It is also capable of running for years or even decades without refuelling, and scientists say that because it produces neither dust nor smoke, even on a small island a resident would hardly notice its existence.
The research is partially funded by the People's Liberation Army.
Researchers at the Chinese Academy of Sciences' Institute of Nuclear Energy Safety Technology, a national research institute in Hefei, Anhui province, say they hope to be able to ship the first unit within five years.
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"Part of our funding came from the military, but we hope – and it's our ultimate goal – that the technology will eventually benefit civilian users," Professor Huang Qunying,a nuclear scientist involved in the research, said.
The Chinese researchers admit their technology is similar to a compact lead-cooled thermal reactor that was used by the navy of the former Soviet Union in its nuclear submarines in the 1970s.
However, China would probably be the first nation to use such military technology on land.
While these "baby" reactors would able to generate large quantities of electricity and desalinate huge supplies of seawater for use as fresh water, they have also attracted serious environmental concerns.
If any one of them were to suffer a catastrophic problem, the radioactive waste would affect not only the countries nearby, but also spread around the world via the region's strong sea currents.
This type of reactor is often known as a fast reactor, as it uses high-speed neutrons to split the fuel atoms. A fast reactor has some significant advantages over normal reactors. The fast neurons can split the atoms of nearly all fissile materials, including the waste left over by traditional thermal power plants, thus dramatically increasing fuel efficiency.
Also, the lead-based liquid metal the reactor uses as a cooling system does not boil until it reaches a temperature of 1,400 degrees Celsius, which makes the reactor safer than any existing thermal one in commercial operation today.