EUROPEAN COMMISSION Brussels, 27.2.2019 SWD(2019) 1015 final COMMISSION STAFF WORKING DOCUMENT Country Report Luxembourg 2019 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2019 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2019) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Competitiveness reforms and investment Annex A: Overview Table Annex B: Commission Debt Sustainability Analysis and fiscal risks Annex C: Standard Tables Annex D: Investment Guidance on Cohesion Policy Funding 2021-2027 for Luxembourg REFERENCES LIST OF Tables Table 1.1:Key economic and financial indicators - Luxembourg Table 2.1:Summary Table on 2018 country-specific recommendations assessment Table 3.1.1:Gross average replacement rate (% of average wage at retirement)

Table 3.2.1:Financial soundness indicators, all banks in Luxembourg Table 3.2.2:Distribution of investment funds per specialisation (% market share) Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Breakdown of real GDP growth Graph 1.2: Composition of investment spending (% GDP) Graph 1.3: Breakdown of potential GDP growth Graph 1.4: Consumer inflation Graph 1.5: Beveridge curve Graph 1.6: Breakdown of value added content in exports (% of GDP) Graph 1.7: Market share decomposition: contribution of export shares' drivers to exports market share growth (% cumulated) Graph 1.8: Decomposition of external position (current and capital accounts) - Luxembourg Graph 1.9: Decomposition of Debt by Sector (non-consolidated) - Luxembourg Graph 2.1: Overall multiannual implementation of 2011-2018 CSRs to date

Graph 3.1.1: Age-related expenditure (as % of GDP) and population projections in selected Member States (2016-2070 % change) Graph 3.1.2: Number of new pensions, by type (thousands) Graph 3.1.3: Environmental tax revenues as a share of GDP (2016) Graph 3.2.1: Household debt and leverage ratios Graph 3.2.2: Housing prices overvaluation gap with respect to income, rents and fundamentals Graph 3.3.1: Activity, unemployment, long-term unemployment, youth unemployment and not in employment and education or training rates Graph 3.3.2: Employment rate by age group in Luxembourg Graph 3.3.3: At-risk-of-poverty or social exclusion rate and its components in Luxembourg Graph 3.4.1: Targets and emissions under the effort-sharing legislation - Luxembourg (percentage change from 2005) LIST OF Boxes Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Luxembourg Box 3.2.1: The rental market in Luxembourg Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 3.4.1: Investment challenges and reforms in Luxembourg Executive summary While recent economic trends in Luxembourg pointed to a moderate economic expansion, prospects are now clouded by a deteriorated external environment, to which the economy is highly sensitive. Although the economy is forecast to continue growing, this could signal a need for Luxembourg to step up efforts to address key structural issues potentially hindering a more sustainable economic growth. At the current juncture, public finances remain sound and strong job creation is feeding into low unemployment. The country could bolster its economy and improve the conditions for sustainable growth by ensuring that labour supply and skills levels match labour market needs. This, in turn, would help to better address the long-term health of public finances. The resilience of the economy would also be strengthened by further diversification efforts through engaging the domestic business and investment community in the current technological and digital transformation. Private and public investment is needed to foster innovation, improve housing and transport infrastructure, and stimulate inclusive skills development. ( ) After slowing to 1.5 % in 2017, GDP growth picked up again and is estimated to have reached 3.0 % in 2018. Growth has been supported by a sizeable expansion in exports of (mainly financial) services, Luxembourg’s main economic driver, which had been exceptionally weak in 2017. Private consumption growth also strengthened in 2018, building on an improvement in the labour market and higher disposable incomes as a result of taxation reforms and a new wage indexation from August 2018.

Growth is projected to decelerate to 2.5 % in 2019. The slowdown in world trade, and euro area GDP growth, has contributed to higher volatility in financial markets. A broad set of indicators suggesting that these trends may continue in 2019 has weakened growth prospects for financial services and the economy as a whole. Therefore, external trade is expected to weaken markedly. This should drive down GDP growth despite supportive domestic demand, which is forecast to provide the main contribution to growth in 2019. Business investment is set to remain subdued, reflecting lower expectations of economic growth and greater uncertainty. Business investment is projected to remain below 11 % of GDP, one of the lowest rates in the EU, while residential investment is also set to remain low in contrast with the high demand for housing. Productivity remains among the highest in the EU but it has declined since 2014, as GDP has grown more slowly than employment. While the recent downward revisions of past GDP growth seem to reflect exceptional events and methodological changes, they cast additional doubts on the reliability of statistics in general and productivity figures in particular. Luxembourg’s public finances remain sound. The general government balance is estimated to have posted a surplus of around 1.3% of GDP in 2018 and it is forecast to remain in surplus in 2019. General government debt is expected to continue to fall in 2019, from around 21 % of GDP in 2018 (well below the 60 % threshold). However, significant budgetary challenges could remain in the long term, with population ageing and growing benefit ratios driving up spending on pensions and healthcare. Focussing investments ( ) on fostering digitisation and innovation, improving housing supply and sustainable transport infrastructure, and stimulating skills development would improve economic resilience, and strengthen the long-term potential growth of Luxembourg. Public investment remains high and focussed on knowledge-intensive sectors, including a strong Information and Communication Technology sector. However, this has not spilled over, nor helped to stimulate private investment in innovation and digitisation, which remains low and appears insufficient to support the transition to a datadriven economy, and to improve significantly the low levels of economic digital integration and sluggish productivity growth. While firms increasingly perceive the shortage of qualified workforce as an obstacle to investment, heavy traffic congestion and insufficient housing supply may also be negatively affecting the country’s attractiveness (see Section 3.2), which calls for significant investments in construction and sustainable transport infrastructure (see Section 3.4). Effective investments in education and training are needed to make the most of people’s potential and thus improve inclusion and employability, and foster technological and digital transformations to improve productivity and longterm growth potential (see Section 3.3). Annex D identifies key priorities for support by the European Regional Development Fund and the European Social Fund Plus for the 2021-2027 period in Luxembourg, building on the analysis of investment needs and challenges outlined in this report. Overall, Luxembourg has made limited progress in addressing the 2018 country-specific recommendations. There has been limited progress in the following areas: ·Increasing employment among older people, by enhancing their employment opportunities and employability, and further limiting early retirement. ·Further reducing regulatory restrictions in the business services sector. Such restrictions remain above the EU average in most regulated professions. Regarding Luxembourg’s progress towards its national targets under the Europe 2020 strategy, the employment rate target of 73 % is still out of reach despite substantial job creation. Luxembourg almost complies with the municipal waste recycling target of 50 % and is broadly on track to reach the targets for energy efficiency. On the other hand, it is at risk of failing to meet the targets for reducing the risk of poverty or social exclusion, early school leaving, postsecondary educational attainment, research and development intensity and reducing greenhouse gas emissions. ·Luxembourg performs overall well on most indicators of the Social Scoreboard supporting the European Pillar of Social Rights. The labour market is performing very well, and social indicators on inequality, poverty and exclusion, remain close to or above the EU average, despite some signs of weakening. Significant skills shortages have emerged recently in certain sectors and school pupils’ opportunities are still strongly influenced by their socioeconomic status. Other key structural issues analysed in this report, which point to particular challenges for Luxembourg’s economy, are the following: ·Despite recent reforms, pension-related and long-term care costs are still expected to increase markedly in the long term. Recent projections of long-term trends in pensions and long term care expenditure point to risks to the sustainability of public finances. In its 2018 report, the government’s pensions working group discussed various ways to improve longterm pension sustainability – the contribution rate could be increased gradually, the pensionable age could be raised to take account of longer life expectancy, and phased retirement could be encouraged. The report suggests a multipronged strategy of calibrated reforms to guarantee the long-term sustainability of the system while minimising the impacts on both the economy and pensioners. ·Projected increases in expenditure threaten the long-term sustainability of the healthcare system. The 2018 reform of long-term care insurance is expected to ensure financial viability until 2030. The government finances 40 % of long-term care expenditure. The reform will gradually increase workers’ contributions to the healthcare system from 1.4 % of the wage base to 1.7 %, keeping costs in line with the proportion of dependent people. ·Luxembourg’s total tax burden as a share of GDP is close to the EU average. Luxembourg’s corporate income tax revenues are above the EU average while revenues from taxes on consumption, recurrent property and environmentally oriented taxes are all below the EU average as a share of GDP. The recent coalition agreement has announced a number of tax reforms in support of the country’s environmental commitments. ·Luxembourg’s tax rules appear to be used by multinationals engaged in aggressive tax planning structures, but some steps are being taken to limit such practices. Some elements that may facilitate tax planning include the absence of withholding taxes on interests and royalties as well as possible exemption on dividends. However, Luxembourg has taken steps to amend aspects of its tax system to curb aggressive tax planning, in particular by implementing European and internationally agreed initiatives. ·As one of the world’s largest financial centres, Luxembourg is deeply integrated in the international financial industry’s global value chain. The financial sector is the main engine of the country’s economy, accounting for 25 % of GDP, 11 % of employment and 21% of fiscal revenues. Luxembourg’s banks display solid capital ratios. Despite a weakening in 2017 and 2018, their profitability remains comfortable and reflects a diversified revenue mix. Banks need to deposit large sums at the Central Bank to comply with liquidity ratios. Recent stress tests have found that banks would be able to withstand realestate price shocks and high default rates. Potential risks stemming from the interconnectedness between banks and funds appear limited. ·Despite being wealthy at the aggregate level, households have high levels of debt compared to their incomes. Rising household indebtedness stems in particular from increasing property prices, as mortgage loans account for around 80 % of household debt. Increasing debt means that some lower income households may struggle to make ends meet, particularly if interest rates go up or if there is an economic downturn. ·House prices continued to rise in 2017 and the first half of 2018, but not as much as in previous years. Rising rents and property prices could affect competitiveness and social inclusion. The strong housing demand remains driven by population growth, favourable financing conditions and a large cross-border workforce. Housing supply and investment appear insufficient, constrained by insufficient land availability and low housing density, largely due to a lack of incentives for landowners to build new housing. The supply of social housing also appears insufficient and points to a need for significant investment to alleviate rising tensions in the housing market. ·Luxembourg plans to take measures to stimulate housing supply. These include changes to urban planning laws to increase building areas and develop affordable and social housing. Other measures involving land purchase, new tax incentives and technical assistance for municipalities should increase the amount of land available for building. Planned incentives are expected to encourage owners to sell or rent out properties that are currently vacant. Public authorities may also be given stronger powers for the compulsory purchase or exchange of land to unblock development projects. ·Unemployment is low and the current favourable economic environment results in strong jobs creation. However, certain groups are still less likely to find work. People aged over 50, people with disability and workers with reduced working capacity make up a large share of the long-term unemployed. Many employment measures aim to help the most vulnerable jobseekers (in particular those aged 4550 or more) back into work.

·Nevertheless, the employment rate among older workers has stagnated since 2010 and remains among the lowest in the EU (39.8% in 2017). Limited progress has been made on reducing early retirement and targeted policies have so far failed to encourage significantly more older people to work or look for a job. Age management strategies, which should also help to keep older workers in employment, have not been a legislative priority so far. ·Although social benefits play a pivotal role in lifting people out of poverty, their impact has weakened further and inequality got worse in 2016. The minimum income arrangements are being reformed to tackle social exclusion (in particular for households with children), encourage people to look for work or training and remove disincentives to work. The Revenu d’inclusion sociale scheme replaced the previous scheme in January 2019. Its success will depend largely on whether beneficiaries can find successful pathways back to work. ·Luxembourg is among the best performers in the EU in terms of tertiary education attainment, but the basic skills of 15-year-olds are below the EU average. Performance is strongly influenced by students’ linguistic background and socio-economic status. Several measures have been taken to close the performance gaps among pupils of different backgrounds. ·To become more employable, people need skills and training that are more in line with employers’ needs. The public employment service has stepped up its cooperation with employers to ensure that their needs are met. Investing in skills development, including training courses for jobseekers (in particular those aged 30-45), in response to requests from employers, remains a priority. ·Overall productivity has remained high, even in the difficult 2007-2010 period, but no significant gains have been recorded since 2014. Luxembourg’s productivity gains were obtained from its involvement in global (largely financial) markets. However, cost competitiveness indicators are worsening, partly reflecting the sluggish productivity growth. The cost of labour, per unit of output, grew by 5.2 % in 2017, after very limited increases in previous years (around 1%, on average, between 2013 and 2016). This was due to a further decline in labour productivity coupled with a wage indexation, triggered (from January 2017) by a sharp rise in inflation. However, these trends eased in 2018. ·Luxembourg’s export market shares for goods and services exports recorded a net loss of 4.5 % in 2017. Luxembourg is highly dependent on the contribution of foreign trade to economic activity, domestic employment and public finances. Intermediate inputs account for 70 % of the country’s trade, suggesting a high level of market integration, in particular for financial activities. ·Luxembourg has kept up its efforts to strengthen knowledge-intensive sectors and pursue its economic diversification strategy. Stronger private investment in research, technological innovation and digitisation can be key drivers of productivity growth and of the transition to a datadriven economy. The weak connection between the public science base and businesses calls for action to promote knowledge transfer to firms. The lack of a national research and innovation strategy and stagnant public support for business research and development investments, are among other challenges that prevent Luxembourg from exploiting the full potential of its innovation eco-system. ·Ambitious climate and energy policies can provide Luxembourg with opportunities for growth and jobs through increased productivity, diversification of exports and business creation. Additional measures, as envisaged in the new coalition agreement, could contribute to bridge the gap to reach Luxembourg’s 2020 and 2030 decarbonisation targets. ·Regulatory barriers remain in the business services sector, and some bottlenecks weigh on the business environment. Regulatory restrictions in business services remain above the EU average for several economically important professions. Measures have been taken to ease restrictions in the retail sector. ·Luxembourg’s location at the crossroads of one of the EU’s most economically dynamic regions gives rise to significant mobility issues. Traffic congestion, low air quality or long commuting times affect many cross-border workers. The projected increase in population and the number of commuters will require significant investments in infrastructure, including, education and health services. 1. Economic situation and outlook GDP growth After slowing to 1.5 % in 2017, GDP growth picked up again and is estimated to have reached 3.0 % in 2018. Growth has been supported by a sizeable expansion in exports of services (mainly financial), Luxembourg's main economic driver, which had been exceptionally weak in 2017 (Graph 1.1). However, historical figures need to be taken with caution given the frequent and substantial revisions to Luxembourg's national accounts data ( ). Private consumption growth also strengthened in 2018, on the back of an improvement in the labour market and higher disposable incomes as a result of taxation reforms and new wage indexation from August. Graph 1.1:Breakdown of real GDP growth Source: European Commission According to the Commission's winter forecast, growth is projected to decelerate to 2.5 % in 2019. The slowdown in world trade, and euro area GDP growth, has contributed to higher volatility in financial markets. A broad set of indicators suggesting that these trends may continue in 2019 has weakened growth prospects for financial services and the economy as a whole. Therefore, external trade is expected to weaken markedly. This, in turn, should drive down GDP growth, despite supportive domestic demand, which is forecast to be the main growth driver in 2019. The recovery of net exports of goods and services in 2018, reflects somewhat a normalisation, after an exceptionally weak outcome in the previous year. Nevertheless, growth is projected to drop subsequently as the external environment becomes less supportive. Exports rebounded in 2018, after stagnating over 2016 and 2017. These developments mainly reflect a recovered dynamism in the financial sector after a period of reduced activity, including the exceptional exit of a few large companies, which ceased activities in the place. Although these developments did not change significantly the weight of the financial sector in the economy, they entailed a reduction in the balance of externally oriented operators. Increased uncertainty and less support expected from the external environment are projected to moderate the external sector contribution to GDP growth. Graph 1.2:Composition of investment spending (% GDP) Source: European Commission The deceleration projected for business investment reflects lower expectations about economic growth amidst increased external uncertainty (Graph 1.2). Some cyclical effect is also expected, as growth will slow down and should stay close to potential. The business investment-to-GDP ratio is projected to remain below 11 %, which is one of the lowest in the EU.

Investment in construction has been buoyant thanks to public infrastructure projects and non-residential buildings. However, residential construction remains low. The housing investment-to-GDP ratio of around 3.2% should remain stable despite the high demand for housing. While supply constraints remain entrenched, price pressures are expected to build up further (see section 3.2.3). As the government investment cycle gets started, following the general elections in 2018, public investment might slowdown in 2019. Nevertheless, the public investment-to-GDP ratio is expected to remain stable at around 4.0 % of GDP, which is among the highest in the EU. Potential growth Potential growth has halved compared to pre-crisis records, due to total factor productivity slowdown slowdown. Annual estimates of potential GDP growth were revised down by 0.4 pps on average, between 2010 and 2017, albeit significantly more in 2016 and 2017. Potential GDP growth averaged 2.1 % in the period 2010-2017, compared with 4.1% in 2001-2007. A larger decline in total factor productivity underlays the new estimates of potential growth (Graph 1.3). Revised data also suggest that the decline in productivity since the global crisis has been larger (see Country Report, 2018) and its pace accelerated in the four years to 2014. Large productivity losses in 2015, 2016 and 2017 deserve special attention, as they were concurrent with exports stagnation and GDP slowdown, amid an allegedly supportive economic environment. Lower growth coupled with high job intensity resulted in a degradation of labour productivity. This might point initially to a situation of labour hoarding ( ). However, statistics on firms' results show that profitability was maintained overall and, in particular, in the banking sector. Notwithstanding the likelihood of some labour hoarding behaviour by firms, as skilled labour shortages are being reported in some sectors, it seems to exist also some inconsistency between the revised national accounts and the results of the business and labour surveys. Indeed, the frequent revisions of national accounts-data are witness of the uncertainty surrounding national accounts statistics, which need to be taken with caution, including the fall in productivity growth. Overall, Luxembourg continued showing among the highest levels in labour productivity, real GDP per head and trade openness in the EU. Graph 1.3:Breakdown of potential GDP growth Source: European Commission Inflation The Harmonised Index of Consumer Prices inflation fell marginally to 2.0 % in 2018 from 2.1% in 2017, slightly above the euro area, where the average was 1.8 % (Graph 1.4). Inflation was sustained mainly by mainly oil price movements. Oil prices are assumed to ease significantly in 2019, which should drive down headline inflation to 1.6%, although this effect will gradually dissipate in 2020. At the same time, domestic price pressures, including from past wage increases, are set to reassert their influence and headline inflation should increase from 1.6% in 2019 to 1.8% in 2020. Graph 1.4:Consumer inflation Source: European Commission Labour market Luxembourg labour market is growing at a robust pace. Employment growth accelerated markedly over the first half of 2018, to near 4 % (y-o-y) in July, when it started decelerating. On average it increased by 3.7% in 2018, after 3.4 % in 2017. This growth momentum appears to have moderated, with employment growth stabilising progressively. The unemployment rate continues to fall, also helped recently by a deceleration in active population, which is largely driven by inflows of new residents, especially from border countries. Resident employment (used for computing the unemployment rate) is rising markedly, helping to curb the unemployment rate. Unemployment fell to 5.3% in 2018, from 5.6 % in 2017. This downward trend is forecast to slowdown progressively, stabilising towards 2019. Youth unemployment decreased from 19.1% in 2016 to 15.2% in 2017 and reached 12.3% in the last quarter of 2018 while the rate of young people not in employment, education or training is very low. Notwithstanding the recent labour market reforms and the good performance in terms of job creation, additional efforts are needed to improve inclusion of certain population groups in the labour market. In particular, the employment rate of older workers remains substantially below the EU average. Part time underemployment has increased but remains at relatively low levels compared with other Member States. In time, labour market shortages have become more apparent in some industries and evidence points also to lower matching capacity. Estimates of the Beveridge curve hint at two outward shifts and higher steepness of the curve over 2010-2012 and 2013-2018 and a deterioration of matching mechanisms (Graph 1.5). Such evidence indicates the possibility of shortages arising at higher levels of unemployment under intense recruitment needs ( ). Graph 1.5:Beveridge curve Source: European Commission Despite the expected closure of the unemployment gap ( ), there remain some important ‘pockets’ of untapped capacity. The most significant ones stem from low participation of older people, immigrants and women (in particular non-EU-born women), as well as among those with lower skill levels. The observed outward shift of the Beveridge curve since 2010 is consistent with evidence of labour shortages (as reported in business surveys) arising at comparatively higher levels of unemployment due to lower matching capacity (e.g. skills mismatch). Such shortages are also compatible with the prevalence of lower employment rates than before the crisis among those with lower skills, which together with lower matching efficiency, amplifies frictions in job-to-job transitions between different sectors. Demographic policies would need to concur with education and training policies, taking a holistic approach to consider both the challenges and possibilities of changes in demography as well as in the digital economy, in order to sustain social cohesion and public finances, as population ageing remains a challenge in the long term. Social developments Poverty and social exclusion risks are increasing but they are still among the lowest in the EU. Income inequality remained stable in 2017 at the level just below the EU average but the overall risk of poverty or social exclusion (AROPE) situated at 21.5% in 2017, below the EU average (22.5%), but it is trending upward. In 2017, in-work poverty was the second highest in the EU. The number of persons affected by the risk of poverty or social exclusion amounted to roughly 126,000 in 2017 while Luxembourg’s Europe 2020 target corresponds to around half of them, a maximum of 66,000 persons at risk. Social transfers play a pivotal role in lifting people out of poverty. Yet their impact has weakened further, against the rise in market income inequality ( ). Furthermore, the link between socioeconomic status and educational outcomes remains particularly strong in Luxembourg, pointing to high educational inequality. Competitiveness

Cost competitiveness conditions appear to have become less favourable in Luxembourg. Unit labour costs picked up in 2017 to 5.2%, after a very contained increase in previous years (around 1 % on average between 2013 and 2016). Wage increases, prompted by a sharp acceleration of inflation through the wage indexation mechanism, which together with additional productivity losses, explain this increase. However, a visible deceleration in unit labour costs growth has taken place over 2018. Exports market shares of goods and services recorded a net loss of 4.5% in 2017. However, figures might be not fully consistent, partly due to methodological changes in the series. Gains in Luxembourg's exports market shares of goods and services have trended down steadily since 2014, before recording a net loss of 4.5% in 2017. These developments have become visible with the latest statistical revision, which also points to a reduced activity in the external sector, where the bulk of the revision was concentrated. However, as mentioned above, some consistency issues are apparent in the national accounts-data. To some extent it owes to methodological changes ( ), which had a significant impact on exports reported under the National Accounts of Luxembourg ( ). This might also help explaining the apparent inconsistency in productivity, employment and profit developments in Luxembourg. Intermediate inputs account for 70% of the country's trade, suggesting a high level of market integration, largely related to financial activities. OECD Trade in Value-Added indicators (TiVA) suggest that around 70% of operating costs are determined by intermediate inputs (140 % of GDP) (Graph 1.6), of which more than 60% are imported. On this regard, the country is deeply integrated in global value chains, as it features the highest global value chains participation across OECD countries. Recent studies show that global value chains participation is most significant in the financial sector ( ), starting at an early stage and since constantly evolving towards specialisation, diversification and expansion. Trade related to financial intermediate services, such as the ones provided by the funds management agencies, depositary banks or a varied range of professionals abroad, is much higher than the value added generated in the country. Graph 1.6:Breakdown of value added content in exports (% of GDP) Source: European Commission calculations, OECD-TiVA database (December 2018). Luxembourg shows high dependence to foreign trade, as it contributes strongly to economic activity and domestic employment. Luxembourg shows one the highest levels of market integration among OECD countries, with trade related activities also attracting a high share of employment. Recently, market deepening has increased further, helping Luxembourg to keep the high TFP levels accumulated in the past from access to external markets. However, the later seem less closely related to innovation investment and might be less supportive for future growth. Moreover, effective access to international markets varies across sectors and firms, leading to productivity gaps that cumulate over time. Overall productivity has been kept at a high level in Luxembourg, even in the period 2007-2010. Productivity growth was barely changed over the period 1999-2014. As suggested in Graph 1.7, at high levels of market integration, production becomes the main adjustment variable, easing the pressure on profit margins ( ). However, high market integration also implies higher exposure to external shocks, whereas barriers to trade have a cumulative impact on costs thus on productivity. In this vein, the recent apparent slowdown in aggregate productivity warrants a close monitoring. Specifically, comparing relative performance across sectors and relative contributions to market integration, productivity and economic growth, may help identifying potential productivity gaps and investment needs in Luxembourg (see section 3). Graph 1.7:Market share decomposition: contribution of export shares' drivers to exports market share growth (% cumulated) Source: European Commission. Data from CompNet (October 2016). External position The current account balance recorded a surplus of 4.9 % of GDP in 2017 from 5.1 % in 2016. The current account balance continued on a slow decreasing trend in 2017, which turned up in 2018, to around 5.5% of GDP. This is explained by the increase in the secondary income surplus (Graph 1.8). The current account balance is driven by the surplus of the balance of services, which corresponds mostly to financial services related to the funds industry. Concomitantly, the primary income deficit reflects mainly the returns on investment in the funds industry. Moreover, Luxembourg is a net creditor to the rest of the world. Its net assets, measured by net international investment position, have risen to around EUR 26.4 billion (47.0 % of GDP). The net position encloses large international investment assets. At the end of 2018, gross external assets and liabilities reached EUR 10.5 trillion (around 200 times the country's GDP). Net investment flows to the fund industry have stagnated since the first half of 2018, after increasing markedly in 2017, which might be due to increased uncertainty, with valuations signalling higher volatility in financial markets. Graph 1.8:Decomposition of external position (current and capital accounts) - Luxembourg Source: European Commission Private debt Private debt remains at high level, in particular for non-financial companies, although most of it is intragroup lending. Private sector debt stood at 323% of GDP in 2017. This is mostly due to a high non-financial corporate debt (257 % of GDP in 2017), most of which is linked to cross-border intercompany debt due to the large presence of multinational companies. In addition, a significant active deleveraging took place in 2016 and 2017, which might be partly linked to a few large companies ending operations in Luxembourg (Graph 1.9). Graph 1.9:Decomposition of Debt by Sector (non-consolidated) - Luxembourg Source: European Commission Despite a favourable aggregate wealth position, households' indebtedness remains high compared to income. Household indebtedness has rapidly increased over the last 10 years. While household debt has risen from 39 % of GDP in 2000 to 67 % in 2017, the ratio of debt-to-assets is still very low (36 %). Yet, household debt is estimated at 178 % of income in 2017, among the highest in the EU. Household indebtedness reflects real estate inflation, as around 80% of it stems from mortgage loans. House prices have continued rising in 2017 and in the first half of 2018, although more moderately than in previous years. (see section 3.2.3). At the same time, rising indebtedness generates some concerns as to the solvency risks related to households with lower income, notably in case of rising interest rates or economic downturn (see section 3.2.2). Public finance Luxembourg's public finances remain sound. The general government balance is estimated to have posted a surplus of around 1.8% of GDP in 2018 and it is forecast to remain in surplus in 2019. General government debt is expected to continue to fall in 2019, from around 21 % of GDP in 2018 (well below the 60 % threshold). However, significant budgetary challenges are likely to remain in the long term, with population ageing growing and growing benefit ratios driving up spending on pensions and healthcare.

Table 1.1:Key economic and financial indicators - Luxembourg Source: Eurostat and ECB as of 31-1-2019, where available; European Commission for forecast figures (Winter forecast 2019 for real GDP and HICP, Autumn forecast 2018 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011 ( ), 34 % of all country-specific recommendations addressed to Luxembourg have recorded at least ‘some progress'. Looking at the multi-annual assessment of the implementation of the country-specific recommendations (CSRs) since these were first adopted, 34 % of all the country-specific recommendations addressed to Luxembourg have recorded at least 'some progress'. 66 % of these country-specific recommendations recorded 'limited' or 'no progress' (Graph 2.1). Substantial progress and full implementation have been achieved in several areas of the fiscal policy, for instance preserving a sound fiscal position and strengthening fiscal governance. Graph 2.1:Overall multiannual implementation of 2011-2018 CSRs to date Source: European Commission Over the past years, Luxembourg has significantly strengthened its budgetary framework. In 2014, Luxembourg transposed in national legislation the requirements of the 2011 Council Directive on budgetary frameworks and the fiscal compact. In 2017, the authorities further adjusted the domestic regulation to bring it into full compliance with the 2011 Council Directive on budgetary frameworks. Since then, Luxembourg, which is under the preventive arm, has remained committed and compliant with the provisions of the Stability and Growth Pact. The implementation of the savings measures identified by the 2014 spending review is largely on track. The national authorities have implemented 80% of the measures identified in the review, most of them spending cuts integrated in the domestic budgetary planning. After overachieving savings target in 2015 (the first year of the multi-year budgetary strategy), the targeted savings for the 2016-2018 period were revised downwards by 25-35 %, partly linked to the reconsideration of a number of reform steps in vocational education and social transfers. Several measures have been adopted to address the long-term sustainability of public pensions, though their impact has been limited. A pension reform was adopted in 2012, but its impact on pension expenditure has been limited. A law aiming at keeping workers with disabilities longer in the labour market entered into effect at the beginning of 2016. Additionally, the 2017 tax reform introduced some incentives for increasing working time. A reform of the long-term care public insurance was enacted at the beginning of 2018, which keeps the evolution of long-term care costs in line with that of the share of dependent people in the total population. Meanwhile, the expenditure projections reveal a heightened requirement for long-term care spending in the future. Additionally, the ‘pré-retraite de solidarité’, a special scheme allowing people to retire from the age of 57, was abrogated in 2018 but its impact might not be significant, as some restrictions on other kinds of early retirement were loosened. The employment rate of older workers has stagnated since 2010 and remains among the lowest in the EU (39.8% in 2017). More fundamental reforms have not been considered yet or are pending approval, such as the so-called 'Age Pact', which includes a whole package of measures to keep senior workers longer in employment. Finally, no measures have been taken on the recommendation for aligning the statutory retirement age to changes in life expectancy. Some progress has been made on enhancing participation in the labour market, but challenges remain. The main efforts have focussed on reducing youth unemployment, where progress has been substantial. Regarding upskilling, has been recently addressed: the vocational education and training system had identified several fields for improvement. The law on vocational education and training, amended in 2016 and in application since 2016/2017, aims at improving the qualitative skill sets and study success rates of students. The employment of older workers remains among the lowest in the EU, particularly for the low-skilled, who are also particularly affected by long-term unemployment. In 2017 45.84% of the inactive were low-skilled (ISCED 0-2) while only 12.02% of the inactive were high-skilled (ISCED 5-8). Luxembourg has made some progress in addressing bottlenecks that hamper housing investment. Numerous measures have been adopted or are planned, especially on the supply side, trying to increase the market offer. Recently, the Parliament endorsed a law empowering the "Fonds de Logement", a land management agency, to support the supply of housing. Measures are also envisaged to increase the land available for real estate development, through land purchase, new tax incentives and technical assistance to municipalities. New incentives are envisaged to bring to the market properties that are currently vacant. Public authorities may also obtain stronger powers to expropriate or exchange land to unblock development projects. Nevertheless, supply remains limited and the challenge ahead for the Luxembourg authorities continues to be sizeable. House prices have continued rising in 2017 and in the first half of 2018, although more moderately than in previous years. Luxembourg has made limited progress in reforming the wage-setting system. After a modulation of the automatic wage adjustment to inflation in the period 2013-2014, no further measures have been adopted. A study was published about the impact of the wage indexation on the evolution of labour cost. Based on the study conclusion the current government announced its intention to consider reviewing the existing wage setting mechanism only in the case of a surge in inflation pressures. Luxembourg has made some progress on strengthening its strategy to diversify the economy. Public investment remains high and other measures to foster innovation remain activated. Yet, private investment, especially on innovative technologies and digitisation, remains low compared with the euro area average. Luxembourg has made limited progress ( ) in addressing the 2018 country-specific recommendations. In addition to limited progress on employment of older workers as outlined above, Progress has been limited in removing regulatory restrictions in the business services sector. Several measures have been taken, although some regulatory restrictions remain above EU weighted average in several regulated professions (according to available indicators). Luxembourg engaged in further reforming the profession of architects (a new draft law is envisaged in the first half of 2019). With the law of 18 July 2018, Luxembourg removed the requirement for professional qualifications to obtain a standard business license. Table 2.1:Summary Table on 2018 country-specific recommendations assessment Source: European Commission

Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Luxembourg Financial allocation from the European Structural and Investment Funds (ESIF), aimed to support Luxembourg in facing development challenges, amounts to up to EUR 140 million in the current Multiannual Financial Framework, equivalent to around 1% of all public investment per year on average. As of the end of 2018, 56 % of the total has already been allocated to specific projects. In addition, EUR 66.1 million was allocated to specific projects on strategic transport networks through a dedicated EU funding instrument, the Connecting Europe Facility. Furthermore, numerous Luxembourg research institutions, innovative firms and individual researchers benefited from other EU funding instruments, notably Horizon 2020 which provided EUR 87.57 million. EU funding has helped to address certain policy challenges identified in the 2018 CSRs. Given Luxembourg's relatively modest ESIF allocation, the programmes concentrate on addressing specific aspects of the issues identified in recent years in the context of the European Semester. Increasing R&D investment is of crucial importance for creating greater economic diversification and increasing the number of Small and Medium size Enterprises involved in research. Support is provided to the sustainable professional integration of jobseekers, inactive persons and young people (including through the implementation of the Youth Guarantee), active inclusion, and skills development through better access to lifelong learning. Helping to answer the need to provide incentives to older workers to work longer, the European Social Fund supports measures to mentor job seekers and workers aged 45+. The Commission can provide tailor-made technical support upon a Member State's request via the Structural Reform Support Programme to help Member States implement growth-sustaining reforms to address challenges identified in the European Semester process or other national reforms. In Luxembourg, for example, work has started on providing technical support to help the authorities develop a comparative and benchmarking study on the General Law of Customs and Excise with a focus on some parts of the law, which should be aligned with good European and international practices to make them more efficient and operational. EU funding contributes to mobilisation of private investment. In Luxembourg, total financing under European Fund for Strategic Investment (EFSI) amounts to EUR 123 million and is set to trigger EUR 623 million in additional private and public investments. Luxembourg ranks 18th as to the overall volume of approved operations as a share of GDP. Under the Infrastructure and Investment window the 7 projects ( I ) approved were financed by the European Investment Bank with EFSI backing, for a total of approximately EUR 30 million set to trigger EUR 343 million in total investment. Under the small and medium-sized enterprises component, the 6 approved agreements with intermediary banks or funds financed by the European Investment Fund with EFSI backing reached EUR 93 million in total financing, set to trigger approximately EUR 280 million in investments with some 977 small and medium-sized enterprises and mid-cap companies expected to benefit from improved access to finance. An example of EFSI-backed project in the country is “Flen Pharma”, a small and medium-sized enterprise which develops medical devices to care for wounds. Thanks to EFSI financing, the company has been able to expand its Research and Development department and hire extra highly-skilled staff. https://cohesiondata.ec.europa.eu/countries/LU 3. Reform priorities 3.1.Public finances and taxation 3.1.1.Long term sustainability Fiscal sustainability risks remain low on the short to medium term. The debt sustainability analysis, as well as the S0 ( ) and the S1 ( ) indicators, in the Fiscal Sustainability Report 2018 (European Commission, 2019) point to low risks, due to the low public debt (21.6 % of GDP at end 2018) and the favourable initial budgetary position. Risk indicators related to Luxembourg’s long-term fiscal sustainability remain high. Luxembourg is projected to face a rise in ageing-related costs up until 2070. This is highlighted by a high S2 long-term fiscal sustainability gap indicator ( ), at 8.1 percentage points of GDP. It is entirely driven by the expected increase in age-related expenditure, in particular pensions (5.8 pps of GDP) and health care and long-term care expenditure (2.8 pps of GDP). 3.1.2.Pension, Healthcare and long-term care The pension system is expected to remain in a favourable position in the short to medium term ( ). Luxembourg's population is ageing at a slower rate than neighbouring countries due to the continuous inflow of foreign workers (both immigrants and cross-border commuters), which increases pension contributions while only modestly raising the average workforce age (see country report, 2017). In 2017, the pension system recorded a surplus of EUR 1.0 billion, pushing its accumulated reserves to EUR 19 billion. Concerns are set to arise on the long term. The overall population and resident labour force are projected to increase to 1 million and 0.4 million respectively by 2070 (Graph 3.1.1), which should push up age-related expenditure (European Commission, 2019). According to the government-appointed pension working group, the operational balance of the general pension scheme for the private sector is projected to become gradually negative and eventually reach -7.6% of GDP by 2070. Accumulated reserves are expected to ensure the viability of the system until 2041 (Rapport du groupe de travail pensions, 2018). Graph 3.1.1:Age-related expenditure (as % of GDP) and population projections in selected Member States (2016-2070 % change) Source: Eurostat, European Commission Despite recent reforms, pension-related costs are still expected to increase markedly. The contribution rate is currently 24 % of the wage mass, with employers, employees and the state each contributing one third. Following the 2012 reform, the rate has been fixed so that contributions cover pension payments over a period of 10 years. However, based on the latest simulations, the contribution rate needs to increase to 37 % to prevent the reserve of the general pension scheme to fall below the legal threshold of 1.5 times annual pension expenditure by 2070 (Ministère de la sécurité sociale, 2018). The 2012 reform also introduced changes to the benefits calculation method, incentivising longer working careers. Nevertheless, the gross average replacement rate is projected to remain well above the euro area average, (Table 3.1.1). In 2017, Luxembourg recorded the highest benefit and replacement ratios in the EU. In its 2018 report, the government-appointed pension working group discusses possible solutions to improve long-term sustainability. According to the report, the contribution rate could be gradually increased, while the formula for computing pension benefits could be further adjusted. In parallel, the eligible age to pension could be increased to take into account longer life expectancy, while gradual retirement could be encouraged. The report suggests a multi-pronged strategy of calibrated reforms to guarantee the long-term sustainability of the system while minimising the impact on the economy. The conclusions of the report are expected to guide future evolutions of the pension system legislation. The next evaluation of the general pension scheme is expected to be issued in 2022. Table 3.1.1:Gross average replacement rate (% of average wage at retirement) Source: 2018 Ageing report Pre-retirement schemes which contribute to early exit from the labour market age are being reconsidered. In 2017, the average effective retirement age stood at 61.5 ( ), below the statutory age of 65. Only 24.9 % of new personal pensions (average effective age: 60.0) were granted to those aged 65 or older (Graph 3.1.2), 57.5 % were early old-age pensions (average effective age: 59.9) and 17.6 % were invalidity pensions (average effective age: 53.0) (Ministère de la sécurité sociale, 2018). However, the 2016 reform of the professional reclassification scheme for persons with working disabilities could reduce the share of disability pensions. Additionally, the ‘pré-retraite de solidarité’, one of the pre-retirement schemes allowing people to retire from the age of 57, was abrogated in 2018. Projected increases in health care expenditure threaten the long-term sustainability of the system. Luxembourg’s per capita spending on health care has consistently been the highest in the EU since 2012. Total and public per capita expenditure accounted respectively for 141% and 146% of the EU average in 2015. Total expenditure on health accounted for 6.1% of GDP in 2015, below the EU average (10.2%). According to the Ageing Report 2018, public health expenditure in Luxembourg is going to increase by 1.2 pps (Ageing Working Group Reference Scenario) or even by 1.7 pps (Ageing Working Group Risk Scenario) by 2070, which is going to add to age-related spending due to pensions and long-term care. In 2016, public health spending (in per capita Purchasing power standard) was above the EU average for all but one spending function ( ), while cost-sharing across services remains limited. There appears to be some scope to increase the efficiency of the hospital system. Hospital bed occupancy rate is low, inpatient discharge rates are below the EU average and decreased over the last ten years, while the average length of stay is above the EU average. This may partly be a consequence of a financing system based on global hospital budgets, which does not directly incentivise savings. Activity-based reimbursement, by contrast, can lead to a more efficient use of resources. Public pharmaceuticals spending is below EU average as a share of GDP but above average in per capita Purchasing power standard terms, while out-of-pocket payments are the lowest in the EU. The expenditure projections reveal a heightened requirement for long-term care spending in the future. As far as demographic drivers are concerned, the "Ageing Working Group reference scenario" forecasts public expenditure on long-term care as share of GDP to grow from 1.3 to 4.1, increasing by 2.8 pps. According to this scenario, the projected increase for Luxembourg over the period 2016-2070, 219%, is considerably higher than the EU average of 73%. The "Ageing Working Group risk scenario", which captures additional cost drivers to demographic and health-status related factors, projects an increase of even bigger magnitude (5.2 pps) bringing public spending on long-term care from 1.3% to 6.5% of GDP by 2070, an increase of 405%, again well above the EU average of 170%.

Graph 3.1.2:Number of new pensions, by type (thousands) Source: European Commission The long-term care insurance system reform is expected to ensure the system's financial viability until 2030. The government finances 40 % of long-term care expenditure (excluding additional contributions). The long-term care insurance system should remain financially stable until 2030 if the contribution rate is gradually raised from 1.4% to 1.7%, according to an analysis carried out by the General Inspectorate of Social Security. Meanwhile recent measures and the projected evolution of long-term care use patterns increase pressure on the budget. A new collective agreement with an important revalorisation of the career of nurses was negotiated in 2017. Due to this change, the hourly fees paid by long-term care insurance will increase in 2018, raising the budget by an estimated 5% on a permanent basis. In combination the long-term care reform, long-term care spending is expected to increase to 8.2% of expenditures in 2018. In addition, Luxembourg is characterised by a relatively costly provision of institutional care. Although there are more beneficiaries of home care setting, the number of persons in residential care has been increasing rapidly and is projected to accelerate and push long-term care spending up ( ). 3.1.3.Fiscal framework The mandate of the National Council of Public Finances, Luxembourg’s independent fiscal body, was broadened in 2017 to include the ex-post evaluation of macroeconomic and budgetary forecasts ( ). The first such analysis by the Council was published in June 2018( ) and was based on 10 to 20 years-worth of forecast data (1996-2016). The analysis covered projections for real growth, employment and unemployment, inflation and nominal general government balance. In its analysis, the Council identified a pessimistic bias in the projections for the budget balance and employment, leading to upward revisions in the years following their first publication. On an institutional note, the mandate of the members of the Council came to its end in November 2018 and the new composition is currently awaiting approval by Parliament. The authorities provided their answer to the public finances evaluation formulated by the National Council of Public Finances. In line with the Memorandum of Understanding concluded in October 2017, the Ministry of Finance provided a public response to the recommendations of the Council’s report of June 2018 on the evaluation of public finances. The public position was in apparent disagreement with the main Council’s recommendation on the appropriateness of running budgetary surplusses beyond the Stability and Growth Pact benchmarks, in seek the long-term sustainability of public finances, and it refused the recommendations on the macroeconomic scenario underlying the budgetary projections, as it lays under the responsibility of the STATEC, which is an independent body. 3.1.4.Spending review The implementation of the savings measures identified by the 2014 spending review is largely on track. The national authorities have implemented 80% of the measures identified in the review, most of them spending cuts integrated in the domestic budgetary planning. After overachieving savings target in 2015 (the first year of the multi-year budgetary strategy), the targeted savings for the 2016-2018 period were revised downwards by 25-35 %, partly linked to the reconsideration of a number of reform steps in vocational education and social transfers. 3.1.5.Taxation With a total tax burden close to the EU average, Luxembourg’s corporate income tax revenues are above the EU average while growth and environment supportive taxation remain moderate. The overall tax burden amounted to 38.9 % of GDP in 2017, close to the EU average of 39 % of GDP. Slightly less than half of the revenues come from labour taxation (17.3% of GDP vs 19.4 % in the EU in 2017) and the tax wedge on labour ( ) for average and low-income earners was below the EU average in 2017. The high level of corporate income taxation revenues and large contribution from the financial services sector reflect Luxembourg’s international position as a global financial hub. Revenues from consumption taxes, recurrent taxes on immovable property and environmental taxes were all below the EU average in 2017 (both in terms of GDP, and as a share of total taxation), while environmental taxes have gradually decreased over the last ten years (while they remained stable on average for the EU). Luxembourg’s revenue from environmentally related taxes remains the lowest in the EU. Environmental taxes accounted for 1.8% of GDP in 2016, well below the EU average of 2.44% see Graph 3.1.3). This is due to the low revenues from both transport taxes and taxes on pollution and resources. Moreover, environmental taxes are not indexed, which could lead to a gradual reduction in revenues over time (in % of GDP). Finally, Luxembourg applies a reduced Value Added Tax rate of 8% on natural gas and electricity, 14 % on heating fuel oil and 17% on other fossil fuels, which has adverse effects on energy consumption and is not necessarily the most targeted and cost-efficient support for well-off population groups. Graph 3.1.3:Environmental tax revenues as a share of GDP (2016) Source: Eurostat, European Commission Transport fuel tax rates are among the lowest in the EU, which provides a disincentive for reducing fuel consumption. While revenues from transport fuel taxes are well above the EU average (1.6% vs 1.3% of GDP in the EU on average), tax rates on transport fuels are low compared to EU averages. They are also considerably lower than in neighbouring countries, inducing cross-border fuel purchasing which enables the country to raise sizeable tax revenues despite very low rates. This contributes to traffic congestion (see also in Section 3.4.3), with highly negative ecological and health impact. Moreover, the level of tax on diesel is also low compared to unleaded petrol, despite diesel having higher carbon content, while some tax exemptions remain in place in the country for the use of fossil fuels in agriculture, horticulture, or for heating purposes ( ). Nonetheless, the use of alternative fuels in new passenger cars sold in Luxembourg has increased over the past few years. The share of new passenger cars using alternative fuels (mostly electric vehicles) was three times higher in 2016 than in 2012 ( ). On environmentally related taxes, the recent coalition agreement envisages a number of new measures. Revenues generated by an increase of the energy taxation would help decrease the fiscal contribution of natural persons. The taxation of fuels and mazut would be adapted, starting from 2019, to comply with the objectives under the Paris Agreement. The current tax incentives for electric vehicles would be replaced by targeted subsidies, and tax incentives for zero-emission or low-emission vehicles would be reinforced. Despite a particularly effective Value Added Tax (VAT) collection, the economic efficiency of Luxembourg’s VAT system is limited by a number of reduced rates and exemption ( ). The administration of VAT collection is particularly effective as Luxembourg consistently displays one of the lowest VAT compliance gap in the EU (0.83% in 2016 vs 12.3% in the EU). Nevertheless, the standard VAT rate of 17% applied in Luxembourg is the lowest in the EU. A super-reduced (3%), a reduced (8%), as well as a parking rate (14%) also exist. Along with numerous non-compulsory exemptions, these lead to a large actionable policy gap (33% in 2016). The more efficient, recurrent property taxes are low and based on outdated property values. Revenues from recurrent property taxes were among the lowest in the EU in 2017. This is mainly due to the tax base, which stems from a scale that dates back to 1941 and is not aligned with current market values. Not updating the tax base regularly gives support to rising property prices, particularly for housing (see also section 3.2.3). Moreover, the tax rate on real estate transactions is high, which may affect transaction decisions, while generating rather volatile revenues. A shift away from transaction taxes towards recurrent property taxes would maintain a constant level of revenue while reducing the distortions caused by transaction taxes. Moreover, the Luxembourg tax system tends to favour owner-occupied housing, as it is one of the few countries still providing mortgage interest deductibility. Home ownership is further favoured by the absence of imputed rent taxation, which was abolished in 2017. In 2016, Luxembourg adopted significant reforms of its corporate income tax. The reform of corporate income tax sought to boost competitiveness by gradually lowering the statutory rate to 18% in 2018. Including the surcharges, this represents a 26.01 % corporate income tax rate in 2018, above the EU average. The tax burden effectively paid by companies is however impacted, not only by the tax rate but also by the definition of the tax base and possible tax incentives. Among others, the reform provided for amendments to the tax credits for investments. The rate applicable to corporations with a taxable income below EUR 25 000 has been reduced from 20 % to 15 %. The recent coalition agreement envisages lowering the statutory rate to 17% in 2019, while the threshold for corporations to benefit from the low corporate income tax rate of 15 % will be increased from EUR 25 000 to EUR 175 000. High capital flows, coupled with the absence of withholding taxes on interests and royalties and possible exemption on dividends, may be an indication that Luxembourg’s tax rules are used by companies that engage in aggressive tax planning. Inward and outward foreign direct investments are among the highest in the EU, with a majority linked to special purpose entities ( ). The level of capital flows (dividends, interest, but also royalties) are also among the highest in the EU, and at a high level compared to the size of the economy ( ). Luxembourg is a small open economy, with a large financial sector, which partly explains those financial flows and foreign direct investment stocks. These flows can also be explained by the large presence of foreign-controlled companies in Luxembourg which undertake intra-group financing or treasury operations ( ). The absence of withholding taxes on outbound interest and royalty payments, and the possible exemption from withholding tax on dividends with treaty partners ( ), may lead to those payments escaping tax altogether if they are not subject to tax in the recipient jurisdiction either. Luxembourg is acting to curb aggressive tax planning through the implementation of European and internationally agreed initiatives. The law to transpose the Anti-Tax Avoidance Directive (ATAD 1) was adopted by the Parliament in December 2018. It strengthens existing anti-abuse rules (in particular the exit taxation)( ) and general anti-abuse rules) and introduces new anti-abuse rules, in particular controlled-foreign companies rules ( ), interest limitation rules and rules to tackle hybrid mismatches.( ). In addition, Luxembourg also introduced in the same bill, changes to its tax laws aiming at making the recognition of a permanent establishment abroad more stringent ( ) and avoiding some abuses linked to the use of convertible loans ( ). Regarding outbound payments, as per a recent circular (“circulaire”) ( ), transactions with related companies located in non-cooperative tax jurisdictions listed by the EU will have to be reported and will be subject to greater scrutiny. These measures apply from transactions made in 2018 and it is therefore too early to assess their effects. In order to translate into its double tax treaties the outcome of the G20/OECD Base Erosion and Profit Shifting project, Luxembourg’s Parliament adopted a bill to ratify the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (‘Multilateral Instrument’). Luxembourg has chosen to apply the Multilateral Instrument to all its treaty partners but has put reservations on numerous articles not forming part of the minimum standard. This means that these anti-abuse rules will not necessarily apply in a constant manner as their impacts will rather rely on whether Luxembourg’s treaty partners have also signed the Multilateral Instrument and with which reservations. Luxembourg will rely on bilateral negotiations to amend Treaty provisions in line with the Base Erosion and Profit Shifting results. This negotiation process may take time to be completed. The actual review by Luxembourg of its double tax treaties therefore deserves to be analysed. Moreover, anti-abuse clauses regarding the exemption of withholding taxes have also been introduced in a number of tax treaties. No information is available yet on whether these clauses have been applied and with which results. 3.2. Financial sector

3.2.1.Financial sector Luxembourg is among the largest financial centres in the world, a platform for fund administration, private banking services and foreign currency operations. The country hosts numerous banks and insurers, with most banks (132 out of 136) belonging to a foreign group. Half of them are custodian banks working with the fund industry. The other half, typically smaller institutions, are mostly specialised in wealth management. Seven entities are classic domestically-focused retail banks ( ). After the USA, Luxembourg is the second-biggest fund administration centre worldwide. The financial sector is Luxembourg’s main economic engine. The sector accounts for 25 % of GDP, 11 % of employment and 21% of fiscal revenues (Cour des Comptes, 2018). Within the financial sector, banks record the main contribution to GDP while the balance of payments largely reflects the activity of the funds industry. Luxembourg's funds account for 26.8% of money under management in Europe, reaching EUR 4,065 billion in December 2018, 71 times the GDP of the country. Although the number of bank employees has remained broadly stable at around 26,000 since 2010, employment has grown in the financial auxiliary services( ) (professionels du secteur financier). Despite competitive salaries, the financial sector also encounters problems in recruiting and retaining talent due to structural mobility problems and expensive real estate market. Luxembourg’s financial sector is deeply integrated in a financial global value chain. Luxembourg’s participation in global value chains in financial activities started at an early stage. Specialisation policies implemented in the past were instrumental in the sector's early development, as well as in allowing Luxembourg to capture large benefits from the financial industry’s global value chains (for instance in terms of technology or price transfers). Global value chains might have played an important role in Luxembourg's evolution as a global financial hub, with a favourable environment for multinationals and financial firms' offshoring activities. This is also suggested by the high content of imported intermediate inputs in external demand, as well as the high inward Foreign Direct Investment stocks (360.9 % of GDP, excluding Special Purpose Entities ( ), the highest in the EU). However, long global value chains also imply a higher exposure to external shocks, including global value chains disruptions, which could add to the volatility in destination markets, mainly financial. Luxembourg’s banks display solid capital ratios. Luxembourg's capital conservation buffer was front-loaded and is at 2.5%. Additionally, 7 banks must respect an O-SSI buffer ( ) of 0.5% of risk-weighted assets and one bank a buffer of 1%. The countercyclical capital buffer was introduced in 2016 and has been fixed at 0.25% for the first quarter of 2019, applicable from 1 January 2020 onwards. The profitability of banks remains comfortable, despite a weakening in 2017 and 2018. Net profits have shrunk recently, dragged down by lower non-recurrent income due to extraordinary operations and increasing volatility in financial markets. These developments are also reflected in the profitability indicators (see Return on Equity and Return on Assets in Table 3.2.1). Over the past years the share of commission and fee income over total income has increased markedly (from 43% in 2010 to 58% in 2017), reflecting higher income diversification in a context of historically low interest rates. Operational costs have also increased, as financial institutions adapt to the changing technological and regulatory environment and try to attract skilled workers despite mobility issues and high house prices. Table 3.2.1:Financial soundness indicators, all banks in Luxembourg Source: ECB Recent stress tests highlight banks’ capacity to withstand real estate price shocks and high default rates. Solvency ratios remained well above the regulatory thresholds and showed high resilience, both quantitatively and qualitatively. With a CET1 ratio at 21.2 %, Luxembourg banking system has sufficient own funds to absorb shocks. Regular stress tests ( ) run by the Commission de surveillance du secteur financier highlighted that the 5 domestically-oriented banks, which hold 90% of mortgage loans, could withstand dramatic increases in mortgage defaults combined with sizeable real estate price corrections without significantly falling below regulatory capital minimum requirements (European Commission, 2018). Losses would mainly stem from relatively recent vintages of high loan-to-value mortgages for which banks need to set aside extra capital. This is notably due to the steep rise in housing prices over the past years. The supervisor has floored mortgage risk weights at 15% for banks applying the internal risk based approach, although this is in place as a recommendation (European Systemic Risk Board, 2018). For banks applying the standard approach, a higher risk weight applies to the part of a mortgage exceeding 80% of the value of the collateral. A draft law introducing stricter borrower-based measures awaits parliamentary approval. Banks need to deposit large sums at the Central Bank to comply with liquidity ratios ( ). Most banks in Luxembourg do not take deposits and cannot rely on them to fulfil liquidity ratios. In addition, Luxembourg government bonds, another major component to fulfil those ratios, are in short supply. Hence, in order to fulfil either ratio most banks have to resort to depositing with the Central Bank. Indeed, banks’ significantly increased their deposits at the Central Bank in recent years, from EUR 16 billion at end 2014 to EUR 131 billion at the end of the third quarter of 2018, reflecting the phasing in period for compliance with the new international liquidity requirements. Most funds in Luxembourg invest only in equity and/or bonds, benefiting from a network of specialised service providers. Luxembourg’s funds are mostly “plain vanilla” funds (Table 3.2.2), i.e. they only invest in equity, bonds or a combination of both. Fund of funds, money market and real estate funds are smaller in size. Private equity and venture capital funds keep increasing their share of money under management. Most plain vanilla funds choose to domicile their fund in Luxembourg due to the eco-system surrounding the funds industry. This includes roughly 8,000 audit professionals, many legal specialists and IT providers, as well as around 70 custodian banks. That environment shortens considerably the time it takes to set up a fund. Custodian banks manage investment funds’ treasury operations. Investment funds rely on custodian banks to provide treasury management and overdraft facilities. Investment funds held EUR 124 billion of deposits in Luxembourg's banks, or 17% of total bank liabilities, in December 2017 (Banque Centrale du Luxembourg, 2018). By contrast, funds accounted for only 1% of banks' assets, mostly short term loans for cash flow management. Given notably their size and interconnectedness with the domestic financial sector, some custodian banks are considered as other systematically important institutions by the banking supervisor and must therefore comply with additional capital buffers. Table 3.2.2:Distribution of investment funds per specialisation (% market share) Source: European Commission The potential risks stemming from the interconnectedness between banks and investment funds appear limited. Concerns have been raised regarding the potential risks for domestic banks and the real economy in a scenario of severe liquidity crisis in the funds industry (IMF FSAP, 2017, European Commission, 2018, Banque Centrale du Luxembourg, 2017). Such risks appear limited as they are mitigated by several elements. First, the risks of potential liquidity shortfalls in domestic banks through the interbank market were identified using extreme stress test assumptions (IMF, 2017). Second, most banks in Luxembourg benefit from potentially sizeable intragroup liquidity support from their parent institutions in case of stress. Third, the recent activation of international regulations on liquidity has improved the enforcing power of supervisory authorities to ensure sufficient liquidity levels are maintained by financial institutions, which is also reflected by large deposits with the Central Bank. Finally, the very diversification of investment funds and their large holding of very liquid securities make a run on funds highly unlikely under normal market conditions, as sufficient time is generally allowed between a redemption query and the final pay-out to prevent liquidity shortfalls. However, the Commission de surveillance du secteur financier has started internal work to better assess the potential risks on system-wide liquidity stemming from investment funds liquidity shocks. The insurance sector is diversified and growing. Luxembourg hosts 45 life insurance companies, 49 non-life insurers and 202 re-insurers. The sector employs 4,000 full time equivalents in Luxembourg, and its total assets accounted for EUR 235 billion in 2017, 3.2% more than in 2016. The bulk of the balance sheet (EUR 179 billion) was held by the life-insurance sector, while 90% of premiums came from non-residents. Profits grew for life insurance, remained stable for non-life insurance, but fell 80% for re-insurers due to the impact of several natural catastrophes. Several insurers have decided to relocate some activities from the United Kingdom to Luxembourg in recent months. This notably reflects the competitiveness of the country's tax environment, which allows for generous deductions, and the advantages of providing a specialised focus through a dedicated supervisory entity. 3.2.2.Private sector indebtedness Corporate indebtedness remains high due to Luxembourg's position as an international treasury centre, but leverage can be assessed as moderate. The non-consolidated debt of non-financial corporations accounted for 3.5 times GDP as of June 2018, down from 3.8 in 2015. This remains very high, well above the EU average. The ratio of gross consolidated corporat debt, as a share of GDP, is also well above prudential and fundamental-based benchmarks ( ), with gaps of 132% and 166% of GDP respectively in 2017. As explained in previous reports, this high level of indebtedness stems from Luxembourg's position as an international business treasury centre and reflects large amounts of intra-company cross-border loans. Liabilities are therefore usually matched by equivalent assets, which is illustrated by the relatively moderate leverage ratios when comparing debt to equity or financial assets. Despite a favourable aggregate wealth position, households' indebtedness remains high compared to income. Household debt is growing slowly and accounts for a moderate share of households' financial assets (40% in 2017) highlighting the largely positive aggregate net asset position of households of about 100% of GDP. However, debt accounted for 178 % of gross disposable income, one of the highest levels in the EU, as mortgage loans registered sustained growth in recent years thanks to low interest rates and surging property prices. As illustrated in previous reports (European Commission, 2018) rising indebtedness generates some concerns as to the solvency risks for lower income households, notably in case of rising interest rates or economic downturn. This was notably pointed out by the European Systemic Risk Board in its 2016 warning about the medium term risks linked to household indebtedness and residential prices. A package of borrower-based prudential measures is intended to address concerns over some households’ solvency. The government has proposed the introduction of mortgage borrower-based tools, placing limits on loan to value, loan to income, debt to income, debt service-to-income ratio, and loan maturities ( ). The proposal allows the financial sector supervisor (la Commission de Surveillance du Secteur Financier) to set thresholds. As these limits will have distributional consequences, the Conseil d’Etat ordered to better define the accountability framework in which the Commission de surveillance du secteur financier will set these limits. The draft bill is currently pending approval in the Parliament, but is expected to pass parliament in early 2019. Graph 3.2.1:Household debt and leverage ratios Source: European Commission 3.2.3.Housing market Developments Housing prices continue to rise amid increasing indications of overvaluation. Real residential property prices increased by 4.5 % on the year in June 2018, compared with 5.1% in the same period of 2017. Prices appear markedly above their long-term average when compared to the level of rents and income, with a gap of 39 % and 37 % respectively as of June 2018. This rather large overvaluation estimate contrasts with a more measured model-based estimate taking into account other fundamental variables (Graph 3.2.2). The overall house price gap calculated by the Commission, an average of the above indicators, shows signs of an overvaluation of prices close to 30 %. Other institutions have estimated overvaluation of 6.9% (Banque Centrale du Luxembourg, 2018) and between 4% and 52% (European Systemic Risk Board, 2018). Although their range is very wide, there seems to be a consensus pointing towards a moderate overvaluation of housing prices, which might, if continued, lead to a potential correction in the future.

Graph 3.2.2:Housing prices overvaluation gap with respect to income, rents and fundamentals Source: European Commission Strong housing demand remains driven by demographic growth, benign financing conditions and a large cross-border workforce. The population of Luxembourg increased by 2.2% on the year in 2017, bringing overall growth from 2010 to 17.6%. 82% of the demographic growth since 2010 is due to migration, as Luxembourg's dynamic economy attracts labour from neighbouring countries. The low interest rate environment eased financing conditions and supported housing price increases (BCL, 2018). The large share of cross-border workers (40 % of employment), combined with high traffic congestion and insufficient supply of public transport (see section 3), also contribute to a sustained housing demand. Significant investment is needed to increase housing supply. At this point investment in dwellings remains insufficient, constrained by insufficient land availability and low housing density, and largely due to lack of incentives to landowners to build new housing. The pace of construction of new dwelling has increased by 50% between 2011 and 2015 but remains only slightly above the annual average observed since 2000 (2,700 new housing units per year). As a result the built-up areas in Luxembourg increased marginally in the past two decades (Luxembourg’s built up area only moved from 8.1% of the territory in 2000 to 9.8% in 2016), which contrasts heavily with a very dynamic demographic growth. This is despite the apparent efficiency of Luxembourg's procedures regarding building permits and property registration (World Bank, 2018) and the recent increase in building permits ( ). As analysed in past reports (European Commission, 2018), there currently seem to be insufficient incentives for private landowners, who own more than 90 % of available land, to sell their assets or undertake construction projects. Luxembourg is one of few EU countries where the investment in dwellings as a percentage of GDP does not increase. Indeed, as real estate values increase steadily and property taxes remain very low, land and property ownership provide high potential returns for a very low risk. The low density of housing built in Luxembourg also contributes to the scarcity of supply, as 80 % of dwellings are one-family houses and half of collective housing units contain less than four apartments. Therefore, part of the constraints weighing on housing supply appears to stem from insufficient fiscal, financial and regulatory incentives to extend built-up areas and achieve higher-density housing. Box 3.2.1: The rental market in Luxembourg Mostly concentrated around Luxembourg city, rented housing is becoming increasingly expensive, notably for lower income households. In 2017, about 30% of Luxembourg residents rented a dwelling in the private market, and almost half of rental housing units were located in the Luxembourg canton (45.5%). One of the reason driving this concentration of the rental market in Luxembourg is linked to the presence of international and European public institutions, and international firms, whose employees tend to favour renting instead of buying, for flexibility reasons. Rental is more prevalent for lower income households, as about 50% of households at risk of poverty are homeowners. The rental burden has increased for lower income households over the last decade, with 26% of tenants dedicating more than 40% of their income to rental costs in 2016 (in line with the EU and euro area averages). The introduction of a rental subsidy in 2016 intends to alleviate the housing cost burden for the most vulnerable. The limited supply of housing in the main cities, particularly in the capital city of Luxembourg, is the main driver of the rise in rental costs. The comparatively lower housing costs and better housing supply in neighbouring countries therefore contribute to explaining the large number of cross-border workers and the high level of traffic congestion in Luxembourg. Social housing remains largely underdeveloped compared to neighbouring countries, pointing to some investment needs so as to increase the supply of affordable housing units. In 2017, there were 2,000 publicly-owned social housing units, accounting for 0.9% of the total housing stock (compared to close to 20% in France). The new Government’s coalition agreement highlights plans to develop the supply of affordable housing through the Housing Fund (Fonds du Logement) and the Société nationale des habitations à bon marché (SNHBM). The medium-term objective is to multiply by three the supply of affordable housing units for rent. Delegated social housing is also promoted, whereby privately-owned dwellings are rented, through a public entity, at lower rents to people who are not eligible to social housing or who are on the waiting list. This service is provided by the Agence Immobilière Sociale, which rents about 300 housing units. The State also grants subsidies to social associations (non-profit organizations, foundations) acting as intermediaries between private homeowners and low-income households. These associations rented about 500 housing units in 2017. Given the very low starting point, the government's objective regarding the supply of social housing might not be sufficient to significantly alleviate the existing tensions in the rental market. This might point to more important public investment needs in this particular area. Luxembourg intends to introduce measures to stimulate housing supply and investment. A consultation process was initiated in May 2018 towards adapting urban planning laws. Proposed legislative changes would increase the area dedicated to housing by 13% and would raise the share of this area set aside for social housing from 10% to 30%. This would also allow State authorities to supersede municipal authorities in defining the areas dedicated to housing. In addition, a series of measures are envisaged in the new government’s coalition agreement to increase housing supply. The authorities intend to make more land available for real estate development, either through public purchase of private land, the introduction of tax incentives or increased technical assistance to municipalities. Stronger incentives are envisaged to encourage owners of vacant land or properties in urban areas to make their properties available on the market. Public authorities also intend to strengthen their powers to expropriate or exchange land to unblock development projects. Rising rents and property prices could be having negative consequences on competitiveness and social inclusion. Relatively high compensation levels in some key sectors (finance, business services, and technology) allow Luxembourg to remain an attractive workplace internationally. However, the comparatively faster growth of property prices compared to income might eventually weigh negatively on the attractiveness of working in Luxembourg, notably in sectors where wages are less dynamic. This could exert upwards pressure on salary expectations. Rising housing costs might increase the currently low share (10% in 2017, STATEC, 2018) of households dedicating more than 40% of income to housing (see Box 3.2.1), notably for more vulnerable low income and single-parent households. In addition, lower income households might be pushed further away from urban and economic centres, leading to more traffic congestion, longer commuting time and higher transport-related expenditure. It is uncertain whether the expected increase in the supply of affordable housing and in the availability of rental subsidies will prove sufficient to offset the consequences of rising housing costs. 3.3. Labour market, education and social policies 3.3.1.Labour Market Supported by a favourable economic environment, the labour market is showing strong and continued job creation with a low and declining unemployment rate. In 2017, total employment grew by 3.3%, up from 3% in 2016, still benefitting more cross-border workers (+4.2%). This trend is expected to continue in 2018 and progressively stabilise towards 2019. The most dynamic sector remains business services, while industrial employment has also been growing since 2015. After a continuous increase between 2011 and 2015, unemployment fell in 2016 and again in 2017 (5.6% against 6.3% in 2016) and even declined to 4.9% by the end of 2018. Youth unemployment decreased from 19.1% in 2016 to 15.4% in 2017, and reached 12.3% in the last quarter of 2018. However, the rate of young people not in employment, education or training, though still low, increased from 5.4 % in 2016 to 5.9% in 2017. Graph 3.3.1:Activity, unemployment, long-term unemployment, youth unemployment and not in employment and education or training rates Source: Eurostat, LFS Despite the overall good labour market performance, the employment rate is stagnating and specific groups still face challenges. With an employment rate of 72% in the third quarter of 2018, Luxembourg has not yet reached its Europe 2020 target of 73%. According to the National Statistics Institute, the decline in the employment rate (20-64) over the last years is mainly due to longer studies of young people, parental leave and an ageing population. In this context, substantial untapped potential stems from the low labour market participation of some groups, in particular older people, underlining further investment needs. Graph 3.3.2:Employment rate by age group in Luxembourg Source: Eurostat, LFS Old-age employment The employment rate of older workers (55-64) has stagnated since 2010 and remains the second lowest in the EU (39.8% in the first three quarters of 2018, against 57.1% on EU average). Limited progress has been made on reducing early retirement (see European Commission 2018, 3.1.2 and 3.3.1) and targeted activation policies did not improve substantially the older workers' participation in the labour market. Age management strategies which should also help to keep senior workers in employment are not a legislative priority, neither for the government nor for the social partners, as the draft bill introduced in 2014 seems definitely stalled in parliament (see European Commission, 2018, section 3.3.1, page 29). In the same vein, the transposition of the European-level framework agreement on active ageing between social partners is yet to be negotiated in Luxembourg. Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights is designed as a compass for a renewed process of upward convergence towards better working and living conditions in the European Union ( II ). It sets out twenty essential principles and rights in the areas of equal opportunities and access to the labour market; fair working conditions; and social protection and inclusion ( III ). Luxembourg performs overall well on most indicators of the Social Scoreboard supporting the European Pillar of Social Rights. The labour market in Luxembourg shows very good results with low unemployment and gender employment gap, accompanied by good childcare provision for very young children. Although there are signs of weakening with regard to the overall risk of poverty or social exclusion rate and the impact of social transfers on poverty reduction, the social situation in Luxembourg remain close or better than in the EU. Income inequality is currently at a level close to the EU average, and remained stable since 2016. Despite good overall performance some challenges related to the labour market and education still remain. In particular, important skills shortages have recently emerged in certain sectors. Furthermore, the education system still faces inequalities in opportunity among pupils in relation to their socioeconomic status and migrant background. The employment rate of older workers has not improved. The fundamental reforms have not been considered yet or are pending approval, such as the so-called 'Age Pact', which includes a whole package of measures to keep senior workers longer in employment. The Luxembourg government took steps towards a better work-life balance for fathers and more equal sharing of care responsibilities between women and men. The government explicitly referred to the Social Pillar and to the Commission proposal for a Directive on work-life balance for parents and carers to amend its bill on paternity leave. The law (passed in December 2017 ( IV )) extends paternity leave from 2 to 10 days starting in January 2018, among other changes related to family leave.



The financial disincentives to work stemming from the tax-benefit system are a persistent problem, especially for older people. The issue of high disincentives to work embedded in the tax and benefit system, in particular for older people, has been addressed in previous country reports (see European Commission 2017, page 29, and 2018, page 29). In 2017, 24.5% of the total working age population (20-64 years) was inactive in Luxembourg (respectively 20.5% of the working age men and 28.8% of women). 59% of those aged 55-64 were inactive and Luxembourg has one of the highest rates of inactive people aged 60-64 (82.3%) in the EU. In 2016, for people aged 55-64 and inactive, 58% of men and 37% of women were inactive due to retirement or early retirement, 1% of men and 12% of women because of family/care responsibilities, 6% of men and 7% of women were inactive because of illness/disability. At least for men, financial disincentives to work were the main reasons for low old age activity rates in 2016. However, this situation might evolve due to recent changes in the income tax between 2016 and 2018. People aged above 50, people with disabilities and workers with reduced working capacity make up a large share of the long-term unemployed. Long-term unemployment, although well below the EU average, reached its highest level in 2016 (2.2%) but slightly decreased in 2017 (2.1% against 3.4% on EU average), a downward trend further confirmed with 1.6% in the third quarter of 2018. The share of long-term unemployment in total unemployment increased from 30.7% in 2015 to 37.2% in 2017 (Eurostat), highlighting the difficulty in integrating some unemployed people in the labour market. Many employment measures target the most vulnerable job seekers, in particular those aged 45 or 50 and more, to help them re-integrate the labour market. According to the Public Employment Service, many new measures already show positive results. The creation of subsidised permanent jobs in the public sector and social enterprises to give long-term job seekers better prospects and avoid job insecurity (see European Commission 2018, page 29) already covered workers whose 83% are 50 years old or more (October 2018). The professionalisation placement programme (six-week work placement) and re-integration employment contracts (12 months) deliver respectively a job placement rate of 68% and 94%. Other measures (known as "social initiatives") support vulnerable people furthest from the labour market for up to two years. The law reforming the professional reclassification scheme for persons with working disabilities confirmed its impact with only 45% of people affected by external reclassification in 2018 (i.e. registered in the public employment service) instead of 70% before the adoption of the law. In March 2018, the Government presented a draft law establishing assistance to help employees with disabilities or in external reclassification to better integrate themselves in their job (for the private sector), a step towards the transposition of the Convention on the rights of persons with disabilities. The ongoing legislative process involves social partners, as usual in Luxembourg. Labour market participation of women

Despite increasing participation in the labour market, there is still untapped potential of female workers. The female employment rate continued to increase, reaching 68.0% in the third quarter of 2018 (against 65.1% in 2016) whereas the male employment rate further declined in the third quarter of 2018 to 75.0% (against 76.1% in 2016), resulting in a significant reduction in the gender employment gap (7.0 pp). The labour market performance of non-EU born women remains weak with an employment rate (age group 20-64) of 54.4% in 2017 (same as the EU average) against 72.5% for their male counterparts and 66.7% for native-born women, resulting in a gap slightly below the EU average. The gender gap in part-time employment remains very high. It stood at 25.2 pp. in the third quarter of 2018 with 31.0% of women working part-time against 5.8% of men. Part-time work is more widespread among native than foreign workers. The impact of family and care responsibilities decreases with age. This suggests that the presence of small children in the household is a contributing factor to inactivity despite the high number of available places in childcare and good affordability with free vouchers or at a very low fee for low-income groups, Luxembourg being one of the best performers in this field. Training and upskilling Adapting skills and training to labour market needs remains an important venue to improve labour market participation. The analysis on macroeconomic skills mismatch shows that skills mismatches in Luxembourg have remained low throughout the last decade. Luxembourg has the second lowest shortage in the EU after Ireland according to the labour shortage index in the period 2013 to 2017. However, Luxembourg is among the member states where the low-skilled comprise the majority of the inactive population, justifying particular attention to low-skilled in activation measures. In 2017 45.84% of the inactive were low-skilled (ISCED 0-2) while only 12.02% of the inactive were high-skilled (ISCED 5-8). At the same time, sizeable labour shortages have recently emerged in certain sectors. For example, the public employment service reports that around 70% of vacancies registered by the Information and Communication Technology and financial sectors remain unoccupied while the average overall vacancy rate is 28% (see also sections 3.3.3 and 3.4.1 below). Vacancies also concern some low and medium-skilled jobs such as butchers, electricians or in the Horeca sector. Though high-skilled workers are less vulnerable to changes in economic trends, the public employment service also intends to adapt its services to this specific group, which represents a non-negligible share of the job seekers (around 20% in October 2018). Prioritising investments to both upskill and reskill the labour force could strengthen its employability. The public employ