The Economics of the Private Finance Initiative in the NHS

Sussex, J.

Monograph
April 2001

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The Private Finance Initiative (PFI) is officially described as a means for providing skilled and efficient services to public sector organisations and hence to the communities they serve. But the PFI has also become the main source of capital funds for major investment projects in the NHS and the rest of the UK public sector. Since 1997, 85% of the funds for major NHS capital projects has come from PFI sources. Private provision of services to public bodies such as local authorities and National Health Service (NHS) hospitals long predated the advent of the PFI. What was new about the PFI was that it involved the private financing of capital assets of a type that had previously been publicly funded, and that it bundled together the provision of additional related services with these assets. A typical PFI contract for an NHS Trust would provide not only new hospital buildings, but also the range of services needed to operate those facilities: cleaning, laundry, catering, heat and light, maintenance, security and so on.

During a long teething process under the 1992-1997 Conservative government, and despite strenuous efforts by both the public and private sectors, not a single major PFI deal was signed in the NHS. However, since its election in May 1997 the Labour government has enthusiastically advanced PFI in all parts of the public sector. In the NHS the first major PFI deal was signed in July 1997 and successive waves of hospital PFI projects have followed, as well as a range of other NHS capital schemes including other health care facilities, information technology, incinerators, scanners, and so on.

The operation of the PFI in the NHS continues to be the subject of debate. It seems that there has been far more scepticism, even hostility, towards the PFI in the context of the NHS than in other sectors such as transport or prisons. Numerous criticisms have been made of PFI in the NHS and counter-arguments offered. The question of whether or not the PFI provides better ‘value for money’ than equivalent investment financed by Exchequer is controversial. This is partly due to the impossibility of constructing the counterfactual, i.e. of knowing what would have happened to costs and benefits if a conventional procurement route had been followed instead of a PFI scheme. But the controversy also arises because the sums of taxpayers’ money being committed to PFI schemes every year are large and are being tied up for long periods as contract terms are typically of the order of 30 years. One area of general agreement, however, is that the cost of borrowing a pound of capital to fund an NHS investment will be higher under the PFI than if borrowed directly from the Treasury. Where the controversy reignites is over the question of whether this is entirely due to project risks being recognised in the cost of private borrowing but not in Exchequer borrowing.

The purpose of this book is threefold. The first is to assess the costs and benefits of NHS PFI schemes relative to conventionally financed alternatives. An important part of this assessment centres on the relative costs of private and public borrowing for NHS capital investment. The second purpose is to draw out the lessons learned from the experience of the PFI so far, for improving the NHS’s procurement and operation of buildings, plant and equipment. The third purpose is then to consider how far the provision of private finance is integral to achieving these benefits. Putting this another way: can the benefits of private sector involvement in designing, building and operating NHS facilities be achieved without incurring extra financing costs?

The experience of PFI schemes will therefore not only be compared with conventional procurement as historically practised. The lessons for procurement in general that the PFI has taught the NHS will also be considered. Applying these lessons so as to enhance the Exchequer financed approach to procurement might then yield an approach whose overall balance of costs and benefits is superior to the PFI.

PFI schemes can and do cover all types of NHS asset: land, buildings, plant and equipment including information and communications technology (ICT). The focus of this book, however, is on the construction and operation of large buildings, and the purchase and maintenance of associated land, plant and equipment, rather than on the purchase of ICT or other equipment on its own. Relative to hospital construction the latter type of scheme is generally small and involves much less of a service element so that PFI and Exchequer funded purchasing might be characterised as essentially alternative ways of procuring fixed assets. This raises rather fewer cost-effectiveness issues than the more complex PFI projects.

The book is organised as follows. Chapter 2 provides the context. It describes the scale and role of capital in the NHS, capital expenditure trends and official policy, including the introduction of capital charges and other pressures to use capital assets efficiently. Chapter 3 places the PFI in this context and summarises the history of the initiative as it has applied to the NHS. The difficulties confronting research into the PFI are described in Chapter 4, particularly the ambiguity that exists about the true objectives of the policy. Chapter 5 then assesses the scope for PFI to yield net benefits when applied to the NHS.

Chapter 6 pays particular attention to whether there is a gap between the private and public sector costs of capital for NHS projects. It discusses different arguments about whether private sector capital should or should not be expected to cost more than public sector capital and reviews the available evidence. Chapter 7 discusses the evidence on whether PFI in the NHS is providing value for money overall, when all elements of design, construction, service provision and financing are taken together. It demonstrates how the apparently technical issues of the discount rate and quantification of risk may be biasing this assessment. Chapter 8 pulls the earlier arguments together and draws out policy implications. In conclusion this chapter sets out the possibility of pursuing a new, ‘unbundled’ approach in which the NHS retains the PFI’s potential benefits in procuring services and capital assets without suffering its extra costs.