Luxembourg - Economy High growth rates, followed by a sharp downturn From the mid-1980s until 2000, the average real growth rate of the Luxembourg economy reached a level hitherto unknown over such a long period (more than 5.5% per year) and exceeded that of the other European countries apart from Ireland (over 6%). The annual average growth rate in the Grand Duchy was even more than 7% in the period 1997-2000. The contribution of financial services is determinant for this evolution. Between 1996 and 2000, financial services contributed for more than 25% to the total growth of gross value added. Nevertheless, the impact on growth of some other economic sectors should be noted: transport and communications (which contributed for nearly 18% to the total growth from 1996 to 2000), trade, rental and business services, and health and social services. Manufacturing industry, despite its decline in relative terms, remained also a significant contributor to growth. The impact of financial services is strongly apparent in the economic downturn of 2001. The GDP growth rate fell from 9.1% in 2000 to little more than 1% in 2001. This was due to the decline of gross value added (GVA) at constant prices in financial services (negative growth). The growth rates of GVA in other economic sectors, which remained positive in 2001, were unable to balance the decline of GVA in financial services. The forecasts show that the average growth rate of the Luxembourg economy for the period 2001-2005 will probably not exceed 2%. Productivity: Luxembourg well placed In terms of level and growth rates of productivity the Luxembourg economy was rather well placed in the 1985-2000 period. The average growth rate of labour productivity (GVA at constant prices/employment) in the market sector, excluding public administration and the education sector, reached 2.7% in that time period. In some economic sectors this rate has even been higher: the average labour productivity growth in manufacturing industry was 4.7% per year and in the iron-and steel industry more than 8%. In business services, which are important job creators, growth in productivity was, however, very low. High productivity in manufacturing industry is reflected in unit labour costs. In 2000, labour costs expressed in % of value added in manufacturing stood at 60% in Luxembourg, 76% in Germany, 71% in France, 68% in Sweden. The effects of the slowdown of economic activity in 2001 and 2002 on productivity are significant. As factors of production could not be adjusted in a few months, labour productivity dropped by more than 3% in 2001 and by 2% in 2002. Productivity can also be analysed in terms of its level (output per worker). The value added at current prices per person employed stood at around 75 000 EUR in the Grand Duchy in 2001, which, we must notice, is the year of the economic downturn and drop in productivity. The corresponding value for the EU-15 as a whole was only 48 700 EUR, for Belgium 60 100 EUR and for France 54 700 EUR. Economic structure: From steel-making to finance ... Whereas in 1974, the Luxembourgish steel industry still accounted for 25% of the sum of values added in Luxembourg's economy, it accounted for only 12% by 1975, following the crisis linked with the first oil shock which hit this industry very hard. The relative weight of the steel industry in the economy continued to drop in the following years and reached less than 2% of total value added in 2002. On the other hand, since the end of the 1970s (in the middle of the steel-crisis which lasted from the mid-1970s to the mid-1980s) the rapid development of financial services began to stimulate growth in Luxembourg. The share of financial services in the sum of values added grew from less than 5% in 1970 to 22% in 1985 and to over 28% in 2002. At the end of the 1990s, financial services were accounting for over 40% of the tax receipts of the central government. The number of persons employed in financial services increased from 4 300 in 1970 to 11 200 in 1985 and 33 400 in 2002. As for the number of banks, it went from 37 in 1970 to 223 in 1996. Since that year, however, the number of banks in Luxembourg began to decline (172 banks in October 2003), not because the country had become any less attractive as a financial centre but because of the wave of mergers and acquisitions which had started to affect Europe as a whole. For this reason, although the number of banks has fallen, their total assets have continued to rise. It is clear that this rationalization movement was reinforced by the economic downturn of 2001/2002, which affected the performance of financial activities. Over the years financial services have extended their activities from the traditional area of Eurocredits and private banking to other activities like funds administration and distribution, and asset management. Undertakings for Collective Investment (UCIs) took off in 1983 when Luxembourg, anticipating forthcoming Community regulation of undertakings for collective investment in transferable securities (UCITs), set up a modern and flexible legislative framework. The total net assets of Luxembourg UCIs increased from 16 billions of Euros to over 900 billions of euros in 2003. In the space of only a few years Luxembourg has become the world's second largest centre for investment funds after the United States. It has a European market share of over 22%, and Luxembourg assets account for over 15% of the world total excluding the United States. Insurance and reinsurance companies also have developed strongly since the beginning of the 1990s. Financial globalisation provided the Luxembourg financial market with the framework for expansion that was evidently due to the favourable and flexible legal context, but also to the adaptation of financial products on an expanding global financial market. The development of financial services has had favourable repercussions on such sectors as hotels, catering, air transport, business services (consulting, advertising, legal services, cleaning, security) and IT services. The civil engineering and construction sector also benefited enormously from the healthy general economic situation. ... on to transport and communication services The share of the transport and communication sector as a whole, including road transport, rail transport, air transport, and post and telecommunication services, in the total value added of the Luxembourgish economy rose from 6% in 1985 to about 10% in 2002. The employment in the sector has doubled and is now over 23 000. Transport of goods by road was booming since the beginning of the 1990s. Between 1995 and 2001, the number of persons employed by road transport firms went from 3 500 to more than 6 000. Foreign companies attracted by competitive social security taxes have set up business in Luxembourg. International traffic (transport of goods by road outside Luxembourg) by vehicles registered in Luxembourg accounts for a large proportion of the growth. Air transport is also increasing rapidly. Two large airlines are based at the Luxembourg airport, namely Luxair (passenger transport) and Cargolux (cargo transport). Cargolux is now among the world's largest air cargo companies. The traffic at Luxembourg Airport is reflecting these developments: from 1995 to 2001 landings and take-offs rose from 69 700 to 86 000. The number of passengers increased from 1 072 264 in 1990 to 1 625 232 in 2001. Cargo transport went from 143 667 tonnes in 1990 to 510 965 tonnes in 2001. Compared to population, the number of cars registered in Luxembourg reaches one of the highest levels in the world: the number of licensed motor vehicles went from 186 000 in 1980 to over 330 000 in 2001. This development has a positive impact on car selling and repair, but a negative impact in terms of congestion of the Luxembourg road network. Luxembourg's adhesion to the international motorway network has been a priority in recent years. From 44 km in 1980 the length of the motorway network increased to 126 km in 2002, the total length of the road network remaining at the same level (2 800 km). Rail transport has some difficulties to find its way in competition with road transport. The number of rail passengers fell from 14 million in 1980 to 11.1 million in 1996 and has recovered quite strongly in recent years, reaching 13.6 million passengers in 2001. In terms of employment, the share of telecommunications in the Luxembourg economy is still relatively low. Telecommunications are employing around 1 000 people, representing 0.3% of total employment in 2002. Its contribution to growth is however important. Telecommunications contributed for around 2.5% of the total value added of Luxembourg economy at the beginning of the 21st century. The sizeable growth in the sector is shown in the statistics of the Post & Telecommunications company (P&T). The number of installed telephone lines grew from 184 000 in 1990 to about 350 000 in 2002. Outgoing international calls increased from 150 619 to over 330 000 in the same period. The total number of mobile phone subscribers (P&T and the competing network "Tango") is over 380 000 (nearly 90 subscribers for 100 inhabitants). Internet traffic of the P&T provider rose from less than 100 million minutes to more than 500 million. Around 55% of Luxembourgish households were connected to the Internet in June 2002 (4th place in the European comparison). In the telecommunications sector, we should also mention satellite transmission. The "Société européenne des satellites" (SES) was set up in 1986, based on a concession granted by the Grand Duchy of Luxembourg for broadcasting audiovisual programs. The first satellite was launched in 1988 and the SES-ASTRA system continued to develop becoming the Europe's largest operator of satellite services employing around 350 staff in Luxembourg. In 2001, SES-GLOBAL was created from the association of ASTRA and AMERICOM, one of the largest operators of satellite services in the United States. SES-GLOBAL, with more than 40 satellites belonging directly to SES or to partner companies, covers 95% of the world's population. ... and to business and IT services IT activities, comprising consulting in information technology systems, software production, data processing, database activities, etc., currently constitute the most dynamic sector of the economy in terms of employment and value added. From 300 people in 1985, employment rose to nearly 5 000 in 2002. The share of IT activities in the total value added of the Luxembourg economy increased from 0.2% to 1.2% over the same period. The employment in business services practically quintupled from 1985 to 2002 (from 7000 people to more than 35 000) and represented approximately 13% of total employment in the Luxembourg economy in 2002. The share of business services in total value added grew from 3.1% in 1985 to 6.3% in 2002. Within the sector itself, there is a juxtaposition of activities requiring the use of specialist staff, including accounting services, architecture and engineering, management consultants, legal advisors, R&D, etc., and activities requiring less skilled staff, such as cleaning, surveillance and security, etc. Ongoing efforts to diversify the economy and the industry in particular The policy of economic diversification which the public authorities have doggedly pursued since its new launch in 1977 (creation of the "Société Nationale de Crédit et d'Investissement", SNCI) aims to combat the relative decline in iron and steel-making and industry in general, and reduce the risks resulting from overspecialisation. The "Board of Economic Development" pursued its promotional activities, and, since 1975, more than 170 new production units from various countries have set up in Luxembourg, employing over 15 000 people at the beginning of 2002. Efforts to renew the economic fabric have also centred on encouraging existing small and medium-sized enterprises to invest in modernization. From the early 1980s there was an increasing recognition of the importance of innovation and research/development (R&D). The law of 9 March 1987 laid the legal foundations for the creation of Public Research Centres (CRP) promoting scientific and technical cooperation between the business sector and the public sector. A law of 1993 provided for government budgetary contributions to efforts made by businesses in the R&D domain, while the National Credit and Investment Company (SNCI) was authorised to grant loans for innovation. "Luxinnovation", a joint initiative from the Luxembourg government and employers' associations, is responsible for assisting businesses wanting to get involved in innovation projects. The National Research Fund was set up in 1999 and the creation of the University of Luxembourg (developing an existing partial university structure) should help to promote R&D. Nevertheless, the situation in the field of R&D can be improved. In 2001, the total R&D expenditure of the public sector and the business enterprises was 279 million EUR (of which 244 million in the business sector) representing 1.36% of the GDP. This rate reached however 1.94% on average in the EU-15. The apparent domination by a particular economic sector (i.e. the financial services from the 1980s on) is also the result of the small size of the country. In a small economy, the impact of a competitive sector that is experiencing strong growth is particularly visible and, in some measure, hides the dynamics of other sectors. As we already saw, the industrial sector as a whole did very well in terms of productivity. Despite its loss of relative weight in total value added (the share of manufacturing industry declining from over 20% in 1985 to a little more than 10% in 2002), employment in the sector remained stable. Even the iron and steel industry, whose total impact on the Luxembourg economy is decreasing, has been completely restructured, with cutbacks in jobs accompanied by the thorough modernization of the manufacturing structure (blast-furnaces were replaced in the 1990s by the electrical process) leading to a clear improvement in productivity. In 2001, ARBED, the only remaining steel company in Luxembourg after a series of mergers, acquisitions and rationalization, ACERALIA (Spain) and USINOR (France) merged to form the ARCELOR Group, which is currently the world's largest steel-making group (around 5% of world's steel production) and which employs over 100 000 staff in over 60 countries. ARCELOR, whose registered office is in Luxembourg, remains the country's largest employer with more than 7 000 staff (of which 5 800 in steel-making) employed in 2002. Another important industrial sector, partly linked to steel-making, is the processing of metals (structural steelwork, etc.). Among the main operators in the rubber, plastic and textile products industries are branches of Goodyear and Dupont de Nemours, which were established in 1951 and 1965 respectively. The chemical industry, boosted by the arrival of "TDK Recording Media Europa S.A." in 1991 (production of cassettes, disks for audio and video recording), has also positive results to report. The two main non-metallic mineral products are glass (Guardian Group) and ceramic tableware (Villeroy & Boch). The media sector, which is strongly represented through the activities of the CLT (Compagnie Luxembourgeoise de Télédiffusion), should also be mentioned. The "decline" of agriculture The amount contributed by agriculture to gross value-added is still falling. It went from 2% in 1985 and to 0.6% in 2002. Although in 1985, 6 800 people were still employed in this sector (4% of total employment), there were only 3 700 in 2002 (1.3% of employment). The total number of farms decreased from nearly 4000 in 1990 to around 2 800 in 2000 (the number of "full-time" farms of 2 ha or more declining from 3 280 in 1990 to 2 236 in 2002). On the other hand, productivity gains are important: labour productivity grew by over 5% per year in the agricultural sector between 1985 and 2001. Small agricultural holdings are giving way to holdings of 50 ha and over, which nowadays account for half of all full-time farms. The average area per farm went from 38.4 ha in 1990 to over 55 ha in 2002. In the period 1990-2002 milk production was rather stable at around 265 000 tonnes, but the milk yield per cow was rising from 4 800 kg to 6 400 kg in the same time period. The share of milk in total agricultural output stays at more than 30% and represented over 50% of the commercialised agricultural production (given that much of the crop production is not commercialised). The share of beef in total agricultural output is around 20%, and that of wine little more than 10%. An open economy As a very small country, Luxembourg is obliged to be open to the outside world in terms of use of foreign capital and workers from other countries, but also in terms of imports and exports of goods and services. Exports of goods and services represented more than 150% of the Luxembourg GDP in 2001. This rate was only 36 % for the EU-15 and some 95% for Ireland, which is also characterised by its openness. Foreign direct investment (FDI) reached nearly 60 000 $ per head of population (20 000 $ excluding the banks) in 2000. This figure has to be compared to the EU-15 average which stood at 6 300 $ FDI per head of population. The structure of the current account balance is reflecting the structure of the Luxembourg economy. Since 1975 only the balance of services has been positive, while the balance of trade and the balance of transfers are showing a structural deficit. Financial services represented more than 35% of exports of goods and services on average in the years 1995-2001. The overall current account balance is consistently in the black, with a surplus growing until the mid-1990s and stabilising since then. Sound public finances, threatened by the economic slowdown The economic development in the last 15 years of the 20th century, characterised by high growth rates, had a positive impact on revenues of the central and local administration, as well as on revenues of social security schemes. This allowed, one the one hand, high public investments which are favourable to growth. In the mentioned time period, gross fixed capital formation of general government reached more than 4% of the Luxembourg GDP, and only little more than 2% of GDP on average in the EU-15. Rising revenues allowed also to develop an efficient redistribution policy, without threatening the balance of public accounts. Expressed in % of GDP, general government expenditure fell slightly from 45% on average from 1991 to 1995 to 42% on average between 1996 and 2000. Compulsory deductions could also be maintained at a competitive level. Public authorities were able to avoid high indebtedness. Luxembourg's public debt represented only 5.7% of GDP in 2001, compared with an average of over 60% of the GDP in the Fifteen. As a consequence, public expenditure on interest is very low. The net financing capacity (surplus) of general government, including social security, increased from 2.1% in 1995 to about 6% in 2001. Reserves (budget reserves and special funds) could be built, which amounted almost 11% of GDP in 2000. The economic slowdown since 2001 has important direct effects on public finances. The financing capacity (surplus) in 2002 is declining although remaining positive (2.5%). If there is no heavy economic upturn, financing capacity will however be negative in 2003 and 2004. In that case, reserves could eventually be exhausted in 2005/2006. Nevertheless, it should be noticed that in terms of public finances Luxembourg can develop on a healthy basis. Text finalised in March 2004.