The recent high profile failure of Carillion, owing c. £900m to banks and c. £520m to its own pension fund, give rise to a lot of thoughts about the issues involved. Many of the questions have been asked before, swept under the carpet, and will not be answered this time around either. Questions about the role of their auditors (KPMG), the contrast between the apparent attitude of the HMRC Inspectors to small businesses with VAT payments of a few thousand pounds each quarter and that of major businesses who appear to be able to fail to pay massive sums of tax due without consequence, the role and attitude of the banks and, again, the contrast with their attitude towards small businesses seeking funding……

Anyway, the particular point I want to pull out of the mess this time round is the role of large private companies in the realm of public expenditure and major public projects. I am old enough to remember the introduction of the Private Finance Initiative by John Major’s government in 1992. At the time it was controversial and opposed strongly by Labour, who then made massive use of it after they came into power in 1997. It suited the New Labour ideology, kept large infrastructure spending out of view and “off balance sheet”, and thereby made the country’s finances look stronger than they were while allowing levels of public expenditure which the party’s supporters looked for.

As is often the case, while enormously complicated in practice, in theory it is a very simple idea, and one with which every householder is familiar. The purchaser (normally a local or central government body) enters into a long term contract to make monthly payments for, 25 or 32 years, in exchange for having an asset available for use now. Most of us would call this a mortgage or loan, but if it had been so classified then the liability would have been brought onto the country’s accounts and our financial position would have looked worse. That was what the government wanted to avoid, so the PFI deal were carefully documented to appear to be a purchase of services over time, thereby each monthly payment could be treated as paying for that month’s services, and the long term obligation to keep paying for 25 years or so ignored.

This involved a whole new vocabulary with “Output Specifications”, “Service level Agreements”, “Payment Mechanisms” and the like being developed by lawyers and accountants (of whom I was one, initially working alongside my former employers, Price Waterhouse). It also demanded complicated and large scale financial models, several of which I developed, to show the returns to the (tiny) equity investments alongside the (95%+) of senior debt, sometimes combined with bonds. This all had to be risk modelled using a “Risk Matrix” for both the public sector and the private firms which, initially cautious but then rushing to gorge themselves, were a required part of the process. It was a festival for advisors of all types, lawyers, accountants, financial modellers, structural engineers, surveyors and so on. It certainly had the effect of maintaining and boosting investment in the country’s infrastructure, improving the employment figures and so on.

However, it also created a set of liabilities from the state to the private sector, and from the construction management firms to their banks, which in many cases has become unsustainable, leading to unsuitable assets (white elephants) which cannot be touched without breaching the complex network of contracts underpinning their initial development.

Carillion cannot really be blamed for any of this as they were formed in 2009 from Tarmac, by which time PFI was 12 years old and no longer surrounded by the hype or misplaced optimism, and had become just another tool in the box pf public sector procurements.

However, one aspect of PFI which did help to form and grow Carillion was the idea that major public sector projects should not be funded out of taxation or by issuing government bonds, but by tapping into the private sector financial markets, whether that be privately issued bonds, bank debt or other more innovative financing instruments. This led to much greater involvement of the private sector in such projects than previously. Instead of the public sector specifying what they wanted, funding it and having it built, then operating and maintaining it themselves, the accepted way of providing public sector assets became to treat them as a service and to outsource their whole life to the private sector. This has created staggeringly large and profitable companies who provide cleaners to service schools, local authority offices, hospitals and so on. It has created project management businesses which monitor the long term contracts on behalf of the public sector, not to mention financial businesses who place the funding needs with a variety of private sector institutions, in some cases creating new types of financial instrument as they do so.

On the upside this new industry generates foreign currency for the UK through training, knowledge transfer and overseas companies bidding for UK assets. It has enabled a big move forward in developing financial instruments tuned to funding long term public assets, increased our knowledge of the risks in such developments and made us think twice about where we build things like hospitals, how long we build them for and so on. It has transferred much knowledge and experience from the private sector to the public sector and vice versa, I myself have benefitted from being exposed to the dual nature of these projects and negotiations.

But, it has created private companies, answerable to their shareholders and run by their directors, which are responsible for much of the public sector’s assets and services. This creates a mismatch, the funding for the project is coming from the taxpayer but the rules of the game are those of the private sector, with its banking covenants, directors bonuses, stock market announcements and so on. These are two different worlds and neither has necessarily benefitted from their intermingling.

Perhaps a new “Old” Labour government, should we get one in the near future, will start to back away from what Alan Milburn called “the only game in town” as he widened the scope of PFI in 1997 into the NHS, the biggest single sector.