A few readers responded to my post on the European Commission’s efforts to regulate interchange fees in Europe. One commentator pointed out the lack of evidence in Australia that merchants passed on lower interchange fees to consumers in the form of lower prices. Another one responded that the amount of money was so small that empirical work couldn’t detect it and so asked why we shouldn’t just rely on economic theory that lower costs get passed on.

Here’s my response to and some further thoughts on interchange fee regulation. Actually, economic theory and empirical work on the pass through of price changes predicts that there wouldn’t be much benefit in Australia. A large portion of the retail market in Australia is highly concentrated with some sectors such as supermarkets having just a couple of major firms. In these cases theory predicts and empirical evidence confirms that businesses will pass on only a portion of a cost decrease. So my guess is that a good portion of the interchange fee decrease has thus far gone into the pockets of the retailers and hasn’t been passed on to consumers. The card market in Australia is more competitive and therefore likely to pass on more of a cost increase: in any case we do know what banks did in response to the lower interchange fee revenues–cardholders paid higher fees and took a hit on rewards. Of course, Australia has peculiarties and its experiences won’t necessary say what will happen in other countries.

In any event, I think people who advocate the regulation of interchange fees should bear the burden of showing that the payment system in Australia HAS IMPROVED as a result of this massive government intervention. We have now done the experiment on a massive scale in Australia. We would never approve a drug for sale based on such a massive clinical trial without some demonstration that the drug actually worked. Why should the EC be able to administer the “lower your interchange fee” drug without having to prove, based on hard evidence collected from Australia and Spain which has also lowered its interchange fee, that the drug works?