AD: How did plastic first catch on?
RS: The first payment card systems faced a classic â€œchicken and eggâ€? problem: as long as consumers didn't carry cards, merchants had no reason to accept them, and as long as merchants didn't accept cards, consumers had no reason to carry them. Card issuers solved the problem by using aggressive marketing techniques including mailing unsolicited cards to many consumers and then stressing this to merchants.
AD: In 10 or 15 years will we recognize credit cards as we know them today?
RS: We will certainly be using small plastic cards to make retail purchases in 10 or 15 years, if only because their size and shape will remain convenient. I expect some will continue to provide credit and debit functionality, and features nobody has yet imagined. The Internet and its progeny are likely to produce new methods of payment that are faster than credit cards. For instance, if a relatively cheap terminal, linked to a fast and smart network, can quickly recognize my fingerprint (or my retina) and link it to a billing address or checking account, I could make purchases without any card at all. Future means of payment will penetrate only to the extent that they produce net reductions in transaction costs for consumers and merchants.
AD: What is the future of the â€œsmart cardâ€? [a card with a chip in it that acts like an electronic purse, rather than debiting money from a credit line or bank account through a network] in the U.S.?
RS: In Europe, where telecommunications have been more expensive than in the U.S., it made more economic sense to make cards â€œsmart,â€? rather than having all intelligence reside in the network. As chips become cheaper, Americans will come to use cards with more memory than magnetic strips now provide. But nobody knows what features that memory will allow. The AmEx Blue card counts as a smart card, but it doesn't offer anything that can't be duplicated with a dumb card and a smart network. Information can always be stored remotely instead of on the card, particularly if communication is cheap and easy.
AD: Do you think cash will ever disappear?
RS: I don't think cash will disappear in my lifetime, though it may come to be used only for small transactions of no aggregate significance. Cash transactions now have the advantage of speed; the main drawback on both sides is risk of theft. New systems will reduce cash's speed advantage and displace it if they are also low-cost.
AD: What do payment systems have to do with consumer debt patterns?
RS: Credit card debt has historically had a counter-cyclical component, tending to rise in hard times. In the last few years, credit card debt has increased substantially during great prosperity, tending to displace other sources of credit. I expect this trend to continue. Credit cards offer a very easy way to borrow, and competition and improved information will match interest rates and credit limits better to individual default risks and other characteristics.
AD: In your book, Paying with Plastic, you explain how Visa and MasterCard came to dominate the credit card business. What new entrants could disrupt these incumbents?
RS: Advances in computer technology and the emergence of third-party acquirers have made the entry of new systems easier â€” witness the success of Discover. A new entrant would need a moderately deep pocket, but no deeper than could be mustered by Citibank or the Japanese card system JCB.
In the classic 1967 movie, The Graduate, Dustin Hoffman's character, Benjamin Braddock, is pulled aside at a party by one of his father's friends for some condensed career advice. â€œJust one word,â€? the man says. â€œPlastics.â€?
The famously ironic line sought to capture the synthetic quality of life in the late 1960s. In fact, the line was also prophetic. Plastic has become central to at least one role we all play: that of consumer. In 1998 alone, U.S. consumers applied for and received 780 million plastic payment cards. Four million merchants in the U.S. and 15 million worldwide accept plastic card payments. Each household, on average, charges roughly 20 percent, or $830, of its monthly income. MasterCard and Visa, which together control about 70 percent of the payment card market, process an astounding 12 billion transactions a year.
In his book, Paying with Plastic: the Digital Revolution in Buying and Borrowing (MIT Press, 2000), Richard Schmalensee and co-author David Evans, both renowned economists in the field of industrial organization, describe how plastic payments, which are really electronic payments, became predominant. Steady increases in computer power, the Internet and other new technologies seem likely to play a role as our payment behavior continues to evolve.
American Demographics' David Whelan interviewed Schmalensee, who is Dean of MIT's Sloan School of Management, to get his thoughts on the future role of plastics in consumers' lives.