On Trade and the Stability of (Armed) Peace

We consider an environment in which two sovereign states with overlapping ownership claims on a resource/asset first arm and then choose whether to resolve their dispute violently through war or peacefully through settlement. Both approaches depend on the states' military capacities, but have very different outcomes. War precludes trade between the two states and can be destructive; however, once a winner is declared, arming is unnecessary in future periods. By contrast, a peaceful resolution under the threat of war today avoids destruction and supports mutually advantageous trade; yet, settlements must be renegotiated and the states must arm in future periods to resolve their ongoing dispute. Paying special attention to the importance of trade on arming incentives and payoffs in this context, we explore the conditions under which "armed peace" arises as the perfectly coalition-proof equilibrium over time. Our analysis reveals that, depending on the destructiveness of war, time preferences, and the distribution of initial resource endowments, greater gains from trade (jointly determined by trade costs and the substitutability of traded commodities) can reduce arming and pacify international tensions. Even when the gains from trade are relatively small, peace might be sustainable, but only for more uneven distributions of initial resources.