Some Pretty Strange Reasoning On Credit Cards
I am one of the rare individuals who enjoyed studying economics in college. I loved microeconomics and was fascinated by macroeconomics. As I listened to the lectures and read the texts, I had so many “ah ha” moments in which I felt like I finally understood why so many things were the way they were. The downside was that I was destined to spend the rest of my life rolling my eyes when I read editorials that mess up basic economic principles in order to prove some point.
Case In Point
Today’s New York Times features an Op-Ed by Albert A. Foer of the American Anti-Trust Institute in which he argues that we are all being gouged by credit card companies in fees to the tune of 48 billion dollars a year. As I will explain, you pretty much have to throw out some of the basic laws of economics to sustain his argument. Foer argues that Congress should set the fees that credit card companies are allowed to charge merchants. The foundation for his argument is that these fees are being passed directly to consumers:
Card companies generate those returns by charging an “interchange fee” for every credit or debit transaction they run — when a merchant accepts your card for a $100 item, it gets approximately $98 in payment. These costs are passed on to all consumers — even those who pay by cash — in the form of higher retail prices. None of this is new or controversial information.
Foer omits the simple economic fact that prices are set by the market. This principle invalidates his argument that merchant fees should be regulated, and that the cost is passed on to consumers. Merchant fees vary based on the card accepted. American Express has higher fees, and fewer merchants choose to accept it. Here, the market sorts this out. Some companies choose not to accept any credit cards at all.
When it comes to the prices that merchant charge, supply and demand will again set the price. Merchants will charge the highest price the market can bear, regardless of what their costs are. The idea that the interchange fees are passed directly on to consumers is a fallacy. Companies have all sorts of expenses as well as the need to generate a profit. You can take any line item from a company’s balance sheet, from worker’s health care to executive’s private jets, to the profit itself, and exclaim that these costs are passed directly on to consumers. Merchants pay the costs of doing business out of their own expenses on the belief that the expense is justified. A company pays part of its employee’s health care in order to attract top talent. They may purchase corporate jet to minimize the amount of time an executive wastes in airports. Profits are taken in order to justify keeping the business open. Likewise, merchants may pay interchange fees to credit card companies in order to reduce the costs and risks of accepting, counting, storing, and transporting cash, as well as to provide a convenient method of payment and financing to its customers to encourage sales. None of these expenses are passed on directly in the price paid by consumers. Prices are set by the market and non-tax expenses only exist because their value can be justified.
None of the benefits a merchant receives from accepting credit cards are addressed in Foer’s Op-Ed. Neither does Foer mention the market forces at work that determine the interchange rates.
The Worst Deception
The part I despise the most about his method of reasoning is where he tries to solidify his specious argument with the statement: “None of this is new or controversial information.” This line is a staple in the propaganda of charlatans around the world; “Well everyone knows (insert unsupported idea)”.
Where Is This Is Going?
Foer then argues that the government should step in and abolish merchant’s debit card fees and set a limit on credit card fees. He reasons that debit cards are the same as checks. Tell that to a merchant who takes a loss because he or she accepted a bad check. As for the government setting an arbitrary limit on merchant fees for credit cards, that does not really sound like a very free market approach. Even if the problem is that the market for interchange fees is not working, as I suspect it may not be, I have a hard time believing the only solution is government mandated price fixing. I only hope the credit card companies have less influence in Congress than the merchants, or they might convince lawmakers to just double these fees! A merchant’s version of the CARD Act would be a better solution. Like the consumer version, a merchant CARD Act should not fix rates.
Foer rests his argument on the idea that fixed fees would be more fair and would “save” $36 billion dollars a year resulting in “significant economic stimulus”. If merchants “save” these billions, than it is just the credit card companies who are loosing these billions. Frankly, as a consumer, I really don’t care how much money is saved or lost between my credit card processor and the various merchants I spend my money with, but I know it is a zero sum gain to the economy as a whole rather than a stimulus.
What I do care about is that a huge portion of these interchange fees are refunded to cardholders in cash back and other loyalty programs. If his idea were to be implemented, we can be sure most of these rewards would go away. Prices will not change, they will continue to be set by the market, but savvy credit card holders will loose out on much of their valuable rewards.
