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The Private Finance Initiative: Let the future pay

The Private Finance Initiative is a large example of government attempting to improve the social infrastructure now and pay for it later, a lot later, so far in the future in fact, that the debt doesn't appear on the books and we can only guess how much the next generations will have to pay.

Summary

PFI is not about 'rolling back the State' rather it's about reconfiguring the relationship between the public and private sectors. One consequence of the proliferation of PFI projects has been to blur the distinction between public and private and, indeed, has been to erode the certainties surrounding public provision of goods and services. The old notion that the State provides the services that the private sector is unwilling to is shot.... for a fee, the private sector will provide. However, and here's the punch line, it's still the State that's providing.

Introduction

The PFI is one of a range of government policies designed to increase private sector involvement in the provision of public services. And your starter for ten, name another one? The fact is that 'the PFI' is the range, lots of companies, lots of projects, lots of sticky fingers in the money jar but there is no 'range of policies'.

When the wizards of Whitehall dreamt up the PPP, that is, the Public Private Partnership idea, (yes, let's call it an idea), perhaps they thought that it would breed all manner of innovative ways of paying for things that the State couldn't afford.

Well, all it ever begat was 'the PFI' - count your blessings it was an only child.

This will commonly involve the private sector supplying a new major capital asset, such as a hospital or a school, on a design, build, finance and operate basis.

What is the PFI ?

It's just like taking out an overly expensive interest only mortgage. PFI is about smoke and mirrors, slight of hand, all manner of conjuring tricks - especially the one where the rabbit goes missing before the conjur0r can pull it out of the top hat.

The 'missing rabbit' here is the title deeds to the asset at the end of the lease. Under some PFI contracts the asset, i.e. a hospital or school becomes the property of a contracting consortium. So the State pays a rental on the asset for 25 - 40 years and then ends up with nothing to show for it.

However, it's not only the title deeds that go missing, so do the accounts of the Nation's long-term indebtedness to hundreds of private consortia that the Government has done deals with. Someone described the process as akin to Enron-style off-balance sheet accounting. The use of PFI schemes therefore give the appearance that Government Departments are keeping within annual spending limits.

Today’s capital investment thus becomes tomorrow’s current spending.

Public Private Partnerships

The term PPP is confusing and unhelpful. Nearly all commentators mention PPP/PFI and then go on to discuss PFI without clarifing what they mean by PPP or to provide any examples.

Clearly, or perhaps not so clearly, these commentators, reporters and the like, are assuming that their readers know what the distinction between PPP and PFI is. Alternatively, these commentators may not actually be very clear themselves what the distinction is?

PPP must exist because it has a PPP Policy Team which sits within Infrastructure UK, which sits within HM Treasury.

(Maybe it's a bit like the Ministry of Silly Walks, doesn't exist but people still have silly walks, which must be noted.)

These agencies provide the wrapping for the PPP idea, for the very flaky rationale that the private sector can deliver public services best, i.e. better quality, value for money and greater efficiency. 

Infrastructure UK (IUK) advises government on the long-term infrastructure needs of the UK and provides commercial expertise to support major projects and programmes.

Really, was it they who advised on the PFI scheme currently holding up traffic on the M25 for the next several years. Good deal, struck at the hight of the credit crisis - paying well over the odds for the funds, tut, tut.

Flavours of PFI

HM Treasury (1993) distinguished three types of PFI project:
Financially free-standing projects where the outlay can be recouped through user charges such as the Skye Bridge.
Joint ventures where the public sector provides the PFI contractor with a subsidy to reflect the social benefits of a project not reflected in cash flow, such as the Docklands Light Railway extension to Lewisham, the Manchester Metrolink and the Channel Tunnel Rail Link.
Services sold to the public sector such as those provided by Bridgend Prison, Design, Build, Finance and Operate (DBFO) road schemes and new trains for London Underground’s Northern Line.

The last of these is the one that most people think of when the PFI is discussed.

Political Ideology

Our leaders are interested in PFI for political reasons. Political elites no longer have much faith in the ability of the state machinery to deliver. This tends to generate a self-fulfilling dynamic of poor quality and inefficient operations - but it also prompts the elite to search for solutions outside of the state, in the private sector. Turning to the market is often seen as a way of addressing the problem of political legitimacy. Rubbish health service? Bring in the private sector. Falling educational standards? Bring in the private sector.

In addition to this, PFI fulfils a traditional role for the state by giving support to the private sector.

PFI follows in the post-Keynesian tradition of appearing to limit the economic role of the state, while business dependency on the state increases. (more smoke and mirrors?)

Throughout the 250 years of capitalism, private capital has needed the support of state intervention. Usually, this has involved the state creating institutions or performing the social functions necessary to maintain capitalist relations. The state has also passed laws that are inimical to the short-term interests of particular capitalists, but necessary in the longer-term interests of capitalism itself - for example, health and safety legislation.

History

Norman Lamont 1992

"I also want to ensure that sensible investment decisions are taken whenever the opportunity arises." And what's the interest rate today Mr Lamont?

The Private Finance Initiative (PFI) was announced in the Tory 1992 Autumn Statement and continues to this day. However, nothing much happened until 1997.

In 1993 Tory MP David Willetts wrote a pamphlet called The Opportunities for Private Funding in the NHS, which proposed using Private Finance Initiatives (PFIs) and other commercial mechanisms to provide health services in the UK. Conservative ministers thought Willetts’s proposals too radical. They were consigned to the shelf until 1997, when the New Labour Government put them into action.

As an interesting aside, the reader may care to ponder that Willetts's pamphlet was paid for by BUPA.

Willetts's Tory chums may not have liked the idea but they got busy changing the Treasury rules, that previously had kept private money out of public projects, laying the groundwork for what was to come. By 1998 all the paving legislation was in place.

PFI projects signed to date have committed the Government to a stream of revenue payments to private sector contractors between 2000/01 and 2025/26 of almost £100 billion. As at 1 September 2001 there had been almost 450 PFI deals signed with a total capital value of £20 billion.

Hospitals - first among many...

Cumberland Infirmary in Carlisle, the first hospital completed under the (PFI) system. Opened in June 2000 by Tony Blair and hailed as a flagship, the £87 million Infirmary has 442 beds and acres of glass, all paid for privately and leased back to the NHS for 45 years.

Over a hundred PFI hospitals have been built over the last ten years.

Conflict of Interest

The ethos and aims of a school or hospital, in terms of their core functions, educating and healing are not those of the PFI managing agents. The BMA and teaching unions have been vocal in their criticism of PFI schemes.

And elsewhere, where consideration of the public interest should weigh heavily in the operation but instead the aims of the private sector operator predominate - sluggish delivery of services, e.g. six weeks to hang a notice board at Norfolk Hospital.

NHS Trusts will be expected to make cuts but they will not be able to cut payments to their PFI partners. Investors and contractors will naturally seek to maximise their profit margins, at the expense of the Trusts.

Criticism of the Scheme

Critics were quick to suggest that PFI funding for the NHS was not just bad news financially – because the Government was forced to pay higher interest rates to PFI consortiums than it would have paid to borrow on the open market – but that it was causing financial shortages for cash-strapped primary care trusts (PCTs), that clinical care was being compromised because funding considerations were driving medical conditions, that future generations were being thrown into hock, and that the NHS was being forced to sell off its land to pay for the new builds. And, perhaps most trenchantly, that the whole thing was a con: that private money had been chosen, despite the cost to the country, simply because it could be hidden in the Government’s books, concealing the fact that national borrowing had increased massively, and perhaps unsustainably.

Straitjacket of provision

“The next 30 years are going to show a revolution in health care – yet we will be committed to services designed in the Nineties and early Noughties."

The New Labour View

"PFI or Bust - Plan B, what plan B, there was only ever going to be PFI to replace Britain's Victorian hospitals."

Standard & Poor’s

Risk at the start of a PFI project BBB and at the service delivery phase, AAA.

The money grubber's code

AAA - highest quality
AA - high quality / very strong
A - upper medium grade / strong
BBB - medium grade
BB - somewhat speculative
B - speculative
CCC - highly speculative
CC - most speculative
C - imminent default
D - default (Greece)

 

Risk and Borrowing Costs

The Treasury argument in flavour of PFI schemes is that the private contractor bears the risk of financing the project but where substantial public assets are at risk it will always remain the case that the State or local authority will be the guarantor of the last resort. Ask Transport for London or reflect on the National Insurance Recording System, National Air Traffic Service, the Passport Agency and Royal Armouries - all cases where, despite the contract terms, State bail outs were called for.

In practice, the main risks for PFI contrators are at the beginning of projects, at the build stage, the risk reduces substantially throughout the managing phase. This reducing risk factor actually allows companies with a high profile in the PFI market, i.e. with lots of different contracts, to gain access to cheaper credit because of the stability of future earnings.

Further, there is evidence that companies engaged in major PFI infrastructure projects factor in an additional margin for cost over-runs. For non-PFI schemes 7% would be the norm but some reason the norm for PFI schemes is 12%.

Most importantly, the high risk factor at the start of projects explains why borrowing is more expensive for the private sector with a mediocre medium rating as opposed to the State with its AAA rating.

Wait, there's more..... Sharing the benefits of refinancing.

Now, the sharp witted financial types among our readers will have noticed by now that the coincidence of declining risk and rising credit rating presents an opportunity to do some refinancing.

The Public Accounts Committee issued a strongly critical report on the refinancing of the Fazakerley prison PFI contract, which enabled contractors Group 4/Carillion to obtain a windfall profit of £10.7m. The Prison Service very unwisely accepted a reverse risk transfer, in
return for a rebate of just £1m. In some instances, PFI contract refinancing increased contractors’ profits by as much as 80%.

Serco, operating the Norfolk and Norwich Hospital made itself a tidy £4.5 million from refinancing, meanwhile the Health Trust is squarely in the red.

Unsurprisingly the PFI rules do not stipulate that contractors have to share refinancing windfalls with their public partners. Strangely, the Treasury did note the oportunity for profits to be made by contrators through refinancing and thought it might be nice if these might be shared equitably.

New deals now do stipulate that the public sector should gain from refinancing but this varies from 70/30 to 50/50, in favour of the contrator.

Special purpose vehicles - SPVs

Special purpose vehicles (SPV) are companies created for a particular purpose and often have no assets. For PFI contracts, these SPVs are created to bid for the contracts and they are legally the contractor that the public body deals with. The shareholders in the SPV are the construction and service contractors, plus, perhaps, the project investors.

SPVs really are 'special purpose' since they allow companies not to show their own financial involvement on their own balance sheets and to walk away when things go wrong.

At the Norfolk and Norwich for instance, Octagon Healthcare is running the show but is owned by Barclays UK Infrastructure Fund, 3i Group, Innisfree PFI Fund, John Laing Investments, and Serco Investments - none of these is a majority share holder and we all know why that is, don't we.

Secondary Markets and Disposals...

Over the past ten years the private sector has been playing pass the parcel with PFI assets, who owns what and for how long is simply unknown - except by a very special few. When PFI contracts are handed out citizens might be forgiven for hoping that a part of the selection process will include the contractor's expertise in the provision of a particular service. However, that can't be guarenteed in the PFI market where the initial contractor is not tied to or obligated in any sense to continue with a project to the end of its term.

What a Waste... Value for Money?

The Treasury has come up with a remarkable new definition of value for money. Since the credit crunch, the cost of private finance for public infrastructure has become even more expensive; but rather than reviewing PFI projects the Treasury has judged them value for money in the context of stimulating the economy.

Government is pushing ahead with a massive increase in these projects, particularly for waste, and has allocated £2bn to seed dozens of (mostly) giant waste incinerators. The National Audit Office reported in July that the costs of the Greater Manchester Waste PFI will increase by 12 per cent per year under the new regime. These extra costs will be met by local taxpayers and will be classed as "off balance-sheet" debt. In a separate report to a House of Lords inquiry last March, the NAO warned that rigid long-term PFI contracts "could have an adverse impact on the budgets available to public authorities for other, non-PFI, expenditure", and that "essential public services in future years [must not be] unduly constrained or jeopardised by such commitments".

The Unions' Position

The main concerns can be summarized as follows; it's not private money that is provided for public services that's the problem but the conditions applied to such investment and the consequences of such investment in
relation to the quality of public service provision, the employment conditions of the workforce and the preservation of the public service ethos. (see side note)

PFI Duds

Metronet

The most spectacular private finance initiative failure was the collapse of Metronet in 2007. The deal between Metronet, Tube Lines and Transport for London (TfL) was put together in 2003 to upgrade London's creaking Underground network. Within five years, the Metronet consortium collapsed, costing taxpayers £2bn as its functions were taken over by TfL. Earlier this year Tube Lines was also bought out by TfL.

HM Revenue & Customs estate

The PAC concluded in April that the PFI deal covering ownership and management of 60 per cent of the HMRC's estate is also failing to deliver value for money. The 20-year deal signed by Mapeley Steps Contractor in 2001 has cost the taxpayer 20 per cent more than expected so far, the PAC said. (PCA = Public Accounts Committee)

NHS

Latest estimates suggest that the NHS faces a £65bn bill for 103 new PFI hospitals with an estimated value of £11.3bn at the time they were built. The Government says the schemes provide value for money. But some trusts are now handing over more than 10 per cent of their annual turnover.

Housing

More than four-fifths of local authorities' 25 PFI housing projects are over budget, the National Audit Office said in June. Nearly half are running at more than twice the anticipated cost. And the average delay is two-and-a-half years.

Airtanker Ltd

The Ministry of Defence's biggest ever private finance initiative (PFI) is "inappropriate" and not proving value for taxpayers' money, according MPs on the Public Accounts Committee (PAC).

The £10.5bn, 27-year Future Strategic Tanker Aircraft (FSTA) programme – which is to supply air-to-air refuelling and passenger transport planes – is just the latest of a string of PFI deals to attract criticism.

The most serious charge levelled by the PAC, chaired by Labour's Margaret Hodge, is that the MoD should have grasped that a PFI may be suitable for projects with a clear specification – such as building a school or a hospital – but it does not work well with less predictable plans likely to be changed along the way. "Using PFI to procure the FTSA project was inappropriate and has not secured value for money," Ms Hodge said.

Under the deal for 14 modified Airbus A330s, AirTanker Ltd, a consortium of Babcock, Cobham, Rolls-Royce, Thales and EADS, continues to own the aircraft but is contracted to provide to the military when required. The group is also contracted to service and maintain them.

There were signs of trouble with the PFI structure from the beginning. Although the MoD started the procurement in 1999, the deal negotiations took twice as long as anticipated and the contract was not signed until March 2008. Delivery is also running behind schedule – when the first of the planes is delivered next year it will be five and a half years late. Even then they may not be equipped to fly into danger zones such as Afghanistan.

Even before the final FSTA deal was agreed, the contract was proving too inflexible. It is "simply astonishing" that the MoD did not decide until 2006 that the new aircraft should be able to fly into high-threat environments such as Afghanistan, says the PAC. Four years later the decision to fit the necessary protective equipment to the aircraft has still not be taken, because of the cost implication for the MoD of changing the original contract specification. If the decision to armour the 14 planes is taken, it could add hundreds of millions of pounds to the bill, and delay the scheme still further. In the meantime, the military is relying on old Tristars and VC10s, some of them dating back to the 1960s.

Trident Replacement

And the contract goes to Ahmadinejad & Partners, who will own the sub's and let us have 'em "as required" to launch against middle-eastern lunatics.

Conclusion

If PFI shows anything it shows the vacuity of late capitalism at work. Keynes suggested State financed job creation schemes to keep the show on the road. PFI is just a variation of Keynes's idea of burying bottles filled with money and paying workers to dig them up again.

Without the PFI schemes many of the new hospitals, schools and other infrastructure put in place over the last ten years wouldn't exist. There is an argument that what has ever been done under PFI could have been done without it. All we can say is perhaps since no alternative was put forward and would the electorate have stood for the obvious associated debt rather than one held in store for future generations.

Clearly, PFI is a dogs dinner and the City spivs are busy enjoying the feast but there are signs that the 'piss up' will come to an end. PFI schemes are coming under increasing scrutiny and as the regulatory arrangements are reshaped the wide boys and spivs will seek to turn a penny elsewhere.

 


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