Private sector, public benefit: Labour will never make the dream of free finance without taxation come true, says Rupert Darwall

GORDON BROWN, the shadow Chancellor, would have us believe that Labour is outbidding the Government with its proposals to mobilise private finance to invest in the public sector. But the reality is different and reflects incompatible philosophies between the two parties. This is summed up in Labour's attitude to privatisation. For Labour, privatisation is something to be sneered at: witness yesterday Mr Brown talking of 'the complete irrelevance of Tory privatisation dogma'. For the Government, privatisation is one of its few unalloyed successes: a bold, innovative policy that was good on paper and works in practice, delivering better services at lower cost.

The Government's private finance initiative is about extending privatisation to the remaining parts of the public sector. With the exception of the Post Office, virtually everything in the public sector which is capable of making a profit has been privatised.

But there are plenty of activities - from owning and operating motorways to managing prisons - which do not necessarily make a profit but would benefit from the adoption of a commercial approach. In some cases that means the Government has to make a large grant, reflecting a project's wider benefits, for the investment to be profitable and thus attractive to investors.

And this is where there has been a breakthrough, so that projects such as the new rail line to the Channel tunnel can be transferred to the private sector. In other areas it means extending the principle of contracting out services, the NHS being a prime example. The purpose of all this is to raise efficiency and thus improve the quality of investment in the public services.

Labour's aim is quite different. It is about maximising the volume of spending without increasing public borrowing. That is why Mr Brown has called for 'a new approach to the PSBR'. But one thing is guaranteed: the shadow Chancellor will not make every finance minister's dream of free finance without taxation come true. Whether spending on public services is 'on-budget' or disguised, it still has to be paid for.

Here the private sector has a great deal to teach the public sector. In the Eighties many companies had ambitions greater than their borrowing capacities and so built up liabilities that were not disclosed on their balance sheets. But debt has to be paid for, whether you can see it or not, and the unexpected collapse of some companies was due to the presence of hidden liabilities. Even if companies wanted to do this again, it is more difficult because the disclosure rules have been tightened up. Labour wants, in contrast, to relax the rules for the public sector.

While it was shareholders and banks that lost money in these collapses, when public spending is taken off-budget it is the taxpayer who still picks up the tab. With the exception of export guarantees, Britain is fortunate that its public finances are straightforward. What you see is what you get. Central control of public borrowing may cramp the style of state-sector managements, and it is tempting to shuffle off debt into state-owned companies; but it does mean that there is clarity in terms of what the taxpayer can afford. The solution to the dilemma of Treasury control of nationalised industries' borrowing is to become private, which is precisely why BT was privatised - the first of the large-scale privatisations.

Some other European countries take a different approach. In France, nationalised industries carry enormous debts. The cost of France's nuclear power programme is reflected in Electricite de France's debt of FF162bn ( pounds 19bn), while the burden of financing the TGV network leaves SNCF with more than FF118bn ( pounds 14bn) of borrowing. This indebtedness is backed by the French government and eventually the customer has to pay higher prices; or the French state has to step in and recapitalise the debt before it gets to this point. Either way, it is still disguised spending, which is why the French government maintains a tight administrative reign on its public sector enterprises.

Because the taxpayer stands as the ultimate guarantor of public sector investment, it is particularly unwise to encourage public sector 'entrepreneurship' and, as Mr Brown has argued, 'give the public sector the freedom to innovate in order to get things done'. The problem is that the incentives for success and penalties for failure are completely different from those in the private sector.

Unlike lending to a private firm, government guarantees completely insulate banks from the consequences of financial failure, and so they have an incentive to lend as much money as they can. For this reason the fundamental principle underlying the Government's approach is that the private sector assumes risk when it provides finance, otherwise lenders are simply getting a free ride from the taxpayer.

It is true that the Government's private finance initiative has taken time to gather momentum, but the time has not been wasted. The largest project, the Channel tunnel rail link, is a much better project than it was, despite having assumed a totemic significance, symbolising the modernity and achievement of the French state in contrast to the fumbling, haphazard British. The sense of inferiority this induces is misplaced. SNCF may have the fast trains, but InterCity is the most efficient railway in Europe.

The route adopted by the Government was promoted by the private sector and is better than BR's original proposals, and the project is considerably less expensive than it was. And it is easily forgotten that the case for the new line, and the large contribution from the Exchequer, is not simply about higher speeds. It would be difficult to justify a pounds 2.5bn investment for the sake of 30 minutes off London-to-Paris journey times. It is about creating extra capacity to relieve pressure on London's airports and Kent's roads.

Labour does not see the link between finance and risk, and thus the need for the private sector to own the activities for which it has responsibility. Ownership does make a difference. Just ask the builders of the Channel tunnel whether they would have preferred to have had the Department of Transport as their client, rather than the man who is now at Kenneth Clarke's elbow, Sir Alastair Morton.

The author is a former special adviser to the Treasury.

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