Feature

PFI – you’ll Pay For It later

Far from solving the cash shortage in the NHS, the Private Finance Initiative makes matters worse by draining the budgets that pay for services and staff, explains Allyson Pollock

With the Treasury coffers showing a healthy surplus, debate on public spending and, in particular, the use of private finance to raise capital for the public sector is long overdue.

The private finance initiative, once the jewel in the crown of a Conservative government committed to privatisation of the public sector, is now central to Labour’s economic and fiscal strategy.

So how does the PFI work? Under the umbrella of public-private partnerships, the government goes to the private sector to raise money to replace or build public sector services such as hospitals, health centres, leisure services, roads and schools. The private sector raises money for the investment then designs, builds, owns and operates these services, in return for which the government hands over its existing assets and undertakes to pay the private sector for services for periods of between 20 and 60 years.

The first large schemes involved roads, bridges and prisons. PFI is now being extended to health, education, defence, fire and police stations, and the courts. Capital projects worth £12bn have so far been committed under PFI. The annual expenditure commitments early in the next decade from existing PFI contracts amount to 3 per cent of government spending, excluding transfer payments.

So will PFI solve the chronic problem of underinvestment in the public infrastructure, as the government claims? The answer requires a closer look at the root of the current problems and the solutions being advanced under PFI.

Paying for capital in the NHS

As Charles Webster has described, the first wave of capital investment in the NHS did not occur until the Hospital Plan of the 1960s.¹ In the event, only a third of the planned hospitals were completed due to the squeeze on public expenditure in the early 1970s. Capital investment never recovered: since 1974 capital expenditure across the public sector has fallen from £28.8bn to £3.3bn in 1998 (at 1998 prices).

The capital drought meant that the NHS increasingly had to meet its capital requirements from elsewhere. Over the last two years, 1997-98 and 1998-99, when there has been no public exchequer funding for capital, the NHS funded its capital requirements from land sales and savings from the revenue budget. In 1996, savings on the revenue budget amounted to 7 per cent of total NHS expenditure, on top of the annual 3 per cent efficiency savings the government has required NHS trusts to make since 1983.^{2 3}

The PFI is often presented by its proponents as a new source of funding. This is not the case. PFI is simply a method of financing; ultimately the costs of borrowing capital from the private sector are met by the public purse. Under PFI, the government goes from landlord to tenant – leasing back the services it once owned and operated. It no longer pays for capital from a capital budget but for a stream of services from its revenue budget, ie the budgets that pay for services and staff. PFI is revenue hungry.^{4 5}

The policy of using the revenue budget to pay for NHS capital began with the capital charging regime introduced in 1991 as part of the internal market. Under it, trusts and health authorities are required to make a return to the Treasury on their assets equivalent to 6 per cent of the current replacement cost. The effect of this is to require trusts to make an annual surplus or saving of around 8-10 per cent of their operating income back to the Treasury and to meet the costs of depreciation and some new capital investment internally.

The imposition of capital charging made competing claims on the revenue budget. The result has been a rising cumulative deficit for health authorities and trusts, which in 1998 stood at over £1bn. To counter this deficit, trusts have had little alternative but to make major cuts in services such as long-term care, rehabilitation and elective surgery. At the same time, the backlog of maintenance and repair in the NHS now stands at over £2.4bn.

Trusts have had two choices: to go to the wall or to merge with a neighbouring provider. When trusts merge the Department of Health cancels their cumulative deficit. Although this does not solve the problem of having insufficient income to pay the bills (the recurring deficit), mergers eliminate competition between local providers and allow the goals (financial surplus/break even) to be met more easily.

Trust mergers usually involve service closures but this ‘service rationalisation’ is presented not only as a rational solution to previous financial difficulties but as a technical and quality issue to overcome staff shortages. Sold under the rubric of a primary care-led service, providers can present a united front with their health authority and in this way override public concerns and public campaigns against service closures.

The PFI solution

Land sales and hospital closures are clearly short-term solutions to the drought in the NHS capital budget and revenue shortfalls. Under PFI, trusts retain proceeds from land sales, which would normally be returned to the region for new capital investment, and secure a 30-year future through a contract with ring-fenced guarantees. But the lack of new public capital and the policy of raiding cash-limited revenue budgets to pay for capital will not be solved by PFI.

Currently, under the capital charging system, hospitals are paying a charge on capital to the Treasury on the basis of a 6 per cent replacement cost of the asset base. Under PFI the charge on capital will almost double. The proportion of income the trust will pay from its revenue will rise from a current annual average of 8 per cent to between 12-18 per cent. This is because construction costs are much higher than total replacement cost estimates. This is surprising given that each new PFI hospital is usually replacing two or even three existing sites, is often being relocated to a cheaper site and will provide fewer facilities. The higher costs are due to three factors.

First, cost escalations occur before the contracts are signed. Cost overruns of capital projects on publicly owned sites are currently around 8-12 per cent. In contrast, cost overruns under PFI are on average 170 per cent from outline to full business case. Second, the public sector is paying for supposed risk transfer – but most of the risk being transferred is construction cost risk and not patient care risk. And third, the private sector consortia charges the public sector for not doing its own borrowing and the high costs of financing can add a further 20-60 per cent to the price.

And yet under PFI the private sector is borrowing at rates almost as low as the government itself can borrow at because the projects are underwritten by government. But these low costs are not passed back to the public sector.

The bottom line is that all these increased costs (cost overruns, risk transfer and financing costs) have to be met by the revenue budget and, without an enormous increase in NHS expenditure, that means patient care budgets. This immediately translates into cuts in services and cuts in staff.

One notable feature of all new public-private partnerships is the shrinkage in the asset base and volume of service provision. Across the country, under the rubric of centralisation and rationalisation, local government, local authorities and central government are disposing of major public assets. Schools, playing fields, hospitals, community centres and care homes are sold for derisory amounts to the private sector and then transformed into superstores or luxury flats. Public space and public facilities are lost. The new capital programmes are predicated on the sale of assets and involve not just substitution of public with private but a major shrinking of publicly funded services. Loss of space is a proxy for loss of services.

A third of English health authorities have a PFI hospital scheme. This means every area will experience a contraction in the number of sites from which services are provided but, more importantly, each health authority will experience average reductions of a third of acute hospital beds and major reductions in the numbers of clinical staff and staff budgets. For example, in Edinburgh the high cost of the new Royal Infirmary PFI hospital was met from central government subsidy by selling three existing hospital sites and cutting 33 per cent of the beds and 20 per cent of the staff budgets.

PFI is not a cure for the problems of absence of public capital, the requirement that the NHS pay for capital from land sales, and the competing claims on revenue budgets of having to generate savings to make a 6 per cent return on assets back to the Treasury as well as pay for capital expenditure. The NHS will continue to have to meet the new costs of capital by liquidating its asset base and by squeezing its revenue budgets. Staff budgets and patients’ services will be sacrificed to pay the high costs of private finance, placing an even greater strain on remaining services, staff and patients. Ironically, the largest hospital building programme is being paid for by the largest service closure programme in the history of the NHS⁶.