The latest funding rise is too small to safeguard the proven excellence of Scotttish higher education, warns Anton Muscatelli. I will not be the only Scottish vice-chancellor disappointed at last week's Scottish Government's spending review announcement. The real-terms increase of ?30 million pounds over three years, or 3 per cent over that period, is much less than the ?168 million the higher education sector had asked for. Universities Scotland's original bid was carefully costed and committed the sector to raising a further ?170 million competitively from other funding sources.

While the full effects are not yet clear, it is impossible to see how we can increase the number of students as hoped, expand research as much as we planned, and make as big a step change as we wanted in knowledge- transfer work with business and industry. These are all about ensuring that Scotland maximises the economic benefit it gets from university research.

The consequences are potentially a major disadvantage for a sector that has been hoping for a measure of stability. We wanted an increase in undergraduate and postgraduate places because we believe that we need more graduates to meet future high-level skills needs. These increases are now in doubt, but our priority has to be to maintain quality.

Nevertheless, we must look forward from this announcement and decide what Scotland's ambitions are for its economy and hence its higher education sector.

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Higher education in Scotland is remarkably efficient as measured by outputs in relation to inputs, and there is a strong case to make that any further savings are likely to be at the expense of quality. The political consensus in Scotland remains that at present higher education should be publicly funded. Scotland invests about 1 per cent of gross domestic product in universities. The Nordic countries invest 1.4 per cent to 1.75 per cent, and the low-tax, low-spend federal government in the US still spends significantly more as a percentage of GDP on higher education than we do in the UK generally or in Scotland. Despite this lower rate of spend, by many measures Scottish universities deliver more than most of our Organisation for Economic Co-operation and Development counterparts in terms of student completion rates, research impact (as measured by citation rates), competitively won research funding and knowledge transfer (as measured by spin-offs and licensing activity).

Universities in Scotland are also less reliant on core public funding: on average 51 per cent of overall funding comes from the Scottish Funding Council. In the case of Heriot-Watt University, that figure is closer to 39 per cent, with 61 per cent coming from other sources. The sector should and will continue to develop these alternative funding sources, but we must ensure that we can do that without affecting our core mission, which is to generate and communicate new knowledge through our graduates and our research.

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Conversely, the higher education sector in Scotland is crucial to our economy. The importance of innovation to advanced economies, particularly small advanced economies, cannot be overestimated. Scotland outperforms the rest of the UK on the number of patents filed and granted per capita despite the fact that the industry research and development rate in Scotland is poor, and only because of research and development in Scottish higher education (Scotland has 8 per cent of the UK population, filed only 6.1 per cent of industry patents but 15.2 per cent of higher education patents). Thus, while the rate of innovation of Scottish business is well behind the UK, it is actually higher in Scotland overall. Higher education is Scotland's research base, and its universities are a real driving force for the economy. A healthy higher education research base may not be a sufficient condition for rapid economic growth but is a necessary condition.

That is in addition to the 210,000 graduates that Scottish universities produce every year, the consultancy and research services provided to business and industry and the fact that higher education in Scotland is a ?1.9 billion business in its own right. My own university has more students studying for its programmes outside the UK (10,700) than on our Edinburgh campus (7,000).

Scottish firms employ a higher proportion of science and engineering graduates, compared with the UK average, and make good use of them, with Scottish innovators being more likely to work closely with universities and research organisations.

The particular make-up of the Scottish economy means that its universities are vital to its research and development success and long-term wellbeing, a health warning we can only hope the Scottish Government takes on board. This decision could be to the fundamental detriment of Scotland's economy.

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Crucially, the question is what role we believe the sector should play in the country's economic strategy, and the nature and size of the sector required to fulfil this strategy. Funding decisions should be determined by an ambition to make Scotland competitive and not driven by short-term budgetary considerations.

Anton Muscatelli is principal and vice-chancellor of Heriot-Watt University, Edinburgh.