Beyond PFI: Mark Hellowell
Edinburgh University’s Mark Hellowell considers what the future holds for the Private Finance Initiative after the financial crisis and spending review.
What is driving the change away from PFI?
There are a number of factors, but perhaps the primary one in the Northern Ireland context is that, due to the intervention of the Audit Office, there are no longer accounting advantages to using private finance. In other words, PFI fails to deliver additional capital resources.
There are also concerns about the sustainability at UK level of the accounting advantages (i.e. the fact that PFI expenditure doesn’t score against departmental capital budgets, nor against the calculation of public sector net debt). That partly explains the collapse in political will behind the PFI model, I think.
The other prominent factor is that the cost of senior debt (which accounts for about 90 per cent of project finance at the point that projects are signed) has become very expensive in the wake of the financial crisis, and the link between the risk premium demanded by investors and the risks they actually bear has broken down.
The weighted average cost of capital (WACC) on an availability-based PFI scheme is now much higher than it was pre-credit crunch, and resembles the WACCs seen on much riskier deals in other sectors of the economy. For value for money and affordability reasons (and probably the latter is more important), PFI is now very much less attractive than it was prior to September 2008 and the collapse of Lehman Brothers.
What are the main alternatives going forward?
There are no obvious answers. One option that has a great deal of prominence in the National Infrastructure Plan is the concept of the regulated asset base (RAB). In essence, the advantage of the RAB is to stimulate investment – in particular, cheap debt capital investment provided by institutional investors like insurers and pension funds.
By guaranteeing returns on sunk costs (investment in capital expenditure) by, essentially, passing risks to customers, the RAB de-risks investment in infrastructure and should mobilise greater liquidity. The RAB already exists in the regulated sector. The proposition is to expand it to include the decarbonisation programme, high-speed rail and road transport and much of the PFI programme.
But there are limits here. For the de- risking mechanism to work, risk must be transferred to customers. This is not possible in social infrastructure because users of services do not pay for these services. It is possible that risk could be transferred to the taxpayer, but the issue then – putting efficiency considerations to one side – is whether there would be a balance sheet impact.
How would you sum up the Coalition Government’s approach to capital investment?
The Coalition Government’s approach to capital investment is still at an early stage of development.
We know in the background that public sector net investment is going down to a level, as a percentage of GDP, not seen since the early 1990s. The question is what they will do to provide additional resources.
PFI will continue (there are some quite large deals being procured – in hospitals, for example) but the pipeline will be much reduced in comparison with pre-Lehman levels. The Government has signalled that it wants to deliver some form of revenue-sourced investment programmes, presumably involving some model of private financing, but they have not yet provided a comprehensive answer.
Mark Hellowell is a lecturer in the Global Public Health Unit at the University of Edinburgh’s School of Social and Political Science.
