I was showing my good friend, Jack, who was visiting China from the United States, around Shanghai. I hadn’t seen Jack in more than a decade, since our boarding school days at St. Paul’s School in New Hampshire, and it was great seeing him again. Jack is one of those incredibly brilliant people whose talent causes your jaw to drop. He started a hedge fund, runs marathons, and speaks five different languages.

As we walked down the street, he kept blurting out, “There’s one, and another one!” He was pointing at the beauty salons with their pink-neon-lit interiors. Inside each one sat dozens of middle-aged, bloated women wearing cheap makeup. The necklines of their tight shirts plunged low, exposing their propped-up cleavage and giving them the appearance of overstuffed, raw sausages.

“I can’t believe there are so many brothels!” Jack continued, his brow wrinkling. “How can prostitution be so open?” he asked as he pointed at the elementary school less than 20 yards away on the corner. He found it especially odd because he had read in the news that the Chinese government was holding a morality campaign to crack down on prostitution and pornography. “Wasn’t there that college professor in Nanjing that just got busted for organizing orgies online?” He was baffled that there could be such blatant flouting of the law in what he assumed would be a tightly controlled authoritarian state.

With his observation, Jack touched on an issue that goes far beyond the realm of prostitution and deeper into contemporary Chinese society: the divide between the central and local government and how laws are enforced. It is common for Westerners to think of China’s government as a large, monolithic authoritarian entity. But in reality there are many different parts.

Aside from the central government, there are provincial, county, municipal, and district governments. Although technically they are under the central government’s authority, they are given leeway in implementing and interpreting national policies. They all pull in different directions. Different regions—and different ministries within the government—often have competing and, in some cases, diametrically opposed interests. One needs to analyze different parts of the government through a more nuanced lens to understand how the end of cheap China increasingly will force the bureaucracy to change.

Despite the central government’s attempt to eradicate prostitution—a process aided by the proliferation of better job opportunities, which is lowering the beauty quotient of the average prostitute—finding a hooker, albeit an ugly one, is not difficult in any city in China. All one needs to do is look for pink lights or a salon whose occupants are all just waiting around. Their easy availability confuses many visitors like Jack, who only get their information about the structure and policies of the Chinese government from foreign media sources.

It is true that the central government is always cracking down on prostitution. Every time I pick up a copy of one of the state-run newspapers, I see headlines like:

GOVERNMENT EMBARKS ON ONE-HUNDRED-DAY CRACKDOWN ON PROSTITUTION

Or:

GOVERNMENT SENDS HOOKERS FOR TRAINING FOR OTHER JOBS

In some cities it has become popular for authorities to publicly shame prostitutes as part of their punishment, and the news often has photographs of large groups of women in correctional facility uniforms being paraded through town. The government bans pornographic publications entirely and is generally strict about any sexual content in television programs. Plans to open a Playboy Club in Shanghai were quashed by local authorities for fear of it being too risqué, and television shows like the popular singing competition Super Girl were banned. Yet Jack and I passed more than a dozen brothels in less than an hour in China’s most cosmopolitan city, and in smaller-tier cities business deals are commonly cemented at karaoke clubs and saunas swarming with prostitutes, with hardly any interruption by local authorities. How could this be?

The answer is pretty simple: Sometimes corrupt local officials ignore central-government directives. During his administration the previous president, Hu Jintao, said official corruption is a pervasive problem that the central government must tackle. The state-owned newspapers China Daily and Global Times reported that 4,000 corrupt officials have smuggled $50 billion in state funds out of the country over the past 30 years. His successor, President Xi Jinping, has agreed and has made cracking down on corruption a major tenet of his administration. Under Hu and Xi, anticorruption police arrested Communist Party of China Shanghai Committee Secretary Chen Liangyu and sentenced him to 18 years in prison on charges of financial fraud, abuse of power, and accepting bribes. The former vice mayors of bustling coastal cities Hangzhou and Suzhou were executed for taking millions in bribes. The vice governor of Hainan province was arrested, as was Bo Xilai, the former head of Chongqing. Despite attempts by the central government to eradicate corruption, it remains a serious problem—especially at the local level—that constantly undermines the Beijing authorities.

Local official corruption is a large reason why the food sector has been disrupted by poor quality despite the best intentions of the central government. Local officials are paid poorly, many earning only a few hundred dollars a month—less than the workers stapling furniture together in Laura Furniture’s factories. They are not even allowed to travel abroad when they reach a certain rank unless they are on officially sanctioned tours. Even powerful ministry heads make less than $2,000 a month. By comparison, most U.S. Cabinet secretaries make around $200,000 a year (or more than $16,000 a month), and the average salary in the U.S. Department of Energy is more than $5,000 a month.

Furthermore, the government restricts officials above a certain rank from transitioning into the private sector after they retire, so there are few avenues for local officials to make personal money aside from two sources: bribes and relying on their children to earn for them. Retirement housing and food allowances for officials are contingent on their continued support for the Communist Party, which makes their allegiance much easier to secure. The Party’s control over housing benefits is a canny strategy aimed at discouraging divisive factions from emerging—it’s hard to make trouble without an independent supply of cash and food. It is even rumored that all-powerful former Prime Ministers Li Peng and Zhu Rongji have been prevented from publishing memoirs. These restrictions and contingencies show the importance the Party places on ensuring harmony and limiting the power of one individual to disturb society.

Rules that limit officials’ job hopping from the public to the private sector also ensure that decisions are in the country’s best interests rather than for their personal future financial gains. Recall American officials such as former Secretary of the Treasury Robert Rubin or Vice President Dick Cheney, who ended up managing or lobbying for the industries or companies (Citigroup and Halliburton, respectively) they previously oversaw during their time in government. Sometimes I wonder if the decisions they made in office would have been different if they were barred from entering the private sector afterward.

Although these measures are designed to rein in corruption and ensure more objectivity among local officials, the result is that financial prospects for local officials are less impressive than for their Western counterparts or Chinese in the private sector. As in every country, some greedy local officials turn to corruption to enjoy a better life. While they are still in office and have influence they protect brothels out of simple greed or to provide the best for their families.

Many local officials also have no interest in getting promoted in the party hierarchy. They mainly care about how much leeway their direct supervisor grants them, rather than what the central government wants. As long as they don’t threaten the primacy of the Party and thus threaten stability, they are given some flexibility in implementing state directives.

Corrupt officials protect illegal operations such as brothels as long as they do not cause spillover effects that harm their district, such as violence, forced prostitution, or drug use. They know that these will cause local citizens to protest and that the central government will step in when that happens, so they seek to control them. Moreover, because of the large numbers of urban migrant workers, who are away from loved ones and family for months at a time, local officials understand that pragmatism must sometimes prevail over ideology or morality. They often turn a blind eye to prostitution so that male migrant workers are satisfied. One municipal official I spoke to saw it in practical terms and summed the situation up this way: “Better they go to prostitutes than vent in other ways, like rape or causing social disorder.”

For ordinary Chinese people, vices such as drugs and violence are intolerable because of the immediate impact on their everyday lives, but often they will tolerate prostitution as long as it is kept behind closed doors and distant. Here we see the divide in thinking between levels of government: Local officials and people confront prostitution pragmatically, whereas the central government upholds a more morality-based approach.

However, restrictions on televised portrayals of sex and campaigns against Internet pornography are run by ministries that report directly to the central government in Beijing. Unlike corrupt local officials, who expect to remain in their current positions, those who report to the higher administration in Beijing enforce national directives to the letter because they aspire to rise within the Party hierarchy. This is why you end up with professors in Nanjing being arrested for arranging sex parties (under “licentiousness” statutes), while hookers ply their trade in pink-lit barber shops in front of policemen patrolling the streets. The orgy-organizing professor was arrested because he was using the Internet to arrange his trysts. This made it impossible for him to bribe someone for protection because the ministries overseeing the Internet report directly to leaders in Beijing.

The conflict between official policies on prostitution and pornography versus their actual implementation at the local level symbolizes the many divergent interests between regional and central governments. Despite the central government’s power to set national directives, it is not quite the monolithic and totalitarian state that many Westerners imagine. My friend Jack discovered this complexity via the pink brothels glittering along the roadside. Many foreigners never understand this complicated dichotomy, but ordinary Chinese people walk along these streets and live within this system. Their understanding of this duality explains why they often direct their anger at local governments, accusing them of corruption while remaining generally supportive of the central government, which they trust to have the interests of the general public in mind.

When high-level officials are found guilty of corruption, they often receive serious punishments that help mollify some of the anger. Zheng Xiaoyu, the former director of the State Food and Drug Association, was executed for corruption in 2007. The former railway minister, Liu Zhijun, has been arrested for allegedly stealing more than $100 million. He is being blamed for cutting corners on safety, which may have helped cause the July 24, 2011, train crash that killed 39 people and injured hundreds. He most likely will face a similar fate to Zheng’s.

In China, competing interests, local and regional officials, and various government ministries are often given room to diverge from the central administration. This is actually a healthy situation because it forces the central government to listen to other voices that are closer to the common people and to form a consensus among different orders in society to develop a unified strategy going forward.

• • •

One of the biggest problems facing China today is forced land appropriations and the eviction of peasants, done to allow real estate developers to build more housing units or so the government can launch new infrastructure projects such as high-speed railways or subway systems. Many unsavory local officials, bribed by real estate developers, use corrupt local police and thugs to drive peasants out of their homes to build new projects. Because local governments often raise the bulk of their tax revenue from land sales, or their officials benefit from family relationships, some of them push for real estate development at all costs. They often do not adequately compensate those who need to be relocated. The more courageous citizens fight back against this injustice. In some instances, thugs are sent to beat and maim holdouts, and riots spill out into the general population.

Fueled by bubbling anger at endemic local corruption, these riots soon turn into massive conflagrations. Thousands of people quickly congregate and start causing bedlam. Protesters generally are not trying to overthrow the entire political system; they are just attempting to stop what they see as thievery and brutish behavior on the part of local officials.

Western analysts often wrongly blame the central government for these battles or assume that rioting means that local populations want to overthrow the government, similar to what happened in Egypt and Tunisia during the Arab Spring. International news media often gloss over the distinction between local and central governments or miss it entirely, so many times mass protests against corrupt local authorities in small, county-level cities get framed in the headlines as demonstrations against “Beijing” or “the Chinese government” that threaten their very legitimacy.

However, the central government does not condone these practices. The state-run China Daily, for instance, quoted research results from the Centre for Research on Social Contradictions that showed the biggest cause for unrest and mass protest in 2010 was forced evictions. They point to unfair local officials as the cause for nearly 180,000 instances of mass protest in that year. Former Prime Minister Wen Jiabao also issued edicts preventing local police from participating in forced evictions and demolitions. Central authorities have also banned the use of violence and coercion to force people to move and have pushed for giving evicted homeowners the right to appeal.

Yet with the money and skullduggery involved with real estate (the Hurun Report found that 23.5 percent of the 1,000 wealthiest Chinese earned their money primarily through real estate development), the situation is bound to worsen if the government does not enforce regulations in place.

The anger is very real, and for people who lost their homes, anger can potentially erupt into violence. Most people I have spoken to who have been evicted against their will are enraged but believe the blame rests squarely on corrupt local officials in bed with real estate developers, rather than the whole government system.

Beijing’s leaders understand the situation is dire. One exasperated senior leader told me, “We have to stop these thugs at the local level. Some of these people are truly evil. Some of these people act like gods and are not intent on helping the people but enriching themselves. They don’t care about anyone but themselves.” One of the problems that has prevented crackdowns is the difficulty of controlling local officials, especially if they have powerful patrons at the central-government level. Many officials fear that the rot is far too widespread to be able to beat easily, so they arrest a few high-profile people in the hopes of scaring the rest into order.

Local officials are given an extent of freedom that allows them to adjust application of policies to the local situation. However, the central government feels it needs to maintain its grip on power over local governments whenever it can, precisely because rampant corruption at the local level disrupts social stability and hurts everyday citizens. Central-government officials think that if they let their control slip and delegate their power, chaos could ensue. They are wary of American-style direct elections for the same reason. One official I spoke to summed up the government’s worries about elections this way: “Imagine how corrupt it would be if we had elections,” he said. “All the corrupt real estate developers could beat people up and intimidate voters to get their man elected. It would only hurt the people. We cannot allow elections when local officials in cahoots with tycoons could intimidate voters.”

• • •

One cool spring day in Shanghai I got a firsthand taste of how many of these demonstrations must be developing in cities all over China. I was driving along a main thoroughfare near a Carrefour hypermarket when suddenly dozens of balloons flew into the air. As they made their way into the gray sky above, my son, Tom, shouted and pleaded from the backseat that he wanted one.

I turned to where the balloons seemed to be ascending. As we got closer, I saw a dark-skinned man, wearing blackened clothes that looked more like rags, yelling at a parked van. Inside was a group of four chengguan—local officials from the City Urban Administrative and Law Enforcement Bureau, or city enforcers.

Most problems with government thuggishness are not a result of the normal police—the gongan, officers from the public safety bureaus—but to the chengguan. They are poorly trained, lowest-level security enforcers, often people who had been unemployed. The government gives them jobs to help enforce routine laws, like clearing out unlicensed street vendors. As one vendor told me while hurriedly packing up her stock of mugs, “I’m not afraid of police—they are polite. It is them,” she said, pointing at a group of chengguan. “They hit.” They are not a part of the police force, but many Western journalists don’t make the distinction when they publish reports about fights or protests in Chinese cities. In fact, in my experience, the Chinese police are for the most part well trained and responsive to the needs of the people.

I went up to the roadside balloon salesman, who was near tears. He told me that the chengguan approached him without warning. He said they took out a machete-like knife, told him that he was not allowed to sell balloons, and cut the strings on the balloons, sending them all spiraling into the sky. He told me that lost him two weeks’ wages. I could see him wondering how he would pay for his family’s food, so I gave him money to cover his losses and confronted the chengguan in the van.

A group of furious onlookers surrounded the van and started yelling at the chengguan. Some started taking videos of the scene on their mobile phones. They had all seen what had happened. People started shouting that it was not right for the chengguan to simply take the balloon salesman’s livelihood away, especially when so many officials are corrupt. One man yelled that if the man had paid a bribe, he would have been allowed to keep his balloons.

Tensions ran high outside the van as the screaming continued. Inside the van, the four chengguan looked bored and ignored us. After about 5 minutes, the chengguan in the driver’s seat turned the ignition. Everyone outside parted and the van just drove off. And that was that—everyone just dispersed.

This probably would count as a situation of unrest, one that gets tabulated by the government among the hundreds of thousands of yearly instances of social instability and which Western analysts use to indicate growing dissatisfaction with the government. But that would be an exaggeration.

Certainly no one in the crowd wanted to overthrow the central government and the entire administrative system. They, like me, simply wanted more accountability from the chengguan. In fact, many people in the crowd I spoke with said they wished the central government would do a better job of educating the chengguan. A middle-aged man who joined the crowd told me, “It is tough. Those chengguan are probably just doing what they are told to do. None of us like it. They need jobs, too. I hope the government can train them better.”

• • •

Often, local officials simply ignore central-government regulations meant to protect everyday people, which explains why Chinese can support the central government while still protesting brutality at the local level. Aside from this contention, there is also much debate in different parts of the government over the best policies for the country. For some reason, Western media often oversimplify the political legislative process in China. They perpetuate the inaccurate notion that all decisions originate from the nine old men on the Politburo Standing Committee, completely insulated from external opinion or input. Western media portray these nine men as caring only about how to enrich themselves and their families, while perpetuating their own power through fear and violence.

The reality is that the Standing Committee of the Politburo does not exist within a vacuum. Members, like leaders in the democratic countries, also have constituents that they need to represent and placate. In many ways, because of the lack of direct elections, they have to listen to the needs of their constituents even more closely than members of elected governments. After all, in the West, voting only displaces people, but transitions in Communist countries are far rockier.

If we analyze one of the hottest topics in policy circles around the world right now, the exchange rate of the renminbi and its race with the U.S. dollar, it is obvious that senior leaders are not making decisions in a bubble but are in fact listening and getting pressured by different constituencies. How the debate plays out within China will help senior officials make this key monetary decision, in an example of bottom-up-generated policy.

Many economists, like Nobel Prize winner and New York Times columnist Paul Krugman, argue that China artificially manipulates its currency to keep it low compared with the U.S. dollar to ensure that China’s exports remain cheaper. With the renminbi artificially low, Krugman argues, American manufacturers outsource to Chinese factories rather than to those in the United States. Krugman calls China a “bad actor” for its policies, and in a column titled “The Chinese Disconnect,” he says it is “stealing” American jobs by running a “beggar thy neighbor” currency strategy that undermines global growth.

Even though the Chinese government has allowed the renminbi to appreciate more than 25 percent in the past five years, Krugman argues that the Chinese government is stealing jobs from hardworking American citizens. However, as the Laura Furniture case in Chapter 2 showed, it is far more likely that American firms would relocate factories from China to Vietnam or Indonesia or keep manufacturing in China and simply increase end prices to the American consumer. It is unlikely that companies across most industries will shift production back to America.

Hu Jintao has repeatedly stated that the Chinese government will raise the renminbi, but at a slow and steady pace, to ensure stability in world financial markets and allow for long-term business planning. The renminbi has appreciated against the U.S. dollar by more than 25 percent since de-pegging from the dollar in 2005. Disregarding for a moment the economic reasons why the renminbi should or should not appreciate, let’s take a look at the different constituencies within China that influence Hu and other senior officials’ plan of overseeing a gradual appreciation rather than a faster revaluation.

The first constituency is manufacturers and their employees. Domestic factory owners making low-value goods like toys in places like Guangdong Province often operate on paper-thin margins of 2 to 3 percent. Their margins are getting squeezed further by soaring labor and real estate costs, leaving thousands of them at the cusp of bankruptcy. These factories employ tens of thousands of workers, are often connected to local officials through family relationships, and supply local government coffers with tax revenue.

For this group, a strong renminbi would further accelerate factory shutdowns already being precipitated by rising costs. For this reason, the manufacturing constituency has been lobbying hard to delay increases in the value of the renminbi. They want to slow the outward flow of Western brands, such as Laura Furniture, that are relocating manufacturing or sourcing operations to lower-cost markets such as Indonesia or Vietnam.

In 2010 I met with Mr. Xu, a clothing accessories factory owner from the southeastern coastal city Wenzhou, for an interview. Mr. Xu grew up dirt poor in Zhejiang Province in the 1970s. He told me getting access to food was a daily challenge for his family. Through years of hard work, he has built up a clothing accessory empire and is now one of China’s 1 million U.S.-dollar millionaires. He has a Mercedes and a BMW and owns luxurious homes in different cities in China—and even several in Italy. We were sitting in one of his homes in Shanghai, a palatial apartment with a breathtaking view overlooking the Huangpu River.

“An appreciating renminbi kills my margins. I do not want it,” Mr. Xu told me. “It will mean that I have to shut my factories down.” Nearly every one of the dozens of factory executives I have spoken with has echoed this sentiment. Mr. Xu’s operations were big enough to make him rich, but they were not big enough for him to be able to relocate to other markets or regions, so he was facing factory closures.

Local governments in factory-laden municipalities have been lobbying the central government alongside factory owners against a fast-appreciating renminbi. Shuttering factories would hurt these regions’ tax revenue, cause massive unemployment, and potentially spur destabilizing labor unrest. Local officials are equally anxious for a more important and much more personal reason: GDP growth is one of the major criteria upon which they are judged to determine future promotion potential.

Other factions and constituencies, however, are lobbying for an appreciation of the renminbi. Energy companies that have to buy oil priced in U.S. dollars on the open market, for instance, would benefit. The government caps end prices of energy and gasoline for consumers to ward off civil unrest and inflation. Oil and energy prices have gone up in China over the past several years, but it has been far slower than the rise of oil prices in the international markets, which is eroding energy firms’ margins.

Brownouts occurred in the summer of 2011 in 10 major manufacturing provinces because energy companies cut back on power generation. Former Prime Minister Li Peng’s daughter, Li Xiaolin, who runs China Power International Development, one of China’s largest energy companies, has pointed out that energy companies’ problems are the result of rising commodity costs.

Also, some groups want the renminbi to appreciate even faster than energy firms do. Factions within the government that want to lower China’s trade surplus with America and other nations, and to move China away from high-pollution manufacturing toward more sustainable service businesses, are pushing for higher consumption. They urge greater appreciation of the renminbi to allow everyday Chinese to buy more goods.

Groups urging a stronger renminbi are motivated by the fear that China will fall into the “middle income trap,” as many developing countries, like Mexico, have done. The trap is a per capita GDP of about $6,000, at which point it is common for average salaries to stagnate while the gap between the wealthy and the poor increases. To avoid the income gap and becoming a failed developing economy, Zhou Xiaochuan, the governor of the People’s Bank of China (the country’s central bank), has made it a priority to try and implement better social security and medical benefits so that everyday Chinese feel more confident about their future well-being and are willing to spend more. Zhou has made it clear that stimulating more consumption will be a key goal of the central bank in the coming years.

Government institutions also support a faster appreciation of the renminbi. Some officials in the Ministry of Health are worried that pollution is causing the state-run medical system to creak under the pressure. They have told me they also want the renminbi to appreciate, which they believe will accelerate the shutdown of high-polluting factories, whose emissions are a major source of public health problems such as higher cancer rates. For these officials, who see their hospital budgets getting hit hard by pollution-related diseases, weaning the country away from low-value manufacturing to a more domestic consumption and service-oriented market would be critical; the appreciation of the renminbi would help this cause.

Manufacturers, energy companies, central bankers, health officials—these are just some of the various constituencies lobbying for and against renminbi appreciation and vying to influence China’s future currency policies. In the midst of all these sometimes conflicting interests sit the central-government decision makers. The central government must consider all of these important constituencies while thinking strategically about where to steer the country overall. It needs to ensure that the country moves toward a sustainable growth model without alienating powerful interest groups and destroying short-term economic growth. It is an extremely delicate balance to strike.

As noted, the Chinese central government has more people to satisfy than in a democratically elected administration because its legitimacy derives from the satisfaction of different constituencies with its policies, rather than just one particular side or base. The central government needs to throw bones to and mollify many diverse sectors because it does not have the numerical legitimacy that an open, democratic vote would provide. It is within this complicated matrix that its policies are conceived and decided upon.

One benefit of this model of governance is that all constituencies understand that they will have to compromise to be part of the consensus. This understanding minimizes risks of overt factionalism that could lead to a return to the chaos and radicalism within leadership circles that I highlighted in Chapter 3. Compromise and leading by consensus have been the hallmarks of leadership under President Hu Jintao, which contrasts greatly with the grandstanding and total lack of compromise in the U.S. Congress during the debt-ceiling crisis, during which Standard & Poor downgraded America’s debt precisely because of the inability of its political leaders to compromise and do what was best for the country and the world economy.