PFI: Is Gordon Brown
“Peter Robinson, the IPPR [Institute for Public Policy Research]'s
chief economist, says the idea the government could not have afforded new
schools and hospitals without the PFI is ‘economically illiterate’. He says
it's just wrong to present the PFI as a free lunch from the City: it is simply
an alternative and more expensive financing method. …
“The funding still comes from the taxpayer over the lifetime of the
project, and it will only prove a cheaper route if the firms make significant
“‘The argument about extra investment has been made in the past,
because if the private sector pays the capital costs up front then they do not
show on the government's balance sheet, even though they remain public
liabilities,’ the IPPR says. ‘This is little more than an accounting trick: the
public finances are no more or less sustainable than if the scheme had been
carried out in a traditional way.’
“In the short term, taking the financing of the PFI projects back into
the public sector would not endanger either of Mr Brown's fiscal rules. The
first allows him to borrow for investment purposes, while with public debt now
just 30% of GDP, the government has room to manoeuvre under its second rule,
which fixes a ceiling for indebtedness of 40% of GDP.
“Privately, Treasury officials say the PFI projects could be financed
conventionally without breaking either of these rules.” (Privately
financed revolution, Charlotte Denny, Guardian, 3
What is going on
at the IPPR, which up until recently was New Labour’s favourite think
tank? Back in March they published a
report, which was highly critical of the mess New Labour has made of the
pensions system since 1997. Now, IPPR’s
Chief Economist declares PFI, New Labour’s preferred mechanism for building
schools and hospitals, to be both unnecessary and expensive.
A few days
earlier Gordon Brown told the Labour Party conference that PFI was vital to
their programme for modernising public services. “I have
to tell you but for PFI we simply could not have started so many [schools and
hospitals] so quickly in so many communities”, he said. The message from the party leadership to
conference was that opposing PFI is equivalent to opposing new schools and
hospitals. Nevertheless, conference
approved a resolution calling for a review of PFI.
So, despite his
formidable reputation, is the Chancellor actually “economically illiterate”? Of course, not. He’s just devious. He
knows very well that new schools and hospitals could be paid for by the state
borrowing (more cheaply) in the conventional manner. And he is careful never to say dogmatically that PFI is essential
to the building schools and hospitals.
Instead, he engages in devious formulations, which give the impression
that it is essential, while not quite saying so. That is true of his conference speech and of his article in the
Times on 26 September justifying PFI.
lost the vote on PFI at conference, but it cannot be said that they lost the
argument, because the opposition to PFI, chiefly from the trade union movement,
failed yet again to make a coherent case against it. It will be easy for the leadership to ignore the vote as they
said in advance they would.
objection to PFI is that it is, as Peter Robinson says, an expensive method of
public borrowing, more expensive that the conventional method. It is more expensive because the state can
always borrow more cheaply than the private sector, and the essence of PFI is
that the state employs a private agent to borrow on its behalf. As such, PFI is a waste of taxpayers’ money
and a prudent Chancellor would ban its use for public projects rather than
insist on its use as Gordon Brown is doing.
It would be nice
to report that the New Labour leadership is reeling from the battering it got
at conference for wasting taxpayers’ money.
It would even be nice to report that one or two opponents of PFI made
this point clearly at the conference or in the accompanying public
discussion. Sad to say, this
fundamental point about PFI was, to the best of my knowledge, never clearly
made. The nearest approach to it was a
remark in the conference debate by Louisa Was, a delegate from Bolsover, who
compared paying for hospitals via PFI to “putting the bill for your
semi-detached on your Barclaycard” rather than a conventional mortgage. (She also suggested that PFI actually stood
for “Pay For it Indefinitely”.).
This failure to
attack PFI at its weakest point is unfortunately a characteristic of the trade
union opposition to PFI. I have just
read a 44-page report by the GMB about its “Keep Public Services Public”
campaign. The report contains lots of
interesting information about the use of PFI and related matters, but there
isn’t a single mention of the fact that the central flaw in it is that it is an
expensive method of public borrowing, the use of which wastes taxpayers’ money. How the union expects to win a campaign
against PFI while keeping quiet about its basic flaw is a mystery.
The first thing
that needs to be emphasised about PFI is that it is public borrowing,
which like conventional public borrowing has to be paid back with interest by
the state. This is not always
obvious. Indeed, one could be forgiven
for thinking that PFI is an extraordinary act of philanthropy by private
companies, who are generously donating money to build public schools and
In his Times
article on 26 September, Gordon Brown wrote that PFI “provides private money to
invest in the health service”; in his conference speech, he spoke of PFI
providing “private money additional to public
investment, helping us to provide in constituencies that desperately need them
schools and hospitals”.
It’s a donation, isn’t it? How
could anybody object to the use of private money to build schools and hospitals
when it appears to be a free lunch?
But it is far
from being a free lunch. What happens
is that money is borrowed by a PFI contractor to built a school or a hospital
and the state pays the interest and repays the capital over 25 years or so, and
purchases services (for example, maintenance and cleaning) at the same time. That is public borrowing by another (more
expensive) means. The state does not
pay the interest and repay the capital directly to the lender, but it is part
of the overall charge for renting the building, and purchasing other services,
paid to the PFI contractor.
Like a mortgage?
shared with Gordon Brown the burden of defending PFI before and during the
party conference. He advanced the
dangerous argument that using PFI to build a hospital or a school was like
taking out a mortgage on a house and having use of the property while paying
off the mortgage. The analogy is, to
say the least of it, less than perfect.
First of all,
nobody in his right mind consciously chooses anything other than the cheapest
mortgage available when buying a house.
PFI is equivalent to demanding an 8% mortgage when a 6% one is
can only take out a mortgage on a house you own. An NHS Trust that commissions a hospital may never own it (of
which more later); it will certainly not own it until the end of the contract
term. Until then, the PFI contractor
who built it owns it.
That has very
serious consequences. While you are
paying off your mortgage, you are free to make any alterations you like to your
house, subject only to planning permission.
You can even sell it and buy another one. However, if a PFI hospital becomes unsuitable for the delivery of
the services required (which isn’t a remote possibility after a couple of years
let alone 25), the NHS Trust is not free to make alterations to make it more
suitable, since it doesn’t own it.
That is a matter
for the PFI contractor who owns the building.
Changes to the building, and to the services delivered in the building,
can only be effected with his permission and he is therefore in a position to make
the Trust pay through the nose for the changes. He cannot be blamed for that: he would be failing in his duty to
his shareholders if he didn’t exploit this monopoly handed to him by the state
in order to enrich his shareholders.
That is another
serious problem with building schools and hospitals using PFI, a problem that
will become more and more apparent as time passes.
is ostensibly seeking to increase competition, and lower cost, in the supply of
public services by introducing private providers. It is ironic that it is going about it in such a way as to
eliminate competition in large areas of the public sector for the next 25 or 30
years and to grant monopolies to a few private consortia, monopolies which are
enshrined in legally binding contracts (and cannot even be overturned by
Parliament) committing the state to paying loads of taxpayers’ money for many
Who owns PFI
eventually own PFI-built assets? It
used to be the case that only roads and prisons built in this way were
scheduled to revert to the public sector at the end of the contract term. Hospitals and schools were to remain the
property of the private contractor.
This caused an outcry in the case of, for example, the new Edinburgh
Royal Infirmary, since it amounted to the privatisation of public assets by the
backdoor, old publicly owned assets being replaced by new privately owned
The New Labour
leadership have all along attempted to dampen down opposition to PFI by
insisting that it is not privatisation, which they imply only evil Tories
engage in. Of course, it is not
privatisation in the sense of selling, or giving away, public assets to the
private sector, but there is a fine distinction between that and replacing old
publicly owned assets with new privately owned assets.
has now changed this practice for PFI-built hospitals at least and contracts
now give the NHS Trust the option to take ownership of the hospital at the end
of the contract term – no doubt in exchange for loads of money. This makes it easier to say that the use of
PFI isn’t privatisation. But we will
have to wait for 25 years or more to see how things work out in practice.
It is the very
foolish for any organisation to contract to purchase services from a single
supplier for 25 years. 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 25-year contract, 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. How could anybody have known in
1977 what services are needed, for example, in a hospital today, when medical
technology and medical practice has changed out of all recognition in the
No doubt PFI
contracts 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 taking out a contract for a service delivery for a
period so long that service needs cannot possibly be predicted. Why are public bodies encouraged by the
Treasury to engage in this 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 that 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.
Of course, the Government is fully
aware that 20 to 30 year contracts for the supply of public services are not
wise. You have only to look on the
Department of Education & Skills website to confirm this. There you will find a Purchasing
Guide for Schools produced by the Department’s Value for Money Unit, which
contains the following good 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.”
good advice to beware of contracts in excess of 3 years, there have been many
examples of school Boards of Governors being bludgeoned into accepting 25-year
PFI contracts for school maintenance and cleaning, for example, in the Haringey
Schools PFI scheme (details of which are described in an excellent report by
Melanie McFadyean & David Rowland, commissioned by the Joseph Rowntree
That is not the
whole story. It is foolish for anybody
to take out a long-term contract for the supply of services, since it reduces
the leverage he has on the supplier to deliver. An alternative lever is that he can easily terminate the
supplier’s contract on the grounds of inadequate delivery.
However, it is
in general very difficult for a public body to terminate a PFI contract. The Treasury advises that it be so:
“The Contract must achieve a fair balance between the (Public Sector)
Authority’s desire to be able to terminate for inadequate service provision …
and the Contractor’s and its financiers interest in restricting termination to
the severest of defaults” (Treasury Taskforce, Standard
Contract Terms, 18.104.22.168).
If the public
authority terminates the contract, the income stream used by the contractor to
service his debt is cut off at a stroke.
Therefore, the easier it is to terminate a contract for inadequate
service provision the greater the risk that the contractor will default – and
the higher the interest rate he will be charged by his financiers at the
That’s what the
Treasury advice above is about: in its negotiations with the contractor, the
public authority must bear in mind that easy contract termination translates
directly into high interest charges to the contractor, which the public
authority will have to pay. So to keep
the cost of borrowing down the contract must be difficult to break, even if the
service delivered under it is wholly inadequate. For example, rather than having a contract terminated
immediately, the contract should allow for long “rectification periods” during
which the contractor has the chance to improve service delivery.
(In addition, it
now appears to be a common, if not universal, feature of PFI contracts that, if
a public authority terminates the contract, it is obliged either to find a
successor to take over the debt or to take it over itself. This is another mechanism geared to keeping
the interest rate down, since it amounts to the state guaranteeing the
situation has come about because under PFI the state is buying both finance to
built PFI assets and services delivered in them under a single contract. To minimise the cost of finance, the
contract needs to be long-term and unbreakable, but to ensure good service
delivery the contract needs to be relatively short-term and breakable if
service is not delivered adequately.
PFI is an inappropriate coupling of the purchase of finance and purchase
of services in a single long-term contract.
answer is to decouple them and have two contracts between the public body and
the PFI contractor, an unbreakable one for finance and one for services which
is breakable if delivery isn’t up to scratch.
But that would never do since then the state would plainly be liable for
PFI debt, and treating it as public, rather than private, debt could not be
avoided (of which more below).
PFI: the only
answer to all criticism of PFI is that it is playing a vital role in the
modernisation of Britain’s public services.
That can hardly be denied since Gordon Brown has decreed that it be so.
question is why he has decreed that it be so, at considerable cost to the
taxpayer for the next 20-30 years. The
great man is always very reticent on this point and there was only the tiniest
hint about his reasons in his conference speech, when he said:
“It is, friends, a question of trust and with promises to keep and
fiscal discipline to maintain it is my duty to say to the British people that
we will hold to our long term course for building schools and hospitals so that
every community has the high standard of public service they need and deserve.”
The hint is in
the phrase “with … fiscal discipline to maintain”. The implication here that borrowing the necessary sums by
conventional means would have caused him to break the fiscal rules he has set
for himself, that is, public borrowing for investment is allowed but total
National Debt should not exceed 40% of GDP (which was one of the Maastricht
criteria, and is now part of the rules of the Euro zone).
addiction to PFI as a means of financing public projects is driven by the fact
that from the outset PFI debt has been not treated as public borrowing for
accounting purposes and therefore doesn’t contribute to the PSBR [Public Sector
Borrowing Requirement]. This piece of
trickery means that the Chancellor can say he is maintaining “fiscal discipline”
while running up vast amounts of expensive PFI debt to build schools and
hospitals, but cannot when he borrows more cheaply by conventional means.
It is true that
under PFI the private contractor does the borrowing. But the state is contractually bound to make payments to the
private contractor, which are in part used to service the loan. In other words, if the contract goes to full
term without the contractor defaulting, the state is as liable for paying off
PFI debt as it is for conventional public sector borrowing. The only difference is that it pays off PFI
debt through a private sector intermediary.
What happens if
the contractor defaults on PFI debt depends on what it says in the contract
between the public body and the contractor, which is not generally in the
public domain. But, as we have said, it
is increasingly the case that the public body is contractually obliged to take
responsibility for the debt or find another contractor who will.
In practice, the
state is never able to escape responsibility for the delivery of essential public
services. And if existing private
delivery arrangements break down, the state will have to take responsibility
for putting together new arrangements.
In all probability that will include taking responsibility for existing
PFI debt, whether it is legally obliged to or not.
The state has
legal liabilities as a consequence of PFI debt just as it has legal liabilities
for debt generated by conventional borrowing.
That they are treated differently for accounting purposes, with PFI
excluded from the PSBR, in other words, not counted “officially” as government
borrowing, is accounting trickery with no logic to it. The state can no more escape liability for
PFI debt than Enron could escape liability for its off balance sheet debts.
This piece of
accounting trickery lies at the root of Gordon Brown’s insistence that public
bodies go down the PFI route to borrow money.
He is very fond of boasting about how since he became Chancellor he has
reduced the National Debt, and the amount of current expenditure necessary to
service the National Debt. PFI debt is
“officially” not public borrowing and “officially” doesn’t add to the National
Debt, and therefore it can be run up at will without undermining his ability to
continue boasting. Public borrowing by
conventional means would threaten that ability, even though it would save
There is not the
slightest doubt that the money raised for public projects via PFI could have
been raised by the, less expensive, traditional route. It is “economically illiterate” to say
otherwise, to use Peter Robinson’s phrase.
It is simply the case that Gordon Brown has banned the traditional route
for his own political purposes.
Even the most
partisan supporters of PFI admit that the state can borrow more cheaply than
any private sector agent acting on behalf of the state. It is even admitted in official documents:
for example, in the Treasury document Public Private Partnerships: The
Government’s Approach, published in 2000, where is says
that “the private sector
’s cost of borrowing is higher than that of the public sector”. For obvious
reasons, Gordon Brown didn’t labour this point in his speech at party
justification for using PFI borrowing despite this obvious drawback is that (1)
the difference is small (1-3%) (bought at the price of almost unbreakable
contracts, as we have seen) and (2) that this extra cost of borrowing must be
balanced against “efficiency savings”, which we are assured flow from employing
the private sector to deliver public services.
One doesn’t have to be a genius to see that this isn’t
a justification for using PFI at all.
There isn’t a God given rule saying that one must buy finance and
services in a single contract. In fact,
as we have seen, there are very good reasons for not doing so.
In the PFI method of procurement the public authority
employs a private contractor under a single contract to (1) provide finance for
the project, (2) undertake the building work, (3) maintain the building, and
(4) provide other services in the building for 25 years or more. The range of the latter varies from contract
to contract, but in the case of a hospital it could include cleaning, the
provision of porters, catering and laundry.
Public employees working in these areas will be forced to transfer to
the private sector.
Before PFI, finance was raised in the conventional
manner but the private sector was always employed under contract to do the
building work. Other services used to
be carried out wholly by public employees, but since the 80s contracting out
has increased the role of the private sector.
The proponents of PFI claim that “efficiency savings” is a
characteristic of private sector involvement, but they point especially to the
benefit from having the same contractor build and maintain assets, the
reasoning being that if a contractor has to maintain a building for 25 years he
will build it to a good standard in the first place.
Be that as it may, it is obvious that private sector
“efficiency savings”, if there are any, does not need to be combined with
expensive finance. There is no reason,
apart from Gordon Brown’s passion for Enron style accounting, to prevent the
finance being raised by conventional means, in which case the private sector builder
would be paid up front, the building would pass into public ownership, on
completion. The maintenance of the
building for 25 years could be part of the initial building contract. And the provision of other services need not
be but if they are contracted out at least contract(s) can be more appropriate
for service delivery, that is, relatively short-term and breakable if service
is not delivered adequately.
The inappropriate coupling of the purchase of finance and purchase of services in a single
long-term contract, which is inherent in PFI procurement, would be avoided.
A great deal of
nonsense is talked about the advantages of PFI procurement over the
conventional method, not least by the Chancellor. Listen to this from his Times article:
“Before the PFI private companies handed projects
over to the public sector with little or no obligation to repair their own
faults, and certainly none for future upkeep. The public sector met the costs
of the building and responsibility for its upkeep. The private contractor could
walk away with no ongoing responsibility for the quality of their work.”
before PFI private companies had “no obligation to repair their own faults”,
then there was something seriously wrong with the project contract. Imposing such an obligation does not require
a switch to PFI procurement but a contract that says the contractor doesn’t get
all his money until he has repaired his own faults. Likewise, there is nothing to stop a contractor being made
responsible for the future upkeep of what he has built within the conventional
procurement method. What the Chancellor
claims as advantages in PFI procurement are nothing of the sort.
major claim for PFI procurement is that time and cost overruns are a thing of
the past. Time and time again,
government spokesman cited London Underground’s failure to complete the Jubilee
Line extension on time as evidence that its maintenance must be contracted out
under a PFI scheme. This is another
example of claiming advantages for PFI procurement that are readily available
in conventional procurement with an appropriate contract and the will to
enforce it, in particular, a contract that lays down penalty clauses for late
Lamont says NO
Finally, let me quote from two interested parties in
the PFI debate. First, from Norman Lamont, the man
who invented PFI. In his account of his
time in government published in 1999, he wrote:
“The PFI is not a ‘free lunch’.
For private finance to work properly it has to provide greater value and
efficiency to make it worthwhile. The
Government can always borrow money more cheaply than any private sector
borrower, so the efficiency test for a private finance project has to be real. Secondly, it is an essential that the risk
in the project really is wholly transferred to the private sector, otherwise
privately financed public expenditure ought to count towards Government
borrowing. Lastly, there is a risk that the private sector may provide finance
up front but that the long-term consequences will be the silting-up of public
expenditure with a stream of never-ending rental payments. I suspect that in the long run some of these
projects will go wrong and appear again on the Government’s balance sheet,
adding to public expenditure. We shall
see.” (In Office, p309)
on Today on Radio 4 on 1 October, the morning after the Labour
conference debate on PFI, it was put to him that the Conservative Party had
introduced PFI. He replied that that
was true but they anticipated that it would be used to attract private
investment into projects that would be additional to public provision. This Government appear to be using PFI as a
means of keeping public expenditure off the balance sheet, he went on. There is a scent of Enron economics about
what they are doing. We always knew
that the private sector borrows money at a higher rate. PFI looks cheaper in the short term but in
the long run it is likely to be much, much more expensive.
Accountants say NO
And finally the opinions of public sector
accountants. The Association of
Chartered Certified Accountants (ACCA) recently (September 2002) published a
report on a survey about PFI of a cross-section of their members working in the
public sector. Nearly 200 of them
responded. The report is entitled Do PFI schemes
provide value for money?. I quote from its summary:
“Only 1% of the respondents strongly
agreed that PFI generally provides value for money whilst well over half of the
respondents disagreed with this statement.
The survey also showed that most public sector accountants believe that
public sector organisations are prevented from achieving value for money as PFI
is the only available option for obtaining much needed capital investment in
public services. In addition, less than
1 in 7 of those returning the questionnaire felt that PFI schemes are
objectively tested to see if they provide value for money.
“PFI is the route the government
prefers for all major public sector capital schemes and few such schemes are
now able to use traditional direct public sector procurement. Comments from the respondents to the survey,
however, indicate deep scepticism with the potential benefits of the public sector
adopting the PFI approach.
“These comments included:
‘an extremely expensive option
generated through political dogma which ought not to be necessary if central
government were prepared to allow organisations to borrow money to invest’
‘I believe that PFI is a short-term quick
fix, but in the longer term it is very costly to the public purse. The government itself can raise finance at
the lowest interest rate.’”
& Trade Union Review