B Explanatory
memorandum by Mr Moscoso del Prado Hernández, rapporteur
1 Background
1. In October 2010, meeting in Strasbourg, the enlarged
Parliamentary Assembly of the Council of Europe will hold its annual
debate on the work of the OECD. This provisional report provides
key findings from the rapporteur’s recent contacts with OECD staff,
undertaken in preparation for the debate. This report was reviewed
by the Committee on Economic Affairs and Development and revised,
in consultation with national delegations, before being submitted
for adoption to the enlarged Committee on Economic Affairs and Development
and the enlarged Parliamentary Assembly.
2. The rapporteur expresses his thanks to all those at the OECD
who have helped in the report’s compilation. Their advice and expertise
have been crucial in gaining a broad perspective on the ongoing
effects of the economic crisis, and the challenges it poses for
the future. This year, as last, uncertainty is a dominant theme,
and so this report offers a cautious overview of current data and
key economic trends, together with a discussion of likely developments
over the year to come. As in previous years, it also provides a
summary of the position in individual OECD member countries and
other key emerging economies.
3. Having made an assessment of economic prospects, the report
will examine how the OECD believes that they can be improved. It
will outline the main lessons to be drawn from the crisis, in the
OECD’s view, and how specifically they should be addressed. In particular,
it will discuss issues of corporate governance, including executive
remuneration and risk management, which have proved especially controversial.
Finally, it will look at an important development in the fight against
bank secrecy and tax evasion, jointly undertaken by the OECD and
the Council of Europe, and launched in May 2010.
2 Introduction: prospects
for the world economy
The recovery is stronger than
expected, but risks are increasing
4. Last year’s rapporteur opened her report by quoting
from the OECD’s interim Economic Outlook, which radically downgraded
their forecasts for the year, and spoke of “the deepest and most
synchronised recession in our lifetimes”. Indeed, the scale and
speed of events – a near meltdown in global financial markets, followed by
a collapse in world trade – made it difficult to form a credible
forecast, but the headline figures were dramatic: in the first quarter
of 2009, the GDP of member countries shrank by 2.1%, the fastest
contraction since OECD records began. All the same, the report pointed
to early signs of a “tepid” recovery, based, in their view, on the lessons
of the 1930s having been borne in mind, with open markets maintained
and with broadly correct macroeconomic policy (that is, monetary
and fiscal) responses, as well as measures to support financial markets
and institutions.
5. This view has been borne out by events and, in fact, the pace
of recovery has continued to accelerate, though at varying speeds
across the world. Having contracted by 3.3% overall last year, GDP
in OECD countries is projected to rise by 2.7% this year, well ahead
of the 1.9% forecast last November; next year, steady if unspectacular
growth of 2.8% is expected, as the effects of government stimulus
and industrial restocking fade. Amongst the major OECD economies,
the United States will lead the way, with growth of 3.2% expected
during this year and next. Overall, in its latest economic outlook,
the OECD describes the current situation as “relatively auspicious”.
Strong growth in emerging market economies is contributing significantly. However,
the strength of the recovery greatly differs across OECD areas and
it has been the weakest and the most erratic in the euro area.
6. The key reason for this rapid recovery is that, with a measure
of financial stability achieved, world trade has rebounded. After
shrinking by 11% in 2009, its first annual decline since 1982 (and
registering the steepest monthly falls since the 1930s), global
trade growth of 10.6% is expected this year, and 8.4% in 2011, thereby returning
to pre-crisis levels. This dynamism is very much driven by the larger
non-OECD economies – which, as a whole, registered negative growth
only during the last quarter of 2008 – and particularly China, India
and Brazil. Accordingly, global output growth is expected to be
around 4.5% during this year and next. One impact of the crisis
has therefore been to hasten the decline in weight of the major
developed countries within the world economy, their share of global
trade volumes having fallen by around 2%, and of global industrial
output by around 4.6%.
7. These trends suggest a range of complex, and inter-connected,
risks for the recovery. On the one hand, the relatively slow growth
expected in many OECD economies, and particularly in the euro area
(where 1.2% GDP growth is likely this year, and 1.8% in 2011), is
likely to act as a drag on global growth potential. In addition,
these growth disparities could imply a resumed widening in global
economic imbalances, whereby some countries run huge trade surpluses,
others huge deficits, and much of the increase in world trade is funded
by borrowing. Such extremes disrupt stable investment and growth,
and their emergence in recent years contributed to the recent crisis.
8. On the other hand, there is some danger of “overheating” in
the larger developing economies, which becomes more likely, and
would be all the more significant, as these countries assume a greater
share of the world economy. With sizeable capital inflows from the
rest of the world, and with energy and commodity prices once more
increasing, inflationary pressure is apparent in Brazil and India,
and particularly in China, where stimulus spending has fuelled domestic
demand and a property-price bubble has arisen. The OECD notes that domestic
demand in China has also helped to boost imports and reduce their
trade surplus – which is, so far, helping to lessen the growth of
global economic imbalances – and points out that any “boom-bust”
outcome would have a particular impact on those whose growth is
now driven by exports to China.
Major economies face a post-crisis
“hangover”
9. Apart from these risks, many countries – and particularly
the large, developed economies – face a series of difficult policy
challenges. The financial crisis called for a rapid and massive
response on the part of governments, and this support will need
to be unwound without jeopardising recovery. In the OECD’s view, governments
need to prudently re-tighten monetary policy, bringing an end to
such processes as quantitative easing, and raising interest rates
as appropriate, so as to prevent inflation taking hold; hopefully,
this will avoid the need for dramatic tightening of policy later
on, which would seriously damage growth. The key challenge is to
strike the right balance between policies aiming at achieving fiscal
consolidation while at the same time supporting the recovery and
job creation.
10. At the same time, though, governments will have to address
the consequences of exceptional stimulus spending and the rescue
of debt-stricken institutions. More than €1 000 billion was injected
into OECD countries under fiscal stimulus packages in 2009, and
although broadly successful, these interventions have increased
deficits, leaving some governments carrying levels of debt unprecedented
in peacetime, while social costs (such as unemployment benefit)
have increased and revenue expectations have been slashed. So an institutional
debt crisis threatens to become a sovereign debt crisis, as markets
worry that governments cannot meet their commitments, and this new
crisis of confidence begins to erode the world’s recently recovered
stock indices, and to destabilise foreign-exchange markets.
11. Although the phasing out of fiscal support will to some extent
slow recovery, the OECD feels that countries must begin to end such
exceptional measures now, or no later than next year, depending
on their circumstances. For with rising debt levels having threatened
national credit ratings, countries face an increasing cost of debt-servicing
that will itself hold back growth and make debt even harder to support
in the long term. This threat is compounded, because a synchronised
recession is leading to a synchronised consolidation: with so many
countries curbing spending at once, governments will have little
ability to “grow their way out of debt” in the short term.
12. At this point, the market’s most pressing focus is on the
euro area, with concern about the ability of Greece to service its
debt having expanded to include members such as Portugal and Spain,
along with anxiety over the lack of economic convergence within
the euro area overall, and doubts as to its long-term viability. Market
turbulence and the real prospect of an effective default by at least
one euro member have highlighted the need for a stronger institutional
and operational framework, and for bolder measures to be taken to
ensure fiscal discipline. However, while the euro’s unique structure
makes its difficulties exceptional, it is not alone in facing a
challenge to its fiscal credibility. The United Kingdom is also
faced with a difficult challenge in reducing its budget deficit,
as is Japan – and so too is the United States, though the pace of
its recovery and the dollar’s role as an international currency
have helped to protect it.
13. Meanwhile, although economic activity is picking up, the growth
in jobs is not keeping pace – a very difficult challenge in a period
of financial austerity. Over the last two years, the number of unemployed
in OECD countries has risen by 16 million; the OECD believes that
the rate may now be peaking, at an average 8.5% – well short of
the 9.9% that was predicted last May – but that it is likely to
fall only slowly in the near term. While there may be significant
job creation in the United States, it is likely that in Europe and
Japan increased demand will be largely met by increased working
hours and productivity. The OECD points out that social and labour-market
policy can do much to promote employment in a period of recovery,
especially cost-effective programmes that target those at risk of
being long-term unemployed, and measures that increase labour-market
flexibility. It cautions that schemes aiming to remove labour supply,
such as early retirement, will instead distort the labour market,
while also increasing fiscal pressures.
Long-term growth prospects depend
on decisive action
14. Summing up at the launch of this year’s Economic
Outlook, the OECD Secretary-General described this as “a critical
time for the world economy”. While the overall picture is far brighter
than might have been expected at this time last year, the recovery
is still highly vulnerable. Governments are likely to be carrying
excessive debt levels for some time to come and output gaps remain
large, while the global economy is, once again, in danger of growing
imbalance, and facing inflationary pressure. In short, a recession
unprecedented in modern times is leading to an unprecedented range
of threats and a great deal of uncertainty – with some commentators
now warning of the possibility of deflation, brought on by a combination
of high debt and low growth, or even a “double-dip” recession. Although
the OECD does not see this as likely, it is unsurprising that global
markets and investors lack confidence. Indeed, for the “relatively
auspicious” growth scenario described earlier to be fulfilled, monetary
tightening and fiscal consolidation will have to be successfully
implemented, without derailing recovery, while the groundwork needs
to be laid for long-term growth. Therefore, to address the structural
problems confronting the world economy, the OECD calls for a comprehensive
programme of reforms.
15. In its latest Economic Outlook, the OECD features a series
of predictive models looking as far ahead as 2025, which suggest
that without decisive adjustments to global policy, OECD-member
growth is likely to remain mediocre, while unemployment and fiscal
deficits stay high and imbalances continue to grow. In many countries,
this picture will be exacerbated by demographic trends. But, says
the OECD, such an outcome is not inevitable: a combined package
of measures, beginning in 2011 and involving fiscal consolidation, exchange
rate realignments and structural reforms in most regions of the
world, could add substantially to growth prospects, adding perhaps
2% to 3% to the baseline growth scenario.
16. The current economic crisis had led to record unemployment
in many OECD countries and has given rise to fears of a jobless
recovery. Unemployment and output gaps are likely to remain high.
The rapporteur believes that appropriate labour market and social
policies can do much to promote a job-rich recovery. As countries
face the challenge of fiscal consolidation, it is particularly important
to continue to make room in budgets for cost-effective labour-market
programmes that support workers at greatest risk of becoming long-term
unemployed and thus losing attachment to the labour market. Moreover,
major labour market reforms need to be implemented to raise potential
output, support innovation and prevent high unemployment from becoming
entrenched. Here it should be noted that improving the effectiveness
of national educational and training systems has also been identified
by the OECD as another policy priority related to achieving a strong and
sustainable recovery (the OECD is developing a comprehensive “Skills
Strategy” in this field). This report will examine the lessons that
the OECD believes should be drawn from the crisis, and the measures
they recommend, including the need for financial regulatory reform.
But first, we will conduct a brief survey of specific developments
in the world’s key economies, as viewed by the OECD’s experts.
3 A survey of key
economies
17. Though expected to shrink by 4%, the economy of the
United States contracted by only 2.4% last year, and is expected
to grow by 3.2% this year, and again in 2011. While bank lending
has not yet returned to normal, consumer demand has recovered well,
and corporate profits have rebounded, bolstered by efficiency savings,
particularly in terms of headcount reductions. Job creation has,
accordingly, only been evident in recent months, and unemployment
is expected to remain relatively high, falling back from 9.7% in
2010 to 8.9% next year.
18. This moderate pace of recovery is expected to be sustained,
as households recover from an average 15% fall in wealth and employment
levels begin to rise. With domestic demand increasing, a strong
export performance is likely to help offset increased imports, preventing
a surge in the trade deficit. But despite the positive trends, output
remains below 2007 levels, and capacity utilisation is lower than
at the bottom of the last two recessions. And while large companies
are recovering well, smaller firms are still constrained by lack
of credit. United States growth performance is likely to remain
weaker than it was after recent recessions, with house prices recovering
only gradually, and housing starts remaining at very low levels.
19. For the United States administration, a key judgment will
be the timing and speed of policy stimulus withdrawal. Monetary
policy has already tightened somewhat without adverse effect, but
it is unclear whether output growth is yet self-sustaining. However,
the United States’ fiscal position is poor, with the government deficit
at 10%, and likely to fall only slightly as the current stimulus
programme subsides. Current fiscal plans are therefore unsustainable,
with debt likely to keep rising as a ratio of GDP, and a plan for
fiscal consolidation is needed. At the same time, there are signs
that the recent structural improvement within the United States economy
is petering out, with savings rates already starting to fall as
private consumption rises – posing the risk that the imbalances
that contributed to the recession will widen once again.
20. In Mexico, where the economy contracted by 6.6% last year,
growth of 4.5% is expected this year, and 4% in 2011. A strong export
performance has led the way, but domestic demand is likely to improve
as unemployment falls back, from 5.5% in 2009 to 4.5% next year.
However, oil production remains in decline, and given its important
contribution to government revenues, this calls for caution in fiscal
plans. With a relatively strong exchange rate, real inflation under
control and a large amount of slack still in the economy, the OECD
feels that monetary conditions can be kept supportive to help maintain
the recovery. Canada is also rebounding strongly, with GDP expected
to rise 4% this year and 3.2% in 2011, driven by strong exports,
easy monetary conditions, domestic credit and stimulus spending.
Unemployment is falling, inflation is muted, but the ratio of household
debt to disposable income is at a record high, as are house prices.
The OECD feels that monetary policy should continue to tighten gradually,
while making allowance for the strong currency, and remaining stimulus
measures be allowed to expire, while the government should provide
more detail on its deficit-elimination plans, and embark on the
structural reforms needed to achieve them.
21. Brazil, too, has recovered dramatically, supported by huge
stimulus spending; growth of 6.5% is likely this year, and 5% in
2011. Unemployment has fallen to levels not seen since 2002, though
inflation of 6.2% is expected. Monetary stimulus is being gradually
withdrawn, and strong tax receipts have maintained a primary government
surplus. However, with long-term budget pressures, the OECD welcomes
the 1% spending cuts announced in the budget, which should help
to restrain inflation without the need for interest rate hikes. Meanwhile
in Chile, the recovery was interrupted by the earthquake and tsunami
that struck in February. However, the country is well placed to
finance reconstruction, and under this impetus, growth is expected
to rise from 4.2% this year to 5.3% in 2011.
22. Japan has made an impressive recovery, boosted by demand from
China, which accounts for a quarter of its exports. Total exports
are likely to grow by around 18% this year, while fiscal stimulus
has offset the impact of declining wages and employment. Accordingly,
having contracted 5.2% last year, growth is expected to reach 3%
this year, falling back somewhat to 2% in 2011. However, with industrial
production still below capacity, unemployment is expected to remain
above 4.5%. Despite job-protection subsidies, employment levels
have fallen and this has intensified deflationary pressures, which
had returned with the economic crisis. By early 2010, core consumer
prices were falling by 1% annually, the fastest rate since 2001.
23. The OECD therefore recommends that Japan maintain interest
rates at near-zero levels and, in these exceptional circumstances,
implement qualitative easing measures to restore a degree of inflationary
pressure. At the same time, while fiscal stimulus has helped to
create recovery, it has also helped increase the budget deficit
from 3% of GDP in 2007 to 9% in 2009. Given that overall public
debt is expected to reach 205% of GDP next year, an all-time record
in the OECD, while net debt will be the highest in the OECD after
Greece, there is a need to scale back public expenditure and develop
a credible medium-term plan to bring the budget into balance. This
should include tax reform proposals and sit alongside a growth strategy
that offers reforms designed to boost productivity growth and improve
living standards in the context of a fast-shrinking working age
population.
24. Korea has achieved one of the strongest recoveries in the
OECD, with exports and production surpassing pre-crisis levels.
Now the world’s ninth-largest exporter, it has been helped by a
fall in the value of the won, and demand from China, to which a
third of its exports go. Fiscal stimulus has been reversed, unemployment
has fallen and growth of 5.8% is likely. The OECD feels Korea should
now focus on its deficit-reduction plans and on structural reforms,
particularly in services, while remaining monetary stimulus and special
assistance to smaller firms should be removed.
25. Having slowed to 8.7% in 2009, growth in China is likely to
reach 11.1% this year. There has, however, been a significant structural
shift, with stimulus measures boosting domestic demand as the major
source of growth; so, despite booming exports, the current account
surplus has fallen from around 10% of GDP in 2007, or US$220 billion,
to an expected 2.8% this year, around US$70 billion. Inflationary
pressures are evident, with rising import and commodity prices,
but food prices have fallen and companies have so far absorbed cost increases,
so that headline inflation has reached only 2.8%. However, there
are signs of overheating, especially in urban property prices; measures
have been taken to restrict credit, but further action is suggested to
curb land prices.
26. Growth is predicted to moderate in 2011, to around 9.7%, as
infrastructure spending and other stimulus declines. But with wages
having risen strongly, consumer confidence is high and private sector
investment remains strong, so that the economic rebalancing should
continue and the trade surplus remain subdued. The OECD feels that
progress toward neutral monetary conditions should be maintained,
involving some increase in interest rates, and measures to allow
a gradual appreciation of the currency.
27. Following a poor harvest, a sharp fall in agricultural output
has held back growth in India, though it should still reach 8.3%
in 2010 and 8.5% next year. Export growth has resumed, and the current
account deficit is set to remain below 3% of GDP. Partly as a result
of food costs, inflation has surged to 7.7%, though it should moderate
to 6.1% in 2011. All the same, consumer demand pressures, the curbing
of price subsidies and increases in excise duty are likely to make
inflation a persistent problem, and perhaps the most significant
risk that India faces, especially if there is a further harvest
failure. In addition, the substantial budget deficit may cause government
borrowing to exert pressure on firms’ own borrowing costs. The OECD
notes that steps have been taken toward fiscal consolidation and
the ending of support measures introduced during the crisis. Interest
rates have begun to rise, though they are still at historically
low levels, and sizeable monetary tightening is recommended in the
coming months, to help control inflation.
28. In Russia, GDP has bounced back from a contraction of 7.9%
last year, to 5.5% growth in 2010, with 5.1% expected next year.
Higher oil prices have helped to drive up the current account surplus;
but with rising real wages and higher capital inflows, domestic
demand is also likely to improve strongly, despite restricted availability
of credit. Inflation, meanwhile, has fallen back. The OECD feels
that this unexpectedly strong recovery provides a platform for fiscal
deficit reduction and that measures to support demand should now
be phased out, while longer-term structural measures, such as those
promoting competition and innovation, should be prioritised.
29. The euro area has experienced a moderate recovery, with growth
likely to strengthen from 1.2% this year to 1.8% in 2011. This has
largely been driven by domestic stimulus and demand in export markets,
which is now being bolstered by a weakening currency. Exports from
Germany and France are expected to grow by around 10% this year,
and business confidence here has recovered – as it is also doing
in Italy, though having recently lost competitiveness and without
strong markets in the developing economies, firms there are finding it
hard to build export share.
30. Employment levels are ceasing to fall, though unemployment
is likely remain stable, at over 10% during this year and next.
Inflationary pressures remain subdued, reflecting considerable spare
economic capacity. Investment is likely to recover only gradually,
given weak growth prospects and, crucially, the uncertainty caused
by current financial market turbulence, which itself jeopardises
the chances for recovery in at least some member countries.
31. The decline of stimulus support measures, and in particular
the phasing out of “car-scrapping” schemes, had a negative impact
on growth in many countries during the early part of 2010. With
housing markets still generally weak, and many households concentrating
on paying down debt, monetary policy has therefore been accommodating.
Instead of focusing on consumption increases, the OECD thinks interest
rates in the euro area should rise as confidence returns and the
economy strengthens,
32. The euro area budget deficit rose from 2% of GDP in 2008 to
6.3% in 2009 and, while there is substantial variation between members,
a determined process of fiscal consolidation is clearly needed (given
that this average is more than double the Maastricht criteria of
3%). Several euro members – notably Greece, but also Ireland, Portugal,
Spain and Italy – have promised, or are implementing, early and
in some cases drastic action to tighten their fiscal plans, despite
some of them still being technically in recession. But it is not
clear that these will be sufficient, in all cases, to restore lost
confidence. The OECD suggests that every effort should be made to
present credible and transparent plans, based on measures that have
a good track record in achieving results. It also points out that
other countries, such as France, will now need to present credible
medium-term fiscal consolidation plans, and that Germany, too, will
face challenges in meeting its newly passed deficit reduction rules.
33. Prompt and massive response by euro-area governments and the
European Central Bank have calmed financial market turbulence, but
the region’s underlying weaknesses are far from settled. Moreover,
as the instability has gone on, the markets have raised broader
concerns about the perceived internal contradictions of the currency,
and even cast doubt upon its long-term viability. Such concerns
will need to be directly addressed, the OECD says, by strengthening
the area’s financial regulatory and supervisory architecture, and firmer
adherence to rules. There is certainly a need for stronger oversight
of domestic policies, taking account of competitiveness issues,
and consideration should be given to the following options: external
auditing, effective sanctions for non-compliance, and even the possibility
of de facto fiscal union. It has now become evident that stronger
institutions, stronger enforcement procedures and a stronger will
to introduce unpopular reforms are essential – indeed a “quantum
leap” in the euro-zone economic governance.
34. After the deepest recession since the 1930s, the United Kingdom
economy has returned to growth, led by household and government
consumption, and some recovery in export performance. GDP, which
fell by 3.1% last year, is likely to grow by 2.2% this year, though
the recovery will only gain strength next year, when growth will
be 2.6%. Unemployment, which was at 5.4% in 2007, will ease back
from 8.1% this year to 7.9% in 2011 (these figures refer to 4th
quarter over 4th quarter rates). Though wage growth is subdued,
headline inflation has reached 3%, driven in part by the phasing
out of VAT cuts at the start of the year – but the overall outlook
for inflation remains highly uncertain. Given the United Kingdom’s
very high public debt, the OECD believes that far-reaching fiscal
consolidation plans will need to be announced this year, and that
monetary tightening will need to continue. Moreover, it warns that
if inflation should turn out in excess of expectations, further
fiscal and monetary measures may be unavoidable.
35. Throughout central and eastern Europe, similar processes of
fiscal adjustment and restructuring are getting under way. In Hungary,
where an end to recession is expected soon, the initial success
of public spending reforms has boosted investor confidence and supported
the currency, but recent concerns about the prospect of default
highlight the scale of the challenge in restoring finances. The
Slovak Republic, which expects 3.5% growth this year on the back
of strong exports, has put forward an ambitious programme of spending
cuts, while Poland, which led the way in growth amongst OECD members
last year, is continuing to perform strongly and has announced some
consolidation measures. However, further steps are awaited here that
would allow the country to meet the Maastricht criteria. In the
Czech Republic, which withdrew fiscal stimulus measures early and
began limited consolidation, further spending restraint is generally
agreed to be necessary, but no consensus has yet been reached on
how to achieve it.
36. In Turkey, meanwhile, the economy has rebounded, with a strong
export performance likely to bring 6.8% growth this year. The rapidly-growing
labour force means that unemployment levels are expected to keep rising,
but domestic and international confidence continues to improve,
boosted by prudent macroeconomic management. Ongoing progress in
fiscal transparency should maintain this progress, while the OECD
also recommends labour-market reforms that would improve competitiveness
and the economy’s ability to create jobs.
4 Specific areas
of OECD activity examined in depth
4.1 Lessons of the
crisis – A strategic response
37. The OECD believes that the global response to the
crisis has been impressive, with co-ordinated action taken on a
sufficient scale, and with sufficient speed, to avert its worst
consequences. This success has only confirmed the need for all major
players to be involved in economic governance, and to address the weaknesses
and failures – particularly those of regulation and economic imbalance
– that have become evident. In the OECD’s view, this means creating
a new global model of economic growth, a task that becomes ever
more complex, and more essential, as the number of major players
increases along with the expansion of world trade. On the other
hand, these competing economic models directly influence the work
and perceptions of the OECD through its member countries.
38. In addition, as previous sections of this report describe,
the recovery is fragile and many countries face a difficult immediate
task in stabilising their economies, particularly in reconciling
economic and social support with the need to achieve more sustainable
finances. But even so, the OECD believes the lessons of the crisis need
to be drawn without delay, such as the importance of policy advice,
setting standards, and monitoring effective implementation by member
countries, partly because there are short-term economic benefits
to be gained from rapid action, and partly because, as they put
it, “the long term starts now”.
39. From the early days of the crisis, the OECD has maintained,
and kept constantly updated, a “Strategic Response to the Crisis,”
which acts as a resource for reform and development, and forms part
of the action plan agreed at the G20 London summit. It highlights
the need to align financial sector regulations and incentives, so
as to achieve more effective oversight and risk management. And
it calls on governments to respond to the economic imbalances and
structural limitations highlighted by the crisis, through co-ordinated reform
of national policies. Most OECD countries, it says, could improve
their immediate growth prospects by measures such as the reform
of anti-competitive product market regulation, the reduction of
tax burdens for low-income workers, a focus on environmentally friendly
technologies and more effective training programmes for the unemployed.
40. Overall, the “strategic response” has three key themes:
41. Growth should be stronger: in
order to avoid the mediocre growth described earlier in this report,
we need more stable international markets and more effective national
policies. Certainly, there needs to be better regulation of financial
markets, to encourage a better relationship between the search for
return and the assessment of risk, while at the same time striking
a healthy balance between business and governments. This includes
reforming capital regulations, to reduce the amount of leverage
placed at risk and improve liquidity management, while also streamlining
the international regulatory framework, to improve governance and ensure
disclosure and accountability to owners and creditors. In the future,
when a better regulatory system is in place, the OECD believes that
those who place capital at risk, including large creditors, should
be allowed to lose money when things go wrong; at the same time,
they point out that the increasing complexity of financial products
and instruments will require improved education and protection schemes.
42. Stronger growth also requires that governments address the
imbalances within their economies, so that national instability
is avoided and global imbalances are not allowed to widen once more.
In part, this means the successful unwinding of emergency support
measures, but more fundamentally it entails correcting disproportionate
levels of savings, investment and consumption. In recent years,
saving and spending rates have diverged between economies, as some
have become excessively focused on consumption and some on production.
Governments have a big role in influencing this – for instance,
by not borrowing excessively themselves and siphoning off resources,
by not distorting markets, but also by ensuring that there is adequate social
protection and pension provision, so that consumers are not induced
to save excessively. A sustainable growth model requires that savings
and investment are well distributed globally, and not excessively concentrated.
Moreover, innovation policies are needed more than ever to create
new products, jobs and possibilities to tackle the lasting effects
of the crisis.
43. Growth should be cleaner:
the crisis has shown, once again, the distorting effect of relying
on finite resources, which are subject to heavy price swings, while
causing pollution and waste, thereby both lowering living standards
and creating inefficiencies. Overall, the world economy is substantially
more resource-efficient than it was a generation ago; but with its
rapid expansion, the imperative is greater than ever to move to
a new low-carbon model of energy and resource management, which
will, in turn, do much to raise living standards and has a huge
potential for creating high-quality and productive jobs. Future
growth needs to be smarter and more knowledge intensive, and this
is more than ever possible with the spread of communications and information
technology. Moreover, such a transition is vital in the fight against
climate change – and increasingly, we have learned that investments
that are harmful to the environment should not be made simply so
as to support the economy, for they contain hidden costs for future
generations. These objectives can be assisted by “green” tax reform,
ending subsidies to fossil fuel production and consumption, and
by removing barriers to energy efficiency. Also, many of the stimulus
programmes emphasised environmentally friendly infrastructure, such
as power and public transport projects, and these can be used to
give new impetus to public and private investment directed toward
a low-carbon economy. In this respect, the rapporteur welcomes the
OECD’s work on the Green Growth Strategy which has become an important
flagship project.
44. Growth should be fairer: for
future growth to be socially sustainable, more effective trade and development
policies are needed, with common principles of global governance,
based on co-operation between developed and emerging economies.
OECD members can obtain much greater impact from their international
development efforts, if they ensure that these take place on a more
level playing field, with policies and resources more effectively
co-ordinated, and deployed in partnership with recipients. And increasingly, development
efforts need to pay attention to open markets; it is a great success
in the response to this crisis that free trading principles have
been maintained and the energy and speed of recovery shows what
a powerful force an open trading system can be. But we now need
to ensure this is built on, both by ensuring that any distortions
put into the market are removed, and also by extending trade opportunities
more broadly than before. Not only will this help to build a stronger
trading system that delivers greater prosperity for all, but will specifically
help to increase opportunities and living standards for the world’s
least developed countries.
45. Moreover, all round the world, growth must be focused on increasing
employment – unemployment breeds poverty and hinders long-term growth,
while the social deprivation it causes can exacerbate the very protectionist
and isolationist sentiments that make poverty itself so difficult
to tackle. With only a slow short-term fall in unemployment expected
in most OECD countries, the strategy suggests a range of employment incentives
and schemes, and suggests that a priority be placed on encouraging
new businesses, pointing out that nearly all the additional private
sector employment in the United States seen over the last twenty-five
years has come from companies less than five years old.
46. The “strategic response” also emphasises the contribution
to fairer growth made by strong health care, and particularly by
educational policies. Launching the OECD’s Innovation Strategy in
May, the Secretary-General noted that, as part of stimulus measures,
many governments had wisely raised spending on education and research.
As the focus now turns to spending restraint, he suggested that
waste can be curbed by steps such as reforming universities, cutting
red tape and sharing research data, and that in many countries there
is a great deal of scope for rationalising policy so as to foster
innovation and research investment so that, in short, a simpler
approach could make research more productive.
47. Of course, these efforts to encourage growth that is at once
stronger, greener and fairer rely on transparency. The world needs
growth that is demonstrably equitable and respects the rights of
all. This entails initiatives to combat corruption, bribery, tax
evasion, bank secrecy, and to promote equal opportunities and a fair
basis for investment, whether at a local, global or national level.
Of course, tackling these areas requires a relentless focus, but
they are indispensable to fulfilling economic potential, and the
OECD believes that solutions must be internationally co-ordinated,
continuously applied and constantly monitored and verified. This is
especially true for the OECD Convention on Combating Bribery of
Foreign Public Officials in International Business Transactions
(Anti-Bribery Convention). Implementation
of this legally binding instrument by its 38 parties is rigorously
monitored by the Working Group on Bribery in International Business
Transactions.
48. To assist in the development of this new economic model, the
OECD is involved with the Global Standard initiative. Launched by
the G8 last year, and also known as the Lecce Framework, the Global Standard
is a co-operative forum of international organisations, which aims
to build on existing international tools and instruments so as to
develop a common set of principles and standards. The Financial
Action Task Force on Money Laundering, World Bank, IMF, and Financial
Stability Board are amongst other key members. On 25 May 2010, OECD
ministers adopted a “Declaration on Propriety, Integrity and Transparency
in the Conduct of International Business and Finance”. The issues
addressed by the declaration include competition, corporate governance,
investment and responsible business conduct, financial regulation,
tax co-operation, anti-corruption, interaction between government
and business, financial literacy and consumer protection.
49. Naturally, those collaborating on the Global Standard are
taking into account other current international initiatives, in
particular the Global Charter for Sustainable Development. Accessibility
is also a priority for those involved with the Global Charter, which
is regarded as “work in progress” and aims to generate informed opinions
and contributions and to stimulate debate.
4.2 Lessons of the
crisis for corporate governance
50. As discussed above, the OECD regards corporate governance
as a crucial area in which lessons need to be learnt, and best practice
extended, in the aftermath of the global crisis. Over the last eighteen
months, the OECD Corporate Governance Committee has consulted widely,
conducted a series of meetings that included representatives from
Brazil, Russia, China and India, and in February published its conclusions
in a paper entitled “Corporate governance and the financial crisis”.
51. The committee found that corporate governance weaknesses had
played an important role in the development of the crisis, particularly
in terms of remuneration, risk management, board practices and the exercise
of shareholder rights. And they found that such weaknesses are not
confined to financial sector companies, but exist more broadly.
Reviewing the specific failures that have taken place, it was felt
that the OECD Principles of Corporate Governance (first published
in 1999, and updated in 2004) provide a good platform to address
the failures, and that the priority should be to see these principles
thoroughly adopted, rather than to replace them. Here, we’ll examine
some of the key points these principles set out, relating to the major
weaknesses revealed.
52. As a preliminary, it should be noted that corporate governance
is an immensely complex field, and that a “one size fits all” approach
is often unworkable or inappropriate. Hence, the OECD continues
to believe that the use of self-regulating codes and standards is
preferable to tightly defined regulation. Nevertheless, given clear
recent instances of regulatory failure, the paper calls for jurisdictions
to regularly review the capacity of their supervisory and enforcement
authorities, to ensure that best practice standards are adopted,
that correct monitoring is in place, and that they are updated as
and when appropriate.
53. Executive remuneration is perhaps the most highly charged
public policy issue of corporate governance. Many countries have
therefore introduced, or are considering, rules that curtail or
regulate executive pay packages.
54. The committee’s report reaffirms the position of the principles
that a company’s board is responsible for setting out clear strategic
goals and a judgment on the level of risk that is acceptable; it
is then the board’s responsibility to establish a compensation structure
that meets a range of performance metrics based on these goals.
Well-designed and transparent procedures are therefore required,
but companies do need to have the flexibility to adjust their policy
to suit their own conditions. Therefore the steering group suggests
that legal limits and caps be applied only in exceptional circumstances,
and it also warns against regulations that might tend to make the
fixed element of compensation packages become excessive.
55. The report suggests that the first priority is that compensation
be set through an explicit governance process in which the roles
and responsibilities of all are clear; beyond the board, this includes
limiting the influence of company managers, defining the part played
by compensation consultants and ensuring the boards have sufficient
information to exercise objective and independent judgment. Secondly,
while disclosure is obviously important, transparency is crucial:
companies should be able to explain their remuneration strategies
clearly and concisely, including an assessment of the total cost,
performance criteria and the degree of adjustment involved due to
risk.
56. This will address the weaknesses seen in some schemes today,
which can be obscure and overly complicated, and have links between
performance and remuneration that are weak, or based on too crude
a range of metrics (such as a company’s stock price), or where rewards
are given before the performance is realised. It should then be
seen as good practice for remuneration policies to be submitted
to a company’s annual meeting – and, where this is appropriate,
put up for shareholder approval. Such “say on pay” measures have
been widely introduced in recent years and, even when non-binding,
have been shown to be effective in raising the level of compensation
package design and transparency, and in building shareholder confidence.
57. Risk management is another area of corporate governance put
under the spotlight by the crisis. As with remuneration policy,
an important conclusion of the weaknesses revealed is that company
boards need to be responsible for establishing and overseeing enterprise-wide
risk management systems, with clearly defined responsibilities for
all involved in the process.
58. In most cases, the OECD says, risk management is still insufficiently
addressed in corporate governance codes, and this was evident during
the financial crisis, with company boards sometimes ignorant of
the risks for which they were responsible. For financial companies,
which operate in a volatile environment and which trade via short-term
borrowing and long-term lending, the requirements for oversight
are stringent, and the failures have been obvious. But companies
outside the financial sector also face significant risk issues,
for instance relating to health issues for pharmaceutical and food
companies, and oil spills for a petroleum company.
59. To address this, the OECD says risk-management policies need
to be more forward-looking, more clearly expressed and closely related
to company strategy. In many companies, the board is advised on
risk by the Chief Financial Officer, and a great deal of risk oversight
is delegated to the company’s audit committee, but the OECD recommends
that a Chief Risk Officer, reporting directly to the board, should
be regarded as best practice, supported by risk managers who are
not separated from company management, but are independent of corporate
profit centres. In addition, there should be a degree of external
disclosure so that, without breaching commercial confidentiality,
markets and investors can be made aware of relevant risk factors in
an understandable way, and can be confident that the board has a
clear idea of what their risk policy is. It is also worth pointing
out that the design of executive compensation programmes is inevitably
related to the risk policy of a company, and should therefore be
included in any risk management system.
60. The performance of company boards have come under a great
deal of scrutiny, in part because of the issues discussed above,
but also more broadly. Many criticisms have been made of part-time
boards, and their ability to discharge their duties effectively
and independently, which the OECD’s principles set out as their essential
function. To perform better, says the OECD, boards need to be properly
supported. For instance, the chair should be able to ensure that
the board tackles the most important issues facing the company,
and should be provided with the tools and information needed to
build appropriate management structures, such as those relating
to risk management. The role of chair should, in general, be separated
from that of CEO, and board members should have access to specialised
training, while also being subject to periodic evaluations. When recruiting,
some sort of board nomination committee should be formed, to specify
the skills required and identify potential candidates – and, equally,
shareholders themselves should be able to nominate board members
and play a significant part in their appointment.
61. The role of shareholders has also been questioned; in the
run-up to the crisis, shareholders were often seen to be reactive,
or merely passive, in approach, and rarely presented any sort of
challenge to company boards. Some have associated this problem with
the growing importance of institutional investors, who also pose
increasing conflict of interest questions. This is a particularly
complex area, with many variations between national jurisdictions,
so “one size fits all” solutions are difficult. Overall, however,
the OECD says participation can be improved by removing barriers
to voting, by more flexible voting mechanisms, and by increasing incentives
to vote (though equitable treatment needs to be assured for all
shareholders). It also suggests that more effective alignment between
private and public enforcement instruments could encourage the growth
of more active and informed shareholders.
62. Meanwhile, good practice requires that investors disclose
voting records, so that there is transparency over any conflicts
that exist, and institutions should disclose any codes or principles
they follow in exercising their rights. It is, too, important that
companies disclose the voting results of shareholder meetings. The authorities,
meanwhile, need to ensure good co-operation between shareholders
regarding voting by making sure that “acting in concert” rules are
clear and understood; and, lastly, the provision of proxy advisory
services needs to take place in a transparent and competitive environment.
4.3 Update on OECD
enlargement and enhanced engagement
63. Formed in 1960 with a membership of 20 countries,
the OECD has in recent years pursued a strategy of vigorous expansion
and outreach. For while its original membership represented the
key economic players at that time, the organisation had to grow
to reflect the expansion of trade and to maintain its position as
an influential voice in the world economy. Accordingly, the membership
of the OECD rose to 30 countries by 2000 and, in May 2007, OECD
countries decided to open accession discussions with five countries:
Chile, Estonia, Israel, the Russian Federation and Slovenia. The
accession processes of four of these countries have now been completed.
Chile formally became an OECD member on 7 May, Slovenia on 21 July
2010, and Israel on 7 September 2010, bringing the total membership
to 33 countries. Estonia will become a member as soon as her domestic
procedures have been completed. The process for the accession of
the Russian Federation is now well under way.
64. The OECD accession procedure is an extremely rigorous and
demanding process for a candidate country with in-depth reviews
by some 20 OECD committees in diverse fields from investment to
anti-corruption, from environment to fiscal affairs, from public
governance to scientific and technological policy. An “accession
road map” sets out the terms, conditions and procedure for the accession
of each country. Each committee examines the candidate country’s
willingness and ability to implement OECD legal instruments and the
degree of coherence between the policies of the candidate country
and those of OECD members. The committee then makes a set of recommendations
for further action by the candidate country, some of which need
to be implemented before OECD accession. At the end of the process,
the OECD Council decides whether to invite the candidate country
to become a member on the basis of “formal opinions” from each of
the committees as well as all other relevant information.
65. One of the most remarkable features of the OECD accession
process is its transformational nature. In each case, the accession
process has been a catalyst for reform and the candidate countries
have acted quickly and resolutely in responding to OECD recommendations
through changes in legislation, regulations or policy. As a result
of the accession process, Chile adopted key legislative reforms
to ensure full exchange of bank information for tax purposes in
line with the OECD standard, to create liability of companies for
bribery and to improve the corporate governance of both state-owned
and private companies. Estonia liberalised market access for OECD
investors in its financial services sector and adopted legislation
for better corporate governance of state-owned enterprises. Israel
joined and took significant steps to implement the OECD Anti-Bribery
Convention, further liberalised its financial services sector and
agreed to make changes in its framework for the protection of intellectual
property rights. In the run-up to the decision on its accession, Slovenia
adopted major legislation to reform its corporate governance framework
for state-owned enterprises, creating a new central ownership agency
to manage the state’s interests in these companies.
66. As regards Israel, overall the accession process has been,
says the OECD, “a catalyst for reforms”. The OECD points to a series
of rapid developments which have resulted from discussions with
Israel. These include Israel’s signature of the OECD Anti-Bribery
Convention, having made relevant legislative changes, and a comprehensive
review of environmental standards and regulations, culminating in
a commitment at the Copenhagen summit to cut greenhouse gases by
20% by 2020. In addition, the OECD’s review of Israel’s labour market
and social policy (published in January 2010) focusing on the situation
of Israeli-Arabs and ultra-Orthodox Jews has had what the OECD calls
“an immediate and high-level impact” on policy discussions. So, too,
have the findings of last year’s OECD “Economic Survey of Israel”,
particularly in relation to the need for improving education opportunities
throughout the population.
67. During the accession process, there was much debate and discussion
as to the geographical scope of Israel’s statistical data. Since
this includes data on the Golan Heights, East Jerusalem and Israeli
settlements in the West Bank, a footnote will be included in all
relevant OECD documents stating that this data is the responsibility
of the Israeli Government and that its use by the OECD is without
prejudice to the status of these areas under international law.
In specific subjects, however, such as population, labour force,
poverty and household income, Israel will provide data broken down
separately for these areas. Meanwhile, within a year of the date
of its accession, Israel will take part in a joint study with the
OECD to measure the impact of including these areas in key economic
and social aggregates. This is an unprecedented step, which will
help to clarify reporting for the future.
68. Beyond the accession of these five countries, the OECD is
determined to continually expand and deepen its global relationships,
especially with the major emerging market economies. Accordingly,
a process of “Enhanced Engagement” has been offered since 2007 to
Brazil, China, India, Indonesia and South Africa. It aims at promoting
the engagement of these countries in core OECD work and their active
participation in OECD committees, regular economic surveys, and
peer reviews in specific policy areas, as well as their adherence
to OECD instruments and integration into OECD information systems.
In the future, such co-operation will only intensify and in the
long term, of course, it has the potential to lead to OECD membership, should
the countries involved wish to do so. In addition, the OECD continues
to develop its policy dialogue and co-operation with a broader range
of non-member economies through a series of global forums in key
policy areas and in the framework of regional initiatives including
with South-East Asia as a region of strategic priority interest,
Africa, Eurasia and Latin America.
4.4 The OECD and the
Council of Europe: working together to beat tax evasion
69. For many years, the OECD has worked to improve transparency
and exchange of information in order to beat tax evasion – with
mixed results. But at last year’s London summit, the G20 declared
that “the era of banking secrecy is over” and affirmed the readiness
of members “to take action against non-co-operative jurisdictions,
including tax havens”. In addition, they called for action “to make
it easier for developing countries to secure the benefits of the
new co-operative tax environment, including a multilateral approach
for the exchange of information”. Thus, the year 2009 saw unprecedented
progress on international tax co-operation: the OECD Global Forum
now comprises more than 90 countries including all OECD and G20
members and the OECD principles on transparency and exchange of
information are now generally accepted.
70. To combat tax evasion, information exchange between states
is paramount. If bilateral treaties can be viewed as a useful step
in the right direction, (and some 3 000 currently exist), a comprehensive
multilateral convention offers far greater advantages, as has been
made clear in the G20 discussions. A multilateral approach has an
obvious benefit in setting a uniform standard for information exchange,
as well as providing adequate guarantees for the respect of taxpayer
rights. Both the OECD and the Council of Europe have long been leading
activists in this field, and over the last year have substantially
renewed their co-operation. In response to the G20’s declaration,
the OECD and the Council of Europe have together developed a protocol (CETS
No. 208) that amends the Convention on Mutual Administrative Assistance
in Tax Matters (ETS No. 127), aiming to reflect technological developments
in information transfer, to bring it into line with the “international
standard on exchange of information for tax purposes” – the leading
code of its type, which was originated by the OECD, and with G20
support has facilitated rapid improvements in international banking secrecy
regulations and thus to counteract tax evasion and tax avoidance
– and to open it up to countries that are neither members of the
OECD nor of the Council of Europe.
71. The convention, originally opened for signature in 1988, was
prepared jointly by the Council of Europe’s Committee of Experts
on Legal Co-operation and the OECD’s Committee on Fiscal Affairs.
In many ways, it was ahead of its time, in pushing for more structured
international collaboration on information exchange to combat tax
evasion. The convention was designed to apply to all taxes, other
than customs duties, and covers a broad range of tax matters, including
provisions for cross-border exchange of information, multilateral simultaneous
tax examinations, service of documents, cross-border assistance
in tax collection, recovery and judicial prosecution. In addition,
it imposes extensive safeguards to protect the confidentiality of
the information exchanged. As the protocol enters into force, the
convention will become an even more powerful tool for multilateral
tax co-operation as it will enable a wider group of countries to
become parties, while requiring full exchange of information on
request in all tax matters, without regard to a domestic tax interest
requirement or to any claim of bank secrecy for tax purposes.
72. It is hoped that the pioneering work of the convention will
now achieve a new scale and scope. Previously, the convention had
been ratified by 14 of the 54 states to whom it was potentially
applicable, and signed but not yet ratified by Canada, Germany and
Spain, while only two G8 members, Russia and Japan, had yet to sign.
In May, the updated convention was presented at the annual OECD
ministerial meeting in Paris, and was signed by 11 countries already
parties to the convention (Denmark, Finland, Iceland, Italy, France,
Netherlands, Norway, Sweden, Ukraine, the United Kingdom and the
United States). In addition, Korea, Mexico, Portugal and Slovenia
have signed both the convention and the protocol. Poland signed
the protocol on 9 July 2010.
73. Speaking at the signing ceremony, the OECD Secretary-General
described the new protocol as “another success story in the fight
against offshore tax evasion”, and praised the speed with which
OECD and Council of Europe officials had been able to bring it forward.
And with increasing international awareness of the revenues lost
to tax evasion, he predicted that the number of signatories will
“increase exponentially in the near future, thus making the Convention
a keystone for international tax co-operation”.
5 Concluding remarks
74. The most important consequence of the economic crisis
is the massive level of public borrowing. The rapporteur is concerned
that government stimulus programmes and rescue packages have led
to a sharp deterioration of public finances in many OECD countries.
Governments will therefore have to address the consequences of exceptional
stimulus spending and the rescue of debt-stricken institutions.
More than €1 000 billion was injected into OECD countries under
fiscal stimulus packages in 2009, and although broadly successful,
these interventions have increased deficits, leaving some governments
carrying levels of debt unprecedented in peacetime. At the same
time, social costs (such as unemployment benefit) have increased and
revenue expectations have been slashed. Public spending cuts and
tax rises to deal with "very unfavourable government debt dynamics"
(as the OECD has warned in its Economic Outlook) seem indispensable
in advanced economies by next year at the latest. The rapporteur
agrees with Mr Pier Carlo Padoan, the OECD Chief Economist, who
stated: "Exit from exceptional fiscal support must start now, or
by 2011 at the latest." Budgetary plans should be "based on credible
and well articulated medium-term consolidation plans to restore
fiscal soundness". At the same time, the rapporteur believes that
the key challenge is to strike the right balance between policies
aiming at achieving fiscal consolidation while at the same time
supporting the recovery and job creation. We must be flexible in
adjusting the pace of consolidation and learn from the mistakes
of the past when the fiscal stimulus was too quickly withdrawn.
75. Moreover, it is not enough to rein in the deficits in reaction
to what has happened. Countries across Europe need to fundamentally
change the way they deal with public finances so that debt crises
of this magnitude can never happen again. That means that the stability
pact must be taken seriously. There must be better safeguards against
member states spending and borrowing too much and an early-warning
system to identify problems before they get out of hand. Public
trust in our political institutions is also being severely tested.
The eurozone faces huge pressures from a “one size fits all” monetary
policy and there may be further shocks in the system to come. Therefore,
the measures to strengthen the eurozone should aim at three objectives:
tighter fiscal rules, efforts to boost competitiveness as well as
economic growth and job creation, and the installation of a crisis
resolution mechanism to avert or at least to cope more effectively
with Greek-style emergencies.
76. To buy time for budgetary tightening, the OECD rightly said
that countries should publish detailed plans on how to get their
public finances in order, be clear about what they would do if different
circumstances arose, cut spending rather than raise taxes and enhance
the credibility of their plans by subjecting them to independent
monitoring. However, the rapporteur believes that many OECD countries
need to reconcile support for a still fragile recovery with the
need to move to a more sustainable fiscal path. In other terms, governments
must tackle structural reform if they are to cope with the damage
wrought by the economic crisis and avoid future financial collapses.
Moreover, innovation policies are needed more than ever to create
new products and jobs, and to tackle the lasting effects of the
crisis.
