War Signals: A Theory of Trade, Trust, and Conflict

Abstract

We construct a theory of persistent civil conflicts, where persistence is driven by the endogenous dynamics of inter-ethnic trust and trade. In times of peace, agents belonging to two groups are randomly matched to trade bilaterally. Trade hinges on trust and cooperation. The onset of conflict signals that the aggressor has a low propensity to cooperate, harming future trust and trade. Agents observe the history of conflicts and update their beliefs over time. The theory predicts that civil wars are persistent. Moreover, even accidental con.icts that do not reflect economic fundamentals erode trust, and can plunge a society into a vicious cycle of recurrent conflicts (a war trap). The incidence of conflict can be reduced by policies abating cultural barriers, fostering inter-ethnic trade and human capital, and shifting beliefs. Coercive peace policies such as peacekeeping forces or externally imposed regime changes have instead no persistent effects.