In 1997, the Irish Government took a bold and controversial decision. As New Labour implemented the recommendations of the Dearing report in the UK, forcing British undergraduates to pay tuition fees for the first time, Ireland moved in the opposite direction and scrapped them.

A decade on, Irish higher education institutions are agitating as the impact of a funding shortfall grows. Although the Government offered universities a grant in lieu of their lost fees, this income stream is gradually being reduced, leaving Ireland's vice-chancellors cash-strapped.

In an open letter to the Government published in The Irish Times in March, University College Dublin president Hugh Brady and Trinity College Dublin provost John Hegarty hit out at the lack of funding available to the sector.

"Investment in education is not a tap which can be turned on or off as circumstances require without deep or long-term impact. Failure to invest now will place an entire generation of students and the future of this country at a serious disadvantage," they write. "To gamble with our future in this way is, simply, wrong."

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The letter continues: "Education is the key to our future and investment in the creativity, skills and talent of our people will always pay dividends. The difference today is that our recent economic success has irrevocably raised the bar in terms of the standards we need to achieve, the global benchmarks we must match and the level of investment required to do so."

Although Ireland has only seven universities, the sector has international influence beyond its size. And it is growing every year: between 2000-01 and 2004-05, enrolment in higher education overall increased by 17 per cent. Undergraduate admissions increased by 7 per cent, despite a decline in the school-leaving age cohort. In the two decades since the 1980s, the proportion of Irish school leavers attending college or university has increased from 35 per cent to 55 per cent.

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The growth in student numbers is one of the "great success stories of modern Ireland", according to Ned Costello, chief executive of the Irish Universities Association, the sector's umbrella organisation.

The sector's growth has also been encouraged by a rising appetite for research. Between 2000 and 2007, business expenditure on research and development increased from €1 billion (?792 million) to €1.6 billion.

Universities have become a focal point of research investment. Under the Government's national strategy for science, technology and innovation for the years 2006-13, more than EUR8 billion will be spent on research and development.

"Government policy aims to ensure that Ireland's production base, and the technology sector in particular, is underpinned by an increasing emphasis on Irish-based research and development," Costello says.

Irish universities have reinvented themselves since the millennium, with previously fragmented departments coming together to form academic schools where related fields of study are grouped together.

"The past decade or so has been a time of massive change and development in the universities. The system has effectively managed to restructure itself, expand the scope of its activities and cater for increased student numbers, while maintaining its quality," Costello says.

So far, so positive. But like the rest of Europe, Ireland is facing a downturn. The country's recent economic success was built on unprecedentedly low interest rates, a buoyant property market and government policies attracting profitable high-tech manufacturing companies to the country. Many of these advantages are now waning, and concern is being raised about a loss of competitiveness and the vulnerability of the Irish economy.

And although funding for higher education has increased in real terms (as Mary Hanafin, former Education Minister, claimed in her response to Brady and Hegarty's open letter), as a proportion of gross domestic product it is still lagging behind Ireland's major competitors.

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New funding streams introduced by the Government in 1997 are not covering the gap created by the abolition of tuition fees. It is feared that under these conditions Irish universities will be hard-pressed to produce the graduates the country needs to remain globally competitive.

As the IUA's Costello explains: "In simple volume terms, the total level of resources going into the system has increased, and it has done so at a relatively rapid rate. However, as with most areas of public expenditure in Ireland, this reflects the transformation of the economy and the process of catch-up that Ireland is playing relative to its GDP peers, the majority of whom have a much longer history of economic growth and capital accumulation.

"Clearly, that process of catch-up has some way to go. On a per-student basis, it is significantly below that of countries having broadly similar GDP per capita," he says. "The very heavy dependence of the publicly funded higher education institutions on the Government's purse leaves limited scope for manoeuvre. Now that Ireland is moving from a period of exceptional GDP growth to levels more in line with European norms, it is hard to imagine those government purse strings being loosened," Costello says.

With high aspirations but falling revenues, Ireland is at something of a crossroads in its education policy. Politically, changes are already afoot. The appointment in May of a new Taoiseach, Brian Cowen, does signal a new opportunity, if not necessarily a new direction. The Fianna Fail leader and head of Ireland's coalition Government has spoken openly about the importance of education to Ireland's future development as a nation and as an economy.

"I take some comfort from the new Prime Minister," says Tom Boland, chief executive of the Higher Education Authority, the funding authority for Irish universities. "At the very top of government, the value of education is understood. Education will get its due recognition."

One of Cowen's first acts was to promote Batt O'Keeffe, a former lecturer at the Cork Institute of Technology, from Environment Minister to Minister for Education and Science. He takes up the role at a challenging time. The Government's policy is to aim for a 70 per cent participation rate by 2020, which would equate to 7,500 additional entrants into higher education each year. Where is the funding for this policy going to come from?

"Government is the obvious source for that funding. Whether the Government can afford to do it or not remains to be seen," Boland says. "Everybody says the major contributor to (the Irish economic boom) was our education system, and we continued to invest at a time when it didn't seem profitable, when graduates were emigrating.

"If it worked in the past, then I think we have to stand by our rhetoric and say that it will work for us in the future as well. If there are more choppy economic times ahead, education should be guaranteed," he says.

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Realistically, according to university leaders, the funding to plug these widening gaps cannot all come from the state. In fact, additional funding may not even produce the results one would hope for.

"It's a fact that by international benchmarks Ireland's higher education system is relatively underfunded," Boland admits, "but you could also see us as more productive. There is some evidence internationally that better funding doesn't necessarily lead to a better education system."

Nevertheless, a funding deficit exists. Dublin City University is the newest of the Irish universities, having achieved full university status in 1989. It is a research-led institution under pressure to find new ways to meet its financial needs.

"While the volume of funding has grown strongly, it has been significantly outstripped by the actual growth of (Irish) universities, so that both teaching and research are funded below cost," says Dublin City University's president, Ferdinand von Prondzynski. "In teaching, the grant per student has decreased noticeably, while research is funded at a level that does not yet recognise the full economic cost. Therefore each of these activities needs to be subsidised from other revenue sources, putting university strategies under extreme pressure."

Von Prondzynski has responded to this challenge with a programme of commercialisation, looking for other revenues from a variety of sources and capitalising on the intellectual property of the institution's academic staff. "This has had some success, and has kept us out of deficit, but it is not the long-term solution for the sector as a whole," he says.

However, he believes that only the return of student tuition fees or an increase in funding for research programmes will actually address the gap.

Personally, he advocates the return of fees, however politically unlikely such a move may be. "The abolition of fees did not produce some of the desired effects (such as widening participation), and has arguably led to the taxpayer disproportionately supporting middle-class families, while neglecting to give more targeted support to the disadvantaged," he argues.

"One of the main risks we face is that no improvement will be forthcoming because the government may feel that the necessary steps will be electorally risky. But action is needed very urgently, as we are at risk as a sector of sliding into serious debt," von Prondzynski says.

Other institutions are focusing on capitalising on the income generated from international and postgraduate students. Culturally this seems to make sense, with immigration to Ireland still on the rise and, as student numbers grow, graduates increasingly choose to gain further qualifications to stand out from the crowd. The Government is keen to promote postgraduate education as a way of ensuring that the country continues to make a smooth transition from a production-driven to a knowledge-driven economy.

The growth in the numbers of postgraduate students over the coming years is expected to be so significant that specific funding is being allocated by the Higher Education Authority to help universities support a new generation of postgrads and postdocs, who will also be expected to graduate with a more comprehensive range of skills.

"There is a very clear need to deliver on numbers of PhDs and therefore numbers of supporting staff by 2013," Boland says. "Our programme is very specifically focused on the physical infrastructure and development to accommodate those numbers. There has been a very strong sense from the world of work - from industry and business - that although our graduates, in particular at PhD level, are very good, their readiness for work isn't as it should be. More generic skills are lacking in our graduates."

Michael Murphy, president of University College Cork, believes that improving postgraduate provision will secure its future as an institution. "It is government policy; as an institution we're expected to deliver on policy," he says. "Beyond that, there are other issues. We recognise that the economy and society are demanding higher-skilled individuals. The complexity of business and social and political life demands that added value from education, so doctoral students are in demand."

Murphy is also committed to internationalisation - both the recruitment of more international students and expanding overseas - for which the "economic argument is just one". Of course international students bring in high fees, but there are other benefits.

"I'm very conscious of the fact that our graduates are going to work in a global economy and it's very important that during their formative years they're exposed to diverse people and cultures, and that's a good reason for diversifying the campus," Murphy explains. "If you look back historically, Ireland has punched way above its weight globally, partly because of the diaspora and because of the impact of 150 years of missionaries travelling to deliver education. I think it's hugely important that we retain this role for education as a means to ensuring global political influence," Murphy says.

University College Cork is also working with other institutions to boost the status of Irish higher education internationally. Together with the University of Ireland in Galway, UCC is planning to open a new campus in Asia.

Murphy believes this kind of partnership is the first step towards a series of mergers, or a federalist structure bringing Irish institutions together to remain competitive on a global scale. "I think that's inevitable," he says. "Ireland is a country of 4 million - we really only have room for two universities. For a country of our scale we're going to have to have a more managed sector."

But these are concerns for the future. While 85 per cent of funding for higher education comes directly from the Irish Government, achieving a healthy, thriving and globally attractive sector is a major challenge for the seven university provosts and presidents.

"Autonomy is the major determiner of the success of universities globally. Dependency on a single source undermines our autonomy and our competitiveness," Murphy says. "It's time to reopen the discussion."

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IRELAND BY NUMBERS

The Republic of Ireland's higher education sector includes:

• 7 universities: University College Dublin, Trinity College Dublin, Dublin City University, University College Cork, the University of Limerick, the National University of Ireland, Maynooth and the National University of Ireland, Galway
• 19 technology colleges (there are no plans for these to receive university status)
• 55,000 undergraduates
• 15,000 postgraduates
• 12,000 non-EU international students
• 55 per cent of Irish school leavers go on to third-level education
• 85 per cent of funding for higher education comes directly from the Irish Government
• Two Irish institutions appeared in the 2007 QS/Times Higher Education World University Rankings: Trinity College Dublin (53) and University College Dublin (177)
• Tuition for EU-domicile undergraduates is free. The average cost of undergraduate tuition for non-EU students is EUR12,000 (?9,600) per year for courses in arts, business or law, EUR16,000 (?12,800) for science and engineering.