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The Private Finance Initiative (PFI) was announced in the 1992 Autumn Statement with the aim of acquire closer partnerships between the public and private sectors. It was one of a range of policies introduced by the Conservative Government to increase the involvement of the private sector in the provision of public services. Following two reviews of the PFI by Sir Malcolm Bates, the present Government has continued to pursue the delivery of some public services through this means.
PFI entails transferring the risks associated with public service projects to the private sector in part or in full.
The PFI has meant that more capital projects have been undertaken for a given level of public expenditure and public service capital projects have been brought on stream earlier.
What is the Private Finance Initiative (PFI)?
The Private Finance Initiative (PFI) was announced by the then Chancellor, Norman Lamont, in the 1992 Autumn Statement with the aim of increasing the involvement of the private sector in the provision of public services. The PFI is a form of public private partnership (PPP) that marries a public procurement programme, where the public sector purchases capital items from the private sector, to an extension of contracting-out, where public services are contracted from the private sector. PFI differs from privatisation in that the public sector retains a substantial role in PFI projects, either as the main purchaser of services or as an essential enabler of the project. It differs from contracting out in that the private sector provides the capital asset as well as the services. The PFI differs from other PPPs in that the private sector contractor also arranges finance for the project.
Types of PFI projects
Under the PFI three broad types of projects can be identified: free-standing projects, joint
Ventures and services sold to the public sector.
The private sector undertakes a project on the basis that costs will be
recovered entirely through a charge for the services to the final user, for example the Queen Elizabeth II (Dartford) Bridge.
Joint ventures are projects to which both the public and private sectors contribute, but where the private sector has overall control. In many cases, the public sector contribution is made to secure wider social benefits, such as road decongestion resulting from an estuarial crossing.
Services sold to the public sector
These are services provided by the private sector to the public sector, often where a significant part of the cost is capital expenditure. For example:
a private sector firm selling kidney dialysis services to a hospital;
the private sector providing accommodation and day-to-day care for the elderly; or
the provision of prison places by the private sector through designing, building, financing
and operating new prisons.
The public sector purchaser needs to be assured that the value for money of obtaining services in this way is better than the alternatives. Contractual arrangements must be on a commercial basis and not involve the public sector in underwriting the asset's use by other customers.
The Ryrie Rules
The Ryrie Rules were formulated by a National Economic Development Council (NEDC) working party in 1981 under the chairmanship of Sir William Ryrie, then Second Permanent Secretary to the Treasury. The Rules sort to establish criteria under which private finance could be introduced into the nationalised industries. The Ryrie Rules said that:
decisions to provide funds for investment should be taken under conditions of fair competition with private sector borrowers; any links with the rest of the public sector, Government guarantees or commitments, or monopoly power should not result in the schemes offering investors a degree of security significantly greater than that available on private sector projects;
such projects should yield benefits in terms of improved efficiency and profit from the additional investment commensurate with the cost of raising risk capital from financial markets.
The PFI helps government overcome a perceived fiscal dilemma: it enables the government to increase public investment through higher capital spending while maintaining a tight fiscal stance. The 2001 FSBR highlights the two fiscal rules, against which the performance of fiscal policy is currently judged:
the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending.
the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. Other things equal, net debt will be maintained below 40 per cent of GDP over the economic cycle.
Does the PFI offer value for money?
Proponents of the PFI argue that it is an improved form of public procurement that, under the right circumstances, yields efficiency savings and greater value for money for public services than projects that have traditionally been wholly dependent upon the public sector for finance and management. Under such qualifications, the PFI provides better value for money by transferring risk, achieving lower construction costs, lower operating costs and perhaps more efficient maintenance in the long term, than comparable public sector projects.
Advantages of PFI.
Advocate of the PFI argue it is advantageous for a number of reasons.
It is suggested that the main advantage of a PFI is its 'value for money. This concept cover the idea that although it is more expensive for the government to use private finance than borrow the money directly, efficiency gains in the private sector absolve those of the public sector. This, therefore, negates the extra cost of run into debt.
In Julian Le Grand's paper 'Competition, Co-operation or Control?' he talks of 'Knights and Knaves', explaining the inherent differences in motivation between the private and public sectors. In studying the 1981 NHS reforms, Le Grand documented that NHS workers were more interested in forming long lasting relationships within the new internal market and were adverse to competition. It is hoped that through PFIs the NHS will benefit from private sector management and expertise, which under the pressure of market forces and competition, will lead to positive, fresh ideas and innovation. (reference Julian Le Grand's Paper)
A further argument in support of the PFI is the transfer of risk away from the public sector to the private sector. The risks transferred include both design and completion risks. This is viewed as advantageous because the private sector is thought to more efficient at handling certain risks.
Most NHS hospitals were built before the occurrence of the NHS in 1948. By using the PFI model of achievement, outdated Victorian infrastructure in the NHS can be Replaced. New ways of working, and new approaches to service delivery the public Sector defines the service to be delivered, but it is for the private sector partner to decide how to deliver it.
Adversary of the PFI argues the following.
The rate of interest at which a company may borrow reflects the level of risk associated with that loan. With confined amounts of risk a company can borrow close to the base rate, which is termed by economists to be the risk-free rate of interest.
One argument against PFI hospitals is that they are simply too expensive. In PFI hospitals in Durham and Hertford the projected number of beds is suspected to fall by up to 40%. The largest PFI hospital project so far is to be in east London.
Hospital services will be planned by private companies, not by health authorities, and they will provide as many beds as profitable. These companies will want to build new hospitals to make big profits. They will be very much keen to build big hospitals to make big profits. They will be much less keen to build smaller locally accessible community facilities.
The PFI system is heavily criticised for the commercial confidentiality that is commanded by the private consortiums as this obscures accountability, and makes it difficult to compare publicly financed and privately financed schemes.
High bidding costs
Private partners have often criticised the high cost of organising bids for PFI projects. It is argued that private sector contractors who tend for PFI project bids have to cover higher 'front-loaded costs when drawing up detailed specifications and contract terms than when preparing bids for public services projects under conventionally tendered contracts. There is little hard evidence for the cost of the tendering process as it is usually considered confidential.
Are PFI projects specific to the UK?
Various forms of PPP are being used by Governments around the worlds. Some countries, such as France and Spain, have a long history of public and private sectors working together, with France concession set up as far back as the 16th century. In Europe, Portugal, Spain, Ireland and Netherland are at the forefront of PPP procurement. These countries have recognised PPP as an integral part of national infrastructure development.
Outside of Europe, the most active PPP markets are Canada, the Middles East, South Africa, Japan and Australia. The arrangements of the PPP models involve a range of different relationships including privatisations, outsourcing and private financing.
Public finance and the PFI, Has the PFI increased Public Expenditure?
Before the late 1980s, increased PFI spending occurred alongside planned falls in public sector capital spending, leading to suggestions that some public sector investment was being displaced by PFI spending. By retiring the Ryrie Rules in 1989 it seemed that the Treasury was introducing an additionality principle into public sector projects (funding from the private sector should be additional to public sector funding and not instead of it).
The new policy was clarified further in the 1990 Green Paper New Roads by New Means: There has been much misunderstanding about additionality. many have claimed that privately funded schemes must be additional to those funded by the Exchequer if private finance is to attract the construction industry.
The private financing of a scheme already in the road programme, and for which public expenditure resources have been allocated, will not free that public expenditure for other projects. For these reasons the Government, in roads as in other fields (such as housing), has to take account of the provision being made by the private sector in considering the size of its public sector programme. But it is not practical - the timescales are wrong - in the great majority of cases to decide whether individual schemes are additional or not. The Government therefore gives the assurance that it will not subtract privately financed roads from public sector provision on a scheme-by-scheme basis. The Government believes that in practice private sector schemes will provide the opportunity for more roads than would otherwise have been built.
According to the 1995 Red Book, the government's net capital spending programme over the planning period 1995-96 to 1998-99 public sector capital expenditure was set to fall by £2.5 billion. Department of Transport, New Roads by New Means, Cm 698, 1990
Table: Public sector capital expenditure
Further refinancing of PFI projects
A recent article in The Observer attacked refinancing as 'robbery of the public by the private sector. The article detailed some PFI projects where the authors believed refinancing deals were "currently being worked on" which included:
The £133m, 423-bed new Dartford & Gravesham hospital in Kent, developed by Carillion, United Medical Enterprises and Innisfree, a specialist PFI investment fund.
A similar process is to be under way at another hospital, the £67.5m, 424-bed Hairmyres in East Kilbride, being run by contractor Kier and Innisfree.
The Bridgend prison project in South Wales will see WS Atkins, Securicor
and construction giant Skanska scoop close to £5m by refinancing a
£77.5m loan at a 4 per cent cheaper rate.
Five prisons run by Premier Prison Services - a joint venture between
controversial US security giant Wackenhut and facilities management
outfit Serco - is thought to have yielded a £7m windfall by bundling
together separate loans totalling £185m.
The £241m scheme to redevelop an 11-building estate owned by the Inland Revenue in Newcastle stands to make millions for the consortium involved, which includes Amec and Interserve. The main debt - £168m loan arranged by Royal Bank of Scotland - is being refinanced, and the increased returns are being spread over the life of the contract.
Road projects are also involved. Investment banker ABN Amro is organising refinancing of the pounds 268m link road between the A1 and M1 near Leeds, Yorkshire.
In the schools sector, Jarvis has refinanced the 1,060-place Colfox secondary school in Dorset in 1999, and the Barnhill School in Hillingdon, west London.