The interchange debate involves a lot of details that I haven’t had the time to fully digest, so I won’t claim to have a high level of confidence about whether regulations being proposed are  good idea or not. But I would like to offer a note of concern and skepticism about an issue I haven’t seen seriously addressed by the otherwise very informative bloggers, like Felix Salmon and Mike Konczal, who have been covering this topic: what impact will the proposed regulation have on potential market entry?

I think we can all agree that more competition is, when feasible, the best way to deal with undesirable market power.  This point has been echoed several times by Matt Yglesias, but the most I have seen it discussed so far is by Konczal, who is not optimistic that this represents a feasible solution:

Technology breakthroughs, the other things to break up oligarchies, also don’t look likely. I can’t find it now, but recently there was an article about the future of consumer finances online (maybe in Wired?). A lot of revolutionary stuff could be coming, but none of it looks to be able to cut the legs out from the interchange system. I talk a lot to the online tech finance people, and try to keep up on what is happening in the medium term, and I don’t see much that is moving in order to put competitive pressure on the credit card model. I think that plastic will be the future in the 21st century, and there’s a clear structure of who sets these prices.

I think this issue deserves a much closer look, because some not so futuristic technologies like mobile payment seem to be potentially disruptive market entrants that could upset the Visa/Mastercard duopoly. Lawmakers need to be cautious with this, because if you’re going to start setting prices, then you’re messing with the profits for potential entrants, and thus possibly disrupting the future path of innovation. The welfare impacts of accidently preventing a market entrant or technological innovation here would be huge, and would likely trump any welfare benefits of the proposed regulations.

Price floors strike me as very dangerous in this regard. If the Fed gets tasked with ensuring that card issuers only charge “fair” prices that reflect marginal costs, then potential market entrants will never be able to recover the large up front costs needed overcome the initial network effects and economies of scale, and so they won’t make the necessary investments.

And even if the initial regulations don’t function as barriers to entry, how hard would it be for Visa and Mastercard to use regulatory capture to make sure that they evolve into them? Mr.Konczal is doing a great job writing about the goings on of interchange regulations now, but two years down the line will anyone still be holding legislators to task on this issue? Probably just Visa and Mastercard.

Maybe I’m worrying about nothing here, I certainly hope so, and if I am I would sincerely like to be convinced. Would the proposed interchange regulations reduce the incentives for market entrants and disruptive technologies? Please, disabuse me of my worries.

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