Last week the House of Commons Treasury Committee published its report on the Private Finance Initiative (PFI). The report is critical of PFI in many respects and calls for urgent reforms.
The ups and downs of PFI
The report does not purport to be a comprehensive study of PFI – instead, it draws together existing research and evidence. Crucially, it is intended to be relevant for early changes in policy.
At present, PFI officially remains a viable means of delivering investment in infrastructure for the current coalition government (which may be a surprise to many).
Although there are definite theoretical benefits of PFI, the unique disadvantage of PFI is described in the report as follows:
"The use of PFI has the effect of increasing the costs of finance for public investments relative to what would be available to the government if it borrowed on its own account."
In other words, the case for PFI rests on its ability to allocate risks more effectively and to ensure that the public sector gains from the resulting savings. The report concludes that, unfortunately, this has not always been borne out in practice.
The report highlights one of the key flaws of PFI, which is not so much a flaw in the model itself but rather in the justification for its continued use – the existence of incentives to use PFI which are completely unrelated to value for money.
There is a two-pronged criticism. Firstly, PFI debt does not appear in government debt or deficit figures, providing a strong reason for the public sector to proceed with PFI rather than conventional procurement routes. Secondly, government can use PFI to leverage up their budgets without using their allotted capital budget, ensuring that capital investment can be accessed without unduly affecting budgets.
The report recommends that these accounting and budgetary incentives be removed and stricter rules and guidelines introduced. The figures are startling – according to the report, debt would increase by £35bn, i.e. 2.5 per cent of GDP (although this is somewhat dwarfed by the £1 trillion pension liability). Nevertheless, this would provide much needed transparency over the true cost of PFI, as well as removing artificial incentives for turning to PFI.
Value for money
Treasury has consistently said that PFI should only be used if it is the best value for money route. The report considers various factors and concludes that the price of finance is significantly higher with a PFI with no clear evidence of savings and benefits in other areas to offset this.
Value for money factors considered by the report and its conclusions - click here to see table.
The most interesting aspect of the report is its recommendations for future infrastructure investment – and perhaps more so, what is not said:
The report concludes that:
- There are serious doubts about the widespread use of PFI;
- More robust criteria are required for the use of PFI – the Treasury should seek to ensure that all assumptions that future PFI are based on objective and high quality evidence;
- There is recognition that this may over time sharply reduce the aggregate value of remaining PFI projects;
- The Treasury should consider using more direct government borrowing to replace PFI – there may also be merit in making more use of the design and build model.
In terms of current contracts, it is suggested that the most straightforward solution is for the Government to buy up the debt once the construction period is completed. Public finances would not be any less sustainable because it will be more affordable to service the visible government debt rather than the hidden PFI debt. This would not necessarily mean a higher financial liability for the Government but rather a more transparent debt.
There is also a call for an appraisal of data to ensure that the public sector gets a good second price on deals currently being negotiated. Quite how this will be achieved without significant delay is unclear.
The much heard plea to improve procurement and project management skills in the public sector is of course mentioned. Although there is a recognition that PFI has perhaps exacerbated this skill deficit (by focusing attention on unique PFI issues), no real solution as to how this should be tackled is given.
Only towards the end of the report does some new thinking start to become apparent. The report considers (but does not particularly advocate) the need for a national balance sheet and an infrastructure fund or bank.
More interestingly, the report recommends that the Treasury consults on the possibility of using other financing models, including the regulatory asset base and local asset-backed vehicles, as alternatives or replacements to PFI.
A regulatory asset base is where an asset earns a regulated return for the investor through the public sector (perhaps through an infrastructure bank) buying completed projects and putting a regulatory asset base wrap around them. Local asset-backed vehicles, a model increasingly seen in local government regeneration schemes, allow the public sector to use their assets to attract investment. Neither is explored in detail but at least there is recognition of a need to look at alternative models. The only other solution mentioned (used of fixed-price design and build contracts) is uninspiring.
The report signals a step towards the post-PFI world, a world in which PFI may survive but is unlikely to be dominant.