How does the way we pay influence GDP?
…After all, as long as we pay, it counts towards GDP, doesn’t it?
A recent report by Moody’s Analytics emphasizes how credit card payments have contributed to the economy. In the period from 2008 to 2012, greater usage of electronic payments added $936 billion in global economic growth. In the same time, card usage raised consumption by an average of 0.7% across the 56 countries in the sample.
Credit card usage has raised global consumption to the tune of nearly one trillion dollars. This huge sum was added to the economy solely because a large group of people preferred to use their card instead of handing over cash.
Now let me enlighten you to an eternal truth:
When you pay with a credit card, you are not paying with cash.
As obvious as it is, the implications of this are much deeper and wider-ranging that we might think at first.
Cash is actually not that easy to spend
Take the perspective of central banks. If people are using immaterial money to make payments, it means they use less “hard cash”. Printing and minting this hard cash comes with costs (for materials and people): if you reduce the amount of notes and coins that people use on a daily basis, you automatically reduce the cost of producing that cash. Remember this does not mean that a country is contracting its money supply, as that has totally other connotations and consequences. Simply, if you spend with a credit card, you transfer one balance to another, without requiring the actual legal tender to do so.
Cash is easily left unspent. You might be thinking “Well try telling that to my shopaholic friend!”, but it’s true. Consider the amount of cash that is not in circulation, and is, to all intents and purposes, lost for the general economy, because it is lying under sofa cushions, behind furniture and in other hard-to-reach places full of dust bunnies. And let’s not forget the drum of the washing machine. This is a serious drain on the economy! Joking aside, we have all had the experience of coming home after a holiday abroad and being left with some spare foreign change. This potential spending power is lying dormant and can’t be used unless and until we go back to that country.
This cash can’t be spent – but this doesn’t happen with a credit card: the amount of money that you have on the card is always accessible and usable. You can’t lose a couple of euro out of that behind the sofa.
As a result, the more cards there are, the faster money will circulate in the economy – cash, being material, can be prevented from circulating, as you have to have it with you and actually exchange it. Credit and debit cards remove this point of friction and exchanges are faster as a result. The quicker circulation of money in an economy directly translates as growth. In economic terminology, we call this the “velocity of money” and the higher it is, the greater the effect of the Keynesian Multiplier.
The double-edged sword of ease of transaction
Now from the point of view of the consumer, this quicker circulation might not be ideal, since it facilitates impulse spending. But from the point of view of the general economy, the resulting increase in transactions is a good thing. Imagine you, the consumer, are in a shop making a buying decision. Does it push your budget? Do you want to treat yourself? Is the item on sale? After a bit of mental tug-of-war you decide to buy whatever the item is. But what if you don’t have cash with you and the shop only takes cash? You will have to leave the shop, find an ATM, make sure it is working, get the cash, and walk back to the shop. This, in effect, is a cooling-off period. Now you might have a sobering realization, and never make the purchase. Or perhaps the person who is with you and doesn’t think it’s reasonable to buy the item will have had more time to make a compelling argument…
Paying with a card, for better or for worse, makes the transaction immediate and removes friction. Buying decisions are made more quickly and there is no delay in accessing funds, thereby explaining the huge growth in consumption as a result. The role of psychology in those decisions cannot be understated: what if I have to hand over a big fifty euro note, then another, and then another, for that beautiful skirt? Suddenly I see the cash bleeding from my wallet or purse, which will feel lighter afterwards. There is a reason serial shoppers are advised to always pay in cash in order to control their spending – suddenly transactions are made vividly real!
But, again, for the wider economy, the frictionless, easy transactions that credit and debit cards allow are good and amount to economic growth. On a side note, the Irish citizen in me would like to point out that this ease of payment is also one of the factors that, on an extreme level, can lead to an economy in which people hold the highest level of household debt in all of Europe…
Dematerialized transactions mean less theft,
robbery and grey economy
The third perspective is that of merchants. To them, credit card payments are wonderful because those payments are guaranteed: merchants are paid immediately, while the onus is on the credit card company to get the money from the buyer. Issuing an invoice, on the other hand, leaves merchants vulnerable to the possibility of bad debts. This translates into a higher cost, to them and to other buyers – more effort and non-billable hours spent chasing down reluctant payers mean businesses have less billable hours in which to make the money they need to make.
In shops, less cash and more dematerialized transactions mean less chance of theft or robbery, less calculations and less margin for error since there is less handling. If less money is lost in this manner, it can make its way into the economy and feed into GDP as greater sales. This also means there is less bookkeeping to be done and more of it is automated, which, again, brings down the cost of trading.
Note also that each credit card payment is recorded: this reduces, and in the long term might even eliminate, the grey economy. If every single transaction is documented, it can be taxed, regulated, monitored and can be counted within the computation of GDP.
No card? No E-commerce, less international trade
A final point is that, without credit and debit cards, there would be no e-commerce and no m-commerce (transactions from mobile phones). This last sector is enjoying huge growth: from $1.2 billion in 2009, it reached $11.7 billion in 2013 and is predicted to reach $23.8 billion in 2015. Both e-commerce and m-commerce represent a considerable part of GDP… and both are totally down to credit and debit cards. Secure credit card payments remove many issues of trust, or simple logistics, between buyer and vendor. Efficiency enjoys a huge boost, and consequently more money is spent.
If you think of it, this is also reflected in international trade. “Tourism”, in the economy of a given country, is money that is spent “abroad” and is part of imports. You can “import” something even though you never take it back home, and you can engage in “tourism” activities even though you never leave your living-room. Say you go to Australia and use your credit card to pay for a meal at a restaurant – this is tourism in its literal sense, but you have also “imported” something by paying for a foreign product or service with income from a different country than the country where the product or service is created. If you buy a book from a UK bookshop and have it sent to your address in Ireland, this is in effect an import, as your payment will take place in a foreign country.
Either way, credit and debit cards and e-commerce directly contribute to an increase in the tourism trade and in international exchanges of goods and services. Easier, frictionless payments mean more transactions are taking place,that directly contribute to the growth of the economy. This is both a threat and an opportunity to an economy, but it’s up to us to create the best online shopping experience we can, to ensure that it’s the latter.
The way in which we pay is directly related to economic growth and GDP. Personal consumption is a part of GDP: if it rises as a result of payments becoming easier, GDP will rise accordingly. This is facilitated by the fact that more people now have credit and debit cards, and by the growth of card usage.
Are you on the list?