Why, following so much antipathy to PFI while in opposition, did the Labour Party, when in Government, embrace PFI projects with such enthusiasm? Matthew Flinders argues that, under the Conservative Governments of the 1980s and 1990s, there had been 'a hollowing out' of the state so that, by the time that Labour came into power in 1997, institutional fragmentation had undermined the strategic steering capacity of ministers (Flinders 2005, 216). This administrative fragmentation coincided with a political context in which the public were perceived as demanding improved public services while being reluctant to pay increased taxes (Flinders 2005, 217)
It was in this political and administrative context that New Labour came into power with a 'Third Way' approach, presented as one which rejected both the dogma of the Right that was said to insist that the private sector should be the owner and provider of public services and the dogma of the Left which was said to insist that the State must be the sole provider (Flinders 2005, 218 and Shaw 2004, 64). Thus the New Labour model of a revised social democracy claimed to harness the expertise and vaunted efficiencies of the private sector while maintaining public sector values (Flinders 2005, 218).
As a result, the PFI fitted quite neatly into a situation of administrative fragmentation, of perceived political resistance to higher taxes and the 'Third Way' of New Labour. PFI was attractive because it offered the capacity to fund public sector investment without raising income tax or public sector borrowing while also promoting the private sector which many in New Labour genuinely believed (and doubtless still believe) to be more efficient than the public sector. PFI financing fitted neatly into constraints on public expenditure - constraints which the new Labour government imposed on itself.
Soon after the 1997 election, Gordon Brown (the then Chancellor) announced that he would enforce two fiscal rules. The first was the golden rule - that, over the economic or business cycle, current spending would be covered by government revenue8. The second is what Brown called the sustainable investment rule, that there must be a prudent debt-to-GDP (Gross Domestic Product) ratio.
But what is a prudent debt-to-GDP ratio? On June 11 1998, Gordon Brown stated that;
"In the interests of greater stability I propose to bear down on the debt-GDP ratio. Indeed the plans that we are publishing this afternoon show the debt ratio falling from 45% when we came into Government to 40.5% next year and in the following years down again to 39.5% and 38.25%. The comparable figure in the European Union as a whole is 78%. Britain will now plan on the basis that our debt-GDP ratio will be 40% or lower" (Treasury 1998)
In the same speech, Gordon Brown had bemoaned the fact that so much of current government expenditure was being spent on debt interest9. And so we have the second of the fiscal rules and it was this anti-borrowing rule that made private financing so attractive.
Here it is worth pointing out the European context in which the Labour Government was operating, namely the Stability and Growth Pact (SGP) which was adopted in June 1997 to regulate the conditions under which the common currency (the Euro) would operate after its introduction on January 1st 199910. The UK is not within the Euro-zone but the Labour Government has held this open as a possibility. The purpose of the SGP was to prevent an excessive budgetary deficit emerging in the Euro area as a result of individual member-countries spending a lot while taxing a little. So individual country members were to be required to avoid an excessive budget deficit - defined as 3 per cent of GDP - and fines were envisaged for countries breaking this rule. In addition the debt-to-GNP ratio of member-countries should not exceed 60%.
Gordon Brown's debt-to-GDP target of 40% was therefore set at a very low level - some would argue unnecessarily low - compared to the SGP threshold of 60% and certainly very low compared to the average of about 70% (in 2002) for the Eurozone countries11.
Keeping the debt-to-GDP ratio low was presented as a major reason for the Labour Government adopting the PFI. As I have pointed out earlier, under the PFI, the assets are not owned by the government and therefore the government does not have to borrow - whether from the banks or directly from households - to finance the schemes. The assets - hospitals like the new Norfolk and Norwich University hospital - are financed by privately-owned companies (usually special purpose vehicle companies created for the PFI project) and then leased to the government over long contract periods (usually 30 years or more). As a result, public sector debt has been lower than it would otherwise be. As the PFI supplement to the Private Eye in 2004 put it; "There can be no doubt that this device was the chief reason for New Labour Ministers' almost evangelical enthusiasm for PFI" (Private Eye, March-April 2004, 11)
However while PFI projects enabled public sector borrowing to be lower than otherwise (at least in the short to medium term) and therefore they enable Brown's borrowing or sustainable investment rule to be met, they increase the danger of missing the other - the golden - rule; namely for the government's budget (of current expenditure against current revenue) to be in balance over the economic cycle. This is because, although the capital costs will appear as year-by-year annual expenditures rather than as large but one-off public sector projects, the government may end up (over the 30 or more years of a PFI contract) paying far more for the capital and operating costs of the hospital than it would otherwise have done. In the short term, government investment will be lower than otherwise but in the medium to long term, the government's current expenditure is likely to be much higher than otherwise and the 'golden rule' is likely to be tarnished. It is for this reason that Flinders argues that the PFI may represent a 'Faustian bargain', namely a bargain in which a short-term gain is offset by much greater costs in the long run (Flinders 2005, 234). Of course as Shaw points out, "…it makes electoral sense to stretch out the payment of the bills even if the final total is much larger" (Shaw 2004, 73).
8 The 'golden rule' was not, as Private Eye recently stated, that "all public spending has to be met by government income" (see "Leak Stew" in Private Eye, June-July 2004, page 26; my emphasis). Instead it was that current (that is, non-capital) spending was to be met from revenue.
9 In a Spending Review speech of July 2004, Gordon Brown pointed out that payments on debt interest by the UK government amounted in 1997 to 3.6% of UK National Income. By 2004 this had been cut to 2%
10 The SGP is part of the Maastrich Treaty on European Union which was signed in 1992 and which came into force in November 1993. As part of the Treaty, it enables the European Commission to take action against offending countries.
11 . I come back to a further discussion of PFI and public sector debt in chapter 11 and in Appendi x 2.