Corporate Strategy
Financial Engineering

CARILLION’S COLLAPSE MATTERS MORE THAN YOU THOUGHT ... PFI INCREASED COSTS AND CUT QUALITY. BUT THERE ARE ALTERNATIVES.

Burgess COMMENTARY

Peter Burgess

CARILLION’S COLLAPSE MATTERS MORE THAN YOU THOUGHT ... PFI INCREASED COSTS AND CUT QUALITY. BUT THERE ARE ALTERNATIVES.

As a colleague of mine recently pointed out, if you went into a restaurant and found almost every kind of cuisine on the menu, you’d probably conclude that none of the dishes would be much good. And so it was with Carillion.

Carillion was the rather ashen phoenix that emerged from the flames of a demerger with Tarmac. The gritty, muck and brass bit of the company still trades under the Tarmac name, while Carillion flew off to become the lighter, category-defying winner of multiple public procurement contracts.

Even the name was apparently devised to free it from its sticky roots in aggregates and road surfacing; because meals cooked for you by Tarmac would have made hospital food even less palatable.

And that was the point. The prevailing ideological wind was blowing resolutely in the direction of outsourcing public services and Carillion was the perfect renaissance company to make the most of the opportunity – whatever that opportunity was.

Famously it won major, conventional public infrastructure contracts, such as its part in the HS2 consortium – made controversial due to the timing of the letting of the contract. But Carillion also built hospitals under PFI deals, managed the maintenance of around half of the UK’s prisons, prepared tens of thousands of meals for hospital patients and even ran operating theatres. It’s probably easier to list what it didn’t do.

“PFI WAS ESSENTIALLY ABOUT KEEPING CAPITAL INVESTMENT OFF GOVERNMENT BOOKS WHILE ‘SUPPOSEDLY’ TRANSFERRING BORROWING AND PROJECT RISK TO THE PRIVATE SECTOR.”

It was not the smorgasbord that was Carillion’s ultimate undoing. It was in fact its failure to deliver two hospitals and a road. Its entry into receivership has led to further delays in the completion of the two hospitals (in Liverpool and Sandwell) and brought all of its other contracts crashing down in the process.

I doubt anyone is arguing that roads and hospitals should actually be built by government rather than private companies. But both the Royal Liverpool and Midland Metropolitan Hospitals are being constructed under PFI schemes and that does throw up a big issue. Concocted during the salad days of privatisation, PFI was essentially about keeping capital investment off government books while ‘supposedly’ transferring borrowing and project risk to the private sector.

WHAT IS PFI?

A Private Finance Initiative (PFI) is one way that the government finances and manages new infrastructure projects. Traditionally, the government would raise the funds from taxes or bonds to contract private construction companies to complete infrastructure projects. Instead, when the government uses a PFI, a private firm (a Special Purpose Vehicle (SPV)) is created to raise the finance from capital markets.

This means the debt used to finance the project does not immediately appear on the governments books; it’s ‘off-balance-sheet’. The project is then managed by the SPV, and the government pays a ‘unitary charge’ (including interest repayments, shareholder dividends, and maintenance costs) to the SPV for the duration of the contract (typically between 25–30 years). You can see where this is heading!

PROBLEM 1: PFI HAS CREATED A DYSFUNCTIONAL MARKET

The trouble is that most public infrastructure is too important to fail; in the case of hospitals, lives depend on the infrastructure. Neither NHS trusts nor central government would allow a company to default on loan repayments that enable a hospital full of sick people to continue operating. So, while the financial risk technically sits in the private sector with PFI, if a company like Carillion is unable to meet the necessary repayments, these debts are effectively transferred to the taxpayer.

At the heart of this lies an issue with accountability. After almost 7 years of austerity in which local authorities and other public bodies have been forced to shed staff and knowledge – the chances of holding large, more-or-less monopoly-holding companies to account for their conduct are slim. In fact key institutions like the Audit Commission have been dispensed with altogether, only compounding this issue further.

As a consequence of PFI, public bodies are locked into future service charges for key infrastructure like NHS hospitals. Image credit: Natanael Melchor on Unsplash

Aside from this, it’s hard to believe that many PFI deals are good value, simply because the government can always borrow at lower rates than private firms. As economist Simon Wren-Lewis points out, PFI is the wrong way round as the private sector borrows at a presumably higher cost, pockets any profits and then transfers the risk to the public sector.

Figures from a recent National Audit Office (NAO) report highlight this point. Debt and equity investors of PFIs are estimated to receive a return of between 2–5% above government borrowing. These returns can have a considerable impact on the overall cost of a project. In fact, the NAO analysis shows that private finance procurement resulted in schools and hospitals costing between 40–70% more, than if the costs had been covered via public finance and procurement. With PFI, we are essentially getting 2 schools or hospitals for the price of 3!

A second part of the glorious logic of PFIs is that private firms are inherently more efficient. But is that true? Even the NAO has been unable to tell whether many of these deals are good or not, because the Treasury was unable to come up with a credible account of benefits in terms of savings. But whether any of the PFI logic stands up or not, the NAO report concludes that public bodies are now locked into £199 billion of future charges due to the existing 700 or so operational deals.

“WHILE THE FINANCIAL RISK TECHNICALLY SITS IN THE PRIVATE SECTOR WITH PFI… IF A COMPANY LIKE CARILLION IS UNABLE TO MEET THE NECESSARY REPAYMENTS, THESE DEBTS ARE EFFECTIVELY TRANSFERRED TO THE TAXPAYER.”

Add to that the cost of bloated CEO salaries and bonuses, the transfer of value to shareholders, the probable elaborate ‘tax planning’ by the outsourcing firms, the financialisation and selling-on of the assets to wring further value out of them and you’re left with a level of risk and precarity that school children and hospital patients really shouldn’t be exposed to.

It’s also easy to see why firms like Carillion want to be the bankers as well as the builders. If you lend and collect repayments, then you can make even more of the opportunities afforded by financial markets – you can play with taxpayers’ money. But there is nothing inexorable about PFI. It was a political choice based on an ideological predilection for private-sector-everything; other options are available.

The mutant children of PFI are already stalking the public sector landscape. Because local authorities aren’t able to borrow much themselves, they are now setting up their own third-party investment vehicles to access the roulette wheel of international financial markets themselves. Here, lie more disasters waiting to happen.

Hospitals and schools, public housing, railway lines and roads will almost certainly be built by private firms. But if borrowing can be done for less by the state, and if the risk will ultimately fall on the shoulders of public bodies anyway, PFI should be consigned to history. We are already saddled with repayments to private firms which amounted to £10.3 billion in 2016/17. That’s enough.


Upton Park, London is in the borough of Newham where the local authority has suffered after taking out LOBO loans. Image credit: Mikey on Filckr

PROBLEM 2: QUALITY MATTERS AS MUCH AS QUANTITY IN PUBLIC SERVICES

I live on a council housing estate in west London. Across the five blocks there are two different landlords (two were sold in the 1980s to a housing association, which was then taken over by another housing association, which is now just merging with another) and three separate contractors. One of them manages the council owned blocks, one maintains the blocks and the other contractor cleans.

Except they don’t. Because getting anything done is a task that requires residents to make multiple phone calls and often invoke the involvement of very good, but essentially powerless, ward councillors; the contracts are all long-term and the burden of proof for termination firmly rests on the shoulders of the local authority.

“AS A CONSEQUENCE OF PFI, PUBLIC BODIES ARE NOW LOCKED INTO £199 BILLION OF FUTURE CHARGES”

Recently we established a residents association across the blocks and brought all of the agencies and companies together in an effort to force them to work collaboratively. Have they? Not on your life. The lighting along the communal walkways hasn’t been working properly for months, yet no one will take responsibility for it. Often residents buy and replace the bulbs themselves because it’s easier than trying to get one of the contractors to do it.

Trivial though this seems, the multiple failures to provide even the most rudimentary of services have something of the Grenfell about it. The repeated, un-listened to cries of residents for proper services go unheeded.


Housing estate in London. Image credit: Nico Hogg on Flickr.

You don’t have to look very hard to find examples of outsourcing firms facing criticism for providing poor services, from the trivial to the more potentially serious.

Wren-Lewis repeats the casual fallacy that the incentive structure of profit means the private sector will probably be more efficient. But does that still apply in markets where competition is dubious at best and in which a small number of very large companies have hoovered up everything? And is efficiency per se even the right goal in public services.

Of course, there’s no excuse for wasting public money – such as by paying too much for the financing of infrastructure through PFI – and because private firms will always play some part in building public infrastructure or delivering services then, if well governed and regulated, there might well be an efficiency premium.

But if ‘efficiency’ translates into a poor, faceless and – critically – unaccountable services, from the mundane of replacing a light bulb to the profound of running operating theatres, then I for one don’t want it. What I want, and what I suspect many public service users want, is good quality services.

“WHEN INFRASTRUCTURE IS BEING BUILT WITHIN A GOOD REGULATORY STRUCTURE, PRIVATE EFFICIENCY IS FINE. BUT IF EFFICIENCY TRANSLATES INTO A POOR, FACELESS AND CRITICALLY UNACCOUNTABLE SERVICE, THEN I FOR ONE DON’T WANT IT.”

Before the contracting out madness began, all of the day-to-day maintenance and cleaning of our estate was done by one person – a council employee who lived nearby and whom everyone knew and trusted. I don’t honestly know whether it’s cheaper or more expensive to hire a person to look after a housing estate than it is to contract a web of firms to outsource the work too. However, I do have a hunch that most council employees mostly don’t invest their pay in exotic financial products and tax avoidance schemes – they probably just spend it in the local economy; that in itself may be a sound reason to bring back our estate’s caretaker.

WHY IT MAKES SENSE TO VALUE QUALITY AS MUCH AS COST

It’s easy to view the past through rose-tinted goggles, but the key with the provision of many services is not only ownership and control, but relationships too. When public bodies are deciding which services to outsource to external providers, quality – including relational considerations – should be as much of a priority as value for money. These factors should even be priced in to the cost-benefits analyses, assuming there are any.

Just as PFI rose on a cloud of ideological hot air, so we should avoid deifying public provision. The real key to better services is accountability and the involvement of people. While there are plenty of examples of public sector failure, there are also a growing number of instances where services have been improved by involving service users and local communities in their provision.

In Preston, after a decade in which the city was let down by large, private sector investors, the local authority is now trying to do things differently. The issue here is not private versus public per se, but about how the mighty procuring power of all local public institutions – the council, health trusts, the university and schools – can act together to direct capital where possible into locally owned and run endeavours, be they private, non-profit or public. Where those businesses do not exist, these ‘anchor institutions’ are working together to set up mutually-owned providers to fill the gap.

“THE REAL KEY TO BETTER SERVICES IS ACCOUNTABILITY AND THE INVOLVEMENT OF PEOPLE. “

Preston’s approach not only keeps money flowing around the local economy – as was the case in my area when a local caretaker was employed to look after our estate rather than several international firms – but it also brings service delivery closer to people and clearly creates opportunities for users to be directly engaged in running and managing public services.

If Carillion has killed PFI, then that’s a very good thing. But unless we fix the ability of the state to procure with power, change our view of capital investments in the public accounts so that they are seen as creating assets rather than only as debt, focus on service quality as well as cost and make services accountable to users, we can only expect more Carillion-like failure.

The other Carillions in the public contracts market – currently no doubt picking any tasty morsels off their competitor’s carcass – are really no different; it won’t be long before the next ashen phoenix falls on our heads. At the very least, let’s not allow any more to take to the wing.

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