More on the economics of credit cards

by on January 6, 2010 at 2:12 pm in Economics | Permalink

Joshua Gans directs my attention toward this symposium, led by Geoffrey Manne.  Here is an excerpt from Manne's summary statement:

…theory and empirical evidence suggest that lowering interchange fees does nothing to help consumers, and in fact harms them by raising annual fees and thus again by limiting competition among cards at the point of sale.  Perhaps there is some policy reason why we would want to help merchants at the expense of consumers, but the issue, often framed as merchants and consumers against banks and card networks, really seems to be merchants against consumers.  At best, we have no idea what the full social implications of capping interchange fees would be–but there is still a conflict between merchant and consumer interests, and we should be wary.

Here is Joshua Gans's post on the importance of the "no surcharge rule":

The better rule to subvert would be the ‘no surcharge rule’ that prevents merchants from offering different prices to consumers based on payment instrument. That rule was abandoned in Australia and we see many instances where it bites. In that situation, the strong theoretical prediction is that what fees Visa uses to extract payments from merchants do not matter for overall efficiency; even if they do matter for prices. This is one of those cases where there are relatively simple regulatory interventions to try that could have a big effect.

I am not endorsing all of these materials but simply offering them up for evidence that a moral condemnation of Visa is an overly hasty response.

Larry D'Anna January 6, 2010 at 2:49 pm

It seems to me that Visa owes it’s entire business model to vendor lock-in. If we were designing a payment system from the ground up, nothing like visa would be required. The merchant computer would talk directly to the bank’s computer over the Internet, the cards would all be smart-cards. If Visa and Mastercard were to instantly disappear and be replaced by such a system, literally everyone else in the economy would be better off.

Andrew January 6, 2010 at 3:31 pm

Will the next guy build a network if his reward is nationalization?

Paul McCaffree January 6, 2010 at 4:03 pm

talkin’ to myself, feel free to skip over. sorry if the previous commentary was not taken as indicative of idiosyncratic, subjective experience of the author — as per comments can generally be stellar around here, if austere.

Bill January 6, 2010 at 4:35 pm

For those interested in the economics of this issue by an expert in network economics, you should look up Nicholas Economides at NYU Stern School of Business.

Here is one of his articles on the payments issue and competition: http://www.stern.nyu.edu/networks/Economides_Competition_Policy_Payments_Industry.pdf

LoneSnark January 6, 2010 at 5:32 pm

Visa only gets to keep pennies on each transaction. It is the issuing bank that gets the 2-3%, all Visa gets to keep (as I understand it) is the transaction fee, which is measured in cents even on a thousand dollar order.

Bill January 6, 2010 at 7:13 pm

As the above post by Stephen indicates, in a network industry fees can be taken in several nodes. Stephen’s post, however, indicates that when fees were pushed down one node, they popped up in another, but he doesn’t indicate on net whether the total transaction fee increased or decreased. What he does show, however, is that the disruption caused competition between plans to attract and displace other plans–competition which did not exist previously in the steady state. What his comment also indicates is that there is latent unexercised market power by one of the nodes figuring out they could increase a fee and blame the other party. What I’m interested in is whether net transaction fees increased or decreased in Austrailia and EEC, and whether incumbent players became more competitive (that is, whether there was instability which would cause one player to lower prices to attract more volume) than they was before. What Economides article indicates is that transaction costs are unnecessarily high through network rules which mute competition.

Bill January 6, 2010 at 8:38 pm

What I like about conferences like this is that if you search the background of the presenters, you find such things as:

1. as per author Richard Epstein, in another publication he wrote on credit cards this as a footnote:
Richard A. Epstein is the James Parker Hall Distinguished Professor of Law at the
University of Chicago Law School and the Peter and Kirsten Bedford Senior Fellow at the
Hoover Institution.
Thomas P. Brown is a partner in the international law firm of O’Melveny & Myers and a
former vice president and senior counsel for Visa USA.
Both authors have consulted with Visa USA. The opinions they express are their own and
may not represent Visa USA.

2. As per Muris, acknowledgment in the text of the program, consultant in the past for Visa, and comments do not reflect the views of Visa.

No surprise as to the conference conclusions referenced in the post.

zbicyclist January 6, 2010 at 9:16 pm

If merchants were allowed to pass along the CC fees to the customer (aka offer a discount for cash), (1) cash customers would benefit, (2) fewer people would get lots of credit card debt from buying consumables like groceries, (3) there would be less money diverted in fees to intermediaries such as Visa and banks.

Sure, banks will TRY to raise fees somewhere else. They’re banks.

luke January 6, 2010 at 9:46 pm

@andrew

who said anything about taking the cc network away. why not build a bunch of independent networks? why not have the consumer’s own bank issue a card?

anon January 6, 2010 at 10:47 pm

Will the next guy build a network if his reward is nationalization?

Maybe they will do it “for the children”….

anon January 6, 2010 at 11:03 pm

If two card issuers offer the exact same services at different prices, merchants can’t just go with the cheaper one, so prices remain inflated.

Sorry to deal with these in separate comments.

No, AmEx charges much more, yet we accept it because our customers and clients want to use it. We accept AmEx, MC, Visa, Discover, PayPal, Google Checkout, and soon Amazon checkout and Intuit’s new offering, so that we have the widest array of payment types for our customers. The rates on all of these differ, but that is not what drives us to use one or not use one. As I said earlier, we treat the merchant fees as part of our overhead.

We will try almost every national payment method available and if our customers use it – even once per year – we keep it since we pay a fee only when the payment method is used.

You’re thinking way too much like an economist or antitrust lawyer and not like a small business owner. Not a criticism.

Dan January 7, 2010 at 1:59 am

anon, I understand that you’re better off accepting lots of different payment methods, because if you refuse to accept one you’ll lose some customers who want to use it. That’s the point. You can’t decide “instead of using AmEx for this transaction, let’s use this other card which is just as good but cheaper” because that’s not up to you – your customer has chosen AmEx, and if you don’t take AmEx you don’t get that customer. And the customer doesn’t care that the other card is cheaper, since they’re not the one who’s paying. So, unlike in a competitive widget market where widget-sellers have to keep their prices low in order to attract business away from each other, the card issuers can keep their fees high. But maybe with a different regulatory system that wouldn’t happen, and we’d see the costs of transactions dropping.

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gnat January 7, 2010 at 10:45 am

This problem is common in network industries where the customer picks the network provider and the network provider can bill the called party. It has “scam” some aspects, e.g., see http://www.dailyfinance.com/story/company-news/atandt-vs-google-voice-sex-money-the-feds-and-your-phone-bill/19190409.

Clark January 7, 2010 at 11:13 am

The better rule to subvert would be the ‘no surcharge rule’ that prevents merchants from offering different prices to consumers based on payment instrument.

Unless I’m very mistaken the no surcharge rule is part of the contract with each of the various card companies. Supposedly they will stop working with you if they find you are charging surcharges. Yet I find, especially at gas stations, that they in effect do just this. In our area many gas stations have a credit card price and a non-credit card price. Some even do this on snack purchases from inside.

mulp January 7, 2010 at 12:18 pm

If merchants were allowed to pass along the CC fees to the customer (aka offer a discount for cash), (1) cash customers would benefit, (2) fewer people would get lots of credit card debt from buying consumables like groceries, (3) there would be less money diverted in fees to intermediaries such as Visa and banks.

You forgot: (4) consumers faced with a high fee for a credit transaction would look in their wallet for cash and finding none, will decide to make that impulse purchase on the next trip, and then after talking with their spouse realize they can’t afford it and thus the merchant doesn’t make a sale; (5) the merchant failing to make the profits from impulse sales loses market share to his competitor who eats the credit card fees, and goes bankrupt.

Credit cards with the fees hidden from the consumer at the point of sale transfer wealth from the card holder to the merchant and banks.

paul January 8, 2010 at 9:11 am

The sufficient statistic to understanding this debate is the size of the rents that Visa receives. If it the market is efficient and there are no rents, then capping interchange fees will only raise annual card fees. If the market is inefficient, and Visa is collecting significant rents, then capping interchange fees may improve efficiency.

Anthony January 8, 2010 at 1:21 pm

Clark:
Unless I’m very mistaken the no surcharge rule is part of the contract with each of the various card companies. Supposedly they will stop working with you if they find you are charging surcharges. Yet I find, especially at gas stations, that they in effect do just this. In our area many gas stations have a credit card price and a non-credit card price. Some even do this on snack purchases from inside.

As I understand it, the CC contract does not allow credit surcharges, but does allow cash discounts. This limits competition between CC systems, as it’s plausible that a merchant might pass through the actual service charge (which varies between CCs), while it’s more difficult, psychologically, to offer different levels of discounts for different types of cards.

timber lake January 11, 2010 at 10:30 am

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Repair Credit July 22, 2010 at 12:18 pm

There should be a no surcharge rule as there has to be a cap. http://www.urcreditrepair.com

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