The problems of the Private Finance Initiative mount

The crossover and interrelationship between the private and public-sectors is a big economic issue. I was reminded of it on Saturday evening as I watched the excellent fireworks display in Battersea Park but from outside the park itself. The reason for this is that it used to be council run and free albeit partly funded by sponsors such as Heart Radio if I recall correctly. But these days like so much in Battersea Park it is run by a company called Enable who charge between £6 and £10 depending on how early you pay. You may note that GDP or Gross Domestic Product will be boosted but the event is the same. However there is a difference as the charge means that extra security is required and the park is fenced in with barriers. I often wonder how much of the charges collected pays for the staff and infrastructure to collect the charge?! There is definitely a loss to public utility as the park sees more and more fences go up in the run-up to the event and I often wonder about how the blind gentlemen who I see regularly in the park with his stick copes.

Private Finance Initiative

Elements of the fireworks changes apply here as PFI is a way of reducing both the current fiscal deficit and the national debt as HM Parliament explains here.

National Accounts use the European System of accounts (ESA) to distinguish between on and off balance sheet debt. If the risks and reward of a project is believed to be passed to the private sector, it is not recorded in the government borrowing figures, and remains off balance sheet. Approximately 90% of all PFI investment is off balance sheet, and is not recorded in National Accounts. Public
spending statistics, such as the Public Sector Net Debt, also follow ESA.

I like the phrase “believed to be” about risk being passed to the private-sector as we mull how much risk there actually is in building a hospital for the NHS which will then pay you a fee for 25/30 years? However we see why governments like this as what would otherwise be state spending on a new hospital or prison that would add to that year’s expenditure and fiscal deficit/national debt suddenly disappears from the national accounts. Perfect for a politician who can take the credit with no apparent cost.

Problems

The magic trick for the public finances does not last however as each year a lease payment is made. So there is a switch from current spending to future spending which of course is the main reason why politician’s like the scheme. However the claim that the scheme’s offer value for money gets rather hard when you see numbers like this from a Freedom of Information reply last month.

The Calderdale and Huddersfield Hospitals NHS Foundation Trust entered into a PFI with a company called Calderdale Hospitals SPC Ltd. Prior to May 2002, the all in interest rate in respect of bank loans that the company had
taken from its bankers was 7.955% per annum. After May 2002, when the PFI Company refinanced its loan, it was 6.700% per annum.

As you can see the politicians at that time in effect took a large interest-rate or more specifically Gilt yield punt and got is spectacularly wrong. Even with the refinancing the 6.7% looks dreadful especially as we note that we are now a bit beyond the average term for a UK Gilt. So if a Gilt had been issued back then on average it would be being refinanced now at say 1.5%. Care is needed as of course politicians back then had no idea about what was going to happen in the credit crunch but on the other hand I suspect some would be around saying how clever they were is yields were now 15%! On that note let me apologise to younger readers who in many cases will simply not understand such an interest-rate, unless of course they venture into the world of sub-prime finance or get a student loan.

In terms of pounds,shillings and pence here is the data as of 2015.

The total annual unitary charge across all PFI projects active in 2013/14 was £10bn. The cumulative unitary charge payments sum to £310bn: of this £88 billion has been paid (up to and including 2014/15) and £222 billion is outstanding. The unitary charge figures will peak at
0.5% of GDP in 2017/18.

Inflexibility

This is not only an issue on the finance side it is often difficult for the contracts to be changed as the world moves on. Or as HM Parliament puts it.

It can be difficult to make alterations to projects, and take into account changes in the public sector’s service requirements.

Are supporters losing faith?

Today the Financial Times is reporting this.

Olivier Brousse, chief executive of John Laing, which invests in and manages PFI hospitals, schools, and prisons, said PFI had lost “public goodwill” and needs “reinventing” with providers subject to a “payment by results” mechanism where money is clawed back for missed targets.

That is true although he then moves onto what looks like special pleading.

“The market in the UK is going away so we need to get back around the table and agree something acceptable,” said Mr Brousse. “The UK’s need for new infrastructure is significant and urgent. The private sector stands ready to deliver this . . . If the current PFI framework isn’t fit for purpose — then let’s completely rethink it to make it work.”

Indeed we then seem to move onto the rather bizarre.

“The problem with PFI isn’t transparency. It is outcomes,” he said. “I’m a citizen and if a school is built under PFI I also want it to commit to reducing bullying and violence.”

Surely the school should be run by the Governors rather than the company that built it? Perhaps he is trying to sneak in an increase in his company’s role.

There were also mentions of this which as I note the comments to the article seems set to be an ongoing problem whether it s in the public or private sectors.

In August John Laing agreed to hand back a lossmaking £3.8bn 25-year PFI waste project in Greater Manchester for an undisclosed sum. One of Britain’s biggest PFIs, the Greater Manchester waste disposal authority bin clearance, recycling, incinerator and green power station project had struggled to remain profitable. Manchester council said it would save £20m a year immediately from access to cheaper loans and £37m a year from April 2019.

Comment

To my mind the concept of PFI conflated two different things. The fact that private businesses can run things more efficiently than the public-sector which is often but not always true. For that to be true you need a clear objective which is something which is difficult in more than a few areas. The two main dangers are of missing things which turn out to be important as time passes and over regulation and complexity which may arrive together. Then we had the issue that whilst it was convenient for the political class to kick expenditure like a can into the future this meant a larger bill would eventually be paid by taxpayers. Even worse they have ended up trapping taxpayers into deals at what now seem usurious rates of interest.

Pretty much all big contracts with the private-sector seem to hit trouble as this from the National Audit Office on the Hinkley Point nuclear power project points out.

The Department has committed electricity consumers and taxpayers to a high cost and risky deal in a changing energy marketplace. We cannot say the Department has maximised the chances that it will achieve value for money.

There is of course the ever more expensive HS2 railway plan to add to the mix.

Thus we see that some of the trouble faced by UK PFI is true of many infrastructure projects. Yet some of it is specific to them and frankly it is hard to make a case for it right now because of some of the consequences of the credit crunch era. Firstly governments are able to borrow very cheaply by historical standards and secondly because adding to the national debt bothers debt investors much less than it once did especially if it is also simply a different form of accounting for an unaltered reality.

One of the arguments of my late father was that the UK needed an infrastructure plan set for obvious reasons a long way ahead. In many ways now would be a good time because the finance would be cheap but sadly we just seem to play a game of tennis as the ball gets hit from the private side of the net to the public side and back again.

 

 

 

 

 

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17 thoughts on “The problems of the Private Finance Initiative mount

  1. Hi Shaun
    PFI’s are generally hyper expensive and
    are in my view morally corrupt.
    As for your late fathers analogy I would
    suggest squash is the game, the walls are always
    there.

    JRH

    • Hi Kevin

      That would get even worse if we ended up with targets of the sort recommended by Olivier Brousse of John Laing. With my recent knee surgery I could not help thinking of infection rates especially after reading about what happened to Santi Cazorla of Arsenal but what would that have to do with any PFI structure?

  2. Yes indeed! PFI…..invented by the Tories, expanded colossally by New Labour, but always an expensive con which benefited their respective friends in the City, rather than the taxpayer. An utter disgrace from the start.

    • Hi Mickc

      The simple truth is that the objective is to keep the debt/deficit out of the national accounts until later. For that reason alone it needs looking into as whilst politicians are always loading bills on future governments these schemes do not seem balanced and fair.

  3. I think you’ve summarised the position very well here.

    However, I would question your assertion, in the penultimate para. that: “it is hard to make a case for it right now”. I think the problem is that the case is that we have structural budget deficit (one of the original reasons for PFI) and no-one has any idea of how to close it by palatable means hence the need to kick the can down the road continuously and get spending off balance sheet. However, between the venality of the private sector and the ability of the public sector the likely cost over time may well be far, far greater than it would be by traditional means which may be bad for the taxpayer but it does get the politicians out of yet another hole (for now) and we know who will win that battle.

  4. Mmmm nice investment at 6.7% per annum. Strange I’ve never seen PFI schemes publicised which might have given me an opportunity to invest!! Presumably they’re not available for we mere mortals?

      • ?? – https://data.gov.uk/sib_knowledge_box/ministry-justice-offenders-released-peterborough-prison

        In fact I was approached amongst others to invest in this PFI bond. One of the less esoteric targets , if I remember correctly was something like 50% of ex offenders had to re- offend less than 3 times over the next 5 years to be declared a “success”.. Being generally anti establishment I am certainly not in the establishment social group.

        I walked away because of civil service involvement in setting targets which appeared obscure, difficult to measure and didn’t seem to be really achieving anything as outlined in the link at paras titkled:
        1. Outcomes and prices to be paid for outcomes

        2. Impact measurement

        I later found out that there was a very poor response from private investors, unsurprisingly, so the establishment then went to the usual suspects The return was 13% if targets were met and I found out that it was deemed all targets had been met at the end of the bond with a good profit being paid out to investors, so I missed out on that, hey ho.

  5. One example of a PFI (in a way) that worked out well for the country was the Channel Tunnel. Mrs Thatcher (as she was at the time) was determined there wouldn’t be any public money put into the project. In times previous to her such infrastructure would have all been funded by the Government. Of course costs were much larger than anticipated for the project (although today it looks like a bit of a bargain) and the initial investors lost their shirts but we as tax payers got off scott free. This is how it should be, no guarantees of any return for PFI. Unfortunately the arrogant Blair and Brown didn’t really understand how it was supposed to work, and basically gave gifts to the financiers. In the case you quote, for instance, any Government guarantee of payment should at least be linked to gilt rates, then any windfall of a fall in rates is recovered.

    In terms of future deals, my ideal would be to have such projects funded by a national investment company, which the revenue is used to pay the state pensions. Once a large enough fund had been created, the current tax payer Ponzi scheme could be retired, and pensions paid out of the real income of the country. I could see most motorways converted to toll roads for instance. Then ideas like HS2 would have to be presented for investment to the pension board as sensible commercially before getting any funding. This would bring some much needed discipline to these infrastructure projects, which are often not properly costed or worked out.

    • Hi Chris A

      Your scheme does not sound light years away from what my father was suggesting. However there is a difference perhaps in terms of scale because to get another money to pay the state pensions you would need a lot of income from your projects. I like the idea of at least some financial discipline being applied though.

  6. I suspect there are areas where PFIs could be well used, though those from the late 90s and early noughties were just boondongles where everyone took a share at the greater expense of the tax payer.

    One advantage of PFIs for certain departments though is that they can’t be cut. Whilst this appears to break the notion that one parliament cannot bind the next it appears to hold true.

    For instance the Armed Forces financed much of their accommodation upgrades through PFIs, which gave them surety given the way their budgets work.

    Other projects though saw everyone either taking a cut or outright taking the piss. Picture the RAF contract for air to air refueling which stated that no other platforms could be used for the role. They paid the sticker price for the commercial aircraft when every airline knew the sticker price was merely the start of negotiations and discounts of 50% on it were more than possible. Also they decided to PFI all of the maintenance and support for the Tornado fleet, out to 2025. Rumours persist that due to the nature of PFIs we’ll carry on paying for Tornado maintenance six years after they’ve left service ( as it ws brought forward to next year).

    So admittedly the military is clearly crap at this, no susprises there given the MoD’s fearful reputation,but I would have thought there could still be some utility. With industry’s ability to borrow at very low rates and capital expenditure budgets a bit tense surely something along the lines of new ships ( which are likely to be in service for 30 years) being PFI’d would both guarantee them from defence cuts, shift the capex off balance sheet and help to regenerate local industry.

    A bt like defence industry QE with industrial benefits. So long as the kit is produced in country anyway ( unlike the tanker aircraft, or for that matter the A400 military transports which can also tanker but aren’t allowed to due to the PFI deal).

    On an unrelated point… Rumours of instability in Saudi very recently. If the oil price shot up to, say, $80 a barrel or more what would be the likely results on the eurozone?

    • Hi Chaffers

      Well one organisation would be pleased as the ECB would get some higher inflation figures.Beyond that though the economic news would be negative.Consumption would presumably be hit as the higher inflation reduced real wages. On the overall economy then the Euro area would be a loser as it is an energy importer on a large scale as this from Eurostat points out. Although it is for the European Union we get the general idea.

      ” Indeed, more than half (54.0 %) of the EU-28’s gross inland energy consumption in 2015 came from imported sources.”

      It would also matter what gas prices did….

    • PFI on a new ship would not disappear if/when a political decision was later made to scrap it (the Government would never think of selling them and even if they did the MOD would resist viciously on the grounds that military secrets may be learned by the potential buyer) due to manpower costs etc. You would then be left with a continuing PFI payment for a ship that no longer existed. The same problem exists with Government expenditure but PFI won’t address this issue unless you can get a ship builder to agree that in the event of the early retirement of said ship the PFI contract ceases to have effect immediately. Good luck with that.

  7. Your comment about the Battersea Park fireworks reminds me of a film released yesterday, The Florida Project. In that case it was a poor family watching the Disneyworld Orlando fireworks.

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