Luxembourg has the highest per capita income levels in the OECD when measured by GDP, and the third-highest after Switzerland and Norway, when measured by gross national income (Figure 1.1, panel A). Growth is jobs-rich, with the unemployment rate one of the lowest in the OECD. However, growth in GDP per capita has been below the OECD average since the global financial crisis (2008-09), following high growth in the early 2000s (Figure 1.1, panel B). The economy proved resilient in face of the shock from the 2020-21 COVID-19 pandemic, and the recovery was broad-based. The Russian war of aggression against Ukraine and high inflation in 2022 have affected consumer and business confidence, stifling the economic recovery and making the outlook more uncertain.
OECD Economic Surveys: Luxembourg 2022
1. Key Policy Insights
Figure 1.1. Incomes remain high despite growth slowing down since the global financial crisis
Note: Gross national income captures the activity of residents, whereas GDP includes consumption by the large share of cross-border workers that enter the country every day.
Source: OECD National Accounts (database).
Luxembourg performs well relatively to other OECD countries across several non-economic indicators such as health, civic engagement, and safety, on top of high living standards (OECD, 2020[1]). Trust in government and in public institutions is above the OECD average and public integrity is perceived to be high (OECD, 2022[2]) There is still room for improvement: access to affordable housing is a concern, and educational attainment is uneven and strongly related to students’ socio-economic background (Figure 1.2) (European Commission, 2022[3]). While life satisfaction is comparatively high, obesity has been on the rise, in particular amongst younger people (OECD, 2020[1]). This could have an impact on the longer-term health of the population, and associated costs for long-term care of the elderly (European Commission, 2021[4]; OECD, 2021[5]; OECD/European Observatory on Health Systems and Policies, 2021[6]). Environmental factors, such as high air pollution, also weigh on well-being in the country (OECD, 2020[1]).
Successfully maintaining the country’s high living standards, whilst transitioning to a green economy that secures the long-term health of the environment, will require fundamental changes in consumption and production patterns, and the effective use of all resources. Higher investments will be critical to enable this change, provided that they are aligned with long-term incentives to reduce carbon reliance and environmental protection. Successfully lengthening working lives, whilst maintaining the population’s health, will support growth, and also help reduce the pressure on housing, land and energy-use. This requires tackling longer-term challenges related to sluggish productivity growth and an ageing population, which will put pressure on government spending. Supporting higher productivity growth alongside the sustainable use of resources will minimise waste and the pressure on resources, ensure Luxembourgish firms are well-positioned to take advantage of new markets and reduce the need for drastic decisions on fiscal spending in the future.
Figure 1.2. Household income is high, but long-term unemployment and housing can improve
Well-being indicators, scale 0 (worst) to 1 (best), 2020
Note: This chart shows Luxembourg's relative strengths and weaknesses in well-being when compared with other OECD countries. The index is constructed so that 0 represents worst outcome and 1 represents the best outcome among OECD countries.
Source: OECD calculations based on OECD How's Life? Well-being database.
In terms of productivity levels, there are sharp differences between Luxembourg’s best performers and the global best performers, as well as within Luxembourgish sectors. While productivity in Luxembourg’s manufacturing sector, which includes large multinational firms such as Arcelor Mittal, often exceeds the OECD average, the sector is a small part of the national economy. Other sectors perform less well, including the large financial sector, which on average had the second lowest productivity (measured as value-added per person employed) in the OECD, in the period 2001-21 (OECD, 2021[7]). Skills-mismatches are high, which is also weighing on productivity, and those excluded from the labour force are difficult to integrate back into the system.
Strong public investment has not been matched by the private sector, owing partly to the structure of the Luxembourg economy which is characterised by a high share of financial services. Corporate investment as a share of gross fixed capital formation is the second lowest in the OECD, at 45.7% (compared with an average of 60% in the OECD, and 90% of total investment in Ireland), while the share of general government investment is the highest anywhere in the OECD (OECD, 2021[7]). A rapidly ageing population will pose challenges for sustaining workforce growth, particularly if current early retirement rates persist. The old-age dependency ratio will more than double (from less than 25% to more than 56%) by 2070, leading to a steep increase in pension expenditure and the cost of long-term care (European Commission, 2021[8]). Without efforts to raise productivity growth or increase labour supply to offset an ageing workforce, fiscal pressure will increase by more than 10 percentage points of GDP by 2060 (Guillemette and Turner, 2021[9]).
The transition towards a low-carbon and digitalised economy should be taken as an opportunity to support stronger long-term growth. The climate strategy to 2050 outlines a large number of plans to respond to climate risks. Strong co-operation between the state and the private sector in the financial services sector has supported innovation in the financial sector. More generally, the authorities have taken a proactive stance to create the foundations for a flexible, responsive, and fast-growing economy into the future. This is important since, given Luxembourg’s high economic openness, the country needs to be resilient to external shocks, such as higher inflation brought by Russia’s war of aggression against Ukraine, or supply-chain shocks (Figure 1.3, Panel C).
In this context, this Survey’s key messages to strengthen further the resilience of the Luxembourgish economy in the face of new challenges are the following:
Fiscal support to households vulnerable to the current energy shock should be targeted and temporary to avoid fuelling inflationary pressures and to maintain incentives for energy savings. Significant reforms to the pension system are necessary to reinforce fiscal sustainability.
Migration policies and incentives to raise the working age in Luxembourg are required to offset the ageing workforce’s impact on potential growth. Lifelong learning programmes are needed to ensure workers’ adaptability.
Meeting ambitious green transition goals requires a broad set of policy tools. Reducing overall energy intensity requires adjusting incentives to densify housing and to reduce the reliance on cars. Setting a more ambitious long-term carbon-tax path, accompanied with adequate support for vulnerable firms and households, is also key.
Raising productivity growth and reducing resource intensity requires laggard firms to absorb better existing innovations, and faster digitisation in small-and medium-sized firms (SMEs). To support productivity growth and economic diversification, public innovation investment should better target specific projects, while corporate R&D investment could be better supported through matching public funding.
Luxembourg rebounded strongly from the pandemic but is facing new risks
The post-COVID-19 recovery has been strong, but high inflation creates significant risk
The economy proved resilient to the COVID-19 pandemic, thanks notably to decisive government action early on. COVID-19 support measures were sizable and equivalent to just over 4.2% of GDP, including government loan guarantees as detailed in a 2022 OECD report on the Luxembourgish government’s response to the pandemic (OCDE, 2022[10]). Household assistance during the pandemic included direct income support, supplemented with financing of partial unemployment. Firm level support included direct transfers as well as furlough schemes to help meet staff costs. COVID-19 related assistance was broad-based and delivered quickly, in keeping with best practice given the breadth and depth of the economic shock. Most of the assistance was directed towards employment support, with a higher share of GDP directed towards wage support than many peers. A relatively high proportion of liquidity support was provided via deferred tax and social security payments, which were almost double the value of guarantees granted. To date, the long-term impact on the economy from bankruptcies and permanent exclusion from the labour force seems limited (OCDE, 2022[10]). Government support has continued to respond to ongoing shocks.
The high share of services that could rely on teleworking also helped limit the impact of the crisis. Nearly 40% of jobs are in the services sector, including public administration. The downturn in 2020 was comparatively mild, and the recovery has been robust, taking real GDP growth to 5.1% in 2021. A strong recovery in financial markets lifted growth in the financial sector, which accounts for around 25% of the economy.
Job creation has been brisk since mid-2021, in step with the recovery. Total unemployment is at its lowest level for over 15 years, and vacancies are high (Figure 1.3, Panel D). Thanks to buoyant activity, the surplus on services trade has supported a persistent current-account surplus in recent decades of around 4%-5% of GDP, despite large deficits on the primary income account (Figure 1.3, Panel B).
Figure 1.3. Growth is broad-based, and pressures are rising in the economy
Source: OECD (2022), Economic Outlook (database); Eurostat, Job vacancies; and STATEC.
Luxembourg, as the rest of the European Union, has been affected by the rising gas and electricity prices owing to the supply restrictions arising from the Russian war of aggression in Ukraine, even though Luxembourg has relatively little direct exposure to Russia, which accounts for just 1.7% of total trade. Base metals imported directly from Russia account for just 0.4% of all base metal imports, versus 97% from the European Union (some imports may have transited through third-party countries, but this is not accounted for in official data). Oil and gas imported directly from Russia are negligible (Figure 1.4). Natural gas accounts for 25% of all energy consumption and much of the gas imported is used for industrial purposes, mainly steel and glass manufacture, but also in the textile and cement industries, in addition to electricity production. Imported gas runs mainly from LNG terminals in Belgium, which increases potential suppliers, for instance from Canada or Algeria. Luxembourg does not possess its own gas storage facilities, but it participates in the Pentalateral Forum on Energy (comprising Benelux, France, Germany, Austria and Switzerland). An agreement was signed in late March 2022 to improve gas storage co-operation, and to force suppliers to fill stocks before the winter heating period (Gouvernement Luxembourgeois, 2022[11]).
Figure 1.4. Exposure to Russia’s oil and gas is negligible
Oil and gas imports, 2021
Source: Eurostat; and IEA.
Russia’s war against Ukraine has aggravated inflationary pressures, which had already started building towards the end of 2021 on the back of supply bottlenecks. While some increases are supply-driven, rising demand is also contributing, and inflation has broadened to include personal services, travelling and entertainment, as well as clothing and household goods (Figure 1.5). Headline inflation is expected to average 8.2% in 2022 according to the harmonised price index, on the back of higher energy and food price inflation. Rising inflation is eroding consumer confidence and disposable incomes (Figure 1.6) and, combined with labour market bottlenecks, fuels wage pressures. All wages, salaries, and some social benefits, such as pensions and family allowances, are indexed to inflation. They are automatically increased by 2.5% when the price level has gone up by 2.5% since the time the last wage indexation occurred. The total wage rate rose by 5.4% in 2021, in part owing to a wage increase of 2.5% in October 2021 because of the wage indexation scheme. A further 2.5% increase occurred on 1 April 2022 when the automatic indexation kicked in again, contributing to the 6.2% annual rise in hourly wages in the second quarter of 2022.
Figure 1.5. Inflation is broad-based
Headline inflation and its main components, year on year % change
Note: "Housing" includes housing, water, electricity, gas and other fuels; "Miscellaneous" includes personal care, social protection, insurance, and other services n.e.c.
Source: Eurostat, Harmonised Price Indices.
Figure 1.6. War and rising inflation are depressing consumer confidence
Source: OECD, Monthly Economic Indicators (database); and Eurostat, Business and consumer surveys (database).
To mitigate the negative effects of rising prices on household incomes and competitiveness, the government responded with a series of support packages costing close to EUR 2.6 billion (3.3% of GDP). The total cost of the latest package, agreed with social partners in September 2022, is EUR 1.1 billion. The latest measures aim to limit inflation increases – and related wage-indexation increases – by capping domestic gas and electricity price increases between October 2022 and December 2023, and reducing most VAT rates by 1 percentage point in 2023. Rent subsidies and an annual energy bonus for lower-income households, introduced earlier in 2022, have been extended into 2023. Until June 2023, businesses can apply, if their energy costs are at least 80% higher than in 2021, for a subsidy covering 70% of their additional energy costs over and above this 80% increase. Moreover, state-backed business guarantees remain in place (Le Gouvernement du Grand-Duché de Luxembourg, 2022[12]). Subsidies for energy efficiency investments were strengthened and introduced for long-term renewable energy power purchase agreements. Social partners agreed that any future wage indexation increases will be implemented in full. In March, they had agreed to postpone the July 2022 wage indexation increase until 1 April 2023.
Figure 1.7. Policy support is tilted towards non-targeted measures
Budget measures 2022-23, Euro million
1. Targeted measures are directed at households or firms, based on criteria such as income or energy consumption levels.
Source: Ministry of Finance, Draft Budget Plan 2023, OECD estimates.
New sizeable energy price increases could pose risks for firms and households that are unable to quickly reduce energy consumption Targeted support measures are welcome as there is a small but growing set of households in energy poverty, at 4.9%. The government’s latest support package is estimated to limit expenditure increases from higher living costs to 3% for all income groups in 2022 (STATEC, 2022[13]). In addition, an expanded and free public transport network provides important flexibility to reduce transport-related energy consumption, and subsidies for energy efficiency investments in homes and businesses are available.
The risks arising from policy support in the form of price measures will rise if energy prices are very high over the medium term. Wage increases from indexation would be postponed, and could increase pressure for continued fiscal support. VAT reductions may not be fully passed on by business and could be difficult to phase out. Price caps for gas and electricity will disproportionately benefit those who consume the most, and are likely to blunt incentives to lower consumption. Overly generous support to protect households’ income could further increase inflationary pressures, which are already broadening to include personal services, travelling and entertainment, as well as clothing and household goods.
To minimise these risks, the authorities should ensure that support is temporary and well-targeted to the most vulnerable. The government should monitor the impact of VAT reductions, and ensure rates are normalised promptly, as Germany did in 2020-21. More targeted support measures, delinked from energy consumption, would be a more effective tool to support the most vulnerable without blunting the incentives to increase energy efficiency. This is particularly the case in Luxembourg, where the retail price of energy is relatively low compared to neighbouring countries (see Chapter 2). Price caps can be applied to a fixed quantity of energy per household to minimise energy savings disincentives. In the Netherlands, price caps were applied to the quantity of gas consumed by the median household, with higher levels of consumption incurring higher prices.
Government support to firms must avoid the risk of encouraging low-productivity “zombie” firms that are unviable without state support. Support to firms should be targeted to viable firms, whose cost structure make them particularly vulnerable to high energy costs. Larger firms that have access to finance or pricing power can better manage the transition to higher energy costs. To the extent that government supports these firms in the energy transition, it should encourage the switch to alternative production technology (see Chapter 2).
The current period of high inflation has highlighted the potential risks stemming from the automatic wage indexation system. Wage indexation can induce a price-wage spiral, particularly in the current context of high inflation and tight labour markets. Shocks to inflation can have longer-lasting effects in the presence of second-round effects, and the latter are more are more likely in the presence of wage indexation. There is also a risk of a longer lasting upwards effect on inflation expectations (Lünnemann and Wintr, 2010[14]; Koester and Grapow, 2021[15]; Boissay et al., 2022[16]). Generalised wage increases also disproportionately benefit those with higher salaries.
Although Luxembourg’s social partners have demonstrated pragmatism in considering the impact of indexation, agreements can take time to implement. There is no clear policy to guide lawmakers or social partners as to how best apply retroactively any delayed increases in indexation, such as the one that was decided by the social partners in March 2022. Retroactively introducing these increases could exacerbate business cycle effects, if introduced too early or too late in the recovery. After the current period of high inflation, social partners should be consulted, and the government should implement reforms to the wage-indexation system to better guard against the risks to productivity, employment and inflation.
Whilst wage indexation mechanisms are intended to protect living standards, they can have a detrimental effect on competitiveness. In Belgium, the wage formation process is legally prescribed by a ceiling for wage growth, known as the wage norm, and wage indexation. The wage norm varies over time, and is set with reference to historic divergences in wages between Belgium and its main trading partners, projected Belgian inflation, projected wage growth in core trading partners and a “safety margin” to account for forecasting errors (OECD, 2022[17]). The OECD recommended to Belgium to closely monitor the effect of wage and price inflation on international competitiveness (OECD, 2022[17]). Connecting wage indexation to other countries’ wage growth could be part of a solution to protect competitiveness. However, a broader range of cost-competitiveness criteria could be considered and be given a sufficiently high weight.
Growth will slow down in 2022-23 and risks are on the downside
GDP will slow to around 1.7% in 2022 and 1.5% in 2023, before picking up to 2.1% in 2024. Falling consumer sentiment, supply constraints in goods exports and slowing manufacturing activity, along with rising global interest rates will hold back economic growth in 2023 (Table 1.1). From a household perspective, higher interest rates will increase payment obligations and the vulnerability of certain borrowers, particularly those with lower incomes or with variable rate loans, and confidence has plummeted to the lowest level in two decades owing to the war in Ukraine and rising uncertainty (Figure 1.6). Nonetheless, government support and a cut in VAT rates, alongside a still-strong labour market, are expected to partially offset the impact of high inflation on disposable incomes and will sustain private consumption in 2023. Spending is set to pick up as energy prices normalise towards the end of the forecast period, and inflation starts falling back during 2023, as a result both of rising interest rates, and some impact from the energy price cap and VAT rate cuts. Core inflation is projected to be sustained in 2023, owing to second round effects of energy price increases, high wage growth and supply-constraints related to COVID-19 lockdowns in China. If energy prices stay high for longer, inflation may remain higher than foreseen, and household demand could be further depressed.
Table 1.1. Macroeconomic indicators and projections
Annual percentage change, volume (2015 prices)
1. Contribution to changes in real GDP.
2. As a percentage of potential GDP.
3. As a percentage of household disposable income.
4. As a percentage of GDP.
Source: OECD (2022), OECD Economic Outlook: Statistics and Projections (database) with projections from "OECD Economic Outlook No. 111" and updates, November 2022.
Public investment of over 4% of GDP annually will continue to support infrastructure, the green transition, and innovation. Business investment, in contrast, will be subdued in 2022-23 as higher interest rates, labour market shortages and supply constraints delay investment decisions, despite some support from the government Recovery and Resilience Plan (RRP). Because Luxembourg’s economy recovered fairly swiftly from the COVID-19 pandemic compared to some other EU member states, the total size of the NextGenerationEU (NGEU) recovery package (of which the RRP is part) for Luxembourg was reduced from an initial EUR 93 million to EUR 82.7 million. The impact on GDP for Luxembourg is highly dependent on spillovers from neighbouring countries. The European Commission has estimated that 0.7 percentage points of the total projected 0.8% GDP impact by 2026 will come from spillovers from the packages of other countries (European Commission, 2021[18]). These estimates do not include the impact of additional structural reforms, which could significantly boost the overall growth benefits (European Commission, 2021, p. 38[18]). Box 1.1, and Table 1.5 present OECD estimates of the impact of these structural reforms. As discussed further in this chapter, the labour market is tight, and several sectors are struggling to find enough skilled workers, including in the construction and the information-communications-technology (ICT) sectors, which may hamper implementation of the RRP. Export growth will moderate, as global financial market conditions remain difficult, and some supply-chain restrictions endure.
Risks to the outlook are tilted to the downside. Domestically, low interest rates in recent years have compounded the impact of structural factors in supporting rising real-estate prices and increased mortgage indebtedness. Indicators point to historically high risk in the credit and housing markets (Figure 1.8), although holdings of financial assets and wealth gains for past price increases should mitigate the impact of potential shocks. Externally, Luxembourg remains vulnerable to supply-side shocks, which would affect its main trading partners. Further sharp rises in inflation and long-term borrowing rates would worsen financial conditions, and cause stock markets valuations to fall. If this was to be compounded by defaults of bonds or a sharp drop in investment fund assets, for instance in the case of a faster-than-expected tightening of monetary policy, this could create a ripple effect in financial markets, which could harm Luxembourg’s growth prospects (see also Table 1.2).
Table 1.2. Low-probability events that could lead to major changes to the outlook
Figure 1.8. Macro-financial vulnerabilities have increased in the asset and housing markets
Index scale of -1 to 1 from lowest to greatest potential vulnerability, where 0 refers to long-term average
Note: 1. Each aggregate macro-financial vulnerability dimension is calculated by aggregating (simple average) normalised individual indicators from the OECD Resilience Database. Individual indicators are normalised to range between -1 and 1, where -1 to 0 represents deviations from long-term average resulting in less vulnerability, 0 refers to long-term average and 0 to 1 refers to deviations from long-term average resulting in more vulnerability.
Source: Calculations based on OECD (2022), OECD Resilience Database, April.
Financial sector risks are rising
Fast-rising housing prices pose challenges
House prices have been increasing rapidly since the start of 2019 for both new and existing dwellings. On average, prices have risen by 9.7% per annum over the past five years, almost double the 4.9% EU average. The sharp increases in housing prices have worsened most household affordability ratios. Mortgages account for the bulk of household debt, which stood at 180% of total net disposable income in the first quarter of 2022 (Banque Centrale du Luxembourg, 2022[19]) (Figure 1.9). Price-to-income ratios are well above their long-term trends. Aggregate debt service to income ratios have remained high since 2018 at above 40% for all income categories. Loan-to-value ratios of new loans increased since 2018 from 73.0% to 76.5%. New loans are increasingly weighted towards those with higher incomes.
The risks to the financial sector from the housing market boom require continued monitoring. Aggregate sector exposures are low: household debt makes up just under 10% of the total banking loans issued, and almost two-thirds of that are in Luxembourgish mortgages. However, most of this debt is held by a handful of Luxembourgish banks, who hold on average 22% of their assets in mortgages. This concentration requires intensified monitoring, as these banks could suffer difficulties if house prices decline in response to higher interest rates.
From a household perspective, higher interest rates could increase payment obligations and the vulnerability of certain borrowers, particularly those with lower incomes. 51% of homeowners still have variable rate loans (Banque Centrale du Luxembourg, 2022[19]), even though since 2015, most new loans have been issued at a fixed rate, and central bank estimates of loan origination suggests many households renegotiated at lower fixed rate mortgages (Banque Centrale de Luxembourg, 2022[20]). Valuation gains in houses and holdings of liquid assets should help borrowers smooth any shocks to interest payments. Residential real estate data from the regulator (Commission de Surveillance du Secteur Financier‑CSSF), shows that debt-service-to-income ratios of lower- and medium-income households (earning less than EUR 75 000 a year) are 42%, similar to the 40% average of all households. Debt-to-income ratios are 999% for lower and middle-income households, compared to an average of 1024% for all households. 31% of low-income households in Luxembourg are overburdened by housing costs, compared to 28% in the European Union, according to the 2020 Eurostat Survey on Income and Living Conditions (Koulischer, Perray and Tran, 2021[21]). Luxembourg faces a much lower risk of default on mortgages within five years in the case of job loss than t neighbouring countries (3% compared to 10%) (IMF, 2021[22]). Nonetheless, the IMF (IMF, 2021[22]) estimates that low and middle-income households face a much higher risk of default (30%) than this average, in the event of losing their job.
The authorities activated several new macroprudential policy measures in 2021 to protect borrowers from housing market risks. As of January 2021, legally binding loan-to-value limits have been put in place, of 80% for buy-to-let loans, 90% for primary residence loans and 100% for first time buyers. A higher countercyclical capital buffer requirement of 0.5% of common equity tier 1 capital was also introduced in 2021. Macroprudential policy may have helped to reduce tail-risks for new borrowers (IMF, 2021[22]) According to the CSSF, 35% of new loans with a debt-to-income ratio above 900% went to lower-income households in the second half of 2021, down from 41% a year earlier. The current rising interest rate cycle is expected to further reduce risk appetite, mortgage lending and house prices. Nonetheless, authorities should stand ready to apply additional macroprudential measures if needed. In Norway, Sweden and Denmark, countries with buoyant housing markets, counter-cyclical capital buffers are 1.5% and will increase further in 2023.
Borrower-based measures such as debt service to income caps can help mitigate risks whilst potentially restricting access for first-time buyers less (OECD, 2021[23]). An expanded set of regularly updated public data to evaluate housing market developments and risks by household borrower types could support policy co-ordination. For example, higher interest rates or macroprudential policy to reduce borrower vulnerability could reduce mortgage access for certain types of borrowers, who might be in a particular need of a mortgage to finance deep renovations to green their homes. A regularly published report, with analysis according to household income categories as well as buyer types, could increase information to policy makers and the market. For example, the Swedish Financial Supervisory Authority publishes an annual report on the local mortgage market, with detailed information on the volume and distribution of household debt, as well as stress-test related information. Expanding the set of aggregate indicators to also estimate the risks of over-consumption and over-investment associated with the housing market would improve understanding of the channels through which the housing boom may affect macroeconomic stability (Svensson, 2020[24]). The Bank of England for example provides estimates of housing equity withdrawal.
In addition to macroprudential measures, a wide range of measures will be necessary to increase the flexibility of housing supply over the long term. Structural factors have played an important role in supporting high house-price growth. Land hoarding and high administrative costs (e.g. lengthy building permissions procedures) have hindered investment in the housing stock, exacerbating the impact of continued population growth, shrinking household sizes and demand for larger homes (OECD, 2019[25]; Reinesch, 2022[26]; Paccoud et al., 2021[27]; Observatoire de l’habitat, 2022[28]).
The government has taken steps to raise housing supply (Table 1.3). Planned increases in national tax rates for vacant land and unused buildings to discourage land hoarding are welcome and must be implemented quickly (OECD, 2019[25]). Increasing the supply of affordable housing is a core focus of the government’s strategy. The Pacte Logement 2.0, released in 2021, includes technical and financial support for municipalities to develop their affordable housing strategies, and financial incentives to increase the supply of rental housing. Social housing must make up a defined minimum amount in new developments under the special development plan, which will be transferred to municipalities or the state. The supply of government-built affordable housing units is expected to increase by approximately 200 units a year. Housing supply incentives should only apply to areas identified for development in the Master Programme for Spatial Planning, to discourage further urban sprawl and car usage (see Chapter 2). Encouraging greater densification of homes alongside energy efficiency renovations could help to reduce the pressure on the built environment and reduce the potential trade-off between housing supply and resource intensity (see Chapter 2).
Figure 1.9. The housing market continues to place households under pressure
Source: OECD Analytical house price indicators; Banque Centrale du Luxembourg; and OECD, National Accounts at a Glance.
Mortgage interest deductions for owner occupied property should be removed gradually to reduce distortions in housing demand, which favour wealthier households (OECD, 2019[25]). To ensure that this does not hurt access to the housing market, the interest deduction could be replaced by more targeted measures, such as an income-tested property tax credit (Causa, Woloszko and Leite, 2019[29]). In the United States and Canada, some regional governments provide lump sum exemptions, whilst others provide support in the form of tax credits to low-income families (Brys et al., 2016[30]). Increasing immovable property taxes could bring wider socioeconomic benefits. Whilst corporate wealth taxes are relatively high, Luxembourg currently collects almost no recurrent taxes on immovable property compared to a level of 1% of GDP on average in the OECD. In addition to potentially raising revenue (OECD, 2018[31]) and increasing housing supply, higher immovable property taxes could support a more sustainable housing market and encourage investments in other assets, rather than residential property. The liquidity impact of raising property taxes on people with low incomes and non-liquid assets could be managed by spreading immovable property tax payments throughout the year.
Table 1.3. Previous recommendations to boost economic resilience and access to housing
Financial risks need to keep being closely monitored
Low interest rates in recent years have been supporting high levels of demand and risk appetite, which in turn have underpinned rising asset prices. Luxembourg has benefitted from the resultant steady growth in financial market activity. However, low rates have also imposed costs. Low interest rates have contributed to low bank profitability, as in most of Europe. More recently, the robust local economic recovery in the context of the low interest rates has contributed to accelerating inflation. The lags in price setting could mean that inflation continues to increase even as economic activity slows in response to higher interest rates. If the euro area monetary policy stance proves too loose for Luxembourg, additional financial (but also fiscal, see next section) measures might need to be taken.
Luxembourg’s financial industry is well placed to cope with potential risks, and several steps have been taken since the last Economic Survey to raise its resilience (Table 1.4). Assets held by the financial sector grew by a robust 24% between 2019 and 2021. Supportive global fiscal and monetary policy offset market turbulence and the COVID-19 crisis. Non-performing loans are low as a share of total assets compared to OECD counterparts (Figure 1.10, panel A). Regulatory capital buffers are high (Figure 1.10, panel B), and liquidity has been increasing, even as capital buffers have fallen. The banking sector received around 60% of its deposits from financial intermediaries in 2021. Historically, investment funds’ bank deposits have increased in periods of high volatility. Authorities have continuously enhanced system-wide oversight of the investment funds sector. The proactive stance of regulators and firms in developing products to best utilise the green and digital transitions has maintained the attractiveness of Luxembourg as a financial market.
Nonetheless, as global monetary policy tightens, strains will increase, warranting continued monitoring. In March 2022, it was estimated that 17% of Luxembourgish banks had made a loss in 2021 (CSSF, 2022[32]). Higher rates should help to restore profits over the long term for both insurers and banks. However, in the short term, both banks and insurers will have to contend with the drop in the market value of their fixed-income holdings. In addition, non-performing loans are likely to rise further in 2022 and beyond, given that the war implies a second shock in quick succession for vulnerable firms, not just in Luxembourg but in Europe as a whole. Support from EU governments for firms affected by the war has not been as large as during the COVID-19 pandemic, although loan guarantee schemes have been increased in many countries including Luxembourg, helping to mitigate credit risk somewhat (Table 1.4). Heightened financial market volatility could prompt outflows and procyclical asset sales by investment funds, particularly open-ended ones. The authorities should continue to monitor banking exposures, including large cross-border exposures and intra-group transactions. They have undertaken a number of efforts to strengthen the investment fund sector’s macroprudential monitoring, including system-wide liquidity stress testing, and these efforts should continue.
Figure 1.10. The financial sector is in a strong position to respond to additional shocks
Note: Data for 2021 for Denmark, Iceland, Latvia, Luxembourg and Poland. All other countries 2020.
Source: IMF Financial Soundness Indicators.
Table 1.4. Previous recommendations to improve fiscal resilience and financial market surveillance
The fight against money laundering has been given greater prominence
The authorities have further strengthened legislation to reduce the risks of money laundering and corruption since the last Economic Survey. Important advances include strengthening beneficial owners’ registers, with a new register created for trusts and requiring foreign nationals to use a national identity number in the companies register. This activity is appropriate given the need to maintain the standing of Luxembourg in global finance. Compulsory compliance with the national identity numbers system should be accelerated, instead of leaving an open-ended timeline.
Luxembourg’s digital sophistication could be better harnessed in the fight against money laundering. Big data techniques are used by the prudential regulator to identify risks related to investment funds. They should be a core part of the strategy employed by the prudential supervisor to assist the Department of Justice to identify an increased number of cases for audit based on risk profiles. In France, for example, the prudential authority makes use of artificial intelligence and machine learning to understand risks. The prudential regulator could also provide guidance on how to manage anti-money laundering risks using artificial intelligence and machine learning, in much the same way it published guidance on the use of distributed ledger technologies and blockchain (CSSF, 2022[33]). In Hong Kong, case studies of “Reg-tech” solutions have been published to provide concrete examples to the market on how to tackle risks, including verifying customer identity and monitoring transactions (Ashurst, 2022[34]). Sharing information across financial institutions can also be a way to investigate risks, if privacy risks are appropriately managed. In Singapore, the monetary authorities have been working with six of the largest financial institutions to create a safe data platform to share information (Ashurst, 2022[34]).
Overall perceptions of corruption remain low in the country, with Luxembourg one of the best performers in the OECD (Figure 1.11) A constitutional amendment is underway to strengthen the independence of the judiciary from an already high standard. It seeks to introduce a council that will select magisterial candidates before they are appointed by the Grand Duke (European Commission, 2021[35]). Legal protection for whistle-blowers was strengthened with the transposition of the European Whistle-blowers Act. The framework to govern conflicts of interest could be strengthened through extending the current revolving doors policy beyond members of government (European Commission, 2021[35]) and the disclosure of assets and gifts (GRECO, 2020[36]).
Figure 1.11. Perceptions of corruption are low
Note: Panel B shows the point estimate and the margin of error. Panel D shows sector-based subcomponents of the “Control of Corruption” indicator by the Varieties of Democracy Project.
Source: Panel A: Transparency International; Panels B & C: World Bank, Worldwide Governance Indicators; Panel D: Varieties of Democracy Project, V-Dem Dataset v12.
Fiscal policy should be used to tackle long-term challenges
Significant fiscal policy support has been provided, but debt remains low
Policy support during the coronavirus crisis was substantial, mainly thanks to a sharp increase in spending (Figure 1.12, panel A). Nonetheless, the rise in total debt was markedly less than in most OECD peers (Figure 1.12, panel B) and well below the 8.5 percentage points increase in debt following the global financial crisis. This is mainly due to the resilience of tax revenues and economic growth during the COVID-19 pandemic.
The impact of the war in Ukraine accounts for most of the increase in support in 2022, offsetting the withdrawal of COVID-19 related measures. The budget deficit, according to the government’s latest estimates (Ministère des Finances, 2022[37]), will gradually return to balance by 2026. In the context of rising but still very low real interest rates, tight labour markets and rising inflation, fiscal policy support should be highly targeted to the most vulnerable, to avoid contributing to cyclical inflationary pressures.
Figure 1.12. Debt levels remained contained despite a strong policy response to the COVID-19 crisis
Source: OECD Government at a Glance (database) OECD calculations.
The largest risk to the long-run debt outlook remains pension spending. Luxembourg’s very low current levels of gross debt as well as sizeable public assets will provide an important buffer. Total public assets stand at over 80% of GDP, reflecting both large numbers of state-owned companies in key utilities, as well as sizable holdings in certain private companies. Over the longer term, however, spending pressures related to ageing will reduce fiscal flexibility in the face of shocks (Figure 1.13). The draw-down of pension assets between 2030 and 2050 will help to offset rising pension costs, but once these assets are sold, pension liabilities are projected to rise steeply in the absence of meaningful pension reform.
Even a significantly higher rate of growth would require difficult fiscal choices to keep pension liabilities in check. The recent report assessing the pensions system showed employment growth of 2.7% is required alongside a reduction of an adjustment to real wages of benefits, in order for the system to be sustainable over the long term (IGSS, 2022[38]). STATEC’s 3% long-term growth scenario (Haas and Peltier, 2017[39]) projects employment growth of 0.7% per annum, with 50% of the workforce as cross-border workers. Employment growth of nearly 3% would imply a substantial increase in growth and demand for housing, transport, and energy, which would further compound the challenges of the green transition. Therefore, pension system reform is crucial for economic resilience.
Figure 1.13. Ageing is the largest long-term fiscal risk and cannot be solved with growth alone
Gross public debt, Maastricht definition, % of GDP
Note: The scenario with no ageing related reforms includes the impact of projected rising net public pensions, long-term care and health costs, consistent with European Commission estimates, which add 8.6 percentage points of GDP to annual government spending in 2060. The drawing down on pension fund reserves from 2027, reflected by the decline in gross financial assets, helps fund pension spending increases until the late 2040s, when pension reserves reach zero. Non-pensions gross financial assets grow at 0.61% per annum throughout the forecast, the average annual return over 2000-20. Pensions reforms including raising contribution rates, raising early retirement to 62 years, linking retirement to life expectancy, increasing migration by 33% and raising the employment rate of older workers by 10 percentage points. The structural reforms scenario assumes real GDP growth is 1 percentage point higher each year compared to the baseline due to structural reform implementation. The costs of the green transition are based on achieving a range of targets set by the government. This list is non-exhaustive and subject to significant uncertainty, including the pace of the transition and the costs of financing, and do not include any revenue effects from the transition.
Source: Adapted from OECD (2021) Economic Outlook: Statistics and Projections (database); and Long-term baseline projections; (European Commission, 2021[8])
The challenges of the green transition will also need to be accommodated. The government has already undertaken a number of measures to encourage greater energy efficiency, including in response to the energy crisis. Direct investments and subsidies to support the green transition investments will require sustained spending commitments, in addition to private investment. The rate at which spending rises will vary according to the price of carbon, the generosity of subsidies as well as take-up rates. Forecasting the direction of revenues from the transition is less certain. The potential revenue gains or losses from a carbon tax, and how they might be used, will depend on various factors, including the chosen level of carbon tax and how neighbouring countries’ fuel pricing will evolve (see Chapter 2). Table 1.7 highlights potential net fiscal implications of the green transition at -0.35% of GDP annually over the medium term. The uncertainty of this estimate increases over the long term, as levels of uptake on subsidies and infrastructure spending plans evolve.
The green transition could also have significant growth implications for Luxembourg. Chapter 2 presents a modelling exercise which suggests the economic impact of a rising carbon tax on the economy would be slightly positive if carbon tax revenues were positive and redistributed. However, there are also downside risks – for example, a disorderly global green transition could have knock-on effects on the Luxembourgish economy, substantially lowering long-term growth. Given the uncertainty of the green transition’s fiscal impact, integrating it into the budget framework would allow for a holistic approach to public debates regarding other long-term spending commitments such as pensions. Chapter 2 recommends enhancements to the fiscal framework to take these considerations into account.
Box 1.1. Quantification of the structural reforms recommended in this Survey
This box shows the results of quantifying the effect of some of the structural reform measures proposed for Luxembourg in this Survey, based on an OECD quantification framework (Égert and Gal, 2017[40]; Guillemette and Turner, 2021[10]). The effects are derived from a series of reduced-form regressions on a sample of OECD countries (in some samples, non-OECD countries are included as well). The estimated results are allowed to vary across countries because of differences in factor shares, the level of employment by age group, and a country’s demographic composition. The approach is meant to serve as an illustration of a potential impact of reform and is not a projection. Therefore, it should be treated with care.
Additional positive effects could be expected from other recommendations, notably to reduce friction in the labour market and improvements to the business environment, but these are harder to quantify. Examples include a reform to the insolvency regime, streamlining of the administrative burden for firms and broader measures to reduce financial risks (which would have the effect of reducing the frequency and severity of financial crises, and therefore the associated economic risks).
Table 1.5. Illustrative impact of structural reforms on GDP per capita
Effect on GDP per capita levels*
Note: Calculations are based on (1) a reduction in the OECD Product Market Regulations sub-indicator of professional services regulations to the average of the best-performing (i.e. less restrictive) OECD countries, which corresponds to lowering the overall PMR indicator from 1.68 to 1.33; (2) increasing ALMP spending as a share of GDP by 0.1pps of GDP to approach the top-third of OECD countries (from 0.75% of GDP to 0.80% of GDP); which corresponds to increase spending per unemployed as a ratio of GDP per capita from 27% to 30%; (3) increasing capital deepening by increasing business spending on R&D from 54% of total spending to 62% (against an OECD average of 64%); and (4), increase the legal retirement age by 2 years, gradually phased in over a five-year period, with policies to limit early retirement. * Projected increases in GDP per capital levels. ** Improving ALMP increases multifactor productivity as well as the employment rate, both of which will lift GDP per capita over time.
Source: OECD calculations based on (Égert and Gal, 2017[40]).
Table 1.6. Growth impact of pension reform
Expected growth effect on the variables after increasing the effective retirement age by 2 years
Source: OECD calculations based on (Guillemette and Turner, 2021[41]).
The fiscal framework’s resilience to shocks can be increased
The fiscal framework could be enhanced to improve resilience in the face of more frequent shocks. Economies are exposed to a rising number of physical shocks (Centre for Research on the Epidemiology of Disasters, 2022[42]) (Figure 1.14), whilst the COVID-19 outbreak highlighted how interconnectedness increases the likelihood of pandemics (Marani et al., 2021[43]); (Smith et al., 2014[44]). Russia’s war of aggression against Ukraine has ushered in a period of heightened geopolitical uncertainty. At the same time, expectations have risen that policy makers can and should play a significant role in absorbing these shocks, acting as a lender of last resort and protecting the most vulnerable (Office for Budget Responsibility, 2021[45]).
Having a range of policy tools in place contributes to resilience. Automatic stabilisers and fiscal rules are crucial to allow governments to respond quickly to crises (Orszag, Rubin and Stiglitz, 2021[46]). Luxembourg’s low level of public debt is its principal fiscal shock absorber, and the government has committed to keeping public debt levels below 30% of GDP. The size of the automatic stabilisers, which are important to absorb immediate shock impacts, are estimated to be in line with that in peers (Maravalle and Rawdanowicz, 2020[47]) or slightly larger (Bouabdallah et al., 2020[48]). Discretionary spending policies are necessary when the impact of the shock is expected to be persistent (Bouabdallah et al., 2020[48]). If the shock is permanent, automatic stabilisers may no longer work as effectively as before because the structure of the economy has changed. In addition, specific policies may be required to address fundamental shifts in behaviour or prices that are not affected by existing automatic stabilisers. In this instance, governments should prioritise high-impact programmes for long-term resilience (OECD, 2021[49]).
The identification of high-impact policies can be difficult. In Luxembourg as elsewhere, evaluation of the impact of policy choices has been insufficient – for example, spending reviews have not been used since they were applied to achieve significant budget cuts in 2014. Budget documentation does not systematically reference performance information or evaluations. Even though periodic ex-post evaluations of regulations have been undertaken in Luxembourg, they are not a consistently applied tool (OECD, 2021[50]). The OECD and the European Commission (OECD and European Commission, 2020[51]) noted that a missing culture of evidence-based policy making may result in insufficient investments in human and financial resources to adequately draw on administrative data in the development of policies.
An evaluation framework, including a clear methodology, could help to ensure that regulations remain fit for purpose – and that associated spending is appropriate. A system to link rigorous policy evaluation directly to the budget allocation process would significantly improve the capacity of the fiscal framework to respond to shocks and their aftermath. A large crisis can have a lasting impact on the composition of spending that outweighs the impact of traditional budget planning choices (Figure 1.14, panel B). Greater input from the independent fiscal institution on the quality of spending and its overall growth impact could stimulate greater debate on policy choices, if its mandate were expanded.
Advances in information technology could be used more proactively in Luxembourg to support a performance-oriented budget (see Box 1.3). Notably, a clear policy commitment to open and transparent data evaluation should help motivate additional funding. Anonymised social security data are already provided to public researchers via the Luxembourg Microdata Platform on Labour and Social Protection and were a valuable source of information for understanding the impact of COVID-19. Luxembourg’s high quality administrative data could be anonymised and made available to the broader research community. Digitised tax data could allow for more granular impact evaluations. The project to evaluate COVID-19 policy responses (OCDE, 2022[10]) has linked firm-level and administrative data, which can be used to monitor on an ongoing basis where policy support is being directed. Including additional policy measures will develop a credible evidence base, which can be used to inform the design of spending programmes further into the future.
Figure 1.14. Shocks are becoming more frequent – and can have a lasting impact on spending choices
1. Change in spending from the COVID-19 shock is calculated as the difference between the 2022 and 2019 budget projections for 2022 spending. Despite the relatively small changes, the projected increases for investment spending and social spending are sizable, as per OECD and EC recommendations to provide ongoing social support from the crisis. Investment spending will grow 6.5% a year, reaching 4.7% of GDP by 2025.
Source: OECD calculations based on the Emergency Events Database (Centre for Research on the Epidemiology of Disasters, 2022[42]); and Ministère des Finances (2021, 2018).
Box 1.2. Estimated fiscal impact of reform
The table illustrates the potential impact on the fiscal balance of implementing some of the reforms proposed in this study. The estimates are meant to show the potential direction of change and to provide an indication of magnitude. Actual results may differ, and the estimates below are merely illustrative.
Table 1.7. Fiscal implications of reform
Medium-term expected annual change as a % share of GDP
Notes: 1. STATEC near-term estimates for an increase in carbon tax to EUR 30 per tonne by 2023. Preliminary modelling estimates that consider the direct impact of the carbon tax on revenue suggest a 0.05% decline in revenue in 2025, assuming a carbon tax of EUR 50 per tonne by that time. Over the longer term, revenue receipts are expected to rise (see chapter 2, Box 2.3 for more details). 2. Based on surcharge of 5 cents per km and 20% reduction in car use for travel. Only work-related travel included. 3. Assumes 8 400 homes a year renovated receiving EUR 25 000 a home. 4. Increased infrastructure provisioning to cover the cost of higher maintenance and potential upgrades to e.g. hydrogen fuelling. 5. Assumes current municipal tax rates apply to 8% of the existing residential buildings and 1 115 hectares of vacant land. 6. Most pension gains accrue later (see Table 1.5 and Table 1.6). 7. Assumes poorest 40% of households receive the equivalent of a 2.5% wage increase every 15 months. 8. Increase total ALMP spending towards the top 10 OECD performers.
Source: OECD calculations.
Box 1.3. Key elements to consider in designing a more performance-oriented budget framework
A strategic link with the budget. In Chile, the budget law requires evaluations to be considered in the budget process, whilst in Canada, ministries are encouraged to present evidence from evaluations as part of their budget submissions.
A prioritised and planned process. Continuous evaluation should give priority to high value, high risk and politically important programmes. Rather than a fixed schedule, Canada’s policy for results prioritises evaluations based on a schedule of risk and other considerations. In the Netherlands, performance information is only selectively presented in the budget, which has increased its relevance. Clarity about the schedule of evaluations also helps stakeholders to prepare for engagements - which is a practice rarely implemented in Luxembourg.
Supporting co-operation alongside accountability. Policy evaluation can become a tick-box exercise, when strategy is sacrificed for completeness; it can also become a compliance tool rather than an instrument for identifying the best tools to use. In Canada, line ministries are responsible for prioritising and undertaking the evaluation of programmes and individual projects. All findings must be made public, and ministries must also explain why they are not evaluating certain programmes. The Treasury Board may also independently evaluate programmes. In the Netherlands, the budget system’s performance metrics have been decoupled from the audit process.
An evolutionary approach. The implementation of an evaluation framework involves multiple stakeholders and takes time to implement successfully. In the Netherlands, the performance budgeting system has been evolving since 2008. In addition, generally, evaluations require time for data collection and for policies to impact policy. Australia conducts post-implementation reviews two to five years after policy implementation.
Administrative datasets in the public sector offer a significant opportunity for policy impact assessments, particularly when combined across sources. Tapping this potential requires a strong commitment to preserve confidentiality and anonymity, a well-documented and understood process for combining and analysing administrative datasets, and a secure way of sharing information with external researchers and institutions. In Luxembourg, the General Inspectorate for Social Security has developed state-of-the-art protocols for sharing anonymised social security data, in line with the general data protection regulation, which could be used for other administrative datasets. A single entity responsible for pooling administrative data together is a significant benefit. In Norway, Statistics Norway matches numerous administrative datasets and provides this anonymised and encrypted data to external institutions and researchers.
In Luxembourg, a pilot programme focused on a limited set of policy goals, such as understanding the impact of policies on the green transition (see chapter 2) or on well-being, could be applied to a small set of high-impact, high-value policy programmes as a mechanism to develop the system in practice.
Source: (Barth, 2012[52]); (Budding, Faber and Vosselman, 2019[53]); (de Jong, 2016[54]); (OECD and European Commission, 2020[51]); (OECD, 2018[55]); (OECD, 2020[56]); (OECD, 2021[50]).
Ageing costs from pensions are the largest long-term fiscal liability
OECD projections indicate that pension and health expenditure will increase fiscal pressure significantly by 2060 (Guillemette and Turner, 2021[41]). European Commission projections show a similar trend, with total age-related expenditure projected to rise from 16.9% of GDP in 2019 to 27.3% of GDP in 2070, with the bulk of the increase due to old-age pensions (European Commission, 2021[8]). By 2070, the European Commission projects pension expenditures alone to rise to 18% of GDP, the steepest increase in the European Union (Figure 1.15) (European Commission, 2021[8]), as the old-age dependency ratio will more than double by 2070 (Table 1.8). Domestic projections point to a more contained, but still high, increase in pension expenditure to 14.5% of GDP, based on more favourable assumptions on employment and economic growth related to cross-border workers and levels of immigration (IGSS, 2021[57]).
Reform of the pension system is needed to ensure financial sustainability
The government has undertaken the ten-year review of the sustainability of the pension system foreseen in the 2012 pension reform (see Box 1.4) to assess whether the current total contribution rate of 24% should be revised for the next ten-year coverage period 2023-2032 (IGSS, 2021[57]). An interim review in 2016 recommended no changes. The review provides an important opportunity for new reforms to ensure the pension system’s financial sustainability whilst having positive impacts on the labour market. In the near term, the pension system enjoys a surplus of contributions over outlays, thanks to favourable labour market dynamics (IGSS, 2022[38]). Surpluses are accumulated in the pension reserve fund (Fonds de Compensation) which stood at 37% of GDP by end-2020 (OECD, 2019[25]; IGSS, 2021[57]; European Commission, 2021[4]). But, if no changes are proposed, simulations indicate the system will move into deficit in the early 2030s, and the authorities will start using the pension reserve fund to make up for shortfalls; the reserve would be depleted in the late 2040s (IGSS, 2022[38]). Therefore, the authorities should explore all possible options, in consultation with social partners, to ensure the affordability of the pension system and enhance intergenerational equity.
Since the 2012 reform, a deficit in the ‘prime de répartition pure’-indicator, which measures the theoretical contribution rate needed to cover the system’s current expenditure, is expected to trigger a semi-automatic stabiliser: a reduction of the indexation of pensions to real-wage developments. However, this stabilisation mechanism will be insufficient to prevent the deficit from widening, in part because the large cohorts who moved to Luxembourg during the great economic expansion in the late 1980s and 1990s are set to start retiring from the early-to-mid 2020s boosting pension expenditure (IGSS, 2022[38]). Rather than waiting for the system to tip into deficit, corrective measures should be implemented sooner rather than later. For instance, the indexation of pensions to real wages could be put on hold until replacement rates reach more sustainable levels, whilst ensuring protection of the most vulnerable pensioners.
By delaying action, the size of any future adjustments is likely to be larger, implying that a heavier burden of the adjustment would fall on the contribution rate. Current estimates point to the contribution rate needing to increase to between 31% and 35% by 2070 from 24% currently, under the assumption of no change in policy (IGSS, 2022[38]). This in turn would strongly raise the tax wedge on labour, penalising lower-income and younger workers.
Box 1.4. Overview of Luxembourg's pension system
Luxembourg's general pension system is a mandatory, pay-as-you-go system, with defined benefits. The contribution rate is 24% of gross salary, paid in equal shares by employers, employees, and the state. Occupational pension schemes are a very small part of the total. Since 2019, they have been open to the self-employed. Fewer than 4% of workers have a private pension. There is a separate scheme for public employees.
The statutory retirement age is 65 years for men and women. Early retirement is possible at 57 if an individual has 40 contributory years, and from 60 onwards with 40 contributory and qualifying non-contributory years (e.g., study, or some unemployment), with at least 10 years of paid contributions.
The pension benefit is the sum of four components:
an income-related part with an annual accrual rate.
an incremental increase to the income-related part adjusted for years worked and one's age.
a lump-sum, which depends on the number of years of insurance.
an end-of-year allowance bonus. The end-of-year bonus (EUR 869.4 per year as of 1 April 2022) is paid only as long as the system is not in deficit.
Benefits are adjusted both for inflation, as part of the general inflation indexation of all wages and benefits, and for real-wage growth.
Rising concern of the financial sustainability of the system led to a reform in December 2012. The reform mainly changed the parameters of the pension benefit formula in order to incentivise people to work longer. It has a transition period of 40 years (2013-52) and left the retirement age unchanged.
Under the reform, the lump-sum benefit gradually rises (from 23.5% of the social reference income in 2012 to 28% in 2052), while the accruals rate is gradually reduced from 1.85% in 2012 to 1.6% in 2052. The age-related element increases gradually so that the sum of pension age and career years will have to be higher than 100 years in 2052 instead of 93 years in 2012 in order to obtain an increase in the accrual rate. For an individual entering the labour market at 22, this would kick in after 36 years working.
The 2012 reform added mandatory ten-year reviews of the system, as well as some stabilisers. In addition to the readjustment mechanism for real wages, the reserves accumulated in the pension fund must be at least 1.5 times the yearly pension expenditures. In 2020, Luxembourg’s pension reserves were around 4.8 times annual pension expenditure (some 37% of GDP).
The 2012 pension reform was a step in the right direction but still not enough to guarantee long-term sustainability. A number of more radical proposals, such as fully eliminating real-wage indexation, or a faster decrease of the accruals rate, were not passed, but should continue to be considered. By 2021, the projected rate of increase of pension expenditure by 2070 was still the highest anywhere in the European Union.
Moving to a fully-funded system, with defined contributions, as in Denmark or in the United Kingdom was debated in the 2000s. Such a switch would imply that current cohorts would continue to contribute to the pay-as-you-go system while also needing to contribute to their own pensions, raising the question of intergenerational fairness. These high costs would require substantial socio-economic reforms to be socially acceptable, as occurred in Denmark. As witnessed in countries that have successfully carried out pension reform, it requires a high degree of social consensus about the need and direction for reform to put pension schemes on a firmer footing and ensure that the new system is stable and sustainable. The search for consensus can lead to the watering down of required changes and it may be necessary to phase-in some reforms as those close to retirement have less time to adjust their situation to the new system. However, slow transition implies that the eventual adjustment will be somewhat more costly and carries the risk that reforms may be reversed.
Table 1.8. Ageing-related spending is projected to increase substantially
As a percentage of GDP unless otherwise indicated
Note: 1. AWG baseline scenario, 2. AWG Reference scenario. 3. Males.
Source: (European Commission, 2021[8]).
Figure 1.15. Luxembourg’s pension outlays will see the fastest increase among EU countries
Gross pensions, as % of GDP1
Note: 1. AWG baseline scenario 2019-2070.
Source: (European Commission, 2021[8]).
Three main levers can be used to limit the increase in pension expenditure: delaying the effective retirement age, reducing the generosity of the pension system, and increasing contribution periods. Tackling early withdrawal from the labour market should be the first action to raise the effective retirement age. The statutory retirement age is 65, about the OECD average, but the effective retirement age is stagnating at 60, one of the lowest in the OECD (Figure 1.16, panel A and C) (Gbohoui, 2019[63]; OECD, 2017[64]). A person aged 57 can retire early, provided they have 40 years’ worth of contributions, or at 60, with 40 years’ contributory and non-contributory periods (and a total of 120 months’ full contributions) (OECD, 2021[58]). Early retirement deprives the economy of an important skilled resource and increases the tax burden of future generations when pensioners currently enjoy a very high standard of living (Figure 1.16, panel B and D). Raising the effective retirement age from the labour market to 62 would lower the projected expenditure increase by at least 0.6%of GDP (Table 1.9).
Table 1.9. Potential impact of pension reform
Changes in pension expenditure as percentage point of GDP, in that year
Note: Linking the retirement age to increases in life expectancy would yield a decrease in pension expenditure of 1.6% of GDP by 2070, according to the AWG projections. Measures to increase the effective retirement age would extend the number of contribution years, which could add 0.6% of GDP to pension contributions. Delaying the entry of new pensioners would initially have less of an impact, but as the new pension cohorts grow larger, delaying entry by raising early retirement to 62 years, would increase the savings and reduce the length of pensionable years. Higher inward migration with an increase of 33% over the projection period, would lower pension expenditure by 1.1% of GDP. *Simple summation, unweighted. **Assuming a 4% annual return on the pension fund, and no draw-down on the fund after 2027.
Source: OECD calculations based on (European Commission, 2021[8]); (IGSS, 2022[38]); (IGSS, 2021[57]).
Several options could provide incentives to delay retirement. Luxembourg could increase the required contribution period before early retirement to at least 42 contributory years and reduce the possibility of taking early retirement before 62 unless in exceptional circumstances, e.g. for trades involving hard physical labour. Pension benefits should be reduced for early retirement, reflecting the longer duration of retirement. Within the OECD, only Luxembourg and Belgium do not impose such a penalty (OECD, 2021[65]). Actuarial adjustments should be applied to the benefits of those retiring early, as in Finland and Sweden. Conversely, most countries have a bonus for those who defer retirement, to compensate workers for the shorter time spent in retirement. These tend to be higher than any penalty for early retirement, with a maximum rate of 12% per year in Denmark (for a ten-year deferral). Only Luxembourg, along with Belgium, Colombia, France and Greece do not have such a bonus (OECD, 2021[65]), although the current pension parameters provide for a small actuarial incentive for longer careers (after approximately 36 years, for someone having entered the labour market at 22).
Figure 1.16. There is room to address key imbalances with a new pension reform
1. Average effective labour market exit age, unweighted average of men and women, (based on labour market participation rates)
2. Net replace rate is defined as individual net pension entitlement divided by net pre-retirement earnings, taking into account personal income taxes and social security contributions paid by workers and pensioners. It measures how effectively a pension system provides a retirement income to replace earnings, the main source of income before retirement. This indicator is measured in % of pre-retirement earnings.
3. Incentives for older people to continue working at an older age are captured by focusing on i) a combination of current retirement ages (men), ii) the gross replacement rates and iii) the impact on benefits when working and deferring pensions.
4. Net pension wealth is the present value of the flow of pension benefits, taking account of the taxes and social security contributions that retirees have to pay on their pensions. It is affected by life expectancy and by the age at which people take their pensions, as well by as indexation rules. This indicator is measured as a multiple of annual net earnings by gender.
Source: (OECD, 2019[66]), (OECD, 2019, p. 29[66]), Net pension wealth (indicator).
Ultimately, both the retirement age and thus the overall benefits paid out over the time spent in retirement should be linked to life expectancy, as noted in previous surveys (Table 1.10). Longer life expectancy should be reflected by raising statutory retirement ages, as this protects financial sustainability and supports intergenerational pension fairness. Finland adjusts both benefits levels and retirement ages to changes in life expectancy, supplemented by a balancing mechanism adjusting contribution rates if needed. While individually these reforms are unlikely to have a significant impact on keeping older workers in the workforce, the combined impact could be greater, and would make the system more affordable (Box 1.1, Table 1.5). To avoid that a delayed retirement age translates into higher unemployment of older people, pension reform should be coupled with efforts to increase opportunities for older workers in the labour market. Luxembourg should encourage longer and more satisfying careers through more flexibility in work-retirement transitions, including by promoting phased retirement, better balancing work and leisure, and easing taxation for those combining pensions with work income.
Beyond increasing the retirement age, there is room to reduce the pension generosity to support the sustainability of the system. Net pension wealth is the highest in the OECD, and replacement rates are close to 90% for average wages (Figure 1.16, B and D). At the same time, 10% of older people (65+) are classified as poor or vulnerable to poverty (compared with 18.5% in the European Union) (European Commission, 2021[4]). Reducing the replacement rate could support long-term sustainability of the system while targeted measures could support poorer pensioners. For example, the current end-of-year allowance, which is not linked to earnings, could be means-tested, or ceilings for high benefits could be considered. Pension policy measures to take account of socio-economic differences in life expectancy could be included in the benefit formula (granting higher accrual rates for low earnings, as applied in Portugal, or the contribution rates could increase for higher incomes, as in Brazil (OECD, 2019[66]). Reducing the current accruals rate at a faster pace than envisaged by the 2012 reforms, combined with an increase in the time required to contribute before benefiting from a full pension, from 40 to 42 years, reflecting longer life expectancy, would support sustainability while only gradually reducing replacement rates. Alternatively, contribution rates could increase with income, or include a higher wage ceiling for contributions for pension entitlements (as in Norway) (OECD, 2019[66]). The recent reform of the pension system in Portugal is an interesting example of a reform that tries to strike a balance between equity objectives and the need to sustain the long-term financial sustainability of public pensions (Box 1.5).
Box 1.5. Improving financial sustainability whilst offsetting inequalities: example from Portugal
Portugal has implemented several pension reforms since the mid-1990s to improve financial sustainability. These included increasing the period to calculate the reference wage; aligning the retirement age for women; linking the retirement age to life expectancy; reforming the minimum pensions; consolidating the scheme for civil servants with the general regime for private-sector workers; and formalising indexation rules. Following a 2014 reform, the statutory retirement age rises by two-thirds of life expectancy gains at 65, which aims to improve the financial sustainability of the pension system while keeping the ratio of adult working life to time spent in retirement roughly constant. In addition, people with very long careers can retire slightly earlier. A worker with a 43-year career can retire 1 year before the standard statutory retirement age. For someone who started working at age 20, this means that the retirement age in effect rises by half of life expectancy gains rather than two-thirds.
At the same time, higher accrual rates are granted for lower earnings, offsetting the pension disadvantage for low-income earners from lower life expectancy.
There are several advantages to this approach:
Linking the retirement age to life expectancy removes the need for recurring political debates every time pension parameters need to be adjusted to demographic realities.
The two-thirds increase maintains a broadly constant ratio of working life to life-in-retirement. This may be more acceptable than a one-to-one link of retirement ages to life expectancy.
The provision included for long careers represents a progressive element that is beneficial for economically disadvantaged groups, but which nevertheless maintains a link to life expectancy for everyone.
When designing pension reform, sustainability measures need to be included to account for ageing and longer life expectancies. These can be counter balanced by more progressivity in the pension system to make up for the reduction in low pensions that long-term sustainability may entail, to better share the burden across generations.
Source: (OECD, 2019[67]); (OECD, 2021[68]).
Table 1.10. Previous recommendations on pension reform
Health-care spending will rise only moderately
The ageing of the population will also increase spending on health and long-term care, but these are likely to be mostly well contained. Total health spending as a share of GDP is one of the lowest in the OECD, and the finances of the health system appear to be in good shape, while health outcomes are generally above the EU average. Between 2015 and 2019 health expenditure per capita rose by 1.5% a year in real terms, below the rate of economic expansion (OECD, 2021, p. 191[69]). This is quite remarkable and may be a result of the structure of Luxembourg’s labour market. Strong inflows of cross-border workers and immigrants over the past decade means that the population is comparatively young in relation to surrounding countries. Around 14.5% of the population was aged 65 and over in 2021, against 20.6% in the EU, meaning less demand on health services. Outpatient care accounts for 33% of total health spending. To contain health spending in the longer term, a greater focus on preventive care and policies where Luxembourg currently spends less than the EU average would help (OECD/European Union, 2020[70]). Specifically, this would involve more preventive action on lifestyle factors that could lead to rising healthcare costs in the longer term: alcohol consumption is among the highest in the OECD, while obesity among adolescents is high and has been rising steadily since 2006 (OECD, 2021[69]; OECD/European Observatory on Health Systems and Policies, 2021[6]).
The cost of long-term care is expected to more than double by 2070
Projections from the European Union Ageing Working Group (AWG) point to long-term care as the fastest-expanding old-age related sector for Luxembourg (European Commission, 2021[8]). The AWG and researchers at the Central Bank of Luxembourg both project public expenditure to rise from 0.7% of GDP in 2020 to 2.5% of GDP in 2070 (European Commission, 2021[8]; Giordana and Pi Alperin, 2022[71]). Life expectancy at 65 is currently around 20 years (slightly more for women), but only 10 of these (50%) are expected to be healthy life-years, defined as the number of years spent without activity limitation, below the OECD average of 51.5% (OECD, 2021[69]). All citizens with health insurance are also entitled to long-term nursing care, whether in an institution or at home. In 2019, 12.7% of adults aged 65 and over received long-term care in Luxembourg, above the OECD average of 10.7%. Of these, 58% do so in their own home, below the OECD average of 68%. Luxembourg has the highest number of long-term care beds in institutions and hospitals per inhabitant in the OECD (81.6 per 1000 inhabitants, against 46.6 for the OECD). The many long-term care beds in institutions suggests there is room to develop further nursing care at home, which is cheaper than institutionalised care and often preferred by the elderly. This would also contribute to improve the access to medical care for people living with limitations in activities, who reported a higher share of unmet long-term care needs (OECD, 2021[69]).
A higher supply of labour and lifelong learning are required for sustained growth
Domestic labour supply remains limited by the small population size, while labour demand is rising fast owing to the dynamism of the economy, creating tensions in the labour market. Those tensions are compounded by skills shortages and mismatches, and frictions related to inter alia the need to master one or more of Luxembourg’s three official languages (BCL, 2022[86]; Lawson, 2010[98]). In the longer term, labour demand by firms is expected to grow by nearly 2% per year (Figure 1.17), while Luxembourg’s population is set to increase by only 0.7% each year (European Commission, 2021[8]). Reducing labour market tensions will thus require an increasing supply of workers, partly by using available resources better, notably older workers, the young and the unemployed, but also by attracting more migrants, including non-EU nationals. This, in turn, means further facilitating their arrival and integration (OECD, 2017[64]; OECD, 2021[72]).
Figure 1.17. Labour demand will remain strong in Luxembourg
Percentage employment growth in Luxembourg and in the EU-27 past and projected
Note: Data from 2022-2030 is a forecast.
Source: Cedefop, 2020 Skills Forecast (database).
Augmenting labour participation of older workers will be required to increase supply
Luxembourg has one of the lowest rates of labour force participation for older workers (45%) in the OECD (Figure 1.18), largely due to early exit from the workforce. In the period 2013-18, one-quarter of men retired at 54 or younger in Luxembourg, mainly lower-skilled workers (OECD, 2019, p. 42[66]) (Figure 1.19). In addition, relatively low participation rates by the 20-24 year-olds contribute to lowering the overall labour supply. Low levels of domestic labour force participation increase the number of additional, foreign workers required for economic growth, which in turn increases demand for housing and energy for a given level of output. To increase the supply of older workers, the statutory retirement age should be increased while avenues for early retirement should be further restricted unless for exceptional circumstances as discussed above.
Figure 1.18. Low participation rates of older workers are limiting labour supply
Source: OECD (2022), Labour force participation rate (indicator).
Figure 1.19. A large share of workers that retire, do so well-before the age of 65
Age below which 25% of older retirees left the workforce, 2018
Note: The effective retirement age refers to the weighted average age of labour market exit for persons who were in the labour force in 2013 and aged 40 and over but no longer in the labour force in 2018.
Source: OECD calculations based on the average effective age of retirement dataset (unpublished).
Keeping older workers in the labour market requires improving their employability, enhancing their incentives to work and a greater openness from employers to hire older people. Countries that perform well in those three dimensions have better labour market outcomes for older people (OECD, 2019[66]). Workers above 55 need to receive better training to increase their employability in growth sectors in Luxembourg (Cedefop, 2020[73]), which will also support long-term productivity growth (OECD, 2021[74]). Though around 28% of 55-64 olds in Luxembourg have tertiary education, above the OECD average (OECD, 2018[75]), older workers are still predominantly lower skilled than younger cohorts, and their skills may not match the requirements of rising digitalisation (European Commission, 2021[76]; Cedefop, 2020[73]; Eurofound, 2017[77]). Nearly 70% of over-55s indicated that older job applicants may be at a disadvantage when looking for a new job (OECD, 2019[66]).
To support older workers’ employability, the national employment agency, ADEM, could actively encourage employers to train older workers, by actively subsidising on-the-job training. To optimise the effect, this should be coupled with, on the one hand, measures to limit the possibility to take early retirement, and on the other hand, higher rates of co-financing training for older workers, for instance, as part of the Skills-Plang programme that was launched in late June 2022. In Germany, the public employment agency supports training of low-skilled and older workers in SMEs through a 75% subsidy to the training costs of workers aged 45 and older, while micro-enterprises (with fewer than 10 employees) receive a 100% subsidy (WeGebAU programme). This has helped participants to increase their time spent in employment (OECD, 2019[66]). Luxembourg could also more pro-actively invest in improving digital skills of older workers and prepare them for new forms of work. Germany implemented a programme to help SMEs develop management strategies with a particular focus on training measures to help workers prepare and adapt to the digital economy (UnternehmensWert Mensch). The programme subsidises consultancy services for SMEs for up to between 50% and 80% of these costs (OECD, 2019[66]).
In the OECD, Luxembourg scores very poorly on providing sufficient incentives and opportunities for older workers to remain in the workforce (OECD, 2019[66]). It also performs poorly in enticing employers to hire older workers. Luxembourg could encourage individuals to work longer by allowing phased retirement, which is currently not possible. Australia provides so-called Transition-To-Retirement Pensions (TRIPs) that let workers move from full-time to part-time work and complement their earnings with pension (superannuation) entitlements (OECD, 2019[66]).
Luxembourg should also further address barriers to hiring older workers, including issues of age-discrimination. In the Netherlands jobs adverts are scrutinised for references to age (OECD, 2019[66]). In France, job seekers applying through the national employment service (Pôle emploi) are selected for employer interviews based on aptitude tests and without regard to age or previously held employment (OECD, 2019[66]). Luxembourg already has in place a scheme that subsidises the employment of workers above 45 years of age by reimbursing the employers’ social security contributions. A recent study found however that the scheme, costing the state EUR 27 million annually, has had relatively little take-up by qualified firms (Marguerit and Nguyen-Thi, 2022[78]). Although the scheme is not new, employers may need more awareness-building about the scheme, and in particular about the benefits of hiring older workers. ADEM is working on an action plan for workers aged 45 and over, which includes more communication about its benefits. Additional monetary incentives such as short-term tax credits could also be used, as in Sweden, or direct government-contributions to salary costs.
Attracting non-EU foreign workers to help fill vacancies
As a small, open economy, Luxembourg relies heavily on foreigners. Employment growth has consistently been supported by high levels of net immigration and cross-border workers (Figure 1.20). In the long term, the EU population will decline, and Luxembourg should aim to attract more non-EU nationals (European Commission, 2021[8]). To continue to attract foreign workers, Luxembourg needs to remain an attractive place to live and work (Cedefop, 2020[73]). However, Luxembourg is the third-most expensive country to live in, after Denmark and Ireland, in the European Union, based on household consumption expenditure, and excluding rental costs (and still the sixth-most expensive country, after the EEA countries, Switzerland, Iceland and Norway, are added) (Eurostat, 2022[79]).
The EU Blue Card visa scheme for highly qualified workers has failed to attract a sufficiently large number of the higher skilled workers required in particular for the green and digital transformation (OECD, 2021[80]). A 2021 EU Directive will harmonise the conditions of entry and residence for high-skilled workers in the EU as recommended by the OECD (Lecerf, 2017[81]; European Council, 2021[82]). However, as in most other OECD countries, Luxembourg enforces its own working permit conditions for non-EU nationals with lower qualifications, assessing whether a particular job could be performed by a job-seeker available on the national labour market, before allowing to fill the existing vacancy with a foreign worker. These remain cumbersome and expensive for prospective employers. Examples include the requirement to offer at least between 1.2 and 1.5 times the average salary for higher-skilled workers and requiring the employer to sign a contract before the prospective worker has obtained a residence permit, while the worker can only obtain the permit once the contract is signed.
Luxembourg should therefore implement additional measures to receive and integrate migrants, including non-EU nationals, as recommended in the 2015 and 2017 Economic Surveys (OECD, 2015[83]; OECD, 2017[64]). Recently, further steps to integrate non-EU nationals have been taken, for instance, allowing voting in municipal elections, without the five-year prerequisite residence, since July 2022. Adding more professions to the accepted EU Blue Card occupations list and lowering the conditions that impose higher salaries for non-EU workers, would support a higher intake of highly skilled non-EU nationals, as also recommended in the 2017 Economic Survey (OECD, 2017[84]). Elaborating a shortage-occupation list both for lower-skilled and higher-skilled jobs may also be an option. The preparation of this list should involve a dialogue between national authorities responsible for migration policies, sectoral representatives facing the shortages, and the public employment service (ADEM), as the vacancy data provider (OECD, 2022[85]), and should be updated every quarter. More intensive language training would also help the integration of foreign nationals living in Luxembourg, such as the Words4Work programme, but also for children of immigrants, to enhance their integration and future job prospects (OECD, 2021[72]). Immigrant workers could help fill current job vacancies, provided the language requirements were relaxed in some occupations, such as the care sector. Communication could be facilitated by making better use of digital tools, such as hand-held translation software, notably in the care sector or service activities such as cleaning.
Figure 1.20. Net migration is the main contributor to population growth
Note: Net immigration includes EU and non-EU nationals.
Source: STATEC, with OECD calculations.
The quality of the labour supply can be improved with more training and active participation of the unemployed and women
Better training of the unemployed is needed to help increase the quality of the available workforce (Cedefop, 2020[73]). Unemployment in Luxembourg affects in particular the low-skilled and older workers (Figure 1.21, panel B) and long-term unemployment is particularly high for the age-group between 45 and 60 (Figure 1.21, Panel A). The national employment agency, ADEM, has several active labour market policies (ALMPs). Official data indicate that around two-thirds of the registered unemployed participate in them, but many of the ALMP remain short-term activation schemes, such as public works, that do not lead to permanent employment (OECD, 2015[83]; Lawson, 2010[86]). Luxembourg also spends less than the best performers on active labour market policies (ALMP), at 1.28% of GDP, compared with nearly 3% for countries such as Denmark or Australia (and only 0.74% of GDP when unemployment benefits are removed, compared with around 2% of GDP for Denmark and Australia on active policies, such as training). Luxembourg’s ALMP need to receive more funding. Raising spending on ALMP, especially for training, could also support productivity growth (see also Box 1.1 for estimates of reform impact).
The reactivation programmes could have a larger uptake. Some of the training schemes on offer in Luxembourg are only partially funded and administratively heavy, requiring multiple supporting documents and justifications, which is likely to deter those that need the training the most (ADEM, 2022[87]). A new training programme, Future Skills, which teaches soft skills such as digital skills and management skills, was initially aimed at the public sectors and requires speaking French. A requirement to speak Luxembourgish was dropped (Ministère des Finances, 2021[88]; OECD, 2021[89]). Schemes that teach soft skills are welcome and should be extended across the private sector with appropriate incentives for employers to hire the trainees. A new programme, Skills-Plang, presented in late June 2022, is an extension of the Future Skills programme, and aims at reskilling and upskilling, but still requires French. For success it is important that access to skills programmes is not systematically conditioned on language requirements.
Figure 1.21. Long-term unemployment affects older, low-skilled workers in particular
Source: ADEM, OECD Calculations.
The green and digital transitions will induce changes in the labour market, as discussed in Chapter 2. Labour needs will become much more skills-intensive (IMF, 2022[90]). Hence, Luxembourg should also focus attention on workers at risk of displacement (Conseil national de la productivité, 2021[91]). Luxembourg should take pre-emptive action to direct workers to those sectors where their skills are still needed or can be upgraded at minimal cost. France has a training subsidy that was originally developed for firms undergoing structural changes. The Fonds national de l’Emploi-Formation fully covers training costs (OECD, 2020[92]) and the government compensates workers for 84% of the gross wage but 100% if they participate in training. France also introduced Transitions Collectives in January 2021 to provide funding for the re‑training of workers at risk of redundancy during the pandemic; fully covering training costs for small and medium‑sized enterprises (and partially for larger firms). Such measures help to pre‑empt potential disengagement from the labour market for workers in firms that are struggling to adapt (OECD, 2021[93]).
Young workers represent an important potential source of labour. However, young people continue to suffer from high unemployment, which at 17.3% remains well above the OECD rate (Figure 1.22), and above the 3% unemployment rate for 25-54-year-olds in Luxembourg. The comparatively high rate of secondary school dropouts (8.2%), which remains below the European Union target of 9%, reduces the employment chances of the youth. The National Youth Service (Service national de la jeunesse) is actively involved in helping reorient young people who have left school. Leaving school before completing secondary education is partly related to the practice of grade repetition (60.9% of early-school leavers have accumulated a school delay of at least two years) (MENJE, 2022[94]). Moreover, 55% of early-school leavers are of immigrant background, although they represent fewer than one-third of pupils (OECD, 2021[72]). Children of immigrants are less well integrated, which is linked to the strong emphasis on the need to master Luxembourg's three languages during schooling, which leads to dropping off the ladder: around 25% of 15-34-year-old second-generation immigrants are neither in education, employment or training (OECD, 2021[72]). As highlighted in previous Economic Surveys, Luxembourg should reduce the use of repeating school years (OECD, 2017[64]). The fact that students are oriented towards vocational training at a very young age, also narrows opportunities (OECD, 2016[95]). Rather, the first part of secondary education should be reformed to offer a more general and broad-based education and avoid too early selection (OECD, 2019[96]). More generally, to address early leaving from education and training, the OECD (OECD, 2022[97]) recommends:
developing early warning systems to identify students at risk of early leaving.
implementing preventive measures and targeted interventions for young people and their families.
promoting accessibility of second chance and alternative education to help early leavers re-enter education.
making flexible pathways accessible to effectively retain young people in education or training.
A bill submitted to parliament in March 2022 will extend compulsory education by two additional years, to the age of 18, and promote access to second chances, which it is hoped will help reduce the rate of school drop-out. It would be important to actively monitor the impact of these legal changes and follow up with further adjustments if needed.
Figure 1.22. Despite strong growth, unemployment remains high for the young
Unemployment rate, 15-24, Q4 2021
Source: OECD Short-term Labour Market Statistics.
Figure 1.23. Female participation rates outstrip the OECD average but remain below those of men
Labour force participation rate, % of population, 25-64
Source: OECD Labour Force Statistics.
Female labour force participation should still be encouraged. Participation rates have increased significantly but remain below those of men (Figure 1.23). The government has implemented several measures to help facilitate women’s return to the labour market after childbirth, including 20 hours’ free provision of childcare per week. Paternal leave, which can also support working mothers, is however limited to ten days after the birth of the child, compared with 30 days in Lithuania, or six months in Denmark and Iceland where 12 months statutory maternity leave is evenly split between the mother and the father (with six weeks transferable between parents). Luxembourg does have in place a scheme of parental leave which can be taken by both mothers and fathers, when the child is older, but before the age of six. Pre-school (nursery school) is now compulsory from the age of four (and available from the age of three). To ensure better equality of opportunity, affordable and good-quality childcare should be made available on a means-tested basis, including during school holidays. The authorities have also made more efforts to make taxation gender neutral. Since 2018, there is an option to be taxed individually for both resident and cross-border married or co-habiting workers. This reduces the marginal taxation of second earners, increasing their work incentives. Since second earners tend to be women, sometimes working part-time, individual taxation is also welcome from a gender neutrality and inclusion perspective. The authorities are still analysing the feasibility of full individual taxation, which would be welcome as it would likely reinforce the impact on work decisions (OECD, 2017[64]; OECD, 2019[25]).
Lifelong learning will be important to ensure skills adapt to changing needs
Luxembourg will need workers who can adapt to the future needs of the labour market (OECD, 2018[75]; Cedefop, 2020[73]; OECD, 2022[85]). The European Centre for the Development of Vocational Training (Cedefop) forecasts that about 50% of all job openings between 2020 and 2030 will be highly qualified positions, and fewer than 10% will be low-skilled (Cedefop, 2020[73]). In particular, occupations such as financial and administration professionals, ICT professionals, medical doctors and technical and logistic engineers are in short support and projected to remain so (Cedefop, 2020[73]). Meeting these needs implies continued efforts to reskill and upskill the workforce, particularly over the long-term as the workforce ages and working lives will need to be extended (OECD, 2016[95]; OECD, 2017[64]; OECD, 2022[85]).
Skills-mismatches as much as skills-shortages weigh on productivity growth and innovation (OECD, 2021[74]; BCL, 2022[98]; OECD, 2017[84]; McGowan and Andrews, 2015[99]). Skills mismatches are consistently reported as a reason holding back growth by company managers (Conseil national de la productivité, 2021[91]; OECD, 2022[85]; BCL, 2022[98]). About 40% of Luxembourg’s CEOs in one survey identified the availability of skills as a threat to their growth prospects (Hauret and Marguerit, 2020[100]; OECD, 2022[85]). 46% of Luxembourg resident workers report that their skills do not match those required for their occupations. As trends such as advances in ICT and artificial intelligence change the demands of the labour market and the skills needed for workers to succeed, people need to rely even more on their ability to “learn to learn” throughout their life (OECD, 2017[101]). The pandemic accelerated the digital transformation and digital skills needs (OECD, 2019[96]; OECD, 2021[89]).
The Luxembourgish authorities are taking steps to improve adult education and vocational training, as mentioned in previous surveys (Table 1.11). 16% of adults participated in education or training in Luxembourg in 2020, above the EU average but still well below the best performers (Figure 1.24). Efforts by the Ministry of Education to enhance digital education are welcome, and should bolster current efforts to provide adult learning and on-the-job training, as noted previously (OECD, 2019[25]; OECD, 2021[74]; OECD, 2015[83]; Lawson, 2010[86]). The lifelong learning programme being implemented as part of the Recovery and Resilience plan goes in the right direction (Ministère des Finances, 2021[88]). Recent evidence indicates that to meet its skills needs and improve the accessibility of adult learning opportunities, Luxembourg should develop a long-term strategy for adult learning, with clear goals and implementation measures; and establish an adult learning quality-assurance agency, similar to the quality assurance system, which exists in France. This includes setting minimum standards to accredit new training providers, as well as regular audits, and evaluations of existing providers (OECD, 2022[85]). In addition, in January 2022, the Ministry of Labour and ADEM presented seven sectoral studies that aim to prepare for future skills needs, by analysing trends in future professions and anticipating skills gaps (Table 1.11). Such initiatives are welcome but need to be followed up with impact assessments. Luxembourg has not taken part in the recent PISA and PIIAC exercises while new programmes are being rolled out.
Figure 1.24. Luxembourg performs relatively well in terms of adult education and training
Participation rate in formal and non-formal education and training in last 4 weeks, % of persons aged 25-64, 2021
Source: Eurostat Adult learning statistics.
Table 1.11. Previous recommendations to improve the labour market outcomes
Faster productivity growth is critical for long-term resilience and economic diversification
Luxembourg enjoys high levels of labour productivity compared with other OECD countries, but productivity growth has been stagnating for the past decade (Figure 1.25) (Conseil national de la productivité, 2020[102]). Productivity gains are needed to maintain high living standards and well-being in the context of an ageing population. Between 2010 and 2019, Luxembourg’s economic growth was mainly sustained through high employment growth, which was the strongest within the OECD. The contribution from the productive capital stock and capital quality were more modest, in contrast with countries such as Ireland or Korea where growth was driven by productive capital stock, or Denmark, where capital quality was the largest driver. Multifactor productivity growth, which measures technical advances and efficiency, was negative over the period. Apart from Luxembourg, only Greece and Ireland had negative multifactor productivity growth in the period (OECD, 2021[103]). Faster growth in investment and productivity could help to reduce the resource intensity of growth in the future, which in turn could help to support meeting the goals of the green transition, without compromising living standards.
Figure 1.25. Productivity is high, but has flattened out for over a decade
GDP per hour worked, USD constant prices, 2015 PPPs
Source: OECD Productivity Statistics.
The COVID-19 crisis accelerated digitalisation and spurred more businesses to enhance their ability to operate remotely for business continuity (Conseil national de la productivité, 2020[102]). Many ICT, business and financial services were able to continue to function during the pandemic thanks to teleworking, leading to an increased contribution of these sectors to labour productivity growth in the past two years (Figure 1.26). This demonstrates the importance of increasing innovation and technological diffusion to raise productivity growth in Luxembourg. A better use of ICT tools could boost efficiency among low adopters; this should also support efficiency gains of some of the low-productivity firms (Conseil national de la productivité, 2021[91]). Other levers include addressing persistent skills mismatches (see above) and liberalising the stifling regulatory environment, which is holding back firm creation and expansion.
Figure 1.26. Services contributed positively to labour productivity growth during the pandemic
Annual industry contribution, percentage points, 2020 and 2021
Note: This figure masks some heterogeneity among the sub-sectors: the transport sector performed very well in 2020-2021 whereas the activity in accommodation and food services fell sharply in 2020 and did not totally recover in 2021.
Source: OECD Productivity Indicators.
Investment spending, in particular on R&D, could be increased to support more innovation
To support long-term productivity, Luxembourg should increase investment in research and development (R&D), especially for laggard firms (Berlingieri et al., 2020[104]). Technological change (whether it comes from automation or the creation of new tasks) tends to improve productivity, leading to higher incomes and lower prices, ultimately generating greater labour demand even in sectors not directly affected by innovation (Acemoglu and Restrepo, 2018[105]; Bessen, 2018[106]; Autor and Salomons, 2018[107]). Investment in research and development is a key factor in stimulating technological diffusion, especially for firms with slower growth (Berlingieri et al., 2020[104]). However, overall spending on R&D has been declining steadily for the past two decades, in contrast with neighbouring countries and the OECD average. This appears to be part of a broader trend of declining investment since the beginning of the 2000s (Figure 1.27, Panels A and B). Total R&D spending is just 1% of GDP, significantly below the OECD average of around 2.5%. In addition, despite the high concentration of employment in knowledge-intensive services, which is the highest anywhere in the OECD (Figure 1.29, Panel B), the proportion of researchers per employees is low (Figure 1.29, Panel A).
Figure 1.27. Investment and spending on R&D have been falling steadily
Source: OECD Economic Outlook (database); and OECD Main Science and Technology Indicators.
Domestic R&D is government-led, and the public share of R&D is comparatively high, reflecting the government’s dedicated innovation strategy, which has been implemented since the first OECD Innovation Review in 2007 (OECD, 2016[108]). The government budget allocation to R&D is 1.43% of government expenditure, which is around the EU average. This accounts for just over 0.6% of GDP, or as much as in Israel and more than for instance in Italy and the United Kingdom. Conversely, the private sector contributes relatively little to the national R&D effort. Business enterprise research and development (BERD) accounts for 54% of R&D, significantly below the OECD average of 72%, and R&D investment intensity by firms is very low at around 1% of GDP, from 1.5% of GDP in 2010 (Figure 1.28) (STATEC, 2021[109]). Whilst R&D in the manufacturing sector is comparatively high (6.7% of value-added by industry), a rather low R&D intensity in trade and services, which overall account for 40% of business R&D spending, lowers aggregate R&D (STATEC, 2021[109]). This may be due in part to the fact that several large multinational corporations with a presence in Luxembourg carry out their R&D at other sites.
Figure 1.28. Business investment intensity is low
Business enterprise expenditure on R&D, as percentage share of value-added in industry, 2019
Source: OECD Main Science and Technology Indicators.
Improving the efficiency of government R&D funding could help generate more private R&D. Unlike most of the OECD and the EU, Luxembourg does not provide indirect support in the form of tax credits or tax relief for R&D. The other countries with no tax relief for R&D are Bulgaria, Cyprus, Estonia, and Latvia (OECD, 2022[110]). Currently, the government allocates 75% of its R&D budget to institutional funding, such as Luxembourg University and other research institutions, and only 25% to specific projects, including those with private partners. Only 6% of business R&D is funded by government. Switching to better targeted funding of innovation projects in partnership with the private sector could optimise the outcomes of its funding. Direct funding of R&D projects through grants, subsidies or procurements may effectively raise firms’ absorptive capacity, that is, their ability to integrate and put to use new technology, and might be more effective policies for firms with a growth potential to access support (Berlingieri et al., 2020[104]). With better project-oriented funding, Luxembourg could focus its R&D investment not only on the most innovative sectors, such as ICT where investment is fairly low, but also on manufacturing and small crafts that have seen comparatively little investment in recent years (OECD, 2022[111]). Government support to R&D through direct financing of business expenditures in R&D has the potential to boost diffusion of knowledge, suggesting that it can effectively expands firms’ absorptive capacity and support the innovation process necessary for diffusion (Berlingieri et al., 2020[104]).
Figure 1.29. Despite a high number of people working in knowledge intensive industries, few are dedicated to research
Source: OECD Main Science and Technology indicators.
Luxembourg has an ambitious innovation policy, which has already seen a number of successes, driven by Luxinnovation, the national innovation agency. As recommended by the OECD Innovation Review (OECD, 2016[108]), Luxinnovation’s mandate runs on four-yearly contracts under the Ministry of Economy, the Ministry of Higher Education and Research, the Chamber of Commerce, the Industry Federation (FEDIL) and the Chamber of Crafts. The next performance contract, based on the Luxinnovation Strategy 2022-25, aims to reframe its objectives on activities towards the dual challenges of digitalisation and long-term economic sustainability. However, the new Strategy could be better focused. It includes four strategic priority areas, which are very broad in scope, such as becoming a key enabler to help companies; becoming an efficient accelerator and facilitator of digitally enabled and sustainable economic development; being an organisation that is exemplary for being both data driven and human-centric; and having staff that are interconnected with the ecosystem at all levels. These are further broken down into seven strategic goals, most of which are difficult to quantify, such as providing a good customer experience or empowering the staff (Luxinnovation, 2021[112]). Narrowing down the targets, while identifying measurable indicators for performance, could help maximise the effectiveness of the programme. In addition, Luxembourg’s digital innovation programme should establish an actionable roadmap for the development of digital infrastructure and services, with clear milestones that should be re-evaluated at regular intervals. Such a programme could be more explicitly integrated in Luxembourg’s Roadmap for a Competitive and Sustainable Economy 2025 (Ons Wirtschaft vu muer), which has overlapping aims (Ministry of the Economy, 2021[113]).
Luxembourg could for instance use its series of “Fit4” programmes, which aim to upskill Luxembourg’s businesses, to assess the innovation readiness of the firms that participate in the programmes, in order to better target their financial support towards boosting relevant R&D and innovation spending. The Ons Wirtschaft vu muer roadmap in particular highlights the role of Luxinnovation to use the Fit4Resilience and Fit4Circularity programmes, designed to provide Luxembourg’s SMEs and large companies with the strategic assessment and know-how to set up circular value-chains (Ministry of the Economy, 2021[113]). These programmes can have a particularly important impact on helping future-proof SMEs in light of the fundamental changes required of doing business in the green transition (see Chapter 2). Part of the financing should be used to encourage better co-operation and co-financing between public entities and businesses. While the Fit4 programmes do encourage public-private engagement, there is so far little assessment of their impact. To ensure that the efforts are delivering the expected outputs, firms that receive support should be evaluated against a number of performance indicators, to be established jointly with the agency and businesses. These could include annual turnover, creation of domestic jobs, the ability to attract foreign investment, or generating export revenues, after a certain number of years of receiving public support.
Other successful ways to support state intervention may be to focus growth poles around existing agglomeration economies. This allows dynamic sectors to exchange and diffuse knowledge and innovations, share pools of skilled labour and infrastructure while minimising the required involvement of public goods and services, to follow good practice (OECD/World Trade Organization, 2019[114]). Luxembourg has implemented a cluster around its steel industry in Belval in the southern part of the country. They can build on such experiences to advance similar spatial policies to target missing skills. In France, a national economic diversification programme around such growth poles, the Territoires d’Industrie, is being implemented with a particular focus on trades that lack skilled labour, such as high-tech industries, but also more traditional trades that struggle to find labour, such as furniture, ceramics, leather, or manufacture of precision instruments, amongst others (Ministère de l'Economie, 2022[115]; Versailles GrandParc, 2022[116]).
Improving ICT adoption can boost productivity for SMEs
Small and medium-sized enterprises (SMEs) accounted for 99.5% of all non-financial firms in Luxembourg in 2018 (latest available comparative data) and approximately 66% of the labour force. SMEs in Luxembourg have lower innovation intensity than larger firms, with the exception of micro firms. While SME performance, in terms of innovation, is around the OECD average, there is a big gap to the best-performing countries, with around half reporting some innovation activity, against two-thirds in Estonia, Norway, Belgium or Germany (OECD, 2022[117]). Business surveys indicate that among the most important factors holding back growth of SMEs in Luxembourg are the availability of skilled labour and experienced managers, whereas access to finance is only cited by 6% of the surveyed Luxembourgish SMEs as the most important problem they were facing (European Commission, 2021[118]). Nonetheless, more could be done to support R&D and innovation spending by SMEs. The SMEs surveyed reported little use of government guaranteed funding. A structured support programme for SMEs with government guaranteed funds or grants earmarked for investment in R&D could therefore help them to better direct their investment.
The pandemic accelerated the uptake of digital tools, but digitalisation needs to increase further. Business R&D expenditure on information technology is less than 0.05% of GDP (OECD, 2021[119]). In particular, SMEs lag behind in digital adoption (Figure 1.30) despite Luxembourg having a strong ICT infrastructure, with a 98% 4G coverage and 87.9% of businesses enjoying broadband (although only 62% with high speed). Only 10% of SMEs make e-commerce sales, against an OECD average of 25%. With a generally well-educated workforce, the country should be in a good position to rapidly increase the use of digital technologies. However, businesses report persistent shortages of qualified ICT professionals as a brake on digitalisation (Conseil national de la productivité, 2021[91]; European Commission, 2021[118]). Skills-mismatches should be addressed with dedicated adult training programmes, vocational education and training programmes (VET), and earlier introduction to key skills such as programming from primary school. As part of its strategy for digital skills, the Ministry of Education, Children and Youth has included coding and computational thinking in the official curriculum of primary and secondary education since 2021. Regular monitoring and, if needed, dedicated resources should continue to be made available to support and embed the digital transition for future generations.
Figure 1.30. Small firms lag behind in adopting digital technologies
% of firms adopting
Note: ERP = Enterprise Resource Planning software, CRM = Customer Relationship Management software. Small: 10-49 employees, Medium: 50-249, Large: 250.
Source: ECD (2021), ICT Access and Usage (database).
A recent survey of businesses points to the high costs of investment in digital technologies as another reason for the low investment in information and communication where Luxembourg lags behind peers, especially SMEs (Figure 1.31) (Conseil national de la productivité, 2021[91]). OECD research indicates that policies for financing targeted SME investments in ICT technologies may foster their adoption by laggard firms (Andrews, Nicoletti and Timiliotis, 2018[120]). A particular challenge remains to further integrate Luxembourg’s businesses into the circular economy (Schosseler, Tock and Rasqué, 2021[121]). Digital technologies can help to overcome some of the obstacles limiting the uptake of circular economy opportunities, through their ability to monitor, interconnect and manage objects in the physical world electronically (Barteková and Börkey, 2022[122]). The Ministry of the Economy’s Ons Wirtschaft vu muer roadmap, mentioned above, aims to further the readiness of businesses for the circular economy, notably through a set of pilot programmes on data exchange or digital procurement (Ministry of the Economy, 2021[113]). To support the roll-out of the programmes, they should also involve direct financial support to help especially smaller businesses overcome the investment hurdle.
To support a better digital diffusion, particularly to SMEs, Luxembourg should increase direct support to SMEs, including business advisory services and testing facilities. Some measures exist already within the Fit4Digital programmes, intended to support the digitalisation of SMEs, which provides financial support to carry out a business diagnostic (Guichet.lu, 2022[123]). Luxembourg has also recently implemented a Digital Innovation Hub (www.dih.lu), with a mission to be a ‘one-stop-shop’ for addressing the digital transformation of the Luxembourg industry and in particular the SMEs with offer and demand matching services, skills and trainings service, “test before invest” services and support to find investment at local and European levels for digital transformation projects (Ministry of the Economy, 2021[113]). However, there are little data available on the impact to date of these programmes. While awareness building and diagnostics are important tools, the authorities should also support financing schemes to help smaller businesses invest more directly in IT equipment, as well as offer training onsite on how to use the equipment.
Figure 1.31. ICT investment is relatively low
ICT investment, by type, % share of GDP, 2017
Note: ICT investment refers to gross fixed capital formation (GFCF) of "information and communication equipment" and "computer software databases" as defined by the System of National Accounts 2008 (SNA08).
Source: OECD Going Digital Toolkit.
The relatively slow development of public digital services is also a concern. About 80% of the population, aged 16-74, uses the internet to interact with public authorities. While this is above the OECD average, it is below the OECD front-runners, including all of the Nordic countries, but also the Netherlands and France (Figure 1.32). The government is undertaking a Digital Survey with the OECD in 2022 to improve digital governance and public sector digital capacity. However, one of the difficulties with the government’s e-services remains the high administrative burden (Conseil national de la productivité, 2021[91]). Most current e-services are merely digital versions of paper forms that can be submitted online. The government should use the move to digitalisation to reduce the administrative burden for all citizens. Denmark has developed a single personal digital key (“Easy-ID”) which allows citizens to access all public services, including health information and tax payments, in a secure and highly simplified way. For instance, tax forms are automatically prefilled. Housing purchases are also signed electronically using the Easy ID, with no paper or physical deeds changing hands; properties are registered in an electronic cadastre. The Easy-ID is also integrated with a range of private services, such paying utility bill via private banking, using the single digital ID number.
Figure 1.32. Interaction with public authorities is relatively low, hindering efficiency gains
Share of individuals aged 16-74 using Internet to interact with public authorities (%), 2021 or latest
Note: Public authorities refer to public services and administration activities at the local, regional or national level.
Source: OECD Going Digital Toolkit.
Lifting regulatory restrictions will help increase allocative effectiveness
Enabling allocative efficiency is a key driver of productivity. In Luxembourg, there is some evidence of productivity dispersion between firms following the financial crisis. The frontier firms in non-financial services and in manufacturing have been able to rebound towards their pre-financial crisis levels, while laggards have been in a protracted decline (Conseil national de la productivité, 2021[91]). Keeping non-performing firms in the market acts as a drag on productivity and prevents a better allocation of the best productive resources (Andrews, Criscuolo and Gal, 2016[124]). Successfully reducing Luxembourg’s dependence on the financial sector is also an overarching longer-term challenge (OECD, 2019[25]). Over-reliance on a single sector creates potential economic vulnerabilities that can be mitigated with diversification.
To support allocative efficiency, the regulatory environment needs to ease entry and exit of firms and support start-ups and business development. The birth rate of companies in Luxembourg of around 9% is below the OECD average, which is closer to 11%. Data are somewhat dated, but the death rate of firms (2017 data) of around 7.6%, is also below the OECD average of around 8.6%. A low churn rate would indicate a slightly less dynamic business sector (Canton, Ciriaci and Solera, 2014[125]). One driving factor is likely to be that product market regulation in Luxembourg is less business-friendly than in most OECD countries (OECD, 2018[126]). The low churn rate may also be related to Luxembourg's highly inefficient insolvency regime. Some of Luxembourg’s current insolvency laws date back to 1935 and are ill-equipped to deal with a modern economy. Recovery rates are around 43%, compared with an average of 70% in high-income OECD countries, and 92% in Norway (the best performing country). The process is lengthy (2 years on average), and the cost is higher than in other high-income OECD countries (World Bank Group, 2020[127]). To enhance allocative efficiency, Luxembourg should speed up the passing of the 2019 EU Directive on Insolvency, Restructuring and Second Chance and take the opportunity to enhance the domestic bankruptcy regime as previously recommended (Table 1.12). Two draft bills implementing the 2019 EU Directive, and which will modernise the Luxembourg insolvency law, are pending review by the Luxembourg Council of State and adoption by the parliament, which is expected by end-2022. Provided these laws are passed, exit and churn rates should improve.
The regulatory framework needs to provide the right incentives
Providing the right incentive framework to attract start-ups and investors is a key factor to support economic diversification and the resilience of the economy to the green transition. Luxembourg is an open economy, with few barriers to foreign investment and trade (OECD, 2018[126]). However, the business environment, in particular for start-ups, is hampered by strict licencing and permit requirements, which act as a drag on business dynamism (OECD, 2018[126]). Luxembourg should take advantage of the current review of its digital strategy (OECD, forthcoming) to simplify the licensing requirements. This includes minimum capital requirements, which have been shown to hold back start-up activity (OECD, 2014[128]). While Luxembourg has created the “Simplified limited liability company” (SARLs) with a one-euro capital requirement for most craftsmen, traders, manufacturers, and certain liberal professionals, this still requires the agents to apply for a business permit first with the Ministry of the Economy, which requires amongst others demonstrating proof of one’s professional integrity, required qualifications and physical premises. Moreover, some liberal professions face stricter licensing requirements.
New firms face a cumbersome licensing regime. Starting a business is more expensive and requires more steps than in several neighbouring countries such as Netherlands, France, Belgium and Denmark. New business permits, with the exception of SARLs and sole proprietors, need to be registered by a notary public, which is both a lengthy and costly process. Luxembourg should liberalise business permit rules to allow for easer business creation, including the abolishment of the need to register deeds and business licences with a notary public. Denmark and the UK, for instance, allow business licences to be directly registered online, without a notary.
Restrictive regulations on key professions that deliver business services (such as accounting or engineering) are associated with lower churn rates in the market (Canton, Ciriaci and Solera, 2014[125]). Access to most regulated professions is highly restrictive: barriers to entry and conduct constraints are present in the regulation of most professions (Figure 1.33) (OECD, 2018[126]). The professional licensing rules are highly restrictive, and all tradespeople need an establishment licence in addition to the authorisation to exercise. Only a few foreign (non-EU) qualifications are automatically recognised. The main exceptions are for doctors and most types of nurses, given that Luxembourg opened its first national medical school in 2021 only. Current regulations still require firms to have physical premises in order to obtain an establishment licence, which is a barrier to the development of e-commerce, and property registrations are lengthier and costlier than in other high-income OECD countries (OECD, 2018[126]; World Bank Group, 2020[127]). The physical premises requirement seeks to avoid letter-box companies but there may be other ways to guard against this risk.
Figure 1.33. Luxembourg’s business regulatory environment is restrictive
Index scale (0-6) from the most to the least competition friendly (6=most restrictive)
Source: OECD 2018 PMR database.
Luxembourg should undertake a competition assessment review of the regulatory environment for the regulated professions as well as the retail and network sectors. Since the mid-1990s, Australia has systematically carried out a thorough review of all business and product market regulations in the economy, reviewing more than 1 800 laws. Several countries have undertaken such reviews with the support of the OECD, including Iceland, Portugal, and Greece. By lifting the regulator restrictions identified, benefits to the Greek economy exceeding 2.5% of GDP were identified (OECD, 2014[128]).
Table 1.12. Previous recommendations to enhance the business environment
Competition law and policy need strengthening
Competition policy plays an important role in the expansion of an efficient and diverse private sector. Anti-competitive conduct by dominant firms can seriously inhibit incentives to innovate and diversify. An effective competition law and enforcement framework are necessary to complement regulations that enable firm entry and rivalry (Hasanov and Cherif, 2021[129]; Aghion et al., 2005[130]). Luxembourg’s competition agency, the Conseil de la Concurrence, is relatively small, with just 11 employees, especially given its remits. In addition to competition law enforcement, since 2021 it also oversees consumer protection, as well as regulatory assessments of new laws (Conseil de la Concurrence, 2022[131]). By comparison, Iceland’s competition authority (with half of the population) has 23 full-time staff.
In addition to its small size, the effectiveness of the Council in stimulating competition in Luxembourg is hampered by the fact that the national Competition Law does not provide for merger control powers. Instead, the Council relies on European legislation (Article 102 of the TFEU), as well as a 1973 ruling by the European Court of Justice, on the abuse of dominant position, to verify whether mergers in the Luxembourgish market have an anti-competitive effect. As no merger control law is in place, this occurs after the mergers have taken place, no matter the size or value of the transaction, and only provided the merged entity also has a dominant position in Luxembourg. With these obstacles, it is not surprising that an ex-post dissolution of a merger has never happened in Luxembourg, as the burden of proof of a significant impediment of effective competition in this case falls entirely on the Competition Council (Bleser, 2020[132]; Conseil de la Concurrence, 2022[131]). To strengthen the powers of the Competition Council, more resources, in the form of staff, should be granted to the Council. In addition, the competition law framework could be strengthened, for instance through a Peer Review of Luxembourg's Competition Law and Policy with a view to updating and modernising the competition law.
To embed an economic diversification programme, such as Luxembourg’s national research and innovation strategy (Luxinnovation, 2021[112]), the institutions must be able to sustain interventions over time and manage the risks of regulatory capture and rent-seeking, inherent in public-private interaction (OECD/World Trade Organization, 2019[114]). This is a challenge owing to Luxembourg’s small size. Public ownership is extensive, and the governance of state-owned enterprises is only partially in line with key OECD best practices (OECD, 2018[126]). In some sectors, there is no separation between the public body that owns the state-owned enterprises and the industry regulator. In addition, there are no rules regulating the interaction between interest groups and policymakers (OECD, 2018[126]). To enhance the effectiveness of Luxembourg’s ambitious diversification programme (Luxinnovation, 2021[112]), clear separations between the various agents should be put in place, as well as clear reporting lines, including for accounting purposes, for projects that are publicly funded. Sector regulators should be granted independence of line ministries.
Table 1.13. Main findings and policy recommendations of the Key Policy Insights Chapter
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