Shocked, shocked! that there is fraud here

21/03/2013 § Leave a comment

So the Right Honourable Winston Peters is alleging widespread fraud in Christchurch, and challenged the Rt Hon Gerry Brownlee to come clean about what he knows. The Serious Fraud Office has already said that they stymied fraudsters last year, saving the country millions of dollars (tens of? hundreds of?).

Fraud was always going to happen. It happens at the best of times — employees walking off with money, false invoices, work not done, etc. Recovery after an earthquake is not the best of times, so the potential was higher than baseline.

And, of course, there’s all that money. As Willie Sutton may or may not have pointed out, you rob banks because ‘that’s where the money is’. Same principle applies to Christchurch.

There are essentially two ways to combat aberrant behaviour: social pressure and good contracts. A high level of trust and goodwill — social capital, if you will, although I know it’s a contested term — and people will tend to behave as they should. Not everyone, not all the time, but it’ll get you most of the way there.

Good contracts can substitute. Well-defined goods and services, clear provisions for variations or re-negotiation, good measurement and monitoring processes, and you’re away.

But here’s the thing: earthquake recovery is exactly the sort of situation in which good contracts are hard to write. As we’ve found out, it isn’t as simple as ‘return the house to its pre-quake condition’. Which cracks do you fix? What’s the tolerance for a sloping floor or a wall out of plumb? What quality of finish and materials is specified? The permutations are endless.

What to do? Well, you can try to make better contracts. That takes time for negotiation, which is time you aren’t spending on the rebuild. You can have looser contracts but stricter monitoring and enforcement. This could work if you can specify what the results should be — which could be easier than being precise about a process. Or you could try to rely on social capital, but that capital is going to be diluted by all the new people coming in to help the rebuild. Any time and effort you spend on fraud controls, though, take away from the actual rebuild.

All of that means that the control processes won’t be perfect. There will be fraud. Get used to it.

But…the cost of dealing with fraud can be shared out in different ways. There are different costs: money, time, effort, anxiety. The EQC and Cera have, as bureaucracies do, privileged process over people. They have focused on screwing down the process to make fraud difficult, but that makes it harder for honest people, too. To save money, they have increased the cost in time and anxiety for Christchurch people.

Think of it another way: type I and type II errors. The rebuild is focused on type I, false positives. They want to make sure that all rebuild work is exactly as it should be, to reduce the incidence of paying for stuff that didn’t happen. But the two types of errors are inversely related. When you focus on the type I, you increase the incidence of type II, false negatives. You increase the amount of time chasing down fraud that isn’t there.

Oh, and incidentally, you burn through what social capital you have. As a result, you increase your need for strict processes and contracts. It’s a vicious spiral.

Of course there’s fraud in Christchurch. But the solution isn’t to treat everyone like a crook. That’s just imposing more costs on the people of Christchurch to avoid a little embarrassment in Parliament.

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