Why was PFI so popular in the 2000s?

19 January 2018

Andy Burnham: “We shouldn’t have been told ‘PFI or no hospital’ [when Labour was in government].”

David Dimbleby: “Who told you that?”

Andy Burnham: “That was the Treasury.”

Howard Davies: “Treasury officials have never liked the PFI. I was a Treasury official myself. They never liked PFI.”

BBC Question Time, 18 January 2018

We can’t say what Treasury officials may have thought or said about Private Finance Initiatives (PFIs) off the record, but there’s still plenty of evidence for the position it has taken publicly.

PFIs were seen as the only viable option for funding construction projects among some public bodies in the 2000s—and were widely used across government departments compared to today—which is the point that Mr Burnham is getting across.

The Treasury’s official guidance has stressed that PFIs should only be undertaken if they’re seen as delivering value for money, but it’s clear that many public bodies may have been taking other considerations into account as well.

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What are private finance initiatives?

A PFI normally happens when a public body wants to build something like a school, hospital or road, and decides to fund it through private finance rather than with money it normally gets from the Treasury.

When PFI isn’t used—in fact more than 90% of the time—the Treasury raises money itself through taxes or borrowing and allocates a budget to the public body. The public body then pays a contractor to build the project.

In a PFI, the government doesn’t pay the upfront cost. A private finance company raises the money, mainly through its own borrowing, and also tends to be responsible for some of the design, operation and maintenance of the project. The public body is effectively the purchaser of the services, leasing from the private provider.

The government ends up paying for the project later, in annual payments over a period of typically 25 to 30 years.

PFIs tend to cost more than the alternatives, so the official test is whether they deliver value for money

As the National Audit Office (NAO) summarised yesterday: “In general, HM Treasury discourages public bodies from borrowing privately”.

The Treasury’s own guidance says that: “Public sector organisations may borrow from private sector sources only if the transaction delivers better value for money for the Exchequer as a whole. Because non-government lenders face higher costs, in practice it is usually difficult to satisfy this condition unless efficiency gains arise in the delivery of a project (eg PFI)”.

PFIs do usually cost more in the long-run than in publicly funded projects. That’s mainly because it tends to cost private companies more to borrow money than it does for the government, and the interest on the annual repayments adds up to a lot more over several decades.

At the same time, there are potential advantages to PFIs. One of the main perceived benefits is that they transfer the risks associated with construction—like running over time or budget—on to private companies, because they’re the ones funding the construction upfront.

The evidence on whether PFIs deliver more efficient, high quality services isn’t clear-cut. Both the NAO and the Institute for Government think tank have highlighted a lack of data on the benefits and drawbacks of using PFIs. The NAO presents some recent research showing a mixed picture.

But PFIs were still widely seen as the “only game in town”

If PFIs were chosen based on value for money in theory, there’s a lot of evidence this wasn’t always the basis in practice.

The House of Commons Treasury Committee found in 2011 that in many cases: “there is an incentive for both HM Treasury and public bodies to present PFI as the best value for money option as it is often the only avenue for investment in the face of limited departmental capital budgets.”

Several public bodies told the Committee that PFIs were seen as “the only game in town” in the 2000s, due to the lack of alternative sources of funding.

Another reason PFIs may have been popular is the way they appear—or don’t—in the government’s accounts. Most PFI debt the government takes on is recorded as off-balance sheet—in other words it doesn’t show up alongside most other spending or debt figures in the national accounts.

As the Office for Budget Responsibility (OBR) commented in 2014: “this generates a perception that PFI has been used as a way to hold down official estimates of public sector indebtedness for a given amount of overall capital spending, rather than to achieve value for money.”

These considerations aren’t supposed to be part of the decision to sign up to a PFI, according to the Treasury itself and others. In practice though, it does seem to have been an incentive.

The Treasury Committee heard from an expert in the construction industry in 2011 that there were “clear examples” in the 2000s where “there was a distortion in the structuring of deals in order to achieve a particular accounting treatment”, although he went on: “hopefully, we are moving beyond the world in which the off balance sheet tail was wagging the value-for-money dog”.

In interviews last year the Institute for Government heard cases where the Treasury had encouraged the use of PFIs for this reason. However, given the more limited use of the finance since 2012, it commented that “the strength of this accounting pressure is therefore questionable”.

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