Over the past few months, the Chinese government has been cracking down on many of its domestic industries. The most extreme case has been witnessed last week. It was reported that the government is completely banning the for-profit education sector.
Private education is big business in China, with the industry raking in $100 billion dollars per year in revenues. The crackdown is viewed as an existential threat for the publicly traded education companies.
New Oriental Education boasted a market cap of more than $30 billion dollars just a few months ago. It has since declined 90% and has almost achieved penny stocks status. TAL Education Group had a market valuation of more than $50 billion dollars at its peak in February. It has since lost more than 95% of its value.
Popular Reddit forum Wall Street Bets is paying close attention to the unfolding situation with TAL Education Group entering the top 10 tickers mentioned on the forum.
These are just two of the biggest publicly traded education companies, but there are many other examples. The general fear about the government’s crackdowns has tanked the entire Chinese tech sector.
China’s education system is extremely competitive because there are so many students competing for a limited number of spaces at universities. Education is taken very seriously and getting into a good university is viewed by many the only way to escape poverty.
To give their children an advantage, many parents hire private tutoring companies to provide extracurricular exam preparation. The cost of tutoring can range from thousands to tens of thousand of dollars per year.
In recent years, private tutoring has become almost ubiquitous and children will fall behind if they don’t do any extracurricular studying. This has forced poor families to spend exorbitant amounts of money on for-profit education. It has become something of a rat race with the studying culture becoming more and more competitive.
But, it has been great for the private education companies who make billions of dollars in profits every year. Besides a direct financial burden on families, the educational race also contributes to China’s decreasing birth rate. With the cost of education so high, most parents can barely afford just to raise one kid.
To sustain a level of population, the average couple must have at least 2.1 kids. The fertility rate has declined significantly over the past 20 years as a result of the one child and later the two-child policy.
Recently, the government has been concerned about the population becoming too old and relaxed restrictions to allow three children per couple. But most parent can’t afford to have three kids anyway even if it is allowed. This is a big problem as it means the population will continue to age.
The crackdown on for-profit education is likely an indirect way to boost the lagging birth rate. The question now is how far will the government be willing to go with this crackdown? And will it be successful at reducing educational expenses for families?
The current reporting is that the government will ban these companies from making any profit which will obviously make their shares worth nothing. The stock market seems to be pricing in a pretty high probability of this actually happening and shares are down close to 90%.
According to draft regulations seen by the Financial Times, the Chinese government will require existing education companies to register as non-profits and no new education agencies will be allowed to open. They would ban education companies from raising money through IPOs. They will also establish official guidelines on how much tutoring classes can cost to make sure the companies can’t make any profits.
The Chinese for-profit industry is worth an estimated $100 billion dollars and employs well over 1 million people. New Oriental Education alone employs almost 100,000 people. Shutting down these companies overnight seems rather unlikely as this would cause a massive increase in unemployment and be a major hit to economic growth.
It is possible they could let the companies keep operating but just not making a profit. They could charge prices barely enough to pay the tutors salaries and other expenses. This would allow most of the employees to keep their jobs but the stocks would be worth nothing.
It is also possible they could water down the proposed regulation such that the companies are still allowed to operate profitably. It’s very hard to predict exactly what will happen because the government may change the regulations before they are implemented.
China is not the first country to crackdown on for-profit education. South Korea had a similar crackdown in the 1980s. Similar to China, South Korea has a highly competitive education culture and parents spend huge amounts of money on so-called Cram schools. Throughout the 70s, Cram schools would price gouge the students. They would often bribe teachers at real schools to pass along answers to upcoming exams.
They would give answers to the paying students at the Cram schools and give them an unfair advantage. In 1980, South Korean President Chun Doo Hwan banned the for-profit Cram schools saying it unfairly burdens poor family with high fees and creates inequality. The ban was widely considered to be a failure because wealthy parents just hired private tutors for their kids at home.
Also, many Cram schools continued to operate in secret. When there is so much pressure for the kids to get into top universities, parents will almost always find a way around the regulations. In the 1990s, the courts ruled that the ban was unconstitutional and the for-profit Cram schools were once again allowed to operate.
While there have been some regulations limiting class hours and tuition fees, they had proved hard to enforce in practice and most Cram schools operate with impunity.
If China does ban these for-profit education companies, it would seem unlikely to stem the problems of low birth rate in exorbitant education spending. Similar to what happened in South Korea in the 1990s, Chinese parents will likely hire private tutors which may even be more expensive than the current after school classes.