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, a private company handles the up-front costs instead of the government. In return, the government authority makes payments to the private company over the long term.
The term private finance initiative is used primarily in the United Kingdom and Australia. In the United States, PFIs are typically 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.
How Private Finance Initiatives (PFIs) Work
Private finance initiatives are used to fund major public works. Many are infrastructure projects that benefit the public sector. These include highways and roadways, and 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.
Instead of funding these projects up front from taxpayers, private firms are hired to finance, manage, and complete the projects. The private firms typically make their money back through long-term repayments from the government or revenue generated from the project — for example, highway tolls. Under this arrangement, the government does not have to lay out a large sum of money at once to fund a major project.
Depending on the type of project, PFI contracts typically last 20 to 30 years. They can run longer or shorter depending on the project.
The public sector partner is responsible for clearly defining the objectives of the project and making sure the private sector partner complies with the terms of the partnership.
Real World Example of a Private Finance Initiative
In 2020, the U.S. government engaged in public-private partnerships in response to the COVID-19 pandemic. It partnered with private vaccine developers such as Pfizer, BioNTech, and Moderna. The end result was launching effective vaccines within less than a year.
Public-private partnerships were also responsible for innovations in COVID-19 testing, treatment options, and distributing the vaccine throughout the country.
Advantages of Private Finance Initiatives
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.
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.
Financial advisors, such as investment banks, help manage the bidding, negotiating, and financing of a PFI.
Disadvantages of Private Finance Initiatives
A key drawback of private finance initiatives is that since the repayment terms typically 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.
In addition, terminating a PFI contract before it ends can be highly complex, as most projects are not able to secure private financing without assurances that the 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.
Criticism of PFIs in the UK
Private finance initiatives were first implemented in the United Kingdom in 1992 and became more popular after 1997. In the 2000s, controversy 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 by some as an accounting gimmick to reduce the appearance of public sector borrowing.
What Are Examples of Private Finance Initiative Projects?
Private finance initiatives typically include major government projects such as highways, public transport, airports, bridges, and tunnels. Others examples of private finance initiatives include hospitals, arenas, prisons, and public schools.
What Are the Benefits of Private Finance Initiative?
One of the main benefits of private finance initiatives is alleviating the immediate financial burden on a government and taxpayers to finance major public sector projects. PFIs can also transfer some of the risks associated with a project from the public sector to the private sector.
How Long Do Private Finance Initiative Projects Last?
Private finance initiative projects usually take decades to complete. Contracts typically last 20 to 30 years.
The Bottom Line
Private finance initiatives allow governments and the private sector to join forces to finance and implement projects that benefit the public sector. While PFIs have some potential downsides, for decades governments around the world have used them to finance a wide variety of projects, ranging from highways to hospitals. Referred to as public-private partnerships in the United States, such partnerships were instrumental in developing COVID-19 vaccines.