PFI: Perfidious Financial Idiocy?

OULC member, Michael O’Connor, critically evaluates successive UK governments’ use of the ‘private finance initiative’ (PFI) in light of Carillion’s recent liquidation debacle.

PFI stands for ‘private finance initiative’ or ‘perfidious financial idiocy’ depending on your viewpoint. PFI contracts were first introduced under the Major government and have been haunting us ever since. Now it’s about time for us to recognise that they are not a universal solution to public sector problems, and that they have done more harm than good.

In a PFI deal, the government commissions a private company to construct a piece of infrastructure and then pays out regular sums of money to cover debt repayment, maintenance and the operation of services such as prison security or school catering. The idea is that private companies can deliver projects at a lower cost and run them more efficiently than the government because they are less bureaucratic and more dynamic due to the presence of competition and monetary incentives. PFI projects were enthusiastically championed by New Labour and recent Conservative governments have rolled them out across the country.

According to the National Audit Office (NAO), the PFI contracts signed by successive governments over the past two decades could cost the taxpayer £200bn before the last one expires in the 2040s. The NHS alone is expected to pay out nearly £82bn in that period. Both of these figures could end up being even higher if new contracts are signed over the next twenty years. Given these large sums of money, it seems reasonable to ask whether PFI projects are in fact cheaper or more efficient than their public sector equivalents, as proponents like to claim. According to the NAO, the answer to that question is largely negative: PFI projects are usually more expensive than their public sector equivalents even though maintenance costs are often higher and maintenance standards lower. Indeed, a 2011 report by the Treasury Committee found that privately financed hospitals can be as much as 70% more expensive than those built using public money.

Of course, PFI does have some advantages. For instance, PFI projects tend to remain within budget more often than those funded by the public sector. However, this is balanced by the fact that they tend to cost more in the first place. Other well advertised benefits of PFI contracts prove similarly doubled-edged on further inspection. It is often argued that PFI contracts reduce the financial risk to the government. Certainly, the day-to-day risks of building and managing PFI projects fall on private companies. But if the operator of a PFI project goes bankrupt, it is the state that must step into the breach. In the month since Carillion’s collapse, the NHS has sent additional staff to 14 hospitals, the prison service has redeployed staff to ensure that prisons can continue to operate, and a number of infrastructure projects have been put on hold. Moreover, the government has been forced to provide financial support to sub-contractors and small businesses affected by Carillion’s demise. In the end, the state is responsible for picking up the tab when PFI contractors fail.

In part, PFI projects are expensive because private borrowing costs are greater than public borrowing costs. Yet private companies are also driven by the profit motive and many PFI contracts are designed to maximise profits for PFI contractors. A report by the Centre for Health and the Public Interest found that the rate of return on PFI contracts is well in excess of those on almost any other sort of investment. For instance, the consortium responsible for delivering the Skye bridge, which cost £25m to build, was paid £93.6m for its work. Poorly negotiated contracts of this sort can lock public bodies into a legacy of debt and contribute to their collapse. In 2012, the South London Healthcare NHS Trust was put into administration by the government. At the time, it was spending 14% of its income on repaying PFI debts. Similarly, the Peterborough and Stamford NHS trust was bailed out by the government in 2012 after running a £46m deficit in 2011–12 due to the cost of paying PFI debts.

Why, then, do we keep on signing PFI contracts if they are more expensive, less efficient, and substantially riskier than public sector alternatives? Unsurprisingly, the reasons for doing so are largely political. New Labour and the Conservatives have demonstrated a general preference for private sector solutions even when they are not necessarily suitable. Hence Labour ministers approved the Peterborough and Stamford NHS trust’s PFI deal even though they had been warned by an NHS regulator that it was not financially viable. Meanwhile, the Treasury continues to provide monetary incentives that favour the use of PFI projects over public sector alternatives. In turn, this means that PFI is often the only option for public bodies operating on shoestring budgets. The net result is that PFI contracts are more common than they ought to be and are often chosen by those least suited to them.

PFI contracts are also politically advantageous because they are not included on the public balance sheet. In other words, any money sunk in PFI projects is not recorded in the public accounts as an increase in sovereign debt. This is basically a financial sleight of hand that allows the government to build infrastructure and operate services while meeting its fiscal targets. George Osborne briefly considered including PFI debt in the public accounts but soon abandoned the proposal after making some token gestures towards transparency and accountability. Private finance is simply too useful for a government that is committed to reducing public debt but unwilling to expose itself to the political risk of cutting services even further than it already has.

What can we do about PFI? Ideally, infrastructure ought to be brought back into public hands if it could be run just as well by public bodies. This would entail the buying out of PFI contracts by the government. However, this may not be possible in many cases due to the prohibitive costs of honouring break clauses in the original contracts or, indeed, the lack of any break clause at all. Jonathan Appleby, Chief Economist at the Nuffield Trust, estimates that the cost of buying out existing PFI contracts could be as high as £56bn for the NHS alone. The likely amount of money required to buy out all (or most) PFI contracts would, one assumes, be astronomical. We seem, then, to be trapped in a cycle of long term debt.

The only way to break the cycle is to unilaterally cancel or renegotiate PFI contracts where necessary. A large scale review should be carried out, with cost-efficient contracts retained or renegotiated to reduce interest payments and inefficient ones brought to an end. Private companies whose contracts are cancelled should be paid compensation based on past performance and, within reason, future loss of profits. Contractors should be consulted on what counts as fair compensation and break clauses should be honoured as far as possible. But PFI operators should not be able to dictate terms. Ultimately, the state should set out how much compensation it is willing to pay.

At a time when public bodies are expected to find savings across the board, it makes no sense for PFI repayments to be ring-fenced. The cost of repaying PFI debt falls on the taxpayer and it is unfair for them to continue paying large sums of money for inefficient services simply because a set of poorly negotiated contracts drawn up ten or fifteen years ago requires them to do so. In the future, we ought to weigh the costs and benefits of private involvement in public services more carefully. There is a place for public-private partnerships but we should not let political expediency and a dogmatic devotion to the credo of marketisation overrule our common sense and commitment to effective, universal public services.

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