Labor Freedom Is the Best Explanation for the US-Europe Income Gap
Germans have such terrible policies it's amazing they have any economy at all
This is the third part in my series of articles against labor unions. See Part I clarifying concepts and showing how unions practically always require government coercion, meaning that they cannot be justified in a classical liberal framework. Part II relies on basic economic principles to explain why unions are a terrible way to help workers. After publishing those two pieces, I got distracted by other things and it’s now been 17 months. Sorry for keeping everyone waiting.
The impetus to finally write this article came from seeing the excellent essay “Why Europe Doesn’t Have a Tesla,” by Peter Garicano in Works in Progress (see also this podcast). In fact, it’s so good that I think he’s done much of the work for me, so I’m going to post large excerpts and share some additional thoughts.
One reason I hesitated to finish the third part of the series was that I wanted to write that labor laws are a large part of the explanation as to why the US is so much wealthier than Europe. This has always been a hunch, but I didn’t know if I could sufficiently prove it. Garicano’s article has helped convince me that I am correct, and if anything I underestimated the degree to which labor laws hold Europe back.
Before I start, I want to note two things. First, I now realize that in the earlier articles of this series I focused too narrowly on labor unions. They’re very bad, but the issue is actually broader and is really about having a free market in labor. You could have a country with no unions but that nonetheless enacts worker protections that are terrible for individual liberty and growth. Labor unions are a mechanism through which countries get bad policy. But governments often do many of the same things through legislation. It’s important to be anti-labor union, but you should just as strongly be against worker protections that mimic what unions do.
Second, I arrive at the view that the free market in labor is key to the US-Europe wealth gap partly through a process of elimination. Americans do much better than Europeans, but the US is not clearly economically freer in most areas. For example, Heritage’s 2025 index of economic freedom puts it behind eleven European countries. The US is ranked 27th in the world in overall economic freedom, but 3rd in labor freedom. Given the degree to which the US has surpassed other major nations, perhaps indexes like this are underweighting the importance of this one particular category. America is far from a capitalist paradise; particularly in housing and allowing people to build, we do a pretty poor job.
Having read Garicano’s article helped me realize how massive the gap in labor freedom is between the US and Europe. Imagine if the entire force of government policy was put toward enforcing a status quo bias in other contexts: government created every possible financial incentive to keep people in the same homes; made sure they continually drive the same cars or buy vehicles from the same companies; or put up an endless number of barriers in the way of them switching grocery stores or banks. Everyone would realize that such policies represent the height of economic illiteracy and would be bound to have all kinds of unintended consequences. Yet we treat labor as different, even though the underlying economic principles are exactly the same.
Garicano begins:
In recent decades, Europe has fallen behind the United States. In 2000, incomes in the original six members of the European Union were just 10 percent behind Americans. Today, they are 20 percent lower. One factor behind this has been the lack of innovation in European business. To a striking extent, Europe lacks tech giants like Google, Meta and Amazon. But even in industries in which it has traditionally excelled, like carmaking, Europe has failed to keep up. Tesla is now worth more than the next nine largest carmakers in the world put together. Six American cities are now served by robotaxis made by Waymo. Understanding why Europe doesn’t have Google is important. Understanding why it doesn’t have a Tesla is existential.
There are many partial explanations: high energy prices, expensive housing, excessive proceduralism, high taxes, extractive interest groups, and politicians with a penchant for degrowth. But all of these problems are true of California as well [emphasis added], which is nonetheless home to Waymo and birthed Tesla before it moved its headquarters to Texas in 2021. Explanations often blame Europe’s lack of research spending, but governments spend more on research in Europe than in America. And just seven companies globally – Google, Apple, Amazon, Meta, Microsoft, Samsung, and Huawei – spend more on research each year than Volkswagen.
What really sets Europe apart from states like California is different. Relative to income, it costs large companies four times more to lay off Germans and French than American workers, a difference arising entirely from different regulatory approaches. As a result, it virtually never happens: Americans are ten times more likely to be fired than Germans in any given year [emphasis added]. In this respect, the European economy differs greatly from the American one. By American standards, a European business has to be exceptionally confident that it will want an employee for a long time before hiring them.
So California clearly screws a lot of things up. Taxes basically reach European levels at the highest income brackets, and we don’t get anywhere near the quality of services. Nonetheless, California contains the heart of the global tech industry. There aren’t many things that the state appears to be doing right. By just being in the United States, it has much weaker labor protections than Europe, at least in the private sector.
All businesses make mistakes. Dismantling these failures often means shedding physical assets: writing down investments and breaking factory leases. But for many companies, most of the cost of failure comes from making employees redundant. These payments are large even in countries with laissez-faire labor rules like the US: when Google restructured in 2023, it spent $2.1 billion laying off 12,000 workers, about $175,000 per person. Its second largest expense, breaking office leases, was $1.8 billion…
Some American employers offer more generous redundancy packages, like Google in the example above. But this happens because American businesses want the concessions that they extract in exchange…
The opposite is true in most European countries. Severance payments are often mandated by law and are much larger than in the US. In Germany, a worker who is fairly dismissed due to business needs is entitled by law to 15 days of pay for every year they have spent with the employer.
Getting as far as making these severance payments can be a challenge for German employers. Under the Protection Against Dismissal Act, the Kündigungsschutzgesetz, redundancies over ten employees must pass a social selection test (Sozialauswahl). Employers cannot choose who leaves: they must rank employees by age, years of service, family maintenance obligations, and degree of disability, and then prioritize dismissing those with the weakest social claim to the job. If someone is dismissed for operational reasons but the company posts a similar job elsewhere, the dismissal is usually invalid.
Disabled employees can be dismissed only with the approval of the Integration Office (Integrationsamt), a public body. The office will weigh the employer’s reasons, whether they have taken sufficient steps to integrate the employee, and whether they could be redeployed elsewhere in the organization. Workers who also become caregivers cannot be dismissed at all for up to two full years after they tell their bosses they fulfill that role.
As a company becomes larger and tries to let more workers go at once these difficulties increase. In many European countries, companies with more than a certain number of workers – 50 in the Netherlands, 5 in Germany – are obliged to create a works council, which represents employees and, in some countries, must give its approval to decisions the employer wants to make regarding its employees, including layoffs or pay rises or cuts.
Much of this was news to me. In Germany, they not only tell you if you can fire people, but you can’t even decide who to keep! Paying employees indefinitely to leave is the optimistic scenario when they are no longer needed. The worse outcome is that you’re forced to hold on to them indefinitely.
Basically, what this system amounts to is a welfare state, while placing the burden on those who create jobs in the first place. To make another analogy, imagine we wanted to provide healthcare for the poor. But instead of paying for it through general taxation, we said anyone who provides any amount of charity to someone living in poverty must be the one to pick up the tab for their health insurance. How would such a system make sense? And this isn’t simply a matter of finding ways to provide welfare, but something much more extreme, involving locking employers in relationships they can’t get out of. You’re also misallocating labor, since having workers in places where they’re not needed prevents them from making a contribution elsewhere.
Here’s the situation in France.
French law requires any restructuring involving more than ten employees in a month, even if they work in different parts of the company, to be approved by a special regulator and reviewed by the works council in two meetings over multiple months. It is only allowed after a ‘good faith’ attempt to protect the jobs of the workers involved (by attempting to give them jobs elsewhere in the company, keep them on part-time, or induce other companies to hire them). To prove that financial conditions justify the layoffs, French companies often impose hiring freezes across the company when employees in one division are let go.
If a court determines that a company that has laid off employees was not in a financial state to merit laying off workers, that court has the power to reclassify the dismissals as unfair and impose even higher severance as a fine. Continental, a tire company, tried to shrink its French workforce during the financial crisis. A court decided that there was a ‘lack of economic justification for the dismissals in light of the overall situation and results of the global Continental group’. The company was obliged to pay up to three years of salary to the 680 employees involved.
These rules – severance, negotiating periods, works councils, buyouts, and waiting periods – collectively impose high costs on a European company that tries to let workers go. The costs of restructuring are so high that companies will often try and bribe their workers to leave. In 2023, Amazon offered French employees a year’s salary to leave voluntarily so they didn’t have to fire them and go through a legal restructuring. In 2024, German chemical manufacturer Bayer offered long-tenured workers 52.5 months of pay, or over four years’ worth, in exchange for quitting.
According to a rough estimate by Olivier Coste and Yann Coatanlem, a corporate restructuring in Germany and France costs companies the equivalent of 31 and 38 months of salary per employee laid off, putting all of the above costs together. In Italy, this is 52 months. In Spain, it is 62 months. In the United States, the cost per employee is just 7 months.
Imagine wanting so desperately to get rid of workers that you pay them four years’ salary so they go away. These employees must be providing remarkably little value. You’d rather they do nothing for four years and eat their salaries than get all the work they produce over that time period and then have to keep paying them for work in years 5+.
Surprisingly, all of this doesn’t seem to lead to that much unemployment.
The standard story is that these rules lead to lower wages, when employers can negotiate wages directly with individual workers, or lower employment levels, when companies have to bargain with workers en masse and cannot just price the cost of firing them into wages. But Europe’s stagnation, especially in the north, has ceased to be primarily a problem of unemployment. In the Euro area, about 71 out of every 100 people of working age have a job. This is nearly the same as in the United States, where about 72 out of 100 working-age people are employed.
Rather than reduce hiring in response to more expensive firing, companies in Europe have shifted activity away from areas where layoffs are likely. European workers are for sure, solid work only. This works well in periods of little innovation, or when innovation is gradual. The continent, however, is poorly equipped for moments of great experimentation.
By overcoming government foolishness, markets demonstrate their resilience and flexibility. European workers don’t simply go to waste. Rather, the entire economy becomes centered around making decisions that are financially safe rather than those that can lead to major payoffs. The unemployment rate doesn’t look so bad, but you still get society-wide stagnation.
Garicano continues by showing how these laws affect specific industries.
Building self-driving cars has involved lots of failures. Apple spent $10 billion on its self-driving car project, before scrapping it and never transported a single paying customer. General Motors acquired Cruise, an autonomous taxi company, for $1 billion in 2016, only to close it down in 2024. It had sold just $102 million worth of rides in 2023, making a loss of $3.4 billion that year.
But failures like these are unavoidable in pursuit of innovations that succeed. Waymo is estimated to serve a fifth of the San Francisco ride hailing market, and, as of April 2025, carries a quarter of a million passengers each week in five cities. Uber and Lyft, which had halted their self-driving cars in 2020 and 2021 after years of losses, have partnered with Wayve and Baidu to offer autonomous alternatives to Waymo and the Tesla cybercab.
For both American and European companies, the upsides of success from bets like these are similar. But the downsides from failed bets are much greater for Europeans. On top of the lost investment, many European companies also face significant severance costs, negotiations with worker representatives, requirements to redeploy unneeded workers internally, and the need for permission from regulators to approve layoffs.
In 2018, Audi launched the Q8 E-Tron, a fully electric SUV. As bets go, the E-Tron wasn’t even that bold: Porsche, Jaguar, BMW, and Volkswagen would all announce major electric models that year.
Unfortunately, the E-Tron saw weak sales, and it was cancelled in 2024. The factory where it was built, Audi Brussels, was to be closed. But instead of just writing off the plant, as an American company would have done, Audi had to set up a huge scheme to pay departing workers. After months of negotiations, Audi agreed to spend €610 million on severance, or over €200,000 per employee. These payments to employees more than doubled the costs of closing the car factory, costing more than writing off all its assets.
A luxury electric SUV may still turn out to be a good idea, and Audi may still be the company that will make the best one. But Audi executives have learned their lesson. A future E-Tron, they have indicated, will be built at a plant in Mexico.
Failure costs lead some European companies to try and avoid having to innovate altogether. For years, the German car industry refused to see that the writing was on the wall for traditional cars powered by an internal combustion engine.
Cars have come to rely more and more on software. But Europeans seem afraid to hire software engineers because then they can’t fire them, with predictable results.
In part, this was the product of complacency. Volkswagen’s leadership, made up of traditional automotive executives, saw software as an inferior artform to traditional manufacturing. They committed to highly ambitious public timelines and to developing all software in-house. The company’s in-house software team was short-staffed and struggled to meet demand. As one insider put it at the time: ‘It’s an absolute disaster’. In the months leading up to the launch, the team was finding up to 300 new bugs a day.
It was also the product of a company that has been unable to allocate and reallocate workers effectively for decades. Since 1994, Volkswagen has guaranteed German factory jobs at the company – the result of a negotiation with the union where, rather than firing people, the company cut costs by switching to a four-day workweek, an arrangement which was in force until 2006. The result has been that, for the past three decades, being hired has effectively resulted in a lifetime appointment.
In June 2024, Volkswagen admitted defeat and set up a joint venture with American electric vehicle startup Rivian. In exchange for an investment of up to $5 billion, Volkswagen received immediate access to Rivian’s software for use in its own cars. In essence, Volkswagen has had to license core technology from a small American rival because it has found innovating so hard.
I’ve quoted a lot from the piece, but there’s much more there, and I do recommend reading the whole thing.
The article was almost too convincing. I was left wondering how a country like Germany has had any economic success at all given how dysfunctional its labor laws are. I now suspect that Germany must be culturally superior to the US in terms of qualities that are conducive to economic growth. This is consistent with stereotypes about Germans being well behaved, punctual, etc. They can be seen as East Asians without going nearly as far with regard to introversion, fear of sticking out, and deference to authority. The fact that Americans are beating them so decisively in terms of economic growth and innovation reflects how superior our labor laws are, and probably differences in energy policy too.
There’s another recent article that unintentionally makes the same point. The left-wing website Drop Site News just ran a piece by Sam Carliner with the title “Javier Milei Is Set to Roll Back Argentina’s Historically Strong Labor Rights.” When you find yourself praising the status quo in a country with a century of economic failure behind it, you might want to stop and consider that maybe the policies you’re defending aren’t such a good idea. It reminds me of how Bernie Sanders responded when he was asked a question about why the US outperforms Europe at a recent event.
Carliner is anti-Milei, but shows the degree to which unions make reform more difficult. Compared to other bad policies, strong labor protections create institutions invested in stopping course corrections while also using thuggish and semi-legal or illegal means. Carliner sympathetically reports that some workers are occupying factories that their owners are trying to close. This isn’t a matter of sharing profits, it’s at the point where economic conditions are such that business owners simply want to move on from an investment, which has to happen for there to be economic growth. The article shows both how bad policy has been in Argentina, and how unreflective leftists are when they defend laws that are pro-union and supposedly pro-labor.
The point of this series is to convince you that if you’re going to have one opinion on economics that goes against conventional thinking, it should be hostility to protections for current workers and empowering labor unions. Cartels and mandates are bad, but in 95% of cases economists and those who are economically literate in advanced nations are able to recognize that, which is why we don’t have, for example, price controls on the vast majority of products. Labor law in most countries applies a unique degree of coercion and central planning as a matter of course, and Europeans moving toward the American model is low-hanging fruit. This should also be a warning regarding where the US might go wrong, given the left’s continuing enthusiasm for organized labor being echoed among many postliberals and those on the new right.
As Garicano points out and I’ve mentioned before, you don’t have to give up on redistribution. He brings attention to Denmark, Switzerland, and Austria as nations that make it relatively easy to fire someone while having the government provide a social safety net. Note that Switzerland is one of the few European countries that is on average about as rich as the United States.
There’s an interesting psychological dynamic going on, as most workers see their job from the perspective of a transactional relationship with their employer. It is easy to miss the reality that a job is not simply a negotiation over a set amount of resources between two parties. Rather, it involves providing a good or service that there is a market demand for. Perhaps you might think that voters’ roles as consumers would wake them up to that fact, but when they deal with firms all they see is the end result of market competition, missing the innovation, false starts, and broken dreams that led to them being able to shop at a certain store or order a product from an online retailer.
Moreover, you might notice that your boss is a jerk without keeping in mind all the people who never would have given you a job in the first place. And practically nobody witnesses the processes of innovation that lead to new technologies being developed.
Strong labor protections are a straightforward example of Bastiat’s idea that many economic fallacies result from focusing on the seen over the unseen. They are a textbook case of tunnel vision leading to bad policy. We think about the worker and the employer as the only two actors worth considering. Because they’re not immediate parties to the transaction, we ignore other workers who might be hired, shareholders, consumers, businesses that might benefit from creative destruction, or individuals who might in the future benefit from greater technological and business innovation. It’s a misnomer to even talk about pro-union policies or government mandates as “pro-labor,” because the benefits generally go to a narrow slice of the workforce, and not even the neediest part.
We get thoughtful articles like this mixed with shitposting. I agree that shitposting drives short term engagement, but it could very well reduce influence among the “cognitive elite. “
Good piece. Please square this with your claims that the smarter people are left of center.