PFI Blues

Health Secretary Andrew Lansley’s somewhat opportunistic outburst about PFI debts in the NHS yesterday brought the whole issue of PFIs back onto the agenda. (I was on BBC Radio 4’s PM program yesterday talking about it). The debate about PFIs usually generates more heat than light, as protagonists and antagonists slug it out. In reality PFI are neither wholly good nor bad, but have often been badly implemented.

PFIs were created to address a very big and real problem. The most vulnerable bit of public spending is nearly always capital spending – on building or repairing public infrastructure like schools and hospitals. Why? Because when governments are looking for urgent savings slashing building and repair budgets seems like an easy option – the impacts are long term and slow, so they usually provoke far less opposition

During the 1960s and 70s British net public investment ran at an average of about 5.3% of GDP. After 1979 this slumped to just 1.4% over the lifetime of the Thatcher-Major governments, falling to only 0.7% in the last year of the Tory regime.

This chronic under-investment over a long period led to a situation it is easy to forget now – Britain’s public infrastructure was falling down. Kids being taught in leaky classrooms was hardly worth a news headline it was so common – hospitals that were falling apart likewise. By the end of the Tory era even they recognised this could not go on and came up with the idea of PFIs as a way of plugging at least some of the yawning gap in public investment.

New Labour came to power committed initially to holding down public spending. In the first four years net public investment ran at 0.6, 0.7, 0.6 and then an amazing 0.5% of GDP in 2000-01, the lowest in nearly four decades. Although this later crept up to 2.2% in 2009-10, it was still only averaging 1.4% – exactly the same as the Tories – over the lifetime of the government.

Gordon Brown seized on PFI as a way of plugging the gap. It seemed to have many advantages: capital would be raised by the contractors, not the government, and would therefore be ‘off balance-sheet; projects would get done for which government funding simply couldn’t be provided; risk would be transferred to private corporations who agreed to deliver for an agreed price; private sector management would mean a more rigorous approach to projects than Whitehall usually managed; and so on.

But there were downsides and implementation problems. The most obvious downside is that PFI contracts usually cost more, in the long run, than public sector borrowing from the bond markets because governments usually get cheaper money than corporates do. It was hoped that the private companies would off-set that through better management and efficiencies – but that has clearly not always happened. Some PFIs have ended up costing a lot more if government had borrowed the money themselves.

Risk transfer has also turned out to be often illusory. To take an obvious example – the famous new GCHQ building in Cheltenham, purpose built for them and a fabulous development (I know, I’ve in it). Does anyone seriously think that the consortium who built and run it would be allowed to simply go bust and the building be put in the hands of receivers? The same is true of many buildings, like hospitals and schools.

Why did so many PFI contracts end up being much poorer value for money than originally thought? Mainly because of lack of competence in Whitehall. Back in the early Noughties hardly any Whitehall departments had professionally qualified financial managers running their finance departments – the norm was the “gifted amateur” generalist Mandarin with a PPE from Oxbridge. It largely still is, although things have improved a bit. The big contractors they were signing up for PFIs usually ran rings round them.

This was even more the case because Whitehall was desperate to get PFIs rolling. As I pointed out in 2001 to both the Treasury Select Committee in evidence and to the BBC, the government was £10bn underspent at that point, with capital projects especially falling behind.

The combination of less than well-equipped Mandarins and a rush to get PFIs going was a recipe for disaster, as I pointed out at the time. And so it has come to pass – a decade later we are living with the consequences of many ill-judged PFIs conceived in the heat of the early 2000s rush to spend.

The longevity of these PFI deals has proved a double-edged sword in some respects. The downside is obvious – we are tied to buildings we might not need in 30 or more years time. In the NHS we have built lots of large hospitals, just as everyone agrees we need to shift a lot of treatment out of hospitals. Part of the problem for those NHS Trusts running into financial difficulties is under-utilisation of buildings that still have to pay for, and although this effects both non-PFI and PFI buildings its clearly worse where there is a difficult to alter contract.

Ironically though this longevity has had one positive effect, and not just for the public sector. I was talking to some senior executives from construction companies a while back who explained to me that PFIs had made them think more long-term about building construction. Thet were now building for a “life-cycle” because they would have to maintain it for 30 years too. And they’d transferred these life-cycle design ideas to their private sector projects too. So it’s an ill wind…..

And as for Mr Lansley – if he doesn’t sign off new PFIs, or something remarkably similar, over the next couple of years it will only be for one reason – he’s not Secretary of State for Health anymore.


3 thoughts on “PFI Blues

  1. An interesting piece by Colin on an approach to capital asset procurement rather too often condemned [ by some academics as well as axe grinding ministers ] without consideration of the different modes of ‘PFI’ that were put in place over a decade and a half . It’s a little like condemning domestic mortgages in their entirety rather than being wary of some forms of mortgage for some people.
    I see 2 key issues here:
    The asymmetrical skills set as between ‘governments ‘ and developers /contractors that led to some of the more egregious PFI projects can also be seen at the root of problems in projects such as our trams development here in Edinburgh . On one side we have a group of officials – no matter how bright and generally capable , even with finance experts involved – who are dealing with one project [ hospital or something else ] that will be the biggest thing they have ever handled in their professional lives. On the other side we have developers /contractors/ finance backers who do this all the time in some form or another…. the result is not hard to predict.

    Another key factor seems to be the extent to which, at a conceptual level , career public officials find the ideas of tradable assets and the risk value of money hard to grasp. If I am on that development team and plan a risky project , once it is successfully up and running then I am incentivised to sell it on , for a higher sale price than it might have been worth when it was in the high risk window. The early PFI projects completely ignored the possibility of the public procuring agencies agreeing some form of success bonus so tax payers could share in the resale benefits of any PFI project .

  2. The UK is undergoing a radical reappraisal of public services. After a sustained period of increasing investment, with reforms introduced across all major service areas, there is a danger that we return to a view of the public sector as a destroyer or user of value, inherently inefficient and a burden on the productive economy. This means shifting from a model in which the quality of governance and public provision directly determines the performance of both the economy and society to a ferocious commitment to markets.

    Clarifying the precise nature of the value created by government, and how it should best be defined, managed and cultivated, is not straightforward. The short definition is that it consists of the things that the public values and for which they are willing to make sacrifices to government, whether of money (through taxation) or freedom (through giving government powers to act and regulate). The public place a high value on how fairly public services are allocated. They value the existence of some services that they themselves do not receive, they value integrity and due process, and they expect government to take some responsibility for future generations. The most important difference is that democratically elected representatives determine what is to be value rather than competitive markets.

    These points are obvious but there is a danger that they are ignored in both the theory of public service reform and its practice under the Coalition Government – public services are not indistinguishable from mass consumer services in the private sector. We need clarity about what is being done and why. In my experience a clear definition of the objectives, outputs and outcomes to be achieved through a project or programme, and the ongoing measurement of performance, is too often overlooked. The key criterion for using an institution or system should be whether it delivers better public value. So, for example, if a private company can provide better skills which overcome its higher costs of capital and the possible loss of ethos compared with a public provider, there may be a strong case for using it. If greater competition can bring additional innovations and efficiencies and not damage trust and motivations, it may be desirable. On the other hand, if a non-profit organisation can better motivate staff and engage users, and thus deliver better value, it should not be excluded. And, contrary to recent speeches by the Prime Minister, the public sector has been responsible for many of the world’s key innovations and in some areas Britain’s public services have been highly innovative in recent years

  3. PFI deals to date still remain off balance sheet for national accounts purposes, which is what Eurostats uses to measure government fiscal position. This method of procumement makes infrastructure projects more affordable from a goverment perspective. The sovereign debt crisis in Europe illustrates the fact that the accounting for transactions under national accounts are not adequate. Governments in Europe and in other parts of the world needs to give some consideration to their own guidance and rules around accounting for transactions under national accounts. We need government to be open and transparent; and also to do things properly.

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