(FORTUNE Magazine) – The promise: The summer heat in Henan province in central China is so oppressive that it feels like a great blazing hand pressing down on your head all day until, finally and mercifully, the sun dips below the horizon shortly before eight. For her entire adult life, Chen Zhilan, 44, has labored under that sun, working a small plot of land in the undulating wheat fields that roll on as far as the eye can see. And she has the skin to show for it, lined and deeply brown, like uncut tobacco. Chen and her husband, Zhang Hongli, and their three children live in a tiny two-room house that abuts the fields she tills. Save for the electricity that lights the Zhangs' home, theirs has been a life not unlike those endured by Chinese peasants who came before them, one of 19th-century arduousness (Chen and her fellow fieldworkers put in minimum ten-hour days) and poverty (she earns about $40 a month). And for the past 16 years, Chen has supported her family by herself. Her husband lost a leg below the knee in 1987 to a vascular inflammation. He has not worked since.

One day this summer, Chen worked her ten hours in the sun as always. But this day, in early July, was unlike any other for the Zhang family. It was the day everything changed. Hundreds of miles away in Beijing, their eldest son, Zhang Xin, did something no boy from his village had ever done. He graduated with a degree in computer science from one of the nation's most prestigious universities--Qinghua, the MIT of China, as it is often called. Three days after graduation, Xin took the long train ride home to visit his parents and take a one-month break before beginning his new life.

A few months earlier he had accepted a job offer in Beijing at Huawei, a Chinese company you probably haven't heard of but probably soon will. It produces, among other things, the infrastructure for cellular-phone networks, and is already making life miserable in China for companies you have heard of--Nokia and Ericsson among them.

Zhang Xin was born in 1979, the year Deng Xiaoping changed the course of modern history by placing China on its path toward a market economy. His is one of the tens of millions of lives that have been radically improved by his country's progress, and he now stands to inherit the opportunities that the next stage of reform holds out as China opens even more to the world. By the end of the year China will take its next great step toward economic liberalization when it joins the World Trade Organization, the Geneva-based international body that supervises and encourages global trade.

This transition is not a one-way street. It is not just about promise and progress. It is also, as the Chinese government is well aware, about pitfalls. Big ones. During the next decade China will experience economic dislocation on an unimaginable scale. Brutal decisions about what to do with huge, uncompetitive state-owned industries--still by far the largest component of the economy--will be front and center. For all the optimism about China, "the contradictions" between socialism and capitalism, as Deng termed them, have yet to be fully resolved. Now, with WTO looming, China is attempting to do so, and one inevitable result will be millions more unemployed. Consequently, unrest--already on the rise in the impoverished regions that foreign investors usually don't see--is guaranteed to increase as, in many places across the country, the poor get even poorer.

Those would include places like Henan, from which Zhang Xin is about to escape. During his train ride home in July, he spoke to FORTUNE about the opportunities he had inherited and the responsibilities they entail. He will be able to drag his poor, peasant family firmly into the 21st century. Soon, he said, as a prized recruit at Huawei, he will be able to afford a place in Beijing big enough to house both him and his parents. And then his mother's days in the wheat fields of Henan will be over. "I promised her that," he said.

They say--those who believe that China's moment has now truly arrived--that you need to pay attention to "China: The Movie" and not "China: The Snapshot," because the snapshot can still be ugly. American University scholar Gao Zhan was released in late July after five months of detention on bogus espionage charges and often being grilled for 12 hours a day under a 300-watt bulb. Those kinds of snapshots evoke a central reality that the movie, in its grand sweep, sometimes glosses over: China is still a thuggish police state, run by a single party that has no intention of giving up its monopoly on power.

The story of a family like the Zhangs, by contrast, forms the core narrative of "China: The Movie." China is a country being transformed in little more than a generation; it is, quite literally, a (rapidly) moving picture, with living standards rising for hundreds of millions of people at a rate that is unprecedented; it is a country that still, more than 20 years after Deng said getting rich was glorious, has extraordinary momentum. China is growing at 8% a year, on the back of vibrant exports and strong domestic demand. It is inhaling foreign direct investment--$66 billion last year alone. After years of hype about the riches to be earned in a nation of 1.3 billion people, the conviction has taken hold in executive suites that China's economic traction will endure.

The nation's long-awaited emergence into the world trading system only reinforces that conviction. Indeed, it is WTO membership, not the 2008 Olympics, that will mark China's real coming-out party--the biggest coming-out party in the history of capitalism, in fact. "It is a no-going-back, transforming moment," as Henry Paulson, CEO of Goldman Sachs, puts it. Part of the promise of WTO is, of course, supposed to drop straight to corporate and national bottom lines. For example, according to a conservative estimate by the National Bureau of Asian Research, Beijing's entry will swell its purchases of U.S. goods to $44 billion by 2009, up from $19 billion in 1998.

But accession is about more than numbers. First, WTO's rules and regulations put real flesh and bones on what has been a goal of U.S. Administrations going back to Richard Nixon's: integrating the world's most populous nation into the global system. Right now China is, in many ways, the centripetal force of globalization--attracting capital and companies at an increasing rate; in the process, given its inexhaustible supply of cheap labor and surprisingly swift ascent up the technological food chain, it is rewriting the economics of scores of industries. Simply put, to have China doing that inside the world's formal trading system, rather than outside it, is unambiguously a good thing. It envelops Beijing in the web of global trading rules--everything from lower tariffs to antidumping regulations to wholesale removal of rules restricting distribution and retailing, even (believe it or not) stiff penalties for intellectual-property piracy. As such, accession will touch every corner of the country's economic life. For the outsider trying to do business in China, WTO means "more transparency and more rules," as Paulson puts it, and in the murky land of guangxi (the endless search for the right connections) that can only help.

But before elaborating on what WTO will do, it's also important to understand what it will not do. It will not make or break any foreign company in China. Some of the coming changes are incremental, an acceleration of liberalizing trends in place for two decades. As Gordon Orr, head of McKinsey & Co.'s China practice, puts it, "Any sweeping conclusion that WTO accession will allow foreign corporations to overtake Chinese companies just like that is wrong. Things are much more complicated than that."

The first thing to remember is that even in industries where massive change is coming, it is going to take time--more time than the five-year WTO transition period calls for. Consider, for example, the auto industry, in which radical change is certain thanks to the forthcoming dramatic reductions in tariffs and the elimination of many distribution barriers. An exhaustive analysis just published by German consultancy Roland Berger & Co., examining what WTO means for the global car business in China, begins on the following jarring note: The first thing everyone should expect post-WTO is "more protection" for the home team. There are more than 120 separate vehicle assemblers in the car and truck business spread across China, and in several provinces they are important local employers. Most of them either will be wiped out or will end up allied with the five or six global auto companies that will eventually dominate the Chinese market. That competitive reality, not surprisingly, scares the daylights out of many Chinese government officials. Xu Jian, head of Roland Berger's China practice, recounts a recent conversation with a powerful provincial politician in which the consultant asked a straightforward question: If it comes down to protecting the large local auto company or abiding by WTO rules (and Beijing's command to obey them), what will you do? Xu says the official didn't even hesitate: "I will protect the local employer."

That reality may well end up confirming the wisdom of those companies that have chosen already to spend millions and endure countless frustrations (not to mention losses) to become "insiders" in the Chinese market. Among U.S. auto firms, that means General Motors. GM now produces two passenger cars with its main Chinese partner, Shanghai Auto. Under WTO rules, GM will have much more flexibility in purchasing components (duties on which will also come down sharply) and expanding capacity, which should improve the quality of its cars and reduce costs. It is hard, under these circumstances, to see how GM could not end up being one of the five or six dominant players in China that everyone foresees emerging a decade or so down the road.

Other huge companies that have been completely blocked to date from China's market will also be beneficiaries. Banking, for example, is now dominated by a handful of huge state-owned institutions whose basic job over the years has been to shovel money to lousy state-owned manufacturers. Not surprisingly, those banks now suffer from Japanese levels of bad debt. All are so entrenched across the country and so politically connected that no foreign firm will take them on directly. Instead, Citicorp believes that with personal income growing rapidly for millions of Chinese, particularly in the country's more prosperous southeastern crescent, an all-out drive to flog credit cards and home mortgages makes eminent sense. It is probably right. China's most adept retail bank, Bank of China, understands that, too, of course, and already has millions of "Great Wall" cards in the hands of Chinese consumers. But even with Bank of China's head start--2005 is when the China market will crack open for foreigners--few analysts doubt that Citicorp will make lucrative inroads in post-WTO China with the products it peddles all over the world. Neither does Bank of China CEO Liu Mingkang have doubts: "We know we can expect very stiff competition from a whole range of foreign competitors. Our whole goal now is to prepare for that."

There is, though, probably more cumulative importance in the small changes that WTO will bring. Consider the decidedly unglamorous world of distribution and retail. Getting products to market and then being able to sell them is fundamental to success. Yet in present-day China it can be a nightmare. Companies cannot set up their own distribution chains, service centers, or dealer networks, which means they rely on local partners. And as lots of foreign companies have discovered, that can mean trouble: For example, your main distributor could also be the distributor for your main competitor.

WTO is supposed to change all that--and that's why U.S. companies like Caterpillar are counting the days until accession. China today is one vast construction site, with highways, dams, buildings, and neighborhoods springing up everywhere. For Caterpillar it should be a dream market. But Cat is conspicuous by its absence. At one level, the reason for that is simple: Its products are too expensive for Chinese buyers. The construction industry, like the automotive, is chock full of small, inefficient producers that practically give stuff away. "We have the strongest demand in our industry's history in China," says Richard Kahler, the company's Hong Kong-based China director, "yet prices are falling."

Though it will expand its locally made products, Cat will never be a bargain-basement buy in China. For that reason its own distribution networks, feeding a chain of dealers and service centers across the country, are critical to changing how customers think about buying, say, a hydraulic excavator. Right now the only thing most buyers look at is price. What they need to think about, Kahler says, is productivity. Cat's products will last longer; when they do break down or require spare parts, help will be available pronto. Kahler insists Cat's "value proposition," as B-school jargon would have it, is compelling; the company just needs the ability to make the case to customers who wouldn't, for the most part, know a value proposition if one fell out of the sky and conked them on the head. A distribution and dealer network--which the rules of WTO will allow it to build--makes the education process possible.

For all the benefits WTO entrance may bring to foreign companies, the idea wouldn't have gone anywhere if it had not also had powerful domestic constituencies. Chinese Prime Minister Zhu Rongji and his team understand very well that those constituencies exist (even if some of the old guard in Zhongnanhai, home to China's central government, still don't). The most obvious are consumers, particularly the swelling middle class (the 120 million who now have disposable income of up to $8,000 per year, a group that could, according to Morgan Stanley, grow to nearly half a billion by 2010); they will see their purchasing power increase as prices come down and choices expand for almost everything. Other domestic constituencies for change include certain state-owned enterprises. Cosco, for example, is an emerging player in international shipping, and its stake in WTO membership for China couldn't be clearer. Its CEO, Wei Jiafu, says a big problem for the company is that container ships steam for the U.S. full of exports "but come back mostly empty." If WTO expands trade in both directions, as it should, "that's a good thing for all of us," he says.

Other important constituencies for WTO-induced change are in less obvious places. An hour and a half up China's grand canal from the booming city of Shanghai sits a state-owned company, the Dongfeng agricultural machinery group, which makes tractors. At first glance Dongfeng seems like just the type of company that will be clobbered in post-WTO China. Most of its production lines are labor intensive and inefficient; it desperately wants an alliance with a foreign partner, like Deere or CNH, but for now the major foreign players in agricultural machinery are "already married," as general manager Li Jianming puts it, to other Chinese companies. Finally, its sales base, the Chinese agricultural sector, will be affected more by WTO entry than any other. Twenty years from now lots of Chinese farmers will either be doing something else for a living--or not be doing anything at all.

But Dongfeng's attitude toward WTO is not entirely one of fear and loathing--provided the government rigorously implements the rules. Because if that happens, life will in some ways become easier for the company even as barriers for foreign competitors come down. Don't think, for example, that only Microsoft and Gap have stakes in seeing antipiracy laws enforced. Dongfeng cares too. A lot, in fact. In the early '70s, Mao Zedong ordered the "mechanization" of the farm in China, and Dongfeng was ordered to give away its tractor design. That legacy now haunts it. Dongfeng is a known brand name that to Chinese farmers connotes a cheap price and, by domestic standards anyway, relative reliability. But across the country, other companies use the Dongfeng engine and sell it as their own--sometimes even selling under the Dongfeng brand name. "We expect and hope that something will finally be done about this because of the WTO era," says Sun Liangjun, a vice general manager of the company.

Those are the types of little changes that WTO will probably allow, benefiting both Chinese and foreign firms. Economically it will be the opposite of death by a thousand cuts; it'll be life by a thousand stitches--the knitting together of literally thousands of rule changes, big and small, that will make China a faster-growing, more efficient economy. That in turn will mean more capital investment, higher productivity, and higher living standards for the Chinese.

There is, however, a view prevailing now among foreign investors and China watchers--the "view from 30,000 feet," as Denis Fred Simon, president of Monitor China, a consulting firm, puts it--that all this can basically be taken to the bank; that virtually nothing can go wrong between now and when the rules are finally and firmly in place. But the view on the ground can be very different from the view from 30,000 feet.

The pitfalls: Twenty-five million is a big number, even in a country of 1.3 billion. Twenty-five million is the number of additional unemployed Chinese there are likely to be over the next five years, thanks in large part to the necessary restructuring of industry as the WTO era bears down, according to Morgan Stanley economist Andy Xie.

That is a number that doesn't seem to bother the China optimists. But it sure has the attention of the country's leaders. Not long before he graduated, Huawei-bound Zhang Xin listened to a speech at Qinghua given by Zhu Rongji. In it Zhu, one of WTO's major proponents in China, very explicitly said that some aspects of the "reform" needed to "slow down under the current situation, for safety." He continued, "If we want to conduct [further] reform," the state-owned enterprises needed to reduce their work forces "by two-thirds." Then he asked a straightforward and very important question: "Where can they go?"

To understand the historic gamble China is now taking, it's important to know that for all of its undeniable progress over the past 20 years, the country today has, among its huge and enormously powerful state-owned enterprises, what amounts to an economic caste system: scores of companies across industries that are divided, in effect, into first- and second-class citizens. The first-class citizens are those that are listed on various stock exchanges, whether in Shenzhen, Shanghai, or Hong Kong. These companies have been carved out of their bigger mother ships, usually handed the best assets, because the best assets, of course, draw higher valuations when the companies go public. The unlisted companies, which are enormous, still act more as social buffers than as economically rational, competitive companies. They employ huge numbers of people--more than a million at a single oil company, Sinopec--and still run all the cradle-to-grave social benefits, from cheap medical care to schools to hospitals, that are part of the legacy of the Communist system.

But under the lower tariffs of WTO, the increased foreign competition coming to China will not discriminate between "listed" and "nonlisted'' companies. They are going to make everyone's life tougher. That's why Zhu used the startling "two-thirds" figure when he spoke of how many people probably need to lose their jobs for those companies to be competitive.

That is where the audacity of China's decision to pursue WTO entry lies: In effect, Zhu felt there was no way to push the reforms to the next stage--to turn China into a truly competitive market economy--by pushing harder from above. What WTO provides is a critical external force, a battering ram that would allow reformers, when confronted by backsliding conservatives as unemployment mounts, to say, simply, "The WTO made us do it." This is ready-or-not-here-it-comes economics.

Clearly, huge swaths of the economy are nowhere near ready. Consider Dongfeng Motor Corp., one of China's largest truck and auto makers. If you were running a contest to select the single spot on earth where not to locate the production base and headquarters of a new global car and truck company, the rugged mountains of northwest Hubei province in midwestern China would at least make the finals. Dongfeng (which is not related to the tractor-making company mentioned above) was created in the early 1970s, when Mao was in a particularly apocalyptic mood. A man of many slogans, the Chairman at the time was fond of "Dig deep, store food, and love the motherland." ("Dig deep" was a reference to bomb shelters. Mao feared--not without reason in the wake of border skirmishes with the Soviet Union--that China might be nuked at any moment.) He ordered a production plant for military trucks to be built in an isolated mountain village called Shi Yan.

Then as now, Shi Yan is a long way from anywhere. Its isolation makes simply getting parts to the place an ordeal. But Shi Yan is home to no fewer than 30 assembly lines, mainly for trucks of varying sizes. The company as a whole, in Shi Yan and a town called Xiangfan, a few hundred kilometers away, employs thousands of workers. Like most of China's large state-owned companies, Dongfeng is a motley mix of assets; a joint venture with Cummins Engine, a truck-engine plant in Xiangfan, is world class, yet several of the truck-assembly lines are anything but. And Miao Wei, the direct, intelligent former government bureaucrat who runs Dongfeng, already acknowledges that the company may well have to get out of the "midrange" trucking segment once tariffs are reduced and foreign companies like Isuzu and Volvo make more headway in the market. He is also at the moment without a world-class partner in either the car or the truck business (its main auto tie-up is with Citroen). And Miao realizes that the number of employees will have to come down, something that really hasn't happened yet in company town Shi Yan.

But in Xiangfan, where the company is one of several large employers, there has been a whiff of what China's leadership fears most: the unemployment that produces trouble. Dongfeng says it has not laid off many people yet in Xiangfan, a city of 400,000, but many smaller state-owned enterprises around it have. A young man whose parents have both been laid off from local state-owned companies says there have been sporadic demonstrations against the local government by the growing numbers of unemployed. He offered a sarcastic critique of a recently constructed riverside pedestrian mall, asking why some of the money didn't go to his parents and others among the swelling ranks of the city's unemployed. If Dongfeng Motor is to cut it in the WTO era, those ranks are going to increase sharply in a place without a lot of obvious alternative employment possibilities.

The government is acutely aware of dilemmas like this across China. "The expectation of many government officials and national managers [is] that Chinese traditional state firms can rise to the challenge of global competition," says Edward Steinfeld, an MIT professor who studies China's state-owned enterprises (SOEs). "It is also, for the most part, wrong." The possibility of a bigger-than-expected backlash against the only thing that the Communist Party can hang its hat on anymore--a market economy and the relative prosperity it has delivered so far--petrifies the leadership in Beijing. That's why, not long before Zhu's speech at Qinghua, the party published a pamphlet that contained remarkably frank descriptions of public anger and unrest in both rural and urban areas.

That puts managers of the big SOEs in a very hot seat. Liaoning province, in the northeast, is the cradle of centrally planned industrial economy in China, home to hundreds of large metal-bending companies. One of the largest and most prestigious (it was the first "Red Chip" to list on the Hong Kong exchange after the handover in 1997) is a company called Angang Iron & Steel. Since 1995 it has cut 30,000 people, though it still employs 165,000 workers. Liu Jie, the company's blunt chief executive, says that number will continue to shrink. But as he knows better than anyone, the question the company must address is, How quickly? Angang eventually needs to compete with, among others, a highly competitive South Korean company, POSCO, which is today six times more productive than Angang: POSCO churns out 26 million tons of steel with 20,000 workers, while Angang produces 9.3 million tons with its 43,000.

But as Bai Jingpu, one of Liu's lieutenants, makes clear, it is more than the bottom line the company must watch. "After all,'' he says, "these workers have worked in your enterprise for years; you can't simply push them out into society because of 'reform.' " And the reason for that, Bai says, is straightforward: "If the policy is misdirected and harms large numbers of people it might lead people to complain to the authorities en masse. In doing our reform, the most important consideration is to avoid this."

That tension, between what WTO-driven reform means for China's biggest companies and its economy (relentless pressure for more efficiency and thus faster growth) vs. what it means for a government worried about social unrest, will be Beijing's central dilemma for the next decade. For WTO accession to go as smoothly as the China bulls envision, it means the country will, economically speaking, need to thread the needle. Very little can go wrong. It means the economic growth of 8% a year that China has enjoyed for most of the past two decades must continue for another in order to absorb some of the vast numbers who will lose their jobs. It means the country must knit a tighter social safety net on the fly, which is why in early July Beijing announced that 10% of the revenue raised in every new listing on China's stock exchanges will go straight into a social security fund. And it means the central government will have to allow even more migration from poorer regions to the richer urban areas than has already occurred.

Those poorer regions include, unmistakably, the wheat-growing region of central Henan, where Zhang Xin grew up. His mother has no idea that among the biggest "winners" of China's WTO accession are likely to be the large, brutally efficient foreign growers of wheat. According to Jun Ma, chief China economist for Deutsche Bank Securities in Hong Kong, China's additional appetite for wheat imports is likely over the next ten years to equal 6% of total world demand today.

The cheaper imports are good for consumers. But they're not going to be good for the village that, thanks to their bright son, will soon be the Zhang family's former home. Shortly before FORTUNE left that village, Xin's father said what he thought of local government officials and their relative level of concern for the plight of people like him and his neighbors. The remarks were sharp enough to prompt his son to plead that they not be published, lest they cause the family "trouble."

For those who will be left behind after the Zhangs are gone, and for millions like them in villages and cities across China, a hard life is going to get considerably harder over the next decade. How they respond to that fact may well dictate whether China's current extraordinary ascent will continue or whether it will turn into something else entirely. Today's prevailing WTO-driven optimism among the China bulls may well be justified, but as they might put it in Henan province, better not bet the farm on it just yet.

REPORTER ASSOCIATE Daniel Walfish

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