Luxembourg’s Path to Economic Innovation: A Case for Using Debt to Drive Growth

A few weeks ago, Jerome Bloch and I were having coffee and discussing whether Luxembourg should stick to its cautious debt policy or explore potential improvements, perhaps even adopting a more aggressive stance. We noted that despite Luxembourg's prudent approach, it enjoys a similar credit rating to Singapore, which follows a much more aggressive debt strategy. This prompted me to look into the matter further, and here are some of my thoughts.

Over the past decade, Luxembourg and Singapore have emerged as two financial powerhouses, both securing top credit ratings from agencies like Moody’s and S&P. Yet, despite their similarities in creditworthiness, these two countries approach fiscal management in distinctly different ways. Singapore, while maintaining a high debt-to-GDP ratio, uses debt strategically to generate long-term value by investing in infrastructure, technology, and high-quality assets. Luxembourg, on the other hand, enjoys low levels of public debt but is more conservative in leveraging debt to fuel its economy. This article will explore why Luxembourg, with its strong economic foundations and credit rating, should adopt a more progressive approach to debt, particularly by investing in industries of the future, education, and technological innovation. We will also examine the historical evolution of debt-to-GDP ratios in both Luxembourg and Singapore and argue why Luxembourg should embrace debt-driven investment as a tool for long-term growth.

Luxembourg’s Fiscal Prudence and Singapore’s Strategic Debt Use: A Comparison

Singapore: Using Debt to Create Value

Singapore’s debt-to-GDP ratio has consistently been high over the last decade, ranging from about 100% to 110%. In 2022, for example, Singapore’s debt-to-GDP ratio stood at 131.2%, which is considerably higher than most developed economies. However, this figure is misleading when taken out of context. Singapore's high debt levels are not a sign of economic distress; rather, they reflect the country’s strategic use of debt to finance investments in infrastructure, education, and technology, all of which contribute to its economic competitiveness. For instance, Singapore has heavily invested in its world-class Changi Airport, public housing projects, and transportation infrastructure—creating assets that drive economic growth.

Furthermore, Singapore channels much of its debt into sovereign wealth funds such as GIC and Temasek Holdings, which manage a diversified portfolio of investments globally. These investments yield returns that not only strengthen Singapore’s fiscal position but also enhance its ability to service its debt. By adopting a long-term investment strategy, Singapore turns its liabilities into value-generating assets, securing its future as a hub of innovation, finance, and trade.

Luxembourg: Cash-Rich but Conservative

Luxembourg, on the other hand, has maintained a relatively low debt-to-GDP ratio over the past decade. As of 2023, Luxembourg’s debt-to-GDP ratio stood at just 25.6%, a figure that has remained consistently low since the early 2010s. Luxembourg’s economy is marked by substantial fiscal surpluses, a strong financial sector, and a high standard of living. This fiscal prudence has allowed Luxembourg to weather economic challenges, such as the Eurozone crisis and the COVID-19 pandemic, with minimal economic fallout.

However, Luxembourg’s conservative approach to debt may be holding it back from realizing its full potential in the rapidly evolving global economy. Unlike Singapore, which actively leverages debt to invest in future industries, Luxembourg has been cautious in adopting a similar strategy. Given its robust financial position and low debt levels, Luxembourg has significant room to adopt a more proactive approach to borrowing, using debt to invest in strategic sectors such as technology, education, and tourism, thereby positioning itself as a leader in the industries of the future.

Why is Luxembourg conservative when it comes to debt?

Although I am rather new to Luxembourgs fiscal approach and economic history, there is enough information available to make an informed assesment. Luxembourg's conservative approach to debt can be attributed to several factors, deeply rooted in its economic history, policy choices, and the unique characteristics of its economy. Here are some key reasons for Luxembourg’s caution with debt:

1. Strong Fiscal Health and Surplus Economy

Luxembourg has historically enjoyed a strong fiscal position, with consistent budget surpluses and a robust economy driven by its financial sector. The government’s revenue exceeds its expenditure, reducing the need to borrow. Luxembourg's conservative debt policy is a reflection of this financial health, as the country sees little immediate need to take on debt when it already has sufficient resources to meet its fiscal needs.

2. High Dependence on the Financial Sector

Luxembourg’s economy is heavily reliant on its financial services industry, which contributes a significant portion of its GDP. With a highly globalized financial sector, Luxembourg faces the challenge of managing external risks, such as regulatory changes, market volatility, and global economic shifts. Maintaining low public debt allows the government to cushion its economy against potential shocks, especially since a downturn in global finance could affect the country more dramatically than others with more diversified economies.

3. Commitment to EU Fiscal Rules

As a member of the European Union, Luxembourg is bound by the Stability and Growth Pact (SGP), which sets limits on budget deficits and public debt. Although Luxembourg’s debt levels are far below the EU’s threshold of 60% of GDP, the country adheres to a fiscally conservative stance to maintain its leadership position within the EU, promoting itself as a model of sound fiscal management. By keeping debt low, Luxembourg remains compliant with EU rules while maintaining fiscal flexibility.

4. Cultural and Political Conservatism

Luxembourg’s political landscape has traditionally favored fiscal conservatism. Political leaders and policymakers tend to prioritize financial stability and long-term sustainability over short-term gains. A cautious approach to debt aligns with this broader cultural mindset of stability, risk aversion, and prudence in economic governance.

5. Small and Open Economy

As a small, open economy, Luxembourg is highly exposed to global economic fluctuations. The government maintains a low debt-to-GDP ratio as a buffer against external risks such as international market volatility or economic crises that could disproportionately impact smaller economies. By keeping debt low, Luxembourg ensures it has sufficient fiscal space to respond to crises with spending measures or bailouts if necessary.

6. Risk Aversion and Historical Experience

Historically, Luxembourg has managed to avoid the worst of major financial crises, in part due to its conservative fiscal approach. During the 2008 global financial crisis and the subsequent Eurozone debt crisis, Luxembourg’s low debt levels allowed it to weather the storm without significant economic damage. This experience reinforced the country’s cautious approach to borrowing, as policymakers saw the benefits of maintaining low debt levels during periods of uncertainty.

7. Sovereign Wealth and Fiscal Reserves

Luxembourg has accumulated substantial reserves from its strong economic performance over the years, particularly due to its role as a financial hub. These reserves provide a cushion against potential financial needs, reducing the necessity to borrow. The government prefers to use its existing assets and reserves to finance infrastructure and development projects rather than taking on debt, even when interest rates are low.

8. Reputation as a Financial Hub

Luxembourg’s reputation as a global financial center depends in part on its fiscal responsibility and credibility. By maintaining a low debt-to-GDP ratio, Luxembourg signals to investors, international institutions, and credit rating agencies that it is a stable and reliable country with sound fiscal policies. This reputation helps attract foreign investment and reinforces its status as a financial hub, particularly for asset management, banking, and fund administration.

Should Luxembourg’s adopt a more aggresive debt approach using Debt as a Catalyst for Growth

Luxembourg’s low debt-to-GDP ratio and high credit rating provide the country with a unique opportunity to invest in its future without compromising fiscal stability. Here are several areas where Luxembourg could use debt to drive growth and enhance its long-term competitiveness:

1. Investing in Industry and Technology

One of the key areas where Luxembourg could benefit from a more aggressive debt strategy is technology and industry. While Luxembourg has already made strides in fintech and digital innovation, it could significantly expand its reach by investing in emerging technologies such as artificial intelligence, biotechnology, and green energy. By creating public-private partnerships and fostering innovation hubs, Luxembourg could position itself as a leader in these sectors. For instance, Singapore’s government has invested heavily in its Smart Nation initiative, which aims to transform Singapore into a hub of technological innovation. Luxembourg could adopt a similar approach, using debt to finance the development of cutting-edge industries that will drive future economic growth.

2. Tourism and Unique Attractions

Luxembourg’s picturesque landscape and rich cultural heritage make it an attractive destination for tourists, but the country could do much more to capitalize on this potential. By using debt to invest in unique tourist attractions, such as space tourism, high-end resorts, and cultural landmarks, Luxembourg could significantly boost its tourism sector. Singapore’s investment in attractions like Marina Bay Sands and Gardens by the Bay has made it a global tourism hub, attracting millions of visitors each year. Luxembourg could take a similar approach by creating unique experiences that draw high-spending tourists and elevate its global profile.

3. Education and Workforce Development

Luxembourg is in a prime position to become the education hub of the European Union by forming partnerships with top universities from around the world, such as those in the U.S., U.K., India, and Asia. By using debt to invest in world-class educational institutions and offering scholarships to top students, Luxembourg could attract global talent and foster the development of a highly skilled workforce. A highly educated workforce would not only benefit Luxembourg’s domestic economy but also make the country an attractive destination for multinational corporations seeking top-tier talent.

Singapore’s investment in education has been a key driver of its economic success. The country’s universities and vocational institutions are ranked among the best in the world, and its focus on STEM (science, technology, engineering, and mathematics) education has created a workforce that is well-prepared for the demands of the global economy. Luxembourg could take inspiration from Singapore’s approach, using debt to fund scholarships, research programs, and partnerships with top institutions, thereby creating a pipeline of talent that will drive innovation and economic growth in the years to come.

4. Futuristic and High-Quality Skills Training

In an era of rapid technological change, countries that can quickly adapt and equip their populations with new skills will be the ones that thrive. Luxembourg could use debt to create world-class training programs in fields such as AI, data science, renewable energy, and robotics. By investing in skill development, Luxembourg could ensure that its workforce remains competitive in the global market and attracts investment from high-tech industries.

Singapore’s SkillsFuture initiative, which provides lifelong learning opportunities for Singaporeans, is a prime example of how a country can invest in its workforce to stay ahead of the curve. Luxembourg could create a similar program, offering training in cutting-edge skills that will be in high demand in the future economy.

Arguments for Luxembourg to Embrace Debt

1. Low Interest Rates

Luxembourg’s low debt levels and high credit rating make it an attractive borrower in the global market. With interest rates at historic lows, Luxembourg has the opportunity to borrow cheaply and invest in its future. By taking on more debt now, Luxembourg could finance large-scale investments in infrastructure, technology, and education, reaping long-term benefits without burdening future generations with excessive debt.

2. Diversification of the Economy

Luxembourg’s economy is heavily reliant on its financial sector, which accounts for a significant portion of its GDP. While the financial sector has served Luxembourg well, diversifying the economy is essential for long-term stability. By using debt to invest in industries such as technology, education, and tourism, Luxembourg can reduce its dependence on finance and create new sources of growth.

3. Maximizing Economic Potential

Luxembourg’s conservative approach to debt has served it well during times of economic uncertainty, but in today’s rapidly evolving global economy, taking calculated risks is essential for growth. By strategically using debt to invest in value-creating assets, Luxembourg can maximize its economic potential and secure its position as a global leader in innovation, education, and industry.

Debt is often viewed negatively, but the reality is that it's how you use it that determines whether it's beneficial or harmful. There is no right choice in my view but it appears that Luxembourg stands at a crossroads. Its conservative stance on debt is a product of its strong fiscal health, reliance on the financial sector, adherence to EU rules, and risk-averse political culture. While this approach has served the country well in maintaining economic stability and avoiding debt-related risks, it also means that Luxembourg may be missing out on opportunities to invest more aggressively in future industries and innovation.However, this conservatism is deeply rooted in Luxembourg's economic strategy, balancing stability and growth.

With its strong fiscal position, low debt-to-GDP ratio, and high credit rating, the country has a unique opportunity to embrace debt as a tool for driving long-term growth. By investing in industries of the future, education, and tourism, Luxembourg can ensure that it remains competitive in the global economy for decades to come. Singapore’s example shows that debt, when used strategically, can create value and drive innovation. Luxembourg should take inspiration from Singapore’s approach and adopt a more progressive debt strategy, positioning itself as a leader in the industries of tomorrow.