The public has lost faith in private finance initiatives (PFI). We need a new way of accessing private funding.
The latest World Economic Forum study ranked the UK 28th in the world for the standard of our infrastructure. This demonstrated a significant economic and social disadvantage that must be overcome. Government is keen to do just that with the national infrastructure plan that sets out around 500 projects to be supported over the coming years.
This work is crucial to returning the UK to growth, and around 70% of it will be paid for privately with little need for financial input from government. Broadband networks will continue to upgrade and expand thanks to private companies driven by a strong profit motive. Likewise, water companies will invest in new reservoirs and pipelines using money taken from the regulated prices charged to users. But in many areas this is not possible, and this is where PFI has conventionally played its part.
Since 1996, private finance initiatives have generated more than £50 billion of private investment in social and economic infrastructure across the UK. But with public mistrust and government concern at the high cost attached, it is time to find an alternative public private investment model.
In defence of PFI, it is worth saying that it did get things built. Many towns across the country have a new or upgraded road or school that testifies to this and a great many roads have been built or better maintained thanks to PFI projects. The problem with PFI though, is that the price attached to the outcomes doesn’t convince the public that they get value for the money it eventually costs them.
There are two key reasons for this. One is the seemingly high price of some deals done. For example, the Department for Communities and Local Government spends less than £3 of public money over time for every £1 raised up-front in private investment. Meanwhile the Ministry of Justice spends nearly £12.
To put that in context, this might be like a bank offering a mortgage interest rate of five per cent to one couple and 20% to another. Of course with PFI the mortgage provider would also have committed to re-pave the driveway regularly, plant daffodils in the garden and replace broken light bulbs whenever needed. But even with that in mind, the disparity in cost raises concerns for the public.
It is fair to say that in some cases variations in cost need not cause public concern. The public is perfectly comfortable with a major new hospital costing significantly more to build and operate than a new local GP surgery, just as they accept that the price of a new Aston Martin will be higher than that of a new Fiat 500. The problem is that PFI struggles to demonstrate whether the infrastructure provided constitutes a supercar or a city run-around.
And that is the most significant problem. There was always a lack of public understanding about the costs involved because the contracts agreed were often very complicated and because there was not enough transparency or perceived accountability about how the public’s money was being spent. Quite aside from stories about £300 light bulbs, this lack of transparency is problem enough with any system of government procurement that it should be replaced.
The problem for government though, is that a replacement is definitely needed. With France and Germany both ranked in the top five in the world for infrastructure, this competitive disadvantage has to be reversed. And with government deficits making it difficult to commit public funding up front for new projects, some new means of generating private investment must be developed.
This is why ACE has spent the last year talking with institutional investors and government alike. And it is why we have produced our own research report that sets out ideas for new public private finance models (PPFM), learning the lessons – both good and bad – from PFI.
One lesson to learn was that there appears to be a link between experience in PFI within both government and industry, and the final cost to the taxpayer. Between 1996 and 2000 the cost to the taxpayer of every £1 raised was over £7, while in the following five years it fell to around £4. Likewise it seems that the departments that procured more PFI projects faced lower costs for every £1 raised than those that used PFI for fewer projects.
This suggests that a centralised body of expertise should be a vital part of planning for new models of generating investment. If that central expertise can build up its knowledge of the process and the projects, and if industry is able to learn over time what it is that team wants, the taxpayer should get a better deal. The Government has taken some steps in that direction with the creation of its Efficiency Reform Group, which can take a role in a wide range of activities across government departments.
Another lesson to learn is that a lack of transparency from the start must not be repeated, even as commercially sensitive information remains protected. This may require a new model that breaks down the investment and costs attached to the construction phase of the project, the interior fittings phase, the long term maintenance work, and the on-going upgrade work that improves performance beyond the original core standard.
These phases work very differently because of the risks involved. Construction comes at a significant economic risk because costs can escalate and deadlines can be missed. This is a particular problem when, during construction, the client seeks to change the design or add supplementary facilities. Because the risk is high, the cost of raising finance is relatively high.
This contrasts with maintenance work or installing fixtures and fittings to a newly constructed building. These processes tend to have lower risks attached and so are less likely to encounter costly disruptions. As such, investors can be attracted to finance this work at a lower rate of return which widens the pool of investors to those who are more risk averse at the same time as benefiting the public purse.
Another lesson to learn is that one model need not be applied to all projects. While PFI may have worked well in some situation, that does not mean it works well in all situations. For instance, while a split model might work well for the building of a school, the development of a new museum facility might be better managed with some level of direct public equity alongside private investment to secure a better rate and better share the risks attached to the project.
Bringing these lessons together will be a big challenge for government and industry alike over the coming months, as the Treasury reports on its own consultation into the use of PFI. But overcoming that challenge is crucial to delivering the infrastructure and growth that the UK needs while protecting the taxpayer.
Nelson Ogunshakin OBE is the chief executive of the Association for Consultancy and Engineering.
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