Zywicki's interchange paper repeats a claim made by other opponents of interchange regulation that cross-subsidies, even regressive ones, exist throughout the economy, so there's no reason to get worked up over the interchange cross-subsidy imposed by credit card network rules. 

Zywicki provides several examples of cross-subsidies in the consumer economy:  Starbucks charges the same price regardless of whether a consumer takes sugar and cream, so those who take their coffee black subsidize the sugar and cream of the others.  Supermarkets offer free parking, so the walkers subsidize the drivers. 

Zywicki's examples, however, are false analogies to the credit card
interchange cross-subsidy from users of low cost payment methods (cash, debit, nonrewards credit) to users of high cost payment methods (rewards credit).  The Starbucks' cross-subsidy is Starbucks' business decision.   The free parking cross-subsidy is the grocery store's business decision.  But the interchange cross-subsidy is not the merchant's business decision.  It is the card network's business decision.  Card networks force merchants to impose a cross-subsidy.  It's an affront to the nose-picking rule of commerce:  you can pick your friends, you can pick your prices, but you can't pick your friends' prices….

With this in mind, it's worth examining another cross-subsidy caused by interchange.  Interchange fees are paid from acquirers to issuers.  The fees are the same for all banks.  Therefore, the safer banks are subsidizing the riskier banks in a card network.  But there's a catch.  The safer bigger banks often get rebates from the card network in addition to interchange fees. 

Two interesting points about this.  First, it shows that the card networks won't tolerate cross-subsidies for themselves. Second, it casts some doubt on the efficiency rationale for interchange fees–that one-size-fits-all fees are sensible as a way to avoid the transaction costs of individually negotiating every issuer-acquirer contract.  Truth is that 20 or so banks make up 95% of the credit card market.  The transaction costs for these banks to negotiate with each other is fairly low.  This points to the question of whether small banks should be in the card business at all.  Cards are very much an economy of scale business; smaller issuers tend to see cards as loyalty devices, not profit centers.  Would a 20-bank card market be a more efficient arrangement than the current networks with thousands of institutions? I'm not sure, but I think the efficiency of the interchange system is far from proven.