(Fortune Magazine) -- China can be scary.

One reason is people like Pu Chaunming. He and his wife make exhaust systems in an industrial park outside Shanghai. They each earn about $1.56 an hour, commute to work by bicycle, and live in a small one-bedroom rental apartment. Because of their long working hours and lack of day care, their 4-year-old son lives with Pu's parents, 240 miles away. Pu and his wife talk with him every night on the telephone and visit him occasionally. Pu is philosophical about the separation, which he believes is a necessary investment in his child's future. "My son is having a better education," he says. "I believe he will have a better life than me."

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On the Job How the two factories compare 2005 data Shanghai Litchfield Employees hourly/salaried 225/50 296/28 Wages monthly, blue-collar $210 - $250 $1,880 - $4,064 Wages, as % of total cost 1 12 Production number of units 400,000 1.4 million Revenue millions $53.20 $171 Capacity(2005/2006) 85%/100% 65%/85% Employee turnover hourly/salaried 5%/13% less than 1% Absenteeism 1% 10% Average Age 29 40

For many people in high-wage countries like the U.S., Pu exemplifies the China threat - a hard worker making a tenth of U.S. wages. Who can compete with that? In 2005, China exported $202 billion more to America than it imported, accounting for more than a quarter of the U.S. trade deficit. There is no question that, thanks to the labor of tens of millions of people like Pu, China has become a genuinely fearsome economic competitor.

To get a sense of how China's rise is playing out, Fortune went to two factories -one in China and one in the U.S. - that make the same product for the same company. Our conclusion: China's progress is impressive, and it will continue.

That said, America's factories have strengths of their own: U.S. manufacturers have improved productivity at least 4% a year for the past decade. Although wages in Shanghai are rising sharply, labor is still comparatively cheap. But that is an advantage that goes only so far.

Consider: At Tenneco's plant in Shanghai, labor represents just 1% of production costs; at its Michigan plant the figure is 12%. It is Michigan, however, that wins hands-down in terms of profit, reporting gross operating margins that are a third higher. The death of U.S. manufacturing has been greatly exaggerated.

Tenneco (Charts), a maker of auto parts based in Lake Forest, Ill. (2005 revenues: $4.4 billion), opened its Shanghai plant in 1998. At the time the company was still part of a conglomerate; it broke off the following year. The idea of going to China was to grab a chunk of the fast-growing market and to satisfy customers like General Motors (Charts), which want suppliers to be able to service them everywhere they manufacture.

The timing was excellent. Auto sales in China are forecast to reach 3.5 million in 2006, compared with fewer than one million in 2001. Tenneco owns 55% of the Shanghai operation in a joint venture with a state-owned company, Shanghai Tractor & Engine Co., a subsidiary of automaker Shanghai Automotive. The factory provides exhausts to GM (Charts), Volkswagen, and Peugeot and to Chery, a local manufacturer.

Sparsely automated and a little grubby, Tenneco's Shanghai factory resembles a large barn with an attached warehouse that, open on one side, is little more than a shed. The place is clean but scuffed around the edges. The workers' white cotton jumpsuits look as if they are cleaned about as often as a car owner changes the oil.

In winter the only heat is in individual offices; in summer rolling electrical blackouts are common. The plant employs 275 people in two eight-hour shifts; they produce about 400,000 exhaust systems a year. Machinery is scarce. Though wages are going up 10% a year, labor is still cheap. Blue-collar workers make $210 to $250 for 160 hours of work a month. White-collar workers like engineers start at $625 a month. Profits, says Tenneco, are "average" in a competitive market.

The Shanghai workers appear engaged, but concepts like self-directed teams and even safety - workers have to be prodded to wear protective glasses, steel-toed shoes, and earplugs - have been slow to arrive. Making improvements is difficult; many workers, used to working for state-owned Shanghai Automotive, are ferociously resistant to change. Relationships with supervisors are often testy, with neither side much interested in diplomacy.

Tenneco Shanghai uses low-tech techniques to build a medium-tech product. Welding machines help workers connect the tubes to the catalyst and the muffler, but they are simple rotating devices, not more sophisticated five-axis, numerically controlled machines. Except for a few forklifts, little other machinery is visible. There are no automated material handlers to ease the strains on workers, no robots to perform repetitive tasks, no lasers to guard against slips and falls. You wouldn't be surprised to see someone haul out a hammer and start bashing a pipe to fit it into a muffler. The place feels like an outpost on the fringe of industrialization.

There is another aspect of the Shanghai operation that isn't visible to the eye. Because of its lack of sophistication and machinery, the factory is dependent on its 51 suppliers, 33 of them local. But quality is uneven because suppliers have little familiarity with statistical process control; employers prefer to use cheap human inspectors instead.

When Tenneco contracted with a China-based company for a metal casting, the supplier tried and failed three times to meet the requirements for flatness and surface finish. "It didn't understand the importance of the specification," says Tenneco's global supply boss, Paul Schultz. And it is not exactly unknown for rogue suppliers to sell duplicate parts to competitors. The result is that Tenneco Shanghai creates only 10% of the added value in the products it ships.

On the human front, Tenneco has to be very careful about whom it hires, because firing is difficult. All workers have one- to three-year contracts and can't be furloughed until their contract has expired or the employer buys it out. Laying off a worker with ten years of tenure (including years of service with a joint venture partner) requires a voluntary buyout. Still, with a burgeoning economy right outside the factory gate, turnover is a problem. "It is a seller's market," sighs Tim Jackson, head of Asia-Pacific operations.

Zhang Yiqi, 26, is self-possessed and ambitious, with a stylish close-cut hair style. A pipe bender at Tenneco Shanghai, he has seen his wages double in the past six years, to $250 a month. He graduated from vocational school and now attends evening classes. Zhang says he spends his free time seeing his girlfriend, working out, and riding his motorbike. Before he moves out of his parents' home and gets married, though, he'd like to move up in the ranks.

Tenneco's China employees with fewer than five years' employment get one week's paid vacation; workers with five years or more get two. They also get time off for Chinese New Year and various national holidays.

The government provides medical and pension benefits; the company provides allowances for housing and transportation, plus a free hot lunch of meat, two vegetables, and rice. Whatever Tenneco's workers may think of their present condition, they believe that their future as the world's low-cost assembler is only going to get better. "Very likely I can be promoted to supervisor," says Zhang. "I'm very happy with my job."

Take a look at the two factories.

More than 7,000 miles and a world away from Shanghai (pop. 18 million) is Litchfield, Mich. (pop. 1,458), where 324 Tenneco employees work on three shifts. Unlike in Shanghai, this plant is heated in the winter. Pu's counterpart might be someone like Dave Houghton, a rangy, fit-looking man of 46. Houghton and his wife also make exhausts. But they commute to work in two cars, own a home, raised their own children, and recently returned from a vacation to Hawaii.

Combined, they earn about $30 an hour (plus benefits), enough to provide a comfortable living in this farming community in rural south-central Michigan. Still, Houghton admits to concerns about the effect of global competition. "It makes me nervous," he says, "but we think our management is doing everything possible to keep us very competitive."

The atmosphere at the Litchfield plant is businesslike; the workers are attentive, careful, and restrained. Partly that's due to the subdued economic times, partly to the maturity of the workers. The workforce in Shanghai has few people over 40, which is the average age in Litchfield. Average seniority is ten years, and turnover is minimal. The workers' experience shows in the productivity results.

Last year, with about 20% more employees than in Shanghai, Litchfield built more than three times as many muffler systems for GM and DaimlerChrysler (Charts), producing gross revenues of $171 million. Executives at Tenneco call the plant a "money machine."

Litchfield workers make about ten times as much as their Chinese counterparts, and they appear solidly middle class. But wages in Shanghai are rising much faster. Tonya Wilson, a repair technician, started at Tenneco 11 years ago when the average salary for her position was $8.50 an hour; it now averages $14.10. She worries about the future. "I don't feel safe," she says. "My daughters are both straight-A students. I hope they go to college and get good jobs."

If other workers share Wilson's uncertainty, they don't act that way. Ten percent don't make it into work on any given day (in China, the absenteeism rate is less than 1%). Family emergencies take a toll, but it is not a rash of sick children that make Mondays after the Super Bowl particularly high in no-shows.

The first day of deer season in November is so widely observed that the plant closes. With wages high and attendance patchy, Tenneco would like to reduce the amount of labor in its mufflers. "The goal is to automate as much as possible," says supply chain boss Schultz. "We want a lights-out plant." In China the reverse is true; the plant there automates as little as possible to take advantage of the cheap labor.

To boost productivity, Tenneco's Litchfield facility also tries to work smarter. It bristles with evidence of the latest efficiency techniques: Lean Production, Six Sigma, Continuous Improvement. Workers take an active interest in reducing bottlenecks.

Every day starts with a 30-minute production meeting in the second-floor cafeteria, which has its own television screen. Some 30 representatives from engineering, operations, and human resources go over the previous day in great detail, identifying snafus in deliveries, materials, production, and shipping. Each defect - a misaligned hanger hole, an inaccurate pipe bend, a cracked "brick" in a catalytic converter - is tallied.

"If our scrap is up and quality is poor, we could be the next ones filing for bankruptcy," says Sandy Giberson, a stern 26-year-old production coordinator who has worked at Tenneco since 1998. There is a strong sense of safety, and regulations are stiff.

Workers get 14 holidays and four weeks' vacation after ten years on the job. Most drive to work, a few ride bikes, and in winter some arrive on snowmobiles. Everyone qualifies for a bonus, paid quarterly based on the plant's performance. Last year hourly workers received $900 for the plant's work plus another $480 for Tenneco's corporate achievements - equivalent to about seven months' pay for their Chinese colleagues.

Unlike in China, where new production contracts seem to come in every day, they are hard-won in Litchfield. Tenneco recently received a big contract from General Motors to supply 250,000 exhaust systems a year for a new crossover SUV, giving morale a sharp boost. Investors have also been bullish; evaluating tighter emission regulations as a spur for business, they have pushed Tenneco's stock price up 50% over the past two years.

Unless exhaust systems and mufflers can someday be teleported across the ocean, the Tenneco plants in Litchfield and Shanghai are unlikely ever to compete directly against each other - their products are just too bulky to ship economically. Yet Tenneco's experience in China hasn't encouraged it to make the country a platform for its easier-to-package parts like shock absorbers either.

The value of cheap labor, it has discovered, is important but limited. "A company that says its manufacturing footprint is a nail and China is the hammer is in trouble," says Jackson, the head of Asia-Pacific operations.

For now, except for labor-intensive industries like textiles and toys, China isn't that efficient a manufacturer. In auto parts China accounts for less than 1% of the value of components in U.S.-made cars and trucks, according to a 2005 article in the The McKinsey Quarterly by consultants Stefan Knupfer and Glenn Mercer. They argued that Chinese producers lack the scale to produce parts in high volume and that many are deficient in the engineering know-how needed to meet complex federal standards. In products with little labor content, like steering knuckles, China cannot compete.

There are other factors that make China a risky place for Tenneco to operate. "Law and order is a weakness," says CEO Mark Frissora during an interview in China (Frissora has since left to head Hertz). Enforcement of intellectual-property rights is a particular problem.

Tenneco has filed three lawsuits against counterfeiters in China. (All have been settled.) Both national and local government agencies have lots of clout, and Western companies often do not have a clear understanding of the terms of engagement. Violations of poorly understood rules and regulations can cause operations to be interrupted and managers detained.

But that hasn't stopped Tenneco from expanding. Having opened five plants and invested $21 million in China thus far, Tenneco expects to spend an additional $30 million over the next three years. Over the long term, Tenneco clearly sees China as the growth market; company executives believe that Shanghai can become as profitable as its U.S. operations.

With the expiration of laws requiring Western companies to pair up with local joint venture partners, Tenneco is experimenting with setting up wholly owned operations. That means it can call its own shots but won't get any help with sometimes sticky government regulations.

Despite its big new GM contract, meanwhile, Litchfield is swimming hard just to stay in place. Its Big Three customers in the U.S. are losing market share, and Japanese and Korean transplants are located too far away for Litchfield to supply them. The most likely scenario is that work at the plant will continue to bump up and down.

In Shanghai the view of the future from the factory floor is more expansive. The palpable sense is that tomorrow will be brighter than today, and workers are hungry for their next raise and promotion. Pu Chaunming recently bought some furniture and plans to buy a motorcycle, which will cost him three months' wages. At night he takes courses in management. "I want to buy a house, bring my parents to live with me, and set up a business with my wife."

It is that kind of ambition - multiplied 1.3 billion times - that can seem intimidating. In an echo of the demonization of Japan in the late 1980s, China is accused of gaming the world economic system to steal American jobs. In Michigan the Democratic Party has accused the Republican GOP candidate, Amway founder Dick DeVos, of being a "dear comrade" of Chinese President Hu Jintao and of supporting "unfair trade agreements and failed Washington policies that send Michigan jobs to China."

So the question is, Will China be a beneficial driver of global economic prosperity? Or should Americans be scared of it, as a threat to jobs and living standards? Yes and yes.

Economic growth benefits the collective whole, but individuals will suffer. And while China is not yet poised to compete with the U.S. across a broad spectrum of industries, it certainly poses a challenge to any with a high labor content. For now, Pu Chaunming and David Houghton can co-exist peacefully, each reasonably content with their lot. Their children may not find it so easy.

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