The Economics of Interchange Fees and Their Regulation: An Overview
This essay surveys the economic literature on interchange fees and the debate over whether interchange should be regulated and, if so, how. We consider, first, the operation of unitary payment systems, like American Express, in the context of the recent economic literature on two-sided markets, in which businesses cater to two interdependent groups of customers. The main focus is on the determination of price structure. We then discuss the basic economics of multi-party payment systems and the role of interchange in the operation of such systems under some standard, though unrealistic, simplifying assumptions. The key point of this discussion is that the interchange fee is not an ordinary price; its most direct effect is on price structure, not price level. We then examine the implications for privately determined interchange fees of some of the relevant market imperfections that have been discussed in the economic literature. While some studies suggest that privately determined interchange fees are inefficiently high, others point to fees being inefficiently low. Moreover, there is a consensus among economists that, as a matter of theory, it is not possible to arrive, except by happenstance, at the socially optimal interchange fee through any regulatory system that considers only costs. This distinguishes the market imperfections at issue here for multi-party systems from the more familiar area of public utility regulation, where setting price equal to marginal cost is theoretically ideal. Next, we consider the issues facing policy makers. Since there is so much uncertainty about the relation between privately and socially optimal interchange fees, the outcome of a policy debate can depend critically on who bears the burden of proof under whatever set of institutions and laws the deliberation takes place. There is no apparent basis in today's economics - at a theoretical or empirical level - for concluding that it is generally possible to improve social welfare by a noticeable reduction in privately set interchange fees. Thus, if antitrust or other regulators had to show that such intervention would improve welfare, they could not do so. This, again, is quite unlike public utility regulation or many areas of antitrust including, in particular, ordinary cartels. By the same token, there is no basis in economics for concluding that the privately set interchange fee is just right. Thus, if card associations had to bear the burden of proof - for example, to obtain a comfort or clearance letter from authorities for engaging in presumptively illegal coordinated behavior - it would be difficult for them to demonstrate that they set socially optimal fees. We take a pragmatic approach by suggesting two fact-based inquiries that we believe policymakers should undertake before intervening to affect interchange. First, policymakers should establish that there is a significant market failure that needs to be addressed. Second, policymakers should establish that it is possible to correct a serious market imperfection, assuming one exists, by whatever intervention they are considering (such as cost-based regulation of interchange fee levels) and thereby to increase social welfare significantly after taking into account other distortions that the intervention may create. We illustrate both of these points by examining the recent Australian experience.
|Date of creation:||08 Jul 2005|
|Contact details of provider:|| Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA|
Web page: http://mitsloan.mit.edu/
More information through EDIRC
|Order Information:|| Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716.
- Graeme Guthrie & Julian Wright, 2003.
"Competing Payment Schemes,"
Departmental Working Papers
wp0311, National University of Singapore, Department of Economics.
- Guthrie, Graeme & Wright, Julian, 2003. "Competing Payment Schemes," Working Papers 173, Department of Economics, The University of Auckland.
- Wolters, Timothy, 2000. "‘Carry Your Credit in Your Pocket’: The Early History of the Credit Card at Bank of America and Chase Manhattan," Enterprise & Society, Cambridge University Press, vol. 1(02), pages 315-354, June.
- Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-122, June.
- Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
- Mark Armstrong, 2006. "Competition in two‐sided markets," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 668-691, 09.
- Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
- Chakravorti Sujit, 2003. "Theory of Credit Card Networks: A Survey of the Literature," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-19, June.
- Sujit Chakravorti, 2003. "Theory of credit card networks: a survey of the literature," Payment Cards Center Discussion Paper 03-09, Federal Reserve Bank of Philadelphia.
- Chakravorti Sujit & Roson Roberto, 2006. "Platform Competition in Two-Sided Markets: The Case of Payment Networks," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-25, March.
- Sujit Chakravorti & Roberto Roson, 2004. "Platform competition in two-sided markets: the case of payment networks," Working Paper Series WP-04-09, Federal Reserve Bank of Chicago.
- Gans Joshua S & King Stephen P., 2003. "Approaches to Regulating Interchange Fees in Payment Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-21, June.
- Jean-Charles Rochet & Jean Tirole, 2014. "Platform Competition in Two-Sided Markets," CPI Journal, Competition Policy International, vol. 10.
- Jean-Charles Rochet & Jean Tirole, 2003. "Platform Competition in Two-Sided Markets," Journal of the European Economic Association, MIT Press, vol. 1(4), pages 990-1029, 06.
- Jean-Charles Rochet & Jean Triole, 2002. "Platform competition in two sided markets," LSE Research Online Documents on Economics 24929, London School of Economics and Political Science, LSE Library.
- Jean-Charles Rochet & Jean Triole, 2002. "Platform Competition in Two Sided Markets," FMG Discussion Papers dp409, Financial Markets Group.
- Rochet, Jean-Charles & Tirole, Jean, 2003. "Platform Competition in Two-Sided Markets," IDEI Working Papers 152, Institut d'Économie Industrielle (IDEI), Toulouse.
- Hunt Robert M., 2003. "An Introduction to the Economics of Payment Card Networks," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-17, June.
- Robert M. Hunt, 2003. "An introduction to the economics of payment card networks," Working Papers 03-10, Federal Reserve Bank of Philadelphia.
- Paul De Grauwe & Laura Rinaldi, 2002. "A Model of the Card Payment System and the Interchange Fee," CESifo Working Paper Series 796, CESifo Group Munich.
- Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
- Hayashi Fumiko, 2006. "A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
- Fumiko Hayashi, 2004. "A puzzle of card payment pricing : why are merchants still accepting card payments?," Payments System Research Working Paper PSR WP 04-02, Federal Reserve Bank of Kansas City.
- Wilko Bolt & Alexander F. Tieman, 2004. "Skewed Pricing in Two-Sided Markets: An IO approach," DNB Working Papers 013, Netherlands Central Bank, Research Department.
- Wilko Bolt & Alexander F Tieman, 2005. "Skewed Pricing in Two-Sided Markets: An IO approach," Money Macro and Finance (MMF) Research Group Conference 2005 75, Money Macro and Finance Research Group.
- Daniel A. Ackerberg & Gautam Gowrisankaran, 2006. "Quantifying equilibrium network externalities in the ACH banking industry," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 738-761, 09.
- Gautam Gowrisankaran & Daniel A. Ackerberg, 2003. "Quantifying Equilibrium Network Externalities in the ACH Banking Industry," Working Papers 03-06, NET Institute, revised Sep 2003.
- Daniel A. Ackerberg & Gautam Gowrisankaran, 2006. "Quantifying Equilibrium Network Externalities in the ACH Banking Industry," NBER Working Papers 12488, National Bureau of Economic Research, Inc.
- van Raalte, Chris & Webers, Harry, 1998. "Spatial competition with intermediated matching," Journal of Economic Behavior & Organization, Elsevier, vol. 34(3), pages 477-488, March.
- Wright, Julian, 2003. "Pricing in debit and credit card schemes," Economics Letters, Elsevier, vol. 80(3), pages 305-309, September.
- Rochet Jean-Charles & Tirole Jean, 2003. "An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-11, June.
- Bolt Wilko & Tieman Alexander F., 2006. "Social Welfare and Cost Recovery in Two-Sided Markets," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-15, March.
- Bergman, Mats, 2005. "Two-sided network effects, bank interchange fees, and the allocation of fixed costs," Research Papers in Economics 2005:1, Stockholm University, Department of Economics.
- R. G. Lipsey & Kelvin Lancaster, 1956. "The General Theory of Second Best," Review of Economic Studies, Oxford University Press, vol. 24(1), pages 11-32.
- Fumiko Hayashi & Richard J. Sullivan & Stuart E. Weiner, 2006. "A guide to the ATM and debit card industry - 2006 update," Monograph, Federal Reserve Bank of Kansas City, number 2006agttaadci2, July.
- Sujit Chakravorti & William R. Emmons, 2001. "Who pays for credit cards?," Occasional Paper; Emerging Payments EPS-2001-1, Federal Reserve Bank of Chicago.
- Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, 03.
- Wright, Julian, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Working Papers 176, Department of Economics, The University of Auckland.
- Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
- Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790.
- Wilko Bolt & Alexander F. Tieman, 2005. "Social Welfare and Cost Recovery in Two-Sided Markets," IMF Working Papers 05/194, International Monetary Fund.
- Littlechild Stephen, 2003. "Reflections on Incentive Regulation," Review of Network Economics, De Gruyter, vol. 2(4), pages 1-27, December.
- Fabio M. Manenti & Ernesto Somma, 2002. "Plastic Clashes: Competition among Closed and Open Systems in the Credit Card Industry," Industrial Organization 0211012, EconWPA.
- Schiff, Aaron, 2003. "Open and closed systems of two-sided networks," Information Economics and Policy, Elsevier, vol. 15(4), pages 425-442, December.
- Joshua S. Gans & Stephen P. King, 2003. "A Theoretical Analysis of Credit Card Reform in Australia," The Economic Record, The Economic Society of Australia, vol. 79(247), pages 462-472, December.
- Wright Julian, 2004. "One-sided Logic in Two-sided Markets," Review of Network Economics, De Gruyter, vol. 3(1), pages 1-21, March.
- Jeffry M. Netter & William L. Megginson, 2001. "From State to Market: A Survey of Empirical Studies on Privatization," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 321-389, June.
- Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
- Evans David S., 2003. "Some Empirical Aspects of Multi-sided Platform Industries," Review of Network Economics, De Gruyter, vol. 2(3), pages 1-19, September.
- Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-28, June. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:mit:sloanp:18181. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If references are entirely missing, you can add them using this form.