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							                    effective use of these two tools. In these countries, bankruptcy procedures are
                    often extremely slow and cumbersome. For example, in many countries,              cred-
A holder of debt.   itors (holders of debt) must first sue the defaulting debtor for payment, which
                    can take several years, and then, once a favorable judgment has been
                    obtained, the creditor has to sue again to obtain title to the collateral. The
                    process can take in excess of five years, and by the time the lender acquires
                    the collateral, it well may have been neglected and thus have little value. In
                    addition, governments often block lenders from foreclosing on borrowers in
                    politically powerful sectors such as agriculture. Where the market is unable to
                    use collateral effectively, the adverse selection problem will be worse, because
                    the lender will need even more information about the quality of the borrower
                    in order to screen out a good loan from a bad one. The result is that it will be
                    harder for lenders to channel funds to borrowers with the most productive
                    investment opportunities, thereby leading to less productive investment, and
                    hence a slower-growing economy. Similarly, a poorly developed legal system
                    may make it extremely difficult for borrowers to enforce restrictive covenants.
                    Thus they may have a much more limited ability to reduce moral hazard on
                    the part of borrowers and so will be less willing to lend. Again the outcome
                    will be less productive investment and a lower growth rate for the economy.
                          Governments in developing and transition countries have also often
                    decided to use their financial systems to direct credit to themselves or to
                    favored sectors of the economy by setting interest rates at artificially low lev-
                    els for certain types of loans, by creating so-called development finance insti-
                    tutions to make specific types of loans, or by directing existing institutions to
                    lend to certain entities. As we have seen, private institutions have an incen-
                    tive to solve adverse selection and moral hazard problems and lend to bor-
                    rowers with the most productive investment opportunities. Governments
                    have less incentive to do so because they are not driven by the profit motive
                    and so their directed credit programs may not channel funds to sectors that
                    will produce high growth for the economy. The outcome is again likely to
                    result in less efficient investment and slower growth.
                          In addition, banks in many developing and transition countries have
                    been nationalized by their governments. Again, because of the absence of the
                    profit motive, these nationalized banks have little incentive to allocate their
                    capital to the most productive uses. Indeed, the primary loan customer of
                    these nationalized banks is often the government, which does not always use
                    the funds wisely.
                          We have seen that government regulation can increase the amount of
                    information in financial markets to make them work more efficiently. Many
                    developing and transition countries have an underdeveloped regulatory appa-
                    ratus that retards the provision of adequate information to the marketplace.
                    For example, these countries often have weak accounting standards, making
                    it very hard to ascertain the quality of a borrower’s balance sheet. As a result,
                    asymmetric information problems are more severe, and the financial system is
                    severely hampered in channeling funds to the most productive uses.
                          The institutional environment of a poor legal system, weak accounting
                    standards, inadequate government regulation, and government intervention
                    through directed credit programs and nationalization of banks all help
                    explain why many countries stay poor while others grow richer.
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