Could a New Zealand dairy trader have done more to explose China’s tainted-milk scandal?

Truth be known, few China-watchers were startled to learn that dairy giant Sanlu Group, based in Hebei province, had sold baby formula tainted with the industrial chemical melamine. Last year we saw thousands of U.S. pets sickened or killed by melamine-spiked pet food made in China. Since then we’ve seen headlines about Chinese exports of adulterated toothpaste, toys with toxic lead paint, food tainted with poison dyes, tires that shred.

Nor was it all that surprising to learn that Sanlu had covered up the scandal since December 2007. After all, last year the Beijing’s quality watchdog chief Li Changjiang had called Western news reports “demonizing so-called unsafe Chinese products” a “foreign plot” akin to a new kind of trade protectionism. Last week Li was forced to resign because of the melamine contamination, which has killed four Chinese babies, sickened another 53,000, and triggered import bans and recalls in dozens of countries.

What is startling, however, is the involvement of a major Western player. Forty-three percent of Sanlu was owned by the New Zealand dairy cooperative Fonterra, which isn’t exactly an obscure little Kiwi mom-and-pop operation.

Fonterra is the biggest dairy products exporter on the planet, responsible for more than a third of the world's traded dairy goods. It had three representatives on the seven-member board of Sanlu and yet its executives say they were unaware of the mass poisoning until Aug. 2. Nor did Fonterra manage to persuade its local counterparts to go public until six weeks later.

Even then, it was the New Zealand government that informed China’s central government. “I can’t think of a bigger consumer scandal involving a foreign firm in China,” says Paul French, chief China analyst for the Shanghai-based consumer consultancy Access Asia, “Fonterra apparently believed all the ‘doing business in China’ books in which foreign executives are taught not to let their Chinese partners lose face.” (French cited one such book that describes “saving face” as “more important than life itself”.)

The Sanlu scandal proves that even long-time China traders can be naive about the opaque and cutthroat business environment here. Fonterra has been operating on the mainland for two decades. Its website proudly cites “long-term trust-based relationships” with Sanlu, which was a long-term customer before becoming a joint-venture partner in 2005.

That trust appears to have misplaced. Fonterra first heard about the melamine – apparently added by milk collectors to disguise watered-down milk (because the nitrogen-rich chemical artificially boosts protein levels during product testing) – at a Sanlu board meeting Aug. 2. The New Zealand reps learned that 62 customers had phoned the hotline to complain about infants with kidney stones or discolored urine after drinking Sanlu baby formula; tests begun in June detected melamine but there was no information about deaths.

Sanlu’s Chinese executives indicated they were reporting the poisoning to Beijing, as industry protocols required. But it turned out that was a lie.

Fonterra chief executive Andrew Ferrier decided to work “within the system”, to try to reach a consensus with the Chinese side regarding a recall. Fonterra met three times with Chinese partners to push for getting as much contaminated milk as possible out of private homes as well as off of store shelves. But local-level authorities were loath to go public, citing worries that anti-government anger might endanger “social stability” during the delicate period of the Olympics, which were due to kick off Aug. 8.

In a telephone interview with Newsweek, Ferrier revealed, “It was very clear that local authorities in China were going to block us from doing a public recall. If we tried to do it by going over their head, its possible we’d be excluded and have no influence whatever.”

Sanlu chairwoman Tian Wenhua also happened to be a local party secretary – a conflict of interest that may worsened the deceit.  As a grassroots commissar, she would have known that communist party censors had decreed that sensitive topics – specifically including food-safety concerns -- were to be suppressed during the Aug. 8-24 Beijing Olympics. Sanlu violated industry protocols by “lying” and failing to take action, according to Chinese media. ( Now Tian and dozens of other officials are behind bars.)

At an Aug. 14 social event, Fonterra executives told New Zealand embassy diplomats about the poisoning; the embassy informed its government back home. Ultimately it was New Zealand’s Prime Minister herself who decided the embassy should blow the whistle to Chinese central government authorities, which took place Sept. 9. Two days later, Beijing went public -- six weeks after Fonterra first learned of the contamination.

The Olympic Games had conveniently had taken place without being tarnished by the tens of thousands of Chinese babies sickened by Sanlu’s toxic milk formula – but at what price?

At what point must a foreign company jepardize its hard-fought relations with a longtime business partner? It’s a familiar dilemma for Westerners keen to do business in China. You might get your deals done more quickly by back-slapping with Chinese officials and kow-towing to the system – but the system itself can be crooked, not to mention dysfunctional.

Ferrier insists Fonterra did the right thing, and that its actions had nothing to do with saving face. But at very least the Kiwis were gullible about their local partners. Sanlu didn’t come clean even when Chinese media began to hint at the health problems months before the scandal broke.  In July the cable channel Hunan TV, which broadcasts nationwide, aired a program about kidney damage in infants and used Sanlu brand packaging as a backdrop. (It didn’t name Sanlu outright, in order to avoid provoking party censors.)

Many previous product safety scandals in China had featured lax enforcement, lies, delays, incompetence and passing the buck. The possibility of a Sanlu cover-up should have been a top-priority concern for Fonterra.“This was a case of Stockholm syndrome,” maintained French of Access Asia, “We can all be sensitive about not letting Chinese lose too much ‘face’ when it’s a case of a little missing money or dodgy accounting.  But not when it’s a matter of life or death. You have to draw the line.”  And to see clearly what’s being lost for the sake of saving face.