IE Focus | By Gayle Allard, Professor at IE Business School

We keep hearing about “flexible” and “rigid” labor markets, but what do these terms mean exactly? Does any one model work better than others?

We are hearing a great deal lately about “flexible” and “rigid” labor markets. What exactly does this mean? Is there any particular labor market model that works better than the rest?

Generally speaking a rigid labor market is one in which it is difficult to hire and/or fire workers, because such changes are subject to strict regulations and tend to be extremely expensive exercises. In Spain, up until the labor reform implemented earlier this year, it could take four years for a company to fire a worker who had worked there for many years. These norms seemed to put companies off hiring in general and created a “dual market” where some people were permanent and enjoyed too much protection, while the rest were in a far more precarious position, as well as earning considerably less.  A situation like this tends to reduce a country’s rate of productivity, given that permanent workers have no incentives to be more productive, and temporary employees are unable to produce more because the firm is not willing to invest in training them.

The US model is the most flexible of all, with few regulations governing the hiring process and no law that says fired workers should receive any kind of redundancy pay.  In this kind of model it is easier for workers to find a new job. Before the crisis, the average amount of time that passed between losing a job and finding another was only 10 weeks. The rate of unemployment was lower than in Europe, and the number of long-term unemployed is still lower, even now.

The difference between the two models boils down to two basic issues: job security and who funds the cost of job losses. The European model seeks a greater level of security for the worker than the US model. In the US, it is the individual who takes the hit when jobs are lost. In Europe, the way redundancies are handled varies from country to country. In Southern Europe – Portugal, Italy, France, Spain –, the company covers the cost. In Northern European countries there is a greater tendency toward “flexisecurity”, whereby the state covers the cost of job losses. It is easier for companies there to fire their workers, and the public sector provides generous unemployment benefits and extensive training programs.  These countries tend to have low levels of unemployment, although it has taken years of reforms to learn how to control the situation through the careful administration of large amounts of public spending on support programs for the unemployed.

So which model works best? It is obvious that cultural preferences play a key role. Nevertheless, it is essential to evaluate the results afforded by the different models. In Spain and other Southern European countries the current model has produced very poor results. It would be worth trying out another combination of policies and laws to see if it is possible to achieve better results in terms of productivity, costs, employment and job losses.

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