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Government Debt

February 20, 2007

Government Debt

Mr. Mark Field (Cities of London and Westminster) (Con): It is a pleasure to serve under your chairmanship, Mr. Pope. I wanted to say a few words during the previous debate, but the Minister was saved by the bell.

I welcome the Economic Secretary and am glad that he will reply to my debate. That is probably apposite, because I want to raise a number of concerns that go back some time?indeed to before the Government came into office.

Politicians in this country are being neither open nor transparent about the state of public finances. Too much Government borrowing is funding current consumption, and we are mortgaging our future and expecting subsequent working generations, some of whom have not yet been born, to foot the bill for the cost of today’s health care, education and pensions.

That approach is neither prudent nor sustainable.

That cavalier outlook to public expenditure has a fairly long political tradition in this country. After the Second World War, Britain frittered away its Marshall Aid on welfare consumption, in contrast, of course, with the Germans under Konrad Adenauer and Ludwig Erhard who invested the US-backed aid in rebuilding a world-beating German industry. My own party also failed to address that fundamental problem. During several periods in recent decades, particularly in the early 1970s and early 1990s, the national debt rose as a result of an unwillingness to take difficult and unpopular political decisions to curb public sector consumption.

The Chancellor of the Exchequer’s diversionary tactic over the past decade has been to use the mechanism of the private finance initiative?now the public-private partnership?to remove from the public balance sheet a proportion of the capital costs associated with the Government’s much-vaunted investment in the public sector. The Treasury’s response to criticism of the PFI has always been robust. The Chancellor argues that it was set up by the previous Conservative Administration, which is true, but he also says that his Government are simply adopting the same rules, but under tighter accounting standards. We were wrong then, and he is wrong now.

The concept of unitary payments?the amalgamation of the capital and service costs of PFI projects?has been adopted as a supposedly simple method of allowing easy comparison between contractors during the PFI bidding process. However, that means that a huge amount of current capital expenditure, which the Government would have had to borrow against, is turned into future payments to contractors. In short, I contend that the PFI acts as a form of disguised borrowing, with repayment postponed for up to 30 years.

There is no fundamental economic difference between PFI projects and the raising of cash from issues of Government debt. The principal and the interest must be repaid in both cases. The shrewd device of the unitary payment, however, gives rise to a misleading picture of future Government financial commitments. The obligation to repay principal sums under PFI projects should be accounted for as a Government debt obligation, and unitary payments which contain a capital-equivalent component should be treated in accounting terms in the same way as ordinary Government debt.

I fear that it is a little difficult to describe the working of PFI projects without being beset with arcane or complex terminology, but I contend that the lack of transparency and use of off-balance-sheet funding is not acceptable in the private sector. Any company, never mind its auditors, adopting such tactics would be subject to critical scrutiny.

The supporters of PFI claim that one of its greatest benefits is the ability to transfer the risk of a project or service failure to the private sector. That assertion is often used to justify the superficially generous deals that operators of PFI contracts appear to have won in the course of negotiation. However, the significant profit potential that those contracts endow on operators, which is evidenced by the inflated share price of many companies that have won lucrative PFI contracts for school, transport system and hospital building here in London, comes at a real cost to future generations of taxpayers, who will foot the bill for today’s consumption. All too often, far too little risk is transferred. I suspect that some of that is down to poor negotiation, with most operators?for example, the bus companies in London?running rings round their public sector counterparts when drawing up repayment terms.

The Treasury admitted to the absence of risk transfer as long ago as July 2003 when it said in the document “PFI: meeting the investment challenge”:

“It is impossible to predict with accuracy the percentage of PFI projects which may fail, but it is important to understand that in these extreme circumstances of failure…the Government will be prepared to terminate such contracts in accordance with its legal rights, even if at a loss to financial participants in the scheme. Where this happens, it will also act within its legal right to ensure that public services will be maintained.”

On the one hand, the Government commit themselves as the ultimate guarantor, and in truth many PFI projects cannot be allowed to fail if only for purely political reasons, as evidenced by the vast and unsustainable deficits accrued by many National Health Service trusts. On the other hand, there is often no sum representing the cost of being the ultimate guarantor on the Government’s balance sheet.

While, admittedly, some £20 billion of the capital value of PFI projects has been included on the current Government balance sheet, estimated payments on the PFI contracts for the 25 years to 2030 total some £138 billion, leaving £118 billion of public sector debt currently unaccounted for. That, of course, takes no account of those PFI contracts that are set to last beyond 2030, which is, admittedly, a relatively small minority. Most independent calculations suggest that at the very least an additional £25 billion should be added to the balance sheet by including a risk-rated percentage of total liabilities arising from PFI. Even that aggregate of £45 billion?the existing £20 billion and the additional £25 billion?wildly understates the truth of the situation.

The fact is that the great majority of PFI projects are undertaken by local authorities as, I suspect, my constituents and those of all other London MPs will soon discover to their horror when the financial implications of many of the contracts agreed to by the Mayor of London become apparent. Worse still, there has never been any pretence about the balance of risk assessment being made for any of those projects and, again, given the vital social and political importance of the schemes, the Government as the ultimate guarantor will have to cough up.

We have already seen the early skirmishes in what I suspect will be a particularly high-profile battle between the Treasury and the Mayor of London in relation to the budget for the 2012 Olympics which has, as some of us always predicted, spiralled totally out of control. Clearly, a guarantee from the Treasury would have immediately placed that entire project on the Government balance sheet and would amount to public borrowing. I understand, for that reason alone, why the Chancellor and the Financial Secretary would not have had much truck with that option.

There is also a further category of debt, which is classified as contingent liabilities by the Office for National Statistics and the general rule is quite plain; financial reporting should follow the substance of the commercial effect of a transaction, not the form in which it is dressed up. As a result, some £1.25 billion of bonds issued by London and Continental Railways?the body responsible for the channel tunnel rail link?were reclassified as Government debt in August 2005 because the debt was ultimately guaranteed by the Government and the bondholders were not deemed to be at risk from default. It had been hoped that the Statistics and Registration Service Bill, which received its Second Reading in the House in January, would provide the opportunity to end the uncertainty surrounding the Government’s accounting. I suspect that that may prove to be wishful thinking, but the Bill has been in Committee and we shall no doubt examine it on the Floor of the House before too long.

As some of our brightest investment banking brains create ever more complex financial instruments, the line between substance and form becomes ever more blurred. I accept that transparency in these matters may not always be easy to achieve, but the case of Network Rail gives rise to the strong suspicion that the Government have sometimes deliberately manipulated the calculation of Government debt. Following the collapse of Railtrack five years ago, Network Rail was set up in such a way as to be legally independent of the Government. The management restructuring and the fiction that Network Rail, as a company limited by guarantee, was under the control of its members has helped to mask the fact that the company ran up £18.2 billion of debt by July 2006.

Just over two years ago, the Office for National Statistics received advice from the Department for Transport that the Government’s support for Network Rail’s borrowing was a “contingent liability of government” and was classified as such in the national accounts. Nevertheless, the Government have guaranteed the debt, and the fact that the company, which is limited by guarantee and has almost £20 billion of debt, is still regarded as having an AAA credit rating gives rise to the presumption that the market, at least, recognises that those debts are effectively owed by the Government. If we were to put substance before form, therefore, they should be on the public balance sheet.

One reason why criticism of PFI has been so muted is that, over the past decade, private sector operators, contractors, consultants, lawyers and accountants have made hay as advisers in a process that has proved extremely lucrative for them. It is incontrovertible that the explosion in PFI projects will vary from bad to appallingly bad value for the taxpayer, although as a means of avoiding up-front Government debt, they have also allowed an almost unprecedented level of school and hospital building.

However, we need to stand back and face some harsh political facts. In the same way that privatisation under Conservative Governments in the 1980s and 1990s proved irreversible?even the present Government’s pledge to reverse rail privatisation in the final year of the Conservative Administration had to be quietly dropped?so too will PFI, even though the positions will be reversed. In many ways, from the Labour party’s point of view, that is the great genius of the vast expansion of such projects that has taken place since it came to office. The cost that the taxpayer will have to meet in the future for PFI projects that are agreed now?the agreements have been reached, and the projects have been or are being carried out, but they will have to paid for in the decades ahead?will amount to an ongoing additional burden on public expenditure over the next 25 years or so. However, the political fallout of trying to unravel PFI projects in essential services means that the room for manoeuvre for any future Conservative Government in public expenditure and taxation will be considerably limited.

This country’s economic fundamentals do not look so smart going forward, and we are simply kidding ourselves about the true costs of accounting in the future. Ironically, the Chancellor of the Exchequer recognised that expressly in his early justification for his golden rule that the Government will borrow over the economic cycle only to invest and not to fund current spending. He stated:

“the Government does not pass on the costs of services consumed today to the taxpayers of the future?each generation is expected to meet the current costs of the public services from which they benefit.”

I have spoken in the House before about the principle of generational conflict, and nowhere is it more pronounced than in the area of pensions reform. Unfunded public pension liabilities mean that tomorrow’s taxpayers will be obliged to fund today’s ever-larger deficits. Alternatively, those who have made their pension contributions in good faith will see their entitlement collapse. Pensions payments are another example of deferred expenditure or, to put it another way, Government borrowing.

Another element of the unsung extent of Government borrowing is in the field of public pensions. The Government have claimed that their unfunded public pensions liability amounted to £460 billion as of 31 March 2004. However, that figure was calculated on the basis of a discount rate of 3.5 per cent., which the Government Actuary’s Department has now revised downwards to 2.8 per cent. In answer to parliamentary questions on the matter, the Treasury accepts that the total liability for unfunded public pensions amounts to £650 billion and that the unfunded element of local government pension schemes amounts to an additional £70 billion.

Once more, there is no easy way out. In essence, today’s pensioners and those retiring in the near future will be able to rely on considerably more generous benefits than those just entering the workplace, who will pay for those liabilities. Given that there are twice as many voters over 55 as there are under 35, and that they are twice as likely to vote, it is unrealistic, to put it mildly, to expect anyone in the political arena?on either side of the political divide?to stand up and state some fairly bald facts on this matter.

Nevertheless, despite orchestrated campaigns by today’s pensioner groups, the fact is that today’s pensioners have never had it so good. The reason why many pensioners in their 70s and 80s believe that they have so little is that they have failed to pay anything like enough into the system to warrant what they now expect to receive. I am sad to say that such unrealistic expectations have been created, and are periodically raised, by politicians across the spectrum. That somewhat unpalatable message plays no part in the policy prospectus of any major political party, perhaps for rather obvious reasons. However, it is clear that such a state of affairs cannot continue indefinitely. The unspoken message of the political class to anyone under 30 is that their generation will need not only to foot the bill for the unfunded cost of pensions for those who are older, but significantly to lower their own financial expectations when the time comes for them to retire and benefit in some way from public pensions.

We run the risk of quite serious social unrest in the decades ahead, as the evidence of that appalling generational pyramid sales scam becomes evident. There is no doubt that future Government spending will have to be much higher, not least because there will be ever fewer people in the work force to subsidise an ever larger number of dependants, while the costs of the national health service, for example, will continue to rise exponentially as the population ages.

I fear that off-balance-sheet financing is delaying some of the tough decisions that need to be made about the future of public spending. It also delays our debate about the way in which we will need to manage public services in the future to deliver equity and social cohesion, as well as to provide for the vulnerable and voiceless in our society. One of the more depressing prospects in the years ahead is that my generation will be seen as having had it easy, and I fear that this era will be seen as the best of times. We are consuming what we believe we are entitled to without regard to the costs, and future generations will have to meet the liabilities for that short-sighted and selfish approach.

The Economic Secretary to the Treasury (Ed Balls): It is a pleasure to serve under your chairmanship once again, Mr. Pope, although I think that this is the first time that I have done so in Westminster Hall. I congratulate the hon. Member for Cities of London and Westminster (Mr. Field) on securing the debate. He does a great deal of work in the City of London in pursuing the interests of the companies that operate there, and I have had the opportunity to discuss such issues with him many times. I also appreciate the fact that his comments were sincerely made, and I should like to respond to them.

The hon. Gentleman was rather brave to make a Macmillanesque reference to today’s pensioners never having had it so good. I agree that no one wants to be in the position of mortgaging the future or stacking up liabilities that future generations will be unable to afford. However, I hope to reassure him that we are not being cavalier in our outlook, short-termist or selfish and that the fiscal framework that we are operating and the decisions that we have made within it, alongside our commitment to best international practice in accounting standards, mean that we have kept a firm grip on the national debt. At the same time, we have put in place investment resources that will deliver returns for the current and future generations.

The hon. Gentleman talked about our inheritance, and it is true that we inherited a PFI programme in 1997. Its operation was characterised by a rather blanket approach at the time and required some refocusing by the incoming Government. We also inherited a commitment to adopting international practice in the scoring of liabilities and assets on the public balance sheet, and we have continued to honour that commitment, as well as developing it as international best practice has changed. In addition, we inherited a high level of national debt; it was not the highest of any country’s, but it was higher than we felt was comfortable. Finally, we inherited a public investment position that had led to substantial backlogs in investment in our schools, hospitals and transport infrastructure.

The fiscal regime that we put in place?the golden rule that the hon. Gentleman referred to, and our commitment to borrowing on the balance sheet within a ceiling for overall net debt?has allowed a substantial increase in public spending on public investment. The majority of the advances in investment in health, education and transport have occurred on the public balance sheet. That is where the majority of our investment in public services has gone.

At the same time, the hon. Gentleman is right that we have reformed and expanded our approach to using the private finance initiative. More than 185 health facilities have been built or refurbished under PFI; there have been 230 new or refurbished schools, 43 new transport projects, nine waste and water projects, and 180 other projects in sectors including defence, prisons, housing and leisure. We have used the PFI where we have judged that we could achieve a better contractual relationship?a better partnership?between the public and private sectors; we have done so, to use the best skills and techniques of the private sector in management and cost control, so that we could provide better public services.

There is one fact that explains why, for me and for the Treasury, the experience of PFI has been positive: nearly 90 per cent. of major PFI investment projects that have been completed were completed on time. In every case since 1997, the public sector paid what it set out to pay, whereas historically, using traditional procurement, there was a tendency for three quarters of projects provided by the private sector to the public sector to be late and for three quarters to be over budget. We have managed, through PFI, to bind the private sector into a better contractual relationship with the public sector, while harnessing its innovation and discipline to modernise public services. Those have been the benefits of PFI.

The intention and motivation for the Government in relation to PFI have never been to move public spending off balance sheet. As I said, the great majority of the expansion in investment in public services has been on balance sheet; but where we judged, for particularly long-term and large projects, that the traditional procurement mechanisms entailed a risk of being late or over budget, PFI provided a much better way of getting value for money for the public sector.

With small projects or IT projects, for which it is hard to specify in advance, in a contract, the nature of the procurement, we have withdrawn from the use of PFI. We announced that in a document a couple of years ago. In such areas, it was difficult to specify PFI. When projects are large and can be specified, and when procurement traditionally has been expensive and late, PFI has in my experience given much better value for money for the public sector. However, at all times, the decision on whether a PFI project is on or off balance sheet has not been made by the Government; that decision is made independently of Government.

The accounting judgment is taken by the relevant independent audit body, the National Audit Office, the Audit Commission or the audit bodies for the devolved Administrations. Those auditors use the same independent accounting standards that the private sector uses, which are consistent with UK generally accepted accounting practice. Where the independent accountants judge the deal to be off the public sector balance sheet because the risk is genuinely being transferred, it seems to me that it would be wrong to second-guess their view and score it on balance sheet anyway, exactly as it would be wrong for us to override the judgment of independent auditors and accountants who judged that the PFI project should be dealt with on balance sheet.

As the hon. Gentleman will know, about half of all PFI projects have been scored on to the public balance sheet?including the tube and most, or probably all, of the prison building programme, because the risk, as he said, is with the public sector. In other areas, the risk has been transferred, but even where the risk is still with the Government and the project is therefore scored on balance sheet, we judge that there is value for money for the public sector, because of the improvements in quality, timeliness and affordability, and because of the innovation that can be had from a proper partnership between public and private sector in continuing with PFI. We are advised by an independent advisory body that studies such issues all the time; we try to make sure that we keep in touch with best international practice.

On the PFI rules that we use, the hon. Gentleman talked about the unitary payment, and we correctly classify those payments on to the balance sheet, depending on the advice of accountants. Indeed, we do so exactly in line with the practice of private sector accountants. The Audit Commission makes the judgments on local authority deals. When there is no genuine risk transfer or it turns out that we are not providing value for money, the Government have been willing to act. In one contract, involving the Teddington science laboratory, the contractor failed to deliver through the PFI project and the Government terminated the deal, so it is not true that we have not been willing to act when the private sector did not deliver.

However, in the majority of cases, the PFI process has given value for money even when it has been scored on to the public balance sheet.

The hon. Gentleman quoted two cases: one was that of London and Continental Railways, in which at every stage the Government provided full information to the Office for National Statistics and the National Audit Office. We acted in good faith and told the ONS all the relevant facts in 1998. The Department for Transport has always accounted for its relationship in a correct and transparent manner, and the hon. Gentleman is right that the ONS re-examined the case in the light of evolving international accounting practice and changed its view on the scoring. That is perfectly appropriate; it was for the ONS, not the Government, to decide that. We have never tried to second-guess those judgments.

Mr. Mark Field: How did the Office for National Statistics become involved in that sort of process: through its own work in the matter, or because central Government asked whether various PFI projects should appear on balance sheet? I think that that question goes to transparency. I accept that things of that kind are not entirely straightforward, because we live in a complicated financial world where ever-more financial instruments are being created. It is with that in mind that we need to know how independent the judgment of the ONS is about the example in question and many other projects that Opposition Members think should be going on balance sheet.

Ed Balls: I challenge the hon. Gentleman to produce evidence to suggest that the Office for National Statistics has not been allowed to act in a free and independent way in such matters. He also raised the issue of Network Rail, which was a body set up at arm’s length from the Government in the aftermath of the Railtrack difficulties. The judgment about where Network Rail should score was a matter for the ONS in its capacity as an operationally independent agency. It judged it to be a private sector company, and in reaching that decision, it used internationally agreed standards for producing national accounts?the European system of accounts. It sought and received advice from the EU statistical agency, EUROSTAT. That was a matter for the ONS, not for the Government. The same was true in the case of LCR, when a different view was taken. In each year in the national accounts, decisions about the scoring of PFI are made not by the Treasury but by the ONS. It is its responsibility to produce the accounts. If they, or international practice, change, the Government will need to respond, but we use the best practice of the time.

The hon. Gentleman also mentioned public sector pensions. Again, the scoring of those liabilities is long established on the basis of international best practice, and the Government’s position has not changed from the pre-1997 position. I urge the hon. Gentleman not to be fooled into believing in an off-balance-sheet ruse. As I said, the majority of projects are going on to the Government balance sheet. What we are talking about is an effective partnership between the public and private sectors, to secure the best value for money in the procurement process. Where we can demonstrate that that can be provided, PFI is the right answer. Where it does not give value for money, we should not go down the PFI route. In my judgment, that is independent of the scoring or balance-sheet decision, which is a matter for international advice and best practice.

It being Two o’clock, the motion for the Adjournment of the sitting lapsed, without Question put.