements are daunting: first, in the relatively near future, the budget will need to run substantial surpluses; second, in the medium and long terms, growth in health care spending must be brought down to half its current rate; and, third, labor market performance must improve. To make the authorities’ strategy work, attention needs to be focused not only on controlling public spending per se but also on boosting medium-term growth. Here, labor market and pension reforms will be key.

To make the authorities´ strategy work, attention needs to be focused not only on controlling public spending per se but also on boosting medium-term growth. Here, labor market and pension reforms will be key.

Reforming retirement benefits

Public spending on early retirement programs amounts to about ½ of 1 percentage point of GDP. Since these programs reduce the number of available workers, they lower the productive potential of the economy and its tax base. Phasing them out would therefore not only reduce direct fiscal outlays but also benefit the budget indirectly by expanding the tax base. Making a fair decision about who is to retire when is technically more difficult, but it could be done. The decision would have to appeal to Belgian citizens’ strong sense of equity and require careful explanation.

Even though they are difficult to quantify, the effects of a reform of early retirement benefits on fiscal policy and the labor market will undoubtedly be favorable. But does Belgium also need a more wide-ranging pension reform along the lines of what has been done elsewhere in Europe? Probably not. Significant reforms were introduced in the 1990s, and Belgium’s pension system is now one of the least generous by international standards. In addition, the framework for a funded private pension pillar (commonly referred to as the “second pillar”) has been in place for some time now, and the number of participants in privately funded pension schemes is gradually rising.

Streamlining labor market policies

In Belgium, it is possible to receive unemployment benefits without ever having worked; one-third of all unemployed women are reportedly in this situation. Unemployment benefits are also paid to those coming straight out of school, thus contributing to the high incidence of youth unemployment. Moreover, unemployment benefits in Belgium are, in practice, largely open-ended (with some exceptions). Even though workers are eligible for benefits only if they are actively looking for a job, this condition is seldom enforced. Benefits are based on the previous working wage, subject to a cap, and remain at that level indefinitely. It is therefore not surprising that one in two unemployed Belgians has been so for more than a year.

Unemployment benefits have been extended to so many groups because of the perceived inadequacy of the social safety net for people who are truly unable to find jobs. An equitable solution could consist in requiring a work history to be eligible for unemployment benefits and in introducing phasing and a limit to the duration of unemployment benefits. Unemployment insurance features such as these are quite common in other advanced economies. Of course, the social safety net would need to be strengthened at the same time. But if properly designed, such a policy shift would have substantial net benefits for the budget and labor supply—without leading to an increase in poverty.

Successive governments have not only provided income support to those without work but have also actively assisted problem groups in finding employment. A variety of policies and programs has been put in place for this purpose, including training, employment subsidies, and public employment schemes. Belgium has more than 200 active labor market programs, all of which require budgetary outlays and relatively intense administrative follow-up.

Are these resources well spent? There is an emerging consensus that active labor market programs are of limited effectiveness in placing people in private sector jobs. Enterprise-specific training and targeted reductions in social security contributions and taxes—both of which the government is pursuing—seem somewhat effective. But general classroom training and public employment programs, which are also prevalent in Belgium, appear to be of little value. Some observers even claim they have a negative effect because they make people unavailable for the private sector. Streamlining the many programs could lead to substantial budgetary savings. But even without savings, a reallocation of resources toward the most effective programs would improve the functioning of the labor market.

Health care sector must cap costs

Reforms will also be needed in the health care sector. Rising living standards, technological progress, and population aging will keep pushing up health care expenditure for the foreseeable future. Continuing spending at the current budget norm, or even at recent historic rates, is fiscally unsustainable: publicly funded health care costs as a share of GDP would rise rapidly and absorb most, if not all, of the savings that pension and labor market reforms could generate. The government is aware of the need to reduce spending growth in the health sector but, as experience in other countries has shown, there is no magic recipe for success. Lowering the spending norm will be a necessary first step, but it is unlikely to be sufficient. Mechanisms to increase all stakeholders’ cost-consciousness will also be needed. In the end, while the public should be allowed to choose its desired level of service, it should also be made aware of the costs.

Creating a virtuous circle

If implemented, all of these measures would result in a substantial improvement in Belgium’s fiscal position. But savings should probably not be used only to retire public debt. Belgium’s tax burden is clearly too high; cutting taxes would deliver a significant boost to economic growth by encouraging more people to work and businesses to invest. Also, the fiscal gains from comprehensive reforms could result in savings beyond what is required for a long-term improvement in the budget position, thus creating considerable scope for reducing taxes. Most of the tax burden currently falls on labor, through social security contributions and income taxes, or on consumers (who already have their income taxed) through indirect taxes. Lowering this burden, with reductions targeted to those groups that face the highest tax rates, will create new jobs, one of the government’s key objectives.

Taking advantage of the synergies between fiscal consolidation and labor market reform would do more than just trigger a virtuous circle on public debt dynamics. Combined with tax cuts, it would also be likely to set in motion a virtuous growth circle, with positive feedback on public finances. Provided that reforms are implemented soon, Belgium should be able to maintain its high level of income and its welfare accomplishments—including an accessible and equitable health care system.

Copies of IMF Country Report No. 04/48, Belgium: Selected Issues, are available for $15.00. Please see page 79 for ordering details.

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