Ready, steady, slow: Ukraine’s bid for Kherson

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Hello and welcome to the Intelligence from the Economist. In New York, I'm John Fassman.

And in London, I'm Jason Palmer. Every weekday we provide a fresh perspective on the events shaping your world.

You may not know what interchange fees are, but if you've paid for anything in America, they've hit you in the wallet hard. They are an artifact of a duopoly, and at long last, legislators have them in their sights.

And springtime on America's east coast is a dangerous time to be a horseshoe crab. The creature's blue blood is extremely useful in the biomedical industry, even though there's a cheaper synthetic alternative. We ask why the crabs are still being bled. But first, A Ukrainian counterattack is continuing today against Russian defenses around the city of Kherson, the occupied capital of Ukraine's Kherson region. Last night, President Volodymyr Zelensky gave little away about the military's progress and its intentions. You will not hear any specifics about our plans, he said, because this is war. But the occupiers must know, he went on. We will chase them to the border.

On Monday morning, Ukrainian forces launched a counteroffensive against Russia in the southern Kherson province.

Oliver Carol is our Ukraine correspondent and is based in Kyiv.

And this is the culmination of several months of preparations trying to soften up the Russian defenses, disrupt their logistics and transport lots are still unclear. Given a media blackout which the Ukrainian military have imposed, they're very careful not to call it a full on counterattack. And they've been emphasizing the fact that this is going to take a long time. But the deputy head of the neighboring Odessa military district has put it quite bluntly, writing the battle for Kherson City has begun.

And why does Kherson matter so much in all this?

Well, Kherson is a key part of the military jigsaw. Depending on your point of view, it's either a gateway to Ukraine's strategic Black Sea ports including Mykolaiv and Odessa, or it's the gateway to Crimea. On the other hand, important economic area for Ukraine, it's an agricultural powerhouse, but also it's got symbolic features as well as a region which put up a fight against the Russian invaders while some of its officials seemed to do the opposite and apparently fled. So it has a three pronged significance for Ukraine. For a long time Ukrainian generals have been hinting that they were preparing a counteroffensive, but this seems to be the time when things are coming into play.

And we've been talking about this potential counterattack for a couple of months now. What's been happening in the meantime?

Well, Ukraine has been doing its best to render bridges and river crossings inoperable. These are important supply and potentially retreat routes. But in the last few days there have been attacks on at least four points along the 200 odd miles of southern front line. And the most interesting are happening northeast of Kherson Centre, where it seems that a Ukrainian unit has broken through and pushed back Russian troops. Some of the elite troops have actually fled, according to reports. I spoke to a Ukrainian military intelligence source about this operation and obviously they're keeping their cards close to their chests. But he said that the operation had been made possible by another offensive in the east of the country which had essentially diverted Russian air resources and it had taken six villages in the process. So on Sunday night, Monday morning, Ukraine turned its attention back to the south, striking key bridges, river crossings, ammo dumps and Russian military headquarters. So that when the Ukrainians attacked the front lines, the Russian side was unable to call on the necessary coordination. So as the official told us, we, when we stormed them, they simply ran. But their aim is not explicitly to take Kherson's city back, at least not yet.

What do you mean by that?

Well, if the Ukrainians were to take Kherson, the fear they have is that the Russians would shell the city from the other side of the river where they have very strong artillery positions. So instead the feeling I'm getting is that the offensive is planned to continue without any hurry and not in actual Kherson itself, but further down the river upstream. The likely aim certainly, as I'm told, is to weaken Russian positions around Kherson City and drive a wedge through the contingent on the western bank of the Dnipro, that is the northern bank. There's about 20, 25,000 Russian troops there. And the Ukrainians, it seems, want to encircle the northern contingent and cut them off from supply and retreat routes and push the southern contingent out of the city. Retreating on their own Ukraine is helped in this because Kherson is quite hard to defend. There's no high ground to speak of, but it's certainly going to be a difficult operation.

And is this the sort of the shape of counteroffensive that you would have expected a couple of months ago?

What's interesting and what's new is that this counteroffensive doesn't just involve strikes on the rear areas like the depots and the headquarters, which have been happening for quite some months now, using American supplied Himars missiles, which are highly mobile, high precision and highly destructive rockets. This is the first time they've been using a tactical battlefield situation. In other words, they've been striking infantry and other frontline positions as opposed to the attacks on logistics and command hubs. And that's been continuing for the last few days. What I was told again by the military sources was that they're using Himars in such a way seems to demonstrate that Ukraine is confident that it has a good supply of these rockets coming through. And the second point as well, which people were impressing on me, was how reluctant Russia has been to use aviation in the area. So they apparently, according to Intercept, called it in on Monday. It didn't come on Tuesday and Wednesday. It was working, but apparently without great confidence. So that would suggest that Russian aviation is not too keen on entering these frontline areas because it might come under Ukrainian air defense, and there's obviously been quite a few losses in that area. And the third thing that Ukraine was saying was that they're very happy that there seems to have been some soldiers essentially fleeing, and they think that that indicates the morale of Russian soldiers might be quite low around that area.

So essentially Ukraine's military thinks this is the right time to make a sharp strike rather than the sort of chipping away that's been going on.

Yeah, I think There's a few things coming into play here. I think it believes it has the trained men in the numbers it needs to attack. And for any offensive like this, according to the local doctrine, it needs at least 3 to 1 in the areas it's talking about. But that would mean that they have been building up to this point and using soldiers being trained abroad in the UK and so on. So that almost certainly has been organized to coincide with this push. But also they seem to want to reach the west bank of the Dnieper before Russia has a chance to send in reinforcements. Russian units at the moment appear to be severely under strength in this area. And the country's 3rd Army Corps, which is a new formation, they've been raising new volunteer battalions, and some of them are equipped with quite advanced platforms. How effective they'll be remains to be seen, but they certainly could allow Russia to pose a greater offensive threat in the coming months. So Ukrainian generals seem to have taken the opinion that this is the time to strike.

But as you say, they're going to do so slowly and carefully. I mean, what to look out for in the coming weeks and months as this goes on.

Certainly in the coming week. It's a crucial period because Ukraine's frontline troops are especially vulnerable. As Russia tries to contain that advanced Ukraine is likely taking significant losses again. That's another reason for the media blackouts. The Russian Ministry of Defense says Ukraine has lost already 1,200 men. That's not likely, but a soldier who's fighting there did tell me that it's very tough out there, and they are taking significant losses. And a harder test lies ahead because they've gone through the first line, but penetrating the second line, which is secured less by infantry, is tougher and more mobile. Mechanical units will be a lot harder. But if it does succeed in doing that, then it does have a chance to move past a third line of defense and towards the banks of the Dnieper River. And that raised the prospect of encircling, but we're a long way from that. At the same time, Ukraine believes it's seizing the initiative here in Kyiv. I mean, people are very excited by this move. The Ukrainian military, certainly not euphoric, but confident. What worries me is that the situation, we've been here before in the summer of 2014, when Ukraine really thought it was turning the tables on Russia. But Russia found a new level, and the rest is history. But certainly the Ukrainian military, they're confident that this is very well planned. They're confident the aims are not Crazy. And they're confident of moving this into a new phase of war which ultimately will favor them.

Oliver, thank you very much for joining us.

Pleasure.

Around the world, people are using cash less and less often.

I don't really carry much cash around.

Anymore because I use my contactless CAT card for most things where I can. I don't use cash very often because I've got my debit card. So it's more convenient to use that.

Paying for goods and services electronically with credit or debit card or your smartphone is convenient. But for retailers, especially those in the United States, the fees they pay to process card transactions are a significant cost of doing business, one that's often passed on to customers through higher prices. Now, questions are being asked about the level of those interchange fees and the market dominance of the two companies that run the card networks.

Americans use credit or debit cards for well over half of their shopping transactions, and that's up sharply over the past five to 10 years.

Alice Fulwood is our Wall street correspondent.

And people like using them because they're very easy to use. They come with lots of perks, like earning airline miles or protecting you from fraud. But in the US at least, they come at a much higher cost than most people realize. America actually has the highest interchange fees of any major economy. That system in the US Benefits two firms in particular. About three quarters of the country's credit card transactions are facilitated by Visa and MasterCard, and they are two of the most profitable companies in the world.

Why exactly are Visa and MasterCard doing so well out of this?

So Visa and MasterCard set interchange fees across the network. The fees are collected by banks who use those fees to fund all of that sort of good stuff that I was talking about, those perks for consumers, those consumer protections. Then the banks pay huge periodic fees to the card networks for processing all of the transactions. And that is a particularly lucrative business to be in in the US because credit card interchange fees are unregulated here. They're usually about 2% of the transaction, and they rise to as much as 3.5% for some premium rewards cards. By contrast, debit cards in America are regulated by something called the Durbin Amendment, which gives the central bank the authority to enforce a cap on fees. So those fees aren't as high. And elsewhere in the world, interchange fees in general are much lower as well. So the European Union has capped interchange fees for credit cards at 0.3% of the transaction value. And in China, the big tech apps Alipay and WeChat take just 0.1%.

And what does that mean for shoppers, for people who use the credit cards?

Retailers have passed those costs on to consumers by raising prices at the checkout. A paper by Joanna Stevens of the Federal Reserve bank of Boston last year found that retailers raised prices on average by around 1.4 percentage points. And that causes a couple of problems. The first is that this system is kind of expensive and, and consumers don't really realise that. And the second is that those premium credit cards, the ones that charge the most to retailers to process, tend to be used by wealthier people and poorer Americans tend to use cash or debit cards, which have a much lower processing cost for merchants. So because everyone pays the same inflated price at the till, there is a significant regressive transfer that goes on under the American system as it currently is.

What are the options for making this system fairer?

So the best solution would be for consumers just to pay the cost that they impose on the merchant. Now, for a long time, the card networks used to forbid adding on surcharges or offering discounts for cash. But there was a major class action lawsuit in 2013 and now merchants can impose a surcharge. But it's still difficult to sort of pass on the exact cost, in part because a lot of merchants don't really know what different cards cost them. What you're seeing now is legislators actually taking an interest in credit cards and looking at how they could improve the system.

Tell us about that, which legislators and what are they trying to do?

So in July, Richard Durbin, who is the same Democratic senator who regulated debit interchange a decade ago and sort of gave his name to that Durbin amendment, introduced something called the Credit Card Competition Act. Now, it wouldn't impose a cap on interchange fees, as you've seen in the European Union and you saw for debit cards in the us. Instead, it would try to spur some competition by breaking the links between card networks and banks. So right now your credit or debit card is issued by a bank like JP Morgan Chase or Bank of America, and that card is partnered with typically one of Visa or MasterCard. Every transaction will go over that card network's Rails. That means that the bank that issued that card is guaranteed the interchange level that that card network sets. If the Credit Card Competition act becomes law, it will force banks to offer merchants at least two rails. For that transaction to go over, the bank would have to offer the merchant a Visa rail and some other smaller network rail. And that might make it possible for that smaller network to compete on the interchange rate.

And what do Visa and mastercard think about this bill becoming law?

So they're quite critical of the bill, which I guess you might expect. Their argument is essentially that if you provide this kind of choice to merchants, the choice to route over different kinds of rails, then you're in effect stripping that choice away from consumers who can't choose to use the Visa Rails and get all of the sort of benefits of the system as it currently is. Their lobbyists are also quite critical of the 2010 interchange regulation as well. They say that the Durban amendment and the efforts to regulate then didn't really have that much of an effect on driving down prices at the tills. And their argument is that perhaps you should be cautious about regulating credit card interchange. If the impact of the debit card interchange regulation wasn't quite what legislators hoped it would be.

I would imagine to a lot of our listeners around the world, using a credit card seems passe. They're using smartphones using their payment apps. It seems these smartphone and app based payment systems have mostly caught on outside the US I would assume that that's going to change, right?

Yes. And if you think about a transaction in person, you know, the only thing in between the merchant and the consumer is that sort of physical card machine that you can only use your credit card for. Now, when you pay online, you have all of these fintechs who actually don't have to just offer credit card payments. They can offer bank to bank transfers, any sort of payment option that becomes viable. And there are a lot of new payment systems becoming viable in the U.S. so one is FedNow, which is a real time bank transfer system being built by the Federal Reserve that's due to be launched next year. And you are now seeing merchants partnering with fintech firms to try and encourage customers to use other kinds of payment. Rails say, for instance, I recently bought a pair of trousers from the sort of millennial online brand Everlane. They encouraged me to pay using Kat, which is a fintech app, and that linked to my bank account through another fintech app called Plaid. And to encourage me to pay using that app rather than using my credit card, they gave me a 5% credit for my next transaction on Everlane. I am actually wearing the trousers that I got from that transaction right now. And it's clear that Visa and MasterCard think that apps like this could potentially be a threat in 2020. Visa actually tried to buy Plaid for $5.3 billion, but antitrust regulators blocked it on the grounds that it would potentially have allowed Visa to eliminate a competitive threat. So where we are now is that you've seen these sort of really radical transformations of payment systems around the world that have really driven down costs for consumers. You still have quite an expensive system in the US but it does seem as though there are real challenges for the system as it stands in the US Now.

All right, Alice, thanks so much for joining us today.

Thank you for having me, John.

Each year, fishermen across the Atlantic coast go out to harvest horseshoe crabs.

Rebecca Jackson writes about American affairs for the Economist.

They bring them to pharmaceutical laboratories where the companies bleed them for up to a third of their blood, and then once they're done being blood, release them back into the wild. The bright blue blood is critical to the biomedical industry, and it can be sold for as much as $15,000 per liter.

So in what way is this blue blood critical to the biomedical industry?

So, as crazy as it may seem, the blood is the only natural source of a material called limulus amebocyte lysate, or what we refer to as lal. And what LAL does is it's critical to endotoxin testing. Basically, endotoxins are particularly nasty and even deadly bacteria. If, you know, even a tiny bit of endotoxin gets into the bloodstream, a person can develop a stroke and even die. And this LAL material instantly clots when it comes in contact with a contaminant. So it's critical for testing a broad array of medicines and medical devices that go beneath the skin. So basically, anything that gets in contact with the bloodstream needs to be tested for endotoxins. And lal, or horseshoe crab blood, is the material that lets us do that. And the reason that this blood has become so expensive is because in recent years, there's been a surge in demand for endotoxin testing. Take, you know, all the millions of vaccines that have been produced in America. Each of those was tested using LAL.

And all that LAL came from the crabs themselves, which you said were released, but they just go off and make more of it.

Yeah, but as you can imagine, if you were to lose a third of your blood, you probably wouldn't be too happy. And I think the crabs aren't either. It turns out that they're quite harmed by this. Conservationists have a really hard time estimating exactly how many die upon release, but estimates range between 5 and 30%. But a bunch of academics from New Hampshire followed a set of female crabs and found that they tend to be really lethargic after the bleeding and that they actually have trouble making their way into the egg laying areas and following the tides. So this means that they're probably less likely to spawn, which means less horseshoe crab babies. And the Wetlands Institute, a nonprofit, found that in the last 15 years, the population of horseshoe crabs at the Delaware Bay, which is where most of the crabs spawn along the Atlantic coast, has declined 90%. So much so that they're listed as vulnerable to extinction, one step below an endangered species.

And horseshoe blood really is the only source of a substance that can do this kind of testing.

So it's actually not. And that's what's kind of crazy. So in 2003, which is quite a while ago, Lonza, a Swiss biotech company, cloned crab DNA, basically using exactly the same chemistry as LAL to make recombinant factor C, called RFC for short. And it's basically a totally synthetic version that doesn't rely on animals at all. Jay Bolden, a biologist at Eli Lilly, a pharmaceutical company in Indiana, basically pioneered using RFC in America. In 2017, he ran a study that found that RFC was just as effective, if not more effective than LAL at detecting endotoxins. In fact, it turned out fewer false positives and was cheaper to run. So it seemed all around better. And in 2018, the FDA approved the first drug that was tested with RFC instead of LAL. And that was kind of a turning point for Eli Lilly. Since then, they vowed to switch over all their new products to RFC. And the company is now 80% converted away from LAL, but very few others are following suit. And in America, we still primarily use lal, but in other countries, like across Europe and in Japan and China, they've shifted. And America's really dragging its feet on this. It's kind of an outlier.

But why would that be? If there's a more effective and a cheaper test that doesn't require grabbing horseshoe crabs off a beach, then why aren't more companies using it in America?

So it's sort of a regulatory problem. Basically, there is an organization called US Pharmacopoeia, or usp, which has been granted statutory powers to set medical guidelines. Basically what they do is they say this is the way to produce this sort of drug. And for endotoxin testing, the only method that they've approved is lal, and they have not adopted the synthetic version. This is a little bit baffling because pharmacopoeias in Japan and China and across Europe have adopted the method, But USP in America has been dragging their feet. Basically, the FDA makes it really hard for companies to get drugs approved that aren't in the USP manual, they have to put a lot more effort into proving that their drug is effective and safe for the FDA to approve it. If it's not in the USP manual, that means that it ends up being pretty risky and expensive for pharmaceutical companies. Eli Lilly decided the trade off was worth it, but many others don't think so. So until the USP decides that they're going to add it to their manual to their pharmacopoeia, it's going to be very difficult for pharmaceutical companies to get drugs approved.

And meanwhile, things get even more difficult for the horseshoe crabs themselves.

Yes, the holdup is pretty costly, right? You can imagine that we're doing damage to this vulnerable species. They're really on the decline and the demand is soaring. But we have this alternative. And the alternative is also cheaper and easily mass produced. So it seems very confusing that we're not using this synthetic alternative. Charles river, one of the four domestic producers of Lal, maintains that the fears about supply chain are overblown and that their bleeding really does little harm to the crabs. But we know that that's not entirely true. If the usp, the pharmacopoeia, were to approve the synthetic alternative, the floodgates would open and many companies would shift away from using lal. But until then, it's not looking good for the crabs.

Thanks very much for joining us, Rebecca.

Thank you, Jessica.

That's all for this episode of the Intelligence. Let us know what you think of the show. You can get in touch@podcastseconomist.com and you.

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