A Facebook that appeases the Chinese government might be a net positive for Chinese netizens, but I think it'd be a disaster for Facebook. It'd piss off far more than just 'rights groups.'(Kai is also quoted in a Christian Science Monitor article about Facebook's prospects in China, a topic which is being floated because Mark Zuckerberg is currently on a trip to that country.)
It'd probably also go against one of the fundamental missions of Facebook (as stated by Zuckerberg during our CS106A guest lecture): Facebook lets users share more of our lives, allowing us to better understand each other. That enables us to have a greater sense of sympathy for others.
If you trim away a whole set of topics, i.e. if you censor political, religious, or civil society issues, then you may be shearing away a significant part of a person's identity.
Furthermore, Facebook is also an intentioned platform for activism, not only a passive glimpse into someone's life. We spread news among friends, post commentaries, sometimes even issue explicit invitations to take action. A Facebook persona isn't a whole person, but it's definitely a closer glimpse of some of the things one believes in and chooses to make public. Editorial choices about what to post, and what we write, help us form a greater impression of our friends -- to recognize some of the things they care about that one might not get a chance to chat about on a daily basis.
You do wonder if Facebook will start going through the well-China-is-a-big-market/we'll-do-more-good-than-harm rationalizations that Yahoo, Microsoft, and Google adopted. Or just sidestep concerns and become enablers, like Cisco. (Props to Google for trying to realign its actions with its ideals. Given the ethos of Silicon Valley, it's important to those companies from there that they live up to and propagate their ideals. Corporations aren't formed only to make money, but to build and create, and maybe, if they believe in it strongly enough, to change lives).
Yet Facebook doesn't seem to lack for users ... if the "citizens" of Facebook formed a country, it'd be like #3 in the world in terms of population, right? So perhaps they're not rushing to beat down the door to the "China market." (They were accessible until they were unceremoniously blocked a couple years ago.
So maybe it's better that they create the right experience for most of the planet -- for the communities of users who are willing to engage in that (necessarily collective) enterprise of mutual understanding and the consideration of others' viewpoints. Then, until China is ready to "play nice" and connect with the world, they'll simply have to live with a segregated, sanitized, "harmonized," somewhat crippled intranet.
Crippled in terms of lacking whole worlds of ideas and open discussion, though maybe not crippled in terms of functionality. After all, even if there's no YouTube, there are plenty of video-sharing substitutes like Youku or Tudou, right? On the other hand, some might call the open exchange of ideas one of the Web's most important functions.
In the end, I'd vote for Facebook staying true to its mission. No capitulation: Companies like Facebook and Google can win.