Power to Build
An innovative scheme to finance and manage major public projects such as new schools, hospitals and transport links is unveiled by a leading Scottish think tank.
The need to move on from the PFI system has become clear. In some respects, its record was good. For example, the National Audit Office found that 80 per cent of PFI projects came in on time and on budget compared to only 20 per cent of projects delivered through traditional public procurement.
However, PFI has failed to live up to expectations for two main reasons. The first is that the long-term costs of PFI are higher than public procurement because the funding is largely in the form of bonds and bank debt with commercial interest rates that are higher than government rates. This might be acceptable if the risk associated with such projects was genuinely transferred to the private sector. In reality though, when it came to politically sensitive and vital infrastructure projects, the risk remained with the public sector and it was taxpayers who were left to pay back the debt when there was default on the contract.
The second main problem associated with PFI was the complicated nature of the contracts which were long – anything up to 35 years – and inflexible. The public sector was forced to accept a bid from a whole consortium covering design, finance, building maintenance and facilities management rather than being able to select the best bits from each bid. Furthermore, the funder was part of the consortium, on the opposite side of the table from the public sector, and with no incentive to negotiate the best deal with other consortium members for the benefit of the public.
Reform Scotland’s alternative, Scottish Capital Partnerships or SCP, is designed to address these problems and ensure that infrastructure projects deliver much better value for money in future.
That must start by recognising that the debt element of funding, usually around 90 per cent of the total capital, should come from government either at UK, Scottish or local level. This would enable projects to take advantage of the lower cost of government borrowing and so reduce the cost of funding infrastructure projects.
This public sector borrowing could be achieved in a variety of ways such as straight UK Government borrowing or Scottish Government borrowing if it is given such powers as advocated by both the Calman Commission and Reform Scotland amongst others. Equally, there might be ways of using the existing local government borrowing powers to create some sort of pooling arrangement or Scottish Infrastructure Bank. There are also ways of borrowing against future revenues from taxation, as in Tax Increment Financing which is common in the USA, municipal bonds or road tolls.
Together with lower financing costs, the other element of a successful approach to infrastructure projects is better management. This can be achieved if management companies from the public, representing a group of local authorities for example, private or third sectors bid to operate and manage projects as well as putting up the risk capital which is usually around 10 per cent of the total funding. The public sector would agree a return with the management company so that they receive the benefit of any cost savings, efficiencies and additional sources of income in each project as this provides an incentive for efficiency as well as causing the management company real loss if they fail to deliver.
Once agreement had been reached between the public sector and the management company, they would then work together and invite tenders for other aspects of the project. Crucially, this would ensure the best providers were chosen for each part of the job. The deal would also be structured in such a way that the public sector held A shares which guaranteed it retained control over the land and buildings and any potential refinancing benefits, while the management company held B shares which would deliver a return if they managed the project well.
The purpose of the Scottish Futures Trust has been very confusing over the last two years since it was announced. We propose the Scottish Futures Trust has a clear role as the facilitator of projects that deliver value for money as well as deciding which management company was awarded the tender for each project.
The credit crunch has meant that funding for new infrastructure projects has been limited no matter what method was adopted. However, now is the time to put in place the right mechanisms so that as more funding becomes available we can move as quickly as possible to enable new infrastructure projects to proceed.
Reform Scotland believes that its proposal for Scottish Capital Partnerships offers a way forward to ensure that Scotland is investing in its future and we have the right environment for sustainable economic growth.