(FORTUNE Magazine) – As advertising's prognosticators talk up a recovery (recent predictions peg 2004 growth at 5% or more), we turned to the ultimate insider for a reality check. Sir Martin Sorrell, chairman and CEO of WPP Group, assembled one of the world's largest communications conglomerates, which includes ad giants Ogilvy & Mather, J. Walter Thompson, and Young & Rubicam plus Burson-Marsteller in PR and Landor Associates in corporate-image making. WPP now spans 104 countries, so Sir Martin, 58, is usually in the air on his way to see global clients such as IBM, Unilever, Coca-Cola, and Ford. He was just back from nine weeks in Asia when he sat down with FORTUNE's Patricia Sellers to talk about Bush, China, and going with your gut.

Q: Is the industry recovery for real?

A: 2004 is going to be a better year. Political advertising will help the industry, and we have the Athens Olympics, though they won't be as helpful as the Beijing Olympics in 2008. My one worry is U.S. government spending. It's rising faster than anytime since 1967. After November, spending may be so excessive that whoever gets in the White House has to pull in the reins.

Q: What are your clients worrying about most?

A: One word: distribution. The growing power of retail. My favorite statistic comes from the world's biggest advertiser, Procter & Gamble; 18% of P&G's sales go through Wal-Mart. If you look at just their U.S. sales, it's probably 25% to 30%. And it's safe to say that one-third of Sony PlayStations are sold through Carrefour.

Q: So what's the problem? Wal-Mart is boosting those companies' volumes ...

A: And saying to the brand company, "I've raised your volume 14%. Now what are you going to do for me in terms of discount?"

Q: So margins are seriously squeezed. Let's shift to Asia. Why the marathon trip?

A: Two-thirds of the world's population will be in Asia by 2014. Anytime a country has had relative hegemony to the extent that America has, something always pops up to replace it. Clearly that thing now is China.

Q: Besides building WPP's Asia business, what else are you working on?

A: Functionally, we're half traditional advertising and half other marketing services. We'd like it to be one-third advertising and two-thirds other. Why? Our clients are going that way because TV advertising continues to go up in cost. We want to expand in market research and direct and Internet marketing. We call these areas quantitative aids to decision-making. People aren't going with their gut as much as they used to. Direct or interactive marketing is more measurable than traditional advertising--so it's more pleasurable for the decision makers.

Q: The WPP unit MindShare is developing TV shows with ABC. Why?

A: This is emblematic of where advertising is going. With clutter and the rising cost of network TV, we need to offer clients a very different way of marketing brands.

Q: Why do even the best brands seem to be struggling more than they used to?

A: To some extent, it's cyclical. One of the biggest pressures on our clients is the lack of inflation. A nice bit of inflation--let's say 4% or 5%--would give pricing flexibility. I hate to say it, but it would be good for our clients and for our industry.