Exploding the myth of a PFI panacea

April 12, 1996

The Government's plans to involve the private sector in the construction and operation of large projects through the Private Finance Initiative has made little impact in higher education. Despite the PFI's embryonic nature, it was thought to be a replacement for public funding. In the 1995 budget, capital funds in England were cut by almost 50 per cent over three years.

The Government stressed that universities must raise more of their capital from the private sector using the PFI. In their haste to cut public funding at the behest of the Treasury, ministers at the Department for Education and Employment seem to have overlooked the fact that a large part of universities' formula capital funds are used to buy equipment, an area which the PFI is much less likely to help fund.

The universities have expressed strong concern at the massive cut in capital funding and have sought its reinstatement in the 1996 budget. The cut in capital grants means a substantial extra charge on universities' recurrent resources which will have to service the cost of capital provided by the private sector. This funding could come from a conventional bank loan or through a PFI scheme, but the financial impact is similar. Unless a private capital investment produces adequate compensating savings or makes sufficient extra income, it represents a further squeeze on recurrent funding that universities are unlikely to be able to afford. These charges come on top of a continuous reduction in universities' unit funding, which has amounted to a 29 per cent squeeze over the past six years. The phasing out of public funding without considering the full consequences will mean a further rapid deterioration in the learning environment.

The Government's reliance on the PFI is completely misplaced. It is still at an experimental stage and there are very few examples of successful projects on the way. For many, the definition of the PFI is still largely obscure and it is widely confused with conventional loan finance. It will involve a transfer of risk and profit from the university to a private sector partner. In theory, the university will gain from cost savings during the development phase and will benefit from lower operating costs achieved by a private sector manager.

However, in practice these benefits remain unproven. The cost and complexity of developing a PFI project (which could mean risking up to Pounds 500,000 in abortive fees on a major proposal), the unwillingness of the private sector to take real risks and its demand for income guarantees all need to be taken into account in assessing value for money. Long-term management contracts will tie a university into a specific operator and will reduce its financial flexibility at a time when public funding is unstable.

There are some limited circumstances in which universities may benefit from PFI partnership. They may be useful when a university cannot offer enough security for a conventional loan. Facilities such as residences, sports facilities and catering outlets, which have the potential for all year round use, may make enough money to justify a PFI scheme. Academic buildings do not usually offer these money-making chances and normal loan finance may provide better value than PFI. In either case the university will be forced to pay the bill from its overstretched recurrent funds. The PFI route is unlikely to offer real savings in equipment purchase unless alternative income-generating uses are found. In most cases a normal purchase will produce the cheapest solution.

The debate on the role of private capital continues. The DFEE has responded to the Committee of Vice Chancellors and Principals' funding campaign by launching a joint inquiry into the operation of the PFI. This inquiry will produce a report to the Secretary of State by the end of May. The CVCP aims to convince the DFEE about the PFI's limits to ensure that the sector's capital needs are recognised in the 1996 Budget settlement by the announcement of a significant reversal of the last year's ill-judged cuts.

In the long term, universities recognise that private capital is likely to play a major part in the provision of new buildings but only if they have enough income to service borrowings and attract private investors at competitive rates. This in turn depends on bringing more recurrent funds into higher education by ensuring that each of its direct beneficiaries, including the taxpayer and graduates, makes an adequate contribution to its costs. If the opportunity for a long-term funding solution is missed by the Dearing inquiry, the funding future is bleak. Downward pressures on the unit of public funding would continue indefinitely and universities would be denied full access to the capital markets, which they need if they are to invest properly in their infrastructure. Funding reform rather than the ill-judged application of the PFI will provide the only firm basis for an effective long-term partnership between higher education and the City.

Tony Bruce is director of policy development at the Committee of Vice Chancellors and Principals.

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