What is a Private Finance Initiative (PFI)?
A private finance initiative (PFI) is a means of financing public sector projects through the private sector. PFIs relieve the government and taxpayers of the immediate burden of finding the capital for these projects. In a private finance initiative, a private company manages the initial costs on behalf of the government. In return, the government authority makes payments to the private company over the long term.
The term private finance initiative is mainly used in the UK and Australia. In the United States, PFIs are generally referred to as public-private partnerships.
Private finance initiatives and public-private partnerships
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 roads, as well as transportation projects such as railways, airports, bridges and tunnels. Private sector companies can also be contracted to build water supply and sewage treatment facilities, prisons, public schools, arenas and sports facilities.
Instead of these projects being funded upfront by taxpayers, private companies are contracted to finance, manage and complete the projects. Private companies usually get their money back through long-term reimbursements from the government or revenue generated by the project – for example, highway tolls. Under this arrangement, the government does not have to shell out a large sum of money at a time to finance a major project.
Depending on the type of project, PFI contracts typically last 20 to 30 years. They can last longer or shorter depending on the project.
The public sector partner is responsible for clearly defining the objectives of the project and ensuring that the private sector partner respects the terms of the partnership.
Concrete example of a private finance initiative
In 2020, the US government has engaged in public-private partnerships in response to the COVID-19 pandemic. It has partnered with private vaccine developers such as Pfizer, BioNTech and Moderna. The end result was the launch of effective vaccines in less than a year.
Public-private partnerships have also been responsible for innovations in COVID-19 testing, treatment options and vaccine distribution across the country.
Benefits of Private Finance Initiatives
Governments have traditionally had to raise funds on their own to finance public infrastructure projects. If they are unable to come up with the money, governments can also borrow in the bond market and then hire and pay contractors to complete the job. This can often be very cumbersome, which is where PFI comes in.
PFIs aim to improve the timely completion of projects and transfer some of the risks associated with the construction and maintenance of these projects from the public sector to the private sector.
PFIs also improve the relationship between the public and private sectors, while providing long-term benefits. Through this relationship, the two sectors can share knowledge and resources.
Financial advisers, such as investment banks, help manage the bidding, negotiation, and financing of an IFP.
Disadvantages of Private Finance Initiatives
A major drawback of private finance initiatives is that since repayment terms typically include payments plus interest, the burden may end up being shifted to future taxpayers. Additionally, arrangements sometimes include not only construction, but also ongoing maintenance after projects are completed, further increasing a project’s future cost and tax burden.
There is also a risk that private sector companies do not meet applicable safety or quality standards when managing a project.
In addition, terminating a PFI contract before its end can be very complex, as most projects are unable to obtain private financing without the assurance that the project financing will be reimbursed in the event of termination. In most cases of termination, the public sector is required to repay the debt and take ownership of the project. In practice, termination is only considered as a last resort.
Criticism of IFPs in the UK
Private finance initiatives were first implemented in the UK in 1992 and became more popular after 1997. In the 2000s, the controversy surrounding PFIs revealed that the government was spending far more on these projects than ‘they were only for the benefit of the private companies that ran them and to the detriment of taxpayers. Also, 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 large government projects such as highways, public transportation, airports, bridges and tunnels. Other examples of private funding initiatives include hospitals, arenas, prisons and public schools.
What are the benefits of the private finance initiative?
One of the main benefits of private finance initiatives is to ease the immediate financial burden on government and taxpayers to fund 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 typically take decades to complete. Contracts generally last 20 to 30 years.
Private finance initiatives allow governments and the private sector to join forces to finance and implement projects that benefit the public sector. Although PFIs have some potential drawbacks, for decades governments around the world have used them to fund a wide variety of projects, from highways to hospitals. Called public-private partnerships in the United States, these partnerships have been instrumental in the development of vaccines against COVID-19.