Q291 Lord Levene of Portsoken: You said in answer to Baroness Hamwee's question that that was the solution and therefore if that is the solution I assume it is the solution for all ills, and certainly our experience in the past has been that public sector procurement has left a lot to be desired. I think it was Professor Pollock who said that she studied what happened in London Underground. I had to sort out some of the mess at London Underground and I can tell you that was a far from satisfactory procurement. It may well be that in some areas it works but to offer that up as a solution to the problems which you have identified there as being over PFI, if you believe that PFI is not the solution, so be it, but I think to offer up public sector procurement as being the answer, from past experience, that has not worked. If you believe the evidence and you say it has always been successful, which I think you said earlier, if you had studied London Underground and other projects, that is simply not the case.
Professor Pollock: I would take a different approach and I would start from the principles first. For health we are still committed to universal healthcare and redistribution on the basis of need, et cetera, and one of the things we do know about the capital charging system coupled with PFI is that it is working against those core principles. The second thing is there has been a huge history of doing public procurement for more than 100 years. The introduction of PFI, is a radical departure and is very, very recent and I think we need to re-visit this fundamental reversal of policy with respect to the Ryrie rules where the presumption was in favour of public procurement. Capital charges were the subject of a lot of debate in the 1950, by academics and others; but the position (to use public capital and substitute private finance) was reversed very dramatically without any proper debate or scrutiny of either the theoretical underpinnings or the evidence, so that is probably what we really need to do. Now the default position is PFI or nothing. We also need to recognise not just the overturning of the Ryrie rules but the recognition of the constitutional and regulatory changes which have made PFI possible. We have talked about some of these- availability of capital, the accounting balance sheet treatment, public expenditure rules, the loss of public sector capacity and in-house expertise and also the transaction costs now. It is no good now saying we will just go back to where we were because where we were no longer exists. What we need to do is be honest and scrutinise the issues and actually go back to history to see what the arguments were, how things were managed, and then we probably need to put in new systems all over again; back to Gladstone.
Q292 Baroness Hamwee: Can I pursue this for one moment. We had witnesses from the local government world two or three weeks ago and they were arguing to have greater freedom to select different types of procurement as suitable for their own particular circumstances in different areas and for different projects. How do you respond to that? Dr Edwards: That evidence was from Buxton and Kemp, was it not?
Q293 Baroness Hamwee: Yes.
Dr Edwards: And Mr Kemp I think suggested that public procurement worked as well as the PFI, if you look at the evidence, which is in draft form admittedly.
Q294 Baroness Hamwee: He was arguing to be allowed much more flexibility.
Dr Edwards: Yes, exactly, and he was arguing that they did not have much choice when PFI was put forward.
Q295 Baroness Hamwee: Because of the credits?
Dr Edwards: Exactly.
Q296 Baroness Hamwee: So you are saying you agree with them?
Dr Edwards: I am just trying to recall what their evidence was, namely that they were not necessarily anti-public procurement, that they were in fact arguing that public procurement was at least as effective, where they were given a chance, as PFI. Admittedly, this was mostly in schools, if I remember.
Baroness Hamwee: A lot of it was about schools.
Chairman: We have only a few more minutes. We started a little late so I will allow a few more minutes. You have made your points very clearly. I want to see if there are colleagues who want to ask more detailed points. Lord Tugendhat, do you have any questions you particularly wish to raise?
Lord Tugendhat: I have asked my questions.
Q297 Lord Griffiths of Fforestfach: Could I raise one question and that is on this business of the cost of capital. Clearly, the cost of capital is higher in private markets than it is in the government market, but no-one in the private sector has the ability to levy taxes like government does, so the reason the cost of capital is cheaper for government is because the taxpayer is paying the risk. If you think of all the risks associated with building and running a hospital, in the one case the shareholder, the equity provider of capital, is bearing that risk and that risk is out in the open; it is explicit. When that is raised by government and then handed to the National Health Service, that is disguised, and therefore your argument really in saying that the cost of capital is always cheaper in government and always more expensive in the private sector and therefore everything in the NHS should be financed by government, is simply on the basis that the risks of capital provision are disguised in the public sector by taxation and are very explicit in the private sector, and therefore I think your argument, with due respect, is wrong. Let me put that as a question to you.
Dr Edwards: This question of risk is interesting because one question you need to ask is how is the risk assessed in this comparison between what was called the public sector comparator and the private finance initiative. Invariably you had allowances for optimism bias built in. That optimism bias, as I have described, was about 13%. The average run over in 2002 was running at about 13% for fairly routine projects like general hospitals, and since then it has actually been reduced. If that is the risk then you obviously need to feed that in. The Treasury used to feed this into their analysis of appraisal and evaluation by taking the discount rate of 6%-3.5% which they now use plus an allowance for risk. Even if you build those in, the public sector comes up as much more cost-effective. Why? Because the risk built in by the private sector is greater than the real risk. There is not sufficient competition in the banking market, certainly in the early stages of PFI, and the NNUH was a classic example of this. If you look at the National Audit Office evidence to your Committee, they endorse that. So what I am saying is the private sector's cost of capital exaggerates the risk. That is what I am saying.
Q298 Lord Griffiths of Fforestfach: We will have to carry on this discussion later.
Professor Pollock: It is just where is the evidence? In 17 or 18 years the Government or the industry has yet to provide any evidence around the size of that risk premium and justify the risk premium both on the debt and the equity, so that is all we can say. I think there is other evidence. You touched on competition and I do not know whether you want to go into that.
Chairman: We have time for three more questions so I will ask Lord Moonie.
Q299 Lord Moonie: Professor Pollock, coming back to Scotland, there was a big controversy at the time the new Edinburgh Hospital was opened because of the reduction in the number of beds compared to what was originally talked about being necessary. It was clear that the number of beds provided was modelled according to the amount of capital that was available for the hospital. What has been the outcome of that over the medium term as the health centres in Edinburgh have adjusted to the change, because services do adjust of course? Secondly, I know that in Scotland PFI has largely been abandoned. Has anything happened in Scotland since the change of administration which could give some back-up to what you have said on the public sector?
Professor Pollock: One of the issues of course is that Scotland, unlike England, has reversed the NHS internal market and the NHS is reintegrated so that the cost no longer lies at the level of the hospital unit. The unitary charge, the PFI cost, is borne at the level of the health board so it does not put quite such a pressure on local trusts. However, we do know that the planned community re-provision did not take place because of the affordability issues. We also know that the hospitals are working under a great deal of pressure, so the Royal Infirmary barely has a week go by when it is not on what is called 'red alert' i.e. bed shortages. Of course the other problem with affordability is the way in which costs are externalised. Some PFI schemes build in that ability to externalise through concessions or user charges, but that is not possible in the NHS which is free at the point of delivery, so the externalisation happens in a different way, as in Norfolk and Norwich it was accompanied by the closure of community hospitals and community beds and community provision, so that is a loss of entitlement and those services then get shifted or redefined as social care which are then means-tested and paid for. There is no doubt that has actually been happening. One only needs to look at the growth of numbers of people in receipt of community social care to see that. There are all sorts of externalities that result from the affordability issues. Scotland has not abandoned PFI. Indeed, it probably has more problems than anywhere else because it has more PFI per capita in the round. It has also signed off a scheme recently in Kirkcaldy, a PFI hospital, where there are really serious issues there about the cost of private finance because the banks formed a "club", as it is known now, because of the lack of liquidity in the market. The banks are getting together now for these private finance deals and actually, as KPMG has said, the most opportunistic of the banks are setting the price and seem to get their way, so this is creating new pressures in terms of the cost of finance and affordability. As you know, Scotland also has been exploring the whole issue of the Scottish Futures Trust as an alternative model but that simply removes the equity element but it does not leave the whole problem of the cost of debt, and of course cost of finance/debt is now becoming a real issue for the future of private finance. Scotland is interesting in that the reintegration has taken away some of the transaction costs and allowed more of a smoothing out in terms of the impact of the unitary charge.
Lord Best: Trying to get to the heart of the case you are making, which is a different case than we have heard from a lot of other people, let me just try this on you to see whether I have grasped it. You are saying that one is paying this huge premium on the cost of capital and this is not just justified because, on average, the overrun in real costs, which you and I can expect across the next one to be much the same, would only add about 13% to the capital costs and therefore this is disproportionate. I did not know that it was as low as that and that the public provider is able to get that close, to within 13%, so that is good news, but supposing the cost overrun is not 13% but in the particular case one has in front of one, it is 100%, or it is your Parliament in Scotland, which I cannot remember what multiplier of the original number it was-
Lord Forsyth of Drumlean: Ten times.
Q300 Lord Best: Then surely one would have done better? You do not know in advance perhaps but then you would have done an awful lot better to have paid the risk premium but to have got it in on time and on budget. Have I understood it?
Dr Edwards: Just one quick answer to that. That 13% is 2002. In fact, there is evidence that it was much less than that later. The second point I would make is, yes, of course, the Scottish Parliament building was an overrun, but that is hardly a routine general hospital in the way that we are talking about in the Health Service. So those are two points. The third point is when you look at cost overrun, and comparing the public sector and private sector, I think it is important to look at the private sector's overruns as well and look at the overrun of the cost at similar stages. There are various stages in the PFI. There is the strategic outline, there is the outline business case, there is the full business case and there is the final closure. Between the approval (that is full business case) and final close of the contract, there is evidence that there is tremendous escalation in the price. It is not overrun but it is equivalent to overrun, is it not? Are you with me? So that is my answer.
Professor Pollock: I think that is quite important. The preferred bidder is chosen and then you have a long period where there is no competition happening where there may be enormous cost changes, for whatever reason, and then you have a cost escalation and then the contract is signed at the full business case and you may get no cost overrun there. That is one of the big problems with the Mott MacDonald study and the study of optimism bias that it did. It did not take account of the preferred bidder stage, a period where there is no competition which on average I recall the NAO as saying could be nine to 15 months. I would have to double check that.
Dr Edwards: If you look at the NAO evidence, paragraph 5.8.