Funding or financing? Untangling a policy confusion
August 08, 2016
When advising the public sector on projects, I’ve often found my clients can be confused between the meaning of 'financing' and 'funding'. This confusion can lead to lost opportunities to get assets and infrastructure part paid for by the private sector and end users.
For instance, it can lead politicians to ask for large swathes of foreign money without realising it comes with a cost, or public officials to ignore opportunities to use private sector funding to contribute to the cost of public assets and services. For example, you often hear people saying things like "the Sovereign Wealth Funds will fund HS2" (the UK's new high speed line). No they won't! Despite their name, sovereign wealth funds don't fund anything; they finance them. Ultimately they want their money back, with a return (or may require their country to deliver that infrastructure at a (hidden) cost).
It is scary when politicians do not realise that such finance comes with a cost.
So what's the difference?
Being clear about the difference between the two terms may seem pedantic, but helps clear thinking:
- Who finances a project means who, at the outset, raises the cash to build it. This could be the public sector or private sector, who raise debt and equity to finance the building of public sector assets. In international Public Private Partnership structures like the UK's Private Finance Initiative, for instance, the private sector finances billions of pounds of investment in schools, hospitals, roads, trains, accommodation and housing.
- But who funds a project is a question of who ultimately pays for it over the long term; is it the user, the taxpayer or the customer? While the private sector may be happy financing infrastructure, its return on its finance and its repayment will come from a payment from government for the use of those assets, ultimately funded by the taxpayer or the users.
Finance comes at a price; normally above a government’s cost of finance, so there must be a good reason for any government to want to pay for that finance. There's no such thing as free money!
What return do they want? For how long? With what conditions attached?
More fundamentally, why is that finance worth the premium it typically earns over the public sector's cost of finance? Is the private sector taking on building or life cycle cost risk? Is it introducing efficiencies and expertise? Fundamentally is it overall value for money to the public sector for the private sector to finance a project and take delivery risk? It will only be good value if either risks transferred to, or efficiencies introduced by, the private sector compensate for their higher finance cost. If they don’t, while their financing a project may make it more affordable to the public sector in the short term, in the long term the amount of public sector funding needed (from taxpayers) will be higher. So be careful when asking for private sector finance.
Can the public sector benefit from private sector funding?
In addition to whether private finance is good value for money, the public sector should also ask a second fundamental question –just because it is a public asset, is it a given the public sector needs to fund 100% of it, or that it should be funded by just one authority? Are there sources of user, customer and private sector or local government funding that can be accessed to lessen the burden on taxpayers or central government?
For instance, if the NHS is building a hospital, can a wing be built by the private sector who want a research facility that can feed off the medical experts the hospital attracts and can treat many of the patients in the hospital, using shared, jointly-funded facilities? Can local government offices benefit from private sector occupants to share the cost of building, facilities management and occupancy risk?
Particularly in times of prolonged austerity, the public sector should look for opportunities for the private sector and users to jointly fund projects, to share the burden and lessen the call on taxpayers. Sounds simple. But it can feel a very radical approach. It will often blur the distinction between public and private sector delivery in a way that will give purists sleepless nights. For instance, in the UK should an NHS (the public sector health provider) cancer patient be monitored by a scanner part-funded by the private sector, as it will also be used by private patients?
In my view - absolutely! Using assets partly funded by the private sector in no way undermines the public sector ethos of the NHS. It just simply lessens the burden on the taxpayer.
Looking for additional sources of funding will also be important in the drive for devolution and regional growth. For example, involving local businesses and authorities in the funding of new stations, for instance for HS2 or Network Rail in the UK, will both reduce the finance burden of central government and improve the local involvement, commitment and decisions of businesses and local authorities.
Financing and funding normally go hand in hand; funding opportunities often arise where the private sector is already financing an asset. But they are fundamentally different. The approach of looking for more private sector opportunities for funding will be a key component of future procurement in a world of continued austerity. It is an opportunity for quite radical thinking.