It is one of the world's largest construction projects – to turn a desert island, known only for its turtles and soft sand dunes, into the greatest intellectual and cultural powerhouse of the Middle East.

Saadiyat Island ("Happiness Island" in Arabic), a once uninhabited stretch of coastal desert close to Abu Dhabi's city centre, is steadily being converted by tens of thousands of migrant workers into a $27bn (£16.5bn) cultural metropolis. The centrepieces will be a New York University campus, a $1.3bn Jean Nouvel-designed Abu Dhabi Louvre and the Frank Geary-designed Guggenheim. Close by, the British Museum is chief partner on the Zayed National Museum, created by Norman Foster. Along with 600,000-year-old cave art and abstract expressionism, the National Museum will include glass cases of memorabilia dedicated to the founder of the United Arab Emirates, Sheikh Zayed al-Nahyan. Already, the growing hub is surrounded by five-star hotels and hundreds of luxury villa and apartments.

But amid the splendour, opulence and massive investment, there is a dark side to life on Happiness Island, particularly if you are unlucky enough to be one of the foreign legions of migrant workers charged with building the dream. In a three-month investigation, the Observer has uncovered evidence of intimidation, strike-breaking, mass riots and an employment system trapping thousands of labourers on poverty pay.

It was not supposed to be like this. At the outset the Louvre, Guggenheim and New York University paused before agreeing to become involved in the Abu Dhabi projects, fearing the Gulf's reputation for harsh working conditions would cause uproar among board members, donors and students. It was insisted that worker rights would be guaranteed. The cultural institutions involved point to an independent audit of working conditions commissioned by the Tourism Development and Investment Company (TDIC), the main developer on Saadiyat. A second audit report is expected to be delivered this month.

The first, which was published in December 2012, found that, while the TDIC "faces significant challenges ... in a region with established practices and norms" when it comes to working conditions, there had been improvements – for example, in relation to allowing workers access to their passports. New York University, the only non-TDIC project on Saadiyat, said it had its own independent auditors to assess compliance with agreed standards.

Meanwhile, to reassure its foreign partners, the UAE has built the world's greatest labour camp, complete with manicured cricket grounds, a chess centre, a multilingual library with works by Ayn Rand and Barack Obama, the UAE's first multi-denominational prayer hall, film screening rooms, tug-of-war competitions, a coffee shop and landscaped grounds. Regular government press releases show groups of smiling dignitaries who have come to admire the Saadiyat Construction Village, while promotional videos show smiling workers playing cricket in spotless whites.

"The only thing these men lack is room service," Nabil al-Kendi, chief development officer for TDIC, told an international conference last year.

So far, so admirable. But to encounter an alternative reality, one needs only to travel 20 miles from Saadiyat village, along sandy desert roads, to the most remote corner of the Mafraq industrial area, the location of Al Jaber Construction's Worker City No. 1. Here, workers are surrounded not by landscaped gardens, but by a trail of rubbish trucks snaking their way around the camp to the city tip next door. Next to the tip, on top of a hill, sits the city's sewage treatment plant, where lorries dump raw human faeces, the stench of which wafts down to the camp on the warm evening air. At the back of the camp is a large stretch of desert wasteland, where workers cut up raw meat and fish surrounded by piles of rubbish, stepping on shaky planks of wood to avoid the streams of polluted water running down from a nearby industrial reservoir.

The company insists it has tried to shut this place down many times but the men would not listen. Meanwhile, workers complain of bad food and needing somewhere to cook their own meals.

The tales from inside the camp are poignant and pitiful. Take the case of Mohammed Arif, whom the Observer finds climbing the stairs using a cheap, ill-fitting artificial leg donated by the Red Crescent. His stump is red and bruised and Arif is in constant pain, but the company refuses to move him from the cramped third-floor bedroom he shares with eight other men.

"My big hope is to go back to India, to Jaipur city. They make good artificial legs. I want one of those legs, they are light, not cheap like this one," he says.

Arif got his Red Crescent leg only in November after his employer, Al Jaber Construction, refused to pay for one. For a year he had to get around on one leg and a pair of crutches he bought in Abu Dhabi. "I could not balance on one leg, I fell down the stairs many times," he says.

He shows the spot at the back of his head that smashed into the stairs in his worst fall. "My head was bleeding, but I still went to work."

Arif lost his leg in November 2012 – he claims a barrel of waterproof chemicals fell on him in a store room on Saadiyat, where Al Jaber is building more than 1,000 luxury villas. The company is adamant that Arif had a pre-existing condition that led to the loss of his leg.

Al Jaber has refused all requests by Arif and a supervisor to allow him to sleep in ground-floor accommodation. He has also fought an unsuccessful court case to try to get the company to pay for his artificial leg and medical bills.

"Why don't they just let him on the ground floor? All year we see him on one leg trying to get to the top of the stairs," said one Al Jaber official who wished to remain anonymous.

A short drive from Arif's camp, past sheets of sand that frequently cover the road, lies the sprawling, featureless complex of Worker City No. 2, home to hundreds of workers on the Louvre site, along with over 20,000 other men.

Here, we meet Hamdan (whose name has been changed to protect his identity). Hamdan is from the mountains of Pakistan. His face is worn with care. He paid $1,624 (£1,000) to a Pakistani recruiter who told him he would have a job with the UAE's largest construction firm, Arabtec, as "a carpenter in Dubai", earning between $217 and $300 a month. When he arrived in Dubai, he was placed in a vast industrial zone outside the city, where he learned he would be working six days a week on the "museum site" in Abu Dhabi, earning just $160 a month. Arabtec had already taken his passport and he was trapped. His only choice was to work for 10 months – 11 hours a day, with an extra two hours' travel time, to repay the agent before he could start to save anything for his family.

"They cheat us," he says. "I would tell anyone not to come here." Beside him sits another Arabtec worker, "Omar". He says he was assaulted by a camp boss just days earlier, after they discovered he had made a complaint to the police. "He was very angry. He hit me hard in the chest and he said: 'You never go the police. Not even if you are being killed. Never'."

Living conditions for migrant workers elsewhere can be even worse. The Observer followed one bus coming out of the New York University construction site, the only non-TDIC project on Saadiyat. It led to a filthy, overcrowded camp housing 43 Bangladeshi workers at the heart of the polluted, industrial Musaffah area, next to car repair and welding businesses. There the men, hired to paint the campus, complained of being trapped by recruitment fees that exceeded a year's salary and of the high cost of even the most basic healthcare. Some, hired from myriad unregulated subcontractors, had to pay for their own work clothes on a salary of £149 a month.

The men were crammed nine or 10 to a windowless room measuring 13x14ft, and had to put up a sheet over the corridor toilet for privacy. All said they hated the camp and had been tricked by their recruiters. One man said: "Look how we live. We are no better than animals. That is all we are to them. Sheep that are to be sold, and nobody in the world is listening."

Challenged by the Observer to explain why the evidence suggested that only a small minority of the workers on the island appeared to be living in the Saadiyat village, a TDIC spokeswoman said that "in principle" all workers are housed on Saadiyat.

Last May, the frustration and resentment felt by Abu Dhabi's migrant workers boiled over. In a country in which trade unions, strikes and protests are strictly prohibited, thousands of Arabtec workers went on strike.

For a full day, the Louvre site fell silent. By 2am, workers could be seen gathering in groups of 30 or 40 in the Saadiyat Construction Village, listening to strike leaders, while police were assembling at the camp entrance. By the next morning a combination of the Labour Ministry, the police and Arabtec bosses had confronted the workers head on. The strike leaders were arrested and mass deportations began. Arabtec warned that "this unwarranted stoppage was instigated by a minority who will be held accountable for their actions".

Dubai police estimated that more than 460 workers were "helped to go home", but the Arabtec workers said the real figures are much higher.

In an apparent effort to divide the men, the deported Bangladeshi workers were replaced by Pakistanis, which soon became a new source of strife. In August, riots broke out between rival groups. Workers described men being beaten with lump hammers and stabbed with spears in the dining halls. Golf carts, normally used to carry diplomats around on tours, were being used to ferry injured workers to ambulances. Video smuggled to the Observer from within the camps shows men jumping out of windows to escape the onslaught, while police fire into the air to try to stop the rampage.

One Louvre worker said he was sure he was going be killed. "I was hiding in my room, praying to God for mercy. I could hear the screams outside. They came to our room and we could see they were Pakistanis. I shouted in Urdu: 'We are Pakistanis. Don't kill us!' Don't kill us!"

Three months later, the cream of the global art industry gathered for Abu Dhabi Art, a fair that showcases work on the Louvre, Guggenheim and Zayed National museums. Red carpets were rolled out for dignitaries and Asian waiters carried canapés to the milling crowds. Guggenheim director Richard Armstrong said the museum was working closely with its partner, TDIC, to provide "exemplary" treatment of workers.

Louvre Abu Dhabi architect Jean Nouvel said he had not visited the Saadiyat Construction Village, but had visited the Louvre site the previous day and saw nothing unusual. "I saw very good conditions at work today," he said.

Both the Louvre and the Guggenheim talk of constructive and continuing dialogue with the TDIC over working conditions and point to the employment practice policy for Saadiyat workers, which they say sets high standards.

As the recent festival took place, however, Louvre worker Amraz Shadrat and 19 other Arabtec men were being led under tight security to Abu Dhabi airport to be sent home to Pakistan for refusing to work for wages which left them struggling to pay the recruitment fees to the agents who took them to Abu Dhabi in the first place.

It was an unusually wet night, after the worst storm Abu Dhabi had seen in years, and large puddles filled the mud outside the Worker City No. 2 camp, as Hassan hugged his fellow labourers to say goodbye. At the airport the Arabtec men said they were not allowed to go the toilet in case they tried to escape. Hassan managed to have a brief conversation with the Observer. Tired and frustrated, he said that, after discovering he would make only $160 a month, he had demanded better pay to compensate for more than $2,000 he paid to an agent.

"I was three months in this country, three months with no money," he said. How can I work for this? I would spend a year trying to make the money. The whole thing is cheating."