As noted in section 2, under the current NI funding regime, capital spending financed through the direct use of resources or conventional borrowing is tightly constrained. The capital used will count against the already limited NI capital budget, thereby reducing the scope for other projects, and capital charges and depreciation count against the NI revenue budget.6 In contrast, the upfront costs of off-balance sheet PPPs have no impact on the capital budget, and only the annual charges appear on the public sector's accounts. This means that, while conventional capital spending is constrained by capital and revenue budgets, only the latter impacts on most projects financed through PPP.
This provides NI administrations - whether devolved or Westminster-based - with an incentive to use PPP, as it appears to provide scope for investment that is additional to what could be provided through conventional capital spending or borrowing.7 Because capital budgets are so low in NI, and the power to borrow is tightly constrained, this incentive operates even where the revenue impact of private finance is greater than alternative methods. Section 2 of this report shows that the NI Executive was - quite openly - responding to this incentive when it chose to expand its use of PPP, with both the CFP and the finance minister emphasising PPP's 'additionality'. NI Office ministers also faced these constraints during direct rule, and therefore operated under the same incentive.
As the International Monetary Fund (2004) notes, the "off-balance sheet" status of PPPs introduces an "unwarranted bias in their favour", providing a "superficial" relaxation of budget constraints. The relaxation is "superficial" because investment through PPP has exactly the same revenue effect as conventional capital spending or direct borrowing. This public sector costs that PPP gives rise to can only be met through a redirection of revenue from other parts of the public sector, increased taxation or, for sectors like roads and water, higher user charges. The budgetary advantage of PPP - that while direct borrowing counts against the capital budget, borrowing through a PPP intermediary does not - is the consequence of financial reporting structures developed by the Treasury, and does not reflect any economic difference between alternative forms of financing (Heald 1997).
If PPP cannot provide additional resources to devolved administrations, why might the Treasury wish to give ministers a budgetary incentive to use it? The reason is that the Treasury faces a very similar political incentive to the one outlined above, largely because of self-imposed fiscal constraints.
Across Europe, finance ministries are interested in PPP because of its ability to deliver investment, the upfront costs of which do not count against measures of public sector debt. All EU member states are subject to fiscal constraints under the Maastricht Treaty which restricts 'gross government debt' to 60% of national Gross Domestic Product (GDP). In the UK, the fiscal rules are less flexible. Since 1998, the Labour government's 'sustainable investment rule' has imposed a ceiling of 40% on the ratio of 'public sector net debt' (PSND) to GDP, which is consistent with a much lower debt-to-GDP ratio than that specified in the EU Stability and Growth Pact.8
As long as privately financed investment is recorded off the public sector's balance sheet, then it does not count towards the PSND.9 And, as the sustainable investment rule is an important benchmark of the Treasury's economic prudence, it has an incentive to encourage the use of private rather than public finance for new investment, even where the present value cost will be higher.
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6 Public entities must pay the Treasury for the use of their buildings through annual capital charges.
7 Because England uses PPP to finance most of its large-scale capital investment, the capital budget for NI may be set lower than it would otherwise be under the Barnett formula for territorial revenue allocation. The incentive to use PPP is particularly strong for devolved governments in the UK, since not using private finance implies a lower level of capital expenditure than England, which may have political consequences.
8 It is likely that this ratio will be changed in the forthcoming Autumn Pre-Budget report, due to new economic circumstances and rising public debt. Whatever ceiling is imposed, the Treasury will retain an incentive to circumvent it if it can achieve politically desirable results - e.g. higher levels of investment - by doing so.
9 For example, the Treasury's seminal statement on its policy towards PFI states that private finance "can relieve the pressure on public finances" (HM Treasury 2000; p.13).