Alongside the humanitarian and health tragedy, the COVID-19 crisis has had an unprecedented impact on the global economy, and therefore on the European and Luxembourg economies. In the Grand Duchy, which is one of the world’s five most open economies, the general lockdown and the sudden halt to economic activity are threatening the foundations of a healthy, stable, prosperous and dynamic economic and financial ecosystem.
Though vulnerable by nature given their dependence on the international developments, these foundations are also the basis of our population’s wellbeing through social cohesion, an efficient redistribution model and a generous welfare system, the latter of which is now clearly demonstrating its benefits.
Our socioeconomic foundations are therefore being shaken in more ways than one. In the rest of this article, I will focus on the five prerequisites for limiting the socioeconomic damage from this unprecedented crisis.
1.Protecting economic substance and jobs
In this unprecedented situation, we above all need to avoid a chain of bankruptcies. This means keeping the bases of our ecosystem fundamentally healthy, otherwise a quick recovery and sustained, qualitative growth when the crisis ends will be unimaginable.
In the very near term, many companies of all sizes are facing serious liquidity issues, especially given the ban on a number of activities following the implementation of the amended Grand-Ducal regulation of 18 March 2020 ‘introducing a series of measures in the fight against COVID-19’, supply problems and interruptions in value chains, the unavailability of many workers, disruption to deliveries, and the cancellation of orders, etc.
This creates a short- and medium-term risk of collapse for businesses of all sizes, operating in nearly all sectors and, in the vast majority of cases, in good financial health before the crisis.
The array of measures presented on 25 March 2020 is an initial response to the more serious challenges facing companies in this deep crisis, namely cash and liquidity problems. Through strong support measures, both direct (subsidies, advances, guarantees) and indirect (deferral of tax and social security contributions, including partial exemption from the latter for the worst affected industries and companies), the goal is to do whatever it takes to prevent the massive destruction of Luxembourg’s productive fabric, which could have dramatic, lasting consequences for the economy and therefore the social cohesion of our country.
While the ambition behind this first package of measures is admirable, there will have to be close and permanent monitoring of the situation as it evolves. If the lockdown period is extended, the government will have to make the temporary and structural adjustments needed to avoid the destruction of Luxembourg’s economic substance and jobs.
The economic, societal, social and financial cost of such a scenario would by far surpass the budgetary cost of ambitious, coherent, complementary and clearly defined stimulus measures, supporting companies not just to help them deal with very short-term liquidity problems, but also to respond to threats to profitability and solvency in the event of restrictions being imposed over the longer term. The same goes for the social cost of this crisis, which, without bold, concerted efforts, could be substantial due to bankruptcies – possibly in a chain reaction – redundancies and, therefore, over time, a vastly different economic fabric.
While direct grants of EUR 5,000 to certain micro-enterprises and self-employed workers are a real cash and liquidity lifeline, this kind of support will probably have to be increased quickly through an extension of the aid, widening the list of eligible beneficiaries, and extending the forms in which they are granted and the amounts made available. Lastly, easy access to assistance and rapid, non-bureaucratic processing of applications, ideally in digital form, needs to be guaranteed.
Moreover, we welcome the guarantee scheme, introduced on an unprecedented scale, for loans granted between 18 March and 31 December 2020, up to a maximum of EUR 2.5 billion for new loans granted by credit institutions, which should facilitate lending to businesses affected by the crisis.
For companies that were already financially unstable, the current crisis will doubtless be the final blow. It is regrettable that these companies are excluded from several measures being taken by the government. We need to consider the reality of these entrepreneurs who will not survive another crisis if they are refused public aid. I am thinking in particular of city-centre businesses already bearing the brunt of work on the tram system. Many struggling companies are perfectly capable of getting back on track and becoming profitable. Moreover, this is clearly shown in the SME support project (formerly, the Viability Centre) that the Chamber of Commerce developed in 2018, and which, since then, has saved more than fifty businesses that had been considered to be in distress and therefore excluded from any kind of aid.
2. Maintaining the stability of the banking system
Protecting the international financial system, the collapse of which was behind the global crisis in 2008, is paramount. It should be borne in mind that it took nearly 10 years for the major economies to recover from the shock caused by this global systemic crisis.
With the current crisis, banks are not the root of the problem, but have the solutions needed to support the real economy and businesses short of cash. Given the risk of insolvency facing a great many businesses, we need to avoid the balance sheet weaknesses of companies being transferred to the balance sheets of banks that have already had to shoulder the substantial compliance costs arising from the considerable tightening of regulations and prudential control following the outbreak of the economic and financial crisis in 2007-2008.
At the current time, credit institutions are best placed (from an operational viewpoint) to inject liquidity into the economy quickly and efficiently, thus avoiding the looming chain of defaults. For this, they will have the support of the aforementioned government guarantee. To limit the damage, we will therefore need the full support of banks.
The Luxembourg economy is faced with an unprecedented threat. It is impossible to know when this will be brought under control and when activity can really pick up, or – more importantly – the magnitude and sequence of the recovery.
3. Public spending: A fine balance between a proactive approach and prudence over the medium term
Public aid measures intended to finance the protection of public health in general, the survival of businesses, and the preservation of the purchasing power of consumers require a very high level of public spending at a time when public revenues are slowing drastically. The budget deficit that will result is unknown; the exact amount will depend on the length of the lockdown and the period during which production and services are shut down.
A quick calculation, which probably underestimates the extent of the problem, already shows that the impact of this crisis on our public finances will be substantial[1]. Even if the lockdown were to be lifted as early as the end of April, and disregarding any temporary problems in restarting operations in the weeks following this suspension of business activity, and also assuming that a third of the quarterly GDP lost as a result of the lockdown is permanently lost (due to bankruptcies, a lasting reduction in private consumption or investment, a rise in unemployment, etc.), the GDP would be around 5% lower in 2020 than in 2019, whereas growth of nearly 3% was still being predicted barely a month ago.
All other things being equal, this would mean a decline in the general government balance of around 4% of the GDP in 2020, and this would come on top of the cost of the measures adopted, i.e. a little over 1.5% of the GDP for furlough, family leave and aid of EUR 5,000 to micro-enterprises and some self-employed workers. As a result, the government would see a total fall in the balance of 5.5% of the GDP, which would lead to a simulated deficit of nearly 4% of the GDP in 2020 (whereas a surplus of 1.7% was still being forecast last month). And this is without considering the impact of essential future measures if the crisis were to last, complementing the government’s first salvo of measures (in particular additional emergency measures, recovery support and stimulation of public investment).
If the lockdown were to run into May 2020, our simulation shows an even heavier impact: the change in the GDP over 2020 would be -10% and the general government deficit would be around 7% of the GDP.
However, a strong rebound would come in 2021, with growth (automatically) becoming very positive at around 6%. The general government balance would also improve in this scenario, with a (still high) deficit of around 3% of the GDP.
Fortunately, Luxembourg, which is one of the few countries in the world to have an AAA rating, has a degree of leeway to increase exceptional public spending, apply macroeconomic stabilisers and support the recovery through an anti-cyclical fiscal policy. However, as a small country without a large domestic market or internal borrowing capacity, making it disproportionately dependent on international trade in goods and services, Luxembourg has a much lower borrowing capacity than larger countries.
Here again, though, Luxembourg’s debt currently stands close to 20% of the GDP, a long way from the 30% debt limit that the government set itself as part of the coalition agreement at the end of 2018. In absolute amounts, public debt currently amounts to EUR 12.6 billion and the 30% limit equates to EUR 18.4 billion, meaning that the leeway of about EUR 6 billion seems comfortable at first sight, considering the cost of direct aid (certified emergency indemnity (EUR 50 million), repayable aid measures (EUR 300 million), furlough (EUR 1 billion for two months), family leave (EUR 400 million for two months)), so around EUR 1.75 billion.
An intelligent balance will have to be struck between introducing emergency measures to avoid the permanent destruction of socioeconomic substance, and the ability to finance these measures over the long term. While great flexibility is needed in the short term – facilitated moreover by the European authorities that have agreed to a temporary suspension in 2020 of the rules of the Stability and Growth Pact – a lasting derailment of public finances must be avoided. This would mean future tax hikes, which would damage the country’s economic appeal.
A balancing act, to be clear, aimed at reconciling essential short-term responsiveness with the long-term future of our economy!
4. The recovery must be coordinated and gradual
We have to be all the more proactive as the recovery will not just happen smoothly overnight, and the situation could vary between sectors depending in particular on the measures that need to be taken to protect workers, such as disinfection, social distancing in the workplace and protective equipment, opening times, etc. Confidence in public transport will also need to be restored, and consumer safety ensured.
The economic recovery must be gradual and organised by the authorities in close consultation with economic agents at sector level, and in some cases even at company level.
Production facilities, which have been reduced to their most vital functions, cannot be re-started from a virtual standstill to their pre-crisis capacity. Close consultation with the health authorities will also be essential during the recovery period: any double dip must be prevented, as this would be an unbearable situation for society after an already extended period of lockdown.
Everything will depend on how long the lockdown lasts: if the recovery is rapid, company order books should fill quickly and pre-crisis levels of activity could be reached in most sectors.
Otherwise, the recovery should be supported by ambitious public investment to raise medium-term economic growth potential, provided that such investment targets a list of priority projects to strengthen our country’s structures with a view to generating qualitative and sustainable growth (mobility, healthcare, areas of economic activity, etc.). Research carried out by STATEC in particular has shown that the macroeconomic multiplier (i.e. the economic knock-on effect) of public investment is much higher than that of current spending. What matters most of all is that these investment choices work to increase Luxembourg’s medium-term economic growth potential.
Post-crisis, investment in human capital will also be a priority: help with ongoing training costs for reskilling/upskilling, the flexibilisation of employment law to encourage job retention and returning to work at a time when confidence is still quite low, with solutions such as ‘first job created in a micro-business exempt from social security contributions for three years’ in order to make the labour market more resilient.
The legal and regulatory framework will also have a role to play, by allowing the launch of new activities, for example, but also by simplifying procedures or even introducing tax incentives to support Luxembourg’s attractiveness and competitiveness.
5. Europe must emerge stronger from this crisis
A major challenge for the post-crisis period will be to firmly and ambitiously tackle the European project, which for some people means ‘saving it’ and for others ‘completing it’. Indeed, numerous examples of both dysfuntion in the internal market (uncoordinated closure of borders, interruption of vital supply chains, etc.), and European solidarity (requests for help from the Italian health authorities, etc.) have made the headlines during this health crisis. In these rather turbulent times, Jacques Delors was less reserved than usual when he said that ‘The climate that seems to be prevalent between heads of state and government, and the lack of European solidarity, present a mortal danger to the European Union’.
On the other hand, some fine examples of solidarity between Member States (especially in terms of collaboration during the health crisis) provide hope. A unanimous European solution to the problem of financing the economic shock from COVID-19 would be another positive example. While ‘corona bonds’ have yet to meet with unanimous approval, it is essential that a mechanism based on European solidarity can be agreed on quickly.
Several Member States have proposed the creation of pooled eurozone bonds to provide substantial funding in response to the economic shock resulting from the coronavirus epidemic that is hitting the continent hard. Their aim is to support a resumption of growth, which has been badly affected by the lockdown, with money guaranteed by a common European fund. Corona bonds are equivalent to the eurobonds that were mooted in 2011 during the Greek debt crisis, but which never saw the light of day. For the moment, each country is issuing its own public debt. Lower quality debt requires a higher yield.
But it all depends on the country’s ability to repay its public debt. And this repayment ability is greater in Germany, for example, which is borrowing at negative interest rates, than in Italy where the markets demand a much higher yield because public debt – even before the crisis – exceeded 136% of the GDP.
The idea behind corona bonds is as follows: the European Stability Mechanism would issue corona bonds and allocate the proceeds to any Member State that needs them. These bonds could have very long maturities of several decades, to spread the annual contributions of Member States over as long a period as possible. They could finance both efforts to fight the epidemic and those aimed at limiting its economic impact.
Germany and the Netherlands are among the countries to have refused this proposal. These countries had already objected to eurobonds in 2011, referring to the ‘dichotomy’ between the ‘good pupils’ in northern Europe that stick to their budget, and the ‘bad pupils’, considered too spendthrift. With its favourable budgetary situation before the crisis, Germany has always refused the principle of pooling debt in Europe.
Is a change of position or a compromise solution conceivable? One possible compromise would be to issue corona bonds only for a very specific length of time covering the worst of the crisis and the time period of economic and health rebuilding in the Member States worst affected by the virus. Moreover, this would have to be accompanied by plans to reduce the public debt ratio in the most heavily indebted countries – over a sufficiently long horizon that includes a grace period, as it would be inappropriate to impose an overly drastic budget streamlining before the economies concerned have been reinvigorated.
Such a compromise is necessary, as a lack of cooperation in this crisis would permanently weaken Europe’s ability to build a real European project capable of benefitting its citizens. With the help of motivated, pro-European Luxembourgers, we will have to ensure that the balance leans towards a more accomplished European integration.
By taking into account these five areas of attention and forms of action, and combining them with bravery, solidarity and individual and collective sacrifice, it will be possible to overcome this unprecedented crisis in Luxembourg and in Europe, whose destinies are inseparable.
[1]The figures shown are based on Chamber of Commerce simulations for different scenarios.