Warwick Lightfoot: 'Naive' Boris has the wrong policy on Livingstone's too costly PFI schemes

Warwick Lightfoot is a candidate in the London Primary to select the Conservative Candidate for Mayor of London. He is an economist and was Special Adviser to the Chancellor of the Exchequer 1989-92.  He believes that Londoners have been "fleeced" by the PFI schemes and calls for London to receive a fairer share of national revenues so that it can afford direct investment in new infrastructure for London.

The Conservative Mayoral Primary and its hustings have shown the Greater London Conservative Party in a good light. We have shown that we are open to debate and argument and we know that as a party we have to address the concerns of everyone living in Greater London. Common themes have emerged about tackling crime, improving transport and getting greater value for money from the £10.7 billion spent through the Mayor of London’s budgets.

Clear blue water has also emerged in the hustings between Boris Johnson and me about how to finance the transport and other investment that Greater London needs. In my judgement the Private Finance Initiative (PFI) and the PPP arrangements that Gordon Brown used for the modernisation of the London Underground do not work. The private sector cannot take on the risks of such investment at a reasonable cost. Whereas the government can borrow and finance awkward risks more cheaply through the gilt market. Gordon Brown would never have allowed Scotland to be treated in the way that London has been treated in relation to the modernisation of the Tube.

In the long-run PFI increases the costs of investment. Taxpayers get fleeced and shareholders coin money. Our debate should be about getting London access to the taxes that it already pays, and not loading Greater London with higher borrowing bills that have to be paid for one way or another. London's investment is justified in economic and social terms. London generates the taxes needed to pay for this investment, but national governments have refused to give London its own money to pay for the investment it needs.

Boris Johnson offered the platitude that we should approach PFI in a non-ideological way and expressed the naïve hope that it could offer incentives for efficiency in investment. He also expressed concern that without the private finance initiative the taxpayer would have to finance London’s investment. There is nothing ideological about the present debate on PFI. It is a practical matter of the relative cost to the taxpayer in the long-run. The only ideologues on the issue are national politicians, like Gordon Brown, who construct convoluted financial rules that ensure that investment can only be carried out through PFI off-balance sheet schemes.

Boris Johnson’s concern that without PFI London’s investment would have to be financed through public spending, means that he must believe that the investment that London needs can only go ahead, if it is dressed up in some form of convenient off-balance sheet manner that avoids national public expenditure in London. London needs a fairer share of the taxes that it pays to the Treasury and a Mayor who fight for London’s interests with the Treasury.

The Conservative Party needs a Mayoral candidate who speaks for Greater London. Boris Johnson’s defence of PFI shows that he is acting by instinct as the spokesman for the Conservative Shadow Cabinet brief on public spending, and not necessarily as the spokesmen of the financial interests of Londoners.

When it comes to the investment to modernise the tube and the other investment that London needs for transport and flood defences, London needs a fairer share of the taxes that London pays to the Treasury. The debate should be about getting a fair distribution for London within the UK public expenditure settlement.

London needs to be properly funded. This is at the heart of the London Council’s campaign for a funding settlement that takes account of the social and unemployment problems of Greater London. As a Conservative Mayor I will make a powerful, cogent and persuasive case to get the public spending and investment that London needs whether it is a Labour Treasury or a Conservative Treasury.

The hustings have been good because they have enabled the candidates to set out their stalls and develop their ideas for the metropolis. The process of cross-examination and questioning has also had the benefit of drawing out genuine and reasonable differences of opinion and judgement that we have.

London Needs Investment Funded By The Taxpayer

Ken Livingstone has got one thing right as Mayor of London. He was against Gordon Brown’s decision to pay for the modernisation of the London Underground through the Treasury’s creation of a hybrid Public Private Partnership (PPP). The collapse of Metronet is an illustration of the broad failure of the Private Finance Initiative (PFI). I worked at the Treasury when John Major’s Government first explored PFI. It was plain to me that it could not deliver what it was cracked up to offer. It was supposed to give the taxpayer investment projects - from schools to railways -more efficiently managed and at the same, if not lower cost, compared with normally financed government investment. This was always implausible.

The British Government can always mobilise huge sums of money for public spending and complex investment projects more cheaply than private sector investors. The Treasury does this through general taxation and its capacity to borrow in the gilt market. It is, moreover, something that has been demonstrated from the time of the original creation of the Bank of England and funded national debt in 1694, through to the Napoleonic Wars and the financing of the two world wars in the 20th century.

Enron Finance and the Tooth Fairy: Gordon Brown

Only someone, who believed in the tooth fairy, could have imagined that the Private Finance Initiative (PFI) could offer both genuine value for money and the real transfer of risk from the taxpayer to private sector. But there are many politicians and businessmen and women who find it convenient to believe in fairy tales when it comes to the PFI. For politicians its attraction was straightforward. It enabled them to announce spending to-day that would neither have to be paid for until tomorrow nor would breach their framework of fiscal rules. For politicians, it had all the attraction of the Enron factor: off-balance sheet accounting. For business, it meant lucrative government contracts ultimately paid for by the taxpayer and huge scope to manipulate the financial arrangements of the projects for the benefit of their shareholders. The scope for this has been so great that traditional construction companies have rebranded themselves to their investors as ‘sexy and exciting’ service companies generating predictable, recurring revenues from PFI contracts.

The only surprise in all this has been the way the Treasury and Gordon Brown embraced it. Under all previous governments the Treasury has been the Praetorian Guard protecting the taxpayer. Yet over PFI in general and the PPP for the Tube, the Treasury sold the long-term interest of the taxpayer down the river.

The lesson from this saga is that there are some risks that only the taxpayer and the public sector can sensibly take on. They cannot ever effectively be transferred to the private sector at a reasonable cost. These big infrastructure projects need to be funded by the state. The issue should not be how could the Treasury get them financed by the private sector, off-balance sheet, at greater longer-term cost. Instead, the question that should be asked is whether the project is justified on a rigorous and robust application of full cost-benefit analysis.

The Lessons Of PPP And The Metronet Fiasco

We should learn the principal lessons of this PPP fiasco and PFI more generally. Only the government and the taxpayer can take on these massive investment risks at a reasonable cost. In the end these risks come back to the taxpayer as they have done in this instance.

The PPP structure for the tube was hugely complicated and loaded with debt. This debt carried a government guarantee precisely because the risks involved could not be transferred. Gordon Brown did not want to finance the modernisation of the tube in a way that would be recorded on the Government’s own balance sheet. His difficulty was that he could not get companies to come forward and undertake the work and the genuine risks involved. To persuade the private sector to participate, a complex structure was created where the companies borrowed, inevitably at a higher cost than in the gilt market, and their debt had an effective government guarantee.

Nice Work If You Can Find It: Shareholders Coin It

The company structure involved was too complex. The companies put up too little equity and got too much in the way of government guarantees for risk to be transferred. But without those guarantees, given the risks, the companies would never have got involved. British construction companies traditionally make their money out of the customer changing their minds: variation costs. And there was a perverse incentive in the PPP structure to ensure that this happened. Metronet’s principal shareholders ensured that their companies were employed without competitive tender for the subcontracted work. So their own companies have minted money out of it. The structure was flawed from the start an artificial, but hardly commercial, entity.

Financing the modernisation of the London Underground through private borrowing makes the work more expensive.  It also means that the costs to the travelling public in tubes fares is high. The worst consequence is that PFI inflates the cost, and that inflated cost can only be recouped from the fare paying public, which is why travelling in London even with an Oyster Card is so expensive. This in turn greatly reduces its value to Londoners and the wider economic and social benefits that it should generate. London has an entrenched unemployment problem. The cost of getting to work is part of it. Travel to work costs in turn aggravate London’s serious unemployment problem.

PFI And PPP Increase Taxpayers Bills In The Long-Run

The PFI and the PPP have not been about taxpayer value or public value in the broadest sense. It has been about off balance sheet financing where in the long run the full costs are greater. It is emphatically not about the interests of the taxpayer in the long-term. It is about governments trying to dress up public spending in a way that the full cost of a project is not apparent today. The political convenience of this means that Gordon Brown used PFI even though the full costs to the public in the end would be greater than conventional public finance.

London Needs A Fairer Share Of Taxes It Generates

London as a regional economy is in an odd position. It is by any international standard an economic powerhouse. London desperately needs a huge improvement in its rail transport infrastructure. Projects like Crossrail and the Chelsea-Hackney line would yield huge economic and social benefits. They would expand the economic and tax base not just of London, but also of Britain as a whole. Yet the government will not finance them properly. The population of Greater London makes up about 12.5 per cent of the UK population, generates slightly under 19 per cent of GDP and about 19 per cent of total UK tax revenue. Arguing that investment in London transport infrastructure is complex and involves huge risks that cannot realistically be carried by the private sector and should be therefore be principally paid for by public spending, is not about arguing for higher public spending. It is about arguing that Greater London should be treated more fairly and more realistically within the UK public expenditure settlement. When politicians talk about say they are still looking to PFI as a means of offering the ‘taxpayer value’ and management incentives for efficiency, what they are doing is avoiding the difficult choices that have to be made in public expenditure, taxation and borrowing. Moreover, in the context of Greater London what it means is that they will not fight for London to retain a fairer share of the tax revenue for the investment that London needs.

Comments

[Moral minority]

Boris has his faults. There was, however, no need to turn an attack on Brown's botched PFI contracts into a personal attack on Boris. Victoria Borwick hardly mentions the Tube ever. Andrew Boff appears to have little knowledge of transport. Why not attack them?

I have read the candidates' literature and attended the hustings. No candidate has attacked Livingstone's huge rises in bus, tube and taxi fares - or his plan to close Tube booking offices as part of his associated plan to force everyone onto Oyster cards. No candidate offered any detailed proposals to improve transport services, e.g. more late night services. All we got was the soft target of the congestion charge. The candidates were stuck in a pro-car, central zone mentality.

There are no votes in attacking the PFI contracts. But there are many votes to be gained by cutting fares and improving services. Warwick Lightfoot has shown that he is out of touch with the real needs of Londoners (rather than hacks and policy wonks in the Westminster village) and has lost my vote.

[Conservative W8]

At last a Conservative with the guts and knowledge to speak the truth about the PFI mess.

[CCHQ Spy]

I wouldn't worry about Moral minority's comments Warwick. He's negative about everyone and everything all over this site. I very much doubt you had his vote in the first place so don't worry about having lost it!

[FedUpWithCameron]

This is economic illiteracy. Shareholders in Metronet lost a lot of money. PFI means the private sector takes the risks and gets rewarded when it goes well.

That is called capitalism. It is what David Cameron promised to campaign for when he was after members' votes and it is what he has attacked ever since.

[Justin Hinchcliffe]

I don't know how any Conservative could support PFIs: they're a rip-off. If we had been voting on policy alone, Warwick would have won hands down. The Party should utilize this man!

[James Cleverly]

Our battle lies with Livingstone not with the other candidates for Conservative nomination.

Whatever the result of the primary it is essential that the candidates do not provide damaging sound bites against each other.

[Moral minority]

CCHQ Spy. I have many years experience in large PFI/PPP projects. PFI contracts are neither good or bad per se. Some are excellent, other average or bad. Their effectiveness depends on whether the risk transferred is worth the higher finance costs.

There have been literally thousands of successful private sector infrastructure projects around the world. They include major transport projects such as toll roads (e.g. Birmingham) , metro systems (e.g. UK tram and light rail networks) and high speed rail links (e.g. in Japan).

So Warwick is wrong to declare that only the public sector, financed by gilts, offers better value than PFI or PPP is wrong. The public sector has no incentive to control costs. Network Rail is a prime example. It has wasted billions, far more than the cost of bailing out Railtrack that inherited the proverbial dog's breakfast from British Rail.

The contractor's rate of return reflects the risk, especially its ability to undertake detailed due diligence. In the case of the Tube, as with Railtrack, the state of the track and stations was far worse than expected. The former state owners took a maintenance holiday to save money and give the private operators a poison pill. The contractors have got wise to that and rightly managed their exposure in the contracts.

Warwick argues that the contractors should have invested more equity. Equity is the most expensive form of finance. The contractors would have required even higher returns and profits. This argument was really a device to make the private sector less competitive to the public sector.

This article is the sort of nonsense I would expect from a leftist economist such as John Kay. It is truly prejudiced against private sector involvement in major infrastucture projects despite international evidence to the contrary.

I can only conclude that Warwick is either ignorant or disingenous for political reasons.

[Moral minority]

PFIs were introduced by Norman Lamont when Warwick Lightfoot was his Special Adviser. He should tell us if he advised Lamont against their introduction.

[Yet Another Anon]

I worked at the Treasury when John Major’s Government first explored PFI
That was at a time of course when John Major and Norman Lamont with Michael Hestletine cheering on had embarked on a huge programme of spending increases coupled with tax cuts - a balance that later came back to bite them on the ass as the Budget Deficit shot up. It is not surprising that they were eager to keep a lot of the spending out of the books because otherwise the headline figures for deficits at the time would have been much worse and the Conservatives 1997 result probably would have been much worse.

I have no faith in PFI or PPP - bureaucratic schemes that require huge amounts of monitoring and delay a lot of spending and encourage private contractors to spend their time thinking up ways of extracting money from the Treasury through novel ways of charging.

Sometimes the state will need to pay private operators to provide some kind of service for which there is no provision either through omission or as part of deliberate policy - if it is a public sector programme then the public sector should keep control of it including deciding which organisation private or public does particular bits of work, and not hand over the management of it lock stock and barrel to a private operator - if it should be handled by a private operator to that extent then full scale privatisation or transferal to some kind of not for profit charity is the answer.

With regard to the London Underground it should probably be handed over to Network Rail, the alternative would be to create a new private charity limited by guarantee to run it, or to convert it to a plc and start selling shares in it either partial or whole - in the case of an asset sale, money raised could be put into it to pay for upgrading the network. Indeed Ken Livingstone's plan for the London Underground of issuing bonds was actually a far sounder idea than PPP.

[Yet Another Anon]

It has to be said though that the PFI\PPP contracts of the 1990s and early 21st century are mostly at far too advanced a stage for there to be more than damage limitation - it leaves a mess committing future governments to having to pay for expensive and possibly failing schemes not of their making for decades to come - costs of PFI\PPP schemes should probably be accounted for under PSBR, if they were governments would be far more hestitant to use them and far more concerned that they really were of better value with regard to the public finances and quality of work.

[Moral minority]

Where is my detailed post on PFI project finance? There was no abuse, just a fisk of Lightfoot's article, yet it was deleted without comment. Is Con Home campaigning for Lightfoot?

[Moral minority]

I am pleased that the Editor finally approved my earlier fisk of Mr Lightfoot's article.

Yet Amother Anon wrote "Ken Livingstone's plan for the London Underground of issuing bonds was actually a far sounder idea than PPP". Those bonds would have been underwritten by the London council taxpayer. Such a proposal, in practice, would be no different to Lightfoot's. There would be no contractual or shareholder discipline to manage and control costs. That problem would manifest itself if the Tube network was owned or managed by Network Rail.

PFI/PPP projects can deliver better value for money. They require

- excellent negotiation skills and management on both sides
- high quality information for bidders and
- bidders to carry out extensive due diligence.

It is easy to criticise bad deals and the Labour government has done more than it should. I note, however that Yet Another Anon failed to criticise the successful examples that I gave in my fisk of Lightfoot's article.

A large proportion og private companies use off-balance sheet financing, e.g. operating leases. It can be an excellent and affordable alternative to traditional financing methods, e.g. large long-term loans. There is no reason why government should not use it if it offers value for money.

I should also point out that most governments bind their successors contractually, e.g. in defence contracts. Is Yet Another Anon proposing that we should not replace aging defence ships, submarines and weapons?

[Mike A]

This article is fine in terms of its technical analysis, but it perfectly demonstrates why Lightfoot would be a terrible mayor (admittedly, not something we have to worry about).

The mayor's direct powers are limited, even with the new GLA Bill. He is most influential as a lobbyist - a voice for London. That means he needs to know when to pick his battles.

Both the treasury and Osborne have committed themselves to maintaining the current rules on debt. They are also unlikely to fiddle with the accounting rules. No stamping of the mayor's feet will change that - full government backed bonds *will not happen*.

Livingstone knew that, and fought tooth and claw anyway. The result was that, because of POLITICAL RISK (fighting between whitehall and city hall) and despite the government guaranteeing almost all the risk on lending to metronet (95%) the banks still gave the company a lousy credit rating. That made it more difficult for metronet to stay afloat, and increased the amount the taxpayer was eventually liable for.

Sometimes refusing to compromise with central government and their stupid rules makes the situation worse. A good politician knows that. Lightfoot clearly doesn't.

Rather than an attack on Boris, this perfectly demonstrates why
Lightfoot should remain an economist, and Boris a politician. If it really comes to the crunch, Boris could hire someone like Warwick, but Warwick can't buy in Boris' political judgement, charm or charisma.

In fact, looking a the bigger picture than that, it's even worse. Lightfoot knows he's lost, and probably by a wide margin. I'd imagine he'll come in third, but rather than conceding carefully and gracefully, he has chosen to try to damage our leading candidate by calling him naive.

[Yet Another Anon]

I should also point out that most governments bind their successors contractually
PFI and PPP provide a framework for governments to commit their successors to far more than ever before, and what then happens is that someone down the line will get blamed for the mistakes for many of these things and when anyone comes back to look at the original decisions on these things, the person who took the decisions probably will have finished their political career and may well be dead by then. Generally it is best to minimise commitments to future spending rather than mortgaging the future of the country, it's not an absolute but the use of PFI by both political parties in government seems to have been quite casual and almost routine.

[sjm]

The last thing we need is losing candidates knocking the winner - thanks for contributing to the disfunctional image of the Party, Warwick. Rather in line with some of your childish behaviour at one of the hustings?