Afterpay tells us were suckers for the illusion of free
Thereâs more to be learnt - sorry, there are more âlearningsâ â" from the phenomenal success of Aussie âfintechâ start-up Afterpay before it drifts off into corporate history. Learnings about human nature, public policy and what switched-on economists call âmarket designâ.
Economists need to do more thinking about the way markets are â" and should be â" designed. The sub-discipline of market design recognises that, increasingly in the real world â" especially the digital world â" markets donât work in the simple, transparent, what-you-pay-is-what-you-get assumed by economics textbooks.
Afterpay is currently working on a merger with US group Square.Credit:Attila Csaszar
This means thereâs more scope for âmarket failureâ â" market forces not delivering the benefits that economic theory promises they will.
Afterpayâs first âlearningâ is that, far from being ârationalâ â" carefully calculating â" consumers (and taxpayers) are hugely attracted by the illusion that something is free. Afterpayâs success seems explained by Millennials being greatly attracted by its promise to let them BNPL - buy now, pay later - without charging any interest.
It seems young people are turning away from credit cards and their very high interest rates in favour of BNPL. When you think about it, however, you see there isnât much difference between a credit card and an Afterpay BNPL interest-free loan.
A standard credit card is also an interest-free BNPL loan provided you pay it off at the end of the month, in full and on the dot. Fail to manage that, however, and you soon see how high credit card interest rates are.
(Warning to all lawyers and judges: apparently, your legal learning robs you of the ability to understand the argument that follows. To a lawyer, any payment to a lender canât be a payment of interest unless itâs wearing a label that says âinterestâ and is expressed as a percentage of the amount lent. Youâd all make good Millennials.)
With an Afterpay BNPL loan, itâs only interest-free if you make four equal fortnightly repayments on time. If youâre late with a repayment, youâre charged a $10 late fee. And if youâre more than a week late youâre charged another $7.
The usurious nature of these charges is disguised by their small absolute size (but the amount borrowed is also pretty small) and by our practice of expressing interest rates on an annual basis (this loan is only for eight weeks, not 52).
But thatâs not all. As Milton Friedman didnât win his Nobel prize for discovering, thereâs no such thing as a free lunch. Even if the borrower using either a credit card or BNPL manages to repay their loan without incurring any penalty, the lender still has to receive the equivalent of an interest payment to make the transaction worth funding.
In the case of both credit cards and Afterpay loans, this is achieved by a âmerchant feeâ paid by the retailer that made the sale. The fee is a percentage of the amount lent although, in the case of Afterpay, itâs a huge 4 to 6 per cent plus a flat 30c. (My guess is the 30c is there to fool lawyers into thinking the fee couldnât possibly be payment of interest).
Whatever the reason, Afterpay has managed to convince the lawyers that, since BNPL obviously has nothing to do with borrowing and lending, it cannot be subject to the Credit Act, meaning Afterpay is not subject to the âresponsible lending obligationâ and so escapes the expensive obligation to do credit checks and verify the borrowerâs ability to repay the debt. (Weâre assured, however, that Afterpay and its many imitators are subjecting themselves to a voluntary code of conduct.)
This raises another âlearningâ right there. Almost invariably, the many market disrupters produced by the digital revolution â" including Uber and Airbnb â" amount to the combination of a genuine, productivity-enhancing innovation (something every economist wants to encourage) and a trumped-up claim that, because weâre so new and different, none of the regulation that shackles the existing industry applies to us.
âTheir workers are employees, ours arenât. The firms weâre disrupting have to provide employee super contributions, annual and sick leave, and workers compensation insurance, as well as comply with health and safety requirements, but we donât.â
This, of course, is why weâre developing a two-class workforce, where those unfortunate enough to be able to find work only in the âgig economyâ have badly paid, precarious employment with bad condition and few rights.
The thought that this regression to feudal conditions for some should be allowed to persist in an economy as rich as ours is utterly repugnant. And to respond to it by introducing a universal basic income is an admission of defeat.
But before we leave Afterpay, thereâs another learning. Using merchant fees to hide the interest cost of BNPL schemes, whether credit cards or Afterpay-style, involves an arrangement thatâs both inefficient and unfair. It encourages retailers to recover the effective interest cost by raising their prices to all their customers, thus obliging those who pay cash or with a debt card to subsidise those who choose to BNPL.
Afterpay prohibits retailers from recouping the cost by asking those who choose BNPL to pay a surcharge. Just as Visa and Mastercard used to prohibit retailers from imposing a surcharge on those who choose to pay by credit card.
For obvious reasons, the promoters of supposedly interest-free loans want the true cost of this free lunch to remain hidden. The Reserve Bank â" which has oversight of payment system regulation â" laboured for years to get the prohibition on credit-card surcharges outlawed, and finally succeeded.
These days, credit-card surcharges have become common. My guess is that these surcharges, not just the advent of Afterpay and its imitators, help explain the big shift from credit to debit cards. This is just what the Reserve wanted to see.
But itâs utterly inconsistent for the authorities to stop the banks from banning surcharges while allowing Afterpay to ban them. Maybe theyâre applying some kind of infant-industry argument. Let them get established, then rope them into the regulatory fold.
Final learning: look around and you find our human susceptibility to the illusion of âfreeâ in lots of places. Starting close to home, free-to-air television and â" until Google and Facebook stole our business model â" almost-free newspapers and websites were so much a part of the furniture that it was easy to forget that the cost of all the advertising they carried was buried in the cost of most of the things we buy.
The internet still carries a host of free sites with interesting and useful information, even if the legacy newspaper companies have finally moved to making most of their money via subscriptions.
Then there are Google and Facebook, for whom the market-design people have invented a new bit of jargon. They are âmulti-sided platformsâ whose ostensibly free services are paid for by selling to advertisers the myriad information the platforms have gathered about the preferences, actions and locality of their users.
But our love of the supposedly free â" our preference for having the true cost of things hidden from our sight â" applies just as much to us as taxpayers. It took the Liberals a long time to realise how much voters loved Medicare, and didnât want it fiddled with. Why the great love? Bulk billing. The way it makes visits to GPs and hospitals appear free.
Despite all their speeches on the evils of higher taxes, the Libs (like Labor) have never needed to be told of the one tax increase we donât mind because we donât see it: bracket creep. When it comes to kidding ourselves, weâre past masters.
Ross Gittins is the Economics Editor of The Sydney Morning Herald.
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