At its heart, China is still low-end. But it's hard to remember that fact when dining with David Shen, CEO of embedded CPU maker BLX IC Design, or sharing a drink with Tom Zhang, co-founder of multimedia chip designer Vimicro Corp., or chatting on the phone with Ya-Qin Zhang, director of Microsoft Research China.

These men are like Shanghai itself, with its impressive glass and steel skyscrapers and newly built fabs, in that they are among the best of what China can produce. They will help shape the direction of the tech industry both inside and outside the country.

But it is not far from Shanghai, in the assembly plants on the outskirts of Suzhou, where one sees why China is a powerhouse. There, hundreds of young women shuffle through sterile hallways, dressed in identical gray jackets, on the way to their next shift of mind-numbingly repetitive tasks.

Sitting in long rows on short stools, under the ceaseless stare of fluorescent bulbs, they dab solder wands across green circuit boards that will be stuffed into the products from Dell or BenQ bumping along on another line not far away. The women earn less than $100 a month, making the guts of LCD monitors. They seem cheery nonetheless. That's good money here.

But back in Shanghai, that won't buy much of the city's new chic. In technology, China wants to be Shanghai, but for now it is Suzhou, Hangzhou, Dongguan and Shenzhen, or any of the dozens of dingy industrial cities spanning the country. China easily has one of the longest histories of engineering and innovation — gunpowder, paper, porcelain and printing, among other inventions — but thus far its IT success survives off low-tech, low-end work.

Still, the strides China has made during the past few years make one wonder whether the innovation woven throughout the rich fabric of its ancient history will resurface. In particular, its top foundry — Semiconductor Manufacturing International Corp. — has officially stepped into the spotlight with an initial public offering of company stock. One of its largest consortia, TCL Holdings, has entered joint ventures with two global giants — Thomson for television sets and Alcatel for mobile phones. And, more recently, its largest PC maker, Lenovo Group, bought the PC division of IBM, giving Lenovo instant access to a global market and the management expertise of Big Blue.

Local design houses

Meanwhile, just out of the spotlight, a small cadre of local IC design houses — led by overseas returnees — has steadily pushed ahead with development of more-sophisticated products. Startups Spreadtrum Communications and Comlent have released their first comms ICs, and Vimicro, already a powerful player in PC camera chips, is quickly moving into multimedia ICs for mobile phones.

China has earmarked more money for investment in fabs — about $14 billion — in the past five years than it did in the previous 30 years, according to figures supplied by the U.S. Information Technology Office in Beijing. And the country is steadily increasing its graduates in software and computer science — about 140,000 in 2003.

But this is only the very beginning. Just as the glitz of Shanghai is an exception to most Chinese cities, so, too, are such companies as SMIC, Huawei Technologies, Grace Semiconductor and Vimicro Corp., all of which have shown they can compete on a global level.

SMIC founder and president Richard Chang has achieved impressive success with the company, but Chang still must guide SMIC to long-term success and prove he can build a sustainable strategy against the likes of Taiwanese foundry giants TSMC and UMC.

It would be premature to say China is fast becoming a technology powerhouse, but the country's moving in the right direction. The next phase should be to devote more attention to soft infrastructure, such as IC design houses, which typically make better use of capital.

Some signs suggest this is already happening. After the nation ends its controversial tax rebate on domestically made semiconductors, which violates World Trade Organization rules, it will begin to spend some of that money on its IC design industry through an expanded technology fund. The Ministry of Science and Technology (MST) as well as the Ministry of Information Industry (MII) will dole out the money to cities and provinces .

MII already hands out about $60 million a year to the tech industry; MST also has a pool of funds to commission projects. Additionally, big cities like Beijing will offer up several million dollars a year in incentives to tech firms. But planners will have to be smart about the way they allocate funds. China already has some 500 IC design houses, most of which will fail in the next few years.

Scanning the landscape from 50,000 feet, it's easier to see that most of China's tech firms will still struggle in the near future with strategies largely based on a cost-down model. In mobile phones, for example, impressive gains in market share (just over 50 percent of the market last January) by domestic low-cost providers are being wiped out (38 percent in June) as foreign competitors combine lower pricing with a better understanding of the technology.

PERSON TO WATCH

Wang Xudong became chief of the Ministry for Information Industry in March 2003, succeeding longtime MII leader and telecom insider Wu Jichuan. Wang, a former engineer, is considered somewhat of an outsider in the telecom world, but he is generally a reliable comrade.

Wang's bureaucratic machine watches over over everything from 3G licenses to new standards espoused by China and policies that will affect the development of the semiconductor industry, such as subsidies for companies developing products based on Chinese standards and seed money for IC design startups.

Right now, telecom policy is the most pressing matter for Wang. After nearly four years of talking about 3G licenses, the country may finally issue them in 2005. Wang's MII has been closely watching field tests of China's domestic standard, TD-SCDMA, and it's likely that Wang will direct one of the country's major fixed-line carriers to use it. If Wang gives the go-ahead for 3G licenses, it will spark another boom in the country's infrastructure spending.

COMPANY TO WATCH

In 1999, a small group of expatriates in Silicon Valley used seed money from the Chinese government to found Vimicro, a small design house in China focusing on image processors for PC cameras. Today the company is considered one of China's top independent design houses. Vimicro controls about 60 percent of the global market for PC camera chips and counts Logitech among its clients. Already, it has moved into embedded image processors and audio chips for mobile phones.

This year, the company will integrate the functions into a single multimedia chip, with video and audio that comply with all standards, including MPEG-4, H.264 and China's upcoming AVS specification. On the horizon is another major milestone: an IPO, scheduled for the first half, that would make Vimicro China's first design house to be listed on the Nasdaq. That might teach engineers in China that stock options do count.

AT A GLANCE

Population (2002): 1.28 billion

2002 GDP: $1.2 trillion; $6 trillion

1998-2002 GDP growth: 7.7 percent

Major exports (2002): apparel and clothing (12.7 percent); computers (11.1 percent); electronic equipment, parts (9.8 percent); telecom products (9.8 percent)

2004 forecast share of world semiconductor market (CCID, IC Insights): 3 percent

Leading technology: 90-nanometer CMOS process from Semiconductor Manufacturing International Corp.

Top companies: SMIC, Huahong NEC, Datang Microelectronics, Vimicro.

Favorite pastimes: mahjong; drinking tea

Source: The Economist Intelligence Unit; EE Times, CCID, IC Insights, CIA World Factbook