European labour markets are often described as rigid with comparatively high levels of job protection that do not allow for the flexible adjustment of employment to economic fluctuations. This interpretation overlooks important sources of flexibility, however. Research has shown that recent labour market policy reforms have allowed for the creation of two-tier labour markets consisting of insiders in standard employment relationships and outsiders in non-standard employment. This outcome has typically been explained by pointing to the representational interests of unions or social-democratic parties. It has been argued that rather than protecting all labour market participants, unions and social-democratic parties focus on the interests of their members and their core constituency, respectively, most of whom are in standard employment relationships. In contrast, it is argued here that unions' institutional power resources are the crucial variable explaining this outcome. In difficult economic times, when unions are asked to make concessions, they will assent to labour market reforms, but only to those that do not fundamentally threaten to undermine their organisational interests. In the context of job security legislation, this means that unions defend the protection of permanent contracts while they compromise on the regulation of temporary employment. This ‘second best solution’ allows them to protect their organisational interests, both by retaining their institutional role in the administration of dismissals and by living up to their institutional role as one of the organisations responsible for the direction of labour market policy reform. Using fsQCA this article shows that unions' institutional power resources are more apt to explain the observed two-tier reform pattern than the unions' or the social-democratic parties' representational interests.