The U.S. economy is built on a belief that markets should be allowed to function freely. To free marketers like me, this belief is bedrock. Consequently, I view broken or malfunctioning markets, like the current debit payments market, with abhorrence.
Broken markets should have no allies. Their inability to serve consumers efficiently is assured, and the damage they can cause to the economy can be great. An inability or unwillingness to address broken markets is as great a threat to our free market system as unjustified government intervention.
Throughout my career I have stood in the way of efforts to erect barriers to free markets. Without free markets, the entrepreneurial spirit that has made our economy the most successful and resilient in the world would become a paltry shell of what it is today.
Broken markets, on the other hand, stifle innovation, incentivize inefficiency, and ultimately harm consumers and the broader economy.
So what’s wrong with today’s debit card market? Well, lots.
Under the current debit payments scheme, networks such as Visa and MasterCard set interchange rates at levels above those needed to entice banks to issue their cards. The interchange fee is paid by the retailer who accepts the debit card, and is then transferred to the bank that issued the card. The fee is hidden from the consumer. Yet, as these fees rise, it is ultimately the consumer who pays in the form of higher prices at the register.
Under this dysfunctional system, the networks’ competitive incentives are to raise fees rather than to reduce them. One network raises its fees higher than the other to encourage banks to issue their cards. Then, soon after, the other network raises its fees for the same reason. The result is rapidly escalating fees, such that according to a survey conducted by the Federal Reserve Board, today merchants on average pay 44 cents for every debit card transaction, despite the fact that the transaction itself costs less than 4 cents.
This broken system would not survive were it not for the fact that Visa and MasterCard represent a combined 90 percent of the debit market. With this market share, new entrants to the market stand little chance of success and thus fail to create the normal competitive forces that would reduce interchange fees. Merchants are powerless to negotiate and can’t take their business elsewhere, so they’re left with no choice but to pay. And pay they do, more than $20 billion last year alone.
Throughout my career, I’ve been a skeptic of government intervention. However, I was neither surprised nor dismayed when Congress stepped in to address the debit card fee problem last year in a way that is clear and justified. Congress told the Federal Reserve to require that interchange fees be reasonable and proportional to the cost of the transaction. Congress also directed the Fed to require networks to give merchants more say in the routing of debit card transactions, a way of injecting competition into the debit card market.
I generally welcome the strong anti-regulatory sentiments that are such a part of today’s political discourse. However, it would be unwise to apply these sentiments indiscriminately and allow broken markets to go unchecked. Congress was wise to step in and address the broken debit card market last year, and now the Federal Reserve must follow through with implementing these reforms.
If either shirks from its responsibilities or gives in to the wishes of the broken debit market’s allies, responsibility for the long-term harm to consumers and the economy will rest on their shoulders.
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James C. Miller III, a consultant to the Retail Industry Leaders Association, served as chairman of the Federal Trade Commission under President Ronald Reagan.
