Belgium: recovery at a snail's pace
The centre-right government has successfully implemented several policy measures to improve Belgian price competitiveness. High public debt, inflation and security issues are the most prominent downward risks for a stable economic recovery.
Strengths (+) and weaknesses (-)
(+) Solid financial position of the household and banking sector
Household balances remain healthy and the banking sector’s restructuring in recent years has not influenced the supply of credit to the economy. Low interest rates might stimulate private sector investments.
(+) Strong institutions
Even during periods of political uncertainty, strong institutions have led to policy continuity. Furthermore, Belgium has an excellent primary and higher education system, with good math and science education.
(-) High government debt and aging population
Without additional reforms, government’s spending on pensions and healthcare will rise substantially due to an aging population, further increasing the already high government debt.
(-) Rigid labour market institutions
Structural labour market rigidities (employment protection legislation, automatic wage indexation) continue to weigh on business competitiveness.
1. Steady economic growth
The Belgian economy is showing stable economic growth, with a real GDP growth projection of 1.4% in 2016. Growth is mostly driven by an increase in private consumption and investments (Figure 1). Private consumption is growing on the back of low commodity prices, solid wage growth and improving labour market conditions. The labour market shows healthy employment growth, declining unemployment and a relatively high vacancy rate.
In addition, the Belgian business climate improved markedly due to a number of policy initiatives of the Michel administration, such as a wage indexation suspension and a tax shift. The tax shift comprises a cut in social security taxes for employers from 33% to 25% over two years. Due to Belgian high public budget debt, however, the reduction of the tax wedge is paid for by higher taxes on consumption and dividends. Although we expect these policies to contribute to a further reduction of Belgian total unit labour costs, there is a risk that the relatively high inflation will be compensated for in the upcoming period due to the automatic wage indexation mechanism. This would nullify the positive impact of the previously-mentioned policy initiatives to enhance price competitiveness vis-à-vis Belgium’s main competitors. More in general, the government will need to continue to work on addressing deep-rooted problems labour market rigidities, such as wage inflexibility and employment protection legislation. Another problem is high unemployment and inactivity among specific groups, including the young, the low-educated, and non-EU immigrants. This not only weighs on economic growth in the long term, but also leads to all kinds of social problems. The lack of economic opportunities and social cohesion could induce young Belgian Muslims to be coerced by the path of radicalisation more easily. Finally, Belgium needs to address the high administrative burden and heavy product market regulation, which limits competition and puts a brake on export growth.
2. Risk of budgetary non-compliance
Until recently, public expenditure in Belgium continued to outpace GDP growth. This resulted in persistent fiscal deficits and a public debt well above 100%, making fiscal sustainability highly susceptible to adverse GDP shocks. The Michel administration has committed itself to reaching structural budget balance in 2018. According to the IMF, structural balance would require an additional structural effort of 1¾−2 percent of GDP in the coming three years. This is acknowledged by the European Commission: the Eurogroup statement in March on draft budgets for 2016 explicitly mentions that Belgium is at risk of non-compliance with the rules of the Stability and Growth Pact. It will be a tour-de-force for Belgian authorities to bring down structural spending, but at the same time mitigate the negative effects on economic growth.
3. Direct impact of terrorist attacks is limited, but long-term consequences could be significant
On 22 March 2016, terrorists detonated three bombs in Brussels, two at Zaventem airport and one at metro station Maalbeek. The attacks, claimed by Islamic State, were the deadliest acts of terrorism in Belgian history, killing 32 people and wounding over 300. The direct economic ramifications of the attacks thus far have been limited, and financial markets have barely responded. The spreads on 10 year Credit Default Swaps (CDS), which is an indication of default risk, hardly budged in the week of the attacks and neither did Brussel’s main stock market index (Bel20). However, the implications in the medium to long term could be more severe. First, consumer and business sentiment could be negatively affected in the period ahead. Public perception is growing that a well-coordinated European response against terrorism is out of reach and new attacks are to be expected. Second, the attacks in combination with the ongoing refugee problem will provide a fertile breeding ground for anti-immigrant sentiments. In response to the attacks, support in Belgium for Flemish national party Vlaams Belang has surged. The uprise of nationalist parties could affect economic growth negatively, as many of them adopt a protectionist and anti-reform stance. Third, although the scale of the attacks did not initiate a complete security clampdown, such as one after the 9/11 attacks, spot checks have increased in vulnerable strategic areas, which could ultimately lead to a further erosion of the Schengen free movement of people-treaty. If the free movement of people is restricted, it will negatively affect trade and economic growth in the EU and Belgium, since the EU is Belgium’s largest export market. Fourth, the attacks have increased the likelihood of the UK leaving the EU, which could hurt trade between Belgium and the UK. Finally, the attacks could imply a slightly higher budget deficit for Belgium.
 The high inflation is caused, above all, by higher tuition fees for higher education, a higher VAT on electricity usage due to the tax shift, and additional health taxation of soft drinks.
Belgium is a small, open, and private-enterprise-based economy, with around 11 million inhabitants and a nominal GDP per head of approximately 43,500 USD (PPP). The economy has benefited from its central geographic location combined with a good transport network and excellent education systems. Its diversified industrial base is mainly concentrated in Flanders in the north. As Belgium has few natural resources, it imports a large number of raw materials and exports significant quantities of manufactured goods (partly for re-exports), exposing its economy to volatility in world markets. Most of Belgium’s trade, around three-quarters, is with other EU countries. Belgian banks were damaged by the 2008 financial crisis but have recovered substantially since 2013. The financial position of the private sector is one of the healthiest in Europe, due to very high household savings and only moderate net debt levels of firms. In contrast, at 107% of GDP, public debt is very high, but the public sector has a reliable track record of repaying its debt. Belgium has barely taken any policy action to encourage activity of older workers. The limited policy initiatives that have been taken have not resulted in higher structural participation rates of older workers. Low activity and employment rates of older workers, low educated and non-EU immigrants, will endanger the economy’s growth potential over the medium-to-long term. Tensions between the Dutch-speaking and French-speaking parts of the country have in recent years led to constitutional amendments granting Belgium’s regions and language communities more formal recognition and autonomy. This, and wide social and economic differences between the language communities, impede agreement on necessary reforms and coordinated security activity.