Why an ONS ruling is set to kick-start a new debate about the Scottish Government's investment strategy

Ben Wray, Head of Policy & Research at Common Weal, looks at a new ONS ruling on the Scottish Government's 'non-profit distribution' model for carrying out infrastructure investment, and argues that it leaves Finance Minister John Swinney at a crossroads: go more down the PFI root, or look to the public-sector for the answers?

COMMON WEAL has been following developments and discussions over the Scottish Government's capital investment strategy as we prepare to publish our own papers outlining our proposals on this subject; on banking & finance, investment models and industrial policy. We think this is no small issue: what a country invests in its future and how it does it is a major determining factor in long-term economic performance. We noted at the end of last year that two-thirds of growth in Scotland can be accounted for by the Scottish Government's investment in big infrastructure projects like bridges and roads. Investment matters.

A new development has caught our attention because it could radically alter the way the Scottish Government approaches investment. A bit of context is needed first to understand this.

One of the major levers the SNP Government has used for investment since it came to power in 2007 is something known as 'NPD's' - non-profit distribution, which is a method for the Scottish Government to contract out the building of public projects to the private sector now and pay them for this service in the future, through setting aside a certain amount of future revenue spending over a 20-30 year period.

NPD's were the SNP's answer to PFI, which the nationalists had vociferously opposed in the run-up to the 2007 election. NPD's maintain the essence of PFI which is hard for governments to resist - getting lots of shiny new buildings, roads and bridges and leaving the payment of it to future governments. The term 'non-profit distributing' is misleading - private sector companies make profit in mostly the same way as they did before.

"There's a choice: you either do it now through NPD, or you wait many years until the capital budget is available before going ahead." Barry White, Scottish Futures Trust

The difference with NPD's is that they limit some of the worst excesses of PFI: private companies don't get equity returns in the project, and therefore only receive the interest agreed when the deal is signed, preventing a situation where most of the PFI projects signed off in the Jack McConnell era are still rising in cost today, and are set to peak in 2022/23.

The head of the Scottish Futures Trust (which leads the Scottish Government's NPD work), Barry White, said the decision to use the NPD model was simple: "There's a choice: you either do it now through NPD, or you wait many years until the capital budget is available before going ahead." Whereas the biggest PFI profits for the private sector used to be upwards of 15 per cent, now they are more like 12 per cent, White claimed.

Edinburgh University professor and PFI expert Mark Hallowell, who describes NPD as 'PF2', is more critical, stating that private equity (or 'shared capital') "made up roughly one per cent of financing under PFI", with the government contract for the service being where the big profits were made.

There has been a PS2.5bn investment in NPD's since the SNP came to office, and PS1bn more was scheduled for 2015-20. Those scheduled projects are now all in jeopardy. In July, The Guardian reported that the ONS had ruled NPD's as public-sector projects and must now count on the Scottish Government's current balance sheet, rather than on future revenue spend.

"There has been a 2.5bn investment in NPD's since the SNP came to office, and PS1bn more was scheduled for 2015-20. Those scheduled projects are now all in jeopardy."

A report by the Scottish Parliament Information Centre (SPICe) this month on Finance Minister John Swinney's 2016/17 draft budget has shed more light on what this ruling will mean in practise. SPICe stated: "Projects that are deemed to be public sector projects require upfront budget cover to be provided from the capital budget over the construction period of the asset... The change in treatment means that affected NPD projects impact on the capital budget."

In a footnote the exact fiscal impact was outlined: "PS398m of the PS909m capital value of planned NPD investment has required upfront capital budget allocation." This change has led to a quick shifting around of the Scottish Government's PS3bn capital budget, so much so that Health is seeing a 112.8 per cent real terms increase in its capital spend, as plans to build hospitals using NPD have had to be rearranged.

Some smaller projects have had "the design" adjusted so that they now are considered private sector projects and can be paid for through NPD. It's unclear what this adjustment means in terms of the ownership of the buildings as the exact change has not been outlined. But this approach has not been possible for bigger projects, with decisions yet to be reached over four major projects worth hundreds of millions. It's possible they could be scrapped.

This presents a crossroad for Swinney in his investment strategy: either he has to move more in the direction of private control over public projects, which could raise questions about what is not PFI about NPD, or he has to find a new model which looks to greater public control over capital investment. We would advocate the latter.

"Allyson Pollock's work on PFI and NPD has proven conclusively that the private-sector is both more expensive and less proficient than the public-sector in building hospitals, schools and bridges. Thinking pragmatically, the public sector is the way forward."

The big boon of PFI and NPD for governments was that they didn't have to pay until later, and Ministers would therefore accept higher long-term costs for their successors rather than bigger short-term costs for themselves. With Scotland's capital budget seeing an unprecedented stagnation since the recession (although it is set for a 5 per cent rise over the next five years) this is in a sense understandable - money is tight.

However, with the ONS ruling that major plus of PFI/NPD looks like it is on the way out. The rest is only negatives: Allyson Pollock's work on PFI and NPD has proven conclusively that the private-sector is both more expensive and less proficient than the public-sector in building hospitals, schools and bridges. Thinking pragmatically, the public sector is the way forward.

How to do this is the subject of our upcoming paper, but the SNP's vision for the Scottish Futures Trust back in 2008 is the direction they should be heading in now. Back then, NPD's (which actually came about under the previous Labour-Liberal administration but were rarely used because PFI was all the rage) were a short-term means to keep projects going that had been signed under the previous administration.

The big plan was to make Scottish Futures Trust a vehicle that "could design, build, finance, operate, manage and own the facilities created." An all-singing all-dancing national public investment company. It never happened, and Scottish Futures Trust became a sort of co-ordinator between the government and the private sector. But sometimes we have to look to the past to find the ideas of the future.

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