OECD Economic Outlook, Volume 2019 Issue 2

Luxembourg

Growth is projected to ease to 2.8% in 2020 and to 2.3% in 2021, amid subdued investment and persistent weakness in the euro area, which will hamper further export dynamism. Solid private consumption growth will underpin domestic demand. The buoyant labour market will keep creating jobs, though at a decelerating pace and benefitting primarily cross-border workers. Consequently, the unemployment rate is projected to decline only slightly.

The fiscal position is sound and fiscal space is ample. Fiscal policy should be eased if the current slowdown worsens and reduces growth significantly below potential. Increasing the supply of social and private rental housing is key for making the access to housing more equitable and slowing house price growth. Rising household indebtedness creates vulnerabilities for some families and banks, calling for the introduction of borrower‑targeted macroprudential tools.

Growth is relying more on domestic demand

GDP growth was strong in the first half of 2019, mainly due to surging exports. This largely reflected a significant rebound of financial and insurance activities, in part as compensation for a very weak end of 2018. Consumer confidence and retail sales are still strong. Construction maintains an upward trend. However, business surveys are beginning to show a deteriorating outlook, reflecting the slowdown in activity in the euro area. The unemployment rate has declined and there is growing evidence of skill mismatches and shortages, signalling potential capacity constraints.

Economic growth, domestic demand and house prices: Luxembourg

Source: OECD Economic Outlook 106 database; and OECD Analytical House Price database.

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Luxembourg: Demand, output and prices

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Policies are needed to promote green growth and increase productivity

The fiscal position is strong, with the fiscal surplus projected to remain close to 3% of GDP and the gross public debt ratio among the lowest in the OECD area. After some corporate income tax cuts and reduced VAT rates for certain products introduced in 2019, the fiscal stance is projected to remain broadly neutral over the coming two years. Fiscal measures can improve green growth through higher taxes on transport fuel, the introduction of congestion charges in Luxembourg City, an increase in car taxation and investment in electric vehicles infrastructure.

Productivity growth has been subdued in recent years. Skill shortages, regulatory constraints in some professional services and lack of innovation, even among the top productive firms, are among the drivers of the productivity slowdown. Labour market policies should aim to undertake regular exercises for the assessment of future professional needs and ensure their outcomes feed into enhanced training offers. The modernisation of bankruptcy law should aim to ease restraints on early restructuring and promoting second-chance opportunities, as well as facilitating the exit of non-viable firms. Policies should also ensure a level playing field between FinTech and traditional financial intermediaries, promoting a risk-based approach in regulating financial innovations.

House prices have been growing strongly, driven by population growth, a high rate of household formation, sustained demand pressure from cross-border workers and limited use of land available for construction. As a consequence, housing affordability has been deteriorating, in particular for low-income households. A mix of policies addressing supply‑side restrictions, together with measures to increase housing tenure neutrality and better targeted fiscal support will be needed to make the housing market more efficient and inclusive.

Growth will ease but remain robust

Growth is projected to weaken but to remain comfortably above 2% in 2020 and 2021. Investment growth is set to decline and exports to slow from their strong performance in early 2019, making their contribution to GDP growth ebb to modest levels by historical standards. Robust private consumption, in the context of a strong labour market, will help sustain economic activity.

Risks to the outlook are tilted to the downside and include weaker‑than‑expected euro area and global growth and uncertainty about Brexit, even if in the medium-run Luxembourg could benefit from the relocation of some UK-based financial services activities. The financial sector is poised to remain profitable, but increased volatility in global financial markets may accelerate the pullback in global equity markets and the corresponding decline in net assets under management by investment funds.