In yesterday’s budget, the UK Chancellor Philip Hammond announced that the government would be abolishing PFI schemes.
Short for Private Finance Initiative, PFI schemes were popularised under Tony Blair’s Labour government. They saw private companies take on the challenge – and risks – of delivering public projects such as schools and hospitals, with the state instead paying regular amounts over several decades following their completion.
Their abolition follows the high-profile collapse of construction giant Carillion, and the move has generally been welcomed by industry experts. But as both the public and private sector count their losses over PFI schemes, were they ever a good idea, and will what follows be any better?
The public sector view of PFI schemes
The vision behind PFI was always to lower the barrier of entry to public infrastructure projects, without needing to spent large quantities of government money up-front. However, this resulted in long-term problems and associated costs.
“PFI was always an accounting mechanism to get capital infrastructure upgrades without it appearing as increased government expenditure. The health, education and other sectors which participated are now paying for this with extended loans and high service costs,” explains Martin Ingham, an architect who worked on several PFI projects in the healthcare sector.
“The process financed middlemen; specifically legal teams and the financial institutions that provided the capital.”
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Despite being designed to help the public sector, critics say PFI was instead harmful, as evidenced by a number of recent projects.
“[PFI] was primarily a way of taking public sector borrowing off the books during a period of high interest rates, and transferring risk – and hence profit – to the private sector,” adds Russ Glennon, senior lecturer in management and leadership at Nottingham Business School.
“Much of the public sector found itself out-negotiated by the private sector. Recent failures such as Carillion have led to the government bailing out essential projects such as the redevelopment of the Royal Liverpool Hospital or the Bulwell and St Ann’s health centres.”
The problem with long-term contracts
In the majority of cases, private contractors not only took responsibility for the construction of public infrastructure, but its long-term operation, and it is here where the problems with PFI schemes became particularly acute.
“It is hard to get a clear picture, but the National Audit Office has suggested that potentially billions of pounds have been diverted away from delivering public services and into private profits,” says Glennon. “According to its latest report, PFI contracts cost between 2-4% more than other forms of government borrowing.”
“Insufficient consideration appears to have been given to running and operation costs with too much attention paid to getting a bespoke and over specialised design, rather than a flexible more generic multi use building,” adds Ingham. “As a result end users have found themselves out of pocket, tied to a very long term financial commitment, with a building that cannot be adapted to the changing needs of the service.”
As the long-term issues with PFI contracts became clear, this gave rise to further problems.
“The payment mechanism has penalty charges for any rooms not available or not meeting the original specification, so end users have been scouring the agreements looking for any aspects of the completed buildings that can be claimed not to meet the contracted specification, in order to get out of their financial commitments, making the sector very litigious,” explains Ingham,
“This has been complicated by the widespread selling on of PFI contracts, once the high risk construction phase has ended, and they have become packaged as financial portfolios of debt and finance, some profitable, others toxic.”
How PFI harmed the private sector
While much has been made of the harm PFI did to the public sector, it is important to note that it also caused significant problems for private companies involved in the bidding process.
In order to ensure value for money, private firms or partnerships were involved in extremely long bidding projects in order to be selected for the work. And this meant that those who were not awarded the final project wasted years of work without ever receiving payment.
“The bidding process was very lengthy and wasteful. Even efficient bid processes took three years and many had to wait through years of delay before being signed off,” explains Ingham.
“For every PFI hospital that went into production, bidding teams had produced at least three to a high level of detail and one would be to a full planning level of detail, in order to provide competition.
“This was incredibly wasteful and the costs of abortive work were never factored into the process.”
Is scrapping PFI the right move?
Given the problems with PFI schemes, it is perhaps no surprise that many have welcomed the decision to end PFI.
“The collapse of Carillion last year was a seismic event for the British business community, the aftershocks of which are still being felt. As such, Hammond’s decision to scrap PFI makes good sense,” says Mike Smith, director of Companydebt.com.
“At the time of its inception, PFI enabled the state to fund new public infrastructure without the government having to raise the money up front. That’s a little like the lure of cheap credit in that it feels good at the time and comes back to haunt you later!”
However, others feel that PFI should have been modified rather than scrapped outright.
“To abolish the use of PFI completely is a blunt instrument. Yes there were some that weren’t value for money but to effectively say they are all bad regardless of how they were structured isn’t correct,” says Michael Wistow, Partner and co-head of the EMEA tax practice at global law firm White & Case.
It is important, however, to remember that there was a value to PFI, notably the fact that many projects were built that would otherwise never have become a reality.
What comes next?
While the government has made it clear that there are to be no new PFI projects, something will need to come in their place. However, Hammons has remained silent on this front.
“Whilst the move away from PFI as a funding mechanism is broadly to be welcomed, it is not at all clear how the government will fund future public sector infrastructure, and this is a real concern,” says Glennon.
In particular, this lack of clarity could be highly damaging if it is not resolved soon.
“Hammond’s brief mention that he is ending Private Finance Initiatives with no explanation of what will replace these schemes could cause huge concerns for the private firms who currently conduct this kind of contract on behalf of the government,” says Jo Sellick, managing director of Sellick Partnership.
Whatever replaces PFI, it is clear that it will need to tackle the core concerns of its predecessor.
“Several credible studies show that private companies used PFI to make absurdly high profits, so whatever is brought in to replace it – and it’s likely the new version will still allow the private sector the opportunity to fund public infrastructure – should have stricter regulation in place to protect the public interest,” says Mike Smith, director of Companydebt.com.
For Glennon, however, the solution may simply be to go back to basics.
“Old fashioned ‘public borrowing and spending’ might be politically unpalatable, but it’s certainly better value for money.”