Private Finance Projects (EAC Report)

Lord Vallance of Tummel Excerpts

Wednesday 3rd November 2010 Lords Chamber

Moved By

[Lord Vallance of Tummel]

To move that this House takes note of the Report of the Economic Affairs Committee on Private Finance Projects and off-balance sheet debt (First Report, Session 2009–10, HL Paper 63).

[Lord Vallance of Tummel]

My Lords, although I am no longer a member of the Economic Affairs Committee, I am pleased to introduce its report, Private Finance Projects and off-balance sheet debt, which was published in March while I was still chairman. Before I do so, I should declare an interest as a member of the supervisory board of Siemens AG, one of whose divisions has been party to a private finance project.

I am grateful to all the witnesses who made the report possible and especially to the National Audit Office for its valuable contribution. I should also like to thank Professor Paul Grout of the University of Bristol whose knowledge and experience were essential to our report. The topic is important and affects all of us, but the terminology is pretty turgid: neither private finance initiative, PFI, nor public private partnership, PPP, exactly fire the imagination. “Private finance projects”, or PFPs—the umbrella term that we adopted in our report—is scarcely more compelling, but it has the virtue of embracing both the PFI concept introduced by a Conservative Government and its PPP rollout, largely under a Labour Government. The term “private finance projects” also says what it means: doing public projects with private finance. I will use “PFPs” as a catch-all term today.

PFPs use private sector capital and skills to provide public infrastructure for a lengthy fixed period. Schools, roads and hospitals are typical examples. The public sector client pays the contractors fixed sums over about 30 years for design, build, maintenance and some services. This whole-life bundling of costs into one package sounds straightforward enough but PFPs are still controversial. Their defenders say that risk-taking private contractors bring to public procurement the rigour, efficiency and skills needed to get the most out of scarce resources and that they mostly deliver to time and to budget. Detractors say that PFPs are expensive, inflexible and do not really transfer risk from the public sector. It is not easy to show where the truth lies, since lack of data on the whole-life costs of traditional procurement hampers objective comparison. This sometimes encourages heated assertion rather than cool analysis. In our report we tried to take a balanced view of PFPs, but it can be only an interim assessment; no final verdict will be possible until the bulk of the PFP deals signed in the last decade or so have run their course. Even then, the success or failure of PFPs is likely to be judged on a case-by-case basis, with type of project and local factors helping determine how each is finally evaluated.

PFPs grew from a combination of circumstances arising in the post-war decades. Broadly, growth in publicly funded services and rising expectations meant that far more public infrastructure was needed, but over time the perception grew that traditional public procurement was inefficient. The public sector specified a project, private contractors built it and the public sector was then left holding the baby. There were delays, cost overruns, contractual disputes and chronic neglect of maintenance. At the same time, Governments trying to find resources to meet ever-rising demand were looking for better value for money. It was clearly in the public interest for them to look for a new and efficient approach to public procurement.

The beginnings of what became PFPs were in the 1980s, when use of private finance in public procurement was still hedged about with restrictions. Those restrictions were largely removed in the early 1990s as the Government set out to attract private capital. Typical PFPs bring together private contractors holding shares in a consortium—a special purpose vehicle, in the jargon—formed to carry out a specific public project. The contract bundles together construction and maintenance over a long period and is financed by the contractors, mainly through debt, in return for fixed payments over the years by the public authority. Although the PFP model emerged under a Conservative Government, its use became widespread under a Labour Government such that by 2009 there were about £64 billion-worth of PFP contracts in force. This rapid growth of private finance projects is striking. It is clear that PFPs have played a significant role in the expansion and renewal of the nation’s infrastructure. Most schools and hospitals are now procured through PFPs. It will be interesting to see whether this pattern of procurement continues under the coalition Government.

It is clear that PFPs have built much in a short time, changed the urban landscape and renewed much public infrastructure. It is also clear that PFPs are best suited to certain types of projects, such as roads, schools and hospitals, since they can be clearly specified and are of a size that the private contractor can readily finance. It was striking that very few of our witnesses wanted to go back to traditional procurement in areas where PFPs had become the norm. The PFP model has also been enthusiastically adopted by other countries. On the other side of the ledger, experience already seems to show that PFPs are not the right approach for very large, complex and uncertain projects, such as the renovation of the London Underground. However, even successful PFPs, built to budget and on time, are still at an early stage in their life cycle. Few have been running as long as a decade, whereas many of the contracts are for 30 years. It will be for our successors in the 2030s to draw up a final balance.

Meanwhile our report drew conclusions and made recommendations on the basis of experience so far. Here are some of them. Public authorities should be free to choose the procurement method that offers the best value for money. There should be no institutional bias for or against traditional or innovative approaches. There should be greater clarity about financial liabilities arising from PFPs, which should be published alongside the national accounts. Data should be collected on whole-life costs of projects procured by traditional methods, including maintenance and services over the years, so that there can be meaningful comparison with the value for money of PFPs. The pros and cons of establishing a national infrastructure bank, as a means of combining financing at government rates of borrowing with the rigor and efficiency of private-sector delivery, should be kept under review. The operation of the secondary market in PFPs—the buying and selling of PFP contracts—should be monitored for any signs of a drop in build quality where contractors are able to sell completed projects that they would otherwise have to maintain. The public sector should enjoy a fair share of the benefits from any refinancing of PFPs. We also recommended that the Government should monitor the risk of jeopardising the delivery of essential services where public authorities’ budgets were constrained and where the obligatory nature of payments under PFP contractual commitments might squeeze out other critical but discretionary expenditure.

I am glad to say that the then Government were commendably swift in producing their response to our report. They were positive about many of our recommendations, including the quantification and publication of the country’s PFP liabilities and the collection of comparable data on the costs of traditionally procured projects. The previous Government also declared their intention to establish a green investment bank, which would operate on a commercial basis and involve both public and private sector capital. However, that Government dismissed our concerns about the potential effect on the ability of public authorities to deliver essential services as inflexible PFP payments took a higher share of reduced budgets. We were told that PFP payments represented very little threat to the flexibility of the Government’s budgets.

There is now a new Government. We note the commitment by the Chancellor of the Exchequer to go ahead with a green investment bank, but we have heard little of the coalition Government’s approach to PFPs. Will they still have an important role in public procurement? How far will new private finance projects be constrained by the spending review? What will be the role of the green investment bank with respect to PFPs? Does the coalition agree that public authorities should be free to adopt whatever procurement method offer best value for money? Will the Government ensure that overall PFP liabilities are clearly quantified alongside national accounts? Do the coalition Government share the view of the previous Government that inflexible financial obligations under PFPs will not constrain the ability of public authorities to deliver essential services, even as the comprehensive spending review bites?

We will perhaps not hear all the answers today. That said, it is already clear that PFPs have been a bold innovation and that their impact will remain with us for many years, although, as I have indicated, it is too early for a definitive assessment. Meanwhile, it will remain important for Governments, including the current one, to keep looking for best value for money in public procurement and to keep trying out new methods. These might include: new combinations of private sector rigour and financial accountability with the public sector's ability to borrow cheaply; the extension of PFPs beyond construction, maintenance and ancillary services to include some of the core functions in health, education or even defence; and embracing a flexible approach that allows the choice of the procurement path best suited to each project. The guiding principle of procurement should always be to get the best value for the taxpayer, especially while money is tight. I beg to move.

--- Later in debate ---

[Lord Vallance of Tummel]

My Lords, PFPs clearly present a complex set of financing and procurement issues, and it is relatively easy for them to become politicised—although not, of course, in your Lordships' House. The very adjectives “public” and “private” can produce knee-jerk reactions—a point to which the noble Lord, Lord Lipsey, alluded. As someone who has spent half of his career in the public sector and half in the private, I know that neither has all the answers. What matters in public procurement is to keep learning the lessons of the past, to keep experimenting with new ideas and, critically, to build up real procurement expertise in the public sector—a point made strongly by the noble Lord, Lord Tunnicliffe, and acknowledged by the Minister.

I am very grateful to the Minister for his thoughtful and positive response to our committee's report, and trust that he will keep it high on his agenda.

Motion agreed.