Making Do with What You Have: Conflict, Firm Performance and Input Misallocation in Palestine

This paper investigates the effect of conflict on firms' output value and input misallocation in the context of Palestine during the Second Intifada. Using a unique establishment-level dataset, we compare firms' outcomes and input usage over time across districts experiencing differential changes in conflict intensity. We show how conflict diminishes the total and per-worker value of firms' output through the distortions it generates in firms' access to input markets. In particular, lack of access to the market for imported material inputs leads firms to adjust input usage accordingly, substituting domestically produced materials for imported ones. We also empirically identify the relative amount of conflict-induced input distortions. Furthermore, we find that conflict affects disproportionally more those sectors which were more intensive in imported materials and had higher average output value in pre-conflict years. Conflict is thus shown to be particularly harmful for the most productive sectors of the economy.