The traditional three-year degree could be coming to an end as the Government dramatically reduces higher education spending.

The announcement of the cuts, which will see £518m lopped off university funding next year, provoked an outcry from vice-chancellors, students, lecturers and opposition MPs last night.

Sally Hunt, general secretary of the University and College Union, which represents lecturers, said: "We will see teachers on the dole, students in larger classes and a higher education sector unable to contribute as much to the economy and society."

Key elements of the plan, outlined by the Business Secretary, Lord Mandelson, include a shift away from the traditional three-year degree to two-year courses.

In addition, universities that recruited more students in the autumn than ministers had budgeted for will face fines of £3,700 per extra head.

One estimate indicated that 22,000 additional students were taken on as demand for places reached an all-time high because of the recession. Universities were allowed to recruit 10,000 extra undergraduates because of the increased demand. Even so, about 130,000 students eligible for a clearing place failed to find one in the summer.

Lord Mandelson made it plain there would be no repeat next year and reduced the funding for higher education from the £7.8bn grant for 2009-10 to just under £7.3bn for 2010-11.

This, coupled with the fines, lowers the Government's chances of meeting its oft-stated aim of recruiting 50 per cent of young people into higher education courses, though ministers will hope that introducing more two-year courses might be enough to achieve it.

Vice-chancellors will now put more pressure on the government review into top-up fees to increase the current cap of £3,240. They have already indicated that they would like to see it doubled to more than £6,500. The review is due to report next year, after the election.

Research funding – which helps the more selective universities like Oxford and Cambridge retain world-class research contracts – is to be maintained.

In a letter to the Higher Education Funding Council for England, which is responsible for allocating university cash, Lord Mandelson said he wanted more programmes "such as foundation and fast-track degrees that can be completed full-time in two years". He added: "Over the next spending review period [to 2014], we will want some shift away from full-time, three-year places towards a wider variety of provision."

Professor Les Ebdon, chairman of the university think-tank million+ and vice-chancellor of Bedfordshire University, said the shift towards two-year degrees was "tinkering with the edges".

"Two-year degrees work for some students, who do not have to fund themselves with part-time jobs," he said. "They will only be offered by a limited number of universities for a small number of courses."

Examples of two-year degree courses already running include one for higher level teaching assistants at Stroud College in Gloucestershire and a fast-track nursing degree at King's College London for those with a degree already.

In his letter, Lord Mandelson went on to warn that any further over-recruitment next autumn could again provoke fines. The £3,700 is equivalent to the average cost of providing one student with teaching and access to facilities for one year.

The Conservatives immediately attacked the Government for fining universities that were trying to meet its own target of getting 50 per cent of young people into higher education. Even with the increase in student numbers allowed by the Government this autumn, the overall participation rate remains at around 43 per cent when, ironically, because of the demand created by the lack of employment prospects, ministers had a realistic chance of nearing the 50 per cent target for the first time this year.

"We now have the bizarre situation that universities are being fined for meeting targets set by this Government," said David Willetts, the Conservatives' universities spokesman.

Lord Mandelson's letter described the extra 10,000 places this year as a "one-off". However, Mr Willetts said: "In contrast to Lord Mandelson, who is restricting access to university... we will be offering an additional 10,000 extra fully funded university places to enable more young people to enter university next year."

Wes Streeting, president of the National Union of Students, said the cuts "will sound chimes of doom for existing students in cuts-hit universities and for talented school leavers set to fail to secure a university place".

Professor Steve Smith, vice-chancellor of Exeter University and president of Universities UK, which represents all UK vice-chancellors, said: "A reduction in the public funding per student could seriously threaten our ability to offer the high-quality experience our students deserve and expect."

Wendy Piatt, director general of the Russell Group of universities, which represents 20 of the leading research institutions in the UK, welcomed the commitment to retain research funding, but added: "With other countries investing more, not less, in their leading universities, we are in danger of losing our international competitive edge."

Making contacts: Mandelson's university days

*When Peter Mandelson went to St Catherine's College, Oxford, in 1973, no one seriously expected the life of an undergraduate to be all study and no socialising.

Oxbridge students, particularly, were part of an elite, for whom the friends and contacts they made were as important as their degree. Mandelson had to resit the exams he took at the end of his first year, after spending too much time running the university's United Nations Association. This setback did not deter him from going on to be a leading light in the university's Labour Club. He emerged from Oxford with only a second class honours degree, but the contacts he made – including Charles Clarke and Benazir Bhutto – were more valuable to his future. The one contemporary he missed was Tony Blair, who was more interested in rock and religion than politics.

_Independent