Using the right economics makes perfect sense of buying back PFI

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According to the CBI, Institute of Directors, and others the world fell apart yesterday because John McDonnell said that he will supply financial markets with what they really want, which is more government debt. Now admittedly, he did so by suggesting he might nationalise some indsutries and buy back PFI contracts in others, but he did not once suggest that when undertaking such activity he would not pay fair value. Indeed, from what I heard, that's exactly what he said would be paid. I accept he suggested parliament could determine that fair value, and without EU law in place it has the right to do that (because that is what taking back control means) but he did not once say that anything but market conditions would be taken into account.

Now let's look at what that means for a minute. What are the market conditions for PFI, for example? I would suggest that the clearest indicator is that when valuing the future net earnings due from these contracts (which is the only reasonable way in which such value might be determined)  the appropriate discount rate to be used should be that implicit in the original PFI contract. After all, that would be reasonable; this is what can be called an 'arm's length term' i.e one set by independent contracting parties that was thought fair.

These discount rates (which effectively set the rate of return in the contract) were often quite high because it was supposed that quite large amounts of risk were transferred to the private sector when these contracts were issued (even though this rarely seems to have been the case in practice). This risk transfer was, after all, the whole reason for PFI and formed the supposed justification for the higher returns payable under this scheme than the equivalent government debt would cost. Given that this risk must still exist, because it would be unreasonable to presume they disappear when the contract was signed , then I think this argument can hold true. And it is this risk factor that should equate why, in a rational market, the higher return on PFI produces a yield that is no more attractive, despite that higher sums apparently earned, than is payable on government bonds, with which John McDonnell is proposing that the contracts be bought out.

The result is glaringly obvious. The PFI contracts will, on this basis, be worth considerably less per pound of future potential profit earned (or lost, since the contracts are to be cancelled) at cost to the public purse than the gilts that will replace them are. That means the payment due will not be the profits lost, but the profits lost when discounted heavily for risk taking into account inflation and the fact that right now the net yield on gilts is close to zero. I'm not giving examples: the evidence is that the pedants then pour onto this blog to nitpick figures. I will concentrate on principles. And the principle is that gilts are worth greatly more per pound paid than PFI. And what this means is that firstly buying these contracts in should not be expensive, and secondly that doing so makes economic sense since gilts are so cheap, so that thirdly public funds are bound to benefit whilst fourthly the market should be entirely happy with the rational compensation due.

So why the horror stories fom the CBI, et al? Three reasons. First, dogma. How dare John McDonnell suggest that the state can do anything well? That is the logic that underpins that.

Second, horror at the loss of this income stream that many will know may not be as risky as the contracts represented, and which is a sinecure as a result (not that they can say that).

And thirdly, noisy distraction from the fact that they have been rumbled.

Bring it on, I suggest. And nationalisation of privatised utilities follows much the same logic.