In the last decade China has emerged as a powerful, resurgent economic force with the muscle to challenge America as the global superpower. But, in his controversial new book, Will Hutton argues that China's explosive economic reforms will create seismic tensions within the one-party authoritarian state and asks: can the centre hold?

For more than 2,000 years, China's conceit was that it was the celestial kingdom, the country whose standing was endowed by heaven itself and whose emperors tried to reproduce heavenly harmony on Earth. All China basked in the reflected glow; foreigners were barbarians beyond the gilded pale who should not be allowed even to learn the art of speaking and writing Chinese.

When I first visited China in the autumn of 2003, such articles of Confucian faith seemed very far away, submerged by the lost wars and the 26 humiliating treaties of the 19th century, subsequent communist revolution and now the economic growth to which Beijing's motorway rings and Shanghai's skyline are tribute. This was a new China that had plainly left behind obeisance to the canons of Confucianism and the later cruelties of Mao. More than three years and a book later, I am less convinced.

All societies are linked to their past by umbilical cords - some apparent, some hidden. China is no different. Imperial Confucian China and communist China alike depended - and depend - upon the notion of a vastly powerful, infallible centre: either because it was interpreting the will of heaven or, now, of the proletariat. In neither system have human rights, constitutional checks and balances or even forms of democracy figured very much. As a result, China has poor foundations on which to build the subtle network of institutions of accountability necessary to manage the complexities of a modern economy and society. Sooner or later, it is a failing that will have to be addressed.

China is both very confident about its recent success and very insecure about its past, a potent mix that breeds a deep-seated xenophobia and shallow arrogance. China's economy in 2007 will be nearly nine times larger than it was in 1978 when Deng Xiaoping won the power struggle with the Maoists and began his extraordinarily sinuous, gradualist but successful programme of market-based economic reforms, groping for stones to cross the river, as he called it. China is now the fourth largest economy in the world - after the United States, Japan, and Germany - and is set to become the second largest within a decade. More than 150 million workers have moved to China's booming cities and 400 million people have been removed from poverty. It is a head-spinning achievement.

China is the new factor in global politics and economics, and its rulers and people know it. It now has more than $1 trillion of foreign exchange reserves, the world's largest. It is the single most important financier of the United States' enormous trade deficit. It is the world's second largest importer of oil. Before 2010, it will be the world's largest exporter of goods. It is, comfortably, the world's second largest military power. Last year, the Pentagon's four-yearly defence review stated that China is the power most likely to 'field disruptive military technologies that could over time offset traditional US military advantages'. A new great power is in the making, but one whose pursuit of its self-interest takes the amorality of power to a new plane. It is not just the Chinese who should be concerned about its institutional and moral failings; all of us should be.

In China, you can almost smell the new self-confidence: it is in the skyscrapers built in months; it is in the brash and unashamed willingness to rip off and copy Western brands; it is in the well-groomed and inscrutable demeanour of the rich entrepreneurs, self-confident officials and assured academics.

I sat in a Beijing bar just over a year ago with a typical member of China's new class of rich businessmen who double up as members of the party, a combination of commercial and political power that China knew well as the old Confucian mandarinate, now strangely reproducing itself in a new guise after Mao tried to eliminate it forever in the Cultural Revolution.

In surprisingly fluent English and with his Mercedes waiting outside, he praised China's communist regime and its curious mix of capitalism and communism with all the enthusiasm of a Tory businessmen praising Thatcher. Chinese corruption? Think of Enron and party-funding scandals in London, he declaimed. Double standards between communist rhetoric and practice? What about the US and Britain's invasion of Iraq, and Guantanamo Bay? What I failed to realise, he insisted, betraying both assurance and insecurity, is that China will not surrender again the natural rank that it should never have lost. Western values, institutions and attitudes were being revealed for being straw men, blown away by resurgent China and the pragmatism of its communist leaders.

Yet Western values and institutions are not being blown away. The country has made progress to the extent that communism has given up ground and moved towards Western practices, but there are limits to how far the reformers can go without giving up the basis for the party's political control. Conservatives insist that much further and the capacity to control the country will become irretrievably damaged; that the limit, for example, is being reached in giving both trade unions more autonomy and shareholders more rights. It is the most urgent political debate in China.

The tension between reform and conservatism is all around. For example, the party's commitment now is no longer to building a planned communist economy but a 'socialist market' economy. The 26,000 communes in rural China, which were once the vanguard of communism, were swept away by the peasants themselves in just three years between 1979 and 1982, the largest bottom-up act of decollectivisation the world has ever witnessed. Hundreds of millions of peasants are, via long leases, again farming plots held by their ancestors for millenniums. China's state-owned enterprises no longer provide life-long employment and welfare for their workers as centrepieces of a new communist order; they are autonomous companies largely free to set prices as they choose in an open economy and progressively shedding their social obligations.

Equally amazing, China's communists have declared that the class war is over. The party now claims to represent not just the worker and peasant masses but entrepreneurs and business leaders, whom it welcomes into its ranks. The party refers to this metamorphosis as the 'three represents': meaning that the party today represents 'advanced productive forces' (capitalists); 'the overwhelming majority' of the Chinese (not just workers and peasants); and 'the orientation ... of China's advanced culture' (religious, political and philosophical traditions other than communism).

Party representatives say that the country is no longer pledged to fight capitalism to the death internationally, but, instead, wants to rise peacefully. China has joined the World Trade Organisation and is a judicious member of the United Nations Security Council, using its veto largely in matters that immediately concern it, such as Taiwan.

But for all that, it remains communist. The maxims of Marxist-Leninst-Maoist thought have to stand, however much the party tries to stretch the boundaries, because they are the basis for one-party rule. Yet the system so spawned is reaching its limits. For example, China's state-owned and directed banks cannot carry on channelling hundreds of billions of pounds of peasant savings into the financing of a frenzy of infrastructure and heavy industrial investment. The borrowers habitually pay interest only fitfully, and rarely repay the debt, even as the debt mountain explodes. The financial system is vulnerable to any economic setback.

Equally, China is reaching the limits of the capacity to increase its exports, which, in 2007, will surpass $1 trillion, by 25 per cent a year. At this rate of growth, they will reach $5 trillion by 2020 or sooner, representing more than half of today's world trade. Is that likely? Are there ships and ports on sufficient scale to move such volumes - and will Western markets stay uncomplainingly open? Every year, it is also acquiring $200bn of foreign exchange reserves as it rigs its currency to keep its exports competitive. Can even China insulate its domestic financial system from such fantastic growth in its reserves and stop inflation rising? Already, there are ominous signs that inflationary pressures are increasing.

These ills have communist roots. It is the lack of independent scrutiny and accountability that lie behind the massive waste of investment and China's destruction of its environment alike. The pace of desertification has doubled over 20 years, in a country where 25 per cent of the land area is already desert. Air pollution kills 400,000 people a year prematurely. A hacking cough in the Beijing smog or the stench when the wind comes from the north in Shanghai are reminders of just how far China still has to go.

Energy is wasted on an epic scale. But the worst problem is water. One-fifth of China's 660 cities face extreme water shortages and as many as 90 per cent have problems of water pollution; 500 million rural Chinese still do not have access to safe drinking water. Illegal and rampant polluting, a severe shortage of sewage treatment facilities, and chemical pollutants together continue to degrade China's waterways. In autumn 2005, two major cities - Harbin and Guangzhou - had their water supplies cut off for days because their river sources had suffered acute chemical spills from state-owned factories.

Enterprises are accountable to no one but the Communist party for their actions; there is no network of civil society, plural public institutions and independent media to create pressure for enterprises to become more environmentally efficient. Watchdogs, whistleblowers, independent judges and accountable government are not just good in themselves as custodians of justice; they also keep capitalism honest and efficient and would curb environmental costs that reach an amazing 12 per cent of GDP. As importantly, they are part of the institutional network that constitutes an independent public realm that includes free intellectual inquiry, free trade unions and independent audit. It is this 'enlightenment infrastructure' that I regard in both the West and East as the essential underpinning of a healthy society. The individual detained for years without a fair trial is part of the same malign system that prevents a company from expecting to be able to correct a commercial wrong in a court, or have a judgment in its favour implemented, if it were against the party interest.

The impact is pernicious. The reason why so few Britons can name a great Chinese brand or company, despite China's export success, is that there aren't any. China needs to build them, but doing that in a one-party authoritarian state, where the party second-guesses business strategy for ideological and political ends, is impossible. In any case, nearly three-fifths of its exports and nearly all its hi-tech exports are made by non-Chinese, foreign firms, another expression of China's weakness. The state still owns the lion's share of China's business and what it does not own, it reserves the right to direct politically.

Mark Kitto, a former Welsh Guardsman, has found at first-hand how difficult it is to sustain private ownership in China. He built up three Time Out equivalents in Beijing, Shanghai and Guangzhou but, after seven years of successful magazine publishing, learnt last year that he was about to become a partner of the state. The only terms on which his licence to publish could be retained was if he were to accept a de facto takeover from China Intercontinental Press, controlled by China's State Information Council, the propaganda mouthpiece of the Communist party. It did not matter that he owned the shares, wanted to retain his independence and had been careful to stay within the party's publishing guidelines. The party now wanted control of his magazines and simply took it. It is an example repeated many times over.

China must become a more normal economy, but the party stands in the way. Chinese consumers need to save less and spend more, but consumers with no property rights or welfare system are highly cautious. To give them more confidence means taxing to fund a welfare system and conceding property rights. That will mean creating an empowered middle class who will ask how their tax renminbi are spent. Companies need to be subject to independent accountability if they are to become more efficient, but that means creating independent centres of power. The political implications are obvious.

China's future is shrouded in uncertainty. My belief is that what is unsustainable is not sustained. Change came in the Soviet Union with the fifth generation of leaders after the revolution; the fifth generation of China's leaders succeed today's President Hu Jintao in 2012. No political change will happen until after then, but my guess is that sometime in the mid to late 2010s, the growing Chinese middle class will want to hold Chinese officials and politicians to account for how they spend their taxes and for their political choices. What nobody can predict is whether that will produce another Tiananmen, repression and maybe war if China's communists pick a fight to sustain legitimacy at home or an Eastern European velvet revolution and political freedoms. Either way, China's route to becoming a world economic power is not going to proceed as a simple extrapolation of current trends.

This book has been something of a personal intellectual odyssey. My hypothesis when I began was that China was so different that it could carry on adapting its model, living without democracy or European enlightenment values. I have changed my mind and now see more clearly than ever the kinds of connection I identified in The State We're In between economic performance and so-called 'soft' institutions - how people are educated, how trust relations are established and how accountability is exercised (just to name a few) - are central. They are equally important to a good society and the chance for individual empowerment and self-betterment.

Early in my research, I tried out the still-emergent thesis at a small dinner in Lan Na Thai, one of the restaurants in Shanghai's Ruijin guest house, a complex of refurbished old mansions and traditional pavilions in the French quarter where communist leaders reputedly once ate and slept.

Over stir-fried curried chicken and crispy fried flying sea bass, the Chinese guests repeated politely and persuasively that China was making up new economic and political rules. Afterwards, I chanced to have a few words alone with one of the local rising government stars as we walked out of the complex. He kept his eyes on the ground. 'Don't allow yourself to be dissuaded, despite what you have heard. You are right that China is not different. I want my children to see a China with human rights and democratic institutions. And I am not alone.' He jumped into a taxi and was gone.

I have often thought about that chance exchange. Britain and the West take our enlightenment inheritance too easily for granted, and do not see how central it is to everything we are, whether technological advance, trust or well-being. We neither cherish it sufficiently nor live by its exacting standards. We share too quickly the criticism of non-Western societies that we are hypocrites. What China has taught me, paradoxically, is the value of the West, and how crucial it is that we practise what we preach. If we don't, the writing is on the wall - for us and China.

China's quest for oil

China's foreign policy is increasingly driven by the need to feed its growing appetite for oil. General Xiong Guangkai, deputy chief of the Chinese general staff, has said that China's energy problem needs to be taken 'seriously and dealt with strategically'.

That means less reliance on the Middle East; less transportation of oil via sea-lanes policed by the US navy; more capacity for the Chinese navy to protect Chinese tankers; and more oil brought overland by pipeline from central Asia.

Over the past two years, China has pulled off a string of strategic oil deals. In April 2005, Petro China and Canadian company Enbridge signed a memorandum to build a $2bn 'gateway' pipeline to move oil from Alberta to the Pacific Coast. In Venezuela, President Hugo Chavez is to build a Chinese-financed pipeline to the Pacific coast through Colombia, having given China oil and gas exploration rights in 2005. Saudi Arabia surrendered to Chinese courtship in 2004 and accorded exploration rights.

In Sudan, a major source of oil, China's blind eye to human rights and mass murder if it hinders its interests is demonstrated by Zhou Wenzhong's comment when Deputy Foreign Minister about the situation in Darfur where more than 250,000 have died.'Business is business,' he said. 'We try to separate politics from business and, in any case, the internal position of Sudan is an internal affair, and we are not in a position to influence them.'

Wrong: China has substantial influence on Sudan if it chose to exercise it. It does not, a commentary on China's approach to foreign policy and an awesome warning of the future if an unreconstructed China became yet more powerful.

Tiananmen: the legacy

The image of a single student halting a tank in Tiananmen Square is one of the most arresting in modern history. But the protests spread well beyond Beijing for six weeks in spring 1989 to encompass demonstrations in 181 cities.

The party and army were divided over how to respond; 150 officers openly declared that they would not fire on demonstrators after martial law was declared, and at least a third of the central committee wanted to reach a compromise with the protesters. The party's then general secretary, Zhao Ziyang, proposed a partial meeting of demands for reform. Nobody should be killed.

That was not the view of Deng and the party elders - the eight 'immortals', veterans of the Revolution. A 'counter-revolutionary' riot had to be suppressed. But before Deng could act, he had to leave Beijing to ensure that army groups 28 and 29, personally loyal to him, would provide the core of the force rather than the uncertain army groups based around the capital. Once in place, Zhao was then brutally deposed, remaining under house arrest until his death in 2005. Martial law was imposed on 19 May and a fortnight later the tanks rolled into Tiananmen Square. Official estimates were that 5,000 soldiers and police officers were wounded and 223 killed. Civilian losses - 2,000 wounded and 220 killed - were lower. Many still languish in prison.

Tiananmen is the event that cannot be discussed in China; websites mentioning it are blocked. It was no 'counter-revolutionary riot' but a demand for freedoms that infected all China and very nearly succeeded.

Current leader Hu Jintao and his successors know they are not Deng and cannot command the loyalty of key elements of the army in the same way. Their best strategy is to deliver growth and jobs while trying to keep the lid on China's growing but still disconnected social protests. Whether the policy will carry on working is the open question asked daily in Beijing's inner circles.

· An edited extract from The Writing on the Wall: China and the West in the 21st Century to be published by Little, Brown on 15 January, £20.

©Will Hutton 2007