Australia will not develop the innovative economy envisaged by Prime Minister Malcolm Turnbull unless it stops rewarding mediocrity and ditches a culture of "every child gets a prize", the nation's most prestigious universities argue.

The Group of Eight universities – including the University of Sydney and University of Melbourne – is urging the federal government to fix the country's "broken" research funding system by targeting taxpayer funds at research judged to be of high quality.

Opponents say the Group of Eight's proposal would entrench inequality. Credit:Andrew Quilty

This includes a contentious push for $680 million in annual funding for PhD and master's research to be restricted to institutions rated at or above world standard in their chosen fields.

The change would hit suburban and regional universities the hardest, leading to warnings it would entrench the privilege of elite institutions.