Geopolitical tensions continue to weigh on economic activity. The war between Israel and Hamas continues, and the fear of its spread to neighbouring countries remains strong. The confrontation between Russia and Ukraine drags on, not to mention the tensions between the United States and China against the backdrop of the US presidential election campaign. Furthermore, the statistics published at the beginning of August in the United States were disappointing. The rise in unemployment of almost 1 percentage point in 18 months (now at 4.3%) and the sharp fall in the ISM manufacturing activity index (from 48.5 to 46.8 in July) caused panic in the financial markets and raised fears of a recession. In China, the sharp slowdown in GDP (+0.7% in Q2, compared with +1.1% expected) comes against a backdrop of crisis in the property sector, municipal debt and weak private sector investment. The contraction in the purchasing managers’ index in June and July indicates that the world’s second-largest economy has been struggling to regain momentum since the end of 2022 and the end of restrictions against the covid-19 pandemic. (PMI is an economic indicator used to assess the health of a country’s manufacturing, services and construction sectors based on surveys sent to purchasing managers who are familiar with company operations and the market situation for the supply and sale of their products and services. A result above 50 indicates economic growth; below 50, contraction).

Short- and medium-term political uncertainties are affecting a growing number of countries. This worries both political observers and investors, who fear increased instability (currently reflected in stock markets) and a less favourable business environment, disrupting the long-term economic outlook.

The deterioration in trade relations between China and the United States is not new, but it is spectacular. The two countries are clashing over tariffs on strategic products such as electric vehicles, solar panels and semiconductors, as well as protectionist initiatives such as the US Inflation Reduction Act (IRA). (This legislation, which massively favours US domestic industry, provides subsidies totalling $369bn over ten years, including tax credits, for companies investing in electric vehicles and other green technologies.)

US imports from China are down sharply, to $29.9bn a month, from over $40bn a year ago. The European Union, an a priori supporter of free trade, is looking for a way forward in the face of the return of protectionism. In a bid to boost economic activity, it has decided to adopt tariff increases on imports. Since 5 July, it has been applying customs duties on electric vehicles produced in China. The measure is precautionary at this stage, with a final decision to be taken in November. In retaliation, Beijing has decided to initiate procedures to apply customs duties on pork and dairy products from the European Union. No one knows where this protectionist spiral will lead.

European economy: mixed trends and lack of momentum

Despite signs of recovery, the European economic climate remains fragile and uncertain. While the 0.3% increase in seasonally-adjusted GDP in the first and second quarters of 2024 (compared with the previous quarters) in the eurozone confirms the recovery initiated at the start of the year, performance varies between member countries. Spain, the eurozone’s new driving force, recorded growth of 0.8% in the first ands econd quarters, underpinned by buoyant household consumption, investment and rising exports (particularly of services).

But Spain’s performance will not be enough to compensate for the slowdown in Germany, where GDP fell by 0.1% in the second quarter, after rising by 0.2% at the start of the year. Activity stagnated in industry and construction, and consumer spending remained hesitant, despite the fall in inflation. Foreign trade, traditionally an important component of German GDP, continues to suffer. With a growth rate of +0.3% over the first two quarters of 2024, France and Belgium are in line with the European average, according to . In short, we are talking more about stagnation than growth.

Luxembourg: a dangerous wait-and-see attitude?

Against this difficult international economic backdrop, how is the Luxembourg economy faring at the start of 2024? And what is the outlook for next year? If the main economic indicators--inflation, growth and unemployment--are anything to go by, as well as confidence indicators, the situation could be described as “subdued.” In its latest flash conjecture, Statec even speaks of a “less buoyant climate than expected.”

In terms of inflation, a trend reversal has been observed since June, when it (finally) fell below the level of the eurozone. This is the first time this has happened since October 2023. The annual inflation rate stood at 1.7% (’excluding sales’ index) in August, compared with an estimated 2.2% in the eurozone. The country has therefore achieved the ECB’s much-vaunted 2% inflation target, although ‘core’ inflation (i.e., excluding energy and food products) is still at 2.3%, compared with 2.0% in July. Despite this slowdown, forecasts are calling for wage indexation in the final quarter of this year, with its negative impact on the competitiveness and profitability of Luxembourg companies, particularly exporting SMEs. Overall, the inflation rate is expected to reach +2.3% in 2024, then 2.6% in 2025 according to Statec, after +3.7% in 2023.

In terms of growth, this remains moderate and below that seen in 2023. In the first quarter of 2024, real GDP rose by 0.5% compared with the previous quarter. As in the eurozone, a recovery phase seems to have begun. However, the sluggishness of the German and European economies as a whole raises fears of repercussions for our economy. For 2024 as a whole, Statec is forecasting GDP growth of 1.5%. It should be remembered, however, that the state budget for 2024 was based on an assumption of 2% growth for this year. If this underperformance were to be confirmed, it would have budgetary consequences in terms of revenue shortfalls. Clearly, we will be a long way from the 3% growth rate that has been our country’s average since 1995.

Unemployment is rising steadily, reaching 5.8% in July, although it remains below the 6.4% figure for the eurozone. Added to this is the decline in cross-border employment in Germany (-0.5% between the end of 2023 and May 2024, according to Statec) and Belgium (-0.2%). This is a worrying trend, given the growing need for a workforce that will be essential to the country's growth over the next few years, if not decades. It is important for the government to bear in mind that the cross-border workforce is particularly sensitive to economic trends, but also to the conditions that Luxembourg can offer (mobility, teleworking, infrastructure, etc.). At the same time, a marked slowdown in the dynamics of the Luxembourg labour market can be observed: the rate of job creation should only be +1.3% in 2024, then +1.7% in 2025. This is a far cry from the +3.1% average since 1995, with obvious repercussions for the funding of our pension system.

In terms of confidence, Statec notes that July’s indicators show that it is once again tending to deteriorate, particularly in industry, retail trade and non-financial services, whereas a certain optimism was palpable at the start of the year. It is true that the confidence of business leaders is seriously affected by concerns about profitability. The Chamber of Commerce’s Barometer of the Economy for the first half of 2024 showed that 34% of entrepreneurs feared a fall in their profitability over the next six months, particularly in the retail (33%) and construction (43%) sectors. Companies in the construction sector are not yet out of the storm. Although there has been a slight upturn in confidence in recent months, they are still much more pessimistic than they were 2.5 years ago. Despite credit applications picking up again since the start of the year--after three years of decline--the construction sector saw its salaried employment fall by 4.7% year-on-year in the first quarter. It is the sector recording the most job losses in Luxembourg. Let’s hope that the housing stimulus package adopted by the government before the summer will show its effects in the months ahead.

State budget 2025: generating confidence?

To regain confidence, businesses need to feel supported, accompanied and stimulated by government action. The 2025 budget, to be presented on 9 October 2024, will be an opportunity for the government that has been in office for less than a year to send out clear signals and restore the confidence of socio-economic players. We expect determination, responsibility and ambition.

Determination in the desire to modernise the state apparatus first and foremost. The new government’s choices include cutting taxes for individuals and businesses, according to the . But one burning question remains: what impact will this have on tax revenues? The government is betting on a revival in business investment and household consumption to stimulate growth and, in turn, generate new tax revenues. However, in its , the Chamber of Commerce expressed reservations that this might not be enough.

In order to restore the budgetary room for manoeuvre needed to deal with future economic shocks, it is imperative to get a better grip on expenditure, particularly that considered to be rigid. The trend in this spending is particularly worrying. In the 2024 budget, the government clearly expressed its determination to contain the rise in the wage bill, limiting its annual increase to 5% in 2026 and 2027. This will necessarily involve digitisation and optimising administrative efficiency. On the face of it, this is good news for businesses, as it responds to the desire expressed by entrepreneurs for administrative simplification.

Keeping rigid expenditure under control is all the more essential given that other “constrained” expenditure is set to rise inexorably in the years ahead. This is the case for defence spending, which is set to double between now and 2030 in order to meet our commitments to Nato. It is up to the government to turn this effort into an economic opportunity, in particular by focusing on ‘dual-use’ investments, which would have both a military and a civilian impact. The same applies to our spending on pensions. This autumn will also see the launch of the major consultation promised by the prime minister on this subject.

Responsibility in the management of public funds. In a world where there are so many risks, our country must rely on what has always been its strength: stability and reliability. In recent years, in the face of crises, it has resorted to massive indebtedness. It is time to put a stop to this dangerous debt dynamic. At the end of 2024, Luxembourg’s public debt should reach €22.3bn, or 26.5% of GDP, according to the 2024 budget. Although this level of debt is significantly lower than that of other European countries, such as Greece (159.8%), Italy (137.7%) and France (110.8%), the trend is worrying. In 2007, it represented just 8.1% of GDP. If growth is less sustained than expected, the symbolic threshold of 30% of GDP could be crossed as early as 2027, a threshold beyond which debt starts to become costly and worrying for investors.

Ambition, finally, to support our businesses in the dual transition to the environment and digital technology and thus transform our economy. In the fight against global warming, the government has already committed to increasing annual spending from €722m in 2023 (0.89% of GDP) to €922m in 2027 (0.94% of GDP). It remains to be seen how these funds will be deployed strategically. It is absolutely crucial to use these resources in a more targeted and selective way than in the past.

As far as the digital transition is concerned, we will have to pay close attention to the allocation of investment in artificial intelligence. Luxembourg, which has built its prosperity on highly productive activities, is now faced with stagnating productivity, affecting its competitiveness and growth. Little by little, the country is losing the competitive edge it built up in the second half of the 20th century, as it catches up with economies (some of which also had high productivity levels) that have been better at pushing back the technological frontiers to boost their productivity. Artificial intelligence could be the long-awaited fuel to kick-start a new production cycle and revitalise the economy.

Conversely, a delay in adopting this technology would be disastrous, as it would set back the Luxembourg economy for a long time to come. The government has set a course: to position Luxembourg as a leader in the data economy. To achieve this, the country will need to rethink its education and training, attract new talent and encourage businesses to transform the way they produce and organise themselves. This is a cross-cutting issue. The financial sector, which contributes almost 25% of gross added value in Luxembourg, must be at the forefront. I also think it’s very important to offer special support to SMEs in this transformation. In the non-financial economy, they account for 64.3% of the value added created in Luxembourg, compared with a European average of 53.1%, according to the SME Fact Sheet 2024. Without SMEs, Luxembourg will not be able to succeed in its digital transition.

Since this summer break has been marked by the Paris Games, as we return to work, let us be inspired by the Olympic motto: “Citius, Altius, Fortius--Communiter.” Faster, higher, stronger--together.

is CEO of the Luxembourg Chamber of Commerce. This article was originally published in .