I saw this on HackerNews last week.
One point was clear to me: that if the employee is adding any "deliberate mistakes" to their work, that needs to stop immediately. I think there is a moral difference between a mistake you are not aware of (whether made in your mind, by your incorrect actions, by forgetting etc.) versus a mistake you knowingly make.
Other than that, this situation to me is reflective of the negative incentives and behaviours resulting from corporate bureaucracies, bean-counter driven decisions and incompetence. It also reflects that paying by the hour when the employer wants in the value of the work done, leads to conflicts and imbalances when the value isn't directly proportional to the hours input; this is a problem in almost all areas of employment, even if you work on a factory line producing x widgets per hour, the company value is measured on overall sales and profit which may not relate to x widgets per hour.
So if the employer is doing the work he's required to do, and doing it correctly, then while the situation is silly and they are in a dead-end job, that is the reality of the system, and I see no problem with them continuing to do that indefinitely. Work given, work done. They should not use the work time to moonlight on another job, as again I think there is a moral difference between using spare work time for non-commercial activities (exercising, reading a novel, study, DIY on your house etc.) and directly commercial activities (second job or money-earning side hustle), but they should be entitled to use the time for non-commercial activities.