particular, a crisis such as a severe drought or flooding might prompt the government to consider reforms, including PSP. A financial crisis at the sector level, in which one or many water utilities were unable to service their debts, might also prompt action from the government. Secondly, loans or grants from multilateral institutions and donors directly or indirectly related to the water sector (such as an urban or rural development project) might also be associated with the decision of the government to open the sector to PSP.<sup>15</sup> Secondly, a government may decide to engage in PSP as a result of a macroeconomic crisis, leading to reductions in government spending. Infrastructure investment tends to be cut more severely and sooner when governments are undertaking programs of fiscal retrenchment than other types of expenditure (Calderon, Easterly et al. 2003). In their review of the Latin American experience with economic stabilization programs, Easterly and Serven show that governments expect privatization to improve the fiscal balance by: generating revenues in the short-term through asset sales; reducing government expenditure on operating and capital expenditures; raising tax revenues, although the medium-term fiscal effects of privatization are not necessarily positive (Calderon, Easterly et al. 2003). This view is also backed up by case studies (Ménard, Clarke et al. 2000a, and others) A further possible explanation for the level of PSP is the catch-up theory. According to this theory, rates of investment will be higher in those countries that are furthest away from the coverage frontier. Henisz and Zelner (2001) find evidence for this in their analysis of telecommunications. Coverage and service quality for water is low in most low- and lower-middle-income countries, and so we might expect the catch-up theory to operate.

However, if we consider the decision of the government to engage in PSP, we should not assume that governments choose to reform the sector directly as a result of poor coverage. In fact, it is common for the water sector to be stuck in a low-level equilibrium of low tariffs, low investment and low service quality (Savedoff, Spiller et al. 1999). Instead, we should see reform in the context of the political economy and the result of a confluence of factors strengthening the interest groups in favour of reform (Estache 2005). We would expect that governments would introduce reform when the coalition of interests in favor of reform had become sufficiently strong to overcome entrenched interests, notably private sector unions.

We use the new WATSAN PSP dataset to test the following key hypotheses emerging from the literature:

- H1: Private investors will be more likely to engage in PSP where institutions support government commitment to upholding contracts or implementing established regulatory rules. The relevant institutions are: protection of property rights; enforcement of contracts; rule of law; ability of the bureaucracy to implement policies and rules; political stability; control of corruption.

- H2: Developing country governments will engage in PSP when implementing fiscal retrenchment

- - H3: Governments will be more likely to engage in PSP where demands for increasing coverage or quality are strong

- H4: Private water companies will be more likely to enter countries where household incomes are high enough to support ‘willingness to pay’ for water services

> 15 Field research in Malaysia (Johor State) and Indonesia (Jakarta) revealed a common pattern: the water utility in each case received a loan from a donor or development bank to carry out service improvements which was linked to considering models for private sector participation in water service delivery.

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