Believable and very disturbing story about lax “financial safety” #Fukishima, over at Bloomberg.
Mitsuhiko Tanaka says he helped conceal a manufacturing defect in the $250 million steel vessel installed at the Fukushima Dai-Ichi No. 4 reactor while working for a unit of Hitachi Ltd. (6501) in 1974. The reactor, which Tanaka has called a “time bomb,” was shut for maintenance when the March 11 earthquake triggered a 7-meter (23-foot) tsunami that disabled cooling systems at the plant, leading to explosions and radiation leaks.
The important and interesting part from a structural point of view, is the comment by Mr Tanaka that:
If the mistake had been discovered, the company might have been bankrupted
Even if the allegations are unfounded, the point at stake here is that it is entirely plausible that a contractor such as Hitachi Ltd, could well find itself under excessive financial pressure to “conceal the damage”. The point is that the possibility of such a scenario, were determined by the contractual arrangements, and the question is whether the risks of this possible scenario were considered in the drafting of the contract (and what role the regulator should have in this arrangement).
The problem here is that the scale of the losses (the threat of bankruptcy), could be too high, and the incentives to come clean too far off in the future, and this combination may have a statistically demonstrable, and adverse effect on management behavior, and therefore the risk of catastrophic failure.
The missing ingredient
I also suspect that, while a good deal of effort may have been put into establishing the credentials of the supplier, and their financial capacity to deliver the project, this assessment may have been made from a financial risk perspective alone, and the technical risk of the physical design being contracted for, but not one which also looks at how the contractual arrangements affect the overall risk profile of the project in terms of safety.
This sort of thinking, one which avoids looking at the system of incentives, both positive and negative, as a whole, but rather separates the legal culpability issues from the financial apsects of the contractual arrangements, is the very same way of thinking about risk that failed us in the financial sector. What is needed is a risk evaluation of contractual incentives, based on an understanding of the social and organisational effects of the incentives that these agreements embody.
In a rational world, the risk of an engineering fault in the manufacture of the blast furnace should have been factored in, together with the consequent increased risk of a management endorsed cover-up. This would in part be a side effect of the scale of the short term economic loss that the company would face, as a proportion of it’s turnover, in the event of having to come clean about the engineering fault. It should be a legal requirement that this structural risk, be held within a reasonable limit, and insured against in cases where this were appropriate. At the very least it should be an explicit part of the overall risk assessment.
I am curious to know how much of this type of analysis is part of the risk assessment that is undertaken by the government and the nuclear industry. It certainly was not a part of the risk assessment for the regulation of the financial industry.
Thought experiment
What could be done in terms of the legal regulatory framework for such contracting arrangements, that could take into account such social risk factors? The answer is plenty of things. Exactly what would work, and what would not is a whole field to be explored, but I see no reason why the standard techniques of insurance cannot be applied to this area as it is to other areas of risk. The insurance companies could also finance the necessary research into this area.
Perhaps there should be an appropriate insurance element of the contract, that insures the contractor against failure to deliver, so that the incentives to cover up a problem are balanced against the incentives to meet the financial terms of the contract. Or perhaps contractors would need to agree to a whistle blowing provision, in which an anonymous wikileaks style facility were deployed, and even incentivised, so that all employees working on the contract would have pseudo-anonymous access to a neutral third party to report any perceived risk related issues. Many things could be tried, modelled, and assessed.
It may not be an exact science, but risk never is, and over time, we would be able to quantify much more accurately the different risks associated with different contractual arrangements. At the moment, we are not even beginning to look at these issues.