Step back from a busy shopping street in Liverpool's city centre and walk through a set of glass doors, and you will find yourself in the spacious atrium of Fact, the Foundation for Art and Creative Technology.

Ahead is the box office, selling tickets to blockbuster and art-house films in its three-screen cinema. Glance to one side, and you may see an art installation: a few months ago, it was a turf-covered telephone box piping birdsong. From this month, a series of vegetable cell cultures grown in vitro are on display. Carry on and you will find yourself in the cafe - all chrome and cappuccinos and humming with laptop activity. Or take a stroll around two galleries of media art, or have a drink in the upstairs bar where, if you are lucky, you will happen upon a poetry evening.

This scene contrasts sharply with all-too-familiar images of the poverty, dilapidation and political strife that have haunted Liverpool for the best part of 30 years.

Instead, the scene belongs to a new Liverpool: the city of regeneration, and the 2008 European Capital of Culture. A brighter future is being constructed in Liverpool, and it is a future being driven and shaped by the city's three universities: Liverpool, Liverpool John Moores and Liverpool Hope.

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The contribution of higher education to regeneration nationally is impressive. It is worth ?45 billion to the economy when all the secondary industries that rely on universities and colleges are taken into account, according to universities' lobby group Universities UK. That dwarfs the pharmaceutical industry and places higher education close behind the legal and financial services industries in terms of economic clout.

Universities and higher education institutions employ close to 350,000 people directly - including 165,000 academics - and, counting the jobs provided in industries that serve and supply higher education, the total number of full-time equivalent jobs generated by higher education exceeds 550,000.

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But nowhere in the UK is higher education's power for good more clearly demonstrated on all levels - economic, social and cultural - than in Liverpool.

In fact, so closely linked with the fortunes of their city are the universities of Liverpool, Liverpool John Moores and Liverpool Hope that people are genuinely stumped when they are asked to imagine what the city would be like without them.

Alan Moody, director for regional development at the University of Liverpool, has a go: "It wouldn't be competitive, it wouldn't attract investment, it wouldn't keep people," he says. "I can't think of any modern European city of significance without a university presence, and a research presence as well."

The only way Kelvin Everest, deputy vice-chancellor of the University of Liverpool, can conceive of a university-less Liverpool is to think of the summer months, when about 30,000 students disappear, leaving many of the restaurants and bars empty and the streets noticeably less busy.

But the impact and influence of the city's universities goes far beyond crowded pubs and high-street footfall. "They pour money and vitality into the place," Everest says.

The three institutions employ some 9,000 people directly, with up to 10,000 other jobs supported indirectly. The trio are worth up to ?1 billion to the local economy in terms of income generated by staff and students.

The European Capital of Culture accolade has helped with money and vitality. For this too, Liverpool's universities can take some of the credit.

The vice-chancellors of Liverpool and Liverpool John Moores sit on the board of the Liverpool Culture Company, which was set up to deliver the city's cultural programme leading up to 2008 and beyond.

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Both universities also have major building programmes due to finish during the Capital of Culture year. The University of Liverpool will this summer open the iconic Victoria Building to the public for the first time as the Victoria Gallery and Museum. Liverpool John Moores' ?23.5 million Art and Design Academy will open around the same time.

The University of Liverpool is to host this year's British Association Festival of Science, as well as the Shipping Lines Literary Festival, and its collection of film footage of Liverpool in the 1900s by Sagar Mitchell and James Kenyon will be shown to the public in St George's Hall in one of the highlights of 2008 for film buffs. The university is also sponsoring artist Ben Johnson's panoramic painting, The Liverpool Cityscape.

Meanwhile, Liverpool Hope is holding a global youth festival, The Big Hope, which aims to bring together 1,000 young people of faith from across the world. Liverpool and Liverpool John Moores have been working together on a research programme to judge the effect on the city of the whole Capital of Culture year.

Without the universities, the audience for all the Capital of Culture events would have been far smaller too.

Of the city's 444,500 population, 50,000 are university students. Then there are other people attracted by the universities.

With 5,000 employees, the University of Liverpool is the second-biggest employer in the city after the council. Research conducted for the university in 2004 found that for every 100 full-time equivalent jobs in the university, a further 36 were created in other industries in the North West, and 62 more in other parts of the UK.

In addition, delegates from all over the world attend university-run conferences, parents visit the city to see their student children, and recruiters attend university recruitment fairs. All boost the number of people enlivening the city streets, hotels, restaurants and entertainment venues.

Increasingly, recruiters are not trying to entice graduates elsewhere. Instead, companies set up bases in or near the city so they can be near a steady supply of graduates skilled in the areas they need.

Mark Basnett, director of investment at Mersey Partnership, which promotes Liverpool as a place to develop businesses, says: "The fact that we have three universities and 50,000 students is a central part of our pitch to demonstrate to employers that they have the skill sets available here to sustain their high-value activities."

Liverpool's universities have been an integral part of its fortunes almost since it was granted city status in 1880. The Victoria Building, the original "redbrick university", was established in 1892 by civic leaders who realised that the city could only be really successful if it invested in high-end knowledge and knowledge generation.

The university's expertise in medicine - particularly tropical medicine - developed because Liverpool shipowner Alfred Lewis Jones was concerned about the threat of disease to his employees and profits alike, and pledged funds to establish the Liverpool School of Tropical Medicine. Its expertise in orthopaedic surgery stemmed from the need to treat injured dockers - and to send them back to the docks fit to work.

When the Atlantic sea trade collapsed, the university was one of the places where things were kept going, says Everest. "We were still bringing in students and were recognised as internationally important."

He concedes that there have been times when the university consciously dissociated itself from the city because of its down-at-heel reputation. The riots, chronic unemployment and political upheavals of the Eighties were not ideal for student recruitment, while the economic climate in the following decade made for continued caution.

"We were a very prudent organisation in the Nineties," says Everest. "We have made a conscious decision to be more risk friendly and do things that are more eye-catching and nearer the front of the picture."

Hence the extensive building programmes, and the keenness of all three universities to get involved in every aspect of city life from its economy to its health and culture.

And while the universities cannot take all the credit for the city's resurgence - generous grants from European Objective One funding, and news that the Liverpool Docks were to receive World Heritage Status also came in handy - their ever closer involvement has coincided closely with an upturn in Liverpool's fortunes.

In any case, it is impossible to divorce even these other sources of help entirely from the universities, which were closely involved in the bids for European money.

"In today's world, it helps a city to have a university that's focused on generating knowledge, and which is transferring knowledge through students or directly through research collaborations," says Moody. "That helps to influence the character of a city. Without that it would be a poorer place. Knowledge is the currency these days and, increasingly, (it is also) the currency internationally."

This story is not unique to Liverpool.

John Goddard, deputy vice-chancellor and professor of regional development studies at Newcastle University, has identified what he calls the "re-emergence of the civic university".

Most of the big civic universities were born out of their local communities, were sponsored by local business and government, and developed specialisms related to the needs of the local economy.

But as their funding came increasingly from national government, universities began to detach themselves from their communities and to concentrate on responding to national rather than local economic needs.

The expansion in student numbers following the Robbins report of 1963 meant that higher education needed more space, and new institutions such as York, Warwick and Sussex found it on campuses outside the city. Established institutions, including the University of Nottingham, followed suit. Even those that remained inside the city centre, such as Newcastle, made it clear that their focus was on blue-skies research rather than social involvement.

But in the Nineties, Goddard recalls, there came a return to localisation. Suddenly businesses woke up to the fact that universities had a lot to offer - not least their contacts all over the world. At the same time, universities realised that their success in attracting staff and students depended, in part, on the quality of the local environment.

Goddard, who submitted a report on universities and communities to Lord Dearing's review of higher education in 1996, is now joint co-ordinator of a project funded by the Economic and Social Research Council and funding councils looking at the impact of higher education institutions on regional economies.

He says that, since Dearing first asked the question of what universities' local involvement should be, it has become a hot topic at every level in higher education, with work under way by the Department for Innovation, Universities and Skills, the Leadership Foundation and the Russell Group, as well as by individual institutions, many of which are appointing senior personnel with responsibility for community engagement.

David Watson, whose book Managing Civic and Community Engagement was published last year by McGraw Hill, says: "The penny is now dropping that you can have an international reputation by being a very effective regional or local player."

He identifies several other reasons for universities showing renewed interest in what goes on in their communities.

First, universities are bigger than they used to be. This means that they inevitably have more impact on their surroundings. More students means not only more people on the streets but more demand for accommodation, shops, entertainment and transport. While this boosts the local economy, and can offer other benefits such as publicly accessible art galleries and sports grounds, it can also cause resentment. Residents of the cities of Nottingham, Leeds and Brighton, among others, have complained that the "studentification" of certain areas has distorted the housing market and driven out locals.

Second, more students than before are locals. More are studying while living at home, and many are mature entrants, with families, jobs and social links that make it difficult to divorce student life from other kinds of life in the city. This trend has been encouraged by the Government's drive for universities to engage in widening participation, which means that most institutions now run projects with local schools and further education colleges.

At the same time, traditional students studying away from home are drawn into local life more than they would have been in the past by the need to work part-time and, increasingly, by their involvement in volunteering activities. A survey carried out by the University of Cambridge last year found that, in 2005-06, more than a million people benefited from voluntary activities undertaken by university staff and students, worth an estimated ?4 million to the community.

Then there is the impact of government policy, from its focus on the regions to its emphasis on the skills agenda and knowledge economy in response to competition from countries such as China and India.

The 2003 Lambert report highlighted the way the economic importance of universities had grown as more traditional industries had declined. Lambert's argument for closer links between universities and business was taken up by Lord Leitch in his 2007 report into the UK's long-term skills needs.

It is an agenda that Liverpool John Moores has embraced, as is shown by its new Graduate Development Centre, which aims to arm students with "world of work" skills, developed in concert with firms such as Marks & Spencer, Ford and Shell.

Stroll through the wide lobby, where entrepreneurial students or graduates can meet business contacts on comfortable sofas; glance into the computer suite where they can practise psychometric tests; or visit interview cubicles where they can experiment with interview techniques while being recorded on video. The experience is more akin to entering a newly fitted-out set of city offices than a university building.

This is deliberate. Liverpool John Moores wants to be a university where its graduates are able to move smoothly from study to employment, and preferably employment in Liverpool.

"It's all about how we create the new industries in Liverpool," says Michael Brown, Liverpool John Moores' vice-chancellor. "That is, the industries that are high value, with high intellectual content, that grow and stay here, and where company headquarters stay here, as opposed to moving to London."

The benefit to the university of this offer is that students want to study there, lured by the promise of jobs and a lively place to spend three years. For industry, the benefits of linking up with a university range from a ready supply of skilled employees, to consultancy services, access to new research and equipment, and even a supply of customers. Without university input, some businesses would not exist at all.

Take Business Bridge, a brokerage service set up jointly by the three Liverpool universities and the University of Chester. Through the scheme, small and medium-sized enterprises - and now some larger companies - are put in contact with students who have the skills they need to carry out specific projects.

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Particularly in demand, according to Paul Redmond, head of careers development at Liverpool John Moores, are students' web design and marketing skills, often a weakness for small businesses, and a particular strength of the university. In 2000, it set up an International Centre for Digital Content, devoted to collaboration between industry and academia in generating multimedia products.

In a graphic illustration of how universities are filling gaps once occupied by industry, the digital content centre is located on a site previously occupied by the telecommunications equipment business Marconi, which closed in 2005 with the loss of hundreds of jobs. As well as developing digital technology in research, the centre provides a "business incubator", which has been responsible for assisting in the launch of more than 30 companies over the past four years.

Meanwhile, around 350 students a year pass through Liverpool John Moores' Student Enterprise programme which, according to Christopher Leyland, head of commercialisation, is about keeping entrepreneurial graduates on Merseyside. In fact, the aim is for this programme to attract back to Merseyside alumni who have worked elsewhere and are thinking of setting up on their own.

"It is a good way of playing a part in economic regeneration," says Leyland.

He estimates that Liverpool John Moores has between 400 and 500 different contacts with companies over a year, from offering academic expertise and use of equipment to continuing professional development. Food manufacturers rely on them for product testing, and the city's football teams come to them for tests on everything from their sportswear and footballs to fitness.

But small businesses aren't the only ones to benefit. Large employers such as Jaguar and Ford rely on the engineering research and graduates that come out of the universities. Liverpool Science Park, which replaced a derelict building beside the city's Catholic cathedral two years ago, attracted 22 new companies within its first year of operation.

Without the universities, the city's thriving service sector - now responsible for most growth in economic activity - would also struggle.

Research by the University of Liverpool in 2004 showed that its 10,000 students from outside the North West spent about ?58 million off-campus in the previous year, while academic visitors spent a further ?280,000. In all, university activities generated nearly ?373 million of output in the North West alone.

"The jobs a university creates are high-value jobs," says Moody. "A region can only be successful if it is employing people and paying rates that will make them spend."

Students' and graduates' willingness to spend means that this year, Liverpool's city centre will see the opening of Liverpool One - a ?1 billion shopping centre development by property developer Grosvenor that has attracted big-name retail businesses, such as John Lewis and Debenhams.

But the universities' contribution is not all about money. It is also about health: the city's hospital relies on graduates and researchers, and many of the students who study medicine as undergraduates stay on to practise in the region. Nutrition and fitness projects, such as monitoring childhood obesity and planning programmes such as after-school cookery clubs, are often university-run. The universities' sports facilities are all open to the public.

It is also about social interventions, through research projects, volunteering and mentoring school children.

John McCarthy, director of marketing at Liverpool Hope, where about 40 per cent of students are local, says that by working with Catholic and Protestant community groups his university has played an important role in helping to bring together a city that has been split along faith lines in the past. It has also contributed to healing social divisions. "The fact that we work closely with faith schools means we are reaching to the heart of communities that wouldn't necessarily have thought of higher education before," he says.

Through Urban Hope, a wholly owned subsidiary of the university with expertise in widening access, regeneration and enterprise, Liverpool Hope has been involved in the Sure Start programme to help young children, a family and lifelong learning centre, and a centre for community enterprise.

The university's links to research institutes in India, meanwhile, offer students from Liverpool Hope the chance to experience life and learning in a completely different culture, and to bring those experiences to bear when they return to work as managers or social workers back in Liverpool.

Finally, the three institutions' contribution to the city is about culture, too. Michael Brown, vice-chancellor of Liverpool John Moores, is chair of the Everyman Theatre Board, and all three universities have links with local television and radio stations as well as art galleries.

So let's try to imagine what Liverpool would be like without its universities.

First, forget the redevelopment. Even those for which university building programmes are not directly responsible are likely to disappear because the local economy wouldn't demand them - replace them with crumbling industrial buildings and boarded-up windows.

Next, forget the Capital of Culture year. There wouldn't be the audience, the venues, the accommodation, the buzz to sustain it. Forget the incomers and foreigners - well, many of them anyway. Although Liverpool has always been outward-looking thanks to its port, without the universities it would have lost many of its international links.

You can forget the new shopping centre, and most of the bars, new hotels, and restaurants - there wouldn't be the conference trade or spending power to sustain them. You can certainly forget the Foundation for Art and Creative Technology. And you can forget many of the people walking the streets - they wouldn't be there, and those left would be older, fatter, more unfit and much poorer.

You may even have to forget decent football, something dear to the hearts of many Liverpudlians. Liverpool FC and Everton FC work with sports scientists from Liverpool and Liverpool John Moores universities.

Liverpool is a unique city with a particular set of issues and problems. The roles played by the city's universities are tailored to its needs.

At the same time, it is a microcosm. In cities and regions across the UK, universities are playing similar roles in education and skills, as engines of regeneration and wealth creation, and catalysts for cultural and social change.

No other industry carries the transformative clout of higher education. It changes lives on an individual scale and is increasingly a major player in terms of the national economy.

It is clear from the speeches of successive education ministers that the Government is aware of the power of higher education and values its contribution to society.

And although many universities are increasingly independent of the state for their income, it is to be hoped that Government continues to support higher education adequately, safe in the knowledge that it is worth every penny ... and then some.

UNIVERSITIES' CONTRIBUTION TO LIVERPOOL

THE University of Liverpool

Number of students: 18,305

Number of staff: 4,900

Annual turnover: ?304 million

Research income (not including Higher Education Funding Council for England block grant): ?79 million

Industry partners: 560

Consultancy contracts: in the region 321

Total income from consultancy contracts: in the region ?4.8 million

Total estimated contribution to the local community: for every ?1 million of institutional output, a further ?1.52 million is generated in other sectors of the economy.

The university estimates that in the city of Liverpool, it supports a total of about 5,010 full-time equivalent jobs and ?365 million in income.

Total student volunteers: 1,459. Students volunteered in more than 170 different projects across local voluntary and community organisations and schools in Merseyside last year.

LIVERPOOL HOPE UNIVERSITY

Number of students: 7,500

Number of staff: 950

Annual turnover: ?46 million

Total value of university consultancy: ?2.8 million

Total estimated worth to the university: ?138 million

About 150 staff are engaged in voluntary work of some sort.

LIVERPOOL JOHN MOORES

Number of students: 24,000

Number of foreign undergraduate and postgraduate students: 2,740

Number of staff: 2,335

Annual turnover: ?140 million

LJMU has established more than 40 spin-off companies and is now spinning off ten per year.

It offers more than 200 short courses and continuing professional development programmes.

Based on research by Regeneris Consulting, the university generates an estimated 2,940 FTE jobs and ?283 million in income for Liverpool.

The university's Roscoe Lecture, a free public event, is attended by about 10,000 people every year.

The university has staged eight exhibitions in its new Albert Dock gallery, Site, established in February 2007. To date, they have have attracted about 20,000 visitors.

In the five years that the staff and student volunteering schemes have been running at the university, more than 500 staff and 800 students have participated.

HASTINGS: A TEXTBOOK CASE OF EDUCATION DRIVING REGENERATION

When University Centre Hastings opened in a former BT telephone exchange in 2003, it was as an explicit part of the town's regeneration project.

Managed by the University of Brighton in partnership with other local institutions, its goal is to provide opportunities for both young and mature students and to establish a solid educational base for the town on which local business can draw. The core idea was that the increase in student numbers would also boost the local economy and make for a more culturally and socially diverse community.

"We have education-led regeneration going on here," says Peter Pragnell, the leader of Hastings Borough Council. He says the atmosphere in the town is already beginning to change, and is likely to change further after 2009 when a multimillion-pound development of expanded facilities for Hastings College is due to be completed.

Noticeable developments include the renovation of a derelict building almost opposite the University Centre that has been made into high-quality office space, and the Jerwood Foundation's recent announcement of plans for a new art gallery. "Hastings town centre is getting very cosmopolitan," says Pragnell.

He says that at University Centre Hastings' graduation ceremony last year, he was struck by the number of students who "would never ever have dreamed of having a university-level education but had read about it in the local paper or had heard about it and were taking a course". Some had literally walked in off the street and signed up for courses, he says.

But the pace of change is slow. In spite of millions of pounds of regeneration money, Hastings moved from 39th to 29th in a list of the UK's most deprived towns last year, while the percentage of residents claiming Job Seekers' Allowance is more than twice the average for the South East as a whole.

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Pragnell says this is why skills-led regeneration is so important, and he is confident that it will eventually deliver more and better jobs to Hastings. It just cannot be expected to deliver instant results.