Finance Committee on June 9th, 2009

[Prof. Ian Lee]

I'll be brief. It pains me, because you were a very distinguished economist at McGill, and I am very respectful of your position, but I have to disagree. I don't believe it is the role of Parliament or legislators to pick winners and losers. If I understood you, you were suggesting creating some mechanism or policy that would give a bias towards Interac so that it could beat or defeat MasterCard or Visa. If that is the argument, I hope you don't, because it's not the ownership of the company but the value and benefits it brings to consumers that should be the driver of the policy.

On the second issue, I agree. The Interac governance structure is archaic and inefficient and should be changed.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much.

Go ahead, Mr. Carr, just briefly.

[Prof. Jack Carr]

Briefly, I can't see how competition could hurt. Whether you want to loosen regulation on Interac is something else. I hear merchants saying that if Interac comes in, it's going to charge a higher price and take over the system. That's inconsistent. It's hard to believe that a competitor could come in, charge a higher price, and take over the system. It is competitors that are more efficient and charge lower prices that can take over the system. You can't have it both ways.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much, Mr. Carr.

We'll go to Monsieur Laforest.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Thank you, Mr. Chair.

Good morning to all our guests.

I will ask you a rather direct question to start. Are you in favour of tighter or increased general regulation of the credit card and debit card systems, as described by Mr. Scholnick?

You can each take a turn in answering.

[Prof. Barry Scholnick]

The question was tied to regulation, and I think my views are similar to my fellow economists. When thinking about regulation, be very, very careful. It seems to me there's a hierarchy of different things, when you're thinking of regulations to resolve this issue, that government as a whole could lose. I think everybody's in agreement about issues such as transparency. Everybody's in agreement about issues such as financial literacy. That's not a debate.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

I will raise another similar point. Last week, we learned that as far as regulation is concerned, there is no definition of electronic currency in Canada, nor in Quebec. This is a major point in the context of the electronic payment card system. Yet, Canada does not have a definition of electronic currency.

Do you not believe that this is a significant problem to resolve and which would force, at the very least, authorities to better define the terms that we are talking about? My question is for all of the witnesses.

[Prof. Ian Lee]

If I could respond, yes, there is a role for legislators to create the rules of the game that govern all of the institutions in the game, and the metaphor I use all the time is that you are the referees in the hockey game. If we can imagine a hockey game between the Toronto Maple Leafs and the Ottawa Senators, we don't want the referees to jump on the side of the Toronto Maple Leafs. Even though they need a lot of help, because they're a bad team, we don't want them to bias the game in their favour. We want them to be independent, neutral, and non-partisan in creating a neutral platform, and not favouring one player over another.

[Prof. Jack Carr]

There's plenty of regulation in the Canadian Payments Association and whatnot. The question, I think, before this committee, and what the retailers want, is regulation of the interchange fees. The question is why? What's the problem? As far as I see, interchange fees have been stable in Canada for a long period of time. There's a strong economic rationale as to why you need interchange fees. My colleague has shown a large number of examples of cases in two-sided markets, and therefore I think there's an economic reason for it. There's no economic reason to regulate interchange fees.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

None of you provided information about your studies or observations. Nobody talked about the effects of loyalty programs. You talked about premium cards, you claimed that consumers are the winners, and that premium cards provide bonuses. But there is a motive behind all this—it is called customer loyalty. Nobody talks about this in concrete terms.

I believe that Mr. Scholnick talked about platforms. You compare all of them, including the Visa platform, and the real estate listings platform. However, these things are very different; profit margins for those platforms are very different. In the real estate market, for example, brokers earn commissions that vary between 5% and 10%; merchants on the other hand have very thin profit margins which make things all the more difficult when interchange fees rise. when you paint all these platforms with the same brush, I find the comparison to be a bit unfair.

[Prof. Barry Scholnick]

I think that's an excellent question. I think when you're thinking about platforms, platforms are very different. Some platforms can be competitive with other platforms, and the example would be shopping malls. When you have one mall and another mall in the next suburb, if the shopping mall owner makes the retailers unhappy, they'll move to the next suburb, to the other shopping mall. It's still a platform. However, the interesting issue with the Visa and MasterCard platform is that right now they are dominant. They have an extremely high market share and everybody has to use them.

So you're absolutely right that different platforms have different levels of success, but I think when you're thinking about platforms, the issue is that there's always around the corner--possibly, maybe--another platform that can come in and compete against them. We don't know, but I think maybe through technological change, through the Internet, through organizations like PayPal, or other kinds of systems, they will possibly reduce--

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

I have one last question. You all compare the systems, but none of you provided an analysis of what would happen if nothing were to be done. I think that both issuers and acquirers make a lot of money. Merchants are the ones who are complaining that profits are falling and that increases are causing difficulties.

The credit card system is like the goose that lays golden eggs. You said so yourselves. Sales increase, everyone seems to be a winner, but has anyone thought about what would happen if there were no regulation? What would happen if there were a total hands-off approach? Has anyone carried out an interesting study, or forecast that we could obtain? When the goose that lays the golden eggs is over-exploited, it will die.

[Prof. Jack Carr]

We certainly have, as far as interchange fees, a laissez-faire approach. A number of countries do in fact have the laissez-faire approach. As far as I can see, the system is working. The interchange fee, which has been complained about by the retailers, certainly changed in complexity in April 2008. If you look at a weighted average of interchange fees before and after, I understand there's almost been no change. It was 1.58% on average before and it's 1.6% on average now. With all averages, some retailers are worse off and some retailers are better off.

Let me get back to your thing on loyalty programs. You said nobody asked or answered questions on loyalty programs. Loyalty programs exist in a number of industries, and they are a marketing method by which banks, issuers, get customers. They seem to work. That's why they use them. We as economists really have no expertise in designing loyalty programs or designing marketing programs, but we know firms out there will design programs that bring in customers. They appear to work, and there doesn't appear to be anything wrong.

With the merchants, what some merchants don't appreciate is that these programs sign up more customers and bring in those customers to their store.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Mr. Carr, we already heard that.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Carr.

Thank you, Mr. Laforest.

Mr. Bernier, you now have the floor.

[Maxime Bernier, Conservative, Beauce, QC]

Thank you, Mr. Chair.

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.

[Prof. Ian Lee]

Clayton Christensen is a professor at the Harvard Business School who has written on innovation very extensively as the most important form of competitive advantage in a business. That's the way I teach strategic management, where we deal with these questions of how to create value in a business and how to attract customers, as Professor Carr was saying. You use innovation, and it could be innovation in loyalty programs or pricing, or in services around the product and so forth. There's a myriad of ways to differentiate the product, to create value, to attract the consumer, and to deliver a competitive advantage.

Christensen has noted over and over that often when innovation comes—disruptive innovation or radical innovation—it comes from a player outside the industry who changes the rules of the game and comes up with a brand-new technology that has similar functionality. I'm agreeing with your comment that when government enters or the legislators put barriers, impose artificial barriers, you're going to inhibit the innovativeness of our economy. It is CATA, the Canadian Advanced Technology Alliance, that points out that we are lagging behind most of the western world in terms of our innovativeness. Some faculties, some professors, believe it's due to excessive government intervention that regulates the innovative capacities of our businesses.

[The Co-Chair, Conservative, Michael Chong]

We're going to go to Mr. Carr and then Mr. Ware.

[Prof. Jack Carr]

I think the system is working well, and we do want to allow as much competition as possible. We also have to realize that there are economies of scale, so within any platform you're not going to have a large number of players, but within that system we have within, say, the Visa or MasterCard system, competition between acquirers and competition between issuers. So there is that competition, and you want to encourage as much of it as possible.

You have competition between payment systems too, which has to be stressed. The payment system that used to be used 40 years ago was cash and cheques. There was a sort of natural monopoly; that has disappeared, and Visa and MasterCard have grown dramatically, not because of artificial rules they have, but because they have provided a better mousetrap. They provided a better product, so they took over from both cash and cheque, and now you have debit and credit cards.

The point you mention is that what Parliament has to worry about is that you always have groups coming to you seeking regulation. Adam Smith, back in 1776—and John McCallum would appreciate this—said you have to worry about merchants and workers coming to you asking for legislation in their favour, which, like tariffs or regulation, would benefit them. That is what you classically see here. Economists call it rent-seeking. You have a system that is working, but merchants and retailers see an opportunity to gain against the system and to improve even better.

I feel bad for the retailers because currently the economy is doing badly, and retailers, along with everybody else, are hurting. But the economy will pick up; they'll be better off. But you don't want to regulate a system and be left with rules that cause an inefficient means of payment. You'll be stuck with that forever, and the price you pay for giving gifts from one group to the other is an inefficient system that's costly to the economy, that reduces the per capita GDP for Canada, and that clearly can't help. Laws that result in inefficient systems are bad laws.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much, Mr. Carr.

Mr. Ware.

[Prof. Roger Ware]

Just very quickly, in the debit area, what government needs to do is reduce the barriers to entry and encourage entry, as I said earlier. If they achieve that, then we will get more competition and consumers will benefit.

In the credit area, just to follow on from one thing Jack Carr said, yes, 40 years ago we had cheques and cash and then credit cards had a huge successful run. Although we're not likely to get a new credit card network entering because the network economies are just too large, one thing I would predict, for example—and we never can really predict innovations—is we will start to see a lot of online debit transactions in the future, because, for example, the Interac card has not been used for online transactions. I think it's a security issue. That's going to change, I expect, and that may in fact reduce credit card use, but as Jack said, that's innovation and that's efficiency, and that's what we want to encourage and allow.

[The Co-Chair, Conservative, Michael Chong]

Mr. Scholnick.

[Prof. Barry Scholnick]

If I could just comment following up on Professor Ware's comments about innovation on the Internet, one of the more important recent developments technologically is the emergence of this organization called PayPal, of which this committee might or might not be aware. This flowed from eBay, where individual buyers are selling to individual sellers. There are no merchants. There are no big organizations. These are private individuals selling to each other, and you couldn't set up a credit card arrangement between these two individuals because you are a private person and you can't set up a credit card account so that people can pay you. What PayPal did was to set up a system, which is beginning to take off and potentially could become very big and very important as eBay grows, which is in direct competition to Visa and MasterCard in this niche of payment on eBay over the Internet. It's a new platform. I think we will have more and more of these new platforms competing with Visa and MasterCard.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much, Mr. Scholnick.

We will now go to Mr. Mulcair.

[Thomas Mulcair, NDP, Outremont, QC]

Thank you, Mr. Chair. I hope that your watch, that you used to time your colleagues from the government side, and which must resemble a painting of Salvador Dali and is stretching out your perception of time, will be the one you use when timing questions to be asked by the official opposition.