Subcontracting in Federal Spending: Micro and Macro Implications

This paper studies the critical but underexplored role of subcontracting in shaping the spatial and firm-level effects of federal government spending. Using newly available data on defense subcontract awards linked to establishment-level data from NETS, we examine prime–subcontractor relationships across regions, industries, and over time. We document three key facts. First, subcontracting reallocates a substantial share of federal dollars across geographic areas, weakening the link between the location of prime contracts and where spending ultimately occurs. Second, subcontracting shifts spending across industries, notably from service-sector primes to manufacturing subcontractors. Third, large firms dominate subcontracting networks, including by receiving subcontracts from smaller primes. Accounting for geographic reallocation implies that conventional estimates understate local fiscal multipliers by about 20%. Furthermore, local multipliers are smaller for subcontracting than for prime contracting, partly because subcontracted spending is concentrated among large manufacturing firms that exhibit more muted employment responses. Establishment-level evidence further shows that subcontracting generates weaker employment effects, even conditional on firm size and industry, reflecting the less stable nature of subcontracting relationships. Overall, our findings show that subcontracting fundamentally reshapes the transmission of procurement spending through the private sector, with important implications for the local and aggregate effects of federal spending.