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, introducing a new-channel through which fiscal shocks propagate. Using newly available data on defense subcontracts merged with firm-level data, we document that a substantial share of spending is reallocated via subcontracts across regions beyond what is implied by the location of prime contracts. Firm-to-firm flows further show that subcontracting redirects spending toward large, goods-producing firms. We develop an empirical strategy that accounts for this reallocation and separately identifies the local effects of prime and subcontract spending. Accounting for subcontracting modestly raises prime-contract multipliers, while subcontract multipliers are substantially smaller. Firm-level evidence shows that this gap reflects both compositional differences and the inherently less stable nature of subcontracting relationships. We build a spatial multi-region model with prime-subcontracting networks to rationalize these findings. Our analysis suggests that subcontracting constitutes an important margin of fiscal transmission and that its rise weakens the transmission of government spending to local labor markets.