PFI: What are Private Finance Initiatives, will they really cost the taxpayer £200bn and is it finally time to get rid of them?

Carillion’s most recent annual report shows that it received around £253m in 2016 from various UK public private partnerships, mainly made up of PFIs

The UK’s spending watchdog, the National Audit Office (NAO), released a new report on Thursday which highlights a lack of evidence that Private Finance Initiatives (PFIs) offer value for money for taxpayers.

It follows the collapse of the construction and services firm Carillion earlier this week, which has shone a bright spotlight on state contracting and outsourcing.

Labour have seized on both developments as vindication of its plans to cancel PFIs and bring them “in house”.

So what is PFI? What’s the rationale for it?

How much is it costing us? How does it relate to the Carillion fiasco?

And is it finally time to get rid of it?

What is PFI?

It’s essentially a way for the state to finance and then look after new infrastructure.

The traditional way for the government to build a new piece of infrastructure, such as a hospital, a school, or a new road bypass, was to raise the money in taxes, or borrow it from the bond markets, and then pay builders to deliver the project. After that, the public sector would own the asset.

But under PFI the state commissions a builder to deliver the project. The builder then borrows from the bond market to finance the construction.

The state then pays the builder (or a separate company that buys out the contract) regularly to effectively lease the building or piece of infrastructure over several decades.

The theoretical justification for PFI is that the private sector is more efficient at delivering and managing infrastructure projects than civil servants. PFI also supposedly transfers the financial risk of a construction project over-running from the public to the private sector.

Another benefit sometimes cited is that PFI financially incentivises builders to improve the quality of their work too, since they will be the ones maintaining the asset after construction.

When did PFI start?

The first PFI was launched by the Conservatives in 1992.

But use of the financing schemes exploded under the previous Labour government.

At the turn of the millennium there were more than 60 new projects being signed-off every year.

But the number has fallen back sharply since then. There were fewer than 10 in 2015.

According to the latest Treasury data there are 716 projects (of which 686 are operational) with a capital value of just under £60bn.

Of this total the Department of Health was responsible for £13bn, the Ministry of Defence £9.5bn and the Department of Education £8.6bn.

What is PFI costing us?

Many cite the total value of all the repayments due, which amounts to around £200bn.

But this is not really a useful way of estimating their financial burden on the state.

For that we need to look at annual payments. The value of all payments to PFI contractors is currently around £10bn a year, which is around 0.5 per cent of GDP.

This outlay is expected to glide down to around £9bn a year by the end of the next decade.

Thereafter such payments are projected to drop steadily to zero by 2050.

What’s it got to do with Carillion?

Carillion was a significant holder of PFI contracts.

The firm’s most recent annual report shows that it received around £253m in 2016 from various UK public private partnerships, mainly made up of PFIs.

These range from upgrading a road in Aberdeen, to building a new hospital in Liverpool, to maintaining a host of school buildings in Leeds and Durham.

What do Labour want to do?

The Shadow Chancellor John McDonnell has said a future Labour government would review all contracts and bring such schemes “back in-house” if necessary.

The Labour leadership regard PFI as part of an ideological project to strip back the size of the state, enrich private corporations at the taxpayer’s expense, and, ultimately, to hollow out public services.

What do the Tories say?

Though PFI began under the Conservatives, they were intensely critical of Gordon Brown and Tony Blair’s much expanded use of the funding method, viewing it as a way for the former government to conceal the true scale of public borrowing in the 2000s.

Something called “PF2” was introduced by the former Conservative chancellor George Osborne and presented as a major improvement on Gordon Brown’s schemes.

Yet, as the NAO states in its report, PF2 is essentially the same as its predecessor in all important respects.

The reality is that PFI is politically friendless, which explains why it being used much less these days, although there’s still, of course, a large legacy of contracts and payments.

So is it value for money for taxpayers?

There are certainly many individual examples of what seem to be bad value-for-money contracts for taxpayers.

Former Prime Minister David Cameron claimed in 2011 that one hospital was being charged £333 by the PFI service provider to change a lightbulb.

In 2014 an NHS Trust in Northumbria bought out its PFI contract in order to save money.

Some have argued in recent days that the fact that PFI providers have encountered financial difficulties implies taxpayers have actually been getting quite a good deal (although the additional public costs involved in re-letting Carillion’s contracts after it went bust diminish the force of this argument).

But the main point made by the NAO is that there has been no systematic evaluation of all PFIs commissioned by the Government so the fact is that we don’t really know.

PFI certainly costs more relative to ordinary infrastructure investment because private companies have to pay more than the state itself to borrow from the capital markets.

The question is whether PFIs actually deliver the project more efficiently and to a higher standard to justify that premium.

There is certainly no compelling evidence that this is the case.

The NAO’s report also notes that the US and Germany compare the cost of private finance with ultra-low state borrowing costs when considering whether to go down the PFI route.

But our own Government’s value-for-money assessment compares it instead with something called the official “discount rate” of 3.5 per cent, which is significantly higher.

Essentially, that implies the decision-making process of officials has been unduly biased in favour of PFI relative to the conventional infrastructure investment model.

Whether or not we should end PFIs altogether and the state should seek to buy out the existing contracts, it’s hard to disagree with calls for a comprehensive, rigorous and independent review of the performance of the contracts that have actually been written over the past 25 years.