Sarah Hogg: Jungle capitalists and tame pussycat partners

There is a difference between involving fashionable businessmen in remodelling Whitehall and achieving successful PFI
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We want "what works", say ministers brightly. Well, that's nice. But after an election campaign in which New Labour was actually rather brave about the need for public-sector reform, the Government now seems to be retreating via platitudes to obscurity. Asked what they think does "work", for whom and why, luckless government spokesmen have been muttering about "private-sector mechanisms", as if these were just pieces of software that could be loaded on to a Whitehall web site. Pressed harder, they gabble on about management and technology, as if Whitehall could not simply hire individuals with these skills – particularly at a time when IT specialists are dropping out of dot-bombed start-ups by the sackful. Oddest of all, however, was to hear trade union leaders, plumped up with dinner at Number 10, regurgitating their host's line on the need for "private capital", as if a government in hefty fiscal surplus had any difficulty in raising money.

Well, some of this is just linguistic politics, reflecting the fact that the Labour foot-soldiers who have just marched messrs Blair and Brown back into Downing Street are shy of not just the p-word (privatisation) but the m-word (markets). The danger, however, is that by ducking the good arguments, they may end up believing some bad ones. A little history may help.

The original Private Finance Initiative (PFI), expanded and relabelled by the Blair Government, was born in the early 1990s. It was the offspring of severe borrowing problems, coupled with cash accounting – which did not allow public-sector capital expenditure to be spread over the number of years the asset could be expected to last. This had long had the effect of distorting public policy decisions against investment, with the kind of consequences we are living with today on our railways. Privatisation, the first and simplest way of getting infrastructure investment off the Treasury's books, had by 1990 covered water, telecoms and energy, but left core public services unaided. Contracting-out had allowed privately capitalised businesses to supply government with such peripheral services as cleaning and rubbish collection. But it was the PFI that helped departments to gain access to capital needed to build prisons, roads, hospitals and university campuses.

Today, however, the Treasury has finally switched from cash to resource accounting, and is running such a large surplus that there should be no financial constraint at all on desirable public investment. Paradoxically, however, public investment has fallen dramatically. The Treasury, once furiously resistant to the PFI, is now rolling it out (under the name of public-private partnerships) by the barrel, sometimes with schemes so complicated – as with the London Underground – as to defy public opinion.

PFI is no free lunch: as the chart shows, the Government has already committed itself to projects involving payments to the private sector which by the middle of this decade will be running at about £4.5bn a year. And since it plans to double the capital sums involved this year, that revenue outflow will increase sharply. What's more, since (in order to prevent the PFI being used for bog-standard leasing deals) the Treasury has insisted that the private sector carry some of the project risk, the capital it provides is not cheap. Private- sector "partnerships" have to justify themselves on other grounds than access to capital – the efficiency gains that flow from involving private businesses carrying risk.

Since the history of old-style public procurement is pretty patchy, there were, and are, such gains to be harvested. But here again, however, politics produces some very woolly thinking. In its love affair with business, the Government is in danger of convincing itself of nonsense: that everyone in the private sector is smarter than anyone in Whitehall, and therefore that the very presence in Whitehall of the business breed makes it all worthwhile. But there is a real difference between persuading yet another fashionable businessman to help remodel the government machine and achieving success with PFI. There is something rather odd about assuming that jungle capitalists become tame pussycats at the hint of a partnership with the public sector. Involving private enterprise in the delivery of public service is not about phoning a friend but about introducing some of the competitive stimuli that force businessmen to pursue productivity and innovate – which means the direct democracy of customers and investors. The private-sector effect, in short, is delivered by markets.

Of course, markets themselves do not always "work". We deal with some well-known failures by passing laws (competition rules, consumer protection, environmental standards); others by raising taxes and spending them on "public goods". For the past 20 years, the pendulum has been swinging from public ownership to public regulation. In the process, we have learnt two important lessons: that privatisation without competition solves little, but also that competition can be introduced even where privatisation can't.

Regulators learnt to simulate competitive pressures on private monopolies, government to inject these techniques into mainstream public services too, through benchmarking, league tables, independent inspection and other performance measures. These techniques, in turn, began to erode the differences between regulated private industries and public services.

This revolution has certainly had costs. The public sector now contains armies of people assessing "value for money". Internal markets brought their own bureaucracy. Breaking up vertical supply chains introduced complex new contractual arrangements, a playground for buck-passers, a mystery to consumers. A mixture of Treasury rules and fear of the Public Accounts Committee led to expensive complexity. Bidders for PFI or PPP contracts complain of the container loads of documents involved. But getting government to behave more like a regulator, less like a monopoly supplier, has forced daylight into some shameful corners of public services. It is notable that the authors of an excellent new report, "Building Better Partnerships" by the Institute for Public Policy Research (otherwise known as "the Government's favourite think-tank"), should have cited the prison service as one of the PFI's success stories. Writing contracts for private prisons has both forced the Home Office to set standards, and put pressure on the monopoly power of the Prison Officers' Association.

As this report points out, the PFI story has, however, been much less convincing in education and health – where the Government is now approving more projects by the minute. Some rethinking is clearly needed. A number of IPPR authors urge new systems of accountability, by which is usually meant more consultation with parts of the public sector or pressure groups. The risk, however, is that this might take us still further from the true accountability of service standards, customer choice and published information. Whatever the weaknesses of league tables, they have provided clear evidence of the power of comparative information on performance to exert competitive pressure, even where true competition is not possible. A "partnership" approach must not lead the Government into cosy little deals between providers, free of such discipline.

The signals are, of course, jumbled by political code. The Government is having some difficulty covering its retreat from claims that its predecessors' public-private deals amounted to "wholesale privatisation" of the NHS. The shrouds waved at the elderly and sick still hang from Labour's ramparts. The Health Secretary was last week doggedly defying logic, proclaiming that "the NHS was not for sale" and would remain a "monopoly provider" while simultaneously allowing primary care trusts to do their own deals for patient care with the private and voluntary health sectors.

Perhaps it is time for the Chancellor, a committed champion of competition, to set the policy story straight.

Sarah Hogg is chairman of Frontier Economics