The recent controversy involving the awarding of a contract to provide bottled drinking water to the SAR Government offices has quickly snowballed. What began as misgivings among civil servants has escalated to a major social incident, casting doubt on the use of public funds, procurement, the regulatory system, and even the Government’s credibility. The crux of the incident is that the Government Logistics Department (GLD) awarded a contract worth more than HK$50 million to Xin Ding Xin Trade Co. Ltd, which is suspected of supplying counterfeit bottled water and falsifying documents to fulfil its contractual obligations. The drinking water, branded “XinLe”, is alleged not to have originated from its purported supplier, the well-known Mainland manufacturer Robust (Guangdong) Drinking Water, while the test reports submitted are found by the Hong Kong Standards and Testing Centre to be falsified.
On the surface, this “drinking water-gate” controversy appears to be a case of commercial dishonesty and regulatory laxity. However, from an economic perspective, it exposes market failure arising from “credence goods”. Bottled drinking water may seem commonplace, yet the incident puts to the test not only the Government’s procurement capability but also the very foundation of societal trust.
Quality hard to judge―even after consumption
Based on the ease with which consumers can obtain information, goods are generally classified into three categories. The first is search goods. Prior to purchase, the quality of products can be evaluated by examining available information, e.g. the specifications of a smart phone. The second is experience goods. The quality of products can be assessed after they have been used or consumed, e.g. a restaurant’s fare. The third is credence goods, the most distinctive of the three. Even after consumption, consumers often find it difficult to determine the authenticity of their quality or the necessity of the service because of significant information asymmetry between producer and consumer.
Health services are a typical example of credence goods. Even after recovering from a surgery recommended by a doctor, a patient has no reliable way to ascertain whether the procedure was necessary or if there was a simpler or cheaper option. Before the operation, the patient can only rely on the doctor’s professional judgment. By the same token, when it comes to car maintenance, consumers generally lack the means to verify a technician’s claim that costly parts must be replaced. More often than not, they simply comply. In view of the substantial cost of quality verification, consumers remain heavily dependent on the integrity of the supplier.
Hidden credence goods highlight regulatory loopholes
How can the bottled drinking water specified in the government contract be regarded as a credence good? When civil servants – the end consumers – drink the water from a dispenser, they have no way of knowing, solely from its taste or appearance, whether it comes from the designated manufacturer or from an unauthorized factory with undisclosed standards. As long as no immediate health issues arise, the true quality of the drinking water remains unknown to them.
The aforesaid incident was exposed not through the personal experience of civil service staff, but by Robust (Guangdong) Drinking Water, which took the initiative to write to the GLD to clarify that it had not authorized Xin Ding Xin to bid for the Government contract, thus triggering the controversy. The Hong Kong Standards and Testing Centre issued a statement declaring that it had never provided any testing services for the company and that the test report was falsified. This underscores the challenges associated with credence goods: given that quality testing is too costly for ordinary consumers, it is essential to rely on regulation by external agencies.
Theoretically, as the procurement agency, the GLD should have had the capacity for thorough inspection, yet it still fell into the credence goods trap. Exploiting information asymmetry, Xin Ding Xin submitted a seemingly complete tender document that included a forged brand authorization and a falsified water quality report. Without active due diligence and ongoing monitoring, the procurement agency was deceived by relying solely on superficial documentary evidence. This demonstrates that in the absence of strict testing procedure, even a government department with adequate resources can be misled in the face of a credence goods fraud.
Trust as economic lifeblood
Without a doubt, the impact of the “drinking water-gate” as a cautionary tale extends far beyond the losses from a single contract. It touches on the foundation of Hong Kong’s economy: trust. As the Nobel laureate in economics Kenneth Arrow once remarked, “Virtually every commercial transaction has within itself an element of trust… much of the economic backwardness in the world can be explained by the lack of mutual confidence”. This is a particularly apt warning for a highly developed service-based economy like Hong Kong.
The prosperity of Hong Kong―as an international financial centre, trade hub, professional services hub, and legal arbitration centre―depends on a “trust infrastructure”. People trust their banks to keep their savings safe, trust auditors’ reports to be impartial, and trust their lawyers’ advice to be professional. Customers pay hefty fees for these financial, accounting, and legal services. What they are truly purchasing is the trustworthiness of the service providers and the systems behind them.
Apart from eroding the Government’s public credibility, the controversy over a drinking water contract will also prompt the outside world to question Hong Kong’s business environment, regulatory effectiveness, and respect for the spirit of contracts. Should the situation continue to unfold, it will inevitably increase social transaction costs and bring far-reaching economic consequences. Any negative incident involving credence goods can compromise the city’s core competitiveness.
Three-pronged gatekeeping strategy
Given the credence goods market’s vulnerability to fraud, it takes a multi-pronged approach to address its problems. The first prong is the reputation-and-brand mechanism. For established brands, the cost of committing fraud is substantial, prompting consumers to favour reliable names to mitigate risks. That the Government made the swift decision to select COOL, a local brand under the AS Watson Group, as a temporary supplier testifies to the effectiveness of this mechanism. On the other hand, the controversy has also uncovered a loophole that enables fraudsters to exploit the system by posing as brand-authorized agents or by forging brand authorizations.
The second prong of the approach is third-party certification and government regulation. Through standards setting, testing, and licensing, independent certification bodies and regulatory authorities ensure quality assurance for consumers. In the incident, the Government may have required the supplier to submit independent test reports, but it failed to verify their authenticity, indicating the existing regulatory process gone awry. The key lies in strict and thorough verification.
The third prong is legal liability and punishment. An enhanced fraud identification rate and greater punishment severity would help to diminish moral hazard. As the person in charge of the company involved in the incident has been apprehended and charged with fraud, the deterrent effect of the judicial system’s verdict would be brought to bear on market behaviour. It is necessary to complement the legal mechanism with brand reputation and government regulation in order to establish a comprehensive governance framework.
Technological empowerment to reinforce integrity
In order to consolidate Hong Kong’s status as an international trust hub, the top priority is to strengthen related systems and embrace technological advancements. First and foremost, government procurement processes must be reformed, replacing the practice of awarding contracts to the lowest bidder with a system that incorporates conducting comprehensive due diligence and assessment of a supplier’s background, business performance, and market reputation. In the event of procuring credence goods that serve the public interest, standard procedures should cover active and frequent random inspections as well as verification measures.
Moreover, technology can play a crucial role in fostering “verifiable trust”. Blockchain and the Internet of Things can mitigate information asymmetry. For example, a drinking water supply contract can require that logistics data for each bottle of water from ex-factory to final delivery be uploaded onto permissioned digital ledger. The Government can trace the product’s origin using a QR code. Such technological endorsement is more reliable than documentation. As a financial centre and a hub for innovation and technology, Hong Kong is well-positioned to pilot regulatory technology in the fields of public procurement and blockchain applications, thereby creating a transparent and highly efficient regulatory framework.
Similar concepts are extending beyond the financial arena into the real economy. By piloting smart contracts and traceability technologies, Hong Kong can prevent the recurrence of such incidents in future, while demonstrating to the international community its leadership in system innovation and technological application. This will not only beef up the trustworthiness of local brands but also attract global investment, thus boosting the city’s economic competitiveness.
All in all, although the “drinking water-gate” controversy will eventually subside, thorny issues related to credence goods merit further contemplation. Trust is both the lubricant of the modern economy and the cornerstone of social capital. In today’s complex and ever-changing environment, safeguarding trust stands as Hong Kong’s defining mission. From institutional refinement to technological empowerment, rebuilding trust demands the concerted efforts of the Government, businesses, and the general public. What we safeguard is not merely water quality, but the very foundation of trust essential to the city’s survival.
