Post‐Contractual Lock‐in and the UK Private Finance Initiative (PFI): the Cases of National Savings and Investments and the Lord Chancellor's Department
| Published date | 01 March 2005 |
| Author | Chris Lonsdale |
| DOI | http://doi.org/10.1111/j.0033-3298.2005.00438.x |
| Date | 01 March 2005 |
Public Administration Vol. 83 No. 1, 200 5 (67–88)
© Blackwell Publishing Ltd. 2005, 9600 Garsi ngton Road, Oxford OX4 2DQ, UK and 350 Main Street,
Malden, MA 02148, USA.
POST-CONTRACTUAL LOCK-IN AND THE
UK PRIVATE FINANCE INITIATIVE (PFI):
THE CASES OF NATIONAL SAVINGS
AND INVESTMENTS AND THE LORD
CHANCELLOR’S DEPARTMENT
CHRIS LONSDALE
According to the UK government, one of the key features of the Private Finance
Initiative (PFI) is the scope it provides to transfer risk to private sector suppliers.
Under the PFI, public bodies are expected to develop interdependent relationships
with suppliers that allow risk to be transferred. However, it is the argument of the
author that it will not always be possible for interdependent relationships to be
engineered by public bodies – on many occasions, public bodies will find themselves
asymmetrically locked-in to their supplier. This situation leads to private sector
suppliers becoming dominant in those relationships which, in turn, will allow them
to pass back risk and obtain greater returns. As a result, the author argues that it is
not a question of whether risk can be transferred under the PFI, but when. This
argument is illustrated by use of the contracts managed by the UK National Savings
and Investments and the UK Lord Chancellor’s Department.
INTRODUCTION
According to the UK government, one of the main reasons why the Private
Finance Initiative (PFI) is an effective procurement mechanism is its poten-
tial to transfer risk to the private sector (Treasury Taskforce 1997). However,
many have expressed concerns as to whether risk does, in reality, get trans-
ferred to suppliers. These commentators point to instances where clear
breaches of contract are not followed up by termination or even the impos-
ition of contractually agreed penalties. The reason often given by public
bodies is that the wider concern of nurturing a long-term ‘partnership’ has
predominated (Ball et al. 2000a). This response should not come as a sur-
prise. Genuine risk transfer under many PFI contracts was, and is, always
likely to be difficult because the nature of the transactions leads to the public
body becoming asymmetrically locked-in to the private sector provider. It is
argued here that this matters because suppliers have a propensity towards
opportunism.
The idea of post-contractual lock-in and its impact on value for money
(vfm) has been discussed by transaction cost economists (TCE) for three
decades (Williamson 1975, 1985, 1995; McGuinness 1994; Hansen 2002).
Chris Lonsdale is in the Birmingham Business School, University of Birmingham.
68 CHRIS LONSDALE
© Blackwell Publishing Ltd. 2005
However, much, although not all, of the debate over the PFI has been under-
taken without an appreciation of the concept. That (small) part of the PFI
literature which has recognized it, for example, Pollock et al. (2001), Lane
(2001), and Parker and Hartley (2003), has either given it a low billing or, in
the view of the author, adhered too closely to the traditional TCE interpret-
ation of the concept. Adhering to the traditional TCE interpretation of the
implications of lock-in is problematic because that interpretation does not
contain a credible model of intra- and inter-organizational management.
There is, in particular, a damaging reluctance to accept the importance of
power relations. These flaws in TCE cause it to be over-optimistic about the
prospect of ‘buying’ organizations avoiding asymmetric lock-in in their rela-
tionsh ips with supp liers and th us being able to transfer risk and secu re good
vfm. This is of direct relevance to the PFI as the expectation that risk will be
transferred under the scheme is underpinned by the same optimistic logic as
that of TCE (Office of Government Commerce 2002; Public Accounts
Committee 2003a).
This article therefore presents an alternative framework for assessing the
ability of public bodies to transfer risk to suppliers. This framework contains
many of the building blocks of TCE, but improves, crucially, upon TCE by
incorporating the concept of power with respect to both intra- and inter-
organizational management. The incorporation of power into the TCE
framework has the effect of making it more cautious in its expectation that
asymmetric lock-in will be avoided and risk transferred. Having presented
the framework, the article then proceeds to provide two PFI case studies,
those involving National Savings and Investments and the Lord Chancellor’s
Department, that highlight its efficacy in explaining both successful and
unsuccessful outcomes.
THE ECONOMIC CASE AGAINST THE PFI: A LITERATURE REVIEW
The initial argument for the PFI related to problems over the UK’s public
finances (Broadbent et al. 2000; Flynn 2002). However, it also fitted in neatly
with the political inclinations of the Conservative Government of the time.
This government saw a key role for the private sector in modernizing the
UK’s public services and infrastructure (Flynn 2002). There were, however,
disadvantages to increasing the role of the private sector through the PFI.
Even the UK government itself never sought to deny that the private sector
incurred higher costs (between 1 per cent and 3 per cent) in raising capital
(HM Treasury 2000). The emphasis, therefore, was on the claimed (or per-
haps assumed) superior capabilities of private sector firms. Those superior
capabilities, it was argued, would not only make up for the aforementioned
higher costs, but actually produce a result that constituted better vfm than
either traditional procurement or public provision – the PFI can replace
either (Dorrell quoted by Gaffney and Pollock 1999).
However, ever since its inception in 1992, the PFI has had its critics. There
have been arguments on a number of fronts, many of them political,
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