A new PFI regime, corporate welfare, and financial deregulation-private finance lobbies are winning big and ordinary people will pay the price

You have to hand it to the various UK private finance lobbies. They have been very effective at persuading politicians and certain civil society organisations that deploying private finance (whether provided by pension funds, insurers, asset managers, banks, or private equity etc) is a good way to tackle the public and social policy crises facing the UK and build a fair, sustainable economy.

Whether it is: greening the economy; transforming the energy sector; building public infrastructure and services; building affordable housing; tackling homelessness; providing social care; levelling up and regeneration; tackling poverty, financial and social exclusion the new Labour Government, following in the footsteps of the previous administration, intends to limit the deployment of low cost public spending and investment and instead rely more on costly private finance.

We are seeing the financialisation of the economy and society, and the creation of new models of the controversial private finance initiative (PFI). Powerful and democratically unaccountable financial institutions will end up with even more control and influence over our lives and futures.

The private finance lobbies have achieved a triple benefit. They’ve convinced politicians, regulators, and parts of civil society to support the:

·??????? Creation of opportunities to extract high returns from social sector assets.

·??????? Provision of corporate welfare[1], de-risking, and deregulation of financial markets[2] to make these assets even more commercially attractive and ‘remove the barriers’ to ‘crowd in’ private finance. Of course, they don’t describe this as corporate welfare or deregulation. The talk is all about ‘partnerships’ between the state and private finance, and ‘enabling’ regulation.

·??????? Rebranding of their return-seeking, value-extracting activities as positive sounding ‘social purpose’, 'social impact', or part of 'blended', or 'catalytic' finance models.

The irony in all this is that pundits say the state can't pick winners and it is best to leave it to financial markets. Yet, the essence of concepts like de-risking, and catalytic finance is that the state is expected to identify and manage high risk ventures to make them viable and profitable for private finance to then extract high returns. This is known as socialising the risks, privatising the rewards.

I don’t think economics and finance pundits, and even civil society organisations, have fully grasped how big a role private finance is going to play in delivering Labour’s programme for government.

Advisory groups that heavily influence Labour policy are dominated by representatives from the financial sector. So, it is perhaps no surprise that Labour’s policy agenda is so skewed towards the interests of private finance. We're being played by the private finance lobbies.

A big challenge for campaigners and civil society organisations will be preventing the private finance sector from exploiting these new opportunities to the max. These private finance schemes will be more costly than low cost public investment no matter how efficient they are. But, it may be possible for campaigners to limit the value extraction by ensuring the design and implementation is scrutinised and abuses exposed. The governance of new schemes such as the new National Wealth Fund and GB Energy will need to be as robust as possible with meaningful public interest representation.

Financialisation and a new private finance initiative (PFI) regime

Why do I say that we are seeing the creation of a new PFI regime? And why does it matter?

The first point to note is that public spending and investment is cheaper than private finance. Private finance demands high returns and fees for providing investment, loans, and insurance. The state can fund policy goals more cheaply by borrowing, introducing progressive wealth taxes, or through quantitative easing (QE) style interventions.

So, the government has a choice. It could use the power of the state to channel low cost public spending and investment to support progressive economic policies, fund public policy goals and core services. Or it could turn to more costly private finance.

We pay a private finance penalty when this happens. The private finance penalty is the difference between the cost of state financing and the high returns extracted by the private finance sector. The private finance penalty really matters. Using more costly forms of finance pushes up the costs of funding core services, building infrastructure, or tackling social problems. Ordinary people, especially future generations, pay a heavy price when costly private finance plays a bigger role.

Moreover, private finance is not only more costly than state finance, it is not aligned with progressive policy goals. Private finance allocates capital to where it can generate the best returns and fees, not to where resources are most needed. So, to fund policy goals, private finance lobbies also demand corporate welfare in the form of deregulation, derisking, and incentives to make that finance even more commercially attractive. In other words, it wants the state (us) to socialise the risks, so it can keep the rewards.

Some pundits will argue that using private finance provided by insurance companies and pension funds is a ‘win-win’ – the economy, deprived regions, and the social sector get the capital and savers/ investors get better financial returns. Financial institutions will indeed provide the capital if the price is right. But, if one group of citizens receives a high return, this is paid for by other citizens who pay higher costs and charges to generate those returns.

Using private finance pushes up the costs of building affordable housing, levelling up, and regenerating disadvantaged regions and communities. Financialisation transfers wealth to the better off so exacerbates regional, wealth, and intergenerational inequality.

And, of course, it’s not a zero sum game where savers/ investors gain and other households pay. Using private finance creates a less-than-zero sum game. The returns generated are not the same as the returns received by ordinary investors because of the high fees extracted by financial institutions such as insurance companies and investment managers. Moreover, the private finance institutions that supply high cost finance and expect high returns are often based overseas so value is extracted from the UK financial system.

The Government says it wants to attract overseas investors. To do that, it will have to ‘compete’ with other nations to attract that finance. So, it will have to offer overseas investors the opportunity to generate high returns and/ or provide generous corporate welfare. The competition for international finance is likely to push up costs of funding priorities such as green infrastructure – see below.

New names, same concepts

The main features of the ‘old’ PFI regime were:

·??????? Governments wanting to limit public spending and investment to appear ‘fiscally prudent’ so turning to private finance to keep costs off the ‘state balance sheet’

·??????? The cost of tackling policy priorities shifted to households who have to pay charges and fees to meet the return expectations of private finance (just because we don’t fund services via the state eg. through taxes doesn’t mean the costs disappear, the costs are just transferred)

·??????? The private finance options deployed are more costly than state finance

·??????? Private finance demanding the state provides corporate welfare in the form of derisking or incentives before making the financial commitments, and the state being willing to do so

·??????? Government not being open with citizens on how private finance is more costly than state finance

Sounds familiar? The new private finance models might use different names and might not be structured in precisely the same way as the old PFI schemes but the conditions today are the same. It still involves a government wanting to appear fiscally prudent, turning to more costly private finance to keep costs off the state balance sheet, being willing to provide corporate welfare to persuade financial institutions to provide this costly finance, and not being transparent with citizens about the costs of turning to private finance. As before, using private finance in this way is a financial conjuring trick to conceal a false economy.

Where can we expect to see this financialisation and new PFI schemes being deployed?

Private finance is going to be deployed across a wide range of policy areas. In some cases, the government will play a direct role in enabling private finance, in others it will be civil society organisations supporting the use of private finance in tackling social issues. ??

The great post war Attlee Labour Government’s vision for new towns was realised by creating public development corporations funded by low cost government loans. In contrast, this Labour Government’s new towns, a key part of its housebuilding programme, will be built by the corporate sector and funded by costly private finance schemes. This will push up the cost of building homes making them less affordable. Instead of new towns built on truly progressive principles, will we see the emergence of ‘corporate towns’?

Labour established a British Infrastructure Council[3] to provide advice on the ‘potential for new financing mechanisms for infrastructure that can deliver viable investment models’. Labour talks about how ‘winning the competition for new infrastructure investment’ in international markets needing ‘new models of collaboration between government and investors’. This can be dressed up as a ‘partnership’ or whatever. But, these will be variations on the same theme of the state ‘encouraging’ or ‘crowding in’ private finance.

Why should this be an issue if that investment materialises? There are a number of major concerns about these models. The first relates to the higher costs of private finance. As outlined above, if private finance institutions expect to generate market returns from infrastructure this will be more costly than public investment. It is simple truth that state finance is cheaper than return-seeking private finance. By definition, using more costly private finance will push up the cost of building infrastructure, which in turn will result in ordinary households and communities paying more in charges and costs to pay for the returns expected by private finance.

Secondly, these models tend to involve some form of corporate welfare provided by the state (taxpayer/ us) to subsidise the risks for private finance. Socialising the risks, privatising the rewards – see above.[4]

Competing internationally for private investment implies that the Government will have to offer investors high returns and/ or generous corporate welfare from the state to attract that private finance. So, the fiercer the UK has to compete for international finance the more upward pressure on costs, which pushes up the costs of funding infrastructure.

Worryingly, many of the members of this Infrastructure Council came from City firms that could stand to benefit from Labour’s plans to limit public investment and expand the use of private finance. ??

It is very disappointing that Labour’s green investment plan has been massively reduced from ￡28bn a year in public investment over the term of the next Parliament to a total of ￡23.7bn over that period. It will instead rely even more on costly private finance to fund the green transition.

Labour is planning to set up GB Energy. GB Energy will not compete with the privatised utilities to provide electricity directly to consumers. Instead, it will be a state owned investment vehicle with ￡8 billion of investment to help finance and build renewable energy infrastructure with a view to improving the security of the UK energy system and to reduce household utility bills. We have yet to see any real detail on how this would work with the private sector. From what we can see, it looks like its main role will be to de-risk projects for private finance.

Labour is establishing a National Wealth Fund.[5] This would be capitalised with ￡7.3 billion over the course of the next Parliament. The remit would be to support Labour’s growth and clean energy missions, and make ‘transformative’ investments across every part of the country. The NWF would set out to attract ￡3 of private finance for every ￡1 of public investment. The funds will be allocated through the UK Infrastructure Bank. We have yet to see the detail on how the NWF would attract that private finance. But, reading the initial report, the basic approach again seems to be that taxpayers funds will be used to de-risk investments to ‘crowd in’ private finance sector. And at the risk of sounding like a broken record, that private finance will be more costly than public investment.

As with the British Infrastructure Council, the Task Force that has developed the blueprint for the NWF is dominated by representatives from the private finance sector.

Social impact finance

But, it is not just the state that is actively promoting new opportunities for private finance. The financialisation of core needs and services by the financial sector is already happening under our noses. Private finance now plays a significant role in the social care sector, building social housing, and other public services. In effect, private finance has turned the provision of our core needs into just another form of asset from which to extract value – what the Financial Inclusion Centre calls social sector assets.

Civil society organisations are helping this market grow by working with private finance on concepts such as ‘blended finance’ and ‘catalytic finance’. The concern is that these terms conceal the real nature of these financial models. In some cases, these models allow private finance to extract market returns from tackling social problems such as financial exclusion.

Previously, corporate social responsibility (CSR) was all the rage. Some financial institutions genuinely cared about CSR, others saw it as a way to reputation-wash. But, at least they weren’t making high returns from providing funds to charities and community organisations. With blended finance and catalytic finance, private finance can now reputation-wash and generate high returns. ?

In the course of research for a project on ‘social impact’ finance,[6] Financial Inclusion Centre found examples of financial institutions promising to provide investors with returns of between 8-13% a year from investing in social housing. It would obviously be much cheaper for the state to provide the financial resources to local authorities to build affordable housing.

If the history of finance tells us anything, it is that ‘harm follows the money’. The market for social impact finance, and sustainable finance generally, is burgeoning. The absence of clear standards and definitions means that as the market grows so does the risks of impact washing. It is far too easy for conventional return-prioritising finance to masquerade as social impact finance and far too easy for financial institutions to impact wash their activities.

The current weak regulation of social impact finance will enable the expansion of the use of private finance in the social sector. It could actually enable impact washing, never mind fail to prevent it.

Why do I say this? The Financial Conduct Authority (FCA) has developed a new sustainable investment label for investment funds. The FCA has produced guidance on what could be considered eligible assets for firms intending to use the regulator's new labels. It includes an example of a hypothetical investment fund called the 'ABC Social Impact Real Estate Fund'.[7] This fund would invest in and make profits from properties used by local authorities to house homeless people. These assets would count towards eligible assets for using the Sustainability Impact? label.

This opens the door for investment funds to claim that making profits from other social assets such as children's residential care[8] should also be classified as 'Impact'.

It surely beggars belief that investments which generate market level returns from hard pressed local authorities trying to tackle homelessness or caring for vulnerable children could be classified as ‘social impact’. It cannot have been the intention of the FCA to legitimise what amounts to financial extraction dressed up as social impact finance.

Conclusion

So, whether it is greening the economy, building affordable housing, building core infrastructure, funding levelling up and regeneration, and tackling social issues such as poverty, exclusion, and care a major expansion of the use of private finance is on the cards.

It may be called ‘crowding in’, ‘working in partnership’, ‘purpose based finance’, ‘inclusive capitalism’, ‘social impact finance’, ‘blended finance’, or ‘catalytic finance’. There are lot of buzzwords in this sector. But, look beyond the buzzwords, and it is clear we are seeing a major financialisation of the economy and society through the use of new private finance models built around the same principles as the controversial PFI regime.

As with the previous experiment with PFI, there will be a price to pay for this financialisation of the economy and society. It might be a short term fix. It might keep costs off the state balance sheet. Yet, this is a financial conjuring trick to conceal a false economy. Unbelievably, private finance institutions are also able to impact wash their reputations while generating high returns and fees from the failure of the Government to provide the necessary financial resources to fund sustainable economic growth, tackle poverty, and fund decent housing, infrastructure, and public services.

[1] Corporate welfare includes ‘de-risking’ ventures and/ or providing incentives to make them more viable for and attractive to private finance.

[2] The main regulation that covers insurance companies, Solvency UK, was already weak. It allowed insurers to use a financial conjuring trick to make their balance sheets look stronger than they really are. It has been further weakened due to pressure from the insurance lobby who argued disingenuously that this was needed for insurers to invest in the green transition, levelling up, affordable housing, and infrastructure. Moreover, the charge cap on workplace pensions that protected workers from high fees has been weakened to encourage investment in infrastructure. The task force that recommended that was dominated by lobbyists from the private finance sector. Finance lobbyists are also pushing to have consumer protection on financial advice to be weakened (the advice/ guidance boundary review) arguing that this will allow financial institutions to persuade ordinary consumers to invest in equities. And it is not just deregulation we have to worry about. The current regime created by the Financial Conduct Authority to encourage green and social impact investment, the sustainable investment label, would enable the expansion of private finance in areas such as social housing, care and so on and provide legitimacy to this private finance by allowing investment firms to use an FCA label. This will not only push up the costs of tackling social issues, it will also encourage social impact washing, the twin of greenwashing. See: ?Social Impact Finance | The Financial Inclusion Centre

[3] A dash for growth: the shadow chancellor prepares for government (ft.com)

[4] There is the option of the state investing in early stage, higher risk ventures and then passing these on to private sector once these ventures are established and profitable rather than underwriting finance from the start. Of course, this still means turning to more costly private finance. There is just no getting away from the basic fact that private finance is more costly than public investment and turning to private finance adds to costs for households. ??

[5] Boost for new National Wealth Fund to unlock private investment - GOV.UK (www.gov.uk)

[6] Social Impact Finance | The Financial Inclusion Centre

[7] FCA Sustainability Disclosure Requirements (SDR) and investment labels Policy Statement PS23/16, p108

[8] See the shocking findings in this report - How can a child in care cost ￡281,000 a year? Ask the wealth funds that have councils over a barrel | George Monbiot | The Guardian