No one likes the tune, but the recession song is definitely getting louder in China.  Denial is a lousy option.  If you’ve got plenty of cash and strong marketing channels, you will probably be able to take hard steps necessary to survive what could be a long, deep recession.  Not everyone will be so lucky.

One man’s crisis is another man’s opportunity, and it’s time for smart managers to look beyond the gloom and misery and try to see through to the other side of this economic cycle.  The question you should be considering – even as you struggle to keep your company afloat – is what will the China market look like when this is over? 

Let’s make some assumptions, just of the sake of discussion.  Let’s say that China goes through 3-4 quarters of sub 8% GDP growth.  The US was hit harder and earlier, and it is probably within a quarter or two of hitting bottom.  It’s possible that the US will start to recover earlier than China – albeit off a much lower base.

What will this mean to US investors and international companies with China interests?  18 months from now, we can expect to see a few new developments – and some existing trends reinforced.

Existing trends that will be accelerated by an economic slowdown in China:

1) Tougher competition within China.
This was happening anyway, but a prolonged recession will fulfill the prophesy of China as a cauldron of capitalism.  If you think that China was a competitive environment last year - just wait.  There will be fewer companies around – but the ones that survive and prosper in a recession will be lean, mean, and nimble.  They will fight hard to hold on to their domestic market, and may look overseas if the US or Japan recovers first.   A prolonged recession in China will act like corporate shock therapy – and the winners will finally be ready to take their act on the road and become truly global competitors. 

2) A sparser corporate landscape.
We’ve already seen a string of bankruptcies in the manufacturing sector, but that’s just the beginning.  As demand collapses around the world we can expect to see more companies fold, pull out of China, reduce their presence or delay expansion plans.  Medium-sized international companies with one or two struggling branches in China may decide to focus on their home markets.  There will be fewer customers out there for B2B services.  For the first time, we may see a drop in the number of new business registrations from overseas. 

3) A devastated manufacturing sector
China is going to be putting a lot more emphasis on services and quasi-services (like software and IP – which you may buy in a package like a manufactured product but really function like a service).  The manufacturing sector was becoming less important before the slowdown, which is natural for a country at China’s point in its development.  Beijing’s game plan has been to climb the value chain and develop homegrown IP and technology.  Don’t expect to see all the shuttered toy & textile manufacturers to reopen when demand picks up again. 

4) A more demanding middle class consumer.
This is another trend that was already developing before the recession hit.  Quality and value are going to be more important than branding or status.  There will be fewer aspirational & lifestyle driven purchases and more attention to quality, function and warranties.  Chinese companies were already ramping up their QC before this, and now domestic customers are going to put enormous pressure on Chinese businesses to deliver higher quality and better value.  The companies that can meet the needs of the more value-conscious Chinese consumer will be well positioned to go after niches in developed overseas markets.

5) Fewer expats
Localization is working this time – because now CFOs and not HR managers are driving it.  Chinese managers are moving up the corporate ranks in multinationals – and an extended slowdown will force them to hone their skills and become more competitive.  Expat packages just aren’t cost effective in this environment. Besides, the status that foreign experts enjoyed in China has been tarnished by the gross mismanagement on Wall St.

New developments:

6) Trade policy may become more defensive
Beijing isn’t going to try to defend every company, but it will step in to make sure that key firms in pillar industries stay afloat.   Look out for trade tensions with the US as the Democratic congress starts talking about exchange rates, product safety, human rights and anti-dumping rules.  The new contract law makes it very hard to fire people – and we can expect to see Beijing apply this law unevenly – with foreign firms finding it particularly difficult to shed large numbers of idle workers.

7) A Chinese managerial class embittered by layoffs, job cuts and hiring freezes.
For the first time, it will be hard for experienced Chinese managers to find jobs.  Layoffs and closed branches will introduce Chinese managers to the bitter reality that they can lose their jobs even when they’ve done nothing wrong.  China’s best and brightest managers used to rank multinationals as their top career choice, but now SOEs and entrepreneurial start-ups will enjoy a positive re-rating.

8) More government controls – but few direct bailouts.
Beijing is trying to spend its way out of this thing – and it will work to some degree.   Banks will focus lending on key state industries (even more than they already are).  It will be hard to lay off staff – particularly if you are a foreign firm that isn’t facing bankruptcy.  Infrastructure and development programs will make Beijing an even more important stakeholder than it is now.

9) Cash-starved entrepreneurial class will be smaller – but much tougher.
No bank loans, no cash flow from operations, and limited VC spending.  The ones that do make it will be tough as nails.  We will likely see roll-ups and mergers in fragmented industries that don’t yet have dominant players. 

10) Pent-up demand & higher savings rates
When this thing finally does end, look for massive consumer spending after the long winter of recession.  The Chinese consumer used to be famous for high savings rates and cautious buying – and we can expect to see a return to that trend.  Beijing is determined to shore up the rural and semi-rural regions far from Shanghai’s gleaming towers.  Domestic Chinese companies are best positioned to service these emerging markets.  When the purse strings start to loosen again a few quarters from now, spending patterns may favor local brands.

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Western economists have long maintained that recessions can have a positive long-term affect on corporate performance (in some cases) as marginal companies fall by the wayside and allow stronger competitors to build up market share.  One of the ironic twists of the global recession is that it may set the stage for local Chinese corporations to raise their skills and leapfrog multinational leaders.   Keep a close eye on the auto and electronics industries for Chinese upstarts that can change the rules of the game.