Public projects obscured by private finance

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From the start, PFI conflated the desirable aim of exploiting private sector management skills in project supervision with the undesirable aim of obscuring public finances with complex funding structures. It created an industry of advisers with a vested interest in its own expansion.

Last week, the UK’s parliamentary public accounts committee published a damning critique of plans to widen the M25, London’s orbital motorway, under the private finance initiative . The proposal to outsource Britain’s air and sea rescue service under a similar arrangement collapsed amid recrimination. When finally unravelled, the complex story of the PFI may illuminate the murky – and to taxpayers costly – relationship between government, business and finance in the era of New Labour.

The PFI represented an attempt to adapt the methods of project finance – developed for activities such as North Sea oil exploration – to public sector infrastructure projects. Project finance was necessary because the industries concerned were better at managing projects than raising money. The government, however, was bad at managing projects but very good at raising money. Public sector projects have routinely been plagued by delays and cost overruns. But the government can borrow on the finest terms: it has all the resources of future taxpayers.

In the climate of the past two decades, it was perhaps inevitable that the bankers would dominate the engineers. Funding structures became more elaborate and complex. The iconic refurbishment of the Treasury’s own premises was undertaken under a PFI, which raised senior debt at 163 basis points above the government’s own cost of funds.

We do not have adequate information on the capital and operating cost of PFI projects, relative to those that would have been incurred by direct public procurement. The assertion that PFI projects came in under budget more often than directly procured activities is valid, and often made, but means little. Under PFI, cost escalation is built into the process at an earlier stage. The public accounts committee correctly judged that bids to maintain the M25, at far less cost than allowed for by the Highways Agency, demonstrated not shrewd purchasing but that the agency had little grasp of what it was doing. Infrastructure projects in Britain almost invariably come in towards the top in international comparisons of costs and there is no sign of general improvement.

There is no doubt, however, that the funding component of PFI projects has been expensive. The rate on the Treasury refurbishment illustrates the point. But the effect, and intention, was to take substantial volumes of government borrowing off balance sheet. Before pointing a finger at Enron or Greece, take a walk down Whitehall.

PFI contracts are inflexible. Schools and hospitals are locked into agreements that may last 30 years or more. This follows from insistence on bundling finance, capital procurement and facilities management into a single contract. Any change in requirements during that period must be negotiated with a monopoly provider who generally has little incentive to be economical or accommodating, as George Osborne, the chancellor of the exchequer, discovered when faced with a quotation for a Treasury Christmas tree so exorbitant that he went out to buy one himself.

Perhaps most seriously, PFI has not improved the public sector’s capacity for project management. Rather than learning to manage construction companies and facilities providers better, public agencies became expert at negotiating elaborate contracts and innovative debt finance. That is not a skill government needs. From the start, PFI conflated the desirable aim of exploiting private sector management skills in project supervision with the undesirable aim of obscuring public finances with complex funding structures. It created an industry of advisers with a vested interest in its own expansion.

The present coalition has agreed to end off-balance sheet funding and to observe international financial reporting standards. It should renegotiate or buy back many existing PFIs and adopt simpler structures to outsource much government activity and develop project skills while minimising the role of bankers and financial modellers.

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