10. Are your concerns about private finance projects specific to the health sector or wider? If the former what is it about the health sector that makes it unsuitable for private finance projects?
The problems in the health sector may appear to be greater because, unlike in local government for example, there is no capital subsidy. The payment of capital and the interest on that capital is largely borne at the local level and thus the impact may be greater than in other sectors. However, in cost-effectiveness terms, there is no reason to suppose that the case for PFI is any stronger in one sector rather than another. The criticisms in health are likely to be experienced elsewhere and need more scrutiny.
Because of the financial complexity and long-term nature of PFIs, transaction costs-such as those associated with tendering, bidding and writing contracts-are high relative to other forms of procurement.
The process of negotiating contracts is especially costly (for both the public and private sector parties) because of the high cost of legal, financial and technical advisory services. Dudkin and Välilä (2005) found that, for a sample of 25 hospital PFI procurements in the UK, ex ante transaction costs for the public sector and the winning bidder were some 8% of the total investment cost (split evenly between the public sector and the winning bidder). Of course, the public sector procurer ultimately bears both sets of transaction costs-its own, and the private sector's through higher contract prices.
The expense of the PFI process also has an indirect impact on cost efficiency by providing a significant barrier to entry for potential bidders, preventing firms from bidding and undermining competition in procurement. The National Audit Office (2007b) found that PFI hospitals and schools projects attracted a lower number of bidders than other forms of procurement, and that competition had declined over time. In a sample of 46 contracts that signed between April 2004 and May 2006, one third attracted only two bidders at the point they were requested to submit detailed bids. The NAO stated: "it was rare for procuring authorities to choose to eliminate weaker bids as the choice was out of their hands" (p 12).
Established firms are also likely to have an absolute cost advantage over potential market entrants since senior debt rates are known to be unfavourable for firms with limited PFI experience (Standard and Poor's 2004). The absence of competition in procurement clearly presents risks that private sector bidders will be facilitated in seeking excess returns.
The procurement process is an additional source of potential inefficiency. Because bidding consortia needs to secure loans from banks prior to contracts being signed, bidders are not required to create fully worked-up bids during the competitive phase of procurement. Instead, there is a period of exclusive negotiation following selection of a preferred bidder-a period that is typically very extensive.
The UK's National Audit Office (2007b) found, in a sample of 20 hospital procurements, that the average procurement time was 38 months, almost half of which time was taken up by the preferred bidder stage. It was common for major changes to be made to projects during this period, including increases to prices.
Most public authorities in the NAO's survey also identified the preferred bidder stage as the point at which advisory costs begin to escalate. During this phase, both public and private parties are making significant investments that are specific to the transaction. Given the scale of these investments, we might view this stage of procurement as a "bilateral monopoly", in which the power of the monopoly seller is balanced by the monopsony power of the buyer such that a mutually advantageous contract can be developed (Williamson 1985).