Benjamin Rosa

Subcontracting Requirements and the Cost of Government Procurement

Government procurement contracts are frequently subject to policies that specify, as a percentage of the total project, a subcontracting requirement for the utilization of historically disadvantaged firms. I study how such subcontracting policies affect procurement auction outcomes using administrative data from New Mexico's Disadvantaged Business Enterprise (DBE) Program. My analysis is based on a procurement auction model with endogenous subcontracting. Theoretically, I show that subcontracting requirements need not translate into substantially higher procurement costs – even when disadvantaged firms are relatively more costly. The intuition behind this result is that subcontracting programs require that prime contractors select their subcontractors from a common pool of disadvantaged firms, which reduces the private information prime contractors have on their own project-completion costs. As a result of losing private information, prime contractors strategically reduce their markups in their bids, and the reduction in markups can be sufficiently high to mitigate the cost increases from using more costly subcontractors. I estimate an empirical version of the model and find that New Mexico's past subcontracting requirements led to only small increases in procurement costs.

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