Spain’s economic woes are triggering renewed fears over a potential default in the euro area, and much of the blame belongs to labor laws that date back to the dictatorship of General Francisco Franco. Unless the government succeeds in changing them, it’s hard to see the country returning to healthy growth even if it manages to stay solvent.

Spain is by now notorious for having the highest unemployment rate in the European Union, especially among the young -- every second Spaniard under the age of 25 is looking for a job. It would be simplistic, of course, to attribute Spain’s severe economic contraction and rampant unemployment to any one cause, but the labor market is a useful place to start. It has taken the financial crisis to force an ambitious attempt to address the problem.

Franco’s camp introduced the foundations of the existing labor laws in 1938, when the Spanish Civil War was still being fought. The new legislation was heavily influenced by Mussolini’s 1927 Carta del Lavoro, and was bolstered by additions in the 1940s and ’60s and, toward the end of Franco’s rule, in the ’70s. Remarkably, much of that legislation remains in effect today.

Dysfunctional Market

The International Monetary Fund has described Spain’s resulting labor market as ”dysfunctional.” The World Economic Forum’s latest Global Competitiveness Report ranks Spain’s labor market 134th out of 142 countries, pointing to labor-market rigidities and the gap between wage setting and productivity levels as an important cause of Spain’s slide down the overall index in recent years.

Franco’s labor laws offered workers rock-solid job security and strong collective-bargaining rights. These were critical elements of welfare systems that were adopted by fascist -- or national socialist -- regimes around Europe, as they sought to maintain social harmony in the absence of democracy. Changing them has been a critical test of maturity for Spanish democracy since its establishment in 1977, and successive administrations have failed. Contrary to what you might expect, it’s the political left that has been most opposed to changing laws that were adopted during Franco’s fascist dictatorship.

Maintaining the status quo was understandable and even laudable during Spain’s post-Franco transition, when the country -- still fearful of slipping back into the deep divisions of the civil war -- sought a consensus that would help to consolidate democracy while the economy was weak and jobs were scarce.

Attempts at reform were made, but most were minimalist and ad hoc, aimed at facilitating employment by indirect, partial and even surreptitious measures. The strategy, until the first conservative government under Prime Minister Jose Maria Aznar came to power in 1996, was to create a parallel labor market, based on temporary contracts. These allowed employers to avoid the rigidity of indefinite contracts, making it easier and cheaper to fire employees by addressing issues such as termination costs, restrictions and procedural duration, among others. The result was a 73 percent increase in temporary contracts from 1985 to 1993, according to Spain’s Annual Statistics Review.

The Aznar administration made the first serious attempt to synthesize temporary and indefinite contracts, reducing the cost of dismissal and at the same time retaining stability of employment. But the reforms that Spain’s current conservative government has proposed are by far the most ambitious to date. They should bring Spain closer to Germany, and further from Greece.

Curbing Unions

The goal now is to create more flexibility in the labor market, enabling enterprises to hire and fire more easily and so better respond to the changes of the economic cycle. For the first time, the reforms also address collective-bargaining agreements that have caused the elimination of thousands of jobs. The proposed changes would substantially curb union bargaining power, giving priority to wage negotiation at the level of companies, rather than industries.

Two pockets of resistance, both cultural, can be easily identified. The first is public opinion, in whose perception formal guarantees still take priority over opportunities. The second is the political intransigence of the labor unions, as they fight against the decline in their prominence as indispensable interlocutors in the collective-bargaining process. Their refusal to come to terms with the dictates of 21st-century economic realities has long kept hostage the national debate over reform. But less than a fifth of Spanish employees are affiliated with the major unions, and many Spaniards question whether organized labor now represents the workforce or their interests.

At the end of March, the unions called a general strike and took to the streets to protest 27 billion euros ($35.5 billion) of spending cuts and tax increases in the government’s freshly unveiled 2012 budget, despite a reasonable economic consensus that such austerity is essential. The alternative risks a disorderly default and punitive interest rates that could trigger a downward economic spiral and force Spain to leave the euro.

Obviously, rigid labor laws are just one aspect of Spain’s story. Complacent credit ratings, easy credit and extravagance in the banking sector led to construction and property bubbles that since burst, damaging the country’s economic framework. In the absence of adjustment mechanisms to compensate for the lack of exchange-rate flexibility, the strength of the euro also hurt Spain’s competitiveness.

Spain’s recovery isn’t just about budget cuts and austerity -- it’s about competitiveness. That means improving flexibility and mobility in the economy, and coming to terms with the need to modernize Spain’s job market and welfare system. We Spaniards need to let go of our sense of entitlement to job security and welfare, if we are to succeed in reviving the economy and preserving the essence of our generous welfare system.

(Ana Palacio served as Spanish foreign minister in the conservative government of Prime Minister Jose Maria Aznar. She is also a former senior vice president at the World Bank. The opinions expressed are her own.)

Read more opinion online from Bloomberg View.

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To read other op-ed articles in this series about Europe's social contract: Iain Begg on the Danish flexicurity model; Josef Joffe on how all of Europe should learn from Germany's reforms; Fredrik Erixon on the last days of Europe's welfare states.

To contact the writer of this article: Ana Palacio at ana.palacio@palacioyasociados.com

To contact the editor responsible for this article: Marc Champion at mchampion7@bloomberg.net