Labor Department stuck in 1930s with rule against independent contractors

The Department of Labor is stuck in the 1930s. That’s the most likely explanation for its new rule that could lead to thousands of freelancers losing their livelihoods. The department is propping up a century-old model of what work should look like at a time when technology is rapidly changing how it could look.

The rule concerns independent contractors, which includes not just “gig economy” workers but freelancers and a variety of other professionals. The new rule states that unless some very specific circumstances are met, contractors should be deemed employees, with their work hours and benefits standardized. Supporters of the rule like Sen. Elizabeth Warren say this is a victory for workers.

Yet when a similar rule was imposed in California, devastation followed. Many freelancers lost their livelihoods, others left the state, and the legislature had to rewrite the law to exempt hundreds of professions. A report by the Mercatus Center at George Mason University found that self-employment in the state fell by 10 percent, and all employment by almost 5 percent. As a result, a popular vote overturned the law.

With a national rule, however, few of those escape options are possible. Freelancers are unlikely to flee the country, and there is no such thing as a national ballot measure. The department has only just finalized the rule, so revisions are unlikely unless there is a change in control of the executive or legislature this November. Independent contractors face an extremely uncertain future.

The reason why the rule is likely to be such a problem is because it is based on a vision of what the workplace should look like from a century ago, when large corporations dominated.

Large corporations made sense when it was harder to be nimble as a business. Nobel Prize winner Ronald Coase explained the reason we have corporations at all is because of the presence of what are called transaction costs. If I have a business idea that requires the services of someone else, I face those costs. If the business idea requires someone with advanced mathematical calculation skills I don’t have, I can either contract with someone who has those skills to do the work every time I need it, or I can hire them as an employee instead and have them always available.

In the 1930s, the way the costs worked out were clear – I should hire them. That held true across a variety of skills and job functions. Everyone from janitor to chief accountant was an employee of a firm. It was in this environment that our nation’s labor and employment laws were formulated, fixing the work week at 40 hours, requiring overtime pay, and tying requirements like medical insurance and retirement planning to the employment contract.

In the nearly hundred years since, business and work have changed considerably. Transaction costs for many skills and functions available outside the firm have decreased substantially. Janitorial tasks became easily contracted out to specialized firms. It became more cost-effective to hire a freelance designer for each design task than having a design department in-house, and so on.

Moreover, falling transaction costs led to people being able to offer services that would have been prohibitively expensive before. The Uber app, for instance, allowed people to offer their private vehicle to transport others at very low cost. Previously, a would-be driver would have had to secure a taxicab license (or ruinously expensive medallion) and drive around touting for customers. All those costs disappeared thanks to technology.

People like Sen. Warren may imagine what people really want is the security of a job with benefits. That’s not necessarily the case. Many of us actually prefer being our own boss, setting our own hours, and having flexibility in work arrangements. It was the presence of transaction costs that stopped us being able to do that before, forcing us into working for a boss. The labor strife of the Progressive Era often centered around the management style of bosses like George Pullman and Joseph Pulitzer. And anyone who doesn’t appreciate the problems of a soulless corporation hasn’t seen the movie Office Space.

Technology is likely to increase this divide between past and future even further. Artificial intelligence could make it trivially easy to find a contractor to do a job, or for a contractor to find someone who needs their services, by such means as automated matching, predictive analysis, cost estimation, and background checking. Transaction costs may be on the verge of collapsing.

In the future, even more of us will be able to be our own bosses – if the Labor Department allows it. Other western countries face similar crossroads. A major regulatory misstep could cede the developing world a chance to leap ahead and define the shape of work in the 21st century. And the American worker will suffer the most. If regulators don’t move with the times, America risks economic stagnation – and an increasingly unhappy workforce.