Ethnic conflict has not been tested using economic theory, except its most extreme forms - violence and warfare. This paper adopts the newer economic approach to conflict to analyze ethnic conflict more broadly defined. The analysis is able for the first time to derive equilibrium discrimination by a dominant group and separatism by a weaker group. Consistent with the predictions developed, cross-sectional instrumental-variables estimates and other evidence indicate that government restrictions on commerce promote separatism and conflict and hamper trust. Economic freedom is thus argued to be a key if thus far largely neglected force for ethnic cooperation within states, consistent with the empirical findings for nation-state interactions.