The debate about the competitiveness of member states in the Euro Area has become more intense, and more controversial, since the Global Financial Crisis and the subsequent Euro crisis. Improving competitiveness is often seen as synonymous with wage cuts and austerity. However, lower wage costs do not always improve competitiveness. First of all, competitiveness can improve even when wages are rising, provided productivity improves as well. Second, when austerity reduces effective demand, productivity will slow down and this may cause a deterioration of competitiveness. Hence, assessing an economy’s labour cost competitiveness requires a more comprehensive analysis that integrates wage bargaining with productivity and growth theory.
In this paper we look at a new method for assessing the competitiveness of labour costs in the Euro Area and apply it to the case of Luxembourg. We conclude by making some suggestions how to deal with this situation.