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Is what matters what works?

Eric Shaw finds the Private Finance Initiative and new Labour pragmatism are undermining the public service ethos, promoting rivalry and distrust. But are they delivering the goods?

The Private Finance Initiative was introduced by the Conservative Government to overcome problems of "chronic capital famine" in the public services caused by its drive to curb public expenditure targets.

Initially it was denounced by the Labour opposition as amounting to 'creeping privatisation" but this hostility soon abated and the PFI has been pursued by Labour with much greater vigour than by its predecessor. Indeed, lauded as "a huge UK success story", New Labour has claimed that it has been "blazing a trail" that "others will undoubtedly follow".

Put simply, under the PFI the public sector contracts to purchase services on a long-term basis from the private sector, which provides finance and accepts some of the venture's risks in return for an operators licence to provide the specified service. The private sector consortium is responsible for constructing and maintaining the necessary infrastructure and makes its return on the investment through the revenue stream arising from the service operations. The Government claims this represents the most cost-effective way of refurbishing the crumbling infrastructures inherited from the Conservatives, with greater efficiency and to a higher standard than could be achieved via direct public funding. By March this year, around 150 PFI contracts worth more than 14bn had been signed, with discussions proceeding over an additional 20bn worth of deals - without taking account of the highly controversial proposals for the London tubes.

In effect, the PFI is now the main mechanism for funding capital investment in new hospitals, schools and the prison service and has been described as a cornerstone of the Government's modernisation programme. The adoption of the PFI by the Labour Party amounts to a major reappraisal in its attitude towards the appropriate boundary between the public and private sector. The role of the state as "owner of capital assets and direct provider of services" has been downgraded in favour of its function as "a purchaser of services from a private sector partner responsible for owning and operating the capital asset that is delivering the service".

The PFI has been instanced as pragmatism in practice. Pragmatism appears to refer to two main precepts.

Firstly, that policy decisions should be made on the basis of evidence, that is a systematic assessment either of past experience or the likely consequences of differing options. As ministers repeatedly declare, "the key test is what works".

Secondly, the belief that "the old argument, as to whether public ownership was always best or whether privatisation was the only answer, is simply outdated". What counts is "outcomes not ownership", "what, on balance, will give the best results".

This argument raises two issues. Firstly, does it make sense to counterpose an "ideological" to a "practical" style of policy-making? Govemments may be more or less dogmatic or narrow-minded in their approach to policy-making. They may exhibit different degrees of willingness to take account of available research and to innovate. But a strict differentiation between "ideological" and "practical" orientations is misleading. All policy-makers, Peter Hall has observed, "customarily work within a framework of ideas and standards that specifies not only the goals of policy and the kind of instruments that can be used to attain them, but also the very nature of the problem they are to be addressing... this framework is... influential precisely because so much of it is taken for granted and unamenable to scrutiny as a whole."

The issue then becomes: what "framework of ideas and standards" is being used to define and decide "what works"?

This bring us to the second question. To what extent does the evidence validate the claim that choice between public and private - public procurement and the PFI - is being made on the merits of individual cases?

Ministers have described the PFI as "central to our drive to modermse our key public services". By the spring of 2000 Andrew Smith, then Chief Secretary to the Treasury, announced that PFI contracts were "present in every area of the public sector and across the country". Over 200 contracts had been signed amounting to capital investment worth more than 12 billion and many more were in the pipeline. The Government insists that PFI schemes had been shown to accomplish efficiencies in the organisation of resources of such an order as to more than compensate for the higher cost of capital. The outcome promises to be better quality, more responsive and more dependable public services.

A useful point of departure is the new Cumberland Infirmary in Carlisle, the first major PFI hospital project to become operational. Opened ahead of schedule by the Prime Minister it was immediately dogged by problems:

  • Poor quality of physical infrastructure. For example, two ceilings crumbled because cheap plastic joints in piping were used.

  • Inadequate health and safety conditions. For example, the sewerage system could not cope with the number of users and the air conditioning was inadequate.

  • Poor facilities-there were too few beds to cope with demand.

Amec, the main construction company involved, acknowledged a few "teething difficulties". But these appear to be not uncommon with PFI projects. In Hereford the number of beds is predicted to fall from 351 to 250; in Norfolk from 1,600 beds to 1,000; in Worcester, from 540 to 380. The British Medical Association estimates that 5,000 beds will be lost to the system once the 38 PFI hospitals, costing more than 3.6 billion, are built.

A group of experts concluded that, as a result of cost factors within PFI contracts a substantial shrinkage in services provision, bed capacity and staffing is inevitable. The same pattern appears to unfold in every PFI project examined. The House of Commons Select Committee reported that "the evidence we have received leads us to conclude that on current trends the projected increases in the number of nurses and other clinical staff fall well short of what is required to deal with current shortages and future developments in the NHS". It concluded that "we believe that further exploration of the impact of PFIs is required before significant levels of recurrent NHS funds are devoted to the servicing of the private capital involved".

But would these capital projects have fared any better under public procurement? Are there any reasons to believe that the PFI suffers from inherent weaknesses as a method of providing public goods and services? The issues involved are highly complex and here we can only skim them. We shall focus, briefly, on three main points: that of risk transfer, information and transaction costs.

According to the Treasury, a cardinal rule is that "risk must be transferred... If insufficient risk is transferred, a project will not represent value for money and will not be pursued under PH". The best indicator of the extent of risk actually transferred, according to Gaffney et al., is the interest rates paid by consortiums to their lenders which, in earlier PFI schemes have been set at extremely favourable borrowing terms on the basis of "little inherent risk." This implies that there is little correspondence between the sums NHS trusts ascribe to "risk transfer" and the views of capital markets on the risks the consortiums have actually taken on.

The point can be pursued a little further. In order to make a fair comparison of the relative costs of PFI and public procurement "account needs to be taken of risks which under public procurement the public sector carries itself, but which under private finance initiative it pays another agent, the private investor, to bear". This is known as the "public sector comparator". This is a crucial element in the methodology since only "when the cost of public sector options is adjusted to reflect this transfer of risk [does] the apparent cost disadvantage of private finance initiative options disappear?" Careful inspection again has revealed the adjustments reflect quite subjective judgments whose effect has been consistently to balance comparisons in favour of the latter.

In a detailed investigation into the contract signed between the Dartford & Gravesham NHS Trust and a private sector consortium, Pentland the Select Committee on Public Accounts discovered that the estimated savings against a publicly-funded scheme had been very considerably exaggerated "because the Trust failed to detect significant errors in the public sector comparator... Had the Trust known that the savings were marginal when negotiating the deal", the report concluded, "it might have made different decisions". The outcome was that funds designed to meet other health needs had to be redeployed to meet the costs of the contract. Again, this appears to be part of a pattern.

The fuller the information and the greater the equality in the amount of information available to the parties to the contract then the greater the likelihood of both benefiting from the arrangement. Conversely, the more it is differentially distributed between the parties, the more one-sided it will be. Though the Government promised "transparency during and after the procurement process", insistence on maintaining commercial confidentiality has meant that "the financial information on which to judge the transfer of risk and the validity of the contracts has not been placed in the public domain". This is not surprising since "private contractors, and public agencies that must compete, want to keep their costs and other commercially sensitive information secret".

Asymmetry in the distribution of information upsets the equilibrium that, in the contract process, is supposed under market conditions to prevail. There is evidence that this is precisely what is happening. For example, the Public Accounts Select Committee, in its investigation of the PFI contract for the new Dartford and Gravesham Hospital concluded that the Health Trust were poorly informed about the gains the contracting consortium stood to make, exaggerated the likely savings from using the PFI and had failed to balance of risks and potential rewards.

The heavier the transaction costs (including the costs of drafting, interpreting and monitoring contracts) the less the value-for-money of a PFI contract. According to the NHS Confederation, health service managers found the PFI to be slow, bureaucratic and requiring "us to put up a vast amount of management time and consultancy fees at risk without the certainty of success" and an academic study of the use of PFI in education concluded that the PPFI negotiating process was much lengthier, more complicated and more expensive than conventional public procurement. The more complex and intricate the process, the greater the reliance on external advisers. A Public Accounts Committee investigation revealed here a clear pattern of cost overruns. It expressed "alarm" in its report into the Dartford and Gravesham contract that the Health Trust incurred costs from its advisors, KPMG and Nabarro Nathanson which, at 2.4 million, exceeded the initial estimated 300,000 by almost seven hundred per cent.

The editor of the BMJ concluded, "much evidence is accumulating to show that private finance initiative schemes are costing much more than traditional public funding of capital development", with fewer beds and fewer trained medical personnel and "with the NHS as a whole having to underwrite these extra costs, meaning that resources shift from providers who remain in public ownership to those privately owned undermining still further the goal of greater equity in the NHS". It is therefore not surprising that the Select Committee on Health concluded that "we believe the

Government should limit PFI to a number of pilot schemes until a proper evaluation of the impact on staff and patient care is produced".

Undoubtedly, for the Government the PFI had considerable appeal as a mechanism for reconciling competing pressures- a massively under-funded health infrastructure, public apprehension about waiting lists and the state of the hospitals, a determination to maintain an image of unbending fiscal "integrity" to the global money markets and (what the Government insists is) the reluctance of voters to pay for the quality of service they demand. Satisfied voters, it appears, being able both to have their cake and eat it, will be disposed to reward those who made this possible. So what does its eager espousal of PFI tell us about the nature of the Blair Government's creed, and hence the future trajectory of its policy.

Differences in organisational structures, incentive systems, reward patterns and so forth, prompt organisational employees to think and act in different ways. The case for public service provision never rested solely on efficiency and equity (important as they were). A fundamental Labour tenet has been the belief that the intrusion of the profit motive into institutions whose purpose was the meeting of basic human need (such as physical and mental health) would have damaging effects, that there were "certain activities that are of such moral significance that they should not be provided by the market, even if they could be, because they will be tainted by the association with financial exchange and profit".

An environment in which people will be treated as ends in themselves rather than as means for securing pecuniary advantage is more likely to evolve progressively, it was held, to the extent that those working in the public services were imbued by a culture "in which professional pride in a job well done or a sense of civic duty or a mixture of both replace the hope of gain and the fear of loss as spurs to action".

Within profit-maximising firms where individuals were primarily motivated by immediate material gain, by contrast, narrowly self-interested behaviour, a disposition to subordinate need to profitability and a proclivity to treat people instrumentally would be more common.

To Bevir and 0'Brien (New Labour and Networks of Public Serice Deilvery) the Blair Government's policy of creating "networks" rooted in public-private partnerships is designed to foster high levels of trust and co-operation. In fact, the logic of its policy leads in a quite different direction. The redesign of the public services along market lines will, as one leading authority commented, generate "a fundamental change in incentives, and, in particular a move away from traditional notions of the public service ethic toward more commercial orientations" which will in time erode trust and co~operation, sharpen division of interests, breeding a culture in which suspicion and rivalry spread" with detrimental effects upon (the always threatened) norms of social obligation, altruism and public service.

Though qualified and modified in a range of ways, new Labour has embraced much of the neo-liberal agenda: its view about the benefits of market forces, the presumption of a natural confluence between private interests and the public good, and its assumptions about the nature of human motivation.

Where does the logic of policy lead? The PFI, a group of experts has concluded, has established a framework of policy that supplies "the mechanisms for reversing the principles that health care should be funded out of general taxation, that public services should remain in public ownership, and that health services should be free at the point of delivery" - The new NHS plan envisages that NHS patients can be treated in private hospitals. The logical next step is that whilst the state "would retain responsibility for guaranteeing that all citizens have access to ... services ... they would be able to choose freely between differein types of provider" public or private. As the editor of the BMJ reflected, "most institutions on the scale of the NHS end not with a bang but with a whimper".

This is an edited version of an article from Revue Témoin 24, www.revuetemoin.fr.

Eric Shaw teaches at the University of Stirling

July/August 2001