(FORTUNE Magazine) – Call it a great leapfrog forward: Chinese medicine is jumping into the genomics era while still at one with remedies like bear bile and dried sea horse. Barely three years old, the Beijing Genomics Institute has already emerged as a world leader--it recently stunned Western scientists by decoding the rice genome in a matter of months. Last year a Beijing team grew dog-bladder tissue on a mouse's back, a prelude to generating human tissue. In Changsha, a city in central China, researchers claim to have cloned dozens of human embryos as sources of stem cells, which promise to rejuvenate failing organs--an apparent world first, the Wall Street Journal reported in March.

The blue-shirted throngs working the good earth are also embracing biotech. In 1988, China became the first country to commercialize a bioengineered crop: tobacco resistant to a plant virus. Last year its officials announced plans to quintuple government funding of ag-biotech research by 2005, to $500 million annually. If that goal is met, China might top U.S. government spending in the area, says Scott Rozelle, an expert on Chinese agriculture at the University of California at Davis.

In short, two 21st-century megatrends--China's emergence as an economic colossus and the global rise of commercial life science--are coming together. For this nexus to yield a world-class biotech industry will probably take a decade or more: Turning science into commerce requires a commercial infrastructure with lots of venture capitalists, strong patent protections, and vibrant stock exchanges--the product of a daunting process of legal and cultural change that China has only just begun.

Much sooner, though, the impact of Chinese science could make itself felt. U.S. companies and universities may well find themselves seeking access to cutting-edge Chinese biotech in drugs, agriculture, and other fields, rather than the other way around (see box). Indeed, hints of that world-turned-upside-down trend are already visible in the work of a Chinese locomotive-factory engineer turned California biotech whiz turned Beijing entrepreneur named Cheng Jing.

Three years ago the ferociously versatile Cheng spearheaded the founding of a San Diego biotech company based on technology from Tsinghua University in Beijing, where he was named a professor in 1999. The startup, Aviva Biosciences, is developing miniaturized "lab on a chip" systems for use in drug research and disease diagnosis. In an extraordinary collaboration, Tsinghua (pronounced ching wa) joined forces with venture capitalists from Taiwan to start the U.S. company. (Roll over, Mao--Tsinghua was known in the 1960s for the zeal of its Red Guards.)

Cheng is internationally recognized as a scientist, but what really sets him apart--and puts him in the vanguard of China's push on biotech--is his commercial drive. Soon after founding Aviva, he led in the formation of a conglomerate in Beijing, Capital Biochip, that now encompasses everything from biochips to dental equipment. Recently named CEO of the company, he describes it as a "biotech empire" in the making.

China's biotech program dates to 1986, when Deng Xiaoping, the country's late leader, anointed genetic engineering as one of seven technologies critical to economic growth. That inspired a few impressive feats, such as the implanting of virus-resistant genes in tomatoes and sweet peppers. Deng's push also engendered the first glimmer of commercial biotech in China. By 2000 there were 39 publicly traded biopharmaceutical firms in China--about a tenth as many as in the U.S., according to IMS Health, a market research firm in Fairfield, Conn. (The Chinese firms mainly sell knockoffs of U.S. bioengineered drugs---no U.S. pharmaceutical patents awarded before 1986, and only some awarded between 1986 and 1993, are protected in China.) But until recently Chinese biotech has largely been an academic affair.

One reason is that cheap labor--which has abetted China's modernization push in other technology sectors, such as consumer electronics--confers little advantage in biotech. Bioengineered drugs are made in vats teeming with genetically engineered microbes, not on assembly lines. China's lack of strong patent protection hasn't helped either. To support its accession to the World Trade Organization last year, the People's Republic upgraded its laws to protect intellectual property. But enforcement remains a work in progress.

The main brake on commercial biotech in China, though, has been its dearth of venture capital. In the U.S., VCs have not only pumped billions of dollars into early-stage biotech companies but also provided them with sorely needed management savvy. Over the past few years China has removed some of its regulatory barriers to foreign investing, but a major hurdle remains for both overseas and home-grown VCs: They lack good "exit strategies" for cashing out their investments in Chinese startups, such as selling shares in IPOs on exchanges catering to high-tech investors.

"The stock markets in China are designed for state-owned enterprises" that have been privatized, explains Victor Li, a native of the People's Republic who manages a biotech hedge fund at Friedman Billings Ramsey Group in Arlington, Va. As such, they provide limited opportunities for sales of new shares. Indeed, foreign investors in China have long resorted to complex maneuvers, such as forming offshore holding companies (whose shares can be traded outside China) that have stakes in joint ventures with Chinese concerns. Few Western VCs have been willing to take on the added complexity and risk entailed by such gambits.

China recently sought to address the VC exit problem by moving to set up a Nasdaq-like exchange in Shenzhen, a high-tech haven near Hong Kong. But the Nasdaq meltdown and accounting scandals in the U.S. put the idea on hold--Chinese officials reportedly still plan to launch the new exchange, but only after beefing up securities laws to protect investors against scams.

Still, China possesses a huge asset to help realize its high-tech dreams: the more than 300,000 students from mainland China who have been trained in foreign universities, mostly in the U.S. and Europe, since the late 1970s. They have included many of China's best and brightest, and thousands have stayed overseas for years, acquiring commercial experience as well as familiarity with cutting-edge academic research. Many probably never will go back to live in China. Indeed, Chinese officials have fretted about a brain drain since the mid-1980s, when they began offering incentives to lure back young scholars gone walkabout. Reversing the drain got much harder after China's leaders violently suppressed its student-led pro-democracy movement in 1989--thousands of visiting Chinese students settled in the West.

But now many of the emigres are giving back, if not going back, to their homeland by advising and investing in its technology ventures. In a survey last year of Asian-born professionals in Silicon Valley, a third of the respondents from mainland China said they had helped businesses back home arrange contracts, according to the Public Policy Institute of California in San Francisco, which sponsored the study. Some 43% said it was at least somewhat likely that they would consider returning to live in China.

Such statistics have prompted talk of a "reverse brain drain" from the U.S. to the People's Republic. Indeed, furious networking between China's expatriates and its home-based entrepreneurs has helped boost its modernization drive to warp speed--China has already become the world's largest market for cellular handsets, and it is expected to represent the second-largest PC market by the end of 2003. But AnnaLee Saxenian, lead author of the California institute's study, asserts that the U.S. has little to fear from the trend--it is more a "brain circulation" than a drain, she says. Of the 43% of Chinese respondents who said they would consider going home, only a third, or 14% of the total, said going back was "quite likely."

Cheng Jing, the biotech entrepreneur, is one of the returnees, but he is also the epitome of the circulating brains. When I caught up with him recently in San Diego, he had just flown in from Beijing for a board meeting at Aviva, his biochip startup, where he's a director. Poised and precise, yet given to disarming flashes of drollery, Cheng, 39, has mastered the art of crossing cultural divides--including the especially tricky one between the lab and the boardroom. Tracing his career illuminates both the rise of the circulating Sino-scientist-entrepreneur and the soul of China's revving biotech machine.

The youngest of three sons born to a law professor (dad) and doctor (mom), Cheng made his first career move, characteristically, by striking out in a direction utterly different from the paths taken by his parents: He trained in Shanghai as an electrical engineer specializing in locomotive engines. Assigned by the government to work in a train factory, he grew bored and after three years engineered an escape that was inspired by his passion for adventure stories. "One day I was wondering if a scientific text could be written in a way that would attract people the way a kung fu novel does," he says. "Something that came to mind was crime investigation."

Deciding that this project would require expertise, Cheng went to his father and asked about studying forensic science at his dad's law school in Chongqing, a city in southwestern China. His father was nonplused, says Cheng: "He said, 'Son, you're a locomotive driver!' At that point, I realized my father had misunderstood my career for a long time."

When the confusion was cleared up, the elder Cheng helped his son land a job as a technical assistant in the university's forensics department. That role brought him to the attention of a visiting U.S. professor, who decided that Cheng was miscast as a low-level techie and offered to help him go abroad for graduate studies. A few months later he was on his way to the University of Strathclyde in Glasgow, where he sprinted through a Ph.D. program in forensic biology, a specialty that exposed him to DNA fingerprinting and other fast-evolving biotechnologies. By the time he left Scotland in 1994, Cheng had begun developing novel devices to automate DNA analysis and won research funding from the predecessor company of Beckman Coulter, a big maker of scientific instruments in Fullerton, Calif.

He spent the mid-1990s as a post-doctoral researcher at the University of Pennsylvania, where he began tinkering with biochips. With his flair for both engineering and biology, he was superbly equipped to play a role in biotech's miniaturization drive. Its goal is to shrink biochemistry's glasswork jungles into automated, postage-stamp-sized devices to analyze DNA and other cellular molecules. "Jing was unequivocally the most innovative and productive post-doc I've had in my career," says Peter Wilding, a prominent biochip expert who oversaw Cheng's work at Penn and who is now CEO of Aviva.

After three years Cheng branched out again. "I had noticed that the Chinese government was strongly encouraging universities to start businesses" based on professors' research, he says. Planning to go home someday and capitalize on the trend, he decided first to seek commercial enlightenment in the U.S. "I wanted to see how a U.S. biotech company is started and goes through an IPO," he says. He got his chance when Howard Birndorf, co-founder of a San Diego biochip startup called Nanogen, phoned Cheng out of the blue to offer a job.

Nanogen was rising to prominence as a biochip pioneer while gearing up for an IPO, completed in April 1998. It offered Cheng an opportunity to help lead a showcase project: developing a novel "bioelectronic" chip, which used electric fields to isolate bacterial cells from blood, cracked them open with high-voltage shocks, and then rapidly extracted their DNA for genetic analysis. Such devices might be deployed, for example, to quickly diagnose infections or identify terrorist-dispersed bacteria in water or food. In June 1998 a landmark report on Nanogen's new chip was featured on the cover of Nature Biotechnology, the field's most prestigious journal. Listing Cheng as lead author, the report gave him something like rock star status in biotech circles. When he visited China soon after, a number of its top universities plied him with dream job offers. Tsinghua won: Known as a life science mecca, it offered him a chance to set up a major biochip lab.

One of his roles was to help commercialize Tsinghua's biochip-related research. He soon found overseas VCs willing to back a startup company based on the technology--but only if an exit were available. That inspired a bold stroke: They would form a Tsinghua spinoff in the U.S. "It was an unknown procedure--the first time for Chinese technology to be transferred out of the country," says Cheng. Three Chinese ministries had to sign off on the idea--a process that took months--as well as skeptical university officials, who at first suspected the foreign VCs were conspiring to give the school too little for its patents. "Gradually, through hard struggling, Aviva materialized," says Cheng, who enlisted as co-founder one of his former Nanogen colleagues, Wu Lei, another gifted Chinese native trained in the U.S. "Afterward I thought, 'Doing one company for the university is enough,'" Cheng says.

But his wheeler-dealer days were just starting. In 1999, China's vice premier toured Tsinghua and stopped by Cheng's lab. Before he left, recalls Cheng, "He said, 'Jing, the time today is too short. I will make arrangements for you to come to the central government and give all of us an in-depth lecture.'" A few weeks later the former locomotive-factory engineer found himself giving a two-hour lecture on the future of biotech to most of China's top ministers. It went well--he'd anxiously rehearsed his PowerPoint presentation for days, using school secretaries as a test audience. Soon after, Cheng was tapped to lead a $40 million, two-part national biochip initiative. One part is a nonprofit research center based on work at Tsinghua and three other top medical schools and universities. The other is a for-profit company, Capital Biochip.

Capital, which Cheng describes as resembling a "train without brakes going down a slope," quickly evolved into a biomedical holding company. Its most ambitious move has been to acquire Beijing-based Wandong Medical Equipment, a maker of X-ray systems, dental equipment, and other medical devices, which has 3,000 employees. Among other things, Wandong's prototyping and manufacturing expertise will jump-start Capital's effort to turn its biochip designs into products, says Cheng. Last year Capital spun off an affiliate in Shenzhen--ChipScreen BioSciences--that will employ biochips to help isolate disease-fighting substances from traditional Chinese remedies and other natural products. Once isolated, such active ingredients can be developed as proprietary pharmaceuticals. In another ambitious move, Capital has formed a unit to market outsiders' biomedical products under its brand name.

One of Cheng's boldest innovations at Capital has been to recruit top talent by offering Western-sized pay--astronomical by Chinese standards. "China desperately needs people with management experience" at high-tech startups, he says. "When we tried to recruit people from the U.S., many were worried that their salaries would be ten or 20 times lower here. So we worked out an unusual plan to match U.S. salaries and stock options." But Capital's hiring criteria are "very tough." And those who make the cut must meet ambitious performance goals--or leave. Cheng says he has already booted several who didn't measure up.

As part of its increasingly farflung ventures, Capital is even funding research at Aviva, the San Diego startup, in return for rights to market the resulting products in China. The U.S. company is developing systems to test prenatally for Down syndrome and other genetic diseases--the devices will obviate the need for amniocentesis by analyzing blood samples from pregnant women, winnowing out cells of fetuses that find their way into the maternal bloodstream and checking those cells for gene glitches that cause the disorders. Regardless of whether the new systems are successful, they already represent a breakthrough of sorts in Chinese-American relations--in effect, a Communist Party-supported enterprise is helping bankroll the advance of U.S. technology. Roll over again, Mao. (To be sure, Cheng and company are merely acting in concert with the pragmatism of the party's current chief, Jiang Zemin, whose "Three Represents" philosophy has put the party on record as supporting entrepreneurial creativity.)

Despite Capital's runaway-locomotive quality, Cheng harbors no illusions about the long haul ahead. "We have to be realistic about what China has," he says. "Down the road, maybe in ten to 15 years, Chinese biotech companies may be able to reach leading positions at the international level. This is not a one-day job. We're really exploring something totally new."