The Organisation for Economic Cooperation and Development says that policymakers should not back down from financial system reforms that toughen banking regulation.

In a new report, the OECD says that “governments should resist allowing current financial sector reform proposals to be watered down.” It finds that prudential banking regulation can be toughened without undermining competition, and that strong supervision “even appears to reduce the cost of credit for firms and households, as it helps to level the playing field”.

The recommendation comes in a report that looks at the growth prospects of countries in the OECD area, and the need for fundamental reforms to promote growth in those countries. It finds that many countries have seen potential output contract in the wake of the financial crisis and recession. It estimates an average 3% GDP loss across these countries due to higher unemployment and a higher cost of capital.

“The global recession has left deep scars,” said OECD secretary-general, Angel Gurría. “The only way to begin healing them is by taking effective action now to help our economies recover their lost potential.”

For each OECD country the report identifies five priority areas for reform in order to maintain decent standards of living and strengthen economic activity, which often includes action on jobs, competition and taxes.

“One of the biggest risks is that people with weaker ties to the labour market such as older workers, youths, those on low incomes or single mothers, will stop looking for jobs. Governments need to boost spending on training and job-search at this critical time. But they also need to provide the right incentives to the unemployed. This means resisting pressure to relax eligibility criteria for social transfers,” the report says.

Also, action to enhance competition should not wait for a stronger recovery, it maintains. “Reducing obstacles to entering new markets, for instance in retail trade and liberal professions, would stimulate the creation of new businesses and boost jobs. This would also deliver incentives to improve efficiency, including through the weeding out of underperforming firms,” it says.

Some of the tax measures taken in response to the crisis could prove beneficial to long-term growth and should be left intact, says the report, pointing to tax credits to foster innovation and promote green initiatives. “However, because the crisis has wreaked havoc with public finances, some taxes which were cut will need to be raised,” it adds. In general, it recommends shifting the composition of taxes away from income and toward consumption and land.

“To minimize the impact of tax hikes – if the need arises – on growth, policymakers could focus on taxes on consumption (and property), which are less harmful to growth than those on income. Green revenue, from green taxes and carbon trading, could also be used. They would yield a double dividend of contributing to fiscal consolidation and encouraging green growth,” said OECD deputy secretary-general, Pier Carlo Padoan. “Efficiency gains may also be possible in public spending, especially in the areas of education and health care, so that the same social outcomes can be achieved with fewer resources.”

For Canada, it observes that “significant progress has been made consistent with the OECD’s tax recommendations, both on the taxation of investment and on reducing marginal effective tax rates for low-income workers. Progress has been marginal on other key priorities, however.” For example, it notes that no significant action has been taken to reform employment insurance, and no significant change has occurred on hospital funding.

IE