Government Contracting, Labor Intensity, and the Local Effects of Fiscal Consolidation: Evidence from the Budget Control Act of 2011

Abstract

The U.S. federal government awards billions of dollars of contracts annually to private-sector firms to produce a wide range of goods and services. However, little is known about how a reduction in federal procurement, also referred to as fiscal consolidation, impacts local labor markets. In this paper, we leverage the institutional details of the Budget Control Act of 2011 (BCA) and highly detailed transaction-level data for procurement by all federal agencies to estimate the effect of fiscal consolidation on local employment and wages. Our identification strategy uses a shift-share instrument and is based on the exogeneity of the BCA-induced spending cuts across industries, i.e. exogenous shocks. Our results show that relative to wages, employment appears to be the key margin for local labor market adjustment in the wake of consolidation. In particular, we estimate that a $1 million reduction in federal procurement spending reduces employment by more than 10 jobs, while a $1 decline in spending only reduces aggregate wages by about $0.19. We also show that the local labor market effects of consolidation depend on the sectors receiving federal dollars. Federal contracts in high labor-intensive industries reduce employment by more than those in low labor-intensive industries, while the effect on aggregate wages is relatively modest and constant across sectors. These findings have implications both for understanding regional economic development and for improving regional resiliency to negative demand shocks.