TCS Daily

Private Money, Public Good

By Jonn Elledge - June 26, 2006 12:00 AM

Britain's infrastructure and public services have long suffered from underinvestment. The fiscal chaos of the 1970s was followed by a decade in which the Thatcher government's first priority was to fight inflation -- and this meant cutting spending. But tightening budgets inevitably meant less money for investment. By 1997 the backlog of repairs needed in schools and hospitals alone was worth £10 billion ($18 billion).

When the Blair government came to power in 1997, one of its main priorities was to tackle this backlog. In an effort to attract private-sector investment, and to bring greater efficiency to an ambitious program, it turned to a device created by the Conservative government of the early 1990s: the private finance initiative (PFI).

PFI is roughly analogous to a mortgage, except that the bank also builds the house and does your cooking and cleaning for you. After a competitive bidding process, a private consortium consisting of investors, banks and construction companies is awarded a contract to design and build a facility such as a hospital. Once construction is completed, the consortium owns and manages the facility, and provides services such as catering and cleaning on long-term contracts. The government pays for both the building and these services through a single annual payment. When the contract ends, the public sector takes ownership of the facility.

To call PFI controversial would be something of an understatement. Critics have described it as an accounting trick, intended mainly to keep government borrowing off balance sheet and make public finances appear better than they really are. The length of PFI contracts has also come in for criticism: population shifts may leave the government a choice between paying for services it doesn't need or facing massive termination payments.

What's more, some projects have undeniably gone wrong. Cumberland Infirmary, the first PFI hospital, quickly became famous for its design flaws, such as a non-air-conditioned glass atrium which had a nasty habit of turning into a microwave every time the sun came out.

Such errors, combined with the massive profits made by PFI companies, have helped turn the initiative into one of the British media's favorite whipping boys. Guardian correspondent George Monbiot has described PFI as "our very own Enron." Nor has criticism been confined to the left. Edward Leigh MP, the Conservative chair of a parliamentary spending committee, recently described one PFI consortium as "the unacceptable face of capitalism" after it tripled its return through a refinancing deal that left a hospital with massively increased liabilities.

So ingrained has this view of PFI become that few seem to have noticed that, more often than not, it has been a huge success. Over the past decade it has built or refurbished 185 health facilities and 230 schools, and also delivered 43 transport schemes and almost 200 other projects. What's more, research by the National Audit Office has found that nearly 80 percent of PFI projects were delivered on time and a similar number to budget. In contrast, 70 percent of other government projects finished late - and 73 percent ran over budget. As Peter Walters, a PFI specialist at law firm Stephenson Harwood, says, "People's memories are short. They forget MoD contracts that ended up five times the original budget, and six years overdue. PFI stopped that in its tracks."

This success can be credited largely to the involvement of the private sector. When the public sector procures its own buildings, there are few incentives to work quickly or keep costs down. The result was often that costs soared as projects were delayed by continual changes. The Scottish Parliament building in Edinburgh, for example, was originally expected to be built in a couple of years at a cost of less than £40 million. Seven years and several thousand design changes later, it was finally completed at a cost of £430 million. A year later, a roof beam came loose in the main debating chamber.

In PFI deals, however, private companies have incentives to work fast and keep costs down: if they don't, it's their profits on the line. Nor can they underbid, in the hope of extracting more money from the government later. Once a contract has been signed, the money has already been borrowed, and any cost overruns are the company's problem.

PFI should also prevent public buildings from skimping on maintenance. The private company is paid on the basis of its performance, giving it incentives to keep buildings in good condition. And the public sector can no longer defer repairs to next year in the hope of a bigger budget. In a well-drawn up contract, no one benefits from cutting corners.

Despite the controversy, the British government remains committed to PFI, and currently has around 200 projects worth £26 billion in the pipeline. It is also exploring various ways of improving PFI procurement, such as developing the public sector's commercial skills and ensuring that projects are better developed before being released to the market.

But perhaps the biggest sign of the initiative's success is the number of other countries that are copying it. Governments elsewhere in Europe and as far afield as Australia, Singapore and British Columbia are all developing their own variants. Whatever its critics say, it looks like PFI is here to stay.

Jonn Elledge is a London based journalist covering finance and public policy. He also blogs at Atlantic Rift and writes for the Sharpener.


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