PFI to be saved by public funds
The last Conservative government
invented the Private Finance Initiative (PFI) but it was New Labour that made
it into a major instrument for the provision of public facilities and services.
The person responsible for that was Gordon Brown. As Chancellor of
the Exchequer, he forced public bodies to use the PFI model.
He did so, even though PFI costs
more than the traditional mode of procurement. In other words, it wastes
taxpayers’ money. It does so in two ways:
It involves public bodies borrowing money at a higher rate
of interest than through the usual means of public borrowing. In other
words, it’s like opting for a 5% mortgage when buying a house, when a 4%
mortgage is available.
It normally involves public bodies entering into long term
contracts for services, the need for which may change dramatically, or
disappear altogether, well before the contract term is over. For example,
the pupil numbers in a school may decline or it may close altogether, but the
annual contract charge may still have to be paid.
In 2007, public bodies were
committed to paying around £170 billion to contractors in more than 800 PFI
schemes up to 2031-2032 (see the Public Accounts Committee report on PFI
published on 27 November 2007 ).
And, of course, this figure is growing all the time as more PFI contracts are
More expensive public
PFI is first and
foremost a form of public borrowing, which, like conventional public borrowing,
has to be paid back with interest by the state.
But, as I have pointed
out, it is a more expensive method of public borrowing than the conventional
method. It is more expensive because the state can always borrow money
more cheaply than the private sector, because a private corporation is much
more likely to go bust and default on its debts than the state. The essence of PFI
is that the state employs a private agent to borrow on its behalf – at a higher
This is one way in which
PFI wastes taxpayers’ money. There is worse. What happens is that a
public body enters into a contract with a private consortium, for example, to
borrow money to build a school or a hospital, to carry out the building work
and to provide additional services (eg building
maintenance or cleaning) for a period of 25 years or more. Under the
contract, the public body undertakes to pay the consortium an annual unified
charge covering interest, capital repayment and payment for any additional
It is very foolish for
any organisation to contract to purchase services for 25 years or more.
The threat that a contract is not going to be renewed is the most effective
lever an organisation has to ensure that a supplier delivers services as
required. With a contract for 25 years or more, the supplier doesn’t need
to worry about that for a very long time.
It is even more foolish
to take out a long-term contract in circumstances where the services required
cannot be predicted accurately for the next 25 months let alone the next 25
years. PFI contracts normally prescribe a mechanism for the modification
of the PFI property and the services to be delivered in it, but the public body
asking for a modification is at the mercy of the PFI contractor that owns the
property and provides services in it. Nobody else can provide the
services, and the services have to be provided, so the public body is in a
hopelessly weak bargaining position when it comes to agreeing the extra cost to
This is a direct result
of the public body foolishly taking out a contract for a service delivery for a
period so long that service needs cannot possibly be predicted.
Why are public bodies
forced by the Treasury to engage in such foolishness? The answer is that
the inappropriately long service contract is dictated by the fact that the PFI
contractor has to borrow over a long period – 25 years or more – in order to
keep the cost of borrowing within reasonable bounds. To borrow over that
period, the consortium has to be guaranteed an adequate income stream
throughout the period in order to service the borrowing. So, there has to
be a contract for service delivery for 25 years or more, even though service
needs cannot possibly be predicted for anything like that length of time.
In other words, the
inappropriately long service contract is a necessary condition for getting
unnecessarily expensive finance for public projects via PFI. Gordon Brown
has brought the world of
PFI is completely
unnecessary for public sector procurement. There is no need for a public
body to enter into a contract with a single private sector consortium to (1)
provide finance for a project, (2) undertake the building work, (3) maintain
the building, and (4) provide other services in the building for 25 years or
On the contrary, there
are very good reasons why the process should be broken into its separate elements.
The state itself should acquire the finance, since that represents best value
for money for the taxpayer, and contract a private company to construct the
building. Contracts for building maintenance and other services, if not
carried out by the public body itself, should be set for a period of time for
which service needs can be predicted, and certainly not for anything like 25
Of course, the
Government is fully aware that long term contracts for the supply of public
services are unwise. You have only to look on the website of the
Department of Children, Schools & Families to confirm this. There you
will find a Purchasing Guide for Schools containing the following
excellent advice in a section entitled Contracts longer than three years:
that is longer than three years may result in inflexibility, particularly if
the agreement does not allow the school to vary its requirements in the light
of changing circumstances.” 
This is written by the
same Government that forces public bodies across the land to take out contracts
for 25 years and more for services that may never be required.
Off balance sheet
Why was the supposedly
prudent Chancellor, Gordon Brown, addicted to PFI as a mechanism for financing
public projects? Answer: because, until recently, PFI debt wasn’t normally
treated as public borrowing for accounting purposes and therefore didn’t normally
contribute to the Public Sector Borrowing Requirement (PSBR). In other
words, PFI debt was for the most part “off balance sheet”, even though the
state is ultimately responsible for repaying it. (The state may not be contractually obliged
to repay PFI debt, but it will always end up doing so if the provision of
essential public services is at risk).
So, by using PFI, total
public borrowing is officially less than it would have been, had Gordon Brown
gone down the cheaper route of conventional borrowing. This made it
easier for him to meet his self-imposed (and entirely arbitrary) “sustainable
investment” rule that total public borrowing shouldn’t exceed 40% of gross
domestic product (GDP). In other words, in order to make himself look prudent with regard to the total volume of
public debt, the Chancellor insisted on the imprudent use of PFI borrowing,
which costs the taxpayer more than conventional borrowing.
You don’t believe that
this is it the root of Gordon Brown’s preference for PFI? Listen to this answer in the House of Commons
on 30 March 2006 from Des Browne, then Chief Secretary of the Treasury, to a
question by Conservative MP, Brian Binley . The latter inquired about the consequences
of moving PFI debt on to the Government’s books. Browne replied that
movement on to the balance sheet would put the country in a position in which
it could not meet the sustainable investment rule and thus could not invest
further in public services and our infrastructure”.
There you have it in a
nutshell: PFI was used to keep on balance sheet debt down, so that the
Chancellor could meet his “sustainable investment” rule.
To summarise: as Chancellor, Gordon
Brown insisted on more expensive borrowing, coupled with long term contracts
for services that may never be required, in order to make himself look prudent.
investment rule dead
That was before the financial
storm. In reality, the “sustainable
investment” rule was breached with the nationalisation of Northern Rock (when
its debt became public debt) though the Government was reluctant to admit
it. It was finally shattered and abandoned
at the time of the pre-Budget Report last November, when enormous sums were added
to the PSBR for the 2008-9 fiscal year and a great deal more for next.
With that, keeping debt off balance
sheet by using PFI over traditional methods of procurement should have lost its
unique selling point for Gordon Brown. (In
addition, new accounting rules operative from April 2009 mean that much less
PFI will be classified as off balance sheet).
A return to the old ways is
inevitable isn’t it, particularly, since, in the present financial climate,
providers of private capital are having difficulty laying their hands on
finance for existing PFI schemes?
Well, no. On 3 March 2009, the Treasury announced a
scheme to save existing PFI projects that are struggling to raise private
finance . Up to £2 billion is being made available to
lend to PFI providers for the purpose. If
necessary, the Government will lend 100% of the funding for an individual PFI project.
Yes, public funds are going to be
used to save the Private Finance Initiative, which was supposed to take the
place of public funds in carrying out public projects.
The Government will borrow money and
lend it to PFI providers. Then, public
bodies, using money mostly provided by the Government, will pay the PFI
providers over a long period and eventually these providers will pay back the
Government. In other words, the
Government is going to lend to itself through a middleman – and pay itself back
through a middleman, who will no doubt insist on his pound of flesh both ways.
You couldn’t make it up.
24 April 2009