The IMF has examined Luxembourg’s indexation system, which it considers outdated due to the multiplicity of crises that have occurred since 2006. Photo: Shutterstock

The IMF has examined Luxembourg’s indexation system, which it considers outdated due to the multiplicity of crises that have occurred since 2006. Photo: Shutterstock

The International Monetary Fund (IMF) has explored different ways of reforming Luxembourg’s indexation system, “a distinctive feature of Luxembourg’s labour market institutions whose relevance has been called into question by the resurgence of high inflation.”

With the successive modulations applied since 2005 during periods of uncertainty or economic slowdown, the Washington-based institution sees this as proof that the index is no longer an absolute value, but a flexible system. It’s a shameful flexibility that threatens the credibility and efficiency of the system. For the IMF’s experts, a reform is necessary.

As a reminder, due to the high oil prices at the time, indexation tranches were postponed during 2006-2009. This led to a delay of several months between the triggering and the payment, which resulted in a reduction in wages compared to the expected evolution of nominal wages. The system was modulated again between 2010-2013, when only one indexation per year was allowed, which again led to several months of uncompensated delay. Finally, more recently, the included a provision to postpone the second indexation tranche for 2022 until April 2023.

And the issue is still being debated. Opponents point to the effect on wage rigidity, second-round effects, falling labour productivity, particularly in the services sector, and a lack of equity, with increases benefitting better-off households more than those in difficulty. And supporters make it the totem of political stability and the cornerstone of all social policies.

Looking only at core inflation

Against this backdrop of highly ideological debate, the IMF makes three reform proposals “to improve its socio-economic performance and the country’s resilience, particularly in the context of supply shocks.”

First, the index should no longer be calculated by reference to overall inflation, which is considered too volatile, but only by reference to underlying inflation.

In Belgium, the automatic system is based on the so-called “health index,” a measure of inflation that excludes alcohol, tobacco and energy. In Italy, where the system is based on negotiation, a three-year inflation projection is used which excludes energy products as a reference for negotiations. The idea is to make the index more forward-looking than backward-looking.

For Luxembourg, the IMF advocates adopting core inflation as the reference. This would have the advantage of increasing the predictability of indexes for economic operators. The effects of this choice on low-income households would then be offset by “targeted and temporary support measures,” which “would have a much lower budgetary cost than the general measures applied to mitigate the impact on competitiveness.”

Making the system more progressive

The second axis of reform is the introduction of progressive considerations. This would “improve fairness in consumption.” In concrete terms, a threshold should be set beyond which the implicit wage change would not fully correspond to inflation.

While the IMF is aware of the complexity of implementing such a system, both from a practical and political point of view, it believes that “proportional wage adjustment could not only improve consumer equity, but also reduce its cost impact on both government and business.”

Decentralising bargaining

The third axis of reform would be the adoption of a rules-based suspension of indexation, “replacing the ad hoc suspensions used extensively over the last two decades.” It’s a way to reduce uncertainty.

Given the “universal” nature of the system, the IMF advocates decentralised negotiations on wage setting in the event of suspensions. This would “alleviate competitiveness concerns at the national level, which often lead to the suspension of the system for all, and give unions and employers more room to agree on the most sustainable way to spread the costs of shocks, which in turn could save jobs.”

This story was first published in French on . It has been translated and edited for Delano.