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It is a striking fact that universities, predominantly through the ever-increasing efforts of those who work in them, have continued to produce high-quality teaching and research despite the savage reduction in public funding.

It is hard for any one university publicly to say that it is not as good as it used to be. It is easier for the system as a whole to say it, and it is true. And if quality is threatened, so is competitiveness.

The international standing of British higher education will decline, and with it the ability to attract first-rate undergraduates, research students and academics from other parts of the world. If this continues, we shall end up with a second-rate university system.

No one wants that to happen. But a great deal will turn on the firmness with which Sir Ron Dearing, and his National Committee of Inquiry into Higher Education, grasp this problem.

The immediate need is to convince government that the cuts planned for the next two years must be abandoned if the university system is to retain its high quality, and that the capital funding cut last year was a disastrous mistake. The Committee of Vice Chancellors and Principals has been energetically campaigning to that end.

The problem does not affect the Department for Education and Employment alone. Research funding comes largely through the Department for Trade and Industry which includes within it the Office of Science and Technology; that department surely cannot but be concerned if supposedly "well-found" laboratories in the universities where research council projects are conducted find their equipment funding halved.

The Department of Health cannot ignore the plight of university medical schools if it wants more medical students. The Department of National Heritage has an interest through its responsibility for museums and galleries, as well as for buildings which form part of that heritage.

The report of the working party which included representatives not only of the DfEE, the CVCP, the Higher Education Funding Council for England and the Treasury, to report on the impact of the budget settlement shows very clearly the effects of persistent cuts in funding: posts to be lost, projects abandoned, and overall financial security imperilled.

Alas, it states equally clearly, on its very first page, that the DfEE "does not necessarily share or accept the views set out in the report". In other words the report is put forward essentially as an account of the problems which the universities face. There is no departmental response to those problems. Response there must be. It seems to have been assumed when capital funding was cut that the Private Finance Initiative would be our salvation. Cut public funds, and the private sector will step in.

There are two fundamental flaws in that approach. The first is that the "capital" was not capital in the real sense, but was largely funds provided recurrently for equipment and maintenance, neither of which can produce the income stream required if the private sector is to supply the service that we need.

The second flaw is that if universities are to fund projects on a recurrent rather than capital basis they need recurrent money to do it with, and if they have not got it they can only find it by cutting something else.

Many universities could have access to the necessary funds simply by borrowing from a bank and, in the process, avoid payment of VAT on a PFI contract. It is the absence of an income stream and of recurrent funding which causes the difficulty: there is little merit in advising someone who is short of money to go and buy some.

A second working party report, while it indicates some areas where private finance might assist, recognises there are others where it could not; it also recognises the income-stream problem, recommending that "in reviewing the government's expenditure plans in the 1996 Public Expenditure Survey, account should be taken of the recurrent effects of PFI deals, in addition to the burden of servicing existing borrowing". It is crucial that regard is paid to this report in the next public expenditure round.

Peter North is vice chancellor of the University of Oxford.