Executive summary 1

1. Scene setter: economic situation and outlook 1

2. Imbalances, risks and adjustment 7

2.1. Cost competitiveness 8

2.2. Non-cost competitiveness 18

2.3. Public indebtedness 26

2.4. Household indebtedness and the housing market 33

3. Other structural issues 43

3.1. Labour market and education 44

3.2. Taxation and fiscal framework 53

3.3. Service and product markets 59

3.4. Greening the economy 63

AA. Overview Table 65

AB. Standard Tables 76

LIST OF Tables

1.1. Macroeconomic Imbalance Procedure: scoreboard 5

2.1.1. Share of total final gas consumption 15

2.1.2. Share of total final electricity consumption 15

2.2.1. Manufacturing exports by type (%) 19

2.4.1. Financial burden indicators — median ratios (in %) 38

3.1.1. Tax wedge 45

AB.1. Macroeconomic indicators 76

AB.2. Financial market indicators 77

AB.3. Taxation indicators 78

AB.4. Labour market and social indicators 79

AB.5. Expenditure on social protection benefits (% of GDP) 80

AB.6. Product market performance and policy indicators 81

AB.7. Green growth 82

LIST OF Graphs

1.1. Real GDP growth and contributions 1

1.2. Inflation (y/y %change) 1

1.3. Labour market indicators 2

1.4. Current account balance (%GDP) 3

1.5. Export market shares: evolution and breakdown 3

1.6. Net international investment position (NIIP, %GDP) 3

1.7. Net lending/borrowing by sector (%GDP) 4

2.1.1. Real effective exchange rate (100 = EA18 2005) 8

2.1.2. Hourly labour cost evolution in the business sector 8

2.1.3. Hourly labour cost levels (2013; EUR) 9

2.1.4. Development of unit labour costs (2000 = 100, total economy) 10

2.1.5. Productivity and wage evolution (2009 = 100) 11

2.1.6. HICP (annual % change) 13

2.1.7. Total electricity prices for base load profile of 500 GWh 16

2.1.8. Breakdown of gross manufactured exports by value added (% of total, 2009) 16

2.1.9. Forward linkages and productivity growth of the Belgian service sectors 17

2.2.1. Breakdown of potential growth 18

2.2.2. Global value chain participation index (%) 19

2.2.3. Quality rank of export products 20

2.2.4. R&D intensity (%GDP) 21

2.2.5. Rate of company start-ups (%, avg 2008-12) 23

2.3.1. Public debt (% of GDP) - Comparison between 2014 and 2015 vintage of the EC winter forecast 26

2.3.2. Contributions to the change in the gross debt ratio (pps. of GDP) 26

2.3.3. Interest expenditure and implicit interest rate 27

2.3.4. Maturing debt of central government (% of total outstanding central government debt) 27

2.3.5. Recent evolution of annual yields on Belgian debt instruments (%) 28

2.3.6. Spread of selected government bonds vis-à-vis German bunds 28

2.3.7. Share of Belgian bonds in total euro area bond holdings by Belgian banks (%) 29

2.3.8. Projections of gross debt (% of GDP) 29

2.3.9. Consolidated gross debt – breakdown between government subsectors (% of GDP) 30

2.3.10. Net financial assets/liabilities by sector (ESA2010) 31

2.3.11. Debt of non-financial corporations (% of GDP): BE versus EA, ESA95 versus ESA2010 31

2.4.1. Evolution of house price index and loans for house purchase 33

2.4.2. Real house price index — selected countries 33

2.4.3. Price responsiveness of housing supply 34

2.4.4. Developments in the average amount of new mortgage loans and aggregate loan-to-value ratio (in EUR 1 000) 35

2.4.5. Household debt 36

2.4.6. Non-performing loans 36

2.4.7. Household debt indicators 37

2.4.8. Percentage of households holding debt by income 38

2.4.9. Price-to-rent and price-to-income ratio 39

2.4.10. Increase in rentals and % of tenants 40

2.4.11. Overvaluation gap with respect to main supply and demand fundamentals 40

2.4.12. Credit constraints (2010) 41

2.4.13. Average price/m² of a 120 m² apartment located in the capital (in EUR, end 2012) 41

2.4.14. Demographic evolution per age cohort 2000-2060 (thousands of people) 42

3.1.1. Employment and activity rate (%, 20-64y) 44

3.1.2. Regional employment and unemployment rates (%, total labour population) 44

3.1.3. Unemployment trap (when taking up work at previous wage level, 2013) 46

3.2.1. Decomposition of the implicit tax rate on labour (2012) 53

3.2.2. Decomposition of the implicit tax rate on consumption (2012) 53

3.2.3. Environmental taxation (2012, % of GDP) 55

3.3.1. 'Churn' rate: professional, scientific and technical activities (avg 2008-11) 59

3.3.2. 'Churn' rate: retail (average 2008-11) 60

3.3.3. Electricity prices for residential consumers (all taxes and levies included) 62

3.4.1. Remaining gap to 2020 reduction target for non-ETS greenhouse gas emissions 63

LIST OF Boxes

1.1. Economic surveillance process 5

2.1.1. Performance of manufacturing activities 12

2.2.1. Adequacy of public infrastructure 24

3.1.1. Net increase in disposable income when entering into work 47

3.3.1. Security of energy supply 61

LIST OF Maps

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The Belgian economy strengthened in 2014 though years of stagnating activity have left their mark. Belgium has entered a slow-moving recovery with GDP growth expected to accelerate from 1% in 2014 to 1.4% in 2016 thanks to company investments and external trade. The unemployment rate is projected to decrease from a ten-year high of 8.5% last year to 8.1% in 2016 as job creation in the private sector picks up. The rising trend of public debt is expected to be halted with debt stabilising at around 107% of GDP in 2016, but debt reduction is hampered by low growth and inflation. The latter has fallen back to around zero and is forecast to increase gradually from the second half of 2015.

This Country Report assesses the Belgian economy against the background of the Commission's Annual Growth Survey. The latter recommends three main pillars for the EU's economic and social policy in 2015: investment, structural reforms, and fiscal responsibility. In line with the Investment Plan for Europe, it also explores ways to maximise the impact of public resources and unlock private investment. Finally, it assesses Belgium in the light of the findings of the 2015 Alert Mechanism Report, in which the Commission found it useful to further examine the persistence of imbalances or their unwinding. The main findings of the In-Depth Review contained in this Country Report are as follows:

· While the loss of external competitiveness incurred continues to pose macroeconomic risks for the Belgian economy, the magni­tude of these risks has decreased. Regarding cost parameters, corrective measures have started narrowing the labour cost gap. Closing it entirely will require additional action and preventing new gaps from emerging hinges on reforms of the wage bargaining system. Energy input costs are found to saddle large industrial users with a competitive disadvantage as well. Scope for improving the non-cost dimension of external competitiveness is considerable, with Belgium not performing particularly strongly with respect to innovation output.

· Public debt remains high but several factors temper associated macroeconomic risks. On the one hand, vulnerability stems from the reduced room to absorb future shocks. Sizeable, though decreasing, contingent liabili­ties related to financial sector guarantees and high domestic debt ownership imply important feedback loops. On the other hand, medium-term sustainability risks appear more manage­able given low financing costs, the resumption of primary surpluses and the relati­vely long average maturity of the debt stock. The strong financial position of Belgian house­holds is a particularly important factor. Despite the high public debt, the Belgian economy continues to enjoy a very positive net asset position so that, overall, short to medium term risks are contained. This is also in line with the track record in the recent and more distant past.

· Macroeconomic risks stemming from the interplay between household debt, the financial sector and a potential correction of housing prices are found to be moderate and expected to be manageable. Robust household balance sheets, high ownership rates, housing shortages, reasonable affordabil­ity, and demo­graphic projections are likely to prevent an abrupt housing price decline. The impact on banks of potential downward price adjustments or adverse income shocks should be limited thanks to sound lending standards.

The country report also analyses other macro­economic and structural issues and the main findings are as follows:

· Structural problems characterising the Belgian labour market result in a chronic underutilisation of labour with a low aggre­gate employment rate. Shortcomings are related to labour taxation and financial disin­centives, educational outcomes and qualifica­tion mismatches, the wage-setting system, labour shortages, and old-age social security systems. Both young and elderly workers face important barriers to entry. People from migrant back­grounds are in a particularly precarious position.

· The Belgian tax system is characterised by a high overall burden and by relatively high rates and narrow tax bases. The tax burden is heavily skewed towards labour. This results in high labour costs, which discourage job crea­tion, and large tax wedges, which contribute to remaining unemployment traps. Certain features of the tax system are environmentally harmful.

· Competition in several key service sectors remains low. This affects the wider economy given that they supply important inputs. Furthermore, the precarious security of energy supply might persist as a result of inadequate domestic generation capa­city, the nuclear phase-out, a rising proportion of intermittent power and the low spare import capacity. There appears to be ample scope to improve public infra­structure through higher investments.

In a letter sent to the Commission in November 2014, the Belgian authorities committed to a number of structural reforms implementing the country-specific recommendations issued by the Council in July 2014. These structural reforms were further specified in two reports sent on 30 January 2015 and 13 February 2015.

Overall, Belgium has made some progress in addressing the 2014 country-specific recom­mendations. Substantial progress was made in the area of pension reforms, with measures taken to narrow the gap between the effective and the statutory retirement age, as well as the intention to increase the latter in the longer term. Some progress was made towards restoring competitive­ness with corrective measures adopted to narrow the relative labour cost gap and first steps taken to reform the wage-setting system. Some progress was made on the employment challenges with policy responses the least developed with respect to increasing labour market access and participa­tion for disadvantaged groups. At the same time, limited progress has been made towards a comprehensive tax reform entailing in particular a clear shift from labour towards less growth-distorting tax bases. There has also been limited progress on the functioning of retail markets and deregulation of professional ser­vices. On the recommendation to ensure that greenhouse gas reduction targets are met, progress is considered limited in the absence of an inter­governmental agreement on the distribution of efforts and auctioning revenues. Finally, progress to align the contribution of transport with the objective of reducing road congestion was limited.

The Country Report reveals policy challenges stemming from the analysis.

· Sustained consolidation efforts would be instrumental in reducing risks resulting from public indebtedness. To offset the budge­tary impact of an ageing population, a success­ful consolidation strategy depends on the swift implementation of planned pension reforms, as well as other reforms to lift economic growth.

· Pursuing tax reforms aimed among other things at rebalancing the tax system towards non-labour tax bases would promote the further unwinding of the competitiveness imbalance. Tax bases with scope for broadening include, among others, envi­ronmental and consumption taxes, certain types of financial income, and recurrent property taxation. In addition, efforts to make wage formation more responsive to the business cycle and productivity evolutions would ease the impact on job creation.

· A stronger perfor­mance on innovation and R&D valorisation could improve the non-cost dimension of competitiveness. The same holds for reducing red tape and administrative barriers, and tackling rigidities affecting product, service and the labour market. This would also strengthen the investment climate.

· Efforts to lift employment would be helped by preventing early school leaving and a reduction of inequalities of education­al outcomes. In view of the low labour market participation of the young and people with a migrant background, the timely provision of customised activation trajectories remains crucial. Policies to promote active ageing and increase demand for elderly labour would assist measures to reduce early exit possibili­ties.

· Eliminating infrastructure bottle­necks and improving the quality and adequacy of the capital stock would strengthen overall eco­nomic performance. Particular attention could be paid to transport and to preventing disruptions to the energy supply by enhancing grid intercon­nectivity and domestic generation capacity.

Economic growth: recovering but unable to reconnect with pre-crisis levels

The Belgian economy took a turn for the better in 2014 though several years of stagnating activity have left their mark. Growth reached 1% in 2014 on the back of company investments and net external trade. Despite several favourable factors, such as energy price dynamics and external demand, growth is projected to accelerate only moderately, reaching 1.1% in 2015 and 1.4% in 2016. Belgium has entered what appears to be a slow-moving recovery with growth considerably below pre-crisis levels. The same applies to the potential growth rate, with the structural growth capacity of the Belgian economy seemingly impacted by the recent crisis. Contributions from productivity, in particular, have faltered, highlighting the impact of certain structural bottlenecks discussed later in this document.

Graph 1.1: Real GDP growth and contributions

Source: European Commission

Belgian companies are expected to contribute significantly to overall growth in 2016. This reflects mainly the initial effects of measures to restore cost competitiveness discussed in section 2.1. Their effect should be compounded by the further easing of already soft financing conditions, relatively low energy prices and accelerating external demand. In parallel, export performance is set to improve.

Company investments and net external trade would compensate for slowing household consumption. The latter has traditionally been an important contributor to GDP growth, a reflection of the high income level the country has attained. Continued strong wage growth given high inflation supported private consumption throughout the crisis. However, this also resulted in a further deterioration of external cost competi­tiveness, prompting the Belgian authorities to pursue wage moderation policies. This moderation has been confirmed by the new government, resulting in a protracted period of low wage growth. While current low inflation partly offsets the effects of low income growth, private consumption growth is expected to slow down from next year.

Furthermore, household investment is expected to show modest growth rates in future. Before 2008 the private housing market performed strongly for several years, partly due to supportive fiscal measures. Investment in homes contracted on average in 2008-13. Overall, house prices rose by about 50% in real terms in 2000-08, but did not see a significant price correction as they remained broadly stable. The housing market is looked at in depth in section 2.4.

Graph 1.2: Inflation (y/y %change)

Source: European Commission

Inflation: gradual rebound in the course of 2015 after going into negative territory

Price pressures have been abating since 2012. Sharper competition on domestic energy markets as well as wage moderation were the initial drivers. Over the past year a VAT reduction and falling international energy prices added to the downward pressure. As a result, headline inflation fell back to zero at the end of 2014 though core inflation was still well above 1%.

This downward trend is set to continue with inflation turning negative in the first half of 2015. As the substantial downward pressure from energy items fades, a slow uptick is forecast for the second half of 2015. Overall, the general price level is expected to rise by just 0.1% in 2015. At 1.1%, it is estimated that price pressures will remain muted in 2016: prices for most components are expected to experience an extended slowdown due to timid economic activity, stagnant wage growth and international price developments.

Labour market: cyclical improvement but lasting structural issues

The slow-moving recovery and the legacy of a prolonged crisis make for a muted labour market turnaround. Prior to 2008, the Belgian unemployment rate compared favourably with the euro area average as well as with the rates observed in most neighbouring countries. Since the outbreak of the crisis, it has crept up to reach a ten-year high of 8.5% last year. As job creation in the private sector picks up, unemployment is expected to decrease to 8.1% in 2016. All the while, vacancy rates have remained comparatively high, suggesting matching issues. Furthermore, a high proportion of the population of working age has pulled out of the labour market entirely, as reflected in a low activity rate, in particular for older workers. The various bottlenecks in the Belgian labour market are probably the country’s deepest-rooted challenge. They are analysed in more detail in section 3.1.

High labour taxation is one of the issues in play. As well as the perverse effects it has on external competitiveness and employment, high marginal rates also discourage people from working, or working more. Taxation in general is looked at in section 3.2. Shifting taxation away from labour — one of the Council recommendations to Belgium for several years — has been a major point of discussion on the Belgian political stage of late.

Graph 1.3: Labour market indicators

Source: European Commission

Current account: returning to surplus despite continuing goods balance deficit

Until 2007 Belgium saw a steady decline in its long-running current account surplus. The main driver was the trade balance, with a narrowing goods balance only partially offset by a rising services surplus. The latter has been fairly stable in recent years at about 2% of GDP. Terms of trade losses due to rising commodity prices and export volume growth being outpaced by import growth were behind the constant worsening of the goods balance. The deterioration accelerated in 2008 and the goods trade balance has been in deficit since.

Recent developments have been more encouraging, with the current account balanced in 2013 and expected to have recorded a surplus in 2014. This shift has its origin mainly in the capital income balance, which in 2013 recorded its highest surplus since 2000 ([1]) and appears to have strengthened further since. To some extent, this reflects a cyclical event resulting from strong gains in financial markets. Yet, the goods balance has also staged an improvement in recent years: from a deficit of almost 3% of GDP in 2011-12 to an estimated deficit of 1.5% in 2014. Whether this heralds a trend reversal needs further confirmation, given the important contribution of price changes as well.

Graph 1.4: Current account balance (%GDP)

- BPM5 methodology until 2007, BPM6 thereafter - 2014: 4Q-2013/3Q-2014 Source: European Commission

The tentative improvement in external performance is also evident in the export market shares. Over the longer term, services have on average delivered a small positive contribution while goods were generally unable to keep pace with global export growth. Substantial losses in export market share in 2010-12 were followed by a gain in 2013. This was the first since 2009, and the largest in many years. Nevertheless, over time Belgium’s share of export markets has suffered a large drop. The dual trend of dwindling export market shares and a weakening current account balance has been pointing to weakness in its ability to compete. Belgium’s external competitiveness is examined closer in sections 2.1 and 2.2. These sections build on findings from previous In-Depth Reviews and try to see whether the recent apparent improvement in external performance can be linked to recent developments in cost and non-cost competitiveness.

Graph 1.5: Export market shares: evolution and breakdown

Source: European Commission

Graph 1.6: Net international investment position (NIIP, %GDP)

Source: European Commission

Overall external position: still very strong

The external sustainability of the Belgian economy is considered robust given its very positive net international investment position (NIIP). The 'NIIP' reflects the balance between external financial assets and liabilities. It has been stable at around 45-50% of GDP. Whereas the current account balance equals flows, the NIIP can be interpreted as the stock indicator of a country’s external position. Considering the accumulated net external assets, this means that Belgium could afford a modest current account deficit without jeopardising overall external sustainability.

While external sustainability does not seem to be at risk, a closer look at the net international investment position reveals that internal balances are nevertheless affected. The strongly positive NIIP reflects the creditor status of the private sector, which broadly offsets the structural debtor position of the public sector. The crisis years shifted the external lending position of the overall economy from a steady surplus towards a broadly balanced position. This is in line with what has been observed for the current account balance.

Graph 1.7: Net lending/borrowing by sector (%GDP)

Source: European Commission (ESA2010)

Public finances: increase to be halted following narrowing of fiscal deficit

The high public debt has been a constant feature of the Belgian economy in recent decades. The long effort to reduce debt stopped in 2008 when the authorities were forced to support several failing financial institutions and the economic crisis pushed public finances into the red. The deficit hit a high of 5.5% of GDP in 2009. It fell to 2.9% in 2013 but is estimated to have widened again to 3.2% in 2014 on the back of looser fiscal policy and disappointing revenue growth. In 2015 and 2016 the fiscal deficit is expected to narrow again, falling back to 2.6% and 2.4% of GDP respectively, according to the latest Commission forecast. This reflects consolidation measures recently taken at all levels of government.

The debt level rose from 86.9% of GDP in 2007 to around 106% in 2014. With still weak nominal growth in 2015 unlikely to offset the impact of further deficit accumulation and stock-flow adjustment, Belgium’s debt is projected to hit almost 107% of GDP, before stabilising in 2016. In addition, contingent liabilities related to guarantees to the financial sector remain not inconsiderable. They have been decreasing steadily but risks are concentrated on one single entity, worth 9.4% of GDP at the end of 2014. Public debt and its implications for the overall macroeconomic stability of the Belgian economy will be discussed in section 2.3.

Box 1.1: Economic surveillance process The Commission’s Annual Growth Survey, adopted in November 2014, marked the start of the 2015 European Semester, proposing that the EU pursues an integrated approach to economic policy built around three main pillars: boosting investment, accelerating structural reforms and pursuing responsible growth-friendly fiscal consolidation. The Annual Growth Survey also proposed streamlining the European Semester to increase the effectiveness of economic policy coordination at the EU level through greater accountability and by encouraging greater ownership by all actors. In line with streamlining efforts this Country Report includes an In-Depth Review — as per Article 5 of Regulation no. 1176/2011 — to determine whether macroeconomic imbalances still exist, as announced in the Commission’s Alert Mechanism Report published in November 2014. Based on the In-Depth Review of Belgium published in March 2014, the Commission concluded that the country was experiencing macroeconomic imbalances requiring monitoring and policy action. In particular, developments with regard to the external competitiveness of goods continued to deserve attention as a persistent deterioration would threaten macroeconomic stability. This Country Report includes an assessment of progress towards the implementation of the 2014 Country-Specific Recommendations adopted by the Council in July 2014. The Country-Specific Recommendations for Belgium concerned the correction of public finances, tax reform, the long-term impact of ageing costs, labour market reforms, competitiveness measures and greenhouse gas emissions.

Table 1.1: Macroeconomic Imbalance Procedure: scoreboard

Notes: (1) Figures highlighted are those falling outside the threshold established in the European Commission's Alert Mechanism Report. For REER and ULC, the first threshold applies to euro area Member States. (2) Figures in italics are calculated according to the old standards (ESA95/BPM5). (3) Export market share data: total world exports are based on the fifth edition of the Balance of Payments Manual (BPM5). Source: European Commission

Table 1.2: Key economic, financial and social indicators

(1) Domestic banking groups and stand-alone banks. (2) Domestic banking groups and stand-alone banks, foreign-controlled (EU and non-EU) subsidiaries and branches. (3) Real effective exchange rate (*) Indicates BPM5 and/or ESA95 Source: Commission, 2015 winter forecast; ECB

Belgium's real effective exchange rate (REER) has been appreciating over the past decade (see Graph 2.1.1). This trend points to a loss in cost competitiveness relative to other euro area Member States. The REER deflated by unit labour costs has appreciated the most, suggesting that the loss can be traced back at least partly to unfavourable labour cost dynamics. However, measurements based on broader price deflators have also been appreciating over the years. On the basis of the REER developments, the loss in cost competitiveness relative to euro area peers appears still limited, at up to 5% over the past decade. However, within the context of a currency union it is crucial to avoid a structural underperformance relative to fellow members. The build-up of a cost disadvantage comes with job losses and will even­tually provoke a correction if left unaddressed. The following sections look into developments in the main cost factors for most companies: labour costs, energy costs, and the cost of intermediate service inputs. Policy measures to address the underlying problems are discussed as well.

Graph 2.1.1: Real effective exchange rate (100 = EA18 2005)

Source: European Commission

Labour cost

Belgian labour costs have on average outpaced those in neighbouring countries (see Graph 2.1.2). This is despite the coordinated, top-down wage-setting mechanism, discussed below. Wages grew especially fast between 2009 and 2011, when the inflation differential with neighbouring countries was particularly high.

Graph 2.1.2: Hourly labour cost evolution in the business sector

Source: European Commission

The fast growth rate added to the country's already high labour cost level. In 2013, Belgium's hourly labour costs were the third highest among EU Member States for the total economy and the second highest for industry (see Graph 2.1.3). The difference mostly reflects Belgium's high social security charges on labour, which add to the large tax wedge discussed in section 3.1. It also underscores the importance of a broad-based tax shift towards non-labour tax bases, as discussed in section 3.2.

While labour cost levels need to be analysed in function of productivity and composition of economic activity, absolute levels have an important signal function for international investors. Multinational manufacturing companies compare the labour costs of (prospective) plants across countries with comparable productivity levels. This is reflected in developments in the Belgian automobile industry, which has suffered substantial job losses over the years, often to other European plants located in countries that cannot be considered to be low-cost producers. This points to the generalised problem of high labour costs for the Belgian economy, with also higher-skilled, highly productive jobs being jeopardised.

Graph 2.1.3: Hourly labour cost levels (2013; EUR)

* 2012 data for NL industry; Including those wage subsidies granted through the withholding tax, such as for shift labour, researchers and the general reduction. Source: European Commission

The wage-setting framework

An important part of total wage growth is due to the practice of automatic wage indexation. Wages in Belgium are commonly adjusted for inflation in a mechanical way through indexation clauses in sectoral collective bargaining agree­ments. The almost universal applicability of some form of indexation introduces a degree of solida­rity between stronger and weaker sectors and helps to assure social stability. However, at the same time it dilutes the signalling role of relative wages, which risks resulting in avoidable job destruction. Wages in countries where the practice of automatic wage indexation is less widespread are also adjusted to rising prices, though in a less mechanical way so that labour market and business cyclical elements can be factored into wage negotiations. This allows temporary shocks to be partly absorbed through real wage reductions rather than permanent job losses.

Higher price pressures have led to fast wage growth, with the wages of nearly all workers being automatically adjusted for inflation. In turn, this has exerted upward pressure through the creation of ‘second round’ effects, not least because of the widespread practice of indexing prices, especially in less competitive sectors. Furthermore, projections for wage growth prompted by wage indexation have generally been underestimated when setting the margin for real wage growth. Real wage increases in Belgium result from a stepwise process, starting at the national level with social partners negotiating every two year an ‘interprofessional’ agreement (IPA). One element of the intersectoral IPA is the wage norm, the maximum increase in hourly wages that can be granted during subsequent collective bargaining at lower levels, in particular at the sectoral level.

The national wage norm introduces a high degree of coordination among sectors, which is further enhanced by other national standards, e.g. on minimum wages, which set the boundaries for negotiations between the social partners at lower levels. This macroeconomic wage policy is based on the 'Law of 1996', which was introduced to safeguard the cost competitiveness of the Belgian economy. To that end, the ex-ante margin for wage growth is set on the basis of the projected development of hourly labour costs in Germany, France and the Netherlands. Adjustments for inflation and automatic wage scale increases fall outside the scope of the law, and are guaranteed on the basis of what was decided in the applicable collective bargaining agreements.

In case social partners fail to come to a comprehensive agreement, the federal government can decide to step in, as it has done in recent IPAs. To facilitate agreement, authorities have often made the precise apportionment of reductions in social security contributions and increases in wage subsidies and social allowances the subject of negotiations between social partners. As budgetary room for manoeuvre has continued to narrow, it has become increasingly difficult for the federal government to play this role of 'midwife' in the negotiations between the social partners. Discussions at the national level have become less successful, with negotiations on the IPAs covering 2011-12 and 2013-14 failing. This has led the government to intervene more directly, giving wage bargaining a more centralised character than before.

With hindsight, consecutive wage norms have been largely respected but were set too high. Underlying assumptions resulted in over-optimistic margins for real wage increases, for which no corrections were made afterwards. Growth in hourly labour costs in the three reference countries has been repeatedly overesti­mated. The wage cost differential this has created has become entrenched as the ex-post verification of follow-up and the appropriateness of the ex-ante wage norm has failed. Indeed, the correction mechanisms provided for in the Law of 1996, with wage overruns under the previous wage norm being compensated under the next one, have never been applied in practice. This was due to lack of consensus between the social partners and within the government, and to the fact that guaranteed wage increases (indexation and wage scales) largely ate up the room for correcting excessive past wage growth. Maintaining the use of a macroeconomic wage norm thus requires basing the norm on actual wage changes in neighbouring countries or more adequate ex-post correction mechanisms to compensate for the difference between projected and effective hourly labour cost developments in the reference countries.

Another major shortcoming of the wage-setting system is its disconnection from domestic productivity developments, which are not considered when determining the wage norm ([2]). In principle, a faster rise in hourly labour costs can be justified if productivity growth is also greater than in competing countries. However, productivity gains in Belgium have been modest. This is made clear by the development of unit labour costs (ULC). These reflect the cost of labour inputs to productivity developments.

Graph 2.1.4: Development of unit labour costs (2000 = 100, total economy)

Source: European Commission, OECD

As illustrated in Graphs 2.1.4 and 2.1.5, the gap between Belgian ULC and the weighted average of ULC in neighbouring countries has widened consistently over the past decade. As shown, this is due both to a slowdown in relative productivity gains (compared with the reference countries) and to faster increases in hourly labour costs. This naturally affects the export performance of the Belgian economy since, together with non-cost elements such as quality, unit labour costs determine the ability of Belgian companies to compete internationally. Whereas the graph shows aggregate data for the entire Belgian economy, the rise in ULC has been particularly steep in manufacturing industries ([3]) according to a 2013 report ([4]). Factors driving overall productivity are looked at in more detail in section 2.2. However, but it can already be highlighted that, when contemplating ways to improve the situation, attention will have to be paid both to stagnating productivity and the increasing wage costs.

Graph 2.1.5: Productivity and wage evolution (2009 = 100)

Source: European Commission

As the wage norm is based on hourly labour costs in the neighbouring countries, Belgian labour costs are indirectly linked to producti­vity developments in these countries. Introducing a link with domestic productivity trends would better align wage cost with the goal of preserving employment. Productivity levels in Belgium are generally high and thus compensate to some extent for high labour costs. However, this positive aggregate picture disguises important differences in performance between sectors and asymmetries between companies within the same sector ([5]).

Furthermore, high labour costs appear to have led to fast capital deepening in manufactu­ring, contributing to the high level of productivity. Strong increases in labour costs create incentives for companies to introduce more capital intensive production methods, which mitigate the impact on unit labour costs but reduce labour demand. This results in job losses for low- to medium-skilled labour, which in turn harbours problems for the sustainability of the social model. This process of capital intensification has its limits, though, as it is subject to the pace of technological progress and has already reached a high level . Also, if other countries pursue strong wage moderation policies, as some did prior to and in the wake of the crisis, this results in a fast deterioration in external competitiveness.

Seniority-based wage growth also contributes to the general problem of decoupling of productivity and wage developments. Most collective bargaining agreements covering white-collar workers include seniority-based wage scales, with seniority used as an imperfect proxy for individual productivity developments. However, productivity generally slows down at some point during one's career as the marginal return on acquired experience declines ([6]). Among other factors, seniority-based compensation also contri­butes to the low employment rate for workers above 55 (see section 3.1) as it inhibits mobility and deters timely job-switching by pushing up the reservation wage, which in turn hurts employment prospects. The federal government has announced that it will take initiatives to reduce the weight of seniority in wage growth within the context of the planned rationalisation of the Joint Committees. The High Council for Employment has put forward several options in this regard.

Recent trends and policy measures

As Graph 2.1.2 shows, the growth rate in hourly labour costs in Belgium has slowed markedly in recent quarters ([7]). While a slowdown is obvious in the light of fading inflationary pressures since 2013, it is important to note that the growth rate of labour costs has also converged with that observed in the neighbouring countries. In the first nine months of 2014 they rose by 0.8% for the total economy, against 2.8% on average in 2001-13. So far, the wage slowdown has been more pronounced in the services sectors than in manufacturing, though at 1.2% labour cost growth in the first nine months of 2014 has also been decelerating in the manufacturing sectors.

Box 2.1.1: Performance of manufacturing activities

Belgium has been no exception to the long-term trend of deindustrialisation in advanced economies. This trend is intrinsically positive as it reflects how more services are consumed as countries grow wealthier. The flipside is that manufacturing (1) is no longer a major source of job growth in advanced economies. Despite a fall of its relative economic weight, it remains nevertheless an important driver of added value and of – generally well-paid – employment. It remains also the key contributor to productivity growth, innovation and trade (2). Aside from these direct effects, there are important spill-over aspects that should be taken into account since industrial activity creates demand for services with a high value added such as R&D or logistics. While this interplay works in both directions, the intermediate use of services by the industry is higher than the intermediate use of industrial output by the services sectors (3) with only 26% of the Belgian economy composed of stand-alone services (4). For these reasons, a fast dwindling of manufacturing activities is not without danger for the performance of the overall economy, not least because the sector creates many jobs for middle class workers.

Table 1: Share of manufacturing industry in total employment

Source: European Commission

The decline of manufacturing in Belgium appears nevertheless to be higher than in other countries (5). When looking at employment, the share of manufacturing jobs in total employment has fallen across the board. This reflects rising productivity through optimization, innovation and automation of production processes as well as the outsourcing of certain activities that were

_________________________________

(1) Industry excluding mining and utilities.

(2) McKinsey Global Institute, Manufacturing the future: the next era of global growth and innovation, 2012.

(3) Avonds, L., De gecumuleerde kosten 1995-2005, Working Paper 9-13, FPB, 2013.

(4) Roland Berger, Reindustrializing Flanders – the burning platform, Voka management report, 2014.

(5) In 2013, BE had the lowest EU27 share of activities traditionally considered 'tradable' (Nace rev.2 A, B-E, G-I, J) in total employment and one of the lowest shares in total value added.

(6) See In-Depth Review, 2014.

(7) Roland Berger, 2014.

erstwhile performed in-house. However, for Belgium the decrease has been steeper than in other EU15 Member States (see Table 1). When looking at the evolution of employment in absolute levels, the manufacturing sector in Belgium has shrunk by more than half since 1970. Aside from the factors described, this reflects the high degree of capital deepening in the Belgian industry in response to elevated labour costs. This deteriorating cost competi­tiveness manifests itself also in the downward evolution of profit margins (6).

Also in terms of the share in total value added the loss for Belgian manufacturing sectors has been more pronounced (see Graph 1). This reflects mainly a price effect with value added in constant prices sketching a more stable picture. This relates to Belgium's specialisation in intermediate products (see section 2.2), which makes it difficult to pass on rising input costs to final prices. The experience in other countries demonstrates that curbing trends in the manufacturing sector is achievable if a focus on innovative activities is maintained. Countries that performed better in the past decade (DE, AT & SE) were found to have a comparatively large machinery sector with focused spending on R&D, resulting in a higher share of high-end products. Other important prerequisites are access to a skilled labour force, a solid business service sector and a generally favourable business climate (7).

Graph 1: Share of manufacturing industry in total value added

Source: European Commission.

Graph 2.1.6: HICP (annual % change)

Source: European Commission

In addition to low inflation, the slowdown in relative labour cost growth rates is the conse­quence of a number of government measures affecting both wage indexation and real wage increases. As well as the decision to freeze wages in real terms in 2013-14 and reduce certain employer social security contributions, the previous government made successful attempts to rein in price pressures. Past inflation was on average higher than in the euro area and the neighbouring countries (see Graph 2.1.6), which can be a problem as monetary policy within a monetary union is geared towards the aggregate.

To mitigate the vicious inflation-wage cycle, Belgian authorities have been focusing efforts on tempering inflationary pressures. To this end, the functioning of the domestic energy and telecom markets was improved. For energy, the ensuing price effect has been compounded by the reduction in the VAT rate for electricity since April 2014, though this effect will dissipate over the course of 2015. Finally, there have been several changes in the way the health index, to which wages and benefits are linked, is calculated. Taken together, these measures have brought inflation into line with neighbouring countries (see Graph 2.1.6). Still, on average, core inflation remained 0.5 pp. higher in 2014, mainly due to higher price inflation for services and processed food items. This underscores how continued vigilance with regard to market functioning remains warranted given that several product and service markets have major shortcomings, while legacy costs risk undoing the gains achieved in recent years on energy prices (see section 3.3).

The structural reductions in social security contributions decided earlier have been maintained by the new government. However, the timing of the reductions (initially EUR 450mn each in 2015, 2017 and 2019) has been changed by combining the 2015 and 2017 rounds in 2016 for a total amount of EUR 960mn (0.2% of GDP). This comprises (1) linear reductions (EUR 300mn), (2) low wages (EUR 300mn), and (3) wage subsidies for sectors exposed to international competition and whose growth potential is at risk because of the evolution of labour costs compared to productivity (EUR 360mn). At the same time, the federal government has announced its intention to reduce the standard rate of employers’ social security contributions from 33% to 25% by the end of the current parliamentary term. This would be done by abolishing some of the existing reductions and wage subsidies, which were partly introduced to offset high and rising labour costs but have led to a complex system and may thwart foreign investments as they coexist with high nominal rates. Ultimately, a comprehensive solution still involves a broad tax reform (see section 3.2). This would create room for wage cost reductions.

The new federal government has also decided to continue the strategy of wage moderation so that slow wage growth is projected to continue in future years. In recent years Belgian wages have been frozen in real terms as the government allowed no increases on top of corrections for inflation, with a zero wage norm applied in 2013-14. For 2015-16 the social partners have agreed a national wage norm of 0.8%, which can be used only in 2016 ([8]). The government has decided to suspend all wage-indexation schemes. This suspension will last until the health index has risen by 2%. On the basis of the current inflation outlook, the 2% erosion in real wages will materialise only slowly, leading to a prolonged period of very low wage growth. According to simulations by the National Bank of Belgium, the suspension of wage indexation implies, all other things being equal, a positive shock for Belgian companies. Over a five-year period, the measure would yield 33 300 additional jobs, boost overall GDP by 0.5 pp. and lower inflation by 1.1 pps., resulting in a further limitation of wage growth once indexation is reactivated ([9]).

All in all, it appears that Belgium's historic labour-cost gap is set to narrow steadily over the medium term following corrective measures taken in recent years. To fully correct the historic labour-cost gap, additional measures might be required as com­parably low inflation in trading partners limits Belgium’s relative gains. This may involve continued wage moderation against the back­ground of subdued inflation or further alleviation of the tax pressure on labour.

To prevent past problems from recurring, a revision of the Law of 1996 is envisaged. Headway on this point is less tangible than for the corrective measures. As well as projections, the wage norm would have to factor in actual wage developments in the reference countries in the past two years. An automatic correction mechanism for past increases above the norm would also be introduced. Furthermore, the norm would be enshrined in a generally binding collective agreement or Royal Decree if no agree­ment were reached between the social partners. Lastly, enforcement of the law would be improved by tightening the sanction mechanism for sectors or companies allowing wage increases surpassing the norm. If enacted, such reforms would improve Belgium’s intersectoral wage policies by strength­ening both preventive and corrective elements.

Evaluation of progress made on labour costs

In spite of the measures listed, important short­comings in the wage-setting framework have been left unaddressed. It is unclear how devia­tions from the national norm in lower-level nego­tiations between the social partners would be made possible. Also, no action has been taken to bring wage and productivity developments more closely into line, including at industry or company level. Finally, wage indexation and seniority-based wage scales would continue to fall outside the scope of the wage norm. This risks undoing certain planned improvements to this norm if inflation differentials with neighbouring countries start to rise again.

Therefore, initiatives to soften the negative effects of how wage indexation is applied should not be a taboo. Indeed, the focus on safeguarding indexation in its current form has led to several measures to lower inflationary pressures, which, although not entirely unsuccessful, came at a high budgetary cost and could produce unintended consequences, such as is the case for the decision to reduce VAT on electricity consumption by households. Still, the government had to resort to the drastic decision of blocking wage indexation altogether to correct for the past. At the same time some of the problematic features intrinsic to the system have been left unaddressed.

The use of all-in wage agreements could com­pensate for the effect of non-anticipated indexa­tion. Such agreements cap nominal instead of real wage growth, as the wage norm does. Their use was promoted in the 2007-08 interprofessional agreement and about a quarter of all private sector employees were covered by sectoral all-in agree­ments at that time. They help to shield the domes­tic economy from exogenous commodity shocks, limit price volatility in case of demand shocks (lowering the need for ex-post corrections) and allow for differentiation between sectors and companies on the basis of productivity differentials ([10]). Especially for sectors or companies facing shrinking margins and heavily exposed to international cost competitiveness promoting all-in agreements could be a viable strategy to strike a more appropriate balance between labour cost growth and employment preservation, on the one hand, and the exact timing of corrections for inflation, on the other.

Energy cost

The Belgian economy has a higher energy intensity than the neighbouring economies and the euro area. These differences are mainly due to a different economic composition of final demand. Exports have a particularly high energy intensity. This reflects the fact that Belgium has a high level of energy-intensive industrial activities, such as the (petro)chemical industry, which typically feed into the country's exports and generate high value added. This intensity is also evident in industry’s share of overall electricity and gas consumption (see Tables 2.1.1 & 2.1.2). Given Belgian exports’ high energy intensity, it is important to ensure competitive prices for energy and gas, in particular for big professional users.

Table 2.1.1: Share of total final gas consumption

Source: European Commission

Table 2.1.2: Share of total final electricity consumption

Source: European Commission

For natural gas, all three Belgian regions were found to have cheaper prices for industrial consumers than DE, FR, NL and the UK in 2010 ([11]). The positive gap was due to taxation and network charges, with many large industrial users avoiding distribution charges by being directly connected to the Belgian transport network. This favourable situation has not changed significantly since ([12]).

Average electricity prices for companies have converged with those in neighbouring countries, but this average probably paints too rosy a picture of the situation faced by the largest industrial users ([13]). For medium-sized industrial users (25GWh/y), Belgium’s regions generally had the highest prices in 2010 due to higher taxes and levies. For large industrial users (250GWh/y) the price difference with the other countries was smaller — though purchased volumes are evidently higher — but prices were still at the upper end, with higher taxes and levies. The federal authorities have taken several measures since to tackle the situation. The federal contribution to financing public service obligations and regulatory costs was substantially lowered. In addition, the contribution was made degressive with rising use and the absolute annual cost ceiling was extended to medium-sized industrial users. A similar decreasing contribution formula was introduced for the contribution to support offshore wind farms. However, rising charges at the regional level have partially offset lower federal charges ([14]).

As a result, prices for large industrial electricity users are still relatively high compared to neighbouring countries although the difference has decreased since 2013 ([15]). This difference falls as consumption rises, though for the largest consumers ([16]) prices in Flanders and Wallonia were still about 10% higher than the average for the three benchmark countries in 2014 (see Graph 2.1.7 for a comparison for 500GWh). This difference primarily reflects higher taxes and the incorporation of costs for renewable energy support in network charges. France and the Nether­lands apply low taxes for high electricity volumes, while Germany as well as the Netherlands offer major discounts on network charges, a policy which France has also introduced recently.

The biggest charges for industrial users are regional ones. Following the sharp decrease in (federal) charges for offshore wind farms, (regio­nal) levies linked to the purchase of certificates for green energy and combined heating accounted for roughly 80% of total charges for the biggest industrial users in Flanders in 2014. Regional contributions to the purchase of green certificates amounted to 75% of total non-commodity costs for the same user profile in Wallonia. This underscores the role of regional authorities in assuring the overall cost competitiveness of their major industrial corporations. The legacy cost of uncharged certificates, the costs of additional renewable capacity and the precarious security of supply only add to the challenge for policy makers. Costs linked to the creation of a strategic reserve in the light of recent supply con­cerns again risk affecting big users significantly (see section 3.3).

Graph 2.1.7: Total electricity prices for base load profile of 500 GWh

Source: Deloitte/Febeliec (2014)

At the federal level, the new government launched the plan for an energy norm similar to the national wage norm. In practice, norms would be created for different user profiles. The aim would be to ensure that the different price components are aligned with those observed in neighbouring countries. Given that certain price components are decided at the regional level whereas others are a federal competence, such monitoring would require close collaboration between both levels. The fact that federal attempts to lower energy prices in recent years have been partly undone by higher regional charges highlights the potential problems a lack of solidarity might create. Further­more, there is the risk of interfering excessively on energy markets and further discouraging invest­ment in already impaired domestic capacity. Enhancing grid inter­connectivity to ensure close alignment between market prices for the commodity component would therefore appear a more rewarding approach, on top of which the other price components could by targeted by the different policy levels responsible. In this respect, it will also be important to make sure that a tax shift (see section 3.2) safeguards the competitiveness of the industrial sectors.

Graph 2.1.8: Breakdown of gross manufactured exports by value added (% of total, 2009)

Source: OECD/WTO TiVA

Cost of service inputs

Services have become increasingly interconnec­ted with the rest of the economy as they supply important inputs for the production process of other sectors. In 2011, Belgian exporting compa­nies purchased intermediary inputs worth at least EUR 10 000 from on average eight domestic com­panies that do not export themselves as they are generally smaller and less productive ([17]). Many of these domestic suppliers are service providers whose activities have become more tradable thanks to technological developments. Services such as R&D, design, marketing and distribution represent more than one third of the value added of total manufactured exports (see Graph 2.1.8).

Graph 2.1.9: Forward linkages and productivity growth of the Belgian service sectors

Source: European Commission

Domestic services thus form an integral part of external competitiveness, even when they do not participate directly in external trade. The existence of large and increasing 'forward linkages' of services magnify their positive spillover effects. Therefore, increased productivity growth in servi­ces, would translate into increased competitiveness at the industry level. As illustrated by Graph 2.1.9 business services can be considered particularly important as they have the largest forward linkages with the rest of the Belgian economy. However, they also show negative productivity growth.

This highlights the importance of ensuring these sectors function properly. To the extent that business services are still relatively highly regulated and shielded from competition, this indicates the untapped potential for productivity gains in the sector and the wider economy. Considering that about half of the value added by services in total exports is imported (see Graph 2.1.8), this could not merely improve cost parameters for goods exporters but could also directly boost activity in the services sectors. It has been estimated that more ambitious implementa­tion of the Services Directive would yield additional gains of up to 1.7% of GDP for Belgium in the long term.

The ability of a country to preserve and even increase high income and employment levels can be greatly influenced by cost factors. However, over the longer term a country’s performance is largely determined by a number of structural factors that define its capacity to withstand exposure to international competition. Previous In-Depth Reviews highlighted that Belgium’s weakened external competitiveness also reflected its performance on non-cost parameters. This section looks at the structural components of competiti­veness and discusses policy measures.

Total factor productivity

These structural factors and their importance for the overall economic performance of a country are generally captured by total-factor productivity (TFP). TFP reflects an economy’s efficiency in allocating the labour and capital inputs available for productive ends. The interplay with these inputs determines potential growth (see Graph 2.2.1). The positive contribution from labour inputs (total hours worked) in recent decades primarily reflects an expanding labour force due to demographic trends, with hours worked per employee much more stable. Belgium’s low participation rate still provides ample scope for enhancing potential growth, though ([18]). This is discussed in section 3.1.

Total labour productivity growth is the sum of TFP and capital deepening. As was discussed in section 2.1 and presented in Graph 2.2.1, capital deepening in Belgium has been solid in the past thanks to developments in manufacturing. This has led to a high productivity level but has also limited the potential for future productivity gains. Such gains would therefore have to come from TFP growth, which in the long term is often considered to be the ultimate driver of growth in advanced countries. Rising productivity due to an improvement in TFP would also be more favourable for employment than capital deepening driven by labour costs.

However, TFP contributions to potential growth have fallen to a very low level. This has been the main driver behind the overall slowdown in productivity growth, with capital deepening lower but still considerable. Even before the crisis TFP contributions were assessed as lower than in neighbouring countries. Part of the divergence over the past decade can be attributed to the creation through subsidised schemes of — generally less productive — jobs for the low-skilled. However, the difference in perfor­mance compared with neighbouring countries predates these measures. An explanation might be the sectoral composition of the Belgian economy. As discussed in section 2.1, Belgium has witnessed a strong shift towards service activities. These generally show a lower productivity growth rate.

Graph 2.2.1: Breakdown of potential growth

Source: European Commission

Disappointing TFP developments point to problems of non-cost competitiveness and the existence of certain misallocations. Total factor productivity being non-observable and computed as a residual ([19]), its precise determinants are generally hard to grasp. However, a number of elements are commonly considered to be crucial drivers. These include the quality of a given amount of inputs of human and physical capital, the general business climate, the allocative capacity of the economy through the labour and product markets, and innovation in its many aspects. A number of these factors are discussed subsequently; others, which relate to the overall functioning of the economy, are looked at in section three on other structural issues. Before turning to performance on innovation and the business environment, Belgium’s position in value chains is discussed to get a better understanding of the non-cost drivers of the country’s export performance.

Graph 2.2.2: Global value chain participation index (%)

- backward integration: foreign value added content share of total gross exports - forward integration: value added content share of total gross exports by other countries Source: European Commission, based on WIOD

Position in value chains

Belgium’s export market orientation reflects the country’s tight integration into regional and international value chains through the dense cross-linkages with the French and German economies and the presence of important ports. Considering the generally slow import growth of Belgium’s trading partners, this traditional trade orientation has been one of the drivers behind a subdued export performance and the general trend of falling export market shares for goods. However, the deep integration into value chains (see Graph 2.2.2) also implies that Belgian exports feed through into third countries’ exports, so that fast-growing markets are in the end more important for Belgian producers than they appear at first sight.

Table 2.2.1: Manufacturing exports by type (%)

Source: European Commission

Belgium’s overall position and specialisation within these value chains is, however, unfavour­able due to its high labour costs. Belgium is broadly positioned in the intermediate range as Belgian exports mostly serve as inputs for final products (see Table 2.2.1). Conversely, Belgian companies export few capital goods: their share in manufactured exports is less than half that of the average euro area country and neighbouring countries. Furthermore, their share has fallen steadily over time. Margins for intermediate products are generally lower as their product differentiation is also lower, resulting in strong price competition. This makes it hard to pass on the costs of imported commodities and domestic labour inputs into final prices without running the risk of losing market shares.

This fits with findings on the average quality of the products Belgium exports, another indicator relevant to specialisation. The typical Belgian manufactured product is of medium to low quality, i.e. skewed to the left in Graph 2.2.3. Moreover, between 2005 and 2011 Belgium saw quality deteriorate as the share of products considered 'top' quality declined sharply. On average product quality, the common peer countries are generally found to perform better, as do most EU-15 countries. This is particularly the case for France and Germany.

Given Belgium’s product specialisation, a misalignment seems to exist with its high labour costs. To compensate for the latter and allow for future export growth, a general upscaling of the product range would be beneficial. This highlights the importance of fostering broad-based innovation.

Innovation

Innovation is paramount in speeding up the transition to a more knowledge-intensive economy as it allows for specialisation in new or better products and services with higher added value and lower price-sensitivity. Innova­tion can take several forms, resulting in different outcomes. Whereas process innovation increases efficiency and lowers costs, product innovation allows the creation or improvement of products which can be sold at a premium or be used to tap into new markets. The latter’s beneficial effect on external competitiveness and the domestic economy is clearly longer-lasting.

Graph 2.2.3: Quality rank of export products

Source: Vandenbussche, H., Quality in exports, EC-DG ECFIN, Economic Papers 528, 2014.

Belgium is considered to have a high-quality research system, with particularly strong public research institutions and universities. Busines­ses have many opportunities to cooperate with both and have been increasing expenditure on R&D. Total spending by all actors rose from a low of 1.8% of GDP in 2005 to 2.3% in 2013 (see Graph 2.2.4), with the main increase stemming from business expenditure: from 1.2% of GDP in 2005 to 1.6% in 2013. The continuation of this trend would push Belgium to within reach of its 2020 target of 3%. The gap to the five best performing EU countries has narrowed over the period under consideration, but was still 0.8 pp. of GDP in 2013.

Graph 2.2.4: R&D intensity (%GDP)

Note: 5 best performing countries in 2013: FI, SE, DK, DE & AT Source: European Commission

The overall increase in business R&D intensity in recent years has been principally driven by a particularly good performance in the bio-pharmaceutical sector. In this sector, high scientific quality, business investment, product innovation and trade performance reinforce each other. Knowledge intensification and broadening of the innovation base beyond this sector has improved but there is potential for further progress.

The rising total R&D intensity also reflects stronger public support for business spending as the different levels responsible have developed detailed policy plans over the years. The federal level has focused on fiscal incentives with a payroll withholding tax exemption for researchers of 80% and an equal deduction for patent revenues ([20]). Regions provide direct support through subsidy schemes as well as indirect support through facilitator policies, with e.g. a focus on clusters in Wallonia — a policy which Flanders has announced it will give more emphasis to as well.

Access to public support is, however, conside­red complex and time-consuming, and the support available fragmented. This discourages absorp­tion, especially by smaller companies. A prolifera­tion of initiatives and institutions also weakens the focus of policies. Consequently Belgium has been recommended to streamline incentive schemes and reduce administrative barriers.

The new Flemish and Walloon governments have announced their intention to address the suboptimal efficiency of innovation support. Flanders plans, for instance, a rationali­sation of the current landscape of intermediate structures and has started merging some entities. Wallonia plans to assess all types of financial assistance to firms in order to simplify the overall system. A point that merits additional attention is the overall coordination of the policy mix. Although the funding of business R&D is split between the federal government and the regions, there is no organised coordination to ensure that support is optimally balanced between the different instru­ments and that trans-regional synergies are fully exploited.

In spite of Belgium’s relatively solid perfor­mance on R&D spending and other input parameters, performance indicators for innovation output paint a more mixed picture. The strengths of the research and innovation system are inadequately translated into economic performance, with Belgium generally lacking fast-growing firms in innovative sectors. This is also evident in the comparatively low share of total company sales resulting from new innovations. To strengthen the translation of research into commercial products, the Walloon govern­ment agreement sets out its intention to reinforce its Marshall Plan by concentrating on innovation policy measures with the highest value added in terms of job creation and commercial valorisation. Flanders aims to strengthen inno­vation by means of a cluster policy.

Bottlenecks discussed in other sections on taxation and labour market performance contribute to the overall innovation challenge. Site selection for R&D operations is primarily determined on the basis of access to qualified staff, universities, R&D funds and suppliers. For decisions on the location of actual labour-intensive manufacturing activities based on research carried out, labour costs are a more important factor. This underscores the importance of rebalancing overall tax pressure, as discussed in section 3.2.

The translation of technology into new ideas and products also hinges on the availability of a vast pool of aptly skilled workers. While Belgium has a generally well-qualified workforce with a high participation rate in tertiary education, the share of science and engineering graduates remains low. Shortages in these fields could become a major barrier to innova­tion, with shortages already emerging for certain functions. This is the case for professional digital skills, for example. Whereas Belgium has good broadband infrastructure and is above the EU average in computer and internet skills, there is a shortage of qualified ICT experts such as applica­tion developers. In 2014, 37.7% of enterprises with job vacancies requiring specialised ICT skills reported problems in filling these positions. For the ICT workforce alone, the shortfall is expected to rise from about 8 000 in 2012 to 30 000 in 2020 ([21]). On the matching between education systems and the labour market, see section 3.1.

In addition, companies could pay more atten­tion to lifelong learning throughout the career of their employees. Belgian companies perform rather poorly on participation in lifelong learning ([22]). However, on-the-job training yields both a wage and a productivity premium, with the latter exceeding the former. Productivity gains from training are slightly higher in the non-manufacturing than in the manufactu­ring sector ([23]). Another enabler of innovation is 'entrepreneurship', which in turn is greatly influenced by the general business environment and the quality of public services.

Business environment

As well as an unfavourable product mix, there is also the fact that relatively few new Belgian companies are created. Belgium generally performs weakly on entrepreneurship. It has a very low start-up rate (see Graph 2.2.5), which suggest a business climate that is unfavourable to the generation of new activities and natural expansion. This in turn lowers the pressure on existing firms to become more efficient. Considering that the main source of job creation is young rather than merely small firms ([24]), it is paramount to facilitate the natural expansion of new companies.

The low start-up rate can be related to several factors discouraging company expansion, including, once more, high labour costs. To soften the burden for start-ups, social security contributions were lowered for the hiring of the first three employees. This federal reduction was recently increased as well as expanded to the first five employees. Company expansion beyond this level nevertheless remains hampered, which might necessitate further action and points again to the general need to shift taxes away from labour. Certain non-labour taxes also come across as very counterproductive for entrepreneurship. This is the case with a number of smaller taxes on capital goods levied at the local level, e.g. on propulsion.

Graph 2.2.5: Rate of company start-ups (%, avg 2008-12)

* Start-up rate: ratio between the number of new firms entering the market and the total number of firms Source: European Commission

Apart from regulated professions, starting a company in Belgium is generally easy in terms of procedures, though associated costs are considerable. Indeed, the World Bank’s Doing Business report ranks Belgium 14th out of 189 countries for ease of starting a business, with a low number of procedures to go through and days involved. Businesses are, however, required to have relatively high levels of minimum paid-in capital, for which Belgium ranks only 167th. In addition, a certificate of company management is required to be allowed to start a commercial activity. The objectives of company survival and smooth market access therefore do not appear to be well balanced, as is evident from the low start-up rate. Start-up rates have been found to show a robustly positive reaction to changes in the cost of starting a business and exporting, even during the crisis.

Belgium ranks only 130th out of 144 countries on the World Economic Forum’s 'burden of government regulation' indicator. Like support for innovation, access to employment and business support schemes is greatly hampered by their vast number. Overall, administrative costs for businesses represented 1.7% of GDP in 2012, with the majority borne by smaller companies and the self-employed ([25]). The overall burden is found to have fallen by half since 2000. Additional gains could probably be achieved by expanding use of ICT solutions in public administration. This would be of particular benefit for fiscal administra­tive procedures, whose costs have risen in recent years while those for employment and environment procedures fell. Existing e-government services are not always considered efficient, according to the 2013 Public Sector Innovation Scoreboard. Modernising and simplifying administrative requirements could, in other words, yield important gains in terms of entrepreneurship and business dynamics.

The low penetration of ICT also hampers the judicial system, as the 2015 EU Justice Scoreboard shows. Maintaining initiatives already started to improve the use of ICT solutions will be of particular importance to supporting the implementa­tion of recent judicial reforms and to helping courts handle the high number of incoming cases. Certain measures that could support the quality of the justice system are still missing, though. In particular, Belgium does not provide data on efficiency indicators for the international exercise assessing judicial systems. This comparative approach supports efforts to modernise the judicial system in Member States. Concerns have also been raised by the new College of courts and tribunals over whether the justice reforms can be carried through in the context of reduced budgets.

Box 2.2.1: Adequacy of public infrastructure

The availability of and the smooth access to public infrastructure are important facilitators of produc­tivity. Higher spending on transport and electricity infrastructure has been found to positively impact economic growth, provided no excess capacity is created ([26]). Investments serve to maintain the quality and volume of the existing infrastructure or to expand it. As a consequence, persistent cutbacks in investment budgets or a continuous deferral of maintenance works may over time result in a significant deterioration of a country's capital stock. Belgium has important investment needs, the tackling of which would give impetus to produc­tivity growth and overall economic performance. Transport infrastructure is the most obvious example (cf. infra), but the country's infrastructure gap surpasses network structures, touching also on education and social infrastructure despite long-term demographic trends that could have been anticipated. Communities have outlined plans to improve the capacity and quality of the educational infrastructure. Graph 1: Net fixed capital formation: general gov't

Source: European Commission

This broad-based adequacy problem of Belgium's public infrastructure reflects the persistently low rate of public investment. This rate has fallen back to 2.2% of GDP in 2013, near the very bottom of all EU countries. Fiscal consolidation in recent decades has been skewed towards investments, a policy choice which has never been fully reversed. In this respect, public spending priorities have not always been optimal despite high aggregate government spending. Since the end of the 1980s net investment – i.e. corrected for use and wear –has been negative on average (see Graph 1), implying that the stock of public investments has shrunk.

Total spending on (non-housing) construction ([27]) gives a somewhat better picture (see Graph 2), though performance remains below that of most other countries ([28]). Some catching-up appears to have taken place in recent years.

Graph 2: Gross fixed capital formation of non-residential construction and civil engineering: economy-wide (% of GDP)

Source: European Commission

The most pressing gap with respect to the general business climate and attractiveness of the Belgian economy probably relates to the transport network. The quality of the latter is of utmost importance to fully exploit the country's favourable geographic position, which provides the country with a natural advantage for the establishment of a logistics base, headquarter or distribution centre. This is underpinned by the World Bank's global 'Logistics Performance Index'. In 2014 Belgium ranked 3rd in the global ranking, up from the 12th position in 2007.

The level of satisfaction with the quality of the transport infrastructure is one of the elements assessed by the World Economic Forum's 'Global Competitiveness Index' (GCI). The most recent GCI ranks Belgium 20th worldwide in relation to its general transport infrastructure. Especially the satisfaction with port infrastructure is high: Belgium is ranked 6th worldwide. For airport infrastructure Belgium ranks 15th. Both for port and airport infrastructure the ranking is rather stable over the period 2006-15.

However, the situation is different for the satisfaction with road and rail infrastructure. Whereas for road infrastructure Belgium was still ranked 10th worldwide in 2006-07, its ranking has dropped to the 27th position since. For rail infrastructure, the ranking went from 11th in 2010-11 to 14th in 2014-15. This steady decline in satisfaction with the Belgian road and rail network

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Box (continued)

indicates that further improvements are needed in order to maintain Belgium’s position as a hub for European and international logistics. To be sure, scope for upgrading or expanding the basic transport infrastructure appears to be ample, especially considering the high concentration of economic activity around the capital and the several ports. Indeed, congestion and missing links are key issues of concern for the Brussels and Antwerp ring roads. In particular action on the Antwerp bottlenecks has been delayed repeatedly. For rail infrastructure the realisation of the Brussels Regional Express Network is the main workload. Following repeated delays due to licencing difficulties, finalisation of the network is currently estimated in 2025. However, available funding runs about EUR 500mn short of remaining needs ([29]). Both for road and rail infrastructure, coordination between the federal and the regional authorities will be crucial to ensure effective planning and project selection, as well as swift implementation. || || _________________________________________________________________________________________________________________________________________________________________________________________________________________ ([1]) European Commission, Infrastructure in the EU: Developments and impact on growth, DG ECFIN, Occasional Papers 203, 2014. (2) In Belgium, certain infrastructure investment has been increasingly financed through off-balance constructions such as public-private partnerships or capital grants. (3) It should be noted that DE, with a performance comparable to that of BE, has received a recommend­dation with respect to the level of (public) investment in infrastructure, education and research. (4) Reply by Minister of Mobility J. Galant to question raised by MP O. Maingain, Chambre des représentants de Belgique, 22-12-2014.

Overall, Belgium has considerable scope to expand the non-cost dimension of competitive­ness. This would help to balance overall macroeconomic risks. Wage moderation will be indispensable in the short term, but it does not provide a long-lasting strategy for a high income country. To safeguard and enhance the welfare level reached, more emphasis will have to be put on productivity gains, in particular those stemming from other sources than a continued capital intensification of production processes. This requires a sustained push towards products and associated services higher up the value chain, implying stronger per­formance on innovation with Belgium being an average performer in terms of innovation output.

With this aim in mind, Belgian authorities would be well advised to introduce major policies to facilitate this change. For instance, public innova­tion support can be further streamlined and made more targeted. Belgium’s weak performance in maximising the commercial benefits of R&D would profit from a reduction in administrative barriers and, more generally, measures to unchain entrepreneurship and unleash greater business dynamism. A timely and resolute approach to addressing infrastructure bottlenecks would also help the country’s overall productivity. The same applies to ensuring that labour and product markets function well, which is discussed later.

The high level of public debt in Belgium is a long standing structural issue. According to the European Commission's 2015 winter forecast, the consolidated public debt reached 106.4% of GDP at the end of 2014. This is substantially above the threshold of 60% of the Macroeconomic Imbalance Procedure and also above the euro area aggregate (94.3% of GDP in 2014). This section discusses the recent evolution of the public debt and its macroeconomic risks.

Public debt – recent developments

Since the start of the financial and economic crisis in 2007, the Belgian government debt has been rising again. However, despite massive interventions in the financial sector and a deficit above or around 3% of GDP since 2009, the recent debt increase is less pronounced in Belgium (BE: 20 pps. of GDP between 2007 and 2014) than in many other Member States and the euro area as a whole (29 pps. of GDP in the euro area on aggregate).

Graph 2.3.1: Public debt (% of GDP) - Comparison between 2014 and 2015 vintage of the EC winter forecast

Source: European Commission

The public debt level has been considerably revised upward since last year's In-Depth Review, when it was expected to stabilise at around 100% of GDP in 2014 (see Graph 2.3.1). This revision is largely due to the reclassifications of corporations into the general government sector, which resulted in an increase in the gross debt level by almost 7 pps. of GDP. This is partly offset (-3.5 pps of GDP) by an upward revision of GDP levels (the denominator) following the introduction of the new accounting system ESA2010. The reclassified units mainly consisted of investment vehicles of regional authorities, and thus the debt increase was accompanied by an increase in government fixed assets.

In 2013, the general government's primary balance had turned positive for the first time since 2008 but it is estimated to have turned slightly negative again in 2014. A negative snowball effect continued, with interest expenditure – although historically low – exceeding nominal GDP growth (see Graph 2.3.2).

Graph 2.3.2: Contributions to the change in the gross debt ratio (pps. of GDP)

Source: European Commission

At unchanged policy, the gross debt ratio is forecast to rise further in 2015, to 106.8% of GDP, and to stabilise in 2016. This would mean that the gap with the euro area aggregate is widening again. Current fiscal consolidation commitments, if implemented, should ensure a steady reduction in the Belgian public debt in the coming years. However, the reduction in the debt ratio is hampered by low inflation, subdued GDP growth, and, in the longer term, the impact of an ageing population (see below). A new economic downturn or financial shocks (e.g. the activation of guarantees to the financial sector, see below), could push debt levels to less sustainable levels. The following sections will put Belgium's high public debt level into perspective.

Risks of short-term fiscal stress

Despite the high level of its public debt, Belgium seems to have rapidly regained market confidence after the sudden increase in risk premium on Belgian government bonds towards the end of 2011. The country currently enjoys relatively low financing costs (see Graph 2.3.3). By refinancing its debt at low rates, the Belgian sovereign has been able to drastically reduce its interest burden, even after debt levels started to rise again.

Graph 2.3.3: Interest expenditure and implicit interest rate

(1) EA12 up to 2010, EA19 as of 2011 Source: European Commission

Currently, Belgium does not seem to face a risk of fiscal stress in the short term. The average life to maturity of the federal debt portfolio (which represents 84% of Belgium's total debt) is relatively long, at 7.8 years in October 2014. The Belgian government used the current low interest environment to refinance the outstanding debt at low rates and pre-financed part of the 2015 financing needs. The 12-month and 60-month refixing risk ([30]) of the federal debt decreased from 20.3% and 56.8% at the end of 2012 to 16.1% and 46.4% at the end of 2014.

Graph 2.3.4: Maturing debt of central government (% of total outstanding central government debt)

Source: Bloomberg and European Commission

In line with developments in the euro area as a whole, interest rates and risk premium on Belgian debt instruments abated further in 2014 (see Graph 2.3.5). The spread between Belgian and German bonds averaged 55 basis points in 2014, against 84 basis points in 2013, and a high of 366 basis points on 25 November 2011. At the end of 2014, it stood at 28 basis points (see Graph 2.3.6).

Although the risk of short term fiscal stress seem to be contained, a sustained period of higher interest rates on government debt would have a substantial impact on Belgium's public finances. Current annual refinancing needs are estimated at over 15% of GDP at federal level alone. Hence renewed financial market turbulence entailing higher risk premium would rapidly increase interest expenditure. Currently, part of the consolidation strategy is built on the assumption of falling interest expenditure. Higher interest expenditure would have to be compensated by a higher tax burden or expenditure cuts elsewhere which could in turn impact economic activity. In addition, interest payments to non-residents would worsen the primary income balance and thus weaken the country's external position.

Graph 2.3.5: Recent evolution of annual yields on Belgian debt instruments (%)

Source: IHS Global Insight

Graph 2.3.6: Spread of selected government bonds vis-à-vis German bunds

Source: IHS Global Insight

Increased financing costs for the government would also pass through to the private sector, driving up financing costs for domestic financial institutions and ultimately for non-financial companies and households. This would have a negative impact on investment and innovation. For instance, the cost of mortgage loans with a floating interest rate is legally bound to the market interest rate of Belgian bonds. The high public debt level also reduces the capacity of public finances to face potential adverse economic shocks, and thus increases the vulnerability of the economy as a whole.

Inter-linkages with the financial sector

Belgium still carries substantial contingent liabilities due to guarantees granted to the financial sector, although they have been substantially reduced since last year's In-Depth Review and now concern only the guarantee scheme for Dexia, which is partly owned by the Belgian state. In December 2014, outstanding guarantees had declined to 9.4% of GDP, from 15.3% at the end of 2012. Belfius, one of the four large banks on the Belgian market, is owned by the federal state and the insurance company Ethias is owned by federal and regional authorities. New capital needs of these corporations might have an adverse impact on government gross debt levels.

The interaction between the sovereign debt and the financial sector also plays in the opposite direction, in particular through the substantial public debt holdings on the financial sector's balance sheet. Holdings of Belgian bonds by the domestic financial sector increased strongly between 2008 and 2012, at the expense of foreign bond holdings. While this increased concentration on the home market may have acted as a buffer at the height of the sovereign-debt crisis, it also increased the potential spill-over effects between the public debt and the financial sector if the market value of government bonds falls.

The trend of increasing exposure to the domestic public sector was reversed in 2013. At the end of the third quarter of 2014, 50% of government bonds were held domestically, down from a peak of 57% at the end of 2012. Likewise, Belgian sovereign bonds represented 64.6% of euro area sovereign bonds held by Belgian banks in December 2014, down from a peak of 72.8% in November 2012 (see Graph 2.3.7). However, the negative feedback loops remain a source of vulnerability in case of renewed financial stress.

Graph 2.3.7: Share of Belgian bonds in total euro area bond holdings by Belgian banks (%)

Source: European Central Bank

Medium and long term sustainability of public finances

On top of the high public debt level, Belgium's public finances are also projected to face a greater than average impact from the ageing of the population. At unchanged policy, ageing costs are projected to push up the debt level to 111% of GDP by 2025 (see Graph 2.3.8) ([31]). A 1 pp. increase in the interest rate assumptions or 0.5 pp. lower GDP growth would bring the debt level to 117% of GDP in 2025. On the other hand, adequate progress towards Belgium's Medium Term Objective (which is a surplus of the government balance in structural terms of 0.75% of GDP), as required by the Stability and Growth Pact, would put the debt on a sustained downward path, reaching around 80% of GDP by 2025. It should be noted that Belgium already has a relatively high tax burden, so the fiscal space to service a higher debt or reduce the burden through revenue-increasing measures is limited. However, there is room to make the tax system less growth-distorting, particularly by shifting taxes away from labour (see section 3.2).

Graph 2.3.8: Projections of gross debt (% of GDP)

Source: European Commission calculation

The federal government is responsible for 84% of Belgium's total public debt. The increase in ageing costs will also occur mainly at the federal level, particularly for pensions and health care expenditure. This contrasts with the federal government's share of total revenue and final expenditure, which are expected to fall below 60% from 2015. This narrowing fiscal base at federal level may be a challenge for further fiscal consolidation and debt reduction. The recent state reform and revision of the financing of regions and communities partly addresses this challenge, among other things by curbing the financial transfers from the federal to sub-federal level, and hence creating fiscal space for the federal level at the expense of regions and communities. On the other hand, the reform puts an additional consolidation burden on the regions and communities, while these levels are responsible for the most growth enhancing expenditure, such as investment in infrastructure and education.

Graph 2.3.9: Consolidated gross debt – breakdown between government subsectors (% of GDP)

Source: Belgostat and European Commission

Lastly, the sustainability of public debt is also determined by the economy's growth potential. Section 3.2 highlighted the current low potential growth of the Belgian economy, especially due to a gradual erosion of the contribution of total factor productivity since the beginning of the 1990s. The loss of competitiveness and the inefficiencies in the labour market discussed in other sections also make the high debt level even more problematic, as they weigh on growth prospects, and in turn make it more difficult to put the ratio on a downward path.

The budgetary impact of population ageing is driven particularly by rising pension expenditure ([32]). The latest national projections indicate that the labour force will start to shrink from 2019. This poses important economic and social challenges including to the sustainability of public finances. As highlighted in section 3.1, Belgium has considerable scope to further increase the effective retirement age (which is well below the statutory age), and boost the employment rate of older workers (55-64). Under the 2014 European Semester, Belgium was recommended to step up efforts to reduce the gap between the effective and statutory retirement age, bring forward the reduction in early-exit possibilities, promote active ageing and align the retirement age with changes in life expectancy. Recently, measures have been taken to reduce the gap between the effective and statutory retirement age (see annex tables). The federal government also announced its intention to increase the legal retirement age from 65 now to 66 in 2025 and 67 in 2030.

The ageing of Belgian society challenges the sustainability of public finances also in relation to long-term care expenditure. In the 2012 Ageing Report, public expenditure on long-term care was projected to more than double as a share of GDP. The increased devolution of responsibilities to the regions and communities still needs to yield cost-effectiveness benefits. In recent years Belgium has expanded the availability of home care services and other forms of community based care services. However, it still has a relatively high capacity of long-term care beds.

Cooperation remains a challenge especially following the fragmentation of responsibilities between different levels of government. The use of the Belgium Resident Assessment Instrument for measuring and monitoring quality is a step in the right direction. A stronger focus on prevention and rehabilitation policies, improved conditions for independent living, a further shift away from institutional care and stronger care coordination between the different actors would be useful for increasing cost-effectiveness and limiting future needs and their related costs. Flanders has announced a reform to better integrate services and benefits.

Public debt and overall financial situation of the Belgian economy

The net financial asset position of the Belgian economy is highly positive (+42.5% of GDP in 2013), and compares with a net debtor position of 10% of GDP for the euro area as a whole. This healthy overall position is mainly thanks to the very high net assets of Belgian households (224% of GDP, against 139% in the euro area), which more than offset the net liabilities of the public sector and the non-financial corporations (see Graph 2.3.10). The financial situation of households is discussed in the next section.

Graph 2.3.10: Net financial assets/liabilities by sector (ESA2010)

Source: European Commission

The net liabilities of non-financial corporations (at 80% of GDP) are below the euro area aggregate (95% of GDP). This figure hides a relatively high indebtedness among non-financial corporations, which is however partly offset by sizeable assets. In previous editions of the In-Depth Review on Belgium, the high indebtedness of Belgian corporations has been explained by a high amount of intercompany loans between intra-group financing centres (non-financial holdings) and subsidiaries of the same group. This feature is brought about by the rather unique system of notional interest deduction (allowance for corporate equity) in the Belgian corporate income taxation system. Consequently, the debt figure stood substantially lower after sector consolidation. As argued in the 2014 edition of the In-Depth Review on Belgium, the consolidated debt figure also still includes substantial intra-group lending, notably cross-border lending, which does not constitute a macroeconomic risk.

Graph 2.3.11: Debt of non-financial corporations (% of GDP): BE versus EA, ESA95 versus ESA2010

Source: European Commission

The changeover from ESA95 to ESA2010 statistical rules brought substantial changes to the debt ratio of non-financial corporations (see Graph 2.3.11). Henceforth, non-financial holdings and treasury centres, which accounted for a large share of intra-group lending, are classified in the financial sector instead of the non-financial corporations sector. Consequently, the non-consolidated debt ratio of the latter is substantially lower under ESA2010 (139% of GDP in 2012, against 193% under ESA95), and closer to the euro area aggregate (97% of GDP in both ESA95 and ESA2010). On the other hand, the consolidated debt ratio of non-financial corporations is now higher, because the consolidation no longer nets out lending and borrowing between subsidiaries and intra-group financing centres. These statistical changes confirm the previous assessment that the apparently high indebtedness of non-financial corporations can be explained by the presence of intra-group financing centres and do not point to sustainability risks.

All in all, while public debt in Belgium remains high and continues to increase, several factors temper associated macro-economic risks, in particular the relatively healthy situation of the private sector. Risks of short term fiscal stress are considered low, and inter-linkages with the financial sector are diminishing. Moreover, the economy as a whole is in a highly positive net asset position, which provides a buffer in case of shocks.

This being said, Belgium's high public debt level is particularly challenging from a public finance perspective. Current efforts to reduce the debt ratio are hampered by low inflation and subdued GDP growth. Interest expenditure, although historically low, still puts a substantial burden on the budget, especially at federal level. Further consolidation efforts are needed, especially in the light of rising social expenditure due to an ageing population. A successful consolidation strategy would thus also require swift implementation of the pension reforms announced, as well as growth-enhancing structural reforms.

In a letter sent to the Commission in November 2014, the Belgian authorities committed to a number of structural reforms implementing the country-specific recommendations issued by the Council in July 2014. These structural reforms were further detailed in two reports sent on 30 January and 5 February 2015 (updated on 13 February). The announced reforms are substantial and are expected to contribute to boosting the economy's growth potential and reducing the risks of macro-economic imbalances, thereby having a positive impact on debt sustainability