Please stop fiddling the books

<em>Special Report: The Private Finance Initiative</em> - The mandarin's view

There were two great discoveries that the Tories made about the public services. The first was that the private sector could often deliver public services just as well as the public sector could. The second was that nobody owed the public sector service entities a living for their own sakes. New Labour, as in so much else, has bought into all this.

We have become used to the idea of straightforward privatisation, and this government is likely to continue with it. And there is nothing new in public-private partnership (PPP). Governments have always had some public services delivered by the private sector. More recently, there have been contracting-out arrangements, or out-sourcing, where public authorities buy in services they would otherwise have provided themselves, specifying clearly what they want and using reputable and experienced private sector suppliers who know what they can deliver. An example here is the early warning defence system at Fylingdales, which has been operated by the private sector for over 30 years.

But then we come to the Private Finance Initiative (PFI). This is where the private sector finances, builds and often operates public sector capital works - hospitals, roads, schools and so on- in return for future payments over time. Though now described as a variant on PPP, in fact it is different in kind. Examples of current PFI projects are shown in the box above.

It's big money. According to the Budget Red Book, it is currently worth about £4 billion annually of capital. The total outstanding tops £13 billion. These are small numbers in relation to the total public expenditure of £300 billion a year, but pretty big in relation to the overall financial deficit or surplus - the Chancellor's "war-chest". PFI commitments can also be very big in relation to the finances of individual authorities. PFI still worries people in a way that privatisation and straightforward PPP now don't worry them. Why?

It is because, instinctively, many people don't think PFI hangs together. They mistrust the motives of chancellors; they think it's a way for them to have both the bun and the penny, allowing them to provide the schools, hospitals, roads and railways which are socially and electorally desirable while not paying for them at the time, thus artificially raising the amount available for tax cuts and the like.

They have a nasty feeling that information is being kept off the balance sheet by the Treasury in the way that, in the bad old days, used to send private sector company directors to prison. People see PFI as undisciplined, with everybody wanting to roar ahead and nobody having a real interest in the longer term. They don't like the feel of "never-never", where projects are paid for with a wedge of expenditure well into the future. The Red Book shows commitments up to £2 billion a year 25 years ahead, long after the need or value - socially economically or technically - of most of these projects will have expired.

People don't like the involvement of the private financier. They don't mind, indeed they probably welcome, the involvement of competent people who do the real work. But they can't understand why, when governments can always borrow more cheaply than anyone else, it is worthwhile engaging in a project that involves using money from the private sector. They don't like the extraordinarily high fees that private financiers charge and they think that the private sector is more risk-averse than it boasts, so that risk transfer is an expensive nonsense. They don't like the way in which private financiers seem able to dictate which project should proceed and which project should not proceed, regardless of actual social and economic need. Trade unions are concerned because of the effect of this apparently random element on their members.

Finally, people have this feeling that PFI just isn't value for money to the citizen, because the calculations are often flawed by not having any proper comparison made with what might have been done had the exercise been carried out completely in the public sector.

Until quite recently, the Treasury would have signed up in spades to these arguments, seeing PFI as a glorified confidence trick. It was, after all, the Treasury in the early 1980s that was the most energetic in shooting down what might have been the first PFI project, which was Michael Heseltine's idea of getting private money to finance the Queen Elizabeth II Conference Centre in London. But now, since 1992, under pressure to make the books look good, the Treasury civil servants have changed their tune.

They say that the PFI isn't actually the purchase of an asset on the never-never, rather that it's the purchase of a stream of services, which is quite different. They say that the additional finance costs are more than outweighed by the private sector bringing in expertise and taking on risks that would otherwise lie with the public sector. They say that the future wedge of spending is not all that big in proportion to total public expenditure, and anyway it is down to individual local authorities and others to consider and manage their future commitments. They say that the figures are all set out in the Budget documentation. They deny indiscipline and say that they and the rules that they lay down guard against over-enthusiasm. The unions need worry no more than in the case of privatisations or PPP. And the Treasury says that value for money is obtained, as compared with doing things the traditional way, by engaging in a proper appraisal before the venture is launched.

Many of these arguments, in my view, are pretty thin. With Gordon Brown and his ministerial colleagues espousing PFI, the discussion is being brushed up a bit. Pressures from the accountancy profession are likely to force some of the hidden spending on to the books. It will be interesting to see what this does to the public sector deficit/ surplus. But since Labour came in, we have seen so many rapes of the normal conventions of recording public expenditure that one more wouldn't make any difference. We have seen the Treasury raiding the National Lottery funds for things that ought to come straight off the top of ordinary public expenditure, and we've seen the government guaranteeing spends such as that on the Channel Tunnel rail link. Elsewhere there are heresies that show both public expenditure and taxes lower than they really are. We should keep a sharp eye on the quality of the figures that are laid out in front of us, which are not as reliable as they should be.

But the most difficult issue remains the question of whether PFI actually gives value for money to the taxpayer. Studies from the National Audit Office have suggested that in a number of individual cases it doesn't. In other cases the Treasury Taskforce claims that it does. But the value-for-money argument in individual cases would be a lot clearer if there were always a study, preferably published, not just to see whether private consortium A is better than private consortium B, but to see that any private consortium bid is measured against a "public sector comparator". This would try to measure what it would cost if the job were done in the conventional manner. The calculations are complex, but it must, in principle, be the way to do it, and it is apparently now the norm. But because of the complexities in the calculations and the judgemental elements that enter, the results are not always reliable.

So the Treasury has to police the calculations robustly and make them public where possible. And the Treasury must enforce a rule that if the comparator shows that the public sector would give better value than any private sector bid, the PFI should not proceed - except perhaps in some very exceptional cases - and the proposed project should either proceed in the normal way or not at all.

Departmental ministers do not like this idea; because it means that, if they want a new hospital, prison or school, they will have to take some money from some other part of their budget. But it is better to ask ministers to make some real hard judgements today than to create a hidden waste of money and an unjustified burden on the future.

But there's another approach. PFI deals are often described as "DBFO" - design, build, finance and operate. The aim should be to get rid of, or at least discount heavily, the "F" element. The economics of PFI rely on the argument that the greater cost of money that the private sector has to meet is more than outweighed by its greater efficiencies and risk-taking. So why not cut the corner, have the project publicly financed at the cheaper rate and retain the value of the private sector's greater skills in building and operating?

The Treasury argues that this is over- simple and that the involvement of the private sector in the actual crafting of the deal is in itself a benefit. It also argues that, unless the "F" element is left in, then insufficient risk will be taken off during the other elements. But in fact public authorities do know a good deal about designing, building and operating public service works, and it ought to be possible to turn what are now PFI projects, with this additional financing cost, into something much more manageable. They would look more like straightforward PPP contracts.

Perhaps that is what the latest effort by the Treasury to breathe life into the PFI Lazarus is leading to. We have the new "Partnerships UK". It's not too clear what this is going to be up to, nor whether public money will be going into it. It has an uncomfortably complicated sort of feel. It could also be a centralising device, rather like the proposed new Office of Government Commerce, which may end up restricting the scope for freedom and innovation which we are promised public sector managers will have. It would be a pity if we find ourselves recreating state monoliths, just when a breath of fresh air is flowing through the machine.

If ever there were an approach that justified the overworked expression "Third Way", an improved PFI must be it, busting down as it does the old and painful public/private splits and the old and painful customer/contractor confusions to make available the resources of the whole economy to help provide better public services. It must be right. But there is a whole raft of problems in substituting one set of approaches and values for another and one set of prejudices for another. And a good deal of effort must be put into what is essentially simple housekeeping: more openness and clarity, better recording and reporting, clearer appraisal rules and more discipline in the identification and rejection of doubtful deals.

Done properly there's a useful addition to the public service delivery armoury here. Not done properly, there will be tears down the line.

Sir Peter Kemp is a former senior Treasury and Cabinet Office civil servant