(FORTUNE Magazine) – THIS WAS supposed to be Europe's year, the magical, long-awaited 1992 that would release all the competitive power locked up by nationalism, tribalism, and protectionism. Instead, Europe got division, monetary turmoil, and, at its edges, the war in Yugoslavia and the threat of chaos in Russia. Plus the worst economic slowdown in a decade. This bad news for Europeans also touches Americans and Asians -- and anybody who does business on a global basis. Without continued progress toward closer political and economic unity, trade barriers in Europe will no longer keep falling. Protectionism is bound to rise, particularly against Japan. Development of new markets, such as Portugal and Greece, will lag. The troubled economies of Eastern Europe could flame out entirely, sending more refugees West, stoking nationalist sentiments and more violence from skinheads and other latter-day fascists. Europe's status as an expanding marketplace for Asian and American goods is in peril. Growth of the 12-nation European Community is expected to be an anemic 0.9% this year, 1.1% next year. Inflation now averages some 4%, unemployment is at 9.5%, and capital spending is stagnant. Former go-go economies like Spain face unemployment as high as 17%. In Britain, the 30- month slump is the longest since the 1930s. Even Germany, Europe's powerhouse, is on the edge of recession. Interest rates in Europe have come down in recent months, but not enough to expect an upturn before late next year at the earliest. Amid this gray scene, Europe faces some very tough choices. Most Europeans still yearn for greater unity among the EC member nations. They would like economic growth to be more balanced among countries, and they want more social harmony. But few admit that political unity requires sacrifices, such as higher taxes, fewer government benefits, and the flow of more aid from richer countries to poorer ones. European companies seek more market share within the EC and worldwide. Yet not many are prepared to make the cuts needed to face global competition. There is one large point to keep in mind. The newly formed European Economic Area, consisting of the 12 EC countries plus Scandinavia, Switzerland, and Austria, is now the largest trading bloc on earth, with more than 40% of the world's GDP. That's what many companies are still banking on. Listen to Glen Walker, chief financial officer for Whirlpool-Europe, a subsidiary of the U.S. company with $2.2 billion in European sales: ''It may take one or two years for Europe to get back in gear, but we're still expecting growth ahead.'' Foreign investment may slow over the next year or so. But whether Europe splinters or pulls together, it remains a magnet for any company that considers itself a global business. It is the European dream of political unity, not just the single market, that needs work. The myriad directives aimed at opening borders and markets under the banner of Project 1992 are being implemented more or less on schedule, with some major exceptions (see table). But 1992 has always been part of a larger plan. Arguably Brussels moved too far too fast in pushing for a single currency and a powerful European central bank. The bureaucrats didn't explain fully enough to ordinary Europeans what they had in mind. The treaty they negotiated a year ago in the Dutch town of Maastricht was so vague that when ordinary voters got a chance to ratify it, they had little idea what it entailed. Confused, many voted no. Besides calling for a single European currency and a single, independent central bank, the 311-page treaty also includes pages of loosely described proposals concerning working, voting, and legal rights with the idea that most of the specifics would be hashed out by Brussels bureaucrats. Rejected by the Danes last spring, delayed by the British, and only narrowly approved by the French, the treaty is feared by many because it could lead to the creation of an unresponsive, supranational body in Brussels. Already, thousands of petty autocratic EC rulings, such as forbidding the sale of homemade jams at country fairs, have alienated voters. More important, though, were economic fundamentals. Europe's system of keeping currencies within specified ranges of one another, known as the Exchange Rate Mechanism (ERM), was part of the EC's strategy to be sure member states marched in step toward monetary -- and ultimately political -- union. But it also depended on convergence of monetary and fiscal policies by the various governments. When Germany held its interest rates high to dampen inflation driven by its steep unification costs, other countries felt obliged to follow to keep their own currencies as strong as the deutsche mark. Speculators guessed that most wouldn't be able to maintain such towering rates, leading to a spectacular run on the weaker currencies last September. For a glimpse of the future of Europe, look at the strongest alliance on the Continent, France and Germany. Within days of the currency crisis and the departure of Italy and Britain from the ERM, French and German officials began talking about forming the core of a smaller, more limited monetary alliance. The process is well along. Europe is rapidly dividing into two groups: countries that have enough economic strength to keep the value of their currencies in line with those of France and Germany, and countries that do not. Many Europeans call this the deux vitesse, or two-speed, Europe. Along with Germany and France, the fast-track countries include Belgium, the Netherlands, Luxembourg, and Denmark. Their governments believe that anti- inflation policies, including tight money and relatively high interest rates, will keep their economies strong. The slow trackers include everybody else, but they're hardly marching in step. Italy and Britain have devalued and lowered interest rates in an effort to jump-start their economies. Other countries, including Spain, Portugal, and EC-hopeful Sweden, are holding interest rates high in an effort to at least keep their currencies in sight of the Germans and French. So far, neither strategy can claim success. As leaders of the European convoy, France and Germany make an unlikely team, given their intense disagreements over farm subsidies and trade, not to mention some bad memories. Still, if the two countries can achieve closer currency links, they can use the resulting economic power to promote European political unity. Says Antoine Riboud, CEO of French food group BSN: ''The French-German partnership is the heart of Europe, and its real force.'' The key, however, will be for other countries to get back on the fast track so that the deux vitesse can blend back into one. That would allow all of Europe to resume the quest for unity. Says Jacob Palmstierna, an elder statesman in Swedish banking and chairman of the Nordbanken group: ''The globalization of the world economy means countries like Sweden can go the Albanian route -- follow the Taiwanese and work 65 hours a week -- or join ! Europe. And joining Europe means putting ourselves under the deutsche mark- French franc umbrella.'' To do so, Sweden and other countries will have to make the kind of changes in their own economies that strengthen their currencies. ITALY IS EAGER to get back with the leaders, but its soaring budget deficit, the third highest in the EC, will keep its currency weak for some time. The government also has its hands full at home. Proposals to make deep cuts in health care and pensions, plus a freeze on government workers' salaries, triggered public outrage. In October, thousands of workers marched in protest. Britain, intensely preoccupied by rising unemployment and its own moribund economy, probably won't even try for now. Executives in Germany and France are optimistic. They believe Germany can meet the huge cost of unification and still retain its role as the economic strongman of Europe. Says Ludolt von Wartenberg, director-general of the powerful Bundesverband Deutsche Industrie: ''We are not nervous about the German economy. We are running into a recession, yes, but we had nine years of growth. So we don't face these problems in a terribly weakened state.'' Adds Jean-Louis Beffa, CEO of French glass and construction materials maker Saint-Gobain: ''East Germany is the only place in Europe showing an increase in construction contracts today. France and Germany together give us a home market of world size. As long as that core remains solid, Europe will be all right.'' Looking ahead, Bonn and Paris have even begun talking about some kind of joint defense arrangements. Says Philippe Moreau Defarges of the French Institute of Foreign Relations: ''Whether we like it or not, America is withdrawing from Europe and we must work together.''

THE UNACKNOWLEDGED but more painful part of the picture is the continued erosion of Europe's 20th-century model for society. Though practically no politician talks anymore about reviving the welfare state in Britain or social democracy in Germany or the Third Way in Sweden, the residue of all this social engineering is embedded in European life: the right to free schools and health care, good salaries, long vacations, and full employment. Go to any truly competitive European company and you'll hear about thousands of job cuts, plans for benefit reductions, and cost squeezing. But these efforts are only the beginning of the restructuring needed. EC members cannot have a real single market, or even consider integrating Eastern Europe, if they want to maintain what's left of their fur-lined way of life. They will not be competitive. Only a handful of European companies, like ICI, ABB, and Siemens, have streamlined their operations to get the most out of a borderless European market. American and Japanese groups are in much better shape. Some industries already know they won't be able to compete and are responding in a typical European manner -- asking their governments for help. In October, the French government stopped Britain's Barclays Bank from paying interest on checking accounts in France, warning that such an innovation was ''dangerous.'' The danger was only to the profits of the country's own banks. Even the EC Commission sometimes caves in to national interests. A long-awaited plan to liberalize telecommunications was finally released this autumn. It called for six more months of deliberations. As for opening trade with Eastern Europe, the EC's posture has been starkly hypocritical. Less than a year ago Brussels signed agreements with Poland, Hungary, and Czechoslovakia, promising a free flow of goods and eventual membership in the community. Tucked into the fine print, however, were trade barriers on agricultural products and ''sensitive imports'' such as iron, steel, chemicals, and clothing -- the very heart of what remains of Eastern European industry. Warns Jacques Attali, president of the European Bank for Reconstruction and Development: ''Europe can no longer be defined by the borders of the EC countries. Eastern Europe, Scandinavia, and Russia all want to be part of Europe. We risk seeing the East go up in flames if we don't recognize these facts.'' The chances for preventing deeper troubles in the East aren't so good. Economist Rudiger Dornbusch predicts that unless Eastern Europe is allowed better trade access to the West, about 10% of the population will try to flee as autocratic governments return to power. Hoping to prevent such a disaster, Attali is promoting what he calls the Continental Common Market, a framework for ultimately removing trade barriers among some 40 countries, including those in the old Eastern bloc and the former Soviet Union. Says he: ''For a long time trade agreements were seen as a trigger for growth. Now people see them as triggers for unemployment, because they think goods come in and jobs go out. Bad times increase tribalism, and that's what we are seeing right across Europe.'' Without the hope of more trade with the West, he warns, Eastern Europe's experiments with democracy will fail. These grim problems are splintering Europe. Without more unity, few if any can be solved. Says German Chancellor Helmut Kohl: ''If we are thrown off the path toward ((a more united)) Europe, then it will be a lot longer than a generation before we talk again. We are running the risk that Europe's ill- fated past will catch up with her.'' FOR MANAGERS in Europe, the next few months are likely to remain unsettled. France and Germany must attend to domestic troubles such as slow growth, high unemployment, and political uneasiness in addition to the matter of patching Europe up again. A focused approach to Eastern Europe's problems may not arrive until a full-blown crisis hits one of those countries. Perhaps the only good thing in Europe's current trauma is the chance to reexamine some of the unsuccessful or undesirable elements of the Maastricht treaty. From the business viewpoint it needs a strong commitment to free and open trade. That would give extra strength to the progression of the 1992 single-market process. While Project 1992 remains the EC's triumph, business leaders can rightly criticize the EC for what it has not done. Though nearly 90% of the single- market directives have already been approved by member countries, enforcement is lax on health, safety, and environmental standards in Southern Europe, especially in Greece and Italy. Some sections of the 1992 program have simply faded away, including plans for Europe-wide corporate law and the creation of a number of EC organizations, such as a food and drug agency and a patent center. Many important areas are not covered by the program to date: regulation of the bulk of the transportation industry, national postal services, and most of the telecommunications industry. Says Sir Denys Henderson, chairman of ICI, Britain's largest chemical company: ''Let's quickly and publicly declare our commitment to the larger internal market, swear love and affection to it, and get on with it.'' But can Europe learn to work together? Attali, Kohl, and others like them believe it must. The troubles now facing Europe, if left to worsen, could set Europe on a backward path for the first time since the end of World War II.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: PROGRESS REPORT ON PROJECT 1992