Europe’s dynamism deficit: how rigid labor markets stifle growth
This paper by Benjamin Schoefer repositions Europe’s persistent labor market institutions as drivers of the ongoing transatlantic gap in macroeconomic performance, arguing that while Europe has largely solved its unemployment problem, rigid labor market institutions continue to stifle economic dynamism and innovation through reduced labor market fluidity.
Key arguments
- The persistence of Eurosclerosis
The paper demonstrates that the symptoms of “Eurosclerosis” diagnosed by Herbert Giersch in 1985 remain remarkably consistent today. Europe continues to lag behind the US in GDP per capita (by about 30%), productivity (by about 20%), and hours worked, with the gap having widened since the mid-1990s. The author traces a direct line from the 1985 diagnosis to the 2024 Draghi report, showing that similar concerns about European competitiveness have persisted for 40 years. - Institutional persistence vs. reform
While Europe has undergone comprehensive deregulation of product and financial markets, labor market institutions have remained largely unchanged since the 1980s. Key features that persist include:
– Strong employment protection legislation (EPL) for permanent contracts
– High labor tax wedges (about 45% higher than the US)
– Robust collective bargaining coverage
– Mandated worker participation in corporate governance (codetermination) - The unemployment problem: solved but replaced
European unemployment rates have converged toward US levels, especially since the mid-2000s. However, this improvement came through:
– Active labor market policies inspired by Danish “flexicurity”
– The emergence of dual labor markets with fixed-term and part-time contracts
– Decentralization of wage setting in some countries
The paper shows that about 30% of European employment now consists of non-standard work arrangements (fixed-term and part-time contracts), representing “bad dynamism” rather than genuine flexibility. - Labor market dynamism: the missing link
The paper’s central innovation is shifting focus from unemployment to labor market dynamism among the employed. Key findings include:
– Europeans switch jobs much less frequently than Americans – only about 2.5% of employed Europeans change jobs monthly compared to higher rates in the US
– Europe has many more “old jobs” (lasting 20+ years) and fewer “young jobs” (under 1 year)
– Job-to-job transitions are crucial for wage growth and productivity – the paper shows strong correlations between labor market fluidity and both individual wage growth and aggregate GDP growth - Macroeconomic implications of low dynamism
The paper argues that reduced labor market fluidity impedes Europe’s performance specifically in areas requiring rapid adaptation such as:
– Technology, R&D, and disruptive innovation
– ICT adoption and digitalization
– Creative destruction and reallocation
– Entrepreneurship and venture capital investment
Employment protection legislation appears to discourage risky activities and innovation by making restructuring costly and difficult. - Regional and demographic variations
The analysis reveals persistent regional disparities, particularly between Northern and Southern Italy, and youth unemployment remains disproportionately high (15-20% across Europe). The paper shows that demographic factors, especially aging populations, further reduce labor market dynamism. - The innovation and technology gap
Drawing on existing research, the paper demonstrates that:
– Countries with stricter EPL have lower employment shares in ICT-intensive industries
– Venture capital investment is negatively correlated with employment protection
– Europe’s institutional rigidities may explain its lag in disruptive innovation compared to incremental innovation where it remains competitive
The paper suggests several directions for reform:
- Reforms that boost labor market dynamism without sacrificing worker protections
- Consideration of targeted exemptions or flexibility for high-growth sectors
- Policies that facilitate job-to-job transitions rather than just addressing unemployment
- Portable benefits systems that reduce “lock-in” effects
- Potential sector-specific carve-outs from rigid labor market regulations
Conclusion
The paper concludes that Europe’s labor market institutions, designed for an era of large manufacturing businesses and incremental innovation, may be unsuited for today’s economy that requires rapid adaptation and disruptive innovation. While acknowledging the benefits of the European model in terms of equity and worker rights, the author argues that understanding how these institutions shape macroeconomic outcomes is as urgent now as during the unemployment crisis 40 years ago.
Eurosclerosis at 40: labor market institutions, dynamism, and European competitiveness
Author: Benjamin Schoefer
From: University of California, Berkeley
