How bad a deal is PFI?

February 07, 2012 11:18 AM

PFI has been associated with some of the worst excesses of Gordon Brown's irresponsibility with the public finances.  Along with other debts like the bill for decommissioning early nuclear plants it is a part of our total liabilities that was hidden off the balance sheet.  The amount at stake is substantial, tens of billions of pounds, though tiny compared to the biggest hidden liability: public sector pensions.

The release of the Whole of Government Accounts has led to fresh scrutiny of the PFI programme with the Independent, for example, reporting that there was a liability of "£131.5bn on the private finance initiative (PFI) such as hospital and school building – four times more than the assets secured by the deals".

It doesn't sound good.  But does that mean PFI is an inherently bad way of paying for worthwhile investments?  Not necessarily.

The Whole of Government Accounts mention that the lifetime of a PFI contract is typically 25-30 years.  That is a long commitment that the firms investing in PFI projects are making.  Based on current gilt rates, it would cost even the Government nearly £70 billion to borrow the £30.9 billion book value of the PFI assets.  That is more than double and therefore - just on the basis of that very rough calculation - the risk free cost of capital can account for about half of the difference between the asset value and cost figures.  If you want to invest a pile of capital in something then one way or another you are going to pay a price for that, however you finance it.

This isn't a simple, risk free investment.  The point of PFI is to transfer risk and management responsibility to private sector firms, who are generally required to turn over a quality hospital or something like that at the end of the process.  That way you avoid the mismanagement that has seen too many major projects go way over budget and arrive late.  In 2009, the National Audit Office found that most PFI projects are "built close to the agreed time, price and specification".  But again private sector firms have to be paid a price for taking that risk on their investment and managing the project.  If the interest rate goes up to about 5 or 6 per cent then that can explain what looks like a quadrupling in costs.

All that doesn't mean that PFI is always, or even generally, good value.  There have been some ridiculous stories about the cost of replacing lightbulbs or electrical sockets which suggest something funny could be going on in the contract.  This wouldn't be the first time politicians and bureaucrats have let canny operators rip off the taxpayer.  And it is important that we have a more honest account of the real liabilities that politicians have been racking up on taxpayers' behalf.  Mike Denham explains the issue in a video below.  But let's be realistic about the cost of PFI and how that compares to other ways of financing major investments.

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