China makes a high-stakes bet on developing its heartland.

(FORTUNE Magazine) – EVEN THE LOCALS GET LOST IN CHONGQING, A CITY obliterating its past before the future has been built. Once China's World War II capital, this industrial metropolis of seven million people, 1,500 miles up the Yangtze River from Shanghai, is a labyrinth of half-finished highways, nearly completed office towers, and just-demolished buildings. Chongqing residents ruefully admit they haven't a clue whether their streets will exist next year. "I know we're going to be knocked down, but I don't know when," says Zhang Yawei, a 26-year-old woman whose gardening shop is threatened by the bulldozers.

But if the view at ground level is murky, China's leaders know where the city is headed. Under the "Go West" strategy launched four years ago, Chongqing takes center stage in China's trumpeted attempt to narrow the gap between the country's landlocked interior and its thriving coastal provinces. The key to that strategy lies 360 miles downriver, at the Three Gorges Dam. Seven years ago, when major construction began, Chongqing and 50,000 square miles of its hinterland were sliced away from Sichuan province and made a municipality directly under the control of the Beijing government. Chongqing now claims to be the world's largest city, with 31 million people--a figure that includes 20 million peasants living in the surrounding countryside and four million residents of outer suburbs and more distant satellite towns. When the dam is completed in 2009, large oceangoing cargo ships will be able to reach Chongqing for the first time. Environmentalists worry that the reservoir created by the dam will silt up the Yangtze. But planners believe Chongqing will become the trading gateway for China's remote southwestern provinces, a market of almost 250 million people.

To back its bet, the state is pouring money into a titanic public-works program that dispatches clouds of construction dust into the fog that regularly cloaks Chongqing's hilly streets. By 2010, $23 billion will have been spent on 105 major infrastructure projects. Some of the bigger-ticket items: eight highways, a monorail network, a sewage system, a container port, and a second airport terminal. The city brashly predicts that over the next decade an additional $200 billion in investment capital will flow into Chongqing, mostly from the private sector.

Such is the plan. What if it fails, as communist plans have been known to do? Many skeptics doubt that the "Go West" strategy can succeed, for a simple geographic reason. "Capital investment will always go where there is the highest return," says Xu Xiaonian, a professor of economics and finance at the China Europe International Business School in Shanghai. And the highest return, he points out, is found in China's richer coastal provinces, which are nearer international markets.

China's current leaders may not believe they can overturn economic geography, as their Soviet-trained predecessors dreamed of mastering nature with grandiose projects like the Three Gorges Dam. But the central government is clearly convinced it has to do something to mitigate the interior's natural disadvantages. For China's rulers fear that if the inland provinces fall too far behind the coastal regions, it will be harder to keep the lid on simmering social unrest. That makes Chongqing a showcase experiment that cannot be allowed to fail.

It isn't the bridges, highways, and railways--welcome though they are--that will give Chongqing the chance to emerge from decades of communist mismanagement. It's the vibrant private sector that now accounts for half of Chongqing's economic output, compared with 30% six years ago. If Chongqing's new generation of entrepreneurs continues to grow, it will sweep away the old economic order as certainly as the bulldozers.

EVERY EVENING a glimpse of Chongqing's middle-class future can be seen in the newly pedestrianized shopping streets around the city's Liberation monument. Fashionably dressed young couples promenade along the tidy boulevards and drink cocktails in trendy new watering holes like the Havana Club, Chongqing's first nightspot with a Latin theme. "More and more people feel they are middle class," says Cao Ping, a 36-year-old lawyer.

In the first half of this year the city registered breakneck GDP growth of 12.4%. That followed a growth rate last year of 11.3%, boosted by $3.9 billion of public-works spending. Chongqing can't continue at this rate, given the Chinese government's determination to prevent the national economy from overheating, but for now most of its citizens seem to be faring reasonably well. In 2003 the average per capita income for Chongqing's urban residents was nearly $1,000, compared with $250 for farmers in the surrounding countryside--in both cases, about two-thirds of what their counterparts earned in the coastal provinces. That sounds good, since retail prices are as much as 50% lower than in the east. But average incomes fail to tell the whole story. In Chongqing, as in other inland cities, a wealth gap has opened between economic winners and losers. Known as one of China's "furnaces" because of its blistering summer heat, the city harbors many whose frustration at being left behind might one day boil over.

At Chongqing's ferry port, it doesn't take long to get an earful from one of the thousands of porters who lug cargo up and down the city's winding streets on bamboo rods slung across their shoulders. "Business is bad because there are too many of us competing for the same customer," complains a 40-year-old farmer from Sichuan province who comes to Chongqing for half the year to supplement his agricultural income. On a typical day this peasant (who wouldn't give his name) makes between $2.50 and $3.50 and spends half of that on dormitory accommodation and food. That leaves little to pay for his two teenagers' high school fees, which he says total $145 a term.

More malcontents can be found on the square in front of Chongqing's Great Hall of the People. Most summer evenings women practice fan dancing here--a sedate spectacle, until the presence of a foreign reporter causes two women in their 50s to compete with hard-luck stories about losing their jobs at state-owned enterprises. It's a fate that since 2000 has befallen thousands of Chongqing workers, most of whom aren't counted in the city's official 4% unemployment rate because they still receive benefits, like housing, from their old work units. "I'm mad as hell," snaps one of the women, who was laid off when her construction firm was privatized. "The former leader of our company got a payoff from the entrepreneur who bought the business."

It's difficult to tell whether such tales are true. What's plain is that Chongqing's state-owned sector--laden with money-losing factories in such heavy industries as chemicals and automobiles--offers no hope for the future, even though it accounts for half of the city's economy. All the promise lies with Chongqing's burgeoning private sector, which is still a work in progress.

Its standard-bearer is Yin Mingshan, the 66-year-old founder and president of motorcycle manufacturer Lifan. Six years ago, when he was last interviewed by FORTUNE, Yin was a bitter man. Between 1959 and 1978 he was persecuted as a "rightist and antirevolutionary element." But having accepted the Communist Party's apology for his treatment, this lean, driven entrepreneur wasn't finding business easy. He was especially angry about the difficulty of getting loans to expand his company from the banks, which favored state enterprises. Today Yin's business circumstances are transformed. "The banks are treating me better," he says. "Because I'm rich, they love me."

Yin's bustling factory is peppered with notices displaying his business maxims in Chinese and English. The slogans are designed to keep his 5,000 employees up to the mark and to impress visitors. IF YOU DO NOT WORK HARD TODAY, YOU WILL SEEK FOR JOB VERY HARD TOMORROW, reads a message by the front entrance. Such exhortations seem to have had an impact: Last year Lifan recorded a pretax profit of $15 million on sales of $553 million, making it Chongqing's fourth-largest company in terms of revenues. Lifan now registers about $200 million a year in foreign sales and has a factory in Vietnam, with plans to open plants in India, Pakistan, and Bulgaria. Meanwhile, Yin's teenage daughter has been sent to private school in England. "I want Lifan to become more international, so she needs to study English language and culture well," he says.

It's evident, too, that Yin's political fortunes have improved. He isn't a Communist Party member and doesn't intend to join, but his spacious office in Lifan's new headquarters is decorated with photographs of himself with senior leaders in Beijing, including the party's general secretary, Hu Jintao. Yin is equally proud of his picture, taken last year, with vice premier Wu Bangguo at a ceremony marking the party's decision to admit private businesspeople. "The new policy of the central government toward private entrepreneurs has made a big difference," he says.

OF COURSE, Yin isn't typical of most Chongqing entrepreneurs. At the other end of the spectrum is Ruan Yongkai, 41, a former physics teacher who in 1996 founded a small company that makes protective plastic overshoes to keep dirt out of computer rooms. Wangguo Technology Institute's factory, on a dusty road in Chongqing's southwestern suburbs, consists of two tumbledown buildings where a dozen young women toil in baking heat over sewing machines to stitch the slippers. Each woman earns an average of $2.40 a day, the going rate in Chongqing for this kind of labor. The institute looks like a sweatshop, but the women seem grateful for the work. Zhao Lian, 20, a farmer's daughter from one of Chongqing's rural counties, was hired by Ruan last year after a brief spell at a clothing factory in coastal Guangdong province. "The weather was too hot," says Zhao.

Ruan worries about his margins, but he appears to be earning a reasonable income. Last year, he says, he made a pretax profit of $9,700. He expects profits to fall this year, because he now spends half his time in Singapore, where his son is in school. When he's away, Ruan leaves the business in the hands of two deputy managers. But he sees his long-term career in Chongqing. "I want to find another product I can make here," he says.

Businesses like Ruan's play a crucial role in soaking up some of Chongqing's surplus labor. Yet their growth prospects are limited because the market is overcrowded with similar small-scale, low-cost manufacturing operations. To provide a more solid platform for expansion, Chongqing's private sector needs a critical mass of younger, well-educated professionals--accountants, lawyers, and tech-savvy graduates--like those who have populated coastal cities since the 1990s.

Many of Chongqing's young professionals can be found on a balmy Friday evening sampling the city's vibrant nightlife on Nanbing Lu. The two-mile stretch of waterfront eateries has everything from the Champs Élysées restaurant to a long-haired street musician with an electric guitar. At the Old Courtyard Restaurant, Yan Yuejuan, a 27-year-old Chongqing bus- inesswoman, is unwinding with some friends. Yan trained to be a teacher, but after graduation she decided to go into business rather than be posted to a rural area four hours from the city. She worked for a real estate developer, then for an advertising company, before deciding last year to set up her own business. "I didn't want to work for other people anymore," says Yan. She employs 12 people at her advertising company, and although she still lives with her family, she plans to spread her wings when she and her fiancé, a doctor at a hospital, get married. Together they intend to buy an apartment for about $36,000 and a car for about $12,000.

The name of Yan's company, Chongqing Climbing, attests to her faith in the city. "I want to stay in Chongqing. This is my homeland," she says. But not all her friends are so sanguine about Chongqing's prospects. Says one, a young woman who works for a foreign diplomatic mission: "Most of my classmates have left Chongqing to seek better opportunities."

Other young Chongqing professionals reflect this ambivalence. Consider the example of Cao Ping. The 11th child of peasants from the rural hinterland (four of whom died in infancy), Cao, 36, has experienced remarkable upward mobility. He began studying English when he was 14 and spent four years as an English teacher in a middle school. In 1992, after receiving a university degree in English, Cao earned a second degree in law. He won a British government scholarship to study law in London, then worked for law firms in Guangzhou and Shanghai. Last year he decided to return to his home city. "I thought that investment was increasing in Chongqing and my opportunities would be bigger," says Cao in his almost flawless English.

Now a partner with Chongqing Senswins, he acts as the firm's international face, guiding foreign investors through the thickets of Chinese law in real estate development and joint venture partnerships. Most of his clients are from Singapore and other Southeast Asian countries, though he would also like to generate business from big Western companies. He and his wife live with their small daughter in a private residential development, close to where he was born, along with his elderly parents. But he has not put down roots. Instead, he plans to return to London when he is 40. "I do not know whether I will continue to like Chongqing or not," says Cao. "In my dreams, London is the place for the rest of my life."

CHONGQING is poised between two worlds. There is the new Chongqing, defined by the shopping streets around the Liberation monument and the dining spots on Nanbing Lu. And despite all the changes, there is still the ugly old Chongqing, defined by pollution, dimwitted bureaucrats, and money-losing state-owned factories.

The main plant of Chongqing Iron & Steel occupies a two-square-mile site by the Yangtze. Coal dust and smoke spew from its blast furnaces, darkening the summer sky. Part of the company was floated on the Hong Kong stock market as a separate subsidiary in 1997, with the parent company retaining a 62% stake. Steel prices reached record highs last year, which meant the listed subsidiary was profitable, with pretax income in 2003 of $117 million on sales of $678 million.

But chairman Tang Minwei explains that although the subsidiary accounts for 75% of the group's sales and about 80% of its pretax profits, the unlisted rump employs two-thirds of the company's 30,000 workers. "I have too many staff," says Tang, 62, who has worked most of his career for the group. "My company is much more difficult to run than a private enterprise." The parent company doesn't publish detailed results; once social obligations such as running a hospital are taken into account, the group probably struggles to make money. Few employees focus on the bottom line. "My staff are paid by the state," says Tang, "so their mentality is hard to change."

At least the steel company has a lifeline in its Hong Kong subsidiary. Most of Chongqing's state-owned enterprises are fit only for the scrap yard. City leaders appear to accept this, clinging to the unlikely possibility that some state enterprises can be strengthened through competition with more efficient private businesses. "There should be full competition of different sectors of the socialist market economy," says Chongqing's mayor, Wang Hongju.

More wisely, the Chongqing government is also trying to attract foreign investment. That is proving an uphill struggle. In 2003 the city secured only $331 million in foreign direct investment, compared with $3.8 billion in Shanghai. Almost half of Chongqing's foreign investment came from Hong Kong firms, some of which may have been Chinese enterprises using Hong Kong shell companies to avoid paying higher mainland corporate taxes. In its bid to attract Western investors, Chongqing isn't helped by the mindset of some municipal officials. One, at Chongqing's Foreign Trade Commission, the city's main office for overseas investors, told FORTUNE that the local inflation rate was a secret that could be revealed only to foreigners with "proper certification." But Chongqing's biggest drawback is its location. "If you're planning to export a significant portion of your product, you're going to locate your operation in the Shanghai corridor or the area round Guangzhou and Shenzhen," says Nicholas Lardy, an expert on China's economy at the Institute for International Economics in Washington, D.C.

That also holds true for big multinationals looking to sell into the Chinese market, because the wealthiest, most populous provinces are in the east. BP, the biggest foreign investor in Chongqing, is a case in point. The British oil giant is building a carbon monoxide facility for an acetic acid plant it operates with Sinopec and the Chongqing government on a bend in the Yangtze. Acetic acid, a chemical used in food, fibers, and paint, requires carbon monoxide as a feedstock; the new facility will allow the acetic acid plant to expand capacity by 75% to keep up with domestic demand. But BP, which has invested $188 million so far, is building another acetic acid plant in Nanjing, closer to more lucrative coastal markets.

The incentive for global companies like BP to come to Chongqing is to sell into this part of China. Yamaha produces motorbikes in Chongqing, mostly for customers in the region. Ford has a small joint venture with Chang'an, a local state-owned automobile company, to produce Fiesta and Mondeo cars. Yet this year Ford also announced plans to build a bigger plant in Nanjing, for the same reason as BP.

True, the lure of Chongqing exists for some major foreign companies, such as resources and engineering multinationals aiming to capitalize on the region's huge infrastructure projects. In April, for example, French building materials company Lafarge announced it would invest $40 million to increase capacity at its cement plant in the city. But as Mayor Wang acknowledges, "The coastal provinces get greater recognition from most foreign investors."

CHINA'S central planners envisage Chongqing as the interior's shining city on a hill, symbolizing the region's economic potential. And in one corner of Chongqing that vision is starting to take shape.

Last summer Hong Kong real estate developer Vincent Lo signed a deal with city officials to be the lead contractor in a $1.2 billion project to restore Hualongqiao, a rundown district along the Jialing River. As is usual with such developments in China, there are plenty of unhappy locals. In March residents organized a protest, complaining that the government had failed to pass on all the compensation money provided by Lo's company for demolishing their homes.

But the redevelopment is going ahead, with the first stage of the ten-year project scheduled to start early next year. In the Chongqing office of Lo's Shui On company, a model is on view, dominated by a tower in the shape of a Yangtze River sailboat. The tower was a nonnegotiable demand of the municipality, which craved a skyscraper statement. "If we get the land costs free, then it might be worth our while," says Lo of the tower. Meanwhile he is focusing on the rest of the development, with its attractive, low-rise apartment blocks and spacious lawns.

In a decade Hualongqiao could be the kind of middle-class neighborhood common these days in Beijing or Shanghai. Sure, Chongqing will never be as rich as China's eastern cities, but it is already a great deal better off than it was six years ago. And a role as the economic hub for a region of 250 million people--mostly poor, but with rising incomes and expectations-- is a hopeful outcome for a city mismanaged by the communists for half a century. To seize the opportunity, Chongqing, like other inland cities, certainly needs more investment to "Go West." It also needs its best and brightest to stay West.