With its moments of respite, the summer break is an ideal time to take a more detached and objective look at current events – both globally, domestically and across Europe – and to nurture renewed reflection. I’d like to take this opportunity to share my thoughts on the current economic situation.
World economy: the geopolitical situation remains tense
Geopolitical tensions continue to weigh on economic activity. The war between Israel and Hamas continues, and there remains a heightened fear that it could spread to neighbouring countries. The confrontation between Russia and Ukraine drags on – and let’s not forget the tensions between the United States and China against the backdrop of the US presidential election campaign. The statistics published by the United States at the beginning of August were also disappointing. The rise in unemployment of almost 1 percentage point in eighteen months (now at 4.3%) and the sharp fall in the ISM manufacturing index (from 48.5 to 46.8 in July) have caused panic in the financial markets and prompted fears of a recession. In China, the sharp slowdown in GDP (+0.7% in Q2 compared with expectations of +1.1%) comes amidst a crisis in the property sector, low private-sector investment and municipal debt. In addition, the contraction in the Purchasing Managers’ Index (PMI)[1] in June and July indicates that the world’s second-largest economy has been struggling to regain momentum since late 2022 and the end of restrictions introduced in response to the COVID-19 pandemic.
Short- and medium-term political uncertainties are affecting a growing number of countries. While this is naturally worrying political observers, it is also a cause for concern for investors, who fear increased instability (currently reflected on the stock markets) and a less favourable business environment, disrupting the long-term economic outlook.
The deterioration in trade relations between China and the United States is nothing new, but recent developments are particularly spectacular. The two countries are clashing over tariffs on strategic products such as electric vehicles, solar panels and semi-conductors, while there is also tension over protectionist initiatives such as the United States’ Inflation Reduction Act (IRA).[2]US imports from China are down sharply: $29.9 billion a month compared with over $40 billion a year ago. The European Union, in principle a supporter of free trade, is trying to find its way in the face of the return of protectionism. In a bid to boost economic activity, it has also decided to increase tariffs on imports. Since 5 July, it has been applying customs duties on electric vehicles produced in China. The measure is a provisional one at this stage, with a final decision to be taken in November. In retaliation, Beijing has decided to initiate procedures to apply customs duties on pork and dairy products from the European Union. No one knows where this protectionist spiral will lead.
European economy: mixed trends and a lack of momentum
Despite signs of recovery, the European economic climate remains fragile and uncertain. While the 0.3% increase in seasonally-adjusted GDP in the first and second quarters of 2024 (compared with the previous quarters) in the eurozone reaffirms the recovery that got underway at the start of the year, performance does vary between member states. Spain, the eurozone’s new driving force, recorded growth of 0.8% in the first and second quarters, underpinned by buoyant household consumption, investment and rising exports (particularly of services). But this performance will not be enough to compensate for the slump experienced by Germany, which saw its GDP fall by 0.1% in the second quarter after rising by 0.2% at the start of the year. Industry and construction activity is stagnating, while consumers remain hesitant despite the fall in inflation. Foreign trade, traditionally an important component of German GDP, continues to suffer. With a growth rate of +0.3% over the first two quarters of 2024, France and Belgium are in line with the European average[3]. In short, the current situation is more stagnation than growth.
Luxembourg: a dangerous “wait-and-see” approach?
Against this difficult international economic backdrop, how is Luxembourg’s economy faring this autumn? And what is the outlook for next year? If the main economic indicators – inflation, growth and unemployment – and the confidence indicators are anything to go by, the situation might best be described as “mixed”. STATEC even made reference to a “less buoyant climate than expected” in its latest Conjoncture Flash.
In terms of inflation, a trend reversal has been observed since June, when it (finally) fell below the level of the eurozone for the first time since October 2023, with the annual inflation rate standing at 1.7% (“excluding sales” index) in August compared with an estimated 2.2% in the eurozone. With this figure, the country has achieved the ECB’s much-vaunted 2% inflation target, although “core” inflation (i.e. excluding energy and food products) is still at 2.3%, compared with 2.0% in July. Despite this slowdown, forecasts predict that wages will be indexed again in the final quarter of this year, which will have a negative impact on the competitiveness and profitability of Luxembourg companies, particularly export-oriented SMEs. Overall, STATEC expects the inflation rate to rise to +2.3% in 2024, then to 2.6% in 2025, having previously been at +3.7% in 2023.
Growth remains moderate and below the level seen in 2023. In the first quarter of 2024, real GDP rose by 0.5% compared with the previous quarter. As has been the case in the eurozone, a recovery phase appears to be underway. However, the sluggishness of the German and European economies as a whole does raise fears of repercussions for our own economy. For 2024 in its entirety, STATEC is forecasting GDP growth of 1.5%. It should be remembered, however, that the 2024 state budget was drawn up based on assumed growth of 2% this year. If this underperformance were to be confirmed, it would have budgetary consequences owing to revenue shortfalls. We are clearly going to be a long way from a 3% growth rate, the average rate recorded by our country since 1995.
Unemployment continued to rise – to 5.8% in July – although it remains below the eurozone’s figure of 6.4%. Added to this is the decline in cross-border workers from Germany (-0.5% between the end of 2023 and May 2024, according to STATEC) and Belgium (-0.2%). Given the growing need for a workforce to support the country’s growth over the next few years – if not decades – this is a worrying trend. It is important for the government to bear in mind that the cross-border workforce is not only particularly sensitive to economic trends, but also to the conditions that Luxembourg can offer them (mobility, teleworking, infrastructure, etc.). At the same time, there has been a marked slowdown in the dynamics of the Luxembourg labour market: It is estimated that the job creation rate will only reach +1.3% in 2024, followed by +1.7% in 2025. This is a far cry from the average increase of 3.1% our country has enjoyed since 1995, with obvious repercussions for the funding of our pension system.
In terms of confidence, STATEC notes that the July indicators show it is once again beginning to slide, particularly when it comes to industry, retail and non-financial services, in contrast to a certain optimism that was palpable at the start of the year. It is true that the confidence of business leaders has been seriously affected by concerns regarding profitability. The Chamber of Commerce’s Economic Barometer for the first half of 2024 showed that 34% of entrepreneurs – and in particular those in the retail (33%) and construction (43%) sectors – feared a fall in their profitability over the next six months. Companies in the construction sector are not out of the woods yet. Although there has been a slight increase in confidence in recent months, they remain much more pessimistic than they were two years ago. Despite loan applications picking up again since the start of the year – after three years of decline – the construction sector saw its number of salaried employees fall by 4.7% year-on-year in the first quarter, making it the sector with the highest job losses in Luxembourg. Let’s hope that the housing stimulus package adopted by the government before the summer can bear fruit in the coming months.
2025 state budget: building confidence?
In order to regain their confidence, businesses need to feel supported, guided and stimulated by government action. The 2025 budget, to be presented on 9 October 2024, will be an opportunity for the government, which has been in office for less than a year, to send out clear signals and restore the confidence of socio-economic players. We expect determination, responsibility and ambition.
First, determination – in the desire to modernise the state apparatus. The new government’s choices include lower taxes for individuals and businesses[4]. But one burning question remains: what impact will this have on tax revenues? The government is betting on a revival in business investment and household consumption to stimulate growth and, in turn, generate new tax revenues. However, in its opinion on the 2024 budget[5], the Chamber of Commerce expressed reservations that it might not be enough. In order to restore the budgetary room for manoeuvre that will be essential in the face of future economic shocks, it is imperative that we get a better grip on expenditure, especially the more rigid one, with the trend in this expenditure being particularly worrying. In the 2024 budget, the government clearly expressed its determination to contain the rise in the wage bill, limiting its annual increase to 5% in 2026 and 2027. This will involve digitisation and the optimisation of administrative efficiency as a matter of necessity. On the face of it, this is good news for businesses, as it is a response to the desire for administrative simplification that has been expressed by entrepreneurs. This control of rigid expenditure is all the more essential given that other “constrained” expenditure is set to increase inexorably in the years ahead. This is the case for defence spending, which will double by 2030 to meet our NATO commitments. It is up to the government to turn this endeavour into an economic opportunity by focusing in particular on “dual-use” investments that would have an impact in both a military and a civilian sense. The same is true of our spending on pensions. This autumn will also see the launch of the major consultation promised by the Prime Minister on this subject.
Second, responsibility – in the management of the public purse. In a world fraught with so many risks, our country must build on what has made it strong: stability and reliability. In recent years, in the face of crises, it has resorted to massive borrowing. It is time to put a stop to this dangerous debt dynamic. By the end of 2024, Luxembourg’s public debt is expected to reach €22.3 billion, or 26.5% of GDP, according to the 2024 budget. Although this debt is much lower than that of other European countries, such as Greece (159.8%), Italy (137.7%) and France (110.8%), the trend is still a worrying one. In 2007, it represented just 8.1% of GDP. If growth is less sustained than expected, the symbolic threshold of 30% of GDP – a threshold beyond which debt starts to become costly and worrying for investors – could be crossed as early as 2027.
And finally, ambition – to support our businesses with their environmental and digital transition and thus transform our economy. In the fight against global warming, the government has already committed to increasing annual spending from €722 million in 2023 (0.89% of GDP) to €922 million in 2027 (0.94% of GDP). It remains to be seen how these funds will be deployed strategically. It is absolutely crucial that these resources are used in a more targeted and selective way than they have been in the past.
As far as the digital transition is concerned, we will need to pay close attention to how much investment is allocated towards artificial intelligence. Luxembourg, which has built its prosperity on highly productive activities, is now faced with stagnating productivity, affecting its competitiveness and growth. Little by little, the country is losing the competitive edge it gained in the second half of the twentieth century – overtaken by economies (some of which already had high levels of productivity) that have been better at pushing technological boundaries in a bid to boost their productivity. Artificial intelligence could be the long-awaited fuel Luxembourg needs to kick-start a new cycle of productivity and revitalise its economy. Conversely, a delay in adopting this technology would be disastrous, as it would set back the country’s economy for years to come. The government has set a course: to position Luxembourg as a leader in the data economy. To achieve this, the country will need to rethink education and training, attract new talent and encourage businesses to transform their production methods and the way they are organised. This is a cross-cutting issue. The financial sector, which contributes almost 25% of gross value added in Luxembourg, must be at the forefront. I also think it is very important to offer special support to SMEs in relation to this transformation. In the non-financial economy, they represent 64.3% of the value added that is created in Luxembourg, compared with a European average of 53.1%[6]. Without SMEs, Luxembourg will not be able to succeed in its digital transition.
With the summer break being marked by the Paris Games, let us take inspiration from the Olympic motto as we return to work to meet the economic challenges that lie ahead: “Citius, Altius, Fortius – Communiter”: Faster, Higher, Stronger – Together.
[1]The PMI is an economic indicator used to assess the health of a country’s manufacturing, services and construction sectors. It is based on surveys sent to purchasing managers who are familiar with a company’s operations as well as the market situation regarding the supply and sale of their products and services. A reading above 50 indicates economic growth while a figure below 50 indicates contraction.
[2]This legislation, which massively favours the US domestic industry, provides subsidies totalling 369 billion dollars over ten years, including tax credits, for companies investing in electric vehicles and other green technologies.
[4]See the State of the Nation Address
[5]https://www.cc.lu/en/opinions-legislation/detail/pl-budget-de-letat-pour-lexercice-2024
[6]Source: SME Fact Sheet 2024