What's in a Name? The Vexed Question of Employment

Backgrounders

SUMMARY

Deregulation of the labour market in Australia has been slow and politically difficult, and the immediate prospects for further reform are not encouraging.

One of the difficulties of reform is that it assumes that the traditional master-servant relationship will continue to be central to the idea of employment.

In this Backgrounder, we show that, even under our relatively restrictive legal regime, there are other, non-traditional forms of working relationships available and in use.  These concepts have the potential in the long run to revolutionise our notion of employment.

Such arrangements, with their emphasis on removal of "control", on freedom of contract and on equality of relationships, should appeal to liberals.

Further, by bringing the internal operations of business closer to market conditions, they should yield better results for productivity and profits than the traditional, non-market, command-and-control notion of employment.

INTRODUCTION

Economists consider that the word "employment" refers to income-producing work by a person.  The ILO definition of those who are employed is "persons who performed some work for pay or profit during a specified brief period, either one week or one day". ⁽¹⁾

This commonly-understood ILO definition is quite different from how the law defines employment.  The law relies on delineating power relationships between people.  In considering employment, the law looks to see if an "employer" has "the right to control" an "employee" in a modified mediaeval master-and-servant style relationship.  According to Revenue Canada, for instance, "An employer-employee relationship exists if you are in a position to control and direct the person or people who perform the services". ⁽²⁾

Legally-defined employment implies the idea that an employee is a physical and psychological appendage of the employer -- unable, unwilling or not allowed to act in an independent manner.

This master-servant "control" legality underpins the regulatory industrial relations system of Australia and other English-based, legal employment regimes.  It dominates management and worker behaviour in the workplace, and is a serious constraint on the wealth of individuals, firms and nations.

THE MODERN STATE OF EMPLOYMENT LAW

Citizens regularly enter and exit employment relationships without the status of that relationship ever being explained to them.  Most of the time, indeed, neither the employer nor the employee knows or understands the legal status.  They usually think they are engaging in a simple work-for-pay relationship.  The work-for-pay relationship, however, is not necessarily considered by the law to be an "employment" relationship.

When a problem in a work relationship results in court action, the courts establish that legal employment exists before they consider the specifics of a case.  They do this by applying common-law "employment" tests.

In the first instance, the courts investigate if the user of labour has the "right to control" the worker.  They will look at the work relationship for indicators of control.  Among the questions they can ask are:

• What is the intention of the two parties?
• Do they wish to be in an employment, "control" relationship?
• Is there an expectation that the worker will attend each day?
• To what degree does the employer dictate what the worker does?
• Can the worker reject work?
• When are holidays taken and are they required to be taken?
• What do written documents say?
• What type of tax is being paid?
• Who is paying superannuation, workers' compensation and other statutory obligations?
• Are there allowances for holiday pay, sick pay, termination pay and other allowances?
• Is the worker compelled to work overtime?
• Who provides work clothing and tools for work?
• Is there stability and continuity in the work?
• Is the work on an hourly rate or job rate?
• Who pays expenses and who retains profit?

This list is not complete, however, and many of these questions may not even be investigated. ⁽³⁾

In investigating the legal relationship, the courts are looking to define whether one of two types of labour contracts exists:  either a "contract of service" or a "contract for service".  A "contract of service" is taken to denote employment.  A "contract for service" does not involve employment.

If the "control test" is not conclusive, which may frequently be the case, the courts may resort to what they call the "integration test".  This seeks to test if the worker is "part and parcel" of the business organisation, and also involves study of each and every specific situation.  The list of questions to be applied can be as extensive as that applied to the "control" test.

In taking all or some of these indicators into account, court rulings are not consistent or predictable.  The courts may look at some or all of the tests, interpret them in different ways in different circumstances and allocate different weightings of importance to different indicators in different circumstances.  The differences between judges, their case knowledge of this particular area of the law, the jurisdiction in which they operate, the evidence brought before them and the specific nature of each case before them all combine to make for an inconsistency of result.

In a most recent high-profile Australian case, the Crisis Couriers (Vabu) Case, ⁽⁴⁾ a single judge ruled that due to the nature of the control operating between the workers and the company, employment existed.  On appeal to the Full Bench, the employment declaration was overturned on the reasoning that the remuneration system indicated that the workers were independent contractors and not employees.

If an employment relationship is found to exist -- that is, that the employer has "the right to control" the employee -- the regulations imposed on the work environment through industrial relations legislation apply.  If no employment exists, then industrial relations legislation, courts and systems, do not have jurisdiction.

It is significant to note that the recent industrial relations reform debates in Australasia have never extended to questioning the appropriateness of maintaining the master-servant "control" situation.  Both the New Zealand Employment Contracts Act and the Australian Workplace Relations Act seek to regulate the "right-to-control" employment relationship.  The "reform" procedures have been limited to resetting the regulations and the legal balance between the employer master and the employee servant.

EMPLOYMENT LAW AND GOVERNMENT AUTHORITIES

Many government bodies legally depend for their authority and revenue-collecting powers on the finding of legal employment.  If there is no legally-defined employment, the government body cannot collect its impost or administer its responsibilities.  Of concern to government bodies is the leakage of both revenue and authority occurring because of the rapid change in workforce engagement arrangements happening in developed economies.  The changes amount to large-scale desertion from legal employment relationships and replacement with contractor or independent contractor systems.

The changes in work engagement are affecting the authorities responsible for collecting payroll tax, workers' compensation, PAYE tax and superannuation, to name the main Australian areas.  The situation is similar in North America and Great Britain.

In the United States, the federal tax base is under stress because of workforce engagement changes.  One US commentator states that "... the IRS decided several years ago that too many businesses are using the independent contractor designation as a tax dodge", and that "according to IRS estimates (1990), $1.56 billion in revenue is lost to the federal government each year because of such abuse". ⁽⁵⁾

In Australia, the trend away from legal employment arrangements concerns the Australian Taxation Office.  In early 1996, the then Federal Treasurer, Ralph Willis, said that the trend "threatened the integrity of the personal tax system". ⁽⁶⁾

Payroll tax and workers' compensation authorities in Australia find themselves fighting to protect their universal coverage capacities:  the Queensland payroll tax authority was recently forced to amend its Act to close a "contractor" loophole, ⁽⁷⁾ after a technical "contractor system" had been created by some individuals which avoided the provisions of the Act.

Payroll tax and workers' compensation bodies, Australia-wide, are currently involved in negotiations aimed at finding resolution on the issue of worker coverage.  High on the agenda is the issue of employment versus contracting and the desired and appropriate scope of their jurisdiction and authority.

Because of the employment definition problems and the changing nature of workforce engagement, government bodies go to great lengths to ensure that some form of legal "employment" can be found to exist.  Having often lost in the courts on common law "control" assessments of employment -- as occurred with the Australian Taxation Office in the Crisis Couriers case -- government authorities resort to writing legislation which redefines employment for the purposes of their particular revenue-collecting powers.  They call this "deeming".

"Deeming" literally means that if legislators wants to call a duck a chicken for the purposes of their legislation, they can do so regardless of the reality that a duck is still a duck.  If the courts determine that there is no "right of control" and so "employment" does not exist, the government body will argue that regardless of the courts' common-law "control" finding, then "employment" will exist "for the purposes of their legislation", enabling the government body to collect the revenue or exercise its authority. ⁽⁸⁾

COMMERCIAL CONFUSION AND RISK

We have, as a consequence, employment defined for common-law purposes which can be inconsistent with and different from definitions for payroll tax purposes, which can be different from workers' compensation definitions, which can be different for income tax revenue collecting purposes -- and so on.

The result is commercial confusion.  Businesses do not know where they stand.

Solicitors, accountants and business bodies, in advising their commercial clients on the application or existence of a legal employment relationship, can never be totally sure of the accuracy of their advice or whether their advice will be confirmed by the courts.  Such legal insecurity compounds the problems which businesses have in attempting to achieve best practice in their operations.

EMPLOYMENT LAW, THE FIRM AND MANAGEMENT

Employment law universally and intimately affects the operations of firms.  The behaviour and performance of workers, managers and firms are influenced by the legal relationships operating within firms;  and the management theories underpinning firms' operations are a product of the details of the internal legal relationships, as are the operational structures chosen by firms.

At the core of the practices, structures and theories is the issue of control.  Traditional pyramid-style organisations, which have so dominated post-industrial-revolution, democratic, capitalist economies, have at their centre classic command-and-control structures, dependent upon the "right-to-control" master-and-servant relationship.  Firms are collectives run by a master.

This was most clearly described by the Nobel Prize-winning economist R.H. Coase, in his seminal 1937 work, The Nature of the Firm.

Coase proposed that a firm's existence and success are dependent upon the ability of an entrepreneur to control the workers inside a firm.  Coase explained why firms exist.  He said that

... the operation of a market costs something, and ... by forming an organisation and allowing some authority (an entrepreneur) to direct resources, certain marketing costs (transactions costs) are saved. ⁽⁹⁾

and further,

We can best approach the question of what constitutes a firm in practice ... by considering the legal relationship normally called that of master and servant or employer and employee. ... The master must have the right to control the servant's work.  We can thus see that it is the fact of direction which is the essence of the legal concept of employer and employee just as it was in the economic concept [of the firm] which was developed above. ⁽¹⁰⁾

Coase reasoned that the "control" inherent in the legal employment relationship is prime to the authority of the entrepreneur and to the existence of the firm.  Given this thinking, if we remove the master-servant employment relationship, then the conceptual understanding of what a firm is and how it operates would presumably collapse.

Whether implicitly or explicitly understood, the link between master-servant control and the existence and operations of firms has underpinned management theory, thinking and practice in post-industrial-revolution economies.  It is, however, under direct challenge in developed societies, where firms are having to find better ways of performing in increasingly competitive and unprotected global economic environments.

In many respects, it is beginning to appear that legal "control" employment has been capable of taking economic development to a certain point, but that beyond that point, the master-servant relationship inhibits further development.

NON-EMPLOYMENT AND THE WAY FIRMS ARE CHANGING

The move away from traditional workforce engagement is readily observed in Western societies, and is perhaps one of the most significant social trends of the end of the twentieth century.

In North America some analysts are predicting that "... by the year 2000, 50 per cent of all Americans will be contract workers". ⁽¹¹⁾  One firm in the US reconsidered who were its key "employees", and concluded that only the Chief Executive Officer should be classified thus.  Its 500-strong workforce are engaged through personnel agencies.  The largest organisation in the United States is the personnel agency Manpower, with 560,000 people in the field.  (This compares with General Motors with 365,000 and IBM with 330,000.) ⁽¹²⁾

In Australia, statistics from the National Institute of Labour Studies indicate a sharp upward trend in the penetration of non-employment arrangements in the workforce.  In 1989, 3.3 per cent of the non-farm workforce were listed as self-employed contractors.  This had risen to 7.5 per cent by 1994, representing 553,900 people working outside legally-defined employment relationships. ⁽¹³⁾

The trend away from traditional workforce engagement to non-employment arrangements is characterised by

• the removal of belief in job permanency and security;
• a sharper focus on performance on a daily basis;
• a shift to remuneration on a results or performance-expectations basis and away from time-based remuneration;  and
• a reassessment of the significance of loyalty between the firm and the worker.

In an address to the US Senate Budget Committee earlier this year, the head of the US Federal Reserve, Dr Alan Greenspan, mused on the reasons as to why the tightening in the US labour market was not resulting in wage-induced inflationary pressures.  He saw this as an important departure from past patterns, one which held prospects for sustained, low-inflationary growth.  "As I see it, heightened job insecurity explains a significant part of the restraint on compensation and the consequent muted price inflation". ⁽¹⁴⁾

In legal employment, the trade-off for "control" has been permanency, security, employer responsibilities and bonding through loyalty.

The question deserving of consideration is, does a shift away from the traditional master-servant relationship, and the death of security, hold promise for future economic growth and prosperity?

Certainly, legal employment has always operated as a key mechanism for the suppression of market forces (labour) within the firm, a factor which was thought to be central to the containment of transaction costs within firms.  Legal employment has operated to isolate the operation of the market to transactions between firms and to prevent the market operating inside the firm.  Legal employment has operated as a protective umbrella similar to tariffs, the beneficiaries largely being management.

This is highlighted in a new publication from the London-based Institute of Economic Affairs, titled Markets in the Firm. ⁽¹⁵⁾  This study provides an excellent explanation of the international trend away from command-and-control employment regimes, and describes the management dynamics operating in firms which have welcomed marketplace principles to their internal operations.

As legal employment breaks down, the market enters the internal workings of the firm.  This trend unsettles entrepreneurs used to thinking in terms of traditional arrangements, who simply fear an escalation in labour costs.  But if the parallel to tariffs and the comments of Dr Greenspan are valid, perhaps the result of the diminution of legal employment will be to force up the productive behaviours of the elements within the firm, including that of the entrepreneurs or managers.

NON-EMPLOYMENT MODELS

The types of arrangements being used to break away from employment are varied.  They may often be legally suspect, subject to testing and, when tested in the courts, will be declared to be master-servant "control" employment.  Some systems are legally secure, representing developments on the path to non-employment.

INSECURE NON-EMPLOYMENT

The legally-suspect non-employment arrangements involve engagement between firms and individuals, or individuals and individuals.  Even though they are legally insecure, they survive because the statutory authorities, unions or opposition firms do not have the resources or motivation to find, investigate and move against all the firms and all the systems.  Possession usually takes place of the law when both the worker and the labour-user find commercial common ground.

The less suspect systems are those where work is arranged between structured companies.

The existence of the companies usually denotes a commercial contract for services.  But when one of the companies is, in reality, a single person, the engagement risks being declared legal employment.

The common feature of legally-insecure arrangements is that the participants take the indicators of employment (discussed earlier) and attempt to structure matters so that the indicators cannot be said to apply to their arrangements.

This approach involves high-level commercial risk if the system developed has not been through prior judicial testing.  Getting the system right is such a delicate task that some observers claim it cannot be achieved with certainty.

According to one US commentator, "... there is no action which I can recommend which will establish an independent contractor relationship, and according to one (extreme) Los Angeles attorney, there is no such thing as an independent contractor". ⁽¹⁶⁾

LEGALLY-SECURE FRANCHISING

Franchising has been one of the great growth industries since its invention by the founder of the McDonald's chain in the early 1950s.  Franchising enables a large organisation to exist, with tight control mechanisms which are not dependent on the master-servant relationship.

In a franchise, the head franchiser controls the operation through commercial contracts with the smaller franchisees who are independent businesses.  The franchisees enter the commercial relationship on an offer-and-acceptance-of-contract basis.  None of the legal elements of master-servant control exist between the franchisee and franchiser.

Legal employment, however, will normally continue to exist between the individual workers and each franchisee.

LEGALLY-SECURE "CONTRACTING-OUT"

Contracting-out is used extensively in the building, construction and mining industries in Australia and more recently is being adopted by government sectors.  For example, it is common for companies who own a mine not to conduct the excavation of the mine.  A contracted company will do the mining.  In public hospitals, it is increasingly normal for private, independent businesses to manage wards, operating theatres and other key facilities within the hospital.

Like franchising, the contractual relationship is between structured companies with no employment arrangement between them.  An employment relationship continues to exist, however, between the workers and the contracted company.

A key element of contracting-out is that the head company is removed from direct managerial control of workers on site, with the contracted company exercising the management employment control.

"EMPLOYMENT" AGENCIES

This is one of the big growth areas of workforce engagement, which should not be confused with legally-secure non-employment.

"Employment" agencies supply workers to a user business in one of two ways.  In the first, the agency is the legal employer but exercises limited, if any, control of the workplace.  If the agency did exercise management control, it would be engaging in contracting-out.  In the second, the agency supplies the worker and the worker becomes an employee of the user business.

Employment agencies most often supply casual workforces, but an emerging trend is for them to supply all ongoing workers to user businesses.  Legal employment continues to exist but the exercise of control can become "fudged".

If an "employment" agency claims to be supplying "contractors", it is making claims which cannot be substantiated unless tested in the courts.  If tested, the workers will usually be found to be employees of someone.

SECURE "ODCO" ARRANGEMENTS

An Australian High Court development in 1991 -- in the case of Odco Pty Ltd vs BWIU -- saw the creation of perhaps the purest form of legal non-employment arrangements yet witnessed, the "Odco arrangements".  The initial trial judge referred to Odco arrangements as "sui generis", something unique and different to any prior known legal work arrangements. ⁽¹⁷⁾

The Odco High Court judgments declared that an individual person can work for a business through a properly constructed contract administrator and be at law an independent contractor.  Under Odco work arrangements, the master-servant, employer-employee relationship does not exist.  The "right to control" workers is eliminated but the user business can "direct" the work.  Work is organised under the principles of "offer and acceptance of contract" with workers having freedom of choice.

Contracts may not be exploitative.  The work need can be of a continuous nature, which is facilitated by new contracts being offered each day.  Contracts exist between the Odco contractor and the administrator, and the user business and the administrator.  Significantly, no contract exists between the user business and the Odco contractor.

The Odco system does not come under the jurisdiction of either State or Federal legislation pertaining to unions or awards.  Odco arrangements are starkly different from "employment agencies" because with Odco, "employment" does not exist.

The significance of Odco is that it is a secure, non-employment system which is portable across all business and industry sectors where there is a need to break free from the constraints of employment.  Odco is unique to Australia and observations to date have not found any similar legal breakthroughs in North America or Great Britain.

There has been significant and growing application of Odco arrangements in the Australian scene in the last two years.

EMPLOYMENT, UNIONS AND FIRMS:  AN INTERDEPENDENCY

It is perhaps no coincidence that the rapid decline in union membership in recent decades has coincided with a shift away from legal, master-servant employment relationships.  Union membership remains strongest in firms and industries where master-servant legalities and master-servant management mentalities prevail.  The reason for the link is the mutual benefit unions and some firms obtain by maintaining master-servant control relationships.

Unions exist because of the master-servant relationship.  The union role has been to act as a countervailing force against the dominant legal position of the employer as the master.  When the employment "control" relationship is removed, the worker exists in a business relationship with the user of labour, with the achievement of commercial common self-interest driving the relationship.  In this business relationship, the workers' need for collectivist action by unions is diminished -- some may say neutralised.

Legal employment and unions have acted to assist firms to gain and maintain monopoly market positions.  Employment regulation has been important to the suppression of market (labour) forces within and between firms, so assisting the minimisation of competition to existing market-dominant firms from new or growing firms.

When non-employment relationships are utilised, unions' reasons for existence are threatened, as is the market position of established firms.

THE FUTURE IS THE PRESENT

The shift away from the legal "right to control" master-servant employment relationships represents one of the great movements of social history.  Yet, like any evolutionary change, the participants rarely realise the full significance or nature of the change occurring to and around them.

To gaze into the crystal ball and declare that "control" employment will be dead in the future, would be simplistic.  The patterns of the future are, however, observable in the present.

The trend away from legally-defined employment is substantial and growing.  Where non-employment is used, the systems which are utilised and the legal security which applies will vary from case to case.  Legal employment will most likely continue to have a solid although diminishing position in economies.

In the immediate future, interest will be on observing how "employment" corporations compete against rising "non-employment" organisations.  Also of interest will be how government bodies, eager to protect both their revenue and regulatory powers, grapple with the growing non-employment trend.

Civilised societies have long recognised that truly creative artistic talent finds its peak when artists are free to explore and develop their creative self.  The same applies to all individuals in a society.  In the work environment, individuals will not release their full potential when they are "controlled".  The error of "wage slavery" is the suppression of individual productive potential.  The promise and hope of legal non-employment systems is the release of creative but latent economic potential, with resulting increases in the wealth of all nations.

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ENDNOTES

1.  Statistics of Labour Force, Employment, Unemployment and Underemployment.  International Labour Organisation, Thirteenth International Conference for Labour Statisticians, Geneva 1982, page 10 6)1) (a).

2.  Employers' Guide to Payroll Deductions 1995-1996.  Revenue Canada Page 1-1.

3.  No one court case provides a definitive picture.  Sources for this list of questions can be found in two ground-breaking Australian judgments:  the Odco judgments of 1991 (which involved six judicial considerations, two being at the High Court);  and the Vabu (Crisis Couriers) Case (involving three judicial considerations, one involving the High Court).

The main Odco judgments are:

the published judgments of the trial judge, Woodward J., in the action Odco vs BWIU & Ors, no. VG 151 of 1988, in the Federal Court of Australia (unreported), 24 August 1989;

the appeal judgment in BWIU & Ors vs Odco Pty Ltd, no. VG 322 of 1989, in the Federal Court of Australia, reported at (1991) 29 FCR 104;

the High Court judgment in Accident Compensation Commission vs Odco Pty Ltd, FC 90/040 of 22 October 1990.

The Vabu case is Vabu Pty Ltd vs Commissioner of Taxation, no. CA 40206/95, 6 September 1996, in the Supreme Court of New South Wales.

4.  Vabu case, op. cit.

5.  Miles Miller, "The IRS finds invisible employees", ACC Communications Inc. USA, October 1991.

6.  "The trend that worries the Tax Office", Australian Financial Review, 8 January 1996.

7.  Office of State Revenue Queensland, "The Pay-Roll Tax Liability of Employment Agents", Circular, December 1996.

8.  For an example of employment "deeming", see Ss. 8 and 9 of the Victorian Accident Compensation Act.

9.  R.H. Coase, The Firm, the Market and the Law, Chicago:  University Press, 1988, page 40.

10.  Ibid., page 53 (parenthesis added).

11.  Fortune, January 1994.

12.  William Bridges, Jobshift:  How to Prosper in a Workplace without Jobs, Sydney, Allen & Unwin, 1995.

13.  M. Wooden and A. VandenHeuvel, "The Use of Contractors in the Australian Workplace;  Evidence from a Survey of Employers", National Institute of Labour Studies, Flinders University, Monograph Series No. 3, 1996;  M. Wooden and A. VandenHeuvel, "Self-employed Contractors in Australia:  What are the facts?", National Institute of Labour Studies, Flinders University, Working Paper Series No. 136, February 1995.

14.  Dr Alan Greenspan, testimony to the US Senate Budget Committee, as reported in the Australian Financial Review, 23 January 1997.

15.  T. Cowen and D. Parker, Markets in the Firm.  A Market-Process Approach to Management, Institute of Economic Affairs, London, July 1997.

16.  Ethan A. Winning, "Pitfalls in Independent Contractor Relationships", from Labour Pains:  Employer and Employee Rights and Obligations, TFM Publications, USA 1995.

17.  Cf. note 3.