PFI: beyond criticism, beyond debate?

Buying public services like hospitals, roads and prisons through Private Finance Initiative contracts, as Britain, Ireland and a host of other countries are increasingly doing, represents a fundamental shift. The sums run into billions, the contracts are binding for decades and moving the boundary between the public and private sectors raises crucial questions about accountability. Victor Smart asks whether copper-bottomed evidence exists that proves schemes offer value for money

A veteran war photographer from the Vietnam era famously complained that trying to take the glamour out of war was as futile as trying to take the glamour out of sex. A similarly thankless task is trying to take the politics out of the Private Finance Initiative and value for money. On the face of it, the questions look straightforward. Surely, the query concerning whether the taxpayer can buy more cheaply from the private, rather than the state sector, for a hospital, road or revamp of London Underground�s failing network are questions that an economist could slice and dice precisely? And the Treasury rather implies this is so with its Public Sector Comparator (PSC) - a formula that shows when commercial partners trump the public sector, and when not.

But in the real world, the value for money argument is mired in troubling uncertainties. One self evident problem is that it will be 20 years before the first slew of PFI contracts are actually completed. For example, the £177m Dartford & Gravesham hospital, the first funded through PFI, only opened comparatively recently. Hence, it will be decades before we know whether commercial firms do their stuff by shouldering the much-vaunted transfer of risk for which they are being paid, and if PFI is indeed a bargain for the taxpayer.

Mind-boggling contractual complexity - and pleas of commercial confidentiality - are another snag. Furthermore, it�s worth bearing in mind that value for money is only one aspect of PFI�s selling points: creating a diverse pool of competitive suppliers in the NHS, moving public spending off the Government�s books, or even lifting the dead hand of the officers� union from prison regimes might be equally compelling motives.

Still, the sheer scale of PFI projects today makes the search for answers urgent. Around 520 PFI projects have been signed in the UK with a capital value of £23bn. The part-privatisation of National Air Traffic Services is worth £1.6bn. And the public-private partnership for the London Underground has an estimated value of £17bn over the first half of its 30-year term. If these projects miscarry, not only will the taxpayer suffer, but so too will the tens of millions of users.

Three years ago the UK Treasury, where PFI was hatched by the Conservatives in the 1980s then adopted with gusto by Labour a decade later, revealed how the PSC formula worked. Each PFI project is individually compared with the best and cheapest publicly-financed alternative to see which comes out on top. Simple. But to put the private sector on an equal footing with the public sector (which can raise cheap sovereign-backed funds), the Treasury requires that future payments to PFI consortia are discounted at the rate of 6% a year. This means that £1,000 paid at £100 a year for 10 years is deemed to have a �present value� of £736. Push the project term out over a few decades and the formulation makes PFI�s perceived advantage swell and swell.

On top of this, a lump sum is added to take account of the transfer of risk onto the private sector. The most significant is usually an amount to reflect construction-cost overruns - for which the public sector, happier playing policy than managing projects, is, rightly or wrongly, notorious.

Unstinting faith that PFI spells good value came from a report commissioned by the Treasury�s PFI unit from Andersen two years ago. It states: �The average percentage estimated savings against the PSC for our sample of projects was 17%. On the basis of the public sector�s own figures, therefore, PFI appears to offer excellent value for money.�

But the headline savings figure of 17%, though it has gained wide currency, is not definitive. Naturally, the sums are projections; they also do not take account of sectoral breakdowns. A report from the National Audit Office, the spending watchdog, suggested that significant efficiency gains in prison and road projects are matched by only marginal gains in two critical areas�schools and hospitals. For example, the NAO reported that Dartford & Gravesham hospital was valuable in paving the way for subsequent PFI hospital projects, but added �there is uncertainty as to the exact level of savings, if any, that will be achieved�. For all its pretended precision, the PSC exercise had inflated the private sector�s margin to £17m, more than treble the correct £5m sum, according to the NAO.

One fatal weakness of the PSC is that small projected savings from PFI will easily vanish if assumptions about risks or the discount rate are tweaked a little. Allyson Pollock, professor of health policy research at University College London, says that, though there is hard data about past construction-cost overruns, the sum for risk transfer is all too often �subjective�. Meanwhile, the Treasury announced last June that it is willing to consider slashing the discount rate from 6% to 3%.

Critics charge that the iron rule embodied in the comparator is in fact a sham. They claim that, under successive governments, PFI has been �the only game in town�. The argument goes that value for money is irrelevant since the Treasury�s credo amounts to �go with PFI, or go without�.

Certainly, the PSC formulation failed to play a decisive role in the two largest and most contentious projects - the multi-billion air traffic part-privatisation and the London Underground deal. No stab was even made at a state-sector comparison for NATS and, with London Underground, the attempt was compromised by the exclusion from the procurement process of those who ultimately would assume overall responsibility for the Tube, the staff of Transport for London. According to a study by the Institute for Public Policy Research, �there was an absence of full and honest scrutiny of all the options� PPPs were a way of evading capital budget constraints rather than exploring the best way to secure value for money�.

There is no hint that the Government is wavering in its faith in PFI as it attempts to drive through a transformation in public services. There is a sense that PFI delivers, in as much as buildings are built on time and to cost. But pleas for a definitive study of PFI�s benefits have been rebuffed by the chancellor, Gordon Brown. As Nicholas Timmins, the well-regarded Financial Times commentator, put it last year: �The suspicion remains that Gordon Brown is reluctant to enquire too deeply into these issues for fear of what he might find.�

Victor Smart is a business writer and former editor of the UK�s Public Finance magazine.