We analyze the constrained-efficient allocation in an equilibrium model of investment and capital reallocation with heterogeneous firms facing collateral constraints. More financially constrained firms buy old capital, consistent with empirical evidence. Thus, new investment induces a positive externality by reducing the future price of old capital, fostering reallocation toward more constrained firms. The equilibrium price of old capital is inefficiently high in general, because this distributive pecuniary externality exceeds the collateral externality, by a factor two in the calibrated model. The constrained-efficient allocation induces a consumption-equivalent welfare gain of 5\% compared to the competitive equilibrium, and can be implemented with subsidies on new capital and taxes on old capital.

Link to paper: drive.google.com/file/d/1XxbO20XFDsbuSlh4fe4Pj1-zvb70W0to/view