The debate on the deficit has been dominated by the cost of bailing-out the banks and the affordability of the welfare state. The impact of expensive PFI contracts should not be overlooked, explains Dr Anne Stafford.
No matter who wins the General Election, the next government will have to deal with the growing cost of inflexible PFI contracts. Those contracts make the task of balancing the books much more difficult.
Under the Private Finance Initiative (PFI), the private sector designs, builds and finances much needed new hospitals, schools, roads, prisons and other social and public infrastructure. It also provides the ancillary services – such as cleaning and security, but not the core professional services such as nursing – for typically 15 to 35 years, in return for an annual fee that covers both the capital cost of the asset and the service delivery.
In most cases, the public authority pays on behalf of the ultimate user. PFI was started by the Conservative government in the early 1990s – and the policy was enthusiastically extended by the subsequent Labour government. Currently there are around 700 PFI projects in operation in the UK with a total capital investment to date of around £56bn. Annual expenditure on PFI contracts has risen to £10bn per year – there is a future total commitment of £222bn in the years to 2050.
Until the 1980s, annual private finance investment represented only 10% or less of total annual public sector capital investment. Yet the last government’s National Infrastructure Plan indicated that in future around 80% of new economic infrastructure will be at least partly privately financed.
But what is particularly significant is that PFI contracts changed how public sector revenue budgets are spent, not just in the years in which the contracts were agreed, but also for many years into the future. PFI contracts will consequently limit the levels of flexibility available to governments throughout the first half of this century.
Firstly, although the rhetoric stated that PFI would offer value for money by delivering projects more cheaply and efficiently than the public sector, there is little evidence to prove that this is the case in practice. Rather, the evidence that does exist points to contracts being more expensive. This is not surprising given that the government has to pay for higher finance charges – the private sector cannot borrow money as cheaply as government does – and the private sector has to build in a profit element.
In addition, the private sector typically adopts very complicated organisational structures for PFI contract delivery through which profits are distributed via complex chains of sub-contracting to sister companies.
Secondly, the PFI contract is used as the main mechanism for managing a project. These contracts are very lengthy legal documents, which set out how payments will be made and when and how penalty deductions for poor performance can be applied.
Any change to a contract results in a costed amendment – in one instance with a hospital PFI we found that adding the cost of marmalade to patients’ breakfasts added an additional £40,000 per year to the contract price.
By contrast, penalty deductions for poor performance are difficult to agree on and typically amount to small figures. Monitoring tends to be weakly enforced, so the public sector is vulnerable to paying the full price while receiving poor quality performance. Furthermore, most contracts are subject to upwards financial reviews against a stated benchmark every five to seven years.
Over time, therefore, annual PFI charges are increasing higher than the original contract cost, whilst public sector budgets are being squeezed. This situation has created an affordability crisis. In an ironic turnaround, although the PFI policy promised a reduction in risk to the public sector by claiming risks would transfer to the private sector, I would argue that risks to the public sector have instead increased due to the need to divert public funds from other budget areas to pay for PFI contracts. Thus other services are put at risk.
This crisis is most evident in hospitals. Last year the foundation trust running Hexham General Hospital bought itself out of its PFI contract, thereby saving £3.5m a year. But it cost £53m to break the contract – for a contract that contained an original capital element of £54m – and the trust had to borrow money from the local authority to pay for it. This is not something that most cash-strapped health trusts can afford. Instead they have to resort to mergers between trusts and the cutting of clinical costs in order to pay for PFI contracts.
But these measures are unlikely to solve the problem of increasing deficits caused by unaffordable PFI contracts. Barts Health NHS Trust, which has the largest hospital PFI in the country at a capital value of £1.1bn, has had to cut clinical costs across its hospitals. It reported a deficit of £38m in 2013/14, which is set to rise to £44m for 2014/15. The trust was placed in special measures in March due to concerns over the standards of care in one of its (non-PFI) hospitals. Standards of care are bound to suffer when savings of this scale are required.
Attempts made so far to amend contracts and cut costs have yielded little results. The next government of any complexion must work much harder to tackle the problem of how to make these unaffordable and inflexible projects more affordable. Not to do so would make a nonsense of pursuing austerity policies elsewhere.