Private Finance Projects and off-balance sheet debt - Economic Affairs Committee Contents

Examination of Witnesses (Question Numbers 220-223)

Crisp, Ms Rachel Lomax, Sir John Gieve and Sir Kevin Tebbit

3 NOVEMBER 2009Lord

  Q220  Chairman: Can I ask a slightly different question about the sources of funds. We know that the cost of capital from the private sector is significantly higher than if the government were a borrower. I wonder if we could tease that out a little. We have heard for example that in the United States there are public infrastructure banks which are able to get sources of funds at the public sector rates. If there were something similar here in the UK, a bit like the European Investment Board but operating internationally perhaps with rather wider scope, would you get nearly all the benefits potentially of a PFI in terms of the contractual relationships and the operational look at both the capital investment, the infrastructure and service throughout the whole life of the project or not?

  Ms Lomax: There was always a cost/benefit calculation. There was this additional cost from the finance but then you had to try and quantify the benefits that you would get from PFI. I do not think there is a necessary relationship between the risk premium, if you like, that the private sector person had to pay and the benefits that you get from PFI, at least in the PFIs that I was involved with. They were bringing in skills, experience and structures that were there in the private sector and which, after a long period of capital rationing in the public sector, were just not in the public sector. I do not think there is a necessary relationship but obviously the hurdle is less high if the private sector, for whatever reason, can borrow at the risk-free rate.

  Q221  Chairman: What I am really getting at is that it seems from what you have said so far that a lot of the benefits are to do with the relationship with the private sector contractor and I was wondering what, if any, were the incremental benefits in having private sector finance? Ms Lomax: I do not think there are any at all. I think the public sector should always be able to borrow more cheaply than a private sector entity. There may be a small margin or a big margin, but basically the public sector borrows at the risk-free rate and almost every private sector borrower is a bit more expensive than that. It may be that there some private sector entities or quasi private sector entities (the EIB is not really a private sector entity) which can borrow very close to a risk-free rate but I do not know there are many around these days. That makes the financial disadvantage of PFIs smaller but I do not think there is ever going to be a financial advantage. I challenge my colleagues to provide an example.

  Sir John Gieve: In a sense your question is could you not do all of this in the public sector, could you not hire the same people and have exactly the same relationships but finance it cheaper? In theory, yes, and actually now, if you like, after the best part of 15 years of this departments could make a better fist of it because they have become accustomed to a new way of working. Certainly going back those 15 years, as Rachel said, the public sector simply did not work that way and even around the Home Office headquarters, which was not the first of the big construction projects, the degree of due diligence that the private sector financiers brought to that deal was quite different from anything that I think the Home Office would have done left to its own devices. You could say if they had been better they would have done it. Yes, but pigs might fly.

  Ms Lomax: I do not think it was because they were at risk financially that they brought these skills in, if that is what you are getting at, although I think there are all sorts of different ways of structuring contracts. DBO contracts are worth doing in some contexts as well as a DBFO context. I think people have got much more sophisticated about what kind of contract matches a particular problem whereas, roll back 15 years, we were pretty unsophisticated.

  Sir Kevin Tebbit: I was very surprised when I asked the Department what has happened since I left four years ago. There have not been that many new PFI projects coming through since then. Of course we know one of the reasons: the drying up of the money markets generally, but I think there are other reasons. One of them is that the departments have got more sophisticated and are more able to do things based on their experiences of PFI and therefore went other routes like PPP and partnerships with the private sector which were not PFI and these used most of the techniques. For example, the PFI unit is the unit the MoD now uses to do commercial appraisals of its conventional procurements because they are good at it, and therefore it is difficult to know whether it is because the money is more expensive through PFI, if one discounts the risk premium, or whether these other things have happened and therefore it is not quite such a popular tool now. It is in the toolkit but it is by no means as dominant as it was.

  Lord Crisp: Can I add one point. Again we are all slightly different on this. I asked a question yesterday about what the premium was and I was told that the average was somewhere between half and one per cent over what you could have borrowed it at, which on a big number is a large sum of course, and that was the cost against which we were weighing the other benefits. One of the things we did try and do in this, which was to manage the market to an extent, was that we only let out a certain number of projects at any time on to the market to make sure there was money and contractors available to do it so we were not chasing too little money. You can try and do that. On your wider question of whether a public sector bank, as it were, could do that, my answer would be yes as long as it was sufficiently independent from the political and departmental process that it did not get sucked back into allocation of capital for reasons other than the local business case.

  Q222  Lord MacGregor of Pulham Market: That is probably helpful. Could I ask about another aspect of this in relation to value for money and that is whether the optimism bias biases the calculation against traditional procurement or not and has that improved?

  Lord Crisp: The bias against traditional procurement?

  Q223  Lord MacGregor of Pulham Market: The optimism bias. The calculation is that traditional procurement has all sorts of disbenefits and sometimes could they be over- exaggerated?

  Lord Crisp: I am not sure I can answer that but if I understand the point you are making it is about saying the private sector will do a better job than the public sector sort of mentality. One of the points I wanted to make earlier is that not just that the public sector has learned but there are people who understand how to do these thing very well in the public sector. The private sector is by no means always better.

  Sir John Gieve: I think you are going back to the times when the Treasury ruled that experience showed that every public sector estimate should be increased by 20% because optimism was rife in the public sector. That was always a pretty crude rule, I thought, and it was while we were trying to peddle the PFI for all it was worth. As I was saying earlier, in IT we found that there were people in the private sector who were even more optimistic than we were. I do not know, I have been out of this for several years, but I think in the experience over time people have become much better at judging what is possible and what is not possible and what those trade-offs are.

  Sir Kevin Tebbit: I think if there had been that degree of optimism bias it should not have taken us as long as it did to do these deals. My concern in the MoD always was that it took forever to get a PFI contract in place and the reason it took as long is because of the caution that the private sector was placing on how they manage the risk and whether they were indeed in a position to price that risk well. If they had concluded these deals rapidly there may have been an optimism bias but my sense was it took so long because there was not really that bias there and people found it very difficult to price these issues.

  Chairman: I fear we have overrun the time that you were expecting to be here and we were expecting to talk to you but that is just a measure of how useful you have been, so thank you very much indeed.

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