Competition an answer for ethical issues

A FEW years ago, WA Business News carried a story about Lehman Brothers and its sales offensive to investors in Western Australia to flog securities backed by sub-prime mortgages.

The targets, and some of the biggest losers from the collapse of the sub-prime market, which ultimately led to the global financial crisis, were what Lehman insiders dubbed the three Cs – councils, churches and charities.

A wide array of salespeople, from the extreme end of sharp to the blunt end of fraudulent, have long recognised the opportunity the not-for-profit sector offers when it comes to unethical behaviour. They are considered soft targets.

Obviously government, which often lacks commercial nous as well, fits that description to a certain degree.

Take a look at the projects that a cartel of WA air-conditioning contractors stitched up when they banded together and fixed prices – acts which have collectively cost them more than $9 million in penalties in the Federal Court after an action brought by the Australian Competition and Consumer Commission.

According to the ACCC, projects that were affected included: an AMP refurbishment ($9.49 million); CSIRO – Petroleum and Minerals, Bentley ($5.23m); Belmont Shopping Centre ($2.67m); UWA Electronic-Electrical Engineering ($919,800); Nickol Bay Hospital – Chillers Replacement ($568,200); Chisholm Catholic College ($654,383); Rydges Hotel Chiller ($211,000); and Murdoch University Education and Humanities ($280,510).

Obviously these were the prices of the projects. The inflated amount is not disclosed and may well be difficult to ascertain.

Most of this above selection has education or government links.

Clearly, the air-conditioning people believe those are soft targets, too.

Recent experience shows that other contractors are capable of this, and the federal and state bureaucracies are perfect victims.

Builders have clearly rorted the federal government stimulus spending on schools, managed by state governments. I am still bemused at how the federal government could mismanage this so badly. Surely a stimulus package was intended to keep in work those who might have struggled. Yet the federal largesse was so great, builders could bid at prices that were more reflective of boom conditions. Cleary those builders did not need the work; perhaps they could have done us all a favour and let the bidding be done by someone else who did. It is our taxes they have wasted.

While it is hard to deny business people the opportunity to charge as much for their services as the market can bear, there is no justification for shoddy work or fraud as we have seen in the case of the insulation program, another wasteful federal scheme.

The worse part of that debacle is that perfectly legitimate businesses, ethical ones that did a good job, have been forced to the wall by the actions of their deceitful competitors.

Regrettably, bad operators give all business a bad name. But governments – and anyone else on the demand side – must share a great deal of the blame. They create an environment where controls are lax and the unethical have an advantage.

Take another example – Melbourne Storm. Sporting codes create a rod for their own backs by conjuring up handicap systems in order to maintain the pretence of even competition. Such systems are asking for rorters to find ways around them even if rugby league, footy and others believe such restrictions are for the long-term good of their game. As such, they ought to enforce their rules more adequately, including looking at signals that something is awry.

Melbourne Storm was in the finals four years in a row, something that the salary cap and player draft systems are designed to stop. Didn’t the NRL notice its plan wasn’t working?

Of course, they could do away with salary caps and let the market do its work.

In almost all of the above cases, competition failed, either through the greed of service providers, the poor practices of customers, the political timing of governments or the unnatural objectives of sporting bodies.

In my view, the best way to eliminate unethical behaviour in all these cases is to create a properly competitive environment. The transparency of competitive processes helps weed out the unethical. Similarly, penalties have to be adequate enough to discourage unethical behaviour. And, of course, there must some form of enforcement.

To borrow from Freakomomics authors Steven Levitt and Stephen Dubner: “Morality represents the way people would like the world to work. Economics represents how the world actually works.” If you don’t control the environment to foster competition, you will end up with distortion and ultimately corruption by providing incentives for people to do anything but offer the lowest price they can.

Former wheat monopoly AWB is a classic example of this.

AWB’s behaviour in Iraq, including bribes to a despotic regime, was supported at the highest levels of the organisation. It should come as no surprise that such activity should occur in a business that had the political muscle to regulate away competition in Australia. This is the opposite way in which regulation should work.

AWB’s monopolistic tendencies allowed it to become a law unto itself, until faced with the consequences of its international activity.

It is too early to comment on the issues surrounding Rio Tinto and BHP Billiton. In Rio’s case, China-based executive Stern Hu may have pleaded guilty but the opaque nature of the Chinese legal system leaves plenty of room for doubt about exactly what happened.

BHP Billiton’s Cambodian incident is more recent and there is even less information about what has taken place.

However, their plight raises the same issue for ethical businesses.

If you operate in environments where notions of bribery and corruption are different, how do you manage that? If you refuse to take part there may be a huge cost. Business opportunities may be lost, assets may be in jeopardy, staff may be threatened with jail or worse.

Ethical businesses think about those issues before they enter new markets and try to deal with them in a systematic way as they emerge in places where they already operate.

Those that countenance unethical behaviour abroad risk it backfiring on them back home – and that is not just direct sanction due to corruption of officials. Take for example the companies that dismally fail to meet basic environmental or human rights standards. These days, the discovery of such corner-cutting will usually cause damage for them, usually via investors or clients.

Environmentalists, human rights groups and regulators have got pretty good at naming and shaming transgressors of real and perceived laws.

I think customers – including the three Cs and government – have to get better at controlling their own environments to make sure they are not victims of unethical behaviour.

Waiting until victim status is awarded is too late. And blaming business is simply avoiding responsibility.