The truth about PFI schemes

The vote against the Private Finance Initiative at the recent Labour party conference is testimony to a wider unease about the issue that is being shown in some quite surprising quarters.

The trouble with the PFI debate so far is that there has been precious little honesty on either side. On the one hand, we have the government publicly arguing that it does not favour the private sector in any way and that it is neutral about the issue, while privately ensuring that local authorities have little alternative but to go down the PFI route. The level of ministers’ arguments seems to be that the repetition of the argument that PFIs are a good thing means that this is true.

It is no better on the other side where we have the trade unions campaigning with grossly simplistic picture opportunies such as John Edmonds, the general secretary of the GMB, throwing plastic bags with large stickers bearing the acronym PFI into a dustcart. The lads should do better than that.

The PFI initiative was first launched by Norman Lamont in 1992 when the Treasury decided to relax its rules over what was then called unconventional finance. Previously, any attempts to fund schemes using private money were stillborn because the Treasury insisted both that schemes should be ‘value for money’ and that they count agains public borrowing. Since interest rates for borrowing privately are always higher than those the government can obtain, this effectively killed off any schemes.

Lamont announced that these rules would be relaxed with private funding no longer counting as government spending. But the Treasury was still circumspect about these ideas and it was not until the arrival of Gordon Brown in No 11 that the idea really took off which was rather surprising given that in opposition Labour had argued strongly against the idea.

The advantages for PFI put forward by the government are that it allows the raising of capital that would not otherwise be avaialble (additionality), that there is a risk transfer to the private sector which means the public purse is no longer responsible for cost overruns; and that private sector expertise is harnessed to improve efficiency.

But all these arguments are questionable, the basis for debating points rather than the type of certainty on which to base a programme that, with the signing of the Public Private Partnership deal for the London Underground, is now worth over £40bn.

Take additionality. Sure, a host of hospitals and schools are now being built on the basis of PFI but it is not new or extra money. It is merely that the private sector has raised the money – at higher cost to the public purse – and that by convention this does not count as government spending. But at the end of the day, the taxpayer pays anyway so it is a nonsense in terms of macroeconomic policy. Moreover, PFI deals are tying councils into long term annual payments which may become extremely burdensome. For the moment, most of the cost is covered by central government, but there is no guarantee that situation will pertain for ever.

In terms of risk transfer, the government arguments are equally specious. Implicitly the government stands behind the schemes as they are for services which simply would not be allowed to collapse should the company operating them get into trouble. Moreover, it is impossible to transfer very much risk. This is because if a scheme starts going pear-shaped and the council or government agency has to take it back, compensation for the value of the asset will have to be paid. If the level of compensation set out in the contract is low, then no bank will lend to the contractor and therefore the scheme will not be viable. Therefore, there is no genuine risk transfer. The contactor will always get back the bulk of its money, however poor its performance.

On the issue of private sector expertise, the jury is out. Sure, there are a lot of efficient private firms, but there are poor ones, too. And there are stories of both good and bad management in the public sector. Above all, efficiency improves when there is competition but once a scheme has been let through the bidding process, there is little scope for any.

What is most damaging about this whole debate is the level of dishonesty means that we cannot have a proper political discussion. Perhaps, indeed, ministers’ instincts are right and the public sector should not be trusted with any capital investment schemes more expensive than filling in the odd hole in the road. But then they should say so and then the issue can be discussed.

In the meantime, this whole smoke and mirrors game is extremely expensive as lots of borrowing is being done by private companies when clearly the state should retain that role. Why not simply develop schemes that involve the government borrowing and the private companies carrying out the work and sod the Treasury rules? Or is that being naïve?

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