The discreet charms of the PFI

19 Aug 11
Mark Hellowell

Two parliamentary reports are increasing the pressure on the Private Finance Initiative, yet it’s hard to imagine the government resisting its fiscal advantages

Should the government use public or private finance when investing in new infrastructure? Feelings run high on this issue, and a showdown between Parliament and the Treasury is inevitable. Government net spending on capital is set to halve between now and 2015, while the Private Finance Initiative is greatly expanded. MPs are not happy.

The Treasury Select Committee has just published a highly critical report, and the Public Accounts Committee will follow suit in September. The former states plainly that the return on private finance – about 8.5% on a typical deal, compared to about 4% on long-term government bonds – is too high to represent good value. The report evaluates the costs of construction, maintenance and services under the PFI and finds no evidence of any savings over normal public procurement that could even partially offset the higher financing cost. It concludes that the value for money case for the PFI is implausible.

The PAC, too, is an increasingly vocal critic. Its report will say that returns to investors have been too high, leading to huge excess costs for public authorities.

Under the PFI, private capital is raised to provide public buildings and social housing, along with waste management facilities, defence equipment and transport infrastructure. It enables construction projects to proceed without showing up on headline measures of the government’s debt and deficit.

The Office for Budget Responsibility believes that the use of the PFI has shaved about 2.5% off the debt-to-gross-domestic-product ratio. This makes the initiative highly attractive for the government, given its commitment to growing the economy through a period of unprecedented fiscal contraction. In Opposition, George Osborne labelled the PFI a ‘discredited’ model, but as chancellor he is ploughing on with new schemes. The Treasury expects £2.8bn to be invested through the PFI in this financial year. Figures also show schemes with a combined capital value of £7bn in procurement.

In addition, the Department for Education is to seek £2bn of private capital for its Priority School Building initiative. Up to 300 new schools will come through the programme, for which the PFI appears the only realistic option.

Education Secretary Michael Gove faces a capital budget cut of 60% over the next five years. A plan to design a new private finance system to support his free schools agenda has come to nothing, so public capital will be required. This has left precious little in the kitty to deliver a much-needed increase in the physical capacity of conventional state schools.

Given that the Conservatives have been strong critics of the PFI since about 2005 (when they realised it was closely associated with Gordon Brown), ministers have to show they will ‘do it differently’. A Treasury press release in July said savings of £1.5bn are possible if authorities implement new guidance on making changes to existing contracts.

This is a welcome step, but oversold. First, this figure has to be set against the total outstanding PFI bill, which stands at £239bn and will grow as new contracts are signed. Second, the word ‘savings’ is dubious. As most of these cost reductions will be secured by shaving the quantity or quality of the services provided under the contracts, ‘cuts’ looks more appropriate.

Despite mounting scepticism in Parliament about the way the PFI has been used, the incentives to use it remain strong. Britain needs higher growth, and austerity in public spending – particularly capital spending – reduces demand in the economy. The PFI enables the government to purchase capital goods and expand demand now, while paying for them later and in such a way that the main fiscal figures are unaffected.

As the government drafts its second growth plan, the PFI appears irresistible. It is telling that a former head of PFI policy at the Treasury, the banker Geoffrey Spence, is to head Infrastructure UK. This body will play a leading role in designing the infrastructure investment elements of the growth plan. Recent months have shown that Parliament can hold the powerful to account when it really wants to.

MPs don’t like the PFI, but facing down the Treasury’s new-found enthusiasm for it will not be easy.

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