Frances Cairncross: The way to fund our universities

The current system is not at all fair. Its main beneficiaries are middle-class children who have overwhelmingly takenup the expansion of places

Universities are the 21st century equivalent of the car industry. Just as, in the 20th century, a successful motor industry brought many other economic benefits, spawning subsidiary industries, export earnings and good jobs, so universities will be central to economic success in this century. They produce the raw material of a flourishing society: thoughtful, articulate and creative young people, trained to ask the right questions and to develop interesting new ideas. Moreover, although other countries can make good cars, Britain's universities are among the world's best.

This success is now under threat. And the threat arises from the fact that universities have another vital role, which starves them of cash and distorts the way they behave. Universities are the gateway through which young people must pass in order to join the middle class. The reason is simple: advertising for graduates only is a short cut to targeting applicants who are sufficiently motivated and well-educated to be good white-collar employees. Not surprisingly, university graduates have, on average, higher lifetime earnings than someone without a degree.

Parents understand this but still see university tuition fees as a tax on entry into the middle class. If school is free, why should university cost money? No wonder the slightest hint of a rise in fees sends voters into paroxysms of fury.

To defuse the whole issue, the last government deftly created a committee under Lord Browne, former head of BP, to study university finance. This autumn, its report will hit the desk of Vince Cable. His party, the Liberal Democrats, want to scrap tuition fees, but his department must chop its budget by a quarter. How to square that circle, without an almighty row, several bankrupt universities and lots of angry middle-class parents whose children cannot get into any university at all?

Dr Cable set out his first thoughts 10 days ago. He pointed out that most students paid for their tuition from their student loan, repaid years later when they were earning a reasonable salary. This was, he said, a sort of graduate tax. But it taxes all graduates at the same rate. Instead, he suggested high earners should go on paying for longer, and pay more than their original education had cost.

It sounds fair, but it won't work. Graduates from the same degree course would pay different amounts; people who studied abroad would pay nothing; and wealthier families would avoid taking a student loan, rather than let their child face an uncertain future repayment bill. Besides, universities need more money now, not in the distant future.

Many universities are already astonishingly entrepreneurial in generating new sources of revenue. But the two main sources are inescapably student fees and government grants. As grants shrivel, they will have to cut spending – mainly by increasing class size and shutting departments. A few (as Cable acknowledges) will go bust.

So what is the alternative? First, universities need to charge students the true cost of their education. Would that be fair? Well, the current system is not at all fair. Its main beneficiaries are middle-class children, because they have overwhelmingly taken up the expansion of places.

What's more, the better the university, the bigger the benefit. The student who does a degree at Oxford receives about £18,000-worth of education a year for a tuition fee of £3,290. Half of students come from private schools, where many have paid far more for their tuition. By contrast, students at the newest universities come predominantly from low-income homes, and receive a less costly education. Yet a degree from a top university delivers much higher average lifetime earnings than one from a renamed polytechnic.

Deregulating tuition fees, and allowing universities to set their own charges, would remove this inequity. It might also help to take the Government out of the whole politically charged issue of tuition fees. And it would force expensive universities to be less complacent about the quality of education they offer. After all, why should a clever student apply anywhere other than a top university, given the extraordinary bargain it represents? But deregulating fees creates an obvious dilemma, apart from the inevitable political row. University education may raise lifetime earnings, but tuition fees must be paid today. Much of the problem of paying for universities is one of the years that elapse between the cost today and the extra money to pay the bill.

The only answer lies in a loan scheme, one that can and should be financed by universities and banks working together, but that will need government underwriting and support. Taxpayers should not subsidise interest costs, as they expensively do at present, but the Government needs to offer insurance against default and a system of deductions to manage repayments.

So should students carry all the cost of their university education? And what about students from poor families? Part of the answer might be a voucher scheme, with the Government giving every university-bound youngster a promise to pay part of the cost of the course. In fact, that already exists – but is disguised as a little understood and complex system of grants paid directly to universities by the Higher Education Funding Councils. For the poorest students, the voucher could be topped up - perhaps making them more valuable "customers" for a university, and thus creating an incentive to recruit them.

If the taxpayer no longer carried most of the cost of a university education, there would be less need to limit the number of university places. Government could, instead, limit the number of vouchers, but let universities offer as many non-voucher places as they liked. Then universities could decide for themselves whether to take extra students who would have to pay more, as overseas students do today.

None of this will be easy. But we must accept two uncomfortable truths: good university education costs money, and families need to carry most of that cost. If we continue to ignore these, then we jeopardise the extraordinary international success of our universities, and risk sending them the way of so many British car companies.

Frances Cairncross is the Rector of Exeter College, Oxford University