Interchange Fees: The Economics and Regulations of What

The Economics of Interchange Fees and Their Regulation: An Overview 31In both Australia and Europe, the regulators (or at least their economic consultants) recognizedthat socially optimal interchange fees also depend on demand factors or network effectsbut, presumably, decided not to incorporate those factors because of the difficulty of doing so,citing instead the “objectivity” and “transparency” benefits of a cost-based measure. 81 Objectivityand transparency may have benefits, of course, but by themselves they do not, necessarily lead togreater economic efficiency.Although cost-based interchange fee regulation could by happenstance improve the efficiencyof the payment system, there are two fundamental reasons to doubt that it would regularly do soin practice. The first is that regulating the interchange fee will not necessarily have a significanteffect on the variable prices paid by cardholders and therefore will not necessarily have a significanteffect on the volume of transactions—generally the putative target of the intervention. The secondis that even if regulating the interchange fee could affect the variable prices paid by both merchantsand cardholders, cost-based regulation is not capable of achieving the optimal prices except by happenstance.Whether cost-based regulation in practice would increase efficiency is unknown giventhe current state of theoretical and empirical knowledge.C. Competition Policy and Interchange Fee DeterminationRelatively early in the development of the payment card industry, the NaBanco court recognizedthe complexity of the role played by the interchange fee and the differences between thatrole and the role of an ordinary price in deciding that interchange fees should be evaluated underthe rule of reason rather than be subject to the per se condemnation of price-fixing under U.S.law. We believe the recent theoretical literature supports this approach. There is a strong economicpresumption that collective determination of ordinary prices harms consumers, relative touncoordinated, competitive pricing, but there is no economic presumption that collectively settinginterchange fees reduces output or consumer welfare as compared to any other feasible regime.Under U.S. law, to evaluate whether the pro-competitive benefits of collectively set interchangefees outweigh the anti-competitive costs (the test under the rule of reason), one would presumablyhave to compare collectively set interchange fees with the results of bilateral negotiations amongacquirers and issuers. 82 As we have discussed, bilateral negotiation would at the very least involvehigh transactions costs in systems, like those in the United States, with large numbers of issuers andacquirers, and it may not be feasible in such systems. But assume it is feasible, and assume away theassociated transactions costs. Then one would have to examine whether bilateral negotiations wouldlead to lower prices and higher output than collectively set interchange fees. Existing theory doesnot provide much help in predicting the outcome of such bilateral negotiations, 83 and, of course, the81Reserve Bank of Australia (2002, p. 12); Katz (2001, p. 29); European Commission (2002).82That is the remedy that was sought by the plaintiff in NaBanco.83As we noted above, Small and Wright (2000) conclude bilateral negotiation would threaten system viability, but it isunclear how robust this result is.