Many countries envy Luxembourg’s budgetary situation, say Jean-Paul Olinger and Nicola Simons, respectively director and economic adviser of the UEL. Despite everything, comparatively speaking and over the medium term, it remains in the black.
Viral infection of public finances
Economic activity slowed by the measures taken to stem the spread of Covid-19, as well as support for households and businesses, have had a considerable impact on Luxembourg’s public finances at all levels. Central government (reporting a budget deficit), local government (with a budget trending towards equilibrium) and social security (positive balance with a downward trend). As a result, expenditure by central government (the state) should amount to 22.9 billion EUR in 2020 – i.e. 2 billion EUR more than budgeted – while revenue should fall by 2.5 billion EUR in 2020 to only 17.8 billion EUR. Also from the point of view of public finances, 2020 was an exceptional year. It was the first year in which public revenue decreased and the largest annual deficit was reported, at 5 billion EUR. The resilience of the financial and administrative services sectors – notably through widespread teleworking – has helped to limit the damage to public finances, compared to other European economies. Although its magnitude is expected to decrease, these deficits are unfortunately expected to continue until 2024. In the least pessimistic Covid-19 scenario, these are forecast to increase public debt from EUR 14 billion in 2019 (22% of GDP) to EUR 24 billion in 2024 (33% of GDP)!
The resilience of the financial and administrative services sectors – notably through widespread teleworking – has helped to limit the damage to public finances.
A starting situation that is less healthy than it seems
The dynamism of the financial sector (the main contributor to tax income) and growth in the labour market (a 110,000 increase in the workforce over the last 10 years) has given Luxembourg enviable public finances. The flip side is that we have become accustomed to this positive but temporary situation, building significant structural expenditure into the system. Almost 3 out of 4 euros of state expenditure is on social security and salaries.
This balance is not sustainable. The fragility of revenues and their strong reliance on the financial sector poses a real challenge to Luxembourg’s financial resilience. This vulnerability (and the corresponding volatility) has to be compared to the structural, rigid and therefore hard-to-adapt nature of expenditure. This balance is illusory. Huge surpluses (EUR 800 million on average from 2010 to 2018) in the social security system mask recurrent deficits at the state level (EUR 400 million on average from 2010 to 2018). It should be remembered that these surpluses result from strong growth in the number of employees, and this money does not belong to the state. They are contributions (mainly for pensions) which will have to be used later to finance the retirement income of today’s working population. However, the public finance figures reported do not distinguish between the two, but merely the total. This comfortable perspective distorts an honest interpretation of reality.
Reacting today and anticipating tomorrow
The UEL (Union des Entreprises Luxembourgeoises) represents companies, and like them, it wants to be positive about the future. Yes, we are in crisis and we dare to believe that after the rain, fine weather will return. Many other countries envy our global budgetary situation which remains – comparatively speaking and despite everything – over the medium term, in the black. This is due mainly to pension fund reserves (22 billion EUR in 2019) and the contributions held by the state. In the short term, it is a matter of implementing a counter-cyclical fiscal policy. It is through ambitious and selective investment that we will strengthen the activity of our priority economic sectors. As well, an ambitious talent management policy will revive the economy and meet the challenges of economic, digital and environmental transitions. It will then be a matter of making our public finances more sustainable and avoiding a return to the previous situation, once the economy has (hopefully) recovered. In conclusion, policy making in this environment is a challenge for government. We can only advise it to take a proactive and rational approach to the difficult tasks of managing public money.