Alive and kicking, by Mark Hellowell

16 Nov 06
Far from being on its way out, the Private Finance Initiative has never been in ruder health. As well as strengthening its role in health and education, it is elbowing its way into new areas such as housing, waste management and GP services. Mark Hellowell reports

17 November 2006

Far from being on its way out, the Private Finance Initiative has never been in ruder health. As well as strengthening its role in health and education, it is elbowing its way into new areas such as housing, waste management and GP services. Mark Hellowell reports

Contrary to popular opinion, there is to be no letup in the use of the Private Finance Initiative. In fact, the number of schemes is going to expand dramatically over the next few years.

In sectors such as health care and education, where private finance has been the major source of capital for more than a decade, billions of pounds worth of new projects are in the pipeline. At the same time, ministers are backing the enlargement of fledgling sectors such as housing and waste management. And while some ancillary services are being withdrawn from the scope of Private Finance Initiative contracts, new public-private partnership models are being developed that will deepen the private sector's role in core service delivery.

The planned expansion will surprise many people. Last year, journalists and academics began questioning the initiative's future. In the context of a wider public service reform agenda, with choice and marketisation the central pillars of policy, it seemed that the PFI, with its expensive and inflexible contracts, was moribund.

Other pressures emerged when the Office for National Statistics announced its intention to include a portion of PFI investment in the figures for national debt. Until recently, privately financed projects did not score in public debt figures, regardless of whether they were on the balance sheet or off it. The ONS change of heart threatened to remove this fiscal advantage and thereby reduce the attractiveness of the PFI to the Treasury.

The impression that the PFI had had its chips was strengthened at the end of 2005 when the Department of Health announced a review of its entire hospital-building programme – almost all of which was being progressed through the PFI.

But events in 2006 have dispelled the rumours. As the year progressed, it became clear that only on-balance sheet schemes – a small minority – would figure in the ONS's new public debt calculations. As long as the Treasury can keep projects off the balance sheet, it has a strong incentive to invest through the PFI, rather than public financing.

In the March Budget, Chancellor Gordon Brown showed he was unmoved by the ONS intervention, releasing details of £22bn of PFI contracts, recently signed or in the final stages of negotiation. The Budget represented a significant endorsement of the PFI, providing an important fillip for its future.

Meanwhile, the review of health care PFI resulted in a pared-down, but still very strong, list of hospital projects. In August, health ministers gave the green light to six new hospital projects, with a combined capital value of £1.5bn. Though smaller than originally intended, these projects are still enormous in value terms compared with their antecedents.

The projects join a group of 12 approved last year, which are valued at £3bn, and the £4.6bn of schemes currently in construction. A further 25 schemes, worth £6bn on current estimates, are in the planning stage.

In Scotland, too, health ministers are gearing up for a major PFI expansion. Some 20 new hospital projects are being planned or negotiated. Many, including a £300m project for Forth Valley and Lothian's £200m 'Improving Care, Investing in Change' plan, are major undertakings. Meanwhile, NHS Glasgow and Clyde is taking forward three new schemes, for the Southern General, Sick Children and Royal hospitals, currently valued at £600m between them.

Across the water, Northern Ireland's technocracy, which includes senior people from the PFI industry, has grasped PFI/PPP with both hands. Four major health infrastructure projects have gone – or are due to go – to market this year, with a combined capital value of more than £1bn. Next year, a further four schemes, worth an additional £900m, are due to be tendered. That adds up to eight schemes with a capital value of just under £2bn: and all this in a province with a population about the same as Leeds or Coventry.

In the education sector, too, there is significant expansion across the UK. England's Building Schools for the Future, the £40bn PPP programme involving 3,500 primary and secondary schools, is now under way. Some 40% of these schools will be newly built through the PFI.

However, the programme is years behind schedule, largely due to the reluctance of local authorities to embrace the 'PPP fundamentalism' inherent in the BSF model. But in the absence of alternative sources of capital, the government is winning the argument, and a few early schemes have achieved financial close, beginning with Bristol's £150m scheme.

A total of £6.7bn has been allocated to BSF's first three waves (each wave covering a year), with other local authorities preparing to join later waves. Meanwhile, Scotland's £2bn schools PFI programme continues, and Northern Ireland is pushing ahead with a £380m programme of schemes.

As the scale of the PFI expands in the established sectors, new parts of the public services are being opened up to private financing. Social housing is a sector that many believe will become core to the industry. The Department for Communities and Local Government has been given a substantial uplift in housing PFI funding in recent government Spending Reviews, receiving an allocation of £1.2bn last year.

The Treasury has said that it wants the PFI to provide new social rented homes and make an important contribution to the government's troubled decent homes programme, through which all social housing is supposed to be brought up to scratch by 2010.

As it stands, the PFI programme will deliver about 27,000 dwellings for the decent homes target, and just under 4,000 rented homes. Nine housing PFI projects have been signed with a total capital value of £429m, increasing the number of decent homes by 8,000. A further 15 are in the pipeline, and there is the promise of many more.

Another sector primed for expansion is waste management, which requires massive investment to achieve European Union landfill reduction targets. To date, nine waste projects have been signed, with a total capital value of £650m. Now, a further 11 schemes are being negotiated and the Treasury, 4Ps and Partnerships UK are working with the Department for Environment, Food and Rural Affairs to ensure the market is 'engaged' for future waves.

Perhaps the greatest opportunities for the private sector, however, will come as the PPP model migrates from asset-based to service-based contracts. The pilot for this approach was to be the Local Improvement Finance Trust, or Lift, which is currently used in primary health care.

The DoH wanted to use Lift to get the private health care industry involved in PPPs. It was felt that this could take place in conjunction with the new rules that allow primary care trusts to seek to privatise GP service provision. But the plan was shelved in the summer after the PPP industry successfully lobbied for Lift to be left alone. Instead, the private sector will be introduced through so-called community ventures.

This model is, in essence, a replica of the service privatisation approach initially planned for Lift. A joint venture company will be established between a PCT and a private partner (the 'third sector' is also due a role here) and the DoH will retain a stake in the company. But the company will be provided with public capital for its buildings, so that the private sector is focused on service delivery rather than the management of assets.

In time, it is expected that these organisations will deliver a large chunk of NHS community care – an area of the NHS that is due for significant expansion as more and more services are stripped from local hospitals. Thus, along with related policies, community ventures will help move health care provision from the public to the private sector.

While all this will make pleasant reading for the private sector, the outlook for the public sector is far less rosy. PPPs are a form of investment, but one that creates a debt that must be serviced for 30 years or more. Already, they are placing a considerable burden on the public finances. For the £8bn worth of hospital schemes that are currently operational or under construction in England, the NHS will pay some £53bn over the 30-year lives of the contracts.

Around 30%, or £16bn, of these payments relate to the facilities management services undertaken in the contracts – that is, money that would have to be spent on services anyway. However, the remaining £37bn clearly represents a very substantial burden of debt for the NHS over the coming decades.

With the planned tripling of the number of large-scale PFI projects in the health service, it is evident that this £37bn will increase to around £100bn by the early part of the next decade; billions more if Scotland and Northern Ireland are included.

These costs will be borne out of the revenue budgets of local NHS organisations, many of which are currently in deficit. It is not surprising, then, that 50% of trusts with major PFI schemes are currently in financial difficulty, much higher than the average across the NHS.

Many of those with the worst deficits have the most challenging PFI commitments. South Tees and the Queen Elizabeth in Woolwich hospitals have been paying an average of around 20% of their turnover to PFI partners since their projects became operational. Both have substantial deficits.

At Dartford and Gravesham, paying 20% of turnover to a consortium making annual returns in excess of 60% has not gone down well locally, in the context of that trust's financial difficulties.

In Scotland, the situation has been eased by the re-integration of acute and primary care, but even here, the PFI is costing some health boards as much as 6% of turnover – well above the capital charges paid by boards without such schemes. It is increasingly clear that spending on the PFI is a major factor in the controversial hospital closures that are currently being planned.

If this is the case for health care, the analysis can be broadened to include many other areas of public service – education, transport, central and local government – where the PFI is the dominant means of public investment. The wiggle room might be greater in these areas, as budgets are more flexible, but it is evident that the PFI will constrain future financing options.

How then will the public purse bear the pressure of the vast swathe of the additional PFI projects that are to come?

Local communities will not welcome the sale of their swimming pools and playing fields as councils seek to get to grips with affordability problems.

The DoH approach has been to pare down its future schemes – it announced a 25%–40% cut in the cost of the hospital programme at the beginning of the year. The experience of the early PFI deals shows that cutting the number of wards, beds and staff results in under-capacity, with grave results for the quality of care. Even then the cuts often do not go far enough, and further cuts and closures are required.

Gordon Brown's passionate faith in the PFI is not without its risks: to his political career, to the public sector and, ultimately, to the public.

Mark Hellowell is a research fellow in public-private partnerships at the University of Edinburgh


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