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.

by Jan Strasky, Luxembourg Desk, OECD Economics Department

Luxembourg’s economy has been buoyant – robust growth has strongly outpaced the euro area average over most of the past decade. However, this success creates new problems, in particular in the housing market, which the 2019 Economic Survey of Luxembourg [link] analyses in detail. Strong population growth, mainly reflecting the number of foreign workers attracted by a buoyant economy, has kept housing demand growing for many years. When coupled with supply-side restrictions, such as limited use of land available for construction and cumbersome zoning restrictions, the imbalance between demand and supply stokes rising house prices (Figure 1). Increasing mortgage debt also raises the debt service burden for a larger share of households than in other countries and a tight rental market impedes housing affordability for poorer parts of the population.

As the housing stock has not expanded in line with growing
demand for many years, the essential part of the solution is an increase in
construction of new housing. Although the land available for housing
construction seems sufficient, it is mainly in private ownership and many
landowners do not have a strong incentive to sell or develop their land. In
order to reduce the practice of land hoarding, where constructible land is kept
undeveloped to capitalise on continuing land price increases, the opportunity
cost of holding land for construction should be increased. Possible ways of
doing so include introducing land value taxes on land zoned for housing
construction or imposing sanctions on landowners and developers for non-use of
building permits. Higher recurrent taxes on immovable property, based on
up-to-date valuations reflecting the market price of the property, could also
help to incentivise the owners to sell vacant dwellings (Figure 2).

Both municipalities and the central government could improve
the situation in this area. Municipal autonomy in spatial planning decisions is
high and the current framework has not delivered sufficient supply of housing.
Some instruments exist in the law, but are simply not used. This is the case of
an annual tax on constructible land not developed for more than three years,
and also of a tax on unoccupied housing. Other instruments, such as a special
property tax on building land for residential purposes, were introduced more
broadly, but they are based on obsolete cadastral valuations and provide
negligible revenues.

Given the high level of urban sprawl, which has important
environmental costs, new housing construction should aim at increasing
residential density, namely by constructing higher buildings, in particular
around transport hubs. To soften municipal resistance to densification, the
targets on new housing construction agreed between the municipalities and the
central government in the Housing Pact could be extended to include numerical
targets for densification measures or social housing construction. It is clear
that a lot remains to be done by the central government, too. For example, a
reduction of mortgage interest deductibility could help reduce demand for
owner-occupied housing, while financing for new land acquisition by public
providers of social housing would help expand the stock of social rental
housing. Measures reducing demand for owner-occupied housing would also help
reduce the build-up of already high household indebtedness, which creates risks
for poorer households (Figure 3).

The stock of social rental housing is small in international comparison, despite recent efforts by social rental management companies, and often allocated to tenants who are not those most in need. The low stock reflects many factors, including the historical policy of building affordable housing for sale, which could later be re-sold on the private market. This practice has now been phased out and the public housing providers focus on building social housing for rental, rather than for sale. The allocation of social housing also needs to be improved. The admission criteria for social housing are often flexible and with low transparency. Recurrent means-testing should be combined with tailored plans for re-entering the private rental sector, similar to those used by social rental agencies. Housing allowances and rents in the social housing sector could also become more geographically differentiated, reflecting the differences in market rents across municipalities: for example, Luxembourg City has clearly higher market rents than the north of the country.

Reference:

OECD (2019), OECD Economic Surveys: Luxembourg 2019, OECD Publishing, Paris.

by Jan Strasky, Luxembourg Desk, OECD Economics Department.

Strong economic performance, comfortable fiscal situation and well-run institutions make life good for most residents of Luxembourg. Average earnings are the highest in the OECD, while labour market insecurity and income inequality are low. Yet, the development of the digital economy is constantly expanding the domain of tasks that can be automatized and affecting both jobs and the skill sets need to perform them. The recent long-term strategy of the government develops an ambitious vision for a smart green digital society, but in order to equip workers with adequate skills, this modernisation strategy will also require improvements in education outcomes and better upskilling of workers over their lifetime (Figure 1).

Figure 1. Upskilling of the labour force is lagging behind the best performers

The recently released OECD Economic Survey of Luxembourg 2017 argues that improvements in the education and training system should focus on lowering the high rate of grade repetition and improving the mobility between various education programmes. Grade repetition is internationally high and concentrated in vocational secondary education, often reflecting language handicaps. Although it is sometimes still regarded as an assurance of quality, the empirical evidence shows that grade repetition is costly and ineffective in raising educational outcomes. More productive strategies focus on providing early, regular and timely support during the school year and limiting repetition to subjects and modules failed.

Vocational education and training should equip young people with technical and professional skills that meet labour needs, but also open opportunities for further learning. Programmes imparting similar generic skills as in more academic upper secondary programmes, better linked to the other parts of the education system, would help closing the skills gap between graduates of academic and vocational tracks.

The world of work is changing fast and in ways that are difficult to anticipate. Flexibility in re-skilling and lifelong learning is likely to become key for successful careers in the future. In Luxembourg, like in many countries, those in employment and with better skills tend to profit most from lifelong learning. To improve participation in lifelong learning, providers should make more use of online and distance learning, along with part-time and modular courses. Individual learning accounts and expanded individual study leave could also enhance access to lifelong learning for low-skilled adults and employees from small firms.

Finally, to make better use of existing skills and to reduce the number of long-term unemployed, the disincentives to work should be reduced further. Inactivity traps are high, especially for part-time workers and low income earners, complicating increases in work effort and transitions from unemployment to employment. Furthermore, the system of joint taxation of spouses and registered partners discourages work of second earners, who are often women. Recent changes in policy, such as the introduction of optional individual taxation and the reform of the minimum income scheme, go in the right direction and should be complemented by further adjustments to the tax and benefit system, and pension system to reduce disincentives to work for low-skilled youth and older workers.

References

OECD (2017), OECD Economic Surveys: Luxembourg 2017, OECD Publishing, Paris.