Amidst all the talk about infrastructure 'guarantees', a new method of state underwriting for PFI projects has been largely ignored. It's a move that brings considerable risks
Yesterday, we learned that the government is to underwrite £40bn of infrastructure investment while providing public funds to support up to £6bn of new Private Finance Initiative (PFI) projects.
Of the two parts to the announcement, the establishment of a UK Guarantees agency within the Treasury attracted the bulk of media attention, and no wonder: the move represents a significant shift in the coalition’s economic policy.
Inevitably, discussion has focused on whether the move is consistent with the coalition’s ‘Plan A’ deficit-reduction strategy, but this only trivialises the issue.
The more important point is that the government’s intellectual framework has shifted. The notion that fiscal contraction can be expansionary is, it seems, dead and buried.
This idea – always implausible with markets in a state of fear and retrenchment – has fallen so foul of the empirical evidence that even the mandarins of Great George Street have had to accept this.
That state intervention is once again recognised as a necessary condition of economic growth is broadly welcome.
The use of guarantees as the means of intervention is probably less so – and the Office of Budget Responsibility (OBR) will want to keep an eye on the contingent liabilities the government is about to place on taxpayers’ shoulders.
Though the media ignored it, the proposal to use public funds to allow dozens of PFI contracts currently in procurement to be signed also represents a significant policy change.
The move will enable some large construction projects – for new schools, hospitals and waste facilities, primarily – to get underway quickly despite the unwillingness of banks to lend into projects for the long term.
There are a number of points of interest here. First, this effectively turns a privately financed programme of social infrastructure delivery into a largely publicly financed one, with the Treasury making clear it is ready to provide virtually all the cash needed to get £6bn worth of projects off the ground over the next 12 months.
The second is that the funds are to be provided at market interest rates – in other words, the rates set by a market that, as the government has acknowledged, is starved of capital and liquidity and in the midst of something approaching a nervous breakdown.
Presumably, this is so that the government can exit these investments when the current market turmoil eases and there are banks – or perhaps other financial institutions, such as pension funds and insurance companies – that will buy up the debt.
But these high rates will to a large extent determine the annual fees paid by individual public authorities, which raises questions about value for money and affordability – especially in the wake of ongoing solvency issues among NHS trusts with large PFI projects in operation.
The third is that the funds are to come from existing departmental capital budgets. This implies a transfer of resources from conventional projects to PFI schemes and also implies that the net effect of this move on demand in the economy will be zero.
Given that the collapse in public investment has been disproportionately responsible for the current recession, according to the Office for National Statistics, this undermines – indeed, perhaps eliminates – the growth-enhancing potential of the move.
Finally – and much less importantly – there is a political point to be made.
The coalition is not the first government to use public funds to support PFI projects. Labour also did this in 2009, when it set up something called the Treasury Infrastructure Financing Unit to lend into projects that were struggling to get hold of bank loans.
At the time, Philip Hammond (then, shadow chief secretary to the Treasury) described the move as ‘a good deal for PFI bankers’ but ‘a bad deal for taxpayers’.
It led Osborne to promise that PFI would be abolished under the Tories. This is a U-turn even the chancellor’s aides will struggle to blame on the LibDems.
