Professor Robert Jupe from Kent Business School considers the fallout from the Carillion collapse and a report from the National Audit Office that suggests the era of PFI-backed infrastructure projects may be coming to an end.
‘The publication of the National Audit Office (NAO) investigation into the Private Finance Initiative (PFI) in the wake of the collapse of Carillion has focused much attention on the relationships between governments and the private sector in Britain. The PFI has been used by all governments since the early 1990s to build assets. In a PFI scheme, a private finance company is established and borrows to construct a new asset such as a school or hospital.
‘The taxpayer is then required to make payments to the company over the life of the contract (usually 25 to 30 years), which cover debt repayment, financing costs, maintenance and any other services provided. There are currently over 700 operational private finance deals, with a capital value of around £60 billion. The annual charges for these deals amount to £10 billion. If no new deals were agreed, future charges which continue until the 2040s will amount to almost £200 billion.
‘The key argument used to support PFI contracts is that there is a transfer of risk to the private sector which can result in benefits. It is claimed that there will be more certainty over construction costs as the private sector will bear the risk of any construction cost overruns. Further, it is argued that where the private sector is responsible for operating the asset it has an incentive to focus on reducing running costs from the outset, and on maintaining the quality of the asset. The NAO report examined each of these arguments.
‘It discovered that while cost certainty was generally seen as a benefit of PFI, increased certainty about price does not mean that the construction cost is lower as ‘some PFI projects charge higher prices for construction to cover unforeseen costs’. The NAO noted also that some benefits can be achieved without the use of PFI contracts. For example, using fixed-price contracts for publicly financed projects ‘can be effective in reducing cost overruns’. Further, the NAO’s investigation of PFI hospitals found ‘no evidence of operational efficiency’, and indeed evidence that the cost of services, like cleaning, ‘in London hospitals is higher under PFI contracts’.
‘While the benefits of PFI contracts are debatable, there are significant additional costs for the taxpayer compared to projects financed by government borrowing. Even though PFI deals are now subject to more rigorous scrutiny than in the past, the NAO found that since 2013 the forecast returns to investors on many new schemes are between 2% and 4% above the cost of government borrowing.
‘However, some 2013 deals have projected annual returns of over 8%, more than 5% above the cost of government borrowing at the time. This is a large price to pay for the key benefit to governments – the borrowing by the private finance companies does not appear as debt on the government balance sheet.
‘The link between PFI schemes and Carillion is that of risk transfer to the private sector. As a result of significant mergers, Carillion grew to become Britain’s second-largest construction company with 45,000 staff worldwide, including 19,000 in the UK. A large amount of its work was provided by the public sector – an estimated 450 contracts. Carillion’s demise was precipitated in mid-2017 when the company had to write down the value of four construction projects – two hospitals in Britain, a road bypass in Scotland, and a luxury development in Qatar.
‘Despite its worsening financial position, which obliged it to issue profit warnings, the company was still awarded new public sector contracts: a £1.4 billion contract on High-Speed Rail 2 in July, followed by a £158 million deal with the Defence Infrastructure Organisation and, in November, a rail electrification contract.
‘Carillion collapsed in January 2018 with just £29 million in cash, which was vastly outweighed by the £1.3 billion owed to banks. Its demise raises many questions about the company’s directors and management, its auditors and the extent of government supervision. The fundamental question for the public sector is whether there is a genuine transfer of risk to the private sector. Ultimately, the risk reverts to the government.
‘This was confirmed on 15 January, when the Conservative Government made clear that it would ‘provide necessary funding required by the Official Receiver to maintain public services’. There needs to be a fundamental re-assessment of both PFI and the outsourcing of contracts, such as hospital cleaning and the provision of care homes to the private sector together with an honest debate about the level of taxation required to support properly funded public services.’
Robert Jupe is Professor of Accounting and Public Management at Kent Business School. He worked as an accountant in the civil service before becoming an academic at Kent. He has a degree in Philosophy, Politics and Economics from Oxford University, and a PhD from University of Kent.