Trade Costs, Conflicts, and Defense Spending

This paper develops a quantitative model of trade, military
conflicts, and defense spending. Trade liberalization between two
countries reduces probability of an armed conict between them,
causing both to cut defense spending. This in turn causes a domino
effect on defense spending by other countries. As a result, both
countries and the rest of the world are better off. We estimate the
model using data on trade, conflicts, and military spending. We
find that, after reduction of costs of trade between a pair of
hostile countries, the welfare effect of worldwide defense spending
cuts is comparable in magnitude to the direct welfare gains from
trade.