In China, Reputation Rules

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by: Shaun Rein

This commentary originally appeared in Forbes.

Last week a drunk and deranged man stabbed two people to death and injured 14 others in Beijing. A few days later, another disturbed man stabbed a foreigner. The police response was not only to arrest both miscreants but also to ban the selling of kitchen knives at large retailers, including Wal-Mart (NYSE:WMT), until after Oct. 1, the National Day holiday. That might seem an ineffective overreaction to tragic but isolated events, but it says a lot about how the government works in China and how businessmen need to navigate it.

Oct. 1 will be the 60th anniversary of the founding of the People's Republic of China, a day when China's leadership to will celebrate how far the country has advanced. Thousands of performers will perform in a spectacle rivaling the pageantry of the opening of the Beijing Olympics. Whereas in North Korea such pageants seem coerced, in China they reflect genuine popular happiness. It may be hard to believe, but the Pew Center recently found that 86% of Chinese are satisfied with the direction in which the government is taking the country.

For its organizers, the celebration is a critical career event. It has to go flawlessly. And they will do anything to make sure nothing tarnishes it, even if that means inconveniencing cooks and housewives.

Most of the Chinese government officials I've run into in the decade or so I've been here are not corrupt or bad. Corruption is certainly a problem in China, but most of the difficulties officials create arise from their not wanting to put their necks on the line to approve anything not explicitly supported by higher-ups. They are all beholden to the Communist Party. They don't want to put their positions at risk, so usually they'd rather duck down and let someone else make a controversial decision.

Once you reach a certain level in the government, you are not allowed to go into private business afterward. There are no lobbying firms, no K Street, no tell-all memoirs, no Halliburtons (NYSE:HAL) or Carlyle Groups to go to. Salaries are incredibly low: Even senior officials often make only several hundred dollars a month. They basically are compensated in expenses. Housing, cars, health care and even vacations are covered or subsidized by the state.

What this means for businesses is quite obvious but is often misunderstood by foreigners. If you want to make an investment that everyone knows is already approved, say, a high-tech or clean technology investment, you'll very easily get your business license. But anything groundbreaking is tough, even if the market demands it. For instance, the medical industry is one of the most regulated in the country, largely because it is extremely profitable for the state, which maintains a near monopoly.

Many investors want to invest in private hospitals, because Chinese consumers have begun demanding better care and can afford it. These investors see the market insisting on a product or service and naturally think the government will approve it. The problem is that no one wants to be the official held responsible for approving a high-profile foreign-invested hospital if someone dies on the operating table. It is much easier for an official to reject such an application than to accept it. For care where there is less risk and where there is no state monopoly, such as a dental clinic, or a clinic for foreign patients, getting a license is easier.

The second lesson to learn from the knife-sale ban is that while the central government has tremendous power--as it has shown with its $586 billion stimulus package--it does not and cannot micromanage all decisions. Most of the Chinese public relations mistakes we read about in the West are the work of junior or local officials, not senior people in the central government. The senior officials I talk to are just as angry about a pollution disaster or last year's melamine scandal as we would be in America. They and their families have to deal with the "Made in China" label every day. They desperately want their food and air and water to be safe.

They are also bewildered that China's reputation as a nation seems to get hit every time something goes wrong. Did the U.S. government or America as a whole get a black eye from the tampered Tylenol scandal in the 1980s, or when salmonella turned up in peanut butter? Of course not. Therefore many Chinese are outraged when Americans hold China's government at fault. They think the West is just trying to keep an emerging superpower down.

Policies set by the central government are implemented at the local level, and there can be different motives there. For instance, as I wrote in "China is Pulling Ahead on the Environment," it is clear that the central government is moving quickly to reduce pollution and improve working conditions. Yet local officials may not be so willing to close a soot-belching factory or a sweatshop that provides most of the jobs and tax revenues in their small city.

For businesses, that means you very often have to get approval from both the local and the central government if your investment is very big or high-profile. If you're looking for an approval in an industry that is well-known to be encouraged by both the local and central governments, you shouldn't have a problem. But don't forget that the different levels of government can disagree about what they want and need.

Finally, the knife ban in Beijing shows us the importance of face in China. The central government will do whatever it takes to ensure that the festivities on Oct. 1 come off magnificently. Whether it takes banning knives or trying to manage rainfall, shutting down businesses at the last minute or closing airports, the government will do almost anything to save face by having a camera-ready event.

The concept of face is truly important in China. In the U.S., businessmen fight and yell at one another in front of subordinates. Once everything is ironed out, they become friends again and all is forgotten. In China, making someone lose face by yelling at them in front of others or otherwise making them look bad can have severe repercussions. Many Chinese don't bounce back from such an embarrassing situation and never truly forgive. Businessmen have to make sure they always let counterparties maintain face. Be firm but never disdainful in negotiating.

For instance, America has to expect retaliation against President Obama's decision to impose a tariff on cheap Chinese tires. Even though the Chinese government is savvy enough to make sure we don't end up in a debilitating trade war, it must react, for reasons of face. Expect more than just threats to ban the import of American chicken parts. The Chinese government will unquestionably make things a little more difficult for Americans. They may give Airbus rather than Boeing (NYSE:BA) a bigger piece of an airplane contract. They may make it more difficult for you to get a visa. They'll do something.

Disclosure: none