Why John McDonnell's PFI pledge is welcome and affordable

John McDonnell caused a stir yesterday with his pledge to bring Private Finance Initiative (PFI) contracts back in house. Commentators who bandy about huge sums of money to pay for this commitment are missing the point.

The shadow chancellor said in his conference speech that Labour had already pledged not to sign any new PFI deals. He then added: “We will go further. I can tell you today, it’s what you’ve been calling for. We’ll bring existing PFI contracts back in-house.”

Unsurprisingly, this was immediately welcomed by UNISON, who campaigned against PFI from the outset, whichever government (Tory, Labour and SNP) used the scheme. Dave Prentis tweeted, “At long last! Our party sees sense on PFI”.

Let’s start by understanding what a PFI scheme is. Instead of borrowing in the normal way, public bodies contract with a consortium of private companies known as a Special Purpose Vehicle, to design, build and operate a public asset - typically schools, hospitals, roads and waste treatment works. The Tories invented the idea, Labour developed it and the SNP use it in Scotland to this day – albeit renamed as NPD or Hubcos. Instead of meeting the borrowing and running costs directly, public bodies pay an annual fee to the contractors.

The scheme has been criticised on many grounds and in the early years the main driver was keeping capital projects off the public sector off the balance sheet. Particularly important in Scotland because of the block grant and led to the saying ‘it’s the only game in town’. 

The main problem with PFI is that the private sector can’t borrow as cheaply as the public sector, and of course take a profit. Government can now borrow very cheaply indeed and this had led to calls to refinance such projects. PFI schemes are notoriously secretive, but we know that they are paying interest rates of 7%+, at a time when public bodies could issue bonds at a little over 1%.

UNISON Scotland set out in our ‘Combating Austerity’ plan how this can be done and save millions of pounds of austerity cuts in the process. The Public Accounts Committee at Westminster, hardly a bastion of socialist economics, also highlighted how such refinancing had been achieved in England. Sadly, while some projects have been brought back in-house in Scotland, progress has been glacial, as our progress report this summer shows.

An important forerunner to any contract renegotiations should be stricter monitoring of contracts and restructuring the existing provisions. A number of public bodies in Scotland are beginning to take this seriously, but again more could be done. At UK level John McDonnell could help by committing to changing some of the Treasury rules that make refinancing more difficult than it might be.

That’s why the commitment from Scottish Labour leadership candidate Richard Leonard is so welcome. He said: “Scotland has a huge liability to PFI and the Scottish Government’s Non-Profit Distributing scheme. The Scottish Government could and should set up a debt disposal department dedicated to raising funds to buy out the total outstanding £28.8bn PFI and NPD debt on operational contracts. Doing this could save the public purse hundreds of millions of pounds. If I’m Labour leader I’ll be pressing them on this issue and as a Labour First Minister it will be a priority.”

McDonnell’s actual commitment is fairly modest and doesn’t commit Labour to a massive increase in public spending. That’s because the public sector is already paying over the top for these schemes, so bringing them in-house would actually be a saving to the public purse. As well as giving public bodies control over vital public assets.

Edinburgh Schools - lessons to be learned

Collapsing Edinburgh schools are a metaphor for the folly of PPP schemes that have cost the taxpayers £billions. This latest scandal should be used as an opportunity to think again.

Fears over safety has forced the closure of 17 Edinburgh schools due to concerns over the standard of construction, leaving 7,000 pupils unable to return to classrooms following the Easter break. Every Scottish council is now carrying out surveys of schools that could be affected.

The schools were all built under the same public private partnership contract by Edinburgh Schools Partnership (ESP). This is a Special Purpose Vehicle - essentially a company set up to run this scheme, owned by the partner companies that are responsible for the contract.

This is how most Public Private Partnerships (PPP) are operated. There are a number of different schemes that come under this umbrella term, including PFI, NPD and the Hub Initiative. The common feature is that private companies finance and then operate a public service building for a contracted period, typically 25 years or longer. They were started by the Tories, developed by Labour and continued by the SNP, who have one of the largest PPP programmes in Europe.

While UNISON opposed PPP schemes from the outset, it is only fair to point out that construction failure is not an inherent element in PPP schemes. They can happen with any construction project and we don't at this stage have all the information on the precise problems with these buildings.

However, there are some reasons why such failures are a bigger risk in PPP schemes.

Firstly, the construction company in a PPP scheme is almost always an equity partner of the SPV running the scheme. In effect this means they are both the client and the contractor. Unlike conventional procurement, there is no council or other public service provider performing the supervisory client role.

Secondly, there is a profit incentive to keep costs to the minimum. Any saving that the construction partner can make, increases profits to both the construction company and the other SPV partners. There is therefore a stronger cost saving incentive than in conventional procurement. 

Thirdly, many PPP schemes have been under pressure to cut costs late in the project because of budget overrun. We know that this has resulted in specification cuts, such as fewer beds in PPP hospitals and the loss of planned teaching areas in PPP schools. There is bound to be a concern that this may drive construction changes as well.

Fourthly, PPP schemes tend to use standard designs to keep architectural costs to a minimum. This has been criticised on aesthetic grounds because designs don't always reflect the local setting. It also means that a design feature that fails, could have implications for not one building, but many.

I should emphasise that I don't believe that this means that anyone has deliberately done anything that is unsafe. However, PPP schemes do not have all the checks and balances that happen with conventional procurement.

Our concerns over PPP primarily relate to the inflexibility of long term contracts and cost. In our latest report on this issue late last year, we argue that with interest rates at historic lows, now is an ideal time to review the cost of PPP schemes that were signed when interest rates were much higher. It is now widely accepted and understood that PPP projects have been extremely expensive ways of funding new hospitals and schools. Estimates of how much the public sector could save now through buying out PPP contracts range as high as £12 billion in Scotland.

Whatever the cause of the construction failures in the Edinburgh Schools scheme, this should be yet another wake up call on the inherent weaknesses in this method of funding public services. Bringing PPP schemes into the public sector is a safer and more cost effective solution for public service delivery.