The Economics of Interchange Fees and Their Regulation: An Overview

This essay surveys the economic literature on interchange fees and the debate over whether interchange should be regulated and, if so, how. We consider, first, the operation of unitary payment systems, like American Express, in the context of the recent economic literature on two-sided markets, in which businesses cater to two interdependent groups of customers. The main focus is on the determination of price structure. We then discuss the basic economics of multi-party payment systems and the role of interchange in the operation of such systems under some standard, though unrealistic, simplifying assumptions. The key point of this discussion is that the interchange fee is not an ordinary price; its most direct effect is on price structure, not price level. We then examine the implications for privately determined interchange fees of some of the relevant market imperfections that have been discussed in the economic literature. While some studies suggest that privately determined interchange fees are inefficiently high, others point to fees being inefficiently low. Moreover, there is a consensus among economists that, as a matter of theory, it is not possible to arrive, except by happenstance, at the socially optimal interchange fee through any regulatory system that considers only costs. This distinguishes the market imperfections at issue here for multi-party systems from the more familiar area of public utility regulation, where setting price equal to marginal cost is theoretically ideal. Next, we consider the issues facing policy makers. Since there is so much uncertainty about the relation between privately and socially optimal interchange fees, the outcome of a policy debate can depend critically on who bears the burden of proof under whatever set of institutions and laws the deliberation takes place. There is no apparent basis in today's economics - at a theoretical or empirical level - for concluding that it is generally possible to improve social welfare by a noticeable reduction in privately set interchange fees. Thus, if antitrust or other regulators had to show that such intervention would improve welfare, they could not do so. This, again, is quite unlike public utility regulation or many areas of antitrust including, in particular, ordinary cartels. By the same token, there is no basis in economics for concluding that the privately set interchange fee is just right. Thus, if card associations had to bear the burden of proof - for example, to obtain a comfort or clearance letter from authorities for engaging in presumptively illegal coordinated behavior - it would be difficult for them to demonstrate that they set socially optimal fees. We take a pragmatic approach by suggesting two fact-based inquiries that we believe policymakers should undertake before intervening to affect interchange. First, policymakers should establish that there is a significant market failure that needs to be addressed. Second, policymakers should establish that it is possible to correct a serious market imperfection, assuming one exists, by whatever intervention they are considering (such as cost-based regulation of interchange fee levels) and thereby to increase social welfare significantly after taking into account other distortions that the intervention may create. We illustrate both of these points by examining the recent Australian experience.Technology and Industry, Regulatory Reform

U.S. v. Microsoft: Did Consumers Win?

U.S. v. Microsoft and the related state suit filed in 1998 appear finally to have concluded. In a unanimous en banc decision issued in late June 2004, the D.C. Circuit Court of Appeals rejected challenges to the remedies approved by the District Court in November 2002. The wave of follow-on private antitrust suits filed against Microsoft also appears to be subsiding. In this paper we review the remedies imposed in the United States, in terms of both their relationship to the violations found and their impact on consumer welfare. We conclude that the remedies addressed the violations ultimately found by the Court of Appeals (which were a subset of those found by the original district court and an even smaller subset of the violations alleged, both in court and in public discourse) and went beyond them in important ways. Thus, for those who believe that the courts were right in finding that some of Microsoft's actions harmed competition, the constraints placed on its behavior and the active, ongoing oversight by the Court and the plaintiffs provide useful protection against a recurrence of such harm. For those who believe that Microsoft should not have been found liable because of insufficient evidence of harm to consumers, the remedies may be unnecessary, but they avoided the serious potential damage to consumer welfare that was likely to accompany the main alternative proposals. The remedies actually imposed appear to have struck a reasonable balance between protecting consumers against the types of actions found illegal and harming consumers by unnecessarily restricting Microsoft's ability to compete.

Auction Design and the Market for Sulfur Dioxide Emissions

Title IV of the Clean Air Act Amendments of 1990 created a market for electric utility emissions of sulfur dioxide (SO2). Recent papers have argued that flaws in the design of the auctions that are part of this market have adversely affected its performance. These papers incorrectly assume that trade can only occur at auctions, however. Our empirical analysis of the SO2 emissions market shows that the auctions have become a small part of a relatively efficient market and that the auction design problems that have attracted the most attention have had no effect on actual market prices

Regulación por incentivos para las empresas de servicios eléctricos

The utilities price regulation in the United States has historically been made by a state commission. Nevertheless, this regulatory system does not incentive cost controls within the utilities. In order to rectify this situation the regulatory commissions have changed their view to one of "incentive regulation" has financial rewards and penalties according to the utility performance. This paper presents a review of the rationales that led to the changes in the regulatory rules and proceedings oriented to the introduction of incentives, of the principles that should guided the construction of solid mechanism of incentives, and of the practical problems that should be solved in order to make the mechanism effective.

Auction design and the market for sulfur dioxide emissions

Title IV of the Clean Air Act Amendments of 1990 created a market for electric utility emissions of sulfur dioxide (SO2). Recent papers have argued that flaws in the design of the auctions that are part of this market have adversely affected its performance. These papers incorrectly assume that trade can only occur at auctions, however. Our empirical analysis of the SO2 emissions market shows that the auctions have become a small part of a relatively efficient market and that the auction design problems that have attracted the most attention have had no effect on actual market prices.Supported by the MIT Center for Energy and Environmental Policy Research and the Acid Rain Division of the U.S. Environmental Protection Agency

1996 update on compliance and emissions trading under the U.S. acid rain program

November 1997This paper reports on the second year of compliance with the sulfur dioxide (SO2) emissions-reduction and -trading provisions of the Title IV of the 1990 Clean Air Act Amendments (CAAA). The material is intended as a supplement to Ellerman, et al. (1997), which evaluated the emissions-trading program in 1995, and to which the reader is referred for background and definitions of terms. In the main, compliance with Title IV in 1996 was very similar to that which occurred in 1995. Sulfur dioxide emissions from affected units were about 4.0 million tons lower than they would have been in the absence of the emissions restrictions specified in Title IV. As in 1995, about half of the emissions reduction could be attributed to the use of scrubbers and the other half to switching. Finally, at 5.43 million tons, 1996 emissions from these units were significantly below the 1996 "cap" of 8.12 million tons, not to mention the 3.25 million allowances banked from 1995 that could have been used in 1996. However, the more interesting aspect of compliance with Title IV in 1996 lies not so much in the aggregate results as in the small changes on the margin that indicate how affected parties were using the flexibility afforded by emissions trading. In this regard, the most significant change was a 6% increase in emission from affected units. With the decreasing number of allowances issued annually as Phase II approaches and a fixed Phase II "cap," one would have expected emissions to be lower in 1996 than in 1995, not higher. The unexpected increase in average emissions rates is, however, the mirror image of the equally unexpected fall in the price of allowances between 1994 and 1995. With lower allowance prices, it is cheaper in at least some locations to spend more on allowances in order to take advantage of lower-priced, higher-sulfur coal

U.S. vs. Microsoft: Did Consumers Win?

U.S. v. Microsoft and the related state suit filed in 1998 appear to have concluded. In a unanimous en banc decision issued in late June 2004, the D.C. Circuit Court of Appeals rejected challenges to the remedies specified in a settlement reached in late 2001 and approved by the District Court in November 2002. The wave of dozens of follow-on private antitrust suits filed against Microsoft also appears to be subsiding, following many settlements and some dismissals. Related issues, however, continue to be the focus of competition agencies outside the United States, including the European Union and Korea. In this paper we review the remedies imposed in the United States, in terms of both their relationship to the violations found and their impact on consumer welfare. We conclude that the remedies addressed the violations ultimately found by the Court of Appeals (which were a subset of those found by the original district court and an even smaller subset of the violations alleged, both in court and in public discourse) and went beyond them in important ways. Thus, for those who believe that the courts were right in finding that some of Microsoft's actions harmed competition, the constraints placed on its behavior and the active, ongoing oversight by the Court and the plaintiffs provide useful protection against a recurrence of such harm. For those who believe that Microsoft should not have been found liable, because of insufficient evidence of harm to consumers, the remedies may be unnecessary, but they avoided the serious potential damage to consumer welfare that was likely to accompany the structural remedy imposed by the original district court and the more extreme restrictions on conduct later proposed by some of the state plaintiffs. The remedies imposed appear to have struck a reasonable balance between protecting consumers against the types of actions found illegal, on the one hand, and, on the other hand, avoiding excessive restrictions that would harm consumers by restricting Microsoft's ability to compete in pro-competitive ways.Technology and Industry

Regulating Emissions of Greenhouse Gases Under Section 202(a) of the Clean Air Act

The authors consider whether the Environmental Protection Agency's denial of the petition to regulate emissions of greenhouse gases from motor vehicles under Section 202(a) of the Clean Air Act was reasonable in light of the global nature of greenhouse gas emissions and the likely superiority of other methods for combating greenhouse gases.Environment, Health and Safety, Regulatory Reform, Other Topics

Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Safety Regulation?

Benefit-cost analysis has a potentially important role to play in helping inform regulatory decision-making, although it should not be the sole basis for such decision-making. This paper offers eight principles on the appropriate use of benefit-cost analysis.Environment, Health and Safety, Regulatory Reform

Benefit-Cost Analysis in Environmental, Health, and Safety Regulation: A Statement of Principles

Benefit-cost analysis can play a very important role in legislative and regulatory policy debates on improving the environment, health, and safety. It can help illustrate the tradeoffs that are inherent in public policymaking as well as make those tradeoffs more transparent. It can also help agencies set regulatory priorities. Benefit-cost analysis should be used to help decisionmakers reach a decision. Contrary to the views of some, benefit-cost analysis is neither necessary nor sufficient for designing sensible public policy. If properly done, it can be very helpful to agencies in the decisionmaking process. Decisionmakers should not be precluded from considering the economic benefits and costs of different policies in the development of regulations. Laws that prohibit costs or other factors from being considered in administrative decisionmaking are inimical to good public policy. Currently, several of the most important regulatory statutes have been interpreted to imply such prohibitions. Benefit-cost analysis should be required for all major regulatory decisions, but agency heads should not be bound by a strict benefit-cost test. Instead, they should be required to consider available benefit-cost analyses and to justify the reasons for their decision in the event that the expected costs of a regulation far exceed the expected benefits. Agencies should be encouraged to use economic analysis to help set regulatory priorities. Economic analyses prepared in support of particularly important decisions should be subjected to peer review both inside and outside government. Benefits and costs of proposed major regulations should be quantified wherever possible. Best estimates should be presented along with a description of the uncertainties. Not all benefits or costs can be easily quantified, much less translated into dollar terms. Nevertheless, even qualitative descriptions of the pros and cons associated with a contemplated action can be helpful. Care should be taken to ensure that quantitative factors do not dominate important qualitative factors in decisionmaking. The Office of Management and Budget, or some other coordinating agency, should establish guidelines that agencies should follow in conducting benefit-cost analyses. Those guidelines should specify default values for the discount rate and certain types of benefits and costs, such as the value of a small reduction in mortality risk. In addition, agencies should present their results using a standard format, which summarizes the key results and highlights major uncertainties.