Funding higher education: a view from Europe

Ben Jongbloed
Email: b.w.a.jongbloed@utwente.nl

Paper prepared for the seminar Funding Higher Education: A Comparative Overview organised by the National Trade Confederation of Goods, Services and Tourism (CNC) Brasilia, October 13, 2008

Center for Higher Education Policy Studies (CHEPS) University of Twente PO Box 217 7500 AE Enschede The Netherlands

Contents 1. Introduction 3 4 8 12 16 21 25 27 30

2. Funding and governance: two sides of the same coin

3. How much funding? 4. How are public funds made available? 5. What are the trends in funding mechanisms across Europe? 6. The composition of university resources in Europe 7. Concluding remarks References Appendix: Country Codes

1. Introduction Higher education in Europe is undergoing a substantial change. As the European nation states collectively pursue policies to integrate their economies, political systems and social structures under a broader, more powerful European Union, it is becoming increasingly clear that higher education is a critical component to fully realising Europes potential. This very idea has given rise to a series of ambitious goals and objectives designed to ensure long term European preeminence as both a knowledge producer and transmitter. Since the late-1990s the rate of change in European higher education has accelerated to unprecedented levels, largely on the shoulders of three key developments: the Sorbonne and Bologna Declarations (1998, 1999), whose objectives are to make study programmes more compatible across European systems, and the Lisbon Strategy (2000), which seeks to reform the continents still fragmented systems into a more powerful and more integrated, knowledge-based economy. The Modernisation Agenda (2007) highlights that education, research, innovation and the modernisation of higher education institutions are main pillars of the Lisbon Strategy. With around 4,000 institutions and 17 million students, the reality of higher education in Europe is necessarily diverse. Though the diversity within European higher education is regarded as one of its major strengths, a common path towards transparency, quality, growth, efficiency and excellence is regarded as an absolute prerequisite for making Europe one of the strongest education and economic leaders in the world. The Bologna Process aims to establish a European higher education area by 2010 and today 46 countries (extending from Europe to the former Soviet states) have subscribed to this idea. The Bologna process structures higher education in three cycles: Bachelor, Master and Doctorate (or PhD). The Bachelor degree is obtained at the end of the undergraduate level, whereas the Master and the Doctorate require graduate level studies. This process first focused on reforming study programmes into the two-cycle bachelormaster structure, but soon concerns about comparability pushed quality assurance, accreditation and degree recognition firmly into the policy mix. In March 2000, the European Union committed itself in the Lisbon strategy to the ambitious objective of becoming the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion. European policymakers intentions took on a more concrete form in 2002 when the more recognizable goal of raising EU-countries investments in R&D to 3% of GDP was outlined in Barcelona. Aggregate public investment in both education and research still lags behind that in the United States and it seems that EU member states abilities to make further investments are limited. The investments differ significantly across countries and even more so across subnational regions (Dill and Van Vught 2008). Although state investments in research have grown, industry contributions grew only marginally. As the mid-term evaluation report (EC, 2004) showed, the political Lisbon summit goals are very difficult to reach, partly due to weak economic growth in the larger member states and due to the fact that the design and the implementation of the policy actions rely on the member states and industry. Another mid-term review in 2006 on a similar note reported a gap between the political rhetoric about the knowledge society and the realities of political financial priorities (Dill and Van Vught, 2008). The Lisbon strategy got a restart with the New Lisbon Partnership for Growth and Jobs (European Commission, 2005) where knowledge and innovation for growth have been determined as one of the three main areas for action. Though it is widely recognised that securing alternative (i.e. private) revenue sources will be necessary in the years ahead to sustain the current capacity, the contemporary social view that higher education is primarily the responsibility of the State has made this a politically difficult option to pursue. For example, tuition increases may

find justification on efficiency and equity grounds yet many European parliaments are still reluctant to increase, let alone introduce, student fees (Jongbloed, 2004). It is against this backdrop that we wish to look at higher education funding in Europe. For the European states, funding is a major steering mechanism for their higher education systems. Funding mechanisms are closely linked to general policy choices concerning higher education (Jongbloed, 2004; Barr, 2003). As on all continents, in Europe governments remain the primary funding source for higher education institutions. And EU leaders cast a wary eye toward figures and trends showing that European investment in education and R&D, especially from private sources, is not pushing Europe towards parity with places like the USA but instead are showing an ever-widening gap. This has prompted the European Commission to call on member states to nearly double aggregate R&D investment and increase the share of industry sponsored research from 56% to 66% by 2010 (European Commission, 2002; 2005). This is easier said than done, as continued economic fluctuations have made it difficult for governments to provide incentives and subsidies that are capable of encouraging private investment in research and development. In the area of teaching, predominantly national policies towards cost sharing are sometimes met with skepticism due to fears of a decrease of access to higher education (Vossensteyn and Mateju, 2008). The Bologna Declaration, Lisbon Strategy and Modernisation Agenda have not been the only influences on European higher education institutions. In many Western European countries a series of reforms were already underway in the 1980s and many current reform initiatives have their origin in this period. The changing role of the state vis--vis higher education institutions (i.e. in the form of enhancing institutional autonomy and stressing quality assurance and accountability) are well-known themes in the last two decades (Neave, 1988; OECD, 2003; Eurydice, 2000; 2008). Globalisation, internationalisation and privatization have all done much to shape the current situation. Some examples are the growing importance of international profiling, international consortia, tuition fees, external research funds and the emergence of private higher education institutions. If, however, one seeks a common thread that links these larger developments to the current state of European higher education reforms, then few would disagree that it is the growing recognition that higher education sectors are both remarkably complex and not immune to the pull of the market. Having sketched these developments, the remainder of this contribution is structured as follows. The next section (section 2) will look at funding from the perspective of governance and steering: funding as one of the instruments to affect the behaviour of organizations and individuals and to try and make that behaviour work towards improving access, efficiency and quality in higher education. The section will also present some of the key questions related to the funding of higher education. Section 3 will present a discussion on the first key question: how much funding? In particular: how much public resources are made available and how much derives from private funding such as tuition fees? The section also presents some information for a set of OECD countries. Section 4 includes a classification of funding methodologies and looks at how funds are made available to the providers of higher education. Here the issues of marketisation and performancebased funding are discussed. Having set the stage, section 5 then includes a presentation of a great number of facts about higher education funding systems across Europe, as well as some trends. The relative sizes of the various public and private funding streams are presented in section 6 for a set of European higher education systems. The funding environment and revenue composition of the European university has changed substantially over the recent decades and this has had an

effect on the strategy of the universities. Section 6 points to some of the impacts of the changing funding environment on university strategies. Section 7, finally, returns to the debate on university reform that is currently going on in Europe. As indicated already, the European Commission plays a large role in the reform debate. This section presents some conclusions that are based on our observations of the trends in funding streams and funding methods.

2. Funding and governance: two sides of the same coin

However, funding (or financing) is more than merely a mechanism to allocate financial resources to universities and students. It is part of the set of tools and other governance instruments that enforce common goals set for higher education (e.g. access, efficiency), set incentives for certain behaviour (e.g. competitive research grants), and attempt to maximize the desired output with limited resources. Funding of higher education is not an end in itself. Rather, it is a means to an end; it is an instrument used by public authorities to affect the behaviour of an agent or an organisation say a spending unit. The funder (or budget holder) is expecting the spending unit to work on achieving particular outcomes. As a steering instrument, the funding mechanism is part of the governments toolkit. This toolkit contains four tools (Jongbloed, 2004): 1. regulation (rules, laws); 2. funding (subsidies, grants, taxes); 3. public production (provision of goods by government-owned providers); 4. communication (information, persuasion). Funding is one of the key intervention instruments for government (ministries, funding councils) as well as university decision-makers (Executive Boards, deans, department heads). In higher education, regulation is related to topics such as standards for the quality of degrees (accreditation), the number of students admitted to public institutions and the freedom of higher education institutions to charge tuition fees and engage in various kinds of other income generating activities. Governance issues and funding systems are therefore often two sides of the same coin. Having mentioned the possibility of governments to step into the market and to issue all kinds of regulation leads one immediately to the topic of deregulation. It is impossible for governments to monitor and centrally steer the activities of the managers and students in higher education institutions. It is no wonder then that many calls are heard to reduce the extent of government intervention and regulation. The growing complexity of our society strengthens the case for relying on markets to make the decisions (Jongbloed, 2004). Indeed the notion of less government and more governance is strong and supported by several factors (De Boer et al., 2006). However, as illustrated by the recent breakdown of financial markets, free markets are also not a realistic option for most sectors of economic activity. In terms of the industrial organisation literature (Scherer & Ross, 1990) this means that only a third best option is available. This option comes down to the leading principle of Competition where possible, regulation where necessary (Kay & Vickers, 1988). Such an approach takes into account that market failures may occur and that national interests may be at stake, calling for government regulation. This principle comes down to a repositioning of government and striking a balance between competition and

regulation. Such an approach may be interpreted as a step into the direction of a state supervising system (Van Vught, 1989) where more room is established for market-type coordination. In a more market-type coordination system it is individual (i.e. decentralised) decision-making by providers and clients that is essential. The diagram below (Van Asseldonk et al. 1999; Jongbloed, 2004) pictures the difference between a state control and a state supervising system. The left part of the diagram shows a traffic junction with traffic lights on all four corners regulating the flow of traffic. Creating acceptable queuing times requires substantial effort in terms of programming the traffic lights. One would have to first study the intensity of the traffic at that exact location, incorporate real time information on traffic flows in response to the duration of red and green signals, install traffic lights for pedestrian crossings, and prevent the lights from turning green all at the same time. This is our analogy of the state control model. Figure 1: Co-ordination systems: the crossing versus the roundabout

Source: Jongbloed (2004)

The right side of the diagram pictures our analogy of the state supervision model: a roundabout. There are no traffic lights and only one simple rule regulating the traffic flows. That rule is: the traffic on the roundabout has priority. This system of co-ordinating traffic flows does not require an extensive information system. The flow of traffic is much smoother compared to the intersection / traffic lights system. But whats more important is that those participating in traffic feel more in control and interact directly with other participants. This provides a different set of incentives for behaviour. In many European higher education systems one can observe market orientation, deregulation, liberalization, and performance agreements. The diagram below shows some important aspects of autonomy as experienced by universities in 14 OECD member states. The table shows that for this selection of countries there is lump sum funding, meaning that the institutions are free to decide on their internal resource allocation decisions. There is also quite a high degree of autonomy on the area of staff recruitment, but in most countries government still sets the level of the salaries. How much autonomy and monitoring universities need in order to meet societal expectations is an important funding issue when it comes to autonomy in internal resource allocation, but it is a larger governance issue in terms of the balance of responsibilities of the higher education institution and state. Funding is therefore not an isolated topic but needs to be seen in the context of a wider set of instruments to achieve the goals of higher education.

The notion of autonomy also extends to the possibility for universities to generate external funds, from business and industry as well as from tuition fees collected from students participating in continuous professional education. Autonomous universities may generate resources through fund-raising or through measures to increase efficiency and will have the freedom to orient their strategy according to the available funds, for example focusing on specific research themes or shifting the balance between education and research. However, national systems can leave quite different degrees of freedom to individual HEI in this respect; moreover, the composition of funds is likely to influence the internal governance of HEI, since some instruments, like most grants and contracts, are attributed directly to individual units and thus tend to strengthen their autonomy and strategic capability in respect to HEI directions. Table 1: Extent of autonomy experienced by universities

Source: OECD Education Policy Analysis (2003).

Some European countries increasingly treat their public service sector organizations as corporate enterprises with the goal to increase their efficiency and effectiveness by giving them more autonomy and at the same time asking for more accountability. There are a range of variations across sectors and countries and higher education is no exception (Pollitt & Bouckaert, 2000). Empirical evidence suggests that the rise of New Public Management (NPM), an organizational approach that supports the notion of public services being run as private businesses, has been influential in modernizing public services (de Boer et al., 2006). NPM is a generic tool for a set of instruments, rationales and changes that stress value for money, the introduction of (quasi) market conditions and, most importantly, the implementation of management by objectives through the use of explicit contracts where organizational performance is linked to budgets. The enhanced institutional autonomy for universities and the stressing of performance has meant higher levels of accountability as well as more stringent and detailed procedures for quality assurance at the state as well as institutional levels. This may be described as the rise of the

evaluative state (Neave, 1988). NPM approaches therefore seek to emulate a market-like environment for publicly-funded institutions but they come along with a different type of accountability. For the issue of higher education funding, the introduction of market or quasi market relations meant that competition for funding was increased in order to enhance efficiency and quality. In light of this, many universities have started to concentrate their research activities, trying to build up a strategic profile and reap the benefits thereof. These changes have been widely documented (Geuna, 1999; Kaiser et al., 2001; Jongbloed and Vossensteyn, 2001; Benninghoff et al., 2005) and are all considered to be part of a changing paradigm towards a different governance model of higher education (Teixeira et al., 2004). Universities have tried to enhance their competitive position and have sought to streamline their organization in order to cope with an increasingly complex environment. Developing institution-wide polices, always problematic because of higher education institutions fragmented character, strategic planning, and identity-building are now regarded as survival strategies. Higher education institutions are increasingly been made to act as corporate actors that act strategically, not only within their own organizations, but also externally in the sense of engaging in dialogue with their external environment and stakeholders. Caveats have also been repeatedly expressed on the risks of this market-like approach since it might favour short term applied research over long-term fundamental and strategic research. Other argue that there are no theoretical or empirical arguments that concentrating funds and research activities would lead to higher efficiency (Bonaccorsi and Daraio, 2007).

3. How much funding? Another factor that clearly shows the move away from direct government steering described in the previous section lies in the area of financing. The already high public expenditures can no longer keep up with the financial demands of continuously expanding higher education systems. Therefore, new financial steering instruments and a diversification of resources are required. We will now look at the question of how much funds are spent on higher education in the EU. But first of all let us ask the fundamental question of why should governments be willing to make public resources available to higher education institutions and their students? The answer is that the nations stock of knowledge and skills (its human capital) contributes to economic growth. Education in general also promotes important core values, attitudes and values in society. Moreover, a well-educated citizenry potentially strengthens the economic and cultural links that a country can have with other countries. Higher education is directly relevant to meeting these national objectives, because producing highly trained individuals and performing academic research increases a countrys capacity to absorb and adopt state-of-the-art technologies. This is relevant both economically and culturally to the broader regions development. Therefore, making funds available to higher education is a way of meeting these economic and cultural goals. How much of a nations productive capacity skilled labour, natural resources, foreign exchange, new construction can or should be devoted to higher education? How does the level of public resources available to higher education compare to other sub-sectors of education, such as primary and secondary education (Salmi, 1991)? What proportion of a nations youth should be expected to pursue some form of post-secondary education? In which programmes and for what degrees, and for how many years? How many universities should there be, and how many colleges, or other non-

university institutions? What should be their target enrolments? Policy-makers who try to find answers to these questions will inevitably be guided by their own ideas of what size and shape a higher education sector should have and what types of programmes are best suited to meet the human capital requirements of the country. Ultimately, the answers to these questions will have to be given by the Parliament. A crucial question related to funding is the extent to which the higher education system should be driven by manpower planning or whether the government can rely on student demand and student choice. This choice has important implications for the costs and design of the system and, clearly, different choices can and have been made here by different countries, depending on their economic wealth, ambitions and the state of development in their (higher) education sector. For instance, the Scandinavian countries and the UK have a closed higher education system. The government limits the number of places available to students that wish to study in a university (known as a numerus clausus system). On the other hand, in Belgium, Italy and the Netherlands access is generally unrestricted: all candidates that possess the right entry qualifications can get a place in a university. In the UK and in Germany there is a decentralised selection system, meaning that higher education institutions themselves set their own limits on the number of places available and apply their own procedures for selecting students. Decisions over the size of the higher education sector and the public resources invested in it may be informed by comparisons with countries having similar levels of economic and social development. A frequently used source for such information is the OECD publication Education at a Glance (OECD, 2008). Figure 2: Expenditure on Tertiary Education institutions (% GDP), 2005
3,0 2,5 2,0 1,5 1,0 0,5 0,0 Private expenditure Public expenditure

S G ER

PO R

IT A KO R

FI N

Figure 2 shows total expenditure on tertiary education institutions as a percentage of GDP and how much of this share originates from public sources and private sources. The figure shows that those countries that have been able to channel more than 2 per cent of GDP into tertiary education the United States, Korea, Canada all raise a substantial share of funding from private sources. Japan and Australia also have a high proportion of private expenditure. The average for the EU19

O EC

D EU 19

K ES P AU S

K SW E C AN PO L FR A

JA

is 15%, with the UK, Portugal and Italy having the highest share (respectively 33%, 31% and 30%). The latter is due to the existence of tuition fees. In its policy documents and tertiary education reviews, the OECD has often suggested that there is sufficient evidence for the private benefits to a degree and therefore a reason to implement increased student contributions. In particular, in continental Europe often students pay only a modest fee or no tuition fees at all (in the Scandinavian countries). This situation is shown in the top-left corner of figure 3 below. There are also no fees in many German universities, although nowadays quite a few have fees of 1,000 following in the wake of a recent federal court ruling that allowed the German states to introduce fees. In the other countries situated in this quadrant, average fees range around 750 (Belgium, Spain and Switzerland). Fees are much higher (around 1,800) in the Netherlands, with Italy and Portugal having fees of up to about 1000. Fees are also substantial in England, Australia, New Zealand, Canada and the United States. In some of these countries the level of the fee is set by the institutions themselves, often within bounds set by the government. Figure 3: Tuition policies

It is often stated that funding levels have stagnated or decreased in recent decades, especially if compared to the number of students. Figure 4 shows the expenditure per student in US dollars for the year 2005. The funding gap between Europe and its main competitors (such as the US and Japan) has also received a lot of attention recently. The EU has urged its member states to raise annual expenditure on higher education and thereby to increase the performance of the higher education sector across Europe. The research performance of Europes universities still lags far behind that of their US counterparts, particularly in the top 50 universities in the so-called

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Shanghai ranking. Increasing university funding and university autonomy are seen as mutually reinforcing factors in achieving this. Since public budgets are overstretched already in many countries, the extra funding would have to come from private sources, including tuition fees and research contracts for industry. It has been argued by a Brussels think tank recently that fees should be increased in particular for the masters level programmes (Aghion et al., 2008). In contrast to the undergraduate level of education, where free access at entry can work well if accompanied by suitable selection during the course of the BA programme, once students move to graduate education, then selection at entry should become the norm and the introduction of fees would be easier to justify, supported by scholarships, income-contingent loans, and teaching assistantships. Countries with better performing universities in terms of the Shanghai ranking (or more precisely the Shanghai Jiao Tong University Academic Ranking of World Universities) devote a higher fraction of their GDP to higher education. Similarly, better performing universities have higher budgets per student. The EU19 spends on average $10,474 per student versus $24,370 in the US. And within Europe, Switzerland, Sweden, Denmark, the Netherlands and the UK are countries with well-funded universities, whereas southern Europe has particularly large but poorly funded universities. Figure 4: Expenditure per student in 2005 (equivalent USD converted using PPPs)
25.000

20.000

15.000 10.000

5.000 0
U er S la nd SW E D K AU S N L U K G ER JA P FI N FR A ES P PO R IT A KO R PO L EC D EU 19 BR A

Source: OECD, Education at a Glance 2008 While it is often assumed that funding per student in Europe went down, the quantitative evidence for such a trend is rather weak (Salerno et al, 2005). Even if one considers the change in student numbers, more than two-thirds of the institutions in a sample of European universities studied by Salerno et al witnessed a real increase in total per-student revenues over the time period 19952003. The issue of the level of spending per student is principally one of faculty salaries, teaching loads, class sizes, equipment, and library expenditures for education. This immediately leads to the problem of what the real cost of a degree should be. Unfortunately, nobody will know the real cost of a degree, simply because pedagogies will differ across different educational institutions;

Sw i tz

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there is no uniform production technology in higher education. This means that there often will be a large variation in expenditure per student, even if different institutions receive the same level of funding to teach a student in a particular disciplinary field. Funding then can only be informed by a cost analysis but never be fully based on it. This conclusion is strengthened even by the fact that an analysis of the cost per student in different higher education institutions will be affected (or distorted) because of particular historical reasons (such as past decisions to open specialized study lines or study methods) and more importantly because of inefficiencies. Some (maybe even all) universities may simply waste resources and incur an unduly high cost. Other universities may argue that their costs are high because of the high quality education that they provide. This leads to the question of what is done to ensure that the maximum output is produced from the resources dedicated to higher education. This is an issue of productivity, efficiency and also lifestyle and ambitions. Should the latest, state-of-the-art techniques and equipment be used? Each nation (that is: Parliament) will somehow have to decide to which class the nation wants to belong within the boundaries set by its national resources and the tax levels it can afford. It may try to belong to the world class or it may choose to set more realistic aspiration levels for itself. In other words, the issue is very much a political issue, but one that needs to be informed by economic analysis of labour market needs and shortages, of externalities resulting from higher education and an understanding of the comparative performance of the higher education sector. Many nations have sought to reduce their public higher education spending per unit (in teaching and research) by encouraging higher education institutions to work more efficiently thereby increasing value for money. Institutions are, for instance, encouraged to take on more students through financial incentives and regulatory instruments or simply forced to contend with fiscal squeezing policies. Other measures include restructuring the higher education system through mergers and creating new types of institutions, such as universities of applied sciences dedicated to higher professional education. Reducing public spending per student has been carried out under the belief that institutions are able to find ways of working more efficiently and procuring supplementary, private funding to offset declines in public resources. Frequently government policies also express the belief that other areas and aspects of society (like health care, infrastructure and social security) have a higher priority than universities and require more resources. Any extra funds then will have to come from private sources. Therefore, the justification for fees is found in the private rates of return to higher education. In the end the issue of funding per student s very much a question of what are we (as a society) prepared to pay?

4. How are public funds made available? While the previous section argued that more private revenues are needed for (European) higher education, this paper would is also meant to put forward the argument that one cannot neglect the mechanisms through which public subsidies are being allocated to the universities. One cannot expect the solution for higher educations problems to come only from increased student (or graduate) contributions. The mechanisms for public funding contain important incentives to achieve higher educations three main goals, viz. quality, efficiency and equity. Bringing these incentives more closely in line with incentives to generate increased private resources for higher education would seem to be the goal to be achieved.

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We therefore turn to the public funding of higher education providers and the mechanisms (the funding models) that are used for determining the budgets that are distributed by the public authorities to the universities and colleges in the higher education system. Funding modes and funding models not only serve to allocate resources for given ends, they are increasingly being used as governance or management tools in situations where institutions operate in an environment characterized by an absence of competitive elements. Changes in funding mechanisms constitute a central package of measures related to public management reforms. At this point we stress that changes in funding mechanisms will often go hand in hand with changes in the other steering instruments. However, for this paper we limit ourselves to the instrument of funding. For the classification of funding mechanisms two questions may be used (Jongbloed and Koelman, 2000): 1. What is funded by the government? 2. How is it funded? The first question concerns the funding base for the government allocations to higher education institutions: Are the funds tied to educational outputs and performance, or rather to inputs? The second question relates to the issue of the degree of market orientation in the funding arrangements. Whose decisions actually underlie the observed flow of government funds to higher education institutions, or: what drives the system? The answer may be found by paying attention to issues such as: to what extent are funded numbers or funded (research and degree) programs regulated (or planned) by central authorities? And: do higher education institutions compete for funds (i.e. students, research programs)? Do they have the right to determine the level of tuition fees by themselves? Can they select their students? Question 1 can be rephrased as follows: What is the degree of output orientation in the public funding? When financial means are made available to institutions to cover distinct costs such as staff salaries, material means, building maintenance costs, investment, or so-called costs to continue, this is called input funding. If the budgets are driven by measures of activity such as the number of students enrolled in an institution, we also speak of input funding, because student numbers will largely determine the level of inputs spent in the instruction process. In contrast, in funding arrangements where institutional budgets are tied to specific teaching and research outcomes of the institutions activities we speak of output funding. Funding on the basis of output is believed to contain more incentives for efficient behaviour than input funding. If budgets depend on performance measures, there is reason to believe that those who receive the budgets will pay increased attention to their performance. Question 2 relates to the issue of market orientation in the funding arrangements. One of the characteristics of market orientation is the degree of competition implied by the funding decisions. Stated differently: Are funded student numbers or funded (research, degree) programs regulated (or planned) by central authorities or are the funding flows driven by the decisions of the clients (students, private firms, research councils/foundations)? The answer to this question may be translated into a measure for the degree of centralisation, distinguishing a situation of intensive government oversight and regulation from a situation in which consumer and producer sovereignty is large. At the extreme end of regulation the government determines the institutions resources centrally, for instance by prescribing the exact numbers of students in different programs. In the deregulated case, individual decisions made by students and education providers drive the system. Here, institutions have considerable latitude to operate as they see fit and institutions have a large autonomy over how funding is procured and spent. In practical situations the degree of centralisation (or market orientation) will lie somewhere between the two extremes.

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In figure 5 the vertical axis depicts the degree of (de-) centralisation and a horizontal axis expresses the degree to which governments are paying for the results (outcomes) instead of the efforts (inputs). We distinguish four quadrants (Q1, Q2, Q3, and Q4) to classify funding arrangements. Figure 5: Classifying funding mechanisms

We now provide a number of examples that relate to the four types of funding mechanisms. Q1: planned, input-based funding through providers The top-left-hand portion of the diagram represents a centralised system of funding. It shows a more traditional type of budgeting, where allocations are based on requests (activity plans, budget proposals) submitted to budgetary authorities. This is known as negotiated funding. In this mechanism, the budget allocation is often based on the previous years allocation of specific budget items. Separate budget items are then negotiated between representatives of educational institutions and the funding authorities (i.e., the ministry, or funding council). Annual changes (usually increases) in each budget item are treated individually, with discussion taking place on the basis of cost projections. In this case, budget items are likely to include categories such as staff salaries, material requirements, building maintenance costs, and investment. Funding is line item based, and shows the different expenditure items as separate lines of the budget. These line items are determined by referring to norms with respect to indicators such as unit costs (or unit cost rises) or capacity (e.g., funded number of students). The German and French funding systems still retain much of these characteristics. Q2: performance-based funding of providers Quadrant two (top right) is still a centralised system but now criteria on which funding is allocated refer to outputs rather than inputs. For example, in such a performance-based funding system a formula generates funds for institutions that are successful in terms of their students passing exams. Depending on the number of credits (i.e., weighted number of passed courses) accumulated by their students and the subject categories concerned, a budget is flowing to the

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higher education institution. This type of model operates in Denmark (taximeter model), while in Sweden a mix of enrolment numbers and credits determines the funds allocated to higher education institutions. In the Netherlands, a mix of the number of first-year students (freshmen) and the number of Bachelor- and Masters degrees conferred determines the funds allocated to the universities (see Jongbloed and Vossensteyn, 2001). Other examples can be found in the UK, where academic research is funded in proportion to a measure of research quality. Research quality is assessed and rated every five years (in Research Assessment Exercises). Q3: purpose-specific purchasing from providers A funding system located in quadrant 3 (lower right) is a market-oriented system. For example, higher education institutions are invited to submit tenders for a given supply of graduates or research activities. The tenders selected by the funding agency are the most price-competitive. In this tendering process, higher education institutions are encouraged to compete with one another to provide education, training, and research to meet national needs. Another example is research funds awarded by research councils. This system makes use of contracts signed between the funding agency and higher education institutions, with the latter agreeing to deliver graduates for targeted labour market needs, or research outputs targeted at strengthening the innovative capacity of the country. When entering into a contract, the funding agency will make sure it obtains the services it wants for a reasonable price. In this way the cost-effectiveness of the delivery is stressed. In the contract, both parties express that they will obey certain criteria. Only if these criteria are fulfilled, will the higher education institution receive core funding. The criteria may concern the types and qualifications of students admitted to the higher education institution, the (maximum) level of tuition fees (if any) charged by the institution, and the commitment made by the higher education institution towards its students in the instruction and teaching processes. Q4: demand-driven, input-based funding through clients In the last quadrant (lower left) the funding system makes use of vouchers. The core funds of higher education institutions are supplied through the clients of higher education institutions. Students obtain vouchers, which can be traded for educational services (i.e., educational consumption), at the higher education institution of their own choice. For the higher education institution the vouchers represent a certain value; they can be cashed at the Ministry of Education. Each (prospective) student is given a limited number of vouchers, representing a value, which can be used in a flexible way (during a certain period of time and for programs supplied by a given number of accredited or recognised education providers). In this funding system it is the consumer that drives the system; the system is demand-driven. The client (student) decides what institution to attend and what programs to enrol in. The higher education institutions must look after the quality of their teaching and their supply of courses, because unattractive programs will not receive sufficient funding. The voucher system can be combined - like many other funding variants - with a system of differentiated course fees. The higher education institutions then charge the students a certain percentage of the course costs. Tuition fees may be regulated to some extent by the government, but flexible pricing is expected to make students pay attention to the quality of the service they get from the higher education institution. Combining vouchers and fees may result in a system that is responsive to individual students demands. A research funding model situated in diagram Q4 would be similar to the research council example given for quadrant three, but in this case there would be more attention paid to basic research instead of research for which the outcomes are easier to specify.

5. What are the trends in funding mechanisms across Europe?

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Having made a general classification of funding mechanisms, it is now time to take a look at what has been happening in Europe in recent years when it comes to the actual funding mechanisms in place. Observing the national higher education systems in Western Europe, we will present some facts that underline our view that there has been a gradual clockwise movement from the northeastern quadrant (Q1) of Figure 6 towards the south-eastern quadrant (Q3). This move coincides with a trend towards steering from a distance or more self steering (as in the roundabout metaphor presented earlier see Figure 1). The result being increased reliance on market-type co-ordination mechanisms in the HE sector. In terms of Figure 6, decision-making is left more to individual agents (students, institutions) who choose on the basis of incentives instead of directives issued from above. Figure 6: Trends in funding mechanisms

centralised (regulated) approaches

Q1
input orientation

Q2
outcome orientation

Q4

Q3

decentralised (market) approaches

This marketisation trend affects both the established government-HE relationships as well as the traditional mode of operation within HE institutions. It is manifested, amongst other things, through increased competition for (both public and private) funds, the introduction of user charges, and a strengthening of consumer (i.e. student) interests. The aims of marketisation are to encourage institutions to operate more efficiently, to ensure they deliver value for money and raise the quality of their services, and to stimulate them into generating revenues from entrepreneurial activities. In the sector of higher education, governance and management traditionally has resorted to a system where the funding of the providers of higher education and research takes place mainly by indirect, formula-driven directives that are tied to inputs like student enrolments or staff positions (Q1 in the above graph). In recent years, we may witness the introduction of competition, user fees, and the stressing of performance-based funding (PBF; see Jongbloed & Vossensteyn, 2001). Rewarding performance through PBF changes the universities focus from inputs to outputs.

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In terms of figure 1, we observe a change where universities government appropriations (their core funding) are increasingly based on measures of institutional performance, using two options, or a combination of the two: 1. budgets are based on actual results, 2. budgets are based on projected results. An example of option 1 is where funding takes place according to a formula that is driven by the number of degrees or credits accumulated by students. An example that falls under the second option is the allocation of grants and contracts in a competitive process, such as through a research council that selectively awards project funds to proposals submitted by research groups. Yet another example that also is part of option #2 is the allocation of public funding in accordance with a performance contract. Performance contracts between individual universities and the relevant Ministry or Funding Council, define institution-specific (hence mission-based) objectives in line with national strategic priorities. Different performance-related measures exist to evaluate progress. Figure 7: Options for the public funding of higher education institutions (HEIs)

Public budget

Discretionary Incremental (previous years budget)

Contracts Mission-based (negotiations with indiv HEI)

Project funding (competing proposals)

Formula funding

Detailed agreements

Framework agreements

Cost based indicator driven

Performance oriented indicator driven

Demand (student) driven: money follows student

Supply driven: risk lies with HEI

These examples are also part of Figure 7 that shows different options for the mix of public funds: the traditional, discretionary approach on the top left side, the more transparent and uniform approach that makes use of formulas (shown on the right) and the options shown in the middle, that make use of funding contracts either with an institution as a whole (contract funding) or with individual researcher and research groups (project funding). Contracts with institutions as a whole can be either very broad, based on framework agreements, but can also be more detailed. In the

17

latter case they may become more similar to the traditional approach to funding where specific budget lines are negotiated with the public authorities in a system of line item funding. To give examples of funding criteria, table 2 contains some information for nine European higher education systems. One may see that there are quite a few countries that use output measures (credits, diplomas) as the basis for determining the size of the budget for the institution. A lot of countries make use of funding formulas to calculate the size of public grants for teaching and/or ongoing operational activity and, in certain cases, research. Parameters in the formula include input criteria and/or performance indicators.

Table 2: Funding of teaching in some European higher education systems Public funding based on: Sweden Denmark Flanders Germany Students; credits (within agreed upon capacity limits) Credits accumulated by students (taximeter principle) New entrants (no selection); credits; diplomas Previous years budget; number of students (loosely based on number of chairs awarded by state to each individual institution) Number of students (agreed upon with university) New entrants (no selection of students); diplomas Number of diplomas (agreed upon with institution) Input criteria (staff, m2, students but: staff on contract with ministry) Students and (in Valencia region) a contract-based part driven by selected indicators chosen by institution

England Netherlands Finland France Spain

Where table 2 is mainly devoted to Western Europe, the table below also shows information for the other European higher education systems. One may observe that higher education institutions in many (Central and Eastern European) countries previously driven by central planning have rapidly reshaped their funding mechanisms that were characterized by an extreme politicisation of funding decisions. These countries have moved away from central planning and control and many now use funding formulas instead of negotiations-based approaches. Table 3 is from a recent study by Eurydice (Eurydice, 2008). It shows for 30 European countries how the direct public funding of public higher education and the government-dependent private higher education takes place. The Appendix to this paper shows the explanation of the abbreviations used for the countries.

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Table 3: Main mechanisms for direct public funding of higher education in Europe, 2006/07

Additional notes to table 3:

Belgium (BE de): As of 2009/10, a new system for awarding operational resources will be introduced based on a budget proposal from the existing higher education institution, including all revenue and expenditure from the previous year. Belgium (BE nl): The means allocated in the past are considered in the funding formula to a certain extent. Czech Republic: Performance contracts and related negotiations concern only public HEIs at ISCED level 5A. For public institutions at ISCED level 5B, funding formulas are established at regional level. For public and governmentdependent private institutions at ISCED level 5B, it is possible to receive funding from the Ministry of Education to develop national objectives. Denmark: In 2006/07, performance contracts concerned universities only. In 2008, the 22 non-university HEIs, which merged into 8 institutions, will also be governed by performance contracts. Germany: Each Land defines the allocation method of direct public funding to HEIs. Ireland: The funding formula concerns universities, whereas the institutes of technology operate on the basis of budget negotiations. Funds are also granted to universities on a competitive basis for activities related to strategic national priorities. Greece: The introduction of performance contracts for universities was recently adopted by parliament but has not yet taken effect. Spain: Each Autonomous Community determines its own method of awarding direct public funding to HEIs. Luxembourg: Information not verified at national level. Austria: Performance contracts do not concern Universities of Applied Science (Fachhochschulen). Slovenia: Negotiations apply only to the investment part of the budget. Expenditure met by HEIs in the previous year is considered to a large extent in the funding formula. United Kingdom (ENG): Although most of the teaching grant is allocated by formula, with performance- related input, it is also subject to a funding agreement (or contract) specifying the volume of teaching activity to be delivered. The volume of teaching activity is defined in broad terms, except for quota-controlled subjects such as medicine and teaching, and in the case of funding for additional student places. The funding agreement specifies a target number of students in these cases. Iceland: Funding formula and performance contracts do not apply to the two HEIs under the auspices of the Ministry of Agriculture. Liechtenstein: The information about research funding relates solely to the Hochschule Liechtenstein.

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When it comes to tendencies that point in the direction of performance-based funding, we observe the following: For the Danish system, the teaching allocation, which on average makes up one third of the revenues of universities, is directly linked to the number of students who pass their exams. In the Dutch funding system, the universities teaching allocation is 50% based on numbers of degrees, and for its universities of applied sciences, graduation rates affect funding. In the research budget, performance elements such as Masters diplomas and PhD degrees are partly driving the funds per institution. While the funding of teaching activities in the Czech Republic is mostly input oriented (number of students, etc), output criteria such as the number of graduates have recently been introduced. In the German states funding is a mixture of historical, input and output-oriented allocation mechanisms (Gbbels-Dreyling, 2003; Leszczensky & Orr, 2004). Based historically on an input system (number of students), the Italian funding system nowadays is also partially based on output criteria related to research performance (through the introduction of a Research evaluation exercise). The Norwegian funding system allocates funds according to a formula based on a combination of a fixed component (60%) and components driven by results in education (25% - based on students credits and graduates) and research (15% - based on the number of publications). The universities in the UK receive a research budget that is based on quality evaluations established in periodic research assessment exercises (RAE). Turning to the line in table 3 that is dedicated to Funding for specific research projects, awarded in the framework of competitive bidding procedures, we note that all countries use instruments to allocate project funds to universities. Many countries have a research council that awards competitive project grants to academic research projects in universities. Often a dual mode for the funding of research is used by governments. This means that next to the core funding of academic research (the institutional, or direct funds) there is a second, competitive funding stream awarded by a research council on the basis of research proposals sent in by research teams. As far as the funding of research is concerned we also observe a trend of attaching new (additional) research funds to specific priorities selected by the funding authorities. In other words, while competitive research council funds still may be for original, curiosity driven projects, many governments are tying specific conditions and goals to new competitive funds. An example of the latter is the emergence of new schemes and research programmes for carrying out strategic research, such as centres of excellence. As we will see in the next section, the proportion of funds distributed through competitive grants schemes (e.g. research councils) is increasing relative to the funding allocated to formulas and other direct (core) funding schemes. Located in quadrant Q3 of figures 5 and 6, another trend that we observe is the use of contracts signed between public authorities and institutions. This is also a way of the government `buying a particular performance from the university. By way of example we make some comments on five countries: Czech Republic: Part of the universitys budget is distributed by contracts according to state plans and programs. Denmark: Since 1999 university development contracts have been established as an instrument in describing the tasks of the institution as defined by each university in consultation with the Ministry of Science.

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France: The university budget derives from a four year contract between the Ministry of Education and the governing board of the university. Switzerland: Most cantonal governments have introduced a contract with their university, even if the level is mostly based on historical considerations and some input criteria. Germany: Most states (Lnder) use contracts (Zielvereinbahrungen) similar to the Danish case to allocate certain parts of the budget.

Overlooking the funding mechanisms for the European higher education systems, we observe a large variety. While we observe a growing use of performance measures, there is as yet no uniformity in the choice of indicators. Use is made of the following performance indicators: number of (BA and MA) degrees, credits, graduation rates, success in winning competitive research grants, academic publications, and research evaluation outcomes. Little consensus seems to exist on the way to weigh the different measures. Maybe as a consequence of this, as well as to allow for some flexibility, we see an increased prominence of contracts and the allocation of project funds to encourage universities to work on particular types of performance. A related trend is the use of measurable performance indicators and output-based assessments to evaluate the way universities spend their public funds.

6. The composition of university resources in Europe In this next to last section we look at the composition of the revenues of European universities where some interesting changes may be observed. First of all we make some general observation on the revenues of the universities for a small sample of 8 countries. The sample was studied in the context of a European Commission-funded research project, called CHINC (Changes in University Incomes and their Impact on university-based research and innovation). This project was unique in the sense that funding data was collected directly from a set of 89 research universities and universities of applied sciences (Slipersaeter et al., 2006; Salerno et al., 2005). Building on institutional-level data from the CHINC project, some funding trends on the national level also become visible. These data must be considered with care, since the CHINC database covers only a sample of institutions, which in large countries Germany, Italy, Spain, UK is far from being representative. We focus on three revenue categories: government appropriations (say: core funding), tuition fees (student funding) and grants & contracts (competitive funding; project funding). 1. Government appropriations are still the dominant source of revenues in all countries except the UK. Their share exceeds two-thirds in all countries, except for the UK, that in 2002/03 displays a share of 37%. 2. Tuition fees are an important source of revenues in only three countries, i.e. Italy, Spain and the UK, while in the other countries fees account for a relatively small share of revenues. 3. The aggregate share of grants & contracts shows some variation between countries the lowest value being 10% in Spain, the highest 25% in the UK -, but most of the countries considered show a range of between 10 and 20%. 4. Over the period 1995-2003 we note a slight decrease in the share of government appropriations, no change at all in the share of tuition fees, and a general increase in the share of competitive grants & contracts.

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The set of graphs in figure 8 below illustrates these developments over the period 1995-2003 in the funding situation for our sample of 89 European higher education institutions. Figure 8: Evolution of main revenue categories by country in four years
% Government allocations UNITED KINGDOM SWITZERLAND SPAIN NORWAY NETHERLANDS ITALY GERMANY CZECH REPUBLIC 0 10 20 30 40 50 60 70 80 90 100 2003 2002 1999 1995

% Grants and Contracts UNITED KINGDOM SWITZERLAND SPAIN NORWAY NETHERLANDS GERMANY CZECH REPUBLIC 0 5 10 15 20 25 30 2003 2002 1999 1995

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% Tuition fe e s UNIT ED KINGDOM SWIT ZERLAND SPAIN 2003 NORWAY NET HERLANDS IT ALY GERMANY CZECH REPUBLIC 0 5 10 15 20 25 2002 1999 1995

Note: National aggregates are based on the CHINC sample. Government allocations for Spain are overestimated since they contain also grants and contracts. For Italy no data on grants & contracts are available.

Source: CHINC project (Lepori et al., 2005)

Table 4, taken from a study by the Bruegel think tank (Aghion et al., 2008), presents some more recent revenue information. The data is based on information from 66 European universities that are in the Top 500 of the 2006 Shanghai ranking. This means that the sample is biased towards the more research intensive universities in Europe. Table 4: Shares (%) of revenues for a sample of European universities, 2006 UK ES DE IT NL SE DK BE IE

SWI

Tuition and fees Government core funding Competitive research grants Other sources

23 35 21 20

16 62 10 13

1 73 22 4

12 63 12 9

7 68 15 10

0 60 34 6

0 70 19 2

5 65 21 9

32 38 18 12

3 72 18 7

Total

100

100

100

100

100

100

100

100

100

100

Source: Aghion et al., 2008. The table contains several interesting facts (see Aghion et al., p. 31): All countries have a share of public core funding of 60-70 percent, except for the UK and Ireland (IE). This fact is explained in particular by the high proportion of the budget coming from tuition fees in these latter two countries, even if southern European countries also have a sizeable proportion of their (relatively low) budgets coming from fees. By contrast,

23

The share of the budget coming from competitive research grants is typically 15-22 percent, with outliers being Spain (ES; 10 percent) and Italy (IT; 12 percent), and Sweden (SE; 34 percent).

These facts are very much in line with the conclusions from the CHINC study. What is somewhat hidden in the data (because it is included in the competitive research grants and other sources lines in the above table) is the fact that business funding of public research is clearly increasing in Europe, giving rise to new relationships between funding sources and research performers. An important issue is whether the changes in resourcing and resource composition have had an effect on the level of the individual university. What has come out clearly from studies like the above-mentioned CHINC project is that developments in the national funding environment are mirrored by developments inside the universities (Salerno et al., 2005). We now will reflect shortly on the implications of the funding reforms for higher education institutions, since, after all, it is in the individual universities and colleges that the core activities (teaching, research, community services) are carried out. From the CHINC study we highlight some of the strategies that were implemented in recent years by individual universities. Universities are: creating centers of excellence on selected strategic areas, to achieve critical mass and to build a profile for their institution making use of financial and budgetary instruments to reward performance strengthening their universitys centres steering capacity start to systematically collect information on research/teaching performance in order to have a better insight into their organisation have support facilities in place to help researchers in generating competitive research revenues and engaging in research commercialisation increasingly are devolving responsibilities for financial and personnel matters to the departments in their organisation putting in place more modern human resources management systems, such as a tenure track system engaging in linkages with the outside world (regional partners, local industry, small and medium sized enterprises). building alliances with other universities (at home and abroad) to work on joint research and joint degree programmes. These internal policies adopted in the sample of European universities studied in the CHINC project may be characterised as efforts of universities to behave as strategic actors (Bonaccorsi et al., 2007). Universities are trying to more clearly position themselves in the European research landscape. Some have developed a strategy of improving research performance through more interventionist research management practices, performance-based funding and selecting priority areas for research. Others are creating large (often multidisciplinary) research units where the best researchers co-operate and produce high quality output that has the potential to reap economic rewards as well. This is particularly relevant in a situation where unconditional government funding is on its way down. Introducing a performance-oriented internal resource allocation often will be complementary to income-generation strategies. Four types of institutional policies were explicitly mentioned in the CHINC study:

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Providing premiums or matching funds for departments that are successful in bringing in external funding/competitive research contracts. Allowing departments that generate research income to keep a substantial part of the earnings. Introducing a form of performance-based funding that rewards units/faculties/departments on the basis of research outputs. Giving greater visibility to institutes/individuals performance.

7. Concluding remarks The issue of higher education funding has multiple aspects: who pays for higher education (including the topics of cost-sharing in higher education and external funding to universities), how public funding is allocated to universities, what incentives the allocation mechanism creates, and how much autonomy universities have in decision-making over financial and human resources. Several funding models were presented in this paper. First they were considered abstractly and placed into a general categorisation, stressing the dimensions of performance orientation and individual (decentralised) decision-making. The higher education funding mechanism is an important ingredient in the wider spectrum of governance arrangements. Trends and practices in Europe increasingly point towards more market-based, or performance-oriented and decentralised types of funding mechanisms. European governments have shown a tendency to augment the direct funding of higher education institutions with competitive funding mechanisms and performance-based funding mechanisms. Alongside this, they have started to grant more autonomy to the institutions, allowing them to make their own decisions about the use of resources and the generation of new often external resources. The introduction or the increase of tuition fees has been one of the most widely debated issues in higher education funding (Teixeira et. al. 2006), but empirical work shows that, with the exception of UK, undergraduate fees do not yet cover a substantial share of educational costs in European countries (Lepori et al. 2007). Surveying the funding mechanisms in place across European higher education systems, we have shown that in most countries the allocation of direct appropriations occurs through a formula that uses a mix of input and to a lesser extent output criteria. Often student numbers are the most important criterion in the funding formula. Overall, we find that institutional budgets depend more on student choice and less on central planning, while for research budgets we observed that competitive funding has become a key allocation mechanism and accounts already for a substantial share of the universities revenues. Some governments have, next to the above developments, started to work with contracts. The extent to which such moves towards autonomy, performance contracts and performancebased funding have taken place naturally varies enormously across countries. In the first part of this paper we already mentioned the Modernisation Agenda of the European Commission, that calls for more autonomy, less fragmentation and stronger ties between universities and private partners. The Commission in one of its earlier communications on The role of the universities in the Europe of knowledge has stated that: The European university world is not trouble-free, and the European universities are not at present globally competitive with those of our major partners, even though they produce high quality scientific publications.

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And: European universities have for long modelled themselves along the lines of some major models, particularly the ideal model of university envisaged nearly two centuries ago by Wilhelm von Humboldt in his reform of the German university, which sets research at the heart of university activity and indeed makes it the basis of teaching. Today the trend is away from these models, and towards greater differentiation. This results in the emergence of more specialised institutions concentrating on a core of specific competences when it comes to research and teaching and/or on certain dimensions of their activities. (European Commission, 2003) The problems identified by the European Commission are the tendency of uniformity and egalitarianism in many national higher education systems; too much emphasis on monodisciplinarity and traditional learning and learners; and too little world-class excellence (Dill and Van Vught, 2008). The Commission notes a number of areas where action is needed, and raises a series of questions such as: how to achieve adequate and sustainable incomes for universities, and to ensure that funds are spent most efficiently; how to ensure autonomy and professionalism in academic as well as managerial affairs; how to concentrate enough resources on excellence, and create the conditions within which universities can attain and develop excellence; how to make universities contribute better to local and regional needs and strategies; how to establish closer co-operation between universities and enterprises to ensure better dissemination and exploitation of new knowledge in the economy and society at large how to foster, through all of these areas, the coherent, compatible and competitive European higher education area called for by the Bologna Declaration, as well as the European research area set out as an objective for the Union by the Lisbon European Council, in March 2000. A clear recommendation, also expressed in other EC communications, is the need for European governments to increase the autonomy of their national universities and revise their governance structures. However, this increased autonomy does not rule out a continuing important role for government. As always, this role lies in providing subsidies, promoting access, organising student support and ensuring quality assurance. On top of that, through introducing performance-based funding mechanisms and more competition will the government set different incentives that may help to achieve more differentiation in quality, funding and pricing in higher education. A mass higher education system requires a greater reliance on markets and their decentralised decisionmaking by individuals and institutions. Compared to many other fields in the economy, the sector of higher education and its students and universities can indeed be trusted to be capable of making good decisions. In the words of Nicholas Barr: The days of central planning are gone! (Barr, 2003). If we believe the European Commission to be right then competition and greater institutional autonomy will drive higher education institutions to become more sensitive to their varied consumers demands for relevance. It remains to be seen whether more countries in Europe will indeed take further steps along the marketisation route to modernise their universities.

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Appendix

30