Q265 Chairman: Good afternoon, Professor Pollock and Dr Edwards, and thank you for coming. I am going to ask whether you wish to say anything by way of opening or would you like to go straight into the questions? Could I just say to you that I would be grateful if you could speak as clearly as possible for the webcast and the shorthand writer. Perhaps if you agree with the previous witness if you just nod and you do not need to add any more. Thank you very much for coming in. In introducing yourselves, would you please state your name for the shorthand writer? Do either of you wish to make an opening statement?
Professor Pollock: I am Professor Allyson Pollock of the University of Edinburgh. As you all know, since 1992 PFI has been the dominant form of procurement for the public sector, and in the NHS around £12 billion of capital expenditure is committed, so most capital expenditure is coming through PFI. I would like to make three points really. Firstly, in the 18 years of the Government's policy there has been very little evidence in support of the policy as to what the benefits are. What evidence there is around the costs and harms, which we will be considering later today, is in general being ignored or suppressed by policy makers and industry in some of their submissions. The second point is that PFI has involved an enormous divestiture of public land and buildings and entitlements and there has been in general a loss of public control and accountability for public services and long-term debt commitments for current and future taxpayers. There have also been constitutional changes raising major questions about inter-generational equity as well. Finally, I think this inquiry is very welcome because one of the key pressures from private finance is the affordability issue. Certainly our research into PFI shows it has always created affordability problems and reductions in services. Affordability has been an issue despite the fact that there have been near unprecedented levels of growth in public expenditure in recent years. But now we are into a new era of financial squeeze, where the cost of private finance, if anything, is rising, and not in relation to risks, and secondly also we have got a problem perhaps of public expenditure austerity, we may well see new affordability problems around PFI, both for current commitments and any future commitments.
Q266 Chairman: Thank you for that. You have part answered the first question I was going to ask you but I am sure you could say more. Dr Edwards: Could I make one comment?
Q267 Chairman: Perhaps you could make a comment in relation to the question I am going to ask.
Dr Edwards :It is a preface really. My name is Dr Chris Edwards and I would like to say to the recorders that in paragraph 11 of my written evidence, in the penultimate line, £100 million should read £100 billion!
Q268 Chairman: I was going to thank you for your paper and we realise that this first session today is mainly being concentrated on PFI in the health sector. Perhaps in view of Dr Edward's paper I ought to declare an interest in that I live in Norfolk and was for many years a Member of Parliament there and the Norfolk and Norwich Hospital, to which your evidence is much directed, served my former constituents. Could you provide, and expand perhaps, a brief overview of what you see as the main problems of PFI projects in the health sector and also what benefits, if any, private finance projects have brought. Professor Pollock: Over the 17 years that we have been conducting research, it has largely been directed at understanding and evaluating the many benefits that have been claimed for PFI, so I suppose the primary one for PFI was overcoming a shortage of public capital coupled with government expenditure constraints. Certainly the evidence that you have already received from Professor David Heald, the NAO and others shows that the balance sheet treatment has been a key driver at department level for PFI, coupled with self-imposed Treasury rules over the limits of government borrowing. That has been a major declared benefit and the off-balance sheet treatment has allowed departments to ease the constraints on their capital budgets. It still remains very important to the Treasury and it still retains some advantages to departments in the Treasury. The balance sheet treatment coupled with a shortage of public capital has meant that since 1997 health officials and others have said that there has been absolutely no alternative, and indeed former Health Secretary Alan Milburn described the PFI as the 'only game in town'. That has been one of the major declared benefits: overcoming a political decision to create a shortage of public capital. I can go into it in more detail or go on. The second benefit, is that the Treasury maintains PFI as being value for money through risk transfer. It is well-recognised that the cost of private finance is always higher than anything that the Government could borrow but the claim from the Treasury and the Treasury's stated position in 2003 is that the higher cost of private finance is due to the risk premium. What we know however is that the private sector charges premia well above what would be acceptable and that has been demonstrated by a number of researchers. Chris has one some work and so have the Cuthberts, and now we are into the new scenario where in fact this premium, which is quite separate from the risk premium, is increasing, so the credit margins are well in excess of government gilts. If I continue on the theme of value-for-money appraisals, the Government will be well aware that the claims around risk and risk transfer are not at all substantiated or borne out by the evidence. Indeed, the financial appraisals themselves have been subject to quite a lot of criticism, including from the NAO and the Audit Commission, and as you know Jeremy Colman referred to them as "pseudo-scientific mumbo-jumbo" and our research has taken apart quite a lot of the value-for-money claims. We have found it very difficult to identify the risks, to measure the risks and to evaluate the risks and that is both ex ante and ex post. The other issues, which I will just touch on, are again related to risk transfer: the design, the construction and operation, for which again there is very little evidence of any risk transfer, and we can discuss that a bit later on. As you know, there are two parts to the Treasury appraisal which are value for money and affordability, and in our own detailed work of case studies what we have found is that there are perverse incentive at work in the financial appraisal such that the trusts have a strong incentive once they begin their procurement process to continue, even when the scheme has become, by any reasonable standard, unaffordable. What happens we have discovered in many of these schemes that time and costs increase during the procurement process and because of the sunk costs on both sides, the amount of money and managerial effort, and in the absence of any funded or public sector option, the temptation is to continue to push on. What we have found is that the affordability issue is serious because the PFI charge is met from the revenue budgets or the operating budgets of NHS trusts, so that what happens is a squeeze on the income and the cost efficiencies are made, either through reductions in numbers of beds, or services, or of course staff (because staff are the biggest component of a hospital's or trust's operating budget). Our research shows that affordability actually begins to distort both the planning and the public health priorities, so rather than clinical need driving the planning process for hospitals and for clinical services, it is largely being driven by financial considerations. Then what we find is that the affordability issue impacts from a very early stage, very early on, even before the contract is signed between the outline and the full business case, but the financial problems then reoccur even during the operational stage of the contract, and this may even lead to further rounds of service cuts. We know that there is some very good research evidence to show that the economic and financial appraisals relating to PFI are systematically manipulated. I have now dealt with some of the government claims for the policy. There is another claim around innovation.
Q269 Chairman: I think we will come on to things like innovation later because we have a lot to get through.
Professor Pollock: Perhaps I could just touch on the Coventry Walsgrave PFI as an example of how PFI distorts decision-making. It started off as a £30 million refurbishment but it ended up as a £174 million new build because there was no public sector capital available. This had nothing to do with the health needs of the area; it was the need to make the project achievable on the basis of private finance. Coventry Walsgrave is very interesting because it was a relatively new hospital, at the time only 30 years old. This comes back again to the theme of PFI having been the only game in town for so long.
Q270 Chairman: Thank you very much. Dr Edwards?
Dr Edwards: Three points. First of all, PFI is a disaster; it is a waste of money. It is bound to be because the cost of capital to the private sector is at least twice that of the public sector. In the case of the Norfolk and Norwich University Hospital it was more than twice. The rate of interest paid on that hospital is 10%a year, on average, over 37 years of the contract whereas the public sector cost of capital is 4.3% per annum. Given that, the private sector must be more expensive in terms of financing hospitals. The transaction costs are higher and those are set out in paragraph 9 of my written evidence. The maintenance costs are higher as set out in paragraph 8 of my written evidence and that higher maintenance cost tendency is endorsed by the National Audit Office's evidence at paragraph 5.26. Allyson referred to affordability. Nowhere was that more true than the NNUH. In 1989, when the new hospital was more or less first proposed for Norwich, the number of beds stated to be required was 1,650. That was reduced by 1995 to 701 because they wanted to get approval on the basis of affordability because at that time PFI was seen to be the only show in town. Ultimately, once approval was gained, it was upped to just under 1,000 beds, 987, but that is 18% fewer beds than in the previous two old hospitals which that new one replaced. There is lots of evidence that is inadequate. What that means is the primary care trust has to buy beds from the private sector, which it has been doing, costing in 2007-08 over £1 million. So in addition to the rent being higher because of the higher cost of capital, the primary care trust is having to buy in beds from the local private hospital mostly, which is Spire.
Professor Pollock: If I could just add to that, in Norfolk and Norwich, as you know, there was a community service strategy (which was completely dislocated from the acute hospital strategy) which also heralded a programme of small community hospital closures. It was kept completely separate but was absolutely related to the affordability issues, so one of the problems with these acute PFI hospitals is that they suck money in and then they drive the planning in the whole area so that much of the community re-provision that is supposed to occur does not occur because it is driven by the need to pay that unitary charge and make the hospital itself affordable. We have seen that repeatedly in hospitals up and down the country, the way in which vital community services, including services for people with learning difficulties, mental health, elderly and frail are actually closed or shut or not re-provided. You can see that from research in Scotland and in England.
Chairman: Could I just say we are intending to stop this session at quarter to four and we have a lot of questions to get through so could I ask you to be reasonably brief in your response to them. Lord Paul?