This Selected Issues paper reviews Belgium’s experience with fiscal adjustment and the long-term outlook for the public finances. The paper discusses the composition and scale of the fiscal adjustment, and the extent to which it has exerted a durable impact on the public finances. It offers a quantitative analysis of the interaction between fiscal policy and developments in saving and investment, with a view to contributing to reflection on desirable policy priorities in the future.

Abstract

This Selected Issues paper reviews Belgium’s experience with fiscal adjustment and the long-term outlook for the public finances. The paper discusses the composition and scale of the fiscal adjustment, and the extent to which it has exerted a durable impact on the public finances. It offers a quantitative analysis of the interaction between fiscal policy and developments in saving and investment, with a view to contributing to reflection on desirable policy priorities in the future.

Belgium: experience with fiscal adjustment and the long-term outlook for the public finances

I. Introduction

The public finances of Belgium underwent a dramatic turnaround in the 1980s and early 1990s. Faced with a public debt that was accumulating rapidly as a result of persistent budget deficits, the authorities sharply reoriented fiscal policy from 1982. As a result, the general government deficit was cut from about 13 percent of GDP in 1981 to below 3½ percent in 1996 (Chart 1); the debt ratio was set on a declining path; and the long-term interest rate differential vis-à-vis comparable German bonds fell to a negligible level.

CHART 1
CHART 1

BELGIUM Fiscal Indicators

(In Percent of GDP)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: IMF, World Economic Outlook.

In spite of the striking progress that has been achieved, the fiscal situation in Belgium remains serious. The debt ratio did not begin to decline significantly until 1994, and—at more than 130 percent—it remains the highest in Europe (Chart 2). Moreover, like other industrialized countries, Belgium will face a steady ageing of its population over the next half century, and this will result in serious pressures on the public finances. Further fiscal consolidation over the medium and long term is thus needed not only in the framework of European Monetary Union (EMU), under which a “Pact for Growth and Stability” is to limit budget deficits, but because of the need to avoid a renewed rise in the debt ratio or an increase in the tax burden from its already very high level.

CHART 2
CHART 2

BELGIUM General Government Finances of EU Countries in 1995

(In Percent of GDP)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: European Commission (as provided by the Belgian authorities).Countries are: AUT=Austria, BEL=Belgium, DNK=Denmark, FIN=Finland, FRA=France, DEU=Germany, GRC=Greece, IRE=Ireland, ITA=Italy, LUX=Luxembourg, NLD=Netherlands, PRT=Portugal. ESP=Spain, SWE=Sweden. GBR=United Kingdom.

A major accomplishment of fiscal adjustment in Belgium has been to reduce the level of primary spending, relative to GDP, by some 10 percentage points since its peak in the early 1980s. On the other hand, a review of the scale and composition of the fiscal adjustment undertaken since 1982 indicates that in order to cut the budget deficit, reliance was at times placed, at least initially, on revenue increases, on expenditure cuts of limited durability, and on one-off measures; moreover, the adjustment process was interrupted for a period in the early 1990s, and the debt ratio at that point began to rise again. The quality of the fiscal adjustment, and thus its impact on expectations, suffered to some degree from this process. Indeed, the continuing high level of private saving in the face of decreased public dissaving—particularly in the early 1980s and early 1990s—raises the possibility that the credibility of the fiscal adjustment may only recently have become firmly established: a somewhat greater offset in private saving behavior would be suggested by experience in other countries and, over a longer period, in Belgium.

With the Government’s long-standing goal of a 3 percent deficit now within reach, it appears timely to review this experience with fiscal consolidation and assess possible lessons for the future. The second section of this paper therefore discusses the composition and scale of the fiscal adjustment, and the extent to which it has exerted a durable impact on the public finances. Section III of the paper offers a quantitative analysis of the interaction between fiscal policy and developments in saving and investment, with a view to contributing to reflection on desirable policy priorities in the future. Against this background, Section IV of the paper discusses the possible impact of different policy options in the areas of social security and tax reform—as well as continuing structural reform in the labor and product markets—in the context of designing policies for fiscal consolidation that will encourage fuller employment and higher growth.

II. Experience with fiscal adjustment1

Fiscal adjustment in Belgium has not proceeded at a uniform pace, and can be discussed in terms of several episodes. During the 1980s, a substantial fiscal effort was undertaken to reduce public sector dissaving and arrest the spiraling public debt and debt-service burden: major programs were initiated in 1982 and 1986. Subsequently, following a temporary setback in 1991, a further adjustment effort was launched in 1992, which aimed to achieve a reduction of the public deficit to a level low enough to set the stage for Belgium to participate in the first round of EMU.

A. Initial Conditions, 1980-81

At the start of 1980s, the Belgian economy was experiencing severe macroeconomic imbalances, which had build up during the two previous decades and greatly worsened following the second oil crisis. The productive structure of the domestic economy in the 1960s and 1970s failed to adapt adequately to the evolving pattern of domestic and foreign demand, and the rise in wage costs in industries exposed to foreign competition was excessive compared to the increase in productivity.2 The resulting loss of competitiveness eroded profitability—leading to a reduction in output, a fall in investment, and a substantial rise in unemployment: in 1981, the unemployment rate reached 10 percent (Table 1). The rise in unemployment was addressed in part by a policy of maintaining employment and supporting growth, which led to a large increase in government spending from 42 percent of GDP in 1973 to over 60 percent in 1981.

Table 1.

Belgium: Selected Economic Indicators

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Source: World Economic Outlook.

Contribution to growth.

To cover the cost of growing public expenditure, the government resorted to increased taxation—particularly higher personal taxes, corporate taxes and social security contributions. However, the increase in revenues did not suffice to prevent a rapid deterioration in government finances, and the overall budget deficit rose from 3½ percent of GDP in the 1970s to about 13 percent in 1981. Consequently, total government debt increased rapidly, reaching close to 93 percent of GDP in 1981, and the differential between interest rates in Belgium and in international markets widened, increasing the financial burden of debt service on firms and on the public sector. Increased interest payments on a rising public debt set off a pernicious spiral of interest payments and further borrowing. In parallel with this deterioration in the public finances, the external current account deficit worsened to 4½ percent of GDP in 1981: financial confidence weakened, and this was reflected in an outflow of short-term capital and strong downward pressure on the exchange rate.

B. Fiscal Adjustment in the 1980s

By 1982, it had become clear that a drastic change of policy was unavoidable, given the seriousness of the imbalances in the economy. As a first step, priority was accorded to restoring firms’ competitiveness and profitability. This had become necessary in order to break out of the vicious circle in which Belgium was caught, in which high unemployment, large twin deficits in the budget and the external current account, and the lack of external competitiveness reinforced each other. The newly-formed coalition government thus decided in early February 1982 to devalue the Belgian franc within the EMS, and to suspend temporarily the indexation of real wages—a marked departure from the two traditional pillars of economic policy.

A stringent budgetary policy was also introduced to dampen domestic demand; indeed, it was during this period that the foundations for subsequent fiscal adjustment were laid down. Government spending was cut by making savings in public sector investment and in purchases of goods and services, while stabilizing total spending on wage and salaries (relative to GDP), and holding down the growth of transfer payments. On the revenue side, social security contributions were raised, mainly following the removal of the “ceiling” on such contributions, and the taxation of benefits such as unemployment compensation was increased. The aim of policy was to restore external balance by 1984; and, in the event, the external current account recovered fairly rapidly.

The magnitude of the budget deficit was cut from double to single digits by the mid-1980s, but it remained quite high, at some 9 percent of GDP in 1985. The rise in the public debt thus continued unabated, with the debt ratio reaching about 120 percent in 1985—and the trend in the debt ratio was widely considered to jeopardize the financial stability of the economy. In May 1986, the authorities therefore embarked on a further determined program of fiscal consolidation, which relied mainly on stricter control of government spending. The share of public spending, which had risen to over 60 percent of GDP in 1981, fell to just above the 50 percent mark, in spite of steeply rising interest payments on the government debt (Table 2).

Table 2.

Belgium: General Government Finances (1)

(In percent of GDP)

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Source: Data provided by the authorities.

Staff estimates.

Projections.

A remarkable feature of the overall fiscal adjustment achieved in 1982-90 is that the deficit reduction was mainly achieved through a decline of primary expenditure by 10 percentage points of GDP (for a comparison with experience in selected other countries, see Chart 3). The growth of public consumption slowed sharply, as public sector wages declined in real terms and the growth of government employment was reduced substantially (Table 3).3 Social expenditures fell in relation to GDP: spending on health, pension schemes and unemployment each declined by about 1 percentage point of GDP. Thus, the per capita purchasing power of retirement and survivors’ pensions fell more than per capita real wages in both the private and the public sector; the replacement ratio of unemployment benefits dropped sharply; and demographic trends led to reduced outlays for family allowances. Overall social security expenditures fell from over 26 percent of GDP in 1983 to about 23 percent in 1990. Subsidies to business also declined as a percentage of GDP, but only after 1986. A major share of the reduction in primary expenditure was also accounted for by public investment, which declined from close to 4 percent of GDP at the beginning of the decade to some 1¼ percent in 1990. Interest expenditure, meanwhile increased from some 6 percent of GDP in 1980 to over 10 percent in 1990; indeed the cumulative interest payments of the 1980s were equivalent to more than half of the public debt—which had risen to about 130 percent of GDP—at the end of the decade.

CHART 3
CHART 3

BELGIUM International Comparisons: Public Finances

(In Percent of GDP)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: IMF, World Economic Outlook.
Table 3.

Belgium General Government Finances (2)

(In real percentage change)

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Source: Data provided by the authorities

On the revenue side, after some initial tax increases, there was a marked reduction in revenue ratio, which declined by 4 percentage points of GDP during 1985-1990. An initial tax program in 1984 provided for a special 2 percent levy on wages and transfer incomes for each of the years 1984 to 1986, and for an increase in the withholding tax on income from savings was raised to 25 percent in 1984. However, an overall tax reform (the “Maystadt” reform) was introduced in 1989 to cut the burden of direct personal taxation, bringing it closer to the European average (see Table 4 and Section IV below).

Table 4.

Belgium: Principal Measures Affecting Public Finances

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The impact of these policy measures on the fiscal position was substantial (Chart 1). The general government deficit declined from a peak of 13 percent of GDP in 1981 to some 5 percent of GDP in 1990. However, on a cyclically-adjusted basis the deficit reduction was somewhat less impressive: the structural component of the deficit declined by only 5 percentage points over the decade, to stand at 7.5 percent of GDP in 1990 (Table 2). Moreover, at the end of decade, the conditions for stabilizing the debt ratio were not yet in place: the structural primary balance, which moved into surplus in the mid-1980s, did not improve suf-ficiently to offset the effect of high interest payments on the public debt.4 These estimates are, of course, very sensitive to assumptions about potential growth and the output gap, which are surrounded by significant margins of error (Box 1).

Potential Output Growth and Cyclical Output Gap

The measurement of productive potential and the identification of the current position of output in relation to potential (i.e., the output gap) are important elements in evaluating the stance of monetary and fiscal policies. However, their assessment is subject to a relatively considerable margin of uncertainty arising in part from the difficulty of estimating the non-accelerating-inflation rate of unemployment (NAIRU).

One approach to estimating potential GDP growth is the segmented trend approach, which assumes that potential output evolves along a relatively stable trend, which is mainly shifted by major shocks (such as the oil shocks of the 1970s). From this perspective, potential output is estimated as the fitted value of a regression of actual output on a time trend. Estimates by the staff based on this method put the potential GDP growth rate of the Belgian economy in 1996 at 2 percent, implying a cyclical output gap of some 1.4 percent. An alternative approach based on an HP filter, by the Bureau du Plan, yields a potential GDP growth of 1.8 percent during 1991-96, with an output gap of 0.2 percent in 1996.

Potential output can also be estimated based on a production function. According to OECD calculations based on this approach, potential output growth averaged about 2.5 percent during 1991-95 with a cyclical output gap of about 3.2 percent in 1996. OECD estimates of potential output vary considerably from year to year, because the capital stock is assumed to adjust rapidly.

In this paper, where the output gap is used to estimate the underlying or structural fiscal balance, the estimates by the staff based on a time trend have been used; these estimates result in a more conservative assessment of the fiscal situation than the production function approach, but are consistent with other indications that there was a significant margin of cyclical slack in the economy, with—correspondingly—some cyclical unemployment.

C. Fiscal Adjustment in the 1990s

The process of fiscal consolidation suffered a setback in 1991. While the slowdown in economic activity was partially responsible for the deterioration that occurred in the public finances, there was also a sense of adjustment fatigue. The fiscal position weakened sharply as a result of a rapid increase in public spending, in part linked to political tensions, and general elections in the fall of that year. Another explanation for the lack of fiscal progress during this period might have to do with the increasingly federalized nature of the government. The growth of primary expenditure accelerated to 5 percent in real terms, compared to 1 percent in 1990 (see Table 3). This was mainly driven by an increase in social security spending, particularly on pensions and health care.5 Despite the mitigating effect of lower interest rates, the overall deficit widened by nearly 1 percentage point relative to GDP (Table 2).

The deterioration of the public finances in 1991 led policy makers to adopt a new fiscal adjustment program with a medium-term perspective. This approach was formalized in a multi-year Convergence Programme presented by the new Government in the spring of 1992. The aim of the 1992-96 program was to achieve during this period two objectives for the public finances related to the Maastricht Treaty: a general government deficit of no more than 3 percent of GDP, and a sufficient downward trend in the public debt ratio. To help ensure this, three general norms were introduced. First, the social security system was to be in equilibrium; second, fiscal receipts should display “unit elasticity”, increasing in line with GDP; and third, primary expenditure by the Federal Government must not increase in real terms. Given the need to create sufficient room for manoeuvre to meet the long-term fiscal challenge of an ageing population, an additional norm was introduced in September 1994: that the primary surplus must remain above 6 percent of GDP in the period beyond 1996.

A sharp weakening of economic activity in 1992-93 greatly hindered the implementation of the Convergence Programme, and the planned deficit path was twice revised upward. However, the goal of a deficit of 3 percent of GDP by 1996 was not changed, and became a cornerstone of the Government’s financial policies. The general government deficit has thus continued on a downward path since 1992, despite difficult economic circumstances. Fiscal measures with a large combined yield were thus taken by the Federal Government in 1993-96, raising the ratio of revenue to GDP to a very high level (Chart 4) and progressively containing the real growth of Federal and social security spending. Initially in 1993-94, reliance was placed on revenue increases, while spending restraint by the Federal Government and in the social security system was outweighed by the expansion of spending by the Regions and Communities.6

CHART 4
CHART 4

BELGIUM Public Revenue Burden

(1992-1994, Average)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: OECD, Analytical Database.1/ Social security taxes in percent of gross income from dependent employment.Countries are: BEL=Belgium, CAN=Canada, DNK=Denmark, FRA=France, OEU=Germanyt ITA=Italy.

The revenue measures implemented in 1993 and 1994 led to a rise in the ratio of revenue to GDP by two percentage points, although the ratio subsequently declined by nearly ½ percentage point in 1995.7 A striking feature was the shift in the relative importance of different categories of receipts as a result of government policy (Chart 5). The “Global Plan” adopted in 1993 emphasized reliance on tax-based (“alternative”) financing of social security expenditure, in order to reduce non-wage labor costs and promote employment. Social security contributions fell by 0.9 percentage points of GDP by 1996, as employers’ contributions were lowered to narrow the high wedge of taxes and social charges in the labor market.8 To compensate for these revenue losses, certain direct and indirect taxes were increased and earmarked for social security under provisions of the Global Plan.9 1994 thus witnessed a peak in the revenue share for the early 1990s at approximately 48 percent of GDP. In 1995, a decrease in the shares in GDP of labor income and of private consumption, both of which are relatively highly taxed, accounted for a decline in the revenue ratio of 0.4 percent of GDP. Increases in corporate taxation and in the average rate of taxation of labor income—due to the effect of continuing measures such as the suspension of indexation of income tax brackets—provided partial compensation, as did the impact of revised tax assessments by local authorities.10 Subsequent revenue measures, in 1996 and 1997, have similarly been aimed at shoring up, rather than increasing, the revenue share.11 The recently announced federal budget for 1997 also includes some revenue measures, including the introduction of a tax on bearer securities and passbook savings, and higher excise taxes. Despite these new measures, the revenue ratio in 1997 is projected to decline slightly.

CHART 5
CHART 5

BELGIUM Taxation Trends

(In Percent)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: Data provided by the authorities.1/ In percent of GDP.

Expenditure-reducing measures during 1993-94 at the Federal Government level and in Social Security included actions to slow the growth in public health care spending, and a nominal freeze of the defense department budget and of subsidies to the post office and railroad (from 1993 onward). Transfers—excluding earmarked taxes—from the federal government declined by 0.5 percentage points of GDP between 1993 and 1995 as they were largely frozen in nominal terms. Expenditure restraint by these levels of government limited the overall rise in public spending to less than 1 percentage point of GDP in 1993, and paved the way for a subsequent decline in the ratio of primary spending to GDP. In 1995, the success in restraining growth of general government primary expenditure to a moderate pace was maintained. The pronounced slowdown in social expenditure can be ascribed to the many corrective measures taken by the Government, notably under the “Global Plan”. For example, the introduction of a “health index” for prices favorably influenced the growth of expenditures on wages and transfers (mainly pensions).12 Expenditure measures adopted in 1996 totaled more than 0.5 percent of GDP, and consisted of reductions in subsidies to public enterprises and in departmental operating costs, cut-backs in health care (by some 0.2 percent of GDP), continued nominal freezes of defense spending, subsidies to the railroad and post office, and a tighter application of unemployment benefits (including cancellation in certain cases of lengthy unemployment). The package included one-off measures amounting to about 0.5 percent of GDP, which were replaced in the 1997 budget by more durable measures, including cuts in health expenditures (reduction in drug prices, medical fees, and hospital outlays) and cuts in the family allowance for the first child.

While the fiscal measures discussed above refer to “Entity I” of the general government (Federal Government and Social Security), an important element of the Belgian fiscal situation has been the devolution of powers to Regions and Communities from the beginning of 1989, which put these entities on a comparable footing with the Federal government (see SM/94/289). In July 1994, the problem of the growth in their spending was tackled: a specific agreement was reached between the different entities on the permissible deficits for each of them, and since then the Regions and Communities have contributed considerably to the consolidation effort. More recently, in 1997 the measures taken in the Federal Government budget and the Social Security system have been matched by a renewed commitment of Regions and Communities to eliminate their deficits progressively over the period 1997-99 (an adjustment of about ½ percent of GDP), thus extending the favorable track record established in 1993-96.

Overall, as a result of the revenue and expenditure policies implemented since 1993, the primary surplus rose from some 3½ percent of GDP in 1992 to 5.3 percent of GDP in 1996 (Table 2 and Chart 6) and over 5½ percent of GDP in 1997, while the structural primary surplus is estimated to have risen from some 2 percent of GDP in 1992 to a projected 6.2 percent of GDP in 1997—one of the highest among industrial countries (see Chart 2). The overall deficit, meanwhile, is projected to have been reduced to just under 3 percent of GDP, while the debt ratio has declined continuously since 1993.

D. Scale, Composition, and Impact of Adjustment Episodes

The fiscal adjustment undertaken in Belgium since 1981 has transformed the fiscal situation—and it is striking in this connection that the latest phase of fiscal adjustment has been achieved in a setting of relatively weak economic activity in the economies of Belgium and its main trading partners. However, the debt level still remains very high, while the revenue ratio is among the highest in the industrial world, with the burden of taxation falling heavily on labor income (Chart 4). Drawing on the recent literature regarding successful and unsuccessful fiscal adjustments in industrial countries, this section of the paper seeks to assess the quality of fiscal adjustment in Belgium by examining the nature of various phases of the adjustment. (Section III of the paper aims to shed light on these issues by a complementary approach, through a quantitative assessment of trends in saving and investment.)

Recent studies have pointed not only to the size, but also to the nature and composition of fiscal adjustment initiatives as key elements in their success. The question of what constitutes a “successful” fiscal consolidation is inevitably open to different interpretations. Following Alesina and Perotti (1996), a successful fiscal adjustment is defined here as a period of tight fiscal stance such that the gross debt/GDP ratio falls at least by 3 percentage points two years later. Because the change in the debt ratio depends in a definitional sense upon the primary balance, the cyclically-adjusted primary balance could be used as a reference measure of the fiscal impulse.13 A tight fiscal stance could thus be defined as “one in which the structural primary balance as a ratio to GDP improves by at least 1½ percentage points over two years and does not decrease in either of the two years”.

In the analysis that follows, both the 1980s and 1990s episodes are broken into two sub-periods of fiscal consolidation with a view to highlighting the shift in fiscal strategy that occurred during both sub-periods. For instance, as shown in Table 2, during 1982-85 the fiscal adjustment effort relied mainly on reductions in primary expenditure, with the revenue ratio virtually constant. In the second half of the decade, the revenue ratio declined in tandem with further cuts in primary expenditure. During the 1990s, the adjustment relied initially on revenue increases (1993-94) but subsequently shifted to cuts in primary expenditure (1995-97).

Scale of Consolidation

The scale of fiscal consolidation is clearly a key factor for the success of an adjustment program: a weak fiscal initiative is more likely to fail than a strong one.14 The magnitude of the fiscal impulse in all four adjustment sub-periods under consideration using various fiscal indicators is shown in Tables 5, 6, 7, and 8.15

Table 5.

Belgium: Scale of Fiscal Adjustment, 1982-85

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Source: Data provided by the authorities and staff calculations.
Table 6.

Belgium: Scale of Fiscal Adjustment, 1987-88

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Source: Data provided by the authorities and staff calculations.
Table 7.

Belgium: Scale of Fiscal Adjustment, 1993-94

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Source: Data provided by the authorities and staff calculations.
Table 8.

Belgium: Scale of Fiscal Adjustment, 1995-96

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Source: Data provided by the authorities and staff calculations.

If the overall deficit measure is used, all four of these sub-periods can be characterized as episodes of tightness in the sense that the deficit was at least 3 percentage points lower two years after the adjustment. However, on a cyclically-adjusted basis, the 1987-88 episode cannot be considered as a “tight adjustment”: while the primary balance improved by 2.7 percentage points of GDP, the structural primary surplus actually fell in the following two years. Moreover, although the debt ratio declined by some 3 percentage points after the adjustment period, the fiscal consolidation was not sizable enough to set it durably on a downward trend; once allowance is made for favorable effects of the business cycle, spending was not curtailed sufficiently to finance the cuts in taxation. By contrast, in the 1982-85, 1993-94, and 1995-96 episodes, there was a substantial improvement in the structural primary balance and structural deficit. Not only did the structural primary surplus improve over the period: it did not decline in any of the years.

CHART 6
CHART 6

BELGIUM Comparisons of Fiscal Performance

(In Percent of GDP)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: IMF, World Economic Outlook.

Despite the magnitude of the fiscal consolidation during 1982-85, the public debt ratio continued to rise, possibly casting doubts on the credibility and durability of the adjustment. During the 1990s, by contrast, the debt ratio has declined significantly in each year since the peak of 1993: the consolidation efforts in the 1990s were sizable enough to set in motion a declining trend in the debt ratio.

Nature and composition

The quality of fiscal adjustment can also be assessed in terms of the nature and composition of the fiscal packages. A high quality and credible consolidation program is considered here to be one that relies mainly on cuts in expenditure—particularly primary expenditure—because these measures may be less prone to be reversed than tax increases (particularly where the initial revenue ratio is already high). However, merely reducing primary expenditure is not enough for an adjustment program to be successful. The types of spending and sources of revenues greatly matter. The lion’s share of deficit cuts in successful adjustments appears to have been concentrated in spending on transfers and government wages, while in unsuccessful adjustments there has tended to be virtually no reduction in these categories but heavy reliance on either tax increases or cuts in public investment. Also, in successful adjustments, tax increases appear to have been concentrated on business and on indirect taxes, while taxes on households did not increase at all, and social security contributions were also spared almost completely. By contrast, tax increases in unsuccessful adjustments appear to have been widely spread over all components of income as well as expenditures.16

Some salient features of the four sub-periods of fiscal adjustment considered in this paper are summarized in Tables 9, 10, 11, and 12. In the 1982-85, and 1987-88 episodes, the burden of adjustment was strongly placed on the spending side, with the primary expenditure declining by about 5¾ percentage points of GDP two years after each of the adjustment periods. However, it is noticeable that capital expenditures bore a large bulk of the cuts, declining by some 60 percent in real terms over the decade (Table 2). Increases in social security contributions also accounted for an increase in the revenue ratio during 1982-85. The favorable composition of the overall fiscal adjustment during these two episodes—leaving aside the issue of its magnitude—is nonetheless highlighted by the substantial decline in the revenue ratio over this period as a whole. With the exception of indirect taxes, which rose by some 0.2 percentage point of GDP, all components of tax revenues declined two years after the 1987-88 adjustment period. While virtually all non-interest expenditure items were reduced over the decade of the 1980s, the adjustment was unsustained; both revenue and expenditures started increasing again in 1991, and the debt ratio resumed its upward trend following a two-year decline.

Table 9.

Belgium: Composition of Adjustment 1982-851

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Source: Data provided by the authorities and Staff calculations.

In this table, “Before” refers only to 1981, and “After” to 1986.

Table 10.

Belgium: Composition of Adjustment, 1987-88

(In percent of GDP)

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Source: Data provided by the authorities and staff calculations.
Table 11.

Belgium: Composition of Adjustment, 1993-94

(In percent of GDP)

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Source: Data provided by the authorities and staff calculations.
Table 12.

Belgium: Composition of Adjustment, 1995-96

(In percent of GDP)

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Source: Data provided by the authorities and staff calculations.

1997 (staff projection) only.

Overall, the interruption of the adjustment of the end of the 1980s cannot be ascribed to the composition of the measures that had been adopted, but rather appears to have reflected three elements:

  • the fact that the structural primary balance declined rather than rose over the latter adjustment episode;

  • the fact this was masked by the favorable effect of the business cycle on the overall fiscal balance; and

  • the inherent difficulty of sustaining an adjustment effort of this size over a lengthy period, against the background of broader political issues that also came to the fore at this time.

With regard to the nature and composition of the adjustment effort since 1993, this has, in essence, restored the control over primary expenditure that had been achieved in the 1980s. During both the 1993-94 and 1995-96 episodes, the growth of primary expenditure slowed considerably in real terms (Table 13). There were, however, striking differences between these episodes in the composition of spending and revenue changes. First, during 1993-94, the fiscal adjustment relied mainly on tax increases, with the revenue ratio rising by some 1.5 percentage point of GDP on average over the preceding period. The only component of primary expenditures that fell was non-wage public consumption, cuts in which may tend to be temporary in nature. Overall, primary expenditure was 0.8 percentage point of GDP above its 1991-92 level. By contrast, adjustment efforts since 1994, when the revenue ratio peaked, have been mainly focused on expenditure reduction. Most of the cuts in spending fell on transfer programs and non-wage public consumption, whereas on the revenue side, there was a significant decline in social security contributions.

Table 13.

Belgium: Real Expenditure Growth 1982-1996

(Cumulative percentage change in period)

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Source: Table 3.
Macroeconomic developments

Another way of assessing the quality of fiscal adjustments is through their macro-economic effects—to the extent that these can be disentangled from the impact of other factors. It is increasingly recognized that successful fiscal consolidation can be less contractionary, particularly for countries with large government debts and deficits, where consumer and business confidence might be depressed because of the fiscal problem and where financial markets may be imposing a large premium on interest rates.17 Alesina and Perotti (1995) found that in a number of fiscal adjustments where the ratio of debt to GDP was successfully set on a declining path, real GDP tended to accelerate and the unemployment rate tended to decline. Real short-term interest rates tended to fall in successful consolidation cases, but to increase in the unsuccessful cases. (Real long-term interest rates tended to decrease in both successful and unsuccessful cases, although perhaps for differing reasons.)

Some key economic indicators before, during, and in the immediate aftermath of two recent adjustment periods in Belgium are set out in Table 14. Prior to 1987, and prior to 1993, the growth rate was below the average of its main partner countries (Germany, France, and Netherlands). The 1987-88 adjustment took place in a more favorable economic environment than that of the 1990s, when the Belgium economic growth was still below the average rate of partner countries (Chart 7). Macroeconomic conditions did not noticeably improve in the following two years after the 1987-88 adjustment. Economic growth dipped below the average rate of partner countries. Both private consumption and investment grew at a rapid rate in the two years during and after the adjustment period, fueling an increase in the CPI, which stood well above the average inflation rate in partner countries two years thence. There was a decline in short and long-term interest rates during the two-year adjustment period, but they rose in the following two years and remained at high levels. The external current account improved only slightly. Following the launching of the latest fiscal initiative in 1993, the growth rate of the economy was somewhat above the average rate of partner countries in 1995-96.

Table 14.

Belgium: Macroeconomic Conditions and Fiscal Adjustment

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Source: World Economic Outlook.

1995.

Given the openness of the Belgian economy, the close integration with activity in its main trading partners, and the fact that in recent years underlying monetary conditions have reflected those prevailing throughout the core ERM, it is difficult to reach conclusive judgments about the impact of fiscal policy on economic growth. Four relevant observations can be made, however:

• One measure of the potential contribution of fiscal adjustment in Belgium to investment and the potential growth rate is the decline in the risk premium in the capital market. The long-term interest rate differential declined markedly in recent years—most notably from 100 basis points in the early 1990s to only about 10 basis points in late 1996.

CHART 7
CHART 7

BELGIUM Growth and Inflation

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: IMF, World Economic Outlook.

• A striking feature of the 1990s episode is the sharp improvement in the current account, which stood at over 5.5 percent on average during 1995-96. While the underlying causes of this large saving surplus are difficult to isolate, fiscal consolidation was a key element.18

• The output gap in Belgium was not wider than in France and Germany, on average, during the early 1990s. Both consumption and investment increased during the two-year period following the tight policy, as interest rates fell dramatically from their levels two years before the adjustment began. The output gap was, however, somewhat wider than in the Netherlands.19

• A question remains whether the saving-investment balance in Belgium is somewhat distorted by a lack of full credibility in the process of fiscal adjustment. There are two aspects to this, first a general concern about future tax levels (hence a need to save in order to smooth consumption, and a reticence about domestic investment because of uncertainty about future post-tax rates of return); and second, uncertainty about the bankability of future social security entitlements—which could lead to the government and the households both saving to meet the same future needs. (These issues, inter alia, are discussed in Section III of this paper.)

Debt dynamics

Finally, the success of a given fiscal policy can be measured by its sustainability in terms of debt dynamics. Persistent budget deficits may result in a growth path for public debt that is simply not sustainable. Debt sustainability depends on the interest rate, the growth rate of the economy, and the ratio of the primary balance to GDP.20 Table 15 shows the sustained improvements in primary balances that would be required for the net public debt ratios in the industrial countries to return from 1995 levels to their average in 1978-80. These mechanical calculations assume that interest rates and nominal GDP growth rates remain constant at their average 1993-95 levels.

Table 15.

Industrial Countries: Primary Balances and Debt

(In percent of GDP)

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Source: World Economic Outlook, May 1996.

In a strategy for reducing the public debt ratio over the medium-term, the Conseil Supérieur des Finances (CSF) noted in 1996 that a primary surplus of no less than 6 percent of GDP would be required in order to achieve a credible reduction in the public debt ratio. It argued that if kept at this level for a prolonged period, regardless of the economic cycle, it would set in motion a reverse snowball effect which would progressively reduce interest payments, the overall deficit and the debt ratio. Calculations by the National Bank of Belgium based on a nominal GDP growth rate of a little less than 5 percent and an effective interest rate of 7.5 percent (the average level of the last 10 years) also show that, if the current primary surplus of 6 percent of GDP is maintained for a prolonged period, the debt/GDP ratio would fall below 60 percent by the year 2020. It is notable that, by 1997, the structural primary surplus—excluding one-off measures—exceeded both the threshold values of 4.3 percent and 6 percent of GDP.

The current budget deficit and the debt ratio are, however, only part of the fiscal story: governments also face explicit and implicit liabilities that are likely to shape future budgetary positions, such as promises to pay public pensions and health care benefits to retirees. With the expected aging of the population, these future liabilities will considerably add to the so-called invisible debt problem.21 In light of this, reducing the debt ratio will require further substantial efforts. In a recent study of the fiscal outlook in Belgium, Delbecque and Bogaert (1994) introduced the concept of a recommended primary balance defined as the primary surplus that will lead to a more sustainable path of the debt ratio taking into account the ageing of the population. For various values of the gap between interest rates and growth rates, they derive a minimum and a recommended primary surplus in order to durably reduce the debt ratio (Table 16). While the calculations reported in Table 15 suggested that under prudent assumptions a primary surplus of 4¼ percent of GDP would be adequate, projections that take account of the ageing of the population suggest that, on prudent assumptions, a surplus of about 7½ percent of GDP by 1997 would be recommended (Table 16).

Table 16.

Belgium: Debt Sustainability with Demographic Pressures

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Source: Delbecque and Bogaert (1994).

Such projections, however, depend very much on assumptions about the extent of future social security reforms that would limit the impact of demographics on spending, and about the impact of other structural policies on employment and growth. For a discussion of longer-term trends in non-pension social spending, and various long-term fiscal scenarios, see Section IV of this paper.

In conclusion, it can be said that, over a series of adjustment episodes and some setbacks, the fiscal effort in Belgium has been sustained, has brought down interest premia, and has recently has set the debt ratio on a declining trend. This improvement in risk perceptions should be of benefit to economic performance both by encouraging investment and by directly reducing vulnerability to future shocks. The quality of the fiscal adjustment has been improved over time, overcoming a fall in the structural primary surplus in the late 1980s, a pause in overall adjustment in 1991-92, and a mainly revenue-based program in 1993-94. The next section of this paper, which focuses on trends in saving and investment, discusses possible indications that this progressive strengthening of the quality of fiscal adjustment, provided it is sustained, could help improve the prospects for economic growth and employment.

III. Trends in saving and investment, 1980-199522

Introduction

Since the early 1980s, Belgium’s current account has been steadily improving, switching from a deficit of some 4 percent of GDP in 1980 to a surplus of almost 5 percent of GDP by 1996.23 This general trend since the early 1980s notwithstanding, three rather distinct stages can be identified. Thus, during the first half of the 1980s the current account improved sharply; this trend was roughly in line with the Belgian franc’s substantial real effective depreciation, which was associated with movements of non-European currencies, notably the U.S. dollar, but also with the franc’s 1982 downward realignment within the ERM. During 1986-90, with the real effective exchange rate roughly constant, the current account surplus stabilized at some 2 percent of GDP. Finally, since 1990, the widening of the current account surplus resumed, even as the real effective exchange rate displayed an appreciating trend.

These trends have their counterpart in the paths of saving and investment during the period under consideration. In particular, while the saving rate rebounded strongly from the cyclical trough of the late 1970s and early 1980s, the rise of the investment-to-GDP ratio was much more moderate. As a result, the national saving surplus rose steadily, with both the public sector and the private sector contributing positively to this development. This section of the paper will examine a number of potential factors that could account for the above trends. Particular attention will be paid to the role of fiscal policy in affecting the private sector (mainly household) saving surplus, and to the impact of relative demand shifts on the production side of the economy and hence on the saving surplus of the business sector. In discussing this latter factor, an attempt will be made to gain some insight into the extent to which the postulated effects reflect changes in factor proportions relating to technological features of the various sectors, as well as the importance of product market distortions in depressing business investment (and possibly boosting business saving). To the extent that such distortions do indeed turn out to be important, a case can be made that there is scope for welfare-improving structural policies.

Background

Since the early 1980s, the Belgian current account has exhibited trends that diverge to a significant extent from those of the 1970s (Chart 8, upper panel). Whereas the 1970s witnessed a steady deterioration of the current account, a sharp reversal of this trend occurred since the early 1980s. Thus, the current account balance swung from a deficit of 4 percent of GDP in 1980 to a surplus of some 5 percent of GDP by 1996. Both the public and the private sector contributed to the steady current account improvement (Chart 1, lower panel). After 1981, Belgium embarked on a course of fiscal consolidation, reducing the budget deficit from some 13 percent of GDP in 1981 to a little over 3 percent of GDP by 1996. While part of the load of the consolidation process was borne by public investment and capital transfers, the current budget balance also improved, so that government dissaving fell by some 6 percentage points of GDP during this period.

CHART 8
CHART 8

BELGIUM External Indicators and Saving Surpluses

(In Percent of GDP)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: National Accounts.

On the private sector side, the household saving surplus, while exhibiting some fluctuations, did not display any marked trend during the period under consideration. In all, and despite the substantial fiscal consolidation since the early 1980s, the household saving surplus was on average at around its level of the 1970s. On the other hand, the corporate saving balance exhibited a strong upward trend during this period, switching from a substantial deficit throughout the 1970s to a surplus during most of the period since the early 1980s, as both its saving and investment components behaved quite differently relative to the 1970s (Chart 9). Thus, improved business profitability has led to a substantial increase in corporate saving since 1980. By comparison, the recovery of business investment was much more moderate: business investment did not start rising until 1987, and remained significantly below business saving during most of the period under discussion. As a result, the ratio of business investment to business saving fell from some 160 percent in 1980 to around 80 percent in 1987, before rising somewhat to around 95 percent by 1995.

The stylized trends discussed above point to two rather puzzling questions, which are the main focus of this chapter. In the first place, what could account for the very limited impact of the substantial fiscal consolidation since the early 1980s on household saving behavior? Second, what factors could explain the very asymmetric recovery of business saving and business investment during the same period?

CHART 9
CHART 9

BELGIUM Corporate Saving and Investment

(In Percent)

Citation: IMF Staff Country Reports 1997, 008; 10.5089/9781451803068.002.A001

Source: National Accounts.

The role of fiscal policy

The discussion that follows examines the impact of fiscal policy on the saving-investment balance and the current account. In principle, the fact that fiscal adjustment on a scale experienced by Belgium since the early 1980s would be accompanied by an improvement of the external current account should not be surprising. While “Ricardian equivalence” models of the Barro (1974) type suggest that an increase in government saving, by lowering the expected future tax burden in economic agents’ intertemporal budget constraints, should be fully offset by a decrease in the private saving rate, leaving the external current account unchanged, this postulated “full offset” has been consistently rejected on empirical grounds. On the other hand, research on this question has confirmed the existence of a partial offset, with the estimated offset coefficient in the range of 50 to 60 percent for most industrial countries, implying that an increase in government saving by 1 percent of GDP tends to be accompanied by a reduction in private saving of the order of ½ percent of GDP.24

While the qualitative direction of the impact of deficit reduction on the current account since the early 1980s for the case of Belgium is therefore broadly in line with the empirical findings for other industrial countries, what does appear surprising is the magnitude of the effect. To form a quantitative assessment of the problem at hand, one approach is to regress the current account as a percent of GDP (CURRACC) on the government saving surplus as a percent of GDP (SAVSURPUB) over the period 1970-1994. The estimation results are as follows (t-statistics in parenthesis):

Period: 1970-1994
CURRACC=3.519+0.511 SAVSURPUB(3.30)(3.10)R2SE=2.032F(1.23)=9.6DW=1.3

The estimation results suggest that the coefficient of the government saving surplus variable is positive and statistically significant at conventional significance levels, implying that an increase in the government saving surplus indeed results in an improvement in the current account. With regard to the magnitude of the effect, the results suggest that an increase in the government saving surplus by 1 percent of GDP can be expected to result in a widening of the current account surplus (or a reduction of the current account deficit) by 0.51 percent of GDP, very much in line with the findings for other industrial countries.

On the other hand, restricting the sample period changes the picture considerably. We present below the estimation results of the same equation for the period 1980-1994 (t-statistics in parenthesis):

Period: 1980-1994
CURRACC=7.707+0.990SAVSURPUB(3.76)(3.67)R2=0.51SE=1.913F(1.13)=13.5DW=1.7

The estimation results over the later sub-period point to a coefficient of the government saving surplus variable virtually identical to 1, implying a one-to-one relationship between deficit reduction and external current account improvement. Moreover, the estimated constant term for the 1980-1994 sub-period is significantly higher than that estimated over the 1970-1994 period as a whole, implying that, for the same level of the government deficit, one would expect a higher current account surplus in the later sub-period.

The point made above can be illustrated in entirely equivalent terms by regressing the private sector saving surplus, again as a share of GDP, SAVSURPR, on SAVSURPUB.25 The estimation results are as follows (t-statistics in parenthesis):

Period: 1970-1996
SAVSURPR=3.519+0.489SAVSURPUB(3.30)(2.96)R2=0.28SE=2.032F(1,23)=8.7DW=1.3
Period: 1980-1994
SAVSURPR=7.707+0.012SAVSURPUB(3.76)(0.04)R2=0.00SE=1.914F(1,13)=0.0DW=1.7

The results in this specification suggest that, whereas in the full period an increase in the government saving surplus is estimated to be offset by 49 percent by a reduction in the private sector saving surplus, in the 1980-1994 sub-period an increase in the government saving surplus receives no offset from the private saving surplus—the relevant coefficient is virtually zero and statistically insignificant. In fact, over the later sub-period, it turns out that the government sector saving surplus has no explanatory power whatsoever with regard to the private sector saving surplus.

The estimation results presented above point to a major asymmetry as regards the response of private saving to fiscal policy between different sub-periods. Specifically, whereas the usual (partial) Ricardian offset can be documented for the 1970s—a period of substantial fiscal expansion, such an effect appears totally absent since the early 1980s—a period of substantial fiscal contraction. Thus, it would appear that, at least for a major part of the fiscal consolidation period, deficit reduction did not lead economic agents to appreciably revise their intertemporal budget constraint, and hence adjust their saving behavior. This in turn raises the question of whether certain aspects of fiscal policy may have rendered fiscal consolidation less than fully credible during (at least part of) the period since the early 1980s. In what follows, an attempt will be made to formulate certain hypotheses regarding some fiscal policy features of this type, as well as to test their empirical relevance.

The evolution of some of the major fiscal variables during the fiscal consolidation period was illustrated in Chart 1. As the chart makes clear, while deficit reduction was consistently pursued throughout this period, the composition of the fiscal adjustment varied considerably.26 In the first place, during a large part of the period under consideration, fiscal consolidation relied mainly on revenue increases, rather than current expenditure reductions. This failure to bring expenditure under control may have kept private agents’ expectations of their future tax burden at a high level, as the government’s intertemporal budget constraint is essentially driven by the path of public sector expenditure. This factor may have become more pertinent in the specific case of Belgium, in view of its already very high revenue ratio and the prospect of increased tax competition in the context of the EU single market: in this setting, the persistence of a high expenditure-to-GDP ratio may have raised the perceived likelihood of an abandonment of fiscal consolidation in the short-term, thus further raising expected future tax liabilities. Under these conditions, private agents with a sufficiently long horizon may have been induced to keep their saving rate high, the steady deficit reduction notwithstanding.

Casual inspection of the trends depicted in Chart 1 would suggest that these considerations could indeed be empirically relevant. Thus, during the first half of the 1980s (the period of the sharpest reduction of the budget deficit), as government expenditure remained high as a share of GDP, deficit reduction appears to have resulted into a virtually one-for-one improvement of the external current account balance. On the other hand, with the expenditure ratio entering a firm downward path in the second half of the decade, the current account virtually stabilized, suggesting a much higher degree of offset to the increase in government saving by private sector saving. Finally, with the expenditure ratio entering a renewed upward path during 1990-93, the current account surplus once again widened sharply.

Second, and somewhat related, the unchecked growth of social security transfers could have raised doubts about their sustainability. This would have been more pronounced with regard to those areas of social security that are particularly sensitive to demographic developments, notably pensions, in view of the projected aging of the population during the first half of the next century.27 Doubts over the ability of the government to satisfy in full its pension obligations in the future may have created a precautionary motive for saving on the part of the private sector.

Third, the substantial pile-up of government debt during the period under consideration, and the concomitant rise in the ratio of interest expenditure to GDP, could also be a relevant factor accounting for the negligible private sector offset to the increase in government saving. On the one hand, the increase in the share of government revenue effectively earmarked to the servicing of government debt could have underscored the perception on the part of private economic agents of likely higher tax liabilities in the future, implying little change in their intertemporal budget constraint and hence their saving behavior. In addition, the rising share of interest payments in GDP could have entailed a substantial shift in the patterns of income distribution.28 To the extent that government paper is predominantly held by upper-income households, with a higher propensity to save, such a redistribution of disposable income in their favor may have raised the overall private saving rate relative to what it would otherwise have been. Once again, the trends depicted in Chart 1 would suggest that these considerations may indeed be empirically relevant, with near-zero private sector offset to increases in government saving coinciding with periods of rapid debt accumulation.

Some of the hypotheses developed above are tested empirically below. It should be emphasized at the outset that