In this short post I argue for a viewpoint of seeing protectionism as a market failure. Although not a definite nor a perfect viewpoint in general, I think it makes clear certain implications which could be important when considering protectionism, trade wars and geoeconomic fragmentation.

What a market failure is not? Just to make the definition clear, it is helpful to explicitly make clear what a market failure is not. The term is often used in public discourse without a clear definition to describe various kinds of phenomena, which in turn has muddied the waters for the actual definition. For example, I have seen the term applied several times to distribution of wealth. However, the optimal distribution of wealth is at least partly a normative question. Thus, even when specific distributional effects are justified, a market based solution not delivering it is not a market failure. The market might very well result in the optimal solution given the current structure. More generally, the market not delivering your preferred outcome is not a market failure. Actual market failures are much more rare than pundits would like you to think.

What a market failure is? A market failure can be simply defined as a situation where agents would be better off if they commit to a co-operative solution, but where agents also have a personal incentive to slip out of that solution. Thus, everyone slips out leading to a solution where everyone is worse off than in co-operation. This can be exacerbated by agents realizing that others also have the incentive to slip. In other words, even with the given structure, the market yields a sub-optimal solution.

Let’s take a lively example. It is September 12, 490 BC. You are a young Persian man serving as a skirmisher, armed with javelins and a light shield. Camping at the beach, you have for several days stared up the slope of the Plains of Marathon towards the camp of the Athenians and the Plataeans about a 1000 meters away. However, today, suddenly a cloud of dust starts to emerge from the plain before you. Your officers start to give hasty orders to form up. You start to feel a tingling feeling in your stomach. You are no man of the line, you are a skirmisher; you are supposed to run around the enemy harassing them by missiles, not to clash with them in a solid line. Especially against these heavily armed Greeks. And even if you were, it takes hours to properly line up tens of thousands of men. The Greeks are approaching much faster. Hesitantly you take your place in the hastily formed formation, standing at the sixth and last rank, all the while peering nervously to your left and right.

The Greeks clash with the front rank. You can feel the men before you taking small steps backwards. You try to push back a bit, but inch by inch the formation seems to move back. After a while, you notice the line being bent back at you far left as the Greeks keep pushing. Running back to the safety of your boats at the beach starts to seem like a good idea while the line still barely keeps the hoplites from cutting you down. After all, if you wait and everyone else runs, you will be left alone.

You decide to take your chance.

However, as a lightning from a cloudless sky, everyone around you seems to have the same thought; in a matter of seconds the line crumbles down. Instead of taking your chance – how small it may be – and sticking together, you and thousands of your brothers in arms are cut down hopelessly; not fighting but individually trying to flee from the plain.

Similar lines of thought can be seen with protectionism. It has been well understood by economists for the better part of the last two centuries that specialization, competition and free trade benefit everyone. So what is the problem at present? The crooks of argument as presented by both the US administration and EU officials when making the case for protectionist policies is that certain countries (read: China) employ unfair economic policies such as exchange rate manipulation and heavy handed industrial policies to rig international competition in their favor. In other words, they are slipping away from the co-operative solution of free trade. They are abandoning the shield wall at others expense.

As a result, everybody follows. Both the US and the EU are erecting more trade barriers and employing more industrial policies even though we know everybody would be better of without any of these.

Viewing protectionism as a market failure helps to realize a key point. As is well understood, when a market failure occurs, it is not a fluke but rather follows directly from the incentive structure at present. Thus, protectionism is the norm in international politics, not the exception. This norm was successfully broken at the end of history which occurred in the 90s and 2000s, but was returned at recently. As such, solving it requires (again) proactive action to change the incentive structure: waiting for the situation to magically solve itself is not going to work. At the hearth of it, solving the problem requires trust between international players: trust in others not to slip from the co-operative solution. As in any market failure, this is achieved by either outright trust between the agents (such as world leaders having good personal relations like Clinton, Blair and Jeltsin had) or by building institutions which re-align the incentives such that we can trust other to do the right thing because it is in their interest (such as has been the aim of the World Trade Organization).

I am not going to lie, building trust at the present does not seem likely. In the 2020s alone, of the current four major global leaders – Trump, Xi, von der Leyen and Putin – at least three have blatantly shown themselves to not even try keeping up the facade of trust: Trump by his constantly evolving trade terrorism, Putin by his illegal invasion of Ukraine and Xi by actively thwarting the international investigations regarding the largest public health crisis in a century (which I am not naming in order to avoid unwanted attention from algorithms).

So do we have to be pessimistic about this? Not necessarily. Let’s take another lively example: in 55 BC Gaius Julius Caesar conducted the first Roman expedition to Britain. After hastily embarking from Gaul in the middle of the night, his fleet was met by an imposing force at the beach they arrived at. Caesar writes in his commentaries, that due to this force and the long shallow waters the legionaries would have to wade through to establish a beach head, the legionaries seemed reluctant to land at first. That was, until the standard bearer leaped into the water proclaiming that he will do his duty. The others followed rapidly.

The moral of the story: others might be more inclined to stay in formation if you show yourself staying there no matter what. Even if you don’t trust each other, you might just convince them that their best shot is to stay in line with you after all.