An education for investors

Angela Merkel has visited China no fewer than 12 times since becoming German chancellor in 2005. Ties between the two nations’ economies are tight and the Chinese have sometimes seemed to taken lessons from the German experience, never more so than in the ‘Made in China 2025’ initiative of 2015, which was said to have been influenced by Germany’s launch of ‘Industry 4.0’ for its manufacturing sector three years earlier. During one of Merkel’s trips to China in 2015, the Chinese openly acknowledged their planning blueprint was inspired by the Germans.

Of course, Beijing’s cadres no longer champion ‘Made in China 2025’ – having come to the conclusion that the 10-year industrial plan was one of the major catalysts for the trade and tech rows with Washington.

But this has not stopped the Chinese from learning from Germany’s experience. Recent actions by Beijing to clamp down on the internet and private education sectors have also spurred discussion among local analysts about ‘the German model’. So to what extent are Chinese planners weighing up the ‘Germanisation’ of China’s economic strategy?

How has Beijing reined in the private education sector?

We reported last month that the Chinese government had stepped up oversight of the private education sector. We noted that in what some saw as the worst-case scenario, the new approach could see after-school tutoring services prohibited during weekends and over the school holidays (see WiC546).

This has now happened – but the worst-case scenarios didn’t capture the full extent of what policymakers were planning. Last weekend the government released its latest round of directives on the tutoring sector and the new rules were much tougher than most anticipated.

In a set of guidelines announced on July 23, the Chinese authorities said they would be introducing a strict approval and supervisory system for off-campus tutoring programmes that offered national curriculum subjects such as mathematics and physics.

Local governments will be instructed to withhold business licences for new tuition centres, while existing ones must be registered as “non-profit institutions”. Besides being barred from offering courses during the school holidays, the tutoring platforms will also be banned from going public and raising further capital from either listed firms or foreign funds.

The broad-based overhaul included some minute details intended to allow China’s students more free time and to reduce the financial burdens of private education on their parents. “Students who can’t finish their written homework after hard work shall go to bed on time,” one guideline demanded. Online tutoring firms must pay attention to protecting student eyesight and each class cannot last for more than half an hour.

Nine major cities including Beijing, Shanghai and Guangzhou – the biggest markets for Chinese edtechs except Shenzhen – have been selected as pilot cities to implement the strict new guidelines.

How has the market reacted?

The fast-growing sector boasts some listed edtechs and privately-held unicorns but the new rules have basically killed off their growth prospects. Doors to private equity fundraisings and stock market IPOs have been slammed firmly shut.

The result was an immediate meltdown in the market values of the edtechs and after-school education providers listed in New York and Hong Kong – an investable segment that some had earlier valued at more than $100 billion.

New Oriental, which raised about $1.3 billion from a secondary listing in Hong Kong in November, dropped more than half in market capitalisation last Friday when news leaked of the draconian new measures. The slide continued this week. Year-to-date, the market value of the New York-listed firm has plunged 90% to about $4 billion.

Most of its counterparts including TAL Education and Koolearn Technology have suffered a similar fate.

In a statement, New Oriental said that the new rules will have a “significant adverse impact” on its off campus tutoring services as it vowed to comply with the diktats.

Private tutoring schools will also be forced to scale down their cramming operations that prepare Chinese students for national exams such as the zhongkao (the entrance test for high schools) and the gaokao (the entrance test for universities). Instead they will be pushed to turn their focus to extra-curricular streams. As a result the share prices of piano and music instrument makers have soared over the past week on anticipation that the tuition providers will try to make money introducing their students to non-academic subjects.

The unexpectedly robust reform of the sector reminds investors again of the policy risks shadowing Chinese stocks – especially the internet platforms listed in the US and Hong Kong, which have experienced the brunt of regulators’ forceful tactics recently (see WiC548).

Most importantly, given that foreign investors are now banned from investing in the education sector, companies including New Oriental will need to undergo a painful restructuring. Shanghai Securities Daily reckons the changes will deal a fatal blow to some of the weaker service providers, who will be cut off from most of the previous financing channels and wholly dependent on the cash generated from the parts of their business still permitted by the Chinese authorities.

So what does the edtech crackdown have to do with the Germans?

China provides nine years of free compulsory education, covering primary school and junior middle school. Beyond that tens of millions of students have to sit the zhongkao and gaokao to compete for positions in higher levels of education.

According to data from New Oriental, 17 million children were eligible for the zhongkao in 2019. About 10 million, or 60% of them, went on to take the gaokao. Private educational groups set out to help these students (and their parents) prepare for the brutal talent-screening tests. But breakneck growth in the sector, fuelled by aggressive capital market activities, is now being blamed for undermining another major policy shift – the implementation of the Three-Child Policy (see WiC543 and this week’s “Economy”).

The rise in private sector cramming schools has had a further impact in clouding the competitive simplicity of the gaokao system. Buoyed by expectations that they will hone their exam-taking knowhow, more students than ever are striving for a place at university (with an increasing number retaking the entrance exam if they fail first time around).

This has led to a huge expansion in university student numbers in recent years. Millions of additional aspiring graduates have found their way onto campuses, with a significant proportion finding jobs in the service sector – in areas like supporting China’s fast-growing consumer economy or figuring out new ways to monetise social media platforms.

However, the underlying trends shaping China’s tertiary education system for more than a decade are not necessarily as well suited to the staffing requirements of programmes like the Made in China 2025 initiative. Indeed, the call for more skilled workers has become more pressing as policymakers push for national self-sufficiency in key industrial supply chains such as chipmaking.

As a result the government has been putting a much heavier emphasis on vocational training in lieu of the continuing expansion in tertiary education (aka the number of university places). In April, as scrutiny of the off-campus tutoring schools increased to a new level of intensity, Chinese President Xi Jinping called for efforts to speed up the development of a “modern vocational education system” in order to cultivate a new generation of high-quality, technical professionals.

Few countries do vocational education better than the Germans. And according to Xinhua, deepening cooperation in the field of vocational education was a key medium-term goal of the China-Germany strategic partnership signed between Xi and Merkel back in 2014. Seven years later that theme has leapt very much back onto the agenda with some of the Chinese government’s most recent announcements and acts.

Is China copying from the ‘German model’?

The moves against tutoring institutions and a host of online education platforms can also be seen as part of Beijing’s efforts to lessen the influence of the big internet and tech firms. Ant Group saw its dual listing plan for its fintech business kiboshed last November and the market was shocked once more when Didi was slapped with a data security probe and other punitive measures only days after its $4.4 billion IPO in New York in June.

Tencent, the biggest Chinese internet firm by market value, is coming under increasing pressure as well. The State Administration for Market Regulation (SAMR) vetoed a proposed merger of leading eSport broadcasters Douyu and Huya – both listed in the US and both backed by Tencent (see WiC550) – this month. Over the weekend the same regulator was busy again, fining Tencent Rmb500,000 for unfair practices in the online music market. Tencent controls more than 80% of China’s music streaming rights after buying out competitors in recent years. But SAMR has instructed the company to drop its exclusive licencing deals with record labels.

Tencent’s most popular messaging app WeChat – used daily by around a billion Chinese – also announced on Tuesday it was temporarily suspending registration of new users in China as part of work it was undertaking to comply with “relevant laws and regulations”.

Meituan, the country’s most popular online food delivery platform, ran into problems shortly after when a number of central government agencies published a directive about safeguarding the ‘basic rights’ of gig workers, including millions of Meituan’s riders (see WiC539).

According to the new guidelines, online platforms must now ensure that contracted delivery workers earn more than the mandatory minimum wage. Internet firms were also warned against relying on algorithms that place ‘unreasonable demands’ on their riders.

The policy salvos against both the edtechs and internet majors have led some observers to ponder the longer-term goals of the measures. Many have come to the conclusion that the campaign isn’t short term or cyclical – so not akin to the loosening and tightening of monetary policies or real estate sector rules – but instead represents a more fundamental shift in the nation’s broader economic strategy.

In a widely circulated WeChat post this week – based on a recent presentation by a strategist from local brokerage Soochow Securities – it was claimed that the Chinese government was making a conscious decision to turn away from “the American way” to “the German way”. One implication: reducing some of the emphasis on services and the consumer economy, and a refocusing on higher-end manufacturing and the value-adding sectors of the industrial economy.

The services sector was a key plank of the two most recent Five-Year Plans (and services grew to over 50% of the Chinese economy last year). But more recent policy blueprints, including the 14th Five-Year Plan, seem to have de-emphasised any mention of the ‘contribution ratio’ of the service sector, Soochow Securities notes. Instead, the State Council’s government work report (which came out in March) made a lot more mention of the importance of ‘smart’ manufacturing to GDP growth.

“What is this major trend all about? This is about reducing the profit and monopoly of real estate, finance, education and the internet, as well as the economic costs imposed by these sectors on the real economy and the people’s daily lives,” Ren Zeping, chief economist at Soochow Securities, wrote on his widely-followed weibo account last week.

Smart manufacturing and vocational education are the two ‘Germanic’ areas Ren says we should watch. But keep an eye out for other similarities to the German model. The Hong Kong Economic Journal agreed that some of the Chinese government’s recent housing policies, especially in curbing home prices and protecting tenant rights, look strikingly similar to the German experience too.

Ich bin ein Berliner?

Perhaps the high-profile Ren and his colleagues at Soochow Securities are exaggerating the Sino-German comparison in a bid to make their point.

The way they have teased out a change of direction from recent policy announcements is already being challenged by critics as a little too dogmatic. Other analysts have dismissively highlighted how Ren was formerly chief economist at China Evergrande, a real estate developer mired in all sorts of financial trouble (see WiC550).

Like most brokers, Soochow Securities doesn’t always get its calls right either. In another widely discussed research report – this time from 2017 – it strongly recommended Xinwei Technology as a proxy for China’s rise as a superpower. At the time Xinwei was believed to be involved in a host of ‘national’ projects ranging from satellite launches to the construction of a $40 billion canal in Nicaragua (see WiC350). But Xinwei has proved to be anything but a superpower-proxy. Instead it’s on a list of firms at the Shanghai bourse threatened with exit after incurring years of losses.

“Understandably observers are second-guessing China’s fundamental strategy as turning to ‘the German way’, although both countries are simply not comparable given the huge differences in population and developmental stage,” the Hong Kong Economic Journal added. “China will not simply take on the ‘German way’ or the ‘American way’ but most likely its own way.”

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