A new name can't save a poor policy

THE private finance initiative (PFI) has been touted as the faultline separating SNP policy from other major political parties. During the elections, BBC opinion polls showed a Scottish electorate in favour of public ownership and public services.

Last month, the Scottish Government published its consultation on the Scottish Futures Trust (SFT), the alternative to PFI. However, it is not so much an alternative as a PFI hybrid. The difference between it and PFI is the removal of equity shareholders and the creation of a "not for profit" trust.

The absence of a public alternative is a glaring omission but so too is the absence of any challenge to the economic constraints imposed by Westminster on capital and government borrowing.

The cheapest way of raising capital for public services is through government borrowing and taxation. The Scottish Government admits PFI is expensive but argues that, because capital spend is capped, it has no alternative but to resort to private finance using its revenue budget to repay the debt. However, it also states that, because it has no borrowing powers, any finance raised must not count as government borrowing. This, it argues, is the logic for the decision to make the SFT a private entity relying on private finance.

The constraint on capital spend and government borrowing has its origin in the "sustainable investment rule" drawn up by Gordon Brown when, as UK Chancellor, he decreed government debt or borrowing must not exceed 40 per cent of gross domestic product (GDP). This is an arbitrary rule. European monetary union policy allows for much higher levels of government borrowing at 60 per cent of GDP.

Many countries regularly flout the limit and some have special waivers that allow them to exclude capital investment in public services from debt calculations. But, in the UK, the rule constrained government borrowing so severely that spending departments had "no alternative" but to lever in private finance and at the same time put public service assets and delivery into the private sphere.

The magic of private finance was that it was "off balance sheet": the asset was transferred from the public to the private sphere and didn't count against government borrowing. It was to prove an expensive policy. In Scotland the 5 billion of investment levered in through PFI will cost the taxpayer in excess of 22 billion in debt and service charges over the contracts' life.

But the flawed logic of PFI policy is crumbling. The elaborate Treasury rules that have been designed to keep most PFI schemes off the government balance sheet have been the subject of fierce criticism in accounting circles. The International Financial Reporting Standards Board (IFRS), whose rules determine what counts as public expenditure and government borrowing, has challenged government decision to put many of its PFI schemes "off balance sheet". It considers most PFI schemes should count towards government debt.

Most PFI schemes look set to come back on to the balance sheet and so will count as government borrowing, thereby undermining the key justification for the policy. But the Scottish Government is curiously uncurious about how new accounting guidance will affect the SFT status, simply saying that "the SFT proposals will develop (or rather not develop?] in the light of the final outcome".

PFI schemes are expensive for the taxpayer. With returns to shareholders often running to hundreds of millions of pounds for an individual scheme. Edward Leigh, Conservative MP and chairman of the Public Accounts Committee, went as far as describing the refinancing windfall gains in PFI as the unacceptable face of capitalism. The private sector argues transferring assets from the public to the private sphere comes with a price tag. The commercial sector expects to be rewarded for taking the risk and this is reflected in the premium or cost of finance to the public sector.

The Scottish Government argues the absence of an equity stake in the SFT will prevent excess profits made by investors in current PFI deals. It omits to put a figure on the excessive profits made so far, nor does it provide the evidence that any risk transfer has or will take place at all. Perhaps this is because the only Treasury data on risk relates to cost and time overruns and these data have been discredited as having no scientific or material basis.

Nor does the Scottish Government say how the risk premium will be calculated in future and how excessive returns to the banks will be prevented. The banks could, for example, simply replace the shareholders and take their risk premium in the form of even higher rates of interest.

Nor does the Scottish Government address whether sufficient risk will be transferred to satisfy the IFRS that the SFT is a private and not a public body.

Finally, there is the question of government control. The SFT is to be a commercial "not for profit" company but discussion of its powers and how it is to be regulated by government are omitted completely.

In the current economic climate, the combination of the Barnett squeeze – which will see Scotland's share of expenditure fall relative to the rest of the UK – and the affordability pressures of new PFI schemes place a big question mark over SFT. If still more of the budget intended for public services is diverted to bankers for their risk premium and expensive privatisation then more cuts to public services and closures of schools, hospitals, clinics, and other services will follow.

The hybrid PFI model being advocated suggests the real debate on the fiscal and economic constraints and the true cost of using PFI will never see the light of day. The Scottish Government has an opportunity to exercise sovereignty and challenge Treasury rules on capital and public borrowing, forging a new path entirely not just for Scotland but for the whole UK.

• Professor Allyson Pollock is head of the centre for international public health policy at Edinburgh University.