A great many capital projects in this country have been procured through Private Finance Initiatives. This is a scheme which began in 1992, and was enthusiastically adopted by all subsequent governments since that time. It is also used in other countries in Europe, so this is not a specifically UK thing, as far as I know. It is batshit crazy, and this was very obvious to ordinary people, at least in my circle. As my mum pointed out, there is no reason at all to suppose that you can give a private company a profit and still do the thing cheaper than you can by not giving them a profit. No reason unless you happen to believe that the private sector is inherently better, as our neoliberal ideologues do.
The House of Commons Treasury Committee has finally noticed this. They have produced a report on PFI which is damning in its conclusions, not least because the outcomes of its investigation are so banal. They are exactly what you would expect as a lay person, and there are no sophisticated or technical issues which are relevant to this. There is no "expert" content to consider and there is no reason why there should be. This is one of those things which was adopted for purely political reasons, and we all have "expertise" in that. The truth is that we, as a country and as a european body, decided to impose absurd constraints on ourselves; then decided to circumvent those constraints we voluntarily adopted; and ended up paying enormous sums of money to the private sector for decades into the future.
What is mindboggling about this is why it was entertained for one moment. Certainly there is corruption, and there is ideology, both of which help to explain it. But I find it honestly difficult to understand why there was not public resistance and protest on a grand scale, at any point. Once again cross party agreement seems to trump any prospect of honest debate and of democratic challenge.
The Treasury Committee report examines the arguments put forward in support of this way of doing things so it is worth considering what we were told at the outset.
First, what is it? PFI (otherwise known as PPP (Public Private Partnership)) is a means of procuring capital assets for the public sector to use. Say you want to build a hospital in the UK. Hospitals are part of the public sector here (with exceptions as there is some private health care) and so the decision to build a hospital is a public sector commitment. Under conventional arrangements the government would make the money available, then they would write a brief for what they wanted: private companies (usually) would tender for the work and the government would choose who got the contract.
Under PFI the government still decides it wants to build a hospital: but now they ask the private sector to bid for a completely different kind of contract. Instead of the tender being to build the thing, the companies are asked to "design, build, finance and operate" the hospital, generally for a period of decades. Effectively the public sector rents the hospital from the private company, though that is not what it is called, for obvious reasons.
Why would you do that? It is not generally a good idea to think that what happens in the domestic sphere applies to government finance, but it is often done and so it is reasonable to start there, I think. If you, as an individual, want somewhere to live then you have a choice of whether to rent or to buy. In this country, if you can possibly manage it, you buy. That was not always true: there used to be a lot of public sector housing available to rent at reasonable prices. Since 1979 that has been eroded, and all governments have promoted home ownership in various ways since that time. It makes sense. Private landlords are notoriously poor and the rents they charge are high. In practice rents are comparable with mortgage repayments, and you don't end up with an asset, as you do if you buy. So most people understand that it is better to buy a house than it is to rent it. What is the difference which makes a difference in government procurement of capital assets?
Well one difference is that up until recently PFI was not counted as government debt. That matters because of the obsession with debt to GDP ratios, which is discussed on other threads. The Maastricht treaty committed government to a limit of 60% debt to GDP and a 3% deficit. It was not wholly binding, but that was the idea and it has been reinforced by subsequent agreements like the stability pact.
If you happen to believe that is a good idea then it is not reasonable to wiggle around those rules. If you have more than 60% debt you cannot have your new hospital; it is as simple as that. That is the stark implication of these wholly artificial constraints on government finance, and if they truly believe that is necessary, then the honest thing to do would be to tell the people that they can't have a new hospital. End of. But they don't believe it, obviously. At least not in this country. Because they built the hospital under PFI, and the money they were not allowed to spend under the rules was spent: it just did not appear as government debt. Everybody knew this, and it was widely discussed, by critics of the policy. The facts were flatly denied, just. What the government said was that they were not driven by these stupid rules but rather by the fact that PFI provided better value for money. It is now admitted that the accountancy treatment was, in fact, a driver: and the rules have been changed. PFI commitments now appear as debt (or at least that is supposed to happen, though ways round it continue to exist and will, no doubt, be used) since 2010. Not one thing has changed in the real world.
However they did deny it, and they gave the value for money arguments instead. So the Treasury Committee has looked at those arguments.
First: the money to build the hospital has to be borrowed (of course that is not true for a state with a sovereign currency, but since this process also applies in the eurozone let us ignore that for the moment). Under conventional arrangements the money is borrowed by the government: under PFI it is raised through a mixture of borrowing and sale of shares in the private sector. That is why it does not appear as government debt. If you borrow you pay interest. The interest rates are higher in the private sector than for government borrowing, even in good times. At present in this country they are about double what the government pays on gilts. The private company must price at a level which includes repayment of the interest on the money it borrows: and must also have a margin to pay the shareholders who bought the shares. Obviously the cost of building this hospital is going to be higher if done through PFI, for that reason.
To counter that it was argued that private sector companies are more efficient and so they would find offsetting savings to eliminate the difference. Do you think that a child of 8 would believe that? A child of 8 who believes that the free market is efficient, and so presumably thinks that the tenders under conventional arrangements are as low as they can be in any case?
That is at the level of argument and it is clearly rubbish as everybody sensible knew when it was put forward. The Treasury Committee has now looked at the outcomes and it is as crap as it looks.
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The use of PFI has the effect of increasing the cost of finance for public investments relative to what would be available to the government if it borrowed on its own account.
<snip>
The higher cost of capital for the PFI option compared to government gilts meant that, without any offsetting efficiencies, the cost of the PFI option would be 70% higher over the life of the project. One other way of looking
at the difference in cost is to consider how long it takes government to pay off outstanding debt. If government borrowed directly and followed the same repayment schedule as the PFI charges the government debt could be fully repaid many years before the equivalent PFI liability could be paid off.
Second: it was argued that because the contracts were long term, the private sector would have a vested interest in making good quality buildings, with a lot of innovation so that the costs of maintenance would be low over the whole period. That was said to be in contrast to the conventional arrangement whereby the builder had no interest in the long term costs. Hmm. Seems to me that the buildings are commissioned by someone and that it is the spec which determines both innovation and quality. I see no inherent reason why public bodies should wish to build crap hospitals with high maintenance costs they have to pay; but private bodies don't, in the same circumstances. If you happen to believe that the public sector is profligate by definition that may make sense to you: but it doesn't make sense to me. My experience tells me something different: the public sector is capable of long term thinking if you let it: but the private sector famously focuses on short term returns, and on cost cutting. It is unlikely, to me, that they will build better buildings to reduce long term costs of maintenance: when they could just reduce the level of maintenance to achieve the same profit. That, too, depends on the spec: but it is far harder to enforce good quality maintenance over 30 years.
Again the Committees's findings support the common sense view, when they look at outcomes
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Although PFI theory states that the process should drive up building quality to keep long term costs down we received evidence which directly contradicted this. The Royal Institute of Architects told us that “the quality of the buildings delivered through PFI schemes remained poor in many cases”. It explained that: “The poor quality of the buildings’ design lead to a number of issues, such as rising maintenance costs over the lifetime of the building”. One of the reasons it pointed to was “value-engineering by contractors”, telling us that there was strong anecdotal evidence that contractors were withholding information from clients. This resulted in “essentially reducing the intended quality and cost of the project compared to that specified by the architect, to the detriment
of the finished building, without the knowledge of an unaware client.” The reason this was done was to “maintain the contractor’s preferred levels of profitability”.72
That leopard is still spotty, it seems. Whoddathunk?
Third: it was argued that the "risks" would be borne by the private sector and not by the public, so there would be a benefit to the public purse because of that. Orly? Forgive me if I have got this wrong but it seems to me that any identifiable "risk" is written into the price of any tender coming from the private sector. That is kind of the nature of the beast, is it not? It is true that government contracts have, in the past, been curiously devoid of penalty clauses for failure, and there have been significant cost overruns in many projects. Unedifying and ultimately costly arguments about whose fault it is are a common feature of conventional procurement: and this is supposed to do away with that. But predictably the price is higher.
The Treasury Committee confirms this too:
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....research which found that hospital trusts were paying a ‘risk premium’—conservatively estimated at 30% of the total construction costs—to ensure projects are running to time and budget. So while it is true that the private sector absorbs the cost of overruns etc, additional charges are written into the contracts to account for
this.
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A report published by the European Investment Bank estimated that the contracted price was 24% higher for PPP roads than conventionally procured roads
If the budget is already 20% higher in a PFI procurement then a budget overrun of less than 20% in a conventional procurement would mean it was still cheaper. It is therefore important to consider how much projects which do not meet their budget exceed it. A National Audit Office report which considered a group of public sector projects that went over budget in 2003 and 2004, reported that the average level of overspend was 4.1%.
Fourth: it was claimed that PFI would increase competition, and that is always a good thing! Except it doesn't. The costs of making a bid and the length of the procurement process mean that only the very biggest companies can tender.
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failed bids cost approximately £2m per school and £12m per hospital.109 Mr Friend told us “We at Laing
thought we were doing well if we won 40% of what we were shortlisted for. So, you are writing off those”.
Apart from the fact that only big companies can bid it does not seem likely to me that those losses are not covered in the price of successful bids, either
As has often been noted, the game is rigged in favour of PFI. The Treasury Committee has details of just how far that is true and it is more than I had been aware of. I knew that the costs of conventional procurement were artificially raised on the basis of ideological conviction: there is a built-in assumption that public sector costs are higher than reported and so an arbitrary percentage uplift is included to take account of that "optimism bias" No such uplift is applied to PFI bids, and that alone is often sufficient to make them look like better value for money. In one case examined by the committee the uplift to the public sector figures was 19% for capital expenditure and 15% for operational costs. As noted above cost overruns for capital expenditure in the real world averaged less than 5%: but of course the outcome would be different if that figure was applied: and of course that assumes that all of the overrun is due to "optimism" and not, for example, to dishonest bids from private contractors to win the contract; knowing that the commissioning body must pay up or cancel if the cost goes up: and they mostly will not cancel.
But in addition to that bias there is also a list of others: for example the transaction costs were assumed to be the same for PFI and for conventional procurement, though the treasury itself acknowledges that transaction costs are higher for PFI; there is also an adjustment downwards of the costs for PFI to take account of assumed tax receipts over the life of the contract: an assumption which means they estimate that a quarter of all revenue paid to the private sector will be profit subject to corporation tax.
This seems to be to some extent "realpolitik". It is contended that if the conventional route is better value the money will not be available because of the accountancy features mentioned above. So the VFM calculation is rigged to make the PFI come out better. As the report notes
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This account was consistent with an Audit Commission report on PFI schools. 9 of the 11 PFI schools that the report considered had relied on a risk adjustment to show they were better value for money than the PSC. It also explained that “where the PSC estimate of construction and running costs was much below the PFI cost, the cost of risk transfer added on was on average higher”.127
And, from the British Medical Association:
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In theory, projects are value tested against what the project would cost under public finance. If this process concludes that private finance does not represent value for money, a public procurement method is supposed to be chosen. In a context where PFI is the only funding available and many NHS hospitals are in need of capital
works, managers have faced ‘perverse’ incentives to ‘manipulate’ their assessments and subsequently we have seen a proliferation of PFI projects.129
While it is fair to point to the realities it is also fair to remember that many hospitals are now unable to meet the payments and this is the rationale for handing them over to private companies, as seen in the case of Hinchingbrooke and Circle. I am not convinced that this is all "unintended consequences": rather it is a mixture of ideology which renders the incentives perverse in the first place; and a desperate response to those incentives which make it easier to privatise our public services. There is some support for that view in the report
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The most straightforward alternative to the use of PFI is capital spending direct from a capital budget. The annual budget allocated to every government department and public body is split out between the current (resource) budget and the capital budget. If a Department does not have a capital budget to meet its investment needs the only alternative is to turn to some form of private financing and use the current budget to meet the annual payments. This issue is likely to become more acute in the coming years as the capital budgets of Departments are cut significantly whereas current budgets are reduced to a lesser extent. The October 2010 Spending Review detailed cuts of 29% in real terms to the total capital budgets of departments, compared to a 8.3% cut to their current spending over the same 5 year period.138
Is it really credible to believe that capital budgets are cut more than operational budgets for sound financial reasons? Or is it possible that it is fine to maintain operational budgets at a better level, since so much of that money will now go to the private sector? When so many of our politicians have direct financial interests in that same private sector? You decide
http://www.publications.parliament.uk/pa/c...y/1146/1146.pdf
