We did it before...

The speed and ferocity of the global financial crisis has shocked many people, as has the severity of the recession that it precipitated. It is probable that the consequences of this crisis would have been even more catastrophic but for the scale of fiscal stimulus and unprecedented easing of monetary policy that has seen interest rates plunge to near zero per cent.

Some parts of the world are now pulling out of recession, especially countries in Asia. That is not yet true of the UK, where it will be some months before we can ascertain whether any recovery will be robust and sustained or weak and limited.

One thing is very clear, however, and that is the scale of public borrowing resulting from bank bailouts, fiscal stimulus and structural imbalance. That currently stands at about 12 per cent of gross domestic product, or £178 billion a year. Debt of this magnitude is not entirely unprecedented in the UK, but it has generally only been seen in the aftermath of a major war. Because more than 60 per cent of the funding that underpins higher education in the UK is publicly provided, this sets a very different context for the funding of the sector over the next decade compared with the past.

The case for public funding

Higher education is now a major driver of economic activity in the UK. With gross income exceeding £23 billion in 2007-08, it was bigger than agriculture and both the pharmaceutical and aerospace industries. According to estimates from Universities UK, powerful multiplier effects meant that its economic impact was more than twice its gross income.

Higher education is also fundamental to future wealth creation. There are well-documented links between "human capital accumulation" (or investment in education) and economic growth. This is important because economic growth is the only sure-fire way we have of raising living standards on a sustainable basis and alleviating poverty. And there are, of course, those less tangible but no less important non-economic benefits associated with building social capital in communities and having better educated, more tolerant, more socially responsible citizens.

In short, there are social returns to higher education. As the taxpayer shares in the benefits of higher education, the taxpayer should contribute to its costs of delivery. Fundamentally that is not an issue; the key questions are, by how much and how?

University revenue from the public sector in 2007-08 was £14.3 billion, which, as a benchmark, is about one third of the schools budget and one fifth of the health budget. The majority is distributed through the funding councils, with direct allocations overwhelmingly for teaching, research and infrastructure and smaller amounts reserved for earmarked schemes. More than £3 billion supports research and knowledge transfer through the research councils. Another £2.1 billion goes directly to student support.

The aggregate "how much" has increased in real terms over the past decade, partly to drive the participation rate towards 50 per cent, partly to reinvest in infrastructure and partly to improve the funding of research and knowledge transfer.

The "how" is through a mix of modes: public funding of teaching is largely by numbers-driven block grants to institutions; research funding is overwhelmingly competitive (both through periodic research assessment exercises and through the research councils); and student support is through means-tested awards directly to students, and an interest rate subsidy on graduate contributions.

How much should be publicly funded?

According to the Organisation for Economic Co-operation and Development, in 2007 the UK invested 1.3 per cent of its GDP in tertiary education, predominantly through public funding. At 0.9 per cent of GDP, UK public funding is not materially different (plus or minus 0.1 percentage point) from public investment in some 14 other OECD countries. It is somewhat less than in most Scandinavian countries (where it is about 1.5 per cent of GDP), although these countries also have minimal levels of private funding. There are just three OECD countries that invest more than 2 per cent of GDP in tertiary education: Korea (2.5 per cent), Canada (2.7 per cent) and the US (2.9 per cent). In Korea and the US, private funding's share of GDP given to higher education is double the share of public funding in the UK.

What should be the overall level of investment in higher education? Who knows? That is a judgment the Government makes on behalf of taxpayers and against competing priorities. One benchmark might be the OECD average of public funding, which is 1.5 per cent of GDP. To take us from present funding levels to that average would require an increase in public expenditure of almost £9 billion. That figure is not a one-off, but rather an annual and sustained increase.

Changes in funding priorities

The prospect of any increase in public funding to higher education in the UK, let alone a £9 billion recurrent increase, is zero for the foreseeable future. Indeed, with the catastrophic increase in public indebtedness it has been obvious for some time that any changes would be negative rather than positive. However eloquently we may make the case for investing more taxpayers' money in the sector, the plain facts are that £178 billion of public debt has to be paid for and the taxpayer has bigger priorities for protection of public expenditure than higher education (starting with schools and healthcare).

So what can we say about public funding over the coming decade? It is clear that less will be available, and almost certainly even less than has been announced thus far. That raises two quite separate issues: first, how should reductions in public funding be allocated? Second, how will individual universities respond?

With regard to the first question, different universities will clearly have different priorities. For example, I believe that a compelling case can be made for most protection being given to research funding. Given that I happen to be a vice-chancellor of a large, research-intensive university that is very successful in securing research funding, I would say that, wouldn't I? But the fact is that most research undertaken in universities is a public good that the market would never provide on the same scale - especially so in the case of curiosity-driven, blue-skies research.

Whether or not there are more changes in the funding envelope, individual institutions will face tough choices in allocating their resources: they will have to continue to deliver what they do now with fewer resources or they will have to deliver more from existing resources. Crudely, productivity and efficiency will have to increase. Different institutions will make different choices around the programmes they offer, the way those programmes are delivered, the balance of face-to-face and remote learning, the length of time it takes to deliver programmes, the balance between teaching, research and other service, the balance between home and European Union students and full fee-paying international students and so on. It is probable that some universities will co-operate to deliver shared services and some may merge to generate efficiencies and create greater critical mass. More specialisation is possible, with greater diversity of mission and provision inevitable.

If there is less public funding available to invest and develop, as well as increasing pressure to use those resources more effectively, universities will have to diversify their (revenue and capital) funding base by bringing in more non-public funding. That will almost certainly mean greater reliance on beneficiaries and other stakeholders, either through higher graduate contributions, more business engagement, greater philanthropy, more reliance on higher-fee students or some combination of these.

Graduate contributions

Since the introduction of graduate contributions via income-contingent loans, the amount that undergraduate students pay towards their teaching and learning has risen to £3,225 for each year of their programme, and now totals £2.5 billion a year for the sector as a whole.

The Independent Review of Higher Education Funding and Student Finance led by Lord Browne of Madingley, which will report some time after this spring's general election, will determine whether or not graduate contributions should increase and, if so, by how much and on what terms. It will also look again at maintenance grants and the loan subsidy that results from repayments being subject to a zero per cent real rate of interest.

Browne will examine the evidence on how the new arrangements have worked, their impact on participation, how universities have deployed their additional funding and what difference it has made, as well as weighing up the costs and benefits of further change.

It is too soon to speculate on whether or not graduate contributions will increase. One thing is clear, however: if they do, it should be via evolution of the current system of no compulsory upfront charges and deferred income-contingent repayments. Compulsory upfront payments would be harmful to access; post-graduation repayment that is not income contingent would be damaging to those who start in low-paid jobs or have the misfortune to experience a spell of unemployment.

If there is to be change, it should not be via a graduate tax, which has the specious appearance of being a "fairer" form of graduate contributions. It is anything but. With income-contingent repayments, the beneficiary repays only his or her contribution to tuition; with a graduate tax, one goes on paying long after that sum has been refunded. Moreover, it is highly unlikely that universities would see the benefit of revenues from a graduate tax. Governments do not hypothecate taxes, and no government would ever do so for a graduate tax in the current climate. Thus the risk of the yield disappearing is higher than ever over the next decade.

Alumni engagement

The most recent evidence continues to show that graduates do better than non-graduates in lifetime earnings and that difference can be attributed to having been to university. Graduates can, as alumni, continue to invest time and resource in their alma mater, and it is essentially this activity that accounts for the difference in funding between the UK and the US. Both nations invest more or less the same share of GDP through public funding, but overall, the US invests more than twice as much of its GDP as the UK.

Annual alumni participation in many US universities is over 60 per cent, whereas for most UK universities it is under 2 per cent. This giving has resulted in massive endowments being accumulated by American institutions to underpin teaching and learning, research, widening participation and infrastructure enhancements. Although many US universities have had to adjust to the pain of endowment values crashing with the markets, this is cyclical rather than structural, and endowments will continue to be a core source of revenue and capital.

The stock response to philanthropy as a potentially meaningful source of recurrent funding is that "the US is different - it could never happen here". But it already does, although clearly not on the scale of many US universities. Some British higher education institutions are coming to appreciate the (philanthropic and non-philanthropic) benefits of an engaged alumni community and are investing accordingly. Although this is a funding stream that will need to be developed over the longer term rather than serving as a quick fix, at a number of universities the commitment of alumni is already making things happen that would not otherwise have been possible.

Business engagement

The business community already supports higher education, often under a corporate social responsibility agenda and often philanthropically, funding studentships, academic appointments, buildings and equipment. But business and commerce also buy many of the services higher education offers: graduate recruitment, basic research, applied research, consultancy, continuing professional development/executive education and conference activity. And these relationships do not depend on business school-related activity alone.

Some universities derive a substantial proportion of their revenue from such activities. Closer engagement offers potential for diversification of income streams. What form that takes and the terms on which engagement occurs will vary with institutional mission and priorities, but it will have to become more important. That will mean greater clarity on what the offer is and how relationships are managed to benefit both parties.

International markets

According to the OECD, there are more than 350,000 international students in UK higher education, the highest number globally after the US. UUK estimates that this brought in £2.9 billion in income in 2007-08, or 13 per cent of the sector's total income. Worldwide, more than 3 million students now study outside their own country. Although this number has grown steadily year on year, it still represents less than 2 per cent of the global student population in higher education.

Increased recruitment of international students will not be the solution for all UK universities, but it will be part of the answer for some. The market for international students will continue to grow, and Britain remains well placed to benefit from the continued globalisation of higher education. Its reputation for quality and the advantages offered by our native language remain key assets. However, this market will become more competitive as new providers enter and the quality of higher education in some of the large source countries improves.

Recruiting international students is not the only source of income from outside the UK. Research funding streams are available, especially in the European Research Area, where the UK does disproportionately well. International business engagement will also offer opportunities to those with well-developed internationalisation strategies.

Back to the future

The next decade will be a more defining one for higher education in the UK than the previous one. Public funding is set to fall in real terms and the international environment to become more competitive. This is realistic rather than defeatist. We can and should make the case for continued public investment to minimise the extent of the cuts to come. But if that is the only response, it is a strategy for decline and, probably, failure. Individual universities will have to review what they do, how they do it and who they do it with. Successful diversification of income streams will be necessary for continued development. That is a long game, and it will inevitably make funding streams more volatile and may not be the solution for everyone.

In moving to a more diversified funding environment, we have things to learn from higher education in other parts of the world. We also have things to learn from our past. In Nottingham's case that starts with Jesse Boot, the university's greatest benefactor. Not because the son of the founder of Boots and the man who would oversee its growth into a substantial national retail chain gave of his own personal means, but because he had a grand vision for a provincial city.

In 1928, Boot relocated the university from the restricted site in the city centre, where it had been since 1881, to a beautifully landscaped park in the suburbs. He created the university's signature Trent Building and set out a challenge for the city and the university to become "the seat of a great people's University, which in each succeeding age will spread the light of learning and knowledge, and will bind science and industry in the unity that is essential for the prosperity of the nation and the welfare of our fellow citizens".

Contemporary narratives of the funding requirements for transforming what was then University College Nottingham into the University of Nottingham are fascinating. Although Boot and others had a vision for an elite seat of learning, they also wanted to widen participation. They saw some responsibility for funding to achieve this resting with local government. For the most part, however, they emphasised the fundamental role of philanthropy, corporate social responsibility and individual responsibility. This is not so surprising, since we are dealing with an age that predates extensive state funding of higher education.

It is worth reminding ourselves of this, if only because the place we may be heading is a place we have been before.

HERE WE GO AGAIN: PAST EXPERIENCE WILL PAY IN TODAY'S TIGHTER ECONOMIC CLIMATE

The funding crisis that the sector finds itself in is not the first time that higher education has found itself the focus of budget cuts. The last major crisis began in July 1981, when the Government announced cuts averaging 15 per cent over three years.

Although the quantum of financial cuts was decided by politicians, the University Grants Committee was responsible for advising on how the cutbacks would be meted out across the sector.

For Sir Martin Harris, now president of Clare Hall, Cambridge and director of the Office for Fair Access, it was a bittersweet time. He had been newly promoted to the position of pro vice-chancellor at Salford University. However, Salford found itself facing cuts of 44 per cent - the worst financial blow in the sector.

"Although this began a period of downsizing at Salford," Harris remembers, "it became the beginning of things that Salford became quite well known for. We started to look to external sources for income and became more entrepreneurial in our outlook."

Harris is unsure whether the downsizing is something that could work as well in today's higher education sector. He points out that academics in the 1980s were awarded tenure, which led to "more generous early retirement packages" than would be available now. He adds: "This clearly will influence the willingness of staff to retire. 1981 showed that you couldn't make academics redundant."

The abolition of tenure as part of the Education Reform Act 1988, which applied to academics appointed on or after 20 November 1987, means that whereas before universities could rely only on the attractive ten-year pension enhancement an early retirement afforded to entice academics towards early retirement, universities today can close entire departments if they feel that they are no longer cost-effective.

One former vice-chancellor says that university leaders do not think that things will be as bad this time around: "If I had to guess about the future I would assume that there will be three or four difficult years and then there will be a recovery and universities will be part of that."

The former vice-chancellor goes on to add that lifting the fees cap may not be the panacea for the funding crisis that some claim it to be. While he concedes that extra revenue will be generated, he also points out that the Independent Review of Higher Education Funding and Student Finance, led by Lord Browne of Madingley, is likely to recommend bursaries for poorer students.

"If you look at the proportions of students who would be net payers of the higher fees versus net receivers of the bursaries, revenue would fluctuate from university to university."

With this in mind, he says that it is "not surprising" that those opposing a rise in fees are those that stand to gain the least revenue from it.

In a sector where funds are tight, it would be easy to assume that poorer students are the ones who would lose out if the fees cap were to be lifted. Nevertheless, Harris says that the Ucas figures reported in last week's Times Higher Education are encouraging: "The proportion of people from poorer families entering higher education has risen in recent years. It would be extremely regrettable if this group missed out because of the government cap on student numbers."

Sarah Cunnane

WHICH WAY FORWARD?: THE FUTURE OF HIGHER EDUCATION CONFERENCE

The Lord Dearing Memorial Conference on The Future of Higher Education, a major event sponsored by the University of Nottingham and Times Higher Education, is to be held on Thursday 11 February.

Key names from the UK sector and senior figures from international institutions will address participants at the venue at the University of Nottingham, where the late Lord Dearing was chancellor from 1993 to 2000.

The one-day event will consider Dearing's legacy; the impact of the global economic crisis on the academy; funding for long-term sustainability; the internationalisation of higher education; and approaches to evaluating performance.

Lord Mandelson, Secretary of State for Business, Innovation and Skills, and Sir Alan Langlands, chief executive of the Higher Education Funding Council for England, will each deliver a keynote address on Dearing's legacy. Also addressing the event will be Rao Zihe, president of Nankai University; M.C. van der Wende, dean of Amsterdam University College; and Jo Ritzen, president of Maastricht University.

David Greenaway, vice-chancellor of the hosting university, will speak about the globalisation of higher education and the rise of Asia, while Julia Goodfellow, vice-chancellor of the University of Kent, will address the issue of financing science and technology.

Insights into the sector's forthcoming challenges and opportunities will also be offered by Alice P. Gast, president of Lehigh University; Dirk van Damme, head of the Centre for Educational Research and Innovation, Organisation for Economic Co-operation and Development; Nicholas Barr, professor of public economics at the London School of Economics; Joanna Motion, vice-president of international operations at the Council for Advancement and Support of Education; Bahram Bekhradnia, director of the Higher Education Policy Institute; and John Haldane, professor of philosophy at the University of St Andrews.

The conference is free to attend. For further information, and to register, visit www.nottingham.ac.uk/lorddearing.