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Interpreting Australian Interchange Regulation's Consumer Impact

By Adam Levitin

A lot of the interchange debate in the United States now is about interpreting the results of the longest-standing interchange regulation experience, that of Australia.  There's a lot of ridiculous claims made about Australia.  So let's clear the deck.  There isn't any conclusive empirical evidence about the effects of interchange regulation on consumers.  I don't know of any study that even purports to study the effect of interchange regulation on consumer prices.  There's a MasterCard-funded study which found (surprise, surprise) that interchange regulation hurt consumers.  But the study reaches this conclusion by looking at annual fees and levels of rewards, which are just two pieces of a much larger picture.  Selective metrics can't tell us about overall consumer welfare (or the distribution thereof).  To do so would require a detailed analysis of, at the very least, Australian consumer prices (including rate of inflation) and Australian credit card products (including interest rates and other fees, not just annual fees and rewards).  The data for such a study doesn't exist. No one can take an empirically-founded stance one way or another.  What this means is that statements from MC/Visa and their defenders that consumers in Australia haven't benefited from interchange regulation are simply nonsense. 

This doesn't mean that we can't make any assumptions about Australia.  Below the break, I explain why contending there isn't a pass-thru to consumers requires arguing against basic principles of economics.  Economics 101 tells us that we can expect a pass-thru, the percentage of which will vary by the competitiveness of the merchant's industry. 

As a general matter, it is axiomatic that if a merchant's costs decline, the merchant will pass-thru the savings to consumers only to the extent required by competitive pressures in the merchant's industry.  Unless the basic laws of economics are suspended when it comes to interchange, there will be pass-thru if there is competition in the merchant's industry.  Strangely, many of the opponents of interchange regulation assume that interchange savings would not be passed-thru, as if they were different from any other cost for merchants. 

Presumably the part of merchant savings get passed on to consumers (if any) depends on how competitive the merchant's industry is.  If the merchant is in a competitive line of business, like groceries or gasoline, the consumer pass-thru will probably be significant.  If the merchant is in a less-competitive line of business, like airlines or telecom, then the pass-thru will probably be small.  This isn't a reason not to regulate interchange, but simply to improve the competitiveness of other markets. 

What this means is that the only way that interchange regulation would not result in a net benefit to consumers is if the credit card market (with unregulated interchange) is more competitive than other industries.  While that might be true for specific industries, I have trouble believing that it is generally true for the majority of consumer transactions by dollar amount.   (I am ignoring distributional issues, which probably argue for extra-weighting to small dollar transactions, which are probably more competitive industries, as they are volume, not margin business models.)  What this means is that unless the card industry overall (not just issuance!) is much competitive than most merchant's industries, there is almost assuredly a pass-thru benefit to consumers from interchange regulation, even if the data and econometrics are insufficient to prove it empirically. 

Full post as published by Credit Slips on May 14, 2010 (boomark / email).