Irrationality is the root cause of major and minor outcomes in the real world.
Whether or not you are outraged by the idea of credit card companies charging their usual fees on donations for Haiti relief, the fact that the issue even arose says something about why the financial fiasco of 2007-2010 occurred.
Start with the kerfuffle. A few days ago, a story appeared fulminating about the fact that credit card companies were “profiteering” by charging their usual 2 percent to 3 percent fees on payments to charities for aid to Haiti.
The issue was a flash in the pan because once such negative stories began to appear in the media and blogosphere, the companies surrendered without firing a shot, saying they would waive fees on money sent to a long list of charities and NGOs.
As an economist, my reaction on reading the wire story was: “Oh, for Pete’s sake!” We don’t fuss about the Postal Service profiteering on payments mailed to the same charities. Nor do most people care about profits on jet fuel sold to haul supplies to Haiti or those of the water bottlers, blue tarp manufacturers or any other vendors of relief materials.
Nor, for that matter, has there ever been much fuss about the tens of millions of dollars credit card processors earn each year on bread-and-butter donations Americans make to a whole range of charities.
The article writer did make a good economic point that the marginal cost to the credit card companies of processing one more z`payment is very low. Most of their costs are fixed ones for staff and information technology infrastructure. Handling 10 million or even 20 million additional transfers doesn’t increase their total costs much. That does contrast with fuel, water or food vendors for whom raw-material costs are large.
But the marginal cost to the Postal Service of moving one more letter also is well below the cost of a stamp. Again, much of the total cost of postal service is for fixed infrastructure. The same is true for the cell phone companies that are seeing vastly increased traffic to and from Haiti. There is no call for them to waive charges.
But, by virtue of experience, I understand that not everyone thinks like economists. Some people are angered that Visa, Mastercard, Discover and American Express would earn $3 million on $100 million from donations to help suffering Haitians. They don’t think about the fact that on typical $10 or $20 gifts, the monetary cost of an envelope, stamp and check plus the opportunity cost of the time involved in writing out the check, addressing the envelope and taking it to a mailbox are greater for most people than the 30 cents or 60 cents that might have gone to Visa.
Economists would deem such attitudes irrational, just like people being happy to sell a house for $1,000 more than they paid for it but refusing to sell for $500 less, even when prices are clearly on the downslide and they are likely to be still lower in the future. Or of game show contestants who would never pay $30,000 for some particular car but won’t sell it for that price if they win it. The list of such “irrational” behaviors goes on.
Yet conventional economic theory rests on the assumption that people are rational in all important decisions. This is particularly true for the micro-level finance theory that markets are always efficient and the macro-level theory of rational expectations that says any government action to stabilize an economy is inherently counterproductive.
Assuming that humans behave rationally was at the core of former Federal Reserve chairman Alan Greenspan’s belief that government regulation was not needed because financiers would never take positions that would endanger their long-term financial well-being. It lay behind the assumption that there was no housing bubble, because there could not be one, according to accepted theory.
What actually transpired over the last 30 months belies years of work by some of the best and brightest in the discipline of economics. So does anger about credit card companies pocketing their usual take from charitable payments.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.