Subcontracting requirements and the cost of government procurement

Abstract

Government procurement contracts are frequently subject to policies that specify a subcontracting requirement for the utilization of historically disadvantaged firms. I study how such subcontracting policies affect procurement auctions using data from New Mexico's Disadvantaged Business Enterprise Program. Theoretically, subcontracting requirements reduce prime contractors' private information on their costs by requiring them to select their subcontractors from a common pool of disadvantaged firms. This feature mitigates cost increases from using more costly subcontractors by causing prime contractors to strategically lower their markups. My estimated model reveals that New Mexico's past subcontracting requirements led to minor increases in procurement costs.