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Written by Helen Mercer: Jubilee Scotland launch 29^th January 2020

There is a strong tendency among campaigners on PFI to see the problems with which we are all familiar – the high cost of finance, poor construction, excessive profits – as stemming from factors such as woolly thinking, incompetence, corruption, fraud, lack of transparency and weak monitoring. I argue first that while such factors may exist they are not the root causes: the problems with PPPs are systemic and structural in an environment deliberately created by governments.

A simple and curtailed history of PFI

1. By the 1990s Britain faced a pent up demand for renewed infrastructure. The IMF loan of 1976 agreed by the Labour government lead to major cuts in public expenditure, continued into the 1980s. By the 1990s major maintenance problems in public infrastructure were apparent, and often the preferred solution was to demolish the entire building and start afresh.

Pent up demand for investment in public infrastructure

2. However by the 1990s public authorities’ traditional access to public borrowing was limited by the Maastricht Treaty and its successors, together with severe unilateral targets adopted by Gordon Brown on levels of government debt and budget deficits. Central government has various tools to secure cheap borrowing rates, but these were no longer available to public authorities to address their infrastructure backlogs.

PFI BECAME THE ‘ONLY GAME IN TOWN’

3. Governments therefore gave the private sector a free hand in providing much needed public investment. Capital markets had been deregulated. Investors were seeking profitable outlets and Government was a willing tool in opening up the state sector as a source of profit. It passed legislation guaranteeing payments on PFI deals and offered special PFI subsidies to public bodies to ensure they could afford to pay the private premiums.

PROFITABLE INVESTMENT WAS UNDERWRITTEN BY GOVERNMENT

4. Public authorities were left to deal with predatory private investors and lenders. In forcing them down the PFI route the government deliberately set up a situation of asymmetric information. All the knowledge and experience was on the side of the private investors and lenders, on the public side was a urgent need for what only they could offer.

PUBLIC AUTHORITIES WERE SENT NAKED AMONG WOLVES

PFI schemes also became a key driver of the outsourcing of public services, as privately provided servicing and maintenance of the PFI building became part of the PFI contract. (This has not been the case for the variants PF2 and NPD/Hub projects but has re-appeared in the Mutual Investment Model (MIM’s) The PFI mix was a toxic one of heavy debt, outsourced servicing, together with a lack of control over the contractors themselves.

This mix of factors shows that the failings of PFI cannot be characterised as unintended or unfortunate. The solutions therefore cannot lie just in FOI requests, or judicial review or tax adjustments. These activities provide publicity and additional knowledge and are therefore useful in campaigning, but such actions cannot be paraded as solutions.

Hence the economic history of PFI shows a systemic, in-built purposeful failure in which even personal or corporate corruption, assuming it can be proven, is of minor importance in understanding the root of the problems. This picture of the system, the environment within which PFIs have developed needs to be complemented by considering the way PFI contracts are structured.

The structure of PFI contracts

To describe the structures set up through PFI and similar projects is again to broach a large and complex area so I want to focus on just one key point element – the role of the company which signs the contract with the public authority – the Special Purpose Vehicle or SPV.

It is the SPV which, in return for an annual payment, secures all sources of finance, pays building contractors and, where relevant, the service providers. They are private companies, whose shares are owned by private investors increasingly infrastructure investment funds, such as HICL, Dalmore Capital, Standard Aberdeen, 3i, Innisfree, Semperian.

The diagram shows an SPV sitting like a spider at the centre of a web of contracts – the primary contract with the public authority and then the various contracts with lenders and with the contractors.

The role of the SPV is effectively to pump public money to various private actors and most importantly to the shareholders themselves. The shareholders extend 10% of the finance needed for the project and their loan carries interest rates usually of around 10-15% and is one of the reasons why PFI is so expensive. In addition as shareholders they are entitled to dividends and these accrue from any difference between what the public body pays the SPV (in debt, payment for services etc) and the monies owed by the SPV to lenders, builders and service providers. In the case of the Scottish Non-Profit PFIs any such surplus does not accrue to investors.

The position of the SPV is the main reason why buyouts as the solution are to PFI are bound to be unsatisfactory. A buyout involves the public authority effectively ending a commercial contract under commercial terms, and as a result penalty clauses must kick in and investors and others will be compensated for the loss of anticipated earnings. They walk off with a lump sum from the public purse.

Solution: nationalise the SPVs as a way to end PFIs

It was recognition of the structural features of PFIs that prompted campaigners to look at the idea of nationalising the SPVs. It is not a buyout because no PFI contract is cancelled or ended: instead ownership of the SPV passes to the government and hence the parties to the main PFI contract are both publicly owned a situation which immediately opens new spaces for restructuring the relationship.

This has two effects which reverse the systemic problems referred to in the first part of this talk. First, control over the terms of borrowing returns to central government which can renegotiate debt with all the lenders. Secondly, the public authorities regain control over all the other contracts, including receiving the profits which had previously accrued to the owners of the SPV. Research with Dexter Whitfield has indicated that, using data up to March 2018, the elimination of SPV profits would reduce the costs to public authorities of their annual payments to the SPV by £1.4bn per year.ⁱ

Afterword

Many plans are being developed for publicly financed and provided infrastructure. However the question remains of how to deal with the toxic legacy we have inherited – from PFIs, PF2s, NPD/Hubs and now MIMs? The question cannot be continually ducked: nationalising SPVs is one option that merits serious consideration.

Read more about this in Nationalising Special Purpose Vehicles to end PFI: a discussion of the
costs and benefits.

The solution is in fact much more detailed than the outline provided in this talk and the full paper considers levels of compensation and the need to honour outstanding debts. It also considers the further changes that need to be made to move towards publicly financed infrastructure and insourced services.

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Presentation by Dexter Whitfield, European Services Strategy Unit, to meeting ‘Rethinking Private Financing of Scottish Public Projects’ at the Scottish Parliament on 29 January 2020, organised by Jubilee Scotland and chaired by Neil Findlay, MSP.

I welcome the refreshing straight-talking report on NDP and hub PPP contracts from Audit Scotland this week. I strongly recommend that the Scottish Parliament, local authorities and public bodies immediately adopt six strategies for public infrastructure projects in Scotland.

1 – Increase direct public investment in public infrastructure and stop all planned Mutual Investment Model projects

The Government should take the opportunity to increase direct public investment in infrastructure in the current period of low interest rates.

Planned MIM projects and those that have been approved with options appraisal and business cases, but yet not commenced the start of the contractual procurement process, should be stopped. The Scottish Government should support the local authorities and public bodies in arranging direct public investment for these projects.

The Mutual Investment Model (MIM) allows the public sector to invest up to 20% of the risk capital in project companies and to meet the private investment classification (off public sector balance sheet). However, the public sector, in effect, becomes a commercial partner with the private sector in sharing all the risks and rewards. This significantly deepens the degree of privatisation, extends the scope of secondary market trading in PPP equity and the takeover or merger of infrastructure funds (Whitfield 2016 and 2017b).

2 – Scotland should adopt a new public design/finance and operate model

This would have three objectives, to integrate the design and construction process, to reduce the cost of construction and to minimise the risk of delays. Two examples illustrate how these objectives can be achieved.

The UK’s Integrated Project Insurance (IPI) offers a guaranteed maximum price and protection against defects underwritten by insurance. A project alliance is formed with a Gain/Pain Share agreement under IPI in which all members of the project Alliance share in risk and reward. It was recently successfully piloted at Dudley College. The target outturn construction cost of £9.83m was agreed and exceeded by only 1.8%. The client share of the additional cost was only 0.34% of the target cost. The building was ready for occupation as planned at the start of the 2017/18 academic year.

Construction Management At Risk (CMAR) has been widely used in many US states for public building, transportation and utility projects. The client selects an architect who commences the design and later selects the construction manager/contractor, based on qualifications and track record, before the design stage is completed. The architect and construction manager work together in the final stage of the design process. The construction manager/contractor gives the client a guaranteed maximum price and coordinates all the subcontracted work. This process strengthens coordination, enhances transparency, delivers efficiencies and minimises delays (Whitfield, 2020).

3 – Local authorities and public bodies should intensify the monitoring of PPPs to identify defaults and poor performance.

Monitoring of PPP projects has often been inadequate due to inadequate monitoring staffing levels being included in business cases and contracts and over-reliance on self-monitoring by the private sector. Local authorities should now intensify contract monitoring focusing on all aspects of the quality of performance and other contractual requirements. This information should be reported to relevant committees and publicly disclosed.

Local authorities should also establish contract reviews where defaults and poor performance have been significant or systemic. They should draw on evidence from service users, community and tenants organisations and trade unions. There remains considerable scope for local authorities and public bodies to consider terminating operational PPP service contracts and return provision in-house. Where defaults and poor performance are evidenced and remain after the issue of contractual warnings by the authority, termination without compensation is a viable and legal option. In some cases a contractor has withdrawn from a contract on technical or operational grounds. There have been 27 PPP contract terminations and 12 buyouts in the UK to date (Whitfield, 2020).

4 – Establish a comprehensive and rigorous Economic, Social, Equality and Environmental Cost Benefit Analysis methodology

This should be mandatory for all infrastructure projects in Scotland. The Scottish Government should also require comprehensive and rigorous impact assessments to identify the positive and negative economic, employment, equality and environmental consequences of projects and to identify where and what form of mitigation action is required.

The quality of impact assessment is reliant on assessment of the impact on inputs, processes, outputs, equity and outcomes to establish cause and effect and the use of a counterfactual (the situation that would exist if the project did not proceed). Furthermore, employment impacts must include a full analysis of current jobs, terms and conditions, health and safety and equality practices and planned changes.

5 – The Scottish Parliament and local authorities should oppose the sale of equity in PPPs

The average annual rate of return on the sale of equity in PPP projects was 28.7% (based on a significant data sample) at the end of 2016 with acquisition mainly by offshore infrastructure funds in tax havens (Whitfield, 2017b). This evidence is in sharp contrast with the expected 12%-15% rate of return contained in PPP business cases or contract documentation.

The scale of equity transactions and offshoring to tax havens is very significant. “A total of 87.5% of Scotland’s PFI/PPP education projects (280 out of 320 schools) are currently partly or wholly owned by offshore tax haven funds. Nearly half the schools had 100% of their equity owned offshore” (Table 11, Whitfield, 2016). The NDP and MIM models in effect lock-in and legitimate public sector investment in PPP projects and the secondary market.

Whilst the sale of equity is legally permissible, there is a very strong case that it should be opposed on political economy and ethical grounds.

6 – Challenge the trend of Scottish pension fund investment in PPPs

There are direct links between Scottish public sector pension fund investments, offshore tax havens and shares in NPD and hub companies. At least four Scottish pension funds have investments in offshore infrastructure funds with stakes in NPD and hub projects. Glasgow City Council, on behalf of Strathclyde Pension Fund, has had a £30m investment in the Equitix Fund IV LP since 2016 which was extended by further £50m investment in the Equitix Fund V LP, managed by Equitix GP 5 Limited (Guernsey).

Edinburgh City Council, on behalf of Lothian Pension Fund and Lothian Buses Pension Fund and the Falkirk Council Pension Fund have investments in the Equitix Fund II LP. Equitix Ltd is one of the largest UK PPP companies and although a registered UK company it is owned by Tetragon Financial Group Limited and registered offshore in Guernsey (Whitfield, 2018).

The targeted 10% annual rate of return of these investments is not in the public interest because it ramps up the cost of public infrastructure. Likewise, public sector investments in NDP and MIM projects feed potential gains in the secondary market which may only cover the cost of risky investment in other PPP projects.

I believe these policies are essential in developing a genuine public alternative to PPPs in Scotland.

References

Whitfield, D. (2016) The financial commodification of public infrastructure: The growth of offshore PFI/PPP

secondary market infrastructure funds, ESSU Research Report No. 8,

https://www.european-services-strategy.org.uk/wp-content/uploads/2017/01/financial-commodification-public-infrastructure.pdf

Whitfield, D. (2017a) PFI/PPP Buyouts, Bailouts, Terminations and Major Problem Contracts, ESSU Research

Report No. 9,

https://www.european-services-strategy.org.uk/wp-content/uploads/2017/02/pfi-ppp-buyouts-bailouts-and-terminations.pdf

Whitfield, D. (2017b) PPP profiteering and Offshoring: New Evidence, PPP Equity Database 1998-2016 (UK), ESSU Research Report No.10,

https://www.european-services-strategy.org.uk/wp-content/uploads/2017/10/PPP-profiteering-Offshoring-New-Evidence.pdf

Whitfield, D. (2018) Ownership and Offshoring of NPD and Hub Projects: Scottish Futures Trust, May,
https://www.european-services-strategy.org.uk/wp-content/uploads/2018/06/SFT-Offshoring-report.pdf

Whitfield, D, (2020) Public Alternative to the Privatisation of Life, Spokesman Books, Nottingham.

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At the book launch Dexter will discuss key points of the book and share his views on what policies and strategies are needed to deliver fundamental change. The event will be chaired by the Director of Commonweal, Robin McAlpine.

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The post Book Launch: Public Alternative to the Privatisation of Life By Dexter Whitfield appeared first on Jubilee Scotland.

This article has been written by Dexter Whitfield, director of the European Services Strategy Unit as an accompaniment to his new book, which will have a launch in Edinburgh later this month.

The new book Public Alternative to the Privatisation of Life sets out the scale, cost and impact of different forms of privatisation and encompasses public goods and services including the welfare state, the public realm or built environment (and right of assembly), public domain or creative commons, public sphere (collective debate and elimination of economic and social inequality) in which nature and biodiversity, climate and the environment are an integral part. A political economy framework assesses the impact of privatisation that combines the concepts of accumulation by dispossession and the primary and secondary circuit of capital. It demonstrates how privatisation is interwoven with, and is co-dependent upon, financialisation, marketisation and individualisation.

Four decades of neoliberal ideology and a decade of austerity have had a major influence in extending privatisation beyond the sale of state-owned corporations and outsourcing of support services to encompass core services, multi-service public private partnership contracts and ‘choice’ mechanisms for patients and pupils in industrialised countries and the global south.The UK developed and exported privatisation on an industrial scale since 1981 – 50 state-owned industries and corporations were sold with net proceeds of £74.9bn (£165.5bn at 2018 prices). Debt write-offs, council house sale discounts and public subsidies to privatized services totaled £174.4bn (£324.4bn current prices). In addition, 770 PPP projects and 340 PPP health centre projects led to £320bn in contractual payments. 

Decline in quality of services and jobs

Neoliberal public management focuses on outcomes but has marginalised inputs, processes and outputs, which are critical determinants of service quality, to try to conceal the full negative consequences of privatization. For example, the downward spiral in the quality of jobs, terms and conditions and pension rights is considered a contractor responsibility and of limited, if any, concern for public clients awarding contracts.

The book details the impact of privatisation in education, health and social care, transport, criminal justice and other services the UK and other countries over three decades, which evidences the consistency of failure and impact of market forces on services, jobs and increased inequality. Offshoring and tax avoidance is rife, particularly as private equity fund ownership of public assets and the growth of secondary market transactions of PPP equity to infrastructure funds accelerates.

The final part of the book analyses why it is vital to challenge new forms of privatisation and public-private partnerships promoted by global institutions and transnational corporations which will continue to embed new ways of extracting profit and control. The potential impact of technological change and automation and the continuing urbanisation and growth of megacities must also be taken into account.

I argue for the centrality of public ownership with scope for community and cooperative provision and why they must not mirror the policies and practices of social enterprises, housing associations and many other third sector organisations in capitalist economies. The development of alternative policies and plans are important because public ownership and re-municipalisation alone are inadequate. The systematic decommodification of services is necessary to strip away the neoliberal commissioning and contract culture to be replaced by new accountable governance, transparency and service user and public employee participation and radical public management. Green New Deals should be part of wider national, regional and local economic, social and environmental plans to ensure a holistic approach that integrates sector strategic plans for public housing, employment, education, health and social care with the preservation of nature and biodiversity and climate action. 

A radical public management is urgently needed to break the hold of neoliberal ideology and managerialism. Ownership alone is no guarantee that a service will be provided effectively to meet public needs and is more likely to be re-privatised. Therefore, all sustainable proposals for public ownership must be accompanied by a detailed plan for how services will be provided, managed and monitored. Increased sustainable public revenue can be obtained through progressive taxation with increased wealth and corporate taxes whilst eliminating the cost of corporate welfare subsidies and tax breaks. Corporate interests must be challenged by building new alliances between trade unions, community and civil society organisations taking joint action to advance a radical agenda. 

Book launch by Dexter Whitfield

We are holding a book launch on

Tuesday 28 January 2020, 3.30pm – 5.00pm at

Jubilee Scotland,

Augustine United Church,

41 George IV Bridge,

Edinburgh EH1 1EL.

Chaired by Robin McAlpine, Director of Common Weal. The event is free but you can book a ticket easily through our event page on Eventbrite.

Copies of the book

Public Alternative to the Privatisation of Life is available in paperback (£25.00) and eBook (£15.00) formats from Spokesman Books; paperback and Kindle (£15.00) formats from Amazon; and paperback copies from bookshops. 

Dexter Whitfield is Director of the European Services Strategy Unit and Adjunct Associate Professor, Australian Industrial Transformation Institute, Flinders University, Adelaide.

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