Interchange Fees Impact on Consumers and Merchants

Frank Maier-Rigaud, Senior Economist. OECD Competition Division,

frank.maier-rigaud@oecd.org

3 angles on interchange feesCost based or fee for service angleRegulatory angleTotal welfare, efficiencyFairness, redistributive aspectsCompetition Law angleCollective price fixing agreementConsumer welfare

2 impacts, 2 themesConsumers (regulatory angle) Who gains and who looses from credit card payments? (Scott Schuh, Oz Shy and Joanna Stavins) Merchants and Consumers again (competition angle) comments on the Tourist Test

Impact on consumersIdea that cash users subsidize card payers can be traced to Carlton and Frankel (1995)Frankel (1998) is the first to connect the subsidy to a transfer from low- to high-income buyersThe logical reverse effect (from card to cash) in case merchant costs exceed card costs was shown by McAndrews and Wang (2008)Schuh, Shy and Stavins (working paper 2011) compute estimates based on a calibrated model of who gains and who looses from credit card usage in the US

Who Gains and Who Loses: key findingsSchuh, Shy and Stavins (working paper 2011) find two types of transfers among buyers:From cash to card users(from cash and revolving card users to convenience card users)From low-income to high-income households

Empirical EstimatesOn average, each cash-using household transfers $50 to households that use credit cards and each credit card using household receives a subsidy of $240 every yearCard users with unpaid revolving debt pay a transfer of $511 and convenience users receive a subsidy of $833On average, the lowest-income households ($20000 or less annually) pay $63 and the highest income households ($150000 or more annually) receives $823 every year

Simplified US payment market

Schuh, Shy and Stavins (2011)

EU MasterCard caseEU MasterCard case: Article 101(1) TFEU: MIF is a collectively set price with the object or effect of restricting price competition between acquiring banksArticle 101(3) TFEU: MasterCard failed to prove that a fair share of any positive effects on innovation and efficiency were passed on to consumersEU states (MEMO/09/143) Of particular importance is the question of whether, in setting a MIF a scheme uses a methodology that aims from the outset at guaranteeing that cardholders and merchants obtain a fair share of the benefitsMerchants are consumers of acquiring services

More Commission quotesthe tourist test provides a reasonable benchmark for assessing a MIF level that generates benefits to merchants and final consumersThe revised tourist test MIF was calculated by comparing merchants costs of accepting payments in cash to those of accepting payments made by a payment card

Quo Vadis Tourist TestTourist test is at best a static regulatory benchmark (but see e.g. Schuh,Shy and Stavins)If competition authorities believe in their qualification of interchange fees, they should be prepared to embrace the logical consequences

A few conclusions(?)2-sided market theory is ingenious, beautiful The concepts of network and usage externalities prevail rightly over cost-based approachesPerfect surcharge approaches are a model platonic curiosity 41 years after Coases problem of social cost but represent an empirical challenge to competition authoritiesReliable empirical estimates of the socially optimal IF and social losses associated with lower (or zero IF) are lackingTourist test is (by definition) an unsuitable antitrust benchmark

Old EU Visa case, OFT MasterCard case

*Impact of changes in interchange fees on consumers and merchants*Lets turn to consumers

Carlton and Frankel (1995), ALJ*??? Tourist test by definition excludes benefits to merchantsTourist test is at best a static regulatory benchmark

*Static as there are doubts on the development if merchants are indifferent, i.e. do not see advantage of plastic over cash

Prepared and find the courage*I should add that from an economics point of view its probably the best that ever came out of private consultingThird point: the challeng stems from the fact that indeed if one accepts the model assumptions, the problem seems to be less with interchange fees as with a lack of perfect issuing competition Forth point is of course the pressing question of the empirical regulatory relevance of interchange fees. Simplistic Hotelling style models are no good substitutes as the question is not what could logically be imagined under a restrictive set of assumptions but what actually happens

In any case it points to the need of an empirical approach to evaluate the real world sinificance of network an usage externalities

Tourist test unsuitable benchmark but maybe a welcome political compromise for competition authorities

Leave you with one thought:If a middle age regulator had introduced a tourist test benchmark based on gold coins or shells, for paper money, effectively imposing indifference between new and old means of payment, where would we be today? I have the feeling thatIntroduction of individual bank issued paper money to replace gold and silver coins was a much bigger network and usage externality challenge

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