Financial Services Cluster Luxembourg

Harvards Microeconomics of Competitiveness
Luxembourgs Financial Services Cluster
Lalit Daga (lalit.daga@grenoble-em.com)

Habib Karam (habib.karam@grenoble-em.com)
Mark Ludwinek (mark.ludwinek@grenoble-em.com)
Erik Norstrm (erik.norstrom@grenoble-em.com)
Arun Rajendiran (arun.rajendiran@grenoble-em.com)
Alex Stckl (alexander.stockl@grenoble-em.com)
Yagmur Yaraman (yagmur.yaraman@grenoble-em.com)
Microeconomics of Competitiveness with Prof. Mark Esposito
26th of April - Spring Semester 2010 MIB 28

MOC Cluster Analysis Luxembourg Financial Services 26th of April 2010
Table of Contents
INTRODUCTION ...................................................................................................................... 4
ECONOMIC ANALYSIS .......................................................................................................... 5
Economic History ................................................................................................................... 5
Economic Performance .......................................................................................................... 7
Trade Situation and Development .......................................................................................... 9
Foreign Direct Investment (FDI) ........................................................................................... 9
Luxembourgs Role in the European Union ......................................................................... 11
THE NATIONAL BUSINESS ENVIRONMENT .................................................................. 12
Factor Conditions ................................................................................................................ 12
Context for Firm Strategy and Rivalry ................................................................................. 13
Related and Supporting Industries ....................................................................................... 13
Demand Conditions .............................................................................................................. 14
Competitiveness and other Business Environment Indicators ............................................. 14
THE FINANCIAL SERVICES CLUSTER ............................................................................. 16
History & Development of the Cluster ................................................................................. 16
Cluster Performance ............................................................................................................ 17
Banking ............................................................................................................................ 17
Investment Fund Administration ...................................................................................... 18
Insurance .......................................................................................................................... 20
Stock Exchange ................................................................................................................ 21
Islamic Finance ................................................................................................................ 22
Cluster Diamond .................................................................................................................. 23
Factor Conditions ............................................................................................................. 23
Context for Firm Strategy and Rivalry ............................................................................. 25
Related and Supporting Industries ................................................................................... 26
Demand Conditions .......................................................................................................... 26
STRATEGIC ISSUES & RECOMMENDATIONS ................................................................ 27
Bibliography ............................................................................................................................. 28
2
Table of Figures
Figure 1 Industry Sector GDP Contribution Development ..................................................... 5

Figure 2 - GDP Growth Rates (compared to selected European countries) ............................... 7
Figure 3 GDP (PPP) per Capita Growth of Luxembourg ....................................................... 7
Figure 4 Macroeconomic Performance Indicators Development ........................................ 8
Figure 5 Macroeconomic Performance Indicators Comparison to other EU Countries in
2009 ............................................................................................................................................ 8
Figure 6 FDI Inward (as % of GDP) in 2005 ........................................................................ 10
Figure 7 Multinational Corporations with (regional) Headquarters in Luxembourg ............ 10
Figure 8 Porters National Diamond on Luxembourgs Business Environment .................. 12
Figure 9 Economic Indicators of Luxembourg (2006-2009) ................................................ 15
Figure 10 Banks in Luxembourg by Country of Origin ........................................................ 18
Figure 11 Evolution of Assets and Number of Funds in Luxembourg ................................. 19
Figure 12 European Fund Investment Market 2008.............................................................. 19
Figure 13 Cross-border Fund Registrations of UCITS in 2009 ............................................ 20
Figure 14 Luxembourg Insurance Sector .............................................................................. 20
Figure 15 Origins of Insurance Premiums in Luxembourg................................................... 21
Figure 16 International Bond Market Market Shares ......................................................... 21
Figure 17 Porters Diamond on Luxembourgs Financial Sector ......................................... 23
Figure 18 Science and Innovation Profile of Luxembourg (compared to EU average) ........ 24
Figure 19 Origin of Owners of AuM for Luxembourgs Private Banking Sector (Totalling
250 Billion) ............................................................................................................................ 26
3
INTRODUCTION
The Grand Duchy of Luxembourg is a small European country at the border of Belgium,
France and Germany. The country is a democracy with a constitutional monarch, ruled by its
Grand Duke, Henri. Luxembourg is a trilingual country with German, French and
Luxembourgish as official languages. Although the state is secular, the country is primarily
Roman Catholic. The currency of Luxembourg is the Euro.
Despite its population of only slightly over half a million1, Luxembourg has managed
to become one of the biggest financial centers in the world. Founding member of the
European Union, NATO, OECD, the United Nations, Benelux and the Western European
Union2, Luxembourg has managed to rapidly increase its political and economic importance
in Europe as well as around the world. With a gross domestic product per capita of $78,000 in
2009, Luxembourg is the country with the highest GDP per capita in the world according to
the IMF3 and the World Bank4, and the third highest according to the CIA.5
Luxembourgs financial sector has been growing for more than the past two decades.
Banking and other financial exports account for the majority of the countrys economic
output. As a result of Luxembourgs growing financial sector, a financial cluster has emerged.
This report analyses the development of Luxembourg, its national business environment and
its financial cluster. It furthermore gives recommendations to Luxembourgs government and
businesses on how to sustain its competitive financial cluster and increase its competitiveness
in the national business environment.
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4
ECONOMIC ANALYSIS
The economy of Luxembourg, while small, is highly developed and is considered a mixed
economy dominated by service and production industries. As a part of GDP, services provide
86%, industry 13.6% while agriculture only stands for 0.4%. Labor is similarly divided, with
most finding employment in the service sector at 86%, in industry 17.2% and in agriculture
only 2.2%. The service sector is driven by the financial and information technology
industries. The Industrial sector is in turn supported through iron and steel, as well as rubber
industries.6
Economic History
Luxembourgs economy has ridden the highs and lows of different economic periods
through its history. With the introduction of metallurgy in 1876 and generous natural ore
deposits, Luxembourg became dominated by a strong steel industry. During its peak in the
1960s, steel and iron accounted for 80% of the countrys GDP.7 With the 1970s came the
decline of the steel industry and the government implemented different programs to diversify
the economy. Part of this diversification was the development of the financial sector which
now accounts for 28% of GDP.8 The developed financial sector increased the attractiveness of
Luxembourg as a location for investment. Hence, foreign manufactures began to open
operations in Luxembourg, diversifying the industrial base with rubber, glass, and aluminum
production.9 Figure 1 shows Luxembourgs GDP distribution by economic sector.
Figure 1 Industry Sector GDP Contribution Development
Source: STATEC
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More recently, the disruption in global financial markets caused the Luxembourg economy to
decline by 0.9% and the government to take measures such as injecting capital into the
banking sector, creating a 2% government deficit.10
It becomes obvious that the government is actively involved in the economic scene.
The main principle guiding government policy has been to encourage foreign investment and
foreign business. To achieve these goals, the government follows the policy of cutting
company taxes, tax credits, and no corporate capital gains taxes. Government agencies are
streamlined to remove obstacles for business and Luxembourg is ranked 21st in the Global
Competitiveness Index, showing that it is open for business.11 However, Luxembourg has
received criticism from foreign governments over its bank secrecy laws, which attract foreign
investors but cause troubles with money laundering and tax evasion.
Besides the intervention of the government, other issues were factors in the
development of Luxembourg. Foremost, its borders with Belgium, Germany and France
encouraged a flow of labor into the country, with 60% of its labor force being foreigners.12
Moreover, the close proximity to Belgium helped to foster a sense of unity and this led
to the creation of economic unions, first with Belgium and later with the Netherlands to form
the Benelux Customs Union in 1941.13 The close borders also resulted in the country
becoming trilingual, with French, German and the native Luxembourgish as official
languages. Open borders and a trilingual population helped to attract new investors and spur
growth.
As shown in Figure 2, Luxembourgs economy is growing or declining at Europes extremes

and has always been over- or underperforming most of its peers.
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Figure 2 - GDP Growth Rates (compared to selected European countries)
Source: Google Public Data, http://www.google.com/publicdata?ds=wb-

wdi&met=ny_gdp_mktp_kd_zg&idim=country:LUX&dl=en&hl=en&q=GDP+growth+graph+of+luxembourg#
met=ny_gdp_mktp_kd_zg&idim=country:LUX:BEL:FRA:DEU:IRL, April 2010
This phenomenon can be explained with Luxembourgs strong economic dependence on its
surrounding countries, so that growth as well as decline of other countries economies is
multiplied reflected in Luxembourgs GDP growth rates.
Economic Performance
However, the GDP per capita income has been increasing since 1980 until 2008 by a total of
$13,329.56 to $82,440.74 respectively, whereas in 2009 it has declined to $78,000; a decrease
of 4.51%, as shown in Figure 3.
Figure 3 GDP (PPP) per Capita Growth of Luxembourg
Source: International Monetary Fund (IMF) World Outlook 2009
7
The reason behind this high GDP per capita can be most likely explained by the large number
of citizens who live in neighboring states but work in Luxembourg. These citizens are not
included in the total population but their income is counted as part of Luxembourg's GDP. 14
Secondly, it has very low taxation policies among EU members and attracts many and major
financial institutes and service providers from all around the world.
Luxembourgs economic development strategy has emerged from the sound

redesigning of the country's economic structure. Through being a steel-based economy, it has
managed to advance into an international financial centre and a key business site.
As shown in Figure 4, reliably high growth, low unemployment, moderate inflation

and continuous job creations are the main factors of Luxembourgs effective pro-business
economic policies which provide an ideal foundation for potential development and success.15
Figure 4 Macroeconomic Performance Indicators Development
Source: STATEC
Despite Luxembourgs strong economic position in the past decades, the financial crisis had a
strong impact on the countrys economy, as shown in Figure 5.
Figure 5 Macroeconomic Performance Indicators Comparison to other EU Countries in 2009
Source: CIA The World Factbook Luxembourg
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While unemployment stayed at a moderate level, the countrys GDP declined by 3.9% in
2009 at an annual inflation rate of 0.5%, which can be explained through the strong
dependence on the heavily struck financial sector.
Trade Situation and Development
Despite the fact that domestic demand has increased in importance for the Luxembourg
economy, the country heavily relies on foreign trade. With the downturn of the steel industry
between 1974 and 1981, the countrys trade situation had destabilized. Imports grew by 55%
whereas exports rose only 7%, as the trade balance swung into deficit. Between 1985 and
1992, imports grew by 42% and exports rose only by 24%.
In 2000, 88.6% of imports and 88.7% of exports were from trade with European
countries. Germany was Luxembourg's primary customer, with 23% of the total exports. In
2000 Luxembourg imported more goods from Belgium (35%) than any other country.16
From the mid 1980s, transportation and communications progressed at an outstanding

speed. The number of human resources employed by these sectors in Luxembourg rose from
11,000 in 1985 to 22,000 in 2001. The Luxembourgish freight company Cargolux has attained
incredible success in the airline industry and is today a world-renowned operator. The
national carrier Luxair has also significantly provided to the economic growth of the
country.17
Foreign Direct Investment (FDI)
Luxembourg allows an extremely encouraging and welcoming approach towards Foreign

Direct Investment (FDI). Through the use of deferred corporate tax payment schedules,
capital investment subsidies and financing of equipment and start-up entities, the state lending
agency, SNCI and therefore consecutive Luxembourg governments have effectively attracted
new investment in medium, light and high-tech industries, as well as services.
In spite of the current global economic crisis, Luxembourg holds the most prominent location
for business investments in Europe, with the benefit of being a member of the European
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Union (EU).18 As shown in Figure 6 Luxembourg has the worlds second highest inward
Foreign Direct Investment as a percentage of GDP behind Hong Kong.
Figure 6 FDI Inward (as % of GDP) in 2005
Source: LuxembourgforFinance
Successful investment relies heavily upon choosing the most suitable site. It is thus not
solely coincidental that several companies from Asia, Europe and North America have
preferred Luxembourg as a major business location over the past decades, as shown in Figure
7.
Figure 7 Multinational Corporations with (regional) Headquarters in Luxembourg
Source: http://www.bed.public.lu/business_location/foreign_investors/index.html, April 2010
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Luxembourgs Role in the European Union
Luxembourg is one of the six founding members of the European Union and has since then
been one of Europes main advocates for free trade and European integration.19 The capital
city, Luxembourg City, is the home for many of the governing institutions of the European
Union, such as the European Court of Justice, the Court of First Instance, the Court of
Auditors, the European Investment Bank and parts of the European Parliament.20
By constantly pushing for development and bringing countries together, yet managing
to stay neutral, Luxembourg is considered to be the model European country.
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THE NATIONAL BUSINESS ENVIRONMENT
Being a very small economy and geographically landlocked country with very little natural
resources, Luxembourg had no choice other than opening up to the outside world thus
providing access to the factors of production, research and technology to the procurement of
goods.
Figure 8 shows Porters National Diamond applied to Luxembourg, analyzing the

countrys business environment and its competitiveness.
Figure 8 Porters National Diamond on Luxembourgs Business Environment
Source: Team Analysis referred from http://www.isc.hbs.edu/pdf/Luxembourg_20050525.pdf
Factor Conditions
Luxembourg has an excellent transport system, communications network, and power supply
system which attributes to its well developed physical infrastructure. The countrys tax regime
and openness had created a strong financial market. Over the years the country had developed
12
an expertise in cross border fund administration which can be well related to its ability to
attract 60% of its labor force from other countries as well the absence of any transnational
issues.
Despite this, the country needs to improve the local skill base which requires constant
focus towards education and information infrastructure. Throughout its economic
development, Luxembourg has made major use of foreign capital and workers
originating from other countries. In 2001 Luxembourg was by far the most open
economy of all the EU member states. 21
Context for Firm Strategy and Rivalry
The blend of high openness to international competition and attractive tax benefits coupled
with political stability had invited more than 150 banks and various financial companies
making Luxembourg become a financial hub of Europe. With its 0% withholding tax on cross
border savings, it has been ranked 10th for Total Tax Rate22 and 31st in Trading across
borders23.
Despite these advantages, the country has managed only moderate scientific research
institutes with lackluster industry-university collaboration which has its direct implications in
the absence of innovation. Local competition has been affected with the weaker policies
which focus less on investors protection clearly demonstrated by its 119th position in the
protecting investors ranking.24
Related and Supporting Industries
With very less national resources, Luxembourgs industrial environment was initially
dominated by steel later diversified and now shaped into a strong financial market supported
by banking. Despite managing an internationally competitive financial cluster, the
government had shown less progress over other emerging clusters such as steel and
telecommunications.
The inclusion of Luxembourg into the grey list of nations with questionable banking
arrangements by the G20 due to its banking secrecy laws and pressures for European wide
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harmonization of tax laws from EU25 have raised serious concerns to diminish the clusters
competitive advantage.
Demand Conditions
Dependency over cluster-specific business environment for the financial services sector had
created sophisticated demand from public and private buyers. The disadvantages here include
weak legal standards and demand for high level of education which is highly derived from the
foreign workers.
On an average Luxembourg asks for six procedures; 24 days and 19.9% of minimum
capital to start a new business which had pushed it to a not-so-encouraging 72nd rank in
Starting a business26 as per DoingBusiness 2010 rankings. The weaknesses also include recent
decline in the salary levels and recruitment market due to the economic turmoil. However
recovery signals come from organisations attempting to solve age pyramid issues since the
average age of their employees exceed 40 years27.
Competitiveness and other Business Environment Indicators
Luxembourg has been positioned 21st in the Global Competitiveness Index 20092010
rankings 28which is topped by Switzerland, United States and Singapore which had shown a
progress from last years 25th position. Competitiveness can be attributed not only to the
economic performance but also to the ability to resist adversities and show resilience over the
economic turmoil. This justifies Luxembourgs position which ranked 12th in the world
competitiveness scoreboard 2009 29 after witnessing a sharp decline from 5th position earlier
in the 2008 scoreboard.
Steady progress in gross domestic product (per capita) over the years followed by a
decline in 2009 similar to that of its employment statistics and unemployment rate, as shown
in Figure 9, can be attributed to the economic downturn which had its direct implication over
the countrys strong cluster. Despite the steep increase in the inflation to 2.071% from
0.884%, still Luxembourg continues to be the highest gross domestic product per capita in the
world as per IMF and World Bank, due to its strong factor conditions.
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14
Figure 9 Economic Indicators of Luxembourg (2006-2009)
Source: International Monetary Fund, World Economic Outlook Database, April 2009 Team analysis derived
from http://www.imf.org/external/data.htm
Furthermore Luxembourgs competitiveness was ranked as follows by different studies:
o Ranked 10th for Total Tax Rate(pg. 218)10

o 7th for extent and effect of taxation(pg. 218)10
o 5th for prevalence of foreign ownership(pg. 218)10
o 5th for tariff barriers(pg. 218)10
o 1st in Financial Market Sophistication, Ease of access to loans(pg. 218)10
o 12th in ethical behavior of firms (pg. 218)30
From the above rankings it can be observed that, favorable tax benefits with the openness
towards financial services had strongly helped Luxembourg to maintain its competitive
national business environment.

15
THE FINANCIAL SERVICES CLUSTER
In 2009 Luxembourgs financial services cluster accounted for about 28%31 of the countrys
$38.37 billion GDP32 and is therefore Luxembourgs key economic sector. Together with the
real estate sector and other business services, it even accounted for 47.3% of value added to
Luxembourgs economy in 2007.33 The financial services cluster is the worlds largest fund
administration center after the USA and the Euro zones largest private banking center.34
Consisting of private, commercial and governmental banking as well as investment

fund administration, insurance companies, as well as financial auditing and consulting
providers, the cluster employs around 40,000 professionals as of September 2009.35
History & Development of the Cluster
The roots of Luxembourgs successful financial sector can be traced back to 1929, when a
new fiscal legislation was implemented favoring banks and holding companies through tax
concessions.36 The history of the conditions which led to a competitive advantage of
Luxembourg as a financial market place is closely tied to the countrys political initiative in
Europe: as a founding member of BENELUX, the International Monetary Fund (IMF), the
World Bank and the European Union (EU), Luxembourg was always at the heart of
movements towards internationally decreased trade and investment barriers.37
With the Maastricht treaty in 1992 the European Union agreed on the implementation
of a single European currency and Luxembourg could finally gain full competitive advantage
of its investment favorable tax legislation: it became highly attractive for neighboring
countries banks to use Luxembourg in order to resell their products to their home country
investors.38
As a result of faster fund registration processes in Luxembourg and the introduction of

a 30% withholding tax in Germany in 1993, the country experienced a major boost of German
investment funds. In the case of Belgium and the Netherlands on the other side Luxembourgs
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government addressed investor needs through a coupon allowing Belgians and the Dutch to
avoid their local inheritance tax. Even Luxembourgs strongest competitor in the private
banking sector, Switzerland recognized its leading position when the Swiss were looking for
an international client base and avoidance of the countrys 35% withholding tax and started
heavily investing in Luxembourg domiciled funds.39
Summarizing, the key issues in the development of Luxembourg as a financial cluster

were the countrys openness toward free trade areas and its push en route for European unity,
its geographical location and close proximity to France, Germany, Belgium and the
Netherlands, as well as high withholding taxes and strict laws and regulations within these
countries.
Cluster Performance
Today Luxembourgs continuous success in the financial services sector can be credited to
several factors. Due to its small size the country and its population are naturally gifted with an
outward-looking mentality which combined with its strong expertise and investor protecting
legislation gives the country a well-built competitive advantage over other financial centers.
Also its multilingual and multicultural labor force; with 43% 40 of the population of
Luxembourg being foreigners; give the country an international perspective, which together
with its stable social, political and economic environment creates great trust in the
marketplace among investors and financial institutions.41
Banking
The banking sector is the largest sector in Luxembourgs financial cluster. As Luxembourgs
domestic market is relatively small, the countrys banking industry is predominantly
international. Currently there are over 145 banks from 24 different countries established in
Luxembourg, with most of them being subsidiaries of multinational banks.42 The majority of
banks are of European origin, whereas there are also several banks from Asia and the
Americas present in Luxembourg, as shown in Figure 10.
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Figure 10 Banks in Luxembourg by Country of Origin
Source: ABBL Banking Statistics 2009, http://www.abbl.lu/useful-information/statistics/banking-sector
The Luxembourg banks offering a wide range of services, from private banking to
capital markets and corporate finance activities, currently employ around 27,000
professionals.43 In 2009 the total Assets under Management (AuM) of banks in Luxembourg
amounted up to 793 billion, equivalent to $1,136 billion, representing 30 times the countrys
GDP.
Additionally the European Investment Bank and parts of the European Central Bank
are located in Luxembourg, making it home of private, commercial and governmental
banking at the same time.
Investment Fund Administration
Luxembourg is after the USA the worlds second largest investment fund administration
center, with 188 asset management companies for collective investments managing 3,371
investment funds, consisting of 12,325 fund units with a net worth of 1,559 billion in 2008.44
Despite the global financial crisis these numbers experienced further growth in 2009
with 3,463 funds under management as of December 2009, representing 1,841 billion under
management. Figure 11 shows the development of Luxembourgs fund industry throughout
the past 15 years.
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Figure 11 Evolution of Assets and Number of Funds in Luxembourg
Source: ABBL Fund Industry Statistics 2009, http://www.abbl.lu/useful-information/statistics/fund-industry
As a result of its strong growth throughout the past years, Luxembourg holds the position as
market leader in the European fund investment market, as shown below in Figure 12.
Figure 12 European Fund Investment Market 2008
Source: ATTF, http://www.attf.lu/about_attf_about_luxembourg.php
In terms of UCITS, Undertakings for Collective Investment in Transferable Securities, which

are investment funds meeting the investment criteria of the European Union, Luxembourgs
position in the fund administration market is even more dominant, as shown in Figure 13.
19
Figure 13 Cross-border Fund Registrations of UCITS in 2009
Source: PwC\Lipper Hindsight, Global Fund Distribution 2009
Insurance
Together with the banking and the fund administration sector, Luxembourgs insurance
industry is the third major pillar of its financial cluster. In 2009 54 life insurance companies
and 37 property and casualty insurance companies, as well as 262 reinsurance captives are
based in Luxembourg.45 Together they accounted for total premiums of 13.19 billion in 2008
as shown in Figure 14.
Figure 14 Luxembourg Insurance Sector
Source: Commissariat aux Assurances, Annual Report 2008
As a result of the freedom for insurance companies to offer cross border services within the
European Union, the demand for Luxembourg domiciled insurance vehicles within the EU is
very high, as can be seen in Figure 15.

20
Figure 15 Origins of Insurance Premiums in Luxembourg
Source: Commissariat aux Assurances, Annual Report 2008
Stock Exchange
The Luxembourg Stock Exchange, despite not being located in a major European business
metropolis as its competitors, is one of Europes most important market places for investment
instruments. It is the worldwide main center for the trade of international securities with
current listings of 46,000 securities, with the majority being bonds.46 In the field of bond
trading the Luxembourg Stock Exchange established itself as international market leader, as
shown in Figure 16.
Figure 16 International Bond Market Market Shares
Source: LuxembourgforFinance Luxembourg, Place Financire 2009
In addition to its dominant position in the bond trading market, the Luxembourg Stock
Exchange is furthermore holding a strong position in the quotation of GDRs, Global
Depository Receipts, being second placed behind the New York Stock Exchange (NYSE) and

21
ahead of the London Stock Exchange (LSE). These certificates signifying the ownership of a
certain number of shares of foreign companies are typically issued in Asia, most specifically
in India.
Islamic Finance
In 1983 Luxembourg was chosen as address for Europes first shariah compliant insurance
company and in 2002 the Luxembourg Stock Exchange was the first in Europe to enter the
sukuk market. Today 15 sukuks worth $5.5 billion are traded in the market and 39 shariah
compliant investment funds are established in Luxembourg. While Islamic finance currently
plays in the financial cluster of Luxembourg only a rather minor, could though be of strong
importance in its future. 47
Luxembourgs government works closely together with the Islamic Financial Services
Board in order to further increase the attractiveness of the financial market for the Arab
world.

22
Cluster Diamond
In order to analyze Luxembourgs source of competitive advantage for its financial sector,
each of the cluster diamond factors is analyzed as shown in Figure 17.
Figure 17 Porters Diamond on Luxembourgs Financial Sector
Source: Team Analysis referred from http://www.isc.hbs.edu/pdf/Luxembourg_20050525.pdf
Factor Conditions
The three major factor conditions in Luxembourgs financial cluster are human resources and
capital resources, as well as scientific and technological infrastructure.
Human resources Since Luxembourg is oriented towards investor protection, the

workforce allocated there from the international banks and institutions, is therefore related to
such activities that can benefit from this. The country has an expertise in information
23
intensive operations such as accounting, middle/back office and other administration. Since
the information handled by these operations is foundation for taxation, it comes naturally to
locate them in Luxembourg. Front office operations like sales and trading are mainly located
to financial centres with focus on networking possibilities for creating relations, such as
London or New York.48
Capital resources A necessary condition for enabling a financial cluster to function

and to attract both investors, employers and other participants, is vast capital resources. The
whole purpose of a financial centre is, after all, to finance investments. At the end of 2008,
bank deposits totalled 765.9bn and SICAV net holdings were 990.8bn.49
Scientific and technological infrastructure Although large investments were made in

developing research centres in the mid 1980s, Luxembourg is still below their target in
government spending on R&D facilities as well as the outcome of it. There is no particular
significant specialization of research towards the financial sector. The R&D institutions
mostly focus on industrial and technological research.50 Figure 18 shows Luxembourgs
science and innovation profile.
Figure 18 Science and Innovation Profile of Luxembourg (compared to EU average)
Source: Stat Link, http://dx.dexi.org/10.1787/453305722035
8#).'32(/1/.'79*330555'%/./-+23%/-20'%+#,1'0/132&+20,#723/17%(-23/17"+&
01+,
46'-$/41)'.*+((1'2
! !
24
Context for Firm Strategy and Rivalry
A significant condition for the success of the financial sector in Luxembourg, which has
proven itself during the financial crisis, is the regulatory bodies. The cooperation (which is
now under draft to become constitutional) between the financial supervisor (CUSS), the
insurance supervisor (COMAS) and the Central Bank (BAL) has encouraged a limited
exposure towards high-leverage investments and activities and this has had a dampening
effect on the outcome of the financial crisis for the actors in Luxembourg.51
The regulatory framework has, as long as Luxembourg has been an important financial
centre, functioned as a modern solution with continuous updating of the regulation based on a
close interaction between the above-mentioned institutions and the private sector.
This together with a political stability and openness to the world are the foundation for
the success of Luxembourg as a financial centre.
The two main drivers, however, behind making the financial sector in Luxembourg so
attractive is, and has been the rules for bank secrecy and taxation. This has made Luxembourg
a hub for private banking in the euro zone and captive reinsurance in the European Union.
The main purpose of the two elements is investor protection, which explains the kinds of
divisions that the banks and institutions allocate to Luxembourg, fund management and
private wealth activities together with administration.52
While the regulatory body can remain modern and dynamic in its implementation, it
will encounter difficulties in maintaining Luxembourgs competitive advantage in terms of an
easier and more investor friendly regulation framework. The secrecy, as in other financial
centres with a high such, in put under hard international pressure since the capital is actually
mostly originated from countries with a more negative approach to bank secrecy. The reason
behind the ambition to harmonise the secrecy levels in line with OECD standards
internationally is the information exchange between governments for taxation. 53
The challenge for the cluster is thus to develop a competitive advantage that is
compliant with international regulation policies and that focuses more on actual competence
than investor protection.
)()'$,.+/ 2)!.1 ').+" (-# !$(($&, -)+)(-$(. -) -# '$("+)0-# ("$(
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3.1 ').+",.''$--)$,.,,!.-.+ )!(%, + 24#--* 000+ .- +,)'+-$& $
*+$&
25
Related and Supporting Industtries
With the finance industry reprresenting 83.3 % of GDP and 16.3 % of GDP being the steel and
chemicals industry, there is noot much room left for supporting and/or relateed industries. 54 The
only goods used in the financee industry are basically IT products and servicces and those are
bought elsewhere.
Demand Conditions
The local demand for the serviices provided by the financial sector is not a specific
s condition
for the existence of the clusterr. Most of the customers are located elsewheree.55
For example, the originn of clients owning Assets under Managemennt (AuM) by private
banks in Luxembourg is to 84 % represented by foreigners, as shown in Figgure 19. This is
fairly similar in the other branches of the industry and even clearer in the reeinsurance business
because of almost all insurance companies being foreign.
Figure 19 Origin of Owners of AuM

A for Luxembourgs Private Banking Sector (Tootalling 250 Billion)

Source: STATEC
,%#("#' (+!#(%-''$
$ ***&''#)%$"'!$%
#'(+!#(%"%&

26
STRATEGIC ISSUES & RECOMMENDATIONS
After an examination of the finance cluster and the government, it is possible to draw
recommendations for both parties. Beginning with the financial services cluster, it is
important to form a professional association to promote industry specific needs. While other
industries, such as steel have organized, the financial service industry has no central body
promoting its needs, attracting top talent or encouraging development of a local labor pool.
Even though Luxembourg was the first to introduce Islamic funds in Europe, the cluster
should further develop these products as well as expand its vision to the emerging markets of
Asia and Latin America.
The government, which exudes the most influence over the financial industry cluster,
has performed quite well, however there is still room for improvement. The financial crisis
has shown that Luxembourg is overly dependent on the financial service cluster. Moreover,
with the possible standardization of banking laws, Luxembourg will have to deal with a
diminished private banking sector. To remedy this, it is recommended that Luxembourg
develops its other industries, such as IT, Logistics, and Communications. By diversifying its
economy, Luxembourg should be able to avoid the sharp economic downturn it has recently
experienced.
The first major obstacle is to improve the education of the labor force. As is, there are
no 4 year universities in Luxembourg and most students travel abroad to receive higher
education. With such a prominent cluster located within the country, the government should
work to establish the newly founded Luxembourg School of Finance (LSF) as a world-class
university that taps into the knowledge of the financial industry. By doing so, Luxembourg
would help support its main cluster by providing a highly educated workforce and by creating
an education industry that can generate substantial profits. Furthermore, it would be wise for
Luxembourg to establish a university specializing in media and information technology. This
would help to support the other up and coming industries, weaning Luxembourg off its
dependence on the financial market.
Although Luxembourg is rated as one of the most globally competitive nations, it is

still plagued by bureaucracy, and stringent hiring/firing laws. To help improve their position,
the government should work on revising labor laws to create more flexibility for firms, and to
reduce the amount of paperwork required to start a business. With the combination of an
attractive tax structure as well as streamlined procedures, additional business is sure to follow.
27
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30

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Harvards Microeconomics of Competitiveness

Luxembourgs Financial Services Cluster

Lalit Daga (lalit.daga@grenoble-em.com)

Microeconomics of Competitiveness with Prof. Mark Esposito

26th of April - Spring Semester 2010 MIB 28

Figure 1 Industry Sector GDP Contribution Development ..................................................... 5

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Figure 1 Industry Sector GDP Contribution Development

As shown in Figure 2, Luxembourgs economy is growing or declining at Europes extremes

" &  -"$&""-'* "'$

Figure 2 - GDP Growth Rates (compared to selected European countries)

Source: Google Public Data, http://www.google.com/publicdata?ds=wb-

Figure 3 GDP (PPP) per Capita Growth of Luxembourg

Source: International Monetary Fund (IMF) World Outlook 2009

Luxembourgs economic development strategy has emerged from the sound

As shown in Figure 4, reliably high growth, low unemployment, moderate inflation

Figure 4 Macroeconomic Performance Indicators Development

Figure 5 Macroeconomic Performance Indicators Comparison to other EU Countries in 2009

Source: CIA The World Factbook Luxembourg

Trade Situation and Development

From the mid 1980s, transportation and communications progressed at an outstanding

Foreign Direct Investment (FDI)

Luxembourg allows an extremely encouraging and welcoming approach towards Foreign

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Figure 6 FDI Inward (as % of GDP) in 2005

Figure 7 Multinational Corporations with (regional) Headquarters in Luxembourg

Source: http://www.bed.public.lu/business_location/foreign_investors/index.html, April 2010

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Luxembourgs Role in the European Union

THE NATIONAL BUSINESS ENVIRONMENT

Figure 8 shows Porters National Diamond applied to Luxembourg, analyzing the

Figure 8 Porters National Diamond on Luxembourgs Business Environment

Source: Team Analysis referred from http://www.isc.hbs.edu/pdf/Luxembourg_20050525.pdf

Context for Firm Strategy and Rivalry

Related and Supporting Industries

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Competitiveness and other Business Environment Indicators

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Figure 9 Economic Indicators of Luxembourg (2006-2009)

Furthermore Luxembourgs competitiveness was ranked as follows by different studies:

o Ranked 10th for Total Tax Rate(pg. 218)10

THE FINANCIAL SERVICES CLUSTER

Consisting of private, commercial and governmental banking as well as investment

History & Development of the Cluster

As a result of faster fund registration processes in Luxembourg and the introduction of

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Figure 10 Banks in Luxembourg by Country of Origin

Source: ABBL Banking Statistics 2009, http://www.abbl.lu/useful-information/statistics/banking-sector

Investment Fund Administration

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Figure 11 Evolution of Assets and Number of Funds in Luxembourg

Source: ABBL Fund Industry Statistics 2009, http://www.abbl.lu/useful-information/statistics/fund-industry

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