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entitled 'Compacts of Free Association: Development Prospects Remain
Limited for Micronesia and Marshall Islands' which was released on June
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
June 2006:
Compacts Of Free Association:
Development Prospects Remain Limited for Micronesia and Marshall
Islands:
GAO-06-590:
GAO Highlights:
Highlights of GAO-06-590, a report to congressional committees.
Why GAO Did This Study:
In 1987, the United States began providing economic aid to the
Federated States of Micronesia (FSM) and the Republic of the Marshall
Islands (RMI) through a Compact of Free Association. In 2004, through
amended compacts with the FSM and the RMI, the United States committed
to provide more than $3.5 billion until 2023. Joint U.S-FSM and U.S.-
RMI compact management committees are required, among other things, to
monitor progress toward specified development goals and address
implementation of policy reforms to stimulate investment. The
legislation implementing the amended compacts (P.L. 108-188) requires
that GAO periodically report on political, social, and economic
conditions in the FSM and the RMI. In compliance with this requirement,
GAO examined each country’s (1) political and social environment, (2)
economic environment, and (3) status of economic policy reforms.
What GAO Found:
FSM and RMI political and social conditions challenge, respectively,
effective compact grant implementation and health and education
progress. Regarding political conditions, for example, the FSM states
and national government have been unable to agree on implementation of
the compact infrastructure grant, while the RMI government has had
difficulty securing agreement from land owners regarding its use of
leased land for compact-related projects. Social challenges in both
countries include persistent health and education problems despite
substantial expenditures. For instance, the FSM and the RMI have low
immunization rates relative to other countries with similar income
levels.
The FSM and the RMI economies show limited potential for achieving long-
term development objectives. Both economies depend on public sector
expenditures—funded largely by external assistance—and government
budgets have growing wage expenditures, heightening the negative fiscal
impacts they will face as compact grants decline (see figure). As a
result, long-term economic growth must come from the private sector and
increased income sent home from FSM and RMI emigrants (“remittances”).
However, poor business environments hamper private industry in both
countries, and FSM and RMI emigrants’ lack of marketable skills hinders
increasing revenue from remittances. Compact management committees have
not discussed the countries’ progress toward budgetary self-reliance
and long-term economic advancement at their annual meetings.
FSM and RMI progress in key policy reforms has been slow. Country
officials reported passing some new mortgage and bankruptcy laws, but
other needed reforms have not been implemented. For example, according
to economic experts, tax systems remain inequitable and inefficient and
foreign investment regulations remain confusing and relatively
burdensome. FSM and RMI development plans include reform objectives in
each of these areas;
however, compact management committees have not addressed the nations’
slow progress in implementing reforms.
Figure: Estimated Per Capita Compact Grant Assistance for Fiscal Years
1987-2023:
[See PDF for Image]
[End of Figure]
What GAO Recommends:
GAO recommends that the Secretary of the Interior direct the Deputy
Assistant Secretary for Insular Affairs, as Chairman of the compact
management committees, to ensure they meet requirements to address the
lack of FSM and RMI progress in implementing reforms to increase
investment and tax income. Interior, Health and Human Services, the FSM
and the RMI generally agreed with the recommendation and the need to
find development opportunities.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-590].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact David B. Gootnick at
(202) 512-3149 or gootnickd@gao.gov.
[End of Section]
Contents:
Letter:
Results in Brief:
Background:
FSM and RMI Face Key Political and Social Challenges:
FSM and RMI Economies Show Limited Potential for Self-reliance and Long-
term Advancement:
FSM and RMI Progress on Key Economic Policy Reforms Has Been Slow:
Conclusions:
Recommendations:
Agency Comments:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Some Regional Socioeconomic Data for the Pacific:
Appendix III: The FSM and RMI Private Sector Environment:
Appendix IV: Comments from the Department of the Interior:
GAO Comments:
Appendix V: Comments from the Department of Health and Human Services:
GAO Comment:
Appendix VI: Comments from the Federated States of Micronesia:
GAO Comment:
Appendix VII: Comments from the Republic of the Marshall Islands:
GAO Comments:
Appendix VIII: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Annual U.S. Assistance for the FSM and the RMI under the
Amended Compacts, Fiscal Years 2004 to 2023:
Table 2: Estimated Levels of Economic Assistance by Major Donors to the
FSM and the RMI, Average from Fiscal Years 2002 to 2004:
Table 3: FSM and RMI Emigrants in Hawaii, Guam, and the CNMI, 2003:
Table 4: FSM and RMI Government Commercial Enterprises:
Table 5: Some Estimated Socioeconomic Indicators for Select Pacific
Island Nations:
Figures:
Figure 1: Annual Compact Assistance to the FSM and the RMI, Fiscal
Years 1987-2003:
Figure 2: Estimated FSM and RMI Real Per Capita GDP:
Figure 3: Estimated FSM and RMI per Capita Compact Grant Assistance for
Fiscal Years 1987-2023:
Figure 4: FSM and RMI External Grants and Estimated Real GDP:
Figure 5: Structure of FSM Revenues and Expenditures, Fiscal Years 2000-
2005:
Figure 6: Structure of RMI Revenues and Expenditures, Fiscal Years 2000-
2005:
Figure 7: Some Noted Problems with the FSM and the RMI Private Sector
Environment:
Abbreviations:
ADB: Asian Development Bank:
CNMI: Commonwealth of the Northern Marianas Islands:
FSM: Federated States of Micronesia:
GDP: gross domestic product:
HHS: Department of Health and Human Services:
IMF: International Monetary Fund:
JEMCO: Joint Economic Management Committee (FSM):
JEMFAC: Joint Economic Management and Financial Accountability
Committee (RMI):
MCC: Millennium Challenge Corporation:
NGO: nongovernmental organization:
RMI: Republic of the Marshall Islands:
WDI: World Development Indicators:
United States Government Accountability Office:
Washington, DC 20548:
June 27, 2006:
Congressional Committees:
From 1987 to 2003, the United States provided about $2.1 billion in
economic assistance to the Federated States of Micronesia
(FSM)[Footnote 1] and the Republic of the Marshall Islands (RMI)
through a Compact of Free Association.[Footnote 2] In 2003, the U.S.
government negotiated new compact provisions with the FSM and the RMI
that established an estimated $3.6 billion in continued U.S. assistance
from fiscal year 2004 through fiscal year 2023.[Footnote 3] These
"amended" compacts provide for decreasing annual grant assistance over
the 20-year period, paired with increasing contributions to trust funds
that are to provide income for each country after compact grants cease.
The amended compacts identify the twenty years of grant assistance as
intended to assist the FSM and the RMI governments in their efforts to
promote the economic advancement and budgetary self-reliance of their
people. To this end, the amended compacts provide for continued
economic assistance in the form of grants to sector-specific areas,
such as education, health, public infrastructure, and private sector
development, prioritizing education and health.
The amended compacts and their subsidiary agreements include
requirements that the FSM and the RMI submit development plans and
provide regular financial and performance reports. The amended compacts
also require that the U.S. and the FSM Joint Economic Management
Committee (JEMCO) and the U.S. and the RMI Joint Economic Management
and Financial Accountability Committee (JEMFAC) meet at least once
annually to evaluate FSM and RMI progress in achieving the objectives
specified within their development plans,[Footnote 4] to identify
problems encountered, and to recommend ways to increase the
effectiveness of compact grant assistance.[Footnote 5]
Regarding specific objectives within the development plans, the
legislation implementing the amended compacts [Footnote 6]directs JEMCO
and JEMFAC to address objectives related to the implementation of
policy reforms to encourage investment and to improve tax
income.[Footnote 7] The fiscal procedures agreements direct JEMCO and
JEMFAC to monitor FSM and RMI progress toward budgetary self-reliance
and long-term economic advancement.[Footnote 8] The legislation
implementing the amended compacts also requires that the United States
and GAO periodically report on political, social, and economic
conditions in the FSM and the RMI as well as on the use and oversight
of U.S. assistance to those nations. In compliance with the
legislation's requirement, this report[Footnote 9] examines each
country's (1) political and social environment regarding, respectively,
compact grant implementation and health and education conditions;
(2) economic environment, particularly respecting potential for
achieving budgetary self-reliance and long-term economic advancement;
and (3) status of economic policy reforms.
To address our reporting objectives, we reviewed U.S., FSM, and RMI
annual compact reports for 2004; FSM and RMI development plans;
FSM and RMI economic reports and statistics; political assessments by
the U.S. Department of State (State) and Transparency
International;[Footnote 10] and Asian Development Bank (ADB), World
Bank, and International Monetary Fund (IMF) reports on both economies.
We interviewed officials from State and the U.S. Department of the
Interior (Interior) as well as country experts at the ADB, the IMF, the
World Bank, and the Pacific Islands Development Program at the East-
West Center.[Footnote 11] We also interviewed relevant officials,
banks, and numerous representatives from private industry (including
local chambers of commerce) in the four FSM states and in the RMI. We
determined that the social and economic data presented in this report
are sufficiently reliable for our purposes. We conducted our review
from August 2005 through March 2006 in accordance with generally
accepted government auditing standards. A detailed description of our
scope and methodology is included in appendix I of this report.
Results in Brief:
Although the FSM and the RMI are stable democracies, each country's
political and social environments present significant challenges
regarding, respectively, effective compact grant implementation and
health and education conditions. Although reports by State and Interior
emphasize that both countries are established democracies with free and
peaceful elections, interviews with U.S. and country officials revealed
that, in each country, political factors have hindered compact
implementation. For example, in the FSM, the states and national
government have been unable to agree on implementation of the compact
infrastructure grant. In the RMI, the national government has had
difficulty securing agreement from Kwajalein Atoll land owners
regarding management of public entities and the RMI governments' use of
leased land for compact-related development projects. With regard to
the social environment, both countries face challenging health and
education conditions despite substantial expenditures. For example,
both countries have relatively low rates of immunization and
significant percentages of teachers who lack basic qualifications.
The economic environments in the FSM and the RMI have not improved
significantly in recent years, and both countries show limited
potential for development objectives of budgetary self-reliance and
long-term economic advancement. As in the original compact period, both
countries' economies are dependent on public sector expenditures;
government spending, which accounts for about 60 percent of the gross
domestic product (GDP) in each country, is funded largely by external
assistance rather than domestic production. Both governments' budgets
are also characterized by growing wage expenditures, exacerbating the
substantial negative fiscal impacts they are likely to face with the
decline of compact grants through fiscal year 2023. Increased economic
assistance from other countries could support FSM and RMI budget needs
and standards of living, but the degree to which such opportunities
could annually offset decreased compact moneys is uncertain. Over the
long term, economic growth will likely have to originate from the
private sector and increased income sent home from Micronesians living
abroad ("remittances"). However, the two private sector industries that
the United States, the FSM, and the RMI have identified as having
growth potential--fisheries and tourism--face significant barriers to
expansion because of the FSM's and the RMI's remote geographic
location, inadequate infrastructure, and poor business environments. At
the same time, FSM and RMI emigrants' current lack of marketable
skills, due to insufficient education and vocational training, is an
obstacle to increased revenue from remittances. To date, JEMCO and
JEMFAC have not discussed the countries' limited progress in creating
conditions for budgetary self-reliance and long-term economic
advancement at their annual meetings.
FSM and RMI progress in key policy reforms has been slow. Country
officials reported that each of the FSM states and the RMI has
implemented some legislative reforms aimed at improving the private
sector environment, including bankruptcy and mortgage laws. However,
according to the IMF, the ADB, and other economic experts, although
such laws are necessary for an effective private sector environment,
they are insufficient for stimulating investment and improving tax
income without key reforms in taxes, land ownership, foreign investment
regulations, and public sector management. These experts argue that the
current tax systems in the FSM and the RMI are inequitable and
inefficient. However, country officials reported that neither country
has begun implementing fundamental tax reform, although the FSM has
generally agreed on principles of a new tax system. In addition,
interviews with economic experts, officials, and private sector
representatives suggest that land ownership structures provide
inadequate access to land for public and private investment, a problem
that has not eased with the establishment of land registration offices.
Economic experts and private sector representatives further describe
foreign investment regulations as confusing and relatively burdensome,
whereas public sector reform efforts have failed to reduce public
sector competition with the private sector. FSM and RMI development
plans include objectives for reforms in each of these areas, yet JEMCO
and JEMFAC have not addressed these nations' slow progress in
implementing reforms.
In this report, we recommend that the Secretary of the Interior direct
the Deputy Assistant Secretary for Insular Affairs, as Chairman of
JEMCO and JEMFAC, to ensure that they meet requirements to address the
lack of FSM and RMI progress in implementing their specified reforms to
improve the business environment and encourage increased investment and
tax income.
We provided a draft of this report to the Departments of the Interior,
State, HHS, and Treasury, as well as to the FSM and the RMI
governments. We received comments from Interior, HHS, the FSM and the
RMI. Reproductions of these letters, as well as our responses to the
letters, can be found in appendixes IV through VII. Interior concurred
with our recommendation and expressed its intention to implement it,
partly through pursuing additional information on the FSM and the RMI
economies. We agree with the importance of further economic
information, but we believe that sufficient information is available
for the committees to meet their requirement to address FSM and RMI
progress in implementing policy reform. HHS also agreed with our
recommendation and requested that it be expanded to include JEMCO and
JEMFAC requirements for establishing reform implementation timelines.
While establishing timelines is not a requirement under the amended
compact or its subsidiary agreements, we encourage the JEMCO and JEMFAC
to consider this idea as one method to improve U.S. assistance. The FSM
agreed with our report findings, but disagreed with our conclusion that
its development prospects remain limited. We assert that the FSM could
advance its compact goals through an improved business environment and
actions to maximize its' unique economic opportunities. However, we
maintain the importance of frank JEMCO discussion of current FSM
economic realities. Finally, the RMI advocated for further JEMFAC
support in policy reform implementation--highlighting the particular
importance of public sector reform--and emphasized that the government
has met its requirement to contribute an initial $30 million to its
trust fund. While we agree with the importance of public sector
reforms, the RMI's trust-fund contribution does not alter the
characteristic dependence of the RMI economy on external assistance.
Background:
After more than 40 years under U.S. administration as part of the
United Nations Trust Territory of the Pacific Islands,[Footnote 12] the
FSM and the RMI became sovereign nations in 1978 and 1979,
respectively. For the last 20 years, the United States' relationship
with the two countries has been defined by the original Compact of Free
Association and the subsequent amended Compacts of Free Association.
Compact of Free Association, 1986 to 2003:
In 1986, the United States, the FSM, and the RMI entered into the
original Compact of Free Association. Representing a new phase of the
unique relationship between the United States and these island areas,
the compact provided a framework for the United States to work toward
achieving its three main goals: (1) to secure self-government for the
FSM and the RMI, (2) to ensure certain national security rights for all
of the parties, and (3) to assist the FSM and the RMI in their efforts
to advance economic development and self-sufficiency. The first goal
was met; the FSM and the RMI are independent nations. The second goal
has also been achieved with the compact's establishment of several key
defense rights for all three countries. The defense relationship
continues with, among other things, U.S. access to military facilities
on Kwajalein Atoll in the RMI through 2016. The compact's third goal
was to be accomplished primarily through U.S. direct financial
assistance to the FSM and the RMI. For the 15-year period covering 1987
to 2001, funding was provided at levels that decreased every 5 years.
For 2002 and 2003, during negotiations to renew expiring compact
provisions, funding levels increased (see fig. 1) to equal an average
of the funding provided during the previous 15 years plus inflation.
For 1987 through 2003, compact financial assistance to the FSM and the
RMI was estimated, on the basis of Interior data, to be about $2.1
billion.[Footnote 13]
Figure 1: Annual Compact Assistance to the FSM and the RMI, Fiscal
Years 1987-2003:
[See PDF for image]
[End of figure]
Economic development and self-sufficiency were not achieved under the
original compact. Both nations remained dependent on U.S. funds;
total U.S. assistance accounted for more than 50 percent of government
revenues throughout the compact period.[Footnote 14] In addition, FSM
and RMI GDP estimates reveal that per capita GDP at the close of the
compact had not exceeded, in real terms, early 1990s levels in either
country (see fig. 2).[Footnote 15] Although U.S. direct assistance
maintained standards of living that were higher than could be achieved
without support, we found previously that compact funds spent on
economic development were largely ineffective in promoting economic
growth.[Footnote 16] For example, compact funds were used to support
general government operations that, among other things, maintained high
levels of public sector employment and wages, creating disincentives to
private sector growth. Compact funds were also used to support business
ventures, most of which have failed. In our examination of a wide range
of projects funded under the compact, we found that many projects
experienced problems due to poor planning and management, inadequate
construction and maintenance, or misuse of funds. In 2000, we
recommended, among other things, that the Secretary of State direct the
Special Negotiator for the Compact of Free Association to negotiate
amended compact provisions that include assistance provided through
grants targeted to priority areas, expanded reporting and consultation
requirements, and the ability to withhold funds for noncompliance with
compact terms and conditions.[Footnote 17]
Figure 2: Estimated FSM and RMI Real Per Capita GDP:
[See PDF for image]
Note: For the RMI, real GDP was determined using the U.S. price
deflator for 1990 to 1995 and the RMI price deflator for 1996 to 2003.
[End of figure]
The compact also gave citizens of both nations the rights to live and
work in the United States as "nonimmigrants" and to stay for long
periods of time. Further, the compact exempted FSM and RMI citizens
from meeting U.S. passport, visa, and labor certification requirements
when entering the United States. In 2001, we reported that during the
compact, a significant number of FSM and RMI citizens had migrated to
the United States and U.S. island areas.[Footnote 18]
Amended Compacts of Free Association:
The United States negotiated separate amended compacts with the RMI and
the FSM that went into effect on May 1, 2004, and June 25, 2004,
respectively.[Footnote 19] The amended compacts continue the defense
relationship, including a new agreement providing U.S. military access
to Kwajalein Atoll in the RMI through 2086;[Footnote 20] strengthen
immigration provisions; and provide direct financial assistance, in the
form of grants, to the FSM and the RMI for fiscal years 2004 to 2023
(see table 1). To promote FSM and RMI budgetary self-reliance and
economic advancement, the amended compacts and their subsidiary
agreements, along with the countries' development plans, target grant
assistance to six sectors--education, health, public infrastructure,
the environment, public sector capacity building, and private sector
development--prioritizing two sectors, education and health. In
addition to providing grant assistance, the amended compacts provide
for the establishment of trust funds for both countries that can
provide income after annual compact grants cease. The amended compacts,
their subsidiary agreements, and the U.S. implementing legislation also
establish numerous reporting and accountability requirements--
including the legislation's direction to the JEMCO and JEMFAC to
specifically address economic policy reforms to encourage investment
and improve tax income.
Table 1: Annual U.S. Assistance for the FSM and the RMI under the
Amended Compacts, Fiscal Years 2004 to 2023:
Dollars in millions[A]: Fiscal year: 2004;
Dollars in millions[A]: FSM grants: $76.2;
Dollars in millions[A]: FSM trust fund: $16.0;
Dollars in millions[A]: RMI grants: $35.2;
Dollars in millions[A]: RMI trust fund: $7.0.
Dollars in millions[A]: Fiscal year: 2005;
Dollars in millions[A]: FSM grants: 76.2;
Dollars in millions[A]: FSM trust fund: 16.0;
Dollars in millions[A]: RMI grants: 34.7;
Dollars in millions[A]: RMI trust fund: 7.5.
Dollars in millions[A]: Fiscal year: 2006;
Dollars in millions[A]: FSM grants: 76.2;
Dollars in millions[A]: FSM trust fund: 16.0;
Dollars in millions[A]: RMI grants: 34.2;
Dollars in millions[A]: RMI trust fund: 8.0.
Dollars in millions[A]: Fiscal year: 2007;
Dollars in millions[A]: FSM grants: 75.4;
Dollars in millions[A]: FSM trust fund: 16.8;
Dollars in millions[A]: RMI grants: 33.7;
Dollars in millions[A]: RMI trust fund: 8.5.
Dollars in millions[A]: Fiscal year: 2008;
Dollars in millions[A]: FSM grants: 74.6;
Dollars in millions[A]: FSM trust fund: 17.6;
Dollars in millions[A]: RMI grants: 33.2;
Dollars in millions[A]: RMI trust fund: 9.0.
Dollars in millions[A]: Fiscal year: 2009;
Dollars in millions[A]: FSM grants: 73.8;
Dollars in millions[A]: FSM trust fund: 18.4;
Dollars in millions[A]: RMI grants: 32.7;
Dollars in millions[A]: RMI trust fund: 9.5.
Dollars in millions[A]: Fiscal year: 2010;
Dollars in millions[A]: FSM grants: 73.0;
Dollars in millions[A]: FSM trust fund: 19.2;
Dollars in millions[A]: RMI grants: 32.2;
Dollars in millions[A]: RMI trust fund: 10.0.
Dollars in millions[A]: Fiscal year: 2011;
Dollars in millions[A]: FSM grants: 72.2;
Dollars in millions[A]: FSM trust fund: 20.0;
Dollars in millions[A]: RMI grants: 31.7;
Dollars in millions[A]: RMI trust fund: 10.5.
Dollars in millions[A]: Fiscal year: 2012;
Dollars in millions[A]: FSM grants: 71.4;
Dollars in millions[A]: FSM trust fund: 20.8;
Dollars in millions[A]: RMI grants: 31.2;
Dollars in millions[A]: RMI trust fund: 11.0.
Dollars in millions[A]: Fiscal year: 2013;
Dollars in millions[A]: FSM grants: 70.6;
Dollars in millions[A]: FSM trust fund: 21.6;
Dollars in millions[A]: RMI grants: 30.7;
Dollars in millions[A]: RMI trust fund: 11.5.
Dollars in millions[A]: Fiscal year: 2014;
Dollars in millions[A]: FSM grants: 69.8;
Dollars in millions[A]: FSM trust fund: 22.4;
Dollars in millions[A]: RMI grants: 32.2[B];
Dollars in millions[A]: RMI trust fund: 12.0.
Dollars in millions[A]: Fiscal year: 2015;
Dollars in millions[A]: FSM grants: 69.0;
Dollars in millions[A]: FSM trust fund: 23.2;
Dollars in millions[A]: RMI grants: 31.7;
Dollars in millions[A]: RMI trust fund: 12.5.
Dollars in millions[A]: Fiscal year: 2016;
Dollars in millions[A]: FSM grants: 68.2;
Dollars in millions[A]: FSM trust fund: 24.0;
Dollars in millions[A]: RMI grants: 31.2;
Dollars in millions[A]: RMI trust fund: 13.0.
Dollars in millions[A]: Fiscal year: 2017;
Dollars in millions[A]: FSM grants: 67.4;
Dollars in millions[A]: FSM trust fund: 24.8;
Dollars in millions[A]: RMI grants: 30.7;
Dollars in millions[A]: RMI trust fund: 13.5.
Dollars in millions[A]: Fiscal year: 2018;
Dollars in millions[A]: FSM grants: 66.6;
Dollars in millions[A]: FSM trust fund: 25.6;
Dollars in millions[A]: RMI grants: 30.2;
Dollars in millions[A]: RMI trust fund: 14.0.
Dollars in millions[A]: Fiscal year: 2019;
Dollars in millions[A]: FSM grants: 65.8;
Dollars in millions[A]: FSM trust fund: 26.4;
Dollars in millions[A]: RMI grants: 29.7;
Dollars in millions[A]: RMI trust fund: 14.5.
Dollars in millions[A]: Fiscal year: 2020;
Dollars in millions[A]: FSM grants: 65.0;
Dollars in millions[A]: FSM trust fund: 27.2;
Dollars in millions[A]: RMI grants: 29.2;
Dollars in millions[A]: RMI trust fund: 15.0.
Dollars in millions[A]: Fiscal year: 2021;
Dollars in millions[A]: FSM grants: 64.2;
Dollars in millions[A]: FSM trust fund: 28.0;
Dollars in millions[A]: RMI grants: 28.7;
Dollars in millions[A]: RMI trust fund: 15.5.
Dollars in millions[A]: Fiscal year: 2022;
Dollars in millions[A]: FSM grants: 63.4;
Dollars in millions[A]: FSM trust fund: 28.8;
Dollars in millions[A]: RMI grants: 28.2;
Dollars in millions[A]: RMI trust fund: 16.0.
Dollars in millions[A]: Fiscal year: 2023;
Dollars in millions[A]: FSM grants: 62.6;
Dollars in millions[A]: FSM trust fund: 29.6;
Dollars in millions[A]: RMI grants: 27.7;
Dollars in millions[A]: RMI trust fund: 16.5.
Source: Compact of Free Association as Amended, Between the Government
of the United States of America and the Government of the Federated
States of Micronesia and the Government of the Republic of the Marshall
Islands, P.L. 108-188.
Note: These figures do not include funding for Kwajalein Atoll
landowners in the RMI or the $500,000 annual audit grant that will be
provided to both countries.
[A] The amounts shown in table 1 will be partially adjusted for
inflation, with fiscal year 2004 as the base year. Grant funding can be
fully adjusted for inflation after fiscal year 2014 under certain
economic conditions.
[B] Beginning in 2014, an additional $2 million will be added to RMI
annual grants to address the special needs of Kwajalein Atoll.
[End of table]
Including estimated inflation adjustments, total combined compact grant
assistance to the two countries is projected at an estimated $3.6
billion over the 20-year assistance period. However, to provide
increasing U.S. contributions to the FSM's and the RMI's trust funds,
grant funding will decrease annually. Assuming current population
growth estimates from the U.S. Census Bureau, this decrease in grant
funding will result in falling per capita grant assistance over the
funding period and relative to the original compact (see fig. 3).
Figure 3: Estimated FSM and RMI per Capita Compact Grant Assistance for
Fiscal Years 1987-2023:
[See PDF for image]
Note: Compact grant assistance was decreased in 1991, 1996, and 2001,
then increased in 2002 and 2003 to equal an average of the funding
provided during the previous 15 years. Compact grant assistance under
the amended compacts (2004 to 2024) is decreased annually. Funding for
compact-authorized federal services, trust-fund contributions, and U.S.
military use of Kwajalein Atoll land is not included.
[End of figure]
While the level of annual grant assistance to both countries decreases
each year, contributions to trust funds--meant to provide an ongoing
source of revenue after fiscal year 2023--increase annually by a
comparable amount. In comparing projected trust fund revenue with the
fiscal year 2023 grant level, we reported earlier that, under certain
conditions, the trust fund revenue available in 2024 may be less than
even the lower level of grant funding in 2024.[Footnote 21] For
example, at an assumed annual 6 percent rate of return, earnings from
the FSM's trust fund would be lower than expiring grant assistance in
2024, while earnings from the RMI's trust fund would encounter the same
problem by 2040.[Footnote 22] If the trust funds consistently earn a
higher rate of return, or if additional contributions to the funds are
provided, the probability rises that the trust funds could provide a
sustainable income source at the level of fiscal year 2024 grants.
However, if the trust funds experience market volatility with years
that have negative returns, the probability that these funds would
yield income sufficient to replace expiring grant assistance declines.
FSM and RMI Face Key Political and Social Challenges:
Although the FSM and the RMI are stable democracies, both countries
face political and social challenges with regard to improving grant
implementation and health and education conditions. U.S. and country
officials told us that political conditions, including a weak
federation in the FSM; disputes over public institutions' and
government use of land on Kwajalein Atoll in the RMI; and both
governments' lack of communication with their constituencies have
hindered compact implementation and service delivery. At the same time,
despite relatively high health and education expenditures, both
countries face development challenges in these sectors. For example,
although the Millennium Challenge Corporation (MCC)--which evaluates
indicators with a relationship to growth and poverty reduction--ranks
the FSM and the RMI in the top 20 percent for health expenditures
relative to other lower-middle-income countries, it ranks both
countries in the bottom third for a key health indicator,
immunizations.[Footnote 23]
Despite Stable Democratic Systems, Political Factors in the FSM and the
RMI Challenge Compact Implementation:
The FSM and the RMI are established democracies with free and peaceful
elections. According to State and Interior, each democracy is stable
despite the challenges of having hierarchical traditional structures;
islands with scattered populations; and a citizenry of distinct
cultures, languages, and histories. Each country also has a vocal civil
society evidenced by religious organizations and nongovernmental
organizations (NGO) that have been active on some political issues.
Internationally, both countries also participate in various regional
organizations, many of which address trade, energy, and environmental
challenges faced by island nations. For example, the FSM and the RMI
are members of the Forum Fisheries Agency--which promotes sustainable
management of fisheries in the Pacific--and the South Pacific Applied
Geoscience Commission, which promotes sustainable development of
offshore resources for member countries.
Despite the two countries' stable democratic systems, interviews with
U.S., FSM, and RMI officials and civil society representatives
indicated that key aspects of the FSM's and the RMI's political
environments hinder effective compact grant implementation.
* Lack of government consensus. State and Interior officials reported
that the FSM's weak federal structure inhibits compact grant
implementation. Because each state has its own constitution and
authority over budgetary policies, the central government that is
represented on JEMCO does not control the majority of compact funds and
have been unable to secure agreement from the state governments
regarding compact needs.[Footnote 24] As a result, FSM access to the
compact infrastructure grant, for example, has been delayed for more
than 2 years owing to national and state disagreements over
infrastructure priorities. Similarly, the RMI government and landowners
on Kwajalein Atoll have been disputing government use of leased land
and management of public entities on the atoll. Such tensions have
negatively affected the construction of schools funded by compact
grants and the management of the Kwajalein utility company and the
Kwajalein development authority, two entities that also receive compact
funds.[Footnote 25]
* Lack of government communication. Interviews with U.S., FSM and RMI
departmental officials, private sector representatives, NGOs, and
external economic experts revealed a lack of communication and
dissemination of information by each government on wide-ranging issues,
including JEMCO and JEMFAC decisions, departmental budgets, economic
reforms, legislative decisions, fiscal positions of public enterprises,
and economic statistics. Additionally, private sector representatives
in several FSM states reported that the public radio station serves as
the government's primary means of disseminating information but is
often nonoperational or censored--a complaint confirmed by the U.S.
State Department's 2004 Report on Human Rights Practices in the FSM. In
the RMI, a State official and an official from the RMI Council of NGO's
reported that the government had been criticized--most strongly by
environmental NGO's and a leading women's NGO (Women United Together
Marshall Islands)--for not holding public hearings or disseminating
sufficient information regarding a proposed dry dock.[Footnote 26]
According to the World Bank, Transparency International, and other
development experts, lack of information about government activities
creates uncertainty for public, private, and community leaders, which
can inhibit grant performance and improvement of social and economic
conditions.
Despite High Expenditures, Both Countries Remain Challenged in
Improving Health and Education Conditions:
Although FSM and RMI health and education expenditures are relatively
high, certain conditions in both countries' health and education
sectors are poor. According to the World Bank, among 171 countries for
which it reports aid per capita, the RMI and the FSM ranked 5th and 6th
highest, respectively, with per capita aid greater than $900 in
2003.[Footnote 27] Much of this aid is directed toward health and
education.[Footnote 28] MCC provides economic assistance to developing
countries, with eligibility determined partially by evaluating a
country's performance--relative to other countries within its income
group--on select indicators associated with economic growth and poverty
reduction. MCC ranks the FSM in the top 35 percent (in the 81st and
67th percentile, respectively) for expenditures on health and primary
education, and it ranks the RMI in the top 1 percent for both
indicators, relative to other lower-middle income countries that
qualify for MCC assistance. However, for another health-related
indicator--immunizations--MCC ranks both countries in the bottom third:
the FSM in the 33rd percentile and the RMI in the 13th
percentile.[Footnote 29] According to the World Bank's World
Development Indicators (WDI), the FSM also performs relatively poorly
in provision of safe water or sanitation--a service necessary for
improved health outcomes. According to WDI, only 28 percent of FSM
citizens have access to improved sanitation, compared with an average
of 57 percent in all lower-middle income countries. In the RMI, the
1999 census suggests that 85 percent of the population has access to
safe water, although the RMI 2003 statistical yearbook reports that
recent tests in urban and rural areas indicate that a significant
number of potable water sources, such as groundwater wells and water
catchments--30 percent or more in some cases--are contaminated and
deemed unsafe for human consumption. (For further information on
socioeconomic conditions in the FSM and the RMI, particularly in
relation to regional averages, refer to app. II.)
Country studies and health and education officials in the FSM and the
RMI also highlight other challenges--for example, the increasing
prevalence of lifestyle diseases such as diabetes or hypertension;
youth health issues; and poor teaching skills. According to the FSM
Department of Health, 80 percent of 35 to 64 year-olds are overweight,
and the number of cases involving diabetes, hypertension, heart
disease, and cancer increased in the late nineties. Likewise, the RMI
Ministry of Health reports that diabetes figured as the leading cause
of adult morbidity in 2000 and 2001. Although the RMI has made progress
in reducing overseas referrals since 2001, the rising prevalence of
lifestyle diseases poses challenges for delivery of health services in
both nations. The care and treatment of such diseases often involves
expensive referrals abroad, lowered funding for public health programs
that serve impoverished populations, and burdens on household and
national budgets. Future health outlays will also be affected by health
challenges facing FSM and RMI youths.[Footnote 30] FSM and RMI health
officials indicated concern about growing youth problems such as
suicides, sexually transmitted diseases, and teen pregnancy. With
regard to teacher qualifications, the FSM Department of Education
reports that 90 percent of teachers need to upgrade skills to meet new
certification standards (a bachelor's degree with courses in child
development). In the RMI, a 2004 Ministry of Education assessment
reported that more than 50 percent of teachers had failed basic English
literacy tests.[Footnote 31]
FSM and RMI Economies Show Limited Potential for Self-reliance and Long-
term Advancement:
In the past 2 years, the FSM and the RMI economies have performed
modestly and have been characterized by continued dependence on
external assistance, suggesting limited prospects for achieving
development goals of budgetary self-reliance and long-term economic
advancement. Private sector employment has largely stagnated in both
countries, whereas public sector expenditures continue to account for
almost two-thirds of GDP. Despite the amended compacts' structure of
declining grant assistance, the FSM and the RMI public sectors have
grown while tax revenues remain relatively small. Unless each nation
can secure other donor assistance, maintenance of living standards over
the long term will likely require private sector expansion or increased
remittances.[Footnote 32] The FSM and the RMI private sectors face
significant constraints to growth, however, and FSM and RMI emigrants'
current lack of marketable skills is a hurdle to increased remittance
revenue. Although the amended compacts' fiscal procedures agreements
require JEMCO and JEMFAC to monitor FSM and RMI progress toward
budgetary self-reliance and long-term economic advancement, neither
organization has discussed these issues at its annual meeting or
defined what actions they will undertake to meet this requirement.
FSM and RMI Economies Depend on Government Spending of Foreign
Assistance Instead of Private Sector Production:
As in the original compact period, FSM and RMI economic conditions in
2004 and 2005 were characterized by dependence on foreign assistance.
In the FSM, 2004 and 2005 GDP fell owing to compact delays and a lower
level of assistance relative to 2003.[Footnote 33] For the RMI, the IMF
estimates that GDP expanded moderately owing to increased public sector
expenditure (see fig. 4).[Footnote 34] While the RMI also experienced
compact delays in 2004, RMI public expenditure increased in both 2004
and 2005, reflecting expected compact funding at levels roughly
equivalent to fiscal years 2002 and 2003, when compact funds were
temporarily increased. Both countries' 2005 public sector expenditure-
-about two-thirds of which is funded by external grants--remained at
about 60 percent of GDP.
Figure 4: FSM and RMI External Grants and Estimated Real GDP:
[See PDF for image]
[End of figure]
In both the FSM and the RMI, however, private sector activity has
remained relatively stagnant and exists largely to provide services to
the public sector. Since 2000, the estimated private sector share of
GDP has fallen in both countries and only Pohnpei state in the FSM has
had modest growth in private sector employment, principally in
wholesale and retail operations.[Footnote 35] Institutions such as the
IMF and the ADB characterize the private sector in both the FSM and the
RMI as isolated from international opportunities, given each economy's
high dependence on imports and negligible foreign investment.[Footnote
36]
FSM and RMI Will Likely Face Significant Budgetary Pressure with
Declining Compact Assistance.
Given the recent performance and structure of FSM and RMI government
budgets, both nations are likely to face significant budgetary pressure
as compact grants decline through 2023. Apart from 2002 and 2003, when
compact assistance was temporarily increased, FSM national and state
budgets have varied widely from year to year; however, each has had
recent budget deficits. RMI government finance statistics reported by
the IMF suggest that the RMI fiscal balance deteriorated after 2003 as
well, with an estimated deficit equivalent to 2 percent of GDP in 2005.
Economic experts emphasize that, structurally, both country's budgets
are characterized by a small local revenue base and recent increases in
government payroll. As a result, unless other donors provide additional
assistance, expenditure reductions will be required as compact grants
decline.[Footnote 37]
* FSM budget structure. Although tax revenue in the FSM increased
slightly in 2005, the FSM tax base is small and the growing wage bill
is high relative to regional standards. In 2005, FSM taxes provided an
estimated $29 million in revenue, or 23 percent of total revenue
(compared with an average of 17 percent from 2000 to 2004).[Footnote
38] In addition, the FSM government receives fishing access fees from
foreign vessels that fish in its exclusive economic zone. However, the
largest income source is external grants, which, at $76 million,
accounted for 60 percent of revenues in 2005 (see fig. 5). In terms of
expenditure, the largest FSM expenditure component is public sector
wages and salaries at an estimated $60 million.[Footnote 39] This
component grew from 36 percent of total expenditures in 2000 to 2004 to
42 percent of total expenditures in 2005.[Footnote 40]
Figure 5: Structure of FSM Revenues and Expenditures, Fiscal Years 2000-
2005:
[See PDF for image]
Note: Transfers include subsidies and represent payments for which no
goods or services are received. "Other" revenues comprise dividend and
interest income, service charges, and fees. "Other" expenditures
consist primarily of current expenditures on goods and services.
[End of figure]
* RMI budget structure. As a percentage of total revenue, the RMI's tax
base is slightly larger than the FSM's. As a percentage of total
expenditure, the RMI's public sector wage bill is also relatively
smaller, although its wage bill increases have exceeded the FSM's.
Taxes in the RMI provide about $22 million in revenue to the
government, or roughly 26 percent of total revenues (see fig. 6). The
RMI also receives fishing access fees. At 64 percent of total revenues,
external grants are the largest income component, providing $54 million
in 2005. The structure of RMI revenues remained roughly the same over
the past 5 years. However, RMI payroll expenditures increased. In 2005,
the RMI's wage bill comprised 34 percent of total expenditures,
compared with the 2000 to 2004 wage bill of 31 percent. In actual
value, the RMI's wage bill increased from around $17 million in 2000 to
around $30 million in 2005.
Figure 6: Structure of RMI Revenues and Expenditures, Fiscal Years 2000-
2005:
[See PDF for image]
Note: Transfers include subsidies and represent payments for which no
goods or services are received. "Other" revenues are comprised of
dividend and interest income, service charges, and fees. "Other"
expenditures are comprised primarily of current expenditures on goods
and services.
[End of figure]
In addition to receiving compact grant assistance, the FSM and the RMI
receive substantial U.S. program assistance from agencies such as the
U.S. Departments of Agriculture, Education, and Health and Human
Services. The RMI also receives large grants from Japan and Taiwan and
the FSM receives large grants from Japan (see table 2) and reports
having received grants from China. As compact grants decline through
2023, government fiscal balances and GDP could be supported, at least
partially, by increased noncompact assistance. However, such increases
in assistance are not guaranteed, may vary from year to year, and may
not be flexible enough to meet FSM and RMI budget needs.[Footnote 41]
Table 2: Estimated Levels of Economic Assistance by Major Donors to the
FSM and the RMI, Average from Fiscal Years 2002 to 2004:
U.S. dollars in millions: FSM;
U.S. dollars in millions: Compact grants: $83[B];
U.S. dollars in millions: U.S. programs[A]: $45;
U.S. dollars in millions: Japan: $8;
U.S. dollars in millions: Taiwan: n/a.
U.S. dollars in millions: RMI;
U.S. dollars in millions: Compact grants: 29[B];
U.S. dollars in millions: U.S. programs[A]: 20;
U.S. dollars in millions: Japan: 5;
U.S. dollars in millions: Taiwan: $10.
Source: The U.S. Department of the Interior, FSM and RMI government
finance statistics, the IMF, and the Organization for Economic
Cooperation and Development (OECD).
Note: Some of the noncompact assistance, such as development assistance
from Japan, is not included in FSM and RMI government budgets as grant
assistance. In addition, China provides assistance to the FSM, although
we were unable to determine the estimated amount.
[A] These figures do not include occasional emergency assistance
provided by Federal Emergency Management Agency.
[B] The FSM and the RMI received less compact grant assistance than the
amended compact provides, owing to delays in compact grant
implementation.
[End of table]
Tax reform may provide opportunities for increasing annual government
revenue in the FSM and the RMI. For example, business tax schemes in
both nations are considered to be inefficient by the IMF, the ADB, and
other economic experts owing to a poor incentive structure and weak tax
collection. Various expert and country studies have concluded that
substantial tax reform could bring revenue growth by broadening the tax
base, altering the structure to be more equitable and business
friendly, and improving administration.[Footnote 42] However, although
the FSM and the RMI governments have made some improvement in tax
administration, tax revenues have largely stagnated. Revenue potential
from further tax reform will also vary by government (national and
state) and will require factors such as a sound design; adequate
resources and capacity for tax enforcement; government commitment for
reform; and, ultimately, private sector growth.
Key FSM and RMI Industries Face Multiple Constraints to Growth:
FSM and RMI development plans identify fishing and tourism as key
potential growth industries. However, in both nations, fishing
enterprises have shown poor performance, and the number of tourists has
been small relative to other Pacific islands.[Footnote 43] In the FSM,
the fisheries and tourism sectors together provide about 6 percent of
employment; commercial fishing has been plagued by poor government
investments in vessels and infrastructure that have resulted in high
debt levels, according to ADB experts; and visitor arrivals have
remained flat over the past 10 years despite growth in Pacific island
tourism. In the RMI, the fisheries and tourism sectors together provide
less than 5 percent of employment; commercial fishing within the RMI's
exclusive economic zone has been declining, and although visitor
arrivals have increased modestly, they remain small in number relative
to other Pacific island nations.[Footnote 44] Economic experts suggest
that the FSM and the RMI fishing and tourism industries could grow
within specialized niche markets such as high-end tourism or dock
services. Such opportunities remain limited in scale, however, and the
IMF, the ADB and other economic experts suggest that growth in these
industries in both countries may be limited by current structural
barriers such as the following:
* geographic isolation and small fragmented markets;
* high airfares and poor flight connections;
* lack of adequate hotel and airport infrastructure;
* low freight capacities and poor interisland shipping;
* inadequate transshipment facilities in some areas;
* a growing threat of overfishing;
* limited pool of skilled labor;
and:
* high production costs in terms of labor, fuel, and other supplies.
In addition to facing structural barriers to growth, private industry
in general faces a costly business environment in both the FSM and the
RMI according to economic experts and U.S. and country officials. In
interviews, private sector representatives also expressed concern with
poor government provision of power, water, and infrastructure services
and government failures to pay bills owed to the private sector for
services rendered--a complaint confirmed by several government
officials including those from the Chuuk State legislature, the RMI
Ministry of Resources and Development, and the FSM Department of
Economic Affairs (see app. III for further information).
Prospects for Increased Remittance Income to the FSM and RMI Require
More Skilled Migrants:
FSM and RMI emigrants could provide increasing monetary support to
their home nations in the future, although evidence suggests that they
are currently limited in their income-earning opportunities abroad.
World Bank data show that remittances, or the personal funds that the
foreign born voluntarily send to their home countries, have become an
important source of financial flows to developing countries--in some
cases exceeding official development assistance and foreign direct
investment.[Footnote 45] For the FSM and the RMI, many citizens have
taken advantage of U.S. migration rights established by the original
compact and extended by the amended compacts.[Footnote 46] As of 2005,
RMI data suggest that about 15,000 Marshallese have immigrated to the
United States. FSM data suggests that almost twice as many Micronesians
live overseas.[Footnote 47] However, the current level of remittance
income provided by these emigrants is unknown. In the RMI, the 2002
household survey suggests that RMI citizens send more money out to RMI
emigrants than they receive in remittances, owing to the emigrants'
lack of high-paying jobs and inability to afford repatriation of funds.
Our previous work has shown that RMI and FSM emigrant populations have
limited income-earning opportunities abroad, largely because of
inadequate education and vocational skills.[Footnote 48] The 2003 U.S.
census of FSM and RMI migrants in Hawaii, Guam, and the Commonwealth of
the Northern Marianas Islands (CNMI) confirms this characterization,
showing that almost half of the emigrants live below the poverty line
(see table 3).[Footnote 49] Nonetheless, economic experts emphasize
that with an upgrading of skills, the FSM's and the RMI's free access
and strong historical links to the U.S. market create potential for the
two nations to achieve an expansion in remittance income that could
contribute to long-term economic advancement.[Footnote 50]
Table 3: FSM and RMI Emigrants in Hawaii, Guam, and the CNMI, 2003:
Population;
FSM: 17,286;
RMI: 3,304.
Percentage that migrated for employment (includes dependents);
FSM: 47;
RMI: 25.
Percentage of labor-force participants that were unemployed;
FSM: 21;
RMI: 18.
Percentage of persons 25 years and older with college degree;
FSM: 6;
RMI: 7.
Percentage of individuals with income below poverty level;
FSM: 45;
RMI: 49.
Source: U.S. Census Bureau.
[End of table]
Compact Management Committees Have Not Discussed Progress toward Self-
reliance and Long-term Advancement:
To date, JEMCO and JEMFAC have not discussed FSM and RMI progress
toward budgetary self-reliance and long-term economic advancement or
the role for compact grants in attaining these development goals. FSM
and the RMI development plans specify the objectives of increased
private sector development, strengthened education and training, and
improved public sector management as means of achieving the goals of
budgetary self-reliance and long-term economic growth. The amended
compacts' fiscal procedures agreements requires the JEMCO and JEMFAC to
monitor FSM and RMI progress toward their long-term development
objectives, however the oversight committees have not defined what
actions they will undertake to meet this requirement.[Footnote 51] At
the fiscal year 2004 and 2005 annual JEMCO and JEMFAC meetings, as well
as at a March 2006 JEMCO meeting, compact management committees focused
on approving sector grants and discussing grant administration issues.
For example, to approve the FSM health and education sector grants,
JEMCO has required supplementary information on health insurance
programs and that a certain amount of the FSM's education grant is
spent on textbooks. The JEMCO meetings have not included discussion of
FSM progress toward its long-term development goals. At the 2005 JEMFAC
meeting, the RMI government provided a brief overview of GDP and
employment data, yet the presenting official reported that there was no
meaningful JEMFAC discussion of RMI long-term growth issues resulting
from the presentation. For example, while the RMI government presented
data on migration to the United States, JEMFAC did not discuss the
linkage between compact education spending and improving RMI emigrant's
skills to encourage increased remittance income over the long-term.
Through agency comments, HHS emphasized that an annualized schedule for
committee meetings does not provide enough frequency for addressing
both grant administration issues and long-term growth issues,
particularly given the relative lack of communication between JEMCO and
JEMFAC members in between meetings. HHS suggested that communication be
improved through periodic teleconference and videoconference updates.
FSM and RMI Progress on Key Economic Policy Reforms Has Been Slow:
FSM and RMI officials report that they have implemented a few
legislation actions to improve the private sector environment, such as
bankruptcy and mortgage laws, yet progress on key policy reforms
required to stimulate investment has been slow. According to FSM and
RMI private sector representatives as well as various U.S., IMF, ADB,
and country reports, an enabling business environment in either country
requires substantial reforms in taxes, land ownership, and foreign
investment regulations as well as a reduction in public sector
competition with the private sector. Despite several years of policy
dialogue on taxes, the FSM has agreed on elements of tax reform but has
no plan for implementation and the RMI has not agreed on structural
change to its tax system. In attempts to modernize complex, traditional
land tenure systems, land registration offices have been established in
both countries; however, in both countries, inadequate access to land
and uncertainties over land ownership and land values continue to
create costly disputes, disincentives for investment, and problems
regarding the use of land as an asset. Further, despite amendments to
foreign investment regulations, the regulations in both countries
continue to be confusing and relatively burdensome, according to
economic experts and private sector representatives. Finally, several
years of public sector reform efforts have also failed to reduce
government involvement in private sector activities. Thus far, the
JEMCO and JEMFAC committees have not evaluated the lack of FSM and RMI
progress in implementing economic reforms to stimulate investment and
improve tax income, identified problems encountered or recommended ways
to improve assistance for these objectives.
FSM and RMI Have Implemented Some Legislative Reforms:
Both the FSM and the RMI identified the need for economic reform within
their national development plans, and both countries have implemented
or are pursuing some legislative actions. For example, FSM officials
report that newly enacted legislation, although varying by state and
national government, include laws for bankruptcy, mortgages, long-term
leases, and secured transactions to allow movable assets to serve as
collateral. Some governments have also tried to improve foreign
investment processes or created small business development centers.
To create continued and strengthened demand for reform, the ADB has
also recently assisted both countries in holding several "Dialogue for
Action" retreats that enable public and private sector representatives
to develop a common vision for sustainable development through economic
reform. Our interviews with ADB and country participants suggested that
these retreats can be helpful for improving the public sector/private
sector dialogue on economic challenges facing each society. However,
ADB experts also emphasized that, in developing country commitment to
reform, the FSM and the RMI will need to overcome the "aid curse"--or
the distorted incentives for effective public sector management
through, e.g., public sector downsizing, which result from dependency
on large external aid flows.[Footnote 52]
Key Policy Reforms to Stimulate Investment Have Not Been Implemented:
Despite several years of commitment to, and recommendations for, policy
reforms to stimulate investment in the FSM and the RMI, key reforms
have not yet been implemented. According to FSM and RMI private sector
representatives and a number of economic and country experts, policy
reforms are needed in the areas of tax, land, foreign investment, and
the public sector to improve business incentives and create an enabling
environment for domestic and foreign investment.
Tax Reform:
Tax structures in the FSM and the RMI remain complex and unequal and
engender business disincentives.
* The FSM tax system has been criticized by economic experts, the FSM
government, and the FSM private sector for (1) multiple taxation of the
same products (2) weak administrative collection, audit, and
enforcement capacity (3) taxation on a gross rather than net
basis,[Footnote 53] and (4) duplicative national and state tax
administrations. Since 1994, the IMF and other experts have
recommended, among other tax reforms, implementing a value-added tax
(VAT), a simplified net profit tax, and a single modernized independent
tax authority. In 2005, the FSM Task Force on Tax Reform developed a
tax reform proposal, endorsed by the FSM President, that included these
principles. Nonetheless, despite the fact that such reforms are
estimated to require 2 to 3 years for implementation, the FSM
government has neither begun to implement the proposal nor specified an
implementation plan.[Footnote 54] Although the FSM government has made
some efforts to improve tax administration, actions by existing tax
authorities in the national government and each state government
continue to exhibit duplication and inefficiency.
* The RMI government and economic experts have recognized for several
years that the RMI tax system is complex and regressive, taxing on a
gross rather than net basis and having weak collection and
administration capacity. The RMI stated in its comments to this report
that their private sector representatives' most common complaint on the
RMI tax system is the need for better and tighter enforcement. The RMI
Office of Tax and Revenue reported that it has focused on improving tax
administration and has raised some penalties and tax levels. However,
legislation for income tax reform has failed and needed changes in
government import tax exemptions have not yet been addressed.
Land Reform:
Inadequate access to land and uncertainties over land ownership and
land values continue to create costly land disputes, disincentives for
investment, and problems regarding the use of land as an asset in both
the FSM and the RMI.
* Land tenure systems in each nation are complex and based on
traditional and customary rights, often for multiple individuals, such
that most parcels do not have a registered, legal title. Our interviews
with FSM and RMI officials and private sector representatives suggested
that costly boundary disputes are common.
* Land values are also uncertain owing to the lack of a developed land
market or price data on lease transactions, such that banks are unable
to effectively conduct mortgage secured lending. Given that a major
proportion of FSM and RMI wealth lies in property, the inability to use
it to secure financing for development is problematic.
* Using land for foreign investment in the FSM and the RMI is even more
difficult. Economic experts report that foreigners are prohibited from
owning land in both nations and are also unable to secure a valid lease
when land values or ownership is uncertain.[Footnote 55]
Land reform issues have been discussed in the FSM and the RMI for
several years, and land registration offices have been established.
However, such offices have lacked a systematic method for registering
parcels, instead waiting for landowners to voluntarily initiate the
process. Both the FSM and the RMI land registration offices reported
that landowners have shown little interest in land registration, partly
owing to the cultural issues associated with traditional land ownership
structures. In the RMI, for example, only 5 parcels have been, or are
currently being, registered by the land registration office. The
functionality of land registration offices in both the FSM and the RMI
has also been limited by a lack of registered surveyors and trained
staff.
Foreign Investment Regulations:
Although the FSM and the RMI have amended various aspects of their
foreign investment laws to streamline the process, the overall climate
for foreign investment remains complex and nontransparent, according to
economic experts and private sector representatives. In the FSM,
experts report that foreign investment regulations vary between states,
creating confusion and additional requirements for investors who want
to invest in several states. In both the FSM and the RMI, foreign
investment regulations remain relatively burdensome, with reported
administrative delays and difficulties in obtaining permits for foreign
workers. According to an Interior official, a shipping company with
service from the U.S. West Coast to Guam has for years been seeking
permission to provide shipping service to the FSM and the RMI but has
consistently been refused entry by those nations. The climate for
foreign investment is also reportedly affected by private and public
interests' protecting local businesses from foreign competition. For
example, experts report that foreign investment is restricted from some
industries in both the FSM and the RMI, and some FSM states require a
certain percentage of local ownership in foreign investment. Pohnpei
state, for instance, requires 30 percent local ownership for foreign
investment and prohibits foreign activity in retail, according to its
Foreign Investment Board. Interviews with country officials, private
sector representatives, and an ADB expert also suggest that local
businesses sometimes lobby the foreign investment boards against
approval of certain applications.
Public Sector Reform:
Extensive FSM and RMI government involvement in commercial activities
continues to hinder private sector development, owing to high public
sector wages and government enterprises that directly compete with
private industry. The FSM's and the RMI's public sector reform efforts
since the 1990s have been based on restructuring government operations
to (1) reduce the size and cost of the civil service, (2) reduce
government involvement in market-oriented enterprises that could be
more efficiently operated by the private sector, and (3) improve
government provision of critical support services. One example of a
reform success highlighted by economic experts is the RMI's
restructuring of its Social Security Administration to reduce operating
costs and improve service provision.[Footnote 56] However, despite
government endorsement of public sector reform principles, early
efforts to reduce public sector employment have generally failed in
both the FSM and the RMI, and the share of public sector employment has
increased over the past few years. FSM and RMI public sector wages also
remain about twice the level of private sector wages, contributing to
the large government wage bill and effectively drawing the most skilled
employees out of the private sector into public sector jobs. In
addition, the FSM and the RMI governments continue to conduct a wide
array of commercial enterprises that compete with private enterprises,
although the share of employment accounted for by these enterprises, as
well as estimated direct public enterprise subsidies, has declined in
recent years (see table 4).
Table 4: FSM and RMI Government Commercial Enterprises:
Share of employment 1997-2002 average 2003-2005 average[A];
FSM enterprises: 6.2% 5.2%;
RMI enterprises: 7.4% 7.0%.
Annual direct subsidies 1997-2002 average 2003-2005 average[A];
FSM enterprises: $4.3 million $1.9 million;
RMI enterprises: $2.4 million $1.8 million.
Estimated number of existing enterprises[B];
FSM enterprises: 45;
RMI enterprises: 16.
Examples of existing enterprises with financial losses or receiving
subsidies[C];
FSM enterprises: Micronesian Petroleum Corporation (2001 subsidy =
$500,000);
RMI enterprises: Copra Production Scheme (2004 subsidy = $900,000).
FSM enterprises:: Pohnpei Fisheries Corporation (2003 loss = $517,000);
RMI enterprises:: Marshalls Energy Company (2004 loss = $2 million).
FSM enterprises:: Kosrae Utility Authority (2004 loss = $427,000);
RMI enterprises:: National Telecom Authority (2004 loss = $980,000).
FSM enterprises: FSM enterprises: Chuuk Public Utilities Corporation
(2001 loss = $1 million);
RMI enterprises: RMI enterprises: Majuro Water and Sewer Company (2004
subsidy = $100,000).
Source: GAO analysis of FSM and RMI government finance statistics and
government audit data.
[A] RMI data are available only through 2004.
[B] The FSM estimate is from a 2001 report on public enterprise reform
prepared for the ADB by the Aires Group Ltd., in association with
Deloitte & Touche. The list represents entities either fully owned or
jointly owned by the state or national governments in 2000. The RMI
estimate is derived from the 2004 RMI Statistical Yearbook.
[C] Financial losses represent expenditures minus revenues or the net
change in assets. Economic experts highlighted several public
enterprises with large financial losses (such as the FSM National
Fisheries Corporation and Air Marshall Islands). These examples are not
included in the table because their audit reports were qualified or
contained material weaknesses.
[End of table]
Nonetheless, IMF and ADB officials expressed concern that the FSM and
the RMI governments are not committed to reducing their participation
in commercial activities, despite the fact that most of the enterprises
have drained public finances through poor financial performance,
requiring subsidization or entailing debt (see examples in table 4). In
conjunction with the ADB, the FSM prepared a comprehensive program for
public sector enterprise reform in 1999 that identified two enterprises
per state and national government for privatization (such
privatizations later became a condition for receiving ADB loan
assistance) and entailed plans for the creation of a Public Sector
Enterprise Unit.[Footnote 57] This unit has not yet been fully staffed,
and the ADB loan requirement was reduced to one enterprise per state
and national government, a condition that has not yet been met. The RMI
has yet to prepare a comprehensive policy for public enterprise reform.
Our interviews with economic experts and FSM and RMI officials
suggested that although they plan to privatize some public enterprises,
they intend to expand others.
Compact Management Committees Have Not Addressed Slow FSM and RMI
Progress in Implementing Reforms:
To date, JEMCO and JEMFAC have not addressed the lack of FSM and RMI
progress in implementing reforms that their development plans specify
are needed to stimulate investment and improve tax income. Different
from the original compact, the legislation implementing the amended
compacts specifically directs the JEMCO and JEMFAC to address FSM and
RMI policy reforms by (1) evaluating progress in implementing these
policy reforms, (2) identifying problems encountered, and (3)
recommending ways to increase the effectiveness of U.S.
assistance.[Footnote 58] In the 2004 and 2005 JEMCO and JEMFAC
meetings, as well as in a 2006 JEMCO meeting, compact management
committees focused on grant approval and administration and did not
address the status of reforms or include discussions of how compact
grant assistance could be leveraged to improve the policy environment
for private sector growth and investment.[Footnote 59] Specifically,
compact management committees did not discuss the lack of FSM and RMI
progress in tax, land, foreign investment, or public sector reform;
factors that contributed to this lack of progress; or the
interdependence of policy reform implementation with effective compact
grant implementation. Opportunities exist to create linkages between
grant administration and economic reforms. For example, sector grants
in public sector capacity building could be used to address capacity
constraints that have been identified as an obstacle to reform
implementation (e.g., the lack of certified land surveyors for land
reform). Further, compact management committees could establish
linkages between, for example, grants to tourism promotion agencies and
progress in reforming foreign investment regulations to improve the
private sector environment for investment or grants to private sector
development offices and progress in reforming public enterprises that
compete with private industry.
Conclusions:
The FSM and the RMI face notable challenges to achieving budgetary self-
reliance and long-term economic advancement, given their current health
and education hardships; dependence on grant assistance; and need to
effect reforms that are often politically, culturally, and technically
difficult to implement. Tax, land, foreign investment regulation and
public-sector reforms, when implemented, will improve the business
environment, in turn facilitating the private sector expansion that may
help the countries advance their compact goals. However, even with the
needed reforms, growth in the FSM's and the RMI's private sectors may
be limited by structural constraints such as geographic isolation and
high transport costs. As a result, the FSM and the RMI may need to
expand economic activities beyond their borders-- including, as some
experts suggest, expanding remittance income by equipping emigrants
with better skills and, therefore, stronger income- earning
opportunities abroad.
Because the amended compacts have been in place for only a few years,
it is difficult to determine whether the assistance they provide will
contribute to the fundamental changes in FSM and RMI economic
structures and institutions necessary to achieve budgetary self-
reliance and economic advancement. Expanding FSM and RMI private sector
activity and remittance income will require effective compact grant
implementation, just as successful compact grant implementation will
require FSM and RMI commitment to policy reform. The scheduled coming
reductions in U.S. grants to both countries create urgency for the
implementation of policy reforms if they require fiscal resources and
for capitalizing on opportunities to leverage compact assistance to
improve social and economic conditions through reform.
Recommendations:
To maximize FSM and RMI potential for budgetary self-reliance and long-
term economic advancement, we recommend that the Secretary of the
Interior direct the Deputy Assistant Secretary for Insular Affairs, as
Chairman of JEMCO and JEMFAC, to ensure--in coordination with other
U.S. agencies participating in these committees--that they fulfill
their requirements in the following three areas:
* evaluate FSM and RMI progress in implementing policy reforms needed
to improve the business environment and encourage increased investment
and tax income,
* identify problems encountered with policy reform implementation, and:
* recommend ways to improve U.S. assistance for these objectives.
Agency Comments:
We received comments from the Departments of the Interior and HHS, as
well as from the FSM and the RMI. A more detailed presentation and
response to the comments can be found in appendixes IV through VII. We
also received technical comments from Interior, State, Treasury, HHS
and the RMI. We incorporated technical comments into our report, as
appropriate.
The Department of Interior concurred with our recommendation and stated
that it is pursuing additional information on the FSM and the RMI
economies to support its implementation of the recommendation. The RMI
advocated for JEMFAC support in policy reform implementation and
emphasized that public sector reforms are particularly vital. HHS also
agreed with our recommendation and requested that it be expanded to
include JEMCO and JEMFAC requirements for establishing timelines for
policy reform implementation. While establishing timelines is not a
requirement under the amended compact or its subsidiary agreements, we
encourage the JEMCO and JEMFAC to consider this idea as one method to
improve U.S. assistance in support of an improved FSM and RMI
environment for investment and tax income. Further, Interior, HHS, and
the FSM emphasized that the JEMCO and JEMFAC have thus far focused
their attention on accountability issues and problems that have arisen
within the various sector grants. HHS suggested that, in order to
ensure the JEMCO and JEMFAC can address all pertinent short-term and
long-term issues, mechanisms to improve communication and information
between annual meetings--such as periodic teleconferences and
videoconferences--should be pursued. The FSM viewed the report as a
potentially constructive contribution to ongoing efforts to pursue
budgetary self-reliance and economic advancement, yet disagreed with
our conclusion that FSM development prospects remain limited.
In addition to providing copies of this report to your offices, we will
send copies of this report to other appropriate committees. We will
also provide copies to the Secretaries of the Interior, State, and
Health and Human Services, as well as the President of the Federated
States of Micronesia and the President of the Republic of the Marshall
Islands. We will make copies available to other interested parties upon
request.
If you or your staff have any questions regarding this report, please
contact me at (202) 512-3149 or gootnickd@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major contributions
to this report are listed in appendix VIII.
Signed by:
David Gootnick:
Director, International Affairs and Trade:
List of Committees:
The Honorable Pete V. Domenici:
Chairman:
The Honorable Jeff Bingaman:
Ranking Minority Member:
Committee on Energy and Natural Resources:
United States Senate:
The Honorable Richard G. Lugar:
Chairman:
The Honorable Joseph R. Biden, Jr.
Ranking Minority Member:
Committee on Foreign Relations:
United States Senate:
The Honorable Richard W. Pombo:
Chairman:
The Honorable Nick J. Rahall, II:
Ranking Minority Member:
Committee on Resources:
House of Representatives:
The Honorable Henry J. Hyde:
Chairman:
The Honorable Tom Lantos:
Ranking Minority Member:
Committee on International Relations:
House of Representatives:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The amended compacts implementing legislation requires that we report
on political, social, and economic conditions in the Federated States
of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) as
well as the use and oversight of U.S. assistance to those nations. In
compliance with the legislation's requirement, this report[Footnote 60]
examines each country's (1) political and social environment for
compact grant implementation; (2) economic conditions, including
overall growth, fiscal balances, and private investment; and (3) status
of economic policy reforms.
To identify key aspects of the FSM and the RMI political and social
environment for compact grant implementation, we reviewed the U.S.,
FSM, and RMI annual compact reports for 2004;
U.S. Department of State reports on FSM and RMI political systems and
human rights practices; political assessments by nongovernmental
organizations such as Transparency International and the University of
Hawaii; and information from the Pacific Islands Forum regarding FSM
and RMI participation in regional agreements and
organizations.[Footnote 61] We identified key areas of concern in
delivery of health and education services by reviewing FSM and RMI
development plans, and reports prepared in conjunction with the Asian
Development Bank (ADB), the World Bank, or the United Nations
Development Program.[Footnote 62] We obtained FSM and RMI socioeconomic
statistics on noncommunicable diseases, access to safe water and
sanitation, teacher certifications and literacy skills, and Pacific
Island Literacy Level student test scores from the FSM Departments of
Health and Education and the RMI Ministries of Health and
Education.[Footnote 63] We obtained regional socioeconomic statistics
on population trends, teenage fertility, child mortality rates,
immunizations, human poverty, and GDP and aid per capita from the World
Bank's World Development Indicators, the U.S. Census International
Database, and the 2005 United Nations Human Development Report.
To assess FSM and RMI economic conditions, we reviewed the U.S., FSM,
and RMI annual compact reports for 2004; FSM and RMI development plans;
recent International Monetary Fund (IMF) Article IV documents for each
nation;[Footnote 64] ADB Country Strategies and Program Updates;
2005 FSM and RMI Pacific Island Economic Reports (PIER) prepared in
conjunction with the ADB; and expert reviews of FSM and RMI fiscal
structures and tax systems.[Footnote 65] We obtained data on FSM and
RMI economic indicators such as gross domestic product (GDP),
employment, government finances, migration, and private sector
development from the IMF; the FSM's 2005 Statistical Tables; the RMI's
2004 Annual Yearbook and 2005 Employment Statistics; the OECD's
international development statistics; the U.S. Department of Census;
and the World Bank's World Development Indicators.
To describe the status of economic policy reforms in the FSM and the
RMI, we reviewed the documents mentioned above; the FSM Tax Reform Task
Force 2005 Report to the President; the RMI 2005 Budget Statement; ADB
progress reports on the RMI Private Sector Development Project and the
FSM Private Sector Development Loan; and RMI Final Reports from the
2005 Dialogue For Action Retreats sponsored by the ADB. We obtained
data on FSM and RMI public sector enterprises from the FSM's 2005
Statistical Tables; the RMI's 2004 Annual Yearbook; and the most recent
available public enterprise audit reports.
In addition, we held extensive interviews with officials from the U.S.
Department of the Interior (Washington, D.C; Honolulu; the FSM; and the
RMI) and the Department of State (Washington, D.C;
the FSM; and the RMI). We also interviewed officials from the U.S.
Departments of Treasury and Health and Human Services (Washington,
D.C., and Honolulu) and experts from the ADB (Manila, the Philippines),
the IMF (Washington, D.C.), the World Bank (Washington, D.C.) and the
Pacific Islands Development Program at the East-West Center (Honolulu).
We traveled to all four states in the FSM and to the RMI (Majuro). We
met with the governor's and legislature's offices in each of the FSM
states and the President's office in the RMI. We had detailed
discussions with FSM (national and state governments) and RMI officials
from foreign affairs, finance and budget, economic affairs, health,
education, land management, tourism and fisheries, environmental
protection, and audit agencies. In each location, we also met with
numerous representatives from private sector businesses, banks, and
community organizations.
To ensure accuracy in our report, we asked experts at the ADB, the IMF,
the World Bank, the Boston Institute of Development Economics, and the
University of Hawaii's East-West Center with knowledge of the FSM and
the RMI economies, as well as former members of the FSM's Economic
Management and Policy Advisory Team, to provide a technical review of
our findings and information on the reliability of data used to support
those findings. In conjunction with our own assessment, we determined
that trade data, remittance data, and data on the private sector
profits contained weaknesses. Exact data for these elements were not
presented in the report and related findings were corroborated with
other reliable data. For other social and economic data included in the
report, we determined they are sufficiently reliable for our purposes.
Nonetheless, our interviews with U.S., country, and international
officials revealed important constraints to the FSM's and the RMI's
capacity to prepare regular, reliable, and complete data that would
allow for a more thorough analysis of social and economic trends,
particularly in the future. Trend data on a variety of social
indicators, such as teacher qualifications and student drop-outs, could
assist in evaluation of the effectiveness of compact education
assistance. However, much of this data are just now being collected in
a systematic way. Also, given that both nations have weak domestic
capacity to produce statistics, they rely heavily on external
consultants for this purpose. In the FSM, the contract for statistical
assistance from external consultants has now expired. As such, both FSM
and Interior officials have expressed concern for that nations'
capacity to produce future statistics.
We conducted our review from August 2005 through March 2006 in
accordance with generally accepted U.S. government auditing standards.
We requested written comments on a draft of this report from the
Departments of the Interior, State, Health and Human Services, and
Treasury, as well as the governments of the FSM and the RMI. All
comments are discussed in the report and are reprinted in appendixes IV
through VII. Further, we considered all comments and made changes to
the report, as appropriate.
[End of section]
Appendix II: Some Regional Socioeconomic Data for the Pacific:
Economic studies of small island economies suggest common challenges
for socioeconomic development. According to international development
organizations, developing nations in the Pacific have exhibited
relatively poor economic performance and face common constraints to
growth such as geographic isolation and high transport costs. Such
nations have also exhibited the need for improvements in delivery of
health and education services, a challenge heightened when youths
account for a large share of the population. Environmental challenges
from climate change and increasing population density are also common
threats to ensuring sustainable livelihoods in the Pacific. Table 5
provides estimated socioeconomic data on various Pacific island nations
in order to illustrate some of these commonalities as well as areas
where the FSM and the RMI characteristically differ. For example:
* The RMI has a relatively small population, but both the RMI and the
FSM have a relatively large population density at 331 and 181 people
per square kilometer, respectively. The RMI also has a very high
teenage fertility rate.
* Except for Palau--also a nation with a Compact of Free Association
with the United States--the FSM and the RMI have the highest levels of
aid per capita.
* The FSM's child mortality rates are significantly lower than the
RMI's, and its immunization rates are significantly higher. The RMI
provides a significantly higher proportion of the population access to
improved sanitation.
Table 5: Some Estimated Socioeconomic Indicators for Select Pacific
Island Nations:
Population, total;
Year: 2005;
RMI: 59,071;
FSM: 108,105;
Fiji: 893,354;
Kiribati: 103,092;
Palau: 20,303;
Papua New Guinea: 5,545,268;
Samoa: 177,287;
Solomon Islands: 538,032;
Tonga: 112,422;
Vanuatu: 205,754.
Population ages 0-20 (% of total);
Year: 2005;
RMI: 50.1;
FSM: 48.9;
Fiji: 41.5;
Kiribati: 49.9;
Palau: 33.5;
Papua New Guinea: 48.0;
Samoa: 39.8;
Solomon Islands: 53.1;
Tonga: 49.1;
Vanuatu: 44.6.
Population density (people per sq km);
Year: 2004;
RMI: 331;
FSM: 181;
Fiji: 46;
Kiribati: 134;
Palau: 43;
Papua New Guinea: 12;
Samoa: 63;
Solomon Islands: 17;
Tonga: 141;
Vanuatu: 18.
Population growth (annual %);
Year: 2005;
RMI: 2.3;
FSM: 0.0;
Fiji: 1.4;
Kiribati: 2.3;
Palau: 1.4;
Papua New Guinea: 2.3;
Samoa: -0.2;
Solomon Islands: 2.8;
Tonga: 2.0;
Vanuatu: 1.6.
Life expectancy at birth, total (years);
Year: 2005;
RMI: 70;
FSM: 70;
Fiji: 67;
Kiribati: 62;
Palau: 70;
Papua New Guinea: 65;
Samoa: 71;
Solomon Islands: 73;
Tonga: 70;
Vanuatu: 63.
Teenage fertility rate (ages 15-19);
Year: 2005;
RMI: 87;
FSM: 36;
Fiji: 42;
Kiribati: 56;
Palau: 62;
Papua New Guinea: 58;
Samoa: 21;
Solomon Islands: 59;
Tonga: 42;
Vanuatu: 32.
Mortality rate,under age 5 (per 1,000);
Year: 2003;
RMI: 61;
FSM: 23;
Fiji: 20;
Kiribati: 66;
Palau: 28;
Papua New Guinea: 93;
Samoa: 24;
Solomon Islands: 22;
Tonga: 19;
Vanuatu: 38.
Immunization, DPT(% children ages12-23 months);
Year: 2003;
RMI: 68;
FSM: 92;
Fiji: 94;
Kiribati: 99;
Palau: 99;
Papua New Guinea: 54;
Samoa: 94;
Solomon Islands: 71;
Tonga: 98;
Vanuatu: 49.
Access to improved sanitation facilities (% of population with access);
Year: 2002;
RMI: 82;
FSM: 28;
Fiji: 98;
Kiribati: 39;
Palau: 83;
Papua New Guinea: 45;
Samoa: 100;
Solomon Islands: 31;
Tonga: 97;
Vanuatu: 50.
Aid per capita (current U.S.$);
Year: 2003;
RMI: 991;
FSM: 923;
Fiji: 61;
Kiribati: 191;
Palau: 1,295;
Papua New Guinea: 40;
Samoa: 186;
Solomon Islands: 132;
Tonga: 270;
Vanuatu: 154.
GDP per capita (constant 2000 U.S.$);
Year: 2004;
RMI: 1,738;
FSM: 1,745;
Fiji: 2,232;
Kiribati: 532;
Palau: 6,360;
Papua New Guinea: 622;
Samoa: 1,417;
Solomon Islands: 621;
Tonga: 1,638;
Vanuatu: 1,110.
Sources: Population, population growth, life expectancy, and teenage
fertility rates are from the U.S. Census international database. All
other data are from the World Bank's World Development Indicators.
[End of table]
[End of section]
Appendix III: The FSM and RMI Private Sector Environment:
Private sector representatives in the FSM and the RMI characterized the
business environment in their nation as obstructive and costly. They
attribute this characterization to elements of the political
environment (e.g., poor information), lack of progress in economic
reforms (both legal and financial), and poor government performance in
providing services. World Bank national business environment surveys
suggest that a high cost of doing business is a common problem for
small island states. However, the survey results show that FSM and RMI
business environments are particularly costly in several
areas.[Footnote 66] For example, of 155 countries surveyed, the FSM and
the RMI are among the worst 10 to 20 countries in terms of the cost of
enforcing contracts and the degree of investor protection. In
interviews with private sector representatives, problems were noted
with FSM and RMI business environments (see fig. 7).
Figure 7: Some Noted Problems with the FSM and the RMI Private Sector
Environment:
[See PDF for image]
[End of figure]
[End of section]
Appendix IV: Comments from the Department of the Interior:
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
United States Department of the Interior:
Office Of The Assistant Secretary Policy, Management And Budget:
Washington, DC 20240:
May 16 2006:
David Gootnick:
Director, International Affairs and Trade:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, DC 20548:
Dear Mr. Gootnick:
Thank you for the opportunity to respond to the U.S. Office of
Government Accountability (GAO) draft report entitled, "Compacts of
Free Association: Development Prospects Remain Limited for Micronesia
and Marshall Islands" (Report).
The Report fairly states the challenges facing the Republic of the
Marshall Islands (RMI) and the Federated States of Micronesia (FSM) as
the two countries attempt to effect systemic reforms required to
achieve budgetary self-reliance and long-term economic advancement. The
description of the political, cultural and technical obstacles to such
reform is accurate, as is the listing of necessary reforms, including
land, tax, and foreign investment policy. The Report's point of view is
shared by the Department of the Interior and, we believe, by the Asian
Development Bank, the International Monetary Fund, and other interested
United States agencies, and underpins the policies of these
organizations toward the freely associated states (FAS).
To maximize the FSM and RMI potential for budgetary self-reliance and
long-term economic advancement, the Report recommends that the
Secretary of the Interior direct the Deputy Assistant Secretary for
Insular Affairs, as Chairman of JEMCO and JEMFAC, to ensure, in
coordination with other U.S. agencies participation in these
committees, that they fulfill their requirements to:
* evaluate FSM and RMI progress in implementing policy reforms needed
to improve investment and tax income;
* identify problems encountered with policy reform implementation;
and:
* recommend ways to improve U.S. assistance for these objectives.
We concur with the Report's recommendations. The long-tern issues
identified in the Report are a prime concern of the JEMCO and JEMFAC,
and we assert that the actions of the committees to date have been made
in cognizance of the need for reforms and have been preconditions for
meaningful evaluation of FAS policies. We would respectfully disagree
with the Report's assertions that "JEMCO and JEMFAC have not discussed
the countries' limited progress in creating conditions for budgetary
self-reliance and long-term economic advancement at their annual
meetings." For example, these issues were addressed extensively in the
enclosed statement that the Deputy Assistant Secretary submitted for
the record at the opening of the 2005 JEMCO meeting.
In its earlier report, Compacts of Free Association: Implementation of
New Funding and Accountability Requirements Underway, but Planning
Challenges Remain, GAO found that certain obstacles and problems have
been encountered in Compact implementation. GAO identified oversight
issues, gaps in planning, and compliance matters. JEMCO and JEMFAC have
by necessity focused attention on addressing these concerns, which have
included directing capacity building funds in the FSM to address basic
financial management issues. While the committees may in the future
direct funds to obtain certified surveyors to assist in land management
reform, as the draft report suggests, the need to assure basic control
of resources is a higher priority today.
A current priority of the Department's Office of Insular Affairs is
working with both nations in establishing elemental information needed
to evaluate FAS budget and economic policies. At the direction of the
Deputy Assistant Secretary for Insular Affairs, consultants provided
through the U.S. Department of Agriculture Graduate School are helping
the FAS prepare economic statistical data sets for the RMI and FSM.
This will include an update of. gross domestic product (GDP), GDP per
capita, demographic trends, income distribution and poverty data;
employment statistics, wages and inflation; a monetary survey and
banking indicators; balance of payments and external debt; and
government finance statistics.
The consultants will also assist in the preparation of two economic
reports on the progress of the FSM and RMI in attaining the economic
goals stated in the strategic development plans and annual budgets. The
reports will contain an analysis of economic performance of the two
economies including: a review of the growth in GDP and GDP per capita
(including state levels in the case of the FSM); an analysis of changes
in the structure of the economies and sectoral developments; an
analysis of poverty and income distribution, employment and wages;
monetary developments and prices; the balance of payments and external
debt; and fiscal developments. The consultants will also prepare a
review of those policies enacted by the FSM national and state
governments and RMI government designed to assist and promote the
development of the economy and attainment of the goals of the amended
Compact.
This information will be broadly applicable and will be of particular
use for JEMCO and JEMFAC to evaluate progress in policy reforms. As a
cautionary note, we would like to point out that JEMCO and JEMFAC do
not, and should not, have the authority to control FAS policy choices
and speed of implementation of FAS policy reform. Although called upon
to monitor progress, the committees are not legislatures, nor may they
impose solutions upon the governments. The committees' influence is
limited to the authorities created by the Compact and the Fiscal
Procedures Agreement.
Thank you for this opportunity to comment.
Sincerely,
Signed by:
R. Thomas Weimer:
Assistant Secretary:
Enclosure:
Statement By Deputy Assistant Secretary:
David B. Cohen Before The Joint Economic Management Committee Meeting
In Pohnpei August 13, 2005:
Good morning, and thank you for the opportunity to address this
Committee. Before I begin, let me clarify that I am delivering this
message not in my capacity as Chairman of JEMCO but in my capacity as
head of the Office of Insular Affairs, manager of the Compact grants. I
address this message both to JEMCO and to all of the FSM officials who
are my colleagues in the administration of the Compact. I realize that
this distinction of roles can be confusing, but my role of grants
manager gives me some unique perspectives that JEMCO and my colleagues
from the FSM may find helpful. I hope that no one gets confused when I
refer to the members of JEMCO as "you", even though one of the "yous"
is "me".
Members of JEMCO, we are at a crossroads, and the ultimate success or
failure of this grand experiment that we call "Compact II" will depend
upon the results of today's meeting. As the U.S. Government
Accountability Office has pointed out, and as we all already know, we
face real challenges. Both the U.S. and the FSM have done their best to
rise up to the level of performance that Compact II demands of us. But
to date, our best-I'm referring to both countries here-has not been
good enough to put the FSM firmly on the path to a secure and
prosperous future. For the sake of all of the people of the FSM who are
depending on the Compact implementation teams from both countries, our
best will simply have to get better.
Some of my fellow Pacific Islanders have observed that while we used to
be able to just live for today, times have changed and we need to focus
more on the future. If we don't worry about the future, we may not have
a future to worry about. Eighteen years may seem like a long time for
the FSM economy to grow sufficiently to survive without Compact grants.
It is actually an alarmingly short period of time, given the distance
that we have to travel and the institutions and policies that would
have to change in order to make the journey possible.
The FSM's economy, which is based largely upon government jobs and
other government expenditures funded by outside grants, is
unsustainable. In order to build a stronger, more secure future,
Compact grants should be used to help generate private sector economic
development and local tax revenue, rather than as a substitute for
private sector development and local tax revenue. Public sector
expenditures, including payroll, should be used to ensure that the
people as a whole have a better life tomorrow, rather than merely to
provide a livelihood for some today. What this really means is that in
order for Compact II to succeed, attitudes and institutions that were
shaped by the Trust Territory economy will have to be retooled for the
future. Some have claimed that Compact 11 is a step back towards the
days of the Trust Territory. I believe that the opposite is true:
Compact II creates an urgent need to for both the U.S. and the FSM to
leave all vestiges of the Trust Territory mentality behind once and for
all.
We commend the FSM for recognizing the need to embrace a high-growth
scenario. Choosing a scenario of high growth is easy. What's difficult
is making the hard decisions and short-term sacrifices that will
actually lead to economic growth. We stand ready to help in any way
that we can, especially through our partnership with you in the
stewardship of Compact funds.
The initial years of Compact II have been a learning experience for all
of us, with successes and disappointments. I am pleased that OIA's
grants management team has developed an excellent relationship with our
FSM colleagues. If I may say so, I think that we've assembled a great
team at OIA. Many people on this team have devoted their entire careers
to Micronesia. We have members of this team who have literally married
into Micronesian culture, and who have children who are at least as
Micronesian as they are American. Each and every member of our team
knows these islands quite well and cares deeply about them. For what
it's worth, I care deeply about these islands.
Every member of this team deeply values the special relationship
between the U.S. and the FSM. Every member of this team deeply
appreciates the service of Staff Sgt. Steven Bayow of Yap and Sgt.
Skipper Soram of Pohnpei, who made the ultimate sacrifice in Iraq, and
of Sgt. Hilario Bermanis and all of the other sons and daughters of
Micronesia who are putting their lives on the line to defend freedom.
Every member of this team deeply respects the sovereignty of the
Federated States of Micronesia.
We have tried to be frank about the problems that we have found,
because every strong partnership requires frankness. But we have never
pointed fingers or laid blame. Our criticisms have been directed at
problems, not people.
In that spirit, let me highlight an issue that, from my perspective as
grants manager, can have a profound impact on the workings of JEMCO and
the implementation of the Compact. I commend JEMCO for its ability to
reach consensus most of the time. But why has JEMCO sometimes failed to
reach consensus when both nations want good schools, good health and a
strong economy? The reasons are complex, but I offer this for your
consideration. It takes time to reach a consensus, and the process as
it is currently managed gives us very little time. When OIA doesn't get
required materials in a timely fashion, we can't spot important issues
until the last minute. We then can't alert JEMCO members about
important issues until the last minute, which may leave JEMCO members
with insufficient time to resolve any differences that may arise among
them. While it is very important for JEMCO to reach consensus, JEMCO
cannot afford to be paralyzed when it fails to do so. Since JEMCO is
responsible for allocating the annual Compact grants, its failure to
act in a timely fashion could interrupt the flow of grant funds.
So who is to blame for JEMCO's occasional failure to reach consensus?
Is the FSM guilty of being dilatory? Are the U.S. members guilty of
railroading? In both cases, I say the answer is "no". The true culprit
here is a lack of capacity. The GAO identified insufficient capacity on
the U.S. side as a major challenge, and insufficient capacity on the
FSM side is a major challenge as well. On the U.S. side, we are going
to make an effort to improve our capacity. For the FSM, the Compact
gives us the tools to make necessary investments in capacity. In my
view, JEMCO has an absolute obligation to ensure that the FSM has the
capacity to generate good information so that we can measure the
success of our Compact expenditures. The FSM also needs to bolster its
capacity to monitor Compact spending, to ensure that funds are reaching
their intended beneficiaries. By developing the capacity to generate
necessary information in a timely fashion, we will all have enough time
to spot issues early on and, more importantly, JEMCO members will have
enough time to thoroughly discuss and resolve any differences that may
arise. I realize that it is painful in the short run to divert funds
from programs to capacity building, but without the capacity to measure
the results of our expenditures, we will have no way to determine which
of our expenditures are wise and which are a waste of precious
resources. If we allocate a little less money to programs and a little
more money to true capacity building for performance measurement and
oversight, we will be able to accomplish much more with a little less.
After this meeting, we must come together to find ways to improve the
process so that it can more effectively serve the needs of the
Micronesian people. We cannot allow process to become the enemy of
progress.
Another issue that challenged us this year was the situation that we
found in Chuuk, resulting in OIA's decision to withhold funds for the
school nutrition program. OIA took this action in order to protect and
preserve precious resources so that they could eventually be used for
the benefit of the people of Micronesia. It became clear to us that
money intended to feed the schoolchildren of Chuuk was not reaching
those children. Investigations which have been going on for several
months now hopefully will eventually determine where the money was
actually going. But for OIA to keep releasing funds, month after month,
when we knew that money wasn't reaching the children, would have been a
dereliction of our duty as grants manager.
If we let money out the door and it gets improperly diverted, that
money would probably be gone forever and would never be available to
help schoolchildren. The money we withhold, on the other hand, will be
available to benefit the people of the FSM as soon as we can establish
reasonable safeguards to protect Compact funds there. Establishing
those safeguards is one of the most important tasks that JEMCO faces
today. The people of the FSM are waiting for you, and they deserve
nothing less than your prompt action.
Finally, it has been brought to my attention that some of our
Micronesian colleagues take offense when I speak about the U.S. need to
protect the U.S. taxpayer investment in the FSM. Perhaps an explanation
would be helpful. I noted before that the members of the U.S. grants
management team care very much about the wellbeing of the FSM and its
people. In my view, however, it would be very condescending of us to
suggest that we care more about the FSM than its official leaders do,
or that we have a better grasp of what's good for the FSM. It is the
job of the FSM's official leaders to protect the interests of the FSM.
We respect the fact that this is your role, and would never presume to
usurp it from you. I therefore prefer to express my role not as the
guardian of the FSM's interests, which would be presumptuous, but as
the protector of the U.S. taxpayer investment. Those are the interests
that I'm paid to protect, and I hope you can respect that. The good
news is that we all want the same things: good schools, good health and
good opportunity for the people of the FSM. It is the job of FSM
officials to measure the success of the Compact on behalf of the people
of the FSM, and it is the job of their U.S. colleagues to measure that
success from the perspective of the U.S. taxpayer. Each side has to use
its own judgment in making these determinations, although the Americans
and Micronesians involved in this process must of course consult one
another extensively as partners to try to get onto the same page.
Hopefully, if the process allows enough time, JEMCO will always reach
consensus. The bottom line, however, is that we all must recognize and
respect each one another's roles in this partnership.
It has been suggested that the phrase "U.S. taxpayer investment"
somehow suggests that the FSM is receiving welfare, rather than a quid
pro quo in a partnership. That is not what it means at all. We
recognize full well all of the benefits that the U.S. has received, and
continues to receive, under the Compact. The bargain of Compact II,
however, is that what the U.S. gives in exchange for these benefits is
not free money for no particular purpose, but rather funds that are
expected to have tangible and measurable results in terms of improved
health, education and economic opportunity for the people of the FSM.
Compact II requires the U.S. to share responsibility for ensuring that
Compact funds actually reach their intended recipients and achieve
their intended results.
We believe that Compact II's accountability requirements greatly
benefit the people of the FSM. It would be very difficult for the FSM,
which is still developing its public sector capacity, to shoulder the
entire burden of ensuring that the people of the FSM receive all of the
benefits that they are supposed to receive under the Compact. Under
Compact II, the FSM doesn't have to assume this burden on its own: It
is the joint responsibility of the FSM and the U.S. Our active
involvement can only increase the likelihood that Compact funds will
achieve strong, positive results for the people of Micronesia.
I understand that some have concerns about the term "investment".
Perhaps this is because people associate this word with the private
sector and, unfortunately, there is deep suspicion of the private
sector throughout the Pacific. Let me be clear: An investment is simply
an expenditure that we expect to generate a positive result.
"Investment" is a very important word because when one invests, one is
giving up something now so that the future will be better. The result
that we're expecting from our investment-and by "we" I will presume to
speak for both countries-is a good, sustainable quality of life for the
people of Micronesia. The benefits of the investment go to the people
of Micronesia. We call it an "investment" because we're not simply
writing a check and walking away. We're sticking around to help ensure
that life actually improves for Micronesians in the way our two nations
intend.
Some have complained that Compact II's accountability requirements
violate the FSM's sovereignty. I would argue that the FSM's ability to
use outside grant funds without accountability is not a measure of its
national sovereignty. That is a false sovereignty. The FSM's true
sovereignty will be enhanced by its ability to develop its private
sector economy and generate local tax revenue, and hence reduce its
reliance on outside grants. Compact II, if implemented properly, will
help the FSM to achieve a much greater level of sovereignty over its
affairs.
Although Compact II contemplates the active involvement of the U.S. in
managing these grants, the U.S. role should be limited. As a general
rule, the U.S. should not usurp the prerogative of the FSM's leaders to
decide priorities for the FSM. In my view, there are two important
exceptions where the U.S. should assert its view, even if it's contrary
to that of the FSM's leaders: First, we must oppose investments of
Compact funds that we believe are outside the letter and spirit of the
Compact, and second, we must act to protect Compact investments and
maximize their chances of success. We recognize that the FSM's leaders
also are responsible for pursuing these objectives. In cases where we
have a difference of opinion, we must work to bridge the gap. If we are
unable to come to agreement in a timely fashion, however, then we are
bound to act according to our best judgment just as you are bound to
act according to yours.
The record will show that every time the U.S. has asserted its will
under Compact II, it has been triggered by a necessity, in our best
judgment, to defend the letter and spirit of the Compact or to protect
Compact investments. It is not surprising that some differences of
opinion have surfaced in the early years of Compact II. We need time to
work through some difficult issues. The process will get better, and we
all will get better at it, over time.
And we had better get better, because the people of Micronesia may one
day demand of us the accountability to which they are entitled. It is
fitting that JEMCO is meeting today, on the first day of school. When I
rode in from my hotel this morning, it was wonderful to see all of the
schoolchildren in Kapinga Village walking to school in their bright
green uniforms. But when parents who are sending their children off to
school today learn that Compact education grants to FSM state
governments have more than doubled since 2000, and that the U. S. is
spending over $1,000 per year for each student in Micronesia, some
parents on some islands may demand to know why their children's schools
are in decrepit condition, why their children don't have proper
textbooks, why their children's schools are not properly staffed, why
their children are not receiving anything close to $1,000 worth of
education. When they learn that Compact health grants to the FSM state
governments have more than doubled since 2000, some people may demand
to know why their dispensaries aren't properly staffed or stocked. If
the people of Micronesia start asking these questions, if they demand
to know where all that money went, what will we tell them? We should
welcome the day when the Micronesian people demand that we answer
difficult questions. It will help us all to become better stewards of
Compact funds. Those difficult questions need to be directed to all of
us and the governments that we represent. We are in this together.
So let us continue to work together as partners to make our working
relationship even stronger. But let us remember that while our working
relationship is very important, at the end of the day it will not be
the strength or weakness of our personal relationships with one another
that ultimately could cause the FSM to shortchange its future and fail
to capitalize on the great promise of Compact II. It will be our
collective failure to protect our common investment in the future of
the FSM, our failure to recognize that time is our enemy, and that we
have a very narrow window to rescue the future. It will be our
collective failure to act with vision and courage, to stand up to
political pressure, to stand up for change, to stand up for the people.
Long after we all have moved on from our current positions, future
generations of Micronesians will live with the consequences of our
actions and of our failures to act. The obligation of accountability
under the Compact runs not from one government to another, but from
those of us from both governments who are responsible for administering
the Compact to the people whose future depends on our wisdom and on our
will to do the right thing. Members of JEMCO, as you do your work today
inside of this room, never forget your solemn obligations to the people
outside of this room, especially the young people who will inherit the
future that you will help to create for them through your actions
today. And let us take comfort in the fact that everyone in the room
today has a common vision of that future: a future for the FSM in which
the people enjoy good health, good education and abundant economic
opportunity.
Members of JEMCO, you have much to accomplish today. I wish you the
best of luck.
The following are GAO's comments on the Department of the Interior
letter dated May 16, 2006.
GAO Comments:
1. Regarding our finding that compact management committees have not
discussed FSM and RMI progress toward budgetary self-reliance and long-
term economic advancement at their annual meetings, we recognize that
the Deputy Assistant Secretary submitted a statement for the record at
the opening of the 2005 JEMCO meeting that mentioned the lack of
sustainability in the FSM's economic dependence on government
expenditures. However, the Deputy Assistant Secretary did not read his
statement to the committee and the issue of FSM progress toward their
long-term development goals was not discussed by the JEMCO.
2. We recognize that Interior has contracted with the U.S. Department
of Agriculture's Graduate School to obtain further economic information
on the FSM and the RMI. While we agree with the importance of gaining
this further information, we believe that sufficient information is
available for the committees to begin meeting their requirement to
evaluate FSM and RMI progress in implementing reforms, identify
problems encountered, and recommend ways to improve U.S. assistance for
these objectives. For example, multiple expert studies as well as FSM
and RMI commitment to, and recommendations for policy reforms in the
areas of tax, land, foreign investment, and the public sector have
existed since the 1990s.1:
[1] Documents discussing these issues include, for example, IMF Article
IV documents for both the FSM and RMI, dating back to 1998; ADB country
assistance plans, country economic reports, and Public Sector Reform
Program loan documentation, dating back to 1997 for the FSM and 1996
for the RMI; the RMI's 2000 Statement of Development Strategies
entitled Meto 2000; the FSM's 2000 Economic Review; and the documents
and information sources listed in appendix I.
[End of section]
Appendix V: Comments from the Department of Health and Human Services:
Note: GAO comment supplementing those in the report text appear at the
end of this appendix.
Department Of Health & Human Services:
Office of Inspector General:
Washington, D.C. 20201:
May 23 2006:
Mr. David Gootnick:
Director, International Affairs and Trade:
U.S. Government Accountability Office:
Washington, DC 20548:
Dear Mr. Gootnick:
Enclosed are the Department's comments on the U.S. Government
Accountability Office's (GAO) draft report entitled, "COMPACTS OF FREE
ASSOCIATION: Development Prospects Remain Limited for Micronesia and
Marshall Islands" (GAO-06-590). These comments represent the tentative
position of the Department and are subject to reevaluation when the
final version of this report is received.
The Department appreciates the opportunity to comment on this draft
report before its publication.
Sincerely,
Signed by:
Daniel R. Levinson:
Inspector General:
Enclosure:
The Office of Inspector General (OIG) is transmitting the Department's
response to this draft report in our capacity as the Department's
designated focal point and coordinator for U.S. Government
Accountability Office reports. OIG has not conducted an independent
assessment of these comments and therefore expresses no opinion on
them.
Comments Of The U.S. Department Of Health And Human Services On The
U.S. Government Accountability Office's Draft Report Entitled
"Development Prospects Remain Limited For Micronesia And Marshall
Islands" (GAO-06-590):
The U.S. Department of Health and Human Services (HHS) appreciates the
opportunity to comment on the draft report. We look forward to working
with the Government Accountability Office (GAO) on this and other
pertinent issues addressed in this report.
General Comments:
HHS agrees with the overall conclusions of the report. However, we
believe there are some points within the report that need to be placed
in context to accurately reflect the situation of these two countries.
First, the draft report provides a thorough description of the
political and social conditions that inhibit the implementation of
compact development plans for the Federated States of Micronesia (FSM)
and the Republic of Marshall Islands (RMI). The articulated problems
are significant, and in large part reflect the inertia and the lack of
political will of these two Governments to make hard decisions to
revamp basic policies and structures that impede change. Some changes
(e.g. laws to govern the title and use of land) will be very difficult
to achieve, given the cultural practices of the two countries.
Second, we agree with the GAO's recommendation that the "Secretary of
the Interior direct the Deputy Assistant Secretary for Insular Affairs,
as Chairman of the compact management committees, to ensure that they
meet requirements to address the lack of FSM and RMI progress in
implementing reforms to improve investment and tax income." However, it
would be helpful for GAO to include specific recommendations to
establish timelines to address policy reforms in these areas. This is
especially critical given that these Governments are more than 2 years
into their second amended compacts, and many of the critical changes
dealing with property and tax laws could take years to implement. In
other sectors, such as health and education, the necessary changes can
probably be made more rapidly.
The report also mentions that considering the amount of funding
invested in FSM and RMI, the health and education indicators in both
nations remain relatively poor. More specifically, the report cites low
immunization rates as an example of a poor health indicator. In 2003
after a large measles outbreak in the Marshall Islands, HHS initiated
steps to address this longstanding problem. These steps included: (1)
the 2005 assignment of a public health advisor to the Pacific Islands
Health Officers Association (PIHOA) to help manage supplies of vaccines
for the Flag Territories and Freely Associated States in the Region;
(2) an ongoing commitment to fund a regional epidemiology position, to
be based in the FSM; (3) the January 2006 placement of a regional
immunization epidemiologist in the Commonwealth of the Northern
Marianas Islands; and (4) a commitment to place a public health advisor
in Chunk State, FSM, to improve immunization coverage. Through these
efforts, the islands should see continuing improvement in vaccine
coverage, even given the tremendous geographic obstacles to delivery of
vaccines among the many scattered islands.
Finally, the report mentions the poor educational backgrounds of both
the teachers and students in both nations, which leave young people
inadequately prepared to obtain skilled jobs at home or abroad to
support the local economies. Yet, because of a lack of support, the
Ponape Agriculture and Trade School (PATS), founded in 1965 as a
regional high school to provide vocational education to students in
agriculture, construction, mechanics, and computer technology, recently
closed. There appears to be no plan by the FSM government to fill this
void.
Recommendations:
To maximize the potential of both the FSM and RMI for budgetary self-
reliance and long-term economic advancement, we recommend that the
Secretary of the Interior direct the Deputy Assistant Secretary for
Insular Affairs, as Chairman of the JEMCO and JEMFAC, to ensure, in
coordination with other U.S. agencies that participate in these
committees, that they fulfill their requirements.
GAO Recommendation One:
Evaluate FSM and RMI progress in implementing policy reforms needed to
improve investment and tax income.
HHS Response:
This draft places very high expectations on the JEMCO and JEMFAC. If
this is the case, GAO should have considered the frequency of committee
meetings and the current committee process. The compact law and the
Fiscal Procedures Agreement only require these committees to meet at
least once a year. So far, JEMFAC meetings have occurred only with that
frequency. JEMCO has been meeting twice a year in recognition of the
additional complexities of the political, social, and economic
situation in the FSM. In between these meetings, there has been a
relative lack of communication between the JEMCO and JEMFAC members,
and there is no established secretariat for either body.
GAO Recommendation Two:
Identify problems encountered with policy reform implementation.
HHS Response:
Given the relative newness of the amended compacts in both countries,
it has taken some time to establish the roles and responsibilities of
the various structures, including JEMCO and JEMFAC, established to
implement the compacts. During this transition period, much of the
focus has been on systematizing the budget process and dealing with
specific issues and problems that have arisen within the various sector
grants. These needs have come at the expense of addressing longer-term
development. There were also delays in completion, submission, and
review of the national development plans required under the amended
compacts. It was difficult to address long- term planning in the
absence of these plans. Now that the amended compact process has
stabilized and the national development plans are available, JEMCO and
JEMFAC should be able to devote more time during and between meetings
to the issues raised by GAO.
GAO Recommendation Three:
Recommend ways to improve U.S. assistance for these objectives.
HHS Response:
HHS would be pleased to help support the mechanisms that keep the JEMCO
and JEMFAC members better informed between meetings, through periodic
teleconference updates, or through videoconferencing. The more dialogue
that occurs, the more likely it is that the parties can address all the
pertinent short-term and long-term issues.
The following is GAO's comment on the Department of Health and Human
Services letter dated May 23, 2006.
GAO Comment:
HHS agreed with our recommendation and requested that it be expanded to
include JEMCO and JEMFAC requirements for establishing policy reform
implementation timelines. The amended compacts' U.S. implementing
legislation does not include establishing timelines for policy as a
specific required action for the JEMCO and JEMFAC. Nonetheless, in
fulfilling their requirement to identify problems encountered with
policy reform implementation and recommend ways to improve U.S.
assistance, the JEMCO and JEMFAC should consider this suggestion. As
noted in our conclusions and by HHS, the urgency of pursuing policy
reform suggests that establishing timelines for such reforms could be a
useful method to improve U.S. assistance. We also appreciate HHS's
suggestion to improve communication and information between annual
meetings through periodic teleconferences and videoconferences and have
added language to the report to reflect this suggestion. We have also
added language to the report recognizing HHS's efforts to improve
vaccine coverage.
[End of section]
Appendix VI: Comments from the Federated States of Micronesia:
GAO comment supplementing those in the report text appear at the end of
this appendix.
Embassy Of The Federated States Of Micronesia:
1725 N Street, N. W. Washington, D.C. 20036:
Office of the Ambassador:
May 30, 2006:
Telephone: (202) 223-4383:
Facsimile: (202) 223-4391:
Email: FSMAMB@aol.com:
Mr. David Gootnick:
Director, International Affairs and Trade:
United States Government Accountability Office:
441 G Street, NW:
Washington, D.D. 20548:
RE: Comments by the Government of the Federated States of Micronesia on
the GAO draft Report: "Development Prospects Remain Limited for
Micronesia and Marshall Islands"
Dear Mr. Gootnick:
The Government of the Federated States of Micronesia (FSM) has no
specific comment on the manner in which its current state of economic
development is described in GAO's lengthy Draft Report. In fact, if
these observations are viewed in the proper light and acted upon
accordingly, the Report could become a very constructive contribution
to the ongoing joint effort between the U.S. Government and the FSM
Government to address and eventually achieve the critical Amended
Compact goals of budgetary self-reliance and economic advancement in
the FSM.
We do not deny that economic development in the FSM slowed during the
latter phase of the original Compact period, and that this trend has
continued during the early years of the Amended Compact. This trend
simply must be reversed if the other goal, budgetary self-reliance, is
to be attained by the year 2023.
You are correct that budgetary self-reliance cannot be attained without
the economic development in the FSM that was envisioned by the U.S. and
FSM negotiators of the Amended Compact. It will not be attained simply
by a Drakonian application of the Amended Compact's broad new
accountability provisions, which has been the sole focus of the U. S.
Government thus far. It is true that those provisions are an essential
component in achieving maximum effectiveness of U.S. Compact
assistance, but accountability alone will not, by itself, lead to the
economic future of the FSM that we all desire.
Before going further, I would like to say that the Draft Report, as
presently written, could lead a reader unfairly to conclude that the
obstacles to economic development in the FSM are so daunting and
pervasive that economic development cannot be attained. Even the
present title of the Report, "...Prospects Remain Limited...," suggests
that not only has the pace of development been slow, but the very
prospect for development has been and remains limited. We strongly
disagree with any such assertion. It is our belief that, with the right
kind of partnering by the US in our efforts to develop our economy, and
with the opportunities presented by the prospective submarine fiber
optic cable, the development prospects of the FSM are not limited, but
rather very bright. What may look to some like a Mission Impossible is
in fact achievable, but, just as we see on television, only with the
application of the right equipment and expertise.
I do not mean to suggest that the constraints to FSM economic growth
are any less than the draft Report lists on pages 24 and 25. Several UN
Summit conferences have been held to examine ways and means of
overcoming these constraints, faced generally by Small Island
Developing States worldwide. Nor does the FSM Government take issue
with the need for the key economic policy reforms discussed in pages 28
through 36. It is incorrect, however, to suggest that the slow progress
in implementing these reforms reflects a lack of commitment by the FSM.
Our nation, at all levels, is trying very hard to live up to the formal
commitments we made under the Amended Compact, given the resources and
capacities we can bring to bear.
The main point I would like to make is that even the full
implementation of these reforms will not, in and of itself, produce
economic development. They may, and hopefully will to some extent,
relieve some of the FSM's budgetary distress and establish a more
rational setting for private investment. They will not, without more,
magically establish an upward trend of private sector development and
economic progress.
I mean no disrespect to our long-standing friends and supporters in the
United States, but it is a fact that throughout the period of the
original Compact many if not most on the U.S. side adhered to the, "If
you build it they will come" philosophy of development in our islands.
That had only limited success then, and even strict accountability
coupled with best efforts by the FSM Government will not make it any
more successful between now and 2023.
It is regrettable, but true, that the FSM continues to have serious
capacity limitations on the government side that hinder our efforts to
cope promptly and effectively with the new Compact requirements. To the
extent that the Draft Report seems to take account of this reality it
is helpful. But limitations of capacity have an even more serious
effect on the necessary growth of the FSM's private sector. Governments
can assist with resources and programs, but neither governments nor
multilateral agencies alone can be engines of private sector
development.
We would hope that in the years to come our discussions with the US
JEMCO Members and other U.S. officials will include finding ways for
the U.S. actively to assist FSM in promoting private sector business
opportunities and to establish connections with the U.S. business
community, aimed at building a flourishing FSM private sector. This
side of the US/FSM partnership must no longer be neglected.
On behalf of the FSM Government, I thank you for the opportunity to
make these comments and will appreciate your consideration of them. In
addition, I would like to express appreciation for the diligent and
long-standing efforts of your Office and staff to ensure the success of
the Compact of Free Association by shedding constructive light on the
implementation of this complex treaty and related agreements.
Sincerely yours,
Signed by:
Jesse B. Marehalau:
Ambassador to the US:
The following is GAO's comment on the Federated States of Micronesia
letter dated May 30, 2006.
GAO Comment:
Regarding the FSM's disagreement with our conclusion that its
development prospects remain limited--the FSM confirms the accuracy of
our description of its recent economic performance, its constraints to
growth, and its need for economic policy reforms. Given these current
realities, we maintain that prospects for long-term economic growth in
the FSM remain limited. We do not assert, however, that economic
development cannot be attained. If key policy reforms were implemented,
the business environment would likely improve and facilitate private
sector expansion that may help the FSM advance its compact goals.
Further, we agree that implementation of policy reforms will not, in of
itself, produce economic development. As such, the FSM will also likely
need to identify and capitalize on niche market opportunities as well
as to create conditions to maximize remittance income, particularly
through improving the education and health of its citizens.
Establishing connections with the overseas business community may be
one way to pursue such opportunities and should be included in
meaningful JEMCO discussions of FSM progress toward their economic
goals. As we emphasized earlier, the scheduled coming reductions in
U.S. grants creates urgency for implementation of policy reforms and
for capitalizing on opportunities to leverage compact assistance. The
coming reductions in U.S. grants, paired with current economic
realities, also suggests the need for JEMCO discussions to be based on
frank assessments of current limited prospects for economic growth in
the FSM and what actions need to be pursued to improve those options.
[End of section]
Appendix VII: Comments from the Republic of the Marshall Islands:
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
Embassy Of The Republic Of The Marshall Islands:
2433 Massachusetts Avenue, N.W.,
Washington, D.C. 20008:
Tel. # (202) 234-5414:
Fax # (202) 232-3236:
June 1, 2006:
Mr. David Gootnick:
Director:
International Affairs and Trade:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Gootnick:
Thank you for providing the GAO Report (GAO-06-590) "Compact of Free
Association Development Prospects Remain Limited for Micronesia and
Marshall Islands (Draft)" to the Government of the Republic of the
Marshall Islands (RMI), and for allowing my Government the opportunity
to provide our comments (please see attached.)
The RMI welcomes the GAO's input and looks forward to continuing to
work with the GAO to identify and address issues under the Compact of
Free Association, as amended.
Sincerely,
Signed by:
Banny deBrum:
Ambassador:
Government of the Republic of the Marshall Islands Comments on the GAO
Report (GAO-06-590) "Compact of Free Association Development Prospects
Remain Limited for Micronesia and Marshall Islands (Draft)"
The following comments are based on a review of the draft document. We
would hope that the changes stated and observations made are clarified
and reflected in the final report.
One overall comment is that the while the report focuses on economic
development prospects, the study does not take into account some
salient factors regarding the transition from the first Compact of Free
Association term (1987-2003) and the Amended Compact's term. First, the
RMI consciously set aside most of the Compact 'bump-up' funds in 2002
and 2003 into the Marshall Intergenerational Trust Fund. The majority
of these funds were used as the RMI's required contribution to start
Amended Compact Trust Fund. The important point is that this funding
could have acted as a social and economic fiscal stimulus during those
two years but, instead, was set aside with future generations in mind.
The second major point was that there were delays in the initiation of
the Amended Compact term which was not officially implemented until May
2004. The delays and the transition to totally new delivery,
accountability and reporting mechanisms as set forth in the Fiscal
Procedures Agreement, the incomplete implementation of the Supplemental
Education Grant and the delay in Trust Fund start-up did have negative
repercussions on public finances as well as caused uncertainty in the
domestic and foreign private sector. Finally, the delay in Trust Fund
start-up will impact performance of the Trust Fund in the long run.
These issues were beyond the control of the RMI government.
One of the major challenges regarding social and economic stability
remains the size of the annual decrement of the Compact Title Two
Section 211 sector grant funding ($500,000) and the only partial
inflation adjustment. The resulting significant annual decline in the
nominal and real value of this funding will place pressure on providing
adequate social services and fiscal stability as well as impact private
sector performance. This is despite the changes the RMI is making in
focusing amended Compact funding mainly on health, education and
infrastructure development and maintenance.
Finally, the draft report fails to take into account the status of the
Section 177 Settlement Agreement regarding the U.S. nuclear testing
program in the Marshall Islands including the fact that the RMI has
petitioned the U.S. Congress for additional measures to address the
ongoing consequences of the nuclear testing under the terms of that
Agreement. Section 177 and its subsidiary agreement continue in effect
under the Compact, as amended, however, the U.S. has to date failed to
address the long term radiological health and other burdens that the
Marshallese people continue to face.
Comments to the report:
1. Economic Assistance and Military Use Payments - The report
references $3.6 billion in U.S. economic assistance on page 2 and the
RMI chart (Figure 1, page 8) shows Annual Compact Assistance trends.
While the figure used on page 7 (Compact of Free Association, 1986-
2003), $2.1 billion for 1987-2003, is footnoted and states that it does
not include federal services or U.S. military use of Kwajalein atoll
land. We are wondering if the other figures do contain U.S. military
use funding? Payments related to land-use and contained in the Military
Use and Operating Rights Agreement (MUORA) are not considered 'economic
assistance' in the Compact or by the RMI. We would appreciate if the
figures used are specifically classified and identified properly.
2. Amended Compact Security and Defense Commitments - The Compact of
Free Association 1986-2003 section states that the "second goal was
achieved" concerning the Compact's establishment of key defense rights
for all three countries. The statement mentions this in the past tense
and no reference early on in the report (except in a footnote) to the
mutual security relationship, including the use of Kwajalein atoll, in
the amended Compact which are further maintained and, in fact, in place
longer than the grant-related economic assistance. The economic
assistance discussion in the Results in Brief section should mention
the unique security and defense relationship provide for in the amended
Compact. This is important for report readers to understand, especially
those who may not be familiar with the previous and current Compacts.
3. Focus on Health and Education - The report mentions in various
places that the amended Compact funding is to make health and education
a mandated priority. While we are not aware of such a requirement in
Title Two or the Fiscal Procedures Agreement amongst the six sectors,
the RMI has made health and education its own priority in its Medium
Term Budget and Investment Framework, associated sector portfolios and
other strategy and policy documents. This approach has been agreed by
the JEMFAC as most sector grant and Infrastructure Development and
Maintenance Program funding are for the health and education sectors.
The RMI will continue this health and education emphasis for FY07.
4. Footnote 7 "address" - It is not clear what this reference means.
5. Growing Wage Expenditure and Tax Regime Reform - The RMI government
has studied and is aware that its public sector wage costs have risen
and that this has created a 'crowding out' effect vis-a-vis the private
sector. We are also aware of the need for tax regime reform. We are
attempting to respond to these major reform items. However, U.S.
technical assistance and ADB technical assistance have not been
supportive of assisting in such efforts in a way to make consistent
change. The Government's focus has been on improving tax administration
since in consultations with the private sector the most often repeated
complaint is not about the structure of taxes but about the need for
better and tighter enforcement. The Government is keen to improve the
tax regime and will continue its efforts but its priority is currently
on better enforcement of existing taxes.
6. Reliance on Remittances -The report highlights two possible
responses to help economic growth: private sector growth and an
increase in Marshallese remittances. We are concerned that GAO is
emphasizing remittances as a possible economic development component.
It is not the policy of the RMI government to promote emigration to the
United States or the repatriation of citizen salaries and wages. Such
an approach may take away from what the government's role should be-
creating the enabling environment for private sector led economic
growth, and thus employment growth, within the RMI. In fact providing a
better environment for the development of the private sector is likely
to ensure that less money is sent overseas if the private sector can
receive a better return for their money domestically. The issue at the
moment is largely academic since the relevant data is not available,
apart from the limited data available from the Household Income and
Expenditure Survey in 2003. The production of Balance of Payments and
remittance data will help to quantify these flows and provide a basis
for any specific policy.
7. Overall Recommendation - The report's overall recommendation (page
6) is to guide JEMFAC "to ensure that they meet requirements to address
the lack of FSM and RMI progress in implementing their specified
reforms to improve investment and tax income." While we understand that
the italicized part of the statement mirrors some of the amended
Compact's implementing language, we are concerned about how such a
statement may be interpreted by the U.S. members of the JEMFAC. Le., we
realize we must increase domestic and foreign private sector investment
but the challenge is how since we have had much experience on this
issue. And, regarding tax income, we realize we need tax reform but not
necessarily to increase tax income.
The recommendations made in the previous paragraph of the report are
more important, namely as mentioned, reforms in taxes, land ownership,
foreign investment regulations, and public sector management. We have
elaborated on each of these issues and have sought assistance or using
our own capacities to address these issues. We require the U.S., ADB
and JEMFAC support to address these major reform areas. This would
involve practical assistance to help the Government implement reforms
rather than further recommendations on restructuring. The Government is
keen to reform but is uncertain of how to implement changes and this
has been incorrectly interpreted as reluctance to reform.
8. Per Capita Grant Assistance - The same comment per item 1, above,
applies to Figure 3. MUORA related funds should not be included or, if
included, should be stated as such and noted that these are payments to
Kwajalein land owners for land use. Also, it is difficult to determine
if the RMI figures include the "bump-up" amounts in 2002-03. Per the
introductory comment, it should be noted that the RMI set aside its
'bump-up' funding to meet its funding obligations for the Amended
Compact Trust Fund. Such an effort not only showed fiscal prudence but
also helped to implement the government's intent to save for future
generations. This comment also relates to the initial para under 'FSM
and RMI Economies Depend on Government Spending on Foreign Assistance
Instead of Private Sector Production.':
9. Tax Collections - One aspect that the report doesn't touch on when
discussing tax collections and amounts is the vulnerability of certain
tax income streams. For instance, fisheries license income does provide
a significant amount in income to the government ($1.3-2.5 million
annually) as well as associated private sector income from supporting
ships. However, this figure is volatile year-to-year and the government
has little control over the amounts generated since it depends on
fishing patterns. Such volatility is symptomatic of other thin income
streams to the government. And such volatility relates to private
sector activity such as: tourism declines due to 9/11 and SARS outbreak
in the early part of this decade; and increased fuel prices which have
an instant negative impact on economic activity and human development
indicators.
10. Tourist Visits - Under 'Key FSM and RMI Industries Face Multiple
Constraints to Growth' (page 24) the comment that tourism flows remain
small in number relative to the RMI's neighbors may be misleading. What
neighbors are being referred to? The footnote mentions Fiji, Samoa,
Palau, PNG and Vanuatu which are not really neighbors. The RMI's
neighbors are the FSM, Kiribati and Nauru. There are various reasons,
such as air connections, relative proximity to originating countries,
etc. that have to be looked at from the supply side as well as internal
issues such as infrastructure and support services can be determined.
11. Footnote 50 ADB Comment - This statement relates to the 1987-2001
period. It does not relate to the 'bump-up' years (2002-03) and the
current amended Compact period. This should be noted.
12. Public Sector Reform (page 33) - The statement that "early efforts
to reduce public sector employment have generally failed" is incorrect
for the RMI. The RMI has had several public sector reform efforts in
the 1990s to include: 1) efforts at enterprise commercialization and
privatization; 2) reducing the size of government by eliminating or
spinning-off government departments and entities; and 3) civil service
reform to include staff reductions. The problem is making continuous
and consistent efforts.
13. Policy Reforms - The section, 'Compact Management Committees Have
Not Addressed Slow FSM and RMI Progress in Implementing Reforms'
provides some suggestions for public sector capacity building. The RMI
has applied amended Compact funds to the Marshall Islands Investment
Authority for tourism promotion and has provided support for the Land
Registration Office.
14. Conclusion - While tax, land and foreign investment regulation
reforms are mentioned in this section, the need for public sector
reform (specifically civil service reform) is not mentioned yet remains
vital. This is important for the RMI's development so that the public
sector becomes less of an economic actor, does not 'crowd out' the
private sector for employees and capital, and provides the enabling
environment for private sector-led development.
The following are GAO's comments on the Republic of the Marshall
Islands letter dated June 1, 2006.
GAO Comments:
1. Regarding our recommendation, we believe that economic reforms in
each of the areas discussed (e.g., tax, land, foreign investment, and
public sector) are needed to improve the RMI's prospects for long-term
economic growth and have clarified the report language. We also agree
that the annual decrement in compact grant funding is a major challenge
to achieving this objective, particularly if implementation of key
policy reforms requires fiscal resources.
2. We recognize that the FSM and the RMI were required under the
amended compacts to contribute an initial $30 million to their trust
funds. Recent RMI GDP performance may have differed if this funding
were used to provide current goods and services rather than for
savings. Nonetheless, the RMI's contribution to their trust fund does
not alter the extent of RMI economic dependence on external assistance.
Our description of RMI economic performance was also based on broad
trends from 2000 to 2005, rather than exclusively on the 2 years of
bump-up assistance in 2002 and 2003.
3. We will address amended compact implementation issues and trust-fund
issues in two separate reports, forthcoming. We have also added
language to this report indicating the RMI's concern over delays in
setting up its trust fund.
4. We have clarified our estimates and figures with regards to funding
streams they include and exclude. Section 177 funds are not included in
our analysis.[Footnote 67]
5. Section 211 of Title Two of the Amended Compact with the RMI states
that compact grants shall be used for assistance in education, health
care, the environment, public sector capacity building, and private
sector development, or for other areas as mutually agreed, with
priorities in the education and health sectors.
6. We have added language regarding RMI consultations with the private
sector and their desire for improved tax enforcement. The effectiveness
of U.S. and ADB technical assistance to the RMI is outside the scope of
this report. We note, however, that the RMI allocated no compact
funding to a public sector capacity building grant in fiscal year 2004
and less than 1 percent of compact sector grant funding to such a grant
in fiscal year 2005.
7. We discuss remittances in our report as one option that the RMI may
consider in pursuing the economic goals under the amended compact and
that the JEMFAC may consider when discussing compact grant
implementation. In the RMI's METO 2000 Statement of Development
Strategies and its 2001 Strategic Development Plan entitled "Vision
2018," the RMI estimates that between 500 to 800 new job entrants will
need to find employment each year from 1999 to 2009. To meet this
objective, the ready access provided under the compact for Marshallese
to live and work in the U.S. must be preserved. These documents also
emphasize that the education system needs to equip Marshallese to
succeed both in the RMI and abroad. Economic experts have emphasized
that the RMI's free access and strong historical links to the U.S.
market provide the RMI with relatively good opportunities to expand
remittance income, particularly if migrants had upgraded skills.
Improved skill provision should benefit both RMI emigrants as well as
domestic economic prospects.
8. We have clarified our reference that 2003 data on international
visitor arrivals are for other Pacific island nations. Such data are
not available for Kiribati and Nauru. The World Bank has estimated
that, in 2002, Kiribati had 5,000 international visitors. However,
Kiribati also has a per capita GDP that is less than one-third of the
RMI's.
9. RMI employment data indicate that the RMI did succeed in reducing
public sector employment from about 3,760 jobs in 1997 to about 3,530
jobs in 2001.[Footnote 68] However, since then, public sector
employment has risen to about 4,320 jobs in 2005.
10. We have modified language in the report to clarify each of these
points. We have added language to the report to include the volatility
in tax income from the fisheries and tourism sectors and the fact that
RMI offices related to reform efforts, such as land registration
offices, have been funded with compact grants.
[End of section]
Appendix VIII: GAO Contact and Staff Acknowledgments:
GAO Contact:
David Gootnick, (202) 512-3149:
Staff Acknowledgments:
In addition to the persons named above, Emil Friberg, Assistant
Director; Leslie Holen; Reid Lowe; Mary Moutsos; Kendall Schaefer; and
Seyda Wentworth made key contributions to this report.
FOOTNOTES
[1] The FSM comprises the four states of Chuuk, Kosrae, Pohnpei, and
Yap. Each state has its own constitution, elected legislature, and
governor and maintains considerable power, relative to the central
government, to implement budgetary policies.
[2] A key goal for this assistance was to advance economic development
and self-reliance for both countries. In 2000, we reviewed the impact
of compact funding and found that U.S. assistance had resulted in
little economic development for either the FSM or the RMI. See GAO,
Foreign Assistance: U.S. Funds to Two Micronesian Nations Had Little
Impact on Economic Development, GAO/NSIAD-00-216 (Washington, D.C.:
Sept. 22, 2000).
[3] For the purpose of this report, all annual references refer to the
fiscal year rather than the calendar year. Note that the $3.6 billion
in assistance includes (a) compact grants; (b) trust-fund
contributions; (c) Kwajalein impact funding provided to the RMI
government, which in turn compensates Kwajalein Atoll landowners, for
U.S. access to the atoll for military purposes; and (d) estimated
values of compact-authorized federal services such as weather,
aviation, and postal services, at around $200 million over the 20-year
period. Services associated with the Federal Emergency Management
Agency have been excluded.
[4] The amended compact with the FSM requires the FSM government to
prepare an official overall development plan. The RMI amended compact
requires the RMI government to prepare an official medium-term budget
and investment framework. The RMI has also prepared two strategic
development reports entitled "Meto 2000" and "Vision 2018." In our
report, we refer to the three RMI documents combined, as its
development plans.
[5] JEMCO and JEMFAC were created under the amended compacts to
strengthen management and accountability and to promote the effective
use of compact funding. Each committee has five members, three from the
United States and the other two from the FSM for JEMCO and from the RMI
for JEMFAC. The Departments of the Interior, State, and Health and
Human Services supply the three U.S. representatives, with the Interior
representative serving as Chairman.
[6] P.L. 108-188.
[7] Specifically, the implementing legislation directs that the scope
of the JEMCO and JEMFAC annual meeting, as outlined in the amended
compacts, shall be construed as to read that the JEMCO and JEMFAC
review required audits and reports, evaluate FSM and RMI progress in
meeting objectives identified within their development plans, with
particular focus on priority sectors and implementation of economic
policy reforms to encourage investment and achieve self-sufficient tax
rates, identify problems encountered, and recommend ways to increase
the effectiveness of U.S. assistance. In this report, we use the term
"address objectives" to refer to these actions.
[8] The fiscal procedure agreement for the FSM specifically states that
JEMCO shall monitor FSM progress toward sustainable economic
development and budgetary self-reliance in relation to its written
goals and performance measures. The fiscal procedure agreement for the
RMI specifically states that JEMFAC shall evaluate RMI progress to
foster economic advancement and budgetary self-reliance in relation to
its written goals and performance. In this report, we refer to both
requirements as "monitoring." Also, FSM and RMI development plans
broadly refer to the terms "sustainable economic development" and
"economic self-sufficiency" in reference to their goals for long-term
economic advancement.
[9] A separate report will examine the use and oversight of U.S.
assistance to the FSM and the RMI.
[10] Transparency International is a global nongovernmental
organization (NGO) devoted to combating corruption. The organization
consists of more than 90 locally established national chapters and
chapters in formation that bring together relevant players from
government, civil society, business and the media to promote
transparency in elections, in public administration, in procurement and
in business.
[11] The East-West center is an education and research organization
established by the U.S. Congress in 1960 to strengthen relations and
understanding among the peoples and nations of Asia, the Pacific, and
the United States.
[12] The U.S. Department of the Navy began civil administration of
these islands on July 18, 1947; this responsibility was transferred to
Interior in July 1951. See GAO, Foreign Assistance: Effectiveness and
Accountability Problems Common in U.S. Programs to Assist Two
Micronesian Nations, GAO-02-70 (Washington, D.C.: Jan. 22, 2002).
[13] This estimate represents total nominal outlays. It does not
include payments for compact-authorized federal services or U.S.
military use of Kwajalein Atoll land, nor does it include investment
development funds provided under section 111 of Public Law 99-239.
[14] In addition to providing compact grants, the United States gave
the FSM and the RMI access to programs from various agencies, such as
the Departments of Education and Health and Human Services. Total U.S.
assistance, therefore, includes compact grants and U.S. program
assistance.
[15] In the FSM, however, state per capita GDP performance varied. For
example, real per capita GDP declined from 1987 to 2003 in Chuuk and
Kosrae while it increased in Pohnpei and Yap.
[16] GAO/NSIAD-00-216.
[17] GAO/NSIAD-00-216.
[18] We use the term "U.S. island areas" to refer collectively to Guam,
Hawaii, and the Commonwealth of the Northern Mariana Islands. See GAO,
Foreign Relations: Migration from Micronesian Nations Has Had
Significant Impact on Guam, Hawaii, and the Commonwealth of the
Northern Mariana Islands, GAO-02-40 (Washington, D.C.: Oct. 5, 2001).
[19] The amended compacts and related agreements addressed most of the
recommendations that we had made in past reports. See GAO, Compact of
Free Association: An Assessment of the Amended Compacts and Related
Agreements, GAO-03-890T (Washington, D.C.: June 18, 2003).
[20] Both the original and the amended compacts provide for the United
States' use of portions of the Kwajalein Atoll for military and defense
purposes. The new agreement provides U.S. military access to Kwajalein
Atoll through 2066, with an option to extend access through 2086. See
GAO, Foreign Relations: Kwajalein Atoll Is the Key U.S. Defense
Interest in Two Micronesian Nations, GAO-02-119 (Washington, D.C.: Jan.
22, 2002).
[21] For our earlier analysis, see GAO-03-890T. Since 2003, the RMI has
also secured trust-fund contributions from the authorities on Taiwan.
However, both the FSM and RMI trust-funds experienced delays in getting
invested. The RMI stated in its comments to this report that such
delays will impact performance of its trust-fund in the long run. To
reflect the most recent market and trust-fund information, we will be
updating our trust-fund analysis in a separate report, forthcoming.
[22] In designing the trust funds, the Department of State assumed that
the trust fund would earn a 6 percent rate of return in order to
reflect a conservative investment strategy. This rate of return can be
compared with the current average forecasted return for long-term U.S.
government bonds of 5.2 percent by the Congressional Budget Office.
[23] The Millennium Challenge Act of 2003 (P.L. 108-199) established
the Millennium Challenge Corporation (MCC) in January 2004;
MCC administers the Millennium Challenge Account. Through this account,
the United States provides development assistance to lower-income and
lower-middle income countries that demonstrate, among other factors, a
commitment to just and democratic governance, economic freedom, and
investing in their people. According to the World Bank's World
Development Indicators, the FSM and the RMI are lower-middle income
countries.
[24] For example, the central government manages less than 10 percent
of compact sector grants. Further, due to confusion about how the FSM
consolidated budget translates into specific state resource flows, for
the fiscal year 2007 budget consultations, the Department of the
Interior will consult with the state governments directly, rather than
through the central government.
[25] In addition to these examples, land issues remain a problem for
U.S. access to Kwajalein Atoll through the defense provisions of the
amended compact. The RMI government is bound by an agreement with the
U.S. government that allows for U.S. access to Kwajalein Atoll until
2086. To date, the RMI government has not reached an agreement with
Kwajalein Atoll landowners (who own the land under use by the U.S.
government) that allows for this long-term access.
[25] [26] In June 2004, RMI officials announced plans for a Taiwanese-
funded floating dry dock to be placed in downtown Majuro (the capital
city of the RMI). Members of the RMI's NGO community opposed this plan
owing to potential negative impacts on the reef, sea life, and the
downtown community.
[27] Countries with higher per capita aid levels include French
Polynesia, New Caledonia, Mayotte, and Palau, which also has a Compact
of Free Association with the United States.
[28] As directed by the amended compacts, the FSM and the RMI have
placed a priority on the health and education sectors. For example,
education expenditures amounted to $221 per capita in the RMI and $192
per capita in the FSM. In the FSM, however, per capita health and
education expenditures varied widely by state, reflecting variations in
per capita assistance received. For example, although Chuuk state
represents an estimated 50 percent of the FSM population, it receives
only 38 percent of compact funds.
[29] MCC also examines girls' primary education completion, but data
for this indicator were not available for either the FSM or the RMI.
Regarding immunizations, the RMI had a large measles outbreak in 2003.
In response to this outbreak, HHS initiated steps to improve vaccine
coverage, including, among other things, assigning a public health
advisor to the Pacific Islands Health Officers Association in 2005;
continuing its commitment to fund a regional immunization
epidemiologist to be based in the FSM;
and committing to place a public health advisor in Chuuk State.
[30] A World Bank study highlights suicide as a serious risk for RMI
youths, with 66 cases of attempted or completed suicides in 2003 (an
increase of 20 percent from 2002). See World Bank, East Asia and the
Pacific Region, Opportunities That Change People's Lives: Human
Development Review of the Pacific Islands - RMI Country Case Study
(Washington, D.C.: 2005). The RMI has pursued a vigorous outreach
program to address this problem, however, and reported suicides fell
significantly in 2005.
[31] According to the RMI's Economic Policy, Planning, and Statistics
Office, only 14 percent of Marshallese staff who took the test passed
both the reading and writing components.
[32] In this report, we use "remittances" to refer to funds voluntarily
transferred by emigrants to their home countries.
[33] Earlier estimates by the IMF and the FSM predicted minimal GDP
growth in 2005, based on an assumption of increased government
expenditure;
however, compact delays continued into 2005.
[34] IMF and RMI government estimates of GDP growth differ due to
different inflation assumptions. According to RMI economic consultants,
RMI estimates will be updated to reflect new inflation assumptions to
accord more closely to those used by the IMF.
[35] Both the FSM and the RMI have limited data on private sector
profits. Employment data and interviews with private sector
representatives confirm the lack of private sector growth.
[36] Reliable exact trade data are not available. However, current
information suggests that imports exceed exports almost sevenfold in
the FSM and almost fivefold in the RMI.
[37] Both economies scaled back public sector employment and total wage
expenditures in the late 1990s as part of an ADB-financed public sector
restructuring program. FSM public sector employment has varied since
2000, but the level in 2005 is the highest over the past 5 years. In
the RMI, public sector employment steadily increased from 2000 to 2005.
[38] FSM tax revenue accounts for about 11 percent of GDP, compared
with Fiji, Palau, Papua New Guinea, Solomon Islands, or Kiribati tax
revenues, each of which accounts for more than 20 percent of GDP.
[39] The FSM public sector wage bill accounts for about 25 percent of
GDP. In contrast, the public sector wage bills in Fiji, the Solomon
Islands, Papua New Guinea, and Samoa account for less than 12 percent
of GDP.
[40] However, the FSM fiscal outlook is complicated by varied state
budget structures that create differences in fiscal vulnerabilities.
For example, 2005 tax revenues ranged from 28 percent of total revenues
in Pohnpei to 16 percent of total revenues in Kosrae, while the 2005
wage bill ranged from 30 percent in Yap to 57 percent in Chuuk.
Moreover, the FSM will face an additional element of fiscal adjustment
as it is required to phase out over 5 years its ineligible use of the
compact capacity building grant for general government operations.
[41] In addition, the RMI's ADB debt repayments will be increasing in
the future. The RMI estimates that annual ADB debt repayments will rise
from approximately $1 million in 2005 to almost $4 million by 2012.
[42] ADB and IMF studies broadly estimate that the FSM could raise tax
revenues by 25 to 30 percent by implementing a value-added tax (VAT).
See Mark Sturton, Strengthening of Public Sector Management and
Administration: Compact Fiscal Adjustment and Transition, a report
prepared for ADB TA-4258, 2004 and the 2004 IMF Article IV Staff Report
and Statistical Appendix for the FSM. For the RMI, estimates of revenue
potential are less certain. One ADB study estimates that the RMI could
raise tax revenues by about 20 percent by altering its income tax
structure and streamlining import taxes. (See Fuat Andic, Tax Policy
and Administration in the RMI, a report prepared for ADB TA-6245-REG,
2005.) However, another ADB consultant suggested that revenue gains
from tax reform would be limited to less than 3 percent.
[43] The World Bank reports that international visitor arrivals in 2003
totaled approximately 18,000 in the FSM and 7,000 in the RMI, compared
with 431,000 in Fiji; 92,000 in Samoa; 68,000 in Palau;
56,000 in Papua New Guinea; and 50,000 in Vanuatu.
[44] The RMI stated in its comments to this report that tax income from
the fisheries and tourism sectors is also volatile.
[45] Remittances are also an important source of income to maintain
standards of living for families in home countries since they are
resilient to economic downturns. We reported that, for several
countries, including El Salvador and the Philippines, remittances from
the United States received by households on a monthly basis tend to
substantially exceed the monthly minimum wage income for these
countries. See GAO, International Remittances: Different Estimation
Methodologies Produce Different Results, GAO-06-210 (Washington, D.C.:
Mar. 28, 2006).
[46] U.S. Census surveys of Guam, the Commonwealth of the Northern
Mariana Islands (CNMI), and Hawaii suggest that a large portion of
Micronesian migrants live in these areas.
[47] As a result of emigration, FSM population growth has slowed from
about 2 percent in the early 1990s to virtually zero since 1995.
[48] GAO-02-40.
[49] FSM and RMI migrants also live in other areas of the United
States. A preliminary survey of RMI emigrants in Springdale, Arkansas
suggests that the emigrant population there has higher education levels
and lower poverty levels relative to the emigrant population in Hawaii,
Guam, and the CNMI.
[50] In addition to income support from remittances, experts also
suggest that returning emigrants may bring back newly acquired skills
and capital that could support growth in the home economy.
[51] Department of the Interior officials reported that their Office of
Insular Affairs has contracted with the U.S. Department of
Agriculture's Graduate School to assist them in preparing an economic
statistics dataset for the FSM and the RMI, economic reviews for the
FSM and the RMI, and a policy review for both countries.
[52] According to ADB experts, large aid transfers to the FSM and the
RMI resulted in an economic development strategy where the public
sector served as the engine of growth. For example, during the original
compact period, large investments were made into public sector
enterprises that were protected through subsidies or tax exemptions.
These activities created distorted incentives for tax reform, public
sector downsizing, and creation of a more open foreign investment
regime.
[53] The FSM Office of Customs and Tax estimated that it collects
between 40 to 60 percent of owed taxes. It attributed this low
collection rate to inadequate collection and enforcement capacity and
to the inability of businesses with net losses to pay taxes levied on a
gross basis.
[54] According to the Task Force on Tax Reform, the FSM will need to
pass a constitutional amendment to implement the tax reform proposal
that revises state and national tax authorities or each state will have
to pass identical tax reform legislation. FSM officials report that
such an amendment had been previously introduced and failed. Our
interviews with state governments suggested that they support the
proposal in principle but are not yet aware of a detailed plan. Our
interviews with private sector representatives suggested some
resistance to the tax reform proposal.
[55] The two commercial banks that operate in the FSM (Bank of Guam and
Bank of FSM) also have some degree of foreign ownership such that they
are unable to accept land as collateral. In the RMI, the Bank of Guam
and the Bank of the Marshall Islands also have foreign-ownership that
prevents them from owning land.
[56] In January of 2000, the RMI Cabinet appointed a new board for the
Marshall Islands Social Security Administration (MISSA) that in turn
appointed new management. The newly appointed management implemented
wide ranging reforms including closer justification of expenditures,
streamlining salaries and wages, elimination of job duplication, and
improved use of information technology.
[57] See The Aires Group Ltd., Privatization of Public Enterprises and
Corporate Governance Reforms, a special report prepared at the request
of the Asian Development Bank, 2001.
[58] The implementing legislation, P.L. 108-188, directs that the scope
of the JEMCO and JEMFAC annual meeting, as outlined in the amended
compacts, shall be construed as to read that the JEMCO and JEMFAC
review required audits and reports and (1) evaluate FSM and RMI
progress in meeting objectives identified within their development
plans, with particular focus on priority sectors and implementation of
economic policy reforms to encourage investment and achieve self-
sufficient tax rates; (2) identify problems encountered;
and (3) recommend ways to increase the effectiveness of U.S.
assistance. In this report, we use the term "address objectives" to
refer to these actions.
[59] FSM and RMI offices related to reform efforts, such as land
registration offices, have been funded with compact grants.
[60] Our forthcoming report on the use and oversight of U.S. assistance
to the FSM and the RMI will be published by December 17, 2006.
[61] The Pacific Islands Forum represents the governments of 16 Pacific
islands and houses a secretariat to perform administrative tasks in
support of the forum's goal of regional cooperation.
[62] These reports include: World Bank, East Asia and the Pacific
Region, Opportunities That Change People's Lives: Human Development
Review of the Pacific Islands - RMI Country Case Study (Washington,
D.C.: 2005); Secretariat of the Pacific Community, in cooperation with
the United Nations Development Program, Pacific Islands Regional
Millennium Development Goals Report (Noumea, New Caledonia: 2004);
United Nations Development Program, in joint publication with the RMI,
RMI Millennium Development Goals National Progress Report (Majuro, RMI:
2005); and Asian Development Bank, Priorities of the People Series (
http://www.adb.org/Documents/Reports/Priorities_Poor/default.asp).
[63] Safe water and sanitation is defined as access to an improved
water source and sanitation, which the World Bank defines as access to
a household water connection, public standpipe, borehole, protected
well or spring, or rainwater collection and access to sanitation
facilities (private or shared, but not public) that can effectively
prevent human, animal, and insect contract with excreta. RMI teacher
literacy levels were determined from the RMI Ministry of Education's
2004 administered Marshall Islands English Literacy Test for Teachers
(MIELTT). The Pacific Islands Literacy Level (PILL) test is a test
administered by the South Pacific Board for Educational Assessment.
[64] Under Article IV of the IMF's Articles of Agreement, the IMF holds
bilateral discussions with members and prepares supporting
documentation on economic developments and policies.
[65] These reviews include assessments by the IMF's Pacific Financial
Technical Assistance Center; Fuat Andic, Tax Policy and Administration
in the RMI, a report prepared for ADB TA-6245-REG, 2005; Mark Sturton,
Strengthening of Public Sector Management and Administration: Compact
Fiscal Adjustment and Transition, a report prepared for ADB TA-4258,
2004; Enterprise Research Institute, Republic of the Marshall Islands
Private Sector Assessment: Promoting Growth through Reform, report
prepared for ADB TA 6037, 2003; and The Aires Group Ltd., Privatization
of Public Enterprises and Corporate Governance Reforms, a special
report prepared at the request of the Asian Development Bank, 2001.
[66] See the World Bank's Doing Business web site at http://
www.doingbusiness.org/.
[67] The compact served as a vehicle to reach a full settlement of all
compensation claims related to U.S. nuclear tests conducted on
Marshallese atolls between 1946 and 1958. In a compact-related
agreement (pursuant to Section 177), the U.S. government agreed to
provide $150 million to create a trust fund. While the compact and its
related agreements represented a full settlement of all nuclear claims,
it provided the RMI with the right to submit a petition of "changed
circumstance" to the U.S. Congress requesting additional compensation.
The RMI government submitted such a petition in September 2000. In
November 2004, the U.S. Department of State issued a report evaluating
the legal and scientific basis of this petition. The report concludes
that there is no legal basis for considering additional payments. The
House Committee on Resources and the Subcommittee on Asia and the
Pacific of the House Committee on International Relations held a joint
hearing on the petition on May 25, 2005. The Senate Committee on Energy
and Natural Resources held an oversight hearing on the effects of the
U.S. nuclear testing program on the Marshall Islands on July 19, 2005.
[68] Public sector employment data includes jobs in the RMI national
and local governments, government agencies, and public-sector
enterprises.
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