In some cases the cost of PFI borrowing has been more than four times the cost of government borrowing.
The Labour Party has promised that when in power it will end the private finance initiative (PFI) contracts which have been so costly and directly responsible for financial woes in hospitals, schools, fire stations and local councils.
Labour’s promise consists of two parts. Firstly, it will not enter into any new PFI contracts. Secondly, it will transfer the existing projects from private contractors to the public sector, “if necessary”.
Traditionally, governments borrowed money to invest in the social infrastructure. The Thatcher years established the view that government borrowing was bad and somehow the private sector was more efficient.
PFI was born in this climate. It was a sort of a hire purchase scheme with taxpayer guaranteeing corporate profits
The private sector formed consortiums, borrowed money, built and operated the assets in return for payments from the public sector. Many of the PFI contracts were conceived during the period of comparatively high interest rates.
In some cases the cost of corporate borrowing was more than four times the cost of government borrowing. This meant that in the era of ultra low interest rates, PFI companies made excessive profits.
However, governments found borrowing via PFI attractive because it was off-balance sheet i.e. not included in the total government debt.
PFI was introduced by the Conservative government of John Major, but massively expanded by the 1997-2010 Labour administration. Currently, there are about 716 PFI projects (686 are operational) with a capital value of £59.4 billion and promised repayments of more than £250 billion.
The profitability is indicated by the NHS data. The private sector has invested £12.4 billion in the NHS assets but will receive payments of £80.8 billion.
Between 2010 and 2015, PFI companies building and operating hospitals made £831 million profits from the NHS. Over the next five years, they expect to make profit of £973 million from the NHS.
Labour can secure control of the current PFI projects in a number of ways:
- Upon taking office, Labour should immediately cap the profits that companies can make from PFI contracts. It can demand more exacting standards of work for matters such as safety, fire risks, and timeliness of delivery of services, equitable wages and environmental impacts.
- Projects with relatively short remaining life probably are not worth buying out. However, their terms could be renegotiated to squeeze out excess profits.
- Labour can consider additional taxes on PFI companies for making excessive profits.
- Interest rates are an integral part of all PFI contracts, but banks have admitted that they rigged the interest rates. This rigging enabled contractors (which include banks) to make excessive profits. Labour should seek recovery of the profits made by rigged interest rates.
- In some cases the PFI contracts were transferred to tax havens. This enabled the firms to avoid UK taxes. Labour has promised to secure repatriation of all PFI contracts form tax havens. This should be accompanied by a demand for the lost taxes. No doubt some would resist that. If so, then the amount of compensation (see below) for such projects should be lower.
The above five steps should considerably reduce the value of PFI contracts and hence the compensation which might need to be paid to companies and their shareholders.
Compensation for the PFI contracts can be in the form of interest bearing government bonds, rather than cash, which match the duration of the PFI contracts.
The value of the compensation will be based on negotiations and legalities but is likely to be strongly influenced by the present value of future cash flows accruing to the projects.
Hence the importance of the first five steps outlined above in reducing those cash flows to ensure that compensation is not based on excessive profits.
In terms of the public balance sheet, the national assets would increase as hospitals and schools would be brought onto the government balance sheet, but this would be matched by the bonds issued by the government.
In principle, the two should be netted off, but commentators are obsessed with government borrowing only. The Office for Budget Responsibility has estimated that the public debt would increase by 2% of GDP if public borrowing rather than PFI had been used to finance projects.
So the government debt may rise, but in the context of billions spent on rescuing banks, the amounts are not big, but the savings to the public sector would also be considerable.
A clear implication of the Labour announcement is that all future investment in public infrastructure will be through finance raised from taxation and/or borrowing.
However, under the Maastricht Treaty EU member states are expected on average not to have deficit of more than 3% of GDP. Therefore, leaving the EU might be a necessary condition for future public investment by a future Labour administration.
Prem Sikka is Emeritus Professor of Accounting at the University of Essex. He tweets here.
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