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Executive summary.

Luxembourg has experienced a severe recession, as it was heavily exposed to the fall in world trade and the international financial crisis. Unemployment has risen and the fiscal position has deteriorated. This follows a long period of continuous and rapid economic expansion during which living standards rose impressively and the economy was transformed by the growing financial centre and large flows of cross-border and migrant workers. While there are encouraging signs of recovery, the future growth path is likely to be weaker than in the recent past reflecting the sluggish international recovery, structural factors and a loss of competitiveness.

Exiting from the crisis. The substantial fiscal stimulus needs to be unwound. The structural deficit in the public finances will need to be addressed given the vulnerability of the Luxembourg economy to external shocks and the longer-term fiscal challenge from ageing. Consolidation plans need to be implemented with an emphasis on containing current expenditure and within a more robust budgetary and institutional framework. The unemployment rate is at a historically high level and could be reduced through appropriate structural measures to boost labour demand and get the unemployed back to work. Economic recovery could be encouraged by improved competitiveness.

Securing long-run fiscal sustainability. The main challenge comes from high pension costs clue to ageing, generous benefits and the increasing number of cross-border workers who will reach retirement age. Pension reform, together with fiscal consolidation, is required to put the public finances on a sustainable footing. Fiscal consolidation is an opportunity to increase public sector efficiency as well as to strengthen budgetary institutions.

Avoiding long-term unemployment. Residents' unemployment rose even during the growth years and the crisis has further increased unemployment. Some groups, including younger and older workers, have relatively low employment rates. The functioning and adaptability of the labour market would be improved by making its regulation less rigid and by ensuring that generous social benefits do not reduce the incentive to work.

Maintaining a well-regulated financial centre. Banking and asset management activities in the financial centre play an important role in the overall economy. They were adversely affected by the international financial crisis, although knock-on effects to the real economy have been rather muted. The risks inherent in these activities, related to substantial cross-border exposures, appear to have been well managed. However, the crisis leaves the financial industry's future prospects more uncertain. Effective supervision and improved cross-border co-operation will help to manage risk in the financial system, while solid domestic framework conditions will contribute to the development of the financial centre.

Achieving growth with flexibility and efficiency. Though living standards should remain high, it is to be assumed that potential growth is likely to be lower in the coming years. This underlines the need for structural reforms. Competition should be enhanced, notably in the services sectors. Further education reforms are needed to raise skills and knowledge standards. Housing and transport policies should do more to support sustainable economic development and continue to make Luxembourg an attractive location for business. Reducing high per capita C[O.sub.2] emissions will be a major challenge.
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Publication:OECD Economic Surveys - Luxembourg
Date:May 1, 2010
Previous Article:Basic statistics of Luxembourg, 2009.
Next Article:Assessment and recommendations.

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