Politics Is a Bitter Pill for Glaxo: How the Glaxo bribery scandal fits into China’s new narrative of re-crafting China’s economy as consumer driven

July 25, 2013, 8:20 p.m. ET

Politics Is a Bitter Pill for Glaxo

How the Glaxo Bribery Scandal Fits Into China’s New Economic Narrative

JOHN BUSSEY

Here’s one takeaway from the bribery scandal GlaxoSmithKline GSK.LN +0.24% is weathering in China: In Glaxo’s anguish, there’s solace for the Chinese consumer, and Beijing is glad about that. China this month accused Glaxo of bribing doctors and officials to sell the company’s drugs at higher prices. Glaxo apologized, saying it appears a small group of wayward managers was at fault, not company policy. It also said it will drop prices in China.In a narrow sense, the story might end there. China has a worsening health-care crisis. Spending on drugs is rising by double digits each year, draining money from the economy. “The Party has made drug-price reform a priority,” says Scott Kennedy, a China expert at Indiana University.

But the Glaxo investigation also fits into the Communist Party’s new narrative of re-crafting China’s economy as consumer driven, not just investment and export driven. To do that, Beijing needs to give citizens not only the wherewithal but also the confidence to spend. That means cutting prices—and graft.

Currently, personal consumption in China accounts for only about 35% of GDP. In the U.S., it’s roughly 70%.

Xi Jinping, China’s paramount leader, elevated this effort to a new level in June when he took a page from Mao Zedong’s playbook and announced a rectification campaign for the Communist Party. He wants to renew the Party’s ties to the masses and root out “decadence.” It’s the latest articulation of his “reform” drive to address China’s slowing economy and rising public discontent over income inequality and corruption.

“Winning or losing public support is an issue that concerns the [Party’s] survival or extinction,” he correctly declared.

With that in mind, cutting drug prices is a big check in the survival column. It may also boost consumption: One reason the Chinese traditionally saved, and didn’t spend, was to have cash on hand for big health-care emergencies.

Party apparatchiks have also gotten Mr. Xi’s message. Flashy suits are out, shirt sleeves are in. For his part, Mr. Xi was pictured in Chinese media recently standing at an industrial site in the rain, holding his own umbrella, with his pant cuffs rolled up out of the puddles. The man-of-the-people image made a splash in China.

How much of this is schtick and how much substance? To truly attack corruption in China, Mr. Xi will have to, among other things, unravel the vast state-owned enterprise bureaucracy, which accounts for half of China’s nonagricultural GDP and is the chief source of patronage and enrichment for the Party. That won’t happen anytime soon.

Nonetheless, regulators have been busy elsewhere. This month they began probing foreign makers of baby formula for possible anticompetitive activity. NestleNESN.VX -0.32% and Danone BN.FR -1.25% soon dropped their prices. In April, under attack by state media, Apple AAPL -0.46% apologized for alleged arrogance toward Chinese consumers.

Chris Murck, who just completed a stint as head of the American Chamber of Commerce in China, says Beijing’s efforts to tame the pharmaceuticals market are likely to increase. “As the health-care reform under way deepens, and given tougher enforcement, it is likely marketing practices will change for the better,” he says.

Prices will likely change faster. In a report this week on foreign drug companies, Xinhua, the Party’s official news agency, abandoned any pretense. “Some believe China may see a nationwide price cut on medicines,” Xinhua predicted. Expect that guidance to resonate with drug makers.

In its race to build a consumer-led economy, Beijing will need to reassure its citizens that all this isn’t just theater to mollify the public, trim some costs, but chiefly leave the status quo, and the Party’s control over the economy, intact.

That’s a tall order.

Look next to the Party’s plenum in October to see which way this breaks.

That official gathering may be where Mr. Xi’s nebulous “reforms” finally get some concrete shape, and where consumers see whether commercial corruption truly is—or isn’t—under assault.