Source: EURLEX
Language: en
Format: md

*|*

# 52013SC0113

**COMMISSION STAFF WORKING DOCUMENT In-depth review for BELGIUM in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances /\* SWD/2013/0113 final \*/**

  

Contents

Executive summary
and conclusions. 4

1........... Introduction. 7

2........... Macroeconomic
situation and potential imbalances. 7

2.1........ Macroeconomic scene setter 7

2.2........ Assessment
of the existence of external imbalances. 8

2.2.1..... The
evolution of the current account 9

2.2.2..... The
evolution of market shares. 10

2.2.3..... Geographical
and product specialisation. 12

2.2.4..... Cost
competitiveness. 14

2.2.5..... The wage
setting mechanism.. 17

2.2.6..... Costs of
intermediary inputs. 20

2.2.7..... Non-cost
competitiveness. 21

2.2.8..... Conclusion
on external imbalances. 23

2.3........ Assessment
of the existence of internal imbalances. 24

2.3.1..... Public
sector indebtedness. 25

2.3.2..... Non-financial
corporations indebtedness. 29

2.3.3..... Financial
position of households. 31

2.3.4..... The
financial sector 33

3........... In-depth
analysis of selected topics. 35

3.1........ The
role of services in the Belgian current account balance. 35

3.1.1..... Evolution
and orientation of trade in services. 35

3.1.2..... Breakdown
of external service surplus. 37

3.1.3..... Conclusions. 41

3.2........ Innovation
in Belgium.. 43

3.2.1..... Belgium's strengths and weaknesses. 43

3.2.2..... Governance of public R&D policy. 44

3.2.3..... Concentration of private R&D activity. 45

3.2.4..... Human Resources. 47

3.2.5..... Conclusion. 48

3.3........ The
housing market in Belgium.. 49

3.3.1..... House price evolution. 49

3.3.2..... House price valuation. 49

3.3.3..... The determinants of house prices. 51

3.3.4..... Risk factors. 52

3.3.5..... Possible macroeconomic impact 52

4........... Policy
challenges. 53

              Executive summary and conclusions

In May 2012, the
Commission concluded that Belgium was experiencing macroeconomic imbalances, in
particular as regards developments related to external competitiveness and
indebtedness. In the Alert Mechanism Report (AMR) published on 28 November
2012, the Commission found it useful, also taking into account the
identification of imbalances in May 2012, to examine further the persistence of
imbalances or their unwinding. To this end this In-Depth Review (IDR) takes a
broad view of the Belgian economy in line with the scope of the surveillance under
the Macroeconomic Imbalance Procedure (MIP). The main observations and findings
from this analysis are:

·
Belgium continues
to suffer from export market shares losses. This is
mainly due to declining shares in goods that are only partially offset by export
share gains in services. While the current account position remains broadly in
balance, the gradual but steady deterioration observed over the past years is a
source of concern. As concluded in last year's IDR, Belgium's export
performance highlights competitiveness issues. In terms of geographical
orientation, Belgium is still predominantly trading with the EU27, although
compared to last year the scope has widened. Should this trend be confirmed, a
softening of export market share losses may follow. As regards product specialisation,
intermediate goods still dominate other types of manufactured exports. However,
high-tech exports have been on an increasing trend, which reflects the
strengths of the Belgian research and innovation system.

·
The specialisation in cost-sensitive products
makes the evolution of unit labour costs a key issue for Belgium's competitiveness. The trend depicted in last year's IDR, with
unit labour costs in Belgium rising faster than in trading partner countries,
has been confirmed, driven to a large extent by the wage setting mechanism. Since
the publication of the 2012 IDR, the authorities have announced measures to reduce
the widening wage gap. However, such a correction will only materialise
gradually and additional measures may be needed to close the historic gap
entirely, the more as several trading partners have been implementing relevant
labour market reforms.

·
Belgium needs
to foster total factor productivity as gains to be expected from labour
productivity are limited. For this to happen, it is
essential for Belgium to speed up the transition towards a more
knowledge-intensive economy, enabling the full exploitation of the strengths of
its research system. As business R&D is very concentrated, Belgium needs to broaden its innovation base and fasten the renewal of its economic fabric.
However, Belgium's weaknesses in terms of entrepreneurship and firms' dynamics
impede this necessary renewal.

·
The high level of public debt still
represents an imbalance in view of sustainability concerns. Since 2008, the public debt has peaked up again to reach around 100%
of GDP. This deterioration of public finances is largely due to the effect of
the crisis on government revenues, temporary stimulus measures and rescue
operations in the financial sector. Recent consolidation efforts have slowed
down the increase but the debt ratio is expected to stabilize only in 2014. The
high debt level makes Belgium vulnerable to tensions in financial markets that
could result in an upward debt spiral. A large share of Belgian debt is held
domestically, which may reduce external vulnerabilities but reinforces risks
for spill-overs between the public sector, the banking sector and the real
economy. Contingent liabilities to the financial sector for around 15% of GDP
constitute an additional risk. Moreover, the remaining fiscal space to address
the debt burden is very limited, while the fiscal sustainability risk is high
in the medium to long-term due to the budgetary impact of ageing in Belgium.

·
The indebtedness level of non-financial
corporations, which is high in terms of non-consolidated debt, does not point
to emerging risks given the still reasonable consolidated level. As pointed out in last year's IDR,
the high divergence between both levels is explained by the high degree of
intra-group loans, which have been fostered by advantageous tax regimes. Although
abolishing this tax policy would result in a reduction of such loans, it would
not constitute a macro-economic risk. Household indebtedness is mostly mortgage
related. As this IDR argues, however, a possible downward correction of housing
prices would only have limited effects on consumption, on the construction
sector and on the financial sector.

The IDR also discusses the
policy challenges stemming from these developments and what could be avenues
worth exploring in terms of policy actions.

·
In order to improve external competitiveness,
the Belgian economy would benefit from a reform of the wage bargaining system,
a reduction of the tax burden on labour, and measures to improve total factor
productivity. The 'wage norm', adopted during a
phase of high productivity growth, would benefit from a modernisation. Some
examples that could be considered include the incorporation of productivity growth
differentials in the wage norm, the application of ex-post corrections, as well
as all-in agreements. This would help align wage developments more closely with
productivity dynamics, allow more wage diversification between sectors and push
back structural labour mismatches. With regard to automatic wage indexation, allowing
a more flexible application would help the very open Belgian economy to absorb
external shocks more smoothly. Competitiveness would also be enhanced by a
further shift in the tax burden from labour to other sources of revenue and a
continued effort to improve the functioning of networking industries. A further
stimulation of investment in R&D and ICT would increase the technological
content of products as well as total factor productivity. While the
orientations taken by research and innovation polices in recent years are
appropriate, efforts need to be reinforced. In particular, further development
of the support to clusters and better conditions for the growth of innovative
firms, as well as the further development of entrepreneurial education and
culture, are required.

·
Concerning the challenge linked to the high
public indebtedness, the economy as a whole would benefit from a continued
implementation of measures aiming at a consolidation of public finances in a
sustainable way, putting the public debt on a firm
downward path, in line with the commitments under the Stability and Growth
Pact. Also the implicit debt associated with an ageing population may be
addressed by curbing age-related expenditure in order to prevent new increases
of the debt levels.  Decreasing debt levels would also provide the authorities
with more latitude to implement a fiscal policy aimed at improving the
competitiveness of the country, as well as to face unexpected developments in
other economic sectors such as financial markets.

1.           Introduction

On 28 November 2012, the
European Commission presented its second Alert Mechanism Report (AMR), prepared
in accordance with Article 3 of Regulation (EU) No. 1176/2011 on the prevention
and correction of macroeconomic imbalances. The AMR serves as an initial
screening device helping to identify Member States that warrant further in-depth
analysis to determine whether imbalances exist or risk emerging. According to
Article 5 of Regulation No 1176/2011, these country-specific 'in-depth reviews'
(IDR) should examine the nature, origin and severity of macroeconomic
developments in the Member State concerned, which constitute, or could lead to,
imbalances. On the basis of this analysis, the Commission will establish
whether it considers that an imbalance exists and what type of follow-up it
will recommend to the Council.

This is the second IDR for
Belgium. The previous IDR was published on May 30 2012 on the basis of which the
Commission concluded that Belgium was experiencing macroeconomic imbalances, in
particular as regards developments related to external competitiveness and
indebtedness. Overall, in the AMR the Commission found it useful, also taking
into account the identification of imbalances in May, to examine further the
persistence of imbalances or their unwinding.[1]
To this end this IDR takes a broad view of the Belgian economy in line with the
scope of the surveillance under the Macroeconomic Imbalance Procedure (MIP).

Against this background,
Section 2 of this in-depth review looks more in detail into these developments
covering both the external and internal dimensions. Section 3 focuses on the
role of services in the current account balance, innovation in Belgium and the evolution of the housing market. Section 4 discusses policy considerations.

2.           Macroeconomic
situation and potential imbalances

2.1.        Macroeconomic scene setter

Having a small open
economy, Belgium was strongly affected by the slump in world trade during the global
economic crisis of 2008-09 (see Graph 1). Following the crisis, the Belgian
economy has not been able to fully benefit from the rebound in global activity.
This has largely been due to accumulated losses of competiveness and a
geographical focus on the weak European market (see section
2.2.3). Belgium's deteriorating competitiveness is also
reflected in a lower potential growth (see Graph 2), with productivity growth below
the level observed during pre-crisis years. In 2012, GDP contracted by 0.2% according
to Commission estimates, while for 2013 an expansion by 0.2% is expected. In
2014, growth is projected to accelerate to 1.5%. The subdued growth in 2012-13
can be attributed to weak domestic demand as shown in Graph 1 with net exports
contributing positively to overall growth since 2010.

Graph 1: GDP growth decomposition || Graph 2: Potential growth rate

||

Source: Commission services || Source: Commission services

With respect to public
finance developments, public debt had been on a steady downward path until
2007, when total debt amounted to 84% of GDP.[2] This substantial decline[3]
was essentially due to high – albeit decreasing – primary surpluses. Between
2007 and 2012, the public debt jumped back to 99.8% of GDP[4]. Around half of this increase
resulted from the operations to stabilize the financial system, which amounted
to more than 8% of GDP. The public deficit has slowly decreased since 2009, but
still stands around 3% of GDP and is currently projected to rise again above
this threshold in 2014. The public debt is projected to stabilize at around 101%
of GDP in 2013-14 (see also section 2.3.1).

2.2.        Assessment
of the existence of external imbalances

The apparent stabilisation
of the current account deficit does not take away concerns about the
significant deterioration over the longer term, highlighted in the 2012 IDR.
The driver behind this decline is the goods balance with the services balance
improving. Belgian exports of goods have lost ground with respect to the
expanding world trade, resulting in a loss in market shares. While the
productivity level is still among the highest in the EU, productivity growth remains
among the lowest and plays an important role in the fact that ULCs in Belgium continue to grow faster than in trading partner countries, eating into Belgium's cost competitiveness. Despite these negative developments, the Net International
Investment Position (NIIP) of the country is positive and has been improving
since 2008 (see Graph 3).[5]
This strong overall NIIP encompasses, on the one hand, sizeable net foreign
liabilities by the Belgian government and, on the other hand, a large net
foreign asset position by the Belgian private sector (see Graph 4).

Graph 3: Decomposition of Net IIP || Graph 4: IIP by Sector

||

Source: Commission services; note: \* indicates estimated figure using quarterly data || Source: Commission services

2.2.1.     The
evolution of the current account

Rather than the level of
the current account, the main source of concern remains its steep downward
trend. After 1999 Belgium's current account balance gradually eroded and
eventually turned negative in 2008 (see Graph 5). With the exception of 2010, Belgium's current account balance has remained negative ever since. For 2012, a deficit of
around 1% is expected according to Commission estimates. The same level is
projected for 2013-14.[6]
The bulk of this deterioration can be attributed to a declining surplus in the goods
trade balance, which moved into deficit as of 2008. This deterioration was only
partly compensated by the gradual improvement of the services balance.
Moreover, the deficit in current transfers has grown over time[7] while the income balance has
remained positive at around 2% of GDP.

The deterioration of the
goods balance can partly be attributed to rising net energy imports, which rose
from EUR 6.7 bn in 2002 to EUR 19 bn in 2012 on the back of increasing
international energy prices (see Graph 6). However, making abstraction of
energy products, imports grew still by 3.5% on annual average between 2002 and
2012, compared to 2.9% export growth over the same period. Aside from higher
energy prices, slower export growth can thus be blamed for the current account
deterioration. In what follows, the focus will therefore be on export
performance.

Graph 5: Evolution of the current account balance (BoP definition) || Graph 6: Evolution of the goods balance (national accounts)

||

Source: Commission services; note: \* indicates estimated figure using quarterly data || Source: NBB; note: \* indicates estimated figure using quarterly data

2.2.2.     The
evolution of market shares

Belgian exports have been
growing slower than global trade and are also outpaced by the exports of other
euro area countries, most notably Germany (see Graph 7)[8]. As all EU15 countries have
experienced losses in export market shares, Belgian losses could be explained
by shifting global patterns. Changes in market shares at constant prices,
however, show that Belgium already began losing ground in 2003. This indicates
that aside from matters of cost competitiveness resulting in higher relative
export prices (see Graph 8), elements of non-cost competitiveness also play a
role in explaining Belgium's worse trade performance compared to the euro area.

Graph 7: Evolution of exports of goods and services (constant prices, 2000=100) || Graph 8: Deflator of export of goods (2000=100)

||

Sources: Euro area and BE: Commission services; IMF: World Economic Outlook Database, October 2012. || Source: Commission services

The loss of export market
shares is only relevant for goods, with a better performance by services (see
Graph 10). Indeed, the 5-year change in export market share for goods and services
combined reached -10.2% in 2011[9]
with the loss in export market share for goods at -13.7% and a gain of 3.4% for
services. As highlighted by the Federal Planning Bureau[10], service sector exports are
less price elastic. While services might be partially replacing goods as the
main growth driver behind international trade, the challenge of increasing the
competitiveness of goods remains. Export of services cannot be expected to
fully occupy the space left by goods as witnessed by the overall loss in market
share (see Graph 9) and the risk that the evolution of services might not be as
positive in the future (see also 3.1.).

Graph 9: Export market shares decomposition || Graph 10: Balance of goods and services as percentage of world trade (BoP data)

||

Source: Commission services || Source: Commission services

The European Commission’s
recent Surplus Report (2012) looks into changes in export market shares  by decomposing total nominal export growth per country (net of the
global import growth) into four components (see Graph 11).[11] According to this analysis, in pre-crisis years (2000-07), Belgium benefited slightly from its initial export specialisation in terms of products and
destination, though in general less so than other ‘surplus countries’.[12] However, competiveness changes in product as well as in geographical
destination were much more outspoken drivers behind nominal export growth
during 2000-07.

Since the crisis erupted,
the strong orientation towards the slow growing EU market has contributed to Belgium’s loss in market shares. While product specialisation proved to be a neutral
factor, competitiveness changes, in geographical destination but particularly
in product market, have been another contributing factor. Market share losses
in product markets can loosely be interpreted as an indication of a loss in
cost competitiveness (with geographical changes being more the result of
demand-driven elements such as quality and preferences of export markets).[13]  It can thus be concluded that
in recent years both geographical specialisation and competitiveness
developments have caused Belgium to suffer a loss in market share. These
individual elements are discussed in the following sections.

Graph 11: Decomposition of nominal export market growth

Source: COMTRADE and Commission
services' calculations

2.2.3.     Geographical and product specialisation

Belgian exports consist
largely of intermediary goods that are traded with neighbouring or other euro
area countries. As to its geographical specialisation (see Table 1), 60% of
Belgian exports are oriented to euro area countries with the largest share going
to DE, FR and NL – 50% of total exports and 80% of euro area exports. This is
in accordance with the finding in the preceding section that Belgium's geographical specialisation has partly been responsible for observed losses in export
market share. Nevertheless, compared with the situation in 2000, the trend in
export orientation goes in the right direction. Between 2000 and 2011, the share
of exports going to the largest emerging markets has increased from 4.7% to
8.4%. Furthermore, export growth towards these markets seems to have
accelerated in recent years given the sluggishness of many traditional export
markets: in 2010 extra-EU27 exports represented 25.8% of overall exports,
rising to 28.1% in 2011. It should also be noted that Belgian exporters benefited
indirectly from the new markets through their exports towards Germany, which increased in importance compared to 2000.[14]

Table 1: Main trading partners (in % of total)

|| || exports || || imports

|| || 2000 || 2011 || || 2000 || 2011

Total || || 100 || 100 || || 100 || 100

EU27 - INTRA || || 79.7 || 71.9 || || 70.8 || 67.9

EU27 - EXTRA || || 20.3 || 28.1 || || 29.2 || 32.1

DE || || 17.5 || 18.1 || || 16.4 || 14.8

FR || || 18.3 || 16.5 || || 12.7 || 10.7

NL || || 12.9 || 12.2 || || 17.5 || 19.6

UK || || 10.4 || 6.9 || || 8.6 || 5.9

US || || 6.0 || 5.1 || || 7.5 || 5.7

Largest emerging markets[15] || || 4.7 || 8.4 || || 5.9 || 11.1

Source: Commission services

Table 2 highlights Belgium's product specialisation in intermediate goods. Compared to neighbouring countries,
Belgium is clearly more dependent on the export of these products, which
represent 60% of total manufactured exports. This reflects Belgium's tight integration in international supply chains. Furthermore, the specialisation
in intermediate goods, already a fact in 2000, has intensified over the past
decade. This mirrors a decline in the prominence of capital goods, which play a
smaller role in Belgium than in DE, FR and NL. This trade specialisation entails risks as
intermediate products tend to be more easily substituted and thus more price
elastic than capital goods. This product specialisation
resonates with a limited proportion of manufactured exports being high-tech in
nature, although it should be noted that the proportion of high-techn exports
is increasing rapidly since 2000 (see also 2.2.7.).

In this regard it is also interesting
to note that overall export similarity with China (a broad indicator of
exposure to price competition) is rather low. Graph 12 shows the degree of
overlap by sector in exports and indicates that traditional sectors such as
textile, footwear and metals seem from this point of view more at risk than
important sectors like vehicles and chemicals. Nevertheless, a continuation of
the reorientation towards harder to imitate products higher upon the value
chain is essential to render the Belgian export industry less exposed to
international competition on cost factors.

Table 2: Manufactured exports by type of goods (in % of total) || Graph 12: Export similarity with China vs. share in total exports

|| || 2000 || 2011

BE || Capital goods || 11.3 || 8.1

Intermediate goods || 56.4 || 59.6

Consumption goods || 31.6 || 31.2

Unclassified goods || 0.7 || 1.1

DE || Capital goods || 22.0 || 20.7

Intermediate goods || 49.1 || 50.4

Consumption goods || 25.2 || 26.7

Unclassified goods || 3.7 || 2.2

FR || Capital goods || 23.2 || 18.6

Intermediate goods || 47.4 || 48.7

Consumption goods || 28.0 || 30.6

Unclassified goods || 1.4 || 2.1

NL || Capital goods || 18.5 || 19.6

Intermediate goods || 49.7 || 52.4

Consumption goods || 26.2 || 25.1

Unclassified goods || 5.6 || 2.9

Source: Commission services || Source: Commission services

2.2.4.     Cost
competitiveness

As concluded above, the
deterioration of the current account and the loss in export market shares can
be attributed at least partially to Belgium's declining cost competitiveness.
The latter is an important issue given the discussed specialisation in
cost-sensitive products, the high tax wedge (see also section 2.3.1.) and the
prolonged wage moderation by main trading partner Germany. The resulting wage differential vis-à-vis Germany could have been compensated by
higher productivity growth. However, international comparison shows that, while
in terms of productivity levels Belgium belongs to the top EU countries (see
Graph 13), in terms of productivity growth, it is among the worst performing
countries (see Graph 14).[16]
Although subdued productivity growth constitutes a general challenge for euro
area countries, this does not take away Belgium's competitiveness issues. Given
that capital intensity of production is already high, further increases are
unlikely to yield the strong productivity gains that warranted rapid wage
increases in the past. This highlights the importance of stronger total factor
productivity, originating from innovation and technological advance or an
improvement of public infrastructure.

Graph 13: Productivity level (2011) – GDP per person employed - EA17=100 || Graph 14: Productivity growth (2011) - GDP per person employed - EA17=100

||

Source: Commission services || Source: Commission services

Belgium's deteriorating
cost competitiveness is reflected in above-average increases in nominal unit
labour costs (ULCs) relative to main trading partners (DE, FR, NL) and the euro
area as a whole (see Graph 15). Although the ULC indicator in the scoreboard
has not exceeded the indicative threshold since 2010, the ULC increases
recorded compare unfavourably with all main trading partners since 2007,
suggesting a worrisome trend.

Graph
16 provides a breakdown of Belgian ULCs. It shows that both a higher wage and a
lower productivity growth resulted in a widening gap vis-à-vis the EU3. When
1996 is taken as a base year[17],
the accumulated nominal labour costs surplus stands at 12.4%
in 2011. Belgian ULCs are expected to continue outpacing the average euro area
ULC in 2013. According to the latest estimates by the Belgian Central Economic
Council[18],
the hourly wage gap amounted to 5.1% at the end of 2012. This figure does not
take into account the effect of wage cost reductions through wage subsidies, which
would reduce the gap by 1.8 pps according to the authorities.[19] At the end of 2012, the
authorities announced measures to narrow the wage gap, discussed lower (see Box
1).

Graph 15: Evolution of nominal ULCs || Graph 16: Components of Belgian ULCs

||

Source: Commission services || Source: Commission services

As
the three neighbouring countries absorb 60% of Belgian exports, Belgium's euro area real effective exchange
rate (REER) gives a more complete picture of cost competitiveness (see Graph 17).
Belgium’s REER appreciated since the late 1990s, indicating that Belgium has indeed been losing cost competitiveness. As can be seen in the graphs below,
between 2000 and 2008, losses in price competitiveness vis-à-vis the euro area
contrasted most sharply with developments in Germany.

This assessment is also
reflected in the development of relative ULCs. While ULC increases in Belgium since 1996 kept pace with developments in France and the Netherlands until 2009, Germany clearly outperformed all three Member States throughout the entire period. As of
2010 however, Belgium has also been losing ground against FR and NL, a trend
forecast to continue over the medium term horizon (see Graph 18). This is
particularly worrisome as it is important for a small open economy like Belgium to keep pace with evolutions in its main trading partners. This has become even
more important given recent developments in the wider European area. Indeed,
several other important trading partners such as IE, IT and ES[20] have been pursuing significant labour market reforms, resulting in
a fast improvement of their cost competitiveness as can clearly be seen for IE
and ES in Graph 17.

Graph 17: REER vàv 35 industrial countries || Graph 18: Relative ULC of the main trading partners vàv euro area

||

Source: Commission services || Source: Commission services

2.2.5.     The
wage setting mechanism

The strong rise in nominal Belgian wages in recent years is linked to
two characteristic elements of the Belgian labour market: the highly
centralized wage bargaining system and the near-universal application of automatic wage
indexation.[21]

Collective bargaining takes place at three levels. Every two years, social
partner organisations represented in the National Labour Council conclude an 'inter-professional
agreement' at national level. It sets a framework for the negotiations
conducted at sectorial and firm-level by fixing the so-called "wage
norm" and the minimum wage. At sectorial level, collective agreements are
concluded on various topics within the framework of the inter-professional
agreement, including on industry job classification systems and salaries. These
sectorial agreements determine which wage increases are implemented and in what
manner as well as the method to adapt wages to inflation[22].  Upon request by one or more
of the signatory parties, they can be made legally binding by Royal Decree for
all companies and employees represented by the sector committee. However, such
extensions are conditional on approval by the government. Firm-level
agreements, finally, are bound by the agreements concluded at sector level.
They can go below the minima defined at industry level when this possibility is
foreseen in the relevant sector agreement and when the conditions stipulated
therein are met.

The so-called 'wage norm'
was introduced by the 1996 Law on competitiveness to
keep labour costs developments in line with these of the main trading
partners (DE, FR, NL). The norm is fixed at the weighted average of the expected
nominal average hourly wage increases in these countries. As indicated, this
system has allowed Belgium to keep ULC increases since 1996 in line with
developments in France and the Netherlands until 2009 but could not prevent a
significant loss of relative cost competitiveness vis-à-vis Germany. What is
more, since 2010 Belgium has been also losing ground against FR and NL,
suggesting that a reform of the collective bargaining system is warranted.

The method by which the wage
norm is determined suffers from several drawbacks.  Conceived at a time of
strong overall productivity growth, the wage norm does not take into account
productivity growth differentials relative to reference countries. In recent
years, productivity growth has been lower than in the reference countries while
nominal wages have been increasing at a faster rate because the wage norm
repeatedly overestimated the weighted average wage growth observed in the main
trading partners. Taken together, this has resulted in the observed losses in
relative cost-competitiveness.

Despite
sector and regional productivity differentials, the wage norm applies to all
sectors and regions in Belgium. This reduces the margin
for sectorial and regional wage differentiation based on productivity
differentials. As a consequence, incentives for labour mobility are weakened
and labour market mismatches are likely to arise contributing
to the large and widening regional
differences in employment and unemployment rates currently observed in Belgium.

While the wage norm determines the maximum increase for labour costs,
automatic wage indexation[23]
ensures that the inflation rate sets the lower boundary. These indexation
mechanisms help safeguard purchasing power, but have a number of disadvantages
for Belgium's cost competitiveness. Most importantly, they narrow the margin
for wage bargaining to the range between the inflation
rate as measured by the health index and the wage norm and they embed incurred losses
in cost competitiveness by complicating the adjustment
of real wages. Also, the indexation system
generates second-round inflationary pressures, explaining to some extent why
inflation has in general been higher in Belgium than in
neighbouring countries (cf. infra).

Another important
disadvantage of the indexation system is the difficulty to apply ex-post
corrections in cases where, as a result of forecast errors or unexpected
inflation hikes, Belgian wage increases turn out to exceed those observed in
the reference countries. According to the Law on Competitiveness, such ex-post
adjustments cannot reduce the nominal wage increases below the level which
would result from the application of the sectorial indexation mechanisms. Since
the difference between the "wage norm" and the "health
index" inflation level is often small, in practice, this implies that
there is only little room for effective ex-post corrections. Moreover, efforts
to reduce the growing wage gap were often offset by new overestimations of
future wage developments in neighbouring countries. In
this respect, the use of 'all-in clauses' could be useful: the determination of
an overall margin that incorporates both inflationary adjustment and real wage
increases so that unanticipated inflationary pressure can be neutralized by
limiting real wage increases.[24]

The wage norm was designed
when Belgium was still realizing high productivity growth and it did have its
merits in the past. However, as trade partners have made considerable efforts
to contain wage pressures and increase productivity, the wage setting system
has become a burden for the Belgian labour market. In
this context, and given the fact that the 1996 Law was specifically adopted to
preserve external competitiveness, a review of the current wage setting
mechanism seems desirable.[25]
Especially as it is questionable whether the tangible
advantage of the indexation mechanism in terms of purchasing power protection[26] compensates for
the creeping disadvantages in terms of growth and employment over the
longer term. In an effort to tackle some of the identified problems, the
Belgian authorities recently announced actions (see Box 1).

Box 1: Measures announced by authorities
to improve cost competitiveness

On 19 December 2012, when proposing its 2013 draft budget, the federal
government declared its intention to Parliament to gradually eliminate the accumulated
wage gap with neighbouring countries over the next five years. The gap was
estimated to amount to 3.4% (excluding the impact of wage subsidies). To reduce
the wage gap the government decided on the following measures[27]:

A freeze in real wages throughout 2013 and 2014 is expected to
reduce the gap by 0.9 pp. according to the authorities although this will be
contingent upon wage developments in the neighbouring countries. While indexation
mechanisms and age-related increases will still be applied in full, no additional
wage increases are allowed.

In addition, the wage indexation calculation formula has been
revised to better take into account actual consumption patterns (e.g. taking
into account the market share of different formulas for telecom contracts,
using scanning data from supermarkets for food and household products, factor
in the price effect of sales periods, measuring fixed energy contracts at time
of effective use instead of time of purchase). The Belgian authorities estimate
that these changes in measurement could reduce labour costs by 0.4pp over
2013-14.[28]

Also, the government has earmarked a budget of EUR 400 million/year
for additional wage cost moderation measures in the form of targeted social
security reductions.  The social partners were requested to identify the target
groups the reductions should focus on in order to maximise the employment
impact. The government expects these additional reductions to further reduce
the relative wage gap by 0.3 pps.

To reduce the risk of overestimating wage developments in
neighbouring countries, a new method will be adopted to set the wage norm,
which would not only be based on forward-looking projections but also on actual
data regarding past relative inflation and wage developments. In addition, the
mechanisms for ex-post corrections foreseen in the Law of 1996 on
Competitiveness would be reinforced and the social partners would be required
by law to ensure that the remaining losses in relative cost-competitiveness are
compensated for by additional measures after 2015.

2.2.6.     Costs
of intermediary inputs

Wages represent an
important part of total costs for companies. Cost competitiveness, however, is
also determined by other factors. For exporting companies to stay competitive, the
price of intermediary inputs also plays an important role. As has been
discussed already in the 2012 IDR, the general price level in Belgium is higher than in the neighbouring countries and the euro area. Given Belgium's product specialisation, producers often cannot pass on these higher input costs to
the price of their products. Deteriorating terms of trade have thus affected
the cost competitiveness of Belgian companies.[29]

An important share of the
observed inflationary differential stems from higher energy prices. Belgian
authorities have recently put in place policies to tackle the inflationary
pressure resulting from rising energy prices. A price observatory has been granted
extra powers and customer mobility has been fostered by enhancing competition
between energy providers.[30]
Following a temporary price freeze, energy prices are
again determined by market forces, though they will have to reflect relevant
and real input costs – i.e. (international) market prices for gas and
electricity – and can thus no longer be linked to the oil price evolution or
incorporate other items such as personnel or exploitation costs. Price formulae
will also be simplified as to enhance transparency, while indexation for
variable contracts is limited to once every quarter.[31] Nevertheless, for some energy carriers prices remain more elevated in Belgium than in many other EU countries, so that vigilance by the Belgian authorities
remains warranted. While progress has been made to reduce energy prices,
distribution tariffs and transportation charges for electricity by the
authorities constitute a large part of the final price.

Nevertheless, in recent
years Belgium has also been performing worse than its neighbours and the euro
area in terms of core inflation (i.e. excluding energy and food prices). Indeed,
price levels for many other goods and services are higher in Belgium, as are price increases.[32]
For one part this can be attributed to relatively weak competitive pressures[33], especially in the retail
sector, due to competition-restricting regulation, and in network industries (postal
services, transportation and telecom, though recent measures seem to have enhanced
competition in the latter), due to high entry-barriers with dominant incumbent
firms, and a weak supervisory framework. The scope for product market
enhancement in Belgium seems to be still considerable in other words. On the
other hand, apart from the high weight of energy prices and weak competition,
the higher inflationary pressure can also be partly attributed to stronger second-round
effects generated by automatic wage indexation mechanisms as well as by the widespread
practice of indexing prices in the services sector.

2.2.7.     Non-cost
competitiveness

There are a number of
additional, non-cost factors that need to be taken into account when analysing
the reasons behind the deterioration of the current account and the loss of
market shares.[34]
For example, technological competitiveness driven by the capacity to innovate
as well as to increase efficiency is an important feature behind overall export
performance.

The technological content
of manufactured products reflects a country's ability to translate innovation
into exportable products with a higher value added. Table 3 indicates that
while the share in manufactured exports of high-tech products increased strongly
between 2000 and 2011, it remains below levels observed in FR and NL, though
close to Germany and the euro area. Moreover, Belgium's technological
configuration has converged in general towards that of the euro area since
2000, implying an orientation towards medium-tech products. This is in line
with the earlier finding that Belgium exports mainly intermediate products. The
still moderate proportion of high-tech products in total exports can be related
to R&D intensity, as discussed in section 3.2., which looks into relevant
aspects of innovation.

Table 3: Manufacturing exports by technological content (% of total) || Graph 19: Break-down of high-tech exports

|| || 2000 || 2011

BE || High tech || 14.1 || 18.0

Medium-high tech || 41.2 || 39.2

Medium-low tech || 19.9 || 24.2

Low tech || 24.8 || 18.6

EA17 || High tech || 22.5 || 19.6

Medium-high tech || 39.8 || 40.4

Medium-low tech || 16.8 || 21.5

Low tech || 20.9 || 18.4

DE || High tech || 20.5 || 18.8

Medium-high tech || 49.9 || 50.5

Medium-low tech || 15.3 || 17.4

Low tech || 14.3 || 13.3

FR || High tech || 31.5 || 26.2

Medium-high tech || 35.7 || 35.8

Medium-low tech || 14.7 || 18.0

Low tech || 18.1 || 20.1

NL || High tech || 34.3 || 27.3

Medium-high tech || 26.2 || 28.4

Medium-low tech || 18.2 || 25.1

Low tech || 21.4 || 19.2

Source: Commission services || Source: Commission services

When
looking into the composition of high-tech exports (see Graph
19), it can be observed that the main rise comes from
a strong performance by the pharmaceutical sector while sectors such as ICT,
telecom, office and transport equipment have lost importance. As
highlighted by the Federal Planning Bureau (2012), the development of ICT
activities has been modest in Belgium in comparison to other European
countries.

The availability of
appropriately skilled labour in sufficient amounts is another important factor
with regard to external performance. While Belgian workers are in general
highly skilled, in terms of volume there are clearly serious problems. Belgium suffers from a persistently low labour participation rate
and the gap with neighbouring countries has widened further in recent years
(see Graph 20). This reflects the fact that Belgium has a high share of
long-term unemployment and particularly low participation rates among older and
non-EU workers. The working life duration lies also significantly lower in Belgium than is the case in neighbouring countries (see Graph 21).

Furthermore, certain sectors
suffer from structural mismatches between labour demand and supply. This results
in the coexistence of high unemployment and a high number of vacancies. Both the
low participation rate and the structural mismatches in labour allocation can
be explained by the rigidities that characterise the Belgian labour market. The
wage setting mechanism can be seen as the main driver as it introduces a high
degree of real wage rigidity and limits the margin for wage differentiation,
thereby hampering labour mobility towards more productive and tradable sectors
as discussed under section 2.2.5. Also financial disincentives to work stemming
from the existing tax and benefit system, ineffective activation policies and the
continuation of early retirement schemes contribute to Belgium's labour market problems.

Graph 20: Participation rate (%) || Graph 21: Duration of working life (y)

||

Source: Commission services || Source: Commission services

2.2.8.     Conclusion
on external imbalances

Belgium has been suffering losses in export market shares for goods over
the past decade, mirrored in a dwindling of its current account surplus. This
trend is unchanged from last year's IDR and reflects an erosion of Belgium's external competitiveness. Although further market share losses might be contained
by the geographical reorientation of Belgian exports, Belgium's growing specialisation in cost-sensitive intermediary goods seems problematic. Goods
exports could benefit from action with respect to both cost and non-cost
competitiveness factors, although it seems to be more urgent to act on the cost
side given the existing wage gap with neighbouring countries and the recent
actions undertaken by other European countries to improve their cost
competitiveness. In this regard, an enhancement of the flexibility of the wage
setting mechanism would allow wages to progress more in line with productivity
developments, absorb external shocks and could introduce more differentiation
among sectors. Additionally, companies would benefit from a better functioning
of product markets.

Regarding non-cost
competitiveness, a push towards more sophisticated goods and services with a
higher value added would shield the Belgian industry better from intense international
price competition. A focused and concerted effort by the authorities on items
such as R&D investment or currently underdeveloped ICT activities would
assist the Belgian economy in its reorientation and allow it to reap its
comparative advantages more aptly. Further considerations on the strengthening of
the research and innovation policy will also be discussed in section 3.2.

2.3.        Assessment
of the existence of internal imbalances

The overall indebtedness
of the Belgian economy is substantially higher than that of the euro area as a
whole: 348% of GDP in 2011, excluding the financial sector, against 253% of GDP
in the euro area(see Graph 22). Both the indicator for (non-consolidated) private
debt (237% of GDP in 2011) as well as the one for the consolidated public debt
(98% of GDP) are above the scoreboard threshold. Non-financial
corporations account for the bulk of the outstanding private debt (182.5% of
GDP compared to 99.0% in the euro area), while household debt is relatively
contained (54.3% of GDP compared to 64.2% in the euro area). However, the
private debt is only at 144% of GDP in consolidated terms, i.e. netting out
lending between non-financial corporations, just below the 146% for the euro
area (see Graph 23). The risks related to the indebtedness of the different
sectors are analysed in this chapter.

Graph 22: Decomposition of public and private debt (non-consolidated) || Graph 23: Decomposition of public and private debt (consolidated)

||

Source: Commission services; note: \* indicates estimated figure using quarterly data. || Source: Commission services

On the other hand, the
economy is still in a net lending position despite the sizeable public sector borrowing
in recent years (see Graph 24). Net lending of the financial sector, the
non-corporate sector and households has been positive in 2010-2011.

Graph 24: Net lending/borrowing by sector

Source: Commission services

2.3.1.     Public
sector indebtedness

Belgian public debt rose
from 97.8% of GDP in 2011 to 99.8% of GDP in 2012, which is substantially above
the indicative scoreboard threshold of 60% of GDP. This makes the Belgian
public debt ratio the 5th highest in the EU, after Greece, Ireland, Portugal and Italy. According to the Commission services' Winter Forecast, the debt
ratio is expected to increase slightly further before stabilizing in 2014.

The Belgian public debt
had declined from 134.2% of GDP in 1993 to 84.0% of GDP in 2007 due to primary
surpluses and uninterrupted positive economic growth. From 2008 onwards, the
debt ratio started to increase again (+16% of GDP), although the rise was more
limited than in many other EU member states where government debt rose by +28%
on average between 2007 and 2012.  Rescue operations in the financial sector
under the form of capital injections (Dexia, Fortis, Ethias), loans (KBC[35], Kaupthing) and the
nationalization of Belfius amounted to almost EUR 25 bn (excluding interest
payments and guarantee fees) or 7% of GDP at the time of the operations. The
accumulation of deficits due to the impact of the crisis on public finances and
the financing of stimulus measures led to a debt increase by 9% of GDP, while
other stock flow adjustments (e.g. participation in the EFSF) accounted for the
remaining debt increase (+1% of GDP).

Moreover, Belgium still carries substantial contingent liabilities due to guarantees granted in the
context of the financial crisis, although the maximum amount of guarantees that
financial institutions can use have recently been decreased. Belgium and France agreed to lower the maximum amount of guarantees to Dexia from 2013 onwards from
EUR 90 bn to 85 bn. The Belgian share will be reduced from 60.5% to 51.45%, lowering
the maximum risk for Belgium from EUR 54.5 bn to 43.7 bn (12% of GDP). On the
other hand, the guarantee fee to be paid by Dexia has been lowered from an
annual rate of 90 basis points to 5 basis points of the outstanding guarantees.
At the end of 2012, Belgium and BNP Paribas agreed to put an early end to state
guarantees of EUR 1.5 bn (0.4% of GDP) on an investment portfolio. The
guarantee scheme granted to KBC has been reduced at the end of 2012 from EUR
15.1 bn to 9.4 bn (2.5% of GDP).

According to the European
Commission's Fiscal Sustainability Report (EC, 2012), Belgium does not appear to face a risk of fiscal stress in the short term. However, risks
to fiscal sustainability are high from a medium- to long-term perspective.  This
reflects the budgetary impact of the cost of ageing, which derives from a
rapidly ageing population and a high level of expenditure on social transfers.
Under a no-policy-change assumption, the public debt would increase to 106.7%
of GDP by 2020 and to 147.4% of GDP by 2030.

In addition, the recent
increase in the debt burden did not go hand in hand with a high level of public
investment or expenditure on growth-enhancing policies. On the contrary, gross
fixed capital formation fluctuated around 1.7% of GDP between 2008 and 2012,
while it accounted for around 2.5% of GDP in the euro area as a whole.

Finally, the fiscal space
to service a higher debt or to reduce the debt burden is very limited. Belgium belongs to the group of EU countries with the highest tax levels, alongside the Nordic
countries, France and Austria. At 44.1% of GDP, the Belgian total tax-to-GDP
ratio was the third highest in the EU in 2011 (EU average 38.8%), while taxes
on labour accounted for 24.0% in 2011 (EU average: 19.7%)[36]. The high burden on labour
mirrors primarily high taxation of personal income. The 2013 top personal
income tax rate of 53.7% (EU: 38.3%) is the third highest in the EU. The 2011 tax
wedge on labour income is among the highest in the EU, at 49.7% for low-wage
earners and at 48.2% for average-wage earners in a two-person household. The
implicit tax rate on labour employed is the highest in the EU at 42.8% in 2011.
As a consequence, marginal effective tax rates on labour are in general
significantly above the EU average while the unemployment trap is very high.

The high debt level makes Belgium particularly vulnerable to tensions in financial markets.[37] This has been illustrated by
the sudden rise in risk premia that occurred at the end of November 2011. The
spread on Belgian 10-year bonds (with respect to the German Bund) rose to more
than 360 basis points, while, at the same moment, the spreads on French and
Dutch bonds reached about 190 and 60 basis points, respectively. Since November
2011, the spread decreased steadily, but debt financing costs remain higher for
Belgium than for France or the Netherlands (see Graph 25).

Graph 25: Evolution of government bond spreads (2007-13)

Source: Commission services

The weighted average term
to maturity of central government debt is around 6.8 years, which is relatively
high compared to other euro area countries. Only 26% of outstanding debt is
maturing before the end of 2014, which might temper somewhat the adverse
effects of temporary rises in interest rates (see Graph 26).

Graph 26: Maturity profile of Belgian public debt

Source: Commission services, January 2013

Due to the high public
debt level, a sustained period of high interest rates could lead to an upward
debt spiral. Increased interest payments can in turn lead to a further increase
in the debt level (snowball-effect), as witnessed in the 1980s, making the debt
developments unsustainable. Given the current financing and re-financing needs
of the Belgian State, an increase in the average risk premium by 1 pp. during
one year may cost the Belgian state EUR 700 mn or around 0.2% of GDP a year. A
sustained increase in the risk premium by 1 pp. would lead to an additional
increase in the debt level by 11 pps. by 2030 (see Graph 27).

Graph 27: Medium term debt projections and interest rate sensitivity

Source: Fiscal Sustainability Report 2012

An increased risk premium
would not only endanger the sustainability of public debt, but could also have
spill-over effects to the financial sector. It may negatively affect the asset
value of bond holdings by Belgian financial institutions, which currently hold around
EUR 70 bn of Belgian bonds. At the end of the third quarter of 2012, around 56 %
of Belgian government bonds were held by Belgian residents (Belgian Debt Agency,
2012), mainly by financial corporations and pension funds. As mentioned above,
the interlinkages between public debt and financial institutions also play in
the other direction: pressure on financial institutions could fuel doubts about
the creditworthiness of the sovereign due to guarantees and loans provided to
financial institutions or due to market expectations about new rescue
operations into the financial system.

Higher risk premia may not
only affect the sustainability of public finances, but could also impact growth
and competitiveness. A high interest rate for public debt may pass through to
the private sector, driving up financing costs for domestic financial
institutions and ultimately of non-financial companies and households, which
would have a negative impact on investment and R&D expenditure. An
additional channel is the fact that the perceived creditworthiness of private
borrowers is influenced by the risks associated with the sovereign creditor.

Variable rates of
mortgages are legally linked to interest rates on Belgian treasury certificates
and 3 to 5 year bonds (although with a legal cap) so that an increase in bond
rates leads to a loss in disposable income for house owners with a floating
rate loan. An increase in non-performing loans would in turn have second-round
effects on the banking sector. Nowadays, house buyers choose more often
mortgage contracts with an interest rate which is fixed for the full term of
the loan (over 80% of new mortgage loans in 2012). However, the level of the
fixed rates financial institutions offer to new customers tends to follow bond
rates. Hence, a shock in lending costs for the Belgian sovereign can filter
through to the housing market, and thus affect activity in the construction
sector.

The government's high debt
service poses a drag on growth since it drives out more productive government
expenditure and increases the (expected) tax burden, which weighs on labour and
capital costs. Recent empirical studies on the subject confirm the existence of
an inverse relationship between the level of public debt and economic growth.[38] In addition, interest payments
to non-residents deteriorate the balance of primary income and thus the current
account balance. Conversely, the loss of competitiveness discussed in the
previous section renders high debt levels even more problematic as it weighs on
growth prospects, which in turn makes it more difficult to put the debt ratio
on a downward path. Lastly, the high debt burden reduces the margin for Belgium to tackle future shocks and loosen fiscal policy in times of recession. As such, it
affects the stability of the economy as a whole.

2.3.2.     Non-financial corporations indebtedness

As already observed in
last year's In-depth Review on Belgium, the scoreboard indicator of the private
sector debt[39]
level (237% of GDP in 2011) is well above the scoreboard threshold of 160%. It
has increased steadily since 2006. Non-financial corporations account for the
bulk of this outstanding debt: 182.5% of GDP compared to 99.0% on average in
the euro area.

The consolidated debt level
of non-financial corporations – i.e. excluding intra-sector liabilities, thus
eliminating the credit transactions between different companies or subsidiaries
of companies inside Belgium[40]
– is significantly lower. It stands only at 89.4% of GDP, against 81.4% of GDP
in the euro area. Belgium is the country with the most prominent difference[41] between non-consolidated and
consolidated data, i.e. 93 pps. in 2011.

The sizeable difference between
non-consolidated and consolidated data can be explained by the large credit
provision between Belgian companies, mainly intra-group loans[42]. This in turn reflects the
wide use of financial centres inside company groups, which for accounting
practices form part of the non-financial corporations sector. The origins of
the large presence of such 'internal banks' in Belgium lies in the previously
advantageous tax regime for the coordination centres (coordinating the
financial and fiscal activities of multinationals) and non-financial holdings
(operating as intermediary in the financing of companies). Since 2006, this tax
regime has been substituted by an allowance for corporate equity (ACE). This
system enables all companies subject to Belgian corporate income tax to deduct
from their taxable income a fictitious interest (3% for tax year 2013, 3.5% for
SMEs) calculated on the basis of their shareholder’s equity (net assets). The
main purpose of this measure is to reduce the tax discrimination between debt financing
and equity financing, and safeguarding the attractiveness of Belgium for multinationals after the gradual phasing out of the coordination centre regime.

The ACE constitutes an
incentive for a triangular construction, where a subsidiary provides capital to
a financing vehicle of the same group, which in turn lends this capital to the
same or another subsidiary.[43] 
The capital increase in the financing centre allows for a more extensive use of
the notional interest deduction by the financing vehicle and thus a reduction
in income taxation, while the interest on the internal loan paid by the
subsidiary to the financing centre also reduces the taxable income of the
subsidiary. Such an intra-group construction leads to an overall increase in
the outstanding corporate debt in non-consolidated terms, but does not affect
the consolidated debt level of the corporation. The above-described intra-group
operations for tax optimization purposes do not constitute a risk in terms of
macro-economic stability even under stressed conditions. Their only cost is
that these operations blur the statistics and reduce tax revenues. A change in
the treatment could possibly induce an internal reorganization of the financial
architecture within each group, but should not affect the real economy, apart
from making Belgium a less attractive location for multinationals to invest. On
the other hand, loans between unrelated companies entail risks related to
insolvency which could lead to contagion under stressed conditions.

Various indicators of
Belgian corporations' financial health do not point to any significant
sustainability risks. As can be seen in Graph 28, the increase in the
debt-to-GDP ratio is not mirrored by an increase in debt-to-asset or
debt-to-equity ratios. On the contrary, these indicators point to a clearly
declining trend in the leverage of non-financial corporations, and the
indicators for Belgium are currently among the lowest in the EU. This could be
due to the presence of the ACE system which seems to have decreased the leverage
of corporations.[44] 
Also, as can be seen in Graph 29, the increased indebtedness of non-financial
corporations was not accompanied by a decline in profitability.

Graph 28: Leverage of non-financial corporations || Graph 29: Profit margins of non-financial corporations

||

Source: Commission services; note: \* indicates estimated figure using quarterly data. || Source: Commission services

The capacity to repay
should also be taken into account when assessing the sustainability of debt
levels. Gross operating surplus might provide a signalling of a firm's capacity
to generate income and thus service its debt. From Graph 30 it can be seen that
Belgium is following the increasing trend of the euro area as a whole, with
the exception of 2008 and 2011 when the relative debt has been increasing more
rapidly for Belgian companies. Again, this could possibly be explained by the
establishment of financial centres of multinationals attracted by the notional
interest system.

Graph 30: Consolidated debt of non-financial corporations as % of gross operating surplus

Source: Commission services

To sum up, despite the
high levels of indebtedness of Belgian firms in non-consolidated terms, several
factors call for a qualification of potential deleveraging pressures. Due to
the high share of intra-group loans, the level is much lower in consolidated
terms. Moreover, debt-to-asset and debt-to-equity ratios have been gradually
declining.

2.3.3.     Financial position of households

Household indebtedness is
relatively low in Belgium (54.3% of GDP, compared to 64.2% on average in the
euro area) but has been increasing steadily since 2001 (see Graph 31). As can
be observed from the graph, the increase in the debt/asset ratio is far less
pronounced, given that the accumulation of debt has been accompanied by an
accumulation of assets. Indeed, more than 80% of the household indebtedness is
mortgage related, and hence the rising indebtedness can be explained by rising
house prices (see section 3.3). The decrease in interest rates could have been
a driver for increased indebtedness. Also the more favourable tax treatment of
mortgage loans since 2005 can explain part of the recent increase. Indeed, while
household debt levels are increasing, the interest burden on households did not
seem to have increased (see Graph 32).

Graph 31: Leverage of households || Graph 32: Interest burden on households

||

Source: Commission services || Source: Commission services

The net financial assets
of Belgian households amount to about 200% of GDP, which is much higher than
the average of the euro area (see Table 4). Looking at the evolution in recent
years, a big impact of the fall in equity prices in 2008 can be observed (see
Graph 33). Net financial wealth dropped from EUR 706 bn mid-2007 to EUR 616 bn by
end-2008. Afterwards, net financial wealth of individuals started increasing
again in nominal terms, to EUR 770 bn in mid-2012,[45] but the increase was
insufficient to compensate for inflation.

Table 4: Households' Net Financial Assets (2007-2011)

|| Net Financial Assets (% of Gross Domestic Product)

|| 2007 || 2008 || 2009 || 2010 || 2011

Belgium || 217.2 || 188.1 || 208.6 || 200.4 || 199.3

Euro area || 134.9 || 119.7 || 131.3 || 132.3 || 127.6

Source:
Commission services

Graph 33: Households balance sheet (BE) || Graph 34: Households balance sheet (EA)

||

Source: Commission services || Source: Commission services

The large accumulation of
net financial assets can be attributed to the high savings rate of Belgian
households. Although the rate dropped considerably after the outbreak of the
crisis, it is still among the highest in Europe (see Table 5). Furthermore, the
deterioration in net financial wealth was accompanied by an increase in the
value of non-financial assets (see section 3.3). Also, the share of risky
assets (shares and other equity) in the portfolio of households is declining (see
Graph 35).

Table 5: Household saving rate (2010-2014)

|| Household saving rate (% of Gross disposable income)

|| 2010 || 2011 || 2012f || 2013f || 2014f

Belgium || 15.4 || 14.4 || 14.7 || 15.5 || 15.6

Euro area || 14.1 || 13.5 || 13.3 || 13.3 || 13.3

Source:
Commission services' 2013 Winter Forecast (Euro area
excluding EL, LU, MT)

Graph 35: Balance Sheet Repair, Households

Source: Commission
services

While the financial
situation of households is reassuring, some risks associated with the housing
market deserve further consideration. A growth in outstanding mortgages could
be observed during the years prior to the crisis. The interest rate structure,
dominated by fixed interest rates ensures some protection to households to
interest rate hikes risks.  The housing market developments will be analysed
more in-depth in section 3.3.

2.3.4.     The
financial sector

Both the macro-economic
situation as well the state of public finances are heavily interlinked with
developments in the financial sector.

Total financial assets[46] of the Belgian financial
sector are estimated to amount to 483% of GDP in 2012 (see Graph 36). Compared
to other euro area countries, the Belgian financial sector is somewhat ahead in
the deleveraging (NBB, 2012), because disinvestment was often a condition for
receiving state aid. The adjustment of the Belgian banking sector is taking
place through a divestment in foreign markets and a renewed focus on the
domestic market. The sector is highly concentrated, although less than before
the financial crisis, with the four largest banks holding more than 84.4% of
total bank assets in 2011.

Graph
36: Balance Sheet Financial Corporations Belgium (left) and euro area (right)

Source: Commission services

Over the last year, the
Belgian banking sector continued to reduce its exposure to the public sector of
European peripheral countries.[47]
On the other hand, Belgian banks further increased their holdings of Belgian
government bonds, from around EUR 61 bn at the end of 2010 to EUR 69 bn at the
end of September 2012. These holdings now represent over 44% of sovereign debt
exposure. The geographical re-orientation can also be observed when looking at
the breakdown of other assets. Not only the exposure to foreign government
bonds decreased, but also the exposure to the foreign private sector continues
its strong decline since 2007, from EUR 322 bn at the end of 2011 to EUR 307 bn
at the end of September 2012. On the other hand, despite the on-going
deleveraging, outstanding loans to Belgian counterparts remained relatively
stable at around EUR 365 bn between the end of 2011 and September 2012. These
figures illustrate the downsizing of Belgian banks to their core market, where they
continue to play their intermediary role in the Belgian economy. As discussed
in the previous section, loans to households have slowed down during the crisis
rather than fallen, but credit standards for mortgages are tightening.
Corporate loan growth was almost flat between November 2011 and November 2012,
due to both demand and supply factors.

At the end of September
2012, the rate of non-performing loans had increased to 3.6% of total loans
from 3.3% in 2011 (NBB). Before the financial crisis, it stood only at 1.5%.
The increase stems predominantly from the corporate sector, but also
non-performing retail loans (households and some SMEs) are steadily rising. The
impaired claims are mainly of foreign origin, but recently the rate of domestic
non-performing loans also started to increase. With a rather subdued growth
outlook in Belgium and in the euro-area, the rate of non-performing loans may
further rise which weighs on the asset quality of Belgian banks.

Risk-weighted assets
stabilized in 2011 and declined in the first 9 months of 2012. As a
consequence, solvency ratios improved (NBB).

On the liabilities side, a
strong increase in the outstanding amount of customer deposits was observed
during the first nine months of 2012, from EUR 500 bn to EUR 525 bn. Other
liabilities are steadily being reduced[48]
as part of the strategy to shrink balance sheets and lower the reliance on the
wholesale market. As a consequence, the liquidity position and funding of
Belgian banks has improved over the last year. The regulatory liquidity stress
test continued to display an improvement while the loan-to-deposit ratio is
stable at around 90%.

Profitability of Belgian
banks remains weak, although it improved in 2012 due to a higher net interest
income and lower impairments.

Overall, risks for the
Belgian financial sector seem to have fallen substantially since last year,
although the adjustment is still on-going. A particular case was Dexia, which
was recapitalized by the Belgian and French State in order to remedy a negative
net asset position and to allow the pursuit of the orderly resolution of the
Group. The increased orientation of the banking sector towards the home market,
also observed in other euro area countries, reinforces the interdependence and
risks for spill-overs between the real economy, the public sector and the financial
sector.

3.           In-depth
analysis of selected topics

3.1.        The role of services in the
Belgian current account balance[49]

3.1.1.     Evolution
and orientation of trade in services

As highlighted above, Belgium has been realising a growing external service surplus. According to the EC's
Surplus Report (2012) this surplus reflects the shift towards an
outward-looking, services-oriented economy and has, to some extent, offset the
declining trend in the balance of goods. This warrants a closer investigation
into the service balance and its composition.

Both in terms of value
added (77.5% vs. 73% for the EU27) and in terms of employment (75.3% vs. 69.1%)
Belgium is more service-oriented than the average EU country. Nevertheless,
when it comes to international trade, services are still dominated by goods:
22% of total exports are services, up from 20% in 2002. For the EU27 this ratio
went from 23% in 2002 to 24% in 2011, though with important differences among
Member States. In general, their intrinsic intangible nature makes services more
vulnerable to trade constraints than goods. As it is often hard to distinguish between the production, the
delivery and the consumption of a service, the proximity of supplier and
customer may be required so that many producers offer their products by the
establishment of foreign affiliates instead of cross-border transactions. This
FDI channel – not incorporated in trade statistics – is often considered to be
at least as important in value terms as ‘conventional’ international trade in
services. In this regard, it should be noted that between 2008 and 2011
services represented on average 84% of the Belgian stock of outward FDI and 82%
of the inward stock according to NBB data.

The National Bank of Belgium provides detailed statistics for the service balance as of 1995, the last year it turned
(slightly) negative. Ever since, the surplus has steadily expanded as seen in Graph
38, reaching close to 2% of GDP in 2009-10, before falling back to 0.8% in 2011
as exports stagnated and imports (mainly travel) rose by 5%, marking the first
time since 2003 that the surplus fell below 1%.[50]

Graph 37:
Service balance

Source: NBB

The growing importance of Belgium's service exports is also reflected in their export market share. While the
downward trend for goods applied also to services until 2006, between 2007 and
2009 this loss was more than offset, even though in recent years services have
again lost some ground as can be seen in Graph 38.[51] Over a longer horizon, Belgium's share in world service exports (in current prices) remained broadly stable
between 1995 and 2011 at about 2.25% as export growth has kept track with world
growth. Though Belgium did not manage to increase its market share, over the
same period many other European countries saw their market shares fall (see Graph
39). While the Belgian economy represents a little less than 3% of the EU GDP,
its share in the EU's service exports towards the rest of the world reaches 5%,
a level it has managed to retain over the past decade following a decrease
during the 90s and despite the EU as a whole losing market share.

Graph 37: Goods and services exports as percentage of world trade (BoP data) || Graph 39: Share of services in world trade in services

||

Source: Commission services || Source: UNCTAD

Table 6: Service exports by destination || Table 7: Destination of intra-EU27 exports

||

Source: Commission services || Source: Commission services

As shown in Table 6, other
EU countries are Belgium’s main trading partner, importing together about
two-thirds of Belgian services. Even though this share has diminished in recent
years, Belgium clearly exports less to the extra-EU27 market than the average
European country. More than three quarters of all intra-EU27 services go to the
five neighbouring countries (see Table 7). While this runs parallel to what is
observed for goods, the underlying distribution contrasts as Germany is only the fourth intra-EU27 importer of Belgian services and the fifth overall importer,
behind the US.

3.1.2.     Breakdown
of external service surplus

As can be read from both Graph
40 and Table 8, ‘transportation’ and ‘business services’ together account for
almost two thirds of all service exports by Belgium – far more than in
neighbouring countries – and are the main contributors behind the overall
surplus with smaller contributions by ‘government services’, ‘information and
communication services’ and ‘financial services’.[52] In fact, travel is the only
category that has seen a net deficit ever since 1995. In this respect, Belgium
stands out compared to most other EU27 countries that realize a (often
sizeable) service surplus since for most of them this surplus is due to a strong
performance in one particular sector such as travel[53], finance[54] or both[55] so that their net surplus can
be considered to be the outcome of a 'single source'[56] while as for Belgium the
surplus configuration is more diverse.[57]
Individual sectors are discussed in what follows.

Graph 38: Composition of service balance

Source:
NBB

Table 8: Composition of service trade

Source: WTO

Transportation

As Belgium’s ports make the country a hub for international trade, transportation is an
important sector, both with respect to exports as to imports. In terms of GDP,
the net transportation surplus has been hovering around 1% of GDP since 2007, a
level that had not been attained since the late 1990s. Transportation services
are by default entangled with trade in goods. As such, the nominal fall in 2009
of both exports and imports reflects the contracting international goods trade
that year (Graph 41).

Maritime freight services
and related activities are predominantly responsible for the transport surplus.
With Antwerp, Zeebrugge and Ghent, Belgium hosts three of Western Europe’s ten
largest ports in terms of traffic volume – Antwerp being the second largest.
Together the Belgian ports attributed a total direct value added in 2010 of EUR
14.7 bn (4.1% GDP) and direct employment of almost 102,000 fulltime equivalents
(2.0% of the working population). Indirectly, another EUR 13.2 bn (3.7% GDP)
value added is created, as well as 131,000 extra fulltime equivalents (2.6% working
population) as stated by the Annual Report of the Flemish Port Authority
(2012).

The transportation sector has maintained its relative position
within Belgium’s export services, as well as its market share in global
transportation exports, with Belgium representing about 3% of global activity
in the sector in 2011 according to UNCTAD data. This market share has been
remarkably stable since 1980 and the same applies to the market share within
the so-called Le Havre-Hamburg range (a cluster of big sea ports), which for
the last two decades has stood at around 24% of total traffic volume despite
the heavy competitive pressures that characterize the sector. In contrast, the
EU’s part in global transportation exports fell from 55% in 1980 to 46% in
2011.

Graph 39: Transportation services || Graph 40: Travel services

Source: NBB || Source: NBB

Travel

As mentioned, travel
services are the only category that holds a substantial and structural deficit
(Graph 42). This deficit has been widening as export transactions have
stagnated while imports have risen steadily. In terms of GDP, the deficit
expanded to around 2% in recent years, whereas until 2007 it was more stable at
about 1.3%. However, little can be read from this deficit as these travel
transactions are more a function of intrinsic attractiveness (climate, historic
sites, nature…) and general income level than of competitiveness. This seems to
be the case for Belgium as no other service sector reports a deficit.

Information and
communication services

As ICT is an important driver of productivity growth in the overall
economy a high propensity to trade would seem logical. But
while ICT services together account for 10% of exports and 8% of imports, in general
they are still little traded (Graph 43 and 44). This is not only the case for Belgium, but also for other EU countries.[58]
According to a 2010 study by Copenhagen Economics, the EU could gain 4.1% of
GDP by 2020 through the creation of a digital single market. Given Belgium's decent performance with
respect to trade in ICT services, it is reasonable to assume that Belgium could
reap important economic gains from such a digital push, though currently no
detailed estimates are available.[59]

Graph 41: Information services || Graph 42: Communication services

Source: NBB || Source: NBB

Government services

A modest but very stable
surplus of 0.3% of GDP originates from government services (Graph 45). The bulk
of export receipts originate from the EU institutions, considered to be
extra-territorial. The amounts recorded under this
heading resulted in total exports of EUR 1.4 bn in 2011 and net revenues
totalling EUR 1.3 bn.[60]
This entails two types of transactions: reimbursement of the collection costs
relating to own EU resources and the operating expenses of the European
institutions. Both are sizeable for Belgium. As a lot of the EU’s trade with
non-EU countries passes through Belgian ports, Belgium gets on average 9-10% of
total EU reimbursement expenditure, amounting to EUR 527 mn in 2011.
Operational spending by the EU such as rents is also recorded as government
service receipts. With the seat of a number of major institutions located in Brussels the corresponding revenues surpassed EUR 830 mn in 2011, equal to one third of
total EU expenditure on this item.

Graph 43: Government services || Graph 44: Other business services

Source: NBB || Source: NBB/Eurostat

Business services

This last category has been a fast grower and is the single largest
contributor to the service surplus with a net balance of 1.2% of GDP in 2011
(Graph 46). Business services form a heterogeneous group that entails
activities such as leasing, R&D, consultancy, legal advice, architecture
and marketing. But also 'International merchanting', implying two consecutive
transfers of ownership of a good: from a non-resident to a resident and
vice-versa. The resulting merchanting margin is recorded in the balance of
payments as a net item. Evidently, this service is very much related to the
international trade in goods and Belgium's ports. Net merchanting exports are considerable
for Belgium, both when compared to other services as when looked to
neighbouring countries.[61]

Even more important are
'Services to affiliated enterprises'. These have grown strongly in recent years
and involve those overhead expenses of parent companies and their subsidiaries
or branches that cannot be allocated more precisely. Belgium’s central location
makes it attractive for regional headquarters of multinationals. For the period
2004-11, these services represented on average a third of all business service
exports, with their share growing further in recent years.

3.1.3.     Conclusions

Belgium has been moving progressively towards a service-based economy over
the past decades and services have been realizing an important external surplus
that has steadily grown to 2% of GDP. In this IDR, Belgium's services surplus
has been examined in greater detail. Taking a closer look at Belgium's services surplus allows drawing conclusions as to the nature of this surplus and
its prospects. The main findings of the in-depth analysis on this surplus are
that:

·
Belgian services have maintained their export
market shares within the EU as well as globally, in contrast to Belgian goods;

·
The net service surplus is more diverse in
composition compared to other EU27 countries that realize a positive service
balance as for these countries the surplus  has its origin often in one single source;

·
The Belgian surplus originates from four main
sources, driven by goods shipments (transportation and international
merchanting) and by the fact that Belgium hosts many multinationals and
international organisations (government services[62] and services to affiliated
enterprises);

·
Together these four sectors realize a net
surplus of 2.5-3% of GDP with travel being the only negative contributor at
around -2% of GDP;

·
Whereas government services are a very robust revenue
source, they are no driver of expansion with a constant net surplus of 0.3% of
GDP ever since 1995. In contrast, the other three sectors have seen their
surplus rise by 0.4 percentage points of GDP in recent years;

·
As these three sectors are to a large extent
subject to external factors (e.g. global trade, investment decisions by
multinationals), keeping the general business climate investor-friendly seems a
key element in nurturing future gains;

·
Given that the share of high-tech goods (in
particular ICT) in trade is rather modest, for Belgium as well as for EU27,
services related to more high-tech products have not increased their export
share and leave an important potential, also for the wider Belgian economy.

All in all, the trend
observed for the Belgian trade in services is promising, even though it remains
to be seen whether these activities can fully compensate for declining
industrial activities, which at the present time is not the central scenario. Still,
services mitigate the loss of market share by goods and the country would
benefit from a full development of its potential. Policy actions might also take
into account that many services operate in the periphery of industrial activity
so that an accelerated deindustrialization may hurt services as well. As a
consequence, tackling matters of cost competitiveness remains paramount for the
Belgian economy and overall export performance. In this respect, it should be
noted that the services sectors are less affected by price developments than is
the case for goods[63],
which helps to explain their better performance. At the same time, as services are
also inputs into other industries' production processes, weak performance of
sheltered service can be considered as a hindrance to the performance of other
sectors and of the economy as a whole. Removing remaining restrictions on the
large part of the service sector that is less exposed to competition through
external trade would contribute to lower the cost of these services, improving in
turn cost-competitiveness of exporting sectors.

3.2.        Innovation
in Belgium

              Non-price competitiveness is
a set of factors that determine the attractiveness of an economy and its
innovation and adaptation potential, through quality, design and product
differentiation offered, marketing of these products and the organization of
the production process. Among the determinants of non-price competitiveness, we
find the quantity and quality of capital stock, including infrastructure, the
volume and the training of human capital, organization of work, R&D
intensity, and the proper functioning of markets for goods and factors. Due to
the already high capital intensity of production, productivity gains could
better be achieved by innovation in products or processes. As identified in
chapter 2.2.7 on non-cost competitiveness, Belgium is still specialised in
medium technological goods, which are easily substituted and are thus more
exposed to competition from lower wage countries, and the share of high tech
goods in total exports -despite its increase- is still below 20%. In this
chapter Belgium's strengths and weaknesses are analysed to understand better why this country does not
reap all the innovation benefits although it is close to the innovation
leaders.

3.2.1.     Belgium's strengths and weaknesses

As set
out in the 2010 and 2011 Innovation Union Scoreboard (IUS)[64], Belgium is an innovation follower, with a performance above the EU average. Relative
strengths are in Human Resources, Open, Excellent and Attractive Research
Systems and Linkages & Entrepreneurship. Relative weaknesses are in R&D
Expenditures, Intellectual Assets and Economic Effects. Overall, the research
and innovation system of Belgium displays a set of very strong indicators.
According to the Innovation Union Competitiveness report of 2012, based on the
2011 IUS, the number of researchers per thousand employees is 7.6, well above
the EU average of 6.3 researchers. The number of international scientific
co-publications per million habitants is more than double the EU average,
giving evidence of the degree of openness of the Belgian research and
innovation system. Moreover, the quality of the scientific production is
evidenced by the number of scientific publications within the top 10% most
cited publications worldwide, as % of the total publications of Belgium (13.6%, well above the EU average). Finally, 38.3% of all innovative SMEs in Belgium introduced a new or a significantly improved product on the market, a figure only surpassed
in Sweden.

Nonetheless,
the Belgian research and innovation system also has some weaknesses: in 2011,
R&D expenses totaled an average of 2.03% of GDP in Belgium, a proportion almost equal to the average of the euro area, but well below those of the
Nordic countries or Germany. Despite a slight increasing trends since 2005 (thanks to increases both in public R&D
expenditure (from 0.56% to 0.65% of GDP) and in private expenditure on R&D
(from 1.24% to 1.37%)), Belgium is not on track to reach its 2020 target (see
Graph 47). Patent applications and conversion of knowledge to products is also
below the average. According to its R&D profile,
the Belgian growth rate is weaker than the EU in public and private expenditure on R&D, PCT patent
applications, employment in knowledge intensive activities and percentage of
researchers in the labour force.

All
innovation leaders (FI, SE, DK & DE), perform very well in business R&D
expenditures, have higher than average scores in public-private co-publications
per million habitants and excel in the marketing of their technological
knowledge. Most of the innovation leaders also perform very well according to
other innovation indicators related to firm activities. Comparing Belgium to the innovation leaders, it can be reaffirmed
that Belgium's weaknesses are a lower level of public & private R&D
expenditure, lower excellence in marketing of the innovations and less
entrepreneurship.

In a
nutshell, it can be said that Belgium has a high quality research system, but
that, in order to enable the full
exploitation of this strength, it needs to speed up the transition towards a
more knowledge-intensive economy and broaden its innovation base.

Graph 45: Belgium R&D intensity projections, 2000-2020

Source:
Commission services

3.2.2.     Governance of public R&D policy

Since the
early 1990s, most of the research policies have been decentralised across
several Belgian governments, each enjoying complete autonomy of decision-making
power in these matters. The regions (Flanders, Wallonia, Brussels-Capital) have
authority on research policy for economic development purposes, thus
encompassing technological development and applied research. The communities
(French-, Flemish- and German-speaking) are responsible for education and
fundamental research at universities and higher education establishments.

The
federal state retains the responsibility for research areas requiring
homogenous execution at the national level, and research in execution of
international agreements (e.g. space research, defence research), as well as for
fiscal instruments. Indeed, on top of grants provided by regional authorities to
help companies to finance new R&D projects, the federal government has
developed powerful tax incentives (in particular a 75%[65] payroll
tax exemption for researchers, as well as a patent tax credit) leading to a
situation where foregone revenues due to R&D tax incentives are almost
equivalent to the amount of direct public funding of business R&D.

There
are formally seven independent Belgian authorities carrying out their own
policy in the wider field of science, research, technology and innovation. In
practice, there are only five active entities, since the region of Flanders and the Flemish community's governments have merged into one and the German-speaking
community does not carry out any policy in the research area due to its small
size.

This
high degree of decentralisation of the responsibilities for research and
innovation policies has not always been accompanied by the setting of
appropriate coordination and cooperation mechanisms. As a result, opportunities
for transregional synergies are missed. In order to address the possible lack of
coherence, the idea of an Interfederal Plan for Research and Innovation has
been conceived. This initiative would aim at ensuring a better coordination of
the efforts made by the Regions and the federal government with regard to
R&D and technological innovation, but it is still not developed.

Moreover,
governance of research and innovation inside each region needs to be
strengthened in order to ensure an overall strategic and integrated approach of
research and innovation across the many organisations and instruments involved.
This should be accompanied by a reinforcement of the mechanisms for monitoring
and evaluating the performance of the organisations and of the instruments.
Further simplification of the intermediary support structure could be
envisaged. The preparation of the post-2014 period should be opportunity for a
comprehensive review of the regional strategies, including the support
instruments.

There
is also a case for the national and regional research and innovation policy to
integrate more systematically demand-side policy tools, such as innovative
public procurement.

3.2.3.     Concentration of private R&D activity

The business
enterprise sector, which is the main contributor to R&D expenses in
Belgium, saw its expenses shrink from 1.51% of GDP in 2001 to 1.37% in 2011,
which is nonetheless still above the EU27 average of 1.26%. This decline is mainly
due to two reasons: the economic structure becoming more service-oriented and a
reduction in the R&D activities of the telecommunications and chemical
sectors.

Even
if this share is slowly decreasing, approximately two-thirds of Belgian
research (66.3%) was performed in the business sector in 2010 (EU27: 61.52%).
In 2007, 44.6% of business R&D expenditure (BERD) was performed by
companies having more than 1000 employees.[66]
Business R&D is indeed highly concentrated in Belgium and under foreign
control: 59% of industrial R&D was realised by foreign-owned companies in
2007. The importance of BERD and the fact that a large part of the BERD
activity is undertaken by foreign enterprises raises the threat of a long-term
decline in R&D intensity if these enterprises are not encouraged to
maintain their R&D operations in Belgium.

While Belgium performs well compared to the EU average in terms of R&D intensity and
innovation rate, it underperforms in the conversion of knowledge into new
products and processes. Belgium still outperforms the neighbouring
countries in the field of innovation process, indicating a possible consequence
of higher hourly labor costs, which is a permanent incentive in the quest of
new process improvements. However, Belgium underperforms on product innovation,
which has a major impact on export growth. Besides, the percentage of firms
with marketing innovation between 2006 and 2008 was lower in Belgium than on average in the three neighbouring countries. This weak performance could be
at least partially explained by the product specialization, skewed towards
pharmaceuticals and chemicals, which are sectors enjoying a slower conversion
rate than ICT  in general.

More
than three quarters of BERD was performed in the manufacturing sector in 2009:
28% by the pharmaceutical sector (2009 data), 11% by chemicals and 5% by radio,
TV and communication.

Over
the period 2000-10, Belgium appears to have increased its comparative advantage
in chemicals and pharmaceuticals, but has reduced its advantage in stone,
glass, plastics, rubbers, transportation, machinery and food products (see
Graph 48). This can be linked to the
change in relative importance of R&D expenditure. Over the period,
chemicals and pharmaceuticals increased their share of R&D expenditure
while transportation and machinery (especially radio, television and
communication equipment) saw their relative share declining. This concentration
is reflected in the number of large companies and foreign owned multinationals
in the chemicals, pharmaceuticals and biotech sectors.[67] In general terms
one can say that research in Belgium is now more than ever dominated by life
sciences.

The
key challenge for Belgium is to generate similar dynamics, where R&D
investments lead to trade performance, across a wider range of sectors. In
order to speed up the transition towards a more knowledge-intensive economy,
enabling the full exploitation of the strengths of its research system, Belgium needs to broaden its innovation base and fasten the renewal of its economic fabric.
However, the weaknesses of Belgium in terms of entrepreneurship and firms'
dynamics impede this necessary renewal. In order to address this bottleneck,
further development of the support to clusters and better conditions for the
growth of innovative firms, as well as the further development of
entrepreneurship education and culture, are required.

Graph 46: Comparative advantages

Source: COMTRADE and
Commission services' calculation

Areas of innovation that might be useful to emphasize
in the current economic environment are innovation towards ICT, durable
products, client services and organizational innovation, which are not yet
sufficiently developed in Belgium, even if regional policies emphasize their
importance in their R&D strategy.

3.2.4.     Human Resources

Belgium disposes of a qualified workforce, reflected in
the ambitious 2020 target in terms of education.[68] The total number
of researchers is growing steadily over time (28.000 researchers in 1998;
38.000 in 2009) and exceeds the growth of the total population and the active
population in Belgium. Most researchers work in the business enterprise sector
(51.3%) and the Higher Education sector (41.1%). However, the number of
graduates in science and technology is relatively low in Belgium, accounting for 15.8% of the new tertiary education graduates in 2008 compared to
the EU average of 21.9%. This lack of
interest does not only concern highly qualified technical staff, also in
secondary schools fewer students choose technical orientations. There is still
a mismatch between labour supply and demand resulting in many firms
considering the lack of qualified staff as a significant barrier to innovation.

It is
also important that workers are learning throughout their careers. In this
respect, the percentage of the population aged 25 to 64 years who reported
having received training declined between 2005 and 2008. Even if between 2008
and 2010 the Belgian indicator rose from 6.8% to 7.2% on average over the
period, it is still lower, at 6.9%, than the average of the three neighbouring countries (10.1%) and the euro area (8%). For graduates of
higher education, the percentage is slightly higher (11.7% in 2008).

Most
indicators identify entrepreneurship to be a problem in Belgium, as in many other European countries. According to the latest Eurobarometer survey
on entrepreneurship, less Belgians (30%) would like to be self-employed than
the EU average (37%). Demand prospects, recruitment of qualified personnel and
strong competition represent major obstacles for SMEs.

3.2.5.     Conclusion

Through
business R&D investments, many firms have been able to exploit the quality
of the Belgian research system leading to excellent export performance in the
sectors in which these investments took place, translating notably in a fast
increase of the share of high-tech products in the Belgian exports. The
strengths of the Belgian research and innovation system have thus to some
extent played a counter-balancing and mitigating role vis-à-vis the Belgian
cost-competiveness issue.

Nevertheless,
although Belgium is among the first of the innovation followers, in order to
close the gap with the innovation leaders, Belgium should speed up the
transition towards a more
knowledge-intensive economy, enabling the full exploitation of the strengths of
its research system. As identified in
this chapter, the weaknesses of Belgium are the low level and concentration of
R&D expenditure, the low conversion rate of innovation into products, the
mismatch between labour market needs and supply and most importantly the
low level of growth-oriented entrepreneurship. In order to move from the
follower to the leader category, it appears useful for Belgium to move towards more ambitious and integrated research and innovation policy,
addressing jointly the present shortcomings. Such a policy could aim at
diversifying R&D to promising sectors and to increase the R&D
expenditure towards the set target, encouraging students to take up scientific
education and upgrade their entrepreneurship spirit, ensuring better
conditions for the growth of innovative firms, further developing the support
to clusters and strengthening multi-level governance of research and
innovation.

1.1.
The housing market in Belgium

1.1.1.
House price evolution

From the mid-1990s the
sustained increased demand for housing led to higher prices on the Belgian
housing market. Specifically, between 2005 and mid-2012, housing prices have
increased by around 31% in nominal terms and 12% in real terms (see Graph 49).
Contrary to other EU countries that saw large upswings in house prices over the
same period, Belgium has not suffered a bust episode but rather a stabilization
of real housing prices since 2008.

Graph 47 : Evolution of House Price Index and MFI Loans for House Purchase || Graph 48: Residential investments  (% of GDP)

Source: Commission Services || Source: Commission Services

The price increase in the
housing market could have led to an increase of investments in new dwellings as
it may be pointing to an excess of demand in the market. However, this was only
the case until 2007. Following the onset of the crisis, the share of the construction
sector in GDP declined from 7.3% in the 4th quarter of 2007 to 6.4% in
the 3rd quarter of 2009. During 2010, there was a temporary improvement
due to fiscal measures ending in 2011. Overall, investment decreased from
around 7% of GDP in 2005 to 5.9% in the 3rd quarter of 2012 (see
Graph 50).

1.1.2.
House price valuation

Assessing whether house
price increases are sustainable remains a challenge. Several methods exist to
determine the deviation from the long-term average. The price-to-rent ratio
compares the evolution of house prices to the evolution of rent. Another method
is based on the affordability, the price-to-income ratio, usually defined as a price index divided by income per capita. But while these are
commonly used methods to assess house prices, they do not incorporate factors
such as deductibility of borrowing costs or the characteristics of mortgage
contracts like the term or the loan-to-value ratio.[69]

Graph 51 presents our
analysis based on three indicators: the price-to-income ratio, the
price-to-rent ratio and an econometric model that includes the interest rates
in the price-to-rent ratio. All three of these indicators point to a current
level of 41% to 58% above their long-term average. If these results point to
either an important overvaluation compared to the long-term average or to an
undervaluation in the past, they need to be interpreted with caution since they
do not include changes in mortgage term and loan-to-value ratio while just one,
the adjusted price-to-rent model, incorporates changes in interest rates. Our
overall assessment of house price dynamics classifies Belgium as a country where no booming episode was identified, due to the reasonable
amplitude and duration of the bull and bear phases but with high downward price
pressure according to the two first indicators and medium pressure according to
the econometric model.

According to a study by
the National Bank of Belgium[70],
taking into account the mortgage term, the loan-to-value ratio and the general
mortgage interest rates, the gap with the long-term average, even if lower
compared to our analysis, still amounts to 16% in mid-2011.

Graph 49: Housing price ratios || Graph 50: Affordability indicator

Source: Commission Services || Source: Commission Services

In order to try to shed
some light on the sustainability of prices, this IDR now takes a closer look at
the annual financial effort households have to make to repay their mortgage.
The annual financial effort indicator constructed by the National Bank of Belgium is the ratio between the monthly debt service and disposable income per household,
including an average maturity of 20 years and a loan-to-value ratio of 80%.
Looking at the evolution of this affordability ratio, just before and during
the crisis, the annual financial effort of households increased from 18% to
22%, peaking at 24.2% in 3Q2008. According to our own calculations based on a
similar affordability index[71]
(see Graph 52), the effort calculated with adjusted loan-to-value ratio and
length of contract points to an annual financial effort of 19% in 2005 to 21%
at the 3rd quarter of 2012 with a peak at the end of 2008 of 25%. On
the one hand, the increase in effort until 2008 is a source of concern. On the
other hand, both its current level and its stabilization are rather reassuring.
Additionally, the loan-to-value ratio is low and decreased from 80% in 2005 to
65% in 2010 and financing at fixed rates is the common practice, with more than
80% of mortgages loans in 2012 being contracted under fix interest rates,
indicating that the interest burden will not rise unexpectedly.

1.1.3.
The determinants of
house prices

While price increases do
not seem to have reached unsustainable levels, the analysis of housing price
fundamentals could reveal additional insights.

First, demographic factors
such as a population growth and a decline in the average household size[72],
have led to an increase in the number of households. Second, stable growth of
disposable income and stable GDP growth have ensured a climate of certainty
encouraging private investment. Third, the fall in interest rates resulting
from accommodative monetary and fiscal policies and financial innovations
(coupled with softened and flexible credit conditions) have triggered an
increase in the demand for loans. Interest rates have dropped from levels of 8
to 10% between 1986 and 1992 to levels between 5 and 7% between 1995 and 2002
and to levels of 3 to 5% between 2003 and 2012. With the decrease in interest
rates, the average loan term has increased from a long-term average of 20 years
to around 22 years until 2007 before decreasing again. Fourth, the financial
crisis has shifted some of the investments in financial assets to property.
Fifth, scarcer land availability also plays a role, particularly in Flanders,
which may partly explain the faster price evolution in that region compared to Wallonia in the last 20 years. The combination of those factors helps to explain why house
prices have increased over the years since demand has been fostered by
structural features while supply has not kept pace.

On top of these drivers,
government policies have supported house price growth. In the 2000s, the
government incentivized households to invest through several measures such as a
reduction of registration fees in Flanders (2002), Brussels (2003) and Wallonia
(2009), a tax amnesty with part of repatriated capital being invested in
housing[73],
a deductibility scheme for capital amortization and interest payments[74]
and tax incentives on refurbishment and energy efficiency works. Furthermore,
cadastral incomes – used to calculate the tax on imputed rent – do not reflect
market prices[75],
leading to a bias towards existing dwellings compared to new ones.

1.1.4.
Risk factors

Following the analysis
above, housing prices seem unlikely to trigger renewed macroeconomic turbulences
in Belgium, thus they do not constitute an emerging imbalance. However, in case
emerging imbalances linked either to competitiveness or to excessive public
debt become so deep as to put at risk the macroeconomic stability, current housing
prices could put additional negative pressure on both the real economy and the
financial sector, which would aggravate undoubtedly a vicious economic circle.

1.1.5.
Possible macroeconomic
impact

Demand for housing remains
stable as the population is still growing, annual financial efforts remain
stable, wages grow more rapidly than repayment, interest rates are still low.
The supply side, meanwhile, is constrained by a building sector in crisis.
Still, in the event of a fall in housing prices, it is to be expected that the
macroeconomic impact will be less important in Belgium than what other EU
countries (e.g. Ireland or Spain) have experienced since the beginning of the
crisis because the increase in house prices has not gone hand in hand with an
excessive increase in the interest burden of households[76] or growth of housing
supply. The vast majority of property being owner-occupied, a house price
correction would only trigger limited wealth effects on consumption since
housing is mostly seen as home and not as investment. For the same reason, a
fall in house prices will not affect in itself the capacity to repay loans for
a vast majority of households. Furthermore, the default rate on mortgage loans
is at a historically low 1.1%. The absence of remortgaging practice in Belgium will also limit the effect on consumption. On the supply side, the impact a price
correction would have on housing investment would be limited since the
construction sector in itself has remained stable in size, at around 5% of GDP,
despite the surge in prices, indicating that the price elasticity of home
building is low in Belgium.

4.           Policy
challenges

The analysis in
sections 2 and 3 indicates that macroeconomic developments in the areas of
external competitiveness of goods and the implications for the real economy
from the high level of public debt are the main challenges of the imbalances in Belgium. It should be recalled that these
challenges were identified under the MIP in the first IDR last year and
relevant policy responses were reflected and integrated in the country-specific
recommendations (CSRs) issued for Belgium in June 2012. The assessment of
progress in the implementation of those recommendations will take place in the
context of the assessment of the Belgian National Reform Programme and
Stability and Convergence Programme under the European Semester. Against this
background, this section discusses different avenues that could be envisaged to
address the challenges identified in this IDR.

Concerning the challenge of improving external competitiveness, a number of
different avenues can be considered as regards:

Cost competitiveness
and labour costs: The analysis in this IDR has
pointed to the importance of cost competitiveness for the export performance. A
key aspect to safeguard competitiveness is to ensure that wage cost
developments do not contribute to an erosion of the external position. As also
shown, in the case of Belgium there is furthermore a case to regain lost wage
cost competitiveness in comparison to the main trading partners. There are
different issues that can be considered. One key element is the role of the 'wage
norm' and how it takes into account developments in labour productivity and
competitiveness. It should be recalled that CSR No 4 from 2012 called for wage
growth to better reflect developments in labour productivity and
competitiveness, by ensuring the implementation of ex-post correction
mechanisms foreseen in the 'wage norm' and promoting all-in agreements to
improve cost-competitiveness and facilitating the use of opt-out clauses from
sectorial collective agreements to better align wage growth and labour
productivity developments at local level.

Against this background,
the adjustment capacity of the labour market would be increased and the
reallocation towards more dynamic firms and sectors would be facilitated if
wage growth would better reflect trends at local and sectorial level. Moreover,
cost competitiveness would be enhanced if the wage norm would not only be based
on expected but also take into account past wage developments, a road the
Belgian authorities have announced to consider as of 2015. The performance of
the system might be further enhanced by broadening the scope through the
inclusion of more trade partners in the comparison.

It should be noted that a
number of reforms have been introduced recently. These should contribute to
making the index used for wage indexation more representative for actual
consumption patterns, thereby somewhat tempering the effects of price increases
(see further below on role of energy prices for indexation). Nevertheless, the
current index mechanisms are automatic, implying that second-round effects or
exogenous shocks would translate into faster wage growth also in comparison to
neighbouring countries. Additionally, wages will be frozen in real terms in
2013 and 2014.

The overall cost
competitiveness of the Belgian economy could also be enhanced by a further shift
in the tax burden from labour to other sources of revenue. Indeed, last year's CSR
No 5 called for a tax shift from labour to less growth-distortive tax bases.
Some measures have been taken in the 2013 budget in order to reduce the tax
burden on labour, such as a reduction in employers' social contributions for
specific sectors and groups. Different additional avenues for progress in this
area could be considered so as to further reduce overall labour costs to be
more in line with average European levels. This reduction may be funded by
increasing environmental taxes (e.g. transport fuel taxes) and by increasing
VAT efficiency (e.g. via limited use of VAT exemptions and reduced rates), by
restructuring property taxation and by improving tax compliance.

Cost competiveness, other elements: The analysis above has also pointed
to the importance of general cost pressures for competitiveness, beyond wages.
In this context, policies aiming at tackling the inflationary pressure
resulting from surges in the prices of energy and commodities in order to
address the loss of cost competitiveness of the economy overall would play a
role. A CSR in 2012 was calling, for example, for strengthened competition in
network industries.

Energy prices remain more
elevated in Belgium than in many other EU countries though. A better
functioning of energy markets would exert downward pressure on energy prices
and hence improve cost competitiveness. While important steps have been taken
recently, such as enhanced mobility on the energy market with a view to
fostering competition between energy providers, a continued enhancement of
competition and supervision of the energy sector is a valuable goal in order to
realize permanent gains. Competition in the wholesale market could benefit from
a more stable framework for investment.

A reduction of the weight
of energy products in the price index would also temper the effect of the
automatic indexation system in times of high imported inflation in order to
leave more scope to adjust wage growth in line with productivity and
competitiveness as discussed above. Here, a price observatory has been granted
extra powers and prices for end-users have been made more transparent, breaking
the link with the international oil price. Distribution costs in Belgium account for a large proportion of the domestic and SME consumer bill and would need
to be reviewed. A proper and independent regulatory oversight, endowed with the
necessary resources, could ensure that all network tariffs reflect efficient
costs and are incentive-based.

In addition, and as
pointed to in the analysis, the fact that Belgium's core inflation is higher
than in the neighbouring countries points to a lack of competition in other
networking industries (telecom, postal services and transportation) and the services
sectors, including the retail sector. A revision of still existing regulatory barriers
and an enhancement of competitive pressure in these sectors would benefit
economic agents and contribute to a moderation in general price pressures. The announced
reinforcement of the Competition Authority is useful in this regard and might
be usefully complemented by action at the administrative level.

Non-cost competitiveness: the analysis has also
pointed to the important role of non-price cost competitiveness issues to
explain the external performance and the fact that, Belgium would benefit from
a further transition towards higher technology exports in which input costs
play a smaller role.

In this context, a further
stimulation of investment in R&D and ICT could increase the technology
content of products as well as total factor productivity. Indeed, while public
R&D spending is foreseen to rise across the different entities despite
narrow budgetary margins, business R&D intensity is stagnating, implying
that further efforts are required to reach the 2020 target of 3.0% GDP spending
on R&D. In order to increase the R&D intensity of the economy, the
federal government allows a 75% payroll tax exemption for researchers, and
regions and communities have developed strategic innovation approaches covering
major aspects of a successful innovation strategy. While
the orientations taken by research and innovation polices in recent years are
appropriate, becoming more demand driven, answering to major societal
challenges and focusing on promising sectors, efforts need to be reinforced. In
particular, further development of the support to clusters and better
conditions for the growth of innovative firms, as well as the further
development of entrepreneurship education and culture, are required. There is also a case for the national and regional
research and innovation policy to integrate more systematically demand-side
policy tools, such as innovative public procurement. Besides, it could be
ensured that better coordination and overall coherence among the various
R&D policies undertaken at federal, community and regional levels are fully
exploited. It is also necessary to attract more young talent into science and
engineering studies in order to avoid skill shortages which may deter future
private R&D investments. A stronger coherence
between regional education, training and employment policies while continuing
to invest in cooperation between regional authorities to boost interregional
labour force mobility might lead to a better match between skills and
labour market demand. At the same time, stronger incentives
to work more and an increase in the effective retirement age would lead to a
better utilisation of the full potential of the available labour force. Some of
the 2012 CSRs were calling for such reforms.

With regard to
geographical orientation, Belgian goods exports are still mainly oriented
towards the largely saturated European market. A reorientation towards more
dynamic regions would therefore allow a faster growth in the volume of goods
exported and a more diversified export portfolio. Conditions in emerging
markets are often more challenging for doing business. Hence, Belgian
companies, especially smaller ones, would profit from customized support from
public authorities to enter into new markets.

Concerning the
challenge linked to the high level of public debt and the implications for the
real economy, a number of issues could be considered:

Controlling risks from
high public debt levels: the economy as a whole
would benefit from a continued implementation of measures aiming at a
consolidation of public finances in a sustainable way, putting the public debt
on a determinedly declining path, in line with the commitment in the Stability
and Growth Pact. A 2012 CSR suggested to address the implicit debt associated
with an ageing population by curbing age-related expenditure in order to
prevent a new increase of the debt level after an expected initial
stabilisation. Since Belgium belongs to the group of EU countries with the
highest tax levels, little scope is left to increase taxes which points to the
need for structural expenditure cuts.

Over the past year, the
Belgian authorities have also implemented budgetary measures aiming towards a
correction of the excessive deficit. Amid a worsening macro-economic
environment since the government agreement of end-2011, the government closely
monitored the budget execution as to keep the 2012 deficit below 3% of GDP,
albeit partly through additional one-off measures.[77] The average structural effort,
measured as the change in the structural balance, only amounted to 0.3% of GDP
between 2009 and 2012. The 2013 draft budget contains additional consolidation
measures in order to keep the deficit in line with the Stability Programme. In
2012, the public debt is expected to rise to almost 100% of GDP. Under the current
projections, the public debt ratio is not expected to stabilize before 2014.

Interlinkages between
the banking sector, the sovereign and the private sector: the large contingent liabilities stemming from the guarantees given
to financial institutions remain a risk for public finances. By recapitalizing
Dexia in late 2012, Belgium could prevent the activation of state guarantees
granted to this group. Two of the biggest banks, Belfius and KBC, are
restructuring their activities following nationalization (Belfius) and state
support (KBC), which should allow them to continue to play their role as
financial intermediaries in the Belgian economy.

Risks from an increase
in interest rates and spreads are not to be discarded. Between November 2011 and January 2013, the spread between Belgian
and German 10-year bonds decreased from 360 basis points to less than 100
points due to measures taken by the ECB and the progress towards a Banking
Union, the reduced political uncertainty in Belgium and the consolidation
strategy presented by the government. Even if interest rates on Belgian debt
instruments are currently historically low, the steep rise in interest rate
spreads in the second half of 2011 showed that such a situation can change
rapidly. This would not only endanger the sustainability of the public debt,
but could have spill-over effects to the real economy due to the large exposure
of domestic financial institutions and households to the Belgian sovereign.
Such an interest rate hike would also affect mortgages: variable mortgage rates
are legally linked to interest rates on Belgian Treasury certificates and 3 to
5 year bonds (though with a legal cap) so that an increase in bond rates leads
to a loss in disposable income for house owners with a loan. While fixed
interest rates predominate for new mortgage contracts, the rates offered in new
contracts tend to follow bond rates.  Hence, a shock in lending costs for the
Belgian sovereign can filter through to the housing market.

Lastly, putting the debt
on a downward path would not only reduce the risk associated to sovereign debt,
but will also provide the authorities with more latitude to implement a fiscal
policy aimed at improving the competitiveness of the country, as well as to
face unexpected developments in other economic sectors such as financial
markets.
REFERENCES

·
Baugnet, V., K. Burggraeve, L. Dresse, Ch.
Piette, B. Vuidar, ‘Belgium's position in world trade’, National Bank of
Belgium, 2010.

·
Belgian Debt Agency, ‘Review 2012 and 2013
outlook’, 2013.

·
Bogaerts, H. and C. Kegels, ‘Competitiveness of
Belgium, Challenges and growth tracks’, Federal Planning Bureau, Planning paper
112, 2012.

·
Bruno, N. and Van Til, J., ‘The Joint Research
Centre of the European Commission’, ERAWATCH country fiche Belgium, 2012

(http://erawatch.jrc.ec.europa.eu/erawatch/html2fo/reports/be\_pb\_country.pdf)

·
Copenhagen Economics, ‘Free the Bytes - A
Digital Single Market can boost European GDP by 4.1 percent’, 2010.

·
Dumont, M., 'Impact des subventions et des
incitations fiscales sur la recherche et le développement des entreprises en
Belgique (2001-2009)', Bureau du Plan, Working Paper 8-12

·
Duprez, C., ‘International Trade in Services – A
growing contribution to Belgium's current balance’, NBB, Economic Review
December 2011, pp. 53-67.

·
European Commission, ‘Assessing the dynamics of
house prices in the euro area’, Quarterly report on the euro area, 2012.

·
European Commission, ‘Current account surpluses
in the EU’, 2012.

·
European Commission, ' Fiscal Sustainability
Report', 2012.

·
European Commission, ‘Industrial Performance
Scoreboard and Member States' Competitiveness Performance and Policies’, SWD
298, 2012.

·
European Commission, ‘Innovation Union
Competitiveness report 2011’, 2012.

·
European Commission, ‘Innovation Union
Scoreboard 2011’, 2012.

·
European Commission, 'Taxation trends in the
European Union – 2012 edition', 2012.

(http://ec.europa.eu/taxation\_customs/taxation/gen\_info/economic\_analysis/tax\_structures/index\_en.htm)

·
Federal Planning Bureau, ‘Comparaison des composantes de la
croissance de la productivité: Belgique, Allemagne, France et Pays-Bas,
1996-2007’ Working Paper 18-10, 2010.

·
LIME Working Group, ‘Assessment of house price
dynamics’, 2012.

·
LIME Working Group, ‘Measurement and
Determinants of Non-Price Competitiveness’, 2012.

·
Ministry of Finance, Notional interest
deduction, 2012 (http://minfin.fgov.be/portail2/belinvest/downloads/en/publications/bro\_notional\_interest.pdf).

·
National Bank of Belgium (2011), ‘End of the
crisis in the housing markets? An international survey’, Economic Review March
2011, pp. 53-41.

·
National Bank of Belgium, ‘Report 2011: Economic
and financial developments’, 2012.

·
National Bank of Belgium, ‘Indexering in België:
omvang, aard en gevolgen voor de economie en mogelijke alternatieven’, 2012.

·
National Bank of Belgium, Central Economic
Council (CCE) and Federal Planning Bureau, ‘De uitdagingen voor het
concurrentievermogen in België’, 2011.

·
National Bank of Belgium, Financial Stability
Review, June 2012.

·
OECD, ‘Recent house price developments: the role
of fundamentals’, Economic Outlook 78, 2005.

·
Princen, S., 'Taxes do Affect Corporate
Financing Decisions: The Case of Belgian ACE', CESifo Working Paper 3713, 2012.

·
Reinhart, C. and K. Rogoff , ‘Debt and growth
revisited’, VoxEU.org, 2010.

·
Reinhart, C. and K. Rogoff, ‘Growth in a Time of
Debt’, NBER Working Paper, No. 15639, 2010.

·
SERV en Vlaamse Havencommissie, ‘Jaarverslag
2011’, 2012.

·
Sleeuwaegen, L. and C. Peeters, ‘Belgium in the new global economy: Export and international sourcing’, Vlerick/Solvay, study
commissioned by FEB-VBO and Deloitte Belgium, 2012.

·
SPF Economie, ‘Niveau de prix dans les
supermarchés’, 2012

(http://economie.fgov.be/fr/binaries/etude\_niveaux\_prix\_supermarches\_tcm326-163021.pdf).

·
Van Gompel, J., ‘The Belgian Property and
Mortgage Market: Trend, valuation and future outlook’, KBC Economic Research
note, 2012.

·
WTO, ‘Manual on Statistics of International
Trade in Services’, 2010.

·
Yaniz Igal, J., ‘The Spanish housing market: are
we in for a soft landing?’, ECFIN Country Focus, Volume 3, Issue 1, DG ECFIN,
European Commission, 2006.

[1]        As was the case last year, on the external side the AMR
scoreboard highlighted a loss in export market shares.  On the internal side,
the high and increasing levels of private and public debt were identified as a
matter of concern. Other indicators pointing to potential problems were rising
house prices and the debt to equity ratio of the financial sector, increasing
again due to losses incurred.

[2]        The assumption of the national railway company's debt in
2005 caused a temporary slowdown of the downward trend.

[3]        In 1993 the Belgian public debt peaked at 134.1% of GDP.

[4]        Commission services' Winter forecast 2013.

[5]        Among EU27 countries, only LU has a NIIP larger than Belgium in terms of GDP.

[6]        According to the national accounts definition, the same
trend can be observed although the current account remained in surplus even in
the crisis years 2008 and 2009. While between 1993 and 2004 the current account
according to the national accounts definition fluctuated between 4% and 6%,
this surplus gradually eroded and is currently fluctuating around 1.5% of GDP.

[7]        Reaching -1.8% of GDP in 2011 and -2.4% during the first
nine months of 2012. This reflects outward transfers by
immigrants as well as the fact that Belgium is a net contributor to the EU
budget.

[8]        Belgian export performance would be
close to the euro area average, if Germany was left out of the equation.

[9]        A loss of 10.2% between 2006 and 2011, compared to an AMR
threshold of -6%.

[10]       H. Bogaerts and C. Kegels, ‘Competitiveness of
Belgium, Challenges and growth tracks’, Planning paper 112, Federal Planning
Bureau, 2012.

[11]       The use of a shift-share analysis can contribute to the
identification of the factors behind long-term changes in export market shares.
The first two components (initial specialization) are structural factors,
capturing the initial product and geographical specialization and reflecting
whether a country is specialized in sectors with dynamic global demand and
whether destination countries are dynamic markets. As such they reflect past
export strategies and competitive advantages. The other two, dynamic components
(market share gains) capture how successful a country has been in increasing
its exports above market growth in product and
geographical markets as a consequence of competitiveness developments. Competitiveness is understood in a broad sense, comprising both
cost and non-cost elements.

[12]       AT, BE, DE, DK, FI, LU, NL & SE.

[13]       LIME Working Group (2012), Measurement and Determinants of
Non-Price Competitiveness.

[14]       Based on the import content of German exports and the Belgian
share in German imports, the Belgian share in overall German exports has risen
from 1.4% in 1999 to 2.2% in 2008.

[15]       China, Brazil, Russia, India, Mexico, Indonesia & Turkey.

[16]       This slower rise in productivity is not a purely negative
phenomenon since it mostly reflects a stronger employment growth with e.g. the
inclusion of many low-productivity workers through the service voucher system.

[17]       As the Law on competitiveness was passed in 1996, that year is
conventionally taken as a base year in the public debate on Belgian cost
competitiveness.

[18]       Central Economic Council, Technical Report December 2012.

[19]       While it makes sense to incorporate wage subsidies when
comparing overall labour costs – the more as such subsidies have increased fast
in Belgium since 2005 – it should not be overlooked that neighbouring countries
also have wage subsidies, which should evidently be taken into account as well
for this exercise. To clarify matters, a panel of experts (comprising
representatives from the Belgian National Bank, Eurostat, the Federal Planning
Bureau, the High Council for Employment, the General Direction of Statistics
and Economic Information and the Central Economic Council) has been requested
by the federal authorities to determine the net wage gap as well as the impact
of wage cost reduction measures in Belgium and the neighbouring countries. The
expert panellists are required to report back before June 2013 and to include
in the analysis a sectoral breakdown of Belgium's cost competitiveness position
vis-à-vis neighbouring countries.

[20]       Together these three countries represent 9.2% of Belgium's export markets.

[21]       On the basis of the Wage Dynamics Survey conducted under the
supervision of the ECB, the Belgian National Bank estimates that approximately
98.2% of all Belgian employees are covered by an automatic wage indexation
system of some kind. This is slightly lower than in LU (100%) but higher than
in most other countries in which price indexation of wage is widespread (CY,
ES, MT, SI).

[22]       A wide range of wage indexation systems are applied at
sectorial level, applying different periodicity rules or modification
triggering systems and different methods of determining the moving average of
the index. They also differ in coverage with some agreements on indexation of
wages only applying to specific categories of employees.

[23]       Indexation schemes are agreed upon at sectoral level and are
legally bound to refer to the so-called "health index". The latter
was introduced by Royal Decree in 1994 in and differs from the HICP in that it
excludes the price evolution of alcoholic beverages, tobacco products and motor
fuels.

[24]       In fact, the real wage freeze for 2013-14 (see Box 1) boils
down to an all-in agreement.

[25]       The National Bank of Belgium discussed different ways to
enhance the flexibility of the system in an elaborate 2012 study.

[26]       This advantage should be put into perspective: the experience
since 1996 of neighbouring countries demonstrates that the absence of an
automatic indexation does not imply an erosion of purchasing power over the
medium term. Real wages did not fall in these countries between 1996 and 2011 –
on the contrary, they rose in all three countries and more in FR and NL than in
BE –, while they were able to absorb sudden external shocks more easily through
real wage adjustment.

[27]       Actions to close the remaining wage gap after 2014 will have
to be decided by the next government. General elections are scheduled for May
2014.

[28]       While the actions announced should reduce inflationary
pressure towards levels observed in neighbouring countries and prevent the wage
cost differential from rising, this does not seem to correspond to a gain in
cost competitiveness as the differential remains.

[29]       As discussed infra, the profitability of Belgian companies
does not reflect a big squeeze in margins. However, as indicated by the Federal
Planning Bureau (2012), product subsidies have prevented margins from falling.

[30]       Through the introduction of on-line price comparability tools
for electricity and gas, the elimination of switching fees, a revision of the
social tariff system and a freeze of distribution tariffs until 2014. More
directly, the dominant player on the market, GDF Suez, has been forced to
divest part of its production capacity (of amortised nuclear plants) and sell
it on the market.

[31]       According to the federal energy regulator CREG, a reason for
rising prices could be found in the monthly indexation of the energy component
of electricity and gas bills, which was based on a formula that took into
account the price of gas but also that of coal and oil.

[32]       See e.g. SPF Economie (2012), 'Niveau de prix dans les
supermarchés', which found that the average price differential with the
neighbouring counties fluctuates between 7% and 12%.

[33]       The Belgian authorities have announced a reform of the
Competition Authority, which should help to address this issue.

[34]       A joint report by different Belgian institutions deals with
the issue of non-cost competitiveness: see NBB, CCE and FPB (2011).

[35]       KBC has received total state support under the form of a loan
for an amount of EUR 7bn, spread evenly over the federal state and the Flemish
Region. KBC reimbursed EUR 500 mn in January 2012 and EUR 3 bn at the end of
2012. KBC intends to reimburse also EUR 1.17 bn to the Flemish Region in the
first half of 2013 and EUR 4.67 bn by the end of 2013.

[36]       European Commission, 'Taxation trends in the European Union –
2013 edition', forthcoming.
(http://ec.europa.eu/taxation\_customs/taxation/gen\_info/economic\_analysis/tax\_structures/index\_en.htm)

[37]       According to a VAR analysis by the IMF, most of the variation
in the Belgian government bond spread appears to be associated with external
factors (IMF, 2012). However, two distinct periods in time have been identified
in which domestic factors played temporarily a more important role. In late
2008 and early 2009, domestic factors are estimated to have accounted for an
average of 15% of the increase in the spread reflecting the concerns around the
banking sector and the needed capital injections by the state, which was
already under strain due to the high debt level. From the end of 2010 onwards,
the political deadlock and renewed concerns around Dexia pushed the spread up
again, which dropped only after the announcement of a 2012 budget agreement at
the end of November 2011.

[38]       For instance, Reinhart and Rogoff (2010) find a 2.6 pps.
difference in median real GDP growth between advanced countries with public
debt below 30% and above 90% of GDP. Kumar and Woo (2010) estimate that for
advanced economies a 10 pps increase in the initial debt-to-GDP ratio is
associated with a slowdown in annual real per capita GDP growth of around 0.15
pp., with some evidence of nonlinearity implying larger negative effects with
initial debt above 90%.

[39]       Private sector is defined as non-financial corporations, households,
and non-profit institutions serving households. The nonfinancial corporations
sector includes both private and public corporations.

[40]       It should be noted that cross-border intra-group and
intra-sector lending is still included in the consolidated data.

[41]       In Belgium, detailed statistical sources on an unconsolidated
basis are used to compile the financial accounts. Differences in coverage with
other Member States may blur the international comparison.

[42]       In the financial accounts, it is not possible to make a
distinction between loans to related companies and loans between unrelated
companies. However, data from the Central Balance Sheet Office gives an
indication. According to the balance sheets of large companies, the amount of
loans between related companies (EUR 465 bn in 2010) was around the same size
as the sum of loans between companies (EUR 352 bn) and cross border non-bank
loans (EUR 104 bn) in the financial accounts. This confirms that the high
non-consolidated figure is largely explained by intra-group loans.

[43]       The Belgian ACE does not contain anti-abuse rules to avoid
such tax planning scheme.

[44]       See for example Princen, S. (2012) who finds that the Belgian
ACE decreased leverage of Belgian non-financial corporations by between 2 and
7%.

[45]       See http://www.nbb.be/belgostat/PresentationLinker?TableId=347000044&Lang=E.

[46]       Excluding Monetary gold and SDR (F1)

[47]       Public exposure to these countries decreased from EUR 16 bn
or 11% of total public exposure at the end of 2011 to EUR 10 bn (6.6% of total
public exposure) at the end of the third quarter of 2012, with Italian
government bonds accounting for the bulk of this figure (EUR 6.8 bn).

[48]       Except central bank financing following the ECB's Long Term
Refinancing Operation.

[49]       This analysis of the trade balance in services does not cover
all services in the economy but the tradable services. A tradable service can
be sold in another location distant from where it was produced, as opposed to a
non-tradable service that cannot be sold in another location.

[50]       Based on data for the first three quarters of 2012 the
surplus reaches 0.9% of GDP, with the 12 month moving average for net services
increasing since Q2-2012.

[51]       As indicated by Duprez (2011), it should be noted that the
increase in export market share for services in 2007 coincides with the
introduction of a new data collection method for the BoP. Nevertheless, Belgium increased its market share further in 2008-09 under the new method, so that these gains reflect an economic reality.

[52]       'Construction' – incorporated under 'Other
services' – does not include building activities abroad by Belgian companies
taking more than one year as the proceeds of these works are regarded as income
from direct. As a consequence, substantial amounts from e.g. dredging works are
not incorporated in the service balance.

[53]       BG, CZ, EL (transportation as well), ES, HU, MT, AT, PT & SI

[54]       LU & UK

[55]       CY

[56]       For DK, PL and the Baltic countries transportation dominates,
with secondary contributions by travel for PL, EE and LT.

[57]       This seems also to be the case for France with a transport
deficit being compensated by most other sectors. The same can be said about the
size of both countries' surpluses, which remain modest in terms of GDP compared
to other countries, presumably a reflection of the broad underlying
composition. Also the surpluses of the Netherlands (comparable to Belgium's in terms of GDP) and Sweden (higher structural surplus than BE, FR and NE) look more
diverse in composition.

[58]       Only IE, FI and SE realized in 2011 a net surplus for IT
services superior to 1.0% of GDP (0.4% for EU27; 0.2% for Belgium). For communication services this was only the case for Luxembourg (0.0% for EU27;
0.2% for Belgium).

[59]       However, the Federal Planning Bureau points out that ICT
activities are little developed in Belgium so that the Belgian industry hasn't
reaped the full productivity gains from ICT innovation. A single market push
for this type of products could render them more accessible for Belgian
companies though, so that economic gains could originate from this side as
well.

[60]       Many revenues from services provided by Belgium to the EU are recorded directly under various other headings in the BoP (e.g. ICT).
As a consequence, the EU contributed EUR 2.3bn to the
Belgian service surplus in 2011.

[61]       The UK being the main consumer of international merchanting
services explains why the country is one of the main trading partners for Belgium in the field of services.

[62]       While ICT services, when taken together, realized a 0.4% GDP
surplus in 2011, the surplus for government services (0.3%) had one single
source, the EU, making it more relevant.

[63]       Services are for example less
energy-intensive than manufacturing activities so that high energy costs seem
less of an issue.

[64]       European Commission, ‘Innovation Union
Scoreboard 2011’, 2012, available at

         http://ec.europa.eu/enterprise/policies/innovation/files/ius-2011\_en.pdf

[65]       Increased to 80% since 1 January 2013

[66]      Data from Belgium Federal Science Policy Office.

[67]       Agfa-Gevaert, Anheuser-Busch Inbev, Barco, Bekaert, Belgacom,
Dexia, KBC, Solvay, UCB, Umicore were the top 10 R&D performers in Belgium in 2009 (IPTS Scoreboard) and are responsible for about 40 % of BERD.

[68]       The general 2020 target calls for a minimum of 40% of the
population aged 30-34 to complete higher education. In 2010, this indicator
already reached 44.4% in Belgium so that the 2020 target has been set at 47%
for Belgium.

[69]       For a deeper discussion on the merits of these indicators and
some qualifiers see LIME Working Group (2012), Assessment of house price
dynamics.

[70]       According to this study, an accurate loan-to-value ratio
would amount to 65%, down from the average of 80% commonly used, and the
accurate mortgage term amounts to 22.2y on average until 2007 and 18y by 2011
instead of 20y on average.

[71]       Yaniz Igal, J., "The Spanish housing market: are we in
for a soft landing?", ECFIN Country Focus, Volume 3, Issue 1,
Directorate-General for Economic and Financial Affairs, European Commission,
Brussels, 2006.

[72]       In Belgium, the average household size fell from 2.49 people
in 1991 to 2.31 in 2008 due to an increase in single person households and
independence of elderly people. This trend is to continue.

[73]       The tax amnesty of 2004 (EBA/DLU) coincided with a jump in
housing prices, continued in the years afterwards. There were continued amnesty
possibilities as of 2005.

[74]       This deductibility is limited in nominal terms.

[75]   The assessed value of properties is based on 1975 values, which
have been indexed to the development of CPI since 1991.

[76]       Household debt, although still lower than the
EU average of 99%, reached a level of 88% of disposable income in 2011, a
record for Belgian households. This should not represent a major risk since the
net worth of households is very high and represents 324% of incomes.

[77]       There is a risk that the budgetary impact of the Dexia
recapitalization (0.8% of GDP) will push up the 2012 deficit to above 3% of
GDP.

[Top](#document1)