Select Committee on Treasury Fourth Report


FOURTH REPORT

The Treasury Committee has agreed to the following Report:

THE PRIVATE FINANCE INITIATIVE

Summary of Conclusions and Recommendations

(a)When the aim was to reduce the Public Sector Borrowing Requirement—particularly when there was a large deficit—PFI was an attractive means of increasing investment. However, the new fiscal framework has made it easier to provide publicly-funded investment, because such investment has no effect on the golden rule, and could be increased significantly without exceeding the Chancellor's chosen guideline that debt should not exceed 40 per cent of GDP. In the new framework, the case for PFI as the main means of obtaining extra investment is very much weaker. The main justification should now be the prospect of obtaining better value for money (paragraph 23).
  
(b)We agree with the CBI's analysis that PFI projects would be likely to be successful where they genuinely combine capital and service requirements; where the risks are primarily commercial; where scope for innovation exists; and with skilled and committed public sector management (paragraph 26).
  
(c)We recognise that the risks which are appropriate for transfer may vary from contract to contract. In the course of approving future contracts we expect that commissioning authorities will set out clearly the risks that are being transferred, how they have been valued and justification for their transfer. When risk is transferred to the contractor, we expect to see arrangements in place to make sure that the contractor may not escape liability for that risk by returning liability to the commissioning authority or to some other public body. For example, we are particularly concerned that the private sector should not be able to minimise operational risk through reduced service specifications once the contract has begun (paragraph 30).
  
(d)The Public Sector Comparator should contain a clear statement of the risks which have been quantified and included in it; and there should be an independent element in its construction and in the evaluation process. The possibility of comparisons with other private sector projects should be pursued wherever such information is available; such comparisons will be particularly valuable when the Public Sector Comparator is unreliable because it reflects a course of action which is unlikely to take place (paragraph 38).
  
(e)We accept that there is a trade-off between competition and the length and cost of negotiations. The best way to ensure competition is for the authority to clarify as early as possible in the process the outputs which are wanted, to avoid the need for too many changes as the negotiations proceed (paragraph 41).
  
(f)We welcome the Government's new commitment that departments should evaluate PFI projects after they have been implemented. This evaluation should include both costs and service delivery, with comparisons against conventional procurement. Research in this area might also usefully be undertaken by the National Audit Office as part of their value-for-money investigations. We also strongly support the suggestion of a central system to collect information on each PFI project to enable the comparisons to be made. In order that PFI can be used in the areas where it offers the greatest gains in value for money, the research should also establish which types of projects are most suitable for PFI, and also which are the particular features that make a project suitable for PFI, such as its size, the expected life of the asset, the type of risks involved and the relationship of PFI services to non-PFI services (paragraph 47).
  
(g)We welcome the reference in Public Private Partnerships: The Government's Approach to the possibility of the public sector benefiting from innovative approaches developed in PFI deals, and expect that, as part of its work, the new Office of Government Commerce will monitor PFI projects systematically for features which can be transferred effectively to publicly-funded projects (paragraph 49).
  
(h)The promotion of PFI projects has clearly led to a considerable and welcome increase in investment in hospitals. It is important to be able to demonstrate that value for money has been achieved; in the short term it is essential to construct valid Public Sector Comparators, and these should be supplemented in the longer term by comparisons between PFI hospitals and conventionally procured hospitals. We recommend also that the National Audit Office studies and reports on the issue of whether PFI procurements have resulted in more, fewer or the same number of beds as conventional procurements (paragraph 54).
  
(i)It is right that workers who are transferred as part of a PFI contract should not lose out as a result, and we welcome the recent changes which have gone further towards ensuring this (paragraph 64).
  
(j)We recommend that the research referred to in paragraph 47 should include research on staffing trends within PFI contracts. We wish to guard against the development of two-tier employment status as between employees covered by the TUPE regulations and newly-recruited non-TUPE employees (paragraph 65).
  
(k)The Treasury's guidance emphasises that value for money, rather than accounting treatment, should be the "key determinant" of whether a PFI project should go ahead. It is essential that this should be demonstrably the case in practice. The introduction of Resource Accounting and Budgeting is intended to ensure better-informed decisions about capital and current spending, and it would be perverse if this were negated by the treatment of PFI projects. The Government should account each year for the current and capital PFI liabilities separately and ensure that its new public spending controls under Resource Accounting and Budgeting recognise that the main justification for PFI is improved value for money (paragraph 73).
  
(l)We welcome the appointment of Partnerships UK as a successor to the Taskforce. There is, however, the risk that because obtaining its advice is optional, a central store of experience will be available only to those who use it. It will be important for this store of experience to be available within the new Office of Government Commerce. We want to see established and published a proper relationship between Partnerships UK and the Office of Government Commerce with the latter having an overriding duty to promote competition. There is a danger of conflict of interest if PUK provides financial assistance in PFI projects on which it has advised; and there is also the risk that financial support for some projects and not others would discriminate unfairly. We therefore recommend that PUK should not have power to provide financial assistance to PFI projects, whether by taking equity shares or otherwise (paragraph 86).

Introduction

1. The Private Finance Initiative (PFI) was launched in 1992.[9] Its methods of operation have, however, changed significantly following reviews conducted in 1997 and 1999. As both these reviews have taken place since our last report on the subject,[10] we decided that it was time for this Committee to look at the operation of the scheme, the latest proposals for reform, and the effects on the public finances as well as the effect on quality of projects of this particular method of procurement. PFI projects fall within the definition of Public-Private Partnerships (PPPs), a wider term which includes various types of joint venture as well as PFI projects,[11] but our inquiry and this Report concentrate on PFI.

2. We took oral evidence from the Major Contractors Group (MCG), the Business Services Association (BSA), the Confederation of British Industry (CBI), the Trades Union Congress (TUC), and several academics and practitioners (Professor Stephen Glaister CBE, Mr Tony Travers, Ms Rosemary Scanlon, Mr Chris Elliott and Professor Allyson Pollock). Our final hearing was with the Chief Secretary, Rt Hon Andrew Smith, Mr Adrian Montague, the Deputy Chairman Designate of Partnerships UK (and previously chief executive of the Treasury Taskforce), and Sir Steve Robson from the Treasury. We have also received written evidence. We thank all those who helped us with our inquiry in this way.

3. The PFI is a complicated subject, involving aspects of contract design, project appraisal, means of raising private sector capital and the operation of particular government departments. We are therefore very grateful to Mr Mike Kerr of Deloitte and Touche, Mr Michael Spackman of National Economic Research Associates, Professor Christine Whitehead of the London School of Economics and Professor Jane Broadbent of Royal Holloway College for agreeing to be our specialist advisers. They have helped us to understand the technical issues involved. We should, however, emphasise that our conclusions are our own and do not commit our advisers.

History of the Private Finance Initiative

4. There have, for many years, been limits to the involvement of private finance in Government activity and, since 1981, these had been expressed as the "Ryrie Rules", which stated that a project funded by the private sector

These rules have been generally held to have provided little incentive to seek private funding.[12]

5. The Private Finance Initiative was launched in the Autumn Statement in 1992,[13] and relaxed the first of the Ryrie Rules. In the words of the then Chancellor (Norman Lamont), "any privately financed project which can be operated profitably will be allowed to proceed" (although public sector comparisons are still expected for most other types of project). The Initiative was launched in the context of allowing more investment; we consider in paragraphs 18 to 23 whether this objective is still appropriate and then examine the other consideration which is offered to justify PFI: improved value for money (including that produced by appropriate transfers of risk to the private sector).

WHAT IS PFI?

6. The principle of PFI is that a public sector body (central or local government or part of the health service, generically called "the authority") obtains a service rather than an asset. A private sector contractor (often specially created for the purpose) funds any asset required and is then paid for the service provided.[14] Usually payments will be made by the commissioning authority, but in some projects (e.g. a toll bridge) they are made by the public. There is also the possibility of charges to the public being subsidised by payments by the commissioning authority (e.g. a railway where the fares are subsidised for public benefit reasons).[15] Normally, therefore, the commissioning authority will avoid the need for capital expenditure at the beginning of the project in exchange for making payments for the service as it is delivered, often over a period of up to thirty years. The private finance is temporary: the public sector still pays in the end. (Even in the case of tolls, etc., the public sector pays in terms of revenue forgone.) Because the contractor is paid for the service provided, it should be possible to arrange that he is taking the risks inherent in the construction of the asset: for example that it will cost more than expected or will be unsuitable to provide the service required. We look further at the allocation of risks in paragraph 27.

7. PFI projects so far include the Channel Tunnel Rail Link (at a cost of £4.3 billion by far the largest single project), prisons, roads, hospitals and computer systems; and a refurbishment of the Treasury Building, which Mr Alan Milburn, the then Chief Secretary to the Treasury, described as a "flagship project".[16] The Treasury estimates the capital spending by the private sector on PFI/PPP deals (or their equivalent before these terms were coined) as follows:

Table: Estimated capital spending on PFI/PPP projects

by year in which deals were signed


Year
Total (£m)
Notable projects (included in total for year)

1986
150
Dartford Bridge
1990
330
Second Severn Crossing
1992
324
Birmingham Northern Relief Road/Skye Bridge
1993
42
Royal Armouries Museum
1994
11
Lothian Forth Health Board/Northern NHS Trust
1995
862
London Underground Northern Line Trains
1996
6,064
Channel Tunnel Rail Link (£4,300m)
1997
1,500
Manchester Metrolink/Ministry of Defence projects
1998
2,679
Several hospitals
1999*
804
National Savings IT/Almond Valley & Seafield Sewage
Total
12,766

Source: Treasury Task Force: evidence p 81-84. There are no projects listed for 1987-89 and 1991.  *As at 1 April.

EVENTS SINCE THE LAUNCH

8. The PFI was initially slow to start—in 1993 and 1994 only three projects which involved over £5m of capital expenditure were signed.[17] A "Private Finance Panel" was set up in 1993, and the Chancellor announced in the autumn statement of 1994 that PFI should be considered for any public sector project (the "universal testing rule").

9. Our 1996 inquiry[18] considered a number of issues, including whether PFI spending was extra or in substitution for government spending; whether the private sector would be setting priorities between schemes; whether the implications for future public expenditure were being suitably controlled; whether, and if so how, better value for money would be achieved; whether it was sensible to consider all projects for PFI; and on the specification of outputs and transfer of risks. The Government reply undertook that future spending implications of PFI would be listed in the Financial Statement and Budget Report,[19] said that value for money gains were expected from close integration of services with design, better allocation of risks and the correct incentive structure; and identified cases where PFI would not be appropriate.

10. At the beginning of the 1997 Parliament the new Government abandoned the "universal testing rule"[20] and commissioned Mr (now Sir) Malcolm Bates, Chairman of Pearl Group and Chairman of Premier Farnell, to review the system of PFI.[21] As a result of accepting the recommendations of the review[22] the Government abolished the Private Finance Panel and replaced it with a new Treasury Taskforce, consisting of two "arms":

      (a)  a policy arm, responsible for rules, procedure and best practice governing PFI and PPPs, together with PFI-oriented staff training of public sector employees; and

      (b)  a projects arm, to approve ("sign off") the commercial viability of all significant projects before the procurement process began (by publishing a contract notice in the EU Official Journal) and monitor them (and other projects, where time and resources permitted) to ensure progress. The Treasury later defined "significant project" as "big, high profile, highly replicable or ground breaking" and the Taskforce undertook to monitor 80 such projects.[23] Local authority projects are signed off and monitored by the Project Review Group, which is chaired by the Taskforce and also contains representatives of Public Private Projects Panel Ltd (the "4Ps"), an adviser to local government established by the local government associations in April 1996.[24]

11. The Bates Review recommended that individual departments should remain responsible for their own PFI projects, and that departmental Private Finance Units (PFUs) should be strengthened by the appropriate expertise. As a result, the Taskforce Projects Arm was not expected to be needed indefinitely, and it was set up with a life of two years (until late 1999).

12. As this initial term came towards its end, the Government announced in November 1998[25] that Sir Malcolm Bates would conduct a second review: the report was made in March 1999 but not published until 22 July. Its principal conclusion was that centralised project support was still needed but that the Taskforce Projects Arm should be replaced by a joint public-private sector body, subsequently named Partnerships UK (PUK). We examine the proposed role of PUK below (paragraph 75). Statutory arrangements for PUK are contained in the Government Resources and Accounts Bill, currently before Parliament.

13. In parallel with the second Bates Review, the Government asked Mr Peter Gershon of GEC Marconi to examine civil procurement in central Government, and his report was also published in July 1999. It recommends that an Office of Government Commerce (OGC) should be created within the Treasury. The Government's conclusions on both reports are set out in a document Modern Government Modern Procurement.[26] The Taskforce will continue within the OGC, but with a "slimmed down projects capability".[27]

14. In the mean time, the National Audit Office (NAO) has been examining the early PFI projects, producing a number of reports,[28] which have given rise to corresponding reports by the Committee of Public Accounts (PAC), which also made a general report drawing together its previous recommendations.[29] The NAO has also made a report setting out the factors that it will take into account in future assessments of PFI projects.[30] We refer to the NAO's findings on value for money in paragraph 43.

15. In July 1999 the Treasury Taskforce appointed Arthur Andersen as consultants to examine value for money aspects of those PFI projects where the delivery of services and payments for them had begun. This report[31] was published on 26 January and we are grateful to the Treasury for supplying us with copies in advance. In addition, the Institute for Public Policy Research (IPPR) launched a Commission on Public-Private Partnerships in September 1999, which is due to report in 2001. We refer to a working paper issued by the Commission in paragraph 21.

16. Finally, in March 2000, when we were about to consider this Report, the Government restated its policy on PPPs and PFI in a document entitled Public Private Partnerships: The Government's Approach. We refer to this document at the appropriate places in our Report.

The purpose of PFI

17. In the public pronouncements on PFI since its launch in 1992, there has been some doubt about the relative importance of two advantages claimed for PFI: one is that it enables more investment to take place than the Government is able to provide by conventional capital spending; the other is that for some types of contract PFI provides better value for money than traditional procurement, and should be used for that reason. We examine each of these assertions in turn.

PFI AS A MEANS OF OBTAINING EXTRA INVESTMENT

18. There is no doubt that the original justification for PFI in the Autumn Statement of 1992 was that it would enable more investment to take place. The phrase "any privately financed project which can be operated profitably will be allowed to proceed" applies most obviously to projects paid for by the users. Proposals such as new road and rail links (including the Channel Tunnel rail link) were mentioned in the statement. In addition, however, the possibility of roads designed, built and operated by contractors and paid for by the Government by fees "relating to their use" was mentioned in the statement: the Chancellor said that the money "contributed by the private sector" would represent "additional resources" in the area concerned.[32]

19. When we asked the current Chief Secretary how he measured the success of PFI, he mentioned both value for money and "the acceleration of flow of projects that we have been able to bring forward". He pointed to the increase in hospital building as "a spectacular acceleration in national capital investment, and PFI should share the credit for that".[33] Similarly, the document Public Private Partnerships: The Government's Approach emphasises that the Government "is using private finance and other types of public private partnerships to add to and complement this additional public sector investment [announced in the July 1998 Comprehensive Spending Review] ... This can relieve the pressure on public finances, allowing Government to concentrate resources on other public services". The document also states that the Government's approach is "to use PPPs where they provide better value compared to public sector investment"[34] By contrast, the Treasury Taskforce document Partnerships for Prosperity of November 1997 emphasised value for money more:

    "The PFI is not about borrowing money from the private sector ... PFI is all about creating a structure in which improved value for money is achieved through private sector innovation and management skills delivering significant performance improvement and efficiency savings."[35]

Similarly the CBI said that "better value for money must be the reason for choosing PFI over conventional capital procurement ... shifting Government expenditure from capital to current is a consequence of PFI—neither good nor bad itself in fiscal terms ..."; they welcomed the way in which the argument had shifted from "drawing in extra money" to value for money.[36] They also said, however, that a feature of PFI was that it could be "conducive to boosting investment by replacing 'lumpy' public capital spending with a steady stream of service payments".[37]

Effect of the Government's Fiscal Rules

20. In summer 1998 the current Government introduced a new fiscal framework, at the centre of which were two fiscal rules which apply over the economic cycle, rather than in any particular year. The rules are intended to govern fiscal policy during the current Parliament:

These rules reflect the Government's view that "a key component to the new approach to fiscal policy is to distinguish between current and capital spending."[38]

21. In a working paper published by the IPPR's Commission on Public-Private Partnerships, Mr Peter Robinson points out that conventional investment by the Government would be categorised as capital expenditure, and would therefore not affect the golden rule; it would, however, have implications for the sustainable investment rule to the extent that it caused net public sector debt to exceed 40 per cent of GDP over the economic cycle. However, if the total investment for PFI investment planned for 1999-2002 of £11 billion[39] was instead carried out conventionally, this would add little more than one percentage point to the ratio of public sector net debt to GDP. This would not put the sustainable investment rule at risk, as the debt ratio is forecast to be significantly less than 40 per cent in these years.[40]

22. The Treasury say that in the past there has been a "bias against [public sector] investment, which often constituted an easier (though short-term) target for spending cuts".[41] The TUC suggested that the Government should adopt the General Government Financial Deficit (GGFD) as their measure of public sector borrowing, as it excludes net borrowing by the public sector for investment purposes.[42]

23. When the aim was to reduce the Public Sector Borrowing Requirement—particularly when there was a large deficit—PFI was an attractive means of increasing investment. However, the new fiscal framework has made it easier to provide publicly-funded investment, because such investment has no effect on the golden rule, and could be increased significantly without exceeding the Chancellor's chosen guideline that debt should not exceed 40 per cent of GDP. In the new framework, the case for PFI as the main means of obtaining extra investment is very much weaker. The main justification should now be the prospect of obtaining better value for money.


9  A few projects mentioned in this Report-mainly toll roads-were approved on lines similar to PFI in the 1980s and early 1990s. Back

10  Sixth Report, 1995-96, The Private Finance Initiative, HC 146. The Government's reply to this Report was published as our Fourth Special Report, 1995-96, HC 513. Back

11  In addition to PFI, PPPs include part privatisation, "the introduction of private sector ownership into businesses that are currently state-owned, using the full range of possible structures (whether by flotation or the introduction of a strategic partner), with sales of either a majority or a minority stake"; concessions and franchises, "where a private sector partner takes on the responsibility for providing a public service, including maintaining, enhancing or constructing the necessary infrastructure"; and "the wider markets initiative and other partnership arrangements where private sector expertise and finance are used to exploit the commercial potential of Government assets (evidence p 69-70, paras 8-9). See also Q 382. Back

12  For more about the Ryrie Rules, see Sixth Report, 1995-96, HC 146, Appendix 17, p 160, by Professor David Heald, the specialist adviser for that inquiry. Back

13  Official Report, 12 November 1992, c 998. See also Cm 2096, Autumn Statement 1992, November 1992, paras 2.111-117. Back

14  "For PFI projects, for example, this means that the Government no longer builds roads, it purchases miles of maintained highway ... it no longer builds prisons, it buys custodial services ... it no longer always buys computers and software, but pays for managed IT services." Partnerships for Prosperity, Treasury Taskforce, November 1997, para 3.07. This report is available on the Treasury Taskforce website: www.treasury­projects­taskforce.gov.uk. The contracting company is often called a "special purpose vehicle" or SPV (MCG evidence, p 4 para 8). Back

15  Examples of financially free-standing services: the Second Severn Bridge and the Dartford River Crossing; of partly subsidised ventures: the Docklands Light Railway Extension (Partnerships for Prosperity, para 1.06). Back

16  See Q 397-8 and Official Report, 27 July 1999, c 400-1W (reproduced in Appendix 2). Back

17  Evidence, p 81. Back

18  See Sixth Report, 1995-96, The Private Finance Initiative, HC 146, and Government reply, Fourth Special Report, 1995-96, HC 513. Back

19  Although the PFI commits the authority to payments for many years ahead, conventional capital projects also have similar implications for future current expenditure, notably for maintenance of the asset and for provision of the service concerned. The difference is that a PFI contractor will include in its charges the cost of building the asset and an allowance for its depreciation (see evidence p 41-2, para 7). However, the Institute for Fiscal Studies points out that "conventional public-sector-financed projects are likely to be more flexible, since future governments can choose to dispose of any unwanted assets" (IFS Green Budget, January 2000, p 36). The Government collects aggregate figures for the estimated payments under PFI contracts for the next thirty years or so and publishes them in the Budget Red Book (evidence p 70, para 13; see evidence p 55 for a comparison of figures from the last two Budget reports). Back

20  The Treasury's written evidence says that the rule "had been responsible for a lot of ill-conceived projects" (evidence p 70 para 17). Back

21  HM Treasury news release 41/97, 8 May 1997. Sir Malcolm was a member of the Private Finance Panel from 1993 to 1996. Back

22  See evidence p 76-8 for the recommendations and progress made in implementing them. Back

23  See evidence p 78-80. Back

24  See Partnerships for Prosperity, paras 2.13-19, for more information about the 4Ps. Back

25  HM Treasury News Release 187/98, 12 November 1998. Back

26  HM Treasury, July 1999. This and the Gershon Report (and also the summary of conclusions from the Bates report) are available on the Treasury website: www.hm­treasury.gov.uk. Back

27  Modern Government Modern Procurement, p 15. Back

28  Evidence p 91-8. Back

29  Committee of Public Accounts, Twenty-third Report, Session 1998-99, Getting Better Value for Money from the Private Finance Initiative, HC 583 (published 4 July 1999). The Government's reply was included in Cm 4469 and is reproduced in evidence, p 98. Back

30  National Audit Office, Examining the value for money of deals under the Private Finance Initiative, 13 August 1999, HC (1998-99) 739. Back

31  Value for Money Drivers in the Private Finance Initiative, A Report by Arthur Andersen and Enterprise LSE, January 2000. This report is available on the Treasury Taskforce website: www.treasury­projects­taskforce.gov.uk. Back

32  Official Report, 12 November 1992, c 998; Cm 2096, paras 2.111-117. Back

33  Q 289. See also evidence p 69 para 6, quoting the Treasury's summary of Departmental Investment Strategies. Back

34  HM Treasury, Public Private Partnerships: The Government's Approach, March 2000, page 13, paras 18-19. Back

35  Partnerships for Prosperity, para 3.02. Back

36  Evidence p 41, para 4; Q 189. Back

37  Evidence p 41, para 5. Back

38  Economic and Fiscal Strategy Report 1998, Cm 3978, page 20. See also Q 189 (CBI). Back

39  Evidence p 70, para 13. Back

40  Peter Robinson, "PFI and the Public Finances", in The Private Finance Initiative: Saviour, Villain or Irrelevance?, IPPR, March 2000; in particular Table 4. See also Pre-Budget Report 1999, Cm 4479, page 142, Chart B1. GDP for 2001-02 is forecast to be £978 to 988 bn: Cm 4479, page 135, Table A8. See also written evidence from UNISON on this point (evidence p 58 para 2.2). Back

41  Economic and Fiscal Strategy Report 1998, Cm 3978, page 20. Back

42  Evidence p 55. Back


 
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