Vaccinations are beginning to bear fruit, large-scale stimulus programmes are aimed at boosting the economy, and demand in particular, and consumers are eager to put the pandemic behind them and look to the future. Circumstances seem to be ripe for a dynamic recovery of the European and Luxembourg economy. But could rising prices and the lack of raw materials and labour spoil everything?
Europe is losing out in the global race for resources
Indeed, supply times are increasing and the prices of many raw materials and intermediate products – from industrial and rare metals to agricultural commodities, wood and semiconductors – have soared since the beginning of the year, fueling fears of an inflationary spiral. For example, the prices of wood, oil, copper and palladium rose by 409%, 130%, 99% and 54%, respectively, between 6 May 2020 and 7 May 2021.
But what are the reasons for this surge? The answer depends largely on the resource in question. Thus, bad weather and a sometimes capricious climate have repercussions on the prices of agricultural products, as do certain geopolitical tensions. Since the dollar is the international benchmark for raw material prices, the drop in its value has also led to an increase in raw material prices. And of course, the pandemic continues to wreak havoc on the global organisation of production, supply and logistics, which directly and indirectly affects supply. In addition, the Chinese and US markets have recovered ahead of others and are buying up huge quantities of raw materials, putting pressure on the demand for related products.
And where is Europe in all this? With the economic recovery following behind the major powerhouses, the Old Continent already seems to be lagging behind in this ‘global race for resources’ (not unlike the European delays in healthcare products and vaccines…), which risks weighing on the organisation, supply and, ultimately, the profitability of European companies and slowing down the recovery. Added to this is a lack of visibility and great uncertainty – a combination that can leave more than one business leader at a loss.
In addition, the EU’s climate ambitions will inevitably drive up demand for raw materials. This is because the expansion of renewables and electromobility, among other things, may be more sustainable in the long term, but requires huge quantities of metals and rare earths in the short term. Globally, the International Energy Agency (IEA) expects demand for raw materials to quadruple by 2040 if global warming is to be kept below two degrees. If the goal of climate neutrality is to be achieved by 2050, demand would even increase sixfold!
Soaring raw material prices could make the ecological transition much more expensive than expected, which in turn would translate into higher costs for businesses and citizens.
In order to address this growing demand for resources, the creation of the European Raw Materials Alliance (ERMA) is most welcome. The Alliance aims to ‘identify barriers, opportunities and investment cases to build capacity at all stages of the raw materials value chain, from mining to waste recovery’, while at the same time addressing sustainability and social impacts.
By strengthening the resilience and strategic autonomy of Europe’s rare earth and magnet value chains, while reducing dependence on third countries (such as China, which currently represents 98% of rare earth imports, according to the Commission), it is a key step in strengthening the industrial ecosystems that depend on raw materials. However, the European Raw Materials Alliance does not provide short-term solutions.
Industry hit hard
The severity of the resource shortage is now being reflected in macroeconomic indicators, with companies in some sectors already navigating troubled waters. According to a survey by the Markit Institute, European industrial firms reported in April that, overall, their purchase prices for products used in the manufacture of finished goods had risen by the most since data collection began. In Germany, 45% of manufacturing companies were suffering from purchasing bottlenecks in April, according to a study by the ifo Institute – the highest figure measured since 1991. It is therefore clear that the shortage of raw materials and intermediate products poses a real risk to Europe’s recovery and its global competitiveness.
The situation in Luxembourg is comparable. So much so that the Conjecture committee (Comité de conjoncture) within the Ministry of the Economy has decided to grant exceptional part-time working measures to building and construction companies that are currently suffering from a shortage of raw materials. In addition, the projections for industrial prices are at their highest in 10 years, according to the STATEC business surveys. In March, factory gate prices for industry as a whole rose, over one year, by 3.6% in Luxembourg and by 2.3% in the eurozone, far more than the inflation rate would suggest.
A real vicious circle could be set in motion as the shortage of materials risks exacerbating other already problematic situations, such as the deadlock in the Luxembourg property market, and pushing prices even higher.
The return of inflation – temporary or long-lasting?
Rising prices naturally mean inflation. In the US, where the economy has been running at full speed for weeks, boosted by the Biden administration’s massive stimulus programmes, inflation, at 4.2% in April 2021, has far exceeded the Federal Reserve’s target. In the eurozone, consumer prices rose by 1.6% over one year as of April, according to Eurostat, mainly due to a standardisation of oil prices and shortages of certain materials. Eurostat expects this trend to continue with annual inflation forecast to reach 2% in May, again driven by a jump in energy prices, which rose by 13% compared to last year. Given this relatively moderate level, European central bankers are calling for calm and are not considering tightening their expansionist monetary policy – probably also because a rise in interest rates could bring already highly indebted economies (especially in southern Europe) to the brink of bankruptcy.
Inflation in the Grand Duchy is traditionally above the European average: STATEC reports inflation at 2.1% in April – a level that slightly exceeds the European Central Bank’s inflation target of ‘below, but close to 2%’. A look at our neighbouring countries shows that inflation is also on the rise. In Germany, consumer prices rose by 2% over one year as of April. In Belgium, as in France, inflation was more moderate, at a rate of 1.2% over the same period.
Indexing and labour shortages, major disadvantages in a recovery phase
Unlike the majority of European economies (and therefore de facto competitors), Luxembourg has an automatic wage indexing mechanism that is tightly linked to inflation. This particularity – often justified by its contribution to social cohesion – can compromise the profitability and therefore the competitiveness of local companies when economic growth is more focused on employment growth (resident and non-resident) than on apparent labour productivity – which is precisely the case in the Grand Duchy.
In times of high inflation, companies are doubly penalised: by the rise in raw material prices and by an increase in wage costs through indexing. According to the latest STATEC forecasts, the next index could be as early as the end of 2021, at a time when recovery is expected to be in full swing.
A 2.5% increase in labour costs would be in addition to the +2.8% increase in the minimum social wage of 2.8% as of 1 January 2021. The resulting additional costs for companies are especially heavy in labour-intensive sectors.
The country’s low-skilled workforce is likely to suffer the most from these increases, while companies are necessarily turning to the more highly skilled workforce in neighbouring countries. In general, the lack of skilled labour, which tops the list of challenges for businesses in the Chamber of Commerce’s Baromètre de l’Économie bulletin, is preventing many companies from meeting their clients’ needs in the best way possible and thus achieving their full potential. As a result, the shortage of labour, in addition to the comparatively higher wage costs, puts local companies at a disadvantage compared to their foreign counterparts and may hamper the development of economic activity in Luxembourg.
To limit the negative impact of the current sliding wage scale mechanism, a ‘sustainable’ national consumer price index should be adopted, excluding from the mix all fossil fuel products, harmful to the health or to which the ‘polluter pays’ principle could apply, while providing adequate compensation for the least affluent households through a targeted increase in the cost-of-living allowance (e.g., to compensate for increases in the price of heating products). Such a ‘sustainable basket’ would align the indexing system with Luxembourg’s ambitious climate policy (which aims, among other things, to discourage the consumption of fossil fuels by making them more expensive, notably through an increase in excise duties or other taxes).
Although Luxembourg currently seems to have better resisted the effects of the economic crisis, thanks to relatively healthy public finances and rapidly deployed aid, which allows still now the possible dreaded wave of bankruptcies to be postponed, a certain number of risks could slow down the recovery if they were to materialise. In the short term, a certain number of shortages could force production to slow down: lack of raw materials of course, but also of qualified labour, one of the challenges considered as the most important by companies according to Chamber of Commerce surveys.
In the medium and longer term, particular attention should be paid to financing the consequences of the crisis, but also to demographic challenges, such as the financing of pensions. This recommendation is shared by the Council of the European Union, which in its opinion on the 2021 Stability Programme of Luxembourg published on 2 June encourages the country to, ‘[…] give priority to fiscal structural reforms that will help provide financing for public policy priorities and contribute to the long-term sustainability of public finances, including by strengthening the coverage, adequacy, and sustainability of health and social protection systems for all.’
 Source: U.S. Bureau of Labor Statistics
 It should be kept in mind that the price of oil has been artificially increased by a drastic reduction of the OPEC oil supply. To a lesser extent, a CO2 tax in some countries is still pushing up the price.
 Source : Statistisches Bundesamt
 Sources : STATBEL and INSEE
 See article published in French by Fondation IDEA (2016), ‘Inflation, Index et Productivité : un possible ménage à trois ?’ for more information on this subject.
 See the Chamber of Commerce’s bulletin published in French: Actualités & Tendances N°24 : Un ‘panier durable’ pour le Luxembourg.