When Is Checkout Time?

Article excerpt

"They always say time changes things, but you actually have to change them yourself. "

-Andy Warhol (1928-1987), The Philosophy of Andy Warhol

The death of paper checks has been predicted for many years. Starting in the 1960s, futurists thought that computers and electronic networks would replace paper checks, long the leader in noncash retail payments. Yet in 2000, 42.5 billion paper checks were still being written. What such prognosticators forgot was that economic agents have to have an incentive to change their behavior because there is always some cost for changing it.

Converting large-value payments turned out to be fairly straightforward because they generally occur among financial institutions and large businesses. For some time, the benefits of converting these large-value transactions from paper-based instruments to electronic ones more than offset any transition costs. By 1987, electronic payments, mostly in the form of wire transfers, accounted for 83 percent of the total value exchanged in trade, while paper checks accounted for only 16 percent. Thus for large-value payments, the futurists essentially got it right.

However, for retail payments, which are far more numerous than large-value payments but for much smaller sums on average, the best we can say is that rumors of paper check's demise were premature. What was not understood was how much more challenging it would be to convert retail payments that take place among millions of consumers and thousands of small businesses from paper instruments to electronic ones. This process has only just begun to occur in a significant way within the last 15 years.

Estimates suggest that as recently as 1987, most transactions were conducted with cash (83 percent), while a sizeable chunk was still done by check (almost 15 percent). Electronic payments were practically nonexistent: All forms of electronic payments together totalled less than 0.5 percent of all transactions ("The U.S. Payment System: Efficiency, Risk and the Role of the Federal Reserve," by Alien Berger and David Humphrey, 1990). Thus, while the value exchanged in trade had largely gone electronic by 1987, the vast number of small-value transactions had not.

Over the last few years, the cost of providing electronic payment services has fallen, so much so that, in many cases, payment providers can offer consumers incentives to use their electronic instruments while still lowering merchants' overall cost of handling these payments. Consumers are responding. A comparison of the shares of various payment instruments in 1987 with those for 2000 shows that the payments market has changed significantly (the 1987 estimates are from the Berger and Humphrey article cited above, and the 2000 estimates are from a survey conducted by the Federal Reserve in 2001 of depository institutions, electronic payment networks, and card issuers). In 1987, checks were the dominant form of noncash payment, accounting for 85 percent of all the transactions that weren't conducted with cash. By 2000, check's share had taken a dive, falling to 59.5 percent. Retail electronic payments, a blip on the radar in 1987, were starting to take over. In 1987, they accounted for less than 2 percent of all noncash transactions; in little over a decade they had grown to 40.5 percent. (Other forms of noncash retail payments in 1987 were credit cards-then considered nonelectronic-travelers checks, and money orders.)

Evidence from other sources suggests that electronic payment instruments are making inroads against paper currency as well. The real value of small-denomination notes in circulation, the type most frequently used in retail transactions, has been falling since the late 1980s (see figure 1). Except for a brief surge just before Y2K, real per capita currency holdings have fallen 27 percent over the last 25 years, even though real per capita personal consumption expenditures have increased 68 percent. …