Private Finance Initiative - Treasury Contents

Written evidence submitted by Dr James Robertson


Which financing approach provides best value for money in public service provision cannot be determined a priori. All approaches have several potential advantages and disadvantages. Advantages may offset other factors even when disadvantages become more marked. Assessment must consider all relevant elements and not highlight any one in making a case. Value for money may remain at risk whatever accounting system is used if controls do not prevent distortion of contracts in order to obtain financing. The successful transfer of risk to private contractors at good value for money requires careful assessment of who can best bear a risk and good due diligence.


What are the strengths and weaknesses of different public procurement methods?

Are there particular kinds of risk which are particularly appropriate for transfer through PFI deals, or particular projects which are suited for PFI?

A simple classification of a number of important possible advantages and disadvantages of the use of private finance is as follows:

Value for money of Public Private Partnerships, PPP, depends on many factors. No one factor by itself provides an a priori VFM justification for PPP and no one factor, for example, the higher cost of capital for the private sector, provides an a priori justification for not using PPP. The question is whether advantages as a whole outweigh disadvantages.

At the current moment, any increase in the cost of private finance will all else equal make this financing route less attractive than public finance, but other factors may continue to outweigh even a higher cost of capital. In particular, a genuine transfer of delivery and cost risk may be valuable characteristics of a PFI.

It should also be borne in mind that while private finance is rationed through the price of capital in the market, public sector investment is currently rationed through quantity or budget constraints. A level playing field would imply the use of an implicitly higher cost of public capital in economic investment appraisals of value for money, compared to the Treasury Green Book rate of 3½% real per year.

In what circumstances are PFI deals suitable for delivery of services?

Generalisations about how to achieve best VFM are elusive and may well be unhelpful. As above, all methods of financing public services have advantages and disadvantages, though as set out in Treasury Standard Contracting guidance, some types of procurement may not be suitable for PFI, for example, because the costs of the procurement are high in relation to the size of the contract, as for individual small contracts, or where projects involve assets with short physical or economic lives. Where public service requirements are known to be changeable in the future, long term contracting may not be suitable. It may not be economic to enter into short term contracts with the private sector.

Beyond this, choice of procurement method and financing should be based on a careful review of circumstances of the type of public services in question and then on a project by project basis. A general analysis of the following type may be informative.

At the highest level, reviewing resource use across Government is the subject of periodic Spending Reviews. Within public authorities, it is beneficial to take a cross department view of the suitability of possible financing options, and at the lowest level, the financing of individual proposals to supply public services should be considered on the complete range of relevant factors.

How should PFI deals be accounted for?

The question is less one of accounting treatment per se, but whether there are sufficient controls to ensure that PFI contracts are not distorted, either in terms of risk and reward, or in regard to control, to obtain finance at the risk of reduced value for money. Transfer of risk to parties able to bear it only at excessive cost is an example of a possible distortion.

How far can risk really be transferred from the public to the private sector?

What state guarantees are explicit or implicit in PFI deals?

While PFI inherently transfers infrastructure and service delivery risk to the private sector, risk transfer is only meaningful if the public sector has a genuine Plan B in the event that a project fails badly. Under PFI the public sector makes no payments until services come on line and it is protected in financial terms. The required services will not be available as planned however, and the public sector might feel it had no choice but to relax the terms of a PFI contract, or to cover service delivery failures itself in some way, for instance, in the case of health services.

Risk transfer can therefore never be guaranteed fully, and involvement of the private sector requires careful up front financial due diligence and assessment of its construction and operating abilities. It should be noted however that the same service failure issues and possible associated costs also arise if a publicly financed project fails to deliver in some way.

There should be few if any explicit guarantees beyond the decision of which party should bear which risk, provided PFI or PPP projects can be allowed to fail if the private sector cannot deliver. Implicit guarantees exist to the extent that a PFI project cannot be allowed to fail and this possibility should be addressed up front in the consideration of the best financing route.

May 2011

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© Parliamentary copyright 2011
Prepared 10 August 2011