In this first article on Coalition Economics, Paul Hare (Heriot-Watt University) addresses the UK government’s approach to public-private partnerships. His findings reflect changes in the approach taken since 2010; the scale of investment resulting; and the range of ongoing criticisms.

1. Introduction

This short paper is an update of Hare (2013), sketching how both the policy and practice relating to public-private partnerships (PPP) and the private finance initiative (PFI) have evolved since the end of the last Labour Government in May 2010.

As soon as it assumed power, the Conservative/Liberal Democrat coalition government (referred to below as the Coalition, for short) was quick to declare that Labour’s form of PPP would no longer be pursued, and that a new model to support public infrastructure would be developed. How this new model evolved, and how well (or otherwise) it has worked, are examined below.

In Hare (2013) it was found that a good deal of much needed public infrastructure spending – on schools, hospitals, and other public facilities – had taken place under the PPP banner, including some spending that might not otherwise have gone forward. While ostensibly, the reason for funding infrastructure through the PPP route was to achieve more efficient construction (lower cost, on budget, on time), and to share risks with the private funders, an underlying justification (often not acknowledged) was the desire to build more schools, hospitals, etc., without the associated capital costs appearing  in the public accounts. In other words, accounting rules in effect at the time allowed what was for all practical purposes public capital spending to be carried out without adding to the public debt.

Towards the end of the period of Labour government, the accounting rules changed, and most PPP-type spending is accounted for correctly at departmental level, but at National Accounts level, much still does not add either to the deficit (current account) or to the debt (capital account) of the public sector.

How effective were the investments carried out under the PPP and PFI headings? The evidence is quite mixed, though with some indication that capital costs and project completion times were often better managed than under the alternative of conventional public sector projects (as was confirmed in a National Audit Office report, NAO, 2009; though the data needed to make these judgements properly was not always available, see NAO, 2011, p.6).

It was far from clear whether much project risk was ever effectively shifted, however. And the principal legacy of these numerous projects is a stream of capital charges (to give the private investors a return on their capital) and service costs (PPP projects usually bundled in some service provision) extending for as long as 30 years or so. These have already proved to be a difficult burden on school and hospital budgets, among others.

Has the Coalition managed to do any better in this important area? We review that next.

2. Developments in PFI and PPP

Having declared that the Labour Government’s approach to PPP, notably the PFI, was not fit for purpose, the Coalition worked to develop a new/amended model.  It started by announcing, in October 2010, an Infrastructure Plan for the nation (HM Treasury, 2010; subsequently updated several times), under which it was envisaged that £200 billion would be spent on infrastructure capital projects over the ensuing five years (see Helm, 2013). Much of this was expected to come from private sources, and it was never wholly clear how much of this spending would be ‘new money’ (i.e. public spending not already committed under some other heading).

The House of Commons Treasury Committee reviewed PFI as it had operated under the old model, publishing its findings in 2011 (see HoC, 2011). It found that PFI projects faced a cost of capital exceeding 8%, as compared to the Government’s ability then to borrow long term at 4% or less. The Committee were sceptical whether other purported benefits of the PFI approach were often sufficient to justify this higher capital cost.

Despite changes in official accounting rules, they found that far too much PFI remained ‘off budget’ and was therefore still not counted as part of public deficits or debt (see Heald and Georgiou, 2011); Departmental public spending rules also still allowed PFI projects to be treated as ‘additional investment’, not part of the allotted capital budget. The Committee urged the Government not to allow much PFI spending without a very clear focus on the Value for Money (VfM) criterion.

The new version of PFI, quickly dubbed PF2, was announced in December 2012 via the publication of a Treasury paper, HMT (2012a), with an accompanying guide to new PFI contracts (HMT, 2012b; running to 400 pages), and a much shorter user-guide issued by Infrastructure UK (Infrastructure, 2012). According to Buisson (2013), the basic PFI model remains essentially intact, with a few changes to address perceived weaknesses. The changes are summed up briefly in Table 1, above (click for full-size version).

Only a small number of new projects has been approved under PF2.  According to HM Treasury data, at March 2013 (more recent data appears not to be available) just 23 new PF2 projects were in procurement with a total expected funding requirement of £3,547.3 million. Treasury data also show that in the financial year 2012-13, 15 PF2 projects were signed, with a funding requirement of £1,539.3 million. The same data source also identified each project’s equity holders and their respective shares; most holders being private, contrary to the intention expressed in the first row of Table 1.

Most projects were funded through a special purpose vehicle (SPV) set up for the purpose, and these too were listed. These modest recent numbers contrast with the total PFI commitment reported a year earlier, March 2012. At that time there were 717 projects in the Treasury database, involving a total capital spend of £54.7 billion; total expected repayments on these projects (covering both return on capital, and the unitary charges), over a period of up to 30 years, came to £301.3 billion.

Not a great deal of time has elapsed since the above changes were brought in as part of PF2, but the House of Commons Treasury Committee has already attempted to review the new model (HoC, 2014). Their report raises some interesting questions about how PF2 is supposed to work, and its likely effectiveness.

The Committee particularly questioned accounting and budgetary issues; value for money; and securing private investment. On the first question, the Committee repeated earlier concerns about much PF2 spending remain  off budget in the National Accounts, and doubted whether the innovation of a ‘control total’ would greatly change the incentives to seek private finance for a proposed project (see Table 1).

On VfM, there was concern about the likely cost of capital under PF2, with its expected higher equity contribution. In addition, while projects are all to be evaluated using the guidance in the Treasury Green Book (HMT, 2011), a VfM quantitative assessment tool was withdrawn by HMT in December 2012, and an alternative tool has not been provided. Hence projects could be approved without undergoing a full quantitative assessment. There was also a risk that splitting out ‘soft services’ from PF2 projects could increase contractual complexity by requiring multiple contracts. Last, attracting private investors in sufficient numbers for competition to keep down the required returns on equity involves a significant flow of PF2 projects coming forward, and this had not yet materialised.

Recent press reports illustrate some of the problems that PFI projects have encountered, notably in the health sector. Thus FT (2014) reports on the first NHS Trust to buy out its PFI contract, replacing private funding with a loan from the local council, and enabling the Trust to cut its charges by £3.5 million per year over the next 19 years. And Telegraph (2011) claims that 22 NHS Trusts were struggling to balance their books due to the high payments expected under PFI contracts, while also noting some examples of waste, including an empty school (no longer needed) for which the local authority would be paying the private investor until 2027. This highlights a drawback of the PFI model, and the new PF2 variant, namely the lack of flexibility in resource use.

In Scotland, while the overall PFI/PF2 framework remains available, and has been extensively used, the Scottish Government has opted to develop its own new model for public-private partnerships, under the heading of Non-Profit Distributing PPPs (or NPDs) (see Scottish Government website, Scottish Futures Trust website).

An NPD project has three features:

• there is enhanced stakeholder involvement in project management (though I confess to being unsure what this can mean);
• there is no dividend bearing equity; and
• private sector returns are capped.

Thus the model does not prevent private sector partners from making a reasonable profit, it merely seeks to limit that profit.  The Scottish Futures Trust is currently delivering through the NPD model a £3.5 billion pipeline of major infrastructure projects, which includes some major motorway improvements as well as projects in health and education.

3. Conclusions

Finally, then, has the Coalition advanced matters much as regards PPP investments? A few points suffice to sum up the current situation.

• PF2, the new model, has brought in some modest changes to the original PFI model, but the changes appear less substantial than has been claimed.
• The flow of activity under the PF2 banner – both numbers of projects and funds committed – has slowed down considerably since the Labour years.
• Scotland has been experimenting with an interesting alternative model, the NPD model, which is already funding a good deal of infrastructure spending.
• Many of the shortcomings of PFI, reported by the National Audit Office and other bodies in the later years of the Labour Government, are still being reported today – both as legacy issues from PFI projects, and as issues affecting PF2 projects.

It seems that despite much well intentioned effort, the UK has not yet found a model for PPP that delivers solid net benefits without the accompanying drawbacks. It is a difficult area to get right.

 

References

• Buisson, Andrew (2013), ‘From PFI to PF2: The reform of the public private partnership model in the UK’, London: Norton Rose Fulbright LLP.
• FT (2014), ‘NHS trust becomes first to buy out its PFI contract’, Gill Plimmer and Sarah Neville, London: Financial Times (read online)
• Hare, Paul (2013),’PPP and PFI: The political economy of building public infrastructure and delivering services’, Oxford Review of Economic Policy, vol.29(1), pp.95-112
• Heald, David and Georgiou, George (2011), ‘The substance of accounting for public-private partnerships’, Financial Accountability & Management, vol.27(2), pp.217-247
• Helm, Dieter (2013), ‘British infrastructure policy and the gradual return of the state’, Oxford Review of Economic Policy, vol.29(2), pp.287-306
• HMT (2012a), A new approach to public private partnerships, London: HM Treasury
• HMT (2012b), Standardisation of PF2 Contracts, London: HM Treasury
• HMT (2011), The Green Book: Appraisal and Evaluation in Central Government, London: HM Treasury, 2003 edition updated to 2011
• HMT (2010), National Infrastructure Plan 2010, London: HM Treasury/Infrastructure UK
• HoC (2014), Private Finance 2, Tenth Report of Session 2013-14, Treasury Committee, HC97, 2 volumes, London: House of Commons
• HoC (2011), Private Finance Initiative, Seventeenth Report of Session 2010-12, Treasury Committee, HC1146, 2 volumes, London: House of Commons
• Infrastructure (2012), PF2: A User Guide, London: Infrastructure UK (part of HM Treasury)
• NAO (2011), Lessons from PFI and other projects, London: National Audit Office
• NAO (2009), Performance of PFI Construction, London: National Audit Office
• Telegraph (2011), ‘Private Finance Initiative: Where did it all go wrong?’, London: The Telegraph