OF ALL the euro zone's many problems, youth unemployment is perhaps the most distressing. Joblessness among young workers is around 30% in Portugal and nearly 50% in Spain. Above-average unemployment is the norm for young people, even in more liberal markets like America's. But Spain's youth unemployment rate jumped by nearly 20 percentage points between 2007 and 2009, compared with a rise of seven points in America. Labour-market regulations take much of the blame: while hard-to-fire older workers luxuriate on permanent contracts, the young are typically hired temporarily and are easier to sack.

Such “dual” labour markets are themselves products of reform. Although American unemployment quickly dropped following the troubles of the 1970s and early 1980s, European joblessness remained stuck at high levels. Leaders recognised the need to inject more flexibility into the labour market but powerful trade unions headed off a full-frontal assault on workers' rights. The answer was to create a less-protected class of employees.

The pain in Spain

Spain's experience is instructive. As the unemployment rate approached 20% in the mid-1980s, the government introduced fixed-term contracts of between six months and three years, which were subject to lower dismissal costs than those for workers on open-ended contracts. At the end of a three-year contract firms could either convert a worker to permanent employment or send him packing. The reforms got results. Unemployment fell from nearly 18% when they began in 1984 to around 14% six years later.

But the reforms had unintended consequences too. Temporary contracts surged, soon accounting for close to a third of Spanish employment. Workers churned from job to job: just 6% of temporary contracts were converted to permanent employment during the mid-2000s. When the economy turned down employees were shed in larger numbers and the unemployment rate rose faster than before. Those more likely to be employed on temporary contracts, such as the young, bore the brunt of the pain. The euro zone's long expansion from the mid-1990s until the crisis of 2008 disguised many of these problems. A construction boom helped Spanish unemployment back below 10%, even as immigration soared. But the crisis has exposed old weaknesses again. Volatility is but one cost of dual labour markets. Frequent job turnover makes households' finances less certain, making it harder, for example, to save regularly for old age. More importantly, temporary employment discourages firms from investing in their workers. The cost to an employer of converting an expiring temporary contract into a permanent one is quite high because of a discontinuous jump in the cost of sacking the worker. So there is an incentive to get rid of him when his contract ends and to invest little in training him.

This systematic underinvestment drags productivity inexorably downward. A 2011 study by Juan Dolado of Universidad Carlos III de Madrid, Salvador Ortigueira of the European University Institute and Rodolfo Stucchi of the Inter-American Development Bank pins 20% of the productivity slowdown in Spanish manufacturing between 1992 and 2005 on temporary work. The young are especially harmed. Between 2005 and 2007 roughly 80% of Spanish workers aged 16 to 19 were on temporary contracts, compared with 32% of 30-year-olds and 24% of 40-year-olds. A lack of training may weigh on them throughout their working lives. A single, open-ended labour contract, in which severance pay rises continuously with tenure, should increase the incentive for firms to retain more employees for longer and to invest more in the human capital of new workers. Incremental protections should also moderate swings in employment. A study of French and Spanish labour markets found that the recent rise in Spain's unemployment rate might have been cut by a third had Spain followed the French example of a shallower gradient between labour-market tiers. At this point, supporters of the model might well point to Germany, where the youth unemployment rate is a mere 7.8% and overall joblessness is at its lowest level for decades. In many respect Germany's labour market mirrors that of its peers. It, too, responded to eurosclerosis with flexible, second-tier contracts. Permanent positions protected by strong employment rules still dominate its labour market. But Germany also sought greater flexibility in other areas. Part-time work became increasingly common: Germany's Kurzarbeit programme, in which firms reacted to recession by cutting hours rather than employees, is just the latest example of this approach. Germany's better performance also relied on ever-stingier unemployment benefits, which increased labour supply and reduced upward wage pressure. Clauses in collective-bargaining agreements allowed individual firms to stray from wage deals when competitive pressures demanded it.

Dual purpose

Germany may have pursued wage restraint, but that is no easy route to prosperity. Indeed, dual labour markets are more likely to have the opposite effect. Permanent workers fearlessly seek higher wages, confident that job losses will fall first on temporary workers. Soaring Spanish unemployment has produced little wage moderation. During 2009 the pay of permanent workers rose by 4% in real terms.

And attractive as the German model is now, across decades American jobless rates are tough to match. The Anglo-Saxon preference for little or no employment protection may be the most effective at herding workers from declining industries to growing ones, driving job creation and innovation. Dyspeptic bond markets are now pushing Spain and others towards reforms that make it easier and cheaper to lay off workers again. Not before time.