Luxembourg: Playing the long game to secure the future of younger generations

By Catherine MacLeod and Ania Thiemann, OECD Economics Department

Luxembourg has weathered the twin shocks of the pandemic and the energy crisis provoked by Russia’s war against Ukraine. Unemployment is low and vacancies are high. By the end of this year, we forecast GDP will be over 8% higher than in 2019.

Growth is forecast to slow to 1.5% in 2023 as inflation remains high at 4.0% – even with the government’s substantial efforts to reduce energy price increases. The immediate priority is to support those households most impacted by the energy crisis. Targeting fiscal policy support more could help to increase the impact on the most vulnerable and strengthen incentives for energy efficiency. In addition, macroprudential policy should stand ready to protect the most vulnerable borrowers from possible housing market risks as interest rates rise.

For Luxembourg, the key policy issue is to support its current and future citizens’ well-being by addressing its long-term challenges (Figure 1). Demand for labour is high. Housing supply remains restricted, raising costs and forcing people to live in outlying areas and rely on cars. Per capita greenhouse gas emissions are higher than the OECD average, even when taking into account the impact of cross border commuters and fuel sales exports. The share of the ecosystem under threat is nearly double that of the EU average. Productivity growth in Luxembourg has lagged OECD peers, and growth is highly reliant on raising employment. The average annual cost of production per worker in Luxembourg has grown 4.7% over the last decade, compared to the OECD average of 2.7%.

Figure 1. There is room to improve the way the economy grows

The government has introduced a number of measures to tackle these challenges. Transport infrastructure is being expanded significantly to encourage lower carbon intensity and greater public transport use. A wide range of incentives are in place for energy efficiency investments. New regulations to support the creation of more affordable housing will be further strengthened with proposed taxes on unused land and buildings. And a new spatial planning system has been introduced to prevent urban sprawl.

The 2022 OECD Economic Survey of Luxembourg sets out a number of suggestions to strengthen investment and support longer working lives to improve the impact of these policies.

Higher investment, if guided correctly, can support more balanced growth – reducing resource use, carbon consumption, and the reliance of growth on an expanding workforce. Whilst government investment spending as a share of GDP is around the OECD average, the low levels of private sector investment mean Luxembourg lags peers at a national level (Figure 2).

Figure 2. Raising investment is critical

The private sector’s low levels of research and development could be countered by targeting public funds to match spending undertaken by firms on research and development. Government innovation funding, currently directed towards public institutions, could be better targeted to projects within the private sector. Supporting investments by SMEs in ICT equipment and training on using digital tools could counter their low levels of digital adoption. Removing the obstacles to setting up a business could further encourage higher levels of investment.

A rising, long-term carbon-tax path will help create the certainty needed to encourage investments required for the green transition. This is especially important given volatile global energy prices, and how quickly changes in these prices will be passed on to the domestic market. Publishing a carbon tax path with an explicit energy price assumption could increase certainty about future carbon prices. It should be accompanied with adequate support for vulnerable firms and households. These support policies should be monitored regularly to ensure that they are having an impact.

Making deep energy renovations of existing homes more profitable given their high inconvenience and monetary costs could raise current low renovation rates of 1% towards the 3% target. Enhanced subsidies, supportive regulations in municipal planning, and the abolition of minimum parking requirements could be granted for renovations that undertake deep energy savings and increase the number of households able to live in the dwelling. Incentives to raise housing supply must apply to the high density areas designated by the Master Programme for Spatial Planning so as to avoid worsening urban sprawl and car dependence.

Encouraging people to work longer will lower pension costs, and reduce the burden of young people, who would otherwise have to pay higher taxes and receiver lower pensions in the future. If people remain in the workforce for longer, the demand for new workers – and resultant housing – can be mitigated. It will also help insulate the economy from the otherwise negative growth impact from the inevitable ageing of the domestic and regional population.

Spending on public pensions is set to rise from 9% of GDP to 18% of GDP by 2070, the sharpest increase in the European Union (Figure 3). This is in part driven by people leaving the workforce too early: just 45% of older people in Luxembourg are in the workforce, compared to over 60% in the OECD. Linking the retirement age to life expectancy and making it less attractive to retire early would reduce the number of early leavers. This needs to be complimented with efforts to improve older workers’ employability, enhance their incentives to work and encourage employers to hire them. Subsidising employers to give older workers on-the-job training.

Ensuring that young people stay in the schooling system for longer will help improve their chances of working productive lives. This is especially important for the children of immigrant background – they make up 55% of early-school leavers but less than one-third of pupils. The first part of secondary education should be reformed to offer a more general and broad-based education and avoid too early selection.

Figure 3. Better utilising older workers can support fairer growth

References:

OECD (2022), OECD Economic Surveys: Luxembourg 2022, OECD Publishing, Paris, https://doi.org/10.1787/9409d9b6-en.