Taoyuan Nights

In Taiwan, it’s easy to see what an absolute curse low interest rates can be.

What happens is this:

Day 1: Person A has a genius idea - selling ice cream for people’s pet dogs to eat.
Day 5: Persons B,C,D… notice that A has been making a tidy sum of money, selling ice cream for dogs.
Day 6: 20 new dog-ice-cream stores open up a few metres away, using cheap borrowed money.
Day 10: Persons A,B,C,D go out of business…. [tumbleweed].

It really does happen this quickly. You wouldn’t believe it. I’ve seen businesses last less than 5 horrifically unprofitable days. They open up, try to grab some of the hot money by copying someone else’s idea on the same street, then close down again right away if they can’t. Usually, a stream of people trying their luck at this game results in the painful destruction of the original, innovative business.

Remember also: This happens after the expensive kitting-out of shopfronts and after running several days of lossleaders. This isn’t a zero-cost exercise for the copycats either.

Currently, each day I walk along a short street (150 metres) that has 10 hotpot restaurants fighting to make their $10 NTD profit per meal (that’s just 15p UK or 30 cents US - and remember, each person takes about 1.5 hours to eat a meal in the restaurant). They are competing against another 30-40 food shops and stalls on the same 150 metre street. This isn’t sustainable in semi-rural Taiwan, even with super cheap labour. It’s just stupid.

My friend opened a Do Hwa shop (Do Hwa is a tasty and healthy Taiwanese dessert). After a few weeks they began to grab some of the local ’sweets’ market… and the very second they did, an old lady sat down a few metres away in a portable stall and started selling exactly the same products for a few dollars less (no business tax, no fixed store costs)! Promptly, another Do Hwa shop opened further up the road.

And of course, it started being very unprofitable very quickly, and after a period of running at a loss, my friend gave up. Of course, so did the old lady.

There’s a wonderful fruit stall nearby. They get a regular stream of business by selling fresh fruit, well presented, very cheaply. A second stall just opened up about 20 metres away the other day. I’m already dreading the 3rd, 4th and 5th ones.

We don’t need 5 identical fruit stalls in one street. We don’t need 10 identical hotpot restaurants in this street either. We need a few great businesses that can compete a little, grow, and offer new products.

In Kaohsiung County, 2 hours out into the countryside, my friend’s parents make a living selling wax apples by the road. Or rather, they did. Now there are 10 stalls within a few metres of them selling wax apples too. And no one is making any money any more. They are all going to go bust.

Until Taiwan raises interest rates, to stop people investing in completely pointless copycat ventures, this problem is simply going to continue. Look elsewhere in the world. In Indonesia, where rates are nearly 10%, the economy is growing twice as fast as Taiwan’s. In Japan, where rates are even lower than Taiwan’s, the economy is growing half as fast.

There has to be some risk - some higher cost for borrowed money - to deter stupid amounts of profitless copycat competition. Otherwise, a good business idea has no chance of surviving, and entrepreneurship is punished rather than rewarded.

Indonesia clearly knows this and is doing rather well from it’s high interest rates. Taiwan has not yet realised this, and is instead obsessed with keeping consumer spending high, and housing/stockmarket bubbles afloat. Until interest rates rise - and sharply - Taiwan is going to succeed only in crushing the entrepreneurship of an entire generation, and wasting a lot of capital pointlessly in the process.

I’ve received some feedback about this post from Michael Turton. He suggests:

Taoyuan nights points out the problems of yi wo feng — everyone rushing into the same business at the same time in the same place. I don’t think low interest rates are the problem there — those vendors aren’t borrowing from banks, but from family.

My view is that all lending must be based on prevailing interest rates in one way or another; whether it’s bank or private individual.

Think of it this way. Imagine you are a family member in a Taiwanese family. And imagine that interest rates are 10%, as they are in Indonesia currently. If you could get 10% return from the bank completely risk-free, would you lend your life savings to some crazy young relative who is hoping to turn a risky 3% profit on your money over the year?

Hell no! Guanxi be damned, they can go get their own loan. You might give them a couple of thousand kuai for the sake of saving face, but you will not be gambling your life savings on that proposition!

Now, re-examine the same situation but assuming you can only get 0.2% risk free from the bank, as is currently the case for many people here. For them, a risky 3% gambling opportunity might look like it could pay off better than the bank, if they misestimate the size of the risk involved in a copycat business.

Copycat businesses can look low-risk (hey, look how much money HE’S making, it must be easy!), which is where family lenders make their mistake. But copycats invariably cause direct competition, price wars, halving of customers, and are invariably followed by further copycats that compound the problem further.

In any event: I hope you can see the logic that it doesn’t really matter where the money is coming from - family or banks. When rates are low, money is more freely lent by everyone; people pay less attention to risk; and consequently hordes of unimaginative, unviable, copycat startups drive the viable companies out of business. This damages the Taiwanese entrepreneurial spirit in the longer term, by ‘punishing’ creative businessmen for any initial success they might have.

More feedback, this time from Battlepanda. He writes:

Taoyuan Night have an interesting theory for how the “swarm of bees” (meaning a crowd mindlessly moving in the same direction) phenomenon came to be — Taiwan’s low low interest rates: “There has to be some risk - some higher cost for borrowed money - to deter stupid amounts of profitless copycat competition. Otherwise, a good business idea has no chance of surviving, and entrepreneurship is punished rather than rewarded.” Of course there has got to be more to it than that since Japan has even lower interest rates and you don’t see the same kind of crazed, unstructured entrepreneurship there. Besides, a rise in the interest rate will punish all entrepreneurship, not just copycat ones. In fact, it could concievably have the perverse effect of suppressing original ventures more than copycat ventures because it is risky to innovate, which is why there are so many copycat ventures in the first place.

There are several responses to this.

• Japan has lower rates, but it has also been battling a deflationary environment vs. the crazy asset bubbles currently seen in Taiwan. Consider the following scenario;

  Country A: 3% deflation (house prices dropping, for example, or strong currency), 0% rates. Doing nothing makes your money worth 3% more!

  Country B: 5% inflation (house prices rocketing, weak currency), 2% rates. Doing nothing makes your money worth 3% less!

  So you need to talk about real rates rather than nominal rates. Unfortunately, that relies on governments providing realistic measures of inflation, and there’s not a country in the world where that happens, except perhaps Zimbabwe :)

• Entrepreneurial spirit. Japan has an ‘inventive’ culture, but entrepreneurial? Not in the way Chinese cultures are.

• Maybe Japan did go through this phase, early in the deflationary period / low interest rate period? But after a while, perhaps it exhausted the ability of banks to lend to businesses that were going bankrupt. I don’t know, and I don’t know how to get data on this. Does anyone else know?

In any event; I think the ‘real’ vs. ‘nominal’ rates issue is the main distinction here, followed by the length of time the cheap money has been available (Japan: very long term; Taiwan: only a couple of years) and the tendency for banks to burn out after excessive lending over a very long period. Thanks, BattlePanda!