Long before the collapse last month of Carillion, one of the government’s go-to outsourcing and building groups, the signs of strain inside Whitehall over the future of financing public projects with private cash were clear. Since 2010 the government has signed 80 contracts under the private finance initiative (PFI). In the 13 years before 2010 it signed 620.

The figures are a measure of Tony Blair and Gordon Brown’s enthusiasm for shaking up the way public sector bodies financed the building of schools, hospitals and prisons, and the reluctance of the coalition government to keep the programme on anything more than life support.

In 2012, the then chancellor, George Osborne, backed a review of the controversial scheme, and in 2016, Osborne’s Tory successor Philip Hammond concluded there was still plenty of mileage in it. He relaunched it as you might a Hollywood film, calling it PF2.

Q&A What are PFI and PFI2? Show Private finance initiative deals were introduced in 1992 under John Major but became widespread under Tony Blair. Typically used for public buildings and infrastructure, PFI schemes introduce private investors into the design, building, finance and operation of new facilities which are then rented back by the state. Why did it become widespread?

PFI allowed ministers to build schools and hospitals with minimal upfront costs to the Treasury. It was a way to commission popular projects without immediately hitting the public purse. Why is it controversial? It massages public finances in the short term, but holds a higher long-term cost. In 2013-14 about £10bn was spent on servicing PFI contracts, with about £4bn of this on debt and interest. Where is the money going? Firms that have built NHS hospitals using PFI deals have made pre-tax profits of £831m over the past six years, according to the Centre for Health and the Public Interest. Firms such as Carillion, Interserve and Kier Group are among the big players. What is PFI2? Created in 2010 by George Osborne, PFI2 aimed to cut long-term taxpayer liabilities and trim excessive profits. In essence, it is meant to be “less private and more public”, with the state taking stakes of up to 49%. A board is appointed and annual accounts printed. It cuts back on bank financing (from 90% to 80%), improves transparency and accountability, and speeds up procurement to cut costs. PFI2 deals aim to be smaller, dealing more with facilities and services, rather than building. The government calls it PF2, not PFI2.



Except that PFI was by then a much-discredited formula. It might have raised £60bn over the years for building schools and hospitals, but the contracts were infamous for allowing businesses such as Carillion, which managed hundreds of public-sector projects as well as vital public services, to make excessive profits. It was a flop.

Only the Department for Transport was keen to embrace the lamely rebadged programme: over the coming months it expects to put together deals to fund a re-routing of the A303 that runs past Stonehenge and the Lower Thames crossing in Essex.

Other departments turned away. For most ministers and top civil servants PFI was toxic and the rebranding, which committed private bidders to provide greater transparency, was not enough to make it palatable. Tony Travers, a professor at the London School of Economics and a renowned expert on the public sector, says: “This is the denouement of a long drama.”

That’s not to say contracting out and public-private partnerships have bitten the dust. They are still very much in the government’s thinking as ministers wrestle with another 10 years of tough spending reviews.

The private finance initiative began life in the early 1990s under the Major administration, which was emerging from a deep recession and wanted to use the flood of money pouring into the City to fund public sector projects.

Tory councils were already outsourcing bin collections and catering contracts to the private sector. PFI was an extension that involved shifting the risk of cost overruns and delays on building projects to the private sector in return for guaranteed payments over the lifetime of a contract, which could run for 30 years.

In part, this was to end a decades-long period during which Whitehall’s sparse capital budgets – always the subject of Treasury whims – made it difficult for new hospitals and roads to get approval (and made them subject to interference when they did).

It wasn’t until the Blair government gained power that the accountancy profession found a form of words that allowed the capital used for a project to go on the private sector’s balance sheet. This was the green light for everything from Isle of Wight ferries to new hospitals to be financed and operated by the private sector.

The Norfolk and Norwich University hospital quickly became the most egregious example of PFI controversy after officials signed a deal in 2001 that was set to run until 2037 and net the winning bidders £1bn – nearly five times the £229m cost of building the hospital.

Last year the Eastern Daily Press reported that the hospital had a £25m deficit after paying a consortium £22m to operate the site and £17.6m in interest payments. Last week the deficit had climbed to £27.3m.

The Royal Liverpool University hospital, one of Carillion’s projects. Photograph: Pak Hung Chan/Alamy

Allyson Pollock, the Newcastle University health expert and campaigner, says the health service has been forced to close hospitals and thousands of beds as PFI deals have sucked the life out of NHS finances.

She warns that while the PFI might be out of favour, health minister Jeremy Hunt and NHS England chief executive Simon Stevens are busy importing new strategies for bringing private finance into the health service that reflect Stevens’s time in the US.

Just as Andrew Lansley, Hunt’s predecessor, pressed ahead without a mandate from the 2010 election to expand the use of private providers, she says Hunt is busy creating a new type of health provision without the parliamentary approval he needs.

She is one of several health campaigners behind demands for a judicial review of the new integrated care bodies known as Accountable Care Organisations (ACOs), which she says will actually be unaccountable and more able than previous NHS organisations to cherry-pick services and hand them over to the private sector.

Health service thinktank the Kings Fund has backed Hunt’s efforts to integrate social care, GP services and hospitals, and dismisses concerns that private firms will make inroads. Its chief executive, Chris Ham, says that, for example, the decision of private health company Circle to hand back its contract in Cambridgeshire shows how tough providing integrated services can be.

He says: “NHS organisations are better placed to compete for ACO contracts, working in partnership with local authorities and third sector providers where appropriate, and national bodies are actively exploring how a new form of NHS organisation might be used for this purpose.”

Opinion is divided among insiders about the legacy left by PFI. Plenty of hospital directors struggling to make ends meet still support the private financing and maintenance of their building. Without it, they say, there wouldn’t be a shiny, state-of-the-art facility in the first place.

Q&A What is a public private partnership (PPP)? Show PPP is a financial invention promoted as a win-win: the companies get lots of lucrative contracts to build stuff for the state; while the government gets new infrastructure more quickly and without the financial risk – private firms bid for the work and the market ensures taxpayer value.

Is it a win-win?? Not really. Tough competition in bids meant the contracts came with skinnier and skinnier margins. If problems occurred, a contractor’s 2% profit would not just be wiped out, but huge losses could be incurred too. Sam Cullen, an analyst at investment bank Jefferies, said that when operating on wafer thin margins "everyone bids each other to death". He added: "It’s a situation not helped when your largest customer, the government, is under huge pressure to get value for money and is more susceptible to accept the lowest bidder.” Why do companies keep bidding? The answer probably lies in the structure of major PPP construction deals, because they hand the contract winner a large chunk of cash upfront. Work on construction can then begin, while contractors such as Carillion may not need to start paying subcontractors for another 120 days. During those four months, much of the upfront payment might be used to pay other debts within the business, meaning doing these deals can create situations where firms have to keep winning new contracts just to keep going.



Another former civil servant who has switched to one of the large consultancy firms says the way forward is a national infrastructure bank to fund privately managed projects. “Most projects have been completed on time and on budget. And civil servants have learned a lot about handling private sector projects,” he says. “But they still need private sector expertise. I would build hospitals and schools using PFI structures, but with money borrowed ultimately from an entity controlled by the state.”

Labour leader Jeremy Corbyn favours bringing public sector contracts in-house and having traditional contracts with building companies to tackle infrastructure projects.

Travers says seven years of budget cuts inside central and local government have taken their toll, with many projects tripped up when the government drives too hard a bargain.

“You can see it in the pressure to drive down contract prices and how this leads to underbidding, and how that has exposed builders like Carillion to insolvency,” he says.

Carillion found itself millions of pounds in the red after it discovered the ground under a road it was building near Aberdeen was unsafe and it was forced to bear the cost of shoring it up. Other discoveries – like cracks in concrete at the Royal Liverpool University hospital it was building – created more financial pressure.

In response to the firm’s collapse, and news that another major contractor, Capita, is struggling, Labour MP Louise Haigh has called for all future contracts to be subject to freedom of information requests.

PF2 allows for annual “health checks”, but most critics say that still allows contractors and civil servants to avoid scrutiny – even from the National Audit Office, which often must guess at the reason for missed targets. “The logic of following public money does offer the possibility of seeing the books,” says Travers. “So far that has been a bridge the private sector is unwilling to cross.”

Rupert Soames, the head of Serco, at the company’s facility for the London bike hire scheme. Photograph: David Levene/The Observer

Vital signs – how the big firms are faring

Serco

Now run by Winston Churchill’s grandson Rupert Soames, Serco is trying to battle back to health after a string of profit warnings. Its troubles began in 2013, when it was temporarily barred from state contracts after overcharging the government for electronic tagging of prisoners, some of whom were either dead or did not exist. The Paradise Papers revealed recently that it was considered “high risk” by offshore law firm Appleby due to multiple controversies. It now runs services ranging from the London bicycle scheme to the Yarl’s Wood detention centre, and state contracts make up about £750m of its £3bn turnover. Profits fell last year but it reported a series of contract wins.

Interserve

The government insisted this month that Interserve would not be the next Carillion after it emerged the Cabinet Office was monitoring the company. But its shares are still sliding. Interserve is a major supplier in a range of areas including health, education and defence, but state contracts only make up 11% of its revenue. It issued two profit warnings last autumn, after it ran into difficulty on a number of waste-to-energy contracts.

Mitie

Mitie’s government contracts include an immigration detention centre at Heathrow, social housing services and repairs to the roof at the Palace of Westminster. About 25% of its revenue comes from government. Investigations into its 2015 financial statements are under way, with the latest inquiry announced in November. The company had issued a series of profit warnings, dragged down by rising labour costs and the fallout from taking low-margin contracts. It is currently in the midst of a restructuring plan.

G4S

G4S is in better shape than most rivals. Like Serco, it was barred from government contracts in 2013 for overcharging and was also damaged by its failure to provide enough security guards for the 2012 Olympics. But a turnaround and restructuring plan have improved its fortunes and profits jumped 14% last year. Its share price has been largely unaffected by any read-across from Carillion that many stock market investors are applying to the sector – possibly because contracts with the cash-strapped public sector make up just 5% of its £7.5bn revenue.

Kier

A joint venture partner with Carillion on the HS2 rail link, Kier has had to take on half of its former partner’s share of the contract, including staff. UK public sector work accounts for around half of its £4bn turnover, including contracting work on Crossrail, which has suffered safety failings, and running hospital and local authority services. Like G4S, it is doing better than many government contractors, reporting profits up 8% last year. It has 19,000 UK employees and net debt of £110m.

Balfour Beatty

Britain’s biggest construction firm had three joint ventures with Carillion, and will take a hit of up to £45m as a result, mostly related to the £550m Aberdeen bypass. It had a dark two years starting in 2014 when its shares fell 75% amid multiple profit warnings, but it swung back to profit last year after a turnaround plan took effect. It also works for Network Rail, HS2 and Highways England, and has 16,000 UK employees.

Rob Davies