One of the announcements in the recent UK Budget was the ending of the Private Finance Initiative (PFI), including its revised form, PF2. PFI was introduced by the Conservative government in 1992. Subsequently, it was to become central to the Labour government’s ‘Third-way’ approach of using the private sector to deliver public projects and services.
PFI involves a public–private partnership (PPP). The private sector builds and/or runs public projects, such as new schools, hospitals, roads, bridges, student accommodation, and so on. The public sector, in the form of government departments, NHS foundation trusts, local authorities, etc., then pays the private sector company a rent for the infrastructure or pays the company to provide services. The benefit of PFI is that it allows private-sector capital to be used for new projects and thus reduces the need for government to borrow; the disadvantage is that it commits the public-sector body to payments over the long-term to the company involved.
As the chart shows, PFI became an important means of funding public service provision during the 2000s. In the 10-year period up to financial year 2007/08, more than 50 new projects were being signed each year.
As the number of projects grew and with them the long-term financial commitments of the public sector, so criticisms mounted. These included:
- Quality and cost. It was claimed that PFI projects were resulting in poorer quality of provision and that cost control was often poor, resulting in a higher burden for the taxpayer in the long term.
- Credit availability. PFI projects are typically dependent on the private partner using debt finance to acquire the necessary funds. Therefore, credit conditions affect the ability of PFI to fund the delivery of public services. With the credit crunch of 2008/9, many firms operating PFI projects found it difficult to raise finance.
- The financial health of the private partner. What happens if the private company runs into financial difficulties. In 2005, the engineering company Jarvis only just managed to avoid bankruptcy by securing refinancing on all 14 of its PFI deals.
Recognising these problems, in 2011 the government set up a review of PFI. The result was a revised form of PFI, known as ‘PF2’. PF2 projects involved tighter financial control, with the government acting as a minority co-investor; more robust tendering processes, with bidders required to develop a long-term financing solution, where bank debt does not form the majority of the financing of the project; the removal of cleaning, catering and other ‘soft services’.
Despite the government’s intention that PPPs remain an important plank of its funding of public services, the number of new PFI/PF2 projects has nonetheless declined sharply during the 2010s as the chart shows. Of the 715 PPP projects as of 31 March 2017, 631 had been signed before May 2010. Indeed, in 2016/17 only 1 new project was signed.
The collapse of Carillion
Concerns over PPPs remained despite the reforms under PF2. These were brought dramatically into focus with the collapse of Carillion plc (see the blog, Outsourcing, PFI and the demise of Carillion). Carillion was a British company focused on construction and facilities management (i.e. support services for organisations). It was a significant private-sector partner in PPP projects. By 2014 it had won 60 PPP projects in the UK and Canada, including hospitals, schools, university buildings, prisons, roads and railways.
However, Carillion had increasing burdens of debt, caused, in part, by various major acquisitions, including McAlpine in 2008. Events came to a head when, on 15 January 2018, an application was made to the High Court for a compulsory liquidation of the company.
A subsequent report for the House of Commons Public Administration and Constitutional Affairs Committee in light of the collapse of Carillion found that procurement procedures were fundamentally flawed. It found that contracts were awarded based on cost rather than quality. This meant that some contracts were not sustainable. Between 2016 and the collapse of Carillion the government had been forced to renegotiate more than £120m of contracts so that public services could continue.
The ending of PPPs?
On 18 January 2018, the National Audit Office published an assessment of PFI and PF2. The report stated that there were 716 PFI and PF2 projects at the time, either under construction or in operation, with a total capital value of £59.4 billion. In recent years, however, ‘the government’s use of the PFI and PF2 models had slowed significantly, reducing from, on average, 55 deals each year in the five years to 2007/8 to only one in 2016/17.’
At its conference in September 2018, the Labour shadow chancellor, John McDonnell, said that, if elected, a Labour government would not award any new PFI/PF2 contracts. He claimed that PFI/PF2 contracts were set to cost the taxpayer £200bn over the coming decade. Labour policy would be to review all existing PFI/PF2 contracts and bring the bulk of them fully back into the public sector.
Then in the Budget of 29 October 2018, the Chancellor announced that no further PFI/PF2 projects would be awarded, although existing ones would continue.
I have never signed off a PFI contract as chancellor, and I can confirm today that I never will. I can announce that the government will abolish the use of PFI and PF2 for future projects.
We will honour existing contracts. But the days of the public sector being a pushover, must end. We will establish a centre of excellence to actively manage these contracts in the taxpayers’ interest, starting in the health sector.
But does this mean that there will be no more public-private partnerships, of which PFI is just one example? The answer is no. As the Chancellor stated:
And in financing public infrastructure, I remain committed to the use of public-private partnership where it delivers value for the taxpayer and genuinely transfers risk to the private sector.
But just what form future PPPs will take is unclear. Clearly, the government will want to get value for money, but that depends on the mechanisms used to ensure efficient and high-quality projects. What is more, there is still the danger that the companies involved could end up with unsustainable levels of debt if economic circumstances change and it will still involve a burden on the taxpayer for the future.
- Find out how PF2 differs from PFI and assess the extent to which it overcame the problems identified with PFI.
- The government is not bringing back existing PFI contracts into the public sector, whereas the Labour Party would do so – at least with some of them. Assess the arguments for and against bringing PFI contracts ‘in-house’.
- Find out why Carillion collapsed. To what extent was this due to its taking on PFI contracts?
- What were the main findings of the National Audit Office’s assessment of PFI and PF2?
- The government still supports the use of public-private partnerships (PPPs). What form could these take other than as PFI/PF2 contracts? Would the problems associated with PFI/PF2 also apply to PPPs in general?
In the last few years there have been growing concerns (see here for example) that markets in the USA are becoming increasingly dominated by a small number of firms. It is feared that the result of this will be a reduction in competition. Consistent with this, evidence suggests that the profits these firms make have increased. Last month The Economist and the Resolution Foundation published evidence (see references below) suggesting a similar picture may be emerging in Britain.
The Economist divided the British economy into 600 sub-sectors and found that in 58% of these the share of total revenue accruing to the 4 biggest firms had increased since 2008. The Resolution Foundation found a similar picture, especially in manufacturing industries where from 2004-16 the top five firms’ share of total revenue increased by over 10%.
Economic theory would suggest that as markets become more concentrated prices are likely to rise and The Economist cites research showing that mark-ups charged by firms in Britain have indeed risen. In addition to consumers facing higher prices, there is also concern that the lack of competition both in the USA and the UK is leading to lower wages being paid to workers. On the other hand, unlike in the USA, the evidence from the UK does not so far suggest there has also been an increase in corporate profits. Instead, it appears that the more successful firms’ profits have increased at the expense of their rivals.
This evidence on profits is line with a number of arguments that suggest we should perhaps be less concerned when markets are dominated by a small number of firms. Large firms may benefit from economies of scale and, being sufficiently large may be necessary for firms to innovate in new products and processes. Furthermore, high market shares may result from the competitive process as a reward for a firm developing a unique product or being more efficient than its rivals.
The Economist cites the supermarket industry as an example where concentrated is high, but competition is intense. Interestingly, this is a market where the British competition authorities have previously been concerned about the level of competition and spent considerable amounts of time investigating.
Despite these two opposing viewpoints, overall, The Economist argues strongly that we should be concerned about the situation in Britain. Not only are prices too high and wages too low, but growth in productivity is slow, even for the leading firms. Furthermore, they make clear that the situation may worsen following Brexit. It is argued that:
leaving the EU’s single market and customs union would reduce trade, easing competitive pressure from abroad.
This is consistent with evidence that joining the EC in the mid 1970s increased foreign competition in the UK and helped to end the low productivity growth that had plagued the economy since the 1930s.
Furthermore, it is suggested that:
to attract investment the government might look more favourably on proposed mergers—and loosening regulations would be easier outside the EU’s competition regime.
Therefore, it is clear that in the future there will be a vital role for the UK’s competition authority to remain independent of political objectives and aim to promote competition. In particular, they must prevent mergers that raise concentration and harm competition and intervene if they believe firms are abusing their dominant positions. Of course, following Brexit the case load of the competition authority in the UK will increase dramatically as they have to take on cases previously dealt with by the European Commission. One estimate is that it will need to look at around 40% more merger cases. It will certainly be interesting to see how competition in markets in Britain evolves over the next few years and the role competition policy plays in regulating this process.
- Outline the ways in which concentration in a market is usually measured.
- Explain the different price levels that arise under the alternative models of market structure.
- Why do you think competition is currently so intense in the supermarket industry?
On 15 January 2018, Carillion went into liquidation. It was a major construction, civil engineering and facilities management company in the UK and was involved in a large number of public- and private-sector projects. Many of these were as a partner in a joint venture with other companies.
It was the second largest supplier of construction and maintenance services to Network Rail, including HS2. It was also involved in the building of hospitals, including the new Royal Liverpool University Hospital and Midland Metropolitan Hospital in Smethwick. It also provided maintenance, cleaning and catering services for many schools, universities, hospitals, prisons, government departments and local authorities. In addition it was involved in many private-sector projects.
Much of the work on the projects awarded to Carillion was then outsourced to other companies, many of which are small construction, maintenance, equipment and service companies. A large number of these may themselves be forced to close as projects cease and many bills remain unpaid.
Many of the public-sector projects in which Carillion was involved were awarded under the Public Finance Initiative (PFI). Under the scheme, the government or local authority decides the service it requires, and then seeks tenders from the private sector for designing, building, financing and running projects to provide these services. The capital costs are borne by the private sector, but then, if the provision of the service is not self-financing, the public sector pays the private firm for providing it. Thus, instead of the public sector being an owner of assets and provider or services, it is merely an enabler, buying services from the private sector. The system is known as a Public Private Partnership.
Clearly, there are immediate benefits to the public finances from using private, rather than public, funds to finance a project. Later, however, there is potentially an extra burden of having to buy the services from the private provider at a price that includes an element for profit. What is hoped is that the costs to the taxpayer of these profits will be more than offset by gains in efficiency.
Critics, however, claim that PFI projects have resulted in poorer quality of provision and that cost control has often been inadequate, resulting in a higher burden for the taxpayer in the long term. What is more, many of the projects have turned out to be highly profitable, suggesting that the terms of the original contracts were too lax.
There was some modification to the PFI process in 2012 with the launching of the government’s modified PFI scheme, dubbed PF2. Most of the changes were relatively minor, but the government would act as a minority public equity co-investor in PF2 projects, with the public sector taking stakes of up to 49 per cent in individual private finance projects and appointing a director to the boards of each project. This, it was hoped, would give the government greater oversight of projects.
With the demise of Carillion, there has been considerable debate over outsourcing by the government to the private sector and of PFI in particular. Is PFI the best model for funding public-sector investment and the running of services in the public sector?
On 18 January 2018, the National Audit Office published an assessment of PFI and PF2. The report stated that there are currently 716 PFI and PF2 projects either under construction or in operation, with a total capital value of £59.4 billion. In recent years, however, ‘the government’s use of the PFI and PF2 models has slowed significantly, reducing from, on average, 55 deals each year in the five years to 2007-08 to only one in 2016-17.’
Should the government have closer oversight of private providers? The government has been criticised for not heeding profit warnings by Carillion and continuing to award it contracts.
Should the whole system of outsourcing and PFI be rethought? Should more construction and services be brought ‘in-house’ and directly provided by the public-sector organisation, or at least managed directly by it with a direct relationship with private-sector providers? The articles below consider these issues.
Carillion collapse: How can one of the Government’s biggest contractors go bust? Independent, Ben Chu (15/1/18)
The main unanswered questions raised by Carillion’s collapse The Telegraph, Jon Yeomans (15/1/18)
Carillion taskforce to help small firms hit by outsourcer’s collapse The Telegraph, Rhiannon Curry (18/1/18)
Carillion Q&A: The consequences of collapse and what the government should do next The Conversation, John Colley (17/1/18)
UK finance watchdog exposes lost PFI billions Financial Times, Henry Mance and George Parker (17/1/18)
PFI not ‘fit for purpose’, says UK provider Financial Times, Gill Plimmer and Jonathan Ford (6/11/17)
Revealed: The £200bn Cost Of ‘Wasteful’ PFI Contracts Huffington Post, George Bowden (18/1/18)
U.K. Spends $14 Billion Per Year on Carillion-Style Projects Bloomberg, Alex Morales (18/1/18)
Carillion may have gone bust, but outsourcing is a powerful public good The Guardian, John McTernan (17/1/18)
PFI deals ‘costing taxpayers billions’ BBC News (18/1/18)
Taxpayers will need to pay £200bn PFI bill, says Watchdog ITV News (18/1/18)
The PFI bosses fleeced us all. Now watch them walk away The Guardian, George Monbiot (16/1/18)
Carillion’s collapse shows that we need an urgent review of outsourcing The Guardian, David Walker (16/1/18)
Carillion collapse: What next for public services? LocalGov, Jos Creese (16/1/18)
Taxpayers to foot £200bn bill for PFI contracts – audit office The Guardian, Rajeev Syal (18/1/18)
A new approach to public private partnerships HM Treasury (December 2012)
Private Finance Initiative and Private Finance 2 projects: 2016 summary data GOV.UK
PFI and PF2 National Audit Office (18/1/18)
- Why did Carillion go into liquidation? Could this have been foreseen?
- Identify the projects in which Carillion has been involved.
- What has the government proposed to deal with the problems created by Carillion’s liquidation?
- What are the advantages and disadvantages of the Private Finance Initiative?
- Why have the number and value of new PFI projects declined significantly in recent years?
- How might PFI projects be tightened up so as to retain the benefits and minimise the disadvantages of the system?
- Why have PFI cost reductions proved difficult to achieve? (See paragraphs 2.7 to 2.17 in the National Audit Office report.)
- How would you assess whether PFI deals represent value for money?
- What are the arguments for and against public-sector organisations providing services, such as cleaning and catering, directly themselves rather than outsourcing them to private-sector companies?
- Does outsourcing reduce risks for the public-sector organisation involved?
The linked articles below look at the state of the railways in Britain and whether renationalisation would be the best way of securing more investment, better services and lower fares.
Rail travel and rail freight involve significant positive externalities, as people and goods transported by rail reduce road congestion, accidents and traffic pollution. In a purely private rail system with no government support, these externalities would not be taken into account and there would be a socially sub-optimal use of the railways. If all government support for the railways were withdrawn, this would almost certainly result in rail closures, as was the case in the 1960s, following the publication of the Beeching Report in 1963.
Also the returns on rail investment are generally long term. Such investment may not, therefore, be attractive to private rail operators seeking shorter-term returns.
These are strong arguments for government intervention to support the railways. But there is considerable disagreement over the best means of doing so.
One option is full nationalisation. This would include both the infrastructure (track, signalling, stations, bridges, tunnels and marshalling yards) and the trains (the trains themselves – both passenger and freight – and their operation).
At present, the infrastructure (except for most stations) is owned, operated, developed and maintained by Network Rail, which is a non-departmental public company (NDPB) or ‘Quango’ (Quasi-autonomous non-governmental organisation, such as NHS trusts, the Forestry Commission or the Office for Students. It has no shareholders and reinvests its profits in the rail infrastructure. Like other NDPBs, it has an arm’s-length relationship with the government. Network Rail is answerable to the government via the Department for Transport. This part of the system, therefore, is nationalised – if the term ‘nationalised organisations’ includes NDPBs and not just full public corporations such as the BBC, the Bank of England and Post Office Ltd.
Train operating companies, however, except in Northern Ireland, are privately owned under a franchise system, with each franchise covering specific routes. Each of the 17 passenger franchises is awarded under a competitive tendering system for a specific period of time, typically seven years, but with some for longer. Some companies operate more than one franchise.
Companies awarded a profitable franchise are required to pay the government for operating it. Companies awarded a loss-making franchise are given subsidies by the government to operate it. In awarding franchises, the government looks at the level of payments the bidders are offering or the subsidies they are requiring.
But this system has come in for increasing criticism, with rising real fares, overcrowding on many trains and poor service quality. The Labour Party is committed to taking franchises into public ownership as they come up for renewal. Indeed, there is considerable public support for nationalising the train operating companies.
The main issue is which system would best address the issues of externalities, efficiency, quality of service, fares and investment. Ultimately it depends on the will of the government. Under either system the government plays a major part in determining the level of financial support, operating criteria and the level of investment. For this reason, many argue that the system of ownership is less important than the level and type of support given by the government and how it requires the railways to be run.
The case for re-nationalising Britain’s railways The Conversation, Nicole Badstuber (27/8/15)
Lessons from the Beeching cuts in reviving Britain’s railwa The Conversataion, Andrew Edwards (7/12/17)
Britain’s railways were nationalised 70 years ago – let’s not do it again The Conversation, Jonathan Cowie (1/1/18)
FactCheck Q&A: Should we nationalise the railways? Channel 4 News, Martin Williiams (18/5/17)
Britain’s railways need careful expansion, not nationalisation Financial Times, Julian Glover (5/1/18)
Right or wrong, Labour is offering a solution to the legitimacy crisis of our privatised railways Independent. Ben Chu (2/1/18)
Whether or not nationalisation is the answer, there are serious questions about the health of Britain’s railways Independent. Editorial (2/1/18)
Why Nationalising The Railways Is The Biggest Misdirect In Politics Huffington Post, Chris Whiting (5/1/18)
- What categories of market failure would exist in a purely private rail system with no government intervention?
- What types of savings could be made by nationalising train operating companies?
- The franchise system is one of contestable monopolies. In what ways are they contestable and what benefits does the system bring? Are there any costs from the contestable nature of the system?
- Is it feasible to have franchises that allow more than one train operator to run on most routes, thereby providing some degree of continuing competition?
- How are rail fares determined in Britain?
- Would nationalising the train operating companies be costly to the taxpayer? Explain.
- What determines the optimal length of a franchise under the current system?
- What role does leasing play in investment in rolling stock?
- What are the arguments for and against the government’s decision in November 2017 to allow the Virgin/Stagecoach partnership to pull out of the East Coast franchise three years early because it found the agreed payments to the government too onerous?
- Could the current system be amended in any way to meet the criticisms that it does not adequately take into account the positive externalities of rail transport and the need for substantial investment, while also encouraging excessive risk taking by bidding companies at the tendering stage?
The car industry has featured heavily in the news in recent weeks with the announcement of plans to ban the sale of new petrol and diesel cars in the UK from 2040. Around the same time, news broke that the European Commission had commenced an investigation into potential collusive behaviour between German car makers.
Since the investigation is ongoing, it is not yet clear exactly what the firms are accused of. However, allegations first published in German magazine Der Spiegel claim that since at least the mid 1990s Volkswagen (and subsidiaries Porsche and Audi), Daimler (owner of Mercedes-Benz) and BMW met several times a year. Furthermore, it is alleged the meetings aimed to give the firms an advantage over overseas rivals by:
co-ordinating the development of their vehicles, costs, suppliers and markets for many years, at least since the Nineties, to the present day.
In particular, Der Spiegel claims that the cartel limited the size of the tanks that manufacturers install in cars to hold chemicals that reduce diesel emissions. Smaller tanks then left more room for the car’s sound system.
Limiting the size of these tanks should be seen in the context of the 2015 emissions scandal where it became clear that Volkswagen had programmed its cars to limit the use of these chemicals and cheated in emissions tests. This meant that 11 million cars worldwide produced excess emissions. Whilst other manufacturers have suggested that the cars they produced may also produce excess emissions, Volkswagen has so far been the only firm to admit to breaking the rules so explicitly. However, if the allegations in Der Spiegel turn out to be true, there will be clear evidence that the harm caused was widespread and that illegal communication between firms played a key role in facilitating this. If found guilty, substantial fines will be imposed by the European Commission and several of the firms have already announced plans to put in place measures to reduce emissions.
It is not clear how the competition authorities discovered the cartel. However, it has been suggested that incriminating documents were uncovered during a raid of Volkswagen’s offices as part of an investigation into a separate steel cartel. It seems that Volkswagen and Daimler are now cooperating with the investigation, presumably hoping to reduce the penalties they could face. It has also been reported that Daimler’s role in the investigation will have serious implications for future cooperation with BMW, including a project to develop charging sites for electric cars. It will be extremely interesting to see what the investigation uncovers and what the future ramifications for the car industry are.
European officials probe claims of huge German car cartel CNN Money, Mark Thompson (23/7/17)
Automotive corruption: German manufacturer collusion could spell bankruptcy Shout out UK, Christopher Sharp (4/8/17)
Germany’s auto industry is built on collusion Bloomberg, Leonid Bershidsky (31/7/17)
BMW reassured top staff about cartel allegations: sources Reuters, Edward Taylor (4/8/17)
- What are the consequences of the coordination between German car makers likely to have been for consumers? What about for rival car manufacturers?
- Are there circumstances in which coordination between car makers might be beneficial for society?
- How do you think the German car industry will be affected by these allegations going forward?