Market Overview

Commentary: Is Classifying Truck Drivers As Easy As ABC?

Commentary: Is Classifying Truck Drivers As Easy As ABC?

Just when the motor carrier sector thought that deregulation was the established practice at the federal and state levels, along comes a new labor law which harkens back to a bygone era. Even after 40 years of deregulation at the federal level, and over 25 years at the state level, re-regulation is being tested in the courts. How did we get here? Basically, California Assembly Bill No. 5 (AB5) requires motor carriers to "learn their ABCs."

A regulator's job is to regulate. Hopefully, any and all regulations have a distinct goal that corrects what economists call market failures. Well-honed regulations create disincentives for negative activities that businesses might undertake. Generating pollution is a good example of such an activity. Environmental regulations represent society's level of tolerance for such things. These are political questions subject to government's accountability to the voters. Without such regulations, so the theory goes, there would be too much pollution – meaning a socially unacceptable level – since private businesses may not feel the incentive to invest in pollution abatement, especially if their competitors do not. 

In simple terms businesses should care about profit-making while governments should care about social welfare. Business is accountable to its customers, while the government is accountable to its constituents.

Of course, regulators exist within different jurisdictions. Things get trickier in the United States when the issues of state commerce run up against interstate commerce, which is a federal jurisdiction. Regulators, no matter the jurisdiction, have one thing in common – they want their regulations to be effective. For this to occur they need to be relatively easy to enforce. For example, it is easier to regulate a business' chimneys and drainpipes than it is to provide subsidies for air filters or water purification devices for every home in the vicinity that might be ill-affected. The regulatory effect on quality of life might be roughly the same; but the transaction cost would be much higher if the subsidy method were undertaken.

Federal, state and local regulations impact every mode of transportation in some way and to varying degrees. Motor carrier haulage is subject to federal regulations when it is interstate. It is also subject to different state-by-state regulations when haulage takes place over two or more.

The art of regulatory policy-making is to be effective while balancing other conflicting goals. This is why all sources of air pollution, for example, should not be banned outright. Since current technology does not exist to replace the speed and range of the internal combustion engine, an all-out ban would curtail the levels of mass production consumers desire. They vote with their wallets. The federal minimum wage could be increased to, say, $50 per hour rather than in smaller increments over decades. The problem with a large increase is that the short run effects on labor costs would lead to unintended consequences like unemployment because businesses likely cannot pass all of the costs onto their customers. In other words, all prices do not move at the same rate. Thus, any drastic change in regulations can cause strains and dislocations that can be harmful in the marketplace and to society.

To impose regulations that overtly harm businesses in viable markets is an example of misplaced regulation. The onus is on the government to demonstrate a market failure leading to some socially unacceptable outcome. In this context consider AB5, which was signed into law in September 2019. The law amends the California Labor Code and Unemployment Insurance Code as they relate to employees and independent contractors. Going into effect on January 1, 2020, it restricted a business from hiring independent contractors to top-up its operations unless certain criteria were met.

Hot on the heels of AB5 going into effect, a preliminary injunction against its enforcement was issued on January 16, 2020 by a U.S. District Court (i.e., a federal court). So, with state and federal jurisdictions involved, now is a good time to appraise the intent and the consequences of AB5. First, the injunction applies only to the motor carrier sector because the complainant is the California Trucking Association. This reprieve gives some breathing space for motor carriers wishing to hire independent owner-operators should they feel it necessary to enhance their fleet of vehicles and pool of driver-employees. However, California-based owner-operators will have to see if there is a long-run prospect of plying their trade in that state. The alternative is to establish a domicile in another state.

Why the need for this regulation? AB5 is intended to give contractors in the gig economy some degree of protection and access to benefits that are typically provided to employees. Such benefits are minimum wage, workers' compensation, paid leave, sick days and the right to unionize. Of course, the Teamsters support AB5 since it provides an opportunity to organize drayage vehicle operators if enough of them feel misclassified as independent contractors by the companies that hired them.

So, Uber Technolofies Inc (NYSE: UBER) and Lyft Inc (NASDAQ: LYFT) drivers in California must be treated as employees of these companies and, before the federal injunction, the same would go for owner-operators working as agents for other motor carriers. Any newly designated employers would be taking on costs that would not normally be a part of a service contract. An agent's contract does not have to be renewed. In parallel manner, can a worker in California be laid-off as easily? How would background checks be dealt with under these different cases?

AB5 includes an "ABC" test to allow businesses to determine if they are de facto employers hiring de facto employees or simply businesses outsourcing activities to an agent. This test was based on guidance from a 2018 California Supreme Court ruling which penalized Dynamex Operations West, Inc. for misclassifying its delivery drivers as contractors rather than employees. There are three questions:

(A) Is the agent free of control and direction by the business?

(B) Is the agent's work outside of the business' usual work?

(C) Does the agent customarily perform this work as part of an independently established trade or occupation?

Naturally, question (B) runs against the frequent practice of a motor carrier hiring an independent motor carrier (i.e., an owner-operator) to perform haulage on its behalf. Basically, under AB5, contracting for someone who practices a company's core business needs to be treated as an employee.

The question is – does it make sense to treat truck drivers who own their own conveyances in the same way as other forms of labor? Though not covered by the federal injunction, the same question could apply to those who use an app on their smartphone to turn their private cars into ride-sharing vehicles. Are gig drivers and owner-operators in need of an employer-provided safety net of benefits? Does the agent/worker owning the conveyance set him apart from other forms of labor? If the work is seen as a "gig" by the service provider, why block the hiring party and the agent from their ability to negotiate a contract? In other words, is there a market failure?  Are businesses exploiting the gig economy or are both parties simply taking advantage of the flexibility they have? 

Pollution is an example of a market failure because it affects parties who are external to the transaction between the buyer and the seller. This is where the word externality comes from. Pollution regulation is designed so that the two parties in the private transaction are made to consider the third-party (or societal) effects of their activities. But attempts to re-classify labor is not about external effects. There is no third-party who is harmed by the gig economy or by hiring owner-operators.

The independent owner-operator is a legitimate business model that requires upfront investment in tractors and trailers as well as the necessary licenses. They want the flexibility, and tax benefits, of an agency relationship. In many ways, this sets motor carriers apart from other modes of transportation. Is that mode less stable than others? Often it is. But by being more competitive, it incentivizes a level of cost control that is ultimately good for the consumer at the end of the supply chain.  

Interstate motor carriers were deregulated through the Motor Carrier Act (1980) in terms of freight rates and routing. These terms would no longer be considered by the government when determining public convenience and necessity. Intrastate motor carriers were subsequently deregulated in 1994, thereby leaving states only with jurisdiction over safety (e.g., truck configuration, weight and insurance coverage). It came from an unlikely source. The Federal Aviation Administration Authorization Act (1994) provided that "a State, political subdivision of a State, or political authority of two or more States may not enact or enforce a law, regulation, or other provision having the force and effect of law related to a price, route, or service of any motor carrier." (49 U.S.C. § 14501(c)(1)) Of course, exceptions exist for motor carriers affiliated with direct air carriers and motor carriers hauling property (i.e., moving companies).

Economist Ronald Coase once asked a simple but powerful question – why do firms exist? In effect, why do we have employers and employees? His answer was that it was a way to control transaction costs. Sometimes command-and-control is better than negotiating and contracting out. Sticking with owner-operators, what is the difference between working under contracts with other motor carriers or being employees of motor carriers? Well, question (B) of the ABC test turns the well-established theory of the firm on its head. Question (B) implies that hiring within one's core competency is akin to taking on an employee. Yet it is relatively easy to establish a service contract in this case because both parties know pretty well what that service is and how it should be performed. Firms are best understood as organizations formed to avoid the problem of "incomplete" contracts. In this regard employees normally do not have all of their duties codified in a service contract because it would be impossible to predict what these would be given all the possible changes in the internal and external conditions affecting a firm. It would also not make sense to open negotiations on a new contract every time one party wanted another to adapt to, say, the latest changes in technology. Command-and-control works better when the hiring party needs a long-term relationship while the range of required duties is in a state of flux.

The ABC test implies that independent contracting is a market failure. On the contrary, spot markets and gig workers are examples of markets working quite well. But is AB5 an inadvertent attempt to re-regulate motor carriers? Its hiring cost would certainly have an indirect effect on freight rates. Also, at the federal level, the House of Representatives recently passed the Protecting the Right to Organize Act (2019) which includes AB5's ABC test. Though not likely to be signed into law by the Trump Administration, the debate over access to employee benefits and the right to unionize is by no means over.

Image by Michael Knoll from Pixabay


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