An Economic History of Luxembourg

This weekend, I decided to check off my list one of those tiny little countries that one rarely has a reason to pass through. While I’m only a four hour journey from Luxembourg, I figured that this might be my last reasonable chance. It’s also convenient because the Ardennes forest is the nearest place for me to find something that resembles a mountain and low population density.

I took off Friday for a three-day weekend, took a bus from Brussels to Luxembourg City, and then had a bit of an adventure with the public bus system to get out to a little town called Mullerthal, where I met up with one leg of a hiking route around the northeast of the little country. I spent a sleepless night in the dense forest and spent the next morning exploring the capital where I had started. The trip had some real highlights that I’ll get to eventually, but they’ll need some context.

For now, I’m going to continue my history kick and share a bit about this tiny country that most of you probably couldn’t place on a map (indeed, many world maps don’t even have enough resolution for it).

That’s actually a good place to start. Where is Luxembourg?

Well, I live in Belgium, and you know that it’s close to me, so it probably borders Belgium.

Indeed, it does, but can you even put Belgium on this map?

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Did you find it? Still struggling? It’s a small country. I’ll zoom in a bit.

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Ok, now you can see it. And even tiny Luxembourg made the cut!

If you’re still struggling, here’s the answer.

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At about 1,000 square miles, Luxembourg is a cutout at the junction of France, Belgium, and Germany.

But don’t let its size fool you. Both the World Bank and IMF have estimated Luxembourg to be the wealthiest country in the world (per capita; the UN disagrees, and I think I know why), and I can attest that it looks like it. Luxembourg city is so well maintained and so full of fancy cars, it’s actually a bit weird. This was the second six-figure car I saw in the first 20 minutes of walking through the city. Most of the others are new luxury cars.

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How did tiny little Luxembourg get so rich?

It’s actually not as complicated of a story as one might think, and it actually has a lot to do with its tiny geography.

Luxembourg has actually been around for about a thousand years. ‘Lucilinburhuc’ (literally translating to ‘small castle’) was a castle which became the centrepiece of what would become the County of Luxembourg over the 11th-13th centuries. The aristocracy of Luxembourg led successful armies and expanded their reach during this time. They were so successful that the house of Luxembourg even led the Holy Roman Empire during the 14th and 15th centuries. In the mid-15th century, neglect by the nobles who had gotten too comfy in their foreign roles allowed the Burgundians to conquer Luxembourg. Over the next four centuries, the area would change hands several times between the French, the Spanish, the Dutch, the Austrians, and the Prussians.

In 1815, with the defeat of Napoleon and liberation of his conquered lands, Luxembourg became a Grand Duchy, but it was divided. The Netherlands (more specifically King William I) was awarded the western provinces of Luxembourg. The eastern provinces became part of the new German Confederation. Most of the area makes up modern-day Luxembourg. Some of the eastern areas are now in Germany, and some came under Dutch control in the twentieth century.

The western provinces were treated just like any other Dutch province, but if you read my last post about the history of the Netherlands, you’ll know that this was a very brief period of unification. The Belgian revolution began in 1830 and ended with the Treaty of London in 1839. I’m skipping over all of this because the important part for our purposes is that the treaty gave Belgium the western half of Luxembourg, which is now (somewhat confusingly) also called Luxembourg (dark blue in the southeast here).

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Actually, when I told my colleague that I would be spending the weekend in Luxembourg, he asked, “The province or the country?”

And that’s how Luxembourg gets its current form.

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Even though the borders would be set for a long time to come, Luxembourg was in no condition to be a sovereign state. It remained part of the German Confederation until its dissolution with the Austro-Prussian War in 1867. Emperor Napoleon III tried to buy Luxembourg from King William III of the Netherlands. The Prussians still controlled the fortress (in what is now Luxembourg City), and they were not about to let the French just walk in. The most dissatisfying compromise for everyone was that no one would get the province, and it would remain neutral and disarmed. Though still technically the personal playground of the King of the Netherlands, Luxembourg was basically on their own at this point. With the death of William III in 1890, Luxembourg passed to the hands of Adolf of Nassau-Weilburg, the progenitor of the dynasty that still reigns today.

But despite all these pretty pictures, it doesn’t seem like any of this would make Luxembourg rich!

No, it didn’t. Luxembourg was pretty poor at this time. It wasn’t until the turn of the twentieth century, that Luxembourg started to put its mineral deposits to use. During the decades leading up to the First World War, immigrants flooded into Luxembourg to work in the mines and steel mills replacing the thousands of emigrants who flooded out of the industrializing capital in the nineteenth century. The increase in labourers led to legislative actions that would lay the groundwork for progressive worker protections in the twentieth century.

The First World War put a real damper on the economy after Germany violated the country’s neutrality, and devastating fighting ruined much of the countryside when they were pushed back. After the war, Luxembourg broke ties with Germany and realigned with Belgium. The “Roaring Twenties” is often characterized in the US by massive steelworks and the first skyscrapers; much of this steel came from Luxembourg. With increasing wealth came pressure for labour reform, and Luxembourg led the world in workers’ rights legislation such as a sliding pay scale that was pegged to the cost of living.

The economic crisis of the 30s hit Luxembourg as well, and another German occupation in the 40s meant that little progress was made until the end of the war in 1945.

It turns out that rebuilding a continent ravaged by four years of the most destructive warfare in history is pretty good for a country whose dominant industry is steel. On top of that, a forward-looking government pursued diversifying policies that attracted investors from around the world and aligned industries with other European nations through the European Economic Community (EEC), a predecessor of the EU.

By the time of the oil crisis in 1975, Luxembourg had 23 registered unemployed. No, I didn’t forget a unit there. Less than two dozen Luxembourgers were registered as unemployed in 1974.

The decade of the oil crisis saw a massive reorganization of industry and government as Luxembourg tried to weather to storm. A fundamental change was the creation of the Tripartite Coordinating Committee. The government was heavily involved in industry (holding a majority stake in the monopolist steel company), and from the 1970s onward, it would do so in a tripartite arrangement: requiring the approval of business owners, labour leaders and public officials. This restructuring alongside other very generous social welfare reforms allowed the Luxembourgish steel industry to survive the crisis and remain an important industry even today.

In the final two decades of the twentieth century, Luxembourg hit its first real boom. Ventures into the financial sector and IT alongside a very friendly tax environment (for both businesses and wage-earners) led to an average GDP growth per annum of over 5%, just behind Ireland, who is often hailed as the great European success story.

The next two decades were even better. With only a small faltering after the 2009 financial crisis, Luxembourg’s GDP has increased every year since 1980.

Good timing, a proactive and nimble government, and some valuable expertise have set Luxembourg in the perfect place to ride the waves of the global economy all the way to immense prosperity.

But this doesn’t feel particularly satisfying because lots of countries are in finance and IT. Lots of places can be seen as tax havens. What makes Luxembourg so special?

I’m going to offer my own hunch here. I think it stems from two things:

  1. They were first. This reorganization took place in the 1970s and 1980s. Most of Europe was still recovering from the war, the Asian Tigers were just starting to figure out how to do modern economies, Latin America and Eastern Europe were mostly trying to figure out how to get rid of totalitarianism, and the US was already too big and diverse to make sweeping reforms.
  2. Labour protections. Wages pegged to cost of living, tripartite decision-making, and strong unions. Luxembourg requires that employers pay fairly, and business-friendly policies attract the kind of capital to make such pay possible. This way, Luxembourg actually pays lower than the EU average in wealth redistribution, yet the minimum wage is about $28,000. That would be about $15/hour.

There is another reason why Luxembourg is the wealthiest country in the world per capita:

Lazy statistics.

Typically, GDP is calculated as the amount of money earned in the country over the course of the year divided by the average population over the year. That would give GDP per person, right?

Kind of.

Here’s a fun fact: about 40% of the people who work in Luxembourg don’t live in Luxembourg. Another third are immigrants and the rest are actually Luxembourgish. I’m guessing that’s why the UN statistics put Luxembourg third behind Liechtenstein and Monaco. Although it skews the data a bit, even correcting for it leaves a GDP per capita of over $100,000 (on the same scale, the US is at about $60k).

I think what you’re seeing when you walk around Luxembourg City is that the only people living there are the ones who can afford to stay. The ones who can’t afford to commute live on the outskirts of town (there are outskirts, and they’re definitely less pretty). The rest live comfortably in places that are a bit less expensive, but they can afford to commute.

So why is Luxembourg so rich? They work with money. It’s the best way to make money.

dammit, I knew I should have gone into finance…

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Mullerthal trail

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These are the kinds of German forests that must have inspired Grimm’s fairy tales.

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Monument to the United States military that liberated Luxembourg twice.

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Upon crossing the bridge into the old city, my first reaction (and I think many others’ is too) was “Is this place real?”

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The city is immaculately well tended.

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Value

How much would you pay for all the stuff you have? For all the stuff you want? How much are you willing to work for that money? Does it make you happier? More fulfilled? How do you answer that question at the societal level? Is money a good proxy for wellbeing?

So many unanswered (unanswerable?) questions!