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:


(1)     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.


(2)     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 [1]).  And, of course, this figure is growing all the time as more PFI contracts are entered into.


More expensive public borrowing

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 interest rate.


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 services.


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 the taxpayer.


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 Alice in Wonderland to the provision of public services.


PFI unnecessary

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 more.


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 years.


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:


“Anything 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.” [2]


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 [3].  The latter inquired about the consequences of moving PFI debt on to the Government’s books.  Browne replied that


“such 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.


Sustainable 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 [4].  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.


David Morrison

24 April 2009