As Californians go to vote on 3 November to elect the 46th President of the United States, they will notice on their ballot papers, Proposition 22: App-based drivers as contractors and labor policies initiative (2020). If voted through, the state statute would consider app-based drivers to be independent contractors and not employees or agents. This would exempt app-based transportation and delivery companies such as Uber and DoorDash from providing employee benefits to certain drivers. This rather specific vote has significant ramifications for the gig economy. It brings into the open a longstanding debate on the inflexibility of US benefits provision, and socially, an ethical and moral debate as to what rights we expect workers to have and how those rights should be protected. This contentious issue intertwines technology disruption, organised labour, politics and the economic impact of COVID-19.

How did we arrive at Proposition 22?

Ubiquity of smartphones and the emergence of a ‘swipe right’ generation has caused a profound shift in how goods and services are consumed, and a resultant disruption in employment patterns. In 2019, seven million Americans used digital platforms to work, notably in ride hailing and food delivery¹.The rampant growth of the gig economy not only generated significant tensions with regulators and incumbents who felt that these disruptors were not playing by the rules, but also highlighted that change may be warranted, given that provisions of benefits in the US have for time immemorial been tied to full-time employment with provision by the employer. The gig economy was built on millions of workers legally defined as independent contractors rather than full-time employees, and therefore not entitled to any work or health benefits. Regulators and disrupted incumbents claim this is a legal charade to enable these new entrants to avoid paying these benefits, giving them an unfair competitive advantage. The gig economy companies retorted that this was a fair and legal reflection of their business models as app-based platforms; their workers preferred the flexibility and independence of this framework with the majority using this app-based work as supplemental income². The battle lines had been drawn.

In recent years we have witnessed various legal skirmishes as disgruntled gig economy workers, incumbent organised labour and lobby groups, as well as sympathetic local government legal offices, tested the legal defences of the gig economy platforms. With limited success it is unsurprising that the more aggressive US states chose to try and change the legislation instead. The headline act was California Assembly Bill 5 (AB5) that came into effect on 1 January 2020. This built on a 2018 Californian Supreme Court ruling that imposed a higher standard for classifying workers as independent contractors via a three-pronged test (ABC test). A key hurdle of that higher standard was that the independent contractor had to perform work tasks “that are outside the usual course of the company’s business activities”. It therefore became a lot harder for a ride-hailing platform to define a driver providing ride hailing services as an independent contractor. AB5 enshrined this higher standard into Californian law.

Armed with this new legislation, we have since seen an escalation of hostility between the California Attorney General and the gig economy platforms. The attorney general has been pushing aggressively to force these companies to comply with AB5 and reclassify their workers as employees. In retaliation, the gig economy platforms said they would put the issue to a ballot vote and have generously funded that lobbying effort with a reported US$190m³. This culminated in a tempestuous August where ride-hailing companies were served with an injunction forcing them to reclassify employees. This led the companies to threaten to shut down services in California – only for that decision to be stayed. In a recent blog post, the chief executive officer (CEO) of a leading ride-hailing company said that they would only be able to offer 260,000 roles to the 1.2 million US drivers currently on their platform⁴. And so, we move on inexorably to the 3 November ballot vote on Proposition 22.

A ‘third way’

Current employment legal framework in California does not allow for any middle ground or compromise. The only choice is to be an employee with access to benefits but no flexibility, or an independent contractor with flexibility but no benefits. While Prop 22’s headline appears to only exempt the gig economy from benefits responsibility and maintain the status quo, in fact the proposition is a compromise, aiming to retain flexibility and independent contractor status in return for guarantees on minimum earnings and maximum working hours, health benefits and accident disability and death insurance. This is the ‘third way’ being advocated by the gig economy to break the historical linkage between full-time employment and benefits. In normal times it would be foolhardy to try to upend such an entrenched relationship, but due to the unparalleled economic impact of COVID-19, we have seen the passing of the federal CARES Act, which was historic in its unprecedented provision of unemployment benefit to independent contractors and the self-employed. The tragic decimation of employment and lack of visibility on the economic recovery also places greater emphasis on those companies that can provide jobs, flexibility and support livelihoods.

In a world where it is too easy to focus on what cannot be agreed upon, it is worth highlighting areas where compromise can be reached. Employment patterns have clearly changed permanently; working for one employer for an entire career is now the exception rather than the rule. In a world of accelerating disruption, flexibility of employment will become ever more important. Yet the current US social safety net remains built on an increasingly antiquated foundation. However, the new employment world should also retain the hard-fought benefits of the old. Independence and flexibility should not come at the expense of a lack of minimum wage protection, paid holiday and sick leave, protection against discrimination and hazard as well as retirement, accident and death benefits. If there is agreement on those two basic tenets, then it is possible to move forward from an archaic social security construct to create a framework fit for today’s world.

What can active investors do?

Whatever the outcome of Prop 22, as well as the wider US election, with the majority of Democrats endorsing AB5 the legal employment status of gig economy workers and their entitled benefits are likely to remain a live debate for many years to come.

As stewards of client capital and as active investors we have a front row seat in these debates. This is not a separate ESG (environmental, social and governance) issue nor one that we can evangelically exclude. The gig economy is a fundamental and wide-ranging economic issue that affects incumbents and disruptors alike across multiple industries. Being able to proactively engage with senior management and assess the risks to business models and from draconian regulation is a core part of fundamental risk analysis impacting the future profit streams and valuations of these companies. As such we think it is important that portfolio managers directly engage with companies on these issues, provide solutions rather than just criticism, and help them stay on the right path. These efforts can help shape a sustainable future where the interests of companies, workers, regulators and shareholders can be protected.

The complexity of ESG debates typically requires sector-specific expertise, which we feel is often lacking in much third-party analysis, undermining credibility with companies as well as the chances of impactful action. We believe thorough ESG analysis can deliver a more holistic risk assessment of companies, the sustainability of their earnings and ultimately their future performance. Therefore, fundamental ESG integration should be a core part in seeking out the best investment opportunities.