By Steve Schifferes
Economics reporter, BBC News
Unemployment is still rising at manufacturing companies
The Organisation for Economic Cooperation and Development (OECD) has warned that the UK's recovery will be slow with unemployment rising to 10%.
In its annual health check of the UK economy, the OECD says more must be done to shore up the banking system.
It also warns that in the long-run, there needs to be a "comprehensive plan to rein back debt to a prudent level".
The financial crisis is likely to lead to a permanent drop in the overall size of the UK economy, the OECD says.
Last week, the OECD revised down its short-term outlook for the UK economy to a contraction of -4.3% this year, worse than the government's forecast of -3.5%.
The report from the group that represents that world's 30 richest nations gives a comprehensive overview of the problems faced by the UK economy in the past year and outlines some of the key policies that will be needed to restore it to health.
It says that the length and severity of the downturn means that the UK needs to concentrate on improving productivity - especially in the public sector and the health service in particular - and do more to retrain unemployed workers.
Public sector finances
Health spending must be controlled, the OECD says
The OECD is concerned that the public finances in the UK, which began the decade in a relatively strong position, are rapidly deteriorating.
It lays most of the blame for the growing budget gap on the government's determination to increase investment in public services despite the downturn, and the unexpectedly large collapse in tax revenues.
And it calls on the government to take tougher measures to balance the budget in the future, especially by bigger cuts in future spending plans.
• The government should go beyond the currently announced "value for money" savings with "explicit targeting of programmes for expenditure cuts and temporary revenue-raising measures" to reduce the high debt levels in the current downturn
• The "off-balance sheet" government liabilities - such as PFI contracts, public sector pensions, and the liabilities of the nationalised banks - should be incorporated in setting public debt targets
• There should be a new set of fiscal rules to replace those the government has suspended during the financial crisis, which had called for a balanced budget over the economic cycle as a whole
• There might be a role for an independent fiscal authority to assess whether the government was sticking to its spending rules - an approach that has been tried in some other European countries.
However, in an interview with the BBC, Business Secretary Lord Mandelson has made it clear that the government has no plans to publish its future spending plans before the next General Election which must take place by June 2010.
The other big issue facing the government is how to reform the financial sector.
It is the continuing weakness in the financial sector which is holding back the UK economy, the OECD says.
The OECD backs the broad approach proposed by Lord Turner, head of the Financial Services Authority (FSA), to strengthen capital and liquidity requirements and "macro-prudential" regulation.
However, it urges the UK to take up "constructive engagement" in European and international initiatives - something which the UK was less than enthusiastic about in Brussels last week.
It says that international cooperation is necessary to ensure that "risky activities do not migrate either internationally or to less regulated financial instruments such as hedge funds".
The government is due to publish its own proposals on the future of financial regulation in the coming days, amidst a row between the Bank of England and the FSA as to who should have the lead powers in banking supervision.
The OECD says that "there remains the risk of unhelpful conflict between the Bank and the FSA" which could also lead to issues falling between the remit of the two organisations.
It argues that "it is difficult to reconcile the overall macro-prudential objective within the structure of two independent institutions," and suggests linking them more closely through a joint board with the final authority to take action.