The Private Finance Initiative (PFI) is a way of paying for new public works schemes.
Rather than the Government or a local authority borrowing money to build a new school or hospital, they find a private firm to do so.
A fixed-term contract is agreed, typically with a lifespan of around 30 years. The company then raises the money itself, builds the requested facility and agrees to maintain it to agreed standards for the length of the deal. The public body agrees to pay a set rate per year to use the facility.
The idea is that the private sector can build and maintain the building more efficiently than a public body would have done, while the public body has all the certainty of knowing how much it will pay each year with none of the associated risk if something goes wrong.
Crucially, while the public sector has effectively agreed to pay a huge amount of money over a 30-year period, this is not classed as debt in the way it would be if the Government or council had simply borrowed the money and built it themselves.
This has made it hugely appealing to successive Governments, each keen to give the impression they are not overspending.
As the Institute for Public Policy Research states: “If the private sector pays the capital costs up front, then they do not show on the Government’s balance sheet, even though they remain public liabilities..
“This is little more than an accounting trick. The public finances are no more or less sustainable than if the scheme had been carried out in a traditional way.”
The key problem, as last week’s report by MPs lays bare, is that private firms cannot borrow money at the rates which Governments can. Typically, a PFI project pays an interest rate double that of one using publicly-borrowed money.
“Private finance has always been more expensive than government borrowing,” the MPs’ report states. “But since the financial crisis, the difference between the costs has widened significantly.
“The cost of capital for a typical PFI project is currently over eight per cent – double the long-term Government rate of approximately four per cent. The difference in finance costs means PFI projects are significantly more expensive to fund over the life of a project.”
Just as importantly, signing up for a fixed 30-year contract means NHS and schools bosses are having to make predictions about he size and type of building they will need for decades to come.
In healthcare and education, things can change fast. But because the buildings are owned by the private firm, asking them to make changes outside of the agreed contract can suddenly become hugely expensive.
The committee adds: “We have received little evidence of the benefits of these arrangements – but much evidence about the drawbacks, especially for NHS projects.”