State of the Nation Address and State Budget 2022: Analysis and reflections

The Prime Minister’s State of the Nation address and the tabling of the draft budget for the year 2022 and the next four years were two of the highlights of the past week. Complementary documents, it is therefore a joint reading that follows. 

Finally on the road to sustained recovery? 

At a time when economic recovery is finally materialising, after difficult months for business activity and profitability for companies, it is now threatened by a spectacular rise in energy prices and resulting inflation. Geopolitical risks, supply chain problems and the impact of international tax decisions are all factors contributing to uncertainty, for the most part exogenous, and the Luxembourg Government has only limited power to address them, except by implementing an effective, agile and flexible framework that takes advantage of today’s opportunities and anticipates tomorrow’s challenges. 

It is therefore important to consolidate the Luxembourg business model through increased attractiveness and continued diversification, to help companies cope with digital and environmental transitions that come with numerous implications, by creating a pro-business framework, and solving the major bottlenecks for the socio-economic model, such as mobility, housing, availability of labour and competitively priced energy supply. 

The analysis of the structural situation in several areas related to these problems and challenges leads to the conclusion that much remains to be done to position Luxembourg among the most competitive economies in Europe and to ensure a sustained recovery for our country in the coming years. 

Public finances under control… in the short term 

One of the key conditions for achieving this is sound public finances, which allow the country to afford its ambitions for increased competitiveness and sustained recovery. 

If the GDP suffered a smaller drop than expected in 2020, i.e. -1.8%, it should ‘rebound’ by nearly 6% in 2021 to return to a more usual growth rate, i.e. around 3.5%, in 2022, thanks in particular to the various aid that has helped to limit the loss of economic substance. Taken as a whole (and admittedly in a broad way), the funding released amounted to a total of EUR 11 billion, about 18% of the GDP. The other side of the coin of the crisis is the 3.4% increase in central government spending, which will continue to rise in 2022, from 22.7 billion in 2021 to 23.5 billion, approaching 26.5 billion in 2025. 

Central administration revenue remains historically weak, rising from 21.4 billion to 22.3 billion in 2022. While the 2022 deficit has been reduced from the ‘historic’ 3.2 billion reached in 2020, it remains high at around 1.2 billion, that is -1.7% of the GDP. A tendency towards improvement is emerging over a pluriannual period, with the deficit being reduced by almost half by 2025. Thanks to the latter and a surplus in the social security sector, public administration should be balanced again in 2024. 

However, given the major uncertainties, significant revisions cannot be ruled out, necessitating a certain caution, especially for a very open economy, which is therefore exposed to possible external shocks. 

Improvement in the public administration finances, as forecast in the budgetary documents, is based on a more moderate evolution of expenditures than in the past. This is certainly a laudable objective, but it will have to be made operational in practice. Nothing is less certain considering the increase in numerous social benefits, with a significant accelerating effect on social finances, often considered as incompressible thereafter. 

Public expenditure is expected to be permanently impacted by the recruitment plans of government administrations and state services. Manpower needs (2,300 new posts planned for the year 2022) in public services are logically the result of the continuous demographic increase, but the recruitment plans should include parallel efforts by the State to increase productivity and efficiency in public services through accelerated digitalisation, simplification of procedures, and increased continuing education. It goes without saying that the high entry-level salary level in public services poses a significant competitive challenge to the private sector, which is facing an increasingly severe labour shortage. 

The gradual impact of demographic ageing must also be taken into account. Social security surpluses would indeed decrease by 2025 according to the pluriannual draft budget. 

The eternal problem of financial sustainability for social protection 

According to the recent report of the National Council of Public Finance (CNFP), expenditures related to population ageing could correspond in 2070 to 24.6% of Luxembourg’s GDP, which would then show a debt of 168% of its GDP. The CNFP based itself on the ‘Assessment of Long-Term Fiscal Sustainability’, published as part of the Ageing Report (AR) 2021 at European level, which focuses on the weight of expenditures linked to an ageing population. The updated projections thus result in a cost of ageing that is still clearly on the rise, even if the methodology and analyses of the Ageing Report must be qualified and put into perspective. 

It is interesting to note that the major trends that recur in such analyses do not elicit any reaction from political decision-makers, while the Grand Duchy is still in the relatively privileged position of being able to prevent very incisive and drastic political actions in the longer term by making relatively painless adjustments today. The status quo of the current model of our pension system – one of the most generous in the world – makes it difficult if not impossible to move from an extensive growth model to a qualitative growth model in Luxembourg, with all the negative consequences that this generates in terms of resource use and the environment. 

Public investment at the heart of both discourses 

Investments were highlighted in both discourses, and are described as ‘record-breaking’, as the 2022 budget year foresees public investments of around EUR 3.2 billion, or 4.4% of the GDP, which is higher than the average of 3.9% observed over the 2016-2021 period. Of course, these figures are encouraging and certain initiatives such as the ‘HEAL campus’ initiative (where companies in the field of HealthTech will be able to develop), the creation of a one-stop shop in connection with the climate transition, or the efforts to digitalise within certain administrations will be welcome. 

In certain areas of vital importance for the future of businesses and the economic model, strong and concrete measures must be taken quickly. Here following are a number of priorities that were either not mentioned in the State of the Nation address or were only briefly touched upon. This is by no means an exhaustive list, but rather complementary measures to those presented on a recurring basis on this blog. 

  1. Support for companies that want to establish housing for their employees 

Current developments in the housing market are already seriously damaging the social cohesion and economic attractiveness of our country. The growing imbalance between housing supply and demand is a known but recurrent problem (given the current increasing rate of housing prices of around 15% on an annual basis), and yet private developers remain relatively excluded from initiatives to build affordable rental housing. 

In order to prevent the lack of housing from further harming companies seeking labour and talent from abroad, it might be appropriate to introduce incentives for Luxembourg companies wanting to provide housing for employees by building it on land they own. This would also have advantages in terms of mobility. 

In terms of spatial planning, a reclassification of currently undevelopable industrial/artisanal/commercial areas into special ‘employee housing’ zones, without new applications for special development plans (PAPs), should be realistic and feasible. At the fiscal level, supporting related investments in new infrastructure (e.g., via super deductions), as well as the creation of a specific acquisition fee for employees on the rent they have to pay to their employer (i.e., a shift from travel costs to housing costs) should be analysed and further developed. 

In addition to this specific measure, the Government must act effectively and decisively on the measures that are indispensable for increasing the housing supply, and more particularly of rental and affordable housing: increasing the density of construction, speeding up authorisation procedures, using the expertise and capacities of the private sector, extending the perimeters where it makes sense, etc. The fiscal adjustments recently proposed by the Government (property tax, speculation tax…) will hardly solve the housing problem. 

  1. Accelerating the digital transition 

Few administrative procedures are digitalised from start to finish in Luxembourg. This delay in the digitalisation of public services – despite major efforts in terms of budget and human resources in recent years – makes administrative procedures more complex, longer and less transparent for citizens, and complicates the processing of paperwork by civil servants. Estonia is an example of a successful digital transformation in the public sector. With 99% of public services available online 24/7, more than 450 million electronic signatures have contributed to optimising working time in public administration.  

Identifying and then fully digitalising the 20 procedures most used by businesses would be a first concrete action, with undeniable benefits in terms of efficiency gains, both for citizens and for the state services concerned. 

  1. Focusing skills on the needs of companies 

The twofold ecological and digital transition must lead to a real ‘skills offensive’. The changing skills sought by companies, particularly in connection with the green transition and the digitalisation of the economy, require reskilling and even upskilling of the country’s workforce, whether people are employed or in transition, and throughout their lives to maintain employability and productivity. Furthermore, Luxembourg companies have been facing talent shortages for years, which are becoming more acute each year. The challenge in terms of skills is therefore substantial for the economy and highlights the importance of greater recourse to professional training, both continuing and initial, to promote skills development in companies and job retention. 

Luxembourg has begun the process of defining, by 2022 and in collaboration with social partners, its national strategy for skills on the basis of a study currently being conducted by the OECD. The debate to be held in this context must integrate all aspects of a more modern vision of lifelong learning and lead to a mainly skills-based approach, systematically taking into account the needs of companies. In parallel with this strategic work, several concrete short-term measures are required: 1. identify the professions and skills of tomorrow in close collaboration with the stakeholders in the field (professional associations and federations, company boards); 2. strengthen the provision of lifelong guidance and provide support to companies, in particular SMEs, in setting up training programmes; 3. develop work/study programmes at all levels of education (technician’s licences, Bachelor’s, Master’s); 4. increase the basic rate of co-financing of in-company training to 20% and include self-employed workers in the scope of eligibility for collective access; and 5. make the legal framework for higher education less restrictive and allow different stakeholders to offer education and training programmes leading to degrees in order to respond flexibly to the demand of companies. 

In terms of the education system, the authorities must increase the number of support courses at all levels and types of teaching. As teachers are on the front line, it is also important to support them and train them in the use of new technology, where appropriate. 

  1. Giving a real second chance to entrepreneurs who have filed for bankruptcy 

The fear of failure is still very present in Europe. A change of mentality could stimulate entrepreneurial activity and promote the entrepreneurial spirit, which remains weak in Luxembourg. Moreover, very few failed entrepreneurs dare to start a new business. However, 18% of successful entrepreneurs failed at their first startup and these re-starters grow faster than businesses started by new entrepreneurs. 

Given the large number of bankruptcies likely to result from the current crisis, which has so far scarcely manifested due to emergency aid, it would make no sense to severely punish honest managers whose business has been harmed by an external event. It is therefore important to adopt a liability system for company directors in the event of bankruptcy that is proportionate and offers a real second chance to entrepreneurs by making a distinction between honest and dishonest debtors. This is not the time to stigmatise entrepreneurs who are victims of an event such as the health crisis or devastating flooding. 

  1. Bringing value to the status of the self-employed 

The entrepreneur is at the root of economic development, innovation, and social cohesion. Entrepreneurship in Luxembourg is currently under pressure due to the precariousness of the status of the self-employed in terms of social protection. Improving the status of the self-employed by reducing the inequalities that currently exist between the status of self-employed and the status of employee with regard to the coverage of ‘social risks’ is essential because these inequalities are the source of loss of income, either temporary or definitive. 

The measures should include both social security law and labour law. In the field of social security, it is necessary to make it more flexible for the self-employed to combine an early retirement pension with a professional income by introducing one single anti-cumulation rule (for the self-employed and employees); to better define the status of the supporting spouse; and to promote the affiliation of the self-employed to the Employers’ Mutual Insurance. In addition, in terms of labour law, the benefits of all the ‘partial’, ‘bad weather’, and ‘accident’ or ‘technical’ unemployment schemes should be extended to the self-employed (via the introduction of a replacement income governed by strict allocation conditions); and the system of full unemployment should be adapted to be applicable to the self-employed, bringing it more in line with that of employees; and a professional reclassification scheme for the ‘self-employed’ should be introduced, based on the existing scheme for accidents at work and occupational illnesses of the self-employed, in order to cover the loss of (temporary) income and output. 

  1. Combining reduction of emissions and profitability of companies 

Companies need to have long-term perspective, and therefore predictability, in order to be able to make informed decisions on resource allocation, investments, and establishing productive business operations. Insecurity reduces the inclination of companies to invest in the short and medium term and, consequently, it compromises the establishment or sustainability of activities and, more generally, the necessary continuous and permanent diversification of Luxembourg’s productivity. A successful climate transition therefore requires a favourable framework for businesses. 

Favourable, economically attractive, and motivating conditions, as well as pragmatic and flexible support measures, are essential. These solutions must be implemented quickly, while ensuring that there is no foreign distortion. Taxation can be a powerful means to achieve this: the introduction of tax incentives, for example in the form of a super deduction for low carbon investments, could be considered, as is the case in France, Italy and the UK. The Government must also review its copy of the waste legislative package, which contains numerous inconsistencies that could have a negative impact on businesses and consumers. 

  1. Implementing a mixed approach to energy that leaves room for opportunity 

New innovations and technologies are likely to emerge in the medium to long term, and these are likely to be more efficient, cheaper, and cleaner than existing technologies. Any situation of a ‘technology lock-in’ – where the State bets on the development of a specific technology from the outset, rather than setting a general incentive framework while giving companies room to innovate on the techniques to be deployed – risks taking away the flexibility needed to switch to the most suitable emerging technologies. 

In order to encourage companies to integrate the ‘best available technologies’ into their production processes at all times, it is essential to reduce the investment risks incurred by the latter. The rapid introduction of a de-risking financing and risk management instrument for energy transition projects, as announced in the NECP, must be implemented quickly. Furthermore, research, development, and innovation in the field of green technologies must be facilitated and supported, while ensuring easy access to adequate financing, especially for SMEs. In view of soaring energy prices, the Government will also have to take firm and swift measures to support companies. 

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