It is a figure as vast as it is terrifying. At least £20bn has been invested by government and the private sector in 450 public-private projects (PPP) in the UK in the past 15 years.
At every stage, the economics of the projects have been tested to see if public finance could complete them cheaper and more effectively. On each occasion private sector accountants said private money should be involved.
However, one of the government's leading economists has said the projects are using accounting projections that are no more than "mumbo jumbo".
The fear is that the government is building up huge off-balance sheet liabilities that would end up coming back to the government if the projects ran into trouble. As a result, government debt would run much higher than official estimates. Some observers are speculating that an Enron-style crisis could be rerun in the public sector.
Public finance initiative (PFI) concerns are not limited to the UK. This form of limited recourse project finance is being promoted as a panacea for virtually every government's balance sheet problems. Australia and parts of Europe are eagerly using the methods pioneered in Britain. They must now understand and factor in the same risks.
Unpalatable aspects of PFI
Other aspects of PFI, which allow private companies to make minimal financial commitments to projects, are likely to undermine enthusiasm further, say some observers. They point to the key role of the special purpose vehicle (SPV) set up by the private company in its relationship with the government counterparty.
In a typical contract, the government can rely only on the SPV's balance sheet, not that of the corporation behind the SPV, to support a project if a financing problem arises. However, private sector contractors (known as the sponsors) typically place very little equity into the SPV. This means that if a problem arises, the SPV provides little relief and the government is forced to take financial responsibility for the project long after the private sector sponsor has walked away with its early-stage profit. The government's alternative is to walk away from the project too, but if a hospital, prison or school is involved, the political consequences are likely to be unacceptable.
EU wakes up to risk
This form of risk to government balance sheets has been little understood. But there is an indication that the European Union might be waking up to a time-bomb ticking in some of its members' public finances.
In a related development, EU governments seeking to securitise state receipts through off-balance-sheet vehicles have been criticised by Eurostat, the European Commission agency. Eurostat has sent out warnings to Greece, Finland, Italy and Spain. It is clear that government finance is going to be viewed through a post-Enron, even post WorldCom, perspective. Devices that looked clever and cost effective before the energy company crashed can no longer be relied on.
Allyson Pollock, an academic at the University of London, says: "PFI is a huge and growing area of export. It is being exported to Canada, New Zealand, Australia and the Far East. The big agenda is to open up public services to the private sector. It has been taken up all around the world with varying degrees of scepticism and desperation. All the 'big five' accountancy firms are promoting it but Arthur Andersen was at the forefront." The major investment banks that promoted privatisation, in particular those such as Rothschild, are promoting PFI equally aggressively.
The myriad of schemes that many developed and less developed countries have adopted involve private sector investment in public activities ranging from raising money from local banks to fund the building and operating of a hospital or prison to massive corporate investment by multinationals to fund pipelines or whole water systems in Africa or Latin America.
Private sector encouragement
The context for the burgeoning of the PFI and PPP form of finance is the encouragement that multilateral agencies give to governments to hand over formerly public projects to the private sector.
The need for governments to appear to restrict their spending has led to inevitable changes in public accounting. So payments to the SPV set up for a PFI contract are treated by government in accounting terms as current expenditure, although these payment obligations typically endure over 30 years and are enduring liabilities. By excluding a PFI contract from the state's balance sheet, a government can give rating agencies and multilateral institutions a more favourable spin to its fiscal position.
Even some of the most active PFI promoters have their doubts about the accounting approach that governments use. John Hawksworth, a senior economist at PricewaterhouseCoopers (PwC), says: "PFI is creating future liabilities for the [UK] government. Not to include PFI on your balance sheet is not to include those future liabilities."
Ms Pollock says: "Government accounting rules should be changed so that the capital value of PFI should be taken into account when calculating the government debt ratio for its sustainable investment rule. The debt should be put back on the government's balance sheet to provide transparency." She is also critical of the long-term impact of the PFI. "The liability embedded in this will come home to haunt the government. PFI is like a structural adjustment programme in the developing countries. It is a form of debt mechanism."
Much of the concern about PFI is targeted at areas of the contracts covering issues such as default risk. "The government is walking into a financial minefield that it does not understand," says Jehangir Masud, an investment banker, formerly of Lazard. "The nature of the SPV ensures that there is no recourse to the deep pockets of project sponsors for any cost overruns beyond the levels of cost overrun support agreed at the outset and fully reflected in the contract price. PFIs are increasingly being used by governments for services, such as hospitals, public transport, schools and prisons, which governments have an obligation to provide, whatever the cost.
"PFI providers are not obliged, or indeed are unable, to raise funds for unforeseen expenditures that are bound to arise over the 30-year terms of these contracts. It is this political reality that makes PFI a one-way bet with all losses going to the public sector and all profits to the developers."
The European Commission has added its voice to the growing chorus of concern by requiring the Greek government to put on hold a tranche of new asset-backed bonds to securitise future pensions and proceeds income from the state lottery.
In the light of this pressure, shifting debt off the government's books to show a nominal reduction in public debt as a percentage of GDP no longer looks so easy, say observers. Attempts by other euro-zone countries, such as Italy, Spain and Finland, to securitise revenues have been similarly questioned.
Yet the UK appears to be continuing with the schemes undeterred, says Martin Kellaway, an economist at the UK government's Office of National Statistics. He says the use of private sector balance sheets to register projects for the UK public sector is increasing fast. "More projects are being done through the private sector. Payments the government makes are now being scored as current expenditure, whereas before they would have been capital expenditure. PFI is one of the reasons that public sector capital expenditure has dropped."
This reduction serves the political needs of a UK government seeking to reduce its GDP-to-debt ratios - it has a golden rule that public debt should be held at a "prudent and stable level over the economic cycle" - but it is arguable whether it is cost effective as a means of achieving value for money.
Public sector doubts
British state institutions are required to test projected costs of a PFI against a state-funded approach before commissioning a private contractor. But economists have publicly questioned whether the use of "public sector comparators" has any value. According to Jeremy Colman, deputy controller and auditor-general at the National Audit Office, government departments are relying too much on "spurious" figures to prove whether PFI initiatives offer value for money. He says those that plan projects need to look more carefully at the benefits and risks involved, and not just at their cost. Many of the PFI analyses suffer from "spurious precision". Others involve "pseudo-scientific mumbo jumbo where the financial modelling takes over from thinking. It becomes so complicated that no-one, not even the experts, understand what is going on", says Mr Colman. Some of the figures and comparisons are "utterly meaningless as they were worked out so late in the deal".
Is it value for money?
Value-for-money claims are further undermined by the differential in the price of capital available to the public and private sectors. Sources inside the UK Treasury say: "The private sector has to pay between 1% and 2% more than government but that is only payable on a quarter of the upfront cost. Over 30 years, that is not necessarily a large amount of money."
Nigel Middleton, a partner at PwC, puts the cost higher. "The whole real cost of capital for a project is around 7.5% and maybe a bit higher, as against 5.5% for a long-term gilt," he says.
Those like Mr Middleton, who say that is an acceptable price to pay for private sector involvement, cite two arguments. First, the government runs projects badly and expensively. Second, the private sector is well suited to manage state projects.
The risk of "political caprice"' undermines all state-sponsored and state-financed projects, says Mr Middleton. If a government or politician is ousted, the conditions for a project may be fundamentally altered. The publicly financed project will not be able to resist such a change and the price may be increased. Mr Middleton says a private sector project underpinned by a contract will ring-fence it from political whims.
Promoters of the PFI assert that project management competence is more highly prized in the private sector than public sector, says Mr Middleton. "The public sector does not engender innovation or forward thinking."
While private sector parties suffer financial penalties for poor performance, these are capped and priced into contracts. Observers argue that the UK government has been reluctant to impose these penalties for fear of "damaging its continuing commercial relationships" with PFI providers.
According to Mr Masud, the penalty for the fiasco of the computerisation of the UK Passport Agency "ought to have been imposed on the IT provider. Instead, applicants for British passports, who presumably did not have a continuing commercial relationship with the British government, paid the bill".
Ahead of their time
Private companies are also capable of boosting their returns by delivering projects ahead of time. The structure of the financing of a typical PFI project allows the government to make its payments when the private contractor delivers the service. The quicker the private contractor delivers the project, the sooner it gets the first payment. This incentive worked for the building of the Docklands Light Railway in London which was scheduled to last 60 months but only took 44 months, to the contractor's benefit.
A private finance initiative typically has two groups of lenders: the construction lenders, who provide the risky and more expensive debt finance during the construction of the project; and the long-term lenders, who "take out" the construction lenders on the completion of the project by providing long-term debt to the completed project at a lower rate of interest because of the reduced risk. Both forms of debt are negotiated simultaneously so the financial model for the project, on which the PFI provider's returns are based, already incorporates the lower long-term interest rate, removing the possibility of a windfall profit for the project developers.
PFI and PPP have served free market government priorities by providing them with schemes to pay for large acquisitions through the means of long-term rent obligations rather than up-front hits to their balance sheet. The schemes have won considerable support among governments but a more cautious and suspicious world needs to have them explained patiently and transparently.
There is no doubt: the critics are banging at the door of the accountants who are in the financial vanguard and their most vigorous promoters. It can only be a matter of time before governments get frightened and ask if, in a post-Enron, post WorldCom world, PFI is a hostage to political fortune they cannot afford.
