Market incentives and allocative efficiency

Taxation, product and labour market regulation, and trade policies shape market incentives and, as a consequence, influence how firms invest and scale up or how individuals participate in the labour market. By affecting both the allocation of resources and the degree and speed at which resources are reallocated across the economy, these policies play a central role in supporting long-term growth and competitiveness.

A country’s tax structure shapes incentives to work, save, invest, and innovate, with important implications for long-term growth. High personal and corporate income taxes tend to be more distortionary, while consumption and property taxes are less harmful to economic activity. Shifting tax burdens toward more efficient instruments, simplifying tax systems, and strengthening tax compliance through digital solutions can support growth while ensuring sustainable revenues.

Reducing inefficient red tape is key to fostering competition, business dynamism, and innovation. Excessive regulatory hurdles discourage new firms from entering markets and can weaken incentives for existing firms to improve efficiency. Streamlined procedures, digitalisation, “silence is consent” rules, and one-stop shops are examples of reforms that can cut costs and delays, making it easier for businesses to start, grow, and compete.

Regulatory barriers in service and network sectors can restrict competition and have economy-wide effects by increasing the cost of intermediate inputs in the production of other goods and services. Promoting open and contestable markets, particularly by reducing unnecessary entry restrictions, can strengthen business dynamism, enhance productivity, and support long-term growth.

High levels of public ownership can limit market entry, reduce efficiency, and weigh on productivity. Reducing public ownership where competition is viable, and ensuring equal treatment of state-owned and private firms can help level the playing field, strengthen competition, and improve overall market performance.

Beyond public ownership, direct government involvement in business operations – through price controls, production mandates or operational subsidies – can influence how markets function and allocate resources. When such interventions are extensive, they can weaken competitive pressures and hamper productivity. In this context, reducing public involvement in business operations helps create more dynamic, contestable, and efficient markets.

Efficient insolvency regimes are important for market dynamism and long-term growth. By resolving financial distress quickly and predictably, they minimise losses, preserve viable activity, and reduce the personal costs of business failure. This encourages entrepreneurial risk-taking, supports firm entry and exit, and helps redirect resources toward more dynamic and productive firms and industries.

Tariffs act as taxes on trade, raising prices, reducing variety, and shielding domestic producers from competition at the cost of innovation and efficiency. While tariffs on consumer goods may have limited long-term effects, those on intermediate and capital goods distort production, weaken investment, and reduce productivity downstream. Lowering tariff barriers can support openness, competitiveness, and sustained economic growth.

Trade facilitation policies aim to make cross-border trade simpler, faster, and more transparent. They encompass measures such as improving access to information, ensuring consultation with the trade community, rationalising fees and charges, and streamlining processes through automation. Effective domestic and international co-operation, supported by fair and predictable governance, helps reduce costs and delays, enabling firms to integrate more easily in global markets and compete more effectively.

Lowering barriers to services trade can deliver significant growth benefits. Because services account for an important share of the inputs used to produce manufactured goods, restrictive regulations – such as visa quotas, nationality requirements, opaque licensing, or burdensome procedures – can reduce efficiency and weaken competitiveness. Greater openness and transparency in services markets support investment, innovation, and participation in global value chains, helping to boost overall economic growth.

Trade in digital services – such as cloud computing and other online services – can drive productivity by enhancing competition and providing firms using these inputs with cheaper, higher-quality products. Yet barriers to cross-border digital services are rising worldwide, even as they are already higher than barriers to goods trade. Easing these restrictions by improving regulations on network interconnections, online payments, and other digital frameworks could reduce prices, support digital adoption and strengthen growth and competitiveness.

Easing restrictions on foreign direct investment (FDI) can widen access to capital, improve resource allocation, and generate valuable technology and knowledge spillovers across firms. Streamlining approval procedures and reducing barriers to foreign participation – while safeguarding national security – can strengthen competition, productivity, and long-term growth.

Financial and regulatory incentives shape labour market participation. High tax wedges, weak returns to work for second earners or lone parents, and limited benefit degressivity can reduce incentives to take up employment and constrain labour supply. By contrast, well-designed family policies support sustained attachment to the labour market and stronger participation over the long term. 

Adaptability and mobility in labour markets are essential for dynamic and resilient economies. Active labour market programmes, balanced employment protection, and well-designed wage bargaining systems help workers adjust to change and move into new opportunities. Housing policies that support affordability and ease residential moves also play a key role, enabling workers to relocate for jobs and improving the overall efficiency gains from labour reallocation.

Pension design and retirement rules strongly shape labour supply at older ages. Linking retirement ages to life expectancy and phasing out early retirement can encourage longer working lives, supporting the sustainability of pension systems at a time when populations are rapidly ageing.