For Whom the PFI Tolls

I'm in Britain at the moment and suffering a severe case of déjà vu all over again. Granted, I was already a bit disoriented after flying overnight from San Francisco at the weekend and heading straight from Heathrow into a philosophy symposium at Oxford. (I don't recommend it. But the gathering was to mark the retirement of Ralph Walker of Magdalen College, a distinguished philosopher and the best teacher I have ever known. An event not to be missed, despite the strain.) Head still aching, I arrive in London in time for tomorrow's budget to find that private finance for public investment--roads, in this case--is back on the UK's political agenda. What does it take to put this perpetual fiscal gimmick to rest?

There's nothing wrong with pricing the use of infrastructure. I'm all for it, especially if the infrastructure is congested, and many of Britain's roads would seem to qualify. Making sure there's real competition in the building of infrastructure also makes sense, obviously--competitive bidding for the contracts, benchmarking of contractors against best practice, and so forth. But arrangements that simply take the assets off the public sector's balance sheet and thereby increase the cost of finance make no sense at all. The British government can borrow long-term for roughly nothing at the moment. If the country needs infrastructure investment, there's no cheaper way to pay for it. There's no financial advantage in these "private finance initiatives". Just the opposite: they're more expensive. The potential gains are economic (so long as pricing and competition are actually allowed to work, and regulations imposed on private providers are well-conceived) and/or political (disguising the public sector's assets and liabilities).

The National Institute's Jonathan Portes explains it very well.

The key point is that "privatising" a service can, in principle, result in two types of benefit:

  • competition to provide the service; in principle, allowing the most efficient (lowest cost and/or highest quality) provider to do so, benefiting consumers;
  • allowing market-based pricing for the service; so that both producers and consumers have the right incentives, the former to produce the products consumers want, and the latter to consume only products that they are willing to pay a market price for.

The problem is that in services that are a "natural monopoly" (either on a national basis, or locally) the latter benefits do not flow automatically from privatisation. So when a natural monopoly is privatised but the pricing structure is left unchanged, then the benefits are far from clear. And against the potential benefits of private provision must be weighed the costs; first, that private providers will generally demand a higher cost of capital than applies to the private sector; and second, and more seriously, that if there is a regulatory framework post-privatisation - and almost inevitably there has to be, otherwise the service would never have been public in the first place - the providers may game the system and find a way to extract supernormal profits at the expense of consumers.

Note that I don't mention the aspect of the announcement that has been most hyped; encouraging "sovereign wealth funds from countries such as China to lease roads in England". Not because I think there's anything wrong with the idea; but because if that's all the scheme does, without realising any of the benefits of competition, then it amounts simply to off-balance sheet financing, with no long-term gains either to taxpayers or drivers.

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