Firms under fire! How insecurity affects formal firms’ existence

This paper studies the effect of insecurity on formal firms’ existence. We develop a flexible theoretical framework in which insecurity affects firms’ market entry, exit, and formality decisions. In our empirical analysis, we combine an original dataset on Afghan firms with georeferenced data on military events during the post-2003 Afghan conflict. In such a state-building context, exposure to military events has an average positive effect on formal firms’ existence. Nonetheless, this effect is highly heterogeneous depending on actors, location, timing and firms’ characteristics. The Afghan conflict has the specificity of deeply involving foreign countries. Mobilising this particular source of exogenous variation, we identify insecurity’s causal effect on formal firms’ existence. We show that an increase of 1% in the exposure to instrumented military events raises the formal activity probability by 4.17%.