Interchange Fees: The Economics and Regulations of What

24 INTERCHANGE FEESstructure that is socially optimal. And, for this reason, there is no reason to presume that unitarysystems have pricing structures near the social optimum.Empirical evidence, not theory, therefore must play the leading role in assessing whetherinterchange fees—and the resulting prices to cardholders and merchants—lead to significantunderprovision or overprovision of payment card services relative to the social optimum. In arecent discussion of the rationale for regulation of interchange in Australia, Ian J. Macfarlane,Governor of the Reserve Bank of Australia, similarly stresses the results of a factual inquiry ratherthan the deductions of economic theorists: 64…we saw that credit cards were growing faster than the other means of payment. Thiswas initially somewhat surprising as credit card transactions are more expensive than mostother means of payment—that is, they involve a larger payment from the users of the paymentssystem to the providers of the payments system. … Why was this possible?Governor Macfarlane poses almost the right question: Are payment system usage patterns significantlyinconsistent with system costs—and, it is essential to add, benefits? There is nothingunusual about a high-cost product driving out cheaper competition if the high-cost product ismuch better. U.S. drivers generally prefer automatic to manual transmissions in their automobiles,for instance, even though automatic transmissions cost more and are more expensive to maintain.Drivers seem to believe the difference in benefits outweighs the difference in cost. 65In our context, U.S. banks typically charge consumers the same variable price for handlinga check as for handling a signature-based debit card payment: zero. Debit cards are nonethelessrapidly replacing checks because consumers find them more convenient.An approach that is based on careful measurement of costs and benefits has the potential todistinguish what is important from what is only a theoretical possibility. Dealing with quantitativeevidence rather than qualitative possibilities can also inform regulatory policies if regulationis deemed appropriate. Since the objective of interchange-fee regulation, where it is warranted,should be to correct the effects of a distortion of price signals, it is important to get a quantitativesense of the importance of those effects. Let us, accordingly, turn to the available evidence.Some studies have argued that payment cards are used too much, based on the observationthat they are more expensive on average for merchants than cash and checks but are neverthelessincreasing in use at the expense of cash and checks. 66 While this is intuitively appealing, it ignoresboth cardholders and the role of benefits in determining the social optimum.64Macfarlane (2005).65Similarly, as Joanna Stavins pointed out in a paper on electronic check truncation and presentment, bicycles may becheaper than cars but that does not mean that society would necessarily be better off if bicycles replaced cars. Stavins(1997, p. 28).66See, for example, Balto (2000) and Reserve Bank of Australia (2002).