Credit Cards in Context: Framing the Discussion

While the GAO report provides a useful summary of many of the issues being debated within the credit card community, the GAO’s mandate was, in some ways, rather narrow.  The GAO was asked to “review (1) how the fees merchants pay have changed over time and the factors affecting the competitiveness of the credit card market, (2) how credit card competition has affected consumers, (3) the benefits and costs to merchants of accepting cards and their ability to negotiate those costs, and (4) the potential impact of various options intended to lower merchant costs.”  We will be talking a lot about their conclusions on these issues, but first I would like to set the stage by talking about where credit cards fit in the economy as a whole.

Credit cards are a way of buying things, but they are only one of many.  Other common methods include cash, checks and debit cards.  Each payment method touches different groups, directly and indirectly.  Academics, central banks and regulators around the world have debated for many years as to which payment methods are best for society as a whole.  The research into this question suggests that there is no simple answer.  Indeed, researchers have not even agreed on how to ask the question.  Some researchers say that trying to figure out all the costs and benefits is just too hard and we should concentrate on the overall costs of the system.  In particular, electronic payment methods are often regarded as less costly than paper payment methods.  Other researchers (including myself) point out that consumers stubbornly continue using paper payment methods even as they become more expensive (relative to other payment methods), showing that there must be benefits to doing so, and that those benefits are important enough to influence people’s choices.  Most researchers agree, though, that different payment methods are better in different circumstances.  For example, for a small transaction at a garage sale, cash is very efficient.  You don’t need any terminals, electricity or approvals.  You hand over the cash and you’re done.  If you’re buying a house, though, cash is not a good choice.  You’re almost certainly going to use a wire transfer.  If you’re at Starbucks getting a cup of coffee, you might use cash or credit, although the cashier and the other people in line are likely to grind their teeth if you choose credit.

That examples brings up another problem that regulators wrestle with.  When you pull out your wallet to pay for something, you ask yourself questions like “Do I have enough cash?  Should I use my credit card for the rewards?  Should I use my debit card to stick to my budget?”  You do not ask yourself, “How much will this cost the merchant?  How much will this cost the bank?  Are other people going to pay a higher or lower price because of this?  Am I going to slow down the line?”  (Well, most people don’t.  If you’re reading this blog, you may be the exception that proves the rule).  That is, you choose how to pay for things, but the “price” you face for using whatever payment method you choose may not reflect all of the costs and benefits to everyone else.

This distinction is important because whether something is good for an individual does not necessarily mean that it is good for society.  If networks take money from some merchants and give it to people using credit cards, at first blush, those merchants are worse off while credit card users are better off.  But what does that mean for society?  Do prices go up?  How does that affect consumers?  How does that affect merchants?  How are the owners of the networks affected?  These are not simple questions.  Hopefully this overview will provide something of a framework to discuss them in.