Multi-Decade Outsourcing Boom Comes to Sticky End in the UK

After scandals, collapses, and the government’s off-balance-sheet debt.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

The United Kingdom, widely considered to be the birthplace of the modern incarnation of the public-private partnership (PPP), in which private firms are contracted to complete and manage public projects, could be one of the first countries to jettison the model.

The collapse in January of 200-year old UK infrastructure group Carillion, whose outsized role in delivering public services earned it the moniker “the company that runs Britain,” has fueled concerns that other big outsourcing groups could soon follow in its doomed footsteps.

Last week the CEO of Interserve, another large outsourcing group, revealedthat the government has given the firm a red rating as a strategic supplier, meaning it has “significant material concerns” about the company’s finances.

Fears are growing that Carillion was not a one-off episode but rather the swan song of a deeply flawed and dying business model. Those fears were hardly assuaged by the release this week of a damning parliamentary reportinto the UK government’s practice of outsourcing public projects through so-called Private Finance Initiatives (PFIs).

PFI deals were invented in 1992 by the Conservative government and then enthusiastically rolled out by the subsequent Labour government. The schemes usually involved large-scale public buildings such as new schools and hospitals which were previously funded by the UK Treasury. Under PFI they were put out to tender with bids invited from developers who put up the investment to build new schools, hospitals or other schemes and then leased them back.

In theory, for a public body to use PFI, or PF2 as the latest iteration of the financing scheme is termed, Treasury rules require it to demonstrate that this financing route provides better value for money than conventional government procurement. In practice, neither the Treasury nor individual government departments have developed any effective means to assess the actual value for money of PFI projects.

“After more than 25 years since the first PFI contracts, the Treasury has not attempted to quantify the benefits of using PFI,” the report states. “This is despite the Treasury telling the previous Committee in 2011 that it would introduce benefits realisation assessment into its value for money guidance, for PFI projects that are underway.”

When the Committee asked whether the benefits of PFI have justified the higher financing costs, the Treasury said (emphasis added) that this was “an impossible question to answer”, because it “did not have the facts needed.” Considering the Treasury has recruited just one member of staff, “pretty much on a full-time basis,” to look across all 700 projects in the PFI portfolio “and see what data exists,” those facts are unlikely to materialize any time soon.

The Treasury’s incapacity to measure the actual benefits of PFI should be of grave concern to British taxpayers given that the interest rate of private-sector debt — these projects are debt financed — can be as much as 2 to 3.75 percentage points higher than the cost of government borrowing. Even if the government doesn’t enter into any new PFI-type deals, it will pay private companies £199 billion, including interest, between April 2017 until the 2040s for existing deals, in addition to some £110 billion already paid. That’s for 700 projects worth around £60 billion.

British taxpayers could clearly “get a much better deal,” the report concludes. For the UK Treasury, which manages (a term I use loosely) British taxpayer funds, the main benefit of PFI is that it allows ministers to harness big sums of private capital to invest in public projects, such as new schools and hospitals, without paying any money up front — and thus keeping the level of current public debt lower than it would otherwise be. This is off-balance-sheet financing.

“Current accounting rules create incentives for public bodies to use PFI for reasons other than value for money, and these incentives remain under PF2,” the report notes. “Under national accounting rules, most PFI debt is recorded off balance sheet and excluded from public debt calculations, which is advantageous for the Treasury.” In 2011 the Parliamentary Treasury Select Committee urged the Treasury to bring PFI onto the balance sheet, thus “ensuring that PFI is not used to circumvent departmental budget limits.” It was ignored.

In other words, much like Enron and other doomed companies and banks, the British government continues to use financial chicanery to keep many of its current liabilities off balance sheet. It’s also awarding well-connected businesses ludicrously lucrative public works contracts that provide scant value to British taxpayers:

“Shareholders in the M25 PFI deal made estimated returns over an eight-year period equivalent to 31% a year when selling their stake in the project. In written evidence, Professor Dexter Whitfeld, Director of the European Services Strategy Unit, told us that returns to investors in excess of 25% are not uncommon in PFI projects.”

Even if a project fails, it must be paid for in full. Liverpool City Council is paying £4 million a year for an empty school. The flawed deal will see over £55 million of taxpayer funds wasted since the school became empty in 2014.

If a developer doesn’t want to hold on to an asset, there’s always the option of “flipping,” or selling on to some other investor, invariably one based in a tax haven, so not even UK corporation tax is paid on the profits. Offshore funds have bought up about half of the equity in PFI and PF2 projects. The Committee raised this issue during the recent inquiry, to which the Treasury responded that “public procurement rules prevent discrimination against non-UK domiciled companies and investors.”

As the Committee says, the deal is clearly not working for British taxpayers. There is a bright side, however: Even the UK government appears to be losing faith in the model it spawned, at the behest of big business and big finance, 26 years ago. The number of projects being launched through PFI has plummeted from a peak of over 60 projects to no new PF2 contracts at all in the last two years. But even if the UK’s love affair with PFI is coming to an end, it’s likely to be a bitter one, what with £199 billion still outstanding. By Don Quijones.

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