History has a habit of storming through China's Northeast, spawning a new incarnation at every turn. Dongbei has served as staging ground for the Manchu conquerors who established the Qing dynasty (1644-1911), as military-industrial center of the Japanese puppet state, Manchukuo (1932-1945), and as muscular embodiment of Mao's state socialism. Today, market reforms are forcing another reincarnation, and Dongbei is struggling to adapt. With a gross domestic product of 176 billion dollars, the region's economy is still relatively large, about the size of Poland's. Yet more than 70 percent of its industrial output still comes from inefficient state-owned enterprises—a reliance that has created a sense of complacency and entitlement at all levels of Dongbei society, from top leaders to laid-off factory workers. William Mako, a World Bank analyst and an author of a recent report on Dongbei, says: "This mindset is the most important thing to change—and the most difficult."

Still, some things in Dongbei are changing with startling speed. Far north in Harbin, a city whose onion-shaped domes hint at its Russian history, a grandiose office-and-residential complex emerges from the carcass of a defunct locomotive factory—with a shiny gold Mao statue standing incongruously at its center. In Changchun, whose pungent corridor of North Korean restaurants reflects the city's proximity to the Hermit Kingdom, the burgeoning middle class clamors for apartments in a high-rent development called Up East Side Manhattan. (Changchun yuppies also pay good money for consultations with Wang Yiyang, a fashion guru whose message of "cultural reeducation" could serve for the region as a whole.) Even Shenyang is getting a makeover. There are now Wal-Marts and KFCs, a high-tech industrial park, and, across one neon-lit intersection, three Ikea-like home-furnishing stores battling for business.

Looming in the background, though, is the darker world of the xiagang—the laid-off state workers. Of the 31 million Chinese who lost their jobs between 1998 and 2003, nearly one-quarter live in the Northeast, giving the region one of the highest unemployment rates in the country. (This has created an economic paradox: Even as Dongbei has posted an annual average growth of 9 percent over the past decade, urban employment has actually dropped.) Dongbei's official unemployment rate stands at just over 6 percent, but the World Bank estimates the real rate is closer to 15 percent. What's so troubling for Beijing is that most xiagang live in the cities, where their suffering is more visible—and their frustration more potentially volatile. The central government has headed off social upheaval by taking over parts of the social safety net that unraveled with the demise of bankrupt state-owned factories. But urban poverty is now a fixture in China's Northeast, and nobody embodies it more than poorly educated, laid-off workers in their 40s and 50s. They are the lost generation.