Guns, Lawyers, and Markets: Economic Consequences of Costly Conflict

Abstract: Costly conflict activities are economically very significant, yet the assumption of perfect and costless enforcement of property rights dominates much of economics research. Conflict follows directly from the methodological principle of self-interest and taking it into account in modeling leads to very different findings than in its absence: in straightforward extensions of basic models of exchange, compensation is inversely related to marginal productivity; prices depend on relative power, as well as on preferences, endowments, and technology; exchange itself can be foreclosed by enforcement costs; wage subsidies, land reform and other seemingly inefficient arrangements can be rationalized as appropriate policies in second-best settings; and comparative advantage is distorted in the presence of conflict. Moreover, the costs of conflict are not inevitable as they critically depend on governance and norms. Overall, in the presence of conflict and appropriation Nirvana or first-best models are not empirically plausible. Attributes of modern states such as law, checks and balances, and the bureaucratic form of organization can partly be thought of as restraining conflict and appropriation. These restraints are better than the typical governance alternative, which is personalized, proprietary governance and typically involves autocratic, amateurish, and corrupt rule.