(FORTUNE Magazine) – WITH THE END of the Cold War, America enters an era in which national power is increasingly determined by economic rather than military might. In this new world where industries, not arsenals, matter most, competitiveness -- a nation's ability to meet the test of the global market while raising living standards at home -- becomes the key index of strength. So how does the U.S. stack up? And what are the essentials needed for success in the future? Gauged by the broadest measures, America isn't doing badly as things stand today. Declinists, who draw fashionably gloomy comparisons to England at the end of the British Empire, are exaggerating. Consider the chart above, based on research by economic historian Paul Bairoch of the University of Geneva. At roughly 32%, the U.S. share of world manufacturing production is about where it was in 1913 and 1938, before the century's two world wars -- hardly the profile of a nation on the wane. The slide in the 1950s was actually welcome, for it was evidence that the U.S. had succeeded in helping its allies rebuild economies that had been devastated by World War II. Since then America has held its ground. Nor has the U.S. economic engine broken down. Economists Robert Lipsey of Queens College and Irving Kravis of the University of Pennsylvania calculate that the trend-line annual growth of real per capita income in the U.S. has stayed at roughly 2% for more than 100 years. Other nations are expanding faster, but they won't glimpse America in their rearview mirrors anytime soon. Herbert Stein, former chairman of the President's Council of Economic Advisers, recently observed that if the trends of the past six years continue, Japan's per capita output would surpass America's -- in 33 years. ''That,'' noted Stein, ''is a big if, and a long time.'' Does this mean the U.S. has nothing to worry about? No. A number of important warning lights have begun flashing in recent years. During the 1980s, American producers lost huge chunks of the market to foreign suppliers of computer chips and machine tools -- high-tech sectors crucial to industrial strength in the 21st century. In 1983, Japan's Ministry of Trade and Industry analyzed U.S. and Japanese prowess in 40 key sectors of commercial technology, from assembly robots to skyscrapers. It found Japan lagging in nearly half. In an update of that study five years later, MITI concluded that the U.S. had held its lead in only one area (database software). America continues to spend less on civilian R&D than its rivals: 1.8% of GNP, vs. 2.6% in West Germany and 2.8% in Japan. Most troubling for the future is the huge and continuing gap between U.S. and Japanese productivity growth (see charts). INDIVIDUAL companies and managers deserve the rap for much of this slippage ! (see ''Lessons From U.S. Business Blunders''). But the government has also served American industry poorly. Says Caterpillar President Donald Fites: ''There's less sensitivity to manufacturing than before.'' The litany of government's shortcomings in recent years is as depressing as it is familiar. Among them: a pathetically inadequate education system and persistently huge budget deficits, which help drive up the cost of capital, foster record trade deficits, and lead to pressures for costly protectionism. Many big American corporations have grown adept at overcoming obstacles without any help from Washington. Take General Electric, which contributed a herculean $4.1 billion to U.S. exports of manufactured goods last year. When GE runs into protectionist barriers, Chairman Jack Welch applies what he calls ''company-to-country relations,'' using GE's connections or muscle in one industry to pry open doors in another. Three years ago, GE wanted to swap its consumer electronics business for the European medical equipment business of France's Thomson, a state-owned conglomerate. The bureaucrats in the Elysee Palace readily agreed -- largely because of the good will created by GE's successful 16-year-old joint venture with Snecma, another government-owned company that makes jet engines. Similarly, in the mid-1980s Texas Instruments got serious about whittling down capital costs when it found it was paying twice as much for funds as chipmakers in Japan. The company has since cut that gap in half. One key, says Chief Executive Jerry Junkins, was gaining the right to sell equity on the superheated Taipei stock market, by agreeing to build a plant in Taiwan with a local partner. U.S. companies have also begun tackling the country's unmet social needs head on. Boeing, the nation's largest exporter, is providing money and technical help to elementary and high schools in Seattle. ''For years we've given money to engineering and computer-science programs at universities,'' says Dean Thornton, chief of Boeing's commercial aircraft unit. ''We have to broaden that now, because the elementary schools aren't getting the job done. The U.S. has got to get off its butt in education.'' To maintain its leading role in the world and ensure its citizens better lives, America must do more to boost competitiveness. But it would be a mistake to forge this sense of national purpose with either the tactics or the rhetoric of crusades past. Call this the metaphor problem. Economic ^ competitors such as Japan or the European Community are not enemies but opponents, and sometimes may even be teammates. Unlike war -- hot or cold -- economic competition can make both sides richer and stronger. The challenge in this new era, then, is to figure out how to play this game more efficiently -- and pursue American economic interests more aggressively -- without destroying the international order of free trade and capital movement that the U.S. has nurtured and sacrificed for since the end of World War II. In wide-ranging interviews with executives, government officials, and scholars, FORTUNE has assembled a checklist of moves to make, and pitfalls to avoid, as the nation pursues this goal. -- CUT THE BUDGET DEFICIT NOW. Yes, it's familiar advice, and politically daunting to pull off. But that doesn't mean it shouldn't be done. The best approach is to start with the spending side, though not by hacking away across the board. Some categories of federal expenditure, after all, represent investments: among them, education, research, and transportation. Paying for more in these areas by trimming the share of the budget devoted to consumption is the ideal way to boost competitiveness and national wealth. Programs that deserve a haircut include subsidies for wealthy farmers and entitlements for the middle class that are not means tested, such as Medicare. If this balancing act can't be maintained and the deficit persists, then taxes will have to rise, as surely as the Washington Monument points skyward. In FORTUNE's view that would be preferable to another decade of gargantuan federal dissaving -- as long as the taxes take their bite out of consumption rather than investment. Many chief executives agree. In a FORTUNE 500/CNN Moneyline Survey last year, 80% of the CEOs polled favored the use of consumption taxes to balance the budget. Most would also like to see Congress change the tax law to encourage more investment, say, by reducing the capital gains tax as President Bush has proposed. As a political first step, the budget-balancing package proposed last month by House Ways and Means Committee Chairman Dan Rostenkowski is right on four counts. It trims consumption through a one-year freeze on Social Security; it raises the marginal tax rate paid by the rich to levels now imposed on the merely well-off; it keeps America's otherwise low tax rates unchanged; and it draws most of the revenue from putting the touch on alcohol, cigarettes, and gasoline. -- STICK WITH FREE TRADE. With the trade deficit still hanging at $110 billion after 14 years in the red, and foreign purchases of U.S. companies and real estate at record levels, Americans do not approach trade issues in a tranquil frame of mind. Though some observers, such as MIT's Lester Thurow, think a unified Europe will be America's greatest challenger by the end of the 1990s, Japan holds that title today. Its stunning success in seizing markets long dominated by the U.S. and its emergence practically overnight as America's biggest creditor have prompted many economists to reexamine their theories of international trade. Some even speculate that Japanese-style capitalism has made America's free-enterprise approach obsolete. In a Gallup survey last fall, more than half of those polled cited Japan as a greater danger to U.S. security than the Soviet Union. Such fears are one reason Congress passed the Trade Act of 1988, which requires the White House either to wrest concessions from Japan or to impose higher duties and other sanctions on Japanese goods. Trade Representative Carla Hills is trying to win openings in the Japanese market for U.S. satellites, supercomputers, and lumber. But thus far, vigorous negotiations have produced handwringing, promises, and little else. Does that mean it's time to give up on free trade? A growing number of politicians and some CEOs think so. Ford Motor's new boss, Harold ''Red'' Poling, argues that the only way to close the $50-billion-a-year U.S.-Japan trade gap is by delivering an ultimatum. ''Just give the Japanese a target, say, reducing the gap by $10 billion a year for five years, and let them figure out how to hit it,'' he suggests. But such a showdown would surely hurt both countries and could send the world spiraling back toward Depression-era economic Balkanization. Besides, even neomercantilists with an exaggerated notion of the importance of trade surpluses acknowledge that bilateral imbalances are less critical than the overall balance. In FORTUNE's view, if the U.S. cuts its budget deficit, thereby lowering its need for foreign capital, its trade deficit will continue to decline as America's export competitiveness grows in the 1990s. -- WANTED: SMARTER KIDS, SMARTER IMMIGRANTS. Like New Yorkers swapping tales about the subway, managers don't need much prompting these days to spill their guts about the failings of America's schools. Here's a horror story from ! Motorola. The company recently determined that employees should have at least fifth-grade math skills and seventh-grade reading skills to work in its plants -- only to discover that fully half its workers need remedial training to reach this level. Now comes Congress's Office of Technology Assessment (OTA), which offers this grim prediction about the quality of American labor in a February report: ''The prospect is that things will get worse, not better.'' With the growth rate of the U.S. work force declining, employers are drawing increasingly on groups that have long been disadvantaged, such as blacks and Hispanics. Business and government will have to share the enormous cost of training these workers. All industrialized economies are facing labor shortages. Where America has a huge competitive edge is in its unparalleled ability to construct a labor force out of a heterogeneous, immigrant population. Says British historian Eric J. Hobsbawm: ''The U.S. may be the only major industrial country that already lives in the 21st century, which will be a century of global labor flows.'' The U.S. absorbs some 650,000 immigrants per year -- more than all other industrialized nations combined. Raising that quota and changing the rules to bring in more immigrants on the bases of their education and skills would be a cost-free way to lift the quality of the U.S. work force while waiting for the long-term payoff from education reform. -- STOP PASSING THE BUCK ON PUBLIC WORKS. The Federal Highway Administration reports that 41% of the nation's 575,000 bridges are ''structurally deficient'' or ''obsolete.'' Some 62% of its highways need to be resurfaced. Not one major airport has been built in the U.S. since 1974, despite a doubling of air traffic in the 1980s. The result: growing gridlock on America's highways and skyways. The cost is enormous. Traffic delays waste precious fuel and time, aggravate urban smog, and play havoc with just-in-time inventory systems. According to Chicago Federal Reserve Bank economist David Aschauer, underinvestment in public works may have caused fully half the slowdown in U.S. productivity growth since the boom years of the 1960s. Even economists who think Aschauer's estimate is too high -- and many do -- agree that this is a problem that needs addressing. The debate is over who pays. President Bush wants to hold federal public works spending constant, even though total physical capital investment by the federal government has shrunk from 24% of federal spending in 1960 to around 11% today. In his new national transportation strategy, Bush calls for shifting much of the financial burden to states, localities, and the private sector. But if the U.S. wants a smooth-running national transportation system in the year 2000, Washington will have to pony up much more cash than the President has proposed. How much? Some estimates are clearly absurd. The National Governors Association puts the bill as high as $3 trillion over the next 20 years. That's over half one year's U.S. GNP -- the equivalent of taking the entire populace and putting it to work for seven months pouring concrete. At a minimum, though, the federal government has to start spending down the $25 billion surplus it has built up in its highway, inland waterway, and airport trust funds. Today these merely paper over the deficit; they ought to pave the way to greater competitiveness. -- ADOPT A NEW TECHNOLOGY POLICY. Back in the 1950s and 1960s, the arms race at least helped galvanize the U.S. economy. Consumers have the Cold War to thank for the speed with which computers, jet airliners, microwave ovens, and the interstate highway system came into being; all these innovations had their roots in defense projects. But in the past 20 years defense R&D has become a drag. It diverts thousands of scientists and engineers from commercial endeavors, and as weapons have grown more exotic, fewer military inventions spill over into marketable products. Abundant evidence of American decline can be found in civilian high tech. While no nation can lead in every area of technical and manufacturing knowledge, an economy the size of America's should strive to compete in all. Market forces can move the country a long way toward that goal. But the erosion of America's advantage in critical areas is so dramatic that the nation ought to consider hedging its bets. That's what lawmakers did at former President Teddy Roosevelt's urging in 1915, after aviation enthusiasts warned that Europeans were beating the U.S. in the race to commercialize the Wright brothers' invention. Congress started the National Advisory Committee on Aeronautics, the predecessor of today's NASA, which gave a huge boost to civil aviation. Among its contributions: providing large wind tunnels that none of the struggling aircraft companies of the day could afford. To make a similar move today, the Bush Administration would have to get beyond its aversion to bureaucrats ''picking winners and losers'' and allow more federal dollars to flow into technologies and manufacturing processes that appear to have long-term commercial promise. At the moment that's just a trickle. In 1986 less than $500 million of the federal government's $56 billion research budget went into industrial research, according to an analysis by Telesis, a Providence, Rhode Island, consulting firm. That same year, Japan focused 80% of government R&D spending -- $9 billion -- on manufacturing industries. WITH THE OUTBREAK of peace, the U.S. can afford to spend more than it has in the past. Grandiose investments in such projects as magnetically levitated trains or hypersonic airplanes would be a mistake. It's hard to forget Jimmy Carter's synfuels program, which sucked $2 billion into a lot of technological dry holes. But the government can reduce the likelihood of similar embarrassments by following two simple rules of thumb. Rule No. 1: Follow where industry leads. If businesses won't put up at least half the money for a project, it's probably not worth funding. Nearly 200 cooperative research ventures have been launched since Congress eased antitrust barriers to them in 1984. The most prominent is Sematech, the semiconductor industry's giant manufacturing research consortium. The government might encourage the most promising of such ventures with matching funds. A recent proposal that deserves consideration: working with industry to bring U.S. homes into the 21st century by replacing their telephone lines with high-capacity optical fibers. This would stimulate rapid development of a whole new generation of consumer electronics products, from facsimile machines to digital television. Rule No. 2: Support lots of little projects. That has been a winning strategy for Darpa, the Pentagon's agency for advanced R&D, which has scored breakthroughs in fiber optics, high-temperature ceramics, and the computing technique known as parallel processing. Says Intel Chairman Andrew Grove: ''You don't need an elaborate new bureaucracy to defend America's technological industries. Just put some additional money in the hands of existing expert agencies that know what the problems are and what can be done.'' In the view of shrewd technologists such as Ralph Gomory, the former head of R&D at IBM, keener attention to the nuts-and-bolts of manufacturing is the key to solving America's competitiveness problems. Here Washington's role should % be to promote excellence by setting goals, such as the new Baldrige award for quality, and by providing modest grants. Removing antitrust barriers for joint manufacturing ventures, as President Bush has suggested, would also help spread knowledge of advanced production techniques. But that's also another reason to adamantly resist protectionist pressure to block foreign goods. Nothing would be more devastating to U.S. competitiveness than to have the government create cartels and then shelter them. FINALLY, Washington should explore ways to make more of the nation's small- and medium-size manufacturers worldclass. Most are not heavily involved in global markets themselves. But as suppliers to big manufacturers, they have an important indirect effect on U.S. competitiveness. West Germany and Japan have many ways to back up such firms. Japan spends close to $500 million annually on a public network of manufacturing support centers. When the president of Showa Precision Tools, a successful $1.2- million-a-year diemaking company in Yokohama, got ready to buy new equipment for his plant in 1988, he received a free evaluation of his purchase plan from manufacturing experts at the Yokohama city office. (The city will also, upon request, dispatch a sensei, or master, to drill shop foremen in quality-control techniques.) So far the U.S. has only a fledgling $10-million-a-year network, run by the Department of Commerce, to provide technical support. The cost of extending it to even half of America's 350,000 small- and medium-size manufacturers could quickly climb toward moon-shot proportions. One way to hold down the price tag -- and provide a market test of the program's effectiveness -- would be to charge a small user fee. As long as the network provides useful information, companies should willingly share the cost. While capitalism now rules the world, it is a diverse, imperfect capitalism that pits American free-marketers against European social democrats and Japanese practitioners of strategic trade. To stay competitive in this friendly free-for-all, the U.S. doesn't need to rethink its basic economic model. It just needs to ensure that, in the areas where business and government inevitably intertwine, its strategies work.

CHART: NOT AVAILABLE CREDIT: SOURCE: PAUL BAIROCH, ''INTERNATIONAL INDUSTRIALIZATION LVELS FROM 1750 TO 1980'' CAPTION: SHARES OF WORLD MANUFACTURING For nearly a century, U.S. industrial production has held strong. +

CHART: NOT AVAILABLE CREDIT: NO CREDIT AMERICA'S PLACE IN THE COMPETITION RACE By almost any measure, the U.S. remains the country to beat. Its share of world exports has rebounded after declining for much of the postwar era. Its wealth per capita, adjusted to reflect differences in purchasing power, is unmatched by any major rival. The same goes for total productivity (see table at right): The average Japanese worker still takes until mid-afternoon to produce what the average American can before lunch. Only in productivity growth -- the key to future prosperity -- does the U.S. look like a country in trouble.