The Economist Perspective
Things Are Looking Better… For Now
After two sharp decreases in GDP at the turn of the year, the Belgian economy contracted less strongly in the second quarter. In fact, GDP ‘only’ decreased by 0.3%. In nine months (probably the length of the recession), GDP decreased by 3.7% and corporate investments 3.5%. More importantly, the 19% drop of exports, the main driver of activity, demonstrates the deepness of the crisis. Finally, firms face a lack of demand as at the beginning of the crisis they accumulated unwanted inventories. During the last couple of quarters they had to clear these inventories out, slicing off a total of 1.5 percent from total GDP growth over the last nine months.
The Upturn has Arrived?
As it has been observed in other countries, leading indicators reveal some signs of a recovery. For example, business confidence has increased for seven months in a row and is supported by all sectors.
In Belgium, economic recovery is traditionally kick-started by external trade. However, to fully benefit from the increase in global trade, Belgian exporters need to maintain – or even improve – their recently deteriorated competitiveness (bear in mind that the automatic wage indexation led to strong wage increases in 2007-2008). On top of this, the strengthening euro is certainly not helping.
That being said, we believe foreign demand will be strong enough to generate positive growth contributions from net exports. After substantial destocking, a restoring of higher inventory levels could contribute to more activity in the short term, as was the case following previous recessions. Yet, despite these positive signs, our economic forecasts remain cautious.
First, there is still some uncertainty about the robustness of the recovery in the global economy. Second, corporate investments could remain substantially weak in the context of a very low capacity utilization rate (73.1% in October) and tight financing conditions. Third, the uncertain employment situation may temper any recovery in consumption. And fourth, the automatic stabilizers and recovery plan deepened public deficits in the first part of the year.
Put these together and it becomes clear that, in order to reach a balanced budget by 2015, Belgium is heading for a period of restrictive fiscal policy. This return to equilibrium will cost a cumulated amount of 1.5% of the GDP in the coming two years (around 5 billion euro) and a total of 6.8% of GDP (20 to 25 billion euro). After a deep recession in 2009 (GDP growth of -3.0%), we expect GDP growth to recover very gradually, and to remain below potential in the two upcoming years. This means we can expect a 1% growth in 2010 and 1.9% in 2011.
To the extent it incorporates fairly modest growth assumptions, the new budget for 2010-2011 can be called prudent. However, we welcome the fact the government extended the life of the nuclear plants, thereby guaranteeing sufficient power supply for the next ten years. The notional interest rate deduction, a key element in making Belgium attractive to foreign investment, has been left relatively unscathed.
At the same time, the government extended some crisis measures, such as the temporary unemployment scheme for white collar workers (very important to stop early retirement schemes) and the reduction of VAT in construction. On top of this, the VAT rate for restaurants was lowered. Unfortunately, two thirds of deficit reduction actions comes from higher income, while such things as unsustainable growth in health care expenditure has not been touched.
All in all, it is not an earth shaking budget and, given the still fragile recovery, it is probably impossible to do much more in terms of deficit reduction. But this means that some of the longer term structural weaknesses still have to be tackled.
The Belgian Balancing Act
In its latest public finance sustainability report, the European Commission characterizes Belgium as having a good starting position in terms of primary balance. At the same time, the long-term cost of ageing in Belgium (4.8% of GDP) is significantly above the EU average (3.3% of GDP). With taxes already high, the burden of further budgetary adjustment should fall on public expenditure cuts. Indeed, with a larger public sector than the European average, there seems to be some room to cut public expenditure, especially in the wake of further technology induced productivity gains (think of e-government).
However, as research from the OECD shows, the devolution of powers in Belgium has created negative economies of scale in the public administration. More fiscal responsibility for the regions and the removal of overlapping competences between the federal state and the regions might cure some of the overspending on public services.
But one thing remains clear: solving these problems will be a difficult balancing act.