Last week’s spending announcement is welcome news. Total government funding for colleges will rise from pound;4.4 billion in 20023 to pound;5.6bn in 20056. This has been advertised as a “pound;1.2bn boost”.

It is more accurately described as a plan to increase budgets by 8.5 per cent a year for three years. Allowing for inflation, it is a real-terms increase of 6 per cent a year.

In all, the plans confirm seven years of sustained growth in post-16 public spending from 1999-2006. This boom followed the three-year bust from 1996-99 and may be followed by a further bust in 2006. Chancellor Gordon Brown confirmed on Wednesday that public finances are now much tighter than they were a year ago.

The cash is impressive but the differences come in the distribution plans. For the past four years, the Department for Education and Skills made budgets conditional on a 1 per cent efficiency gain by saying that x per cent extra cash delivered x+1 per cent more activity.

One per cent was positively generous compared to the 5 per cent expected between 1994-99. Colleges made strenuous efforts to achieve annual 5 per cent efficiency gains but could only do so by driving up lecturer hours and by mass-producing worthless funding units.

Tough targets produced perverse outcomes. The 1 per cent efficiency target was proposed by the Dearing report and set a more reasonable objective but only if pay could be limited.

The college sector spends pound;2 in every pound;3 on pay and faces cost pressures as a result of pensions, national insurance and the difficulty retaining staff. With many colleges running deficits, employers and unions had reached a stand-off over pay. Last week’s announcements have improved the climate by creating the possibility for a longer term settlement.

The loosening of strings from the DfES allows the Learning and Skills Council to offer a 3.5 per cent budget increase to every college in 2003-4. Flexibility also allows the LSC to reserve future money to reward “excellent colleges”.

Excellence will be assessed with reference to development plans agreed between the LSC and college. There will be a reward for colleges which exceed targets for participation, employer engagement, student success and lecturer qualifications. The details will be worked out in the next few months in what the LSC hopes will be a new atmosphere of trust, following acceptance of the bureaucracy taskforce recommendations.

The new funding method will still count students but involves a nice change of emphasis. The current system involves a six-month wait at the end of year until the auditors have checked every last exam result. The new model is expected to involve less accuracy but faster action.

The LSC wants a partnership with colleges so that it can meet its targets more effectively. It still has a contract with the Treasury promising results in exchange for money. The overall aim is to use public spending to deliver a skilled workforce.

Partnership between the LSC and colleges makes their aims collective. Colleges will be expected to use their development plans to improve student results and deliver more courses for employers.

Student results need to improve to meet the qualification targets for young people. A changed economy and education maintenance allowances have made it easier for colleges to recruit 16-year-olds.

The challenge now is to get them through level 2 and level 3 qualifications. The focus with employers will inevitably be on the LSC’s new adult qualification. By 2006, 1 million workers are expected to acquire level 2 qualifications.

Employer leadership is key but colleges will be part of the solution. The key to the new model is a new relationship. For several years, government agencies have been offering colleges various deals: “Do this, and we’ll pay you.” This time, it’s a marriage proposal: “You get some security but you’ll have to forego some independence.”

Increased dependence on public funding is one price of the new approach. Colleges with employer engagement targets will need employers more than the employers need them. Fees will adjust accordingly.

While all this is going on, the DfES is preparing a skills strategy and reviewing adult learning funding. This is almost certainly going to conclude that adults and employers should pay more.

Higher fees for adult learning would fit in with the developing policy on higher education funding and would help make the budgets look balanced.

The review finishes in July 2003 and will help the Government plan the next three-year spending round starting in 2005. In other words, it is an issue for the longer-term, timed for implementation when public finances get tough.

After three years of partnership, an independent source of income may be needed again. Enjoy the honeymoon but keep your bank account separate.

Ted Wragg, Friday magazine, 2 Julian Gravatt is finance director at the City Lit, London