Education is costly, and in the Gulf, it is becoming a very important component of private sector economic activity.

Market Watch Blog AGSIW | Karen E. Young | Oct 3. 2017

Education is costly, and in the Gulf, it is becoming a very important component of private sector economic activity. Dubai-based GEMS Education is one example of a global for-profit K-12 school provider that is gearing up to take advantage of a booming market in the Gulf as governments seek to reduce their expenditure on education through privatization. GEMS plans to raise over $1 billion in corporate debt before the company is listed on the London Stock Exchange in an initial public offering. The company is already backed by regional private and public investors, including Dubai-based Fajr Capital, Bahraini state investment fund Mumtalakat, and private equity firm Blackstone.

While companies like GEMS Education are established in the regional for-profit K-12 market, there are opportunities for new investors, including the Gulf states themselves. Gulf governments are not entirely newcomers as investors in the education sector. Mumtalakat is one state investment vehicle in education, but there are others. The Kuwaiti government has long held investor stakes in private education companies, including the Kuwait Educational Fund, a public-private joint venture between KIPCO Asset Management Company, one of Kuwait’s biggest financial groups, and the state-owned National Offset Company. And, like some of its neighbors have already begun to do, Saudi Arabia plans to invest in private firms and garner tax revenue from this new business. Under a Gulf Cooperation Council-wide 5 percent value added tax to be rolled out in January 2018 in Saudi Arabia and the United Arab Emirates, the definition of a service is not uniformly interpreted. Saudi Arabia will tax private schools; so far, the UAE will not.

In what amounts to a reconfiguration in Gulf economic and social development policy, investment in education is no longer a long-term liability for governments, and is rather set to become an alternative revenue stream. The revenue will come from privatization, from investment opportunity for the state itself, and in some cases, in the taxation of private schools. This shift begs some questions about the appropriateness of “profitability” in education, especially in K-12, and more generally, in the way Gulf governments assess their massive investment thus far.

In essence, the Gulf states have spent heavily in the sector to open it now to foreign investors (and citizens) for profit. When states and state-related entities also act as investors, they may lose some regulatory control, or have competing priorities in profitability and delivery of quality education. While most people agree that investment in education, whether from the state or private sector, is necessary, there remains the policy problem of directing education to job opportunity and long-term economic development needs, especially driving growth away from public sector employment and into vocational skills and technology-intensive fields.

Gulf governments have spent heavily to create a baseline of educational access, literacy, and steps to higher education, but they have not been very efficient at creating pipelines to private sector job growth. Whether the market can act as a better guide remains to be seen. The reform agenda, with its reduced subsidies on electricity, fuel, and water, along with hiring freezes in public sector jobs, and the introduction of fees and taxes, all point to a rising cost of living, for both citizens and migrants. (Track GCC reform initiatives with the Gulf Economic Barometer.) The sheer expense of private education creates tension in the divide between wealthy and poor and could widen some looming problems in the resilience of Gulf populations in the emerging era of economic liberalization. According to a 2017 report by HSBC, UAE parents reported spending on average $99,378 to educate one of their children from kindergarten through the first four years of university – double the global average. At the least, the current reform agenda poses some restrictions on discretionary spending for nearly every family in the Gulf.

Source: Alpen Capital, “GCC Education Industry Report” May 2016.

The shift in consumer (or parent) preference, is already clear. Driven by strong noncitizen immigration patterns across the Gulf, and the willingness of parents to invest in their children’s education, the market for private schools, at the K-12 and higher education levels, is outpacing demand for public schools across the region. The trend is evident even in places like Oman with lower noncitizen-driven demand. According to a study by Strategy&, GCC governments are encouraging private sector participation to help relieve the fiscal constraints caused by diminished oil revenue. The region’s population is growing rapidly, projected to reach 65 million people by 2030, a third of whom will be under the age of 25. With rising disposable income levels, a willingness to spend on education, and the measure of prestige attached to private or “international” schooling, there is a large investment opportunity for private providers. There is also an opportunity for governments to be relieved of spending commitments that have become burdensome as their development agendas have expanded over the years with population growth and rising citizen expectations of service delivery. The structure of these investments is also flexible, as educational providers can act as real estate developers and investors can be passive, as indicated by the strong interest of several local and international private equity funds in the sector. The new availability of real estate investment traded funds (REITs) also opens a window for these convergent investment fields. But is a real estate investor really the best custodian of a long-term investment in human capital?

Source: Strategy& “Investment Opportunities in the GCC Education Sector: Four Plays for Private Equity and Strategic Investors,” August 23, 2017.

Gulf states have been very generous spenders in their education sectors over the past 30 years. The results are impressive, in terms of increased literacy rates, the inclusion of girls, and the proliferation of institutions. In terms of return on investment in student performance, however, especially in math and science, the results for the Gulf states are not strong. In a presentation by Aasim Husain of the International Monetary Fund at a recent International Institute for Strategic Studiesconference in Bahrain, he presented evidence that Saudi Arabia lags behind its Gulf and Middle East neighbors in its spending on education (as a percent of gross domestic product) and its average math and science 8th grade Trends in International Mathematics and Science Study performance. Bahrain, Qatar, Oman, and Kuwait (in descending order of scores and ascending order of spending) all spent less as a percent of GDP and achieved higher scores.

Gulf state budgets have been generous toward education spending, but Gulf governments have also been very active in managing education reform. As Asmaa Alfadala explains in her study of K-12 reform in the GCC states, institutional capacity-building efforts have been massive. Tatweer, the King Abdullah bin Abdulaziz Public Education Development Project, was established to reform the Saudi education system in 2007. Tatweer spent $2.4 billion to reform the Saudi public education system prior to the newest reform initiative via Vision 2030, which is again tackling curriculum changes and teacher training. The National Transformation Program budgeted an additional $6.4 billion to support reforms in education, in addition to welcoming private sector investment and establishing a goal of doubling the number of Saudi students in nongovernment schools. Even in the current period of reduced government revenue, the 2016 Saudi budget allocated 23 percent of reported spending, or $51.1 billion, toward education and training.

Translating education spending into productive employment and diversified economies has not been so successful. The spending-to-quality ratio has been high. Problems with teacher training, retention of expatriate teachers, and curricular design (including the more recent emphasis on critical thinking skills over rote learning) are just some of the issues that have challenged education systems in the region. There has long been a mismatch between training and opportunity, especially for citizens, in Gulf economies. Data from the IMF suggests that the regional labor force across the Middle East and North Africa is set to balloon in size as the youth bulge goes from school age to work age, and the impact on the Gulf will be substantial. Eight million GCC nationals will be in the labor force by 2022. Moreover, the Gulf states have been sources of employment for the region; any decrease in job opportunity and remittance flow will have detrimental consequences on the MENA region.

Source: Aasim Husain, deputy director, IMF Middle East and Central Asia Department. IISS Bahrain Bay Forum 2017.

So, while investors may be excited by the opportunity to provide a service to a growing consumer base, and governments may relish the opportunity to outsource the expense of building and staffing schools, the public policy priority must remain job creation in productive industries, and providing a high quality public education to all citizens who need it. The risk of a wider economic slowdown in the Gulf would put pressure on discretionary spending and potentially leave the public school system unprepared for an influx of students going back to public schools from higher-priced private ones. The growth of the market in some countries, especially the UAE and Qatar, is highly dependent on noncitizen immigration patterns, also sensitive to regional economic contraction.

The reason why governments tend to manage education systems is that they make poor short-term investments; investing in education is a long-term project and a cost that governments assume because the benefit is an expansion of a public good, both in the educational system itself and in the human capital it creates. Privatization of K-12 education in the GCC states could create opportunity for many young people (as well as investors), but it might also weaken the performance of state schools and deepen divides between socioeconomic groups. Governments in the GCC states will need to stay focused on curricula, i.e., what they want young people to learn, and how well schools prepare them for the future needs of Gulf economies, rather than primarily what they need to improve their fiscal positions.

This article was originally published by the Arab Gulf States Institute in Washington (AGSIW)

Dr Karen E Young is a former senior resident scholar at the AGSIW. She is a resident scholar at the American Enterprise Institute in Washington and a senior advisor at Castlereagh Associates.