Western medicines are making China's ancient medical practices increasingly redundant, but their high price tag is also pushing millions further into poverty

Cheng Jianguo drapes a towel over his patient's shoulder, douses it in alcohol and sets it alight. He has already prodded and poked it to identify the trouble spots, applied suction cups to "drag out the dampness and coldness", painted it with herbs and spices and wrapped it in clingfilm to "drive in the active ingredients".

As the flames flare alarmingly, he explains that the burning is vital to soften the tissue before a vigorous massage, the insertion of three long needles and the waving of a smoking cigar above them – in the process known as moxibustion.

By the time the 45-minute treatment is over, the 57-year-old patient, one of our party, declares he is in an "astonishingly relaxed state". His shoulder feels more mobile and less painful than it has for ages, he says.

We are in the Lizuzhengo Traditional Chinese Medicine Clinic, situated at the back of a furniture shop in Xian, an industrial city in central China. Witnessing the treatment is a gaggle of reporters and cameramen from the local media keen to record what is believed to be the first official visit by the British press to view the Chinese health system.

Yet, ironically, while interest in Chinese medicine has grown in the West, it is declining in China. The proportion of Chinese using TCM in the formal medical sector fell from 25 per cent in 1991 to 14 per cent in 2004, according to a survey published in Social Science and Medicine last July.

The local Shaanxi University of Chinese Medicine, which has 10,000 students, has recently diversified to offer courses in English due to dwindling demand for its core discipline.

Gong Guijun, deputy director general of the Foreign Affairs Office in Xian, says: "I use TCM for minor illnesses and Western medicine for acute problems. TCM is more holistic and it is slow. But the problem is people go to Western medicine too late. It is better to go early to TCM, when you feel only a little ill."

It is a refrain you hear often in China, where the young have become absorbed with all things Western, as living standards have risen.

However, Western medicine comes with a Western price tag and high health costs are forcing increasing numbers of poorer workers into poverty, amounting to 2-3 per cent of the population every year. The government – committed to lifting folk out of poverty and recognising the threat to the nation's financial and social stability – has launched a universal health insurance scheme for its 1.3 billion citizens and is struggling to find ways to cope with demand.

The need is urgent. China's booming economy is faltering, as overseas demand for its products slows in the recession. Future growth will depend on stimulating domestic consumption – and the absence of an effective health service is a constraint on that ambition. Fear about health costs is a major curb on spending by the population, which is forced to save against the day when sickness strikes. Unless their anxiety can be eased, efforts to increase domestic demand will fail.

There is another challenge, too, inadvertently revealed to us in a showpiece clinic 20 kilometres outside Shanghai. China is a nation hooked on the idea that any illness can be cured with the right drugs – and the bigger the dose the better.

Our hosts presented the Huachao Community Health Centre – a gleaming, three-storey building with polished floors and white-coated staff – as a model for the future, providing modern Western and traditional Chinese medicine to 1,000 out-patients a day. With its state-of-the-art equipment it would have been the envy of many health centres in the UK.

But in the centre of the complex, the largest department is the intravenous clinic, where patients receive infusions of drugs delivered direct into a vein. Up to 100 patients can be treated simultaneously, each hooked up to a bag of the infusion above their heads. The charge is 7 RMB (70p), which sounds reasonable – until the cost of the drug is added in.

One 52-year-old woman is being treated for a cold with a half litre mixture of antibiotics and glucose. Another, who has a badly bruised face from a fall after a stroke, is receiving an infusion of Gingko Biloba, the popular Chinese herb, which a nurse says is used for dissolving blood clots.

Next to her, a young man with his eyes closed, wearing a blue face mask, is also being treated with intravenous antibiotics for a cold.

In the West such treatment would never be countenanced – colds are caused by viruses and antibiotics, which tackle bacteria, are regarded as rarely necessary.

Moreover, intravenous administration of drugs is reserved for the most seriously ill patients.

Donald Li, a Hong Kong GP and adviser to the Shanghai government, says Chinese patients are sceptical of the value of advice given by doctors, but place great faith in the power of medicinal drugs.

"The belief is that there is a therapeutic value from the drug, but no value in telling me what I should do. Injections and intravenous treatment are liked. This is a culture that seeks intravenous treatment," he says.

But economics plays a part, too. Charges levied by hospitals are set deliberately low by local councils, often too low to cover the cost of the service. Hospitals have to make up the difference in the cost of drugs and diagnostic tests which are not controlled. They charge heavily for them – and encourage patients to have more. The situation is aggravated by doctors' poor rates of pay. They depend on bonuses paid by hospitals from the income generated by drugs and tests. All the incentives in the system are thus aligned, but towards the wrong objectives.

"There is over-diagnosis, over-treatment and bad practice," said Professor Li. "It all comes back to doctors' low salaries. If they were properly paid they wouldn't need to do these things."

Changing the focus of the system from profit to patient welfare will take decades, he added.

Before 1978, healthcare in China was planned centrally. After the economic reforms, the country switched to an extreme market model. But as prices rose, discontent grew. Between 1993 and 2003 costs rose six times for out-patients and four times for in-patients. Patients in hospital still check their bills daily and, if their money is running out, discharge themselves early.

Regional governments own tobacco companies – on the basis that whatever industry brings the greatest profits is legitimate, as they are not given the budgets they need to do what they are required to do.

By 2003, the government recognised that health care was becoming unaffordable, with rapid inflation and growing inefficiency and attempted to address it by ramping up state funding and extending the health insurance scheme.

This has failed to curb medical inflation, however, and while the overall cost of the health service is still low, at 6 per cent of GDP – compared to 9 per cent in the UK and 16 per cent in the US – it is rising so fast that the insurance scheme is becoming unaffordable.

The government has declared its intention to fund the health service while continuing to use market mechanisms, but it is still deciding where the balance lies.

Time is not on its side. Within a decade the country will be hit with a new challenge – caring for the elderly, whose numbers are projected to double by 2025 (from 2000), while the family support they can rely on has dwindled owing to the country's one-child policy introduced in 1979.

There is a deep cultural belief in China that "there is nothing better than living longer".

Unless major reform of the health care system can be achieved, it may prove a difficult belief to sustain.

A history of Chinese medicine

Traditional Chinese medicine dates back 2,500 years and centres on the philosophy of yin-yang and the five elements. It uses a holistic understanding of the human body, and treatments are devised from diagnosis of syndromes. It is often characterised as adjusting the positive and negative elements in the body to keep them in balance.

Typical therapies are acupuncture, herbal medicine, dietary treatments and massage. The first two are widely used in the West and have been shown to be effective in certain circumstances.

Some traditional Chinese herbal medicines have achieved celebrity status. Cordyceps sinensis, the caterpillar fungus, has seen its price rise 500 per cent in recent years as a treatment for a range of ailments from sexual problems to kidney disease and cancer.

A century ago there were 800,000 practitioners of traditional medicine in China, but the numbers have steadily fallen. In 1999, the Government introduced licensing for practitioners and the number dropped to 200,000.

Sales of traditional Chinese medicines in the UK and Europe will be restricted from next April, when a 2004 European directive takes effect. All herbal medicines will be required to have a licence indicating that they have met standards on quality control, reporting of adverse reactions and labelling. So far none have been registered in the EU.