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

I study how industrial development and employment in an emerging economy are affected by urban violence due to drug trafficking. Employing rich longitudinal plant-level data covering all of Mexico from 2005–2010 and exploiting plausibly exogenous spatiotemporal variation in homicide rates during the outbreak of drug-trade related violence in Mexico, commonly referred to as the Mexican Drug War, I show that a violent environment has a significant negative impact on manufacturing plants’ output, product scope, employment, and capacity utilization. The impact is very heterogeneous among plants. Studying within and cross-plant heterogeneity points to two underlying channels through which the Drug War affects firms: violence induced reduction in local demand and violence induced drop in labor supply participation. The output sensitivity of plants to a violent conflict increases in less diversified, locally selling and sourcing plants. The employment sensitivity increases with lower wages and a higher share of unskilled female workers. The results show both channels co-exist, and by reallocating resources from smaller, local, and female-intensive plants toward bigger and more diversified ones, the rise of drug violence has significant distortive effects on domestic industrial development in Mexico.