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A licence to print money

The Association of Certified Chartered Accountants seems an unlikely body to reveal the real story behind New Labour's PPP - public-private partnerships - policy. But a report written by four members of the Manchester Business School at the University of Manchester* does just that. It reveals in cool, accountants' language how PPP is a euphemism for the massive transfer of capital to the private sector by the state.

By Paul Feldman

The emerging market state that New Labour presides over functions to enhance the role and interests of corporate and financial enterprises, whatever the consequences. There are countless examples of this in action, from the part-privatisation of the London Underground to the use of private treatment centres at the expense of the state-funded NHS.

By creating a market within the NHS, New Labour is undermining the health service in a fundamental way. Even the conservative British Medical Association is alarmed by the prospects of "patient choice" announced by health secretary John Reid in February 2005. James Johnson, BMA chairman commented pointedly: "In a market economy such as we now have in the NHS, it is inevitable there will be winners and losers. If this forces some hospitals to close, NHS capacity will decrease. Patients will lose more than surgical beds: where will they get the A&E departments, the round the clock care, the intensive care beds, and where will new doctors and nurses be trained? There is much more at stake here than the Secretary of State seems to acknowledge."

On the news that the next wave of independent treatment centres may (like the first wave) be guaranteed a volume of work and may be paid more for operations than the national tariff set for NHS hospitals, Johnson said:

"The government intends to finance hospitals through Payment by Results. This can only work equitably on a level playing field and not one skewed in favour of private sector providers. Even then it does not cover the additional services provided by an NHS hospital."

Johnson, a vascular and general surgeon, said that ministers and senior officials had no answers to what would happen if hospitals began to close because new, neighbouring private treatment centres were taking their business. That was beginning to happen, he said. An orthopaedic ward at Ravenscourt Park Hospital, west London, had been closed and Southampton University Hospital was in difficulties.

"There is no Plan B. I keep asking, What happens then? I have asked this at the very highest level. The Department of Health does not seem to have a plan for failing hospitals under this new regime." He added: "There will come a time quite soon when the patients moving to the treatment centres will de-stabilise the entire hospital. The NHS does not seem to be able to withstand surplus capacity, in other words empty beds. So it closes them down, sacks the nurses and the plurality of provision has failed."

The diversion of health work to the private sector goes hand in hand with the involvement of business in building and then owning public assets. The ACCA report points out that the introduction of partnership working, known as the Private Finance Initiative (PFI), was heralded with much enthusiasm by the then Conservative government in the early 1990s and was later adopted with even more joy by the incoming Labour government in 1997. New Labour "re-branded" the policy as public private partnerships (PPP and widened it to include several different forms of which the PFI is but one, say the report, adding:

"Under the PFI, the public sector procures a capital asset and non-core services from the private sector on a long-term contract, typically at least 30 years, in return for an annual payment. Subsequently ministers, government officials and others with financial interests in the PFI policy have claimed much success for projects. However, numerous IT PFI projects have failed. Several PFI/PPP projects have had to be bailed out, some have been scrapped and others have been the subject of widespread criticism. The National Audit Office (NAO), the Public Accounts Committee (PAC), the Audit Commission and Accounts Commission have been circumspect about the levels of success, and identified various lessons to be learned."

At least three PFI/PPP schemes have had to be bailed out: the Channel Tunnel Rail Link, the Royal Armouries Museum and National Air Traffic Services, while others have been scrapped. Front line public services such as health and education have required and/or been accompanied by extensive closures and rationalisations that have proved unpopular, say the authors. Lastly, the refinancing of PFI projects after construction has generated extra profits that have led to widespread fears that the private sector is profiteering at the expense of cash-strapped services.

The ACCA's research study focuses on the actual performance in two sectors, roads and hospitals, which have substantial commitments to partnership financing and projects that have been in place for some years. In roads, where PFI projects are known as design, build, finance and operate (DBFO), the eight projects signed in 1996 represented about 35% of all new construction in the roads sector between 1996 and 2001. In the government's 10-year national plan, 25% of the £21 billion allocated for the strategic highway network will involve private finance. In the health sector, there has been a continuous expansion of private finance since the first health contract was signed in 1997 and by 4 April 2003 some 117 schemes had been approved by the Department of Health with a value of £3.2 billion.

Annual payments for the signed deals alone were expected to be £2.9 billion in 2000/1, rising to £6 billion in 2007 or £105 billion over the life of the contracts. The ACCA report explains: "Since these payments relate largely to new deals, rather than to the replacement of existing outsourcing arrangements, the money available to pay for them is what remains of public expenditure after welfare payments and the purchase of external goods and services - the public sector wage budget. Annual payments will therefore divert about 6-7% of the current wage bill, which has declined from 72% of public expenditure (after the welfare payments and external purchases) in 1977 to 38% in 1999, and this is set to increase as new deals are signed ."

In relation to roads, the report finds that:

The report adds:

"Although the amount of tax payable by the SPVs over the whole period was only 7% of operating profits, even this overstates the actual tax paid since this includes an element of deferred tax. This low tax rate, in the early years at least, challenges an important part of the Treasury's new appraisal methodology for PFI, which assumes that tax payable will be about 22%, which will in turn distort the VFM analysis in favour of PFI. The SPVs' interest rate of 11% in 2001 and 9% in 2002 and the high level of debt, which is greater than the construction costs, means that the DBFO contracts are considerably more expensive than the cost of conventional procurement using Treasury gilts at the current rate of 4.5%."

The ACCA points out that in the absence of arrangements to ring-fence the post-tax profits so that they remain available for future commitments, should the DBFOs fail for whatever reason later in the contract, the Highways Agency could find that it has to bear the remaining and higher cost of private capital and the maintenance costs that it thought it had already paid for!

In relation to hospitals, the ACCA report notes that the annual cost of capital for trusts rises with PFI by at least £45m over and above the cost of a new hospital directly funded by the state, even though the hospitals are considerably smaller than the ones they replace. This underestimates the additional cost of PFI, since the construction costs include an amount of up to 30% to cover the cost of private finance, transaction costs and so on. "Conservatively estimated, the trusts appear to be paying a risk premium of about 30% of the total construction costs, just to get the hospitals built on time and to budget, a sum that considerably exceeds the evidence about past cost overruns. Nine of the trusts report off balance sheet schemes, as the Treasury had originally intended, implying that most of the ownership risks have been transferred to their private sector partners. But as none of the corresponding SPVs report their hospitals on balance sheet either, this creates uncertainty as to who has ultimate responsibility."

Within a few years of financial close, PFI charges are in some cases much higher than anticipated, the report finds, adding:

"This raises questions about the reliability and validity of the VFM case that was used to justify the decision to use private finance. The high cost of PFI means that about 26% of the increase in income in between 2000 and 2003 is going to pay for PFI charges for new hospitals."

For the companies, it is all good news, however. The report reveals that they made a post-tax return on shareholders' funds of more than 100% in each of the three years 2000-02, far higher than elsewhere in the industry.

"This financial analysis is likely to underestimate the total returns to the parent companies because the SPVs subcontract to their sister companies and some of these subcontractors benefit from additional income via user charges for car parks, canteen charges, etc."

Six out of the 13 trusts analysed are in deficit, and four of the nine trusts with off balance sheet PFI projects had significant net deficits after paying for the cost of capital.

"Assuming that the financial performance of trusts is a proxy for affordability, then the fact that hospitals with PFI contracts were more likely to be in deficit than the national average in the period 2002-03 suggests that PFI is not affordable. This has potentially serious implications for service provision and access to healthcare."

The report did well to find out what it did. As it points out, financial information about PFI is "opaque", partly because of government-imposed confidentiality. In addition, private sector organisations use complex structures with PFI projects spread between various entities and thus disguised. The ACCA concludes:

"Not only is there a lack of explanation for the treatment of PFI assets/liabilities and income/ expenditure in both sectors, but neither the treatments nor the amounts match across the public and private sectors. Some PFI projects are accounted for on balance sheet but others are off balance sheet and there has been a change in accounting policy in relation to some projects.

"The net result of all this is that while risk transfer is the central element in justifying VFM and thus PFI, our analysis shows that risk does not appear to have been transferred to the party best able to manage it. Indeed, rather than transferring risk to the private sector, in the case of roads DBFO has created additional costs and risks to the public agency, and to the public sector as a whole, through tax concessions that must increase costs to the taxpayer and/or reduce service provision. In the case of hospitals, PFI has generated extra costs to hospital users, both staff and patients, and to the Treasury through the leakage of the capital charge element in the NHS budget. In both roads and hospitals these costs and risks are neither transparent nor quantifiable. This means that it is impossible to demonstrate whether or not VFM has been, or indeed can be, achieved in these or any other projects.

"While the government's case rests upon value for money, including the cost of transferring risk, our research suggests that PFI may lead to a loss of benefits in kind and a redistribution of income, from the public to the corporate sector. It has boosted the construction industry, many of whose PFI subsidiaries are now the most profitable parts of their enterprises, and led to a significant expansion of the facilities management sector."

So, behind all the rhetoric about making public money go further, the ACCA report shows the reality behind New Labour's policies. There is a relentless transfer of wealth to capitalist interests through PFI/PPP while the state guarantees payment and assumes much of the risk. This is the market state in operation and is a graphic confirmation of the role of New Labour as the state management team for big business. Welcome to Britain PLC, where the state will give you a licence to print money.

8 February 2005

Evaluating the operation of PFI in roads and hospitals. ACCA Research report No.84.
Authors: Pam Edwards, Professor of Accounting, Jean Shaoul, Reader, Anne Stafford, Lecturer, Lorna Arblaster, Research Assistant, Manchester Business School, University of Manchester.

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