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PFI discredited by cost, complexity and inflexibility

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PFI discredited by cost, complexity and inflexibility

Private finance initiative

PFI discredited by cost, complexity and inflexibility

Innovative model for providing public infrastructure has fallen out of favour

PFI was used to fund the building of hospitals, including the new Queen Elizabeth Hospotal in Birmingham, and schools across the UK © FT montage; Getty Images

The Labour party’s plans to nationalise assets developed under the private finance initiative have focused renewed attention on PFI as a means of providing the UK with critical infrastructure.

Under PFI, companies not only construct infrastructure such as schools and hospitals, but they also take responsibility for financing the projects, and then maintain these assets over their lifetime.

Why did PFI rise in popularity with UK governments?

Started in 1992 by John Major’s Conservative government, PFI was seen as a way of bringing private sector discipline into public infrastructure projects.

There were good reasons for wanting to do this. Ministers had long shuddered at the horror stories of traditional infrastructure projects, which were designed, financed and operated by the public sector even if they were mainly built by private contractors. These projects kept going wrong. Budgets were bust, the assets produced were often of poor quality, and there was little incentive to maintain them properly.

A Treasury document from 2003 outlined a catalogue of failures. The Jubilee line extension on London’s Tube network was completed two years late and ran £1.4bn over budget. The cost of a Trident submarine berth for the Royal Navy at Faslane docks in Scotland tripled in costs and was completed two-and-a-half years late. “Only 30 per cent of non-PFI major construction projects were delivered on time and only 27 per cent were within budget,” concluded the Treasury.

The bad reason for PFI’s expansion was that Tony Blair’s Labour government rigged the rules so that well-run public alternatives could not compete. Especially in education and health, PFI was the only game in town because the debt used to finance the infrastructure was classified as a private sector liability and kept off the government’s books. As time passed this was the only way that Gordon Brown, the chancellor at the time, was able to comply with his fiscal rule that public debt could not exceed 40 per cent of national income.

How big did PFI become?

In March last year, 716 PFI projects were left outstanding, concentrated in defence, education, health and transport, with a capital value of just under £60bn.

Use of PFI had peaked in 2006. As the financial crisis took hold, the number of new PFI projects shrank rapidly and by 2010, and the advent of David Cameron’s coalition government, the initiative went rapidly out of fashion. The most recent data for the year to March 2016 show that only two new projects have been added.

Private finance chart 1

But few new PFI deals does not mean Britain can forget about the initiative. PFI contracts will be a significant expense for the government until the 2040s, given that deals with companies to provide and then maintain infrastructure often last for 30 years. Charges paid by the government to these companies are currently just over £10bn a year, and will decline to little more than zero by 2050.

Why did PFI fall out of fashion?

Three things killed PFI. In 2008, the financial crisis destroyed government finances such that public debt burst through the 40 per cent of national income ceiling. Once Mr Brown’s fiscal rule was broken, there was little incentive to strain every sinew to secure new infrastructure using PFI.

Second, the financial crisis also significantly raised private sector financing costs and limited the availability of funds, even on government-backed projects.

Third, early PFI projects were shown to be poor value for money, giving equity investors windfall gains not commensurate with the risks they had taken.

Private finance char t2

What were the drawbacks of PFI?

Inflexibility, complexity and costs.

In 2010, the then chancellor George Osborne revealed the difficulties he faced in deciding to buy a £40 Christmas tree from the retailer B&Q for the Treasury rather than stick with the £900 arrangement specified in the department’s PFI contract for it.

More seriously, schools and hospitals found themselves tied into uses for new buildings that became obsolete, but were extremely difficult to change with PFI contractors.

The tendering and financing of PFI projects were slow and opaque, adding to questions over value for money.

What is PF2?

PF2 is an updated version of PFI introduced in 2012 to address many of the problems raised by critics.

Among other things, PF2 was meant to ensure increased contract flexibility, more transparency and better risk allocation. The revamp has not borne fruit, although the Treasury is keen to finance new infrastructure through PF2.

Without PFI, what happens to UK infrastructure?

PFI was never the primary means of delivering public infrastructure — this role remained with the state.

At its highest point in 2000, PFI represented only 16 per cent of public sector gross investment. By 2015, this figure had dwindled to 1.3 per cent.

With the government’s proposed investment in infrastructure set to rise gradually as a share of national income over the coming years, a revival of PFI is no longer mission critical.

Private finance chart 3

Letter in response to this article:

Sir Keith Joseph warned that PFI was a bad deal / From Malcolm Levitt, London, UK

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