Private Finance Projects (EAC Report)

Lord MacGregor of Pulham Market Excerpts

Wednesday 3rd November 2010 Lords Chamber

[Lord MacGregor of Pulham Market]

My Lords, this was a most interesting inquiry and I was very glad to be involved in it. PFI, or PPP, has come a long way since its initial steps, and it was an appropriate moment to judge its successes and failings and to highlight lessons for the future. It was the first parliamentary inquiry since 2000, and the first comprehensive study outside government. We received a massive amount of evidence and I hope that our report will be a valuable source of information on the issues for national and local government, practitioners and academics. I thank our chairman, my noble friend Lord Vallance, for the excellence with which he chaired some complex hearings. I thank also our excellent special adviser, Professor Paul Grout, our committee clerk and the team.

My noble friend Lord Vallance gave a very clear introduction to the background, and covered some of our main recommendations. I agree with almost everything he said and will try not to go over the same ground, except where I have a particular point to make.

The response of the then Government was somewhat cursory and dismissive in places, with very brief responses to some important recommendations. It bore all the marks of being got out in haste before the election. I admit that they did it pretty rapidly. As my noble friend Lord Vallance indicated, we produced our report on 10 March and they responded on 7 April, so it was perhaps understandable that the response was cursory in places. For example, at the outset they said that PFI remains a “small” but crucial part of government investment in UK infrastructure. It is hardly small, given that by 2009 there were approximately 800 PFI/PPP schemes with a capital value of approximately £64 billion. The then Economic Secretary to the Treasury told us that 70 per cent of hospital schemes and 60 per cent of new schools were being delivered through PFI. However, I concede that the response of the then Government accepted a number of our recommendations.

We now have a new Government and I hope that the debate is a timely opportunity to set out the Government's approach to these issues, particularly bearing in mind something that we were very much aware of in our hearings and that we acknowledged in our report. I refer to the fiscally constrained environment in which we now live, the pressures on public expenditure and the impact of the credit crunch on the willingness of the banks to finance PPP/PFI deals, 85 to 90 per cent of the costs of which are usually met by borrowing.

My early involvement with PFI came with the Dartford Crossing in the mid-1980s. I was then Chief Secretary to the Treasury. That was an early example of a private finance project—not a PFI in the current sense—in what would traditionally have been a purely public sector and taxpayer-financed infrastructure scheme. I recall there was some discussion of whether it breached the Ryrie rules that any privately financed solution must be shown to be more cost-effective than a publicly financed alternative. In my view, going ahead with it meant that it was clearly built earlier than it would have been had it taken its place in the priority pecking order in the traditional way, and that was a real benefit. Of course, it was different from subsequent PFIs in that it was financed by tolls not taxation, and it has been very successful.

Subsequently, as Secretary of State for Transport from 1992 to 1994, I was much struck when I first arrived in the department by the average cost overrun on all road schemes of 28 per cent on the original contract. We introduced design and build, which brought the contractor much more into the development, design and construction of the project and helped to bring those cost overruns down. Subsequently, there was design, build and operate and I would very much have liked to have gone further to design, build, finance and operate—finance not through taxation but in schemes that were for motorways or motorway expansion by motorway charging. That was then a step too far for some of my colleagues despite the fact that I produced what I thought was a very good Green Paper, which I still stand by, and I hope that some day it will be done, not least when the infrastructure need on the one hand and the public expenditure constraints on the other make it more desirable.

From the early days, I was a strong supporter of the PFI concept and the report shows that PFI has gone a long way to improving this overrun problem. However, inevitably with a major new innovation one learns lessons as one proceeds and some of the critics of the early PFI projects gave evidence to our committee. Broadly, I think that on the key points that they and others made, lessons have indeed been learnt and implemented and I illustrate this with three examples from our report.

The first is on refinancing. In the early days substantial gains were made by the financial partners by refinancing at lower costs once the building project had been completed and some of the attendant risks had been removed. We drew attention to this in paragraphs 84 and 85 of our report. The National Audit Office particularly criticised the Norfolk and Norwich Hospital project and its refinancing. That was one of the very early ones. Refinancing by PFI partners after the building had been completed resulted in the public sector securing about only 29 per cent of the refinancing gain while increasing the contract’s termination costs. In the report, we welcomed the Government’s action to secure for the public sector a substantial share of refinancing gains. We believe that that has now been recommended and recognised and accepted.

Secondly, there is the question of lack of skills in government departments—inevitably in project management and contract negotiations in the early stages. Again we made a recommendation on this. We recommended that public authorities should do more to maintain and improve commercial skills of staff dealing with private finance projects, with emphasis on long-term contract management as well as contract negotiation. Again, I think the Treasury has recognised and acted on the importance of this point.

Perhaps the third and most important of all the lessons is the failure of the London Underground Metronet PFP, which as we say in our report gave private finance projects in general a bad name. It was of course an exceptional project because of the huge debt guarantees the Government gave—95 per cent of the banks’ loans being guaranteed—which meant that the transfer of risk to the private sector did not happen and the loss to the taxpayer was estimated by the National Audit Office to be between £170 million and £410 million. Unfortunately, the government response does not really deal with our recommendation that PFP should not be used where the state is guaranteeing large amounts and a high proportion of debt as a means to make highly geared PFP happen. The then Government’s response simply noted our views. I hope that the Minister will look at this one again.

Before I turn to what I may describe as the big issue, there is one other detailed recommendation to which I wish to refer. In recommendation 145 we suggested, as Sir John Bourn told us, that the credit crunch, through its limitation on access to funds, thus making them more expensive and available for a shorter period, has tended to reduce competition. We drew attention to one of the problems about the lack of competition related to the high bidding expenses involved in bidding for PFIs. Of course, reducing the competition for private finance projects would increase the cost to taxpayers. We recommended that the Government should examine possible mechanisms for encouraging competition, such as returning an element of bid costs. The then Government in their reply said that the Treasury was reviewing that and that it would publish its findings shortly. I may have missed it, so I ask the Minister whether that has happened and, if so, could he comment on it?

I turn from the detailed recommendations to what I might describe as the big issue. I was an early supporter of PFI, not least for the better project management it involves and the effect it has on maintenance. Quite clearly, one of the other benefits of PFI is that maintenance is contracted for a long period ahead—and all of us who in the past have been involved in public expenditure issues know very well that if the pressures on public finance are very high, maintenance is often the thing that is cut. One of the benefits of PFI is, of course, to be able to do that.

I became somewhat alarmed at the scale and speed with which the Labour Government over the years embraced PFI and appeared to run away with it. It looked like a big wheeze, getting the credit for substantially increasing capital expenditure but without regard to the implications for many years ahead. Also, many witnesses told us that when they approached local authority projects and other projects, the Government implied that there was no game in town other than PFI. It looked like typical off-balance sheet financing, particularly when so little information was available about the level and future consequences of that PFI expenditure. Just as in the private sector, where off-balance sheet financing led to so many consequences for companies and banks, were we building up equal problems in the public sector? The problem was that, in the early stages, we could not get at the figures. Much progress in the accounting for PFI has now been made. In the earlier years, when many of us were in Opposition, we were already expressing concern about increasing public expenditure, and we knew at that stage that this did not even include all the off-balance sheet financing expenditure. At least we know about it now.

Is my noble friend confident that we now have a clear picture of current and future liabilities, and is he satisfied that the response of the previous Government to recommendations 59 and 60 on this matter have been sufficient? Above all, will he look again at our recommendation in paragraph 24? In that recommendation we draw attention to the problem of the build-up of contractual commitments over the years. We advocated that the Government should monitor and control, year by year, the impact of PFI commitments on the budgets of departments and public authorities with a view to ensuring that delivery of essential public services in future years is not unduly constrained or jeopardised by such commitments. As we move into a period of public expenditure constraint, which looks as though it will be here for some years ahead, that becomes more important. The then Government tended to respond by saying that everything was very satisfactory, that there has been full publication of all the details and, after all, that these annual payments under PFI unit charges make up a very small proportion. I do not think that is fully satisfactory. We need to know, and I hope that this Government will look again at our recommendation in paragraph 24. We need to be sure that the crowding-out effect of these future liabilities will not have a major impact on future public expenditure projects. The government response was that if a project had been financed in the traditional way, then of course there would be maintenance requirements in future years. These maintenance requirements were sometimes cut and they will not now be.

Finally, I have one last question on our recommendation on a national infrastructure bank. We recommended that the pros and cons should be kept under review and the previous Government agreed with our recommendation. Can I ask my noble friend to what extent the green investment bank, now proposed by the Government, will meet our recommendation?

In conclusion, there is no doubt that the PFI/PPP project and the whole concept has been a welcome and successful development for all the reasons our report outlines. It has been for many up to now a somewhat esoteric area, perhaps accountancy-led and with, as my noble friend Lord Vallance said, pretty turgid terminology, but it is critical. It needs greater public debate and I am glad that our report has contributed to that. I look forward to my noble friend’s speech, not only responding to some of the questions I have raised, but also giving us some idea of how our new Government see the scope and scale of PFI/PPP in future years.