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China’s crackdown on the online education business marks a turning point

July 31, 2021

TO GET RICH is wonderful, Deng Xiaoping is supposed to have said. “Getting as rich as Jack Ma is clearly not as glorious,” joked an investor last November when Mr. Mas Ant Group’s IPO was canceled by order of the Chinese financial regulators. Many foreign investors interpreted it as a blow to China’s most famous billionaire and thus as a warning to the country’s other plutocrats not to get too big for their boots.

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But in the months since then, the scope of the regulatory crackdown has continued to expand. China’s two internet giants, Alibaba and Tencent, are being dealt with by the antitrust authorities. Earlier this month, Didi Global, a ridesharing service, was caught on the net just days after it was listed in New York. And over the past week, the educational technology industry has become a target. New regulations prohibit companies teaching subjects in the curriculum from listing abroad, having foreign investors, or making profits. When it comes to teaching school children, nobody should get rich.

The market’s reaction to recent bureaucratic dictates has been a sharp sell-off. A trio of Chinese online tutoring companies listed in New York City fell two-thirds. The panic spread to other American listed Chinese companies. The Nasdaq Golden Dragon China Index, which tracks the largest stocks of its kind, fell nearly 20% in three days. Contagion increased across the board in China’s onshore stock market.

China’s preferences now seem clear. It wants capital to be raised on its own stock exchanges, within its jurisdiction and on the terms it dictates. The effects on the financial markets are likely to continue. China itself could be the biggest loser.

Start with the market value impact of tech companies outside of China. The tech-heavy Nasdaq index was also sold in response to the defeat of Chinese technology stocks, as the latest episode signaled that investing in technology carries regulatory risk. In America, Joe Biden’s administration has also tried to strengthen oversight of big tech by strengthening antitrust law. But trustbusting in America takes place in a legal context. There is case law limiting how far authorities can go to curtail the wings of tech giants, even those who make profits, find many obscene: Alphabet, Apple, Facebook and Microsoft all reported record second-quarter profits this week. When Chinese rivals are caught up in red tape, all is good for big tech in America.

And cracking down will indeed damage Chinese technology. Investors who have amassed over the past few years have been beaten up in the public markets this week. Private American capital is also tied up in Chinese startups. The value of these ventures is now effectively frozen. The path to an IPO for a young Chinese company – the reliable way for venture capitalists to get their money back – now borders on dangerous situations. Many Chinese firms have raised money overseas in the form of vehicles known as floating rate units, which are essentially synthetic stocks. This route can now be blocked forever. And venture capitalists are sure to be more ruthless when it comes to helping Chinese tech startups, however promising they may be.

Even more worrying, any investment, even in an onshore non-tech company, is now jeopardized by arbitrary rule changes. This increases the cost of capital for Chinese companies. China’s securities regulator hastily convened a meeting with international bankers this week to assure them that only firms with educational backgrounds will be targeted. It suggests that China’s political leaders who scared the markets have realized that they may have miscalculated.

It definitely looks like it. The capital markets are not a tap that regulators can turn off and on when it suits them. True, investors’ memories can be short. But China is gaining a reputation for regulatory arbitrariness that it can only shed if transparent rules are followed – and it is precisely this kind of submission that the Communist Party abhors.

This article appeared in the Leaders section of the print edition under the heading “Get poor quickly”

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