Development of Retail Payment Systems Since 1949

Abstract

Starting with the introduction of the Diner's Club payment card in 1949, the means of exchange have progressed well beyond traditional instruments such as notes, coins and cheques. I use institutional economics to analyse historical data on the evolution of recently-developed retail payment systems in Australia, Canada, Germany, New Zealand, Norway, the United Kingdom and the United States. The framework I create yields insights into the incentives faced by the users of payment instruments and the payment networks that provide them. It also provides a means to assess the role of government in the evolution of retail payment systems. Ceteris paribus, consumers and merchants will prefer low transaction cost payment instruments. In order to complete a transaction, a consumer will proffer an instrument that may or may not be accepted by the merchant. Together, merchants and consumers will choose the payment instrument that generally reduces demand-side – i.e. consumer and merchant – transaction costs, relative to other available instruments. Consumer irreversible costs of adoption enhance the importance of network effects. To help overcome these, I argue payment networks need to make acceptance of their instrument attractive to merchants, which I find to be supported by analysis of the pricing of payment instruments. It distinguishes recently-developed payment instruments from other new technologies – the most technologically advanced instrument will not likely be adopted unless it is first acceptable to merchants. In workably competitive conditions, profit-seeking payment networks will attempt to provide an instrument that gets used while it at least recoups its costs of supply from fees paid by users. I argue this suggests a process of institutional adaption for profit-seeking payment networks. Network effects mean the use of an instrument grows disproportionately faster, the greater the number of people using it. For instrument supply, this means profit-seeking payment networks have an incentive to increase participation. In the presence of potential inter-network competition, a payment network will likely experience greater participation if, ceteris paribus, it offers an instrument that generally reduces demand-side transaction costs to a greater degree than competing networks' instruments and provides it with lower costs of supply. Governments play two key roles in retail payment system development. First, they can affect the development of systems by how well they protect property rights and enforce contracts. Although this role is performed relatively well in my sample countries, my analysis suggests that the use of recently-developed retail payment systems would fall, substantially, were it not so. Second and more importantly in my sample countries, governments impose restrictions on the freedom of contract for payment networks. If restrictions on this freedom are such that they prevent the trading of property rights, they risk reducing either the demand or the supply of payment instruments. Such restrictions might reduce demand if the instrument that would have been used no longer generally reduces demand-side transaction costs. They might reduce supply in two ways: by impeding payment networks' attempts to offer instruments that reduce these transaction costs or by reducing inter-network competition. In summary, I find that it is government restrictions on the freedom of contract that cause the substantial differences in the use of newly-developed retail payment systems between my sample countries. By risking reducing the supply and demand of retail payment systems, these restrictions may diminish innovation in payments, thereby harming dynamic efficiency.