Firms and Labor in Times of Violence: Evidence from the Mexican Drug War

This paper examines the impact of violence resulting from drug trafficking on manufacturing firms in an emerging economy. By utilizing comprehensive longitudinal data spanning all of Mexico from 2005 to 2010, and employing an instrumental variable strategy that leverages plausibly exogenous spatiotemporal variations in the homicide rate during the outbreak of drug violence, the analysis reveals a significant negative effect of violence on plant output, employment, product scope, and capacity utilization. The negative effect on employment is entirely driven by blue-collar employment and concentrated among low-wage, female-intensive firms. Further, consistent with a violent-environment-induced blue-collar labor-supply shock, the results show positive effects on blue-collar wages and negative effects on white-collar wages at the firm level. Output resilience to violence is also shown to be lower among labor-intensive, domestically selling and sourcing, less diversified firms. These findings show the rise of drug violence has a significant negative effect on development of domestic industrial capability in Mexico and shed light on the characteristics of the most affected firms and the channels through which they are affected.