The vaccination campaign is faltering, and Luxembourg’s performance in this regard (compared with most other developed countries) is in flagrant contradiction with the evolution of its GDP. Indeed, while Luxembourg is still unable to increase the rate of vaccination of its population – an absolute prerequisite for maintaining a certain degree of acceptance of the measures restricting individual and collective freedoms and for giving employees and companies a chance to emerge from this crisis – the Grand Duchy recorded a surprisingly solid economic performance at the end of 2020. In the fourth quarter of 2020, the GDP in real terms (seasonally adjusted) increased by 1.4% compared with the fourth quarter of 2019. Its quarterly evolution was 1.6% compared to the previous quarter.

While this better economic performance, as estimated for the whole of 2020 (which would thus end with a -1.3% evolution of the GDP in real terms, compared to the -6% feared a year ago), is to be commended, it must be acknowledged that both economic and social life in 2021 will depend essentially on the speed and effectiveness of the vaccination of the population, the only guarantee of a return to a ‘new economic normal’ and a phasing out of state aid which has an impact on public finances.

Unfortunately, so far, the Luxembourg vaccination campaign can be described as unsatisfactory, which may be surprising especially in comparison with, for example, the effectiveness of large-scale testing, the accessibility of masks and other medical supplies at the beginning of the pandemic, the organisation of logistics, the responsiveness (after some initial slowness and hesitation) of the authorities in implementing the aid measures introduced to support the economy and households, and the resilience of certain economic sectors, etc.

While waiting for a real surge in the number of people vaccinated per day (with the hope of arriving at a rate of 7 days a week and with the opportunity to include businesses and their logistical capacities in the vaccination strategy), the pandemic continues to affect a large part of the population, of all ages and all socio-professional categories, pupils, students, employees, company directors, the self-employed, pensioners, the unemployed, etc. The administrative closures imposed by the State and other restrictions continue to have a strong impact on the economic and societal fabric of Luxembourg and Europe.

The current crisis is also having a strong impact on the profitability of companies, which is in fact their oxygen and the main driver of their business model. The profitability of companies – and not only those operating in the sectors most affected by the crisis – drops if activity falls more sharply than costs are reduced. The exceptional aid granted to the companies most affected by the crisis has thus proven to be indispensable. Indeed, the collapse of their profitability has nothing to do with their structural viability, but with abnormal economic conditions. Everything must be done to mitigate the effects of the crisis on the profitability of companies, which is jeopardising their viability and their capacity to invest, create jobs and generate fiscal revenue for the State.

However, without investment, the delay in digital and environmental transformation will prove irrecoverable and disastrous for their future competitiveness and for sustainable development. Profitability is not an end in itself, but a factor in the resilience and development of economic entities.

A misleading debate on ‘zombie’ companies…

So-called zombie companies have been receiving some media attention recently. The ‘zombie company’ is a relatively new concept defined by the OECD as, ‘a company that is at least ten years old and whose annual results are not sufficient to finance the interest on its debt, so that its indebtedness increases inexorably. These companies do not have the means to invest. Thus, they just barely get by and become a burden on growth.’ Helping these companies to survive would therefore be a serious mistake that would harm growth, according to the Schumpeterian principles of creative destruction.

While the theory is clear, the economic reality calls for more humility. The development of the concept of the ‘zombie’ company has occurred in parallel with a sustained decline in interest rates in developed economies. In recent years, the simplified financing of companies has made it easier for those in difficulty to survive by continually refinancing themselves, thus inflating the number of unprofitable companies, in Luxembourg and elsewhere. This is illustrated by the rise in the gross debt of non-financial companies. However, in Luxembourg, this movement stopped in 2010, as shown by the OECD data with a debt/surplus ratio of non-financial companies that was lower in 2018 (17.5%) than in 2008 (18.2%).[1]

More importantly, this debate about ‘zombie’ companies has lost its meaning in the current crisis. The reason is simple. It is currently impossible to make a clear distinction between solvent but illiquid companies and structurally insolvent (‘zombie’) companies, because of the current, very specific, unprecedented circumstances. This is even more true as companies in difficulty before the crisis cannot benefit from state aid.

Companies whose survival is due to the aid currently granted were therefore, on the whole, in good health before Covid-19 appeared. Most of them are companies affected by a sudden halt in activity in their sector (hotels and restaurants, transport, events, culture, etc.), and the analyses of their low productivity are based more on the structural density of employment in these sectors than on a solvency problem. Other highly productive sectors are particularly affected, and helped by the public authorities, such as aeronautics. Waves of bankruptcies, triggered by the withdrawal of aid, could quickly snowball, with irreparable losses in terms of labour and skills, equipment and innovation.

Allowing these companies to disappear would be an economic, social and technological tragedy for Europe and Luxembourg. The cost to the community would be much higher than the impact of current aid on public finances. It is therefore inconceivable to withdraw aid from companies before the health crisis has been largely resolved and the intrinsic situation of the sectors and companies properly assessed with sufficient hindsight. It will then be important to make a precise evaluation of the situation, sector by sector and without any ideological posturing.

Finally, this debate should be seen in the context of current questions about the evolution of inflation and the rise in long-term interest rates. Such a scenario, potentially dramatic for economic recovery, would have the consequence of diminishing the phenomenon of ‘zombie’ companies while at the same time strongly affecting indebted European economies. In the face of these risks, solutions will have to be found to deal imaginatively with Covid debt and give priority, first and foremost, to a return to sustained economic activity, which, as a reminder, depends on the speed, efficiency and impact of vaccination.

Zooming in on profitability

The concept of ‘zombie’ companies has at least one virtue: it highlights that indispensable, yet underestimated, profitability. One of the lessons of this crisis, as with previous ones, is that increasing profitability must be the primary objective of any company, among other things, to build up reserves for a rainy day. Too many companies found themselves without cash a few weeks after the start of an admittedly unprecedented downturn. Unfortunately, the current crisis will not be the last and companies will have to regain or even increase their past profitability in order to build up reserves to face future crises. The companies that have fared best in recent months are those that were ahead of the game, particularly in terms of digitalisation and innovation. Profitability triggers a positive cycle that allows companies to invest in order to be at the forefront of their sector and thus to be more competitive in the long term. Conversely, under-profitable companies are unable to keep up with their competitors’ rate of investment, thus falling inexorably behind.

Luxembourg companies have long suffered from a lack of profitability, occupying the last place in the European ranking of the gross operating surplus (GOS) rate of non-financial companies. STATEC[2] points out that this indicator has certain biases, such as structural differences in the production of economies. Nevertheless, this underperformance and the evolution of this economic profitability – from 8.2% in 2007 to 6.3% in 2015[3], the last year counted by the STATEC study – illustrates the need for Luxembourg companies to regain their financial margin. Even more worryingly, a quarter of Luxembourg companies had a negative EBITDA rate.

Le Baromètre de l’Economie[4] from last autumn sheds light on the evolution of profitability during the crisis. 38% of companies with six or more employees expected their profitability to fall in the current period. They represent 55% of the hotel and restaurant sector, 44% are from transport, 40% from retail, and 34% from industry. In addition, 42% considered the debts accumulated since the beginning of the crisis as one of the main challenges for their economic development. The crisis has seriously affected the profitability and cash flow of Luxembourg companies. We must continue to support them to overcome this difficulty.

Four strategies for 2021

It is therefore essential to put business profitability at the heart of economic policies. With this in mind, I propose four priority actions for 2021, alongside an improved and efficient vaccination strategy.

Mitigate the effects of the crisis on business profitability

To achieve this, the continuation of aid is essential in order to restore the liquidity of solvent companies. The withdrawal of aid should not be abrupt and should follow an economic upswing and return to normal activity. It would make no sense to help sectors in difficulty for months on end, only to abandon them once the end of the tunnel is in sight. Moreover, the amounts of aid granted to safeguard the economic fabric must be put into perspective. Despite the exceptional situation, with EUR 700 million spent by the State (including partial unemployment, excluding reimbursable loans), this aid to economic activity is the equivalent, for public finances, of the aid for housing[5] . The future prosperity of Luxembourg will come much more from the preservation of its economic fabric than from the continuation of aid with a notoriously inflationary impact.

Introduce an untaxed investment reserve for SMEs

The introduction of an untaxed investment reserve should enable SMEs to increase their equity capital in a tax-neutral manner and thus have the necessary liquidity for future investments, especially through self-financing. This would also help to smooth out the tax burden, despite economic peaks and troughs. Thus, this system does not increase profitability, but allows it to be optimised over time and to support the viability and development of companies.

Increase the financial literacy of entrepreneurs

Entrepreneurs need to be made more familiar with and trained in financial management and the importance of profitability for their business. Profitability should be considered from the start of the entrepreneurial project and in particular be based on sound hypotheses in the entrepreneurs’ business plans. The topic of profitability is already part of several programmes at the House of Entrepreneurship of the Chamber of Commerce. We are willing to do more in this area and encourage public actors (Ministries, agencies…) to do so with us. Business leaders and managers need to participate in more training, like that offered by the House of Training of the Chamber of Commerce and the ABBL.

Accelerate digitalisation

While digitalisation has a cost, we must convince economic stakeholders that this investment is more than just profitable, it is essential for the long-term viability of SMEs. Although the crisis has accelerated the digital transition of SMEs, it is above all those who had anticipated the digital shift that have made their way in recent months, and who have been able to maintain the profitability of their business. The digitalisation of processes and tools, migration to the cloud, data collection and automation, to name a few, still need to be accelerated within SMEs in order to gain in productivity and, ultimately, in profitability.

If digitalisation was a major concern for 28% of Luxembourg companies in autumn 2019[6], it is safe to assume that now there are many more. At the Chamber of Commerce, we will soon make new concrete proposals to accelerate digitalisation through our dedicated working group.

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[1] https://data.oecd.org/corporate/non-financial-corporations-debt-to-surplus-ratio.htm

[2] Available in / Published in French: Bilan du STATEC – Un faible taux d’EBE au Luxembourg, et donc ? (2018).

[3] Compared to the European average of 10.7%.

[4] Available in / Published in French: Baromètre de l’Economie du 2^ème semestre 2020 – Thématique : Le développement durable.

[5] Available in / Published in French: Logement au Luxembourg : le pire serait-il à venir ?, Décryptage n°1 de la Fondation IDEA, Juin 2019.

[6] Available in / Published in French: Baromètre de l’économie – S2 2019 – Thématique : Transformation Digitale.