Poor Investment and Poor Decisions

Jim Cuthbert discusses the newly developed Mutual Investment Model of public procurement which he claims is worse than the Scottish Government’s current NPD system and was decided upon without proper public scrutiny.

His full report on MIM can be read here.

On April 30th 2019, the Scottish Futures Trust, (SFT), published a paper looking at how the Scottish Government could get capital expenditure on public infrastructure “off the books” in the light of Eurostat’s developing interpretation of the European System of Accounts rules. In particular, the SFT paper looked at the option of adopting the new Mutual Investment Model, (MIM), recently developed in Wales. With very little delay, Derek Mackay then announced on 30th May that the Scottish Government would be introducing the MIM model for some future revenue funded capital projects instead of the formerly used non-profit distributing and hub models. The present paper argues that the decision to implement MIM is a poor decision, poorly taken.

The decision is a consequence of changes in the European System of Accounts specifically, the introduction of the latest version, ESA10, in 2014. These changes meant that the Office for National Statistics subsequently classified capital expenditure procured under the Scottish Government’s Non- Profit Distributing, (NPD), scheme as falling on the government’s books, rather than being off book: and it also became clear that the same fate would befall capital expenditure procured under another major Scottish Government scheme, namely revenue funded hub projects.

This posed a major problem for the Scottish Government, since it threatened its ambitious plan under the National Infrastructure Mission to increase capital investment in Scottish public infrastructure. Without the ability to undertake “off the books” revenue funded schemes, The Scottish Government would have no chance of meeting its targets. Hence the request to SFT to investigate the MIM model, and the subsequent decision to implement MIM.

The MIM model was recently developed in Wales, specifically to achieve “off the books” status under the new accounting rules. It is a form of public private partnership, with a typical project life of 25 or thirty years. Under the MIM scheme, the providers of equity capital will be rewarded through the return on the subordinate debt capital they invest, and also through the potential for taking dividends: this is like in the original form of PFI, but unlike the NPD model in Scotland, where the potential for dividend s was limited. Unlike the original form of PFI, however, the public sector client will be able to inject equity capital themselves, up to 15 or 20 percent of the total equity raised. Apart from the ability of the public sector client to invest in their own scheme equity, MIM has the main features of old PFI.

The SFT paper does indeed indicate that there would be extra costs associated with MIM. For example, on the principal interest rate variant considered, the SFT estimate that total costs under MIM would be about 23% greater than funding capital by public sector borrowing. The SFT paper also acknowledges that the move towards MIM in Scotland and Wales, which is dictated by the constraints of the devolution fiscal settlement, is anomalous compared to what is happening in England, and indeed, other European countries, where the movement is away from PFI like public private partnerships.

What the analysis in the current paper shows, however, is that the SFT paper nevertheless significantly underestimates the actual likely costs of MIM and the scope under MIM for excessive private sector equity profits. This occurs, for example, because the SFT report does not adequately recognise the extent to which the size and complexity of MIM projects is likely to restrict competition, leading to poor value for money. Because the SFT report considers an artificially restricted range of public sector comparators hence underestimating the likely excess cost of MIM over public sector borrowing. And because a questionable choice of subordinate debt interest rate in the SFT’s principal variant has a similar effect. Moreover, by choosing to illustrate an unrealistic profile for the likely rewards to equity holders, the SFT paper implicitly understates the likely ability of equity holders to extract excess profits.

The upshot is that the Scottish Government is adopting a model which has the worst features of old PFI: with the likelihood of poor value for money, and excess profits on the scale of old PFI.

Partly this poor outcome reflects errors in process. For example, if the SFT paper had been part of a proper consultation, it is likely that the weaknesses in its analysis would have been identified before the final decision was made.

But above all, the decision to implement MIM is a product of the context within which the decision was taken namely, the straitjacket implied by the flawed devolution fiscal settlement. It is extraordinarily worrying that Scotland, (and Wales), are being forced, by the limitations on their capital budgets and borrowing powers within the devolution settlement, down a PFI type path which has been abandoned by England: and by most other countries operating under more rational financial regimes. Scotland should be much more willing to challenge the basis of the fiscal settlement. If the Scottish government cannot, or will not, make such challenges, and if it genuinely feels that it then has no option but to go down the MIM or similar route, then it has a responsibility to the Scottish people, and to itself, to make the resulting likely adverse consequences perfectly clear. The worst of all possible worlds is to do what the Scottish Government is actually doing namely, to be forced into adverse decisions, but then not to be open and clear about the likely negative consequences. The Scottish Government’s approach means that it will take full responsibility on its own head for the resulting inevitable disaster.

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