PFI wastes taxpayers’ money


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 7% mortgage when you are buying a house, even though you can get a 6% mortgage.

(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.


A prime example of that has occurred in Northern Ireland.  In October 2000, the Belfast Education & Library Board signed a 25-year PFI contract for the provision of, amongst other things, a school to accommodate 500 pupils.  The school - Balmoral High School - was opened in 2002, but it is going to close next summer, a mere six years after it opened.  However, the Belfast Education & Library Board is having to pay more than £400,000 a year up until 2027, a total of £9.2 million, to the PFI contractor for an empty school.  This was revealed in a report in the Belfast Telegraph on 14 December 2007 [1].


£170 billion owed

The PFI model for providing public facilities and services inevitably costs more than the traditional way of doing these things.  There isn’t the slightest doubt that Gordon Brown was fully aware of this from the outset - although he may have many flaws, economic illiteracy isn’t one of them. 


Today, thanks to his “prudence”, public bodies are committed to paying a total of £170 billion to contractors in more than 800 PFI schemes up to 2031-2032.  This figure was recently extracted from the Treasury by Conservative MP, Richard Bacon, who is on the Public Accounts Committee (see the PAC report on PFI published on 27 November [2]).  And, of course, this figure is growing all the time as more PFI contracts are entered into.


The Prime Minister lies

Despite being the architect of PFI, Gordon Brown has rarely answered questions about it.  When he was in the Treasury, he usually avoided doing so by putting up one of his minions in the House of Commons.  But now that he is Prime Minister, he couldn’t avoid a question on 14 November 2007 from Labour MP, David Taylor, who expressed concern about taxpayer liability for the maintenance of schools under long term PFI contracts, when falling rolls cause these schools to close before the contract term elapses [3].


Gordon Brown didn’t answer David Taylor’s question – understandably, since he had pointed to a major drawback in PFI procurement.  Instead, he sang the praises of PFI, saying: “It simply would not have been possible to build or refurbish such a number of schools and hospitals without using the PFI model”.  That is simply a lie: all of it could have been done, and done more cheaply, by traditional means.


More expensive public borrowing

Let’s look at the PFI in a little more detail.  It is first and foremost a form of public borrowing, which, like conventional public borrowing, has to be paid back with interest by the state.  In fact, as I have pointed out already, 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, whereas a private corporation may go bust and default on its debts, the state will not).


The essence of PFI is that the state employs a private agent to borrow on its behalf – at a higher interest rate.  As I said before, it’s like taking out a 7% mortgage when a 6% one is available.


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 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 from a supplier 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 services are delivered 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 25 months hence let alone 25 years hence.  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 service has 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.” [4]


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 PFI debt is not usually treated as public borrowing for accounting purposes and therefore doesn’t contribute to the Public Sector Borrowing Requirement (PSBR).  In other words, PFI debt is usually “off balance sheet”, even though the state is ultimately responsible for repaying it. 


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 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.


In recent years, Conservatives have been questioning the fact that PFI debt is “off balance sheet”.  On 30 April 2006, Conservative MP, Brian Binley, raised the matter in the House of Commons with Des Browne, then Chief Secretary of the Treasury.  He posed the question: what would be the consequences of moving PFI debt on to the Government’s books, to which 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 is 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.  You couldn’t make it up.



David Morrison

10 January 2008