Thank you very much. I thank the committee for inviting me here today. I should tell you, and I'm sure it exists with my colleagues, that professors are used to speaking in fifty-minute segments, not five. So it's going to be a little difficult.
I have a paper that should be handed out. The things I leave out are in the paper. It's not a long paper. And I should also tell you that my research has primarily been financed by Visa.
Let me get to it, given the time I have. The key feature of the credit card system is that it's a two-sided market, and a two-sided market is somewhat different from the markets economists generally deal with. A two-sided market is a market where there's an interrelationship between the two sides, and in the credit card business the two sides are the merchants and the cardholders. You can't run the system without cardholders. You can't run the system without merchants. The more cardholders there are, the better it is for merchants. The more merchants there are, the better it is for cardholders. It's like a network and there are these interdependents on both sides.
Cardholder demand for system services depends on other things: the level of cardholder fees, the value the cardholder places on the convenience of using the cards over other means of payments, and the number and quality of merchants participating in the system. Essentially merchants' demand is very similar. They depend on merchants' fees, the efficiency of accepting cards over other means of payments, and on the number and quality of cardholders.
The point I want to emphasize from the beginning is that this two-sided nature of the market makes the economics somewhat different from what it normally is.
There are three important points about the payment system. First, it's important to remember that the issuing and acquiring identities are through the payment system organization jointly engaged in the production and supply of services. It's joint production. Second, it's important to understand the two-sided nature of this market.
Evans and Schmalensee give a real-world example. In Asia, particularly, there are dating clubs, and in dating clubs men and women can go and meet one another and see if they are suiting each other's needs. It seems to be that men value these clubs more than women, and what generally happens in these clubs.... It's just as costly for the owner of the club to service the women and the men in the club, and to bring them in, but it's generally the case that women are not charged; they're even given free drinks sometimes, and men pay all the costs. Seems fair. And it's done to operate an efficient system. It's done because men won't come if there are no women. Women won't come if there are no men. You have to balance the system, and the way you balance the system is through an interchange fee. You have men pay this fee, not related at all to cost.
The third economically important feature of two-sided markets is that both sides of the market benefit from the growth and demand of the other side. Recently there have been challenges to four-party systems, particularly in Australia and a number of other countries, and in this country too. There are two important points to understand. First, people who criticize the system argue that merchants should not be required to cover any of the costs borne by the issuers who are providing the services to cardholders, since retailers argue they don't receive any benefits from them. It's claimed that a collectively set interchange fee imposes such costs on merchants. Accordingly, retailers urge that the interchange fee should be calculated on the basis of an objective cost standard, which excludes costs not related to payment networks. Second, it's argued that rules such as honour all card rules and no surcharge rules effectively force retailers to accept Visa and MasterCard.
I'm going to argue that there are flaws in these arguments, and particularly I argue there are about five flaws.
The first flaw is that merchants do receive benefits from payment card systems. They get increased sales and increased convenience. Increased merchant sales rise because when people use credit cards to make purchases, and larger purchases, they bring in new types of purchases, and you get increased sales because there are lower transaction costs. When I go and fill up my car with gas, they don't need as many employees because I pay myself. I put my card into the machine. If everybody paid cash, you would have huge lineups. Also, the merchants don't have to hold cash balances, which generally are costly.
The second flaw is there's no economic justification for cost-based regulation. You don't want to just look at cost. Cost is one factor, but it's not the only factor. It's a more complex system, and by limiting the justification of interchange fees only to cost, the argument fails to account for the respective benefits that merchants and cardholders derive from interchange fees.
The third flaw is that retailers are not forced to accept credit cards as payment methods. They do so because there are benefits. It's less costly for them to use it, when you measure all costs. And merchants can refuse to accept them. There's a large number that do. Costco, a huge merchant, doesn't accept MasterCard and doesn't accept Visa. My wife and I both love Costco.
Four, there's another flaw. There is no subsidization of credit card users by cash users. There's this argument that people who use cash are subsidizing credit card users. Yes, there is a no-surcharge rule, but there's no rule prohibiting merchants from giving a discount for cash. There's no difference, from an economic point of view, between surcharging for credit cards or discounting for cash. Merchants do discount for cash, but it's very rare. A lot of times, I would argue, they do discount for cash in order to avoid paying all sorts of taxes. Cash is a method to get around paying taxes.
Flaw number five is that there's no rational economic basis to distinguish between three- and four-party systems. There's no difference to distinguish between the Amex system and Visa and MasterCard.
Let me conclude with the lessons from Australia, and let me read you a quote from a study by Robert Stillman et al. They concluded that:
||Regulations should only be employed if there is clear evidence of a market failure and only if there is reason to believe that regulation is likely to benefit consumers.
The RBA's regulations have clearly harmed consumers in Australia by causing higher cardholder fees and less valuable reward programs and by reducing the incentives of issuers of four-party cards to invest and innovate. At the same time, there is no evidence that these losses to consumers have been offset by reduction in retail prices or improvements in the quality of retail service.
The empirical evidence does not support the view that consumers have derived any net benefits from the intervention. Generally, economists think of regulating an industry where there's some monopoly power and there's too little output produced and too high a price is charged. Regulation in Australia and regulating interchange fees causes a reduction in output and a higher price to consumers—it goes against what economists generally believe are the necessary conditions for regulation.
Let me conclude. Before analyzing two-sided markets such as the payment system industry, it's critically important to understand the unique economic considerations that drive this efficiency and its competitiveness. Foremost among these is the interdependence of demand among the acquiring and issuing sides. One must consider the cost and benefits provided to both sides of the market rather than focusing on one aspect of the market in isolation.
Thank you very much.
Thank you for having me.
I'm a professor at the University of Alberta. I should emphasize that I have no relationship with any of the various parties that have come before you in the last couple of weeks.
My role this morning is to give you some sense of what economists talk about when they think about this market. This is a very complicated market; it's very different from our standard textbook market. So maybe economists can give you some help in deciding how to approach the problem you have.
I think the key point, as my colleague has mentioned, is the notion of a two-sided market. This dominates economic thinking, and this is the key concept the committee should understand before deciding how to proceed. The idea of a two-sided market is the notion that you have a single platform—and this is the key word, “platform”—that brings together many buyers and many sellers.
What does this mean? What I've done on this slide is try to give you some examples—and there are countless examples—of platforms and how the economics work. The first example of a platform is precisely what you're discussing in these hearings. Visa and MasterCard provide a platform where they bring together lots of people on one side of the market, the retailers, and lots of people on the other side of the market, the consumers. By bringing these two sides together, they create some value. That's the value of their platform.
But there are many other examples, which I've shown you on this slide. For example, for real estate listings, real estate boards have websites all over the country. These websites bring together house buyers and house sellers. But the platform in the middle is the real estate board, and that's the key economic actor we care about.
Another example is shopping malls. A shopping mall can be thought of economically as a platform. What does it do? The owner of the shopping mall brings together two sides—side one, the store owners, and side two, the shoppers. So the shopping mall in itself doesn't do anything or sell anything, but it brings these parties together.
Other examples are the Yellow Pages and PDF files. A PDF file is a platform with readers and writers. And Google can be thought of as a platform; you have Google advertisers and Google searchers. One point to emphasize with these platforms is how their services are priced. How do Google or the Yellow Pages price their services? What you find very commonly with all of these platforms is that one side is highly subsidized—in many cases it's free—and the other side pays. So in the examples I've shown you, when you search on Google, for instance, it costs you nothing. But when you advertise on Google, when you're a seller, it costs you a significant amount of money. And for PDF readers, when you read a PDF document from Adobe, it's free. But if you want to write one of these things, it costs you a lot of money. Similarly with the Yellow Pages; on the one side the readers get it for free, etc.
So what you have as a standard outcome in the economics literature with the pricing of these platforms is that one side bears the costs and one side gets it for free. In fact, I would argue that in the credit card case, not only do the consumers get it for free, but they also actually get rewarded or more money when they use their credit cards. That, of course, is the notion of rewards—air miles and cash back, etc. This fits in very much with standard economic thinking about how these two-sided markets should work.
So what are the implications of these two-sided markets? The key point to emphasize, I believe, is the notion of winner takes all, or what we call “network effects” in economic jargon. What this means is that if you have a platform that everybody loves, if you have a platform that both the buyer side and the seller side use extensively, then you have a very valuable asset.
The second part of the winner-takes-all story is that once you get big, you get even bigger. So the big get bigger. There are built-in economies of scale, the way economists describe this. That, of course, is the situation that Visa and MasterCard find themselves in—and that is the situation every platform owner wants to be in. Another example is Microsoft as a platform. It's so big, everybody uses it. Nobody has a choice not to use it.
The key objective of the people who own the platform, whether it's Microsoft, Google, Visa, MasterCard, Yellow Pages, or whatever, is to get as much money as possible, like every business owner. But at the same time they have to balance and make sure they have enough on the buy side and enough on the sales side to keep the thing going. As soon as you have a situation where either one of these parties leaves the platform and goes somewhere else, the value of the platform gets less and eventually becomes zero. So they have to get as much money as they can, while at the same time keeping everybody using them.
So you have a situation--and this is standard economics and how we understand these two-sided markets--where you find yourself like the retailers you've heard in your committee. If you find yourself in a situation like in the Visa or MasterCard case, where you have a very successful and dominant platform, you're essentially stuck. You can't get out because all your customers demand that you use the platform, and there's nothing you can really do to reduce your fees.
So what do they do? Standard economics literature on two-sided markets says they do precisely what's happening at this meeting this morning. They lobby Parliament and go to the courts, the central banks, and the competition authorities. The economics literature tells us it is not possible for these guys to use standard economic mechanisms to escape the trap in which they find themselves.
So how do we get out of this? What is the threat to Visa or MasterCard, or any of these two-sided markets? I could be talking about Microsoft or Google; it's the same argument. The threat they face is a new and better platform that does things to make more people happy--new technology. I've given you the example of PayPal and the slow emergence of a platform on the web that might one day overcome Visa and MasterCard as a payment provider. That's the thing: once this new platform comes into being, Visa and MasterCard face the problem.
What are the implications of these two-sided markets? What does economics literature tell us to expect? First, the fight you've had before you for the last couple of weeks between Visa and MasterCard on the one side and the retailers on the other side is very predictable. This always happens. This identical fight has been happening around the world. My argument is that this will continue. These meetings will certainly not be the last ones this House hears on this matter.
Even if a new dominant platform overtakes Visa or MasterCard, this kind of conflict between the retailers on the one hand and the platform on the other hand will carry on. Even if, for example, the Reserve Bank of Australia imposes some sort of regulation, this will not solve the problem. There is no nice, easy answer based on economics literature as to how to fix this problem, because of the nature of these two-sided markets.
Thank you very much. As a former banker and a business school professor, I want to thank these two committees for inviting me. I clearly have a bias. I think you are the two most important committees in Parliament, finance and industry, because you're dealing with the most important issues of how we create wealth in our economy.
Just by way of background, I was in banking in the 1970s, in the bank right across the street, the Bank of Montreal, which I understand Parliament is now going to be using. It's a beautiful building. I hope you'll treat it well.
I was a consumer loan manager, a mortgage manager, a commercial loan officer, and I have a Ph.D. in public policy. Now I'm the MBA director in the Sprott School of Business. I do want to mention that I've taught over one hundred times in the Middle East, Asia, and Eastern Europe, including most of the former communist countries, where I saw, up close and personally, the impact of coercive government regulations in destroying the environment, the economy, and human rights.
Finally, I don't consult, advise, or invest in any firm, union, NGO, non-profit, government, or political party, so I come here with complete transparency.
I read all of the transcripts for the past two months in both your committee and the Senate committee. I really want to be somewhat provocative today and suggest that many of the witnesses—the Retail Council, CFIB—suggested that the payment system today in Canada is very expensive and inefficient, and I think this is really an urban myth.
Just to put some reality into the conversation, from time immemorial until the 1970s, even until the early 1980s, banks opened at 10 in the morning and closed at 3. If you couldn't get into the bank during that time, you didn't get your money. There were no debit cards, there was no Internet banking, there was no phone banking. Credit cards only emerged in the mid to late 1970s.
There were two payment systems: cash and cheque. Both were expensive, slow, and dangerous. Why were they so? Because cheques bounced regularly, every day. This was a very large risk to retailers. Cash was stolen in holdups or by workers. Although that risk wasn't so great, it drove every business person to invest large amounts of money to buy insurance, to bond employees, the due diligence, safes, costly cash custody, and so forth.
To endorse what Professor Carr and Professor Scholnick said, the transaction costs are very expensive. But today, debit cards provide instant payment, no recourse, no bad cheques, and the same thing with credit cards. So I'm arguing that the transaction costs are very cheap, at 0.5% to 4%.
This was borne out by a study by two think tanks very recently in Washington, D.C. The conservative American Enterprise Institute and the very liberal Brookings Institution did a study of payment types, and not surprisingly they found that cash was the most expensive form of payment. I heard some of the witnesses suggesting discounting for cash. If I was running a business, I would demand a premium for someone to pay cash because cash is very expensive. Bankers understand that. There are large hidden costs with cash. You have to have complex, elaborate accounting systems. You have to have, for example, two people counting the cash, if you don't want to get ripped off. By contrast, credit cards stimulate big-ticket purchases and stimulate impulse items.
I want to alert you to a study that was done only eight months ago by the Bank of Canada in this city. They did a large survey of businesses across Canada, and they had three findings in this survey of actual business people. They found that debit cards are preferred as least risky—I have no problem with that. Secondly, many businesses perceived that cash was the cheapest and most reliable. That is empirically false. Thirdly, the cards were seen as the most costly and least reliable. For the same reason that I argue the second finding is wrong, I argue this too is wrong. What this demonstrates is that a lot of small businesses are financially illiterate, or at least partially illiterate, and this points to the need for more literacy programs.
In fact, what happened over the past ten years? What was their actual behaviour? On both the consumer side and the commercial side, the use of credit and debit cards went up. In a study done by the Federal Reserve, I believe—I have the sources in my laptop—we're at the mid-point across some 10 or 15 countries in terms of the cost to the merchant for the use of cards.
So what is the problem? I'm arguing that the problem is the misperception of the cost of cash versus credit by business, producing, as my colleagues have suggested, rent-seeking by trade associations coming to Parliament and trying to get you to give them more profits instead of earning it the traditional way, through competition.
This is from the Federal Reserve, showing the profitability of credit cards, and you'll simply note that it's cyclical. It's on the screen. It is cyclical based on two variables: the cost of money and of course the credit losses.
What we're experiencing in Canada right now--this is from the DBRS, the bond rating agency--is that credit losses are soaring. As you can see, the red line, which is the weighted average, is pushing up to 6% for all credit card balances that are going to be charged off to bad debt in 2009. That is a horrific charge-off.
When I was a mortgage manager I had a zero charge-off, and on personal loans we had between a quarter to a half of one per cent. They're up to 6%, which is just off the charts.
Again, you can see this on the next one, the delinquency on loan losses in Canada is up to 35%, and the loan loss rate on credit cards is up to 44%.
I won't belabour the Australian solution. We already know it. You know it from the people who have testified. But I do have a couple of graphs you'll want to look at. These are from the Federal Reserve, which did a study. I believe Professor Carr quoted that study. After, I think it was four years, there was no change in the relative share of credit card use or debit card use. However, what did happen is that merchant fees went down and the banks recouped a very large amount through increased card fees.
You can see the two lines. The green line going up is the card fees charged on standard credit cards and the red line is the fees on the premium credit cards. What the Australians did was they simply shifted the burden from the merchants to the consumers. So what the Retail Council and the CFIB are asking you to do is to not stick it to them; they want you to stick it to the consumer, who is me.
The bank issuers, as this slide shows, recovered 30% to 40%, or a half billion dollars, from consumers. The irony is that the merchant costs fell on a transaction basis. When you run through the numbers, they dropped about four cents on a $40 purchase, which is really quite trivial. So there were no dramatic changes.
I won't summarize, because Professor Carr already dealt with this. The same Federal Reserve economist that Professor Carr spoke about reported that the regulations of the central bank, the Reserve Bank of Australia, failed to achieve their policy goals.
So what are the alternatives? I'll just wrap up.
I make three assumptions. One is that you, the legislators, face a choice of governing instruments from the least coercive, such as required information disclosure, to the most coercive, such as government ownership or the price controls advocated by the Retail Council or the CFIB. My second assumption is that you should select coercive instruments only when all else has failed, when there's clear evidence of market failure, and there is no evidence of market failure in the card systems.
My recommended policy solutions include much more rigorous information disclosure concerning rates, fees, benefits, costs, and interest charges; secondly, enhanced regulatory oversight to address deceitful or anti-competitive practices; and thirdly, financial literacy in the schools, in the education system. And I mention that because some witnesses expressed deep skepticism about literacy programs, but we do in Canada spend billions on primary school education, secondary, and post-secondary, so it would be a bit disingenuous for a professor to advocate against literacy programs.
Thank you. Then I'll include those.
I'm a professor of economics at Queen's University, and I have had an interest in payment cards for quite a long time now, certainly dating back to when I was involved in the Interac hearing in the mid-nineties, which led to the creation of the current debit card system in Canada.
I'm going to begin by talking about interchange fees, as my three colleagues have, but I don't think you need to hear anything more about two-sided markets. Interchange fees, though, are set to balance the incentives of merchants to accept the card with the incentives of the issuer to issue it and the card holder to use it. The interchange fee, in effect, is paid from the merchant—strictly speaking, it's paid from the acquirer—to the card issuer and is not a conventional price.
This is a point, although my colleagues have been over this ground a little bit.... We think of high interchange fees as hurting merchants, because it's a price, and high prices hurt the people who have to pay them. But of course because it's a two-sided price, it's really not that simple. As I said, the interchange fee is designed to balance these networks, which have a joint interest in maximizing the acceptance by merchants, and of course merchants, who have an interest in large numbers of cards being available—as do card holders, so that when they go to buy a shirt they can find a merchant who will accept their card.
There are some theoretical conditions under which the interchange fee is completely neutral, in fact. Changes in the fee are balanced by changes in surcharges and in card fees, so that all parties are indifferent as to the actual level of the fee. Most academic economists who have studied this don't believe that we necessarily have that theoretical situation. The problem, though, in my opinion, is that we do not know enough yet about how the state of competition in acquiring and issuing really interacts to determine what that interchange fee is in the absence of regulation--in other words, from an economic welfare point of view.
You've heard quite a bit, both from my colleagues here and earlier I think about the Australian experiment. As we know, and we just saw some data on this, one thing we do know about it is that the reduction in interchange fees through regulation in Australia led to an increase in card fees and to a reduction in value of rewards to card holders.
There is a subtle and important question, which Jack Carr hinted at. That is, do the various prices and fees in these payment networks distort the pattern of payments? That is, if we think about credit cards, debit cards, and cash—and again my colleagues have talked about this—is there a tendency for, let's say, a higher percentage of payments to be made via credit cards relative to some kind of social optimum? It's an interesting question, and there are some academic discussions of this. My view is that we just don't know the answer yet. I would agree with my colleagues very much that in a case in which we don't know the answer, it's too soon to rush into regulation. Regulation is desirable when we have a clearly identified market failure and understand in which direction our intervention is going to improve things.
There is an important question on which Canada's situation is a little different from that of other countries, and that is the question of whether the credit card network is acting solely as a joint venture of the member banks or whether it's acting as an independent corporation in its own right in order to pursue its own profits. In Canada, as you know, the credit card networks have recently restructured themselves in order to be the latter, partly as a result of prompting from the Competition Bureau, which wanted that change in order to approve the duality—the change to allowing banks to offer both card networks, or to issue cards from both MasterCard and Visa.
Again, in the academic studies, one of the things that's likely to influence interchange fees is whether or not there's more imperfect competition at the issuing end or more imperfect competition at the acquiring end. There have been some studies suggesting that it's likely to be more at the issuing end, and the reason for that lies in the idea of switching cost. For the consumers who hold those cards, it can be difficult to change one card to another card, because first of all, you quite likely have a balance on it, and second, you have a bunch of card numbers in your online shopping networks—if you're me, you have, anyway. So consumers face some switching costs.
But again, I would say we do not know the answer to this. This is an interesting academic question, but we don't know the answer from the policy point of view.
Another question, which again my colleagues touched on, concerns “no surcharging” rules. There are some international differences here that are interesting. For example, in the U.K., where these issues have been studied quite a lot, the no-surcharging rule was abolished in the early 1990s, and yet there has been very little surcharging. As my colleague here pointed out, there's also very little cash discounting.
However, in Australia—at least, my understanding is—since they abolished their no-surcharging law, which was just about five years ago, I think in 2003, there has actually been quite a lot of surcharging. The number I saw is that 23% of credit card transactions through what are called large retailers are now surcharged, if you use a credit card. That's a pretty big number. I throw that out there to say that this is something that is interesting and possibly important, and we don't know a lot about it.
In conclusion on credit cards, just to restate what I've said earlier, I think it's much too early for us to have a definitive conclusion about any form of regulatory intervention in this market. I don't think we understand it well enough. We have the Australian example, and it's not at all clear that it was a success. It's possible there will be some intervention in the U.K. soon, and we may learn something from that.
Let me make just a few remarks on debit cards, if I may. We've had an unusual situation in Canada whereby we've had a single debit card network now for more than ten years—the Interac network. It's been regulated so that it's a not-for-profit organization. The question is, which system is preferable, a regulated natural monopoly, if it is a natural monopoly, or a competitive system in which merchants and consumers choose the debit network they want to use for each transaction? Ideally, a merchant could choose to subscribe to one or more debit card networks, and a buyer might have the choice, for any given transaction, to route it through network A, which might be Interac, or network B, which might be the new Visa debit network that is going to be rolled out, I believe, sometime in the near future.
Natural monopolies have the property that because of network economies and scale economies, a single supplier is the most cost-effective organization within which to supply the market. However, this conclusion is essentially a static one and ignores all the dynamic economies and incentives for innovation that come from a competitive system in which networks compete.
The policy concerns with debit cards mostly have to do with merchant fees, and to some extent with interchange fees. Interchange fees in the Interac debit network are currently set at zero. The concern I've heard is that when Visa debit enters, and possibly MasterCard debit as well, the cost to the merchant will go up.
One of the ways this has been expressed is through the concern that the current fee to a merchant for using an Interac debit card is about 12¢. It's a flat per-unit fee. When Visa debit comes, in I believe they're going to be using a more complicated fee structure, which is partly value based. It's partly a percentage of the value of the transaction.
To just finish up, my view of this is that competition is good. We have to start from where we are. Where we are is we have a monopoly. We should not be throwing up our hands and expressing alarm that we're going to get entry here. Entry is a good thing; entry is going to create competition. It's most likely that entry will create benefits for consumers, because that's what entry does. The concern has been expressed that somehow Visa debit will become a dominant firm in the debit market. It seems to me to be very premature. At the moment, Interac is, of course, the dominant firm.
I wish to say that each one of your presentations was very refreshing. I agree with you, I think the system works. Capitalism works, individual freedom is good, and there is no problem. I do not understand why we need to meet any further since we have realized, along with you, that there is no problem. And the beauty in all this is that companies are making money. In a capitalist system, profit is healthy, as it creates wealth and jobs.
When we politicians seek to regulate or legislate individual behaviour, as we are wont to do, each law or regulation that is enacted gives a privilege to a specific group. In this case, we would be giving preferential treatment to certain groups, to the detriment of others. Personally, I prefer to let individuals be free to choose.
Nonetheless, I have an economic question about our system, and I ask it so that our system will continue to operate as it does currently, that is, extremely well. Are there any barriers to enter this industry? I am referring specifically to fees or the platforms that are now in effect. If a competitor seeks to break through the market, would they be free to do so, or have politicians and legislators created obstacles to enter this market?
Mr. Laforest asked what we should do for the future. I, for one, believe that we must make sure that there is no barrier to entry, so that future competitors may enter this market. I would like to hear your opinions on this subject.
Let me answer your question.
First of all, you implied that my research is financed by Visa. I announced that, and it's certainly the case. But like loyalty programs, professors have brand names. I say what I believe. If the message is consistent and Visa wants to subsidize it, that's clear. But I believe in 100% transparency, and I told you that.
Second, on loyalty programs, what I said was that as an economist I wouldn't know how to design a loyalty program. But I know that they exist in many different industries and they're there.
Now your key question was, who pays? The interesting thing is you assume. Clearly, when people look at costs with credit cards...and one of the reasons why credit cards are more costly is because it costs something to bring those customers in, and the way you bring the customers in is you give them these points and loyalty programs. But the other part of the equation, when you look at the system, is the efficiency gained by bringing them in. When I take my card and I get 2% cash back at the pumps, what I find is that I can do that transaction, and for the merchant, it's much cheaper. I don't have to line up and pay cash. The merchant doesn't have to add cash. So it's more efficient.
The second thing is this. I recently bought an Air Canada ticket with my credit card for a year from now. Now, without the credit card, I wouldn't have done it. Why? Even I wouldn't have paid cash, because I'm worried that Air Canada won't be here a year from now. They may be bankrupt. But with my credit card and with that premium credit card, what they give me is insurance. They give me insurance that if Air Canada goes under, and they can't default—
—so we're going to go somewhere else.
You're not a victim, Mr. Carr, but we will go somewhere else.
Mr. Lee, I have a question for you, and it does have to do with the economics, but it also has to do with the public policy.
I'm working in a business and I'm buying a $40,000 piece of equipment. It's my business. The person I'm buying from says they have a bonus this month and they're giving back 2% cash. I take the $800. If I don't declare it, I've just committed an offence under the Income Tax Act, if I'm trying to deduct the whole forty grand.
Or I'm the employee of somebody's business and a client says they've got a special this month and they can deliver a flat screen TV worth $800 to my cottage if I'm buying this particular piece of equipment. If I do that, I've committed a fraud on my employer.
We've just described how much fun it is to get bonuses, to get the 2%, and why not 4%? How do you deal with that, in terms of public policy, when you've got a lot of people.... I have a friend who's a medical professional. Last year he took a $25,000 trip all on points—hotels, everything—because everything he buys in his medical practice, a lot of equipment, he puts on a credit card. Last year that amounted to about $25,000, for a couple million bucks of purchases.
Where is that money accounted for, and is it taxed? Or is this just an entry-level kickback scheme that society has decided they're going to accept?
There were a couple of comments made, one in particular, that I found a bit disturbing. It had to do with the system as we have it still working and there not being a problem yet.
As parliamentarians we have to look at the good of all society, and I just want you to realize that the fact it's working now doesn't mean that down the road it may not be working. If we see something coming up, I think we want to look at it to prevent any possible problems, for the betterment of everyone.
The system as it stands right now is that you have the providers, who are the card issuers, and you have the banks and the consumers, who are basically the customers of the providers. Under a competitive system where you have two major cards, the providers are vying for the business of the banks and vying for the business of the consumers so that they will take their cards.
The one thing I find very disturbing is that when they're vying for that business, they offer more benefits. They offer to differentiate themselves. And how do they do that? I think Mr. Mulcair asked the question, “Who pays for it?” It's at the expense of the merchant.
I know the argument will be that the merchant is selling his or her receivables and that this is the cost they pay. Usually, when you have a cost, you can negotiate something and it's fixed.
You mentioned Adam Smith earlier. I believe that in the economy Adam Smith dealt with, things were much simpler. You had to have the same product. It's been a few years since I've studied Adam Smith, but basically the economy, in his view, has to be pretty well level: you have similar products and a relatively barrier-free entry into the market.
In a system like the one we have with the banks, in which you have two major players, the merchants are basically the pawns in all this, and the costs are passed on to the merchants, who have to have this service. Do you not find there is something wrong with this system?
I'll respond to that. There are a number of points you made, and let us hope I get all of them.
Let me get to the Adam Smith point that I made about people lobbying government. That occurs all over the world; it has occurred since 1776 and it occurs today. People act in their own best interests—that was Adam Smith's point—and if you have government setting rules and regulations, they'll try to get the rules set in their own interest. That hasn't changed. The nature of the economy is much more complicated, but that fundamental fact is still the same.
On these systems, I think it's important to stress, when one has to understand how it is and who bears the cost, what happened 40 to 50 years ago. Only cash and cheques were used. Then credit cards came along. Credit cards could only survive if they innovated, if they were more efficient. An example I gave is, if I go to Tim Hortons and swipe my credit card, it's fast; or if I go to service stations, it's faster—it's more efficient. They need fewer employees to take cash, if I do it myself. I can make online transactions.
When you have innovation and it's efficient, the new system can offer the product with more benefits at a lower cost. You ask who pays for the benefits. No one does. They result from building the better mouse trap. If you build a better mouse trap, you can sell it cheaper and give a better product. This selling the cheaper.... As Professor Lee said, when you give the loyalty programs or you give all these benefits, the customer is getting it cheaper, because it's a superior product—not in all transactions, but in a lot of transactions.
That's how credit cards could survive. They provide a better product at a lower price. The merchants only see these benefits being given to the customers; they don't see that these transactions are being done more efficiently and that these customers are now being brought in. That's the gain.
Mr. Chair, I will be sharing my time with my friend Mr. Robert Bouchard.
Earlier, my colleague asked if any real action had been taken over the years. He also asked you if you had a study to support the position you hold, according to which everything is fine, life is great, and things should continue as they are. Yet, you have no study, and you did not answer his question. Therefore, we can deduce that since you have no study, your position is simply a personal opinion that you are sharing with us today.
Mr. Lee, you stated that merchants do not have enough competition to earn the 2%. What do you think Visa and Mastercard are doing? These two companies are in the market and are charging interchange fees of 2%. They do not need competition and they can charge any interchange rate they want, change it when they want, and there will be no state intervention.
If someone wants to open a restaurant and earn a 3.8% profit on the meals, they will really only earn 1.8% if a client uses a credit card. Since you are a banker, can you tell me if it would be advantageous for a bank to lend money to someone who wants to open a restaurant? You may answer that a restaurant is free to choose whether or not it will accept credit cards, but if it does not, people will go eat elsewhere.
We are caught up in a system that the banks and the caisses populaires have created by deciding that people's paycheques would systematically be deposited into accounts from which money can be drawn any time. If somebody wants to travel, a credit card is needed to make reservations. If someone wants to go somewhere, a credit card is needed to reserve a spot. This is a credit card monopoly, a spiral in which we are stuck that was created by the banks and the caisses populaires.
Therefore, Mr. Lee, when you say that we need to be more competitive, I cannot help but be a bit skeptical. I do not believe that we can get out of this.
Can you explain to us how we can get out of this?
That's a really excellent question, and I think it ties into my key point to this committee, which is that a change will happen not through regulation, but through innovation, through new developments, through technology.
The example you give is cellphones and the African model. In places like Kenya and South Africa, what you've seen in those countries is very poor people who don't have bank accounts, but everybody in those countries has a cellphone, or at least has access to one. There's one in a village, or a family, or something.
So what you've had in these very poor countries is essentially a payment system that is more sophisticated than what we have in North America. That's because when you buy something from somebody, you go to a store, you take your cellphone and you put it next to the store owner's cellphone. There's a program--or to use the economic jargon, there's a platform--on both of these cellphones. You push a few buttons and the money goes from one person's account that they've put onto the cellphone previously, so you don't have to walk around with cash. You load up your cellphone with some money and then it goes into the shopkeeper's account, so your account goes down and the shopkeeper's account goes up. This is in Kenya, this is in China. They are doing the same kinds of things.
So essentially what you have is that nobody has plastic; nobody has a bank account. You have the emergence of a brand-new, highly innovative competitor for the plastic credit cards from cellphones.
Will this happen in North America? Absolutely. The question is not if; it's when.