Europe Articles and Perspectives

The UK’s Private Finance Initiative (PFI) is being blamed as one of the causes behind the collapse of Carillion. PFI generally involved (and still involves) firms or consortia constructing an asset and then running it for a substantial period of time, then being paid for delivering a “service” related to the asset over that period. In the case of Carillion, that charge against PFI is not really fair; it appears to have been more conventional problems with some major projects that brought the firm down, not anything in particular related to the structure of PFI deals.

However, a more analytical critique of PFI came last week from the UK National Audit Office. Their briefing titles simply “PFI and PF2” looks at information on: “the rationale, costs and benefits of the Private Finance Initiative (PFI); the use and impact of PFI, and ability to make savings from operational contracts; and the introduction of PF2”.

NAO has a nice simple description of what PFI is all about. “In a PFI or PF2 deal, a private finance company – a Special Purpose Vehicle (SPV) – is set up and borrows to construct a new asset such as a school, hospital or road. The taxpayer then makes payments over the contract term (typically 25 to 30 years), which cover debt repayment, financing costs, maintenance and any other services provided”.

There are a few new deals still being originated under PF2 but the value is way down form the peak. However, there are over 700 current operational PFI deals still running in the UK, with annual charges of some £10 billion. Even if no new deals are entered into, future charges will run into the 2040ss and will amount to some £200 billion, according to NAO.

While this sounds like a huge amount, we would point out that the £10 billion a year represents less than 2% of the UK government’s annual expenditure. PFI is emotive because it appears to show “fat cat” businesses getting rich off the back of hospitals, schools and the like, but the noise about it is perhaps out of proportion to its real significance!

Back to the NAO report, which has at its core the comment that “there is still a lack of data available on the benefits of private finance procurement”. While the report is as even-handed as you would expect from the NAO, it does give an overall sense that the benefits of the initiative may not outweigh the negatives.

Those benefits include cost certainty, although NAO points out actual construction costs are not necessarily lower in PFI projects. Then of course the initiative avoids the need for more government debt – the off-balance sheet funding aspect of PFI. But some claimed benefits are disputed by NAO – PFI hospitals do not show greater “operational efficiency” than others, for example.

Often, PFI was the only allowable option for investment presented to the users, and that then led to negatives around the two big drawbacks of PFI. Firstly, the cost of financing was and is much higher than government borrowing rates, so buyers are locked into these high charges for years to come. NAO identifies an “indicative cost of capital of 2% to 3.75% above the cost of government gilts”.

Secondly, cost and operational flexibility are reduced. During the recent period of “austerity”, many government bodies have cut back expenditure in many areas. But PFI payments are fixed and are virtually impossible to charge over the life of the contract. Stories abound of PFI buildings where staff can’t change a lightbulb (and the maintenance charge for doing that is £200 a time), or hospital porters aren’t allowed to touch a patient, all because of the contractual constraints of the PFI deal. There are other cost areas that are perhaps less obvious but are identified by NAO, ranging from fees to lenders and advisers to higher insurance costs.

This is perhaps the key paragraph in the whole report.

The higher cost of finance, combined with these other costs, means that overall cash spending on PFI and PF2 projects is higher than publicly financed alternatives. The Department for Education has estimated the expected spend on PF2 schools compared with a public sector comparator (PSC). Our analysis of these data for one group of schools shows that PF2 costs are around forty per cent higher than the costs of a project financed by government borrowing. The Treasury Committee undertook a similar analysis in 2011, which estimated the cost of a privately financed hospital to be 70% higher than the PSC”.

NAO also pointed out some years back that Treasury (the finance ministry) basically used a flawed value for money assessment model to justify PFI projects. Treasury disputed that, but despite promising back in 2012 to produce a revised guidance, it has failed to do so. That is astonishing and needs further investigation really. Conspiracy theorists might think that better guidance would kill off PFI for ever, hence Treasury and their “financier friends in the city” would rather not publish anything!  

So, in summary, PFI enabled the citizen in the UK to benefit from some very good (and some less good) new facilities that may not have been built otherwise. If the government had borrowed to finance them directly, who knows what effect that might have had on the UK economy, the pound, interest rates and so on. But the real “additional” cost of PFI (measured against public financing and traditional projects) has probably been very significant, perhaps even a hundred billion pounds.

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