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April was a grim month in Wei Jianzhong's sooty, barracks-like neighborhood in Zhengzhou, the capital of central Henan province. That's when the Henan No. 5 Provincial Construction Co. fired its latest round of workers. The victims have gathered in Wei's cramped living room to commiserate. There's Xiong, a 53-year-old former steamfitter who is trying to survive on $12 a month in unemployment benefits. He reminisces about the time two years ago when thousands of workers from a nearby factory blocked railroad tracks and erected huge posters of the patron saint of Chinese workers—Chairman Mao—to demand their jobs back. He participated in the protest "to stand with them," he says. Today he is out of work too. He wonders aloud, "Who will stand with me?" Kong Qingbin, who worked for 30 years as a guard at the same factory, chimes in with an idea: "Execute the factory leaders. Then maybe we'll be satisfied."

Wei shrugs, gets up and leaves the flat to saunter through his neighborhood in his plastic sandals and unbuttoned shirt. At 51, he sells bags of Betty Crocker Bugles for pennies apiece through his first-floor apartment window. It's all he can do to augment the $40 monthly stipend he and his wife receive from the company that laid them off eight weeks ago. Out on the street, he passes idle ex-colleagues, working-age men playing cards on empty fruit boxes. Layoffs by the construction company touch nearly every household. Wei introduces Mrs. Xie, whose husband was fired in April. He came unhinged under the strain of supporting his wife and daughter, grew paranoid and delusional. Convinced that the police would charge him with murder, he tried to drown himself in a barrel of water. Today he's in a mental institution while his wife peddles dumplings of fatty pork and mustard greens under the soot-covered trees. "People here have sympathy," Mrs. Xie says, "but I can't eat sympathy and they don't eat enough dumplings."

If this is China's century, it's getting off to a bleak start for millions of jobless mainlanders. The country has dazzled the world with its remarkable progress since embarking on the capitalist road in 1978. The economy has quadrupled in size in two decades. China is rapidly replacing Asia's tiger economies as a global center of manufacturing, and coastal cities such as Shanghai sparkle with skyscrapers, five-star hotels and modern electronics factories. The streets clog with the private cars of the newly prosperous.

But for every Chinese who has escaped poverty into the emerging middle and upper classes, there are many others, young and old, trapped in hellholes that blight the outskirts of population centers like Zhengzhou. China's headlong rush to join the global economy is creating new jobs in the private sector, but it is simultaneously breeding a gigantic underclass of have-nots—citizens the government fears could one day rise up in open revolt.

Urban joblessness, unheard of when the Maoist government provided cradle-to-grave employment, now averages around 8-9%, according to scholars at the Beijing-based Development Research Center (DRC), a government think tank. (The official rate, by contrast, is a rosy 3.6%.) Joblessness is much higher, perhaps 20%, in industrial rust belts that cut great swaths across the north, where outmoded, bankrupt factories are being shut down and communist-era work units eliminated at a breathtaking pace. Reliable numbers aren't available, but some estimate there are at least 19 million Chinese who are out of work; tens of millions more are unaccounted for by Labor Department statisticians.

And these staggering numbers are getting worse. China has entered what is perhaps the most dangerous phase yet in its transition to a free market economy. Beijing's recent commitment to play by World Trade Organization rules lowers trade barriers. That means more foreign competition pressuring China's most vulnerable industries, such as the country's steel smelters, coal producers and 120 carmakers. If the government lives up to its vow to cut bank lending to money-bleeding state enterprises—something it must do to salvage its woefully indebted banking sector—and curb deficit spending, factory layoffs will soar still higher.

Meanwhile, struggling Manchurian farmers who have spent a lifetime planting grain for the state stand little hope of competing with mechanized agro-businesses in the U.S. Forced off the land, they will decamp for the coastal factories, only to collide with millions of laid-off state workers seeking the same jobs. "In the next 10 years, I predict 150 million farmers will move to cities looking for work," says Chen Huai, a senior research fellow at the DRC. That's a mass of unemployed migrants larger than the total U.S. workforce. After years of downplaying its unemployment problems, now even Vice Minister Wang Dongjin from the Ministry of Labor and Social Security describes China's jobs crunch as "grim." The ministry acknowledges it must create 17 million jobs a year just to maintain its current unemployment rate. Hu Angang, a professor at Tsinghua University in Beijing, warns that China is careering toward nothing less than "an unemployment war, with people fighting for jobs that don't exist."

Beijing's worst nightmare is that job warfare will spin out of control and combatants will challenge the government itself—that a countrywide labor movement will coalesce and become a destabilizing political force. To date, authorities have managed to contain the labor protests that break out like brush fires throughout the nation. It has helped that many laid-off workers are managing to earn enough at odd jobs to eat. "The private economy is providing enough jobs for people to live, so it's less urgent for them to protest," says Ching Kwan Lee, a sociologist at the University of Michigan who researches China's labor market.

Even so, this year, the government has faced its biggest outbreaks of labor unrest since the Tiananmen Square protests of 1989, with tens of thousands of workers simultaneously demonstrating against state-sector layoffs in China's northeastern provinces. Censors kept the news out of the official media—Jiang Xueqin, a Canadian freelance journalist who worked on this story for Time, was deported last week for helping an American documentary crew record a workers' demonstration. But the xiaodao xiaoxi, the news on the street, rings with fresh reports that quickly reach workers in other cities. In 2000, the last year of complete statistics, "labor disputes" of all kinds rose 12% to 135,000. "If the employment situation doesn't improve, there will be a serious impact on social stability," says Mo Rong, a researcher at the Ministry of Labor and Social Security. The DRC's Chen Huai warns, "When these people have nowhere to turn, they'll defend their rights, even with violence."

Increasingly, they have nowhere to turn. China lacks effective institutions that can administer job programs and stipends for the out-of-work. Beijing has been trying to placate the laid-off with severance pay on a case-by-case basis. But the country lacks a national unemployment benefits system—and state enterprises and local governments can no longer afford to support the jobless. Instead, Beijing plans to begin forcing laid-off workers back onto the job market more quickly by cutting their benefits, in hopes the idle will be motivated to find private-sector opportunities. In northeastern Liaoning province, the tarnished buckle of Manchuria's rust belt, the unemployed collect about $30 a month for two years. After that, they're on their own. The rest of the country will join the experiment next year. "I'm not optimistic the measure will solve much," says Luo Yuanwen, a professor at Liaoning University who monitors the results and reports back to Beijing. One reason: foreign steel will decimate mills like the Anshan Iron and Steel Works in Liaoning and its bloated workforce of nearly a quarter of a million people—according to official estimates, the foundry could cut 39 of every 40 workers and, by installing modern equipment common elsewhere in the world, still increase production. "There are too many people chasing too few jobs," says Luo.

The government is trying to buy time for a select few companies deemed too important to flounder. First Auto Group, the single biggest employer in Jilin province, is really a city: a population of 250,000 workers and dependents, 23 schools, a general hospital and a TV station beaming the latest company news to the world's most inefficient autoworkers. An average employee produces just two-and-a-half cars a year; a General Motors worker makes nearly 10 times as many. First Auto could easily cut seven of every 10 workers, estimates U.S. management consultancy A.T. Kearney. But the company muddles along through government subsidies, policy loans and profits from a joint venture with Volkswagen. So far, layoffs have hit only one in 10. "We at First Auto must be responsible to our staff," contends Wo Zongsheng, its deputy director of corporate strategy.

These days First Auto is an exception. Beijing is running out of resources and can no longer maintain life support for its relics. China's banking system has built a mountain of bad loans—nearly all to state enterprises that had little expectation of ever repaying them—that now totals as much as half of China's GDP. By normal accounting standards, the country's biggest state banks are insolvent. Then there's the debt China will incur when it has to follow through on promises to pay worker pensions, which equals another 70% of GDP, according to the World Bank. Add in debts that the government has raised by selling bonds—another 24% of GDP—and the country's balance sheet looks dicey. Alarmed by China's soaring debts, Finance Minister Xiang Huaicheng warned at a news conference this spring that the government must "make sure we don't spend like rich men."

Squeezing subsidies to state enterprises is necessary if China is to put its financial house in order. But the cost on the street is high. The jobless are deprived of services that were once free and that they can't afford themselves—like medical insurance. They are expected to buy their own, and those without it risk ending up like Zhao Honggang, who spends his days on a stinking cot in a bare room in an abandoned building at the Shenyang Antibiotics Factory in Liaoning. Doctors treated him briefly for electrocution after he touched a live wire while walking alone on a rainy night this February, then turned him out when no one paid the bills. Now he can barely walk to the toilet.

Before Zhao lost his job at the factory in 1998, it would have provided care for him. But without that or family support, his condition has drastically deteriorated. Suffering from severe burns, his blackened right arm twisted completely off in March. He keeps it in a bag across the room and spends his days slipping into insanity, babbling and eating steamed buns that former colleagues provide him. "He spent his life at the factory and this is how it cares for him," mutters one.

Today the great hope for China's able-bodied workers is the private sector, the fastest-growing part of China's economy. Private companies, ranging from the biggest real estate developers to the humblest street sweepers, provide a fifth of all recorded nonfarm jobs in China. There are twice as many private-sector jobs today as there were five years ago. Yet it's not clear that enough are being generated to keep pace with unemployment. Between 1997 and 2000, according to the Labor and Social Security Ministry, jobs in state-owned enterprises and collectives decreased by 43 million, or almost one-third. Over the same period, private-sector and other non-state jobs increased by about 16.5 million.

For many the gap is being filled by petty crime, prostitution and menial labor that can barely be called real employment. A 32-year-old former glassworker in Lanzhou in Gansu province, Li Yuxing made ends meet for a time by picking pockets at the train station. He swears he's given it up, but he can't find honest employment. Li has been relegated to China's army of street hawkers and shoe shiners, people who live day-to-day doing subsistence jobs that make up an informal subeconomy—untaxed and unrecorded.

Some local governments are encouraging this kind of job formation, absent any viable alternatives. Recently, Tieling, a small city nestled among cornfields in central Liaoning where most state factories have closed in the past five years, gave workers a onetime severance payout but stopped all other benefits. Instead, it issued licenses to the laid-off allowing them to pedal tricycle-like rickshaws around town. Everywhere today these pedicabs clog the streets; competition is so fierce that even the best drivers earn just $2 in a 10-hour day. It's enough for ex-factory workers to survive, but not much more. Yet Li Dianjun, a corn farmer from a nearby village, considers it a windfall. Li spent the past two months sneaking a pedicab into the city and, for the first time, competing with city dwellers for customers. He carefully avoids policemen who might confiscate his vehicle. "Of course I'll keep going back," he says. "If I couldn't work in the city, my family would go under."

Circumstance turns farmers into reluctant entrepreneurs. Genuine entrepreneurship, however, goes begging. Although small businesses can play a crucial role in generating jobs, there are no programs nurturing small business formation. Three-quarters of all bank loans go to state enterprises, starving private businesses of cash. Yang Qingtao knows well how difficult it is to get seed money. He runs a successful beauty parlor in Shenyang in Liaoning, and wanted to open a shop selling cell phones. After many dinners and many beers Yang finally convinced a bank official to lend him money—to buy an apartment. He put it into his enterprise instead. "It's almost like the banks don't want us to do business," he says from behind the Nokia counter of his new shop. Today Yang employs 10 young clerks, most of whom devote part of their salaries to helping laid-off relatives.

The lack of options forces some of China's jobless to take desperate risks. In 1999, Zhang Xu was laid off from a plastics factory in western Lanzhou, China's most polluted city. His wife lost her job this April. Zhang now heads every morning to the place where he's pinned his hopes: the stock exchange. On Labor Day, the most auspicious date he could think of, he plunged his entire savings of $5,000 into China's notoriously fickle market. Late in the morning he arrives at the Lanzhou trading center, watches prices blink across the large screen and searches for tips among the hundreds of unemployed workers who have also bet everything on stocks. Zhang has lost 10% of his money to the market's slide this year. But he's convinced the government will intervene and prop up ailing stocks. "So many of us put our money here, the government knows what the consequences would be if we lose everything," he says. "It can't let the market slip farther."

That thinly veiled threat of "consequences" is beginning to reverberate. This March, in the northeastern city of Liaoyang in Liaoning, angry workers protested outside the city hall for back wages and pensions in demonstrations that began at a handful of factories and quickly drew workers from all over the city. At the same time, 30,000 workers from China's biggest oil company, PetroChina, besieged their factory in the northeastern province of Heilongjiang to demand more severance pay even though they had received more than $10,000 each—a fortune by the standards of most unemployed. Encouraged, thousands of workers in other cities such as Fushun in Liaoning and Lanzhou also launched protests against layoffs. That it all took place during the annual meeting of China's rubber-stamp parliament showed workers wanted to send a message that carried farther than their local leaders.

Beijing will not tolerate an organized labor movement, however. While the government generally pays off protesters who are genuinely owed money, it also arrests those who lead demonstrations. At least 41 labor activists are being detained in China and another 60 were briefly held during the past three months, according to the International Confederation of Free Trade Unions. The carrot-and-stick strategy—placate the workers, jail the organizers—seems to work for now as a deterrent. Demonstrations continue to flare up, but they have yet to turn ugly enough for authorities to resort to mass arrests or head bashing.

Meanwhile, millions of additional layoffs are looming in the next few years. If China's economy continues to outperform, then the country just might be able to accommodate wrenching social changes without a political crisis and without bloodshed. But the outlook for the ordinary worker is not bright. The best most can hope for is that they will be as lucky as Wang Shanbao, who lost his job at a diesel refinery in Zhengzhou four years ago. In silent protest, the 55-year-old began sketching chalk drawings of Chairman Mao on the sidewalk outside his factory. Crowds gathered every day to admire his work. "The managers became so embarrassed that they gave me my job back," says Wang. Score a rare victory for China's unemployed millions.

• MATTHEW FORNEY
• China's labor problems are threatening stability