Michigan Ross Professor Explores the Financial Implications of DEI Policy in Government Contracting

In the newly published research, Rosa analyzed data from the New Mexico Disadvantaged Business Enterprise Program. The program is a New Mexico Department of Transportation effort to increase the diverse businesses they contract and subcontract for U.S.-DOT-financed highway, transit, and airport projects. Importantly, procurement for public projects like those discussed in Rosa’s study makes up a sizable portion of the federal budget.

"Given the sheer magnitude of government spending on contracting, my research underscores the need to understand whether these awards are made equitably and the programs we have in place to promote equity in contracting," said Rosa.

In the new paper, “Subcontracting requirements and the cost of government procurement,” Rosa found that when prime contractors must choose from a shared pool of such firms, it curtails their private cost insights, subtly influencing them to reduce their profit margins. Therefore, regulation on increasing diversity does not significantly impact procurement costs and does somewhat level the playing field for historically disadvantaged businesses. This nuanced insight challenges pessimistic assumptions on the financial implications of subcontracting directives that promote equity in public contracting.

“I estimate that New Mexico's past subcontracting requirements increased the money given to DBE (Disadvantaged Business Enterprise subcontractors by 13.8% while increasing procurement costs by only 0.2%. These results suggest that New Mexico's subcontracting requirements, although effective in increasing DBE subcontractor utilization, were not responsible for large increases in procurement costs,” wrote Rosa.

The newly published study is complemented by a recently completed study, which finds that although regulations like the New Mexico Disadvantaged Business Enterprise Program attempt to create a level playing field on which firms from disadvantaged backgrounds have an equal opportunity to compete for contracts — buyers may still discriminate within the disadvantaged group. According to Rosa’s study, the key is network access: Government agencies and prime contractors favor working with known or established firms. An equally capable but unknown disadvantaged firm might be overlooked, and affirmative action policies for disadvantaged firms may not reliably correct these inequities.

The study finds in the majority of types of work, the contract awards are highly concentrated, implying that a few disadvantaged firms win most of the deals. In four categories (painting, signing, fencing, and concrete), the top three firms that were part of the program won anywhere from about 70% to 98% of all awards.
“This study made me question whether meeting contract award goals truly corresponds to equity in contracting,” Rosa said.
As in labor markets, the study notes government contracting has been subject to affirmative action policies for decades, with the aim of fixing past and present forms of discrimination. However, it’s competition between contractors that determines incentives to become qualified in contracting, as opposed to potential earnings differences that drive incentives in a labor market.
Such competition, the study concludes, “creates several challenges for implementing corrective policies.” Rosa advises government agencies to consider concentration within disadvantaged groups along with contract award goals when evaluating equity in contracting.