Table A22 provides suggestive evidence supporting the idea that firms reduce total labor costs by substituting skilled labor with less expensive unskilled workers. As shown in column 1, the substitution effect is more pronounced among firms producing non-differentiated products, which are typically more reliant on cost efficiency and less dependent on specialized labor.<sup>25</sup> This is expected, as producing differentiated goods relies more heavily on higher-skilled labor, limiting firms’ ability to substitute for lowerskilled workers. Additionally, column 2 indicates that the magnitude of the substitution effect varies with a country’s labor legislation. In contexts where firing costs are higher (proxied by severance pay levels), the substitution of skilled workers for unskilled ones due to conflict exposure is smaller. These results align with the idea that worker substitution is a defensive strategy employed by firms to reduce labor costs when affected by conflict: when sales decrease due to lower output from reduced availability of production inputs, firms adjust their workforce to lower costs.

The remaining columns of Table A22 help rule out alternative explanations for the observed reduction in total labor costs. Column 3 shows that the decline is not driven by an increased reliance on temporary workers, suggesting that changes in contract structure are not a key mechanism. Column 4 further indicates that the substitution away from skilled labor is not due to supply-side constraints—such as a conflict-induced decline in the availability of skilled workers. Specifically, firms do not report a worsening of the skilled labor supply as a more serious obstacle to their operations. Taken together, these results provide suggestive evidence that the substitution of skilled with unskilled workers is driven primarily by demand-side adjustments—namely, firms responding to conflictinduced reductions in their production possibilities.

# **4.2.3 Market competition**

An important determinant of firm sales is the level of market competition. In Table 2, columns 9–10, we examine how conflict affects market competition. Results indicate that conflict increases competition faced by formal firms from informal ones.<sup>26</sup> Column 9 shows that conflict exposure increases the likelihood that firms report informal competition as an obstacle and column 10 that conflict heightens the perceived intensity of the threat posed by informal competitors.

The conflict-induced increase in informal competition is consistent with two different dynamics: new informal firms entry the market or formal firms shift into the informal 25Drawing from the Rauch (1999) classification, we define a product as differentiated if its trade neither occurs on an organized exchange nor relies on a reference price. As Rauch and Trindade (2002) highlights, goods with a reference price are sufficiently homogeneous, as prices convey all relevant information for international trade; this is not the case for more differentiated goods lacking reference prices. The original classification is available at: `https://econweb.ucsd.edu/~jrauch/rauch_classification.html` .

> 26A large informal sector is a common feature of developing economies, where formal and informal firms often operate in the same sectors and produce similar goods (Ulyssea, 2020).

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