EUROPEAN COMMISSION Brussels, 22.2.2017 SWD(2017) 67 final COMMISSION STAFF WORKING DOCUMENT Country Report Belgium 2017 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP

2017 European Semester: Assessment of progress on structural reforms,

prevention and correction of macroeconomic imbalances, and results of in-depth reviews

under Regulation (EU) No 1176/2011



{COM(2017) 90 final}

{SWD(2017) 67 final to SWD(2017) 93 final}





Contents Executive summary1 1.Economic situation and outlook4 2.Progress with country-specific recommendations11 3.Reform priorities14 3.1.Public finances and taxation14 3.2.Financial sector21 3.3.Labour market, education and social policies22 3.4.Competitiveness and Investment30 A.Overview Table51 B.MIP Scoreboard59 C.Standard Tables60 References65 LIST OF Tables 1.1.Key economic, financial and social indicators — Belgium10 2.1.Summary Table on 2016 CSR assessment12 3.2.1.Financial soundness indicators (in %)21 3.3.1.Size of selected target groups (total population in thousands)24

B.1.The MIP Scoreboard for Belgium59 C.1.Financial market indicators60 C.2.Labour market and social indicators61 C.3.Labour market and social indicators (continued)62 C.4.Product market performance and policy indicators63 C.5.Green growth64 LIST OF Graphs 1.1.Breakdown of GDP growth4 1.2.Breakdown of potential growth4 1.3.Composition of investment spending (%GDP)5 1.4.Consumer inflation5 1.5.Bankruptcies and resulting job losses6 1.6.Employment growth (y/y %change; self-employed & employees)6 1.7.People living in households with very low work intensity (% total population aged less than 60)7 1.8.Breakdown of current account balance (%GDP)7 1.9.Credit growth (y/y): non-financial companies (left) and mortgage loans (right)8 1.10.Residential real estate9 1.11.Valuation gaps: price/income, price/rent and fundamental model9 3.1.1.Fiscal deficit: headline and structural developments (%GDP)14

3.1.2.Public debt trends15 3.1.3.Public debt: medium-term projection and scenarios (%GDP)16 3.1.4.Low wage trap for second earners, 201519 3.3.1.Differences in employment and unemployment rates (15-64 years) at regional level compared to the Belgian average.22 3.3.2.Distribution of the population (aged 0-59) by work intensity of the household — 201523 3.3.3.Relative dispersion of employment rates by education level, 2010, 2014 and 201524 3.3.4.Labour transitions by employment status25 3.4.1.Cumulative (core) inflation and nominal ULC differential between Belgium and neighbouring countries30 3.4.2.Inflation, inflation at constant tax rate and core inflation – Belgium and euro area (January 2005 – December 2016)31 3.4.3.Contribution of the main product groups to the inflation differential between Belgium and its main neighbouring countries32 3.4.4.Unit labour cost by sector33 3.4.5.Labour productivity in EU-28 (2006-2015) — average % annual change35 3.4.6.Share of export value by quality rank, Belgium37 3.4.7.Share of number of different products exported in the top-quality category, EU-28 countries plus Japan, U.S. and China37 3.4.8.European Innovation Scoreboard — distance to EU innovation leaders and to EU average37 3.4.9.Efficiency of public funding of private R&D38 3.4.10.Value added share and employment share - professional, scientific, technical, administrative and support service activities40 3.4.11.Goods market efficiency indicator, 201641 3.4.12.Ease of doing business (distance to frontier), 201741 3.4.13.Ease of doing business and number of reforms, 2010-201642

3.4.14.Restrictiveness indicator, 2016, Belgium and the EU43 3.4.15.Enterprises with high levels of digital intensity — Retail trade, except motor vehicles and motorcycles (2015)44 3.4.16.Gross investment rate of non-financial corporations (2000–2015)44 3.4.17.Gross fixed capital formation by asset type – evolution 2000-2007 and 2008-2015 (% of chain linked volumes 2010)45 3.4.18.Current spending vs. gross fixed capital formation, 2015 (% of GDP)45 LIST OF Boxes 2.1.Contribution of the EU budget to structural change in Belgium13 3.1.1.Selected highlight: the Belgian pension reform17 3.4.1.Investment challenges and reforms in Belgium47 Executive summary This report assesses Belgium’s economy in the light of the European Commission’s Annual Growth Survey published on 16 November 2016. In the survey the Commission calls on EU Member States to redouble their efforts on the three elements of the virtuous triangle of economic policy — boosting investment, pursuing structural reforms and ensuring responsible fiscal policies. In so doing, Member States should focus on enhancing social fairness in order to deliver more inclusive growth. Economic growth is set to maintain a steady pace. The economy grew by 1.2 % in 2016 with domestic and external demand contributing about equally to overall growth. Domestic demand has been driven by investment growth in recent years. Business investment was underpinned both by supportive financing conditions and by government measures. Investment in construction has also been rising due to housing and public infrastructure projects. Job creation has been widespread across the private sector as a result of labour tax cuts and wage moderation, which has also improved the labour cost competitiveness position of Belgian companies. Consumer spending is expected to pick up in 20172018 on the back of continued job and wage growth. The latter is underpinned by government measures to raise disposable incomes, in particular for low- and middleincome earners. The economy is expected to grow by 1.4 % in 2017 and by 1.6 % in 2018. This relatively low growth outlook ties in with relatively low estimates for potential growth. Belgium has had difficulties consolidating public finances in the wake of the financial and economic crisis. The headline deficit widened again in 2016, to 2.9 % of GDP. It is expected to narrow to 2.2 % in 2017 and to remain around that level in 2018 unless additional budget measures are taken. With an estimated structural deficit of 2.5 % in 2016, there remains a wide gap with the country’s medium term objective of a balanced budget in structural terms. Public debt is estimated to have peaked at almost 107 % of GDP in 2016. Overall, Belgium has made some progress in addressing the 2016 country-specific recommendations. There has been limited progress on distributing fiscal targets among various levels of government in a way that can be enforced. Some progress has been made in reforming the tax system. Substantial progress has been made with regard to the reform of the 1996 law on the promotion of employment and the safeguarding of competitiveness. The reform aims at safeguarding the recent wage moderation and the gradual narrowing of the remaining labour cost gap with neighbouring countries. There is also some progress on the functioning of the labour market, especially in terms of activation, and on vocational training and education reforms, also with regard to disadvantaged groups. Higher retirement age and further limits to subsidized early retirement has encouraged older workers to stay in or return to work. Fiscal incentives in favour of work and targeted towards low-income earners have helped to boost the employment rates of vulnerable groups, by reducing unemployment traps. There has however been limited progress on sector regulation. Some of the network industries, professional services, and to some extent also the retail sector, remain sheltered from competition. The impact of newly adopted measures to boost innovation capacity of firms will take time to materialize. The details of the national pact for strategic investment still need to be announced. Regarding progress in reaching its national targets under the Europe 2020 strategy, Belgium is broadly on track to reach the targets for R&D intensity, reducing early school leaving, and increasing tertiary educational attainment. By contrast, there is a risk that the targets on greenhouse gas emissions, renewable energy, energy efficiency and poverty reduction will be missed. Despite substantial job creation, the employment rate target of 73.2 % is still out of reach. The main findings of this country report, and the related policy challenges, are as follows: The recent pension reform was an important step toward addressing the long-term cost of population ageing. Nevertheless, long-term trends of both pensions and long-term care still entail very significant risks to the sustainability of public finances. The planned introduction of a creditbased public pension system is meant to help improve long-term fiscal sustainability, as it would provide for automatic adjustment mechanisms in response to structural demographic or economic developments. Short-term risks of fiscal stress appear to have been contained. The high public debt denotes continuing economic vulnerability. Beyond the current tax shift measures, the design of the Belgian tax system still shows some shortcomings. The large number of exemptions, economic distortions and adverse tax incentives create inefficiencies and lead to high statutory rates. The tax system does not make use of opportunities to shift taxes to more growthfriendly bases, e.g. by ‘greening’ the tax system. Some features of the Belgian taxation system remain sensitive to international initiatives in the fight against tax avoidance.

Job creation has been robust, yet the overall employment rate is weighed down by the lower performance in specific groups. These include the low-skilled, the young, older workers and people with a migrant background. They largely reflect the groups with the highest risk of poverty or social exclusion, as poverty among Belgian households is mainly explained by joblessness. However, this risk is considerably mitigated by taxes and transfers. While skills mismatches represent a significant part of the overall mismatch between supply and demand in the Belgian labour market, other factors such as low geographical and job mobility and language skills may compound the issue. There are persistent and increasing disparities in long-term unemployment and inactivity rates across regions, and transition rates to employment are low. Although ongoing regional reforms of employment incentive schemes aim to rationalise and tailor the system, continuous monitoring of the cost-effectiveness of the policy choices made is warranted. In particular, some design features of the target group policies may have windfall and displacement effects. In addition, tax repercussions and withdrawal of social benefits upon entering the labour market or increasing hours worked may create inactivity and low wage traps, especially for second earners, single people and single parents. Despite good average performance in education, key challenges are the educational inequality and the declining trend in the share of top-performing pupils. While the share of top performers among 15 years-old pupils is still above the OECD average, their share is decreasing significantly. Meanwhile, the share of low-achievers is on the rise. Pupils' performance is strongly linked to their socioeconomic background, in particular for those with a migrant background. Addressing educational inequality will thus require a broad policy response going beyond the educational system. The strong demographic pressure, in particular among disadvantaged groups, risks exacerbating infrastructure deficiencies and teacher shortages, notably in major cities. The inflation differential risks to offset competitiveness gains. Headline and underlying inflation are structurally higher than in neighbouring countries. The figures mainly reflect rising prices in electricity and services, partly influenced by administrative decisions. Dysfunctioning in goods and labour markets added to the differential. Less intensive competition in sheltered non-tradable sectors explains why rising labour costs were easier to pass on into higher services prices, even if productivity growth did not keep pace with wages. Moreover, as wage indexation is common practice, upward inflation easily transmits into wage growth. This risks to translate into a downward impact on the employment of less productive workers, which can entrench over time. Moreover, price increases risk being passed on in traded goods and affecting competitiveness in sectors that are not sheltered. A number of bottlenecks weigh on Belgium's growth potential. Despite fiscal incentives for research activities, patent registrations and notwithstanding the presence of a highly skilled work force, the technological content of Belgium’s exports is behind that of its peers. Its high-quality public research system has not brought about an abundance of fast-growing firms in innovative sectors. Stimulating the adoption of digital technologies and higher human capital accumulation could further underpin productivity growth. Moreover, new sectors capable of creating domestic value added are not sufficiently involved, thereby missing out on multiplier effects, also in relation to employment, especially in services. Apart from downstream services such as distribution, this is a lost opportunity for an upward shift in the production chain, to where margins are bigger and finished products are more differentiated, notably through services such as R&I, design and branding. High regulation in the network industries and some professional services is restricting competition. Regulatory barriers are high in public utilities, such as postal services, public transport, the supply of energy and drinking water, and telecommunications. A number of rules also inhibit market mechanisms for professional services. There are remaining high barriers to entry, in particular requirements for establishing a practice, such as a particular legal or corporate structure. In addition to serving the interests of consumers, more affordable services would support growth and jobs. In the retail sector, significant operational and establishment restrictions are still in place. Insufficient investment in infrastructure, in particular in energy, education and transport, and a low level of public investment in general limit productivity growth. Infrastructure investment shortfalls, in particular in transport, as well as remaining adverse tax incentives, aggravate traffic congestion. Business investment, by contrast, has been resilient and increasingly oriented towards intangibles in the services sector. Nevertheless, some challenges in terms of entrepreneurship remain. Lengthy delays and a high burden of administrative and regulatory requirements — and their unpredictability — impede the creation and expansion of companies, for example in relation to property registration, labour legislation and construction permits. Environment and climate policies in Belgium, although performing well in some areas (waste management, circular economy), remain insufficiently effective to combat local air pollution and greenhouse gas emissions. A long-term climate policy vision is still lacking. The environmental gains of the envisaged change in the company cars system risk being very limited. Belgium remains Europe’s most congested country in terms of hours wasted in traffic and delays, and this is unlikely to change in the short run, partly because of long delays in several major public infrastructure projects. Finally, the high and growing energy intensity of the manufacturing industry calls for additional energy efficiency and cost-effective renewables. 1. Economic situation and outlook Economic growth The Belgian economy proved fairly resilient in the wake of the global economic recession in 2009. GDP quickly regained pre-crisis levels, thanks to strong economic growth in 2010 and 2011 (Graph 1.1). That recovery period was followed by stagnation, with flat growth in 2012 and 2013. In 2014 and 2015, economic activity rebounded with growth reaching 1.7 % and 1.5 % respectively. According to the Commission 2016 winter forecast, economic growth slowed down to 1.2 % in 2016. At 1.4 %, growth would strengthen in 2017 and economic activity is projected to expand by 1.6 % in 2018. The 2016 deceleration coincides to some extent with the March terrorist attacks and their aftermath. The impact from the March events is nevertheless assessed as limited and expected to be transient. Graph 1.1:Breakdown of GDP growth Source: European Commission The modest growth outlook ties in with rather low estimates for potential growth. The decline compared to the pre-2009 estimates for potential growth is broad-based (Graph 1.2). First and foremost, it reflects the continuation of a long-term trend of declining gains in total factor productivity, which is estimated to have stabilised at a low level in recent years. Second, there has been a decline in the contribution of labour due to slower growth in the working-age population without any change in average hours worked. Third, capital accumulation has been somewhat lower than in the past. The negative output gap, an indicator of economic slack, narrowed to -0.4 % in 2015 from its trough of -1.5 % in 2013. It is projected to widen again slightly in 2016-2017 as growth falls short of its potential. Graph 1.2:Breakdown of potential growth Source: European Commission Domestic demand has been the main engine of growth in recent years, with a boost from investment. The latter has held up well in Belgium (Graph 1.3), in contrast to other Member States. The investment-to-GDP ratio was 22.6 % in 2009-2016, compared to 22.1 % in 2000-2008. It is expected to increase to around 23.3 % in 2017-2018. Investment growth has been broad-based across sectors, with business investment showing the way. Business investment is underpinned by supportive financing conditions and by government measures to improve the relative labour cost position of Belgian companies. These measures have led to a steady increase in profit margins. Risks surrounding the positive outlook are mainly rooted in the external environment. Graph 1.3:Composition of investment spending (%GDP) Source: European Commission Investment in construction has also been buoyant thanks to housing and public infrastructure projects. Historically low mortgage interest rates and comparatively low yields on alternative investment assets set the scene for continued investment in housing. At the same time, the local government investment cycle in the run-up to local elections in 2018 is forecast to drive public investment in 2017-2018. The public investment-to-GDP ratio of around 2.4 % is nevertheless expected to remain among the lowest in the EU (see Section 3.4). Household consumption is expected to gain momentum in 2017-2018 as a result of job and wage growth. Private consumption grew by 0.7 % on average in 2011-2016, half of the 2000-2011 average. This trend is in line with modest real disposable income increases until 2015, which in turn reflect a sustained effort by successive governments to moderate wage growth in order to correct for past losses in cost competitiveness. Income growth has picked up since 2016. Wages are again being adjusted for the cost of living following a temporary suspension of wage indexation schemes. In addition, some real wage increases are again being allowed, while income tax cuts have also been introduced since 2016 as part of a multiannual tax reform (see Section 3.1). A relatively strong labour market performance is contributing to growth in households’ purchasing power. Overall, household consumption is estimated to have grown by 0.7 % in 2016 and to rise by 1.4 % in 2017 and 1.5 % in 2018.

Inflation Consumer inflation rose by 1.8 % in 2016, the biggest increase in the euro area, where the average was 0.2 %. Price pressures are expected to remain entrenched, reflecting crude oil price developments, the temporary rise in unprocessed food prices due to poor weather, and picking up wage growth being passed on to service inflation. Inflation is projected to remain at broadly the same level in the near future, reaching 2.0 % and 1.9 % in 2017 and 2018 respectively. This implies a narrowing of the difference with the euro area. Graph 1.4:Consumer inflation Source: European Commission Comparatively high inflation has been a recurrent feature of the Belgian economy. Between 2012 and 2016, headline inflation was on average 0.4 pp. higher in Belgium than in the euro area as a whole. For core inflation — which excludes energy carriers and unprocessed food items — the difference over the same period even amounted to 0.7 pp. (see Graph 1.4). The drivers of this structural differential are discussed in Section 3.4. Labour market and social developments The Belgian labour market is in a cyclical expansion. The number of bankruptcies and resulting job losses has fallen back to a seven year low (see Graph 1.5). Net employment is estimated to have increased by 1.3 % in 2016 and is expected to continue growing in 2017-2018, by 0.9 % annually. This makes economic growth relatively job-intensive. All private sectors have been contributing to job creation; in recent quarters even manufacturing added some jobs for the first time in five years. This suggests that employment growth is benefiting from improved cost competitiveness. Graph 1.5:Bankruptcies and resulting job losses Source: European Commission Graph 1.6:Employment growth (y/y %change; self-employed & employees) Source: European Commission Private sector employment is set to grow further, thanks to continued economic growth and prospective cuts in social contributions for employers. Employment in the public sector has been roughly constant in recent years and is forecast to decline in 2017-2018. This helps to explain why total employment growth has not reached the rates seen during past economic upturns (see Graph 1.6). In addition, past job growth in the private sector was for a non-negligible part due to subsidised work, which has its limits. Overall, the unemployment rate is expected to decline from a peak of 8.5 % in 2015 to 7.6 % in 2018. The good recent performance in terms of job creation nevertheless disguises a number of structural shortcomings. There remains for example substantial untapped potential stemming from low labour participation among certain groups. This has resulted in a labour market divided between insiders and outsiders, which is shown for example by the fact that the number of people living in households with very low work intensity is one of the highest in the EU (see Graph 1.7), whereas high-skilled labour is approaching full employment. This and other structural labour market issues are discussed in Section 3.3, which takes a closer look at regional disparities and the effectiveness of activation policies as well. Raising employment and activity rates will be important to further reduce sustainability risks to public finances from an ageing population. The average working life in Belgium is one of the shortest of all Member States: 32.6 years, versus 35.4 years in the EU28 in 2015. Government measures to tighten eligibility conditions for early and pre-retirement have nevertheless led to an upward trend. Income inequality remains relatively low and stable compared to EU averages ( ). Since 2012, the lowest income decile has benefited from slightly better income developments than the median household, reversing the previous trend. The gap with the median is smaller than in many other EU countries ( ). Social transfers are also more effective in reducing income inequalities in Belgium than the EU28 average ( ). Inequality in net wealth ( ) was higher than income inequality, but was within the range observed in other EU countries for which data were collected in 2013-2014 (ECB, 2016). However, there are signs that the financial situation of lower income households has worsened in 2015-2016. Survey data point to an increase in the financial distress — the necessity to draw on savings or incur debt to cover current expenses — of the poorest quartile in Belgium (ESDE Quarterly review, 2017). Moreover, for the poorest income quintile, the rate of self-reported unmet needs for medical examination due to their cost is above the EU28 average and has been increasing ( ). Graph 1.7:People living in households with very low work intensity (% total population aged less than 60) Source: European Commission External position In 2016 the current account is expected to record a surplus for the second year in a row. From a deficit of 0.7 % of GDP in 2014, it improved to a surplus of 0.4 % in 2015 and to an estimated 0.7 % in 2016 (see Graph 1.8). The recent improving trend — as well as the deteriorating trend in the past — is primarily reflected in the trade balance. Goods exports have been the more volatile component, with exports of services recording a broadly stable surplus over the years. The downward drift of the investment income balance, the result of external liabilities being generally higher-yielding than external assets, could not prevent a strengthening of the overall external position. Graph 1.8:Breakdown of current account balance (%GDP) Source: NBB Following seven years of deficit, the goods balance returned to surplus in 2015 and this surplus is expected to have increased further in 2016. While changes in the oil price go a long way in explaining developments in the goods balance, there is also a marked volume effect. Following a steady decline in global export market shares by volumes gains were made in recent years. Belgium maintains a solid net creditor position in relation to the rest of the world. The balance between external financial assets and liabilities stands at around 60 % of GDP, one of the highest in the EU. This surplus has its origin in the private sector, more in particular Belgian households, who own gross assets — foreign and domestic — representing about 240 % of GDP. Graph 1.9:Credit growth (y/y): non-financial companies (left) and mortgage loans (right) Source: NBB

Private indebtedness Private debt stands at a relatively high level, in particular for non-financial companies. However, corporate debt figures are inflated by widespread intra-group lending, as was discussed in earlier country reports. This practice has been stimulated by the notional interest deduction, an allowance for corporate equity within corporate income taxation. The increase in liabilities as a result of intra-group lending pushes up the debt-to-GDP ratio, though these liabilities are matched by additional assets so that the debt-to-financial asset ratio provides for a better measure of companies' financial situation. This ratio has been steady at around 50 % in consolidated terms since 2010, comparing favourably with other Member States. Access to finance for companies and the conditions attached to it do not appear to impose any restrictions on Belgian companies. Perceptions of credit constraints are at, or close to, a low for all company sizes. According to the most recent surveys, financing conditions are favourably assessed by companies in manufacturing, business-related services and the building industry. Sluggish to negative credit growth in recent years seems thus to have resulted from weak demand. In 2016, credit to non-financial companies grew by 5.1 %, compared to -3.1 % in 2015 and 0.1 % in 2014 (Graph 1.9). Although household debt has risen from 40 % of GDP in 2000 to 60 % in 2016, the ratio of debt-to-assets is still very low, reflecting the favourable wealth position of households. In terms of disposable income household debt rose from around 60 % at the turn of the century to an estimated 104 % in 2016. This increase stems from mortgage loans, which have registered strong growth in recent years thanks to the sharp decline in interest rates (Graph 1.9) and despite the fact that tax deductions have been made less beneficial. House prices rose sharply in real terms prior to 2008. They increased by around 70 % in 1997-2008 or 5 % on average annually (Graph 1.10). They have been broadly flat since, increasing by 0.5 % on average annually. Belgian households spend a larger proportion of their disposable income on housing investment than was the case in the past. This helps to explain the modest growth in household consumption mentioned higher. Valuation estimates based on structural ratios suggest some price overvaluation in the Belgian real estate market. As house prices grew faster than income and rental costs, price-to-rent and price-to-income ratios have risen steadily. The gap to their long-term average suggests an overvaluation of 20-25 % with no adjustment taking place in recent years (Graph 1.11). However, when other relevant variables are considered, it appears that prices are better aligned with fundamentals, with a narrowing of the valuation gap since 2009 as a result of the strong decline in mortgage rates. Massive refinancing of mortgage loans and the closing of new loans at lower rates have resulted in interest payments dropping from around 3 % of disposable income in 2007-2008 to below 1 % in recent years. While supportive financing conditions appear thus to have prevented a house price correction, this also suggests how rising interest rates might put pressure on house prices. Graph 1.10:Residential real estate Source: European Commission Graph 1.11:Valuation gaps: price/income, price/rent and fundamental model Source: European Commission As a result of the fast increase in household indebtedness and price developments, the European Systemic Risk Board (ESRB) has warned for medium-term vulnerabilities in the Belgian residential real estate sector ( ). Despite the fact that household debt amounts to only around 20 % of total assets held by Belgian households (up from 14 % in 2000), there are sizeable pockets of vulnerability. Specific groups of highly indebted households (i) hold large mortgage loans in relation to the value of their real estate property, (ii) spend a high proportion of income on debt service, or (iii) have a low level of net financial wealth compared to their indebtedness (ESRB, 2016). Risk concentrations could materialise in the event of an economic downturn with knock-on effects on income. Such a scenario might lead to credit losses to banks, especially if accompanied by a decline in house prices. The National Bank plans to introduce an add-on to capital adequacy requirements for loans exceeding 80 % of the property’s purchasing price in 2017, in addition to the general add-on introduced in 2013. The ESRB has pointed out that measures to directly address vulnerabilities due to highly indebted households have not been adopted, though, and that the tightening of credit standards applied in recent years appears to have halted. The financial sector is covered in Section 3.2 of the report. Public finances The consolidation of Belgium’s public finances has been a slow-moving process, partly because of extended periods of political stalemate. The fiscal deficit improved from a trough of 5.4% in 2009 to 2.5 % in 2015. However, in 2016 it is expected to have widened again to 2.9 % of GDP. The most recent deterioration has been mainly revenue-driven, resulting from generally disappointing tax collection and revenue measures that fell short of expectations. Conversely, spending restraint has been thwarted by temporary expenditure increases related to the influx of asylum-seekers and the security situation as well as high inflation leading to faster-than-initially-anticipated indexation of public wages and social benefits. According to the latest Commission projections, the deficit would narrow to 2.2 % of GDP in 2017 and, assuming no policy changes, increase again to 2.3 % next year. Public debt rose by 20 pps. of GDP since 2008. It is estimated to have peaked at almost 107 % of GDP in 2016 and to start declining as of 2017 thanks to the return to a primary surplus and a negative ‘snow-ball effect’ as interest expenditures decline while nominal GDP growth picks up. Public finances are discussed in Section 3.1. Table 1.1:Key economic, financial and social indicators — Belgium Source: European Commission, ECB 2. Progress with country-specific recommendations Progress with implementing the recommendations addressed to Belgium in 2016 ( ) has to be seen as part of a process which started with the introduction of the European Semester in 2011. First, against the backdrop of a public debt ratio of 106.6 % of GDP in 2014 and population ageing costs expected to rise considerably over the next decades, it was decided in 2014 to reform the pension system. This builds further on initial steps taken in previous years to raise the effective retirement age. Legislation has now been passed to tighten up the minimum age and career requirements for early retirement and raise the legal pension age for the years to come. The more favourable pension scheme for civil servants underwent a reform as of 2016. In 2015, Belgium has pursued measures focusing on wage moderation and the so-called tax shift, with the aim to raise employment, strengthen purchasing power and reverse losses in competitiveness. In this respect, measures have been taken to reduce the tax wedge on labour through gradual decreases in personal income taxation and employers' social security contributions, with more than proportional reductions for lower salaries. The targeting of low wages favours the young and the low-skilled, who tend to have lower wages, but also the lowest employment rates, and thus supports activation for some of the most vulnerable groups. Overall, estimates by the Federal Planning Bureau and the National Bank of Belgium suggest an additional job creation of 45,000–65,000 jobs by 2021. Additional positive effects are expected from reductions targeting SMEs and self-employed. Taken together, these measures should support job creation and significantly reduce the projected increase in the economic cost of ageing. Investment is also crucial within a longer-term perspective. Although overall investment did not experience the steep decline observed in other countries in the wake of the financial crisis, the situation is far less rosy when it comes to public investment. This has been structurally low for several decades, as a result of policy choices within a context of prolonged fiscal consolidation. Sustained cutbacks in investment budgets have resulted in net public investment, averaging zero since the 1990s, eroding the quality of public infrastructure (cf. section 3.4). The political agreement for a national pact for strategic investments, the announcement of an inter-federal energy pact in 2017 and calls for agreeing an inter-federal mobility strategy could provide renewed impetus for investment, including in energy and transport infrastructure, but details of each still need to be announced.

Overall, Belgium has made some ( ) progress in addressing the 2016 country-specific recommendations. The latter identified several priority areas for reform such as further fiscal consolidation, the functioning of the labour market and the wage-setting system, education and vocational training, the innovation capacity of the economy, competition in the business services sector and retail sector, and investment shortfalls. Since the publication of the country-specific recommendations, the government has taken limited measures on the budget coordination between the different levels of government. The same holds true for the recommendation to simplify the tax system and thus limited progress has been made on country-specific recommendation 1. Substantial progress has been made in reforming the wage-setting framework as recently the government adopted a reform of the 1996 act which introduces a number of crucial amendments to the private sector wage negotiation framework, on issues such as the calculation and legal status of the so-called ‘wage norm’, potential penalty mechanisms for infringement of the norm and the government’s ability to take measures in the event of excessive wage growth. There is moreover some progress on the functioning of the labour market and on vocational and educational reforms. This implies substantial progress on country-specific recommendation 2. Progress on country-specific recommendation 3 is limited as some measures which have been adopted or announced do not appear to fully address the challenge. Table 2.1:Summary Table on 2016 CSR assessment Source: European Commission

3. Reform priorities 3.1. Public finances and taxation 3.1.1.Fiscal policy Belgium’s public finances bear the marks of the financial and economic crisis. The general government balance went into deep deficit in 2009 (see Graph 3.1.1). Ever since, Belgian authorities have had difficulties to reconnect with the pre-crisis situation of a broadly balanced budget and to contain the increase in public debt. According to Commission projections, the deficit widened again in 2016, to 2.9 % of GDP as compared to 2.5 % in 2015. It is expected to narrow to 2.2 % in 2017 and widen slightly in 2018 unless additional budget measures are adopted. Whereas the decline in the revenue-to-GDP ratio is the main driver behind the fiscal delay incurred in 2014-2016, the deterioration since 2008 arose from an increase in primary expenditure. The latter went from 46.3 % of GDP in 2008 to 52.4 % in 2013 and around 51 % in recent years. Graph 3.1.1:Fiscal deficit: headline and structural developments (%GDP) Source: European Commission In structural terms, too, budget consolidation has made only modest advances so far. While the nominal balance improved by 2.5 pps. between 2009 and 2016, the structural balance — which adjusts for the impact of the business cycle and one-off budgetary measures — improved by only 1.5 pps. over the same period, leaving a structural deficit of 2.5 % of GDP at the end of 2016. Moreover, this net structural improvement has been nearly completely due to interest windfalls, with the primary structural change turning negative in recent years (see Graph 3.1.1). In other words, Belgium has not made full use of the supportive conditions for budget consolidation resulting from the sharp decline in interest rates. Long-term debt reduction depends on a return to sufficiently high primary budget surpluses. There remains, however, a long way to go towards the country’s medium term budgetary objective (MTO) under the Stability and Growth Pact, of achieving a balanced budget in structural terms. Attaining and maintaining this medium term budgetary objective would put the debt level on a downward path and pre-finance part of the projected ageing costs discussed below. Together with substantial support for the financial sector, budget deficits have pushed up public debt. The debt ratio is estimated to have peaked at almost 107 % of GDP in 2016. The increase, by as much as 20 pps. since 2007, stands in stark contrast to the period of sustained debt reduction that preceded it (see Graph 3.1.2). Debt rose more in the euro area but the euro area debt ratio peaked in 2014, whereas Belgian government debt is expected to start declining only from 2017. Aside from financial sector interventions, loans to Greece and contributions to the European Stability Mechanism and its precursor partly explain the increase in the debt ratio. Some of the financial sector bailout has been recovered, which has had a debt-reducing impact ( ).

The high public debt denotes continuing economic vulnerability. Combined with a sizeable budget deficit, it limits the authorities’ margin for countercyclical policies or new policies, for that matter, considering the debt service on the hefty debt stock. The gradual advent of age-related costs (see lower) only adds to the challenge. Graph 3.1.2:Public debt trends Source: European Commission At the same time, short-term risks linked to high public indebtedness appear to be contained. Belgian authorities have been using favourable market conditions to refinance the outstanding debt against much lower rates at considerably longer maturity. This has allowed interest expenditure to fall, even despite the increasing debt levels. Total interest payments went from 4.0 % of GDP in 2008 to 3.0 % in 2015 and 2.6 % in 2016. A further decline is expected in coming years (see Graph 3.1.2). The average maturity of long-term issuance rose to 17.5 years in 2016 (14.1 years in 2015 and 15 years and 2014) with an average weighted yield of 0.8 % (0.9 % in 2015 and 2.2 % in 2014) ( ). The proportion of short-term debt in total debt has fallen. This is reflected in the average life to maturity of the overall federal debt portfolio. It rose from around 6 years until 2009 to 8 years at the end of 2015 and to 8.7 years at the end of October 2016, the longest ever. The longer average life shows in the 12-month and 60-month refixing risks ( ). As a result, if interest rates rose, this would trickle through only slowly in the debt stock. A linear increase in the yield curve by 100 basis points would imply higher costs of 0.1 % of GDP in 2017 and 0.3 % of GDP in 2019, though relative to a baseline of falling interest payments (Chambre des représentants de Belgique, 2016). According to the ‘S0 indicator’ Belgium does not seem to face a high risk of fiscal stress in the short term, i.e. within one year ( ). However, the S0 fiscal sub-index exceeds the critical value, pointing to some challenges in the short term due to the fiscal side. 3.1.2.Long-term sustainability Longer-term sustainability indicators paint a less benign picture, with Belgium facing high sustainability risks in the medium term, i.e. up to 10 years. This is because public debt is projected to reach around 102 % of GDP at unchanged policy and because it is sensitive to potential shocks in nominal growth and interest rates. Such shocks would bring the debt level to 108-109 % of GDP in 2027 (see Graph 3.1.3). On the other hand, converging towards the medium term budgetary objective, as required by the Stability and Growth Pact, and maintaining this structural balanced budget stance, would put the debt ratio on a clear downward path, arriving at 80 % of GDP by 2027. The required fiscal effort for reaching the medium term budgetary objective is substantial, considering the estimated structural deficit of 2.5 % in 2016. Moreover, rising expenditure might require additional measures once at the medium term budgetary objective. This risk is confirmed by the sustainability gap indicator S1, which points to high risks in the medium-term ( ). These are mainly due to the distance between the debt ratio and the 60 % of GDP reference value. To a lesser extent, they also stem from the projected rise in ageing costs. Reaching a debt ratio of 60 % of GDP by 2031 would require a fiscal adjustment of as much as 4.1 pps. of GDP between 2018 and 2023 relative to the baseline scenario assuming no policy change. Graph 3.1.3:Public debt: medium-term projection and scenarios (%GDP) Source:

European Commission (Debt Sustainability Monitor 2017) Long-term fiscal risks are assessed as medium-level. Ensuring the sustainability of public finances in the long run would require an additional fiscal adjustment of 3 pps. of GDP. The risks stem from the projected increase in age-related spending, such as pensions, long-term care, and, to a lesser extent, healthcare. These estimates take into account the pension reforms enacted by the Belgian authorities in recent years and discussed also in previous country reports (see Box 3.1.1). The long-term impact of the measures is evident in the latest projections of the Ageing Working Group: pension expenditure is projected to rise by 1.3 pps. of GDP between 2013 and 2060, compared to 3.3 pps. before the most recent reforms. The lower projections allowed Belgium to lower its medium term budgetary objective from a structural surplus of 0.75 % of GDP to a balanced budget in structural terms. Additional pension reforms would further improve long-term fiscal sustainability. There are risks of a shift from early exit through the pension and unemployment systems to exit through the sickness and disability schemes, which would reduce the reforms’ projected gains. The government intends to lay the groundwork for the introduction of a credit-based public pension system by the end of its term in 2019. Once operational, such a system would provide for automatic adjustment mechanisms in response to structural demographic or economic developments. One element is the demarcation of criteria for demanding jobs. People in such jobs will still be able to retire early following the reforms. The government has asked social partners to determine these criteria. The available budget for the period 2018-2021 has already been fixed by the government. Expenditure projections for long-term care contribute to sustainability challenges in the long run. Following the most recent institutional reform, regions and communities have become responsible for long-term care. Dependent people represented 7.7 % of the Belgian population in 2013, about the same as in the EU. Belgium nevertheless had the highest proportion of the population receiving long-term care. As a result, Belgium spent 2.1 % of GDP on long-term care in 2013, twice the EU average. In addition, while the proportion of dependent people in the total population is projected to increase less by 2060 than the EU average (+1.5 pps. vs. +2.8 pps.), the expected increase in spending on long-term care is 1.5 pps. of GDP for Belgium, compared to 1.1 pps. of GDP for the EU as a whole. 3.1.3.Fiscal frameworks Effective budget coordination is essential in a federal country like Belgium. A large part of spending power has been devolved to sub-national governments. In addition, the central government — which is responsible for most of the debt and faces the bulk of age-related costs — does not have the legal authority to impose budget targets on regions and communities. In an attempt to improve internal coordination and to transpose the Treaty on Stability, Coordination and Governance in the EMU (the ‘Fiscal Compact’), the federal government and the regional and community governments concluded a cooperation agreement in 2013. It requires the High Council of Finance to propose multiannual budget targets for each government in preparation for the annual Stability Programme. On this basis, the federal, regional and community governments are expected to reach a binding agreement on overall and individual multiannual fiscal paths. The High Council is responsible for monitoring compliance with the agreed targets and if it signals a significant divergence, the government concerned has to adopt corrective measures; progress on the corrective measures is, in turn, monitored. The federal government is taking steps to reinforce the autonomy of the High Council and the independence of its members. Implementation of the 2013 cooperation agreement has been poor. Both in 2015 and in 2016, the federal governments, the regions and communities did not achieve an agreement to formally commit to the fiscal trajectory proposed by the High Council of Finance. This lack of internal cooperation and burden sharing undermines the viability of the country’s overall trajectory towards its medium term budgetary objective as laid down in the Stability Programme. A task force has been created to remedy the factors that prevented an agreement in the run-up to past Stability Programmes. However, the obstacles appear to be rather political than technical. 3.1.4.Taxation The effects of the ongoing tax reform are beginning to materialise. Taxes on labour, including social contributions, are being reduced in several steps between 2016 and 2020, while others, mainly consumption taxes, have been increased, thus partially compensating for the labour tax cuts. Last year’s country report detailed and assessed the measures mainly from a budgetary and labour market perspective. Positive effects on competitiveness, employment and growth are also expected to help fund the tax cuts, although the overall budget-neutrality of the reform is not assured. Additional positive effects are expected from reductions targeting small and medium-sized enterprises (SMEs) and self-employed people. Nevertheless, the Belgian tax system remains complex, with tax bases eroded by numerous exemptions, deductions and reduced rates. These entail revenue losses, economic distortions and a heavy administrative burden. The latest figures for the federal government show that the total amount of tax expenditures (i.e. tax relief) is sizeable, and that the rising trend as a percentage of GDP continues ( ). A study estimated that the actionable policy gap in VAT was 15.9 % in 2014, above the EU average of 14.9 % ( ). In some cases there may be good reasons to retain specific tax expenditures, e.g. innovative ways of financing start-ups are being fostered through tax breaks and tax incentives at federal and regional level. Nevertheless, a comprehensive rethink of the design of the tax system is warranted as the cost-effectiveness of the various exemptions and reduced rates is not always clear. The tax shift has only partially exploited opportunities to shift taxes to a more growth-friendly base, amongst others environmental taxation and the removal of environmentally harmful subsidies. The most positive changes in recent years were the introduction of road pricing for heavy duty trucks in all regions from April 2016 and changes to vehicle and road taxes in Flanders. No agreement has been reached so far to extend road pricing to passenger cars (see also Section 3.5.2.). A study of the Federal Planning Bureau points to the fact that a kilometre charge on heavy duty trucks alone is insufficient to have a sizeable impact on peak hour congestion. ( ) The tax reform also provides for a steady increase in excise duties on diesel and a reduction in those on petrol with the aim of achieving parity by 2018. Belgium is also one of the few Member States to have introduced indexation for environmental taxes (excise duties, vehicle and road taxes) ( ). Moreover, the Brussels region has introduced a tax on car parks for office buildings, which is designed to become more dissuasive every year. Despite past measures to further align the tax base for company cars to CO2 emissions, private use continues to be heavily subsidised. This impedes further progress in tackling congestion, air pollution and greenhouse gas emissions. In its draft budget plan for 2017, the federal government announced changes to the company car system. First, since 1 January 2017, a less favourable tax deduction for employers concerns all company car costs when a fuel card is granted. Second, as from April 2017, a new framework would allow employees whose pay package includes a company car to opt for a mobility allowance (net pay) budget or additional net pay instead, by agreement with their employer. Although the practical details have yet to be spelled out, the measure is planned to be budget-neutral. Its environmental benefits, however, are probably limited, without a substantial reduction in the number of company cars (currently around 450,000) and the change is unlikely to simplify the system.

Graph 3.1.4:Low wage trap for second earners, 2015 Source: Tax and Benefit database; European Commission (2016), EU Tax Policies: 2016 Scoreboard. Certain features of the tax system still give rise to labour market traps. For example, the upper limit for receipt of the ‘marital quotient’ constitutes a disincentive for second earners ( ) to engage in the labour market or increase their working hours. In 2015, the low wage trap and the inactivity were among the highest in the EU. In both cases, the contribution of the taxation system was among the highest in the EU (Graph 3.1.4). However, this does not yet reflect the effect of the 2016 tax reform. Some of Belgium's tax rules may be used in structures of aggressive tax planning. ( ) The absence of anti-abuse rules ( ) and notably the possibility to cascade deductions under the allowance for corporate equity (ACE) are features of the tax system which may facilitate aggressive tax planning by multinational groups that locate financial companies in Belgium to minimise their overall tax burden. ( ) In that respect, the high level of foreign direct investment positions but also the size and pattern of interest flows ( ) as a percentage of GDP suggests that the country's tax rules are used by companies that engage in aggressive tax planning. Within this context, it is also important to note that corporate tax initiatives (for example the amendment to the Parent-Subsidiary Directive or the Anti-Tax Avoidance Directive) will strengthen Member States' anti-abuse framework and boost tax transparency (for example through the automatic exchange of information on tax rulings or on country-by-country reports). Belgium has taken steps to adjust some of its tax rules facilitating aggressive tax planning. Belgium amended its patent box regime in order to bring it in line with Action 5 of the Base Erosion and Profit Shifting project (see OECD, 2015) as endorsed by the Code of Conduct for Business Taxation. In its draft budget plan for 2017, the federal government announced several measures, including the potential overhaul of corporate income taxation. The current corporate income tax system is characterised by a high statutory rate of 33.99 % (with a lower rate for SMEs), with numerous exemptions and allowances. Reforms under consideration would move towards a system with lower statutory rates and fewer exemptions, and possibly raise taxes on capital gains and increase incentives to channel savings into productive investment. Prior assessment of the various options made clear the difficulty of carrying out a budget-neutral reform that would significantly reduce the statutory tax rate, even if existing exemptions, deductions and specific schemes are abolished, in particular the allowance for corporate equity. The proposals are still under discussion. Both the budget-neutrality of potential reforms and the impact of new measures on the debt/equity bias need to be carefully assessed. The 2017 budget included a further increase in the financial withholding tax rate, from 27 % to 30 % ( ), an extension of the existing tax on stock exchange transactions (doubling the taxation ceilings and broadening the tax base to include transactions on foreign trading platforms), and the abolition of the ‘speculation tax’. 3.2. Financial sector The financial sector seems to remain relatively sound, but low interest rates, digitalisation, clients’ changing preferences and intense competition are challenges for traditional business models. Banks and insurers are undergoing severe and sometimes disruptive restructuring, some more visibly than others. With one of the highest cost-to-income ratio in the EU, restructuring will continue and consolidation is likely. On the banking side, the minimum interest rate on savings accounts (0.11 %) may aggravate the situation. On the insurance side, the negative effects of the 2 % tax on life insurance premiums are still felt by the sector. In addition, if the current very low interest rate environment persists, employers and insurers might find it difficult to achieve the guaranteed return of 1.75 % over the lifespan of the contract. The financial crisis has left the Belgian State with participations in several large banks and insurers. It has a share of about 10 % in BNP Paribas, 100 % of Belfius bank, 100 % of insurer Ethias (including stakes of regions and local authorities), and 50 % of Dexia bank. Dexia is in resolution and it is unclear how much will eventually be recovered because full resolution will take years to conclude. Moreover, Dexia accounts for sizeable contingent liabilities. These stem from the Belgian State’s guarantee of 51.4 % of the bank’s liabilities. This guarantee, on which only limited fees are due, amounted to 8.3 % of GDP on average in 2016, compared to 8.5 % in 2015 and 9.7 % in 2014. In nominal terms, it rose from EUR 31.5 bn at the end of 2015 to EUR 36.7 bn at the end of 2016. Government plans concerning other stakes in the financial sector are currently unclear. BNP Paribas and Belfius have been yielding dividends to the federal budget. Belgium had a number of macro-prudential measures in place in 2016, which were either newly activated or had been extended. Besides phasing-in buffers on systemic banks, in its capacity as the designated authority the National Bank of Belgium prolonged a measure imposing higher risk weights applied by banks to mortgage loans. The NBB has also announced its intention to introduce an additional macro-prudential measure in 2017 to address vulnerabilities in the residential real estate market (see Section 1). Table 3.2.1:Financial soundness indicators (in %) Source: ECB CBD Belgian capital markets function well but are constrained by country-specific factors. Some features of the taxation system favour ‘risk-free’ capital like deposits and bonds over ‘risky’ capital like shares. The stock exchange transaction tax negatively affects efficiency and liquidity. The large inflow of household funds into savings deposits is largely determined by cyclical and structural factors such as a risk-averse attitude to savings, which could be a serious barrier to investment in cross-border funds, and the tax exoneration on regulated savings accounts. The lack of a business ecosystem capable of helping SMEs with the listing process is another potential barrier to expanding Belgium’s capital markets. Efforts to increase activity and value added in the financial sector could focus on niches where Belgium is already well positioned to compete. This includes financial market infrastructures (e.g. Euroclear), but also communications providers such as SWIFT. Belgium is consistently late in transposing financial directives. It is among the Member States with the highest number of open infringement cases for non-transposition of post-crisis financial directives. For most Directives Belgium has eventually communicated full transposition but it is still late in the full transposition of four Directives, including the Payment account Directive and the Directive on non-financial reporting. Belgium is following up the recommendations of the high level expert group created by the Minister of Finance in view of improving the transposition process. 3.3. Labour market, education and social policies 3.3.1.Labour market The performance of the labour market remains mixed as large differences persist between regions and between subgroups of the population. Unemployment remains below the EU and euro area average at 7.9 %, but the proportion of long-term unemployment within unemployment has risen sharply between 2012 and 2015 before stabilising at a high level. Job creation has been substantial over the past year ( ), in spite of some high-profile announcements of collective dismissals. ( ) The employment rate (67.2 %) and the activity rate (73.0 %) remain well below the average in the EU and euro area. ( ) However, there are big and increasing differences between and within regions (Graph 3.3.1). ( ) Labour market outcomes for the low-qualified, the young, older workers and people with a migrant background are far below levels recorded for similar groups in the other Member States. Meanwhile, job vacancy rates consistently exceed the EU average ( ), pointing to mismatches between labour supply and demand at various levels. ( ) Graph 3.3.1:Differences in employment and unemployment rates (15-64 years) at regional level compared to the Belgian average. Source: Eurostat — Labour Force Survey A relatively large proportion of the working-age population is not employed. Unemployment and different types of inactivity are largely concentrated among specific groups such as the low-qualified young people, older workers and workers with a migration background from non-EU countries. Trends also differ across population groups. For instance, activity and employment rates are falling among low-qualified young people (20-24 years), while among low-qualified older workers they are rising. The number of people below the age of 60 living in households with very low work intensity is one of the highest in the EU and still increasing, contrary to the average European trend. At the same time, a relatively large proportion of the population lives in households with very high work intensity (Graph 3.3.2). Graph 3.3.2:Distribution of the population (aged 0-59) by work intensity of the household — 2015 Source: EU-SILC. Beyond the level of qualification, inactivity is strongly linked to age, gender and migrant (versus native) background. For young people (under 24 years), inactivity is essentially explained by education and training. For older workers, retirement is the major reason. Family and care responsibilities are major explanations for women but not for men. In addition, sickness and disability are increasing reasons for inactivity among prime age workers. Inactivity among non-EU-born residents is much higher than for Belgians without a migrant background. This is related to a specific combination of factors including the functioning of the labour market, taxation and welfare policies, as well as integration measures and, specifically for women, differences in gender roles (FOD Werk, 2015).

An increasing number of people are relying on welfare and invalidity schemes. The number of recipients of social assistance benefits has increased by about 60 % over 10 years, with a particularly marked rise for young working age adults (20-39 years) and for men. The 10 % increase in 2009 coincided with the economic crisis, whereas the 13 % rise from 2014 to 2015 reflects the entry into force of the reform limiting the right to an ‘insertion allowance’ for seeking work. About a third of those coming to the end of their insertion allowance rights seem to move onto the social assistance benefit. The number of days paid out on account of labour incapacity and invalidity has also been rising annually, by 4-5 % since 2006, accelerating to 7 % in 2014 and 6 % in 2015. This increase reflects a combination of higher numbers of cases claiming for longer periods. It is more pronounced among workers aged over 50 and for women. Although temporary and part-time employment is becoming more prevalent, labour market segmentation by contract type remains comparatively limited. While part-time work, as a percentage of total employment, is above the EU average (at 24.3 %, against 19.6 %), involuntary part-time work is limited to 10 % of the total (against 29.9 % in the EU). The proportion of temporary employees in the total workforce has risen, from 7.6 % in 2010 to 8.5 % in 2015. This is still markedly below the EU average and the rates observed in neighbouring countries. The average transition rate from temporary to permanent employment also compares favourably, by these benchmarks. This is particularly true for young people, but not for people with a migrant background, who are overrepresented in precarious employment contracts (FOD Werk, 2015). The percentage of temporary contracts among newly recruited employees has risen, from about 30 % in 2012 to 40 % in 2016. There has also been a steady and slightly accelerating trend towards a higher incidence of temporary employment among young people in the past 4 years (SPF Economy, 2016). Taken together, these observations suggest that the abolition of the probation period for open-ended contracts may have contributed to increased contract type segmentation, although the phenomenon remains comparatively limited. The Belgian labour market is characterised by a high degree of mismatch between supply and demand for skills. The relative dispersion of employment and unemployment rates across skills groups is among the highest in the EU and shows significant differences in the respective likelihood of being employed for the low-skilled, medium-skilled and high-skilled. This indicates in turn a mismatch between the supply of skills (proxied by the composition of the working-age population) and the demand of skills (proxied by the composition of employment) (Graph 3.3.3) (European Commission, 2016a). While the employment rates of recent tertiary education graduates is relatively high, the gap with the employment rate of those who have completed only secondary education is markedly wider than in neighbouring countries. This sizeable skills mismatch is the product of various factors. The decline of manufacturing in Belgium has been faster and steeper than in other Western European countries. This contributes to low demand for low-skilled labour. At the same time, Belgium has a relatively high proportion of early school leavers, mainly concentrated in Wallonia, in Brussels and in other urban areas, and a high proportion of young adults with a low level of educational attainment. Participation in adult lifelong learning is also markedly below the EU average and the levels in neighbouring countries. Graph 3.3.3:Relative dispersion of employment rates by education level, 2010, 2014 and 2015 Source: Own calculations based on Eurostat. Annual average based on the average of four quarters. Measures to tackle inactivity and unemployment focus on reducing overall labour costs, strengthening financial incentives to work and activating older workers. The personal income tax reform being phased in includes several measures to increase net wages for low and average wage earners. Earlier reforms that limit young jobseekers’ eligibility for benefits and introduce degressivity of the overall benefit levels have now been fully phased in. With regard to older workers, access to the unemployment benefit system with a top-up from the company is being tightened by gradually lifting the age ceiling and career length requirements. The transition will be complete by 2020. At the same time, it was decided to increase the pensionable age from 65 to 67, in two steps in 2025 and 2030. More recently, the federal government proposed a series of measures to increase the flexibility of working time arrangements and to promote in-company training. The regional authorities, meanwhile, are in the process of reforming the existing employment incentives aimed at specific target groups and the monitoring and guidance activities of their respective public employment services. The ongoing tax and social security reforms are producing positive effects on take-home pay for low and average wage earners and on the participation rate of older workers. The number of young people benefiting from an insertion allowance is dropping, and so is the number of people resorting to early labour market exit schemes. The employment rate of older workers is increasing, from 42.7 % in 2014 to 44.0 % in 2015 ( ). However, the tax and benefit system still puts a heavy tax burden on second earners (usually women) who face a tax wedge which was among the highest in the EU in 2015 (see Section 3.1.4). Table 3.3.1:Size of selected target groups (total population in thousands) Source: Eurostat (2015 Labour Force Survey; LFS ad hoc module: 2014. Migration and labour markets) — own calculations People with a migrant background represent a large proportion of the target groups ( ) selected for employment support. The employment rate of non-EU-born residents in Belgium remains very low and the resulting gap with native-born residents is one of the largest in the EU. The gap is larger for women, which is mainly explained by high inactivity rates, by contrast with non-EU-born men, for whom the gap is chiefly due to higher unemployment. The low employment rate persists in the second generation, despite their being educated in Belgium. Overall, this is a substantial issue. The non-EU-born represent 8.5 % of the population but 14 % of the low qualified young people, and nearly 30% of the prime age long-term unemployed (Table 3.3.1). In addition, the second generation with at least one non-EU-born parent represents 9.5 % of the 20-24 age group but 10 % to 15 % of the target groups. Employment outcomes for first-generation migrants differ greatly according to the reason for migration and to individual characteristics such as age, sex, education level and literacy. However, even when adjusting for these individual characteristics, the second generation is significantly less represented in employment than residents without a migrant background, which is also, as for the first generation, one of the worst outcomes among Member States for which data are available (OECD, 2014a). The unexplained part of this lower employment probability may point to discrimination. This is confirmed by testing studies showing that being of foreign origin directly impacts on the probability of being recruited, other things being equal (OECD, 2013a). Therefore, despite extensive legislation, discrimination still seems to be an important labour market barrier. Despite significant resources spent on activation policies, transition rates into employment remain well below the EU average (graph 3.3.4). Consequently, although Belgium spends more than the average on active labour market measures, ( ) the phenomenon of long-term unemployment remains widespread, mostly in Brussels and in Wallonia and among specific population groups. So for example, long-term unemployment is slightly below the EU and euro area averages among the prime age working population, but comparatively high among young people and older workers. In the latter case, this is partly due to the legacy of relatively easy access to early exit opportunities via the unemployment benefit system. The long-term unemployment rate of low-qualified young people in Belgium has been consistently above EU and euro area averages ( ) and is higher for young women than for young men. Graph 3.3.4:Labour transitions by employment status Source: Eurostat The measures taken by subnational governments represent major simplifications of the existing employment schemes. The sixth State Reform transferred follow-up of the unemployed and 22 targeted employment incentive schemes to subnational levels. The employment incentive system was complex, with definitions and procedures not always aligned, and take-up of some measures was low (Van Landeghem et al, 2015; ONEM, 2015). Throughout 2016, the three regions and the German-speaking community were reviewing these various schemes to streamline and focus financial support on a limited number of priority groups and to better integrate employment support with other types of employability measures. The reformed employment support systems have already become fully operational in Flanders, and Wallonia and Brussels will follow in the course of 2017. However, some features of the reformed employment support schemes, including wider targeting and high wage ceilings, may result in windfall and crowding-out effects. The success of the new employment incentives will depend on the extent of windfall and displacement effects they create and whether they increase labour demand or not. It is significant here that the target group of medium-qualified young people in Flanders has been widened, by dropping the 156 days unemployment spell requirement.. This might entail a windfall effect as employers will pay lower social contributions for someone they might have recruited anyway. However, displacement effects may be reduced, as there is no reason for employers to prefer young people who have had a 6-month spell of unemployment. At the same time, the level of financial support for low-qualified young workers and for the long-term unemployed between the ages of 25 and 54 has been reduced. ( ) Also, in all regions, the wage ceilings set to qualify for employability measures or lower social contributions are high: about 80 to 90 % of young people and older workers would qualify, while low wage earners from other age brackets will not receive any additional support. In addition, there may be adverse threshold effects close to these levels: increases in wages above the ceiling will cost employers much more as the advantage of the scheme disappears. ( ) Close monitoring of the effects of these design features will be needed to evaluate whether the newly reformed schemes are properly targeted and cost-effective. The different choices made may promote inter-regional movement of labour from Brussels and Wallonia to Flanders. There are major differences in terms of the instruments selected. Flanders has opted for a policy based on the place of employment (thereby potentially covering workers commuting from other regions), whereas Wallonia and Brussels have opted for a broader mix of instruments, based mostly on the worker’s place of residence. Brussels is also planning to introduce a training budget for low-qualified young people (aged under 30). These choices make sense in view of the higher unemployment rates in Wallonia and Brussels compared to Flanders. However, inter-regional mobility is not only determined by labour cost considerations. Other factors, such as command of the language, registration fees on real estate purchases, transport infrastructure (including public transport) and wide publication of job offers are also important. 3.3.2.Social policy The stability of the overall risk of poverty or social exclusion, below the EU average but above that of neighbouring Member States, hides divergent trends across population groups. While the at-risk-of-poverty-or-social-exclusion rate for the overall working age population is stable, it has fallen for the elderly (older than 65) and increased for young people (16-24), notably for people with low qualifications, with disabilities or with a migrant background. The worsening social situation of the low-skilled, in particular, is explained by the fall in employment rates for this group and a higher risk of experiencing (very) low work intensity, despite a high overall vacancy rate. This also holds for the high proportion of non-EU born migrants living in a situation of poverty or social exclusion: 50.7 % in 2015 (vs. 27.5% for people born in the EU but not in Belgium and 17.0 % for people born in Belgium), which is higher than the level recorded for non-EU born migrants in the EU (40.2 % in 2015). Moreover, the gap in the at-risk-of-poverty-or-social-exclusion rate between people with and without disabilities amounts to 17.7 percentage points, which is significantly higher than the EU average of 9.7 percentage points. Belgium is one of the few Member States where financial distress for households in the lowest income quartile has increased in the year to Q4 2016 (European Commission, 2016). These developments may point to a shift from a ‘generation gap’ in poverty to a division between highly educated and low-educated people within the working-age population. This is largely explained by inactivity and unemployment, which markedly raise the poverty risk. The at-risk-of-poverty-or-social-exclusion rate among the population in employment is well below the EU average. In contrast, the at-risk-of-poverty-or-social-exclusion rate among the inactive or unemployed population is above the EU average. Nevertheless, the poverty-reducing impact of taxes and transfers for non-standard working and jobless households tends to be particularly large in Belgium, most notably for jobless households, whose poverty rate is more than halved after taxes and transfers (OECD, 2015a). The proportion of children living in very low work-intensity households is above EU and euro area averages. Belgium has reached the Barcelona targets, with 49 % of children younger than 3 in childcare, and 98 % of those between 3 and minimum compulsory school age. However, the number of income-related places in out-of-school care services remains small, particularly in Brussels. 3.3.3.Education and skills The Belgian education system continues to combine good average performance, by international comparison, with persistently high educational inequalities and wide gaps in performance between schools. The impact of socioeconomic status on basic skills proficiency remains above the EU average. Compared with 2012, the 2015 OECD PISA results (OECD, 2016a) point to an increase in the percentage of 15-year-olds who are low achievers (performing below level two in science 19.8 %, reading 19.5 % or mathematics 20.1 %). This is consistent with an even greater deterioration across the EU. Disparities between communities remain, in terms of mean scores and percentages of low and top performers. Despite some improvements, the percentage of low achievers in the French community (around 23 % in science and reading and 24 % in mathematics) is still larger than the national average. In the Flemish community, the percentage of low achievers has been rising and is now close to 17 % in all areas tested; for the German-speaking community this percentage is 14.3%. Although national performance on early school leaving is slightly better than the EU average, large differences between communities and regions persist. Nurturing excellence is essential in order to counter the declining share of top performers among the 15-year-olds students. According to Pisa 2015 results, Belgium’s share of top performers is still above the OECD average in all three areas tested, at 15.9 % in mathematics (against an OECD average of 10.7 %), 9 % in science (OECD average 7.7 %) and 9.3 % in reading (OECD average 8.4 %). However, since 2003, there has been a rapidly down turning trend of top performers in mathematics even when adjusted for the demographic changes. The decrease is especially pronounced in the Flemish community. The proportion of top performers in the French and German community is below the national average in all three areas and is little more than 5 % in science. Moreover, the low proportion of students and graduates in science and technology might hamper future innovation as discussed in the 2016 country report. For further details on science, technology, engineering and mathematics (STEM) students and graduates, see Section 3.4.2. on innovation.

In addition to the impact of socioeconomic status on performance above the EU average, there also is a large gap in performance between EU-born students and those non-EU born or with at least one parent non-EU born. Despite an improvement, the second generation performs only slightly better than the first, even taking socioeconomic background into account. Belgium has a comparatively high proportion of 15 year-old students with a migrant background, and this rose from 15.1 % to 17.7 % between 2012 and 2015 (PISA, 2015). They are, however, unevenly spread across the communities (the figure is 14 % in the Flemish community). In 2015, the share of second- and first-generation students with a migrant background in Belgium was respectively at 9.0% and 8.7%. The percentage of first-generation migrants with educated parents increased compared to 2012; The language spoken at home and the country of origin explain a large part of the difference in basic skills The increased number of refugees since 2015 has reinforced the challenges. The communities have taken measures to increase the capacity of reception classes, the number of language teachers and the budget to support newly arrived students (European Commission, 2016c). Increasing child poverty and greater diversity in language, culture and family structure compound the equity challenge. Often pupils do not have sufficient support from their families due to lower social and/or financial capital, challenges with language of instruction and other related factors. The family structure also matters, with students from single-parent families underperforming more than in other countries (OECD, 2013b). Divergent levels in poverty amongst the school population (Studiedienst van de Vlaamse Regering, 2015; Mc Kinsey, 2015) reinforce disparities between communities and regions (European Commission, 2016c). The problem is especially acute in the Brussels region. Therefore, addressing educational inequalities requires a broad policy response going beyond education. Moreover, the projected growth of the school population is among the largest in Europe and the pace will be even faster for disadvantaged groups, in particular pupils with a migrant background who are largely concentrated in big cities (European Commission, 2016d). Efforts are made to spread the refugees across the country. However, past experience shows that they tend to move to big cities to join people with similar migrant background. Growth disparities ( ) of the school population between the language communities, regions and educational levels are forecast. The growth is the highest in the French Community with a 7 % increase forecast for the next decade. As a result, shortages in educational infrastructure are a growing concern, particularly in cities. A geographical shift in enrolments, demographic pressure and insufficient planning — coupled with long delays in renovation and building — have led to infrastructure capacity and quality issues. At 6.6 %, the proportion of public expenditure spent on school infrastructure is below the EU average of 7.4 %. Shortages of well-qualified teachers are emerging and teachers are not always well prepared or supported to cope with an increasingly diverse school population. Despite a higher than average enrolment rate of students in ‘Education’, there is a shortage of qualified teachers. The main reasons are the difficulty of attracting the most suitable students and candidates to the profession; the high exit rate among starting teachers; retirement conditions; and the unavailability of a proportion of teachers for teaching. Barriers also include the big difference in status and employment conditions of starting teachers compared with those of (not very mobile) established teachers (OECD 2015; Delvaux, B., et al., 2013). Finally, recognition of foreign teachers’ qualifications is one of the barriers for teachers with a migrant background (OECD, 2014b). Participation in training for teaching in a multicultural or multilingual setting is significantly below the EU average (OECD, 2013b). The diversity of the student population is not reflected in the teaching profession. In-work teacher training is not used well to develop skills, or recognised for career development purposes. Teachers’ contracts are still based only on teaching hours. Performance gaps between schools are reinforced by uneven access to experienced teachers, going beyond residential background and also reflecting academic, socioeconomic, language and migrant background (Belgian Court of Auditors, 2015; Mc Kinsey, 2015). Schools with the most disadvantaged pupils are unable to attract the most experienced teachers and school heads, and face greater turnover in teaching staff. Equal opportunities policies for such schools have not delivered the results expected, despite the student-teacher ratio in these schools being one of the lowest by international comparison (OECD, 2013b). There is little monitoring of the performance of individual schools (OECD, 2016b). Major school reforms have been launched, aiming to improve equity, key competences, and the quality and relevance of vocational education and training. The reform process for the French community attests so far to a positive shift towards transparent, participatory and evidence-based policy. Based on the main guidelines of the reform adopted in mid-2016 by the government and on an impact assessment, the December 2016 draft advice from the steering group for the reform proposes a five-point strategy, objectives and priorities, taking into account strict budget constraints. This is an important step in this major reform, which covers the whole system: pupils and competencies, teachers, education provision and governance of the system. After a consultation process, the Flemish government adopted in January 2017 the final key measures of the master plan secondary education. They will be progressively implemented as of September 2018. A new ordering of the study offer and a rationalisation of the study areas are foreseen. Most of the measures are optional. The general, technical and vocational streams are maintained. Future monitoring to ensure that the current pitfalls on educational inequalities are addressed is important. Other specific measures aim to reduce the high rate of children enrolled in special needs education by fostering greater inclusion in the mainstream system; in particular, a major Flemish initiative (the ‘M-decree’) came into force in 2015/2016. However, full implementation of the decree will take time. All three communities are further developing dual learning, involving companies, as part of secondary education, and pursue the preparation of the reform of initial teacher education. Performance at school also depends on a large number of external factors. A good knowledge of the teaching language at school is an important key to a successful school career. Addressing educational inequalities also requires policy responses on employment, social, anti-discrimination and migration policies, coordinated between the various competent authorities. The governance issue in Brussels is particularly challenging. 3.4. Competitiveness and Investment 3.4.1.Prices, costs and competitiveness Inflation An inflation gap has been widening between Belgium and its neighbouring countries. Between 2006 and 2016, the accumulated inflation differential between Belgium and the neighbouring countries reached around 7 % (Graph 3.4.1), with a comparable differential built up for core inflation over this period. This inflation gap widened considerably in the last couple of years. Moreover, according to the latest Commission projections, it would continue to widen in 2017-2018. Graph 3.4.1:Cumulative (core) inflation and nominal ULC differential between Belgium and neighbouring countries Source: European Commission In 2016, prices increased by 1.8 % in Belgium, compared with 0.2 % in the euro area and Belgium's neighbouring countries. Increases in indirect taxation explain only part of the difference (see Graph 3.4.2). Core inflation — excluding unprocessed food and energy items — was also notably higher last year. It amounted to 2 %, compared to 0.8 % in the euro area and 0.7 % in the three neighbouring countries, where it dropped for the third year running. The fact that price growth is structurally higher in Belgium could have implications for external competitiveness. As nearly all Belgian companies automatically adjust wages to the cost of living ( ), higher consumer prices reflect in faster rising labour costs, which undermines cost competitiveness when not offset by gains in productivity. As low productivity jobs become relatively more expensive than high productivity jobs, labour shedding risks to occur and have a downward impact on the overall employment rate over time. Graph 3.4.1 shows that in Belgium the nominal unit labour cost differential has evolved — with a small time lag — in parallel to the total inflation differential between Belgium and its neighbouring countries. A decoupling has taken place from 2014 onwards, though, when wage moderation policies started to take effect and the unit labour cost gap started narrowing. However, without permanent wage moderation, fast price growth risks undoing the gains made in recent years. The recent reforms in the wage setting mechanism (reform of the Law of 1996) aim to address this risk by introducing a safety margin to avoid faster wage growth in Belgium than in its neighbouring countries (cf. infra). Electricity prices contributed significantly to the acceleration of inflation in 2015-2016. Indeed, electricity alone was responsible for 0.3 pp. and as much as 0.7 pp. of total inflation in 2015 and 2016. Although energy price increases are subject to the ‘safety net mechanism’, the impact of this price control mechanism is limited, especially on electricity prices. This is because almost two thirds of contracts are fixed-price contracts to which the mechanism does not apply. Moreover, non-energy components account for a large and increasing percentage of the retail energy prices. Around 75% of consumer electricity prices are network charges (distribution and transmission costs), levies, taxes and VAT, which are not subject to the price control mechanism. The fast rise in electricity prices for end consumers is rooted in hikes for price components other than generation costs. The reduction in the VAT rate on household electricity consumption from 21 % to 6 % introduced in April 2014 was reversed in September 2015. Intercommunales, which include utility suppliers, are subject to corporate income taxes since 2015 and have increased distribution charges as a result. In Flanders, owners of green energy installations have been required to pay a fixed surcharge for use of the distribution network since 2015. Finally, in 2016 Flanders increased a general energy contribution and abolished the free electricity all households were receiving. Graph 3.4.2:Inflation, inflation at constant tax rate and core inflation – Belgium and euro area (January 2005 – December 2016) Source: European Commission Steady core inflation in the range of 1.5-2% primarily reflects services prices. For the period 2008-2016, services explain about half of the core inflation differential (excluding energy and non-processed food) with neighbouring countries, a third is the result of higher prices for processed food, and the residual is due to price developments in non-energy industrial goods. According to the Price Observatory, bars and restaurants (which have a higher weight in the Belgian price index), telecommunication and culture accounted for most of the service price differential between 2008 and 2016 (Price Observatory, 2016) (Graph 3.4.3).

Considering that labour is the predominant input for services, the key determinant of service prices are wage costs. Several service sectors have built up wage gaps relative to the average for the three neighbouring countries. This is particularly true for the sheltered non-tradable services sectors, where productivity growth cannot always keep pace with nominal wages (cf. infra), such as the information and communication sector, bars, restaurants and accommodation, retail and transport (European Commission; Price Observatory). However, the sustained wage moderation in recent years does not seem to have resulted in price adaptations in these sectors, which points to downward price rigidities. Graph 3.4.3:Contribution of the main product groups to the inflation differential between Belgium and its main neighbouring countries Source: INR - ICN Less intensive competition in service markets may help explain price rigidities. Indicators that can be used as proxies for competition include the mark-ups (a proxy for profit), the market churn rate (the sum of birth and death rates expressed as a percentage of the total number of active firms), market concentration, and regulation, e.g. entrepreneurship and administrative barriers (see Section 3.4.3). Several important service markets show a high degree of concentration, which might hamper market dynamics. There are for example only a few big players present on the telecommunication market in Belgium. Low margins could also have an impact in certain subsectors; in restaurants and bars increasing costs due to the labour force regularisation and due to the rise of food prices have, in combination with low margins, resulted in higher prices in 2016. High minimum wages have compounded this dynamic. Prices of regulated services are also influenced by administrative decisions. Given that regulated services account for 28 % of all services in the price basket ( ), its effect on overall inflation can be considerable. For instance, the Flemish authorities increased education tuition fees in 2015, pushing up overall service prices by an estimated 0.4 pp. and total inflation by around 0.2 pp. (Price Observatory, 2016). Other regulated services which have contributed to an increase of services inflation since 2015 include the sewer system, medical services and hospital care. An additional factor explaining the higher service market prices could be that some services in Belgium, such as notaries, public transport, education and insurances, are index-linked — albeit with some time lag. Rent increases are also administered, but have not contributed to the inflation differential. Concerning processed food and retail, different factors can explain the price differential with neighbouring countries. Factors identified include unfavourable market conditions related to bargaining power, the skills and commercial strategy of market players, labour and exploitation costs, distributors’ business strategies and consumer preferences (see, e.g., SPF 2012; Federal Planning Bureau, 2012). Establishment and operation conditions for retailers could also affect market functioning and indirectly impact the price of (supermarket) goods. Some of the factors that explain less advantageous wage costs in the Belgian retail sector include: the employee profile (usually older and full time in Belgium), the rigidity of the labour market, fiscal pressure and the automatic wage indexation mechanism (Centrale Raad voor het Bedrijfsleven, 2010; Cornille & Langohr, 2011; SPF, 2012). However, while these factors could help explain differences in price levels, they cannot explain higher price growth, which may be linked instead to insufficient competition (see Section 3.4.3.). Labour cost competitiveness Belgian relative labour cost competitiveness eroded steadily for almost a decade until 2014, as a result of dynamic wage increases. Starting from an already high level, nominal wage increases frequently exceeded the average increases observed in neighbouring countries between 2004 and 2013. At the same time, productivity increases, equally starting from a high level, lagged behind, especially between 2010 and 2014. As a result, the total nominal unit labour cost differential between Belgium and its three biggest neighbouring countries rose to 7 % in 2013 before falling back as a result of wage moderation policies (Graph 3.4.1 and 3.4.4). Graph 3.4.4:Unit labour cost by sector Source: Eurostat To deal with eroding cost competitiveness, the federal government has successfully enacted wage moderation policies. The need for prompt action was shown in particular by the sharp rise of nominal wage costs relative to neighbouring countries in 2009-2010. Since then, the authorities have intervened in the wage-setting process to slow down wage growth, by setting lower margins for real wage growth throughout the period between 2011 and 2016. In order to close the nominal wage handicap with neighbouring countries accumulated since 1996, the government also imposed a temporary suspension of wage indexation clauses in both the private and government sectors ( ) and is gradually reducing employer social contributions in the framework of the ongoing tax reform (see Section 3.1.4.). Since the beginning of 2014, the measures taken have curbed the unfavourable unit labour cost trends compared to neighbouring countries. Not only did hourly wages in Belgium’s business sector rise at a slower pace than in the three main neighbouring countries ( ), productivity also changed favourably and, consequently, unit labour costs were down both in 2014 and 2015, allowing the economy to close part of the labour cost gap with neighbouring countries (Graph 3.4.4). Unit labour costs are expected to increase at a more moderate pace in 2017-2018 than has been the case in the past. Moreover, to prevent past problems from reoccurring, the current federal government has tightened the existing wage bargaining framework. Wage negotiations in Belgium have been regulated by the 1996 law on employment and the safeguarding of competitiveness. ( ) As illustrated above, however, this arrangement did not prevent the appearance of a growing wage cost handicap, as predicted real wage in neighbouring countries often turned out to be overestimated whereas domestic inflation frequently exceeded expectations (cf. supra). In addition, wage growth in Belgium regularly exceeded the nominal ceiling implied by the wage norm as a result of forecasting errors and/or because of composition effects of workers in certain industries. To prevent such overshoots from happening in the future, the federal government has amended the 1996 law in several respects. From 2017, the calculation of the wage norm incorporates two prior adjustments. The first is intended to prevent the reappearance of an hourly labour cost handicap vis-à-vis neighbouring countries compared to the 1996 baseline. ( ) The second adjustment takes the form of an additional safety margin of a minimum of 0.5 % of the calculated margin for real wage growth. Unlike the existing system, the new method of setting the wage norm would also go beyond the historically accumulated labour cost handicap since 1996 and further close the wage gap with neighbouring countries measured in absolute terms. The new wage norm for 2017-2018 has been set at 1.1 %, which should allow for a further reduction in the absolute wage gap relative to the reference countries. The measures taken go a long way to preventing a wage handicap from reoccurring and improving Belgium’s relative cost competitiveness vis-à-vis key trading partners within the euro area. Due to the more conservative baseline projections and the built-in prior adjustments in the calculation of the wage norm, the margin for negotiated real wage increases is likely to remain very small in coming years. This should result in a steady and sustained decrease in the nominal wage handicap vis-à-vis neighbouring countries. The reform of the wage bargaining framework also provides more guarantees that government measures to reduce non-wage labour costs will effectively benefit cost competitiveness, as it stipulates that all tax shift reductions in employers’ social contributions introduced between 2016 and 2020 are not to be taken fully into account when calculating the margin for real wage increases. Instead, they are to be used to further reduce the nominal labour cost handicap with neighbouring countries. ( ) In addition, the reformed framework expands the role of the government in preventing detrimental cost competitiveness trends as a result of excessive inflation. It is given the responsibility of taking corrective measures if negotiated wage indexation agreements or wage scale increases at sector or company level lead to nominal wage handicaps that cannot be corrected in the space of two years. Although the framework does not establish any formal link between wage and productivity trends, it provides for close monitoring of the latter as well as of non-cost competitiveness determinants by the social partner organisations represented in the Central Council for the Economy. Productivity While the Belgian economy is still among the most productive in the euro area, recent increases have been subdued, especially in the services sector. While slower labour productivity gains in the services sector are not uncommon, this unfavourable development has been more pronounced in Belgium than in neighbouring countries. Part of this is explained by the reallocation of labour factors to sectors with compara