Protected or Stuck? The Hidden Cost of Portugal’s Labour Market

There has been growing debate around the proposed reform of Portugal’s labour market. The current government, led by Luís Montenegro, has introduced measures aimed at increasing flexibility and modernising the system. However, these proposals have faced strong political resistance, failing to secure approval from both the left and the far right. As a result, the reform process remains uncertain, although ongoing negotiations suggest a possible compromise.

Firstly, it is essential to contextualise the current state of the Portuguese labour market. Portugal’s unemployment rate remains slightly above the OECD average, while wages are significantly below the European average, placing the country among the lowest in the OECD. At the same time, the labour market is characterised by relatively high rigidity, with strict employment protection laws.

Furthermore, an important issue that is often overlooked is the mismatch between workers’ qualifications and the jobs they perform. Despite having an employment rate above the OECD average, more than 40% of workers in Portugal are employed in fields unrelated to their area of study, and over 14% are overqualified for their roles. This misallocation of skills represents a significant inefficiency in the economy, limiting productivity and long-term growth.

This raises an important question: is there a direct link between labour market rigidity and the current state of the Portuguese labour market?

While these regulations are intended to protect workers and ensure stability, excessive rigidity can produce the opposite effect, giving rise to a dual labour market divided between insiders and outsiders, with a protected core and limited access for those on the outside. Insiders tend to occupy stable and permanent positions supported by strong employment protections, whereas outsiders, often younger or less experienced workers, face significant barriers to accessing secure and long-term employment.

One of the most significant consequences of this rigidity can be observed in labour market entry, especially among young workers. When dismissal costs are high, firms see new hires as a long-term risk rather than an investment. As a result, they rely more on temporary contracts and internships, leaving younger workers stuck in precarious positions with limited access to stable jobs.

Another consequence of this overprotection is reduced macroeconomic flexibility. In today’s globalised economy, where conditions and challenges are constantly changing, firms must be able to adapt in order to survive. This requires the efficient reallocation of resources, including human capital. When firms are unable to do so, their competitiveness declines, and their focus shifts from growth and innovation to mere survival.

Finally, rigidity can lead to a productivity trap. When firms depend on temporary contracts, they have less incentive to invest in training and skills development of their workers, resulting in lower productivity and weaker long-term growth.

Rather than promoting equality, this dynamic reinforces labour market segmentation and constrains social mobility. This can be understood as a paradox of rigidity, where the very protections designed to safeguard workers end up deepening a persistent divide between those already inside the system and those struggling to enter it.

So why do so many political parties and a significant share of the population in Portugal continue to support a rigid labour market? The answer lies in several important considerations, particularly social cohesion and stability. Stricter labour laws make it more difficult to dismiss workers, providing families with greater financial security and predictability.

At the same time, there is a strong argument for safeguarding workers’ rights and ensuring that employees retain a meaningful role in shaping workplace conditions and decisions.

However, while the defence of rigid labour laws is rooted in a legitimate desire to protect workers, the reality today suggests that these protections can become barriers. Efforts to protect specific jobs through legislation often end up preserving outdated structures, limiting adaptability and slowing economic progress.

A possible solution for Portugal can be found in Denmark’s flexicurity model. It combines flexible hiring and dismissal rules with strong social protection. Firms can adjust their workforce easily due to low dismissal costs, while workers benefit from generous unemployment support, which can reach up to 90% of previous earnings. In addition, the government actively supports re-employment through retraining, education, and job placement services. Wages and working conditions are mainly set through collective bargaining between employers and unions, with minimal state intervention.

It is intriguing that Denmark has an average job tenure shorter than Portugal’s, yet Danish workers consistently report higher levels of job satisfaction, understood here as workers’ overall sense of well-being in their jobs, including income security, working conditions, and confidence in future employment. At first glance, this appears counterintuitive, since shorter job tenure and greater labour market fluidity would normally be associated with instability.

However, the Danish case points in the opposite direction. In a context of rapid technological change and shifting market conditions, firms require flexibility, but this is balanced by a form of security based not on job retention, but on employability. Security does not necessarily come from remaining in the same job for long periods, but from the strength of the institutions that support movement between jobs. In this sense, workers are not protected by the permanence of a specific position, but by the ease with which they can transition between roles without experiencing severe income loss or prolonged unemployment. As a result, ‘security’ is redefined away from job preservation and towards income stability, strong employability, and continuous access to new opportunities.

This distinction is crucial when assessing what it would mean for Portugal to move towards a similar model, as it challenges the assumption that stronger employment protection automatically leads to greater real security.

Portugal faces an important challenge. Although labour laws aim to protect workers, they reduce economic flexibility. By prioritising job security over adaptability, rigidity increases inequality between insiders and outsiders, limits youth opportunities, and lowers productivity. In a fast-changing global economy, Portugal needs a more flexible system that protects workers rather than jobs, allowing firms to adapt while maintaining social security. Without reform, rigidity will continue to constrain long-term growth and competitiveness.