The PFI Puzzle

The PFI Puzzle

News in January was dominated by the collapse of Carillion, the second largest engineering firm in the country employing almost 20,000 British workers. Since Carillion held many government contracts such as on health, schools and prisons, the subsequent liquidation of the company has prompted many to question the use of private finance initiatives (PFI) by the public sector.

PFI schemes aim to use the private sector to complete public infrastructure projects. Companies or consortiums sign a contract with government usually lasting 25-30 years. Proponents of the idea argue that this is a way of improving the quality of public goods by creating a profit motive and using private investors. There is however dispute as to whether this is cost effective.

First used in the UK in 1992 by John Major and his Conservative government, PFI schemes were immediately met with criticism, especially by Labour politicians. However, it was under Tony Blair that PFI became more widespread. Subsequent governments from both parties continued this.

Much of the debate surrounding PFI centres around the costs and quality of outsourced services as well as the idea that it opens the door to privatising the public sector. Services from trains to school meals provided by private firms yet still fall under the banner of being state provided.

The National Audit office reported that PFI funded hospitals cost an average of 60% more than the public sector alternative while schools 40% more. What justifies this extra cost?

PFI schemes transfer debt for these projects off government books and onto the private sector. This however, is problematic as the government is usually able to borrow at cheaper rates than the public sector. This is likely to be a factor of high PFI costs.

Secondly, it has been argued that the risk for these projects in transferred over to the private sector. However, as seen by the Carillion fallout, this risk appears more toxic in private hands. If an infrastructure project runs short of funding under government control, it is more likely that the government will help workers affected. In the private sector, they are simply laid off causing unemployment issues.

The biggest issue with PFI is in the bidding process. Private sector firms will bid for government contracts, competing on costs. This encourages firms to bid far below the value of the contract and thus take on contracts at a loss. However, firms then run over budget, leading to either closure of the projects or further payments from the government. It has been suggested that this is a reason for problems at Carillion. This issue seems to suggest that market competition introduced to large scale government contracts doesn’t work and leads to serious mispricing. The solutions are either for the public sector to carry out these projects or stricter rules on price setting to be implemented with more oversight by the government. The first of these is unlikely to find much political support while the second massively undermines the idea of a free market.   

However, public projects must still be carried out. A compromise solution could involve thinking carefully about what to outsource. PFI prices are often inflated due to unforeseen costs. Thus, it makes sense not to outsource activities and projects which are highly variable. This would include hospital operations or prison maintenance. However, relatively more stable and readable projects, such as maintaining roads, can be opened to PFI, as long as they are closely managed by the authorities.

 

BY: Marcin Scicinski

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