China has been at the forefront of the technological revolution in payments in both the private and public sectors. Chinese technology companies have succeeded in replacing the world of bank-based magnetic striped cards with a technology-based QR code system. Then the People’s Bank of China (PBOC) launched its central bank digital currency, followed by a series of government measures that appear designed to steer the Chinese system away from these tech companies. What is happening in Chinese payments is a fascinating battle between private sector innovation versus government control and big technology versus big banks, putting the usually boring and sober world of payment systems in the spotlight allowing broader narratives about the future to be examined. China and how to play the global economy game. It also provides insight into how the Federal Reserve plans to handle digital payments in America.
The Chinese payments wars stand in sharp contrast to the standard analysis of the global economic game. In the standard model, the United States is the current advanced economy while China plays the role of economic catch-up. At the same time, China is modernizing its own domestic system to resemble Western economies while integrating at various levels into the broader global financial system. The story of the payments begins along this common narrative. The United States has primarily built and dominates global retail payments through a magnetic stripe card-based interface that runs through the global banking system. This system has its roots in a series of inventions going back nearly 50 years in New York, which began as a set of solutions for restaurants and regular customers who couldn’t reach cash over the weekend and looking for an alternative to a paper check payment system. These “Diners Cards” eventually morphed into a series of plastic cards, building a suite of payment bars that process more than 130 billion transactions annually in the United States, representing more than 350 million transactions daily. To put that into perspective, the maximum number of daily transactions in Bitcoin is estimated to be around 400,000.
Striped magnetic cards have dominated the world of retail payments in advanced economies. At an early stage in its economic development, China attempted to emulate and graft this system with several banks offering their own sets of magnetic strips and cards including Union Pay as the most prominent example. Founded in 2002, Union Pay’s reach rose sharply to over 3.5 billion cards in circulation in just a decade, and volume was nearly half of what Visa was processing in the mid-2010s.
The story contrasts with Chinese tech companies, WeChat and Alibaba, who have appreciated the inherent shortcomings of the card-based system: exchange fees, card builders and card readers, and costs to merchants. Chinese merchants, especially the younger ones, lacked interest in this expensive system. By taking advantage of these opportunities, the two technology companies have created a system based on QR code digital wallet scanning, which has essentially bypassed debit magnetic cards. The new system was faster and more efficient than magnetic debit cards, producing a range of direct and indirect benefits for these two companies as well as for the broader community. This innovation allowed China to bypass the magnetic stripe card system that dominates much of the retail payment system in the Western world.
China’s new payment system has exploded from inception to dominance in less than a decade. With over a billion users on each platform, the power of network incentives has been unleashed. The new payment system replaced cards and cash on records, changed the way families give gifts and even improved the way beggars ask for money, with QR codes replacing tin mugs.
This is a powerful example of Chinese innovation, competition, and adoption. It appears, at least to outside observers, to be very organic and internally driven, and not a product of central planning or commissions. For example, the two companies differed in the origin of their payment systems. WeChat Pay is based on a social media platform (Americans think Facebook) and is heavily involved in in-person payments. WeChat Pay was first introduced as a service to facilitate personal money in the form of “red envelopes” (traditional cash gifts) around the Lunar New Year in 2014. WeChat Pay suggested digitizing this exchange, giving them personal social connectivity. The media network was clearly synergistic. The popularity of Red Envelope exchanges has resulted in many customers’ WeChat Pay accounts being seeded with seed money. WeChat launched the Red Packet digital payment idea in 2014, and 16 million packages were sent. The following year, a billion packages were sent. By 2016, it was over 8 billion and in 2017, 46 billion.
Alipay origin varies. Alipay is a payment platform developed by Chinese technology company Alibaba that has roots in digital commerce (think Amazon) and is therefore likely to be used for commercial purposes. Online commerce requires electronic payment systems that integrate with credit and debit cards. The lack of such a system in China prompted Alibaba to develop Alipay to support online shopping platform Taobao. With Alipay’s main competitor, UnionPay, only launching recently and not gaining many customers, the payment market has been wide open. Alibaba offers merchants incentives to use Alipay for purchases through their platform. They offer tangible purchases for both parties, preferential placement on digital platforms for merchants, and ease of payment integration into business processing. These differences provide economic benefits at lower costs and potentially larger transaction volumes that are not widely available in the forked credit/debit card system.
There are potential drawbacks to this integrated model, including a lack of fees to provide the services customers want through payments – such as interest-free credit grace periods – and anti-competitive concerns about integrating business and social networking platforms with payment platforms.
With this technological advancement, China has had many components needed to challenge the current retail payments system and seems ready to jump into the global payments competition, which is in dire need of an advance of the 50-year-old plastic cards that look sad. misplaced in the digital environment.
However, it appears that China did not choose to do so, and instead did its turn in the opposite direction and is now heading in the other direction. Rather than aggressively expanding the system and opening it up to a wider network the way the US card-based system did, China has taken a series of measures to slow tech companies, boost the role of government, and possibly return payments to a central bank system.
The Chinese government intervened in the creation of a central bank digital currency. This digital yuan uses much of the same infrastructure as payment systems on WeChat: digital wallets, QR codes, scanners, etc. Just this month, People’s Bank of China Governor Yi Gang announced a goal of “interoperability with existing payment instruments” for the digital yuan.
The digital yuan is currently operated in more than 10 regions in China with more than 150 million users. It was first launched in Shenzhen, the hometown of Tencent (the company that runs WeChat Pay). It doesn’t take a skilled US-Chinese international diplomat with a deep understanding of history to understand that the decision to roll out the digital yuan in the payment giant’s hometown sends a clear message. If the US government started an online bookstore/retailer and chose Seattle, the message would be universally clear.
In addition to Alibaba’s aborted initial public offering of its financial arm Ant and a raft of systemic problems cited by government officials and regulators, there is a message that China is temporarily halting any prospect of the global expansion of Alipay and WeChat payment systems. On the contrary, what appears to be happening is that instead of exporting Chinese digital wallets in the hope that they will become as ubiquitous as the Visa, MasterCard, and American Express networks, there is instead a desire to redirect the internal Chinese system to be so. It focuses on a central bank digital currency that is operated through digital wallets more closely linked to the Chinese banking system.
Now, it is plausible that this change will eventually lead to the creation of a digital yuan using very similar technology bars to QR codes, which were first piloted by Ali and WeChat and which will in fact be identical to repeating history. The original American credit card, Diners Club, is coordinated between restaurants (merchants) and consumers, not banks. This model eventually lost the race. MasterCard itself is a consortium of financial institutions with a very different history from Visa, which was born out of Bank of America, and American Express, which started as a closed payment system and is today part of a banking holding company.
Previously, it seemed plausible that an Alipay or WeChat-linked digital wallet could be a global phenomenon spreading beyond China into the phones and pockets of billions of people around the world. This now seems unlikely. Instead, Chinese digital wallets via Chinese banks are showing where China is heading. This model seems an unlikely way to facilitate international trade throughout Europe, or even Africa, let alone challenge the United States for a share of the domestic market. Although Alipay and WeChat are accepted in the US in retail stores, they are used almost exclusively by Chinese individuals, not Americans.
This begs the question: When China makes technological advances in globally competitive industries such as payments, is China’s ultimate goal to export this technology and create a global trade network? Or is it ultimately an internal process in which Chinese citizens feel the benefits and costs and the Chinese government maintains control? Gunpowder was called in China centuries before the formula arrived in Europe which used it quite differently.
From an American perspective, there is a bit of a sigh of relief that China has built a mousetrap that is better in many respects. It’s also a snapshot at the arm of the Federal Reserve, which has devoted significant resources to looking into launching its own central bank digital currency. China wasn’t the only entity paying the Federal Reserve. Facebook’s original announcement of the launch of a digital currency (then called Libra, now Diem) was another key moment to revitalize the Federal Reserve to consider alternatives. The Federal Reserve’s consideration of central bank digital currency has been significantly influenced by the payment measures proposed by China and Facebook. This helps explain how the same Federal Reserve that failed to adopt real-time payments in the United States despite the European Union, the United Kingdom, Japan, Mexico and many other countries that had adopted such a system years and decades ago, is now devoting significant attention to this system. Create a new digital currency for the central bank. Whether or not the Federal Reserve will launch a new digital currency is a long way off. Meanwhile, low-income consumers are still paying billions as a result of the Fed’s failure to modernize its payment system. By my estimation, more than $100 billion has already been taken as a result of the Fed’s failure to act when the UK turned over a decade ago. It represents one of the biggest policy failures that contribute to income inequality and needless inequality in America in my lifetime.
In conclusion, while it is currently unclear whether the Federal Reserve will launch a central bank digital currency, China appears to be sticking to the digital yuan’s path. It seems likely that such a move would also favor returning payments on a larger scale to its banking system, away from its two technology companies. However, it appears that the technological system for QR codes and digital wallets will remain in China regardless of who is operating the system.
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