Private Finance Initiative and UKs Construction Industry - Essay Example

Private Finance Initiative and UK's Construction Industry Submitted by: Date Submitted] Introduction Private Finance Initiative (PFI) is a device employed by United Kingdom's government to arguably to make the construction industry more competitive and more profitable. This does not come as a surprise since the UK construction industry provides a tenth of the UK's gross domestic product, employs 1.4 million people and is worth around 65 billion per annum. With an output of 81.9bn in 2006, the UK construction industry is ranked in the global top ten. Thus, it is only then logical to support the industry. PFI is a way of funding major new public building projects such as hospitals, schools, prisons and roads. Private consortiums, usually involving large construction firms, are contracted to both design and build a new project, and also to manage it. The contracts typically last for 30 years. The building is not publicly owned but leased by a public authority, such as a council or health trust, from the private consortium. The private consortium raises the cash to build the project. It is then paid back with interest by the government through regular payments over the period of the contract. PFI projects could be viewed as a means of enabling government services to be "outsourced" to private sector suppliers. PFI is not the same as privatization as the Government retains ultimate responsibility to the public for the service concerned. Outside the UK, PFI is more commonly known as Public Private Partnerships (PPP). (Weaver, 2004) The policy has not been without its critics. As with any form of hire purchase, buying something on tick is more expensive than paying for it up front. The Edinburgh Royal Infirmary is often cited as an example of how expensive the PFI can be. It cost 180m to build and will cost 900m to pay for. Unions are opposed to PFI as they claim that one of the main ways that private companies profit from the PFI is by staffing the buildings as cheaply as possible. The pay and conditions of front line workers in PFI buildings is typically worse than their counterparts in the public sector. This paper aims at looking at how Corporate Social Responsibility can be incorporated in PFI and whether it can introduce significant changes to the issues surrounding PFI. Use of PFI in the Construction Industry Since the advent of PFI, the construction industry has found itself on much more stable ground. Between 2001 and 2002, its output is estimated to have increased by 9.7%. According to the Major Contractors Group (MCG), a major construction trade association which represents UK firms such as Carillion (formerly part of Tarmac), Costain and Amec, construction companies engaged in the private finance initiative expect to make between three and ten times as much money as they do on traditional contracts. (Research and Markets Online, 2003) Bill Tallis, the director of MCG, said construction firms traditionally received rates of return of 1.5% to 2% on contracts but were now expecting margins of 7.5% to 15% on PFI building schemes. The high profit available to investors in PFI schemes explains why John Laing PLC has sold off its basic construction company and bought up stakes held in such projects by hard-pressed Amey PLC. (Macalister, 2003) This strategy is reinforced by figures from the European Construction Industry Federation (ECIF), which show that the UK construction sector grew by over 8% last year while its counterpart in Germany and France slumped by 2.5% and 0.7% respectively. (UK DTI Online, 2007) The UK government defends PFI by its use of something called the 'public sector comparator'. This shows whether or not privately financed schemes offer better value for money than conventional funding. The main problem with this is that the government has provided an accounting device called 'risk costing' which has meant that private firms generally emerge as winners. When a consortium of private companies agrees to build something for a public body, it acquires the risk that the project might fail. This risk is 'costed' and becomes a key component of the value-for-money calculations. Unfortunately, according to the Association of Chartered Certified Accountants (ACCA), this is often exaggerated. For example, the average cost over-run on public hospital building projects is 7%. The private operators are allowed to claim a 'risk' of 12.5%. By contrast, no risk costing whatsoever is added to the public sector comparator. This led Jeremy Colman, the auditor-general at the national audit office, to proclaim that some of the comparators being used are 'utter rubbish' and 'utterly irrelevant'. While the UK Treasury will not agree any scheme that does not beat the public sector comparator it admits that the government is reviewing this model of calculating value. Recommendations with Regards to CSR Implementation The trend nowadays for business firms is to adapt CSR strategies wherein "socially caring" policies and initiatives are integrated into business applications. PFI has been criticized not only because of the spurious "risk costing" but also of the way construction firms have sought to minimize their expenditures. Remember that it is them who manage the project. Carillion was awarded the first hospital PFI contract at Dartford and Gravesham General Hospital where it successfully downsize the number of beds from 451 to 400. Intuitively, cutting down bed requirements by 12.75% would mean that the firm was able to save on space and consequently, construction costs. (Hughes, 2001) The implementation of CSR strategies should not be prohibitive (i.e. it does not result to severe financial and operating costs for the company) but should be adequate enough to ensure that these firms would actually comply. It should be sufficient enough to guarantee a level of well-being that is long term. There are many phases in the project where CSR can be employed. In the procurement and design phase alone, firms can adapt a policy of obtaining environmentally friendly construction materials. The logic that pervades construction is building at the lowest cost which generally means meeting only the minimum standards. In the construction phase, they should include hazard minimization schemes so as to lower the possibility of construction related accidents. However, what would probably be the most "socially responsible" of all the CSR strategies is to lower the value for "risk costing". That is, they should lower their mark-up. It was mentioned earlier that the risk costing can go as high as 12.5% of the total cost of the project. Crude estimates for a 10 million pounds project would indicate that the cost for the government would be 11.25 million pounds. The risk costing should be re-evaluated and a minimum value should be set. Business firms are not expected to lower their mark-up since they tend to maximize their revenues. It should be the government's initiative to implement a regulatory measure on the cost computations. The current implementation of PFI is a profitable venture for the private financiers with the public incurring higher costs (larger government payments = larger government taxes or = lesser social services). Comments on the financial and legal implications of incorporating CSR in the PFI process The rules governing PFI should be modified so as to include a regulatory clause setting the risk costing value close to the normal risk value. This would ensure that construction firms would be aware that they are only allowed to the limit set before they even began thinking of financing the project. The financial repercussions would be mostly felt by the construction industry but the prospect and availability of a project with payments ensured by the government is an attractive venture by itself especially for construction firms which are always on the look-out for projects. However, all the projects already implemented should be paid for since the governing rule applicable to them is the unmodified PFI. Wouldn't this slow down the activity of an industry which plays a major part in UK's economy The question of what is costlier comes into focus. For the general public, the burden will be heavier if the current PFI continues since the risk markup will be placed on their shoulder. However, the jobs generated by the industry are also significant. This is the reason why risk costing was not eliminated in the first place. Firms can still generate profits beyond what would they normally have in a public-funded project. In the end, there will still be growth. Conclusion PFI has certainly boosted the construction industry but there is a need to regulate it. The incorporation of CSR into the system can help minimize the tendencies of firms to inflate their costs. Although it is recognized that the bidding of a project is still by a competition basis, one may never know whether there have been any agreements between competing firms or between firms and government agencies. This paper recommends that a minimum value be set for risk costing and not eliminating it. This move will eliminate the question of economic recession because construction firms still have big opportunities in the state that this paper is recommending. Reference: 1. Hughes, Solomon (2001).'What a carve up!' Red Pepper. Retrieved April 8, 2007 from www.redpepper.org.uk/natarch/solomon.html. 2. Macalister, Terry (2003). 'PFI triples profits, say firms,' The Guardian, 08.09.03. Retrieved April 8, 2007 from http://society.guardian.co.uk/privatefinance/story/0,8150,1037400,00.html 3. ResearchandMarkets Online (2003). 'Construction Industry Market Review 2003,' Key Note Publications, Retrieved April 8, 2007 from http://www.researchandmarkets.com/reportinfo.aspcat_id=0&report_id=34791. 4. Weaver, Matt (2004).'Q&A: Private finance initiative'. The Guardian 01.10.02. Retrieved April 8, 2007 from http://society.guardian.co.uk/privatefinance/story/0,8150,802670,00.html. 5. UK DTI Online (2007). 'Construction Statistics Annual 2006'. DTI. Retrieved April 8, 2007 from http://www.dti.gov.uk/construction/stats/constat2003.pdf. Read More