Asymmetric Industrial Reorganisation and Adaptive Misallocation Post Disasters

This paper presents evidence on how firms adapted following the 2005 Pakistan earthquake, with a particular focus on the vulnerabilities that drove differential impact and the expectation of minimal government aid shaping firm behavior. Using a difference-in-difference methodology on a nationally representative panel of 390 firms, this paper explores three key dimensions: the immediate disruption, short-term adaptation, and long-term resilience. The seismic shock damaged stock and reduced sales asymmetrically. Fragile intermediaries, firms with moderate capital-labor ratios, experienced pronounced declines in sales, while labor-intensive firms, besides highly capital intensive firms demonstrated greater resilience. Firms prioritised skilled labor retention, reducing non-production roles, increasing operational hours, and diversifying across markets. There was no evidence of innovation. Building on these findings, this paper develops a theoretical model showcasing how adaptive misallocation, where firms over-invest in short-term adaptive measures such as increased reliance on backup infrastructure, driven by expectations of minimal government aid, diverts resources away from productivity, erodes public-private trust, and ultimately undermines resilience.