The term Public Private Partnership refers to collaborations between the public and private sectors in the delivery of public projects or services. The Private Finance Initiative (or PFI) is a form of Public Private Partnership.

PFI projects involve long-term contracts and are generally used by local authorities, public bodies and central government to procure the construction or refurbishment of an infrastructure asset (e.g. schools, hospitals, prisons, roads etc) by a private sector contractor or consortium of private sector contractors. The contractor/consortium is then also responsible for operating and maintaining the asset for the duration of the contract (typically between 15 and 30 years). This creates an incentive to use quality materials and workmanship from the outset and to seek out efficiency savings.

The consortium is both incentivised and penalised by a mechanism that involves a series of targets and performance indicators. Instead of the public sector bearing the financial burden of the entire asset up front, the consortium is responsible for the construction/refurbishment of the asset and once it is available for use, the public sector spreads the cost of construction and maintenance/operation over the lifetime of the contract by making regular payments.

The current Scottish Government is opposed to PFI as a method of funding public projects on the basis that it commits the public sector to long-term payments, which usually contain an element of profit for the consortium involved. However, since extracting a public body from a PFI contract can be as costly as allowing it to continue for the 25 or 30 year period originally envisaged, it is unlikely that many existing contracts will be terminated.

While there is little that can be done about the financial obligations under existing PFI contracts, the current administration is committed to not increasing that debt. In fact a proposed PFI scheme for a new prison has already been abandoned. The prison will instead be procured and run by the public sector.

As part of their election manifesto, the current Scottish Government proposed the "Scottish Futures Trust" as an alternative procurement/funding method and they plan to make a further announcement once they are ready to explain the proposal in more detail. Current understanding is that this new model would be designed to encourage greater use of public bonds to achieve lower cost borrowing and the retention of public assets in trust for the Scottish people. This "not-for-profit" vehicle is aimed at reducing the high levels of public debt associated with PFI and the level of profit that the private sector has been able to achieve on some PFI deals in the past.

Detailed information has not yet been provided on how the proposed trust would be implemented. In the August 2006 Scottish Nationalist Party (SNP) paper on Scottish Futures Trust, they refer to similar trusts in the United States where investors can invest in public infrastructure project bonds. However, in the United States such bonds are exempt from income tax and are therefore attractive to investors. This may be difficult to achieve in Scotland in view of the limitations on the powers devolved to the Scottish Parliament under the Scotland Act 1998 and the political issues that would arise were a tax advantage created in Scotland but not across the rest of the UK.

In fact, "Not-for-Profit" education projects, which use PFI contractual structures, have already been implemented in Scotland and the Scottish Government may look to these projects to assist them in working up their proposals for the Scottish Futures Trust. These schemes retain private sector involvement and the associated benefits of the "asset" not being paid for until delivery and the knowledge that a maintenance regime will be in place. However, any surplus profit on the projects is paid into an educational trust for the benefit of the local authority area rather than distributed to the project company and investors.

The concept of reduced borrowing and idea that public institutions could be held in trust for the Scottish people may be appealing but this needs to be weighed against one of the main benefits of PFI – risk transfer. In PFI projects, the party best placed to manage a particular risk assumes responsibility for it. This means that at least part of the risk in a particular project is transferred away from the public sector, albeit at a premium. The reality of a public funded project is that the public will be responsible for the maintenance of the asset irrespective of whether they are in a position to manage that risk.

Irrespective of the procurement method used, there will always be a need for new schools and hospitals and it will be interesting to see how the Scottish Government develop their proposals in this area.