Written evidence submitted by Donald Roy
THE PRIVATE
FINANCE INITIATIVE
This submission deals with the Private Finance Initiative.
It considers the background, context and experience and makes
some suggestions for improvements. It reflects my knowledge as
an economist and my experience (both as a member of the Government
Economic Service from 1995 to 1998 and as an active citizen participating
in the health service since then). The views expressed do not
necessarily reflect those of any institution with which I have
been involved.
THE BACKGROUND—THE
LATE 1980S
In the late 1980s, the Private Finance Initiative
did not exist. Indeed at the time HM Treasury discouraged the
use of private finance in public services. The so-called "Ryrie
rules" implied that if a scheme made sense with private finance
it would make even more sense with public. The one exception was
the Channel Tunnel, which the Government facilitated but did not
finance (or even act as guarantor). More typical was the sustained
effort to prevent local authorities from various devices (including
sale and leaseback of assets such as street lights) intended to
evade restrictions on their spending.
PFI MARK ONE—LAMONT
TO ROBINSON
As a policy the Private Finance Initiative developed
under the 1990 to 1997 Conservative Government led by John Major.
Among precipitating factors were the large cost overruns on the
(conventionally-financed) Jubilee Line and the contrasting experience
of the Channel Tunnel (where the tab was picked up by the private
sector first as investors and later as lenders). In the light
of the difficulties with local government mentioned in the previous
paragraph, it was confined to central government and bodies subject
to it such as the National Health Service and (at the time) London
Transport. PFI was encouraged by the requirement that any procurement
be tested for private finance (the loose wording of initial guidance
and the absence of any lower limit meant that in principle any
decision to buy departmental stationery supplies should have been
preceded by formal examination of the scope for using private
finance - leasing paper from an obliging bank, perhaps!). Rather
less attention appears to have been paid to timescales and value
for money. Nor, crucially, was much thought given as to the willingness
of the private sector to accept transfer of risk in practice.
This last led to a hiatus with regard to schemes in the NHS which
was resolved at the end of the Major Government by legislation
agreed between both front benches which had the effect of rendering
the Secretary of State for Health the ultimate guarantor of all
PFI schemes undertaken by NHS Trusts. This last marked the entrance
onto the scene of s Minister who was interested in getting PFI
to work, Geoffrey Robinson.
PFI MARK TWO—THE
CLASSIC PERIOD—1997
TO 2008
The Government formed in May 1997 had taken the decision
to rescue PFI rather than abandon it. The next few years were
marked by efforts to make it work. First, size thresholds were
introduced (avoiding the absurdity highlighted above of the departmental
stationery order having to be tested for private finance). More
force was given to the idea that PFI schemes should tested as
against a public sector comparator (although this seems to have
had less impact than might have been expected). Some experiments
involving public sector equity or protection of employees' rights
were undertaken. Enough was done to render a reformed PFI defensible.
PFI—THE STANDARD
CRITIQUE
This emerged at roughly the same time as the Robinson
reforms. It suggested that schemes were not value for money as
against a public sector comparator. Almost certainly this was
true for some of the earlier schemes. However this could not be
established by the techniques used by the most prominent and vocal
critics. These employed a high degree of double counting and,
remarkably, refused to contemplate capital charges on state-owned
assets (a stance rejected by most socialist economic thinkers
as early as the 1930s!). The double counting arose because in
many PFI schemes facilities management was included in the PFI
scheme but excluded from the interest payments used in the comparator
used by the critics (a true comparator would have included them).
One of the principal critics told the Health Select Committee
in its 2001-02 session that capital charges should not be used
in the NHS. Unfortunately, this narrow ideological focus led to
neglect of three out of four other objections to PFI. The one
that the main critics recognised was that estimation and valuation
of risk transfer was questionable yet increasingly required to
prove value for money against a public sector comparator. They
missed the consequences of delay, the effects of diverting management
time and, last but not least, the effects of payment obligations
on departmental budgets (they spotted this for NHS Trusts but
not elsewhere). One consequence of delay (due to an elaborate
and lengthy process of negotiation) was that where a scheme was
required urgently, resort was had to conventional finance from
the Treasury (the Elective Orthopaedic Centre at Epsom is a case
in point). Management diversion has, in my view, affected the
performance of NHS Trusts in some cases (lengthy negotiations
over PFI led them to take the eye of the ball). Last the accumulation
of PFI payments, which are contractual in nature, can affect control
of departmental expenditure. This last would be a problem even
when such expenditure could be expected to grow; in current circumstances
(where budgets may be reducing significantly over the next few
years) it is rather more serious.
THE CREDIT
CRUNCH AND
AFTER
The events of 2008 have weakened the case for PFI
both practically and theoretically. Funds for new schemes have
dried up to the point where HM Treasury has had on occasion to
lend public money to support groups offering "private finance"
(surely a situation beyond satire!). The theoretical implications
are more serious and likely to be longer lasting. As critics have
found, value for money depends on the valuation of risk transferred
tot the private sector (without it the vast majority of PFI schemes
would fail the test against a public sector comparator). Yet the
financial crisis has cast doubt on the ability of institutions
to value risk in a reasonable way. At best they may have been
over-ambitious rather than consciously dishonest in their approach
to measuring and valuing risk. If, as seems likely, there may
be no acceptable way of valuing risks transferred currently available
can these be included in a value for money comparison? Yet without
this how many PFI schemes would pass the test?
SUGGESTIONS
Complete abandonment of PFI might have been possible,
if difficult, in 1997. It is impossible now .All that can be done
now is to scale down new commitments and deal with existing ones.
First, reliance on PFI for new public sector investment needs
to be curtailed drastically. A small number of public bodies with
a demonstrably good record on PFI should be allowed to continue
with new schemes. All others should be expected to use public
capital. Second existing commitments need to be managed sensibly.
Departmental ceilings should be set on the proportion of outgoings
that can go on PFI payments—similar arrangements should
apply to NHS bodies. No body near its ceiling should be allowed
to take on further commitments even if was qualified otherwise
to continue with PFI. Bonds in PFI consortia could be included
in purchases by the Bank of England under quantitative easing,
thus transferring them to the public sector.
April 2011
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