THIS tiny South American nation is overhauling itself in a way that could set a radical example for other third world countries, which have long marginalized their Indian populations.
The key aim of the 18-month-old government of President Gonzalo Sanchez de Lozada is to draw the nation's Indian population into Bolivian society for the first time since the Spanish conquest in the 16th century.
''It's been 500 years since we recognized the existence of native communities,'' Mr. Sanchez de Lozada recently said. ''We think that what we are doing is revolutionary and irreversible.''
In keeping with this goal, his administration has:
*Permitted for the first time bilingual education in Spanish and local Indian dialects.
*Legalized indigenous organizations and the practice of folk medicine.
*Revoked a law keeping debtors -- mostly poor Indians -- in jail until they pay.
*Implemented a privatization scheme that may create individual pension funds for all Bolivians older than 18, by 1996.
*Poured money into the countryside to local officials who never before have received significant aid.
Government officials hope that these policies will stop mass migration to cities and possible social conflict.
''If this nation didn't come up with such proposals,'' says Carlos Hugo Molina, national secretary of the newly created Secretariat for Social Participation, ''it could soon find itself facing a Chiapas or a Shining Path,'' referring to recent Indian rebellions in Mexico and Peru.
Bolivia is one of Latin America's poorest nations. An estimated 70 percent live in poverty. Infant and maternal mortality rates are high.
Although descendants of the Aymara and Inca peoples make up 70 percent of the nation's estimated 7 million inhabitants, most of their communities receive little government support.
Now, Sanchez de Lozada hopes to change that by creating thousands of jobs with a novel privatization program that is expected to jump-start the economy and pull Bolivia out of its poverty.
The most dramatic change, however, is a government reform program that decentralizes power and gives rural communities the authority to decide what to do with 20 percent of the national budget.
In 1993, only 9 percent of the federal budget, or $47 million was allocated for the countryside. This year, that share has grown to $172 million. Small towns that once received $300 a year are now getting $300,000, of which only 10 percent can be spent on administrative salaries.
In Patacamaya, for example, a town of 9,000 inhabitants located an hour's drive from the capital, La Paz, the budget has shot up from last year's $11,000 to this year's $250,000. For Mayor Hugo Rodgriguez, it's a relief after years of having to travel to La Paz every time he needed assistance.
''We would shuttle from office to office,'' Mr. Rodriquez recalled, when relating the town's 24-year battle to provide residents with potable water. ''They would throw us a crumb or tell us to come back next week. We suffered.''
At Cahuanota, a village of 180 inhabitants five miles from Patacamaya, residents said that the only government assistance they ever received occurred after 30 trips to the La Paz Education Ministry and several ''payments'' of cheese and potatoes.
Their reward: 10 school desks.
Cahuanota is typical of many Bolivian indigenous rural communities. Residents live in homes with adobe walls, straw, and tin roofs. They have no running water or electricity, and sell onions, potatoes, and lima beans for a living.
Last month, the village was recognized as a Base Territorial Organization (OTB), giving it the right to send a representative Patacamaya to consult and coordinate area projects and audit all spending.
Rural villagers say the administration's best spokesman in the crucial task of convincing distrustful Indians that this government means what it says is Vice President Victor Hugo Cardenas, an Aymara and the first Indian to hold such high office. (A role model for Indians, left).
''We believe in our new power because of our confidence in Cardenas,'' says Cahuanota potato farmer Julian Camino. ''He is of our blood.''
In a recent interview, Mr. Cardenas said, ''Bolivia has always had an exclusionary democracy, representing the paved streets of the cities while leaving rural Indians legally invisible. Native peoples no longer want to be the object of anthropological studies, but participants in constructing democracies.''
But the plans are drawing criticism. Some observers say the government's privatization program won't attract the desired interest or jobs. Some big-city mayors -- like La Paz's Monica Medina de Palenque -- are angry about losing government funding to rural villages.
And teachers' unions and doctors are outraged over the new policy that permits Indian communities to tell them what to do and what services they want.
Others question the judgement of putting so much money in the hands of inexperienced administrators. At Pucarani, a town near Lake Titicaca, these same critics point out, residents opted to build a race-car track to attract tourism.
There is also the question of corruption. Currently, five rural mayors are being investigated, including one who allegedly siphoned off $27,000 destined for a water project to buy himself a luxury car.
Government officials, however, say they expect fewer problems with corruption after May, once an estimated 20,000 OTB watchdogs are operating throughout the country.
In the meantime, Patacamaya's Rodriquez says he has big plans. In the next several years, he wants to use new funds to construct a sports complex, hospital, agricultural school, and sewage system.
Vice President Cardenas loves to hear that kind of talk. ''We have opened a small door for democracy,'' he said.
''But we've been preparing for 500 years.''