Higher education is entering a hugely challenging era. A large cut in public funding (with, in all probability, more cuts to come) has been made after a very good spell under this Labour Government. Compound that with an increasingly competitive international environment and it becomes clear that institutions face some tough choices.

When higher education relies on the public purse for more than 60 per cent of its funding, it is right that universities make the case for continued public investment, if only to minimise the extent of cuts to come, says David Greenaway, economist and vice-chancellor of the University of Nottingham. But as he goes on to warn in our cover story: "If that is the only response, it is a strategy for decline and probably failure."

For those in charge of higher education, this is uncharted territory. There are of course no vice-chancellors in post who were leading an institution during the last major crisis, in the early 1980s, when an average of 15 per cent was cut from funding over three years. Greenaway sums up the current task succinctly: "Universities will have to review what they do, how they do it and who they do it with." Consultant Mike Boxall is much more blunt. The days of "entitlement economics" are over, he says, and universities "must stop simply asserting their special place in the new world order of higher education and demonstrate it in the terms expected by their customers and paymasters".

Both, however, agree that what is needed is successful diversification of funding streams and innovation in higher education offerings and delivery. One creative move Boxall praises is the establishment of university-based "learning hotels", where academics and practitioners work together at solving problems. Bed and mortarboard, anyone?

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A slightly more down-to-earth option to boost income is to recruit more higher fee-paying overseas students. Currently, the 350,000 international students being educated in our green and pleasant land bring in ?2.9 billion, some 13 per cent of the sector's total income, according to estimates by Universities UK. Even if public resources are reduced, institutions cannot afford to compromise the quality of their offering and endanger the reputation of British higher education abroad. An international fillip may seem an obvious choice when there are no financial penalties for over-recruiting foreign students.

But even as they rush to become more competitive, universities will still be funded in the main by the taxpayer, so they will have to continue to provide a public good. For Professor Greenaway, that means conducting research, especially blue-skies investigations, as this is something that the market would never do on the same scale.

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Another "good" is widening participation. It is admirable that universities have made progress on improving access for poorer students: the latest Higher Education Funding Council for England study shows that although there is still a huge gap in participation between the richest and poorest parts of the country, rates in deprived areas are rising more quickly than they are in more advantaged areas. But at what cost, and can the sector carry on doing it at the same level?

When it comes to delivering the goods or doing good, which will win out? That, in the end, may be the toughest choice of all.

ann.mroz@tsleducation.com.