Luxembourg: Selected Issues and Statistical Appendix

Luxembourg's impressive growth performance has been accompanied by regional specialization of production, high labor mobility, export-propelled growth, and the dominance of regional growth fluctuations. Luxembourg's public pension system faces the challenges of population aging and Luxembourg's small, open, and highly specialized economy. Luxembourg's labor market performance holds a seeming paradox, favorable labor market outcomes are coupled with rigid labor market institutions. The supervision of cross-border financial activities raises the difficult challenge of obtaining a complete, consolidated view of the operations of international banking institutions.

Abstract

Luxembourg's impressive growth performance has been accompanied by regional specialization of production, high labor mobility, export-propelled growth, and the dominance of regional growth fluctuations. Luxembourg's public pension system faces the challenges of population aging and Luxembourg's small, open, and highly specialized economy. Luxembourg's labor market performance holds a seeming paradox, favorable labor market outcomes are coupled with rigid labor market institutions. The supervision of cross-border financial activities raises the difficult challenge of obtaining a complete, consolidated view of the operations of international banking institutions.

III. Luxembourg’s Labor Market Paradox20

A. The Issues

40. Luxembourg’s labor market performance holds a seeming paradox—favorable labor market outcomes are coupled with rigid labor market institutions. On the one hand, Luxembourg’s labor market performs well, in terms of both unemployment levels and employment growth. On the other hand, Luxembourg’s labor market institutions incorporate many of the rigidities that have been widely associated with poor labor market performance, particularly in a number of continental European countries. To shed some light on Luxembourg’s labor market paradox, this chapter uses a quantitative cross-country framework that emphasizes the interplay of labor market institutions and economic environments.21

B. Stylized Facts

41. Since the 1960s, Luxembourg’s unemployment rate has been the lowest among the EU countries (Figure III-1). Unemployment in Luxembourg was virtually nil until the steel crisis occurred in the mid-1970s. Over the last two decades, the unemployment rate rose to about 3 percent, still the lowest rate in the EU. Apart from the influences discussed in this chapter—labor market institutions and the economic environment—the gradual increase in unemployment may also reflect a subtle measurement issue: until the mid-1970s, unemployment had been a virtually unknown phenomenon,22 and labor market institutions that addressed the unemployment problem had therefore been largely unnecessary. Thus, when these institutions were gradually put in place in the aftermath of the steel crisis, they may also have promoted a more accurate count of the unemployed.

Figure III-1.
Figure III-1.

Unemployment Rates in the EU, 1960-2000 1/

(In percent)

Citation: IMF Staff Country Reports 2000, 067; 10.5089/9781451824308.002.A003

42. Luxembourg’s cumulative employment growth since the early 1980s has been the fastest among the EU countries (Figure III-2). Employment growth stagnated in the 1970s, but has picked up since then, averaging more than 3 percent a year over the last 10 years.

Figure III-2.
Figure III-2.

Cumulative Employment Growth Differentials, 1981-99 2/

(In percent)

Citation: IMF Staff Country Reports 2000, 067; 10.5089/9781451824308.002.A003

Sources: OECD; Statec; and staff calculations.1/ Diamonds represent unemployment rates in the other 14 EU countries. Data shown are five-year averages (1960-64 to 1995-99), and a projection for 2000.2/ Data describe cumulative employment growth differentials relative to the EU’s average.

C. An Analytical Framework

43. Recent empirical work on understanding European unemployment has stressed the interaction between labor market institutions and the economic environment. For example, Blanchard and Wolfers (1999) use a panel data set of selected countries and show that the interaction between the economic environment and the countries’ labor market institutions can account for much of the rise and heterogeneity in levels of unemployment rates across Europe.23 Assuming, for simplicity, that the economic environment is represented by one explanatory variable (E) and that there are two variables describing labor market institutions (II and 12), the representative equation for country i’s unemployment rate at time t (Ui, t) is:

(1)Ui,t=β0,i+β1Ei,t+β1β2Ei,tIIi+β1β3Ei,tI2i+i,t,

where β0, i is a country-specific effect, β1 describes the impact of country i’s economic environment at time t on its unemployment rate in t, β1β2 represents the combined impact on the unemployment rate of the economic environment and the first labor market institution, and β1β3 does the same for the economic environment combined with the second labor market institution. The error term (εi, 1) reflects the part of the unemployment rate that is left unexplained by the variables in the equation. The time index, t, stands for periods of five years at a time; 1960-64 to 1990-1994, and 1995+ (usually 1995/96). The unemployment rate and the economic environment variable are entered as five-year averages, while the values for the labor market institutions do not change over time.

44. The framework has one major shortcoming: some labor market institutions are affected by the level of unemployment and are thus endogenous.24 This problem is most obvious for the average tax rate on labor income (or tax wedge). A pay-as-you-go (PAYG) system—common to many countries in the sample—requires that the social contribution rates are set to meet the costs of unemployment benefits, health benefits, and pensions. All else being equal, this implies that countries with higher unemployment rates tend to have a bigger tax wedge. In the empirical section, therefore, the framework is reestimated without the variable representing the tax wedge.

D. A Description of Luxembourg’s Labor Market Institutions

45. The flexibility of Luxembourg’s relative labor costs is limited by automatic wage indexation, a high legal minimum wage, and collective bargaining agreements that stipulate across-the-board improvements in wages and nonwage work conditions.

  • Wages, pensions, and other benefits are indexed to CPI inflation.25 Indexation takes place automatically if, over the previous six months, the average cost-of-living index rose by 2.5 percent or more. Since the beginning of 2000, indexation has been tied to a newly constructed and somewhat less volatile CPI that excludes spending by nonresidents in Luxembourg. Automatic indexation can be suspended under difficult economic circumstances, as laid down in the wage indexation law of 1975.

  • A legal minimum wage applies to all employees who are under a contract of employment on Luxembourg territory. The statutory minimum wage is probably the highest in the OECD area and, on top of automatic indexation, can be revised every two years if called for by developments in the economy.26

  • Collective bargaining between trade unions and employers is embedded in Luxembourg’s long-standing social partnership model.27 Union coverage is relatively widespread (some 50 percent of all wage and salary earners are trade union members), but the collective agreements cover an even larger share of employment: they can be declared generally binding throughout the occupation for which they were concluded with an administrative extension to those not included in the agreements.

46. A large-scale social insurance system adds to the cost of labor and reduces take-home pay. Luxembourg has a generous and large-scale social insurance system. The state covers some 50 percent of all social insurance costs, while the remaining costs are financed through a PAYG structure. Social insurance payments are dispersed over a large and increasing base of contributors, including cross-border workers. Large budget transfers to the social insurance fund, together with a rapidly growing contribution base, have kept contribution rates low. When one further takes account of an income tax system that provides for a large basic deduction and a low entry rate of 6 percent, Luxembourg’s average labor tax wedge compares favorably with those in surrounding countries.

47. Employment protection rules are strict on dismissal procedures and the use of fixed-term contracts and part-time appointments. Legislation on working time dates from the early 1970s, and is similarly strict. Statutory working hours are 8 hours per day and 40 hours per week, with a maximum daily working time of 10 hours. While collective agreements can be made on a working time pattern below these norms, other types of derogations (like overtime) are strictly regulated by law and limited to exceptional cases. Recently, the National Action Plan for Employment (1998/99) initiated greater flexibility in working time and introduced a reference period of four weeks over which the average working time should be measured. Shorter or longer reference periods (with a maximum of 12 months) can be agreed upon by way of collective bargaining.

48. Reservation wages are high because of generous unemployment insurance and subsequent benefits. The standard payment rate of unemployment insurance is 80 percent of gross earnings. This amounts to a net replacement rate of more than 80 percent when including family and housing benefits. Although unemployment insurance is limited to 12 months, it is followed by a generous social assistance scheme with unlimited duration. The provisions stipulate that after five years of unemployment, the net replacement rate for a low-paid worker at two-thirds of the average production worker’s wage would continue to exceed 80 percent. Social assistance recipients are discouraged from taking small-time jobs, moreover, as the benefit withdrawal rate for additional earnings is close to 100 percent.

E. Empirical Results

49. The empirical framework described in Section C can be applied to simulate the evolution of the unemployment rate in Luxembourg.28 Given that endogeneity problems may occur in particular for the overall tax rate on labor income, the model is reestimated without the tax wedge. The Luxembourg economic environment is represented (counterfactually) by the EU average, while the scores of its labor market institutions (to the extent that they are part of the framework) are estimated conforming to information that is available on them. The estimated scores are provided in Table III-1 and compared with the EU averages.29 While high scores on the first five institutions are likely to have an adverse effect on labor market outcomes, high values on the coordination in wage bargaining and active labor market policies should improve employment and unemployment performance.

Table III-1.

Luxembourg: Scores for Labor Market Institutions

article image
Sources: Nickell (1997); OECD; U.S. Department of Health and Human Services (1994); and staff estimates.

Basic payment rate as a percent of gross earnings.

In years.

Index (maximum = 20).

Union members as a percent of all wage and salary earners.

Index indicating the share of total workers covered under bargaining agreements (maximum = 3).

Index indicating the degree of coordination on the part of both unions and employers (maximum = 6).

Measured as spending per unemployed person as a percentage of labor productivity.

50. Under the counterfactual assumption that Luxembourg shared entirely the economic environment of the EU, and with labor market institutions scored as in Table III-1, a simulation of Luxembourg’s unemployment rate yields an increase in the unemployment rate that is well above actual developments (Figure III-3): Between 1965 and 1995 Luxembourg’s unemployment rate rises by an estimated 7½ percentage points, which is more than double the actual increase. The estimated increase can be ascribed to the impact of the counterfactual economic environment (at the EU average) reinforced by the existing rigidities in the labor market.

Figure III-3.
Figure III-3.

Luxembourg: Actual and Simulated Unemployment Rates, 1960-1995 1/

(In percent)

Citation: IMF Staff Country Reports 2000, 067; 10.5089/9781451824308.002.A003

Sources: Blanchard and Wolfers (1999); OECD; Statec; and staff calculations.1/ Data represent five-year averages (1960-64 to 1995-96/97)2/ Result of a simulation of Luxembourg’s unemployment rate, using the average economic environment of the EU and Luxembourg’s labor market institutions as explanatory variables.

F. Some Qualifications

51. Some qualifications must be made to the empirical results on the evolution of the unemployment rate in Luxembourg. On the one hand, the framework ignores the presence of a few other labor market institutions in Luxembourg: the legal minimum wage, the automatic wage indexation, and the social assistance payments succeeding unemployment insurance. The first two of these institutions are rather specific to Luxembourg, as few countries still have a legal minimum wage, and only one other country (Belgium) appears to apply a similar wage indexation. On the other hand, the framework may exaggerate actual labor market rigidities. Labor market institutions may not be as rigid as the formal description suggests, and there are indeed indications that some of the Luxembourg institutions have been quite flexible under duress.

  • Luxembourg’s cooperative social partnership model has brought about an aggregate wage moderation that prevented wage increases at or beyond the rate of labor productivity growth. During most of the 1990s (with the exception of 1995 and 1996), for instance, increases in labor productivity exceeded increases in effective average pay by between 1 percent and 3.4 percent.30

  • As many of Luxembourg’s industrial sectors include only a few firms, moreover, sectoral bargaining agreements can be tailored to a firm’s needs, taking account of its specific economic circumstances.

  • The small size of the Luxembourg economy obviates the need for regional wage differentiation.

Finally, discretionary adaptations to labor market institutions have generated flexible labor market solutions in times of crisis:

  • During the steel crisis of the mid-1970s, unemployment was largely prevented through measures of early retirement, subsidized short-time working, employment in public service projects, and retraining of surplus steelworkers.

  • Similarly, at the time of the devaluation of the Luxembourg franc against the Belgian franc in the early 1980s, the economic impact was partly absorbed by a temporary suspension of the automatic wage indexation.

References

  • Blanchard, Olivier J., and Justin Wolfers, J., 1999, “The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence,” NBER Working Paper No. 7282.

    • Search Google Scholar
    • Export Citation
  • European Industrial Relations Observatory, 1998/99, Eironline at www.eiro.eurofound.ei. several years.

  • Grand Duchy of Luxembourg, 1998, Mobilisation Founded on Continuity. National Action Plan for Employment.

  • Nickell, S., 1997, “Unemployment and Labor Market Rigidities: Europe versus North America,” Journal of Economic Perspectives 11 (3), pp. 55-74.

  • OECD, 1999; OECD Economic Surveys, 1998-1999. Belgium/Luxembourg.

  • Statec, 1999, L’èconomic Luxembourgeoise au 20e siècle. Editpress Luxembourg S.A.

  • U.S. Department of Health and Human Services, 1994, Social Security Programs throughout the World-1993.

20

Prepared by Caroline Kollau.

21

This approach to analyzing labor market performance and institutions is based on Nickell (1997) and Blanchard and Wolfers (1999).

22

Official statistics show a zero unemployment rate until the mid-1970s.

23

Apart from most countries in the EU, the set also includes a number of non-European countries as controls.

24

Blanchard and Wolfers also highlight the endogeneity problem.

25

This indexation scheme was originally introduction in 1921.

26

Every two years the government submits to the Chambre Parliament a report on developments in the economy and incomes. If necessary this report is accompanied by draft legislation to raise the level of the minimum wage.

27

Two trade unions have the nationally representative status required to establish collective agreements.

28

Luxembourg is not part of the original panel study by Blanchard and Wolfers.

29

The EU averages are calculated using Nickell (1997) and Blanchard and Wolfers (1999).

Luxembourg: Selected Issues and Statistical Appendix
Author: International Monetary Fund