This paper explores the puzzling inaction of governments in Europe con
cerning labor market liberalization. Although high and persistent unem
ployment Is currently one of the most important political problems, an
d although most economists regard more liberalized labor markets as a
prerequisite for better employment results, in terms of actual reforms
very little has in fact been achieved. In the German case this assert
ion is shown to be especially valid It is argued that this puzzle can
be solved by adopting a politicial economy perspective. Labor market r
igidities serve political economy considerations mainly by benefitting
well organized insiders at the expense of badly organized and politic
ally marginalized outsiders and by creating a larger political core wh
ich is interested in political stability. Hence, devising not only eff
ective but also politically feasible policies for fighting unemploymen
t is a challenging task. However, it is argued that there exist import
ant long-run economic trends, namely skill-biased technological progre
ss and globalization, which work in favor of more liberalized labor ma
rkets.