(FORTUNE Magazine) – CALL IT the new New Europe. In a breathtaking rendezvous on the eve of 1992, the drive for a unified market has converged with the fall of communism to make Europe a far bigger and more competitive place to do business. In this special report, FORTUNE describes both the opportunities and the challenges facing Europe in the decade ahead. The risks are real, the problems deep. For all its immense potential, the fissioning Soviet Union could explode into chaos, unleashing a flood of emigrants that would severely strain Western Europe's economy and poison its politics. Many of Europe's biggest companies -- including most carmakers, airlines, and computer firms -- are far less efficient than U.S. and Japanese rivals. Europe's greatest asset is its new capacity to grow. The 12-member European Community, a sprawling bloc of 325 million free-spending consumers, may well expand to include at least 25 countries and 450 million people by the year 2000 (see map, page 144). The EC is forging links with two big trading blocs: the European Free Trade Association, or EFTA, a longstanding confederation of Western European countries outside the Common Market; and Central Europe's three strongest economies, Hungary, Czechoslovakia, and Poland. The seven EFTA countries -- Austria, Finland, Iceland, Liechtenstein, Norway, Sweden, Switzerland -- are home to 32 million of the world's most affluent consumers. They have just concluded an agreement to start lifting all trade barriers with EC countries on January 1, 1993. Sweden and Austria have applied to become full members of the EC and should be admitted by 1995. Switzerland, Norway, and Finland are debating whether to join the club. The EC is talking about admitting Poland, Czechoslovakia, and Hungary around the year 2000. In the meantime it is concluding sweeping agreements that will gradually establish free trade between the EC and the three countries, starting next year. In January the EC will begin negotiating similar pacts with Romania and Bulgaria. The deals with Central Europe promise to be far more significant than those with EFTA. Major companies in the EC and EFTA already do a thriving business in each other's markets. Taking down the last of the barriers will simply make that trade easier. Central Europe is totally different. Since it now consumes minuscule amounts of Western goods, it amounts to rich terrain for new business. U.S. and Japanese companies will benefit too. Coca-Cola, General Motors, and Sony among many others consider Central Europe one of the world's most promising growth markets for the 1990s. By meshing the economies of the EC, EFTA, and Central Europe, the new agreements greatly enhance the growth prospects for all three. The big dividends from Central Europe won't come right away because it is still trying to adjust to the collapse in trade with the Soviet Union. Scott Vicary, an analyst with the London investment firm of James Capel, thinks Central Europe will start growing slowly in 1993, then sprint ahead at up to an 8% annual rate toward the end of the decade. Says he: ''That's roughly the same growth rate West Germany achieved after World War II.'' Morgan Stanley projects that such rapid growth will lift the collective GDP of seven Central European countries -- including Romania, Bulgaria, Yugoslavia, and Albania -- by 170% in 15 years, to $1.6 trillion. Feeding that growth would in turn increase the combined output of the EC and EFTA by some 23%. Western Europe can use the lift. After reaching 4% in 1988 and 3.3% in 1989, EC annual growth dropped to just over 1% in 1990. Now the outlook is brighter. Says J. Paul Horne, an economist with Smith Barney in Paris: ''I had expected EC growth to coast along at 2.5% a year in the middle to late 1990s. Now, because of heavy demand from the East, annual growth could average 3.5%.'' ! Even more bullish is Norbert Walter, chief economist for Germany's Deutsche Bank. ''With 32 million wealthy consumers,'' says Walter, ''EFTA will boost European growth starting next year.'' Central Europe's contribution will come later, he says, beginning in 1994 or 1995. A Europe-wide investment boom, not unlike the one that has led up to 1992, should provide, Walter adds, ''clear sailing from the mid-1990s onward.'' The two things most likely to go wrong: a credit crunch, and chaos in the Soviet Union that sends millions of refugees west. Either event would play havoc with the one economy that Europe must depend on -- Germany's. Only Germany can lead Europe out of recession. And Germany is highly vulnerable to shocks from the East. To pay for unification, the German government raised taxes and shouldered a large budget deficit. At the same time, it reined in prices by tightening credit, which triggered higher interest rates across Europe, slowing growth in all EC countries. Next year the threat of inflation should wane as eastern Germany begins to satisfy its tremendous appetite for goods and capital. That should allow Germany to cut interest rates sharply from the current 9%. With the tonic of lower rates, Europe should get back on a growth track. A recession-producing credit crunch is either inevitable or unlikely, depending on what assumptions you make about who will pay to rebuild Central Europe and what the final tab will be. On the scary side, the Centre for Economic Policy Research in London argues that all the money for capital investment -- as much as $200 billion a year for ten years -- must flow from abroad in the form of loans, aid, and direct investment. Most of the money, the Centre thinks, would come from Germany, Central Europe's neighbor and natural trading partner. The result would be a replay of unification. Central Europe's huge capital demands would raise interest rates and prolong the slump in Europe. THERE IS a more hopeful view. It is more probable that Central Europe will pay for its own development. Fast-growing countries from Spain to Singapore have produced large tax surpluses, high domestic savings, and strong export growth that swells retained earnings. These countries have tapped those savings and profits to buy the bulk of their imported capital equipment. Says Barry Bosworth, an economist at the Brookings Institution: ''Central Europe should follow the same pattern. The credit crunch is grossly exaggerated.'' According to Bosworth, Central Europe will absorb no more than $30 billion a year in foreign capital. Rapid growth, he reckons, could generate $150 billion a year in hard currency for computers, oil refineries, and machine tools. The real peril is a huge migration. Germany is a magnet for refugees from Central Europe and the Soviet Union. If rising unrest forces Central Europe's governments to scrap free-market reforms, in the mid-1990s their economies will stall instead of taking off. Waves of impoverished refugees would flood into Germany. An economic cataclysm in the Soviet Union could unleash an even bigger influx. Germany, which has by far the most liberal immigration laws in Europe, is already absorbing thousands of refugees. Since 1989 it has taken in more than 1.2 million immigrants, or 2% of its population of 61 million, chiefly from Poland, Yugoslavia, Romania, and the Soviet Union. Many are ethnic Germans, descendants of German settlers in Eastern Europe, whom Germany is obliged under its constitution to accept as citizens. Economic disaster could increase the flow: Another three million ethnic Germans are battling poverty in Poland and several former Soviet republics. In the long term, a steady flow of immigrants will strengthen Germany: The number of native-born workers there will decline steeply in the 1990s, and immigrants will fill blue-collar jobs that the Germans increasingly shun. But the financial strain is already tremendous. Germany expects to spend more than $10 billion in 1991, equal to about 15% of its budget deficit, in order to provide housing, training, and welfare for immigrants. Massive immigration would multiply that figure -- and magnify the traumas of unification. Instead of leading Europe's revival, Germany could be hobbled by swelling deficits, rising inflation, and high interest rates. Fortunately, the new trade pacts should spread prosperity in Central Europe -- and reduce threats of both migration and a shortage of credit. The EC's decision to embrace Central Europe is a stunning reversal accelerated by the aborted coup in the Soviet Union. Until the nations of Central Europe renounced their communist governments, they got the EC's least favorable treatment on trade, along with Vietnam and North Korea. In the late 1980s, Poland, Czechoslovakia, and Hungary supplied just 2% of the EC's imports, or about $9 billion a year, far less than the EC buys from Sweden. In 1990 the EC greeted Central Europe's liberation with more generous terms of trade. The EC temporarily suspended all tariffs and quotas on manufactured goods as varied as cosmetics and electric motors, and lowered duties on politically ''sensitive'' items including shoes, TV sets, and chemicals. The catch: The EC kept tight restrictions on Central Europe's biggest export products -- steel, textiles, and agricultural goods. THIS YEAR negotiations for a new set of trade pacts, or association agreements as they are called, got off to a bad start. The EC offered few new concessions. But the attempted coup jolted the EC out of its protectionist stance. The looming breakup in the Soviet Union threatened to decimate already shrinking trade with its former satellites. Without an new outlet for its products, Central Europe faced an economic catastrophe. That was a risk the EC couldn't take. Says Jan Truszczynski, deputy director in Poland's mission to the EC: ''There's no question that the Soviet putsch convinced the members to open their markets to the East.'' In September, after France briefly blocked the proposal in a disagreement over meat imports, the EC presented Poland, Czechoslovakia, and Hungary with an improved formula for free trade. Slated to take effect in early 1992, the association agreements call for almost totally open borders between the EC and Central Europe within ten years. That timetable is deceiving: Poland, Czechoslovakia, and Hungary have ten years to scrap their quotas and tariffs, which typically average between 15% and 20%, but the EC will dismantle its barriers far faster. The holiday on duties and quotas for consumer products, electric motors, and other manufactured goods will become permanent.

The key concessions by the EC came in steel, textiles, and agriculture. The 18-year-old limits on steel imports from Central Europe will cease in 1992, and the 5% tariff will stop in 1995. The EC plans to phase out restraints on textile imports by 1997, years before it lifts restrictions for its other trading partners under the worldwide Multi-Fibre Agreement. Exports of farm products, just 17% of Central Europe's sales to the EC in 1990, will get a substantial boost. The EC pledges to reduce tariffs on meat, fruit, and vegetables by 60% over the next three years and to increase quotas by 50% in five years. The seed money for the big, rich market that Central Europe could become will come from Western European companies. Central Europe offers two major resources: a cheap, well-educated work force and vast, potentially low-cost agricultural production. Its workers earn Southeast Asian wages but boast a near Western European level of education. Though wages will hardly stay low forever, factory workers in Czechoslovakia right now earn $2,500 a year on average compared with $23,000 in western Germany. Well-trained engineers, scarce in Western Europe, are plentiful east of the Elbe. Scientific education is especially strong in Hungary and Czechoslovakia. In 1988 a Swedish research institute tested high school students from 17 countries for achievement in science. Hungarian pupils finished first, far ahead of the Americans, Germans, and Japanese. Yet Hungarian engineers are a bargain. GE-Tungsram, a Hungarian light bulb manufacturer owned by General Electric of the U.S., pays its engineers $7,000 a year, including benefits, vs. more than $50,000 paid out by competitors like Siemens of Germany. CENTRAL EUROPE is a sleeping giant in agriculture. Even today the three major countries and eastern Germany turn out half the milk, two-thirds the cattle, and three times the potatoes produced by France, the Netherlands, Britain, and western Germany. Despite primitive equipment -- the Poles plow their wheat fields with antediluvian Soviet tractors belching black smoke -- prices for many commodities are already lower than in Western Europe. Polish strawberries, for example, cost 18 cents a pound wholesale, vs. $1 in Britain. In automobiles, Central Europe is a boon to producers seeking to escape Western Europe's high labor costs and tough union rules. Next year General Motors will start exporting 200,000 engines a year from a factory in Hungary to assembly plants in the EC. Volkswagen acquired Czech automaker Skoda, and plans to make it a major brand in Western Europe. For the EC, the sting of competition will be soothed by the rise of the new market in Central Europe. The accords with EFTA are a fat bonus. The free- trade zone embracing the EC, EFTA, and Central Europe provides a sturdy foundation for Europe's future. It will reduce the threat of economic disaster in the East and help revitalize Europe as the glow fades from 1992. A true common market is coming into view, one so vast that even the Community's idealistic founders would have gazed in wonder.

BOX: CONTENTS

The New New Europe 136 Europe's Growing Market 144 Can Europe Compete 147 Stock Trading Without Borders 157 % Who to Call in the Soviet Union Now 163