(FORTUNE Magazine) – COMMUNISM HAS IMPLODED. In country after country, it is proclaiming its own failure, desperately searching for ''reform'' and new beginnings. Yesterday's heresies are today's official promises; yesterday's dissidents are today's rulers. No historical parallel exists for such a swift and (so far) largely bloodless revolution. This revolution, and the nearly global demand for democracy, may well represent the most important development of the 20th century. It is an extraordinary success for the democratic-capitalist system, testifying to its steadfastness, to the essential rightness of its philosophy, and to the soundness of its past policies toward the Communist powers. But while the struggle with Communism is -- in the main -- over, the struggle for the long- range success of capitalism is just beginning. Capitalism's very victories contribute to the new challenges it faces. Capitalism in some form today is widely seen as the remedy not only for the forcibly induced miseries of Eastern Europe but also for the poverty and disorder of much of the Third World. In fact, some rather sudden new converts are expecting ''the market'' to perform miracles. Failure could well spill doubt and disillusionment back into the West. Even in the developed world, capitalism is called on to do still better than it has and to cure serious social ills. The U.S. and the world now face an interlocking complex of issues, ranging from immediate foreign policy questions to long-term economic and philosophical ones. The principal problems: -- Rearguard actions of unreconstructed Marxists in the Soviet Union, Eastern Europe, and the Third World. -- The transition to free markets and free societies where they have not existed before, which is proving painful and in some places may be impossible. -- The need for new policies in a world no longer defined by the U.S.-Soviet conflict. -- The practical as well as existential dilemmas of capitalism itself. The most notable rearguard action, of course, is being fought by the Beijing regime, along with North Korea and Cuba, which is still heavily aided by the Soviet Union. Elsewhere various Communist guerrilla movements remain threatening, and some dictatorships in black Africa have not yet heard that, as Peru's Mario Vargas Llosa says, ''You cannot be a modern man and be a Marxist.'' In the Soviet Union and Eastern Europe, vestiges of the old guard remain. Gorbachev's seemingly dazzling victories over the reactionaries cannot yet be taken as assured; besides, he may adopt reactionary policies himself, as he has in Lithuania. Moreover, midlevel politicians and bureaucrats cannot be replaced quickly if governments are to continue functioning. In Rumania the new regime is still largely Communist, under a new label. Many leaders who declare themselves committed to the move from Marxist dictatorship to democracy don't really understand what it means. Two very deceptive words are widely heard: ''Stalinism'' and ''deformation.'' To lump all of pre-Gorbachev Communism under the Stalinist label is to suggest that only the monstrous dictator was to blame for the system's failure, and that somehow a more benign Communism might be workable. The second word, a favorite of Gorbachev's, suggests that what went wrong was a distortion of the basic Marxist or Leninist vision. The truth is that Communism itself is a distortion of human society. That means the former Communist societies must be totally transformed, and after decades of Marxist indoctrination and little or no history of democracy, they are far from ready for this. The new Polish government seems courageously determined to move to a free market almost cold turkey and to persuade the population to accept the inevitable sacrifices; the results are unpredictable. The Hungarians, who started earlier, are now moving more slowly in the economic field, despite their new non-Communist government. A majority of East Germans in their recent, stunning election voted not only for unification but -- despite many remaining misgivings -- for capitalism. Will Gorbachev follow suit, and to what extent? When he came to power, he obviously believed that the system could be reformed but kept essentially intact. After five years during which things only got disastrously worse, it is still not clear whether he has completely changed his mind. Economic double-think prevails. He shies away from permitting private property, which remains a dirty word for most Soviets, synonymous with exploitation and inequality. There have been reports that he is ready to institute free pricing and make the ruble at least partly convertible. While these moves are necessary, in the short term they would only increase the ordinary people's hardships and intensify Gorbachev's growingunpopularity. In Eastern Europe as well as the Soviet Union, the easing or removal of Communist dictatorships has released not only benign instincts but dangerous ones, including long-suppressed chauvinisms and ethnic animosities. In a sense, we are faced with the re-Balkanization of the Balkans. One danger is that political and economic chaos will become so bad that there will be calls for ''order and discipline,'' and right-wing dictatorships will take over. Witnessing these difficulties, the U.S. is being called on to do more. American critics of the Bush Administration demand some overarching vision, greater imagination, and especially more money. They see the U.S. falling behind Western Europe and perhaps even Japan in its support for the revolutions in the East. The Bush Administration quite deliberately urged the European Community to take the lead in Eastern Europe. True, more U.S. aid, carefully targeted, would be very welcome, but even if U.S. resources were unlimited, throwing money at the East's problems would not be the right solution. The frequent analogies to the Marshall Plan are misleading; the East never had the industrial and entrepreneurial traditions that made Marshall aid effective. ONE PROBLEM is that U.S. and Western assistance takes countless and confusing forms -- public and private; loans, credit, and trade concessions; plus legions of would-be helpers swarming into the Eastern reaches to offer advice on everything from marketing to the black arts of political campaigning. More coordination by Washington, and more visible and identifiable leadership, are necessary. An attempt, however, to impose a grand concept, a dominant vision, would probably be futile in this wholly unpredictable period. (Many critics who used to condemn America's ''arrogance of power'' now seem to be recommending arrogance of vision.) So far, the Administration has done well by pressing for a few basic principles -- political and economic freedom, human rights -- and maneuvering as events have dictated. Specifically, it has smoothly handled the breathtaking rush to German unification. In the past, most people's attitude toward German unification recalled St. Augustine's prayer: Lord, make me chaste, but not yet. Everybody was for unification in principle, but later. The Germans themselves now have made that slow approach impossible. Fears that a united Germany might once again become an aggressive, and possibly fascist, power seem quite unjustified. But economically and politically, a strong united Germany will tend to dominate Europe. Hence a general desire to keep Germany firmly anchored in the West, in the European Community and in NATO. Moscow probably lacks the strength to prevent this but would require various hedges and assurances. The NATO nuclear deterrent will be important while the Soviet Union remains a major nuclear power -- and while some Third World countries pose a similar threat. But the rationale for NATO as a stabilizing force will diminish if the Soviet threat continues to be seen as declining. The Warsaw Pact is just about gone. So the existing structure of alliances in Europe is obsolete, and the U.S. and its allies will have to be ingenious in helping to construct new European security arrangements that, at least for the medium term, do not replace but include NATO. It is now generally agreed that, with the fading of the U.S.-Soviet conflict, the new global order will be based on economics more than on military power and will be arranged around three poles -- the United States, Europe, and Asia-Japan (this hyphen covers a large and open question about how Japan and the rest of Asia will be integrated). The task of American statesmanship will be to help resist the formidable seduction of protectionism, in the U.S. and elsewhere, and to try to reconcile America's interests with those of its rival-partners, especially in dealing with the developing world. That world must be moved toward progress, in the interest of the developed countries themselves. They cannot go on indefinitely trading mainly with each other; the potentially major Third World markets must be brought into the global economy. As elsewhere, the only path to economic progress in the Third World is through the free market. Several Latin American countries have started on this course. But it is politically explosive. These nations still suffer from income inequalities that dwarf anything known in the developed world and often feature irresponsible ruling elites, some of whose members make New York's most ostentatious nouveaux riches look like raving egalitarians by comparison. Small wonder that populist politicians demand not only welfare states but a welfare world in which the advanced countries must subsidize the rest. That is a deadly prescription. More open markets for Third World products are necessary. But above all, political leaders in the Third World must be nudged toward taking the unpopular steps required by a free economy -- fewer subsidies, uncontrolled prices, less protectionism, real competition, less bureaucracy. This may take a generation or more. Now that the ideological conflict between the West and Communism no longer dominates, global politics will obviously change. Third World countries are already finding it much harder to play off the U.S. against the Soviets. Some analysts believe that old-fashioned regional power games will reemerge. In such an era, the U.S. and its allies will need highly sophisticated diplomacy and equally sophisticated, highly mobile armed forces. The most divisive struggles are likely to involve deeply emotional causes, like the Arab-Israeli conflict and Muslim fundamentalism. These are relatively impervious to the West's usual means of influence, including the promise of economic progress. But eventually, even the Iranian masses, for instance, may want a better life in this world rather than waiting patiently for the blessings of the next. Thus in these (to the Western mind) irrational confrontations, economic power, which is an extension of the power of reason, will also be essential.

FOR THE U.S., all this means that, to prevail in the newly emerging world, it must have a reinvigorated economy, which in turn means a reinvigorated society. One need not share the alarm of economic know-nothings who cry havoc at every new Japanese investment in the U.S. to worry about America's economic position in the emerging era. For all its tremendous success, can America be an exemplar of enlightened capitalism with a rotting infrastructure, a lethal, cancerous drug problem, and a seemingly intractable underclass? Can it play a leading part in the new global marketplace with insufficient productivity gains, lagging research and development, an inadequate supply of engineers, and a plainly ill-educated work force? Can it go on indefinitely financing its deficits by borrowing abroad and playing games with Social Security revenues? These are problems partly endemic to capitalism but largely specific to the U.S. So when we speak of the victory of capitalism, or its role as a model for others, the question often ignored is, which capitalism? THERE ARE AT LEAST three major models observable today: the American, the German, and the Japanese. The Japanese combine free enterprise and fierce domestic competition with strategic direction by the government, especially in foreign trade, and an almost tribal unity of national purpose. The West Germans have built one of the world's most successful free-market economies alongside a far-reaching welfare state whose essentials are supported not only by the Socialists but also by the Christian Democrats, although they differ in degree. (It was the father of the German economic miracle, the Christian Democrat Ludwig Erhard, who labeled the system ''social market economy.'') The U.S. displays the purest form of capitalism, which is a relative statement. A completely free market is a myth, as demonstrated in the U.S. by countless subsidies, tax breaks, and regulations. John Kenneth Galbraith, who is not always wrong, evokes ''the highly paid executive ((who)) delivers a speech on the virtues of free enterprise in Los Angeles and then flies in his tax-deductible corporate jet to Washington's federally built National Airport to lobby the Congress for import quotas, bailouts, something from HUD, or, now, research subsidies.'' Capitalism has created more wealth, more comfort, and more equality for more people than any other system, past or present. It replaced an order -- feudalism -- whose very essence was inequality and scarcity. But at the same time, it brought permanent instability. For centuries people accepted the disasters of war or poverty as the inevitable results of human nature or destiny. They also accepted natural disasters as acts of God. But the disruptions of the free-market society -- unemployment, business failures, depressions -- were and are resented as man-made: acts of God without God. That was the great driving force behind Marxism. It started as a deeply serious reaction against the cruelties of early capitalism and an attempt to bring order into the moral chaos caused by the Industrial Revolution. No one has described that chaos better than Marx himself in his Manifesto (''All that is solid melts into air, all that is holy is profaned,'' etc.). We must, if not respect, then at least understand the fallen enemy. Despite its brutality and its disastrous failures, Communism represented a dream of a just and orderly society. That dream and the dangerous utopian misconceptions it embodies will continue to haunt us. In short, the old problem of making capitalism compatible with a measure of stability and social justice, with what most people nowadays consider a decent society, has still not been fully solved by any of the capitalist models. MANY BELIEVE that it has been solved in social democracy. But for all its achievements, that system is today under severe strain. Social democratic economies are finding it necessary to widen free-market incentives, to privatize state enterprises, and to remove various controls. It is not only Communism that has failed but socialism as a whole -- specifically the belief that people function best in collective units, that self-interest and individualism are basically wrong, that government is the ultimate source of justice and well-being, and that economies must be centrally planned. (Not that the socialists have given up -- just ask Mrs. Thatcher.) Some people speak of a growing ''convergence'' of socialism and capitalism. But that is, at most, a half-truth. Yes, capitalist countries have used quasi- socialist devices to soften and stabilize their system. Economist Herbert Stein sees in this the adaptive genius of capitalism, without which it might not have survived. And yes, the convergence theorists are correct when they argue that the perennial debate about the proper mixture of public and private enterprise, the right interaction between government and citizen, is often artificial and too ideological. Matters that touch every aspect of life, from transportation to health care to education to housing, should be judged far more coolly, with more attention to what works.

But even pragmatic solutions add up to something larger: the fundamental orientation of a society, a view of people and what motivates them. No matter how mixed the capitalist and socialist elements are in a society, one or the other must ultimately predominate. That is really what the current counterattacks against ''Reaganism'' are about. They come down to two arguments. One is that it lacked compassion, a view echoed by Bush's ''kinder and gentler nation.'' But the issue is not compassion; rather it is how to pay for compassion -- in other words, efficiency. The second argument is that the combination of huge defense expenditures and tax cuts prevented investment in American infrastructure, education, and other vital areas. There is more justice in that complaint. Raising revenues for such investments will be inevitable. The U.S. is still more lightly taxed than any other industrial country. But it would be highly damaging to raise taxes without also cutting expenditures drastically -- especially various federal subsidies to the affluent -- and rationalizing the maze of government services. This will require responsible, probably bipartisan action that cannot simply be a matter of splitting the difference between opposing tax plans. The issue must be lifted above that plane. However one may disagree with some of its specific policies, or its rhetoric, Reaganism did represent a justified reaction against yearsof indiscriminate social spending and overbearing government. In some ways Reaganism did not go far enough. It never significantly reduced the size of government -- no peacetime government has been bigger. Reagan could never really limit the sway of the bureaucracy or touch the many so-called middle- classentitlements. Government has its role to play, but turning to the government for the solution of every conceivable problem is indeed the Road to Serfdom; it is certainly also the road to inefficiency. One source of confusion is that ''capitalism'' and ''democracy'' are often used almost interchangeably. Obviously, they are deeply intertwined and mutually dependent. In the long run capitalism works only in a democratic political system, though we have seen some temporary exceptions. And democracy works only in a capitalist economic system, where citizens are free to make their own choices and pursue their own goals. Nevertheless, there are also contradictions between capitalism and democracy; the electorate usually demands more than the economy can deliver, and the economy sometimes demands actions that hurt the people. An entrepreneur whose role it is to maximize his profits may have a hard time squaring that duty with the welfare, or the national and international aims, of his state. To bridge this contradiction, and to make this tension creative rather than destructive, is the supremely difficult task of leadership in a capitalist-democratic society. What will it take for the U.S. to do this? -- Above all, a class of clearheaded, uncomplacent managers and entrepreneurs. There have been too many instances of flagging imagination, waning energy, and excessive smugness in the business world. The disaster of Detroit remains a prime example. In semiconductors and biotechnology, U.S. industry led the way but is in danger of losing out in the competitive wars -- and Japan bashing is not the answer. Managers have also paid too much attention to financial strategy, mergers, and LBOs rather than to creativity and productivity. -- Enterprise must be given longer time frames in which to plan, succeed, or fail than quarterly or even yearly bottom-line calculations usually permit. Various tax reforms to encourage longer-range managing are under discussion in Congress and elsewhere, but they cannot be enough without a change in psychology. Although Wall Street is usually blamed for emphasizing short-term success, the fact is that the stock market cheers future-oriented managers and rewards them accordingly. FORTUNE has shown (November 21, 1988) that the 20 largest publicly traded industrial companies on its 500 list derived well over half their stock market value from prospects at least five years in the future. Obvious moral: There is no substitute for courage and vision. -- Employees must be given a greater stake in their companies -- and thus in their capitalist society -- through expansion of profit-sharing and employee ownership plans. That idea has been around for a long time, treated until recently with hostility by organized labor and with benign indifference by a great many businessmen. It is one of those ideas (in a very different sphere, environmentalism is another) that can gradually move from ''ho-hum'' to ''eureka.'' Several new factors are at work: the progressive replacement of traditional blue-collar workers by knowledge workers, the declining appeal of trade unionism, the striking demonstration that socialism and the class war are a dead end. All these make compelling arguments for employee participation in ownership that would help create a far more broadly based and inclusive capitalism. -- The American welfare state must be overhauled. It is more modest than its counterparts in most Western European countries. But at 19% of GNP, our public social spending is still considerable. Yet the distribution of that money is a shambles. Social Security payments to those who are well-off should be more heavily taxed. Other entitlements must be means tested or curbed. It is usually argued that means testing is inefficient and expensive (but surely the computer should make a considerable difference in this respect) and that it is demeaning (but this is precisely the kind of attitude that needs to be changed). Politically hopeless? Perhaps. But some promising ideas have recently gained currency, including vouchers for education and housing, decentralization of school boards, and competition in the delivery of public services. Quite a few projects that were considered politically untouchable eventually came to pass, as for instance the 1986 tax reform (admittedly incomplete and already embattled). Reform is not inconceivable if the existing mess becomes dramatic enough -- in health care, this is surely happening -- and if change comes in an overall package, with trade-offs. There would have to be a demonstration of how increased efficiency and savings would ultimately benefit various groups, including the poor. -- The crisis in public education needs attacking on many fronts, with money being an important but not the most important weapon. There is a vicious cycle. It is difficult if not impossible for schools to be better than their communities, and yet it is equally difficult for communities to improve without better schools. This does not apply only to the inner cities. In America at large, two attitudes have long been in contradiction: the belief that people can better themselves and achieve anything through education, and a certain breezy contempt for formal learning. This conflict has been aggravated by defining the goal of education as self-expression (a code word for lack of discipline), ''relevance'' (code for scandalously meaningless courses), and ethnic or social affirmation (code for putting women's or various minority studies above basic intellectual skills). The American education mess will not begin to be cleaned up, especially on the woeful primary and secondary levels, until we approach a national consensus that education matters, that it begins in the home, that to receive an education is a citizen's right that must be earned through performance, that it requires above all else rigor in learning and in teaching. -- The role of the community and its institutions must be greatly expanded, both for emotional and practical reasons. Capitalism itself does not provide these institutions and does not satisfy most people's yearnings for community except in special situations (for instance in Japan, with its paternalistic firms, complete with company songs and uniforms). Nor are these yearnings satisfied by government, which, even on the local level, has become too complex and remote. Community organizations must fill the space between the citizen's place of employment and the government. A recent survey shows that about 45% of Americans 18 and older are working as volunteers, dealing with everything from health and child care and literacy to campaigns against drunken driving. Another promising form of community organization is represented by the so-called business improvement districts. Under laws in more than 30 states, owners of businesses or real estate in a particular area agree to special assessments that help provide for private security, sanitation, care of the homeless, and physical maintenance, among other things. Volunteer organizations of this kind should be expanded and strengthened. Several bills are pending in Congress to do just that, including a proposal for voluntary national service. The notion that social service cannot be taken seriously unless it is performed by government is profoundly wrong. This kind of thinking not only wastes resources but is also demoralizing, destroying the sense of civic duty and individual responsibility that must accompany capitalism. Such change in the U.S. will not come about as a result of some master plan but only through a great movement of ideas, including a deeper understanding of capitalism itself. Not long ago William Safire pleaded, apparently quite seriously, for ''hapitalism,'' capitalism that makes everybody happy. But capitalism cannot make everybody happy. It can produce enough wealth to give every citizen the minimum for a decent existence. It cannot be expected to provide equality of income or even an artificially determined range of permissible income disparities. It can be expected to base inequality -- which is inevitable and necessary in society -- on some recognizable and acceptable principles, such as individual merit, but not excluding luck. Capitalism is not a religion or a philosophy. As author Michael Novak puts it, democratic capitalism promises liberation from tyranny, from intellectual or religious oppression, and from poverty. But it is not designed ''to fill the soul.'' Rather, it is ''designed to create space, within which the soul may make its own choices'' and spiritual leaders may do their work. Capitalism does dictate unorthodoxy, dissolves traditional social patterns, and applies commercial measurements to much of life. Thus, Novak's spiritual leaders have quite a job to do. A successful capitalist society must develop a stronger value system. America used to have such a system: the Protestant ethic, meaning, essentially, the work ethic. It applied, broadly and nondenominationally, to almost everyone. Whether it can still serve the nation remains to be seen. IN FACING THE FUTURE, the U.S. must recognize that its success or failure as an economy and as a society is not necessarily identical with the fate of capitalism as a whole. The U.S. is no longer the Rome of capitalism, if it ever was. By its very essence, capitalism, which is in constant flux, has no permanent imperial center. Capitalism could fail, relatively speaking, in the U.S. and succeed elsewhere. Other societies could beat the U.S. at its own game -- a game that in essence it invented. The reason is obvious: Capitalism alone is not enough. There is capitalism that works and capitalism that doesn't. But the U.S. has every chance of retaining or regaining its role as the leading capitalist society -- the champion of capitalism that works -- provided it makes the necessary and very strenuous effort.