HOUSE OF COMMONS. SESSION 1995-96 TREASURY COMMITTEE Sixth Report THE PRIVATE FINANCE INITIATIVE Together with the Proceedings of the Committee, Minutes of Evidence and Appendices Oraered by The House of Commons to be printed I April 1996 LONDON: HMSO 146 £20.50 |AW L|NHL| LN IHiIl IAAi| AWI | IANA| | HOUSE OF COMMONS SESSION 1995-96 TREASURY COMMITTEE Sixth Report THE PRIVATE FINANCE INITIATIVE Together with the Proceedings of the Committee, Minutes of Evidence and Appendices Ordered by The House of Commons fo be printed 1 April 1996 LONDON: HMSO 146 £20.50 © INFORMA... SERVICE 5 co Ix “y (9.J UN 998 TM. xg Wellcome Centre for Medical Sci il SIXTH REPORT FROM The Treasury Committee is appointed under Standing Order No 130 to examine the expenditure, administration and policy of the Treasury, the Board of Customs and Excise and the Board of Inland Revenue. The Committee consists of a maximum of 11 members, of whom the quorum is three. Unless the House otherwise orders, all members nominated to the Committee continue to be members of it for the remainder of the Parliament. The Committee has power: (a) to send for persons, papers and records, to sit notwithstanding any adjournment of the House, to adjourn from place to place, and to report from time to time; (b) to appoint specialist advisers either to supply information which is not readily available or to elucidate matters of complexity within the Committee’s order of reference; (c) to communicate to any other committee appointed under the same Standing Order (or to the Committee of Public Accounts or the Deregulation Committee) its evidence and any other documents relating to matters of common interest; (d) to meet concurrently with any other such committee for the purposes of deliberating, taking evidence, or considering draft reports. The Committee has power to appoint one sub-committee and to report from time to time the minutes of evidence taken before it. The sub-committee has power to send for persons, papers and records, to sit notwithstanding any adjournment of the House, and to adjourn from place to place. It has a quorum of three. 13 July 1992 The following were nominated as members of the Treasury and Civil Service Committee: (now the Treasury Committee): Ms Diane Abbott Mr John Garrett Sir Thomas Arnold Mr Barry Legg Mr A J Beith Mr Giles Radice Mr Nicholas Budgen Mr Brian Sedgemore Mrs Judith Chaplin (decd 19.2.93) Mr John Watts Mr Quentin Davies Mr John Watts was elected Chairman on 15 July 1992. Sir Thomas Arnold was elected Chairman in the place of Mr John Watts on 19 October 1994. The following changes in the membership of the Committee have been made. Monday 29 March 1993: Mr Nigel Forman appointed. Monday 13 December 1993: Mr John Garrett discharged. Mr Mike O’Brien appointed. Monday 31 October 1994: Mr John Watts discharged. Mr Matthew Carrington appointed. Wednesday 28 November 1994: Mr A J Beith discharged. Mr Malcolm Bruce appointed. Monday 27 November 1995 Mr Mike O’Brien discharged. Mr Clive Betts appointed. Monday 15 January 1996 Mr Giles Radice discharged. Mr Stephen Timms appointed. ; 7 Te eneo nan ae MIRIe om Cale | . Mit : The cost of preparing for publication the Shorthand Minutes of Evidence published with this Report was £5,110.60. The cost of printing and publishing this Report is estimated by HMSO at £12,627. prario’ CoahaM wt sumo”) somolle WA i - : tee Cre 7 * ee IP my ed THE TREASURY COMMITTEE ill THE PRIVATE FINANCE INITIATIVE TABLE OF CONTENTS Paragraph INTRODUCTION: Additional or Substitutional . 1-10 PREVIOUS PRIVATE FINANCE SCHEMES 11-15 THE STRUCTURE OF THE PFI 16-20 TURNING CAPITAL INTO CURRENT SPENDING 21-25 PUBLIC EXPENDITURE CONTROL .. 26-29 VALUE FOR MONEY 30-44 Xli The analysis of value for money 32-35 Xiil The bidding process 36-44 X1V THE TRANSFER OF RISK 45-50 XVli THE PFI IN HEALTH 51-56 X1X ACCOUNTABILITY .. 57-62 XXl CONCLUSION 63 Xxil PROCEEDINGS OF THE COMMITTEE RELATING TO THE REPORT XXill LIST OF WITNESSES XXX LIST OF MEMORANDA INCLUDED IN THE MINUTES OF EVIDENCE XXXl LIST OF APPENDICES TO THE MINUTES OF EVIDENCE XXX11 LIST OF MEMORANDA REPORTED TO THE HOUSE BUT NOT PRINTED XXXill MINUTES OF EVIDENCE l APPENDICES 116 es: -e “Cyd (ara “estghae Otae cvine — (38 onder ef the Par kyg ree" the CTeyeculation font, [RYORTS - y aa: ar Da Hie F shor tow plger4o pine, reee vasta Thea Hine te Fe ibe. t+ enpoist wea o ane ainta s wn 9 cgmasine h s BR SOF. 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Le | Gi O io eagle f 1 Chive Py pra race ne atome tn eA; a i" . aly ee #3, aa to tt ee two Ahaed * :©” by4" Me“laayr s¢: eave“msa e pt£t ~ C‘ H : QR vy % BR f ae fi it OL daps s : * urn ; é ee hp + gh2r'7 bil ' ; “al wi ya e eyS a ay ue» , Oenrew : bas avt are i f 8 oe 1% Sha i AAs. a4 cet - wes) ( .4 Heine toh a oo ‘ i feayy el Pair a 1x ©4 bm : ? eeee iN P ‘ UP } haw es % Py i et a? 7 Reo te gil ats , 4 i,4 ™P e a’ OT i : oe dai ee i * ee a meh deey ") *, KN ips ‘ i Da Te / ahve sl “ae fears geen eae es ny ie eee sce i hea ne ora g . G & |as pir ‘panne. * Daeaeal e Faie ne : cere ‘ ~ ; ‘ + ‘Biel ' n é ae ‘ , 4 » a . : de sts 7~ SIXTH REPORT THE PRIVATE FINANCE INITIATIVE The Treasury Committee has agreed to the following Report: INTRODUCTION: ADDITIONAL OR SUBSTITUTIONAL? 1. In our Report on the 1995 Budget, we took a good deal of evidence on the Private Finance Initiative (PFI). Then, we did not comment in detail on the PFI, but promised to report shortly on it in a separate Report. We did, however, isolate a few of our concerns. “Does it in fact provide better value for money for the taxpayer? Is the expenditure additional or substitutional? What would happen if a private sector contractor went bankrupt and was unable to fulfil the contract? How can Parliament and the public be kept informed of developments without weakening the power of Government to obtain the best deal? What Clarification should take place of the particular rules and application of commercial confidentiality? What types of project qualify under the PFI, what types do not and where is the dividing line between the two? What approach is adopted towards risk transfer? What are the revenue consequences of PFI?”' In this Report, we address some of these issues. 2. We have taken a consistent interest in the Government’s plans to import private finance into publicly-sponsored capital projects, and have regularly commented on the PFI since its introduction in the 1992 Autumn Statement and our Report thereon.” In February 1993, we took an isolated session of evidence from the Treasury on the subject.’ In 1994, reporting on the November 1993 Budget, we suggested that public sector financial involvement was an important element in allowing such projects to proceed, and asked for more clarity in the spending plans relating to private finance.* In 1995, reporting on the November 1994 Budget, we noted that the scheme had failed to attract significant private interest, and expressed concern that it was unclear whether the PFI was intended to supplement or replace public expenditure.> It was a recognition, while taking evidence on the 1995 Budget, that our concerns had not altered which led us to decide to undertake a short inquiry into the Initiative. 3. Our principal concern was to establish whether the PFI was intended to replace or to supplement public capital spending. On the introduction of the Initiative, and in the 1993 Red Book, it appeared quite plain to us that the expenditure raised in this way would be an additional source of funding for investment in capital projects.° By the 1994 Budget, however, we were expressing doubts as to whether the PFI was still additional, or whether a projected rise in private finance projects was being used to enable cuts to be made in orthodox public capital expenditure.’ 4. Since then, it has become increasingly apparent that the sums of money projected under the PFI are in practice replacing orthodox public capital spending and allowing cuts in expenditure to be made. In the 1995. Red Book, for instance, cuts in expenditure in the transport budget, from nearly £6 billion in 1994-95 to £4.18 billion in 1996-97 are matched by projected rises in capital spending under the PFI to £1.12 billion in 1996-97.2 Our perception has been reinforced by the observations of several ministers and officials, notably the Chancellor, who has said that “The growing importance of private finance has helped us to find significant savings for the taxpayer.”° ' Third Report, The 1995 Budget, Session 1995-96, HC79, para.85. * First Report, The 1992 Autumn Statement and the Conduct of Economic Policy, Session 1992-93, HC 201. > Session 1992-93, HC 508-i. * Second Report, The 1993 Budget, Session 1993-94, HC 87, para.89. > Third Report, The 1994 Budget, Session 1994-95, HC 79, para.41. ° Autumn Statement 1992, para.2.116; FSBR 1994-95, para.5.23. ’ Third Report, Session 1994-95, para.39. * FSBR, 1996-97, Tables 6.6 and 6.5. ? Official Report, 29 November 1994, col. 1085 vi SIXTH REPORT FROM 5. The Health Secretary, who as Financial Secretary was responsible for the PFI, told us “it 1s additional money which in the Health Service is allowing us to substitute what were previously publicly funded capital programmes for quite publicly funded revenue programmes.”'° A Treasury official said that "in the early days of PFI it was pretty clear to me that the projects that were going forward were additional in some sense. When something is established, it is much harder to say whether it is additional because it is very speculative to know what would have happened if it had not been there.”!! The Financial Secretary said that “it is additional at the time it occurs because clearly you are seeing private funding coming in to help the Government procure services...the additionality is the arrival of the private project with its capital to enable that particular project to take place... in the current spending round... there has been a deletion against previous capital plans of certain sums which the Government have planned to spend because the Private Finance Initiative can be seen to provide an alternative way of procuring those services.”'* Witnesses stressed that the value-for-money gains obtained through the PFI had, in fact, led to an ability to increase expenditure in other areas; in other words, the PFI, although substitutional in the sense that it allowed orthodox expenditure to be cut, is additional in the sense that it effectively permits additional spending. 6. If the Government is increasingly prepared to view PFI expenditure as substitutional, and to cut orthodox public expenditure, it is largely in anticipation of a rise in PFI spending rather than in response to it. In our previous Reports which have commented on the Government’s PFI projections, we have expressed scepticism as to their rapid rise. PFI spending, which has slowly risen from £300 million in 1993-94 to an estimated outturn of £600 million in 1995-96, is projected to treble in 1996-97 to £1.9 billion, and to continue to rise to £2.6 billion in 1997-98.'* Some of this money is now agreed, but the Government’s projections are, at the very least, optimistic. If there is a serious shortfall in the PFI projections, it will be difficult to provide money from public capital budgets to fill the gap. 7. In our: view, the Private Finance Initiative is now being treated by the Government as substitutional. It is enabling the Government to cut capital budgets in future plans. We are concerned that, if the PFI projections are met or exceeded and overall capital budgets not diminished, they may still not have an equivalent effect. In this Report, we address concerns that the PFI makes the long-term planning of infrastructure more difficult. It is arguable that the PFI hands over a considerable number of capital projects to bodies whose main concern is the profitability of the facility. If the need for a facility, and its probable profitability, do not coincide, the Government will need to take steps to ensure that services continue to be planned and provided. It would be unacceptable if the Government’s planning for the future provision of roads or hospitals began to be driven by the shorter-term perspectives of private bidders. The Committee would welcome therefore the Treasury’s views as to whether the prioritisation of projects should be the responsibility of Government and Parliament, or those seeking to provide projects on a commercial basis. 8. There is potential for value-for-money gains to be made through the PFI, although we think that the sources of these gains are not quite clear. Moreover, we think that, for confidence in the policy to be gained by bidders, Parliament and the public, it needs to be made more transparent, and the savings to be made through the greater efficiency of the private sector openly demonstrated. One of our witnesses thought that “the cost of doing that [refurbishing and renewing the social infrastructure] is beyond the public sector’s appetite for raising cash with which to do it. So as a society I believe we have to seek to tap other sources of finance.”'> The PFI could become a useful and effective way in which to increase investment. 10 QS. '! Q370. 12 9434, 13 See, eg, Q7 and Q379. '4 ESBR 1996-97, Table 6.4. 15 Q194. THE TREASURY COMMITTEE Vil 9. Despite these comments and reservations we continue to see PFI as an imaginative and very laudable initiative to attract private capital into areas into which it has not before previously been drawn, and, simultaneously, and by virtue of the same mechanism, to introduce into investment appraisal and project management in the public sector more effective techniques and disciplines. 10. In the course of our inquiry we took oral evidence from the Secretary of State for Health, the Financial Secretary to the Treasury, the Transport Minister and independent experts. Memoranda were submitted by a wide range of interested parties. We are grateful to all those who gave evidence, to Professor David Heald, our specialist adviser on this inquiry, and, not least, to the team of shorthand writers who produced expert transcripts within hours of the evidence being taken. PREVIOUS PRIVATE FINANCE SCHEMES 11. The Government has, for some considerable time, been actively attempting to harness private finance to fund investments by public sector bodies. The first major scheme stemmed from the recommendations of a committee, set up by the Treasury under the chairmanship of Sir William Ryrie, which produced a report in 1981. The Ryrie rules established two main principles for the use of private funds in capital projects. The first was that privately funded solutions must be tested against publicly funded alternatives and shown to be more cost- effective. The second was that, unless Ministers decided otherwise in particular cases, privately funded projects should not be additional to public expenditure provision, and provision for public expenditure would be reduced by the amount of private funding obtained. 12. The Ryrie rules engendered a number of major projects, notably a third crossing of the Thames at Dartford and a second Severn crossing. The Government now considers, however, that the Ryrie rules were too restrictive, and gave public bodies no incentive to seek out private finance. The rules were relaxed in 1989 so that private funding would no longer have to be substitutional; the Treasury would no longer require cuts in public capital expenditure to match privately funded projects. 13. Transport had, from an early date, been a primary area in which private finance was exploited. The major expansion of the later 1980s into the field of private funding was the Transport Green Paper, “New Roads by New Means”,!° which proposed means of leasing and charging for roads. Though it has been suggested that this project failed to attract the private sector, since the publication of the Green Paper coincided with a major boost to the public sector roads programme,'’ the Transport Green Paper formed the basis for a wider programme of private sector funding. This was what, on its launch in 1992, was termed the Private Finance Initiative which, in the course of our evidence, was described by the present Health Secretary, a former Financial Secretary to the Treasury, as “a fundamental change in the way Government managed and secured its sponsored capital investment programmes.”'* 14. The PFI, in several respects, loosened the restrictive provisions of the Ryrie rules. As noted, the requirement that private funding would have to be substitutional had already been relaxed, and in the introduction to this Report, we have already mentioned the various perceptions expressed by Government witnesses to the question of whether the PFI 1s now additional to or substitutional for public sector capital spending. Moreover, the other requirement of the Ryrie rules, that privately funded projects always be tested against a public sector comparator, no longer applies. In some cases, for instance where a project involves no '©"New Roads by New Means." A Consultation paper. Department of Transport, Cm.698, May 1989. '7 Private Sector Involvement in Road Infrastructure: the UK Experience, Dr David Starkie, January 1995, p.3. 18 Qo. Viil SIXTH REPORT FROM public money or which would not have gone ahead other than as a PFI project, no public sector comparator is required, and value for money is established through competition. 15. It was expected, on the creation of the PFI, that the less restrictive and more permissive framework of the Initiative would create an atmosphere in which public bodies would find an incentive to put a project out to tender, and private bodies would find an incentive to invest in publicly-sponsored projects. In the words of the Health Secretary, the PFI was designed to remedy a situation where “the public sector was missing both extra access to capital and extra access to good management that could come through a proper partnership with the private sector.”*’ Although we have expressed doubts here, and on other occasions, about whether the private sector capital will emerge to the extent which the Government projects, we do think that the PFI is a more effective tool than previous Government attempts to attract investment from private bodies. THE STRUCTURE OF THE PFI 16. At the launch of the PFI in 1992, three types of PFI project were identified. In the first, the costs of the project are funded entirely by private money, and recovered by means of direct charges to the end user. The public sector here acts as an enabler rather than a supplier of funds at any point. An example of such a project might be a road funded by direct tolls on the user. In the second, the private sector funds the project, and recoups the costs by selling the services the facility provides mainly or entirely to the public sector, as in the case of privately financed prisons. In the third, the capital cost of the project is divided between public and private funds, with overall responsibility for the project resting with the private sector. This type is most appropriate for projects where the social benefit is thought to be greater than the revenue it could generate, such as a road designed to lessen congestion. In the second and third types, the overall effect is to shift capital expenditure into current expenditure, via payments for services. We examine this point below. 17. The PFI is not seen by the Government as an initiative with limited and specific application. It has stated that all public sector bodies should consider PFI options when business strategies and efficiency plans are being drawn up, when the refurbishment or acquisition of a capital asset is foreseen or being considered, and when the future of a public body is under consideration. To encourage wider participation in PFI projects and to stimulate new ideas for the application of the PFI, and a wider understanding of the Initiative in both public and private bodies, a Private Finance Panel was established in 1993 under the chairmanship of Sir Alastair Morton and subsequently of Sir Christopher Bland. 18. Before deciding to embark on a PFI project, rather than one funded by the conventional means of public capital expenditure, two requirements must be satisfied. The first is that value for money must be demonstrated for any expenditure by the public sector. Apart from free- standing projects which do not create a monopoly, where no significant public expenditure is envisaged, PFI projects must be subjected to a value for money test. An economic appraisal is followed by a comparison with a conventionally procured alternative. If the PFI project is shown to represent greater value for money than the public sector comparator - and the Government’s “starting point is a clear presumption that the PFI approach will generally be better than a traditional procurement”*! — the PFI bidders enter into a competition. We examine the value for money principle in paragraphs 30-44 below. 19. The second requirement of the PFI is that the private sector must assume risk. The Government’s view is that the transfer of risk should be allocated to whoever is best able to manage it, and that the transfer of risk is a significant incentive to perform well for a private service provider. In cases, such as free-standing projects, where no value-for-money test is deemed necessary, the transfer of risk is the principal requirement. The risks the Government '9 Private Opportunity, Public Benefit, Private Finance Panel, November 1995, pp.19-20. (Hereafter referred to as the POPB). 0. OST: *! POPB, p.18.