The PFI: A Rip-Off?

The Private Finance Initiative: An Easy Way to Run up Long-term Debt for the Taxpayer?

The origins of this scheme are found in a pamphlet written for the Social Market Foundation by David ‘Two Brains’ Willets, called ‘The Opportunities for Private Funding in the NHS’. PFI was first announced in Norman Lamont’s 1992 autumn statement. The idea was to find a way of involving private companies in the funding of new schools and hospitals. PFI predicated that the private sector would build the new establishments and then run them for periods up to 50yrs with the taxpayer paying an annual ‘rent’ for the privilege. The political advantages were twofold: new schools and hospitals would come on stream; and because they were put up by the private sector, the expense would not count as ‘public debt’; something of which the exchequer in the early nineties suffered great excess.

However, there were problems.
i) It costs private companies much more-sometimes twice as much- to borrow money than government, meaning that these extra costs would need to be passed on to the taxpayer via annual premiums.
ii) The companies involved are guaranteed a high rate of income for decades meaning it’s a species of expensive ‘higher purchase’.
iii) There were no real risks taken by the private sector in that essential services have to continue- so the public sector in practice underwrites the schemes and in practice shoulders the risk.

David Craig, in his excellent polemic, Plundering the Public Sector, (Constable 2006), puts it thus:

‘All told, as is now becoming painfully clear in health and other services, the expenses that taxpayers (and the children of today’s taxpayers) become committed to under PFI vastly exceed the burdens imposed by traditional investment.’

Initially Lamont and Clarke were none too keen on PFI as they were aware of the potential for it to be too costly for too long. Clarke insisted companies should take the risks involved and deliver value for money. However, very few companies thought this viable and by 1996 there were only a billion or so worth of schemes in the pipeline.

Labour in 1997
In opposition Labour opposed the PFI robustly. Perhaps the most swingeing denunciation came from Harriet Harman:

‘When the private sector is designing, building, financing, operating and running the hospital, and employing the doctors and nurses, that is privatization and that is what the Conservative government are all about.’

Alistair Darling, also weighed in: ‘Apparent savings now could be countered by the formidable commitment on revenue expenditure in years to come.’

Labour critics insisted PFI was predicated upon an assumption –much disliked by the left and the centre too- that ‘private equals good: public equals bad’.

However, the one prominent Labour figure not to pour contumely on the scheme was Gordon Brown. As the incoming Chancellor, he faced the need hugely to expand investment in public service infrastructure without hugely increasing public borrowing. To retain City credibility, he set himself two ‘golden rules’:
1. Limit spending during ‘the economic cycle’ to no more than income.
2. Keep borrowing down to ‘a prudent proportion’ of GDP- in practice 40%.
Having inherited a debt of 45% GDP he could ill afford to allow too much of an increase. This is where PFI was such a seductively attractive scheme. Because its funding originated in the private sector it did not appear on the government books as debt.

But Brown faced a serious problem: PFI seemed a magical accounting conjuring trick, but business did not like it. So Geoffrey Robinson was put in charge of massaging the scheme to make it more attractive to companies. His innovations included:
i) Placing no limits on the level of profits to be made if financing suddenly became cheaper.
ii) Fewer risks were to be taken by the private sector with the public sector taking more. 15 kinds of risk were identified and each time one was detected a formula was applied to inflate the theoretical cost of the public sector alternative, thus making the bid more likely to be accepted.
Restraint by business soon turned into a rush of enthusiasm as the potential size of returns were calculated- in some cases margins of over 50%. The whole process was oiled by expensive consultants often brought in from KPMG, Deloitte and PwC. Ministers quoted ‘research’ showing nonPFI projects being 70% late and 73% over budget to make PFI seem more attractive. Craig calculates consultants stand to earn up to and over £5bn from PFI.

By 2006 PFI was central to the government’s strategy. Contracts worth £50bn had been signed with much more to come-see below. Taxpayers were committed to annual repayments of £7.5bn. Much of the repayments hit the NHS meaning current funding had to bear the annual cost of servicing the PFI debt. But similarly huge commitments have been taken on by Defence, Transport and Education

PFI: The Critique
Escalating Costs: Professor Alyson Pollock of UCL School of Public Policy has shown how costs increased dramatically from the ‘outline business case’ to the final figure: eg £90-£200m for the Norfolk and Norwich Hospital; Swindon Hospital from £45m to £148m.
Refinancing: Tarmac and Group4 noticed that money for PFI had become much cheaper as the markets realized PFI deals were so profitable. They were able to make £10.7m extra on top of the expected £17.5m they were anyway going to earn. In these situations the NHS receives back only a third of the ‘profit’ while the rest goes to the companies.
And even then they ‘receive’ it the form of reduced payments over future years. The PFI scheme for the Norfolk and Dartford Hospital produced windfalls of £33m and £115m with returns to investors of 56% and 60% respectively. Edward Leigh, Thatcherite chair of public accounts committee described it as ‘the unacceptable face of capitalism’. Certified accountant investigations into early PFI hospital projects 2000-2002 showed returns of 100% with similar ones for road projects. It showed how companies borrowed at 10% while public sector did so at 4.5% with the difference between the two covered by inflated risks carried by the private sector. British Medical Journal showed how ‘public sector comparator’ (PSC) was always cheaper than PFI figure until risk and optimism weightings were added when suddenly PFI looked marginally the better bet. And if they wanted the new service ‘it’s PFI or bust’ as Alan Milburn was quoted as saying when Minister of Health.

Poor Quality: Often hospitals were built with reduced bed space from what initially had been the plan. In addition faults were reported like sewage seeping into bathrooms and the temperatures reaching 110 Fahrenheit in the atrium of Carlisle Infirmary. Audit Commission reported in 2002 that the 25 schools it has inspected were ‘significantly worse’ and that PFI was not producing cheaper or quicker progress.

Unnecessary: Some hospitals were built to make money for constructors when old buildings could have been improved or refurbished. Kidderminster hospital was to be closed to make way for a PFI one of lower status but Dr Richard Taylor was elected to Commons to stop this. In the end his effort was over-ruled. Taylor complained re his trust having to pay back so much PFI money that wards were being closed.

Contracts: Prisons could be wholly privatized under PFI but costs cut through cutting wages of guards-30% less than the publicly employed ones- not through efficiency of building process.

Payments: Craig maintains that the arithmetic of PFI began to work to the disadvantage of the NHS.

‘Hospitals would compete for the ‘business’ of treating patients and be paid largely according to how successful they were in attracting the sick, while expenditure on huge PFI deals was fixed for a generation regardless of how much use they had for the facilities.’

Percentage National Debt: Writing in The Guardian 30/11/06, Kelvin Hopkins MP, questioned Brown’s ‘golden rule’ of an around 40% of GDP borrowing limit.

‘The latest available international comparisons from the OECD show that Britain has kept government borrowing (at 44% of GDP) well below that of the successful Scandinavian economies(Demark 53%, Sweden, 63%) and even further below those of major euro-zone countries (Germany, 68%, France, 75%). Us borrowing (64%) is also well above Britain’s and japan (156%) is off the scale. In some of these countries there have been economic difficulties, but none have experienced anything like economic disaster. For example Sweden’s rate was 18% above UK’s yet GDP in that country was 3.7% compared with 3.2% in UK. There is no reason why our government could not have borrowed far more for public investment instead of straining to keep investment in the private sector.’

Hopkins points to the illogic of using a device to limit public debt which increases the risk of current account deficits. Private has been more costly than public:

‘Private estimates suggest that the recent cost of track renewals is between four and five times what it was under public ownership.’ Hopkins calls for an abandonment of PFI and the reintroduction of ‘public borrowing as the basis of public investment’.


Chickens Home to Roost?
By the end of 2005 increasing numbers of trusts were running up unsustainable deficits. Queen Elizabeth Hospital Greenwich warned its deficit for 2005-6 could rise to £100m if its PFI burdens –which had increased costs by 300%- were not restructured. UC Hospital reported very similar things. Craig believed that Dept of Health had twigged PFI did not work by end 2005 and had halved prospective PFI deals signed off- a ‘reappraisal’ was being carried out. By this time 725 PFI projects had been signed with many more in the pipeline. But by then the total coast of schemes had increased to £140bn. Local authorities have plundered the PFI mechanism using it to fund street lighting, libraries and schools. After ten years of PFI Norman Lamont surveyed it and declared: ‘It was never intended to be a way of simply finding alternative finance and I think it is dangerous because the reality is that private finance is more expensive’. It is hard to avoid the conclusion that the Labour PFI initiative, borrowed and elaborated upon an original Conservative idea, has proved to be a monumental disaster to add to its other less than successful policy forays.