Will Luxembourg's economic 'miracle' last?

It is a remarkable achievement, bordering on insolence: over the past five years, despite two cataclysmic crises (the health crisis and the geopolitical crisis linked to Ukraine), the Luxembourgish economy has hardly faltered.

On the contrary, it has even progressed in many areas, including a growth in GDP, an increase in available jobs, an increase in hours worked, an increase in exports, an increase in public revenue, and so on.

Crisis? What crisis, the Grand Duchy seems to answer. Except that all is not so rosy. Its economic armour has holes, warns the Idea Foundation in its 2018-2022 economic retrospective, which highlights both the strengths and weaknesses of the Grand Duchy.

Strengths: The return of the state and the employment 'miracle' 

Over the past five years, "Luxembourg's economy seems to have bent (a little) but not broken," the Idea Foundation says. One of the main reasons for this is that, while the last five years have been marked by crises, they have also seen what economist Vincent Hein refers to as "the return of the state."

© Idea Foundation

This return of the welfare state, which served as a protective shield first during the pandemic and then during the energy crisis, is evidenced "by the impressive succession of support plans for businesses and households." In particular, the Grand Duchy has seen "the return of indexation of family allowances, several new tax credits, the (desire to) increase the rent subsidy, a focus on offering more and more services free of charge, and a (mini)revolution in terms of parental leave," with the latter now also gaining popularity among fathers.

Economist Ioana Pop then points to what she calls "the small miracle of employment." Despite the crises, the Luxembourgish economy has continued to create many jobs over the last five years (70,000 additional jobs to be precise), with annual domestic employment growth of +3.1%, compared to +3% between 2013 and 2018. The unemployment rate is also lower than it was at the start of the mandate (4.8% compared to 5.5%).

It is also worth mentioning Luxembourg's lead in Europe on remote working: in 2020, Luxembourg ranked first among EU countries, with 48% of people working from home (this figure fell slightly in 2021 to 45% but remains high).

Finally, Idea highlights another Luxembourgish record, that of gender equality in the labour market: In addition to near gender parity in salaried employment, women also earn more than men on average, which is unprecedented in the EU.

Weaknesses: The challenge of debt and an uncertain future

As one might expect, this state support has not been "free." The flexibility with which Luxembourg cushioned the health and energy crises was based first and foremost on "the prior existence of significant budgetary room for manoeuvre," or simply put, a nest egg. These crises were also averted "at the cost of increasing public debt, which could prove problematic in a context of rising interest rates." Between 2018 and 2023, public spending increased from 42.3% to 44.9% of GDP. "The next government will have to face this challenge of debt," warns Vincent Hein.

The general government deficit has also increased, with the consolidated gross debt rising from 20.9% in 2018 to 26.3% in 2023, and it is likely to approach 30% as early as 2026, especially if it is "accelerated by the rise in rates and by the decisions taken at the tripartite meeting on 3 March 2023." This slump in Luxembourg's public finances "risks reducing Luxembourg's ability to cope with future crises" Idea warns.

The return of inflation is also cause for concern, particularly for Luxembourg-based companies: "Continued high energy prices, rising interest rates, and the wage indexation mechanism could weigh on both the profitability of companies and their room for manoeuvre to invest." Particular mention should be made of the country's crucial construction sector, which "is also experiencing turbulence linked to this new context, which has dampened demand." There are also concerns for the financial centre, as illustrated by the recent tensions in the banking sector at the international level.

And several sectors are already in the red, such as the hotel and catering as well as the trade sectors, which "have shown a decline in activity indicators over the past five years."

The Idea Foundation also lists several economic downturns exacerbated by the crises: "slower growth, increase in the non-market sector of the economy, drop in apparent labour productivity, stagnation of GDP per capita…"

In short, Vincent Hein concludes, "we are entering a new economic cycle, with the return of inflation and high interest rates; this new cycle will have to be monitored," as it is fraught with uncertainty. In addition, households are not mistaken, according to Vincent Hein, as they "feel that this is the time to set aside savings for a rainy day."