Can the trust dream wake us up from nightmare of PFI?

The original PFI scheme was introduced by John Major in 1992 but taken up enthusiastically by Gordon Brown in 1997. PFI is a way of boosting state borrowing without giving the City a heart attack and sending interest rates sky high.

Essentially public bodies buy roads and schools on hire purchase. The capital is put up by private investors. But since – in theory – these investors are running the risk of building something at a fixed price which might not make its money back, the City was happy to pretend this was not government borrowing. Hence we could get more capital investment than by open public borrowing.

Certainly PFI has resulted in a significant amount of capital expenditure – about 100bn worth. However, quantity has not been accompanied by quality or efficiency. PFI has become a licence for excessive profits, poor construction and a hidden public debt burden that is about to catch up on the Treasury.

A new study by two of Scotland's most respected economists, Jim and Margaret Cuthbert, has found that, in the six PFI schemes analysed, the 717,297 put in as equity by private shareholders will produce a profit of 350m. The Cuthberts argue that Edinburgh Royal Infirmary could have been built for half the actual cost to the taxpayer if the money had been borrowed directly from the government's National Loan Fund.

What went wrong with PFI? First, there was so much demand from the public sector that private investors offering PFI deals were in a seller's market and could charge high premiums.

Next, public agencies seeking PFI deals lacked the expertise and machinery to write proper contracts, meaning the buildings were often badly designed and expensive to operate.

Finally, the Treasury was so anxious to use PFI that it had no incentive to seek more cost-effective contracts. Crucially this convinced the City there were no substantial dangers in PFI lending as the Treasury was (effectively) underwriting the risk.

Everyone was locked into a system that gave each what they most desired. But, as we move away from an era of price stability and low interest rates, I doubt if this set-up is sustainable, particularly as the overall level of government debt, PFI included, is starting to worry the City. The real question is: can we find a workable alternative to PFI? This was a popular demand in the SNP's manifesto last year. Yesterday, after wide consultation, John Swinney and Alex Salmond published their first practical blueprint.

Early SNP thinking envisaged side-stepping the current PFI model by setting up independent, not-for-profit trusts which could borrow directly on the markets but deliver infrastructure more cheaply than commercial groups. Ownership of the assets would eventually revert to direct public ownership.

The new document is candid that "at this point in time" such a public trust model "is not possible as Scottish Ministers currently do not have the constitutional powers to borrow".

What is being offered instead is still a significant reform of the current set-up. It will see the creation of a new public-sector body called the Scottish Futures Trust (SFT). Initially, this will provide financial, legal and management expertise to public bodies to help ensure they get the best terms in PFI deals. Longer-term, an arms-length branch of the SFT might work with local authorities and the NHS to set up their own funding vehicles for projects – assuming legal hurdles can be cleared.

Clearly, the SFT idea stands or falls by the calibre of the staff recruited and the resources at their disposal. One reason why hospital and school projects built under PFI are frequently so poor is that individual local authority education departments and NHS Trusts lack the expertise to deal with their private-sector PFI partners. If that imbalance can be addressed, the quality of projects will improve and money will be saved.

Cynics will argue the SNP has laboured to produce not very much. However, in the absence of anyone else trying to clean up the PFI mess over the past decade, the taxpayer may be more grateful. The document suggests the SFT will aim to shave 3-5 per cent off typical out-turn costs, which the Scottish Government puts at 100m to 150m per annum once everything is up and running.

The big question for Swinney to answer is: can he introduce these reforms successfully without delaying the throughput of new projects?

Meanwhile, the government at Westminster is delaying the introduction of new international accounting rules which will force it to include about 30bn of PFI borrowings as public debt. When they bow to the inevitable – probably in 2009 – the end of PFI will be in sight.