European Trade Union Institute, ETUI.

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12 October 2018

Luxembourg: is wage indexation a key source of inflexible wage setting?

Minimum wages in Luxembourg increased ‘automatically’ in October 2018 due to the country’s wage indexation scheme. In mainstream thinking among economists of the ECB and other EU institutions, mechanisms and collective bargaining agreements that link wages with inflation are seen as being incompatible with competitiveness in the internal market. The trade unions, on the other hand, have always seen wage indexation systems as a good starting basis to enable workers to share in economic growth.

As of 1 October 2018, a new round of wage indexation has been applied in Luxembourg. Under the current indexation scheme wages, as well as pension payments and health care costs are adjusted to match (the increase in) inflation. Accordingly, the gross minimum wage for skilled employees over 18 years of age has been lifted to 2,305.23 euro, around 13 euro per hour. Before the increase, the minimum wage stood at 2,249.03 euro.

The purpose of the wage indexation mechanism is to preserve the purchasing power of workers. The first price index, together with an indexation clause for wages/salaries and pensions of railway workers and civil servants, was introduced in 1921. The index was based on a basket of 19 consumption items deemed to be used by a household of five persons. In 1948, this basket was expanded to 36 products; today it covers some 8,000 goods and services grouped into 255 categories. The system was gradually extended to other categories of income recipients before being generalised by the Law of 27 May 1975. From that year, all wages and salaries in the private and public sectors, as well as pensions and apprenticeship allowances, are subject to the rule of indexation, with each tranche amounting to 2.5%. The necessity of an indexation is assessed every two years.

A wage indexation mechanism was originally applied in several countries, under different names, such as the ‘system of automatic indexation of salaries and wages to the cost of living’ or the ‘index’. The European Commission, the ECB, the OECD and the IMF have constantly issued recommendations to abandon automatic wage indexation. Over the years, more and more countries have abandoned the use of this type of adaptation to inflation and the indexation of wages/salaries has become a rarity within the European Union. Luxembourg and Belgium, and to a certain extent Malta and Cyprus, still apply a mechanism for the adaptation of wages to inflation.

Academic interest in the effects of indexation mechanism on the economy goes far back and considerable academic research has been generated on the topic. The research encompasses a wide range of areas from macroeconomic policy to industrial relations research. Automatic indexation mechanisms are often criticised for being a key source of inflexibility of real wages and thus responsible for a lack of adjustment in the labour market and for a deterioration of cost-competitiveness. In a comparative study of four countries with or without indexation mechanisms published by Luxembourg University, it was concluded in 2014 that the presence of institutionalised indexation does not significantly alter the process through which hourly wages are set, as revealed by the long-term relationships or dynamic reactions to an exogenous shock. According to the trade unions, with no negative effects of the scheme, the study confirmed the purposes behind the use of the index.

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