Written evidence submitted by Dr James
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
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.