This paper investigates the role of the institutional framework for the labor market performance in EU countries. The point of departure is the labor demand equation derived from cost minimization behaviour of firms. Labor demand is expressed by its structural parameters, i.e. the output and real wage elasticity. Cointegration relation-ships between employment, output and wages are revealed by efficient estimation techniques. The long run parameters may vary due to structural change. They are explained by indicators for product and labor market institutions using panel fixed effects models. The results suggest that higher flexibility in the product and labor markets are appropriate strategies to improve the labor market record. The response of employment to macroeconomic conditions is stronger in a more deregulated environment, and the absorption of shocks can be relieved.