Compacts of Free Association: Development Prospects Remain
Limited for Micronesia and Marshall Islands (27-JUN-06,
GAO-06-590).
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.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-590
ACCNO: A56005
TITLE: Compacts of Free Association: Development Prospects
Remain Limited for Micronesia and Marshall Islands
DATE: 06/27/2006
SUBJECT: Economic development
Economic policies
Federal aid to foreign countries
Foreign aid programs
International agreements
International relations
Program evaluation
Reporting requirements
Compact of Free Association
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GAO-06-590
* Results in Brief
* Background
* Compact of Free Association, 1986 to 2003
* Amended Compacts of Free Association
* FSM and RMI Face Key Political and Social Challenges
* Despite Stable Democratic Systems, Political Factors in the
* Despite High Expenditures, Both Countries Remain Challenged
* FSM and RMI Economies Show Limited Potential for Self-relian
* FSM and RMI Economies Depend on Government Spending of Forei
* FSM and RMI Will Likely Face Significant Budgetary Pressure
* Key FSM and RMI Industries Face Multiple Constraints to Grow
* Prospects for Increased Remittance Income to the FSM and RMI
* Compact Management Committees Have Not Discussed Progress to
* FSM and RMI Progress on Key Economic Policy Reforms Has Been
* FSM and RMI Have Implemented Some Legislative Reforms
* Key Policy Reforms to Stimulate Investment Have Not Been Imp
* Tax Reform
* Land Reform
* Foreign Investment Regulations
* Public Sector Reform
* Compact Management Committees Have Not Addressed Slow FSM an
* Conclusions
* Recommendations
* Agency Comments
* GAO Comments
* GAO Comment
* GAO Comment
* GAO Comments
* GAO Contact
* Staff Acknowledgments
* GAO's Mission
* Obtaining Copies of GAO Reports and Testimony
* Order by Mail or Phone
* To Report Fraud, Waste, and Abuse in Federal Programs
* Congressional Relations
* Public Affairs
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
Contents
Letter 1
Results in Brief 3
Background 6
FSM and RMI Face Key Political and Social Challenges 13
FSM and RMI Economies Show Limited Potential for Self-reliance and
Long-term Advancement 18
FSM and RMI Progress on Key Economic Policy Reforms Has Been Slow 29
Conclusions 36
Recommendations 36
Agency Comments 37
Appendix I Objectives, Scope, and Methodology 40
Appendix II Some Regional Socioeconomic Data for the Pacific 44
Appendix III The FSM and RMI Private Sector Environment 46
Appendix IV Comments from the Department of the Interior 47
GAO Comments 56
Appendix V Comments from the Department of Health and Human Services 57
GAO Comment 61
Appendix VI Comments from the Federated States of Micronesia 62
GAO Comment 65
Appendix VII Comments from the Republic of the Marshall Islands 66
GAO Comments 71
Appendix VIII GAO Contact and Staff Acknowledgments 74
Tables
Table 1: Annual U.S. Assistance for the FSM and the RMI under the Amended
Compacts, Fiscal Years 2004 to 2023 11
Table 2: Estimated Levels of Economic Assistance by Major Donors to the
FSM and the RMI, Average from Fiscal Years 2002 to 2004 24
Table 3: FSM and RMI Emigrants in Hawaii, Guam, and the CNMI, 2003 28
Table 4: FSM and RMI Government Commercial Enterprises 34
Table 5: Some Estimated Socioeconomic Indicators for Select Pacific Island
Nations 45
Figures
Figure 1: Annual Compact Assistance to the FSM and the RMI, Fiscal Years
1987-2003 7
Figure 2: Estimated FSM and RMI Real Per Capita GDP 9
Figure 3: Estimated FSM and RMI per Capita Compact Grant Assistance for
Fiscal Years 1987-2023 12
Figure 4: FSM and RMI External Grants and Estimated Real GDP 19
Figure 5: Structure of FSM Revenues and Expenditures, Fiscal Years
2000-2005 21
Figure 6: Structure of RMI Revenues and Expenditures, Fiscal Years
2000-2005 23
Figure 7: Some Noted Problems with the FSM and the RMI Private Sector
Environment 46
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
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separately.
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)1 and the
Republic of the Marshall Islands (RMI) through a Compact of Free
Association.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 2023.3 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,4 to identify problems encountered, and to recommend ways to
increase the effectiveness of compact grant assistance.5
1The 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.
2A 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).
3For 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.
Regarding specific objectives within the development plans, the
legislation implementing the amended compacts 6directs JEMCO and JEMFAC to
address objectives related to the implementation of policy reforms to
encourage investment and to improve tax income.7 The fiscal procedures
agreements direct JEMCO and JEMFAC to monitor FSM and RMI progress toward
budgetary self-reliance and long-term economic advancement.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 report9 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.
4The 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.
5JEMCO 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.
6P.L. 108-188.
7Specifically, 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.
8The 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.
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;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.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.
9A separate report will examine the use and oversight of U.S. assistance
to the FSM and the RMI.
10Transparency 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.
11The 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.
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,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.13
12The 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).
Figure 1: Annual Compact Assistance to the FSM and the RMI, Fiscal Years
1987-2003
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.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).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.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.17
13This 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.
14In 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.
15In 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 .
Figure 2: Estimated FSM and RMI Real Per Capita GDP
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.
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.18
18We 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).
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.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;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.
19The 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).
20Both 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).
Table 1: Annual U.S. Assistance for the FSM and the RMI under the Amended
Compacts, Fiscal Years 2004 to 2023
Dollars in millionsa
Fiscal year FSM grants FSM trust fund RMI grants RMI trust fund
2004 $76.2 $16.0 $35.2 $7.0
2005 76.2 16.0 34.7 7.5
2006 76.2 16.0 34.2 8.0
2007 75.4 16.8 33.7 8.5
2008 74.6 17.6 33.2 9.0
2009 73.8 18.4 32.7 9.5
2010 73.0 19.2 32.2 10.0
2011 72.2 20.0 31.7 10.5
2012 71.4 20.8 31.2 11.0
2013 70.6 21.6 30.7 11.5
2014 69.8 22.4 32.2b 12.0
2015 69.0 23.2 31.7 12.5
2016 68.2 24.0 31.2 13.0
2017 67.4 24.8 30.7 13.5
2018 66.6 25.6 30.2 14.0
2019 65.8 26.4 29.7 14.5
2020 65.0 27.2 29.2 15.0
2021 64.2 28.0 28.7 15.5
2022 63.4 28.8 28.2 16.0
2023 62.6 29.6 27.7 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. aThe 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.
bBeginning in 2014, an additional $2 million will be added to RMI annual
grants to address the special needs of Kwajalein Atoll.
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
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.
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 2024.21 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 2040.22 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.23
21For 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.
22In 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.
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.
o 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.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.25
o 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.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.
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 2003.27 Much of this aid is directed toward
health and education.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.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.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.31
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.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.
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 2003.33 For the
RMI, the IMF estimates that GDP expanded moderately owing to
increased public sector expenditure (see fig. 4).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.
23The 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.
24For 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.
25In 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.
26In 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.
Despite High Expenditures, Both Countries Remain Challenged in Improving Health
and Education Conditions
27Countries 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.
28As 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.
29MCC 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.
30A 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.
31According 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.
FSM and RMI Economies Show Limited Potential for Self-reliance and Long-term
Advancement
FSM and RMI Economies Depend on Government Spending of Foreign Assistance
Instead of Private Sector Production
32In this report, we use "remittances" to refer to funds voluntarily
transferred by emigrants to their home countries.
33Earlier 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.
34IMF 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.
Figure 4: FSM and RMI External Grants and Estimated Real GDP
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.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.36
35Both 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.
36Reliable 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.
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.37
o 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).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.39 This component grew from 36 percent of
total expenditures in 2000 to 2004 to 42 percent of total
expenditures in 2005.40
37Both 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.
38FSM 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.
39The 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.
40However, 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.
Figure 5: Structure of FSM Revenues and Expenditures, Fiscal Years
2000-2005
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.
o 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
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.
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.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
Compact grants U.S. programsa Japan Taiwan
FSM $83b $45 $8 n/a
RMI 29b 20 5 $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.
aThese figures do not include occasional emergency assistance provided by
Federal Emergency Management Agency.
bThe FSM and the RMI received less compact grant assistance than the
amended compact provides, owing to delays in compact grant implementation.
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.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.
41In 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.
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.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.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:
42ADB 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.
43The 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.
44The RMI stated in its comments to this report that tax income from the
fisheries and tourism sectors is also volatile.
o geographic isolation and small fragmented markets;
o high airfares and poor flight connections;
o lack of adequate hotel and airport infrastructure;
o low freight capacities and poor interisland shipping;
o inadequate transshipment facilities in some areas;
o a growing threat of overfishing;
o limited pool of skilled labor; and
o 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.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.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.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.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).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.50
Table 3: FSM and RMI Emigrants in Hawaii, Guam, and the CNMI, 2003
Source: U.S. Census Bureau.
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.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.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.
o 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,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.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.
o 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.
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.
o 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.
o 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.
o 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.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.
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.
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.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
Source: GAO analysis of FSM and RMI government finance statistics
and government audit data.
aRMI data are available only through 2004.
bThe 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.
cFinancial 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.
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.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.
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.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.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:
o evaluate FSM and RMI progress in implementing policy reforms
needed to improve the business environment and encourage increased
investment and tax income,
o identify problems encountered with policy reform
implementation, and
o 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 [email protected] . 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.
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
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 report1 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.2 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.3 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.4 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;5 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.6 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.
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:
o 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.
o 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.
o 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.
45Remittances 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).
46U.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.
47As 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 .
49FSM 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.
50In 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.
51Department 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.
FSM RMI
Population 17,286 3,304
Percentage that migrated for employment (includes dependents) 47 25
Percentage of labor-force participants that were unemployed 21 18
Percentage of persons 25 years and older with college degree 6 7
Percentage of individuals with income below poverty level 45 49
52According 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.
53The 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.
Land Reform
54According 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.
Foreign Investment Regulations
55The 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.
Public Sector Reform
56In 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.
FSM enterprises RMI enterprises
Share of employment 6.2% 5.2% 7.4% 7.0%
1997-2002 average 2003-2005
averagea
Annual direct subsidies $4.3 million $1.9 $2.4 million $1.8
1997-2002 average 2003-2005 million million
averagea
Estimated number of existing 45 16
enterprisesb
Examples of existing Micronesian Petroleum Copra Production
enterprises with financial Corporation (2001 Scheme (2004 subsidy =
losses or receiving subsidy = $500,000) $900,000)
subsidiesc
Pohnpei Fisheries Marshalls Energy
Corporation (2003 loss Company (2004 loss =
= $517,000) $2 million)
Kosrae Utility National Telecom
Authority (2004 loss = Authority (2004 loss =
$427,000) $980,000)
Chuuk Public Utilities Majuro Water and Sewer
Corporation (2001 loss Company (2004 subsidy
= $1 million) = $100,000)
Compact Management Committees Have Not Addressed Slow FSM and RMI Progress in
Implementing Reforms
57See 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.
58The 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.
59FSM and RMI offices related to reform efforts, such as land registration
offices, have been funded with compact grants.
Conclusions
Recommendations
Agency Comments
Appendix I: Objectives, Scope, and Methodology
1Our forthcoming report on the use and oversight of U.S. assistance to the
FSM and the RMI will be published by December 17, 2006.
2The 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.
3These 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).
4Safe 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.
5Under 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.
6These 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.
Appendix II: Some Regional Socioeconomic Data for the Pacific
Table 5: Some Estimated Socioeconomic Indicators for Select Pacific Island
Nations
Papua New Solomon
Year RMI FSM Fiji Kiribati Palau Guinea Samoa Islands Tonga Vanuatu
Population, 2005 59,071 108,105 893,354 103,092 20,303 5,545,268 177,287 538,032 112,422 205,754
total
Population 2005 50.1 48.9 41.5 49.9 33.5 48.0 39.8 53.1 49.1 44.6
ages 0-20 (%
of total)
Population 2004 331 181 46 134 43 12 63 17 141 18
density
(people per
sq km)
Population 2005 2.3 0.0 1.4 2.3 1.4 2.3 -0.2 2.8 2.0 1.6
growth
(annual %)
Life 2005 70 70 67 62 70 65 71 73 70 63
expectancy at
birth, total
(years)
Teenage 2005 87 36 42 56 62 58 21 59 42 32
fertility
rate (ages
15-19)
Mortality 2003 61 23 20 66 28 93 24 22 19 38
rate,under
age 5 (per
1,000)
Immunization, 2003 68 92 94 99 99 54 94 71 98 49
DPT(%
children
ages12-23
months)
Access to 2002 82 28 98 39 83 45 100 31 97 50
improved
sanitation
facilities (%
of population
with access)
Aid per 2003 991 923 61 191 1,295 40 186 132 270 154
capita
(current
U.S.$)
GDP per 2004 1,738 1,745 2,232 532 6,360 622 1,417 621 1,638 1,110
capita
(constant
2000 U.S.$)
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.
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.1 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
1See the World Bank's Doing Business web site at
http://www.doingbusiness.org/.
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.
See comment 2.
See comment 1.
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
1Documents 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.
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.
See comment.
See comment.
See comment.
See comment.
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.
Appendix VI: Comments from the Federated States of Micronesia
GAO comment supplementing those in the report text appear at the end of
this appendix.
See comment.
See comment.
See comment.
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.
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.
See comment 4.
See comment 1.
See comment 3.
See comment 2.
See comment 6.
See comment 10.
See comment 5.
See comment 10.
See comment 4.
See comment 10.
See comment 4.
See comment 2.
See comment 1.
See comment 7.
See comment 1.
See comment 10.
See comment 9.
See comment 10.
See comment 8.
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.1
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 2001.2 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.
1The 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.
2Public sector employment data includes jobs in the RMI national and local
governments, government agencies, and public-sector enterprises.
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.
(320371)
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Highlights of GAO-06-590 , a report to congressional committees
June 2006
COMPACTS OF FREE ASSOCIATION
Development Prospects Remain Limited for Micronesia and Marshall Islands
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 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.
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.
Estimated Per Capita Compact Grant Assistance for Fiscal Years 1987-2023
*** End of document. ***