What Is a Private Finance Initiative (PFI)?
A private finance initiative (PFI) is a way of financing public sector projects through the private sector. PFIs alleviate the government and taxpayers of the immediate burden of coming up with the capital for these projects.
Under a private finance initiative, the private company handles the up-front costs instead of the government. The project is then leased to the public and the government authority makes annual payments to the private company. These contracts are typically given to construction firms and can last as long as 30 years or more.
PFIs are used primarily in the United Kingdom and in Australia. In the United States, PFIs are also called public-private partnerships.
Private Finance Initiatives & Public-Private Partnerships
- A private finance initiative is a way for the public sector to finance big public works projects through the private sector.
- PFIs take the burden off governments and taxpayers in terms of raising capital for the projects.
- Governments repay private firms over the long term, and the payments include interest.
- PFIs are typically used in the U.K. and in Australia. In the United States, they're called public-private partnerships.
Understanding Private Finance Initiatives (PFIs)
Private finance initiatives were first implemented in the United Kingdom in 1992 and became more popular after 1997. They are used to fund major public works projects such as schools, prisons, hospitals, and infrastructure. Instead of funding these projects upfront from taxpayers, private firms are hired to finance, manage, and complete the projects.
Depending on the type of project, PFI contracts typically last 25 to 30 years. It isn't unusual, though, for firms to have contracts that are less than 20 or even more than 40 years. The consortium provides certain services during the period of the contract, which was previously provided by the public sector. The consortium is paid for the work over the course of the contract on a "no service, no fee" performance basis.
Firms make their money back through long-term repayments plus interest from the government. Thus, the government does not have to lay out a large sum of money at once to fund a large project.
Termination procedures are highly complex, as most projects are not able to secure private financing without assurances that the debt financing of the project will be repaid in the case of termination. In most termination cases, the public sector is required to repay the debt and take ownership of the project. In practice, termination is considered only a last resort.
Examples of PFI Projects
Many of the projects that are the subject of private finance initiatives are infrastructure projects that benefit the public sector. These include highways and roadways, transport projects such as railroads, airports, bridges, and tunnels. Private sector firms may also be contracted to construct water and wastewater facilities, prisons, public schools, arenas, and sports facilities.
Advantages of PFIs
Governments have traditionally had to raise money on their own in order to fund public infrastructure projects. If they aren't able to find the money, governments may also borrow from the bond market, and then hire and pay contractors to complete the job. This can often be very cumbersome, which is where the PFI comes in.
PFIs are intended to improve on-time project completion and also transfer some of the risks associated with constructing and maintaining these projects from the public sector to the private sector. Financial advisers such as investment banks help manage the bidding, negotiating, and financing processes.
PFIs also improve the relationship between the public and private sector, while providing both long-term advantages. Through this relationship, both sectors can share knowledge and resources.
Disadvantages of PFIs
A key drawback is that since the repayment terms include payments plus interest, the burden may end up being transferred to future taxpayers. In addition, the arrangements sometimes include not only construction but ongoing maintenance once the projects are complete, which further increases a project's future cost and tax burden.
There is also a risk that private sector firms may not comply with relevant safety or quality standards when managing a project.
25 to 30 years
The length of time a typical PFI project might last, although some are shorter or longer, depending on the need.
Criticism of PFIs in the United Kingdom
In the United Kingdom in the 2000s, a scandal surrounding PFIs revealed the government was spending significantly more on these projects than they were worth to the benefit of the private firms running them and to the taxpayers' detriment. In addition, PFIs have been criticized as an accounting gimmick to reduce the appearance of public-sector borrowing.