Prudence versus Predation and the Gains from Trade

We analyze a dynamic, two-country model that highlights the various trade-offs each country faces between current consumption and competing investments in its future productive and military capacities as it prepares for a possible future conflict. Our focus is on the circumstances under which the effects of current trade between the two countries on the future balance of power render trade unappealing to one of them. We find that a positive probability of future conflict induces the country with less resource wealth to “prey” on the relatively more “prudent” behavior of its richer rival, and more so as conflict becomes more likely. While a shift from autarky to trade always raises the current incomes of both countries, the poorer country realizes the relatively larger income gain from trade and also devotes a relatively larger share of its income gain towards arming. Consequently, the richer country rationally chooses not to trade today when the difference in initial resource wealth is sufficiently large and is more likely to prefer autarky when the probability of future conflict is higher. An empirical analysis of the period surrounding the end of the Cold War provides suggestive evidence in support of the theory.