Economic Development of Luxembourg

What about Luxembourg?

Luxembourg, one of the smallest countries in the world with a population of less than 650,000 as of 2021 (World Bank), is the richest country in the world. Its GDP per capita was the highest at US$110k in 2021 (Trading Economics) and its minimum wage is one of the highest in the world at €1,923 per month. Consequently, with such wealth, it is 13th in the world in terms of quality of life QOL, above Japan, Sweden and Canada (Numbeo), and one of the safest countries in the world.

Natural resources kick-started its growth

Its shining ray of hope was its iron ore deposits discovered in the 1840s, which allowed it to launch its industrial revolution, and its membership in the Zollverein. That was the period of the industrial revolution, so steel was used in almost everything and thus was in very high demand. This accelerated Luxembourg’s trade. Subsequently, it played an active role in the European Community (Britannica), including through the establishment of the Belgium-Luxembourg Economic Union in 1921 and participation in the North Atlantic Treaty Organisation. It also had a sound position within the European Coal and Steel Community. 

The 1929 Holding Law was instrumental in its continued success (discontinued)

Companies were allowed to hold multiple subsidiaries under one holding company, which provided many tax benefits to these corporations (Mondaq). This drew many MNCs into the country, pumping investment, jobs and skills into the country. The economy took off in the 1970s when big US holding conglomerates expanded to European markets and chose Luxembourg to hold their European headquarters (HQ) because of the tax benefits. There were also many big banks, law firms and accounting firms that were already operating there, which helped these big conglomerates to set up the HQ. 

The arrival of Big Tech grew its economy exponentially

The 2000s was an era of the dot com boom, in which their economy doubled within 5 years (World Bank), and has been growing exponentially. Luxembourg was the ideal location in Europe for tech companies and was also becoming a financial hub. To date, Luxembourg is the second-largest investment fund centre and a worldwide leader in cross-border fund distribution. There are more than 14,800 Luxembourg-domiciled funds with more than €4.7 trillion in assets as of December 2019. It has a stable business, political and social environment and a wide treaty network and a favourable tax regime (EY). 

Sacrifices of economic progress
Income inequality has been rising. The Gini Index of the country has been increasing over the last few decades (World Bank). 21.5% of its residents live on the brink of poverty and social exclusion, and 18.7% of its working population is considered “the working poor”, who have low-income jobs that fall below the poverty line (SDG Watch Europe). This proportion is one of the highest in the EU. 

Prosperity in the country may not have been the same for everyone. Foreigners make up more than 60 per cent of the workforce (Harrington), holding high-paying jobs, pushing up the cost of buying a house. Furthermore, its public services such as education are lagging behind. Only 74 per cent of adults aged 25-64 finished their upper secondary education, compared to the average of 79 per cent in the OECD (OECD).

My thoughts on the future
I opine that there are two approaches to ensure sustained prosperity and happiness in Luxembourg, namely through continued upside development and reduced downside development. The country is doing good in thinking ahead, as seen by its “City of the Future” blueprint which aims to improve infrastructures, such as through digital transformation and transition to a green economy, such as through improved waste management and reduced energy consumption (Digital Luxembourg). I believe that more can be done, or perhaps done more visibly, in terms of improving its education system and addressing social mobility issues. These mean investing in the people who are the future of the country and modifying or introducing policies to improve their lives.  

The current tension between global powers and the teetering of a global recession paints a grim picture for the financial hub in Europe. The financial sector which makes up more than a third of its GDP will likely shrink or stagnate, possibly causing its GDP to follow behind. Expats might move back to their countries, causing a brain drain and potentially impairing the sector. The country will be less affected by the lack of gas due to the Russia-Ukraine war in the future if it is successful in its transition to alternative sustainable energy systems. Overall, once market activity picks up, its economy will probably pick up as well.

Analysis of Brexit

Edit: this research was done prior to the recent volatility in the UK markets.

Background

It is the withdrawal of the UK from the EU after having voted to leave in 2016. It officially left the trading bloc on 31 January 2020. After leaving the bloc, the UK and EU agreed to keep the status quo on several issues until the end of the year. This gave them time to agree to the terms of a new trade deal. They came to an agreement on 24 December 2020. 

It seems that leaving the EU was due to several factors, including how Brits felt that being in the EU wasn't all that beneficial, unhappiness following the 2008 recession, and the Arab Spring refugee crisis (Essex). 

What are some implications of Brexit?
There is now a restriction to work and living across the border, as well as restrictions on trade and travelling. UK nationals now need a visa if they want to stay in the EU for more than 90 days in a 180-day period. The UK has also become less open with its exit from the EU, which is detrimental to its economy and its growth. It is now less open and competitive (Bloomberg), which ultimately affects its growth. As a whole, the UK’s total trade as a percentage of GDP fell by 8% since 2019, and the country has lost market share in 3 of its largest non-EU import market in 2021 (US, Canada, Japan). The UK will be expected to grow by 3.6% in 2022, and zero growth in 2023, which renders it the slowest growing among the G7 (Guardian). This could trickle down to the individual as an analysis by LSE mentioned that the reduced productivity and lower salaries may result in employees earning 500 pounds less per year by 2030 (Reuters).

With the close integration of the UK and the EU, the impact of Brexit has certainly been reflected in the EU as it has on the UK. For example, with the decreased movement of goods and labour across the border, the EU will likely experience a decrease in labour supply in the financial sector because of the UK’s status as a financial hub in Europe. The market size of the UK is much smaller compared to the EU, so I expect that the decreased labour supply and trade across both regions is likely to affect the EU to a lesser extent. 

The effect of Brexit is not the same for every sector
Sectors that are heavily reliant on cross-border supply chains are among the worst-hit, like electrical equipment manufacturing. The fishing industry was also expected to shrink by 30% with the increased regulations for their catch to their customers in the EU (Reuters). On the other hand, some sectors might actually benefit from Brexit, or at least remain unaffected (Bloomberg). Sectors that focus on service will “remain largely unaffected”, and those that focus on supplying the UK market will benefit from the decreased import of goods and services. One example is food manufacturing, a key industry in the east of England that is set to thrive because it supplies the UK market. 

A silver lining for the UK
There is a glimpse of a rebounding system of economic governance in the UK (Bloomberg). It has started to improve regulation for businesses and consumers by enhancing competition and technology. Trade-wise, exports and imports to and from the EU have increased to above pre-pandemic levels, signalling a reignition of their collaborations.

My thoughts on the future
In order for the UK to retain its position as a hub in Europe and globally over the long run, it will have to make adjustments and establish new trade relations with other countries and trading blocks. Brexit was majorly supported by the older generations while younger generations supported staying. This could mean that in the future, the UK might choose to return to the bloc once the younger generation takes over unless Brexit proves to be the better decision for them (Bloomberg). Ultimately, the direction of the EU economy will not be as affected by Brexit as it has been by the Russia-Ukraine war. If the EU and UK can come to a consensus on a fair-trade deal, I believe this will be the most beneficial to both parties.