Set our universities free, and let them charge students whatever they want

"Universities are autonomous institutions, and rightly so," said David Blunkett, Secretary of State for Education, in a speech at the University of Greenwich in February. This is a fine sentiment flawed only by a single problem. It is not true. Universities ought to be autonomous institutions but they are not. They operate essentially under government control.

In recent times no government has done well by the universities. Over the last 20 years, funding per student in the UK has fallen by more than 40 per cent. While student numbers have more than doubled over the last 20 years, university facilities have been allowed to decay and salaries for university teachers and researchers have declined by 30 per cent relative to other professions.

The recent public spending commitments made by the Government on the NHS, which I applaud, have now confirmed that while Tony Blair is still committed to education in his famous triplet, any money left over from the injection into the NHS will be concentrated in the two tiers of compulsory education. There is no longer any credible excuse for university leaders behaving like Mr Micawber - something is not going to just turn up.

Universities need a new solution to their funding problems. They have to be radically reformed and extra resources found from outside public expenditure. It is not acceptable to condemn higher education to a slow but inexorable decline in standards. We in the UK will not be able to expand, let alone retain, our world-class research departments without new private money. We will also fail to provide the knowledge and technological contribution to economic growth, which is so vital without a thriving university sector.

While the Labour Government courageously introduced the principle of tuition fees, they maintained central control over the level that could be charged. Mr Blunkett hinted in his Greenwich speech that the current funding balance is open to negotiation. Incrementalism will not work. It is time for universities to be free to determine their own tuition fees. Only then will universities regain the independence they began losing in the Sixties.

Radical reform is not without political cost. It presents our politicians with the difficult task of persuading the relatively well-off that they will have to pay far more for the higher education of their children. Graduates should also have to pay back when they earn more because of their education.

The justification for this change is not purely monetary. There is also a defence from social justice. Higher education is an investment in individuals. Graduates earn more than those without degrees - 12 per cent more for men, 34 per cent more for women. The taxpayer is currently paying to subsidise the education of all students, rich and poor alike. But over 60 per cent of the university population is drawn from socioeconomic groups I and II. The status quo is essentially an unjust subsidy.

Yet for a radical scheme to be equitable, no one should be excluded from higher education because they cannot afford to pay fees. Qualified students from all backgrounds must have greater access to higher education and find it easier to fulfil their potential. Nor should the Government see greater private contributions to universities as a way of cutting expenditure on what is a vital element in our economic prosperity. Every year the Government grants money to the Higher Education Funding Council to be distributed to universities to pay for teaching. In 1999 the teaching contribution for England and Wales was £2.93bn. The whole of this amount should be allocated to a new Bursary Fund, which would grant money to students to pay fees. All students would be eligible for a means-tested bursary.

The Bursary Fund would be large enough to grant full fees for all those who are currently exempt from the £1,025 charge and pay part fees for others on a sliding scale. All those students whose parents are not eligible for a Bursary Fund grant could decide whether to pay the fees upfront or take out loans to cover the cost. The balance to be struck will be up to them.

Whether they receive the money for fees from the Bursary Fund or from parents or lenders, this system will unequivocally place students in the position of customers. It is regrettable that the current tuition fee system has failed to give students the level of representation they deserve. It is also a great shame that official student opinion has been dominated by the futile attempt to reverse New Labour's endorsement of fees. Student representatives would do far better to think about the potentially redistributive benefit of a more radical change in student funding.

The Scottish Executive has used its powers under devolution to abolish fees, thereby consigning its universities to an even more prolonged period of underinvestment. I doubt that this settlement will hold up for long. However, there is one idea that arose from the debate over fees in Scotland that could be made use of. The Graduate Endowment recommended in the Cubie Report for the Scottish Executive was intended to provide for a contribution to the cost of university education once a graduate is earning £25,000 a year or more.

Sadly, the eventual compromise introduced set the endowment at the absurdly low level of £2,000 and requires repayment once earnings reach only £10,000. This penalises graduates at the beginning of their working lives - as does the current loans system in England and Wales - and provides little in increased resources for higher education. In its original form and with higher repayments, a Graduate Endowment offers the foundations on which a graduate tax might be built. Such a tax would allow graduates benefiting from their university education to pay back more of the cost of that education.

The purpose of reforming higher education is to improve the quality of teaching and research. Parents who can afford to pay for their children's education should be expected to do so. Students from families who cannot must be provided for by the state. And a balance should be struck in between. One role I would continue to see for government would be in monitoring universities' progress on widening access and penalising them if they failed to do so.

Everyone - students, universities and future employers - will benefit from an injection of new private money into universities. The independence of universities to exploit their strengths, whether in teaching, research or both, is essential. Only by allowing students to decide and universities to develop their own characters will we maintain and enhance a world-class reputation in higher education.

Lord Owen is Chancellor of the University of Liverpool