The Private Finance Initiative (PFI) tends to be viewed with suspicion. The idea of companies making money out of traditional public sector projects like building hospitals makes many people uncomfortable.

The PFI is well worth it to bring in capital which otherwise might not be available

David Currie, City University

High profile cases opposing a bigger role for private companies -- such as London Mayor Ken Livingstone's battle to stop private companies running the underground -- have done little to improve the PFI's image. But emotive issues aside, does the policy make economic sense?

What is it?

The PFI was introduced in the early 1990s by the Conservatives. It involves private companies being appointed by public bodies to design, build and pay for capital projects such as roads, hospitals and schools. In other words, the private sector puts the money up front and the public sector pays an annual charge over the subsequent 30 years or so.

The government asks the private sector to put the money up front and then pays it back through annual charges. The taxpayer still pays the bill

Gavin Kelly, IPPR

In return for being paid for building the project, the private sector is also meant to assume the financial risk - so that if the project has a cost-overrun they have to pay, not the government.

Two arguments are typically put forward in favour of the PFI. Firstly, that it is a good way of financing expensive projects that might otherwise not be undertaken, and secondly that it offers better value for money than purely publicly funded endeavours

David Currie at City University says the level of investment that would be required for some projects like building new schools would spark talk of a fiscal crisis if it was funded with government money.

"The PFI is well worth it to bring in capital which otherwise might not be available," he says. It's a framework to bring in money for services which otherwise might be left to languish, such as schools."

Questions over funding

However, others dispute that logic. Gavin Kelly is research director at the Institute of Public Policy Research (IPPR), and is co-author of a comprehensive analysis of the PFI. He says using the policy as a way of loosening the constraints on capital investment is a particularly bad rationale for the initiative.

"It's just an accounting device," he says. "The government asks the private sector to put the money up front and then pays it back through annual charges. The taxpayer still pays the bill."

And, he points out, if this was the only rationale, then the government could borrow the money more cheaply on private capital markets itself.

Kelly says the second argument -- that PFI projects offer value for money -- is much more important. The theory is that private money brings with it better management plus greater incentives to finish projects on time and within budget.

Evidence lacking

Hard evidence on that is woeful. Advocates of PFI point to the fiasco over the Jubilee Line extension on London's underground. Funded and managed by the public sector, it suffered huge delays and went well over budget.

However, Gavin Kelly says the policy has had mixed results.

"From what we could tell it seems there is a strong reason for thinking the PFI is delivering real value for money in some sectors like prisons and roads," he says. "But in hospitals and schools there's no evidence of significant gains, and in some cases there have been significant losses."

There is also some controversy over where any value for money comes from. If it is driven by cuts in workers' terms and conditions rather than by genuine innovation, then efficiency gains are questionable. Rather than creating economic benefit, money is simply being redistributed from staff to private company shareholders.

Room for improvement?

Abandoning the Private Finance Initiative now would be costly. The policy is in its infancy and is still being finessed. There are also gains to be seen from the PFI that deserve time to mature. However, improvements could be made.

Gavin Kelly at the IPPR says the government should consider other ways of getting the money to invest in long-term capital projects, rather than relying so heavily on PFI.

"The government should stop and think why it's doing so many PFI projects when the evidence doesn't necessarily support it," he says, adding it should be bolder and experiment with different ways of procurement that preserve efficiency incentives.

"It should also evaluate PFI projects more closely and be willing to change policy in light of any evidence. We need to make sure government departments have a real choice."

It may be many years before it is possible to finally decide whether PFI was a good deal for the government.

But with the policy still at an early stage, there are likely to be more twists and turns before any final judgement is made.