Catherine MacLeod
Paula Adamczyk
OECD Economic Surveys: Luxembourg 2022
OECD Economic Surveys: Luxembourg
2. Securing a dynamic and green economy
Abstract
Luxembourg announced ambitious climate targets to accelerate progress towards carbon neutrality in 2050. These objectives require significant mitigation efforts, as progress in the green transition has stalled in the past few years. The emissions reductions required in the next 30 years are greater than the declines of the 1990s, which were driven by reforms to the steel industry and the closure of coal power plants. At the same time, the targets can allow Luxembourg to benefit from the green transition. Owing to the specificities of Luxembourg’s economy, most of the efforts will need to be focused on the transport and housing sectors. The transition will require deep changes in the behaviour of households, whose high carbon footprint is due to car usage and home heating. Sustainably reducing emissions also requires tackling cross-border fuel sales for both freight and commuters. Furthermore, reforms in agriculture are needed to reduce pressures on biodiversity. A wide range of policy tools need to be used to increase public acceptability. A higher carbon price over the medium and long term would lead to lower fuel sales and greater energy efficiency. Better spatial planning policy could reduce urban sprawl and car dependency. Stricter regulations and enhanced incentives would facilitate more environmentally-friendly agricultural practices.
This chapter discusses how to make Luxembourg’s economy greener through a more effective and inclusive strategy. The current environmental challenges are assessed (first section) and the key risks posed by the transition (second section). The policy framework necessary to manage these risks, and policy recommendations to achieve climate ambitions and maintain public support are then proposed (third section).
The foundations for greener growth are in place, but efforts need to accelerate
Climate change is currently one of the most pressing long-term challenges and many governments have put it at the forefront of their political agendas. Climate action is needed since increased droughts, flooding and extreme weather events will become more common if sufficient mitigation efforts are not put in place urgently (IPCC, 2022[1]). Recognising these challenges, the Luxembourgish authorities have adopted ambitious climate targets for 2030, with the long-term goal of reaching carbon neutrality by 2050.
This strategy will require enhanced decarbonisation efforts of all stakeholders as well as efficient policy implementation and coordination. Early action can prevent exacerbating the risks but also help benefit from the economic opportunities generated by the green transition. While Luxembourg is not particularly vulnerable to natural catastrophes, evidence shows that it still faces significant potential costs associated with climate-related weather events (Figure 2.1).
Figure 2.1. Climate-related economic losses are relatively high
Economic losses from extreme-weather events, euros per capita, in 2020 prices
Source: European Environment Agency based on CATDAT of RiskLayer estimations.
A bird’s eye view of green transition challenges in Luxembourg
Luxembourg has made considerable progress towards the green transition. In spite of high economic growth, greenhouse gas emissions have decoupled from GDP and energy intensity remains significantly lower than the OECD average (Figure 2.2, panel A), thanks to the relatively low-carbon intensity of the financial and business services sectors. Substantial investments in renewable energy sources have resulted in the share of renewables in energy supply doubling over the past decade. The government has entered into a Climate Pact with municipalities that provides certification and funding to those implementing environmental and climate measures. The Naturpakt with municipalities aims to encourage nature protection and biodiversity conservation. The government has also implemented ambitious climate targets to accelerate the green transition.
At the same time, there is scope for further improvements to ensure reductions in emissions since 2020 are long-lasting. The consumption and production patterns of Luxembourgish citizens as well as an increasing population have contributed to pressures on the natural environment. The gains in greenhouse gas emissions reductions from early 1990s reforms of the steel sector to arc-furnaces and the phase-out of coal were offset by steady growth in transport sector (including freight) emissions from the mid-1990s (IEA, 2020[2]).
Luxembourg’s residents are the largest per capita consumers of carbon in the OECD, even when excluding fuels sales to non-residents, as shown by the production and demand-based measures of CO2 emissions (Figure 2.2, Panel B). The carbon intensity of demand is much higher than that of production as Luxembourg imports most of its energy needs (Figure 2.2, panel C). Around 95% of energy demand is imported, mainly oil and natural gas, and is not accounted for in the production-based measure. Demand-based CO2 intensity measures the intensity of CO2 emissions based on final demand consumption, excluding the impact of fuel sales, reflecting the actual emissions in the economy (OECD, 2017[3]). It is an indicator of how much carbon has to be imported in order to satisfy the final demand of the citizens (Box 2.1).
Figure 2.2. Emissions per capita are high although energy intensity is relatively low
1. Including Land Use, Land-Use Change and Forestry (LULUCF). Because of the principle of territoriality, it includes fuel sales to non-residents.
Source: OECD Green Growth Indicators.
In addition, Luxembourg’s consumption patterns generate important amounts of waste per capita. The material footprint, which takes into account resources required to satisfy the final demand in a country, is one of the highest among OECD countries (Figure 2.3, panel A). As a result, the amount of waste produced per capita is also significantly above the OECD average (Figure 2.3, panel B). In part, the high levels of consumption and waste are due to the large numbers of cross-border workers that commute to Luxembourg on a daily basis and essentially inflate the numbers that are measured in per capita of the population (OECD, 2020[4]). Encouragingly, the amount of municipal waste going to landfills has significantly declined and currently represents only 4% of total waste generated, against 47% incinerated and 49% recycled (Figure 2.3, panel B). This is a major improvement from the 21% landfilled in 2000, following the First (2000) and Second (2010) Waste Management Plans. The government has also recently introduced the Circular Economy Strategy aimed at reducing waste and promoting reuse and recycling.
Over the past two decades, emissions of small particulate matter into the atmosphere decreased, resulting in air quality improvements in Luxembourg (Figure 2.3, panel C). However, the country’s high reliance on car-based transport and the large number of daily foreign commuters have led to high levels of exposure to other pollutants, in particular nitrogen oxides and carbon monoxide that are the result of burning fuels in car engines. Nitrogen oxide emission levels are much higher than in neighbouring countries (Figure 2.4, panel A).
Figure 2.3. The amount of waste generated surpasses the OECD average but air quality has improved
Source: OECD Green Growth Indicators.
More attention should be paid to the health of Luxembourg’s ecosystem whose quality has worsened over the years. Biodiversity, soil sealing, the quality of water and deforestation and the associated loss of species will need to be addressed (Figure 2.4, panel B). The sharp expansion of the built environment, including the extensive and expanding road infrastructure network, exacerbates soil sealing, and increases pressure on land. Intensive farming practices, such as livestock grazing and excessive use of fertilisers and pesticides, have a negative impact on water and soil quality and contribute significantly to biodiversity losses.
Moreover, climate change impacts, notably periods of heat and drought, have facilitated the spread of pests and resulted in Luxembourg losing more forest space than any other OECD country. The health of trees has significantly deteriorated over the past few years. Only 16% of all trees in Luxembourg are currently without damage while half of them are considered significantly damaged (Figure 2.4, panel C). Projected weather change patterns are likely to intensify problems, as warmer weather encourages the proliferation of pests, such as bark beetle, whilst also potentially having a negative impact on yields for crops. This would worsen the impact of the shift to emissions-intensive cattle production underway since 2010.
Figure 2.4. The natural environment is under pressure
Source: OECD Green Growth Indicators; European Environment Agency; and STATEC.
Greenhouse gas emissions require specific attention
Luxembourg has managed to decouple greenhouse gas emissions from GDP growth since 2005 but progress has slowed over the past few years (Figure 2.5, panel A). After initial reductions in the early 1990s, the rise of transport emissions led to GHG emissions increasing again. Despite a gradual decrease since 2000, total emissions have remained at relatively higher levels compared to top-performing countries (Figure 2.5, panel B).
Box 2.1. International measures of carbon footprints
The territorial-based measure of greenhouse gas emissions is widely used for country emissions targets. It includes fuel sales to non-residents, which would increase Luxembourg’s emissions relative to those countries where fuel exports are proportionally smaller relative to resident fuel sales. The territorial-based measure includes power generated in the territory, rather than the power that is used in the territory. As Luxembourg is a net energy importer, this reduces Luxembourg’s emissions relative to those countries that generate power for their own consumption, especially those that export power. No distinction is made between residents and non-residents in territorial-based measures.
The OECD produces production-based and demand-based measures of CO2 emissions from residents alone, excluding the impact of cross-border workers, and fuel sales. The production-based measure includes all energy that is produced within the country, whether used domestically or exported. The demand-based measure also includes the emissions associated with imported energy, which is an important power source in Luxembourg. This indicator provides a clearer pattern of the emissions intensity of how Luxembourgish residents live and work, but is more complicated to measure. It is also only available for the economy as a whole and not disaggregated by sectors. Both the production-based and demand-based measures cover only CO2 emissions, not all greenhouse gas emissions.
To facilitate international comparisons, emissions are often scaled per capita or by unit of value added produced. In Luxembourg, scaling territorial-based measures by population could introduce an upward bias, since cross-border commuters expand the number of people in the territory by about 30%, but do not affect the total population size. Using the OECD’s demand- and production-based measures of emissions per capita avoids the issue of having different samples of population in the numerator and denominator, as both include just the resident population. Scaling territorial-based measures by unit of GDP may under-represent the carbon intensity of production given the importance of economic activities with a limited physical presence in Luxembourg. Using GNI instead of GDP might give a more relevant measure of emissions per value-added produced in the case of Luxembourg.
In light of these various caveats, it is critical to consider a range of measures to benchmark performance and policies.
Meeting Luxembourg’s international commitments on greenhouse gas emissions will require significant progress in tackling territorial emissions from transport, including cross-border fuel sales, as well as the residential sector (Figure 2.6). The transport sector’s share of emissions (57.4%) is more than double its share in other OECD countries. The transport sector drives a heavy reliance on hydrocarbons in total energy needs: oil makes up 65% of total gross energy consumption in the country (IEA, 2020[2]). The importance of fuel sales to non-residents, including freight transport, has played an important role in the rise in greenhouse gas emissions since 2015 as well as the subsequent COVID-related decline in emissions in 2020. Luxembourg is an international transit hub owing to its geographic position and low fuel prices compared to neighbouring countries. Freight trucks, cross-border residents and other fuel tourists are responsible for around two-thirds of transport-related fuel consumption (IEA, 2020[2]).
Sustainably tackling emissions from the residential sector, which makes up 15.5% of total emissions, will require reducing heating-related consumption and increasing the energy efficiency of buildings, as well as switching out of carbon-intensive heating sources. Natural gas accounted for 53.2% of homes’ heating systems and heating oil accounted for a further 36% of home heating (Ministère de l’Énergie et de l’Aménagement du territoire, 2020[6]). Residential heating related emissions have risen steadily over time. Despite its relatively small industrial sector, the share of emissions from manufacturing are roughly equivalent to the OECD average. The manufacturing sector’s energy needs are dominated by the steel and glass industries.
Figure 2.5. Progress in reducing emissions has slowed since 2015, weakening growth decoupling
Note: Emissions including Land Use, Land-Use Change and Forestry (LULUCF). GDP per capita is based on purchasing power parity.
Source: OECD Greenhouse gas emissions (database); and OECD National Accounts (database).
The carbon intensity of the economy stems from the reliance on fossil fuels for energy consumption. Oil makes up 65% of gross energy consumption, mainly in the transport sector, but is also used for heating in the residential and commercial sectors (IEA, 2020[2]). Natural gas accounts for 15% of gross energy consumption. It is an important source of energy for homes and firms, making up 46% and 41% of their energy needs in 2017.
Figure 2.6. The transport sector accounts for most of the GHG emissions in Luxembourg
Greenhouse gas emissions by source, percentage, 2019
Note: Emissions are calculated on a territorial basis. This includes the fuel sales to non-residents and excludes electricity consumed but not produced in the territory. Note that energy not produced within the territory is also excluded. Since Luxembourg imports 95% of its energy, this means energy sectors account for just 2.2% of emissions compared to an OECD average of 28%. Because of its computational ease, this has been the standard that has been agreed to for international greenhouse gas commitments.
Source: OECD, Greenhouse gas emissions by source (database).
Reducing fossil fuel reliance brings environmental benefits and would make Luxembourg’s energy system more resilient, especially in the current context of Russia’s war of aggression against Ukraine. An EU-wide embargo on coal has been in place since August 2022 and will be extended to seaborne oil by the end of 2022. Oil imports from Russia are negligible. About 25% of natural gas imports were from Russia in 2020, but they have fallen since given the reduction in supply to Europe (Ministère de l’Énergie et de l’Aménagement du territoire, 2022[7]). Most natural gas comes through LNG facilities in Belgium, primarily sourced from Norway and the United Kingdom, transported to Luxembourg via pipeline. Gas shortages are not expected in the near term, given the recent decline in domestic demand. Gas storage facilities are in Germany, and a multilateral agreement is in place with neighbouring countries. While Luxembourg imports relatively less energy directly from Russia than other EU countries, it is still indirectly affected by the conflict and bears the consequences of higher energy prices. Accelerating the shift to non-fossil fuel resources would thus both reduce the carbon intensity of the economy and improve domestic energy security.
Domestically based renewable energy production has expanded, but remains relatively low, at around half the share of OECD peers (Figure 2.7, panel A). Most of the growth has been from biofuels rather than photovoltaics or wind-based power (Figure 2.7, panel B), even though solar capacity per capita is relatively high compared to other EU member states. The supply of renewable energy sources is supported by feed-in and premium tariffs for electricity produced by renewable sources, as well as investment subsidies for renewable energy deployment.
Figure 2.7. The supply of renewable energy is still one of the lowest among OECD countries
1. Data for Costa Rica refers to 2019.
Source: OECD Green Growth Indicators; and IEA, World Energy Balances.
In order to augment its low levels of domestic production of renewables in the context of EU requirements, Luxembourg has purchased statistical transfers of renewable energy, in line with EU regulations. This system allows countries with surplus renewable energy relative to targets (such as Estonia and Lithuania) to sell this renewable energy to countries who fall short of these targets, such as Luxembourg. These transfers are statistical, since they do not require the actual transmission of power between countries - but the money must be used for new measures to develop renewable energies or energy efficiency. In 2020, 1.6 percentage points were added to the renewable share from statistical transfers. This number is envisaged to reach 5.4 percentage points by 2030, as cooperation measures expand to include new instruments such as the European renewable energy financing mechanism.
An ambitious green transition strategy has been put forward to speed up change
Recognising the climate challenges and risks, the authorities have put forward ambitious targets. The government has published two documents to guide its green strategy: the National Long-Term Strategy outlines a vision for the green transition and commits to Luxembourg becoming climate-neutral by 2050. The National Energy and Climate Plan 2021-2030 (NECP) defines Luxembourg’s targets for 2030 both at a national and sectoral level. Guided by the priority areas defined by the EU’s Fit for 55 strategy (see Box 2.2), the national plan commits Luxembourg to:
reduce greenhouse gas emissions by 55% in 2030 from 2005 levels (EU requirement: 40%) (Figure 2.8, panel A).
increase the share of renewable energy to 25% of gross final energy consumption by 2030 (Figure 2.8, panel B).
improve energy efficiency by 44% in 2030. This is with respect to the business-as-usual scenario (based on the benchmark EU PRIMES 2007 model).
Figure 2.8. The 2030 and 2050 targets call for an acceleration in the pace of change
1. ESD = Effort Sharing Directive. These emissions are covered by the EU Effort Sharing Directive and are not part of the EU Emissions Trading Scheme.
2. Luxembourg’s 2020 target for 11% share of renewable energy in final consumption was also supported by statistical transfers from Lithuania and Estonia, as well a large drop in fossil fuel consumption.
Source: Eurostat, Effort Sharing Directive emissions; Eurostat, Air emissions accounts; and Eurostat, Renewable energy statistics.
Box 2.2. The “Fit for 55” EU Package
Fit for 55 package is a set of proposals to update the EU legislation in line with the 2030 objectives. The name comes from the EU-wide target of reducing net greenhouse gas emissions by at least 55% by 2030. The package covers targets in the EU’s emissions trading system, country-specific emissions reductions in sectors not covered by the Emissions Trading Scheme, as well as proposals to increase the EU renewable energy target to 40% and attain energy efficiency improvements of final and primary energy by 32.5-36% and 39% respectively.
Under the EU’s Effort Sharing Regulation, each Member State has a specific emissions reduction target for 2030 for sectors not covered by the Emissions Trading Scheme. For Luxembourg, the target is a 40% reduction compared with 2005 levels. In other policy areas, no specific targets are required: countries set out their objectives in their National Energy and Climate Plans, which are guided by the region-wide targets and assessed by the Commission.
Source: European Commission.
The government has outlined stretching sector-specific energy efficiency targets to reach the overall 44% reduction in final energy consumption. The biggest reductions are expected to be achieved in the residential building sector (-40%), followed by road transport (-38%) and services (-24%) (Figure 2.9, panel A). Over time, the pace of change for firms is expected to be relatively steady, with the adjustment for industry relatively slow compared to other sectors between now and 2030.
By contrast, the targets imply very sharp changes in households’ transport choices in the short term. Households contribute to around half of total domestic transport fuel consumption, which are expected to decline by a quarter between 2025 and 2030 (Figure 2.9, panel B). The government’s strategy seeks to raise the use of public transport and increase use of electric vehicles, with the ambitious target of reaching a 49% share of electro mobility in the vehicle fleet by 2030.
Electric and hybrid vehicles currently make up 4.5% of total vehicle stock. To meet the 2030 target, if the replacement rate remains at current levels, electric vehicles would need to make up 60% of all cars purchases by 2025 and 100% by 2030. In 2021, sales corresponded to almost 20.5% of new registrations. Generous subsidies are available for the purchase of electric vehicles. Citizens can receive EUR 8 000 for electric vehicles whose energy consumption does not surpass 180 Wh/km and EUR 3 000 for electric vehicles that do not meet this criterion. To further accelerate uptake, company car benefits will only apply to electric vehicles from 2025.
A national network of public charging points is being expanded with fast chargers installed along the main routes, whilst incentives are available for the installation of private charging points. The Recovery and Resilience Facility will finance a subsidy scheme for private stakeholders to install publicly-accessible and private charging stations from the second half of 2022. There are currently 14 electric vehicles per publicly-accessible charging point in Luxembourg, one of the lowest rates in the European Union, although as the number of cars expands, the number of charging units will need to increase dramatically. If targets for electric vehicle sales are met, reaching an average of 20 electric vehicles per public charging point would require installing over 10 000 charging points by 2030.
The residential sector’s energy efficiency gains are expected to accelerate substantially between 2025 and 2040 (Figure 2.9, panel B). The greater emphasis on future gains reflects in part the importance of renovations in reaching these goals. Luxembourg has in place net zero energy standards for new buildings, which will help to improve emissions from residential housing. In addition, a large stock of mainly single-family homes will have to be retrofitted, with home renovation rates needing to rise sharply from the current 1.1% to 3%, the NECP’s target to reach the 2030 goals.
Figure 2.9. Stretching targets across households and firms
Note: Each bar represents the annual average reduction in energy use over the five-year period for a given sector.
Source: Luxembourg PNEC; OECD calculations.
These stretching targets occur in the context of a growing population and economic growth, which implies that even greater savings are required from each sector (Figure 2.10, panel A). Luxembourg’s failure to sustain gains in energy efficiency against the backdrop of rising growth is the reason for the increase in emissions between 2015 and 2019 (Figure 2.10, Panel B).
Figure 2.10. Growth both increases the resources for the transition and the required decrease in emissions
1. Households’ consumption increases in line with population growth (1.0%, based on STATEC projections), industry at its long-term average of 2% and commercial business at 3%. This is broadly consistent with growth of 2.75%. The domestic transport sector is projected to grow in line with population, and fuel exports at 2% for freight in Western Europe, based on ITF assumptions (ITF, 2021[8]).
2. TES is total energy supplied. Emissions are disaggregated into the contribution of population growth, GDP per capita growth, energy intensity (energy per unit of GDP) and emission intensity of energy (emissions per unit of energy) or Total emissions = Population × (GDP / Population) × (Total energy consumption / GDP) × (Total emissions / Total energy consumption). GDP is in PPP. The sum of (positive and negative) components is approximately equal to the variation in CO2 emissions.
Source: OECD calculations based on Luxembourg PNEC, IEA, OECD.
Changing the way in which Luxembourg grows can improve the likelihood of meeting these targets and reduce the trade-offs between growth and environmental targets. In the past, growth has heavily relied on contributions from an expanding workforce rather than investment growth (Figure 2.11), with a significant share of this workforce provided by neighbouring countries. Chapter 1 outlines reforms to increase the contribution of investment and productivity to growth, which have been relatively weak. Supporting higher productivity growth alongside the sustainable use of resources will minimise waste and the pressure on resources, and ensure Luxembourgish firms are well-positioned to take advantage of new markets. Tackling the structural factors that result in high car dependence and low housing density can further accelerate progress in reducing emissions.
Figure 2.11. The sources of growth have been very labour intensive
% point contributions to potential growth
Note: The data for 2022 are projections.
Source: OECD Economic Outlook dataset EO111 and updates.
In addition, raising the share of older workers in employment has the potential to help mitigate resource pressures in the economy, whilst meeting the need for an expanding workforce. Luxembourg could add an additional 45 000 workers by 2060 if elderly workers’ participation rates rose to the average projected for the European Union. In turn, this could meet a substantial proportion of the projected expansions of the workforce under different scenarios (see Table 2.1).
Table 2.1. Longer working lives could reduce demand for employment
Note: 1. Based on projections from Table 4 in (Haas and Peltier, 2017[9]), assuming 50% cross border workers in 2030. 2. The elderly workforce is defined as those between 54- 74 years old. Increase in the elderly workforce calculated based on the Ageing Report’s (European Commission, 2021[10]) population growth estimates and participation rates for Luxembourg. The size of the workforce increase is calculated relative to the projected size of the elderly workforce. 3. The participation rate increase is based on the central scenario for the EU average over time. 4. The participation rate increase is based on the EU average plus 10 percentage points, consistent with the scenario put forward by the European Commission.
Source: OECD calculations, (Haas and Peltier, 2017[9]); (European Commission, 2021[10]).
The green transition can significantly improve the well-being of the population, but will also carry risks. Managing the recent sharp increases in carbon prices, alongside significantly accelerating the pace of decarbonisation from current levels could pose risks to economic growth, jobs and households’ cost of living.
These risks are assessed in the next section, alongside the possible physical risks that climate change poses. On this basis, the last section makes recommendations on how best to enhance the existing policy toolkit’s ability to meet these targets, notably in sectors where green challenges are the highest (transport, housing and agriculture).
The transition requires careful management and high levels of resilience
Climate change has wide ranging impacts. The risk of continued lags in global policy commitments and implementation require policy makers to constantly evaluate a number of risks which could impact on livelihoods and the economy:
the physical risks from climate change, including the cost of more frequent catastrophic events that occur with increased, but still unpredictable, frequency.
the transition risks facing firms and households, who must absorb higher costs in the short term to reduce current carbon-intensive behaviours.
the resultant risks that climate change poses for the financial sector, which is exposed to its clients’ ability to both adapt to increased physical disasters as well as to undertake the costs of the transition (NGFS, 2020[11]), (NGFS, 2021[12]).
The manner in which these risks manifest themselves will have substantial implications for policy design and how much it is supported by the population. A resilient transition implies that households, communities and nations will be able to resist, absorb, recover from and adapt to hazards that emerge in the transition (IPCC, 2018[13]), (Dornelles et al., 2020[14]). Ongoing monitoring and evaluation of these risks and their interactions is critical to ensure continued support for and success of the green transition as the economy grapples with the current energy crisis as well as over the long term.
Physical changes from the climate can pose risks for public and private infrastructure
The physical risks from climate change in Luxembourg are expected to be relatively mild on average. Changes in weather conditions are forecast to be quite limited relative to other countries. In Luxembourg, temperatures are expected to become warmer, rising from an average of 8.1°C between 1961 and 1990, to 9.2°C between 2021 and 2050. This will primarily be driven by milder winters. Annual rainfall is likely to remain the same, but summers are expected to be drier and winters wetter.
Despite these relatively mild aggregate effects, periods of drought and low water levels will be more likely, as warmer winters result in reduced snowfall and lower buffer tanks, whilst flooding and more severe storms will exacerbate soil erosion challenges (Ministère de l'Environnement, du Climat et du Développement durable, 2018[15]). This could also increase the risks of severe drought for croplands (Maes et al., 2022[16]). Even these relatively mild climate change impacts could have an outsized impact on an already fragile ecosystem (Table 2.2). Between 2017 and 2021, Luxembourg has experienced an additional five days a year of at least strong heat stress exposure compared to 1981-2010 (Maes et al., 2022[16]).
Table 2.2. Main risks from physical climate change
Source: OECD based on selection of measures highlighted by (Ministère de l'Environnement, du Climat et du Développement durable, 2018[15]).
The increased frequency of extreme events, notably flooding, could increase the associated losses. The probability of extreme flooding risks (a 100 year event) in Luxembourg is projected to increase almost 2.5 times between 2021 and 2050 compared to levels between 1970 and 2005 (Alfieri et al., 2015[17]), (Karagiannis et al., 2019[18]). This will bring Luxembourg’s extreme flood risk in line with the European average. Although the probability of these events may be low, economic losses can be outsized relative to losses from typical weather condition changes, as protection structures may be overwhelmed, and damages increased (Karagiannis et al., 2019[18]). To date, losses due to weather events have been quite limited – Munich Re assessed historic losses between 1980 and 2018 at USD 797 million, with the majority due to windstorms – about half the European average as a share of GDP (EIOPA, 2021[19]).
Most climate models assume a gradual or linear progression of risks and costs associated with climate change. However, there is growing evidence that breaching certain temperature thresholds could result in non-linear effects and tipping points beyond which the climate is not able to recover, if remedial action is not taken soon enough (Klose et al., 2020[20]); (Ritchie et al., 2021[21]); (Sims and Finnoff, 2016[22]); (Fan et al., 2021[23]). The likelihood of extreme events may thus increase even further if global coordination on climate policies fails, generating non-linear economic costs (IPCC, 2022[1]).
The transition risks for firms and households should be manageable
Decarbonising the economy and the speed with which this occurs will have economic, financial and political consequences. Higher levels of investments should help to improve energy efficiency and reduce operating costs. The transition will nonetheless entail costs – not only for funding upfront investments, but also in the early retirement of certain assets and the obsolescence of others, for example as companies switch to alternative fuels. As firms and sectors close and others open, the sources of employment growth will shift, alongside the skills needed of the workforce.
The distribution of the transition’s costs and benefits will vary across households and firms, depending on their capacity to absorb these shocks and the availability and cost of new technologies. The speed of the change will be a critical variable in influencing the sustainability and continued support for the green transition. The speed and size of recent increases in energy prices due to the war in Ukraine could potentially increase the risks of the transition, and need to be closely monitored.
Firms’ transition risks are concentrated in transport and manufacturing
Transition risks capture the extent to which the country faces large disruptions to become green, including how costly those disruptions might be. Changes in technology and shifts in consumer sentiment, alongside policy choices, as well as resilience and productivity of firms can impact the nature of these transition risks (BIS, 2021[24]); (IPCC, 2020[25]).
The total share of firms directly exposed to high transition risks from climate change is expected to be limited. The promotion of the services sector as a source of growth since the 1980s has insulated the economy by reducing the share of – and the potential shocks from – carbon intensive industries. The total weight of sectors assessed by the ECB’s climate stress test procedure (Alogoskoufis et al., 2021[26]) to have high transition risks in Luxembourg make up 17% of GDP. These same sectors account for 31% of GDP in the euro area. Nonetheless, these sectors account for just under 20% of total jobs and 25% of total fixed assets in Luxembourg (Figure 2.12).
Figure 2.12. The structure of Luxembourg’s economy insulates it from the highest risks of the green transition, but there are still risks
Importance of industries with medium to high transition risks, % share
Source: OECD calculations based on OECD National Accounts (database) and (Alogoskoufis et al., 2021[26]).
Firms will be able to absorb higher costs depending on the importance of carbon in their production cycle, demand for low-carbon products and their ability to pass on price increases to customers (Box 2.3). The balance of these risks depends not only on how the transition affects firms that are currently operating, but also on the ability of the economic system to support the emergence of new firms. A conducive regulatory environment will allow high-productivity, low-resource intensity firms to emerge and grow. These firms will employ the workers and resources that are released with the closure of resource-intensive and loss-making firms. Chapter 1 highlighted reforms to support this dynamism.
Estimates from the OECD suggest more stringent environmental policy is likely to have a modest impact on Luxembourg’s GDP and employment. The OECD Environmental Policy Stringency (EPS) indicator, developed by (Botta and Koźluk, 2014[27]), has recently been revised and updated until 2020. It covers 40 countries and 13 policy instruments, focussing predominantly on climate change and air pollution policies (Kruse et al., 2022[28]). (Frohm et al.[29]) uses this rich dataset and a panel of 30 OECD countries and 54 sectors of activity during 2000-14 to forecast the potential impact of increased environmental stringency. Preliminary results suggest an increase in environmental policy stringency is associated with a significant reduction in CO2 emissions after 10 years, with negligible aggregate effects on employment or activity (Frohm et al.[29]). Whilst the design of climate-related policies will influence sector and aggregate impacts, these results are largely in line with the international findings relating to the risks of carbon leakage (Box 2.3).
Aggregating the individual sector impacts for Luxembourg suggests a one index point increase in the overall Environmental Policy Stringency index is associated with a statistically significant 5% decrease in CO2 emissions after 10 years (Figure 2.13, Panel A). This is a smaller effect than for the OECD average, since the share of domestic power generated in Luxembourg is lower than in the aggregate group of OECD countries, lowering the share of fossil fuels in total energy use.
The estimates suggest most sectors would reduce CO2 emissions, with the manufacturing sector, particularly in non-metallic products such as glass, contributing significantly. The transportation and storage subsectors would experience some of the largest cumulative drops in CO2 emissions after 10 years, reaching as much as 20%. These sectors in turn drive most of the decline in employment, although on aggregate, employment would fall by just 0.5% in total over the 10-year period (Figure 2.13, Panel B). Whilst the aggregate impact might be small, policies must support these workers’ reskilling and their reabsorption into less emissions-intensive firms and sectors.
Figure 2.13. Increasing environmental policy stringency can reduce CO2 emissions
Note: The effects are calculated using point estimates from a fixed-effects panel regression of the (log of) CO2 emissions on current and up to 10 years lags of the EPS21 indicator, interactions of the EPS21 indicator with country-sector shares of fossil fuels in total energy use, and additional control variables. Control variables include the current and lagged sectoral (log of) real gross output and country (log of) real GDP, (log of) labour productivity per hour worked, (log of) capital stock, (log of) real labour compensation, a linear country and sector time-trends, as well as country-sector and year fixed effects. The decomposition of the aggregate country effect into sectoral effects is obtained using each sector’s weight in CO2 emissions/total employment in the respective country for the last year of data available (2014). The sector classification is based on ISIC Rev. 4. Fossil fuels include coal, coke and crude, fuel oil, gasoline, diesel, natural gas, other gases and other types of petrol.
Results are preliminary and might still change slightly until final publication as comments are incorporated. The results are indicative and based on past performance. The ultimate outcome of sector emissions, activity and employment impacts will depend heavily on the design of policies.
Source: (Frohm et al.[29]).
Box 2.3. Carbon leakage and transition risks: international evidence
Carbon leakage arises when countries applying low-carbon policies impact emissions in other countries. If producers and consumers switch to cheaper, imported emissions, local emissions reductions will be offset by increases in global emissions. This will negatively affect domestic producers, lowering their market share. More positively, technology spillovers from economies that are applying low-carbon policies can reduce emissions in countries with no regulations. Finally, if a country is large enough to impact on global markets, it could impact on the demand for energy, reducing prices and encouraging greater consumption.
Evidence of imported emissions offsetting local emissions reductions is relatively limited, with few firms suffering a loss of market share as a result of carbon prices. Empirical studies of cross-country evidence have consistently found impacts around a tenth of the size estimated by forward-looking economic models. Part of the reason for the low impact could be due to past mitigation measures, which cushioned the impact – particularly given that many studies of carbon leakage focus on the European Emissions Trading System. In addition, model estimates rarely take into account frictions such as transport costs that can make it more difficult to substitute domestic for foreign production. Low estimates may reflect the fact that the easiest and lowest-cost reforms were undertaken first.
There is limited evidence of firms divesting from high carbon price areas, but there is evidence from multinationals that new investment is more likely to be located in lower-carbon cost areas. The final impact on global carbon emissions is mitigated by the fact that firms tend to transpose technologies from high carbon price areas when investing in low-carbon cost jurisdictions.
For Luxembourg specifically, (Misch and Wingender, 2021[30]) find a relatively high risk of carbon leakage from higher carbon prices, based on a cross-country estimate of carbon price sensitivity weighted by the share of exports and imports. Luxembourg, like most small economies, will mechanically show a higher risk of carbon leakage due to its high shares of exports and imports.
Source: (Albrizio, Kozluk and Zipperer, 2017[31]); (Dechezleprêtre et al., 2019[32]); (Delera, 2021[33]); (Dussaux, Vona and Dechezleprêtre, 2020[34]); (Misch and Wingender, 2021[30]).
Policy must ensure that the most vulnerable households do not bear the largest risks from the transition
For households, resilience will depend crucially on their ability to fund alternative consumption patterns, especially for transport, as well as to undertake energy efficiency investments in their homes. The ability of workers to reskill towards jobs that are in demand will have an important impact on household income vulnerability (OECD, 2021[35]). The reforms discussed in chapter 1 to improve active labour market policies will be an important tool in ensuring climate resilience.
The transition could have particularly negative effects on lower-income households (OECD, 2021[35]). Households are exposed to the risks of the transition through the impact on their incomes – particularly from employment (D’Arcangelo et al., 2022[36]). Displaced low-skilled workers may be more likely to suffer from long-term scarring effects, as they face higher barriers to reskilling, upskilling and geographical mobility (OECD, 2021[35]); (Phylipsen, Anger-Kraavi and Mukonza, 2020[37]); (Zachmann, Fredriksson and Claeys, 2018[38]). These workers are also most likely to face reduced demand for their jobs regardless of the green transition (see chapter 1).
A clear strategy for managing potential transition risks for employment should be developed, to manage both the displacement of lost jobs and the increase in hiring needs for certain sectors. Jobs that seem most at risk in the transition are concentrated in the transport and manufacturing sectors (see Figure 2.13 and Box 2.4). At the same time, the transition will raise employment in construction, and to a lesser extent the financial and business services sectors (see Box 2.4). This is in line with industry estimates that the number of workers will need to rise above 10 000 to meet demands for new construction as well as expanded renovations (Ministère de l’Énergie et de l’Aménagement du territoire, 2020[6]). Results from exercises such as these, as well as scenario analysis conducted by banks should feed into the skills strategy. Establishing a clear link between the green transition and the sectoral skills and occupation demand papers produced by ADEM could support workers most at risk of climate change and minimise the risks of inadequate labour supply on the transition (ADEM, 2021[39]); (ADEM, 2021[40]). Chapter 1 highlights measures to both increase residents’ labour force participation and the supply of skills through training and migration.
The transition to net zero emissions will imply a higher cost of living, as prices rise to reflect the externalities of carbon usage (D’Arcangelo et al., 2022[41]). The size of the impact will depend on the share of spending on high-carbon activities, the ease with which different consumer groups can change their consumption patterns and the design of policies (Reguant, 2019[42]); (Zachmann, Fredriksson and Claeys, 2018[38]). Although in Luxembourg, lower income households do not have a significantly different share of energy or transport costs in their consumption basket compared to higher income households, they may yet be disproportionately affected by higher living costs, as they are less able to switch to different types of consumption in response to higher prices. This means they must either pay higher prices or reduce their consumption altogether. The current system of wage indexation provides protection from increased costs of living – but it can benefit wealthier households more, and also have other implications for cost-push pressures in the economy (see Chapter 1). As such, targeted measures to help vulnerable groups may be required to manage the social impacts of the transition. The recent responses to the energy crisis could provide useful information both on the impact of the sharp price increases on household well-being as well as on energy-efficiency behaviour. In turn, this could inform the redesign of subsidies and support measures.
Many lower income households tend to live outside city centres for affordability reasons. Their access to public transport options can thus be lower, and their car usage higher. They may find it difficult to alter these consumption patterns despite higher petrol prices, if they face limited access to high-frequency public transport or constraints to financing an electric vehicle or moving into denser, more urban areas. Similarly, less wealthy households who rent will rarely be able to undertake energy efficiency investments to lower consumption and energy costs (OECD, 2021[35]). Landlords, who need to make the investments, face limited incentives to improve energy efficiency, whilst efforts to raise the costs for landlords could simply increase rent inflation.
These potential vulnerabilities suggest the need for a clearer analysis of the transition impact across households’ income brackets and possible policy design adjustments (OECD, 2021[35]). If there are significant divergences across income groups, the transition could increase the recent trend in growing inequality in Luxembourg. Whilst per capita income levels in Luxembourg are more than two and a half times those of the OECD, over the past three decades, social polarisation has risen faster than in most OECD countries. The population shares of the rich and poor income groups have risen in roughly equal proportion. Over the same period, the change in the income share of the rich outpaced its population share, worsening inequality (OECD, 2019[43]). The rise in the share of the lower income group is particularly worrying since they face a very high probability of remaining in this group. Some of this may be due to socioeconomic factors such as levels of schooling and past experience. Worryingly, the children of low-income parents are likely to remain low-income too, much more so than in other OECD countries (OECD, 2018[44]). Coupled with the increase in the number of children in low-income families, this could further lock in poverty and polarisation (OECD, 2019[43]).
Box 2.4. Modelling the impact of the climate transition in Luxembourg
The open source ThreeME computable general equilibrium model was calibrated for Luxembourg in order to consider how the economy responds to carbon price changes. This model has been used by policy makers in France, the Netherlands and the United Kingdom. These results are intended to enrich the domestic policy debate, particularly in terms of the potential impact of a forward-looking carbon price. This is one modelling exercise that be considered alongside a range of models to understand the full impact of climate-related policies on income, well-being and inequality.
Key economic impacts from a higher carbon price
The model suggests a carbon price that rises steadily by EUR 10 per annum could support a reduction of emissions in 2050 by 50% compared to a scenario with no carbon price increases.
The economic impacts of the carbon tax are found to be mildly positive. Although the carbon tax increases costs for firms and households, recycling tax revenues from fuel exports to households and firms helps to fund the increases in investments required to respond to higher carbon prices. Employment rises with growth, as well as the fact that tax revenues are redistributed to the most employment intensive firms. Exports decline, primarily due to lower fuel exports, whilst imports fall because of the reduction of fossil fuel imports.
There are a number of reasons for the positive impact:
The assumption of redistributing carbon tax revenues. If positive, carbon tax revenues are redistributed: households and firms receive back what they pay in transfers. Fuel-export related revenues are divided between households (1/3), firms (1/3) and the government (1/3). The most employment-intensive firms receive the largest share of the revenue allocated to firms.
The carbon tax revenues from fuel exports. When positive and redistributed to households and firms, export-related carbon tax revenues help offset the impact of rising carbon prices for households and firms. Without these additional revenues from fuel exports, the model suggests a small negative impact from rising carbon taxes.
Luxembourg’s economic structure. The share of employment and activity in services sectors is high. The domestic power sector is small and does not require transformation.
The model set-up. The model is of a market-based economy that flexibly adjusts to shocks such as higher carbon prices. Whilst the model includes the costs firms and households must bear when increasing investment, there is no estimate of the income losses associated with stranded assets. The model also does not capture any potential well-being or health benefits.
The industrial sector is expected to reduce output as carbon prices increase, driven by the 2% decline in energy intensive industries relative to the baseline (Figure 2.14). The transport sector faces high transition risks, as increased use of public transport such as rail is not enough to compensate for the decrease in road and air sectors. By contrast, the construction industry expands at a faster rate, as the green transition prompts increased demand for new buildings and renovation. Services output increases in the medium term before stabilising, as it benefits from redistributed carbon tax revenues that allow it to maintain its competitiveness, alongside its role in supplying investment for the green transition.
Sectoral patterns in activity are mirrored in employment changes: overall, job growth is expected to be around 1% higher than the baseline. The construction sector’s fast pace of job creation accounts for the bulk of the increase in demand (Figure 2.15). Labour shortages in the construction and services sectors would reduce their cushioning impact in the green transition. Overall investment levels rise by 3.6% compared to baseline (Figure 2.16). Growth in construction is the fastest-rising investment category, contributing about half of the total increase in investment. Investment in machinery and equipment also increases quickly, but its relatively low share in total investment implies a relatively small contribution to total investment growth.
Figure 2.14. Sectoral changes in output, employment and investment vary
% change relative to the baseline
Source: OECD calculations, based on the ThreeME model (2020).
Figure 2.15. The employment impact could be mildly positive
Total employment and sectoral contribution (difference compared to baseline)
Source: ThreeME Model calculations.
Figure 2.16. Investments will rise, particularly in structures such as buildings and transport
Total investment and sectoral contribution (difference compared to baseline)
Source: ThreeME Model calculations.
The model assumes that investment needs are not constrained by domestic savings, and that there are no credit constraints facing households and firms that wish to invest, consistent with Luxembourg’s strong and well-developed financial centre. Government spending is determined exogenously, but taxes are influenced by economic activity. Fuel sale tax revenues are not modelled separately, as the assumption is that these revenues will be offset by higher carbon tax revenues.
These results are sensitive to assumptions on how Luxembourgish fuel exports respond to carbon prices, which in part depend on the fuel and carbon tax policies in neighbouring countries. The model assumes that other countries raise their carbon prices by EUR 155 between 2030 and 2050. Higher carbon prices in neighbours raise fuel export sales and carbon revenues – but reduce emission reductions. Efforts to raise productivity and investment, such as outlined in Chapter 1, would help reduce this trade-off by raising growth and revenues. They would also improve the economy’s resilience to potential shocks in the carbon price in Luxembourg or its neighbours. Policies to reduce the carbon intensity of the transport sector in Luxembourg and across the region will also be critical.
Source: OECD calculations, ThreeME model (2020).
The financial sector is significantly exposed to transition risks
Globally, the financial sector faces financial stability risks from the economic shifts implied by the green transition. The green transition can impact the financial sector through a variety of transmission channels (see Table 2.3). The ability of clients to repay loans, the value of collateral and possible asset price valuations have been the main risk channels regulators have modelled to determine the risks to financial sector solvency.
Table 2.3. The key banking sector risks posed by physical and transition risks
Source: Adapted from (BIS, 2021[24]); (ECB / ESRB, 2021[45]); (ESMA, 2021[46]).
The Luxembourgish banking sector is exposed to effects of the climate transition on its loan portfolio. Just over 40% of loans from the Luxembourg banking sector to non-financial clients are provided to high or very high emitters (Alogoskoufis et al., 2021[26]) (Figure 2.17, Panel A). This is in line with the average exposure in the euro area. These estimates take into account the complex feedback loops between transition and physical risks – where early action can reduce physical risks but increase short-term costs and transition risks. Preliminary estimates of physical risks from (Alogoskoufis et al., 2021[26]) suggest relatively high exposures (Figure 2.17, Panel B), although these conclusions may change as the number of banks surveyed and the granularity of data increase.
Figure 2.17. The financial sector’s exposure to climate change is high
1. Exposure are categorised as (very) high emitters if a firm's relative emissions are above the 70th (90th) percentile; exposures are categorised as low emitters if a firm's relative emissions are below the 30th percentile. Emission intensities include Scope 1, 2, and 3.
2. Exposures are categorized as high physical risk if a firm's probability of suffering from wildfire or a river or coastal flood in a given year over 1%, exposures are categorised as low physical risk if a firm's probability of suffering from a wildfire or a river or a coastal flood is less than 0.1%. Exposures are classified based on euro area creditor countries. This is based on a preliminary sample.
Note loans are non-financial corporation loans.
Source: (Alogoskoufis et al., 2021[26]).
The insurance sector losses associated with asset price valuations are not expected to be particularly large for Luxembourg. (EIOPA, 2020[47]) estimates that under its central scenario, total losses on the sovereign bond portfolio of Luxembourg-based insurers are estimated at around 0.2%. Losses in corporate bonds and equities are around 10%, as the weight of high-carbon assets is about five times that of low-carbon assets. Nonetheless, the combined effect of these losses is expected to be relatively small at 0.7%.
Increased transparency and ongoing data monitoring are critical to help the banking sector manage the operational challenges of responding to these climate risks. The BCL highlighted that currently, banks may be poorly positioned to cope with the required changes, as loans to high carbon-intensity industries actually increased in 2021 (BCL, 2021[48]). Authorities should continue to adapt financial sector regulation and supervision as climate-related risks and vulnerabilities are uncovered by stress-tests and related activities.
The tools to estimate firms’ climate-related risks are becoming more sophisticated, thanks to increased global regulatory scrutiny of climate disclosures. A range of emerging reporting standards aim to improve the granularity of information about individual companies (Table 2.4). The adoption of these reporting standards and disclosures has been increasing, as regulatory scrutiny and investor pressure has risen, even if the quality of reporting continues to lag coverage (EY, 2021[49]). Authorities should continue to promote a classification of green financing that is able to support clear and client-focused labelling, whilst allowing for a diversity of products to be delivered that could support a wide range of investor preferences. Greater diversification in climate investment strategies helps to limit systemic risks. Credible guidance for how loans to carbon-intensive industries can be classified as supporting the transition or not would help to mitigate the reputational and financial risks for the banking sector. The recent expansion of the remit of the banking and insurance regulators to cover green financial disclosures provides an opportunity for an independent channel to communicate with customers and investigators.
Even as more sophisticated techniques for estimating climate risks become widespread, the need for more granular information about companies’ transition strategies and how they impact risk will increase. With an improved understanding of baseline climate risks, risk management practice will likely begin to shift to estimate how well firms can respond to policy and technology changes. This could become a key differentiator of performance for financial institutions over the long term.
As such, supporting the development of the requisite skills to ensure banks measure and manage climate risk will be critical. Specific programmes targeted to increase the quantitative skills required to manage big data should be prioritised. The current CEDEFOP skills forecast for Luxembourg (CEDEFOP, 2020[50]) projects employment growth in the business services industry of 1.9% per year between 2018 and 2030, with an emphasis on continued demand for clerical skills rather than sophisticated data management. The ADEM projection for the financial sector projects that green analysts will be increasingly in demand (ADEM, 2021[39]). However, data management and skills are not highlighted as a particular focal area – even though demand for these skills rose to around 40% of the financial sector job offers in 2021, from 30% in 2015. Prioritising these skills’ prominence in training programmes and efforts to attract international talent could help to mitigate some of the risks of the transition for the financial sector.
Table 2.4. Global non-financial reporting requirements are under development
Note: 1. Proposals are in draft format. 2. Double materiality defines a material matter from the impact perspective (of the reporting company on society or other stakeholders), the financial perspective (of the finances of the reporting company, regardless of time horizon), or both. This is much wider than the financial materiality concept defined in financial statements and used in ISSB standards. 3. The EU ESG reporting standards are expected to be finalised by the end 2022, with sector specific guidelines released October 2023. 4. Note that the combination of financial materiality and scope 3 emissions means that these risks only have to be disclosed if they have a material impact on firms. 5. This includes large public-interest companies with more than 500 employees (the same companies currently obliged to report under the Non-Financial Reporting Directive).
A policy framework to support the green transition
A broad mix of policy instruments that complement one another is the most cost-effective way of achieving decarbonisation goals, while also being inclusive and socially acceptable (D’Arcangelo et al., 2022[41]). A strong governance framework provides the legal basis for climate action. A steady, rising future path for emissions prices is required to guide long-term investment choices across all stakeholders in the economy. Subsidies and regulations can help to improve the impact of emissions pricing by encouraging broader behavioural change, since pricing alone cannot overcome typical innovation coordination failures (Bessen and Maskin, 2009[56]); (Stiglitz, 2019[57]). Key cross-cutting policies in spatial planning, housing and transport can support the transition by influencing how readily households and firms adapt. A transparent policy to consider how any revenues generated from the transition will be used is required.
Environmental policy stringency in Luxembourg has risen sharply since 1990 (Figure 2.18). As a result, in 2020, Luxembourg was among the OECD countries with the most stringent environmental policies, together with France, Switzerland and Finland (Kruse et al., 2022[28]). Non-market-based instruments rose primarily due to more stringent regulations for sulphur and particulate matter between 2000 and 2010. Greater use of feed-in tariffs, market premiums and solar electricity tenders drove the increase in technology support policies, with green R&D support rising sharply between 2010 and 2020. This has been augmented by increases in the subsidies to support energy efficiency investments for both households and firms.
Figure 2.18. Changes in Environmental Policy Stringency over time in Luxembourg
Note: Policies are scored on a scale from zero to six and aggregated. The market based instruments sub-index groups policies that put a price on pollution, such as CO2 trading schemes, renewable energy trading schemes, CO2, Nitrogen Oxides (NOX), Sulphurous Oxides (SOX) and fuel taxes. The non-market based instruments sub-index puts together policies that mandate emission limits and standards, such as emission limit values for NOX, SOX and particulate matter, and sulphur content limit for diesel. Technology support policies include public R&D expenditure on low-carbon energy technologies and renewable energy support for solar and wind from feed-in tariffs and auctions, relative to the global levelized cost of electricity. Panel B: Other OECD countries may also have introduced changes to their market-based instruments in 2021, which are not reflected in the represented OECD average for 2021, which is equal to the OECD average in 2020.
Source: (Frohm et al.[29]); (Kruse et al., 2022[28]); OECD calculations.
Nonetheless, there are gaps in the overall policy mix. The current policy mix relies heavily on subsidies and regulations (Table 2.5). Luxembourg’s score for market-based environmental policy instruments remains below the OECD average in 2020, reflecting low carbon prices. The recently introduced carbon tax, which is not reflected in the data, will reduce the gap with the OECD average. Increasing the carbon tax to the levels observed in the best performing OECD countries, which would imply a carbon tax rate of around EUR 80 per tonne, would raise the overall EPS indicator by 1.4 points.
Table 2.5. Overview of climate policy tools in Luxembourg
Note: 1. Based on international evidence of public acceptability.
Source: (D’Arcangelo et al., 2022[41]); (Dechezleprêtre et al., 2022[58]), national sources, and authors’ assessment.
Climate objectives should be integrated across key government policies
The governance framework has been strengthened
The climate governance framework has grown significantly in line with Luxembourg’s climate ambitions. The governance and accountability of the government’s climate strategy is grounded in a climate law passed in December 2020, which provides a legally binding mechanism for action on sectoral targets that are set every ten years. According to the law, government plans must be guided by a national energy and climate plan every 10 years, which includes updated sector targets for energy reductions and the path for policy direction, as well as a 50-year strategy document issued every ten years, which sets the broad objectives for climate policy. The climate law is an important step: without it, those opposing climate policies can block action; the law provides a basis for policies to be advanced or to block policies that run counter to climate action.
Legally binding targets set into the future are an important commitment mechanism and can send important signals for certainty. The targets are reviewed every five years in line with the National Energy and Climate Plan. Regular reviews based on evidence are intended to allow for new information to be taken into account in setting targets, and will include extensive consultation with industry. Clear and regular entry points in the policy-making process for the civil society would help to enhance public acceptance of ambitious green policies (D’Arcangelo et al., 2022[41]). Luxembourg’s engagement with civil society and its ability to absorb inputs from those actors outside formal business and labour has been raised as a difficulty in general legislative processes (OECD, 2021[59]); (European Commission, 2022[60]). The 2020 climate law established the climate platform, a panel of experts appointed by government to test government policies. The Luxembourg in Transition project, which included a Citizens’ Committee that developed a report with concrete recommendations, forms a good basis for continued engagement. The Citizen’s Office for the Climate (KlimaBiergerRot) has been established to develop proposals to influence the 2024 National Energy and Climate Plan (Ministère d'État; Ministère de l'Environnement, du Climat et du Développement durable; Ministère de l'Énergie et de l'Aménagement du territoire - Département de l'aménagement du territoire, 2022[61]). These provide a platform for the public to engage on climate-related research, including that produced by the Climate Observatory.
To maintain good faith, engagement needs to also consistently show that recommendations are taken into account. In France, the President committed to taking forward the recommendations of the Convention Citoyenne pour le Climat with either a referendum, parliamentary votes or direct regulations (Ministère Ecologie, 2021[62]). The “Climate and Resilience Bill” (“Loi Climat et Résilience”), presented in early 2021, sought to implement many of the measures proposed by the citizens’ convention and to enhance existing environmental policies (OECD, 2021[63]).
Evidence-based, two-way communication is critical to maintain support for the green transition
Support for the green transition amongst Luxembourg’s citizens is high. According to the latest Eurobarometer Survey on climate change attitudes, 78% of citizens consider climate change to be a very serious problem and 63% think the government is not doing enough to tackle the problem (Eurobarometer, 2022[64]). This support may, however, be contingent on the relatively low costs households have faced from the green transition so far. The war in Ukraine and sharp increase in energy prices will test public support.
Government targets imply large changes in household behaviour to reduce transport and residential buildings emissions. This increases the potential resistance to change in the future. Uncertainty about the benefits of the transition, risk aversion, high upfront costs for new investments and learning, and misperceptions of costs can reduce the willingness of firms and consumers to change (see Box 2.5), leaving them poorly prepared in the medium to long term. In the short term, this can increase the risks of a misalignment between policy objectives and the perceptions of firms and households, and itself pose risks for the transition. Experience from other countries, such as in France, suggests that the yellow vests movement, which opposed environmental taxes in 2018 and 2019, was driven by a poor understanding of the social benefits, the lack of compensation schemes and a lack of responsiveness to the combined impact of global prices and domestic policy choices (CEDD, 2019[65]).
The government has primarily responded to political risks to date by trying to keep the costs for households low, with a heavy reliance on generous subsidies and a very gradual increase in the carbon price. But lowering costs that households face is not necessarily the most effective strategy. Denmark, Sweden and Norway have managed the political risks of the transition in spite of sharp increases in the costs faced by households. Critical determinants of policy acceptance were clear communication campaigns, which stressed the objectives of the transition, and clearly defined programmes to support the vulnerable. Continued engagement will be required as policy choices are likely to become more difficult to ensure that society remains committed to the transition (Dechezleprêtre et al., 2022[58]).
Public debate would benefit from more precise quantification of the impact, costs and benefits of different policy tools – including a range of carbon pricing strategies – as well as the fiscal implications of long-term choices. A recent study has shown that across OECD countries, on average, people are more likely to support subsidies for developing clean technologies or bans rather than direct taxes on fossil fuels (Dechezleprêtre et al., 2022[58]). Politically popular policies are not, however, always economically efficient. Explicit revenue earmarking is generally discouraged, as it creates rigidities in spending priorities and reduces the efficiency of government allocations (D’Arcangelo et al., 2022[41]). Compliance costs for standards and rules can be high, particularly for lower-income households and smaller firms. For example, (Gillingham and Stock, 2018[66]) estimate implementing fuel standards could cost up to USD 2 900/tCO2. Others such as (Goulder and Parry, 2008[67]) suggest that regulations double the average costs per unit emission reduction compared to price interventions.
The eventual policy mix chosen by authorities needs to take into consideration the individual and combined impact of policies. Box 2.4 outlines the initial results of a modelling exercise conducted for this Survey, in order to estimate the potential impact of different carbon price trajectories. Given the complexity of the transition, no single model will be able to provide a complete picture of risks. A suite of models to consider the implications of various policy combinations should be used, and the results framed in the context of the risks of action and inaction. In the United Kingdom, Netherlands, Denmark and France, independent bodies play a key role in producing, disseminating and commenting on climate-related research and the potential impacts on the economy.
Luxembourg’s climate law established a climate policy observatory to lead on technical aspects related to climate policy. By establishing its neutrality and focusing on evidence-based policymaking, the Climate Observatory can play an important role in information sharing and acting as a trusted arbiter for social debates. It can commission and disseminate research, including for climate models that allow for a balanced and broad-based assessment of climate risks. The Climate Observatory should also evaluate potential policy tools’ impacts across different types of households, which will allow for a more informed set of public policy debates. Consideration should be given how to best coordinate the work of the Observatory and the considerable expertise in STATEC, which is another trusted body providing neutral assessments of policy choices.
The policy planning framework could better incorporate uncertainty
The timing and costs relating to the realisation of climate risks are not always clear and there can be considerable uncertainty relating to the impact of climate policy. In addition, biases in measuring the risks of acting too soon or too slowly can hamper effective policy formation (Box 2.5). This can pose a considerable challenge in Luxembourg, where individual firms account for a larger share of total employment compared to their OECD counterparts, making it harder to generalise whether changes in firm circumstances are driven by unique events, or market forces. Changes in the fortunes of one firm could have an outsized impact on perceived costs and risks associated with the climate transition. This in turn could generate resistance to change or encourage overly generous subsidies and offsets. Overly generous support will not only represent an opportunity cost for funds, but could lock in lower carbon production techniques that expose the country to sharper transition costs in the long run. Supporting less productive firms could also lower overall aggregate productivity growth further.
Box 2.5. The biases in assessing climate risks and policy responses
Measurement bias. Uncertainty about the transition stems from uncertainty about the impact of policies on behaviours, as well as technological uncertainty on the timing and availability of alternatives (Table 2.6). Risk analysis tends to gravitate towards measuring what is known and over-emphasise the importance of maintaining the status quo - in this case, the costs of moving too fast, which are particularly salient since they are borne immediately, by a concentrated and identifiable set of stakeholders. By contrast, analysing the benefits of firms or households that do not yet exist seems less precise. The costs of acting too slowly (or the benefits of acting sooner) can seem less salient as they are estimated to take place in the future, and the benefits are often diffuse.
Table 2.6. There are upside and downside risks in transitioning to a greener economy
Over-optimism. There is a tendency for policy makers to make unrealistic assumptions about the potential impact of technology on climate goals. Independent audits and assessments of governments’ climate strategies can highlight these problems. In the United Kingdom, the Committee of Public Accounts recently assessed the government’s net zero strategy, including the plausibility of its assumptions relating to technological change.
Tendency towards the mean. The tendency to focus on central scenarios rather than a range of possible climate outcomes reduces the resilience of policy design to potential catastrophic, low-probability but high-impact events or “fat tail” events that have higher probability than a normal distribution would suggest. Policy making should explicitly include a range of potential climate scenarios and then assess the extent to which it will design policy to respond to non-central case scenarios. In South Africa, a range of potential climate scenarios were calculated based on global models. This was then used to understand the possible impacts on the economy and infrastructure costs, and to design the climate strategy.
Integrating the climate transition more holistically into the fiscal framework
The timing and use of climate tools will have significant implications for fiscal policy, which need to be managed. The government has committed that reaching the climate goals will be done in a fiscally sustainable manner. (STATEC, 2020[71]) has produced estimates of the potential impact of the carbon tax on overall revenues. However, as yet, no long-run estimates of the sensitivity of revenues to potential changes in GDP composition associated with the green transition have been provided. On the spending side, it will be critical to estimate the duration and take-up of subsidies (including rebates and tax credits), commitments to new infrastructure, maintenance, and climate adaptations, as well as catastrophe-related spending. Current take-up of subsidies is low, but the generosity of benefits is high. Rapid take-up could substantially increase fiscal costs.
There is room to improve the integration of climate policies in the overall policy framework to better assess policy impacts. Integrated policy making needs to take into account the feedback loops between economic growth, well-being and climate impacts. Chapter 1 has highlighted a number of mechanisms to increase the rate of growth in productivity, which should reduce the resource intensity of the economy if combined with a clear set of prices, regulatory tools and subsidies discussed below. Nonetheless, society will face important trade-offs in deciding which spending, and by implication, which generations and households benefit most. Granular, reliable data is critical to estimate the impact of policies on the economy, environment, and well-being. Better estimates of the potential sensitivity of revenues and spending to the transition can help the government weigh up the potential risks in light of other spending choices, most notably ageing-related spending which will significantly raise debt without pension spending reform, lower spending or higher taxes (see chapter 1).
Clearer estimates of the impact of policies on different households could help to inform the debate. A microsimulation model that allows the fiscal impacts of different tax and spending choices to be interacted with changes in labour market outcomes for households would allow policymakers to better assess the costs associated with the transition across different household sectors, and their interaction with existing policy tools. Making information more readily available on take-up and costs of existing support schemes would allow for alternative assessments of the government’s spending plans, which can enrich public debate about the trade-offs necessary in the transition. The National Council of Public Finance could play an important role in developing a research agenda that better considers a framework for evaluating these risks. This should reference work on policy tools that are recommended to be conducted by the Climate Observatory, as well as the foresight work being undertaken by the government under the Luxembourg Stratégie project. The response of households and firms to the energy price shock and the subsequent policies to help manage the energy crisis can provide valuable information to refine policy makers’ understanding of the transmission channels.
High uncertainty about technological change as well as how firms and households will respond means there is a large margin of error in estimating the fiscal costs of the climate transition that can compound over long time periods. However, these high levels of uncertainty do not have to stymie policymaking. As is the case with monetary policy decision-making under high uncertainty, sensitivity and scenario analysis can allow policy makers to understand the risks and choose a course of policy action that can be sensitive to how these risks develop over time. Sensitivity analysis allows policy makers to consider how much assumptions on policy design (such as take-up or costs per line of road) might alter final costs and revenues. These estimates can be assigned probability weights. Scenario analysis allows policy makers to consider how policy design might have to change in response to a shock in economic growth or the failure of a programme to affect carbon emissions, and the resultant required policy responses.
The public infrastructure planning framework should be adapted to better cope with the uncertainty of the physical and technological risks of climate change and the implications for infrastructure spending. Whilst estimates of expected annual damage to infrastructure for Luxembourg are quite low compared to the rest of Europe, actual climate outcomes could vary substantially. For example, (Forzieri et al., 2018[72]) estimate that on average, expected annual damage to infrastructure would be about EUR 8 million a year, rising to EUR 11 million in 2050s. Torrential floods in 2021 caused large-scale economic damage, estimated at EUR 120 million. The government spent EUR 50 million in support for those affected by the devastation (Edde, 2021[73]).
The difference between expected and actual climate outcomes can create very high adaptation costs for infrastructure projects, which lock in resources for a long time and can be costly to convert. At the same time, building infrastructure for the worst-case outcomes can represent a large opportunity cost and may result in high levels of redundancy. These could be higher in the event of technological shifts. Significant infrastructure outlays are planned for rail and road electrification, and there will be the need to adapt road infrastructure for hydrogen or other fuels. Spending on flood defences will rise, along with water reticulation systems. It may be more appropriate to adapt current infrastructure design rather than to build immediately, to lower the cost of future changes in technology or policy. This could include adapting design to allow for hydrogen pipelines in the future, as electric charging infrastructure is increased along roads that can be adapted in time, without building the full infrastructure at present.
Infrastructure planning should incorporate project evaluation techniques that can be used to understand the value for money of different infrastructure design options in light of uncertainty (OECD, 2021[74]). Project evaluation techniques can be used to assess infrastructure projects in the face of climate risks that may vary over time. The most popular forms are known as “real option analysis” or “NPV+”. Investments are considered in terms of the annual benefits from climate proofing, the costs of implementing adaptation measures, and the time at which the investment’s net present value is maximised. This provides a structured framework for understanding the risks of investing now rather than later (ADB, 2015[75]). Policy makers have a framework to help determine whether an infrastructure project should be built now or later to mitigate the impact of climate damage.
This framework will allow the timing of different investment projects to be weighed up against one another – for example, the impact of additional water distribution systems compared to faster road network expansion for commuters. These have been used in Viet Nam, India and Bangladesh to help the government estimate the potential benefits of acting sooner rather than later (ADB, 2015[75]). (Ginbo, Di Corato and Hoffmann, 2021[76]) list over 80 projects where academic papers have been published on the use of these frameworks. Comparing the costs of different types of infrastructure explicitly can further strengthen the case for green infrastructure: public transport and active transport modes such as cycling have much lower capital costs of construction (Buckle et al., 2020[77]); (IEA, 2020[78]).
There could be significant learning and demonstration effects across the economy if the public finance framework could further strengthen the framework for assessing transition costs. Green budgeting is currently applied through a tagging system that records spending linked to programme objectives. This is relatively common. A more comprehensive approach would include an assessment of the emissions associated with individual projects and programmes, whether or not the policy had a green policy objective. This has been applied in the United Kingdom, according to a set of published guidelines. Different policy options available to the government could then be explicitly evaluated in terms of their carbon impact in the near and long term. Whilst it is inevitable given current technologies that many projects will generate net carbon emissions, the learnings from this work would have broader application. An initial pilot could be conducted with projects that are intended to be funded by the Climate and Energy Fund. Enhancing the cost-benefit framework to evaluate the emissions impact of projects at the design stage, including the use of a shadow carbon price, would create an important tool to embed green transition considerations into project design, in advance of the preparation of public budgets.
Supporting physical risk preparedness
The Stratégie d’adaptation aux effets du changement climatique pour le Grand-Duché de Luxembourg 2018-2023 (Ministère de l'Environnement, du Climat et du Développement durable, 2018[15]) outlines some of the potential adaptive measures that could be undertaken under the most likely climate scenario, but these did not receive much prominence in the 2050 Climate Strategy. Greater emphasis on how government plans to undertake these adaptations is required, as they could entail substantial infrastructure costs and regulatory requirements. The potential measures should be elaborated in more detail in the upcoming update of the Stratégie d’adaptation aux effets du changement climatique pour le Grand-Duché de Luxembourg, and given greater prominence in the policy setting framework. The adaptation measures should be augmented with planning systems that consider other potential catastrophic events, including the national flood risk management plan.
Insurance has an important role to play in the policy toolkit to manage physical risks from climate change (OECD, 2016[79]). Increasing insurance coverage can help to mitigate the individual losses for a firm or household, and provides an important public good since it protects those who are not directly responsible for climate change (OECD, 2016[79]). Higher levels of insurance penetration provide governments with greater flexibility to provide fiscal stimulus in the aftermath of a disaster (Von Peter, von Dahlen and Saxena, 2012[80]). In addition, insurers are able to increase understanding about how risks are evolving, and which adaptation strategies are most useful, by sharing aggregated portfolio information (Hudson et al., 2020[81]).
The authorities are considering alternative insurance models for flooding risks (Jans, 2021[82]). Currently, voluntary flood insurance is complemented with state support following particularly severe natural disasters. Coverage for flood insurance seems high, at 50% of households (Jans, 2021[82]). Recent flood events may have heightened awareness of flooding risks, consistent with international evidence (Hudson et al., 2017[83]); (Gallagher, 2014[84]). The insurance protection gap, which captures the difference between insured and actual losses, is not considered material for Luxembourg (ECB / ESRB, 2021[45]). A 2017 regulation capped flood insurance support to EUR 100 000 per annum for homes in flood-risk areas, and EUR 1million for other homes. Limiting payouts probably helps to keep premia affordable, but a study on the quantitative impacts of the policy would be useful. Alternative models could be considered to keep premia affordable (Box 2.6). Increased efficiency in the non-life insurance sector serving the domestic market, for example through increased use of digitalisation to lower operating costs or increasing competition, could also potentially lower costs and insurance risk premia.
Box 2.6. Supporting the provision of affordable flood insurance protection: what other countries do
Insurance for disasters such as floods can become prohibitively expensive, particularly when risk is very localised and events frequent. Including lower-risk policy holders can help reduce payout risks for insurers and keep premia low. In the Czech Republic, Ireland, New Zealand, Portugal and the United Kingdom, mortgage lenders require borrowers to obtain insurance protection against flood risk. In most Swiss cantons, property owners are required to take out all-risk insurance.
Public support is often provided to help keep premia uniform, regardless of the flood risk faced by the policy holder. In Spain, private insurers can pass on certain flood risks to a public re-insurer. In France, private insurers automatically extend coverage to include natural disasters (at a flat rate) and can reinsure up to 50% of their natural disaster exposure with a public reinsurer. In the United Kingdom, the insurance industry runs FloodRe, a fund which compensates insurers for providing homes built before 2009 in the highest flood risk areas with lower-than-market based premia. It is funded by general levies on home insurance and flat fees charged to subscribing insurers. The scheme is intended to end in 2039, after which premia will fully reflect market risks.
Other public support options that can keep premia low include reducing the cost for insurers in the event of extreme flood risk events. In Thailand, the government reinsures a portion of insurers’ catastrophic risk. In Belgium, the government provides government support above certain thresholds.
In all these instances, standards and regulations are required to ensure that high-risk individuals take action to lower their risks as much as possible, and to ensure that the product offering from insurers is competitive.
The design of insurance could strengthen incentives to reduce the impact of flood risks, at both the community and household level (Lé, 2022[88]). Collective investments in localised areas, for example to support faster drainage of water after floods, can help to reduce overall damages in the event of floods, but can be difficult to coordinate. In France, deductibles increase if there are repeated disasters in the same area and the community lacks a risk prevention plan to manage these risks (OECD, 2016[79]). In the United States, certain flood-prone areas require communities to purchase insurance alongside individual homes. Participating in the voluntary community rating system, which considers land-use planning and other risk mitigation measures, can reduce communities’ insurance premia (Kousky and Michel-Kerjan, 2017[89]).
Insurance contracts can support homeowners to improve flood defences following floods. In the United Kingdom, homeowners receive GBP 10 000 in addition to their insurance pay-out to better prepare for future floods (FloodRe[86]). Increasing the awareness and market value of flood mitigation investments can also incentivise renovations, particularly if concentrated on the sale of homes. In France, sellers and landlords are required to provide information on any compensation received for natural or technological disasters; the risk of flooding must be disclosed as part of the home purchase process (OECD, 2016[79]). Formal certification could further strengthen this signal to markets. In Germany, flood resilience certificates are issued by experts to homes to improve access to insurance (OECD, 2016[79]) – but could be used in a similar way to energy certification.
A uniform, rising carbon price path can anchor incentives to lower emissions
Many emissions have been priced at rather low rates
Carbon pricing is one of the most effective and efficient ways to manage the transition in the short term, as it covers the cost of externalities and the largest polluters pay the most (D’Arcangelo et al., 2022[41]); (OECD, 2021[90]); (D’Arcangelo et al., 2022[91]). A generalised carbon price supports innovation that is broader in application than most subsidy schemes, and as such could increase the impact of existing innovation programmes (EIB /Bruegel, 2012[69]). Carbon pricing in Luxembourg is currently governed by two schemes: the European emissions trading scheme and a carbon tax for emissions not covered by this scheme.
The Emissions Trading Scheme (ETS), which uses a cap-and-trade system to increase the cost of polluters in power stations, energy-intensive industries and civil aviation, covers around 15% of Luxembourg’s total emissions. The ETS is currently in its fourth phase, which includes a number of reforms to try and improve the signal from carbon prices. This should increase its overall impact, and the price of carbon is beginning to rise in these schemes to reflect these changes (Figure 2.19, panel A). Participation in the ETS scheme means that Luxembourg’s industrial carbon pricing is in line with OECD peers, if lagging best performers (Figure 2.19, panel B). The impact of these prices, however, is not fully felt by firms, who receive free allowances to help offset the impacts of the increases. Luxembourg has been relatively unaffected by the reduction in ETS allowances in the fourth round, which are largely unchanged between 2021 and 2025: only four firms’ allocations were reduced by 10% over the period, equivalent to a 0.1% reduction in total allocations by 2025.
In non-ETS sectors, however, the price of carbon is very low compared to OECD peers. Carbon prices faced by the transport and residential sectors, which account for a combined 60% of greenhouse gas emissions, are not included in the ETS scheme. As a consequence, the gap in prices between Luxembourg and peers has been much larger in these sectors (Figure 2.19, panel B). The OECD’s carbon pricing score, which measures how close countries are to pricing carbon at the reference price of EUR 60 per tonne shows the residential sector and agriculture have very low carbon prices (Figure 2.19, panel A). In the case of agriculture, no emissions are priced at EUR 60. In the case of road transport, the price of carbon is higher than in other sectors – but still lags behind neighbouring countries, maintaining the incentive to use Luxembourg as a refuelling stop (Figure 2.20). Box 2.7 outlines some of the key issues to consider when comparing Luxembourg’s energy pricing to other countries based on aggregate pricing indices.
Figure 2.19. Industry faces carbon costs in line with the OECD average thanks to the Emissions Trading Scheme
1. The carbon pricing score measures the extent to which countries have attained the goal of pricing all energy related carbon emissions at certain benchmark values for carbon costs or more. The more progress that a country has made towards the relevant benchmark value, the higher the carbon pricing score. OECD is a simple average of all OECD countries. Key emerging markets includes Argentina, Brazil, China, India, Indonesia, Russia and South Africa. The best 5 includes the countries with the highest sub-sector prices. They are all OECD countries.
Source: OECD Effective Carbon Tax Rates; Refinitiv; and OECD Green Growth Indicators.
Figure 2.20. Pricing of emissions in the road sector is lower than in peer countries
Source: OECD Effective Carbon Tax Rates; and OECD Green Growth Indicators.
The high purchasing power of Luxembourg’s residents is likely to further reduce the impact of these already-weak price signals. Global evidence suggests high incomes reduce the sensitivity of demand to price changes across a range of countries and products such as energy and food (Femenia, 2019[92]); (Labandeira, Labeaga and López-Otero, 2017[93]). Current levels of environmental taxation are low (Figure 2.21).
Figure 2.21. There is substantial scope for higher environmental taxes
% of GDP, 2020
Note: For Australia, data refers to 2018.
Source: OECD Environmentally related tax revenue (database).
Box 2.7. Measuring the effective carbon price in Luxembourg
The OECD Effective Carbon Rates (ECR) database provides an overview of how emissions are taxed at the economy-wide level and within its main sectors, covering 44 OECD and G20 countries. The ECR is measured in euros per tonne of CO2 and consists of three main components: emission permit price, carbon tax, and fuel excise tax. The ECR averages carbon prices across the economy.
The Carbon Pricing Score (CPS) measures the extent to which a country prices its emissions at a given benchmark. For example, a score less than 100% at the EUR 60 per tonne benchmark means that some but not all emissions are priced at that level. The CPS allows cross-country comparisons against a given benchmark and, unlike the ECR, is not distorted by high-value outliers that mask the distribution of carbon pricing within an economy. The CPS is calculated for individual sectors and then aggregated to a country level based on the contribution of those sectors to overall emissions.
Luxembourg’s aggregate CPS score is heavily influenced by the price of carbon in the transport sector, given its high weight in total emissions (57.4% versus an OECD average of 24.1%, see (Figure 2.5). In most OECD countries, including Luxembourg, emissions in the transport sector are typically priced higher than in other sectors of the economy. As a result, Luxembourg’s CPS at EUR 60 was 69% in 2018, the second highest among OECD countries – even though the majority of emissions in non-road transport sector are not even priced at the lowest benchmark of 30 euros per tonne of CO2 and its road freight sector faces lower prices than many other OECD countries. It is therefore advisable to assess Luxembourg’s carbon rates sector by sector, as done above.
Source: (OECD, 2021[94]).
A carbon price has to be set at a level that incentivises a change of behaviour, although there are a range of estimates given the uncertainties as to the behavioural, technological and environmental assumptions used. The World Bank estimates that a price within the range USD 50-100 per tonne by 2030 is needed, together with other policies, in order to not exceed temperature increases of 2 degrees Celsius, the upper end of the Paris agreement (World Bank, 2022[95]). On its part, the OECD has established three benchmarks based on modelling exercises (OECD, 2021[94]); (Kaufman et al., 2020[96]):
EUR 30 per tonne of CO2: a historic low-end benchmark for carbon cost in the early and mid-2010s
EUR 60 per tonne of CO2: a low-end benchmark for carbon cost by 2030
EUR 120 per tonne of CO2: a central estimate of the carbon price needed in 2030 to decarbonise by mid-century, assuming carbon pricing plays a major role in the overall decarbonisation effort
The government recently introduced a carbon price that applies to all sectors other than those in the ETS. The carbon tax rate was raised to EUR 25 in 2022 and will be increased further to EUR 30 in 2023. The main impact of this increase in the carbon tax is expected to materialise in the transport sector as it increases the fuel price and discourages non-resident “fuel tourism”. The introduction of a carbon price is welcome, but in order for it to be even more effective, the government needs to provide more clarity regarding the long-term carbon price trajectory that is consistent with its climate objectives. A clear carbon price signal into the future is also needed in order to encourage investments in the green transition. At present, the government has not set a planned target rate for the carbon tax nor announced further increases beyond 2023.
Since the second half of 2021, following the post-covid resumption of growth and Russia’s war of aggression in Ukraine, global energy prices have been on the rise. Oil and gas prices reached record levels on wholesale markets. Whilst this could potentially speed up the transition to higher carbon prices, the pace of change poses risks, prompting many governments to take measures to cushion households and firms from the full price increases. In Luxembourg, the government decided to provide energy bonuses for low-income households, provide aid to businesses affected by the increase in energy prices, as well as cap the increase in gas and heating oil prices from October 2022 (Box 2.8). The energy price caps are intended to avoid what would otherwise be a more than doubling of energy prices between September 2022 and January 2023. The pace at which authorities will exit these price caps will depend on international energy price developments as well as on fiscal, growth, inflation and social welfare considerations.
Box 2.8. Recent energy efficiency measures to respond to the energy crisis
In response to the recent energy crisis, the government in Luxembourg has sought to cap energy price increases and raise transfers to households and business. In addition, it has increased financial support for household and business investment in alternative energy supplies. The generosity of household subsidies for investments in solar panels has been raised.
To accelerate the green transition to alternative power sources, companies will receive subsidies to install off-grid photovoltaic energy. In addition, companies are encouraged to enter into long-term power purchase agreements for renewable energy, to further encourage the switch away from non-renewable electricity sources. In order to mitigate the risk of entering into long-term contracts at a time of high energy prices, the government has committed to pay two thirds of the difference between the power purchase agreement and the market price, should market prices fall below the levels in the power purchase agreement, up to a maximum of EUR65 per MWh.
The complexity of factors influencing the eventual withdrawal of the energy price caps could introduce considerable uncertainty about the future path of carbon pricing. Uncertainty about the carbon price is likely to discourage investment (EIB, 2021[98]); (IEA, 2017[99]); (Ren, Shi and Jin, 2022[100]); (Blyth et al., 2007[101]), particularly in the context of already high levels of uncertainty about green regulations and taxes (Figure 2.22). Higher levels of certainty can reduce the level of the carbon price required to impact behaviour. It could also leverage the fact that households and firms tend to respond more to changes in taxes than general price increases (D’Arcangelo et al., 2022[91]); (Chetty, Looney and Kroft, 2009[102]); (Andersson, 2019[103]); (Li, Linn and Muehlegger, 2014[104]).
Figure 2.22. Uncertainty about regulations and taxes is an obstacle to green investment
2019, % of all firms
Note: Share of firms citing uncertainty about the regulatory environment and taxation as an obstacle to investing in activities to tackle the impacts of weather events and emissions reduction.
Source: (EIB, 2020[105]).
Choices on energy price caps should be communicated within the context of the medium- and long-term carbon price path, as well as their potential impacts on the economy and society. This information could help demonstrate consistency in decision making and reinforce credibility. The authorities could provide certainty by announcing a carbon price path that includes the impact of energy price caps, taxes as well as market-related energy price developments. Committing to ensure that the price of carbon will at least be at a certain level can still send clear signals about the direction of market movements, without unnecessarily increasing hardship in the short term for firms and households. Such a policy would avoid increasing carbon taxes when market prices of most energy types have increased, which could threaten the sustainability of the transition. Indeed, the timing of the French authorities’ efforts to implement a carbon tax, in light of rising oil prices, has been identified as a reason for the policy’s eventual failure (CEDD, 2019[65]). A clear long-term carbon price would also be compatible with any potential changes that may be introduced at a European level to support the creation of new emission trading schemes (Box 2.9).
Box 2.9. Coordinating the carbon tax and a potentially expanded ETS
To meet the target of net zero emissions by 2050, the European Commission has proposed the introduction of additional, separate ETS schemes to broaden the scope of the current ETS, with a scheme for residential heating and transportation fuels, and a third scheme to govern air emissions. Energy suppliers, rather than consumers such as households, would have to apply for permits for the goods that they sell, passing their higher costs to end consumers. The current proposal has no free allocation to avoid potential over-provision of permits and the associated slack in prices.
A clear, forward-looking carbon price trajectory would be an asset whether or not the multiple ETS scheme is in place, as it allows the government to set a minimum floor for ETS prices that is consistent with its carbon tax trajectory.
It provides a clear price signal to the economy. In the United Kingdom and the Netherlands, the ETS scheme has been combined with a price floor. The first pillar of the Dutch strategy is a carbon levy on industrial emissions which applies if EU ETS prices fall under a certain level. In this case, emitters pay the differential to the floor price. Implemented in 2021 with a clear pathway, it is expected to reach a total of EUR 125 per tCO2 in 2030 (including EU ETS prices) adding some certainty to sectors subject to variable prices under the EU ETS.
In Germany, where a second ETS has been put in place for transport and building heating sectors, the government has pre-published trading prices from 2022 to 2025. In 2026, it will operate within a corridor and thereafter potentially with caps, given that it will be a second trading system, rather than a specific carbon tax. The firms subject to the EU ETS will have an exemption from the costs of this scheme’s ETS.
A minimum carbon price also has the advantage of moving towards a more unified carbon price across sectors, rather than maintaining the current segregated carbon markets. Highly segregated markets can increase welfare losses if sectors with high abatement costs are expected to share a higher adjustment burden.
It provides an opportunity to continue to participate in the broader European project, whilst still progressing towards the more ambitious policy goals that Luxembourg has set itself.
The fiscal implications of a move to higher carbon pricing have become more uncertain. In the short term, if sustained, international energy price moves could increase the size of energy-related expenditure, but may be offset by reduced energy consumption as the economy slows. The current energy price shock could have a lasting effect on long-term energy price demand in Luxembourg and the region. Before the crisis, the short-term revenue implications of a carbon tax for Luxembourg were estimated to be slightly negative (STATEC, 2020[71]). A higher carbon price would reduce fuel sales to non-residents and freight trucks, which in turn would lower excise revenues. (STATEC, 2020[71]) estimated that revenues may be 0.1% lower in 2023 than without the carbon tax, taking into account not only lower fuel sales, but also lost revenues from tobacco sales. In 2021, excise duties on fuel represented about 0.8% of GDP in tax revenues, from 1.1% between 2017 and 2019. In the longer term, a key variable will be the extent to which carbon prices change in the greater region, since this influences the extent to which refuelling behaviour for freight and cross-border workers changes (see Box 2.4). Should revenues materialise in the short and medium term, they could be used to support the transition, offsetting the impacts of a rising cost of carbon.
A clear policy for using carbon price revenues is needed
Although environmentally related taxes are intended to alter behaviour rather than generate revenue, carbon and other environmental taxes result in revenue streams in the short to medium term. Over the longer term, revenues from environmental taxes should fall as behaviour changes. Evidence finds that carbon taxes are best accepted when they are clearly not a revenue-generating mechanism (Dechezleprêtre et al., 2022[58]); (D’Arcangelo et al., 2022[91]). The public tend to favour measures such as earmarking of funds to support either those affected by the green transition, or to help lower the overall tax burden (Figure 2.23). Typically, explicit revenue earmarking is not favoured, since it creates rigidities in spending priorities, reducing the efficiency of resource allocations. However, the earmarking of funds can vary along a relatively wide spectrum, with the largest costs being associated with very narrow earmarking (Marten and van Dender, 2019[112]).
Modelling estimates suggest that redistributing carbon tax revenues back to firms and households can help to mitigate the impact of the carbon tax on economic growth, assuming that the impact of the carbon tax on overall fiscal revenues is neutral or positive (Box 2.4). In the event that the carbon tax structurally lowers revenues (for example due to a sharp fall in fuel and other excise revenues), such a policy would involve additional fiscal trade-offs. These should be considered within broader policy goals, including well-being (see discussion above). The choice of how to use any carbon-tax related revenues should be based on a combined assessment of the size of the revenues and their impact on the fiscal framework, the potential economic and social impact of revenue use, and an assessment of their public acceptability.
Figure 2.23. International evidence suggests public support for a carbon tax is higher if revenues are used for environmental purposes
Proportion of people supporting carbon tax if the revenues are used for the following measures (%)
Source: (Dechezleprêtre et al., 2022[58]).
Higher or more widespread carbon taxes are more likely to require being associated with broad tax reforms or transfers to be socially acceptable (Marten and van Dender, 2019[112]). The distributional consequences of broad revenue redistribution schemes must be estimated, as they could be larger than the direct inequality impacts of the carbon tax itself (Williams, 2016[113]). Revenues could also support green public infrastructure investments that have widespread public support, such as high-speed rail linkages (EIB, 2022[114]). However, revenues should not support higher subsidies for investments to mitigate the impact of the carbon tax, as this is likely to subsidise investments that would likely already have occurred in the presence of the higher carbon tax (Marron and Morris, 2016[115]).
In Luxembourg, higher carbon prices could be associated with reduced tax rates, although the economic case for such a reduction is limited in Luxembourg. Average personal income tax rates are already relatively low, with personal income tax a relatively low share of total incomes earned compared to the OECD average. The system significantly discriminates against single earners, but this group is unlikely to be favoured in tax reform initiatives. Whilst the corporate income tax rate and the effective tax rate are close to the OECD median, the corporate tax rate has declined over time. Immovable property tax rates are also low compared to OECD peers.
It therefore seems sensible to channel at least some of the carbon tax revenues towards transfers. These could be uniform, favouring all households, or targeted towards lower-income households, which the green transition disproportionately affects (EIB /Bruegel, 2012[69]); (OECD, 2021[35]). A portion of the revenues could also be directed towards improving the quality of public transport. In Luxembourg to date, additional carbon tax revenues are used both for social and for environmental measures. The introduction of the carbon tax was associated with higher tax credits for lower income workers, the self-employed and pensioners. Half of the government’s current carbon tax revenues fund tax credits for the lowest 40% of households and the remaining half funds climate-related investments.
A number of countries have used carbon tax revenues to fund explicit redistribution mechanisms. Sweden explicitly announced in advance that subsidies and taxes would be gradually adjusted over time to reflect a higher carbon price, but coupled this with explicit transfers to benefit lower-income households in particular. The green tax increases of 2001 to 2006 were matched with cuts in income taxes focused on low-income households, and the increases of 2007 to 2013 were matched with sharp reductions in labour taxes (Ministère des finances, 2018[116]). In Switzerland, to compensate for the introduction of a carbon tax on heating fuels, two thirds of the revenue from the tax were earmarked to reduced labour taxes, and one third to energy efficiency and retrofitting investments (Office fédéral de l’environnement (Suisse), 2020[117]).
Regulations can complement carbon prices, but need to be well-designed
Regulations can perform an important role when price responses are likely to be muted by helping to overcome important behavioural obstacles to change, such as information asymmetries, myopia and risk aversion. This can support the attainment of lower emissions prices at lower carbon prices. (Freebairn, 2020[118]) highlights in particular standards for household appliances, building insulation, land clearing and waste disposal as important ways to shift behaviour. Technology and performance standards or bans on certain products are necessary to complement carbon pricing. It is critical, however, that these regulations are designed without increasing the overall regulatory burden facing firms (Berestycki and Dechezleprêtre, 2020[119]). Regulatory compliance costs should be kept low to avoid worsening inequalities (OECD, 2021[35]). Luxembourg’s current environmental regulations impose relatively high administrative burdens (Figure 2.24).
Figure 2.24. Luxembourg’s environmental regulations could be better designed
Design and evaluation of environmental policies, index scale from 0 to 6, lowest to highest stringency, 2018
Note: The indicator of Design and Evaluation of Environmental Policies (DEEP) measures potential market burdens created by environmental policies and the extent to which environmental policy evaluations take those into account.
Regulations are an important factor in supporting change in residential housing. The government introduced regulations which require that all new homes be built to standards that will result in no net emissions by 2023. This follows a transition period between 2018 and 2022 where new homes have been increasingly required to be built to near net zero targets. The policy has been supported by an increase in the number of artisans to help with construction, although there are still concerns about the availability of sufficient supply. The impact of newly built homes on urban sprawl and car use can be reduced if undertaken in conjunction with spatial planning regulations (see below).
Regulations to encourage energy efficiency of existing home supply could be improved. At present, there is no regulation governing energy efficiency standards for existing housing supply, although there are plans to increase thermal insulation requirements by 2023 (Ministère de l’Énergie et de l’Aménagement du territoire, 2020[6]). Ambitious proposals for renovation regulations can be hampered by difficulties in monitoring and implementation. For example, whilst an energy passport system has been implemented in Luxembourg, 56% of home owners and tenants stated that they did not have an energy passport for their building or apartment, or were not familiar with the efficiency class of their building (Ministère de l’Énergie et de l’Aménagement du territoire, 2020[6]).
Estimating the energy efficiency of the existing housing stock can be difficult. France has incentivised compliance to regulations by stipulating that owners of non-compliant homes (‘passoire énergétique’) are not allowed to increase rent from 2021 and are banned from renting the properties from 2023. There is an obligation to renovate all worst-performing buildings as from 2028. However, such a model will place renovation policy in direct conflict with the need to increase housing supply in Luxembourg. The current strategy on housing notes that there are potentially labour shortages to meet construction demands from deep renovations. These same restrictions could also limit the extent to which homes can be classified as energy efficient or not. A simpler approach to defining the efficiency levels of existing buildings may help facilitate more rapid change. There is currently a geo-mapping tool for housing that includes the area and average ages of homes (Raum+), which is underpinning the cadastral valuation project. This model could form the basis of a consistent estimate for the energy performance of buildings, particularly if linked to geo-spatial data from the deeds office. If households feel that estimates differ from reality, they can challenge the ruling with a professional assessment.
Regulations are also an important part of the policy tool kit to enforce new standards in industry. The IEA notes regulations such as minimum energy performance standards on key industrial equipment such as motors, pumps, fans and heating and cooling equipment can be among the best cross-cutting approaches to raise efficiency across key industrial sub-sectors (IEA, 2021[120]). Regulations have also been used to stimulate the substitution of clinker, one of the most the energy intensive components of cement, with alternatives such as blast furnace slag, fly ash from coal plants or calcinated clay (IEA, 2021[120]). Regular benchmarking of productive processes, such as the IEA’s heavy industry analysis (IEA, 2021[120]) on steel and cement, would ensure that regulatory standards continue to lead innovation in the sector by ensuring sufficiently ambitious targets. Benchmarking exercises could also provide feedback on the extent to which subsidies for additional investment should be targeted towards specific sectors and companies.
Subsidies should be targeted towards high-cost upfront investments
Subsidies are an important tool to help firms and households overcome high upfront adjustment costs in the green transition. The Luxembourg government has a number of subsidies in place, particularly for households. However, they are unlikely to result in behavioural change if not applied in tandem with other policies, as they rarely address the fundamental behaviour change requirements (EIB /Bruegel, 2012[69]).
Renewable energy supply highlights the limits of relying primarily on subsidies. Despite price subsidies as well as generous subsidies for investments (both can be used simultaneously), households and firms have not invested in expanding renewable supply as fast as the government had hoped.
Competition in renewable energy supply needs to rise. Solar energy tenders, the key instrument to secure higher photovoltaic energy supply in the government’s strategy, have undersubscribed bids that do not always reflect falling solar deployment costs. Currently, two private companies and their partly owned subsidiaries generate almost all wind power and a significant share of hydropower, and own most of the biomass plants and all the solar projects developed under the 2018 tender. In addition, local firms could play a greater role in the supply of energy if restrictions on the supply of energy to the private industrial grid were lifted and if feed-in tariffs were more generous for mid-tier sized plants (below 500 MW, but above 30 MW) (IEA, 2020[2]). Making it easier for firms to strike purchase power agreements could also increase overall competition and the supply of power. This in turn will require making it easier to reach regional purchasing power agreements and to remove local obstacles to Public Private Agreements, such as the lack of eligibility for carbon CO2 surcharges.
Higher energy prices will likely increase the attractiveness and uptake of subsidy schemes. As subsidies are funded through surcharges paid by electricity users, it will be increasingly important to ensure value for money from these subsidies. A more explicit evaluation of subsidy schemes, with a focus on their cost, outcomes and take-up, would encourage faster adaptation and learning. It took some time for the feed-in-tariffs to be adjusted to better meet the needs of small and medium sized enterprises. In Denmark, public tenders of the main support programme are allocated on the basis of least-cost abatement, to ensure an efficient distribution of subsidies.
Alternative contracting methods could be used in the tender process. Contracts for difference mean that if the market price were to fall below a certain level, the renewable energy generator would receive a guaranteed price above this, and if market prices exceed that level, the renewable energy generator would return the price difference. This matters because the price of energy has tended to fall systematically over time, lowering the potential profitability of the investment. Contracts for difference can provide protection for the renewable energy generator from volatile market prices but provide a limit on the liability faced by taxpayers and electricity consumers. They are used in the United Kingdom. The Netherlands recently received approval to use them for a number of renewable projects. Germany has run a pilot of such contracts for energy investments undertaken by the steel, lime, cement and ammonia industries.
Further progress in reducing emissions in manufacturing will require a shift in the approach to supporting the transition (Figure 2.25, panel A). Since 2010, a voluntary agreement on energy efficiency between the government and the Business Federation of Luxembourg (FEDIL) has allowed participating companies to set annual energy efficiency targets, which if reached, lower energy taxes and levies. There are now calls to expand this incentive as the costs of undertaking energy efficiency investments are set to rise. However, these subsidies are likely to take place against a backdrop of rising carbon prices from the EU-ETS. Higher prices would make many of these energy investments self-financing – particularly since Luxembourgish firms are heavily integrated into European value chains, whose customers will increasingly demand greener production. In these circumstances, subsidies carry a high deadweight loss, as investments are likely to be undertaken in any event.
Subsidies for industry should instead be increasingly targeted towards supporting those technologies that are not viable at current carbon prices (Figure 2.25, panel B) and that could reduce natural gas consumption. Natural gas currently accounts for 41% of all energy supply to the industrial sector. The investments that could help achieve this transition have long lifespans and require much higher carbon prices to be profitable, which tends to hold back private investment. This creates a sound rationale for government to support investment in this equipment. Subsidies should be technologically neutral, to allow firms to pick the solution that suits them best. The schemes could either focus on providing direct support or lower the cost of financing to boost the net present value of these projects. Luxembourg is developing a roadmap for supporting the decarbonisation of the manufacturing industry, to identify and evaluate decarbonisation potential for 2030 and 2050. New tools such as direct subsidies, carbon contracts for difference and de-risking tools will be utilised thanks to the December 2021 release of European state aid guidelines and the upcoming general block exemption rules (expected by the end of 2022).
Figure 2.25. The transition in industry will require redoubling efforts
1. The shaded area represents the expected CO2 range in the EU ETS 2021-2030. Technologies represent potential shifts away from fossil-fuel based production.
Source: IEA and (Sartor, 2021[121]).
The proposed Fit 4 Sustainability package includes a consultant to provide advice on firms’ energy efficiency measures as well as generous subsequent financing for approved projects, which range from between 70% for SMEs and 50% for large firms. The programme could be designed in a way to promote these deep energy savings. Interestingly, Eurobarometer shows that consultancy services to improve resource efficiency, as well as demonstration of new technologies and advice on funding were more important than European counterparts. Grants and subsidies by contrast are seen as relatively less important (27% compared to 36% in Europe) (Eurobarometer, 2022[64]).
Energy efficiency subsidies could still be supported to an extent by existing energy efficiency obligations, which require energy providers to meet efficiency targets for customers. With reduced energy efficiency subsidies elsewhere, the schemes may enjoy greater take-up. Outreach to firms – particularly small and medium-sized enterprises – on prospective energy efficiency investments, the implementation of energy audits and energy management systems, can best be achieved through information campaigns and training workshops (IEA, 2021[120]). Given the poor pace of change in the commercial sector, consideration should be given to skewing targets towards these users. In addition, data centres should receive particular consideration given their high potential for energy use in the context of higher temperatures.
Policy should clearly outline how ETS offsets are integrated into overall support. Estimates of support, provided for under European state aid laws for the risks of higher carbon prices for manufacturing firms, should take into account not only how much a firm exports, but also what key demand trends are in export markets, as well as pricing power, transport costs and other frictions. Support levels should also take into account free ETS allocations for Luxembourg, which are largely unchanged between 2021 and 2025. There is little evidence of a reduction in manufacturing production levels from the introduction of the European Emissions Trading Scheme (see Box 2.3).
In line with best practice on providing state support, compensation should be time-bound. Support levels should be recalculated if there is a material change in policy such as the introduction of the carbon border adjustment mechanism. International benchmarks can serve as a particularly important tool for considering performance of domestic firms, as published by the IEA on heavy industry (IEA, 2021[120]) or the ECB’s comprehensive climate risk assessments at country and regional level. To support accountability, decisions which are confidential for commercial reasons should be made public after a specified time lag. In terms of form, rebates for emission pricing are the most efficient solution, but subsidies for investment in abatement technologies, such as carbon capture and storage are a second-best solution.
A more quantitative evaluation of the obstacles to housing subsidy uptake could improve policy design to support home renovations. The PRIMeHouse scheme aims to improve energy efficiency and renewable energy in residential housing, alongside the use of sustainable renovation materials (Ministère de l’Environnement, 2021[122]). However, despite generous support from the government, take-up of the main programmes has been low. Between 2017 and 2021, 1 800 grants through the PRIMeHouse program were approved, at a total cost of around EUR 20 million.
In its long-term renovation strategy, the government identified a number of potential reasons for low levels of renovations, including the lack of awareness, low minimum building regulatory requirements and low energy prices. However, in its most recent iteration of the PRIMeHouse scheme, administrative processes appear to have been identified by the government as a potential obstacle to take-up: the latest scheme from 2022 has relaxed requirements to use an energy consultant before the project begins. This stands in contrast to the stated regulatory aims of the housing renovation programme, which sought to increase the role of consultants overseeing the projects.
Given the generosity of the subsidies offered and the absence of means-testing, there is a need to ensure that renovation projects are sufficiently ambitious. Energy consultants can help identify whether or not deeper renovations could be implemented instead of smaller projects, and also estimate the size of potential savings. Scrapping the requirement to use them could further entrench the existing pattern of light renovations (which save about 14kWh / square metre per year) dominating renovation projects, rather than deeper renovations that save about 159 kWh/ square metre per year (European Commission, 2019[123]). The recent policy change should therefore be closely monitored and a quantitative impact evaluation conducted, over short time frames, to ensure that any adverse consequences from the policy change are managed.
Coordinating policies on housing and transport can reinforce the transition
Lowering transport emissions sustainably requires a regional approach
As the single largest contributor to emissions, transport represents one of the fundamental challenges for Luxembourg’s green transition. Transport emissions are best reduced by i) avoiding unnecessary travel; ii) shifting mobility to sustainable transport options; and iii) improving vehicle technologies and alternative fuels (ITF, 2021[8]); (D’Arcangelo et al., 2022[41]). However, different sources of transport emissions require specific strategies to ensure effective behaviour change (ITF, 2021[8]). Luxembourg’s energy strategy requires a halving of transport emissions between 2020 and 2050. Exported emissions should fall by 46% and domestic transport emissions by 55% over this time frame.
The main tool used by Luxembourg to lower exported transport emissions is higher carbon prices, which will reduce incentives to refuel in Luxembourg. (STATEC, 2020[71]) estimates that for every 1% increase in the price of fuel, foreign demand for fuel falls by more than 1%. A reduction in sales of fuel is not guaranteed, however. The pace at which carbon prices increase relative to neighbouring countries will influence the success of a pricing-based strategy to reduce Luxembourg’s direct fuel sales (STATEC, 2020[71]). Specific policies will be required to support change in both cross-border freight and commuter behaviour.
European freight traffic will require infrastructure investments to shift behaviour
Over the past decade, growth in the freight sector has offset the impact of energy efficiency gains (Figure 2.26). Road freight transport in Europe is expected to expand at an average annual rate of 1.9% until 2050 (ITF, 2021[8]).
Figure 2.26. Growth in freight transport volumes has offset energy efficiency gains in the sector
Variation in consumption between 2000 and 2019, Mtoe
Source: Odyssee-Mure (database).
International evidence suggests that lower freight emissions will require a combination of policies. The ITF estimates that to lower emissions from road freight in Europe by 0.7% per annum, carbon prices must be in the range of USD 150-250 per tonne by 2050, the long-awaited European cross-border rail improvements in TEN-T must be implemented, with a switch from road to rail freight whereby the share of the latter rises from about 2% to 20% in Western Europe (ITF, 2021[8]). Luxembourg is targeting a 3.9% annual reduction in exported transport emissions. The ITF estimated a drop in carbon emissions in European freight traffic of around 4% would be achieved with a carbon price that is double its central scenario, alongside expanded low-carbon charging and refuelling infrastructure being widely available, a much higher share of low emission vehicles (about 20% by 2050), much more widespread digitalisation and autonomous road freight, as well as a doubling in rail freight usage from its central scenario (ITF, 2021[8]).
Whilst on its own Luxembourg will not change behaviour in the European market, it needs to support behavioural change through broader regional initiatives. For freight, this will require monitoring and enforcing stricter EU vehicle standards and regulations, particularly in the short term, as most energy efficiency gains are likely to be focused on energy efficiency (ITF, 2021[8]). Over the longer term, Luxembourg should ensure that its infrastructure encourages users to shift from road to rail and to use alternative energy sources in road freight. This will not require an immediate change for freight transport: unlike for passenger cars, the infrastructure to support alternative fuel technologies, such as hydrogen or electric road systems, is expensive and there is still significant uncertainty about the most viable technology to implement (ITF, 2021[8]). Luxembourg is adapting its road infrastructure to support electric vehicle charging for passenger vehicles and increasing the roll-out of fast charging stations for electric vehicles and trucks. It could be useful to build in additional capacity as this charging infrastructure is rolled out along highways, which could then be adapted to support a particular fuel type – such as hydrogen fuelling, or adaptations to support battery charging. This would complement efforts such as the installation of the first hydrogen fuelling station in 2022.
Shifting to freight rail would help to sustainably reduce emissions across the region. At present, freight rail represents around 3% of total million tonnes per kilometre of freight shipped in Luxembourg. Whilst freight rail will only be suitable for long distances, and the sector poses considerable challenges from a national rail policy coordination perspective, the benefits coordination can be substantial: freight rail infrastructure uses 72% less energy per tonne-kilometre than freight trucks (IEA, 2020[78]). These efforts could be coordinated alongside passenger rail efforts (see below). The energy efficiency obligation scheme provides incentives for modal shifts to freight transport, alongside other energy efficiency measures in freight (Cluster for Logistics, 2019[124]), which are currently being evaluated. Evidence can be used to design future incentives.
Reducing emissions from cross-border commuters
Cross-border workers constitute about half of the total workforce in Luxembourg, implying 200 000 commuting daily, 85% of them travelling by car for an average distance of 49 kilometres (Lambotte, Marbehant and Rouchet, 2021[125]). Cross-border commuter demand is set to grow alongside the economy. STATEC forecasts this workforce could rise to around 300 000 by 2040 (Haas and Peltier, 2017[9]).
Cross-border commuters are being encouraged to use more public transport, given that for longer urban trips, using urban rail instead of private cars delivers a 91% lower final energy use per passenger-kilometre (IEA, 2020[78]). A key part of the strategy to increase public transport usage is to improve user experience. Many commuters are concerned with the quality of public transport and the frequency of services, rather than the price or time spent in transport. The planned expansion of Luxembourg station and an increase in rail line capacity is welcome as it responds to the need for better and more regular services to drive a modal shift towards consumption.
Nonetheless, the targets are challenging. The National Mobility Plan targets 19% of cross-border commuters to use public transportation in 2035, up from 15% in 2017. This 4 percentage point increase represents an increase of about 30 000 daily commuters, roughly double the volume that currently use the public transport system. The share of public transport used by these commuters rose just over a percentage point between 2010 and 2017 (Table 2.7). It seems most likely that cross-border commuters working in the city centre will most easily shift to increased public transport. Their use of public transport is higher at 36.5% (21.2% for the train and 15.3% for the bus) (Lambotte, Marbehant and Rouchet, 2021[125]).
In the short to medium term, it is unlikely that car usage by cross-border commuters will decline sharply, even if fuel prices in Luxembourg rise. Many of these workers are currently not able to use public transport services. A large number of cross-border commuters currently work close to the border, where public transport links are less dense and services less frequent, on both sides of the border (Lambotte, Marbehant and Rouchet, 2021[125]). Their places of residence are dispersed too, with long average travel times. They often work in districts in Luxembourg that lack train services (Lambotte, Marbehant and Rouchet, 2021[125]). In addition, the abundance of free parking, attractive company car benefits and the relative ease of car use will act as further impediments to change.
Combining the existing policy to increase public transport frequency and quality with carbon pricing and other road use charges could over the long-term help increase the attractiveness of housing choices close to public transport hubs. This will also depend on ensuring business operations in Luxembourg are concentrated around public transport hubs, rather than the current dispersed pattern of activity.
Table 2.7. Cross-border transport patterns are heavily dominated by cars
Note: Refers to non-resident cross border workers that are employees in 2019.
Source: STATEC and (Lambotte, Marbehant and Rouchet, 2021[125]). Note 2010 data from the mobility survey of cross-border workers 2010, CEPS/INSTEAD (7,235 respondents); 2017 data from Luxmobil survey 2017, Ministry of Public Works.
Increased railway use also requires more international prominence to resolve persistent coordination challenges. The closure of the Brussels-Luxembourg-Strasbourg-Switzerland direct daytime trains, the last of which were withdrawn in 2016, was due to the inability of the four incumbent railway undertakings to agree on an upgrade plan for the winding Belgian section (TEN North Sea-Mediterranean Corridor). This situation was exacerbated by timetabling conflicts, and the introduction of the European Train Control System in Luxembourg, for which SNCF had no suitably equipped locomotives (European Commission, 2021[126]). International rail coordination is not easy, as evidenced by continued slippage on the European TEN-T rail projects. The agreement “A cross-border operational strategy for the Greater Region” to try and support carbon emissions reductions was released in January 2021. This could form the basis for more engagement at national level. Denmark and Sweden have an agreement that helps to inform the key cross-border priority policies (Box 2.10).
Box 2.10. International cross-border transport agreements
The Greater Copenhagen Committee, an organisation composed of politicians at municipal and regional levels elaborated a so-called Traffic Charter, a shared vision document. The Charter can be used as a basis for dialogue with national governments as well as with other national level actors, such as the train operators in Denmark and in Sweden. It sets out two specific goals in relation to travel – the promotion of a coherent public transport system in the region and that it should take a maximum of one hour by train to get either to Copenhagen or Malmö from all parts of the region.
In addition, employers could be encouraged to employ greater flexibility in hours for cross-border and other workers to further reduce the pressure on traffic nodes at peak times. More active encouragement of teleworking may also help to reduce worker flows, but it could inadvertently support even greater sprawl in the region, pushing up travel needs (ITF, 2021[8]). For this reason, teleworking needs to be combined with other efforts to reduce urban sprawl and encourage public transport use. In addition, increased teleworking allocations could be difficult to negotiate, given the potential loss of workforce and revenue flows for neighbouring countries. At present, the maximum number of days are 19 for Germany, 24 for Belgium and 29 for France (Lambotte, Marbehant and Rouchet, 2021[125]). Belgium and France have agreed to increase the number of days to 34 (PWC, 2021[128]), although the increases are not yet effective.
Reducing domestic transport emissions
The government is targeting a 55% reduction in domestic transport emissions by 2040. By 2025, these emissions are supposed to fall by 25% relative to 2020 levels, which were already sharply lower than in previous years due to COVID-19 (Ministère de l’Énergie et de l’Aménagement du territoire and Ministère de l’Environnement, 2020[129]). Households currently make up just under half of total domestic fuel consumption (Figure 2.27, panel A). Car use is the dominant form of transport for households, who tend to use their cars very intensively - by contrast, public transport usage is relatively low, although it has been increasing (Figure 2.27, Panel B and C).
Figure 2.27. Households’ high car reliance drives fuel consumption and emissions
Source: STATEC; and Odyssee-Mure Database.
Improving the relative attractiveness of other modes vis-à-vis the car can help decrease the time / cost threshold at which a motorist would be discouraged to drive. The government’s strategy to reduce domestic transport emissions focuses on lowering the use of internal combustion engines by increasing the public transport offering and lowering the costs of electric vehicle adoption through purchase subsidies and improved charging infrastructure.
The government has plans to expand the public transport service offering over time, particularly for trains and trams in the centre, with buses used as the main public transport service in outlying areas (Ministère de la Mobilité et des Travaux publics, 2022[130]). Public transport has been free since March 2020 for anyone within the borders of Luxembourg. The impact of free public transport is not yet clear, although initial indications are positive (see Box 2.11). In addition to making public transport free, regional bus networks have been reformed, and by July 2022, almost all residents will live within less than a kilometre of a public transport point, and will be able to access the free bus service at least every other hour. An app (MaaS - Mobility-as-a-Service) simplifies door-to-door travel planning across the bus, tram, train, bike, and walking networks.
Box 2.11. Free public transport and its impact on car use
As of March 2020, Luxembourg introduced free public transport across all modes of transport in the country, expanding eligibility from the youth, young students and the lowest income households. In addition, to try to encourage greater public transport use, the government recently extended free bus use from a park and ride scheme across the French border in a pilot programme to see if this would encourage greater public transport use. The objectives include improving access to public transport and reducing car usage.
A number of cities have implemented temporary free public transport, to help encourage uptake of public transport (Gothenburg) or to lower traffic (Milan, Prague and Turin). However, the evidence of free public transport in cities suggests it is not the main vehicle to encourage car users to switch. Evidence from other cities with free public transport suggests increased public transport from free fares tends to come from people who previously walked or cycled. (Proost, 2018[131]) finds car users make up only 15 -35% of new public transport passengers attracted by lower public transport prices. The low conversion rate of car users may be because car usage is priced too low, which would suggest the costs of car usage must increase, rather than to rely on a lower cost of public transport.
In Luxembourg, public transport was made free following significant efforts to increase the availability and quality of public transport. Data suggest users of the tram, where daily passenger data is available, have increased significantly – average usage in the first half of 2022 is up 52% compared to 2021 (see Figure 2.28).
Figure 2.28. Tram usage has increased steadily
Average daily number of passengers between Monday and Friday
Source: Ministère de la Mobilité et des Travaux publics.
An annual evaluation of free public transport will be conducted, with the next release scheduled for 2023. The study should take into account international experiences and analyse not only increased usage, but also the degree of switching from different modes such as cars, walking or cycling and whether the lowest-income households have benefitted the most, as was anticipated. Results from the pilot park-and-ride scheme to encourage cross-border commuters should also be included.
The government is in the process of promoting cycling as a transit mode, seeking to leverage the fact that 58% of residents own a bicycle and 54% of resident’s trips are shorter than 5 kilometres. At present, less than 5% of trips between 1 and 5 kilometres are done by bicycle, compared to two thirds by car (Ministère de la Mobilité et des Travaux publics, 2022[130]). The National Mobility Plan – 2035 places an important role for cycling in the multimodal transport network. Key cycling objectives include ensuring all major public transport stops are safely accessible by bicycle within at least a 2.5 kilometre radius and the creation of high performance cycle routes linking the three major urban agglomerations ( (Ministère de la Mobilité et des Travaux publics, 2022[130]). The emphasis on creating safe, continuous cycling infrastructure and traffic junctions is critical to both increase the use of bicycles and the safety of those using them (ITF, 2013[134]).
Enhanced policies to encourage shared mobility services could improve the environmental impact of the policy on electric vehicles. Shared mobility can be broadly defined as the common use of a vehicle by multiple users, such as ride- and car-sharing. Encouraging shared mobility services would lower the total environmental costs of the current electric vehicle strategy, and mitigate the risks of missing emissions targets from personal consumption. The IEA estimates that electric vehicles and batteries will be responsible for about half of the quadrupling demand for total mineral consumption over the next 20 years to meet net-zero goals by 2070 (IEA, 2021[135]). These can have significant environmental impacts in the countries in which mining occurs. “Rebound” risks – when travel demand increases due to lower costs – are rarely taken into account in estimates of travel switching modes (OECD, 2021[133]). Global estimates of long-term rebound effects can be substantial, in the range between 15% and 30% (Litman, 2021[136]) – which would mean that a 50% improvement in energy savings could be reduced by between 7.5 and 15 percentage points.
On-demand micro-transit services can encourage shifts away from private vehicles that are more tailored than public transport (although more expensive) – but cheaper and more environmentally friendly than private taxi use (ITF, 2019[137]). The state set up a mobile app (“CarPilote”) to encourage ride sharing amongst citizens, although with low fuel prices and the COVID-19 pandemic, it may be too early to judge the success of its take-up. The draft law to allow greater use of private ride sharing apps such as Uber (Ministère de la Mobilité et des Travaux publics, 2021[138]) has not been enacted. The government has stated its commitment to greater use of ride sharing, to encourage shared mobility and reduce prices paid for taxi services (Schnuer, 2021[139]); (Delles, 2022[140]).
The enabling framework for both the taxi industry and ride sharing apps needs to be carefully designed. Most recent global evidence suggests that ride-hailing services have not helped to reduce emissions, since they currently foster private rides and low occupancy rates at the expense of other shared modes of transport (Crozet, 2020[141]); (OECD, 2021[133]). Ride sharing has not been common. A stringent regulatory framework is needed to ensure that both traditional and ride-sharing apps help lower emissions (ITF, 2020[142]). This can help balance the fact that in many cases, restrictions on the size of the taxi sector have artificially depressed the “normal” levels of usage of these services. Luxembourg has already taken steps in the draft taxi law to ensure that fleets of taxis and chauffeur services would need to be low emitting (Ministère de la Mobilité et des Travaux publics, 2021[138]), but more stringent standards should be applied over time. Consideration could also be given to providing more favourable treatment for pooled transport services.
Increasing the supply of shared scooters and electric bicycles can increase the radius and speed of active transport options, reducing the need for cars (ITF, 2020[142]). Concerns about “wild” parking of shared scooters and bicycles and the safety risks they pose are often disproportionate to the same problems with cars (Brown et al., 2020[143]); (ITF, 2020[142]). Nonetheless, many operators tend to flood the market in order to achieve economies of scale, which can combine with public transport systems that have not been adapted for their use, creating competition for space between pedestrians and other vehicle users (OECD, 2021[133]). This has driven practices such as hard caps on the number of providers (such as in Amsterdam or Mexico City) or high fees (in Mexico City) (ITF, 2020[142]). A better approach is to use softer regulations that change based on surveillance of supply and demand levels, and finding ways to embed space for shared scooters and bicycles in parking and street use objectives (OECD, 2021[133]). Minimum standards that can increase longevity of these shared vehicles and lower energy consumption can further improve their impact (EIT, 2022[144]).
In the medium term, as electric vehicle use expands, a carbon tax would be a less useful way to estimate the other environmental costs generated by cars, such as congestion and space. An expanded form of pricing for car use should be considered. The government is modifying the company car benefit schemes in order to make it solely eligible for zero emission vehicles, but only from 2025 (Ministère de la Mobilité et des Travaux publics, 2022[145]). California went even further, replacing in-kind car benefits with cash. This resulted in many workers pocketing the cash and using public transport (OECD, 2021[133]). Removing company car benefit schemes altogether once the price of carbon is sufficiently high could encourage further behavioural change.
Parking can be an important component of drivers’ convenience costs. (Franco and Khordagui, 2019[146]) find that increasing on-street parking by 10% is associated with a 1.3% increase in the probability of driving, and (Franco, 2020[147]) shows people tend to drive walkable or bikeable distances if parking is easily available. In Lisbon, parking prices differ by three zones, which are determined by public transport services and parking density. Copenhagen has a three-zone parking pricing scheme which is higher in central areas of the city. In Strasbourg, a concentric three-zone parking pricing scheme imposes higher parking prices as well as shorter parking times in the city centre, compared to the periphery of the city as well.
The government has identified parking as a key determinant of car use, and will release a national parking strategy in 2023 to provide guidelines for this municipal competency. This strategy should include guidance on switching requirements in building regulations to drop minimum parking allocations in favour of maximum parking allocations, alongside pricing and taxing strategies for existing parking spaces. Building applications should include multi-modal transport impact assessments, rather than just car transport impact assessments (OECD, 2021[133]).
Road-pricing schemes can also play an important role in delivering behavioural change and climate and well-being goals - if designed with the aim of efficiently using road space, rather than simply increasing traffic speeds or reducing congestion (see Box 2.12). Road use charges could also increase for lower rates of user occupancy (OECD, 2021[133]). The compliance costs of introducing congestion charges are falling as the infrastructure is constantly evolving. Concerns about confidentiality can be managed through stringent standards. These schemes also have the benefit that unlike parking and other planning regulations, they can be implemented at a national level, ensuring a level of consistency in travel pricing across the country.
Box 2.12. Evolving best practice in road user charges
While not yet widely used, urban road-pricing schemes are growing in number. Cities like London, Stockholm, Milan and Singapore have congestion-charging schemes for specific areas, and Tel Aviv has plans to implement them. California, and Seoul, among others, apply road tolls to particular corridors. These schemes have worked in reducing the number of private vehicles on the road in the city centre - by 21% in London, 28.5% in Milan and 29% in Stockholm.
The most efficient road-pricing schemes are those where prices vary according to the scarcity of space – which includes varying over time. The road-pricing scheme in Singapore is an example of best practice. It has electronically applied differentiated pricing based on time and location, and is implemented in both the central part of the city and for several highways. The system has three daily pricing peaks: the morning and evening rush hours and a third peak at 2:30 pm due to the tendency for offices to schedule meetings during this time of day. An electronic road-pricing system also supports lower speeds. Prices are reviewed and adapted as needed on a quarterly basis.
The Norwegian government is considering introducing a GPS-based distance, location and time-contingent road charge along these lines to ensure road users internalise congestion costs and related externalities. Flat pricing schemes, such as applied in London, penalise short trips and could encourage car use once the charge has been paid. They may also not be effective in managing fast-growing transport sectors such as delivery vehicles and taxis. However, they can be easier to communicate and understand. Stockholm opted for a simpler charging structure, which was more politically acceptable to residents. The charges are applied each time the congestion cordon is passed, although the charges vary between peak and off-peak periods.
In order to increase the social acceptability of road charging schemes, exemptions have often been applied, often with unintended consequences. Exemptions for residents in charging zones can raise prices in the centre, compounding inequalities of higher house prices and homes in the (richer) centre compared to those outside. Exemptions can benefit (richer) residents, whilst poorer outsiders have to pay congestion charges to go to work. In Norway, exemptions for electric vehicles from congestion charges and allowing them to use bus lanes may have increased overall congestion and locked in overall car use.
Governments should instead focus on ensuring that complementary policies are in place to encourage greater support. In Stockholm, to encourage social acceptance of congestion charges, the scheme was initially introduced for a seven-month trial period. The trial scheme was accompanied by significant investment in the public transport network.
There are concerns that transport-based policies could generate significant political backlash given the importance of car use across all income levels in Luxembourg. The availability of alternatives will be a key determinant of how severe the impact is. (Mattioli et al., 2019[150]) show that there can be large variations in car use within income groups. Measures of spatial vulnerability are required as well as identifying the availability of alternatives. In the United States, the government uses the housing and transport affordability index to determine levels of support for households, based on the availability of public transport alternatives available to them (OECD, 2021[133]).
Communication is important, as is framing the nature of choices. Surveys in Lyon, Helsinki, Gothenburg and Stockholm showed congestion charges were considered unfair until respondents needed to choose a better option (such as queuing, government allocation or a lottery) (Eliasson, 2016[151]). Evidence suggests support is higher if it is clear that the policy is not a revenue-generating source. In the United Kingdom, it was clear that the congestion charge revenues would be recycled and that environmental effects were more important for the scheme (OECD, 2021[133]).
In addition, policies could be phased in over time, and do not have to be introduced simultaneously. Initial policies should focus on reducing the company perks on cars, as well as raising carbon taxes. A plan for higher road use charges should be clearly flagged to encourage higher occupancy rates as well as to discourage car use.
Spatial planning could be better leveraged to reduce transport emissions and resolve tensions between housing supply and the environment
Households’ use of private transport is not just a personal choice, but one influenced by necessity in terms of housing and work (OECD, 2021[133]). Induced demand and urban sprawl are key dynamics determining car dependence and high emissions globally (OECD, 2021[133]) and Luxembourg is no exception. More than 30% of the urban population in Luxembourg in 2014 resided in areas of very low population density, which the OECD defines as a density of 150-1 500 per square kilometre. (Lambotte, Marbehant and Rouchet, 2021[125]) show public transport use is lowest for residents in outlying regions, where many workers have moved in order to benefit from lower house prices and a relatively small increase in commuting times. Many of these homes are not located in central locations, but scattered, and work tends to be in outlying areas, clustered around shopping malls close to the border (Lambotte, Marbehant and Rouchet, 2021[125]). As a result, reliance on cars is high. The Luxembourgish own the highest number of cars per household in Europe (Eurostat, 2021[152]) and rely on cars for over 65% of trips between 1 and 5 kilometres (Ministère de la Mobilité et des Travaux publics, 2022[130]). The government needs to find ways to reduce the number of cars owned by households towards the European average, as well as the extent of car use.
Integrating land-use decisions and transport planning can reduce transport demand and trip lengths, while improving accessibility for citizens in addition to limiting urban sprawl (OECD, 2018[153]). Model estimates suggest significant gains from spatial planning at a global level. (Fulton, Mason and Meroux, 2017[154]) and (Fulton, 2018[155]) estimate total transport emissions can decline by approximately 76% with integrated spatial planning compared to a 44% reduction when the focus is just on reducing emissions through switching to cleaner technologies (such as electric vehicles). The main impacts come from reducing distances travelled and supporting more intensive use of public transport and shared mobility services. The same studies also estimate that such a strategy lowers costs by about 40%, thanks to the lower number of vehicles that need to be purchased and reduced road and parking infrastructure needs.
Reducing car use will help to reduce the space dedicated to cars, which can increase green or recreation spaces (OECD, 2021[133]). This has important implications for encouraging greater densification in urban areas, to improve perceptions of living in urban neighbourhoods. Despite being one of the least dense countries in the OECD, surveys show that perceptions of noise are relatively high (Stráský, 2020[156]). The COVID-19 crisis could exacerbate urban sprawl by encouraging more people to move out from the centre (Ahrend et al., 2022[157]). Reduced space for cars, densification and brownfield development can also help to reduce the risk of soil sealing. On average 0.46 hectares of soil are urbanised daily in Luxembourg (Ministère de l’Énergie et de l’Aménagement du territoire, 2022[158]). The EU Soil Strategy for 2030 commits countries to reach no net land take by 2050 (European Commission, 2021[159]).
In a small country such as Luxembourg, the competition for space for green use and the need to increase the number of homes by at least 4 000 units a year increase the potential frictions between housing supply and environmental policy objectives (Figure 2.29). The government commissioned research on whether green belts needed to be redesigned to meet potential housing supply needs. The study concluded that no change in green belt policy was necessary, given the potential land available already zoned for development (LISER et al., 2021[160]). For this to hold true in practice, significant barriers to faster densification of housing in existing areas need to be lowered. This in turn requires tackling inconsistent policy objectives between national and municipal authorities and the incentives for land development.
Figure 2.29. Housing-related emissions have increased
Variation in consumption between 2000 and 2019, Mtoe
1. Other effects refers mainly to change in heating behaviours.
Source: Odyssee-Mure (database).
Strides have been made in improving the coordination of national and municipal land-use planning. Luxembourg has envisaged a Master Programme for Spatial Planning that supports densification through the development of three urban centres, reducing pressure on the city of Luxembourg and increasing growth nodes on both sides of the country. This is intended to address the key challenge of ensuring the sustainable use of land and natural resources alongside citizens’ well-being and the need for development. Legislative changes in 2018, strengthened in 2021, increased the legal reach of national policy, requiring that all municipal planning processes are consistent with the four published sectoral master plans for housing, transport, landscapes and economic activity zones. These sectoral plans in turn are drawn up by national government to implement the Master Programme for Spatial Planning (PDAT). The department of the Interior is responsible for monitoring the compliance of municipal land use plans.
This should improve the overall coherence of the system but will not be a panacea for governmental coordination. National policymaking should be consistent with the Master Programme for Spatial Planning. Investment project coordination with the Master Programme for Spatial Planning should be mandatory, including at national level. National tax policy could increase supply by raising the costs of undeveloped land through national taxes, as is currently under consideration (see chapter 1). This would be an important complement to the often under-utilised provisions for municipalities to tax unused land. National tax policy can also reduce excess demand by gradually phasing out the current mortgage interest deduction (as discussed in chapter 1) and reducing incentives for urban sprawl by scrapping current generous national income tax deductions based on the distance travelled to work, which can reach up to EUR 2 970 per year (OECD, 2020[4]).
There is strong resistance to densification in a number of larger municipalities identified for densification. Municipalities are the primary decision makers in the approval of building permits, and the designation of the status of building sites. Frictions between municipal and national priorities may be elevated to national parliament, since over a third of the legislative assembly are also representatives of their local councils.
Incentives of municipalities need to be aligned to support the strategy, allowing their experience and expertise to be properly utilised. Current incentives for housing supply, embodied in the Housing Pact (Pacte Logement), provide cash incentives for homes built, regardless of their location or building characteristics. This has encouraged smaller municipalities to expand faster; it has in turn done little to incentivise the larger municipalities facing more opposition from residents to allow more building (Carr and Hesse, 2020). The Pacte Logement incentives to encourage housing supply should be aligned with – and possibly strengthen – the Master Programme for Spatial Planning. This should include making the subsidies available only for housing in areas identified for densification in the Master Programme for Spatial Planning. Additional criteria could include requirements on encouraging density or the occupancy rate.
Care needs to be taken to improve homeowners’ incentives to support densification. The home-voter hypothesis predicts that homeowners turn to local politicians to protect the value of their housing investment by restricting the additional development of land (Fischel, 2002[161]); (Gyourko and Molloy, 2015[162]). By focusing on broader incentives for households, the supply of land by the private sector can be encouraged. The amendments to the Modified Law of 19 July 2004 concerning Municipal Land Use Planning and Urban Development that deal with the building land contract (Baulandvertrag) aim to speed up procedures for amending land-use plans and allow for ministerial intervention to force the reorganisation of parcels of land (Ministère de l’Intérieur, 2021[163]). The government has currently envisaged the use of transferable development rights as a way of providing new development rights to landowners who are not able or willing to invest within the timeframes dictated by the building land contract bill (Di Stefano et al., 2022[164]). Transferable development rights have been used extensively in the United States, where lessons suggest the benefits from the policy require that the total amount of housing be carefully estimated, and that the transfer of rights is consistent with the rest of the development plan, to avoid urban sprawl.
New housing construction should aim at increasing residential density, namely by constructing higher buildings, in particular around transport hubs (Stráský, 2020[156]). Ambitious renovation policies to reduce emissions could be leveraged to increase the density of existing housing, much of which is single-family dwelling units. Meeting the government’s target of reducing residential emissions by 57% by 2050 will require tripling current renovation rates of the existing housing stock to 3%. This will help to reduce heating costs, which make up the bulk of the residential sector’s emissions (Figure 2.30). The costs of renovations can be substantial. Average investment costs for deep energy renovations of residential buildings in Luxembourg were 30% higher than in neighbouring countries between 2012 and 2016 (European Commission, 2019[123]). The current subsidy scheme (which provides a EUR 10 000 bonus for densifying houses) could be supported with reform of the permitting regime, which in many municipalities limits the density of residences. Allowing the property to be split into more than one dwelling could increase the profitability of renovation projects for homeowners, raise housing supply and improve overall energy efficiency gains, since more dense living tends to help lower energy requirements.
Figure 2.30. Energy intensity of the residential sector in Luxembourg is high due to heating
Source: IEA, Energy Efficiency Indicators.
The policy may need to be complemented with additional support for homeowners that continue to live in the neighbourhood (Figure 2.31). (Wicki, Hofer and Kaufman, 2021[165]) document that in large metropoles, survey respondents tend to resist densification projects that are close to them, but this can be lessened with increased participatory planning as well as a clear policy that improves social equity.
Figure 2.31. There is some room to improve density of existing housing
Source: OECD Affordable Housing Database.
Resistance to densification could in part be driven by concerns about quality of life and already elevated concerns about noise levels. An explicit strategy to consider the space used for streets could improve the quality of living in denser neighbourhoods (OECD, 2021[133]). The current transport strategy provides guidance for municipalities on how to consider parking design, and the national parking strategy will provide further guidance. The ambition of these strategies could be expanded to include the link and place methodology, which explicitly considers how space is used (Box 2.13).
Box 2.13. Changing city design to reduce car use
City design requires confronting the notion that streets are for cars, a notion that was aggressively promoted in the 1950s and 1960s. Streets function as both a link and a place, and explicitly recognising this allows policy makers to re-imagine physical spaces that allow for greater densification, whilst still providing quality of life.
In Barcelona, the authorities introduced the concept of the SuperBlock, which sought to balance access and mobility with reduced car space. Inside each block, space is dedicated to pedestrians, cyclists and green space who have access through the superblock; cars and delivery vehicles only have one point of entry and exit into each block. Outside each block, a grid system of buses has increased access to public transport from each block.
In Pontevedera, the city sought to revitalise itself, arresting suburban sprawl and re-attracting people back to the city centre. This required altering the relationship with cars. Half of all wide streets were dedicated to pedestrians, alongside a revamped parking strategy and improved public transport. The changes have resulted in an increase in residents in the city centre, alongside reduced traffic.
In New Zealand, the link and place methodology was used with the aim of better integrating land use and transport by cities such as Tauranga and Christchurch. This then guided the national framework for road planning and investment decisions, by providing a higher weight to the strategic significance of roads and its adjacent land use. The methodology has also been used in London in order to classify municipal bids for road funding. The government of South Australia used it to upgrade its street network.
To help better integrate the existing physical arrangements, a network of 15 minute cities, which seeks to create proximity and accessibility for citizens by defining three radii accessible by foot and bike within which authorities need to ensure access to a certain number of services. This can help to improve access and reduce car usage.
Radically changing urban spaces can cause resistance, however. Cities have experimented with “tactical urbanism” in order to allow citizens to experiment with space to see whether new structures deliver expected benefits (OECD, 2021[133]). Key success factors include using temporary rather than permanent structures, to allow citizens to become accustomed to the new systems and to see what works in each setting. Numerous cities have used temporary projects to reallocate road space, for example in Copenhagen in Nørrebrogade, the Plaza Programme in New York City, the Yarraville Pop-up Park in Melbourne and the Parklet Program in San Francisco (Rowe, 2013[168]). The city of Brussels benefited from the COVID-19 lockdown to implement tactical urbanism projects. City authorities took advantage of the confinement in early 2020 to accelerate the implementation of the recently developed 2020-30 regional transport plan Good Move (Bruxelles Mobilité, 2020[169]). In addition, high levels of consultation are required in order to ensure success (Box 2.13).
Agriculture needs to be more environmentally friendly
Agricultural policy needs to be significantly strengthened to better support climate goals. Much more progress is still needed to improve biodiversity in Luxembourg. Despite the fact that the surface of protected areas doubled between 1990 and 2020 (Figure 2.32, panel A), most of them are in poor condition. The Natural Environment Observatory, a body that evaluates the state of biodiversity in Luxembourg, assesses that two thirds of habitats in the country and three quarters of observed species are in a concerning or bad condition (Observatoire de l’environnement naturel, 2022[170]).
While urban expansion and construction are contributing factors to the loss of biodiversity in Luxembourg, most of the environmental damage is attributed to the agricultural sector. The high proportion of livestock farming in agriculture as well as high fertilizer and pesticide use, have contributed to the deterioration of natural habitat. The use of fertilisers and pesticides should be carefully monitored as overuse can impose important costs to the environment and human health. EU-wide studies have shown that the use of pesticides has had negative impact on agricultural biodiversity (Sud, 2020[171]). The Farmland Birds Index, which is a common proxy for farmland diversity, shows that in the case of Luxembourg, there has also been an important deterioration over the past decade (Figure 2.32, panel B).
Figure 2.32. Although the surface of protected areas increased, biodiversity has deteriorated
1. Aggregated index of population trend estimates of a selected group of breeding bird species that are dependent on agricultural land for nesting and breeding. Data for Luxembourg is not available before 2010.
Source: OECD Statistics on Protected Areas; and OECD Agri-Environmental Indicators.
In addition to its impact on biodiversity, agriculture contributes to climate change through greenhouse gas emissions. Although the share of agriculture in total GHG emissions in Luxembourg is close to 7%, it is a major source of nitrous oxide and methane, two powerful greenhouse gases. Methane is a gas emitted by ruminant livestock, through manure and gastroenteric release, while nitrous oxide emissions come primarily from nitrogen application in soils, including their inefficiencies (IPCC, 2020[172]). Although nitrous oxide emissions have decreased since 1990 by the same magnitude as the EU average, methane emissions increased in Luxembourg despite a downward trend in the European Union (Figure 2.33, panel A). The intensity of agricultural emissions has also been significantly higher than the OECD median (Figure 2.33, panel B).
Figure 2.33. Methane emissions have been on the rise and overall emissions intensity is high
Source : OECD Agri-Environmental Indicators.
Despite the adverse impacts that agriculture may have on climate change and biodiversity, sustainable land management can contribute to reducing negative impacts of climate change on the ecosystem and society (IPCC, 2020[172]). It is therefore essential to improve agricultural practices, by reducing the livestock intensity and moving to more organic farming in order to preserve biodiversity.
The impact of these regulations could be enhanced by reforming agricultural subsidies so that they incentivize farmers to adopt more environmentally friendly farming practices. Such a reform was carried out in Switzerland for example, which included removing direct payments to livestock farmers and increasing them to farmers able to meet biodiversity goals (OECD, 2017[173]).
The new EU Common Agricultural Policy (CAP) which will be implemented from 2023 and puts a greater emphasis on “green agriculture” will introduce “eco-schemes” as part of pillar I, which are voluntary actions going beyond farmers’ obligations, for example practices related to better nutrient management, agro-ecology or animal welfare (European Commission, 2022[174]). Member States will be required to spend at least 25% of direct payments budgets on eco-schemes, with no upper limit, and will have the flexibility of adopting the schemes to suit the country’s needs. It will therefore provide an opportunity to steer agriculture into more sustainable practices. Luxembourg has already embraced the opportunity to develop eco-schemes in line with the new directive. Transitional payments could be made to the farmers in the short term to allow them to adapt to the changes and improve the social acceptability of such reforms.
Table 2.8. Policy recommendations to secure a dynamic and green economy by 2050
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