Q1 Chairman: Welcome to the Economic Affairs Committee. This is the first public hearing on our new inquiry into private finance projects, often known as PFIs. Dr Stone, thank you very much for coming along. I have to ask everyone if they will speak reasonably clearly and slowly for the benefit of the shorthand writer and the webcast. You have given us some written evidence, for which many thanks. I do not know if you want to say a few opening words or would like to go straight to questions. Dr Stone: Thank you, my Lord Chairman. If I may I would like to say a few words to start with but just make three points. Firstly, the views I express today are mine. I wear many hats: I am a partner at KPMG, amongst other things I am a non-exec member of the board of the EIB and I am seconded part-time as an adviser to ministers. The views I am going to offer today are entirely mine and reflect the logic and philosophy I have used over the last 15 years working in this area. The second thing I would like to say is that overall from my perception PFI is about behaviour modification of the public and private sector partners. The private sector has been involved all the way through throughout history, but neither side in my view has ever been properly accountable. One of the key changes is that PFI starts to drive some sense of accountability for infrastructure and public services. Around this public accounts, in my view, are most unhelpful in planning or managing infrastructure. When ministers and civil servants make decisions they create obligations and consequences that last for generations, but they are not properly recorded and not properly managed. The CO2 reduction targets that we have, that we have to have, will drive massive changes in infrastructure unlike anything we have seen since the Second World War or the Industrial Revolution and we must sort out how to deliver operational infrastructure throughout its life quickly if we are to rise to that challenge. That is my second bullet point. My third is about data. There is very little useful data about conventional procurement but PFI is now starting to deliver some data about itself, so we now have a debate which is more like the sound of one hand clapping than anything else. We have had 12 years of experimentation in a way of delivering public services but there is very little data on the experiment or the counterfactual. Almost all that current data is opinion based, other than the work by my colleague, Dr Rintala, on educational outcomes that both the IPFA and CBI have cited in their evidence. As far as I am aware, there are only two good university departments properly engaged in this area: one at Bristol looking at public services and the UCL team looking at PFI. Both of them need decent data and funding to inform that research. PFI is still a pilot project, let us not forget, this is not some mature, carefully thought through very elaborated design. It has been running for a decade and a half but has not yet been examined for what works and what does not and we have not built PFI 2.0. Those are my starting points, at which point I will hand over to you.
Q2 Chairman: Thank you very much. In your second point you underscored the point about accountability as being extremely important, but what do you see beyond accountability, or including accountability, as the defining characteristics of PFIs
? How do they contribute to the success or otherwise of the approach? Dr Stone: I think there are probably six things to consider here. The first one is that it is about managed risk sharing. I am going to use the word "sharing" rather than "transfer" throughout and if I accidentally say "transfer" please correct the notes to say "sharing". The second thing is it is about the specification of outputs and outcomes. When a minister decides that he wants a new school or a road or a hospital he does not want to pour concrete and lay bricks, he wants to make people better, to teach them better, to make economic activity happen. Forcing the process to focus on those outcomes all the way through is extremely important and starts to produce better incentives, which we will come back to later on I hope. The third thing is that we have a payment mechanism in this which essentially does two things. First of all, it aligns incentives better than we had before, but most importantly it produces a system with a negative feedback loop that controls behaviour throughout. In my view, that systemic aspect is extremely important. Fourthly, we are integrating designing, building, financing and operation into a single system and that integration is vital because they are all elements which are inevitable consequences of that initial decision. As with any system, if you tweak any element of it the system as a whole may behave differently from the way you expect from your individual tweak because of system effects. We are now starting to treat the delivery of services as an overall system. The fifth point is that we are driving proper competitive contracting for the long-term, for the whole life costs of this. The final point that matters here is that with the financing mechanisms that are in place one of the side-effects is that the bankers insist on the level of due diligence before they lend the money that you never, ever see in conventional deals. What that means is before the deal starts the quality of homework done on, "Will it work? Will it work on the basis that has been planned for? Have you thought through the risks?" is a much more rigorous system as a consequence of the financing because ultimately with the levels of debt in these deals the best thing that a lender can do is to get his money back with his interest, there is no upside for him. There is a huge discipline that comes with this as a side-effect. Those are my six things.
Q3 Chairman: All of these six points are positive ones. Are there any downsides?
Dr Stone: Yes. For me, the downside in this process is that we are actually starting to change the way that the system is accountable and what it is doing is forcing a level of enquiry which we have not seen before and some of those aspects of enquiry produce a lot of noise in the system. One of your other questions later on will come to this, I think, if we go down that route. The understanding of this overall process and the understanding of the fundamental consequences of the conventional process are very weak in the minds of many members of the administration and many civil servants. There are very few people in the system who actually understand the whole life consequences of decisions. This is starting to shine a light in many of these areas and in some cases it produces very unpleasant side-effects. Do I think that there are big negatives to it? I struggle, I suppose. I do not care what the answer is in terms of how we do these things, but what I do care about is that we deliver better public services for the taxpayer at better value for money over time. Is this in any way a retrograde step in that direction? I do not think it is. I think there are some unpleasant consequences around it but I am not aware of any fundamental horrors in it. There are lots of things to improve.
Q4 Lord Eatwell: I was going to ask you what you saw as the main contribution of the private finance initiative in the UK but presumably you cannot answer that question because you just told us there is no data.
Dr Stone: There is very little.
Q5 Lord Eatwell: I am very surprised that you made all these positive statements when you tell us we have no information on which to base any result.
Dr Stone: There is little data. If I said "no" I would correct myself and say there is very little data compared to the money that we are spending. There is some data now on the performance of some of these deals. There is virtually no data about the performance of conventional deals. The experience I have had in working on deals in the public sector over the past 15 years has shown me that it is virtually impossible to pull together all the things that an economist or a finance guy would want to see around the overall system. Individual bits you can, but the whole system you cannot. What we are starting to get out of PFI deals is first of all a very clear understanding about the costs of building, the costs of slippage on time and so on. You begin to get some evidence of performance of the overall system. Again, I would refer the Committee to the work of Dr Rintala and I have brought some copies for you to have a look at afterwards. What it is starting to do is to drive an interest in transparency and accountability and it is starting to make people ask questions. It is making you ask questions, it is making journalists ask questions and it is making some members of the public ask questions. It is making visible the consequence of decisions, either the initial one or, indeed, the decision to change a project or service during its life. What it is also doing is making it very difficult now to neglect maintenance. On a PFI deal you are effectively giving up your right to neglect maintenance. You are giving up your right to apparent flexibility because that apparent flexibility traditionally has never been costed. I am originally a chemist and compared to the data I have about my own science, compared to the data I have about commercial deals as a banker, the data around public services is shockingly poor. Most of the data that is there does not qualify for me as data, it is mainly about opinions. Those are interesting but they are very thin grounds on which to do a proper comparison.
Q6 Lord Eatwell: You are posing for this Committee a very challenging issue in the sense that we are attempting to evaluate whether for the UK as a whole this change in public procurement has actually been beneficial overall and whilst you are pointing to a series of procedural activities which you deem to be beneficial, and indeed they sound as if they are, you cannot be sure whether the overall outcome, as you quite rightly said in making people healthier or educating them better or whatever it might be, has been achieved.
Dr Stone: There are two levels of certainty here. One is do I think there is something happening here that I think is very effective? Yes, I do. Can I prove it to the levels of proof that you as an academic would require? No, I cannot. I can certainly see in the midst of data something here which I cannot see in the conventional. What I am saying is in terms of the level of certainty it is very poor, in terms of the signals they are quite strong, but the most important thing as you look, for example, at the NAO report is they regularly say that the data is not sufficient to make proper comparisons. Even in the most recent one looking at conventional versus PFI deals they say you cannot compare the data for the two because it just simply is not good enough.
Q7 Lord Eatwell: This is really the second point of your introduction, is it not, that what this is about is behaviour modification and you feel that this is behaviour modification in a desirable direction. Dr Stone: I am absolutely certain it is. I am absolutely certain it is because the people who operate the services, who use the services as a client, as a provider, have far more visible data for themselves and the way they manage that service than ever they had before. That is absolutely clear. What I cannot do is I cannot stand back and say across the whole of healthcare I am absolutely certain that there are very powerful healthcare outcomes resulting from this. I can say that I think there are some powerful outcomes but I cannot prove it. The issue that you will face is that you will be dealing with a much more qualitative analysis than I would have hoped after 12 years of experimentation.
Q8 Lord Paul: Much of the case for private finance projects has been made on the basis of lack of accountability, poor incentives, poor delivery and low investment in the public sector, but since then a lot of changes have taken place, the public sector has become more efficient, the private sector, especially the private monopolies, have got much worse. Do you share the view still that the original idea of the public-private sector is still a good one?
Dr Stone: I do absolutely subscribe to the view that there is something here, yes I do. What has happened in the improvements in public procurement I would describe as the polishing and refinement of an imperfect process. Conventional public procurement is treated as a stand alone entity. One of the problems that I see conventionally is that there are very many elements over the life of delivery of a public service and they are not joined up, so what we have is the perception that the pure procurement point can be polished and that will fix any problems. You can improve that but unless you have it properly integrated to the rest of the overall process that will not fix it. There have been some improvements and, indeed, the recent NAO report suggests that those improvements are getting better. I would certainly argue that the challenge from the PFI deals is giving a benchmark that the public sector can look at and see how to improve but, again, I am going to come back to my same point: without the data on conventional procurement it is pretty hard to learn quantitative lessons. There is something in this and what has been very interesting is watching the behaviours of these private sector partners in some of these deals and their focus on the outcomes. It has been interesting to watch that transition from firms that conventionally have made their money by conventional construction now becoming much more interested in, for example, the effects of operating a prison. One of the side-effects of some of these prison deals has been that because they have been designed to minimise the numbers of staff, because that is clearly a cost to the system, the designs improve sight lines, they improve the relationship between the custodians and the prisoners, and the general sense from people who work in that sector is that the tensions within some of these prisons have become lower simply because of the physical design. Coming back to the issues about lack of accountability, in my view there is still an appalling lack of accountability conventionally. I have a big issue with the way public accounts work. I am not an accountant, I have no benefit from accounting training, but as a scientist and a banker the way public accounts work means that you do not have the basis for careful measurement and management of these services. Again, one of the side-effects of PFI deals is that the basis around buying availability or buying outcomes means you are starting to measure things which are closer towards outcomes and conventionally you had none of that. There is something here where we are fixing incentives and visibility. Is it anything like perfect? No, it absolutely is not, this is still very much a pilot project and we are right at the beginning of the process. I am interested as I go round the world to see how other countries are learning from their experiences in some respects better than we are.
Q9 Baroness Hamwee: I wonder if I can pick up something you said in your evidence. You used the phrase "senior lenders" and talked about the involvement of senior lenders. One of the things which is desperately frustrating in the public sector is seeing good people-I should not put this so pejoratively-going off into the private sector where they are earning more money. Are you suggesting that there is a relationship between these two things and that the people we have got in the public sector dealing with big contracts, not necessarily at national level, so local authority and hospitals, are frankly not as good as they should be and we have lost good people to the private sector and are suffering? Dr Stone: I would like to take that back a little if I may. I would like to compare and contrast the way the public sector treats a professional in terms of their managing risk. As a private sector individual, if I take a risk and get it right I am rewarded, and I do not necessarily mean financially, I mean somebody says, "Thank you very much, well done. Do it again". If I get it wrong it is a counselling or training event until I get it wrong consistently at which point somebody finds me a new job, but there is a monotonic relationship between risk and I will use the word reward but I do not mean it in a financial sense. For a public official that relationship is completely different. As a public official, if you take a risk and get it right the odds are nobody will notice. If you take a risk and get it wrong, and you are caught, because in many cases people move around quite quickly, if you are caught twice you will be in the Falklands counting penguins. There is a very asymmetric response here. In terms of the behaviours of the individuals we do not reward people in the public sector who manage and deliver anything like as well as we should do. There have been transfers between public and private sector that I wish had not happened, but conversely there have been some very interesting transfers from the private to the public sector, and I will use the Shell executive as an example there, a really good organisation that has benefited from that, but we do not look at the job content, the responsibilities and the consequences of those appointments. We do not think about the fact that the system is almost designed to destroy corporate memory. It is not about the preservation of skills and knowledge, it is much more about pure process. I do have a concern that we are doing nothing like enough to build skills in the public sector.
Baroness Hamwee: My Lord Chairman looks slightly askance when one goes so far off script but I thought that was quite interesting generally as well as on this.
Chairman: That was a good one.
Q10 Baroness Hamwee: What I was supposed to ask you about was the importance of risk transfer and you have already said we really should be using the term "risk sharing". Would you like to say anything more about that?
Dr Stone: Absolutely. Risk sharing is fundamental to value. Risks have to be placed with organisations that can manage and control them and absorb them, and some risks simply cannot be transferred. Mrs Thatcher could not privatise failure. You cannot privatise failure. If public infrastructure goes wrong the problem comes back to government. You have to understand what risks both sides can and should manage and control. To take an extreme example: demand risk in transport is something which is fundamentally not transferable in the long-term because the two things that drive it are, first of all, the big economy, about which the private sector can do something, but the thing is transport policy and, frankly, any private sector organisation that thinks they can manage the risk of transport policy should be locked up. We have the nonsense in some countries that is very long dated toll concessions and you know that organisation that is operating the concession will either make out like a bandit or they will go bust in the long run because you simply cannot manage those risks. One of the great benefits of this process over the last 12/15 years has been that we now talk about this within the public sector in a much more disciplined and organised way and there is an understanding that risk management is extremely important. Again it comes back to my point about public accounts and public data. Because the data is not there you cannot see the consequences of those risks, the risks can be swept under the carpet when they go wrong. There is no equity in a banker's sense in government; there is nothing that attracts failure or success that can be measured. Risk sharing is an extremely important part of this. It is the recognition that risks matters that is the most important thing.