CHELSEA, MASS. -- For years this city's public school system has symbolized the decay of urban education in America. By most educational indicators, the schools are in crisis. More than half the students who enter the public schools will leave without a high school diploma. Students who remain in the system consistently score near or at the bottom in standardized state tests.

Fifty-five percent of the system's 3,500 students are Hispanic. About three-quarters of the students come from families on welfare, reflecting the dire poverty that has made this tiny industrial city of 25,000 one of the poorest in the state. The city's teenage pregnancy rate is the third highest in Massachusetts.

Exacerbating this bleak picture has been a city unwilling to provide the funds needed to revive the moribund school system. The city allocates only 20 percent of its local tax levy to its five schools -- three elementary schools, one combined elementary and middle school and one high school -- compared to the statewide average of 54 percent.

"Education hasn't been a priority in this city for a long time," said Elizabeth McBride, a member of the Chelsea School Committee for 12 years. "The money has gone to the police, the fire department and other city workers. Nobody cares much about kids because they don't vote."

As a result said former School Committee member Bruce G. Robinson, "Chelsea has led the state in just about every category of academic failure."

Boston University has waded into this morass, taking over the running of the school system last September at the behest of Chelsea officials and promising to transform the schools by the year 2000 into a beacon of academic excellence. The program is being monitored by the state-appointed Chelsea Oversight Panel, a seven-member group appointed by Gov. Michael Dukakis, in an effort to assuage concern that BU would operate the school without sufficient accountability. The panel is scheduled to release its first-year findings in mid-August.

The BU-Chelsea agreement, as the 10-year project is formally known, is being closely monitored by educators nationwide, who view it as one of the most dramatic and innovative attempts to overhaul a troubled urban education system.

But the bold experiment -- the first time in the nation that a public school system has been operated by a private institution -- has not gone as smoothly as Boston University had anticipated. Most BU officials believed -- naively some say -- that they would be welcomed into Chelsea as saviors.

Instead, the project's first year has been marked by controversy, including two still-pending lawsuits challenging the agreement's legality, that have polarized the university and the very constituents BU will need to mobilize if the project is to succeed. The university's greatest challenge, both supporters and opponents of the project say, is to forge stronger relationships with local leaders -- the School Committee, Hispanic activists and teachers -- vital to the implementation of the ambitious reforms it has outlined.

Much of the anger toward BU focuses on what critics say is the university's authoritarian and patronizing style of management. School Committee members and the teachers union complain that the university and new superintendent Diana Lam exclude them from important decisions, especially those concerning personnel.

And Hispanic leaders have blasted the university for failing to take their concerns, such as the fate of bilingual education, about the BU-Chelsea project seriously. Both the teachers union and a group of Hispanic leaders have sued to try to annull the agreement.

"BU will get nowhere in the efforts to improve schools unless it starts to do a better job of involving the community," said Massachusetts Education Commissioner Harold Raynolds Jr. "If you don't, then you alienate the people you need to have work with you the most. BU must strive to have all the parties with a vested interest in the schools, parents, Latino leaders and other community activists, committed to working together for change."

Nevertheless, even the university's harshest critics are optimistic that the problems can be overcome and that the project can spark an educational renaissance in this city of the working class and immigrants.

"Despite my criticisms, it still remains my hope that we can transform confrontation into cooperation, that we can change this relationship from one which is quite authoritarian to one where there is a true partnership and that this can be a national model for reform," said Michael Heichman, vice president of the Chelsea Teachers Union.

The drive to have BU take over the Chelsea schools picked up momentum after April 1988, when the university presented to the city a 300-page plan to overhaul the schools. The School Committee in 1987 had asked BU to study the feasability of running its schools after a similar offer by the university to manage Boston's public schools was rejected two years earlier.

In a scathing report that followed a nine-month study of the school system, the university found "a failure to provide adequate educational leadership" and a school system in which "reasoning, critical thinking and creative thought are not central to the instruction and activities at any grade level."

Boston University and Chelsea officials signed the historic agreement in June 1989. In exchange for managing the system for 10 years, BU promised to introduce a number of innovations, including a network of family schools that would offer preschool classes for 3- and 4-year olds, nutritional services for infants and pregnant women, year-round child care and English and job-training classes for parents.

The University pledged to boost the school system's budget by $6 million over five years to $22 million, using state, federal and private funds. (This year the university raised $2.1 million, falling short of its $3 million goal.) In addition, it said it would build a new elementary school, a new high school and that it would renovate buildings in a system whose newest school was built in 1908.

Having crafted such a comprehensive blueprint, BU spent much of the first year laying the foundation. "Many of the things we did this year didn't touch parents and children per se but they are the things that needed to be done," said Peter Greer, dean of BU's school of education and leader of the Chelsea project.

Computers were installed in schools for student use and in the system's headquarters for record-keeping. Teachers took advantage of dozens of mini-sabbaticals to observe successful education programs in surrounding communities. Many teachers also are attending summer workshops.

After a year of contentious negotiations, teachers ratified a new contract that established merit pay and a school-based management plan that gives individual schools more decision-making power.

In controversial moves that drew the ire of teachers and School Committee members, Lam demoted the high school headmaster and fired five nontenured teachers. Opponents of the moves accused her of highhandedness.

At the Shurtleff Elementary School, fifth-graders read to first-graders under a new peer tutoring program. Bilingual students and regular education students were integrated in an effort to ease the mainstreaming of non-English speaking students into the regular education program. (English is a second language for almost half the system's students.) And an interegenerational literacy program was begun at the Williams School with 41 adults, mostly mothers, learning how to read to their children.

Boston University plans to increase the pace of education reform this fall.

The high school will be divided into schools within a school so students can have the stability of spending more time with the same teacher. There will be further integration of bilingual and monolingual students and a reduction in the removal of elementary and middle school children from their classrooms for remedial work in math and reading. Instead, classrooms will have two teachers, one of whom will work with remedial students.

A comprehensive health center will open at the high school to provide everything from physical examinations for all students to prenatal care for pregnant teenagers. A plan to better distribute minority children among the elementary schools goes into effect in September, a preliminary step necessary before the state can allocate funds for new school buildings.

If budget constraints permit, year-round kindergartens will be established. This part of the program is aimed at providing quality early childhood education, which educators consider the key to stemming the nation's appalling dropout rate.

The scope of the changes frightens some community activists, who fear that too much is happening too quickly, but Lam believes they are necessary to reverse a school system long in decline. "Schools here were not student-centered places where needs of children came first," Lam said. "They were regimented places held down by central administration mandates. If we don't take dramatic action then we're never going to turn around the failure rate of urban schools."

But while most Chelsea activists recognize that the system desperately needs help, some bristle at the style they claim BU has adopted.

"I'm not arguing that this system didn't need shaking up but it's the means to achieve reform that I question," said Marta Rosa, who became the first Hispanic on the School Committee when she was elected in November. Rosa based her campaign largely on her opposition to BU. Hispanics make up more than half of the students in the schools and Latino activists been decrying the system's poor performance for years.

"But BU forgets that the community has been looking for empowerment," Rosa said. "BU sees empowerment of the community as detrimental to the project and unless the community gets empowered it will not be an advocate for education and, no matter what the university does, the schools will not improve. We get told what's going to happen and if we don't like it that's too bad."

As an example, Rosa cites Lam's naming an interim high school administrator the morning after a meeting between members of the School Committee and the BU management team to try to improve relations. Lam did not tell committee members until the next day even though she was at the meeting.

But BU officials and project supporters said the reform of Chelsea's schools are doomed to failure if every decision is steeped in controversy. "We're not going to be slowed down by having to check with this group and fight with this group," Greer said.

And Robinson said, "In my estimation the naysayers are people who don't have a lot of their own creative ideas so they spend their time criticizing everything the university does."

Of the complaints by Hispanic leaders, Greer said, "I've sort of ignored them and that's infuriated them. I will continue to do that as long as they continue to make it a fight for political power."

But some familiar with the project say BU has underestimated the importance of gaining the confidence of Chelsea's Hispanic leadership. "The message BU is sending, through the way they have treated the Latino community, is 'we care about your kids, but we don't care about you,' " said Miren Uriarte, director of the Latino Research Institute at the University of Massachusetts at Boston, and a member of the state-appointed Chelsea Oversight Panel. "If parents get alienated from the system, then their children will be alienated from the system. It takes two to tango, and they have to tango with the community to make this work."

Ultimately, BU may be able to win over even its most virulent detractors if the reforms pursued begin to yield improvements in the dropout rate and in test scores, and the system begins to attract parents who otherwise would send their children to private schools or, in some cases, move out. An adequate assessmment will require at least three to five years, most believe.

"For years there's been a malaise over the Chelsea School System," said Morris Siegal, a School Committee member. "And now things are changing. There is hope where before there wasn't any. We have goals toward which we are moving . . . We may disagree over how we get there but at least we're heading there. At least somebody is trying."

Diego Ribadeneira is an education writer for The Boston Globe.