The typical American probably doesn’t think much about the behind-the-scenes workings of his or her credit cards. But beneath the placid surface of swiping and signing, a ferocious legal battle has been waged for years that this week became the largest antitrust settlement in U.S. history. Since the ability to accept credit cards is useful to merchants and launching a new payment network is difficult, Visa, MasterCard, and other card-issuing banks can charge stores for access. And pay merchants do in the form of lucrative swipe fees to the credit card companies. These fees are, somewhat oddly, not only hidden from customers’ view but in a strange way not even charged to the card users whose actions incur them. The standard terms tell stores that not only must they pay extra for each credit card purchase, but they must not up-charge customers who use cards. Insofar as the card fees raise consumer prices, in other words, the pain must be spread evenly across the entire purchasing population no matter how they pay.
Why would retailers agree to this? Well, according to litigation they began pursuing in 2005, it’s because illegal collusion left them with little choice. You could simply decline to accept credit cards altogether, but attorneys representing more than 7 million retailers argued that there was no effective market competition to keep fees restrained. That led to charges of about 2 percent on average per transaction, far above the cost of providing card services and leading to collective earnings of between $40 billion and $50 billion a year on swipe fees. The trial was scheduled to begin in September, but instead banks chose to settle. In doing so they’ve agreed to pay out $6 billion in damages, reduce fees, and, perhaps most interesting, drop the rule against retailers charging swipe fee surcharges.
The settlement is clearly a substantial defeat for the banks and a win for retailers, but—as with a somewhat similar change to swipe fees for debit card transactions enacted as part of the Dodd-Frank financial reform bill—it’s not entirely clear how much of a win it is for consumers.
A basic question, in other words, is whose surplus are the banks expropriating when they charge the fees? The retailers would like you to believe that swipe fees simply push up the prices you pay at the store, and then in exchange for the cash they’ve robbed you of, the banks hand out some low-value frequent-flier miles or other rewards. The banks, by contrast, are pushing the exact opposite story, arguing that they squeeze retailers’ margins in a way you don’t have the clout to pull off and then split the gains with you through lucrative rewards points.
Competing empirical studies can try to estimate the impact in different ways, but economic theory tells us that in a diverse retail economy, the true impact will vary from place to place.
In a highly competitive retail market, retailers won’t have much surplus for banks to expropriate, and the losses will come out of consumers’ pockets. Evidence that this happens comes from the fact that although retailers haven’t traditionally been allowed to implement surcharges for credit card transactions, they can offer discounts for cash payment. This is pretty similar to surcharging and yet rare in practice. One field where you do see it frequently is sales of gasoline. But the gasoline market is unusual for retail products to the extent to which it approximates a textbook case of perfect competition. The product is an undifferentiated commodity, and stations often cluster together. Not coincidentally, gas stations don’t make much money selling gasoline. Instead, the gas gets you in the door, and the profits come from soda and snacks.
The fact that these kinds of cash-discount arrangements are not more widespread suggests that in most cases the retailers have a fair amount of pricing power.* That could be because of brand value—the Apple store or H&M compete with other retailers, but it’s not direct competition between two identical products—or because of convenience issues. Most people do their grocery shopping at the supermarket that happens to be close to their house or on their commuting route home. If prices get wildly out of line with what other markets offer, they might switch. But within a small range, they’re semistuck, and the store owner can profit for having gotten into the area first. In these cases, lower swipe fees are going to be mostly a transfer from banks to retailers rather than from banks to consumers.
That said, a little bailout for retail chains and small businesses might be a change for the better. Over the long term, anything that makes the retail sector more profitable will encourage more investment of both money and human capital. Conversely, a less profitable banking sector will attract less investment. After the misadventures of the past 10 years, though, it’s hard to think that shifting the scales away from financial services and toward millions of small and large stores across the country would be a bad thing. Consumers are unlikely to see a monetary windfall in the near term, but over a longer span, this will probably be a small win in the quest to tame an overgrown financial sector.
Correction, July 23, 2012: Because of a missing word, this article originally suggested that cash-discount arrangements on retail transactions are widespread. They are not. (Return to the corrected sentence.)