Rules for Dividing a Disputed Resource in the Context of the Classical Liberal Argument for Peace

In this paper, we study alternative forms of conflict resolution, both peaceful and non-peaceful, between two countries that compete for claims to a resource used to produce potentially traded goods. Consistent with the classical liberal argument, peace supports mutually beneficial trade, whereas war preempts it. War always induces countries to allocate resources into non-contractible arming ("guns") for superiority in conflict. Under peaceful settlement, countries might choose to arm as well for gaining leverage in negotiations, but arming is typically less than what it is under war. Building on the observation that arming itself affects the countries' bargaining sets, we compare the efficiency properties of division rules generated by three prominent bargaining solutions - namely, splitting the surplus, equal sacrifice, and Nash bargaining - and show how they depend on the gains from trade.