Time to ensure PFI deals come in on time and on budget

It was the last Conservative government that started private finance initiatives (PFI) in 1992, and persevered to get them going. Over the last decade, a number of issues and problems have emerged, which need to be resolved.

Following privatisation, PFI is a fundamental agent to changing and improving the delivery of public services and is a key catalyst to the much-needed reform of public sector culture. Hopefully, as PFI subcontracting is implemented across a wider spread of projects, there will be an increasing culture transfer across the whole of the public sector.

There is growing public recognition of the difficulties and inability of the long-established British public sector structure to deliver, even when huge additional resources are committed.

During the past 50 years, more than 70% of public sector projects in the UK were neither delivered on time nor on budget. Currently, the Scottish parliament building project represents a telling example of what can go wrong with capital projects managed within the public sector. Under PFI, 76% of projects have been delivered on time and 78% within budget.

As the Office of National Statistics data reveals, since 1997, while both the tax take and total government expenditure have risen by 50%, only 18% of this has gone to increasing real delivery. A massive 82% has been absorbed by rising public sector costs; public sector inflation has increased from 1.6% in 1997 to 6.5% this year.

It is also a widely recognised problem that much of the data available within the public sector does not relate to how to improve the delivery and quality of services. But it actually supports the continuation of overweight super-structures and buries mistakes to protect civil servants from the increasing blame culture.

Even the recent, avuncular Ecofin economic advice to the UK government stresses the point that extra public spending is not being matched by extra delivery.

Inevitably, over a decade of experience with PFI subcontracting, a number of problems and criticisms have arisen across the political spectrum.

If these are not addressed, there is the danger that the whole PFI concept will become tarnished and the main advantages it brings, undermined.

The first issue is the decision in principle as to when to opt for PFI subcontracting. It should not be a compromise decision, driven by political considerations, where full privatisation may be the better solution.

There is also no doubt that the Labour government has been motivated in using PFI by wanting to structure as much as possible off the public sector balance sheet – to accommodate both the European Union rules on government debt and chancellor Gordon Brown’s own borrowing framework.

Evaluated on the basis of what it would cost to unwind PFI and other public private partnership (PPP) deals, the extent of government off-balance sheet financing now exceeds £100bn. This has resulted in PFI being used where it might better not have been used, and being forced on public sector entities. This particularly applies to local government, for whom the only way to realise a project has been to sign up to a PFI deal.

As Jeremy Coleman of the National Audit Office comments: ‘PFI is often the only show in town.’ The essential questions are whether PFI is appropriate for particular projects and territories; whether there is a good PFI track record in a particular area; whether there is sufficient competition for particular PFI contracts and whether PFI is logical to the circumstances.

Part of the reason for PFI presenting off-balance sheet financing attractions to Gordon Brown has been the complexity and loopholes in the accounting rules delineating ‘off’ versus ‘on’ balance sheet accounting (the Ryrie Rules). These are now being reformed, which will lead to much more PFI having to be on balance sheet.

Unfortunately, deliberate semantic confusion has also arisen, as the result of the government using the terms PFI and PPP on an interchangeable basis. Indeed, Labour uses the term PPP to cover all areas of third-party involvement with the public services, including privatisation. There is a clear distinction between PFI and public private partnership (PPP) deals.

PFI deals are typically focused on a particular project or service task; are standalone, and are structured to transfer operating risk. PPP deals are far broader, public private partnerships, embracing territories typically requiring government guarantee or letter of comfort support.

London Underground is the main PPP case study, illustrating the difference between PFI and PPP, and the problems with PPP structures. The government support required for PPP deals, via guarantees or letters of credit, inherently undermines the transfer of operating risk.

Also, PPP schemes are typically large and complex, making their overall management and monitoring much more difficult than a focused PFI subcontract.

Network Rail has become a legend of what not to do. It is not a PFI nor strictly speaking a PPP, but a backdoor renationalisation, structured to keep the government’s financial commitment off the public balance sheet under the Eurostat rules.

It is also observable from experience over the past decade that there are some territories better suited to PFI than others.

A major conceptual problem has emerged as to the proper basis for justifying a particular project as between PFI and the public sector route. There has been inevitable pressure for a standard model of financial justification, although what really matters is delivery.

It has become self-evident that public sector comparator exercises are, too often, little more than a post facto justification of the decision to go the PFI route – particularly where it is often ‘the only show in town’.

The Institute for Public Policy Research has also argued that only 6% of PFI projects completed for central and local government have been subject to any proper value for money evaluation by the official audit board.

There is also growing criticism of the large professional fees involved in PFI contracts, where both full transparency and initiatives to streamline and constrain these are needed.

On the MoD building, the MoD fees were £11m and the PFI professional fees £107m; for the Tube, professional fees were £340m.

These appear, not just to the layman, but also to politicians, as extraordinarily large sums for what is not the tangible part of these projects. Quite rightly, the industry is pressing the government to streamline and cut the costs of bidding for PFI projects.

If there is adequate competition, however, the financing costs should be competitive; but again this is an area that needs better accountability.

There have also been criticisms that PFI risk transfer is more theoretical than reality in practice.

As many have pointed out, rather than not delivering if things go wrong, there are inevitable pressures for the public sector to pick up the project and shoulder the costs.

The Royal Armoury Museum in Leeds was one of the main cases cited by the Commons Public Accounts Committee.

The main response to these points is that those bodies in the public sector responsible for PFI deals need to be more robust in their dealings with PFI contractors and make more use of the practical process of administration when things go wrong.

Overall, PFI has been a success, and a major catalyst to improving public sector delivery. It is unfortunate that a major and self-evident motivation of the Labour government for extending PFI projects, perhaps too speedily, has been the sleight of hand of off-balance sheet financing, rather than using PFI where it is demonstrably, from comparable experiences, the best solution.

There is a need for a lot more transparency and public accountability in relation to PFI projects. The accounting rules that determine whether PFI projects are on or off government balance sheet also need simplification.

There is a pressing need for a more honest and meaningful basis of how decisions are taken to opt for the PFI route, where the public sector comparator is widely discredited. Professional and legal costs of PFI projects have cost much more than they should have, and greater competition would serve to reduce financing costs.

Concern must remain, however, that PPP deals cannot meet sufficiently the transfer of risk principle, and can too easily become so convoluted as to damage their ability to deliver.

That said, there is a need for, and there are benefits in, a strong PFI subcontracting and financing industry, which, as with privatisation expertise can also become a significant generator of international service income for the UK, as well as being a crucial element in improving the delivery of public services.