Private Finance Initiative - Treasury Contents

Written evidence submitted by Donald Roy


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.


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.


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.


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.


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 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?


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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Prepared 10 August 2011