(FORTUNE Magazine) – THAT PROPHET of capitalism, Adam Smith, had little use for what we call the service economy. He dismissed the labors of tutors, shopkeepers, and household servants as backward or worse. A visionary in other ways, Smith could not foresee that service enterprises ultimately would become high-powered global competitors, every bit as cosmopolitan and as technologically advanced as manufacturers. Whatever international whippings it has endured in manufacturing, the U.S. is still out front in services, where it is generally tops in efficiency. Last year American companies peddled an estimated $160 billion of ads, auto insurance, and other services to foreigners. Some $70 billion was in the form of service exports, in which the U.S. enjoys a trade surplus; the rest was purveyed by countless overseas outposts of American companies. While service companies as a whole took in roughly 5% of their revenues overseas, vs. 10% for the manufacturing sector, many were much more outgoing. Foreign sales ranged from about 10% to 40% for such service stalwarts as Toys ''R'' Us, Fluor Corp., Electronic Data Systems, American International Group, Citicorp, and Arthur Andersen. U.S. service companies are especially strong in the brainpower-driven services that businesses buy: investment banking, management consulting, telecommunications, information services, commercial insurance, and technical education. And America is no slouch in serving consumers either. More often than not, U.S. retail bankers, hotel chains, hospitals, and mass-merchandisers set the standards for efficiency and quality that foreign rivals strive to match. Only in a few industries -- shipping and tourist travel, for example -- have foreigners gained the upper hand. So far, that is. Many economists and business executives worry that U.S. business, already bloodied in autos, consumer electronics, and memory chips, is headed for a similar fate in services. ''Americans have no more natural advantages in producing financial instruments than in color TVs,'' says MIT economist and Nobel laureate Robert M. Solow. ''We are in danger of losing our edge.'' ON THE THEORY that the best defense is to carry the war into the enemy homeland, foreigners -- many with deeper pockets, faster productivity growth, and proportionately higher R&D outlays -- are attacking U.S. service companies in their own market. From Syracuse to Seattle, Europeans, Japanese, and -- yes -- citizens of Singapore are striving to become Americans' shopkeepers, bankers, builders, and hoteliers. Since 1980 they have almost quadrupled their investments in service enterprises on U.S. soil. Measured by book value, in fact, their $125 billion stake in the American service economy now exceeds U.S. direct investment in services abroad. (The foreign lead partly reflects accounting practices: U.S. investment abroad is older and is therefore carried on the books at lower prices.) Five megatrends guarantee that international competition will heat up: -- Technology. The global village will come into its own, thanks to breakthroughs in transportation, communications, and information technology that are driving down costs, churning out new products, and spreading new ideas as fast as you can fax from Fort Wayne to Frankfurt. -- Globalization of manufacturing. U.S. companies are streaming abroad to supply support services as their clients scatter factories across oceans. EDS, the Dallas-based data-processing giant, went international in a big way on GM's coattails. Japanese construction kings Shimizu, Ohbayashi, and Kajima are busily building electronics factories and auto plants for Japanese clients in the U.S. -- Richer consumers. Buoyant economic growth promises to lift incomes in Asia and Europe faster than in the U.S. As incomes grow, foreign consumers will devote a bigger share of their budgets to buying services. Taiwanese spend a quarter of their family budgets on services, far below Americans' 38%. -- Deregulation. The removal of government's heavy hand has already lured scores of foreigners, such as British Telecom and Japan's Nomura, into U.S. telecommunications and financial services. Now American firms stand to benefit from a parallel trend in Europe and the Pacific Rim. Moves to deregulate international air travel should open new routes to U.S. carriers like Delta, United, and American. -- Tumbling trade barriers. The U.S.-Canada free-trade pact is a boon to the 910 Radio Shacks that Intertan, a Tandy Corp. spinoff, operates in Canada. As 1992 demolishes tariff walls in Europe, real estate consultant Grubb & Ellis, headquartered in San Francisco, expects plenty of calls from American and European clients eager to consolidate their factory and warehouse operations there. U.S. service companies, government figures show, are stunningly efficient. American service workers outproduce their Japanese counterparts, for example, in transportation and communications, business and consumer services, and wholesale and retail trade (see chart). American outfits are, on average, bigger, more automated, and less sheltered from competition. Retail prices are 50% higher in Japan than in the U.S., largely because of inefficient middlemen. Only in financial services is Japan ahead, having splurged on computers, software, and the latest communications gear. The U.S. service sector as a whole is awash in new technology. Service companies have increased their stock of equipment 66% over the past decade, twice as fast as manufacturers. As a result, their gear is much sprightlier. Its average age had fallen below seven years at the end of 1988, vs. more than nine in factories. Impressive as this firepower is, the U.S. service industry will have to strive even harder to stay ahead in productivity. ''Others are growing faster,'' warns C. Jackson Grayson, chairman of the American Productivity and * Quality Center in Houston. American productivity is bounding ahead in a few key businesses -- telecommunications, airlines, commercial banking, and wholesale trade -- but the average gain in the services has slumped from 2.1% a year in the Fifties and Sixties to 0.5% since then. The U.S., with 12.7% of the world market in 1987, is the top exporter of services, ahead of second-ranking France (9.7%) and third-ranking West Germany (9.5%). Services are exported when a citizen of Hong Kong, say, checks in to a Chicago hospital, or a New York management consultant jets to Jiddah to supply advice to a Saudi Arabian client. Despite large deficits in shipping, tourism, and travel, the U.S. has run a trade surplus in services since the Sixties. The surplus ballooned from $3 billion in 1987 to nearly $8 billion in 1988 as surging foreign demand and the cheap dollar drove up U.S. exports by 16%. John Hagens, an economic forecaster at WEFA Group, expects service exports to climb 5% a year after inflation throughout the Nineties, about as fast as U.S. factory exports and three times as fast as service imports. America's export prowess may be even greater than it looks. A recent study by the Office of Technology Assessment speculates that actual sales abroad may be some 60% higher than reported. Missing from the official tally are such professional services as computer consulting, public relations, and the advice purveyed last year by law firms like Skadden Arps Slate Meagher & Flom, which has upwards of 60 Japanese clients. Those given to griping about the litigious nature of American society can take comfort that the U.S. exports twice as much legal advice as it imports. MOST SERVICES American companies sell to foreigners are performed by employees stationed abroad and paid for in local currency; hence, they don't count as exports. Arthur Andersen, the accounting firm, which earns 40% of its revenues abroad, has a network of 48 foreign partnerships. The Big Eight firms dominate Europe. Sales by overseas subsidiaries of U.S. service companies have been rising roughly 6% a year in the Eighties. How can U.S. service companies keep winning in the international arena? A look at seven businesses shows what succeeds and what doesn't. Vigorous American contenders are triumphant in three of them, moving up fast in two others, and counterattacking in two more in which their compatriots have lost terrain. -- Computer services. Abundant capital -- specifically, the largest installed base of computers in the world -- goes a long way toward explaining the substantial U.S. edge in the $95 billion market for data processing, custom software, assistance in setting up computer networks, and the like. Exports recently exceeded imports by an astounding 31-to-1 margin. Indeed, the global wrestling match is pretty much dominated by American companies -- Arthur Andersen, IBM, Boeing, and others -- though Britain's Logica offers growing competition in its home market, and France's Cap Gemini is taking a $160-million-a-year bite out of the U.S. market. Dallas-based EDS garnered $800 million in overseas revenues last year, a sixth of the total, and boosted profits by 19%. Though nearly half its foreign business still is with GM, the company's foreign client list is beginning to read like the Who's Who of global industry. Helping those clients integrate their computer and communications systems is one of EDS's fastest-growing services. -- Retailing. U.S. merchants have been profiting from a classic formula for success: doing abroad what has worked superbly at home. The strategy sometimes misses; ask Sears and J.C. Penney, which flopped in Europe. But it is working wonders for specialty retailers. The foreign sales of Toys ''R'' Us, based in Paramus, New Jersey, shot up 75%, to $367 million, in 1988. The company, which has opened 25 stores in Europe in the past four years, just established its first Malaysian outpost in Kuala Lumpur. Says Joseph Baczko, head of its international division: ''Our strategy is pretty much the same around the world. Eighty percent of our products are the same too.''

Forth Worth's Intertan opened 102 new Radio Shack and Tandy stores last year and expects to top that number in 1989. A breakeven operation before it was turned loose by Tandy Corp., Intertan is chalking up handsome profits now. ''We're not doing anything radically different,'' says chief financial officer Garland Asher, pointing out that the former parent treated the global business as a stepchild. Intertan replaced American expatriates with local managers attuned to local demand. Canadian customers are content with seven different electronic keyboards, but rock-mad British teens want twice as many to choose from. -- Insurance. Around the world, this remains mostly a domestic business. All the more amazing, then, that New York City's American International Group collects 40% of its premiums abroad, vs. less than 1% for U.S. insurers as a whole. AIG's unique advantage is its far-flung archipelago of 375 insurance offices in 130 countries. ''You cannot just sell insurance. You have to service it,'' says CEO Maurice Greenberg, who adds that multinationals of all countries increasingly prefer one-stop shopping for their insurance needs. AIG offers exotic policies like expropriation insurance, and it excels at fine-tuning products to local needs. In Japan, it markets accident and health policies with -- what else? -- built-in savings features. AIG's foreign profits have been spurting 20% a year on average since the mid-Eighties. -- Airlines. In some businesses, a powerful home base can be as much of an advantage abroad as the latest technology or the neatest new product. American Airlines, a classy carrier with a 17% market share in the U.S., is a case in point. So is its most dynamic rival in the North Atlantic, resurgent British Airways, now the leading international carrier worldwide. But American has lower costs, the world's biggest computer reservation system, and a record for reliable service that has helped it become No. 6 in the North Atlantic in just four years. -- Air courier services. The war over the exploding international air courier market is testing the U.S. edge in service organization and efficiency. UPS and Federal Express have used their dominance in the U.S. to vault into the global market, directly challenging Brussels-based DHL, which controls most of the international business. Both invaders are spending heavily to acquire a global air and ground network. Although they are winning customers, neither is yet in the black overseas. Driving down costs is the key to victory in what is increasingly becoming a commodity business. ''That is a way of life at UPS,'' says Donald Layden, senior vice president for international air operations. ''We track our costs per package or kilometer. We let our foreign managers know what they are and ask them to keep costs in line or rein them in.'' UPS has recently expanded its overnight document deliveries from 41 to 163 countries. Should you wish to send a message to Fidel from anywhere outside the U.S., these are the folks to call. UPS is the only courier in Cuba. -- Banking. Measured by share of major banks' world assets, Japan's banks now outrank the U.S., 24% vs. 22%. U.S. banks -- Wells Fargo and First Chicago, to name two -- have mostly been retreating from global markets. A glittering exception is Citicorp, which now employs 26,000 retail bankers in 40 countries. ''We're the only financial service company that has pursued the consumer market worldwide -- with our normal voracious appetite, I might add,'' says Richard Braddock, who head's Citi's $8 billion consumer banking division. Revenues have been growing more than 20% a year abroad for the past five years, faster than in the U.S. In 1988 overseas profits soared 24%. Citi gets business in Britain by processing mortgage applications in a week, one-quarter the time it takes competitors. In Hong Kong it is the biggest financer of taxis. Citi's innovations -- touch-screen automatic teller machines and Citi-One accounts, for example -- are wowing gadget-obsessed Koreans and Japanese. -- Industrial construction. The U.S. is still the world's top international contractor, with 25% of the market in 1987, but that's a shadow of its 45% chunk in 1980. Specialists in big projects, American companies got blasted in the early Eighties by higher interest rates, collapsing oil prices, and Third World debts. Fluor Corp. of Irvine, California, saw its foreign business shrink from 90% of contracts in 1976 to just 10% in 1985. Japanese, not American, builders increasingly pioneer new methods. Also, they can count on cheaper capital. Says Gerald Glenn, the head of marketing for Fluor's international subsidiary: ''The name of the game is, bring some money.'' To become more competitive, says Glenn, ''the smart U.S. companies are spending a lot on R&D and on training.'' Fluor has been spending heavily on computer-aided engineering, communications networks, and cost-control and scheduling systems. The company's new foreign contracts quadrupled last year to $1.4 billion, 24% of the total. Fluor's goal is 40% to 60% by the mid- Nineties, mostly from projects in the Pacific Rim and Europe. AND WHAT of all those foreign service outfits hammering away at U.S. dominance? Some are conquering. Other nations now boast the world's biggest janitorial service, ad agency, and equipment-leasing company. Dow Jones's Telerate, a database giant on Wall Street, is a dwarf in Europe, where British-based Reuters has 70% of the business to the Yank firm's 10%. U.S. service imports jumped 9% last year, with consequences especially galling to Blount, the Alabama-based heavy-construction firm. Blount, which does hardly any building abroad, recently lost a bid to British-owned Taylor Woodrow to build a Jacksonville, Florida, jail. When it comes to services, American companies are no pushovers. But count on the foreigners to keep on pushing.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: THE U.S. LEADS IN SERVICE EFFICIENCY... U.S. PRODUCTIVITY AS % OF JAPANESE PRODUCTIVITY

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: AND RUNS A TRADE SURPLUS... TRADE IN SERVICES

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: BUT FACES GROWING FOREIGN COMPETITION AT HOME INVESTMENT IN SERVICES