Dire is the only word to describe the picture painted by the Higher Education Funding Council for England's analysis of the financial forecasts of English and northern Irish universities. The figures show a rapid slide for the system as a whole from surplus through zero into deficit in a space of just three years, with the number of individual universities operating in deficit rising from 26 to 70.

Dire, yes. But the picture is not simple. The HEFCE figures are a projection of what will happen if nothing is done by institutions to avoid going into deficit. They assume that current cuts in capital will not be restored and that pay settlements will turn out at 3.75 per cent.

In practice, of course, something will be done. Indeed something is being done. This week comes news of six compulsory redundancies at London Guildhall, for example. Overall, the funding council puts a tally of 1,200 on the number of jobs institutions have said will be axed, with more expected. In addition, there is very little sign of a 3.75 per cent pay offer to staff.

Planned work will be postponed, equipment not bought, loans for development not taken out. In other words, the demands of responsible financial management will force universities into actively and rapidly reducing the quality of what they can offer students and staff.

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And that is after taking into account additional income from overseas students' fees which have risen across the system by 9.1 per cent this year and an expectation of endowment income rising steadily year by year. Universities are doing what they can to increase their income even to the extent of running the risk that high overseas fees, for example, will be counter-productive by reducing demand.

This dire scene, all carefully set just as the public expenditure cycle is about to reach its final stages will, it is hoped, persuade the Government to restore at least some of the cuts in last autumn's Budget. But will it? The Treasury, confronted with this dire scene and demands for better funding this time round, will point to the level of reserves shown in the figures and suggest that while universities sit on large assets they have the means to deal with current account deficits themselves and should not expect to be bailed out from the public purse.

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Universities' assets do indeed look impressive. Latest figures show total assets at Pounds 6.5 billion with Pounds 500 million in uncommitted cash, about 7 per cent of the total. To a Treasury concerned with bringing down the public sector borrowing requirement in the next 12 months, a warning that universities' cash reserves will fall from Pounds 500 million to Pounds 400 million over five years can only seem like evidence that the screw can be tightened further. That universities are in the long-term business - centuries not months - cuts little ice.

The truth is that the Treasury wants it both ways. Universities are to take over responsibility for capital investment, turning to the private sector for the necessary finance. They are to raise more money from private sources. Yet at the same time officials are apt to resent institutions, funded largely by public money, accumulating reserves, particularly reserves at the sort of level considered prudent in the private sector. After all, most publicly-funded bodies are not allowed to carry over public money from year to year in the way universities are able to do. The Treasury has often betrayed signs of wishing to end this ability to squirrel away money.

The universities are caught between two models. Largely publicly funded - though less so than 20 years ago - and severely constrained by the various rules imposed on them by government with regard to numbers, fees, subject provision and so on, they are none the less constituted as private, autonomous bodies. As the Government has put on the pressure to turn to private sources of finance, the universities have had to behave more like prudent private companies. Coming at the same time as per capita cuts, keeping sufficient reserves is hard and often resented by staff and students.

The thinking behind the switch to a private sector approach to financial management was set out earlier this year in the report of a joint study carried out by the higher education sector and the Department for Education and Employment - although the department was careful to make clear that it did not "necessarily share or accept the views set out in the report".

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The report, which was sent to the Secretary of State, is based on advice from Coopers & Lybrand to the funding council on levels of surpluses and reserves appropriate for a commercial organisation. Organisations that need to restore reserves, it says, should aim to operate at a surplus of 5 per cent.

Across higher education generally a level "of at least 3 to 3.5 per cent would be reasonable". On reserves, it recommends the equivalent of at least 30 days' expenditure held in the form of cash. The HEFCE figures show cash balances currently at days but falling to 15 days within the five-year planning period. Again this is a warning of potential trouble if nothing is done, to which the Treasury will no doubt be replying "OK, do something".

Several things are clear from all of this. Universities are not rich enough to trade soundly as private corporations, raising money in the private sector and offering a high-quality service. The result of forcing them to try to do so can only be that the slide in quality will become precipitate.

Second, universities will be looking to the next government to alter this situation dramatically. It could promise that no insitution will be allowed to go broke, thereby, in effect, removing the need for the kind of reserves required in the private sector. But that is equivalent to issuing a blank cheque to bad managers and is not likely to have much appeal. It could increase funding, in particular by restoring capital grants. This is the great hope and everyone in higher education will have been watching this week's Labour party conference for signs that help is at hand.

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Labour's ringing commitment to education, education, education seems to carry some hope despite the party's extreme care on spending commitments. There were glowing promises for education at Blackpool, promises to take action to reduce the size of primary classes, a new deal for under-fives, and extra help for 16 to 19-year-olds who continue to study. All of these, high on the party's priority list, are essential if access to higher education is to be broadened socially - as well as being welcome for wider reasons.

The discipline required by the shadow chancellor, Gordon Brown, that departments must find the money to pay for new initiatives from within their own budgets is, happily, much eased in the case of education by the brigading of education and employment. Extra spending is to go on education, savings are to come from reduced unemployment. It may well work and nothing could be more welcome. But, as the Labour leader, Tony Blair, accepted this week, it may not work fast. It also may not work on a scale large enough to do more than pay for those top priorities. To hope for enough savings to help higher education also on the short timescale needed, is optimistic, to put it mildly. Much more likely, unfortunately, is that universities will be in the same hole this time next year. It would be unwise to plan on any other assumption.

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