And yes, idiot is idiot

Now let’s look at what that means for a minute. What are the market conditions for PFI, for example? I would suggest that the clearest indicator is that when valuing the future net earnings due from these contracts (which is the only reasonable way in which such value might be determined) the appropriate discount rate to be used should be that implicit in the original PFI contract. After all, that would be reasonable; this is what can be called an ‘arm’s length term’ i.e one set by independent contracting parties that was thought fair.

These discount rates (which effectively set the rate of return in the contract) were often quite high because it was supposed that quite large amounts of risk were transferred to the private sector when these contracts were issued (even though this rarely seems to have been the case in practice). This risk transfer was, after all, the whole reason for PFI and formed the supposed justification for the higher returns payable under this scheme than the equivalent government debt would cost. Given that this risk must still exist, because it would be unreasonable to presume they disappear when the contract was signed , then I think this argument can hold true. And it is this risk factor that should equate why, in a rational market, the higher return on PFI produces a yield that is no more attractive, despite that higher sums apparently earned, than is payable on government bonds, with which John McDonnell is proposing that the contracts be bought out.

Well, no. Because a PFI contract comes in two parts.

Building something and then maintaining it.

The building it is the risky part, once it has been built it’s less risky. That initial discount rate will cover the risks of both parts of the contract.

Sigh.

9 thoughts on “And yes, idiot is idiot”

  1. TUT, that was so last week. Can’t you keep up with Snippa’s quasi-intellectual dance through the world of ideas that only he is clever enough to think?

  2. When I were a working lad I had to do with people in government about buildings and contracts and all that. They never ever wanted to know about maintenance repair and all that of the future. They wanted their nice new building and now or soonest. If I tried to explain future costs and how they might be met I was lucky to escape being put in a sack and dropped in the river.

  3. Demetrius, thereby one of the unintended benefits of PFI. Govt can ask the contractor to build regular maintenance into the contract and the road, hospital, school will be maintained to an agreed standard. In the public sector, once built it has to compete for maintenance spend with everything else in the authority’s budget. So potholes only get repaired when they are bison-size and rooves get repaired when there are actual holes. Of course, this depends on the authorities thinking about the working life of the asset but the possibility is there. The fact that Snippa, Wilcox, Corbyn and Co are so anti PFI means that it must be a good thing

  4. @ Demetrius
    That is down to public sector procurement rules which require the lowest possible build costs ignoring ongoing maintenance costs which are met out of a separate budget. One one realises this the demolition of the Wilson era tower blocks, despite the national housing shortage, because they cannot be made fit for human habitation becomes comprehensible.

  5. “The building it is the risky part, once it has been built it’s less risky. That initial discount rate will cover the risks of both parts of the contract.”

    But it’s also about the incentives it creates, which Demetrius alludes to.

    I know someone in local government who told me about 2 adjoining buildings in Northampton: The Grovesnor Centre and the Bus Station. One was built by Grovesnor Estates, the other by the council. The one built by Grovesnor spent more money on things like surfaces. Buy good handrails, floor tiles and so forth. Things built to last, because they had to pick up the maintenance bill. Cheaper to spend a bit more on hard-wearing stuff for the amount of labour saved throughout the life.

  6. I thought the issue was the risk premium for build was effectively loaded onto the low risk maintenance contract as well making it like a private mint. Contractors refinanced after build complete and made out like bandits as funding costs were much lower than allowed for in the contract.

    Crap public sector procurement again failing to buy good advice and analogous to cutting capex to the bone and ignoring operational costs downstream.

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