Comments on: The Merchants’ Insincere Concern About Cross-Consumer Subsidies http://truthonthemarket.com/2009/12/09/the-merchants-insincere-concern-about-cross-consumer-subsidies/ Academic commentary on law, business, economics and more Wed, 15 Feb 2012 08:05:47 +0000 hourly 1 http://wordpress.com/ By: Bob Chakravorti http://truthonthemarket.com/2009/12/09/the-merchants-insincere-concern-about-cross-consumer-subsidies/#comment-7995 Wed, 09 Dec 2009 20:34:19 +0000 http://www.truthonthemarket.com/?p=3306#comment-7995 Todd,
I agree that the cross-subsidy argument has more going on with it. Let me first address the cash government subsidy issue. While it is true that the Federal Reserve maintains a fit currency, it earns billions of dollars by providing currency net of these costs. This net revenue is commonly referred to as seigniorage. In fact, most of this income is turned over to the Treasury. Thus, the business of providing cash is a net revenue source for the Federal government. In the case of the U.S., much of this revenue is earned from foreigners who hold more than half the value of US currency outstanding. Private businesses have a form of seigniorage as well. Issuers of traveller’s checks or prepaid cards may earn significant revenue for lost or never redeemed monetary value sold (of course, issuers may earn interest on these funds until they are redeemed as central banks do on currency they have outstanding). For example, according to Starbucks’ Annual Report, it recognized $13.6 million in unredeemed stored value valances for fiscal year ending 9/2008. Therefore, there are clearly benefits from “issuing” currency or “currency-like” substitutes for governments and private businesses.

Furthermore, cash may be expensive for consumers to use because of acquisition costs such as the classic “shoe-leather” cost and possible other costs such as ATM fees and theft. Alvarez and Lippi (2009) quantify the probability of theft at around 2 percent for Italy in 2004. Thus, cash users may also benefit from card use. Ironically, one person at a conference I attended few years ago argued (somewhat jokingly) that if central banks allowed for greater counterfeits to circulate, this would give consumers and merchants greater incentives to substitute for cash. While central banks would not use such a strategy, some central banks actively encourage more non-cash use even though their income may suffer as a result.

Also, as mentioned before, cash users may impose a negative externality on card users in terms of time. As I mention in my second post, the Illinois Tollway tried to encourage non-cash use by charging cash users twice as much. However, some toll way users may be willing to pay higher tolls for other reasons including anonymity. In other words, there may be some instances where cash users would be willing to pay more.

As far as checks, it seems that the no-surcharge rule is a form of par acceptance for payment cards. However, I agree the conversion of these receipts into good funds does not occur at par. But there are fees to clear checks. Furthermore, as mentioned elsewhere, there is greater settlement risk borne by merchants. To mitigate this risk, merchants often use third-party check guarantors and pay a proportion of the value of the check. While the check clears at par, the merchant using this service is willing to give up a percentage of each check payment. In other words, the merchant discount has bundled many services into to it. Two questions arise. First, would the card networks ever unbundle these services? Second, would greater price differentiation that as has occurred for US interchange fees and merchant discounts be the efficient response? Here, I am limiting my focus to price differentiation as it pertains to settlement risk.

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