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A report issued recently by the UK’s National Audit Office (NAO) has identified a number of problems with the UK government’s Private Finance Initiative (PFI). PFI is a programme operated by the UK government whereby public agencies commission infrastructure projects from private companies through contracts to build, own, and operate long-lived facilities using private sector finance (or sometimes just to procure services). Coming at the same time as the bankruptcy of a major construction company involved in PFI projects, the NAO report has led some commentators and politicians to question private sector involvement in a wider range of infrastructure projects, including the regulated utilities that provide water, energy, and transport.

In this White Paper, NERA Managing Director Sean Gammons and Associate Directors Richard Druce and James Grayburn argue that:

  • The PFI model is subject to well-known problems of contract design—problems that were studied and documented in economic literature even before PFI got off the ground;

  • Ambiguities in (and omissions from) the NAO report give a misleading impression of the costs of providing infrastructure, and hence of the relative merits of public and private finance; and

  • The contract design problems of PFI are addressed explicitly in utility regulation, and indeed the solution to these problems forms the core of the regulatory process.

The authors conclude that the acknowledged difficulties of PFI offer no lessons for the regulation of private utilities and that it would therefore be wrong to conclude that the problems of PFI require a reconsideration of utility privatisation. On the contrary, they suggest that the success of utility regulation holds many lessons for the design and implementation of PFI.