Mark Whitehead 01 February 2018

The PFI model

The PFI model image

The collapse of construction giant Carillion has left a terrible mess. Contracts unfulfilled, questions over why auditors gave it a clean bill of health, workers facing unemployment and a massively underfunded pension scheme.

So it's not surprising that some are now demanding an end to the Public Finance Initiative schemes of the kind that Carillion operated with local authorities, NHS trusts and others. The John Smith Institute think tank called for an end to the Government's 'love-in' with outsourcing and PFIs.

It marks the latest twist in a story going back to 1992 when the PFI model - a kind of public-private partnership - was invented by the then Conservative government and later enthusiastically picked up by Labour after its 1997 election victory.

The idea of the PFI is simple: instead of a government, local authority or other public body putting up the money for a project, it links with a commercial company which invests the resources needed. The deal then usually involves the same company managing the operation for a set period, often 25 or 30 years. For its part the public body pays an agreed amount every year for the life of the contract - at a relatively high rate of interest.

The PFI was seen as a way of harnessing the resources and expertise of the private sector to provide facilities the public sector could not provide on its own. It allowed government departments, local authorities and others to secure large sums to invest in popular projects such as new schools and hospitals without paying any money up front.

But since its inception the model has been controversial. Its supporters argue it is an efficient way of making use of the private sector to provide much-needed facilities. But its critics say it drains public resources which are channelled to private companies whose overriding motive is to make a profit.

What is unarguable is that the PFI and its recent successor PFI2 - essentially the same but with some modifications to create greater transparency - have generated large debts for taxpayers. In January the National Audit Office reported that there were currently more than 700 PFI and PF2 deals with a capital value of around £60bn and annual charges amounting to £10.3bn in 2016-17. Even if no new deals are entered into, the NAO said, future charges which continue until the 2040s amount to £199bn.

The NAO concluded that the higher cost of borrowing in the private sector - public bodies can borrow more cheaply because they offer greater security - together with a range of other factors means that PFI deals are more costly than publicly-financed alternatives. It looked at a group of schools in which the PFI deal was estimated to be about 40% higher than a purely public sector deal, and quoted the case of a hospital which had been 70% more expensive than if it had been operated in the public sector.

However, there are potential benefits to the PFI model. As the NAO points out, it can mean more efficient project delivery, while transferring risk to the private sector can result in benefits which outweigh the higher cost of finance. PFIs can offer greater certainty about the final cost of a project and more efficient management.

The NAO said the state should use its huge buying power to obtain better deals from the private sector. But crucially it recommended that public sector bodies should develop their skills to avoid being outwitted by their private sector counterparts. ‘Public bodies often do not have the in-house capability or expertise to effectively manage and identify savings from complex PFI contracts,’ it said.

The point was backed up recently by the Institute for Government. Councils, it said, often do not have the expertise they need to deal with contractors and investors. It means they risk making decisions without understanding their implications.

Some of the reported outcomes of PFI deals look very much like the results of poor procurement practice which would be risky in any negotiations. Dealing with complex, expensive and long-lasting PFI contracts without experienced and highly expert procurement expertise is a risky business.

In the light of the Carillion episode it seems likely councils will be thinking very hard before entering into PFI deals in the near future. But if they do, it will be worth checking if they have the procurement resources to deal with hard-headed negotiators from big companies, backed by massive legal and technical resources aimed at securing secure the best possible commercial deal.

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