The term “Eurosclerosis” was coined by German economist Herbert Giersch to describe what he saw as Western Europe’s economic stagnation. It captured a mix of high structural unemployment, weak job creation, and sluggish growth —, especially in contrast to the more dynamic U.S. economy. Giersch attributed Europe’s malaise to a combination of inflexible labor markets, institutional rigidities, high taxes, and excessive government spending.
Sounds familiar? If it does, then it is because Europe has failed to address many of the issues that were already a problem some decades ago. But let’s start from the beginning.
Europe’s structural unemployment problem in the 80s and 90s
The two oil shocks in the 1970s transformed the economic landscape. They caused a substantial surge in inflation that would last for almost a decade. It is now acknowledged that central banks contributed to the problem by running easier monetary policy than warranted.
In 1979, the Fed finally decided to break inflation’s neck. A massive surge in interest rates and a stronger dollar led to the so-called “Volcker recession” (named after the chairman of the Fed back then). While unemployment rose, the economic downturn brought inflation down.
European central banks adopted tighter monetary policy in the early 1980s (the exact timing varied slightly by country). The main difference to the U.S. was that the initial labor market shock to the economy turned out to be highly persistent. While the increase was temporary in the U.S., excessive unemployment became a permanent feature in European labor markets, getting worse with each economic downturn.
Many laid-off workers in Europe — especially in manufacturing — struggled to rejoin the labor market. Deindustrialization and sluggish economic growth led to a continuous increase in Europe’s unemployment rate throughout most of the 1980s and even early 1990s.
While only a small share of workers historically remains unemployed for over a year in the U.S. — typically less than 10% — the fraction across European economies has always been significantly higher, ranging from 20% in the U.K. to 60% in Italy!
Canada and Denmark are the only two countries that were experiencing even shorter unemployment spells coming out of the pandemic. Both economies are known for having more flexible labor markets.
Why European labor markets have struggled to create jobs
Numerous structural problems have been weighing on European economies, making it harder for labor markets to function smoothly. These rigidities have not just affected the way businesses work but also shaped the opportunities available to workers.
Strong labor unions and worker codetermination: When unions negotiate wages above market levels and lock in inflexible pay, firms become significantly more cautious about hiring. This creates an insider-outsider divide: those with union jobs are protected, but at the expense of outsiders (often younger and/or inexperienced workers who struggle to get a foot in the door). Similarly, worker codetermination limits company flexibility and prevents firms from making the necessary workforce adjustments, especially during economic downturns.
The case of Italy shows how collective bargaining can harm workers. The industrial North has always been richer and more productive than the South. However, Italy’s national wage bargaining system sets uniform pay across the country. As a result, many Southern firms can’t afford to hire workers formally because wages exceed what local productivity can justify. This mismatch drives up unemployment, fuels the shadow economy, and traps the South in economic underperformance.
Similarly, strict employment protection laws can backfire because they create exorbitant firing costs. This goes beyond rigid employment contracts and lengthy notice periods. In countries like France or Germany, justified cause for layoffs is typically required. Companies cannot simply fire the least productive workers. This also means that employers will be more hesitant to hire workers because letting them go later could be prohibitively expensive (or outright impossible). Once again, this creates an insider-outsider problem with some workers being protected at the expense of overall job creation.
Generous unemployment benefits are another double-edged sword. While they provide income support, overly high or long-lasting benefits can reduce job search incentives and create so-called welfare traps. The result? Lengthy spells of unemployment for many workers.
High marginal tax rates act as a hidden barrier to work. The combination of high income taxes with generous welfare benefits has created situations where some workers might be better off unemployed. If having a job doesn’t improve net pay, individuals opt out of the labor market altogether, turning to informal work instead of relying entirely on government benefits.
Finally, geography and culture also play a role. Worker mobility in Europe has always been way lower than in the U.S., creating a problem of persistent unemployment in certain regions even as there are thriving job markets elsewhere. Despite a common European market, cultural and linguistic barriers continue to be an obstacle. And even within countries, workers often stay put, which can help explain the persistent difference in unemployment between the North and South of Italy or Spain.
Population trends have obscured Europe’s structural weakness
Many of you will now say: But wait a minute! Europe’s problem of excessive unemployment has been solved. The Eurozone unemployment rate is at its lowest ever!
Well, that’s true. European companies increasingly need to worry about worker shortages due to a rapidly aging workforce as the generation of baby boomers has started to retire. If it wasn’t for migration, employment might have started to stagnate or even shrink years ago, like in Japan.
Demographic forces have been masking a lot of the underlying weakness that European labor markets continue to exhibit. While reducing unemployment is important, it’s by no means the only metric that matters. How often workers change jobs — the pace of job creation and job destruction — is of particular importance. Salaries typically increase with each job change. One reason why American workers see more significant gains in lifetime earnings is because the median job tenure is about 4 years — while in Germany and other European countries it’s closer to a decade.
Growth and job dynamism: The 2025 Econ Nobel shows the way
This year’s Economics Nobel went to researchers who devoted their lives examining long-run economic growth. One key finding is that dynamic labor markets are key. At the heart of this is creative destruction, the process by which new technologies and firms replace outdated ones. But when labor markets are rigid, that process slows.
Source: Nobel Prize Committee, 2025
If governments protect jobs instead of workers, or if institutions such as strong unions, strict firing laws, and codetermination impede hiring and firing decisions, innovation stalls and the growth engine sputters. The laureates’ research makes it clear: prosperity depends on helping workers move to more productive roles. Too many European countries still perform poorly on this front — a problem we’ll explore in a follow-up piece.
