2.3. External economic relations

• An open economy
• Foreign investment
• Foreign workforce
• Trade in goods and services
• Trade in goods
• Geographic concentration
• Growing services surplus

An open economy

From the beginning of its industrial development,a very small economy in geographical terms has no choice but to be open to the outside world, an obligation that imposes itself in various areas from access to the factors of production and technology to the procurement and sale of goods and services. Throughout its economic development, Luxembourg has made major use of foreign capital and workers originating from other countries. Moreover, it has found itself obliged to import a large number of goods and services and to export a substantial part of its production. In 2001 Luxembourg was by far the most open economy of all the European Union member states.

Exports of goods and services as a percentage of GDP at current prices in 2001

Many efforts towards integration and long experience of international competition can most probably be considered as assets in an economic environment that is becoming ever more international, not to mention global in character.

In terms of its current account balance, Luxembourg has for the greater part been successful in achieving international integration and in implementing structural change. Its specialisation in promising and high-performance sectors has enabled Luxembourg to reinforce the surplus in its current account balance.

Foreign investment

It is generally accepted that capital stock is a crucial aspect of economic development. Thus, for a closed economy, a country’s level of investment depends on national savings. An open economy, and a small economy at that, can and indeed must build on its investment opportunities by utilising foreign capital. Obviously, this exposes the economy to a degree of external dependence.

The first true industrial revolution in Luxembourg (during the second half of the 19th century) was only possible thanks to the provision of foreign capital and technology from Germany and Belgium. Certainly, in the beginning, exceptional Luxembourg citizens played an important part and over the course of time a number of Luxembourg engineers took on managerial roles. However, there is no denying that the input of foreign financing and know-how was critical in getting the economy off the ground in the first place.

At the time, this foreign support was a condition sine qua non, since Luxembourg, having only gained its independence in 1839, was a poor agricultural nation. It was its openness to foreign capital that brought the country major industry and ensured genuine economic take-off.

During the phase of reconstruction after the Second World War, and more specifically from the late 1950s onwards, the powers that be initiated policies designed to diversify the means of production. Despite Luxembourg’s high standard of living and significant national savings, diversification was to a very large extent based on the input of foreign capital.With some rare exceptions, the main new industrial or tertiary activities launched in Luxembourg since the end of the 1950s trace their routes back to foreign support. In 2002, eleven of the thirteen top industrial companies are subject to direct foreign investment. In the banking sector, nearly every single one of the some 180 banks is dependent on abroad.Whilst it is German capital that dominates in the banking sector, it is US money that predominates in industry.

Foreign direct investment per head of population in 2000 (in USD)

Despite its dynamic development and the increase in its financing capacity, the Luxembourg economy makes regular use of foreign resources.What singles out this geographically very small economy is that its residents can easily invest in property or - through banks - in foreign investment vehicles and that foreign capital seeks and regularly finds opportunities for investment in Luxembourg in the production of goods and services.

Foreign workforce

In most countries the availability of a workforce is based on demographic trends, with migratory trends only being of marginal significance. In Luxembourg, however, immigration has largely characterised and accompanied the various phases of economic expansion.

Immigration, notably from Germany, has been in evidence since the early phases of industrialisation. In successive waves, other workers from Italy and subsequently from Portugal have met the needs of many economic sectors. Over the last few years, use of foreign workers has become inevitable given the exceptional expansion of activities and a demographic evolution that has not been sufficient to keep up with the demand for workers. Since the mid-1980s, there has been a clear demand for frontier workers.

Otherwise bound by the constraints of its small size and its demographics, the supply of a workforce in Luxembourg becomes practically unlimited as soon as cross-border workers enter the equation. Moreover, recourse to labour resources is also dependent on remuneration. A dilemma may arise:

• to ensure a sufficiently large supply of workers, high salaries must be guaranteed;
• to encourage new investment, salary costs must be competitive.

Currently, Luxembourg is succeeding in meeting these two criteria, thanks in particular to the fact that its indirect labour costs (social security + professional training + other expenses) are lower than those in neighbouring countries.Without being a low-pay country, the level of non-wage labour costs remains lower than in the majority of EU member states.

Structure of salaried workforce in Luxembourg in 2001 (as a % of total)

Trade in goods and services

During the last twenty-five years of the 20th century, fundamental structural changes in the Luxembourg economy had a clear impact on external trade. Whilst exported goods were worth twice as much as exported services in 1970, the export of goods now only accounts for a fraction of the country’s export activity.

The domination of the services sector has, in addition, created a distortion between the resulting balances in terms of goods and services: whilst the balance of service transactions surplus has grown, the trade balance deficit is tending to worsen.

The reasons behind this turnaround are clear. Its origin lies in the crisis in the steel industry and the expansion of banking in evidence since the mid-1970s. It should be noted, however, that service activities other than banking have also broken through in no small measures onto foreign markets, accounting nowadays for almost half the export of goods,compared with scarcely one seventh in 1970.

As well as this turnaround in the relative importance of the trade in goods on the one hand and services on the other, the respective surpluses/deficits are characterised by one specific phenomenon: with the exception of a slight deficit in 1964, Luxembourg’s current account was consistently in the black, with a surplus that continued to grow until the mid-1990s.

Taking into account the predominance of the industrial sector, the balance of trade largely determined the current account balance until the early 1970s. Since 1975, only the balance of services has been in the black,with the balance of trade and the balance of transfers showing a deficit that has now become structural.

Trade in goods

Structural trading deficit

Dependence on imported energy, an increase in the import of intermediates and the tripling in household consumption are the major factors behind the worsening of the trade deficit since the mid-1970s. However, the structural adaptation of the Luxembourg economy has also contributed to a widening trade deficit. In effect, most service activities require major investment at the outset, which results,notably,in the import of capital goods. Furthermore, throughout the production of services,material goods channelled into intermediate consumption and/or providing support in terms of trade in services are also purchased abroad. Whilst the import of capital goods and intermediates affects the trade balance, tertiary sales are included in the balance of services.

To this direct effect of structural adaptation can be added another induced effect - spending power generated in the tertiary sector is partially responsible for the purchase of imported consumer goods. Thus the trade balance is increasingly influenced by factors other than the trade in goods relating to physical production activity (industry).

Product diversification

Over the last thirty years, the structure of goods exports has substantially changed to the extent that, today, metallic products only represent one third of the total value, compared with twothirds in 1973. This upheaval is due as much to the collapse of the iron and steel industry and the subsequent restructuring of the industry as to the positive effects of industrial diversification.

Despite the greater specialisation in intermediates, the range of exported products has grown: to products with a long tradition (e.g. agri-foodstuffs, tyres, plastic and textile products, earthenware) can be added, among others, glass, non-ferrous metals (copper and aluminium), paper and IT.

Leaving aside this general trend, a breakdown by product group reveals some structural characteristics and, in particular, two forms of diversification: intra-range and innovative.

Luxembourg has traditionally been largely dependent on the import of raw materials and energy products.However, over the past three decades, supplies in semi-finished products have taken the place of some raw materials. Compared with earlier periods, imports of products channelled into intermediate consumption are presented in more developed forms.

Mineral and energy products - which until 1982 represented one quarter of all imports - have fallen in importance to one tenth of total imports following the decline in iron and steel, the relative fall in oil prices and energy-saving efforts.

Luxembourg's current account 1995-2001

The reinforcing and modernisation of the productive structure, on the one hand, and efforts to diversify industrial and service sectors on the other, are the reason behind some of the impetus lend to the import of capital goods. Periodic restructuring of industrial equipment is a basic necessity to remain competitive and is responsible for major imports of plant and equipment. To this traditional demand from the industrial sector can also be added major procurement on the part of the service sectors - importers of sophisticated and high-technology goods (e.g. communication equipment, aircraft etc.).

The increase in demographics and the upward trend in standard of living have sparked off increased imports in all types of consumer good. Since the 1980s, the phenomenon has been reinforced by import/export activities, as well as by increasing imports of consumer goods destined for nonresidents (fuel, tobacco, alcohol etc.).

Geographic concentration

The geographic structure of efforts has remained relatively stable over recent decades with the share of intra-Community exports having represented approx. 80 % and with neighbouring countries accounting for as much as 60 %. A redistribution has taken place between these three markets. The Belgian market has become less important in relation to the German and French markets. More generally, Luxembourg’s main export market lies within the founding members of the European Community.This can be explained both by reasons of geographical proximity and general economic relations, and by the particular effects of the creation of the Common Market. Exports to the other (new) member states of the European Union generally account for less than one percent of total exports.

The general orientation towards the Community market does however depend to some degree on the product group in question. There are significant differences between the five main product groups in terms of both level and development.

As far as the first product group is concerned - metals - there has been a slight drop in market share. On several occasions this sector has attempted to engage more strongly in large-scale exports (extra-Community) as a means of selling some of its production.

Other very dynamic sectors, such as plastics and tyres, have also succeeded in gaining a foothold in other continents, which explains the relative fall in sales in the European Union.

Belgium is by far the main supplier country to Luxembourg, followed by Germany. Accounting for between 10 and 15 % of Luxembourg imports, France lies in third place. Overall, the three neighbouring countries, in terms of direct origin, account for more than 80 % of Luxembourg’s total imports. Even if this predominance is less marked in terms of country of origin, it nevertheless remains substantial (in the region of 70 %).

Overall, Luxembourg procures 95 % of its imports from the “old continent”. Traditionally, the EFTA states and the United States have been the main source of non-EU imports. Over the last few years, the rise in imports from Asia has resulted in a balance between imports from EFTA countries, imports from the Americas and Asian imports.

Growing services surplus

The growing balance of service transactions surplus is due in the first instance to Luxembourg’s net income from its international activities linked to the provision of financial services.

It should be stressed,however, that services other than banking likewise contribute to the positive results in the balance of services, including air transport, audiovisual, telecommunications, insurance and income from “travel”.

Income from travel activities constitutes the most important category after financial services. Between 1995 and 2001 the total amount almost doubled.This category is not limited to tourism in the strict sense of the word - i.e. spending by non-residents who spend at least one night in Luxembourg.It also includes spending by day trippers,cross-border workers and other non-residents passing through Luxembourg who do their shopping on its territory. Purchases of products subject to excise duty (perfume, tobacco, alcohol) by non-residents account for a major share of the income categorised under “travel”. Moreover, spending by frontier workers, at approx. 786 million euros in 2002, is also constantly rising based on the substantial annual increase in the size of this group. Whilst capital revenue is still in the black, earnings from work has recorded an ever larger deficit since the mid-1980s. The exceptional rate of growth recorded over recent years in the number of cross-border workers employed in Luxembourg is responsible for this trend - in 2000, more than 100 000 cross-border workers were registered in Luxembourg,compared with 17 000 back in 1985.

The credit side includes the gross income (including social contributions and taxes) of residents who work abroad and, on the debit side, total gross income paid to non-resident salaried employees who work in Luxembourg.The latter obviously relates to the remuneration of the large number of cross-border workers. The per-head wage bill of a frontier worker has risen from EUR 21 150 to EUR 36 040, equating to an average annual rise of 3.6 %.

The credit side, by analogy, includes the remuneration of some (700) resident salaried employees who work in a neighbouring country as well as those international civil services and local agents who live in Luxembourg and work for an international organisation based either in Luxembourg or abroad. In 2001, 7 700 lived in Luxembourg, out of a total of 9 500 working in the country. The remaining 1 800 were living in the neighbouring region. The organisations concerned obviously primarily include the European institutions, most of which are located in Kirchberg. Other international organisations include NAMSA and Eurocontrol. International civil servants and local agents resident in Luxembourg received an average annual salary of EUR 77 590.