Chapter 3: “The Leaky buildings Crisis: Understanding the Issues
Keywords: Regulation & Taxation;
Introduction[1]
The first commercial transaction in New Zealand involved Maori exchanging with the Endeavour’s seamen fish for tapa cloth. (Not nails; despite their iconic appearance in a host of images; the ship’s officers offered them, but the neolithic Maori did not yet appreciate their significance.) Maori to Maori transfers were then largely gift exchanges in which the transactors knew one another. They involve quite different principles for the focus is on the transactors whereas in a commercial exchange it is on the transaction. If neither party knows one another, or transacts as if they do not, it is a commercial exchange.[2]
The first exchanges occurred without any underpinning of commercial law for there were no operative statutes and no judiciary. Yet the exchange proved to be successful. Why? One factor was that each transactor thought they were obtaining something far more valuable than they were offering. But more fundamentally this was a wysiwyg transaction – what each saw was what each got – so a complex regulatory environment was unnecessary.
Regulating Economic Activity
Today most transactions are considerably more complicated than wysiwyg and there are a host of statutes which regulate them – the Ministry of Consumer Affairs alone administers 11 relevant statutes; others are administered by the Ministry of Economic Development, the Ministry of Justice and other government departments.[3] Additionally there are regulations made under statute.
The overall framework of this law has been built up over the years, but in the late 1980s there was a move to ‘Light-handed Regulation’. Internationally this term commonly refers to a regime for regulating monopolies. In New Zealand it has a wider meaning, although there appears to be no universally accepted or formal definition. Here it refers to public administrative regulation which aims to be minimal and not intrusive, in the contrast to command and control system which grew up with the war economy of the 1940s and, in various ways, was common until the 1980s. In simple terms rather than administrative intervention, each firm is left to regulate itself subject to market pressures in a context of generic law such as on contracts, tort and trusts.
This paper uses the term ‘regulation’ differently from that in much public discussion, which confines the notion of regulation to legal interventions. Economists see the market as a regulatory system in its own right, so their concern is the balance between administrative interventions and market behaviour. Importantly, the profit-seeking firm may be subject to litigation if it fails to meet expectations, while maintaining its reputation among the public can also restrain its behaviour.
The approach recognises that some administrative practices are also regulatory. While the legal framework for regulation may be quite adequate. the administrators may fail to implement it effectively. (A sinister form of light-handed regulation occurs when potentially effective law is not enforced because there are inadequate resources to do so.)
Public policy thus becomes concerned with designing or improving the regulatory system of the economy (and sometimes of non-economic activities), seeking to find a balance between the purity of the market mechanisms and the reality that it may not be totally effective. It recognises the possibility that while some supplementary administrative or legal arrangement may improve the market outcome it may not be totally effective either.
Historically changes have tended to be incremental and in both directions of increasing or reducing – often refining – the statutory and administrative interventions. However in the period 1984-1994 there was a more radical approach which is sometimes called ‘deregulation’ although typically it involved a major rebalancing of the regulation towards greater use of the market mechanism. Hence economists’ preference to call the changes of the late 1980s and early 1990s ‘market liberalisation’. It is important to stress, however, that even the most extreme proponents of this liberalisation emphasised that there was a need for underpinning law to enable the effective working of markets.
While it was generally agreed that there was often excessive public regulation before 1984, and that often the market would do a better job, there was considerable disagreement as to how much government intervention should be withdrawn. Light-handed regulation was seen – even at the time by some who at the time supported market liberalisation – as an overreaction.
More recently there has been a swing back of the regulatory pendulum. The following list indicates how pervasive light-handed regulation has been by giving examples where there has been a retreat from it in recent years because of perceived failure:
– the telecommunication market, in which the dominant supplier, Telecom, was privatised without any consideration of the regulatory environment. (The government-owned business had had some directions from government which regulated some of its ‘monopoly’ behaviour; they were immediately abandoned by the new private owners.) In recent years there has been increased intervention, including a Telecommunications Commissioner in the Commerce Commission and specific directions (such as the separation of line from other businesses);
– recognising that given the supply conditions market competition in electricity supply is not always effective there is a supervising Electricity Authority and some restrictions on the degree of vertical integration;
– the finance industry is now regulated by the Reserve Bank of New Zealand following widespread business collapses in the 2007 to 2010 period, in part blamed on inadequate supervision by the Securities Commission;
– the investment advice industry now has an Investment Advisers’ Act following poor quality performance in the run up to the Global Financial Crisis, when many investors lost wealth (in part because the advisers were not disclosing their conflicts of interest);
– in early 1998 the Auckland CBD suffered a blackout when the cables delivering electricity overheated and failed. This may not be quite as much a regulatory failure as the other examples, but in part it reflected a downgrading of engineering supervision with greater attention to commercial imperatives, similar to that which has occurred in some of the other examples;
– early evidence to the royal commission enquiring into the Pyke River Coal Mine disaster (also discussed below) suggested there had been inadequate levels of mine safety supervision. In August 2011, the Department of Labour’s head of health and safety policy, James Murphy, agreed with journalist John McCrone that the department had taken a hands-off attitude to the detail of mine safety ‘and we are now thinking that actually we were too hands-off.’[4] A few days later the government announced it was setting up a High Hazards Unit, doubling the number of safety inspectors for the mining and petroleum industries.
– the Employment Contracts Act (1991) has been replaced by the Employment Relations Act (2000). While this could be argued to reflect the changes of political power following the election of a Labour Government, there has been no strong call for a major reversal following the election of a National Government in 2008.
– pertinent to this paper, much of the reorganisation of the government involved the abandonment of specialist units and there incorporation at lower levels in mega-departments. The establishment of the Department of Building and Housing in 2004 reversed the trend in the case of the housing construction sector.
In each case light-handed regulation arguably reduced economic performance and equity – hence the need for the retreat – but others also cost lives.
– in April 1995 14 young people died and others sustained severe injuries when a platform overlooking Cave Creek collapsed. In his report on the incident, Judge Graeme Noble found one of the causes of the failure was inadequate supervision by the Department of Conservation. Behind the failure was the 1989 closure of the Ministry of Works and Development which meant their high standards of regulatory supervision of such constructions lapsed. Noble concluded ‘I am left with the overwhelming impression that the many people affected – victims and their families, department employees and their families, and others closely associate with the disaster – were all let down by the faults in the process of government departmental reforms.’[5]
– In April 2008, a coolstore in Tamahere, Hamilton exploded killing a fireman. The manager of Icepak told the inquest that his company operated without knowing it was putting people at risk, and had no one on staff with electrical or refrigeration expertise relying on outside experts. A safety inspector said that an inspection three years earlier had found some safety issues, but there was no obligation for that to be followed up; it is the owners of coolstores who must make sure plants comply with the law, because the industry is self-regulating.[6] At the time of writing the enquiry had not reported as to the cause of the death. (Earlier the company, and associated refrigeration company and the managing director pleaded guilty to charges of breaching health and safety employment regulations. Their fines plus reparations to the injured firemen and their families amounted to almost $400,000.[7])
– in November 2010 29 miners died in an explosion of the Pike River Coal Mine. At the time of writing the resulting Royal Commission has yet to report, but early evidence to the enquiry suggested that had not there been the reductions in the frequency of mine inspections and the standard of mine safety supervision the disaster may not have occurred.[8]
– again particularly pertinent to this paper, it would appear that severe personal and (financial) stress arising from a leaky home has contributed to suicides (and marriage breakups).
The Leaky Building Syndrome is an exemplar of the economic failure of light-handed regulation. As well as the already mentioned reversal of the governmental administration arrangements and the personal stress it has caused, there has also been significant resource costs. The estimates of these losses cover a wide range depending on assumptions; currently the lowest is NZ$11.3 billion (i.e. 6 % of annual GDP), with estimates going up to $33 billion (18% of annual GDP), based on 110,000 dwellings costing an average of $300,000 to fix or replace.[9] These estimates do not include the costs of similar failures in commercial buildings and public buildings such as parts of hospitals and schools.
Leaky Homes: the Beginnings
There is no authoritative account of how the leaky building syndrome (‘LBS’) arose. The following pays particular attention to the role of regulation.
Home construction is a long-established industry, which historically might be characterised as a craft activity. (Do-it-yourself was not uncommon.) Technology was slowly changing, and learning was on-the-job, with an increasingly formalised system of apprenticeship training. Quality control was by reputation, including by professional membership of organisations such as the Master Builders Association (which has been around for over 100 years), and by local government which approved plans and whose building inspectors check a builder’s work. Typically the inspectors were ex-builders – retired perhaps because of physical infirmity but very knowledgeable about building practices.[10] Some new housing also involved other professions such as architects and engineers, although they were more likely to be involved in the construction of commercial and public buildings.
Until the early 1990s, local authority by-laws prescribed the manner in which construction was to be carried out, although different councils prescribed different building methods, a heterogeneity which the building industry found unsatisfactory (especially as often there were a number of local authorities in the same region). Of course mistakes were made, but they were not widespread and the building industry learned from them.
From about the 1970s the rate of technological innovation in house construction began to accelerate. By 1979 the innovation challenge was sufficiently serious to be mentioned in public fora. Eventually this led to the Building Act 1991, described below, which was to move from prescriptive building practices to performance-based ones. There were also institutional changes.
Over the years various institutions had been developed to protect new house purchasers, including the Building Performance Guarantee Corporation (discussed below), which was closed in 1987. The Ministry of Works and Development was also disestablished, a decision usually seen as reflecting the downgrading of engineering relative to commercial accounting in the priorities of policy makers. Some of the functions of the ministry, including those involving housing construction, were transferred to the Department of Internal Affairs which established a Building Industries Commission, whose 1990 report is discussed below.
Other events associated with the market liberalisation also contributed to the series of interconnected events which led to the LBS. The reform of local government would have led to upheaval in many planning approval offices and among building inspectors. There is a view that funding was reduced, so there was poorer supervision. The labour market upheaval resulted in many workers being laid off; some became self-employed, but under-qualified, builders. Although not documented there is a widely held view that apprentices were a mechanism through which new technologies from experts in the class room were transferred to the workplace. A reduction in apprenticeship training in the early 1990s meant the technologies were no longer transferred this way. The ending of import controls facilitated introduction of new materials, not all of which were well understood by the local building industry.
Leaky buildings: the 1990s
The recommendations of the Building Industry Commission which reported in January 1990 were incorporated in a bill introduced into Parliament by the Labour government later that year. It was be passed with bipartisan agreement as the Building Act in the following year (1991). However one major proposal – to reintroduce something like the recently disestablished Building Performance Guarantee Corporation – was not proceeded with.[11]
The effect of the legislation and the subsequent regulations was to change dramatically the Building Code which regulated dwelling construction from a set of prescriptions of the manner in which buildings were to be constructed to a set of performance criteria to be achieved. For instance, structures were required to last 50 years, the cladding 15 years, and the walls and roofs were to be impermeable to water. The belief was that the old regime had stifled the use of new materials, design and construction, thereby discouraging innovation and raising building costs. Under the new regime new methods would be introduced more easily.
The minister in charge of the bill, ex-builder Graham Lee, said its most important element was the development of private building inspectors. If only that had been correct. Not only did the minister overlook the features of the legislation which contributed to the disaster, but private certification has had little impact and many of the certifiers have withdrawn from practising.
‘Cause’ and the Leaky Building Syndrome
The act came into force in 1992 with the introduction of the Building Code. There is a view that the code was the ‘cause’ of LBS. However, as the preceding section indicates, there were numerous factors coming together which led to the failure.
The early 1990s were a period when the market extremists were still triumphant, and the notion of light-handed regulation widespread. It appears that little thought was put into considering the issue of what redress the house owner would have if the performance standards were not attained. Suppose the cladding fell off after 14 years? Under light-handed regulation the aggrieved party can litigate, but who exactly is to be sued? So many are involved, and all, to some extent, may be at fault: the local authority, its building inspector, the builder, the architect, the buildings material supplier, the developer, the home owner who onsold, and even the legislators and their advisers who passed the relevant legislation.
The available law proved useless. The Consumer Guarantees Act (1993) (‘CGA’), which states the good or service supplied had to be ‘fit for purpose’ might seem relevant, but a house is not a single commodity but a combination or mix of commodities that have been brought together. So, if the bathroom basin failed one could use the CGA and seek redress but that does not apply to a whole dwelling.
In the event fault can be, and has been, very difficult to establish in law. A helpful analysis is James Reason’s ‘Swiss cheese causative model’, in which there are a series of slices with holes in them. It is when there is an alignment of the holes a particular untoward event occurs.[12] While this may be useful for explaining a single event, its relevance to explaining a repeated failure is less clear. The LBS involves thousands – perhaps over 100,000 – homes. Alignment of the holes in all these cases cannot be an unfortunate coincidence. Many of the slices were only holes. The failure was systemic.
Given so many potential groups at fault, and given that the building failures took time to identify, litigation is not always quick or effective. Many of those involved will have passed on, companies will have disappeared, and the home may have passed through a number of owners. In any case they cannot possibly collectively find the $11–$33 billion required to fix the problem. Outcomes for the victims of LBS have frequently been unsatisfactory and costly, especially as they frequently bear much of the cost. (While many think the government of the day has the greatest culpability, suing the government is not really an option, parliament having largely ruled it out. Moreover, a Minister for Building and Construction said that the government’s pockets are not that deep either.[13])
For the purposes of this chapter at issue is not so much the inadequacy or failure of the legal remediation process (nor its costliness), but that the threat of litigation appears to have had little impact on preventing poor quality building practices. Building a home is hardly a wysiwyg transaction. Rarely does the purchaser see inside the building structure, and even more rarely has the competence to judge the quality of the work. While the payment side of the transaction is near instantaneous (cash), the other side is an asset which is meant to last many years – often well beyond the effective life and reputation of those who supplied it.
The LBS appears to be associated with at least two innovations which were cost-saving at the time but have often proved very expensive subsequently. The first was the use of a ‘monolithic cladding’ which has proved not to be watertight unless it was used strictly according to specification. The second was the use of untreated timber, without the realisation that treating for borer also better sealed the wood from water. Additionally, some house designers cut back protective features such as eaves.
Ironically, the LBS should not have been as much of a surprise as it was. The Canadians experienced it too, but a little earlier.[14] There are claims that there were people who knew of the construction failures long before they were a public issue, but their response was inadequate. If there was a political environment in which individuals were discouraged from speaking out, here was yet another slice of Reason’s cheese riddled with holes.
When Marcellus told Horatio ‘Something is rotten in the state of Denmark’, he was referring to its governance not its buildings.
The Building Performance Guarantee Corporation
The Building Performance Guarantee Corporation (‘BPGC’) was established in 1978 to offer an insurance scheme designed to protect buyers of new homes against the consequences of poor workmanship, the use of inferior building materials, the bankruptcy of the building, or other failures to complete a house in accordance with the contract. It was closed down in 1987, but as reported above, the 1990 Building Industry Commission proposed to reinstate it, but that recommendation was not taken up.
Suppose it had been. A comparison with the performance of the Earthquake Commission (EQC) suggests that preventative action would have been taken earlier and the size of the LBS would have been contained.
Without wishing to minimise their devastation, the Canterbury Earthquakes illustrates an alternative approach to regulation. Their precipitant was not man-made but the equivalent of the detonation of hundreds of thousands of tonnes of explosives below the earth (most not deeply below the earth). At least 186 people have died and the damage to buildings and infrastructure has been estimated by Treasury to be around $15 billion [this will be updated], in proportion to the region involved far higher than the estimates of the Leaky Building damage.[15]
While each death is a tragedy, the number is surprisingly small. In contrast, the 1931 Hawke’s Bay (Napier) Earthquake resulted in 256 deaths in a population about a fifth the size then of Canterbury today. Some of the Christchurch deaths were accidental, some preventable, but few can be attributed to a failure of the building code for most of those who died from building disintegration were in buildings built before the implementation of the (latest) 1992 code which, not incidentally, had evolved in response to the 1931 earthquake. While harder to judge, the material damage from the Canterbury Earthquakes is probably also smaller in proportion than the Hawkes Bay one. (If the code is criticised today, it is because while it protected people, it failed to incorporate enough resilience in the buildings so there was unnecessary destruction of the structures.)
Why did a performance based building code appear to succeed for the Canterbury earthquakes but not for leaky buildings? A fundamental difference was the existence of the Earthquake Commission which during the regulatory upheavals of the 1980s had been strengthened rather than abolished. It, and the private insurers (the EQC did not cover commercial buildings), had a practical and widespread interest in compliance with the code, illustrated not only in terms of inspection but by the Hazards Research Platform funded by the EQC, private insurers and the public purse through (what was) the Foundation for Research, Science and Technology.
Suppose the BPGC been reinstated that it had functioned similarly to the EQC. Certainly there would have been a lot of grumbling by the building industry at having to pay an insurance levy, but it is reasonable to surmise that soon after the first few leaky buildings had been identified (in about 1995) a BPGC would have taken early action to address the failure.
This seems likely even if the BPGC had been as inept as some of the other public institutions which were involved in the building industry and which failed to take action early enough. First it would have found its levies rising, and there would have been complaints by the builders paying the levies. Second, as a public agency spending public monies it would have been subject to a number of reviews, including annually by the Auditor-General and the Treasury and, ultimately, by parliament itself.
So had there been a BPGC it seems earlier action would have been taken and building inspections would have been tightened earlier. Ironically, had it existed, the cost to the government (i.e. the taxpayer) and the building industry, as well as to the home purchaser, may well have been very much less.
Why was the BPGC abolished in 1987? Arguably the institution was unnecessary under the previous highly controlled regime, as its low profile then showed. Why was it not reestablished as the Building Industry Commission recommended? Possibly because like the EQC it would have been ultimately backed by government funding (which, in various ways, is being utilised as a result of the Canterbury Earthquakes). The simplest explanation though, is these events happened in the days of light-handed regulation (sometimes jokingly described as ‘light-headed’ regulation and, where profits were easily made from it, ‘light-fingered’ regulation.) But if cost cutting was a major consideration, it has proved extremely costly.
What seems to have happened is that insufficient attention was given to the risks which the new building regulation regime raised (although recall that those who recommended the changes wanted to maintain the BPGC). This suggests a major design fault; the neglect of Murphy’s design principle.
Murphy’s Design Principle and Regulatory Assessment
While best known as ‘Murphy’s law’ – anything which can go wrong, will go wrong – Edward Murphy’s original principle was to design a system on the assumption that anything which can go wrong will go wrong. Of course, accident prevention cannot be all-encompassing. Murphy was in the aircraft industry; the easiest way to minimise its crashes is not to let the planes fly. That so few aircraft crashes have occurred compared to the total number of flights, and that even fewer have led to death, indicates the value of the design principle that Murphy enunciated.
Similarly, there are going to be some failures from the building code. However, a lot of grief could have been prevented had its designers of the regulatory framework in the 1990s asked ‘if things go wrong, what happens next?’ Those designing the building code from this perspective may not have precisely identified the possibility of leaky buildings, but a natural question would have been ‘what if the something like the cladding failed before the required period (15 years)?’ Such examples would have quickly drawn attention to the inefficiencies and imperfections associated with a regulatory framework which overly relied on litigation as a means of preventing poor quality performance.
Conclusion
The recourse to law need not always be a failure; it may be far more costly to allow for every possible outcome in a contract than to make provision for arbitration. A couple of cases involving a particular class of commercial transactions going wrong may be a misfortune, 110,000 of them is sheer carelessness – and extremely expensive.
More fundamentally, the LBS, with the benefit of hindsight, is so revealing as to the inadequacy of the light-handed approach to regulation. It demonstrates that such regulation with recourse to the courts may result in potentially preventable failure and costly and clumsy (and often unjust) remedies. Not surprisingly as a result of such experiences there has been a move away from the approach to one where law and formal institutions are more closely involved in the regulation of particular problematic industries. Even so, and despite the guidance provided by the official regulatory impact analysis handbook, it is not yet a comprehensive framework for the design of regulatory interventions. [16] It may well be that the pendulum is swinging as erratically too far the other way. Independent observers have thought some recent changes to the regulatory framework have involved unnecessary requirements and excessive compliance costs in some instances.[17] Nor is Murphy’s design principle – that is paying attention to what can go wrong and, if it does, how it might can be resolved and who bears the costs – embedded into regulatory thinking,
While building an impenetrable safety fence at the top of the cliff is rarely possible, relying on a litigation of lawyers at the bottom to deal with regulatory failure is hardly a strategy for the efficient regulation of anything, but the mostsimple commercial markets.
Other References
Easton, B.H. (1999) Reforms, Risks and Rogernomics, http://www.eastonbh.ac.nz/?p=43.
Easton, B.H. (2010) ‘Crisis Point’, New Zealand Listener, 20 February.
Easton, B. H. (2010) ‘Regulatory Lessons from the Leaky Home Experience’ Policy Quarterly, Vol 6, No 2, May 2010.
Grimshaw, P. (2009) ‘Towards New Zealand’s building regulation reform’, paper delivered at the Building Regulation Forum, 17-18 November.
Howden-Chapman, P., J. Bennet and R. Siebers (eds) (2010) Do Damp and Mould Matter? Health Impacts of Leaky Homes, Wellington: Steele Roberts.
McGregor, A. (2006) ‘Accidents, failures, mistakes and leaky buildings’, paper delivered at the IPENZ national conference, Wellington, March.
Mumford, P. (2011) Enhancing Performance-based Regulation: Lessons From New Zealand’s Building Control System, Wellington, Institute of Policy Studies.
Overview Group on the Weathertightness of Buildings (2002) Report to the Building Industry Authority (the Hunn Report), Wellington.
Endnotes[1] I am grateful to the following without whom this article would be less comprehensive in both content and analysis: Rob Bowie, Elizabeth Caffin, Joan Druett, Peter Foster, Geoff Fougere, Don Gilling, Paul Grimshaw, Roger Hay, Bob Hilliard Warwick Massey, John McCrone, Ian McIntosh, Julienne Molineaux, Diane Salter, John Tizard, John and Pip Wishart, and several public servants who were involved in the management of the LBS crisis, but still being active must remain anonymous.
[2] R. Firth (1959)The Economics of the New Zealand Maori, Government Printer, Wellington.
[3] .http://www.med.govt.nz/templates/MultipageDocumentPage____39978.aspx
[4] J. McCrone (2011) ‘Reaping the Past’, The Press, 20 August, 2011.
[5] Commission of Inquiry (1995) Commission of Inquiry into the Collapse of of a Viewing Platform at Cave Creek Near Punakaiki on the West Coast Commission of Inquiry into Cave Creek. Part II, p.93.
[6] http://www.radionz.co.nz/news/regional/84413/icepak-says-it-was-badly-advised-before-fatal-explosion
[7] http://www.stuff.co.nz/waikato-times/news/3826979/Judge-dismisses-fire-sentence-appeal-bid
[8] Note that the company has gone into receivership while their insurance seems to be inadequate, so there may be no redress for the families of the dead nor for the public purse from these quarters.
[9] PriceWaterhouseCoopers (2009) Weathertightness: Estimating the Cost, report for Department of Building and Housing, Wellington. These are the current best estimates and no doubt will be improved.
[10] The role of the building inspector was nicely recalled by one who said the builder (of his now 30-year-plus-old home) described his building inspector as ‘your friend’.
[11] Building Industry Commission (1990) Reform of Building Controls, Wellington.
[12] Reason, J. (1990) Human Error, New York: Cambridge University Press
[13] New Zealand Herald, 27 February 2010
[14] Commission of Inquiry into the Quality of Condominium Construction in British Columbia (1998) The Renewal of Trust in Residential Construction (the Barrett Report), Government of the Province of British Columbia, Vancouver.
[15] http://www.treasury.govt.nz/budget/forecasts/befu2011/026.htm (released before the June 2011 earthquake).
[16] New Zealand Treasury (2009) Regulatory Impact Analysis Handbook, Wellington.
[17] For instance the qualification requirements for investment advisers may be ineffective and irrelevant.