Academic journal article Economic Commentary (Cleveland)

Resisting Electronic Payment Systems: Burning Down the House?

Academic journal article Economic Commentary (Cleveland)

Resisting Electronic Payment Systems: Burning Down the House?

Article excerpt

In the Cleveland Museum of Art hangs a famous painting, The Burning of the Houses of Parliament, by J.M.W. Turner. The painting depicts an event that provides a fascinating case study of the difficulty of changing payments systems in the face of new technology. This difficulty is surfacing again as modern economies face the switch from paperbased payments systems to a variety of electronic systems. The Rivlin Committee called attention to the phenomenon in its 1998 report when it observed that "...the reliance on paper-based retail payment methods is striking in an electronic age."' The report estimates that the percentage of paper makes up 78 percent of all noncash transactions in the United States and only 37 percent in Europe. Why has the United States been so slow to change`? Much insight into the reason can be gained by examining the events surrounding the original adoption of paper as a means of public record keeping events which led to the disastrous fire depicted in Turner's masterpiece.

This Economic Commentary explores path dependence as a reason for the choice in payment systems. as well as for other economic phenomena. Path dependence means that historical decisions made in the remote past will often determine the decisions made today. It is related to the physical concept of hysteresis. Hysteresis refers to the failure of a system to return to its original value once the source of a change has been removed. Thus, when you put pressure on a bar beyond a certain point, it will bend, and hysteresis will keep the bar bent when you remove the pressure. The bar's shape reflects the historical pressures that made it bend and will therefore show its path dependence. This Economic Commentary will show how path dependence and hysteresis work to determine economic events, particularly when network economies are in effect, and will suggest that policy intervention may be justified where hysteresis is clearly at work. The Burning of the Houses of Parliament represents an event that illustrates the ability of network economies to create a path dependence in payment conventions.

Turner's painting portrays an 1834 fire which destroyed Britain's historic Parliament buildings. Subsequent investigation revealed the cause of the fire to be the burning of a stockpile of old tally sticks. Tallies were hazelwood sticks used in Britain from the twelfth to the nineteenth centuries to maintain tax accounts. Sticks were notched to show the amount paid and then split lengthwise so that both the taxpayer and the Exchequer would have a record of the payment. The larger piece, called the stock, belonged to the payer, and the smaller, the foil, was kept by the government. When foils were no longer needed, they were used for fuel and burned in the fireplace of the tally room at frequent intervals.

Although it was certainly clear by the seventeenth century that paper was a cheaper and far more efficient means of record keeping, the tally system remained in effect as the means of tax recording until 1826, when it was formally abolished. However, reluctance to accept the new medium delayed the complete transfer to paper for nearly a decade and sowed the seeds of the fire; during the transition to paper, tally sticks were used as a backup, and old foils were allowed to pile up.

When Parliament finally decided to dispose of the eight-year accumulation of foils, the clerk assigned to the task decided to burn them in the furnace of the House of Lords. The fire burned intensely and eventually grew out of control. (There is some evidence that the workmen also enjoyed the "astonishing blaze" created by the sticks and may not have been as careful as they should have been.2) By morning, the House of Lords, the House of Commons, the Painted Chamber, and a variety of other buildings had been completely destroyed.

Path Dependence

The use of tally sticks until 1826 reminds us that much of what we do today is determined by what was done yesterday or, indeed, by a minor decision centuries ago. …

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