'We cannot be certain about every step. But the journey will be worthwhile'

One of my favourite features in Times Higher Education is the series on unusual treasures owned by universities. If I could nominate one, it would be the stained-glass window in the Great Hall of the University of Birmingham, the city where I was brought up.

My grandfather remembered being taken to the opening ceremony of Joseph Chamberlain's university, as his father had been one of the glaziers who had made the panels for the window. It looks like a stained-glass window from a Renaissance church. But look closely and you see that the images are not of saints, but figures representing Birmingham's trades and professions. There are miners and engineers, what must be one of the few images in stained glass of an electroplater, as well as physicists and musicians, all celebrated as if they were High Renaissance saints. It is a powerful vision of the civic university, one of the great accomplishments of our nation.

Universities come in all shapes and sizes, and a good thing, too. There are different ways in which they can be world class. We do of course have world-class research universities. But we also have world-class regional universities serving the needs of local employers. We have world-class distance learning and provision for mature learners.

The challenge facing the coalition government has been how to sustain these diverse missions when all three main political parties recognise that savings in public spending have to be made.

One option would have been incremental cuts in teaching funding. But the previous Conservative government presided over a big fall in the unit of resource for students and this had an impact on the quality of teaching. We did not want to repeat that.

Another option would have been to cut student numbers, pandering to the widespread view that too many people go to university. While we need to provide individuals with better information about the costs and benefits of higher education, I believe there is a deep-seated economic and social trend for more people to study at a higher level and this, too, is to be welcomed. Higher education is strongly associated with civic engagement, tolerance, cultural enrichment and, of course, economic growth.

Neither cutting grants nor cutting student numbers would have led to riots in Parliament Square - but they would have let down the younger generation. They would have been politically easier but deeply irresponsible. The challenge we faced was how to ensure that our universities would be well funded and student numbers sustained, while also saving public money.

Fortunately, Lord Browne of Madingley's review had an answer. Graduates, not students, should pay more. Raising money from graduates saves public money as, instead of grants to universities, there are increased tuition fees and student loans, repaid when graduates are earning more than £21,000 a year - up from £15,000 now. This is a genuinely progressive way of funding higher education. The latest figures show the average graduate earning £30,000 a year compared with £18,000 for someone with lower-level qualifications.

The loans to students and the "debt" that results are nothing like a commercial loan. With no obligation to repay on any earnings below £21,000, it is in fact halfway to a graduate tax - and it's the better half. It is striking that whenever any of the three main parties have had to decide how to finance higher education, we have all ended up with basically the same model.

We estimate that about 30 per cent of these loans will not be repaid - close to the estimate reached using slightly different methodology by the Institute for Fiscal Studies. And it is quite right that they are not repaid by those graduates with lower earnings. This is just part of the Exchequer's continuing support for higher education. This Exchequer subsidy for loans is known as the Resource Accounting and Budgeting (RAB) charge - a forecast of the amount of money that will not be repaid - and it is going to be at the core of university financing for many years.

I expect that, in the future, as the data accrue, the policy debate will be about the RAB charge for individual institutions. One reason why we were not able to accept Browne's ingenious idea of a levy on higher fees is that it was indiscriminate and did not reflect the actual Exchequer risk from lending to students at specific universities.

Our model, unlike any other credible proposal I have seen, ensures increased cash flowing to our universities even when we are making savings in public spending. We estimate that, even after allowing for reductions in teaching capital, the funds that my department allocates for higher education should rise in cash terms from £9.7 billion in 2010-11 to £10.4 billion in 2014-15. There are not many public services that can look at figures anything like that in an age of austerity.

The increase in funds for teaching stands alongside our protection for cash for science and research, including funding for the research councils, quality-related research funding and money for the Higher Education Innovation Fund.

This all adds up to a ringing commitment from the coalition to proper financing of teaching and research in our universities. We have been persuaded by powerful evidence on the central role of the university in the modern economy and in transforming people's life chances.

Our commitments on teaching and research also respect the autonomy of universities and have avoided any pernicious temptation to steer the money towards ministers' pet priorities (although the research councils will doubtless want to reflect on the hazards of referring at all to current political slogans!).

I was scrupulous in the science and research settlement not to favour one discipline over another and, of course, we continue to provide funds for blue-sky research. And the reduction in block grant for teaching applies across all four subject price bands - the remaining grant for Bands A and B (science and engineering) reflects their higher costs, not a value judgement. In fact, if anything, it is Band D (social sciences and humanities) subjects that gain most from the shift towards larger loans.

We will never lose sight of what a university is about and why it matters. The sheer richness and diversity of what we study at our universities is one of their strengths. I remember a discussion with medical researchers about their contribution to the health of the developing world. They recognised that developing a new vaccine was not enough on its own if there were rumours that it was a Western plot to endanger indigenous people. To tackle this misapprehension, they needed anthropologists, historians and sociologists to help them understand the society and culture into which their Western medicine was being introduced.

Our changes to the financing system will also drive structural reforms in higher education. The force that is unleashed is consumerism. We would not have been willing to put in the extra funds and go through the political pain unless it was for the benefit of students and their educational experience. I recognise that the very term "consumerism" causes deep anxiety for some. But it is not a threat to the classic relationship between academic teacher and student - it is an opportunity to rebalance academia so that teaching gets its rightful place alongside research.

We achieve this not by ham-fisted interventions compromising the autonomy of our universities but by ensuring that money goes with the student. This was a model that the 1963 Robbins Report saw virtues in: "There is cogency in the argument that, up to a point, it is better to subsidise students than institutions." The 1997 Dearing Report went further in the same direction: "Over the long term a greater proportion of public funding should follow informed student choice so that institutions have greater rewards for responding to that demand."

There has been a lot of focus on the bunching of tuition fees at £9,000, but we have to look behind the headlines at what students will actually pay in autumn 2012 after fee waivers and other support. These measures are an important part of our agenda for widening access. It is still early days.

We also have to keep a close eye on the cost of student loans. Let me set out our original estimates in the public spending settlement for these likely costs.

We expect there will be about 350,000 new full-time undergraduates arriving at English higher education institutions in autumn 2012 who will be eligible for fee loans. At the moment, about 86 per cent of students take out a fee loan. It is possible that higher fees might increase the number of students borrowing. On the other hand, there has been a big interest rate subsidy in the past that may have encouraged students to take out a fee loan when they could have afforded to pay up front - such behaviour may now abate. On balance, we have prudently assumed more students - 90 per cent - borrowing than at present.

We then assumed these students will borrow an average of £7,500. This is not a fee assumption, as they do not have to borrow the exact amount of fee, although most probably will. Multiplying 350,000 by 0.9 by £7,500 works out at about £2.4 billion of new loans for new full-time students in the class of 2012. The 30 per cent RAB charge on this gives an Exchequer cost of about £710 million.

We will not know how much is actually being lent until the end of the 2012-13 academic year when we see how much students actually draw down in loans. It could be rather higher or lower, and we will have to take stock then, but let's keep this in perspective. If, say, an extra £300 million is lent, then the Exchequer cost - based on that 30 per cent RAB charge - is up by £90 million. This is something we would have to address to stay within our spending totals - but out of a higher education budget of about £10 billion. That should not knock us off course when it comes to student numbers or support for teaching.

The focus on the bunching of fees has diverted attention from an equally important form of competition - the quality of the teaching experience. Prospective students will ask: "What am I paying for? What kind of educational experience am I going to get?" I understand the financial pressures that have led universities to edge closer to £9,000 for some courses and some students, although universities do need to do more to achieve efficiency savings.

Above all, however, they need to focus on what the student will get in return for a higher fee. And we know from the National Student Survey that academic feedback, which is at the heart of the educational experience, is one of our weak spots.

I expect university websites over the next year to be more explicit than ever before about exactly how crowded seminars will be, what work experience will be organised, and how rapidly students' academic work will be returned.

For this information really to count, students will need the opportunity to act on it. That means easing controls on student numbers. Recently the trend has been in the opposite direction - entrant controls were one of the first things to be introduced as public spending was tightened in the final days of the previous government. That is the direction in which conventional spending controls take us when money is tight. But Vince Cable, the business secretary, and I both hate having to preside over a system that decides, for example, that the University of Wolverhampton should recruit 3,965 students and the University of York 3,350.

One of the main reasons for the delay to the White Paper is that we have been doing more work on how we can ease up these controls without compromising overall public spending discipline. We have to deliver this to live up to our central aim of putting the students' educational experience centre stage.

But it is not just flexibility for existing institutions that is needed: we also have to make it easier for new entrants to provide higher education, provided it is of suitable quality. The history of higher education in our country is one in which new types of institution have been created in successive waves, and I believe that the next 20 years could well see another wave of creations - for example, new liberal arts colleges.

Further education colleges are looking to an expanded role delivering higher education. I expect some new providers will offer a more transactional model of higher education - saying to potential students, "here is a very efficient way of getting you the higher education qualification you need to pursue your chosen career." This is one of a range of ways of delivering higher education. Of course incumbents have often dismissed new entrants for such reductionism: when University College London was created in 1828 as a challenge to the Oxbridge monopoly, it was denounced as a mere "lecture bazaar".

Our proposals achieve four big objectives simultaneously. First, they save money because we convert grants to loans, and this means that it is only the 30 per cent of the money we don't get back that adds to public spending. We make a big contribution towards reducing public spending by phasing out £2.6 billion of teaching grant over four years.

Second, this very shift - removing the privileged inner circle that gets teaching grant, and instead allocating money via fees and loans - opens up higher education to a wider range of providers and to doing things differently.

Third, universities will get money by focusing on the teaching experience for students - their biggest challenge. It is a good example of saving money and genuine reform going hand in hand.

Fourth, it means that our universities, provided they satisfy students, are well funded. Our universities matter for people's life chances and for growth, and we have no desire to enfeeble them. Higher education could end the Comprehensive Spending Review period with 10 per cent more cash income for teaching, and that means we are offering teaching at least the same sort of protection as science and research.

This all involves big changes in universities. It cannot be micromanaged, nor can we be certain about every step of the way. But the journey is worthwhile for the Exchequer, for universities and, above all, for students.

The critics may dismiss this as mere consumerism. I call it harnessing the power of the student to put the classic values of excellent teaching centre stage once again.