    Foreign Assistance: U.S. Funds to Two Micronesian Nations Had Little
    Impact on Economic Development (Chapter Report, 09/21/2000,
    GAO/NSIAD-00-216).

    Pursuant to a congressional request, GAO reviewed foreign assistance,
    focusing on the: (1) use of the Compact of Free Association funding by
    the Federated States of Micronesia (FSM) and the Republic of the
    Marshall Islands (RMI) between fiscal years 1987 and 1998; (2) progress
    both nations have made in advancing economic self-sufficiency; (3) role
    of Compact funds in supporting economic progress; and (4) extent of
    accountability by the two nations and the United States over Compact
    expenditures.

    GAO noted that: (1) Compact funds were used for general government
    operations, capital projects such as building roads or investing in
    businesses, making debt payments, and improving targeted sectors such as
    energy and communications; (2) while FMS concentrated much of its
    spending on supporting government activities, the RMI emphasized capital
    spending; (3) since 1987, the two countries, particularly FSM, have made
    some progress in achieving economic self-sufficiency, as measured by
    their governments' lower reliance on U.S. funding; (4) however, both
    countries remain highly dependent on U.S. assistance, which still
    provides more than half of total government revenues in each country;
    (5) scheduled decreases in Compact funding as well as increases in
    locally generated funds have reduced reliance on U.S. funding; (6)
    although the amount of Compact funding has decreased since 1987 as
    required by the terms of the Compact, both countries have received other
    U.S. funding through their use of U.S. federal services and programs;
    (7) Compact expenditures to date have led to little improvement in
    economic development in FSM and RMI; (8) per capita incomes have
    stagnated in FSM and fallen in RMI; (9) Compact funds spent to support
    general government operations have maintained high government wages and
    a large level of public sector employment that has discouraged private
    sector growth; (10) Compact spending to create and improve
    infrastructure has not contributed to significant economic growth; (11)
    in addition, Compact-funded business ventures have generally failed;
    (12) while the Compact set out specific obligations for reporting and
    consulting regarding the use of Compact funds, the governments of FSM,
    RMI, and the U.S. have provided limited accountability over Compact
    expenditures and have not ensured that funds were spent effectively or
    efficiently; (13) the U.S. government did not meet the Compact
    requirement to consult annually with both countries during the first 7
    years of Compact assistance; (14) also, the Department of the Interior
    has devoted few resources to monitoring Compact assistance; and (15)
    disagreements between the Departments of State and the Interior limited
    monitoring, as did a Compact provision that guarantees funding to the
    two nations.

    --------------------------- Indexing Terms -----------------------------

     REPORTNUM:  NSIAD-00-216
         TITLE:  Foreign Assistance: U.S. Funds to Two Micronesian Nations
    	     Had Little Impact on Economic Development
          DATE:  09/21/2000
       SUBJECT:  Territories and possessions
    	     Program graduation
    	     Foreign economic assistance
    	     Reporting requirements
    	     International agreements
    	     Accountability
    	     International relations
    	     Foreign governments
    	     Financial management
    	     Economic development
    IDENTIFIER:  Marshall Islands
    	     Compact of Free Association with Micronesia
    	     Micronesia
    	     Trust Territory of the Pacific Islands
    	     Kwajalein Atoll (Marshall Islands)
    	     Pell Grant
    	     UN Development Program

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    GAO/NSIAD-00-216

    Compact Ended U.S. Administration of the Federated States of
    Micronesia and the Republic of the Marshall Islands 14

    Self-government, National Security, and Economic
    Self-sufficiency Are Compact Objectives 18

    Objectives, Scope, and Methodology 22

    Marshall Islands Used Nearly $1.6 Billion in Compact Direct Funding

    26

    The Federated States of Micronesia and the Republic of the
    Marshall Islands Targeted Expenditures in Different Areas 26

    Capital Funds Spent on Business Ventures and Infrastructure 28

    Both Countries Issued Compact Revenue-Backed Bonds 30

    Economic Self-sufficiency

    34

    Government Reliance on U.S. Assistance Has Fallen to 54
    Percent in the Federated States of Micronesia 34

    U.S. Assistance Comprises 68 Percent of the Republic of the
    Marshall Islands' Revenue 36

    U.S. Program Assistance Contributes to Government Revenues
    in Both Compact Nations 37

    Other Donors Also Provide Assistance and Loans 39

    Development

    40

    Compact Funding Supported General Government Operations that Discouraged
    Private Sector Growth 40

    Targeted Compact Funds Spent on Physical and Social
    Infrastructure Have Not Contributed to Significant Economic
    Growth 42

    Business Ventures That Received Compact Funding Have
    Generally Failed 50

    Compact-Funded Projects Experienced Problems With Planning, Management,
    Construction, Maintenance, and Misuse 56

    Provided Limited Accountability Over Compact Expenditures

    76

    Compact Required Accountability for Use of Funds From the
    Federated States of Micronesia, the Republic of the Marshall
    Islands, and the United States 76

    Planning and Reporting Documents of the Federated States of
    Micronesia and the Republic of the Marshall Islands Were
    Generally Incomplete and Insufficient 77

    The U.S. Government Did Not Meet Many Accountability
    Requirements 79

    U.S. Oversight Limited by Interagency Disagreements and
    Interior's Belief That Compact Provisions Restricted U.S. Actions 81

    85

    Conclusions 85

    Recommendations 87

    Agency Comments and Our Evaluation 89

    Appendix I: Compact of Free Association Capital
    Expenditures, Fiscal Years 1987-98

    92

    Appendix II: Record of Accountability for the Federated
    States of Micronesia, the Republic of the Marshall
    Islands, and the United States

    95

    Appendix III: Comments From the Department of the Interior

    96

    Appendix IV: Comments From the Department of State

    104

    Appendix V: Comments From the Republic of the Marshall
    Islands

    108

    Appendix VI: Comments From the Federated States of
    Micronesia

    118

    Appendix VII: GAO Contact and Staff Acknowledgments

    151

    Table 1: Compact Section 211(a) Annual and Total Funding
    Levels for the Federated States of Micronesia and the
    Republic of the Marshall Islands, Fiscal Years 1987-2001 19

    Table 2: Compact Revenue-backed Bonds Issued by the
    Federated States of Micronesia and the Republic of the
    Marshall Islands, Fiscal Years 1987-98 31

    Table 3: Five-Year Economic Development Plans 95

    Table 4: Annual Reports and Meetings 95

    Figure 1: Location and Map of the Federated States of
    Micronesia and the Republic of the Marshall Islands 15

    Figure 2: FSM and RMI Compact Expenditures by Fund Type as a Percentage of
    Total Compact Expenditures, Fiscal
    Years 1987-98 27

    Figure 3: FSM and RMI Compact Capital Account Expenditures,
    Fiscal Years 1987-98 29

    Figure 4: RMI Debt Service as a Percentage of Annual Compact Expenditures,
    Fiscal Years 1987-98 33

    Figure 5: FSM Dependence on U.S. Assistance, Fiscal Years 1987-98 35

    Figure 6: RMI Dependence on U.S. Assistance, Fiscal Years 1987-98 37

    Figure 7: Compact Investment in Communications 43

    Figure 8: Compact Investment in Energy 44

    Figure 9: Electric Power and Tuna Processing Plant, Majuro, RMI 45

    Figure 10: Investment in Interisland Cargo Transportation, FSM 46

    Figure 11: Investment in Air Transportation, RMI 47

    Figure 12: FSM Investment in College Facilities 48

    Figure 13: FSM Fish Processing and Cold Storage Facilities 53

    Figure 14: Pohnpei Pepper Industry Development, FSM 54

    Figure 15: RMI Investment in Garment Factory 55

    Figure 16: Causeway From Ebeye to Gugeegue, Kwajalein Atoll,
    RMI 58

    Figure 17: Ponape Coconut Products, Inc., FSM 59

    Figure 18: Kosrae Road Pavement, FSM 61

    Figure 19: RMI National Capitol Building, Majuro 63

    Figure 20: Ohmine Elementary School, Pohnpei, FSM 64

    Figure 21: Pohnpei State Hospital, FSM 66

    Figure 22: Old and New Ebeye Hospitals Suffer From Corrosion,
    RMI 68

    Figure 23: Udot Dock Project and Junior High School, Chuuk, FSM 70

    Figure 24: Fanapanges Ice Plant: Planned and Actual Locations,
    Chuuk, FSM 72

    Figure 25: "Boats for Votes," Chuuk, FSM 73

    FSM Federated States of Micronesia

    GDP gross domestic product

    RMI Republic of the Marshall Islands

    National Security and
    International Affairs Division

    B-285711

    September 22, 2000

    The Honorable Frank H. Murkowski
    Chairman, Committee on Energy and Natural Resources
    United States Senate

    The Honorable Doug Bereuter
    Chairman, Subcommittee on Asia and the Pacific
    Committee on International Relations
    House of Representatives

    This report responds to your request that we report on (1) the use of
    Compact of Free Association funding by the Federated States of Micronesia
    and the Republic of the Marshall Islands between fiscal years 1987 and 1998,
    (2) the progress both nations have made in advancing economic
    self-sufficiency, (3) the role of Compact funds in supporting economic
    progress, and (4) the extent of accountability by the two nations and the
    United States over Compact expenditures. This report includes
    recommendations to the Secretaries of State and the Interior.

    We are sending this report to the Honorable Bruce Babbitt, Secretary of the
    Interior; the Honorable Madeleine K. Albright, Secretary of State; the
    Honorable William S. Cohen, Secretary of Defense; His Excellency Leo A.
    Falcam, President of the Federated States of Micronesia; His Excellency
    Kessai Note, President of the Republic of the Marshall Islands; other
    appropriate congressional committees; and other interested parties. Copies
    will also be made available to others on request.

    Please contact me at (202) 512-4128 if you or your staff have any questions
    concerning the report. An additional GAO contact and staff acknowledgments
    are listed in appendix VII.

    Susan S. Westin, Associate Director
    International Relations and Trade Issues

    Executive Summary

    In 1986, the U.S. government entered into an international agreement, the
    Compact of Free Association, with the Federated States of Micronesia and the
    Republic of the Marshall Islands. U.S. direct financial assistance under the
    Compact, which began in 1987, is intended to help the governments of the two
    countries in their efforts to advance their economic development and
    self-sufficiency. The Compact represents a continuation of U.S. financial
    assistance that had been provided by the United States for almost 40 years
    after World War II under the United Nations Trust Territory of the Pacific
    Islands. The Department of the Interior's Office of Insular Affairs has the
    responsibility for disbursing and monitoring this assistance. In the fall of
    1999, negotiations between the Department of State and the two nations began
    concerning provisions of the Compact regarding economic assistance and
    certain national security provisions in the Compact that will expire in
    2001.1

    To assist Congress in its consideration of any future economic assistance to
    the two nations, the Chairman of the Committee on Energy and Natural
    Resources, United States Senate, and the Chairman of the Subcommittee on
    Asia and the Pacific, Committee on International Relations, House of
    Representatives, asked GAO to report on (1) the use of Compact funding by
    the Federated States of Micronesia and the Republic of the Marshall Islands
    between fiscal years 1987 and 1998, (2) the progress both nations have made
    in advancing economic self-sufficiency, (3) the role of Compact funds in
    supporting economic progress, and (4) the extent of accountability by the
    two nations and the United States over Compact expenditures. GAO's review
    focused on the uses of payments the United States made to both countries to
    support economic advancement. Successful economic development would include
    increased private sector activity and lead to rising incomes. GAO's review
    did not include payments to the Republic of the Marshall Islands for nuclear
    testing by the United States. In an earlier report, GAO found that the
    nations together, in addition to their Compact direct funding, have received
    other assistance from 19 U.S. agencies totaling close to $600 million during
    fiscal years 1987 through 1999.2 GAO did not include this assistance in this
    review, except during the discussion on economic self-sufficiency.

    The Federated States of Micronesia and the Republic of the Marshall Islands
    spent nearly $1.6 billion in Compact of Free Association funds for fiscal
    years 1987 through 1998. The Federated States of Micronesia spent $1.08
    billion, while the Republic of the Marshall Islands spent about
    $510 million. Compact funds were used for general government operations,
    capital projects such as building roads or investing in businesses, making
    debt payments, and improving targeted sectors such as energy and
    communications. While the Federated States of Micronesia concentrated much
    of its spending on supporting government activities, the Republic of the
    Marshall Islands emphasized capital spending. Although expenditures were
    reported in areas specified by the Compact, annual financial statements do
    not always report on the final use of Compact funds. Both countries issued
    Compact revenue-backed bonds in order to obtain more funding during the
    earlier years of the Compact.

    Since 1987, the two countries, particularly the Federated States of
    Micronesia, have made some progress in achieving economic
    self-sufficiency, as measured by their governments' lower reliance on U.S.
    funding. However, both countries remain highly dependent on U.S. assistance,
    which still provides more than half of total government revenues in each
    country. Scheduled decreases in Compact funding as well as increases in
    locally generated funds have reduced reliance on U.S. funding. Although the
    amount of Compact funding has decreased since 1987 as required by the terms
    of the Compact, both countries have received other U.S. funding through
    their use of U.S. federal services and programs.

    Compact expenditures to date have led to little improvement in economic
    development in the Federated States of Micronesia and the Republic of the
    Marshall Islands. Per capita incomes, when adjusted for inflation, have
    stagnated in the Federated States of Micronesia and fallen in the Republic
    of the Marshall Islands since the beginning of the Compact. Compact funds
    spent to support general government operations have maintained high
    government wages and a large level of public sector employment that have
    discouraged private sector growth. Compact spending to create and improve
    infrastructure has not contributed to significant economic growth. In
    addition, Compact-funded business ventures have generally failed. For
    example, the Federated States of Micronesia spent $60 million in
    unsuccessful fisheries ventures. During its work and site visits to
    80 Compact-funded projects, GAO found that many of these projects had
    experienced problems because of poor planning and management, inadequate
    construction and maintenance, or misuse of funds.

    While the Compact set out specific obligations for reporting and consulting
    regarding the use of Compact funds, the governments of the Federated States
    of Micronesia, the Republic of the Marshall Islands, and the United States
    have provided limited accountability over Compact expenditures and have not
    ensured that funds were spent effectively or efficiently. For example, the
    governments of the Federated States of Micronesia and the Republic of the
    Marshall Islands provided the U.S. government with inadequate economic
    development plans and Compact spending reports. Further, the U.S.
    government, specifically the Departments of the Interior and State, did not
    meet the Compact requirement to consult annually with both countries during
    the first 7 years of Compact assistance. In addition, the Department of the
    Interior has devoted few resources to monitoring Compact assistance.
    Moreover, disagreements between the Departments of State and the Interior
    limited monitoring, as did a Compact provision that guarantees funding to
    the two nations.

    In 1986, the United States entered into a Compact of Free Association with
    the Federated States of Micronesia (a nation comprised of the four states of
    Pohnpei, Chuuk, Kosrae, and Yap) and the Republic of the Marshall Islands.
    Through this Compact, the Federated States of Micronesia and the Republic of
    the Marshall Islands became Freely Associated States, no longer subject to
    U.S. administration under the United Nations Trust Territory of the Pacific
    Islands. The Compact, which consists of separate international agreements
    with each country, was intended to achieve three principal U.S. goals. These
    goals were to (1) secure self-government for each country; (2) assure
    certain national security rights for the Federated States of Micronesia, the
    Republic of the Marshall Islands, and the United States; and (3) assist the
    Federated States of Micronesia and the Republic of the Marshall Islands in
    their efforts to advance economic development and self-sufficiency.

    The first two objectives have been met. The Federated States of Micronesia
    and the Republic of the Marshall Islands are independent nations and are
    members of international organizations such as the United Nations. However,
    both countries maintain a special relationship with the United States
    through the Compact, and citizens of both nations are able to live and work
    in the United States as non-immigrants. Additionally, national security
    objectives were achieved. Under the Compact, the United States agreed to
    defend the Federated States of Micronesia and the Republic of the Marshall
    Islands, gained access to their territory for military use, and secured the
    right to deny military access to other countries. These security provisions
    will continue indefinitely unless mutually terminated. Through a
    Compact-related agreement with the Republic of the Marshall Islands, the
    United States has secured continued access to military facilities (a missile
    testing and space operations site) on Kwajalein Atoll until 2016.

    The third objective of the Compact, promoting economic development and
    self-sufficiency (a term that is not defined in the Compact), was to be
    accomplished primarily through direct financial payments to the Federated
    States of Micronesia and the Republic of the Marshall Islands. The largest
    Compact funding provision provides specific levels of direct funding for the
    Federated States of Micronesia and the Republic of the Marshall Islands over
    a 15-year period (1987-2001), with amounts decreasing every 5 years. These
    funds were provided to cover general government and capital expenditures.
    Additional Compact provisions target funding for use in specific sectors,
    such as energy, communications, maritime surveillance, health, and
    education. Most of this assistance is partially adjusted annually for
    inflation.

    Islands Spent Nearly $1.6 Billion in Compact Funds From 1987 Through 1998

    The Federated States of Micronesia and the Republic of the Marshall Islands
    spent about $1.6 billion in Compact funds on general government operations,
    capital projects such as building roads and investing in businesses, and
    targeted sectors such as energy and communications, from fiscal years 1987
    through 1998. The two countries have used the funding differently. The
    Federated States of Micronesia used about 47 percent
    ($510 million) of its $1.08 billion in Compact funds to support general
    government operations such as salaries and travel. The Republic of the
    Marshall Islands spent 46 percent ($233 million) of its $510 million in
    Compact funds on capital projects such as developing physical
    infrastructure, establishing businesses, and servicing debt. GAO determined
    overall spending in these broad categories from the countries' audited
    financial statements. However, these statements do not provide information
    on the final usage of Compact funds due to the commingling of Compact funds
    with locally generated revenues and because of fund transfers that occur
    that are not tracked to their final use.

    Both countries together issued $389 million in Compact revenue-backed bonds
    from the late 1980s to the mid-1990s in order to obtain more funding during
    the earlier years of the Compact. The Federated States of Micronesia issued
    about $114 million in Compact revenue-backed bonds, while the Republic of
    the Marshall Islands issued about $275 million. As a result of issuing these
    bonds, the Republic of the Marshall Islands has spent 42 percent ($217
    million) of its Compact funds for debt service, which reduced the funds
    available in the later years of Compact assistance for government operations
    and investment.

    Islands Have Made Some Progress Toward Self-sufficiency, but Remain Highly
    Dependent on U.S. Assistance

    The Federated States of Micronesia and the Republic of the Marshall Islands
    have made some progress in achieving economic self-sufficiency since 1987,
    although both countries remain highly dependent on U.S. assistance. This
    assistance has maintained standards of living that are artificially higher
    than could be achieved in the absence of compact funding. GAO used
    dependence on U.S. assistance, or total U.S. funds3 as a percentage of total
    government revenues in each country, as an indicator to gauge economic
    self-sufficiency. The reliance on U.S. funding as a percentage of total
    government revenue in the Federated States of Micronesia fell from 83
    percent in fiscal year 1987 to 54 percent in 1998. The Republic of the
    Marshall Islands also reduced its reliance on U.S. funding somewhat, from 78
    percent in 1987 to 68 percent in 1998. Reductions in Compact direct payments
    that have occurred every 5 years have contributed to a lower reliance on
    U.S. funding. Both countries also receive technical and project assistance
    from other nations, although these contributions are not fully reported in
    government financial statements.

    The use of Compact funds to date has led to little improvement in economic
    development in the Federated States of Micronesia and the Republic of the
    Marshall Islands. Substantial expenditures of Compact funds to maintain high
    levels of public sector employment at high wages have acted as a
    disincentive to private sector growth. High public sector wages have raised
    the threshold for private sector wages, making the private sector less
    competitive in international markets. Both countries have also spent Compact
    funds on infrastructure projects, such as electrical power and
    telecommunications systems, that they viewed as critical to creating an
    environment attractive to private businesses. However, these projects have
    not generated significant private sector activity and have not been
    sufficient to overcome other obstacles to growth such as a remote location,
    a lack of natural resources, and limited managerial expertise. Finally,
    investment of Compact funds in business ventures such as fish processing
    facilities or manufacturing has been a failure. For example, the Federated
    States of Micronesia spent $60 million in fisheries ventures that failed due
    to inexperience and poor business judgment. The Republic of the Marshall
    Islands has made unsuccessful investments in a garment factory that has
    never operated and a resort hotel that requires annual subsidies. Thus,
    primary, export-oriented industries remain small contributors to both
    economies. During its work and site visits to 80 Compact-funded projects,
    GAO found that many projects had experienced problems because of poor
    planning and management, inadequate construction and maintenance, or misuse
    of funds. For example, poor planning and management resulted in the
    incomplete construction of a costly and high-priority road in the Republic
    of the Marshall Islands. In numerous cases GAO found leaking roofs as the
    result of poor construction and maintenance. Finally, GAO identified several
    projects that appeared to be a misuse of funds in that it is questionable
    whether these projects will promote widespread economic advancement. For
    example, in the state of Chuuk in the Federated States of Micronesia, an ice
    plant intended to support community fishing operations was never built,
    despite receiving Compact funding, and an ice machine intended for the plant
    was moved to a Mayor's property.

    The governments of the Federated States of Micronesia, the Republic of the
    Marshall Islands, and the United States have provided limited accountability
    over Compact expenditures. Although the Compact established accountability
    requirements for all three countries, none of the governments fully used
    these mechanisms to ensure that Compact funds were spent effectively or
    efficiently. For example, the Federated States of Micronesia and the
    Republic of the Marshall Islands generally prepared planning and reporting
    documents required under the Compact, but many of the documents were of
    limited usefulness and did not contain sufficient information to determine
    if Compact funds were being spent to promote economic development. For
    fiscal years 1987 through 1999, the Federated States of Micronesia submitted
    annual reports each year except for 1999, while the Republic of the Marshall
    Islands submitted 7 of the 13
    Compact-required annual reports. Neither nation provided adequate financial
    or programmatic control over Compact funds, as documented in audit reports
    prepared by independent and country auditors since 1987. In addition, the
    U.S. government did not meet many of its oversight obligations. For example,
    the Departments of the Interior and State did not hold required annual
    consultations with the two countries to assess progress under the Compact
    until 1994. Further, the Department of the Interior, which had projected in
    1987 that it would need 15 staff positions to implement the Compact,
    currently has 2 people that work exclusively with the Compact nations.
    Moreover, disagreements between the Departments of the Interior and State
    regarding Compact monitoring responsibilities, as well as Interior's view
    that the "full faith and credit" provision in the Compact (which legally
    guarantees funding) impaired its ability to withhold funds for
    noncompliance, further limited oversight.

    GAO recommends that the Secretary of State work with Congress to outline
    negotiating objectives; determine the level, duration, and composition of
    future economic assistance; and identify the appropriate agency to provide
    and oversee future funding. GAO also recommends that the Secretary of State
    direct the State Department official responsible for negotiating future
    Compact economic assistance to include specific measures in any future
    economic assistance provisions for the Compact that will ensure improved
    effectiveness of, and accountability over, future spending. Further, GAO
    recommends that the Secretary of the Interior, as the official responsible
    for providing and monitoring Compact assistance, strengthen oversight over
    remaining Compact assistance.

    We received comments from the Departments of State and the Interior and the
    governments of the Federated States of Micronesia and the Republic of the
    Marshall Islands. The Department of State agreed with three of GAO's
    recommendations. It agreed that the Department should (1) consult with
    Congress to determine U.S. policy objectives for future Compact assistance,
    (2) negotiate Compact provisions to establish greater control and
    effectiveness of future U.S. assistance, and (3) negotiate Compact
    provisions to achieve greater oversight over expenditures. While the
    Department of State agreed with GAO that any future Compact provisions
    should allow for the withholding of funds, the Department reserved judgment
    on GAO's recommendation that any future funding exclude a "full faith and
    credit" provision until the Department better understands the ramifications
    of this action on budget procedures. The Department of the Interior did not
    respond to GAO's recommendations.

    The Departments of State and the Interior, as well as the government of the
    Federated States of Micronesia, stressed that it is important to acknowledge
    the challenges faced by Pacific Island nations, such as geographic isolation
    and a lack of natural resources, in achieving economic advancement. GAO
    further emphasized this point in the report. All four respondents also
    stated that GAO's report downplays successes under the Compact. GAO added
    information summarizing State and Interior views regarding the importance of
    expenditures to support general government operations in both countries. The
    governments of the Federated States of Micronesia and the Republic of the
    Marshall Islands expressed concern over GAO's view that Compact expenditures
    have led to little economic development in either country. GAO maintains
    that this conclusion is accurate. A discussion of these comments appears in
    chapter 6, and the comments appear in full, along with GAO's specific
    responses, in appendixes III-VI.

    Introduction

    The 1986 Compact of Free Association ended almost 40 years of U.S.
    administration of the Federated States of Micronesia (FSM), and the Republic
    of the Marshall Islands (RMI), two Pacific Island nations. The U.S.
    objectives for the Compact were to advance the island nations'
    self-government and economic self-sufficiency and to secure certain national
    security rights.

    Micronesia and the Republic of the Marshall Islands

    In 1986, the United States entered into a Compact of Free Association with
    the FSM and the RMI. Through the Compact, the FSM and the RMI became Freely
    Associated States, no longer subject to U.S. administration under the United
    Nations Trust Territory of the Pacific Islands that was created following
    World War II.

    The two island nations are located just north of the equator in the Pacific
    Ocean (see fig. 1) with populations of 116,268 and 50,840, respectively, as
    of 1999.4

    The FSM is a grouping of 607 small islands in the western Pacific totaling
    270 square miles, of which 65 are occupied. The islands stretch out over
    1,115 miles of the Pacific Ocean, creating an exclusive economic zone of
    1 million square miles. It is a nation comprised of four states (Kosrae,
    Pohnpei, Chuuk, and Yap) and nine ethnic groups. English is the official and
    common language, with each state having its own language as well.

    The RMI is made up of more than 1,200 islands, islets, and atolls, with a
    total land area of about 70 square miles. The Marshall Islands are located
    in the central Pacific, about 2,100 miles southwest of Hawaii. The Marshall
    Islands occupy about 750,000 square miles of the Pacific Ocean. English is
    the official language of the RMI, with two major Marshallese dialects and
    Japanese in use as well.

    Both the FSM and the RMI spent almost a century under the administration of
    foreign powers. Spain occupied the islands of the current FSM in 1875, and
    Germany established a protectorate over the Marshall Islands in 1885. In
    1899, Germany purchased the FSM islands from Spain after Spain lost its
    other Pacific possessions following the Spanish-American War. At the
    beginning of World War I, Japan occupied the FSM islands and the Marshall
    Islands, receiving a League of Nations mandate to administer them in 1920.
    After leaving the League in 1935, Japan declared the islands to be an
    integral part of the Japanese Empire and established and reinforced military
    installations there. The United States occupied the islands of the FSM and
    the RMI in 1944 following heavy fighting.

    In 1947, the United Nations created the Trust Territory of the Pacific
    Islands. The United States entered into a trusteeship with the United
    Nations Security Council and became the administering authority of the
    current four states of the FSM, as well as the Marshall Islands, Palau, and
    the Northern Mariana Islands. The Trust Territory of the Pacific Islands
    made the United States responsible financially and administratively for the
    region. The President of the United States appointed a High Commissioner of
    the Trust Territory of the Pacific Islands, which remained under the civil
    administration of the U.S. Navy until 1951, when authority was passed to the
    Department of the Interior. During the 1940s and 1950s the Marshall Islands
    were the site of 67 U.S. nuclear weapons tests. The economy of the

    Trust Territory of the Pacific Islands was dominated by government
    employment and reliant on external assistance from the United States.5

    In 1978, four of the "districts" of the Trust Territory of the Pacific
    Islands voted in a referendum to form the Federated States of Micronesia. In
    1979, the Marshall Islands voted to form its own national government. In
    1982, an international agreement between the United States and the Federated
    States of Micronesia--the Compact of Free Association--was completed; the
    following year, the Compact was signed between the United States and the
    Republic of the Marshall Islands.

    The economic viability of both nations was uncertain at the time the Compact
    was negotiated. In 1983, we reported that both countries faced serious
    obstacles to becoming economically self-sufficient, such as inadequate
    planning for and maintenance of infrastructure and low savings levels. We
    also noted that both governments lacked sufficient managerial and technical
    expertise and management systems to overcome such obstacles.6 The economic
    growth potential of these countries and their ability to generate revenue to
    replace U.S. assistance was limited by factors such as geographic isolation,
    limited natural resources, and the large and costly government structure
    left by the United States.7

    In the case of the FSM, the Compact entered into force on November 3, 1986,
    while the RMI Compact entered into force October 21, 1986. With the entry
    into force of the Compact, both nations became Freely Associated States, no
    longer subject to U.S. administration under the United Nations Trusteeship.

    Self-sufficiency Are Compact Objectives

    The Compact, which consists of separate international agreements with each
    country, was intended to achieve three principal U.S. goals. These goals
    were to (1) secure self-government for each country; (2) assure certain
    national security rights for the FSM, the RMI, and the United States; and
    (3) assist the FSM and the RMI in their efforts to advance economic
    self-sufficiency.

    The first two objectives have been met. The FSM and the RMI are independent
    nations and are members of international organizations such as the United
    Nations. Nevertheless, both countries maintain a special relationship with
    the United States through the Compact, and citizens of both nations are able
    to live and work in the United States as
    non-immigrants. Additionally, national security objectives were achieved. At
    the time of the Compact's negotiation, the United States was concerned about
    an expanded Soviet Union military presence in the Pacific Ocean. Under the
    Compact, the United States agreed to defend the FSM and the RMI, gained
    access to their territory for military use, and secured the right to deny
    military access to the region to other countries (known as "strategic
    denial"). These security provisions will continue indefinitely unless
    mutually terminated. A security provision that gave the United States the
    ability to preclude any FSM or RMI government action that the United States
    believes is incompatible with its defense responsibilities (the "defense
    veto") will expire in 2001 and is subject to renegotiation. In a 1986
    Compact-related agreement with the RMI, the United States secured continued
    access to military facilities (a missile testing and space operations site)
    on Kwajalein Atoll for a period of 15 years and the right to extend the
    access for an additional 15 years (a right the United States exercised in
    September 1999).

    The third objective of the Compact, promoting economic self-sufficiency (a
    term that is not defined in the Compact), was to be accomplished primarily
    through direct financial payments to the FSM and the RMI. This Compact
    assistance represented a continuation of U.S. financial support that had
    been supplied to these areas for almost 40 years after World War II. The
    largest funding provision (sec. 211(a) of the Compact) provides specific
    levels of funding for the FSM and the RMI over a 15-year period
    (1987-2001), with amounts decreasing every 5 years (see table 1). The total
    funding for section 211(a) over this period for both countries, before
    adjusting for inflation, is almost $1.1 billion.

     Dollars in millions
                 FSM                       RMI                      FSM & RMI
                                                                    Total
                             Total funding            Total funding funding
     Fiscal yearsAnnual      over 5-year   Annual     over 5-year   over
                 funding                   funding
                             period                   period        5-year
                                                                    period
     1987-91     $60.0       $300.0        $26.1      $130.5        $430.5
     1992-96     51.0        255.0         22.1       110.5         365.5
     1997-2001   40.0        200.0         19.1       95.5          295.5
     Total for 15
     years                   $755.0                   $336.5        $1,091.5

    Note: Compact section 211(a) funding is partially adjusted for inflation.
    Inflationary adjustments are not included in this table.

    Source: Compact of Free Association section 211(a).

    The Compact provided section 211(a) funds to cover general government and
    capital expenditures. The Compact requires that over the 15-year period of
    Compact economic assistance, an average of no less than
    40 percent of section 211(a) funding be used in a "capital account."
    According to an agreement related to the Compact, 17 types of projects or
    activities are eligible expenditures under the capital account, including
    construction or major repair of capital infrastructure, public and private
    sector projects, training activities, and debt service. The remainder of
    section 211(a) funding, or no more than 60 percent of the funds, is eligible
    for use in a "current account," which covers the general operations of the
    government.

    Additional Compact sections target funding for use in specific sectors, such
    as energy, communications, maritime surveillance, health, and education
    (total funding provided for both countries for targeted assistance is
    approximately $397 million over 15 years). Most of the Compact assistance,
    including section 211(a), is partially adjusted annually for inflation.

    In addition to direct payments, the Compact provides certain federal
    services through 20018 and gives the FSM and the RMI access to other federal
    services and programs at the discretion of the United States.9 Program
    assistance can include grants, loans, goods, and services provided by
    numerous U.S. agencies, such as the Departments of Education and Health and
    Human Services.

    In May 2000, in response to a request to identify how much money the United
    States has provided to the FSM and the RMI, we reported that the United
    States had supplied more than $2.6 billion in total U.S. assistance to both
    countries from fiscal years 1987 through 1999, based on figures that
    19 U.S. government agencies gave to us.10 The report included three
    categories of U.S. assistance: Compact funds provided directly to the FSM
    and the RMI as economic assistance, funds provided to the RMI as
    compensation for nuclear testing, and U.S. program assistance. The report
    concluded that the Department of the Interior has not maintained reliable
    data on the amount of assistance provided to the FSM and the RMI. Further,
    the report determined that inconsistencies within Interior's own records, as
    well as between Interior's records and those of other U.S. federal agencies
    and the FSM and RMI independent auditors, call into question Interior's
    ability to report accurately on assistance provided to the two nations. In
    response to the report's recommendations, the Department of the Interior
    stated that (1) in the event that it retains monitoring and coordination
    oversight of other federal agency programs as a result of the current
    Compact negotiations, it will develop a system to obtain and maintain data
    on all financial and program assistance provided and (2) it will reconcile
    the amounts reimbursed to other agencies. The Department of State concurred
    fully with the report's recommendation that during the ongoing Compact
    negotiations, provisions should be negotiated that require the maintenance
    of reliable data to ensure better accountability of the assistance provided.
    In addition, State said it is committed to ensuring that any revised Compact
    will include the necessary authority and an effective mechanism to ensure
    complementarity of purpose and accountability of future assistance.

    Direct financial assistance under the Compact is provided by the Department
    of the Interior.11 Additionally, Interior and 18 other U.S. government
    agencies administer programs in the FSM and the RMI. The Secretary of the
    Interior has responsibility for federal program coordination, as well as
    disbursement and monitoring of U.S. funds annually provided to the FSM and
    the RMI under the terms of the Compact. Monitoring is conducted, in part,
    through a Compact requirement for an annual financial and compliance audit
    within the meaning of the Single Audit Act of 1984.12 The single audit
    process is an important vehicle in informing the Department of the Interior
    and other federal oversight officials about FSM and RMI stewardship of
    federal funds. The Department of State is actively involved in U.S.
    relations with the FSM and the RMI as the agency responsible for
    government-to-government relations. In the fall of 1999, negotiations
    between the Department of State and the two nations began on whether and how
    to renew economic assistance and to continue certain national security
    provisions in the Compact that will expire in 2001. To date, the United
    States has had two negotiating sessions with the FSM, while formal talks
    with the RMI government have been delayed due largely to a change in the
    RMI's government in January 2000. If negotiations to establish future
    economic assistance are ongoing between the United States and the FSM or the
    RMI, or both island governments, at the end of fiscal year 2001, Compact
    assistance will be extended until 2003 to the

    nation(s) still negotiating at a rate that is the average of the annual
    direct funding amounts granted under the Compact.13

    The Chairman of the House Subcommittee on Asia and the Pacific, Committee on
    International Relations, and the Chairman of the Senate Committee on Energy
    and Natural Resources asked us to report on the
    (1) the use of Compact of Free Association funding by the Federated States
    of Micronesia and the Republic of the Marshall Islands, (2) the progress
    both nations have made in advancing economic self-sufficiency, (3) the role
    of Compact funds in supporting economic progress, and (4) the extent of
    accountability by the two nations and the United States over Compact
    expenditures.

    For our first objective, we reviewed how the FSM and the RMI used direct
    Compact funding for fiscal years 1987-1998 provided as economic assistance
    through title II of the Compact to further the countries' economic
    self-sufficiency. In reporting on the use of Compact funds, we did not
    assess payments made to the Republic of the Marshall Islands under the
    Compact for nuclear testing compensation (sec. 177) or the assistance
    provided to either country through federal services and programs (secs. 221
    and 224).

    We relied on 72 sets of financial statements of the RMI and the FSM,
    including the four states of the FSM (Pohnpei, Chuuk, Kosrae, and Yap). We
    also relied on the audits of these financial statements that were prepared
    by Deloitte Touche Tohmatsu, the governments' independent auditor for fiscal
    years 1987-98. We also read financial statements and audits for other
    government entities in the RMI. These financial records include data on
    government revenues, expenditures, and U.S. assistance levels. The revenue
    data identify Compact funds and other U.S. assistance as specific funding
    sources and show how these funds were allocated by fund type (general,
    special revenue, capital, expendable trust, and so on). The expenditure data
    identify how each government entity used its funds, including payment of
    Compact funds to Kwajalein landowners. The expenditure sheets in the
    financial statements enabled us to identify, in many cases, how the
    governments used the Compact funds by fund type. However, Compact funds
    allocated to the general fund were commingled with local revenues. Further,
    transfers between fund types take place and, in some cases, information on
    the use of transferred funds is unavailable or the Compact funds are
    subsequently commingled with other government revenue. Thus, details
    regarding the final usage of some Compact funds are not identified in the
    financial statements (with a few notable exceptions such as the use of
    transfers for debt service). This situation is a limitation in our
    reporting.

    To identify capital account spending, we used lists of specific capital
    projects financed with Compact funds contained in the Deloitte Touche
    Tohmatsu audits. We also obtained lists of capital projects for the FSM and
    summaries of capital projects by sector from the FSM Joint Committee on
    Compact Economic Negotiations. We applied the FSM sector categories, such as
    infrastructure and economic development, to the capital projects identified
    in the audits of the RMI in our presentation of capital project funding.

    To determine the debt service ratios for the FSM and the RMI, we extracted
    data from the Deloitte Touche Tohmatsu audits of the FSM and the RMI on the
    amount of bonds issued, the payment schedules, and the annual bond debt
    payments. We calculated the percentage of debt service by dividing the
    annual debt payments by the Compact direct funding provided to the FSM and
    the RMI.

    For our second objective, we reviewed data and economic studies regarding
    the progress these countries have made in achieving economic
    self-sufficiency. As an indicator of economic self-sufficiency, we
    calculated the ratio of U.S. assistance (direct Compact funding plus program
    assistance) to total FSM or RMI government revenue.14 The FSM recently
    adopted a similar approach to measure its self-sufficiency. We relied on
    data from available annual financial statements and single audits (referred
    to as annual audits in this report) for all governments for fiscal years
    1987-98 to make our calculations. The revenue data used understate the value
    of U.S. government contributions to the FSM and the RMI governments. U.S.
    government services provided in-kind, such as weather service, disaster
    relief, development loans, and national defense, do not appear as revenue in
    the FSM and RMI government financial accounts. We also reviewed Asian
    Development Bank documents for available data on other donors.

    For our third objective, we examined budget and project documents for over
    150 projects undertaken with Compact capital account funds and visited 80
    Compact-funded projects in order to assess the role of Compact funds in
    supporting economic progress. We reviewed the budget and project documents
    to determine how Compact funds were used and what procedures the FSM and the
    RMI used to review the projects prior to implementation. We chose over 150
    projects for an extensive file review and made selected site visits. Our
    selection criteria included the largest areas of investment by the
    governments as well as projects that represented a wide range of sectors.
    For example, we reviewed projects such as schools, hospitals, roads,
    electric power and telecommunications facilities, and business ventures. We
    chose projects that were funded at different points during the life of the
    Compact. In our file review, we looked for feasibility studies, evidence of
    competitive bidding, contracts, and inspections. We visited 80 projects that
    the Compact funded to determine if the projects met their objectives and the
    status of the projects. At the project sites we met with officials to
    discuss how Compact funds contributed to the project and to evaluate the
    success of the project.

    Additionally, we relied on assessments prepared by the World Bank, the Asian
    Development Bank, and the International Monetary Fund regarding economic
    performance in each nation. We reviewed available development plans, annual
    reports, and internal audits prepared by each country. We also met with
    senior government and business officials from the FSM at the national and
    state level, and from the RMI to discuss how Compact funds were used and the
    status of various Compact-funded projects.

    For our fourth objective, we undertook an analysis of accountability
    requirements contained in the Compact. We interviewed senior government
    officials in the FSM, the RMI, and the United States regarding their
    compliance with Compact provisions. Additionally, we reviewed documentation
    from the three governments. We reviewed the content of the economic
    development plans and annual reports prepared by the FSM and the RMI. We
    read the reports prepared by the independent auditor of the FSM and the RMI
    contained in 72 sets of financial statements, including the four states of
    the FSM (Pohnpei, Chuuk, Kosrae, and Yap). We read audits of Compact-funded
    projects performed by the Office of the Public Auditor in the FSM to
    identify how well the FSM spent Compact funds and the extent to which it
    responded to findings involving the use of Compact funds. We also discussed
    the responses to findings with the FSM Public Auditor. In order to
    understand the oversight activity of the U.S. government, we relied on
    records of the Departments of the Interior and State and interviews with
    current and former senior officials.

    We conducted our work from December 1999 through June 2000 in accordance
    with generally accepted government auditing standards.

    We received comments on this report from the Departments of State and the
    Interior as well as from the governments of the FSM and the RMI.

    The Federated States of Micronesia and the Republic of the Marshall Islands
    Used Nearly $1.6 Billion in Compact Direct Funding

    The Federated States of Micronesia and the Republic of the Marshall Islands
    spent about $1.6 billion in Compact funds on general government operations,
    capital projects, and targeted sectors, such as energy and communications,
    from fiscal years 1987 through 1998. Spending on capital projects, a
    priority area of the Compact, focused on infrastructure and business
    ventures, although we could not determine from financial records how some
    funds were used. Although expenditures were in the general areas designated
    by the Compact, the financial statements do not report on the final specific
    use of Compact funds. Both countries combined issued $389 million in Compact
    revenue-backed bonds from the late 1980s to the mid-1990s in order to obtain
    more funding during the earlier years of the Compact.

    Islands Targeted Expenditures in Different Areas

    For fiscal years 1987 through 1998, our analysis shows that the FSM spent
    about $1.08 billion and the RMI spent about $510 million in funding provided
    by the Compact (see fig. 2).15 Each government has used the money
    differently to pursue its development objectives. The largest area of
    expenditures in the FSM was for general government operations, which
    accounted for over 47 percent ($510 million) of total Compact expenditures.
    In the RMI, the largest amount of total expenditures,
    46 percent, or $233 million, went to support capital fund activities such as
    building infrastructure, supporting economic activities, and servicing debt.

    Total Compact Expenditures, Fiscal Years 1987-98

    Notes:

    1: The general fund consists of Compact assistance to support general
    government expenses such as salaries, supplies, and contractual services.

    2: The special revenue fund consists of Compact assistance earmarked for
    specific uses, such as medical referrals, scholarships, and marine
    surveillance.

    3: The expendable trust fund consists of Compact assistance that the RMI
    government uses to pay about 80 RMI landowners as compensation for the land
    used by the U.S. military on Kwajalein Atoll.

    4: Figures may not add to 100 percent due to rounding.

    Source: GAO analysis of FSM and RMI financial statements and audits of those
    statements prepared by Deloitte Touche Tohmatsu for fiscal years 1987-98.

    These figures report on the initial breakdown of Compact funds by government
    accounts. They may or may not indicate the final use of funds, as these
    figures for the FSM and the RMI include expenditures from, as well as
    transfers out of, the accounts. Details regarding the final use of transfers
    are unavailable in the FSM and RMI financial statements, with a few
    exceptions, such as the use of transfers for debt service.

    Based on our review of expenditure data for the FSM and the RMI between 1987
    and 1998, both countries met the Compact requirement that an average of no
    less than 40 percent of funding provided for 15 years under section 211(a)
    be used for capital expenditures. The FSM spent
    40.5 percent of its section 211(a) funds from its capital account, while the
    RMI spent 63.9 percent.16 However, officials from the Departments of State
    and the Interior noted that the broad range of eligible uses of capital
    funds listed in an agreement related to the Compact makes it difficult to
    demonstrate that a questionable capital expenditure is not allowed. For
    example, in fiscal year 1998 the FSM state of Kosrae spent $58,080 in
    Compact capital funds for the travel expenses of state athletes to regional
    games in order to develop their skills and as a requirement for their
    participation in the 2000 Summer Olympics in Sydney, Australia.17

    For the capital funds where we could identify specific types of
    expenditures, we found that the FSM and the RMI spent most of their capital
    funds to build infrastructure and support economic development ventures. The
    financial statements of the FSM and the RMI list projects that were paid for
    from the capital fund. Our assessment here of capital fund project
    expenditures includes these data only. Capital fund transfers and capital
    expenditures made from bond proceeds are not included. (Therefore, specific
    capital fund expenditures described here and in fig. 3 are a subset of
    capital fund expenditures listed in fig. 2.) Of these projects, the FSM and
    the RMI spent a total of $484 million from 1987 to 1998 for purposes that
    included building infrastructure such as roads and schools, and supporting
    economic development. (See app. I for detailed information on capital
    project categories for the FSM and the RMI.)

    The FSM spent a total of $344 million out of the capital fund, with
    $156 million (45 percent) of these capital project funds going for economic
    development and business ventures, such as for fishing boats or processing
    plants (see fig. 3). Expenditures on infrastructure followed closely at
    $133 million, or 39 percent.

    1987-98

    Notes:

    1: "Other" expenditures include land lease and acquisition, resource
    management, and unspecified uses of funds. In the RMI this category includes
    expenditures by the Marshall Islands Development Agency and the Kwajalein
    Atoll Development Authority that are not itemized in the RMI government
    financial statement.

    2 "Social services" expenditures include spending on health, education,
    housing, training, and social services projects.

    3: Amounts for the four areas of RMI spending do not add to the total RMI
    figure due to rounding.

    Source: GAO analysis of FSM data, compiled by the Joint Committee on Compact
    Economic Negotiations, and of RMI financial statements and audits of those
    statements prepared by Deloitte Touche Tohmatsu for fiscal years 1987-98.

    For the RMI, 46 percent ($65 million) of total capital fund expenditures of
    $140 million are classified as "other" expenditures. Most of this amount
    ($54 million) was listed as unidentified capital expenditures in the RMI
    financial statements. The Marshall Islands Development Authority and the
    Kwajalein Atoll Development Authority reported $4.5 million and
    $49.5 million, respectively, of unidentified "other" expenditures in the RMI
    financial statements.18 RMI expenditures for infrastructure and economic
    development accounted for 25 percent ($35 million) and 23 percent
    ($33 million), respectively, of these capital funds.

    Revenue-Backed Bonds

    The Compact did not preclude the FSM or the RMI from borrowing funds in
    anticipation of U.S. assistance. Using this flexibility, from the late 1980s
    to the mid-1990s, the FSM and the RMI issued nearly $389 million in Compact
    revenue-backed bonds in order to obtain greater funding in the earlier years
    of the Compact. This funding was used to retire existing debt, pay for
    capital projects, and make financial investments. As shown in table 2, the
    RMI issued about $275 million in Compact revenue-backed bonds, and the FSM
    issued approximately $114 million.

     Dollars in millions
         Fiscal year       FSM      RMI
     1987                0        $65.00
     1988                0        0
     1989                0        20.00
     1990                $14.65   0
     1991                84.96    60.00
     1992                0        0
     1993                14.30    99.96
     1994                0        30.00
     1995                0        0
     1996                0        0
     1997                0        0
     1998                0        0
     Total               $113.91  $274.96

    Source: GAO analysis of financial statements of the FSM and the RMI for
    fiscal years 1987-98.

    By fiscal year 1998, the FSM had repaid $119 million in bond debt (principal
    and interest), with these repayments accounting for 11 percent of total
    Compact expenditures. However, the RMI has used a higher percentage of its
    Compact funding than the FSM to repay bond debt (42 percent, or
    $217 million) through 1998. The debt payments have limited the availability
    of Compact funds for other uses, particularly in recent years (see fig. 4).
    For example, in 1998, the RMI spent $39 million in Compact funds.19 Of this
    total amount, $25 million went to service debt. The RMI was also required to
    spend an additional $8 million to compensate landowners for U.S.

    military use of Kwajalein Atoll.20 This left only $6 million (15 percent) in
    Compact expenditures to support new capital investment, general government
    operations, or particular sectors identified in the Compact.21 According to
    the RMI financial statements, the RMI is not scheduled to pay off its bond
    debt until fiscal year 2002.

    Source: GAO analysis of financial statements and audits of the RMI prepared
    by Deloitte Touche Tohmatsu for fiscal years 1987-98.

    The Two Compact Nations Have Made Some Improvements in Economic
    Self-sufficiency

    The FSM and the RMI have made some progress toward achieving economic
    self-sufficiency, but both remain highly dependent on U.S. assistance. This
    assistance has maintained standards of living that are artificially higher
    than could be achieved in the absence of Compact funding.22 The dependence
    of these two countries on total U.S. assistance, the indicator we have
    chosen to gauge economic self-sufficiency, is identified by calculating the
    percentage of total FSM and RMI government revenues accounted for by all
    U.S. funding--Compact direct funding and U.S. program assistance.

    Total U.S. assistance (Compact and all other U.S. program assistance)23
    still accounts for at least half of total government revenue in both
    countries, although government dependence on U.S. funds has fallen from 1987
    levels in both countries. Reliance on U.S. assistance as a percentage of
    total government revenue stood at 54 percent in the FSM and 68 percent in
    the RMI in 1998. U.S. program assistance has proven to be an important
    supplement to direct Compact funding in both nations.24 The FSM and the RMI
    also receive loans from the Asian Development Bank as well as assistance
    from other donors.

    the Federated States of Micronesia

    While the United States is the main contributor to the FSM government's
    revenues, this dependence has fallen substantially since the Compact was
    enacted, from 83 percent in fiscal year 1987 to 54 percent in fiscal year
    1998 (see fig. 5). In 1987, total FSM government revenue (including all
    states) was $143.5 million and by 1998 had risen to $184.5 million. The
    reduction in dependence on U.S. assistance was due to scheduled decreases in
    direct Compact funds, increases in locally generated revenue, and a change
    in how government revenues are reported. Although the FSM is increasingly
    less reliant on Compact funds, officials of the FSM Department of Foreign
    Affairs predicted that there would be chaos without Compact assistance. In
    1998, total U.S. assistance represented 47 percent of FSM gross domestic
    product, or about $895 per capita.25

    Note: Total FSM government revenues are comprised of direct Compact funds,
    U.S. program assistance, and other revenue such as taxes, fees, and interest
    income.

    Source: GAO analysis of FSM financial statements and audits of those
    standards prepared by Deloitte Touche Tohmatsu for fiscal years 1987-98.

    Islands' Revenue

    The RMI has also reduced its dependence on U.S. funding, though not as
    dramatically as the FSM, and its dependence remains higher than that of the
    FSM. In 1987, U.S. assistance represented 78 percent of total RMI government
    revenue of $75 million (see fig. 6). This figure fell to 68 percent by
    fiscal year 1998. In 1998, total government revenues were $81 million.
    However, the 1998 level of dependence represents an increase from 1995, when
    dependence on total U.S. funding reached a low of 51 percent. The increase
    since 1995 is due to decreased local fees, sales, and taxes, and to a change
    in how government revenues are reported.26 The RMI Foreign Minister reported
    that continued U.S. funding remains necessary for the RMI to develop. In
    1998, total U.S. assistance represented 58 percent of RMI gross domestic
    product, or about $1,085 per capita.

    Note: Total RMI government revenues are comprised of direct Compact funds,
    U.S. program assistance, and other revenue such as taxes, fees, and interest
    income.

    Source: GAO analysis of RMI financial statements and audits of those
    statements prepared by Deloitte Touche Tohmatsu for fiscal years 1987-98.

    Compact Nations

    While Compact direct funding continues to provide most U.S. assistance to
    both nations, U.S. program assistance remains an important source of
    government revenue. When program assistance is combined with Compact direct
    funds to identify total U.S. assistance, the FSM and the RMI are even more
    dependent on U.S. assistance. Total U.S. program assistance revenues for
    fiscal years 1987-98 for both countries were $368 million. The FSM and RMI
    composition of government revenues shown in figures 5 and
    6, respectively, demonstrates the importance of program assistance as a
    supplement to direct Compact payments in both countries, particularly in the
    RMI. Since implementation of the Compact, the largest direct financial
    payment (sec. 211(a)) was reduced following the 5th and 10th year per the
    terms of the Compact. This reduction in funding did not, however, apply to
    U.S. program assistance.

    The RMI has been able to offset, in some cases, the scheduled reduction in
    U.S. direct payments by increasing its use of U.S. program assistance
    immediately following the reductions. For example, aside from direct Compact
    funding, the RMI in fiscal year 1991 received $6.2 million in U.S. program
    assistance from various U.S. agencies. The "step-down" in Compact direct
    funding occurred at the end of fiscal year 1991. In 1992, the RMI's U.S.
    program assistance revenues were $12.3 million. A similar experience
    followed the second step-down in Compact assistance at the end of fiscal
    year 1996. The RMI received U.S. program assistance of
    $15.9 million by 1998, compared to $7.5 million in 1996. Increasing reliance
    on program assistance is also evident for particular RMI agencies. For
    example, in the operating expenditures of the Ministry of Education in the
    RMI, U.S. program assistance increased from 10.1 percent of operating
    revenues in 1994 to 42.4 percent in 1998. In the FSM, a similar shift to
    program funds did not immediately occur following the scheduled step-downs
    in Compact assistance. In fact, in 1992, following the 12 percent cut in
    Compact funds, FSM use of U.S. program assistance fell 40 percent.

    Not all U.S. program assistance is given through grant assistance to the FSM
    and RMI governments. The U.S. Department of Agriculture has provided loans
    for both governments' telecommunication and electric power companies. In the
    RMI, the loans totaled $22.8 million by fiscal year 1998 for
    telecommunications, with an additional $12.5 million for electric power. In
    the FSM, the U.S. Department of Agriculture has provided
    $40 million in telecommunication loans. Additional U.S. assistance is
    provided directly to citizens in each nation. For example, students in the
    FSM and the RMI qualify for Pell Grants. These are federal, nonreimbursable
    grants awarded to undergraduate students who have not yet earned a degree.
    Total awards since the beginning of the Compact came to almost $32 million.
    According to the President of the College of Micronesia in the FSM, over 75
    percent of the college's students use Pell Grants to attend. The President
    also told us that without the availability of Pell Grants, the college would
    not be able to survive.

    The U.S. Department of the Interior does not have complete data on the type
    or amount of U.S. program assistance that is provided to the FSM and the RMI
    each year by U.S. agencies, though the financial statements of the FSM and
    the RMI contain aggregate data on program assistance. While the legislation
    enacting the Compact gave the Department of the Interior the responsibility
    for monitoring program assistance, the Secretary of the Interior determined
    in 1987 that the most effective method for U.S. federal agencies to provide
    continuing federal programs to the Freely Associated States was to create a
    direct grant relationship between the agencies and the island governments.
    As a result, program assistance is provided independently by each U.S.
    agency, and there is no central monitoring agency. The Department of the
    Interior has one individual working in the FSM who is the program
    coordinator for the FSM, the RMI, and Palau. When we met with him, he
    expressed frustration at the difficulties he has faced in trying to compile
    a comprehensive listing of all U.S. program assistance that is provided to
    the region.

    In addition to U.S. aid, both the FSM and the RMI have received assistance
    from other donors. For example, Australia provides technical assistance to
    the FSM to aid in government budgeting and statistics and has provided
    experts in tax and customs issues to the RMI. According to data from the
    embassy of Japan in the FSM, the value of Japan's contribution to the FSM
    from 1994 to 1998 was $109 million. Japan's contributions have focused on
    infrastructure. Based on requests from the FSM government, Japan will
    undertake all aspects of a project, including performing a feasibility
    study, preparing a design, and then contracting with a Japanese company to
    implement the project. In the RMI, we were shown roads and school buildings
    similarly constructed by Japan. China provides technical assistance in the
    FSM and has supplied a loan for a business venture in the RMI. Recently,
    Taiwan has provided loans and built projects in the RMI. Both the FSM and
    the RMI have also received loans and technical assistance from the Asian
    Development Bank. At the end of fiscal year 1998, the FSM had outstanding
    loans from the Asian Development Bank of $10 million, and the RMI had
    outstanding loans of $42 million. These loans are interest free but carry a
    1-percent annual service charge. Loans are reported in the financial
    statements of both countries, but direct, noncash assistance from other
    countries, such as the construction of a building, does not appear.

    Compact Funds Have Led to Little Improvement in Economic Development

    Expenditures of $1.6 billion in Compact funds during 1987-98 in both
    countries have contributed little to improving economic development. Three
    areas in which Compact expenditures have not led to apparent improvements in
    economic development are government operations, physical and social
    infrastructure, and business ventures. Compact funds have supported high
    levels of public sector employment at high wages, creating a barrier to
    private sector growth. Investments in physical and social infrastructure
    have not generated significant private sector activity. Finally, investment
    of Compact funds in business ventures has been a failure, with many
    businesses closed, while others require subsidies. We examined a wide range
    of projects funded under the Compact and determined that these projects
    experienced problems for many reasons, including poor planning, management,
    construction, and misuse.

    Discouraged Private Sector Growth

    Substantial Compact funds ($616 million in both countries combined) were
    used to support general government operations that have, among other things,
    maintained high levels of public sector employment and wages and have acted
    as a disincentive to private sector growth. Public sector wages are higher
    than those in the private sector in both countries. According to a 1996
    Asian Development Bank report on the RMI economy, high RMI government
    salaries stifle private sector development by raising the threshold of wages
    in the private sector.27 Further, in the FSM in 1996-97, public sector wages
    were 82 percent higher than private sector wages. Higher public sector wages
    attract workers from the private sector and drive up private sector wages.28
    These higher wages make the private sector less competitive in international
    markets.

    However, an official from the Department of the Interior stated that without
    substantial financial support from the United States for the status quo
    operational expenditures of the FSM and RMI governments, the goals of the
    United States to create stable independent governments and secure its
    security interests would have failed. Further, a Department of State
    official noted the success of the Compact in supporting the development of
    public institutions needed to further economic development.

    In response to scheduled reductions in Compact funding, the FSM and RMI
    governments have recently begun economic reform efforts to, among other
    things, decrease their large public sectors through actions such as
    government personnel reductions and wage freezes. These efforts have been
    supported by the Asian Development Bank with loans to give severance pay to
    workers leaving government employment in both countries. The prospects for
    further reductions in general government operations are uncertain. For
    example, the current position of the FSM is that reform in the economy is
    best achieved by private sector growth and not by further large-scale
    reductions in government. In fact, the FSM economic strategy does not call
    for further cuts in government spending but rather seeks to ensure that
    government expenditures do not "grow excessively."29 A recent 1999 internal
    evaluation of the Asian Development Bank reform programs concluded that in
    the FSM, the reform program "seems to have lost its way." 30 In the case of
    the RMI, the evaluation found that momentum for reform had been lost, partly
    due to the considerable confidence within the government that external aid
    could be increased. The sources for this aid would be Taiwan, which the RMI
    recognized in late 1998, and successful renegotiations of Compact funding.
    According to the Bank's evaluation, this position had been encouraged by the
    U.S. Department of Defense's statement that the U.S. missile range in the
    Kwajalein Atoll is a "national asset." However, an official at the U.S.
    embassy in the RMI pointed out that the new President of the RMI, who took
    office in January 2000, appears to be committed to keeping the RMI's reform
    program on track. For example, in June, the RMI complied with the reform
    program's government personnel reduction, according to the embassy official.

    Have Not Contributed to Significant Economic Growth

    The FSM and the RMI have spent at least $256 million in Compact funds for
    physical infrastructure improvements and operations. Both nations viewed
    this area as critical to improving quality of life and creating an
    environment attractive to private businesses. While these improvements have
    enhanced the quality of life, they have not contributed to significant
    economic growth in the two countries. Both countries have also spent more
    than $114 million from a health and education Compact funding provision and
    have realized some improvements in these areas, though both rank in the
    bottom half in terms of human development among Pacific island nations.31

    In the FSM and the RMI, Compact funds of at least $97.6 million and
    $24.6 million have been spent to operate and improve energy (including
    electrical power) and communications (including telecommunications) systems,
    respectively.32 An additional $75 million in loans has been provided by the
    U.S. Department of Agriculture to the telecommunications providers in the
    FSM and the RMI (see fig. 7) and to an electric utility in the RMI. The
    companies view this assistance as critical to their improved performance.

    Source: GAO.

    Power systems have improved, with increased capacity and dependability and a
    higher number of residents served, and have bettered their financial
    performance. For example, according to a consultant for the FSM government,
    over 50 percent of FSM dwellings had power in 1999, compared to about 29
    percent in 1980 (see fig. 8). The Marshalls Energy Company, which serves
    Majuro in the RMI, has been operating at a profit since 1994 (except for
    1999) and no longer requires annual government assistance, according to the
    General Manager. In the FSM state of Kosrae, we visited the electric power
    company on a day when electric crews were disconnecting nonpaying customers.
    However, financial and service problems persist in the electrical power
    sector in some locations, particularly the FSM state of Chuuk and the RMI
    island of Ebeye in the Kwajalein Atoll. For example, in Chuuk the power
    company is trying to increase revenue through higher rates and better bill
    collection, including enforcing its disconnection policy for overdue
    accounts. Nevertheless, the utility still depends on a $1 million subsidy
    from Compact energy funds and government funding of all capital
    expenditures.

    Source: GAO.

    Telecommunications services have also improved in both countries, with
    services provided to more residents and the introduction of enhanced
    capabilities such as cellular service and Internet access.

    Improvements in telecommunications and energy have not been sufficient to
    promote significant private sector growth, though in one instance we did
    identify a tuna processing plant in the RMI that recently located to the
    country in part as a result of dependable electricity there (see fig. 9). 33

    Source: GAO.

    Both countries have also spent Compact funds to provide subsidized
    transportation systems. These efforts have been targeted at improving
    transportation between the main population centers and the outer islands. In
    the FSM, ships used to haul cargo between islands have been maintained with
    Compact capital account funds of approximately $5.9 million (see
    fig. 10).

    Source: GAO.

    In the RMI, the national airline, Air Marshall Islands, has been in
    operation since 1980 in order to move people and cargo between atolls (see
    fig. 11). According to the independent auditor for the RMI, the airline has
    received close to $27 million in Compact funding for fiscal years 1989
    through 1997. This funding has been used primarily for operating transfers
    as the airline operates at a loss. Further, we found that for fiscal year
    1998, the airline received $500,000 in operating subsidies, as well as debt
    forgiveness of
    $1.8 million. The airline has received funding for other purposes as well.
    For example, in 1995, over $15 million in Compact funding was used to buy
    one aircraft. According to an airline official, this aircraft was sold in
    1999 for $5 million after a determination that the aircraft was too
    technologically advanced for the airline. According to Air Marshall Islands
    officials, the previous government had used political influence to override
    commercial decisions of the airline and to change management.

    Source: House of Representatives Committee on International Relations,
    Subcommittee on Asia and the Pacific, Staff Photo.

    The two governments have also invested in social institutions, including
    schools and hospitals. Both countries have spent over $114 million in a
    Compact health and education block grant since 1987. A portion of the FSM's
    investment in education has been used to support its college system. The
    College of Micronesia has received $2.9 million in Compact funds over the
    last few years for designing and supplying facilities (see fig. 12). The
    College provides the FSM with a post-high school educational institution. It
    consists of facilities in each of the four states of the FSM, as well as a
    national campus located in the FSM capital of Palikir, Pohnpei.

    Source: GAO.

    Both nations show some improvements in social indicators over the life of
    the Compact, though both are low ranking in this area among their Pacific
    island neighbors. According to United Nations Development Program
    indicators, the FSM and the RMI ranked 9th and 10th, respectively, in terms
    of their human development level out of 14 Pacific island countries in 1998.
    Since the 1980s, both countries have shown increases in school enrollment,
    while in the RMI life expectancy at birth also increased from 60 to 65
    years. RMI data on infant mortality show that mortality declined from 63
    deaths per 1,000 live births in 1988 to 26 deaths per 1,000 live births in
    1999. The FSM reports that as of 1997, infant mortality stood at 28 per
    1,000 live births. Since the 1980s, life expectancy at birth in the FSM grew
    by 1 year, to 66 years.

    Compact expenditures have not promoted sufficient economic growth to
    compensate for population growth and reductions in U.S. assistance;
    consequently, living standards, though artificially higher as a result of
    Compact funding, have stagnated. Both economies grew during the Compact
    period, but per capita income, adjusted for inflation, showed essentially no
    increase during the period in the FSM and fell in the RMI. In 1987, FSM
    gross domestic product (GDP) was $130.3 million and by
    1997-98 had risen to $213 million. However, the population of the FSM grew
    as well, from about 93,000 in 1987 to an estimated population of 116,268 in
    1999. The FSM government estimates that per capita income in the FSM, when
    adjusted for inflation, grew about a total of 2.4 percent during the
    12-year period. In the RMI, the economy grew from a GDP of $70 million in
    1987-88 to a peak of $105 million in 1994-95. The RMI's GDP then fell to
    $96 million by 1997-98. The RMI population also grew, from 43,380 in 1988 to
    50,840 in 1999.34 Estimates from the RMI Office of Planning and Statistics
    show that inflation-adjusted per capita income fell 41 percent from 1990
    through 1998.35

    As noted in chapter 1, the economic growth potential of these countries and
    their ability to generate revenue to replace U.S. assistance have been
    limited by factors such as geographic isolation and limited natural
    resources. Before implementation of the Compact, we reported that the FSM
    and the RMI faced serious obstacles to becoming economically
    self-sufficient, such as inadequate planning for and maintenance of
    infrastructure and low savings levels. Both governments lacked sufficient
    managerial and technical expertise and management systems to overcome such
    obstacles.

    Current living standards depend on U.S. assistance. The FSM and the RMI are
    among the largest recipients of U.S. assistance worldwide on a per capita
    basis and are highly dependent on U.S. assistance. In 1998, total U.S.
    assistance equated to about $895 per capita in the FSM, while per capita
    income was $1,910. The RMI is more dependent, with 1998 U.S. assistance of
    about $1,085 per capita compared to $1,890 in per capita income. The high
    level of U.S. funding has maintained artificially higher standards of living
    in both countries that could not be sustained in the absence of U.S.
    assistance. An Asian Development Bank report describes the two countries as
    "looking over the edge of a cliff" as they face the scheduled end of U.S.
    Compact assistance.36

    Failed

    We identified $188 million in Compact funds spent in the FSM and the RMI for
    business ventures. Compact funds have been invested in fisheries,
    agriculture, aquaculture, livestock, business advisory services,
    handicrafts, tourism, and manufacturing. Other Compact funds went to
    development banks in both nations for business loans. During our visit, FSM
    and RMI officials reported that few Compact-funded business ventures were
    operating at a profit, if at all. Government officials from both countries
    told us that investing in business ventures has been a bad strategy, and
    using Compact funds for this purpose had been a failure. Two FSM state
    governors noted that private sector initiatives, in every sector, had in
    every instance lost money. An official of the Marshall Islands Development
    Bank reported that all but one of the Bank's business investments had
    failed.

    The few successful business ventures that FSM and RMI officials identified
    were the result of Compact funds loaned to businesses by government
    development banks. FSM Development Bank officials identified several
    successful loans, such as loans to the Yap Community Action Program, a
    Kosrae resort, and a car rental agency. However, in general, the Bank's
    lending record using Compact funds was weak. FSM Development Bank officials
    said they made bad debt provisions of $12 million in likely loan losses
    involving Compact funds in 1998, about two-thirds of the value of the
    Compact-backed loan portfolio.

    In the RMI, a Marshall Islands Development Bank official identified only one
    successful business loan; loans using Compact funds generally failed, and
    all business lending has currently been suspended. According to the
    official, business lending had been directed by the RMI President or by the
    Cabinet and was not based on business considerations. A recent audit by the
    Department of the Interior Inspector General of bank lending listed
    questionable loans, including loans to Air Marshall Islands, for an office
    building, for an entertainment complex, and for several fishing ventures.
    Because of political direction and influence, loans of about $6 million went
    to businesses with family connections to the former RMI President, according
    to the Bank's Chairman of the Board and the Managing Director.37 An RMI
    official also noted that the only successful business loan was to the Trust
    Company of the Marshall Islands. This company provides "off-shore" services
    for businesses and individuals, including a ship registry, "off-shore"
    incorporation, and financial trusts.38 According to an attorney for the RMI
    embassy in Washington, D.C., such an enterprise is one of the few
    competitive advantages that an island government has--to leverage off its
    sovereignty. In fiscal year 1998, the ship registry returned about $766,000
    to the government.39

    Examples of failed business ventures are numerous and involve various
    business sectors. For example, we identified failed fisheries and pepper
    ventures in the FSM, and a closed garment factory, a large resort hotel
    operating at a loss, and a dry dock facility in the RMI.

    FSM: Fisheries Ventures,
    $60 Million in Compact Funding

    We identified $60 million in Compact funds that the FSM spent on fisheries
    activities (see fig. 13).40 The FSM has undertaken unprofitable fisheries
    investments in each of the four states. A 1999 analysis of FSM fisheries
    ventures, prepared by a consultant for the FSM government, reported that the
    current valuation of the national and state fishing enterprises, on the
    basis of expected future cash flows, was zero.41 We visited one storage and
    processing facility in each of the four FSM states; none of the facilities
    was operating at the time of our visit. Officials from the states of Yap and
    Chuuk said that ventures in fisheries were failures due to inexperience and
    poor business judgment.

    Source: GAO.

    FSM: Pohnpei Pepper Industry Development, $870,000 in Compact funding

    In Pohnpei, the state government spent $870,000 to develop a pepper
    exporting industry (see fig. 14). As part of this effort, the government
    started a pepper processing plant to provide farmers with an alternative
    buyer to the one successful private sector pepper company already in
    operation that purchased pepper from farmers. The intent of the project was
    to provide an opportunity to pepper farmers to sell their pepper to the
    government enterprise at higher prices than those paid by the private
    company. The government enterprise would then process, market, and export
    the pepper. As a result of the government effort, the private sector company
    went bankrupt. Subsequently, the government enterprise closed. Pepper
    exports fell from $95,000 in 1995 to zero in 1997.

    Source: GAO.

    RMI: Garment Factory,
    $2.4 Million in Compact Funding

    We identified almost $2.4 million in Compact capital funds that were spent
    to establish a garment enterprise that included a factory and a dormitory
    for workers (see fig. 15). This business was a 1993 Marshallese-Chinese
    joint venture to manufacture and export clothing using Chinese workers. The
    government of the People's Republic of China loaned the RMI an additional $2
    million for the joint venture. However, management disagreements ensued and
    the Chinese workers were returned to China. According to RMI government
    officials, the facility never operated and is now closed.

    Source: GAO.

    RMI: Resort Hotel, $11 Million in Compact Funding

    The RMI also used more than $11 million in Compact capital account funds to
    build a major resort hotel, according to the independent auditor for the
    RMI. This hotel was built so that the RMI could host a meeting of the South
    Pacific Forum in 1996. The hotel now operates at a loss and receives
    government subsidies. For example, in fiscal year 1998 subsidies amounted to
    more than $1 million.

    RMI: Dry Dock, $4.5 Million in Compact Funding

    The RMI spent $4.5 million in Compact funding to establish a dry dock
    facility. According to the RMI Minister for Resources and Development, the
    dock is in bad condition due to a lack of maintenance, and the government's
    current concern is that the investment will sink in the water.

    Management, Construction, Maintenance, and Misuse

    After a review of financial records, and project files, or both for over
    150 projects undertaken with Compact capital account funds, visits to
    80 project sites, and numerous interviews in the FSM and the RMI, we
    determined that many Compact-funded projects (infrastructure and business
    ventures) experienced problems as a result of poor planning, management,
    construction, maintenance, and misuse, or all of these problems. These
    problems have reduced the effectiveness of Compact expenditures. According
    to Department of the Interior officials, the ineffective use of Compact
    funds can be partially explained by the fact that neither the FSM nor the
    RMI governments had staff that possessed the skills necessary to plan and
    manage expenditures under the Compact.

    The standard documents in the FSM used to track capital projects--the
    project control document--often contained minimal or very broad descriptions
    of project objectives, costs, and expected benefits and are no longer than
    two pages for projects that cost hundreds of thousands of dollars.42 In the
    RMI, we could find no evidence of any standardized form used to plan or
    track capital projects. In some cases, we found very limited files for
    sizable RMI ventures such as the airline or the resort hotel. Further, in
    both countries, we found that many project files that we reviewed lacked

    complete documentation such as economic feasibility studies, competitive
    bids, contracts, and inspection reports.43

    Poor planning and management were evident for many failed projects we
    visited. Examples of poor planning and management that we identified
    included a causeway in the RMI and a coconut products company, fishing
    venture, and road in the FSM.

    RMI: Ebeye Causeway,
    $9.2 Million in Compact Funding

    The RMI government spent an estimated $9.2 million in Compact capital funds
    to build a road, or "causeway," from Ebeye, an extremely crowded island in
    the Kwajalein Atoll, to a planned development on the nearby island of
    Gugeegue (see fig. 16). This causeway was meant to relieve population
    problems on Ebeye by allowing residents to move to additional islands
    connected by the road. However, the causeway remains unfinished due to an
    inability to budget additional funding for the project. Little development
    has occurred on Gugeegue, and few residents have moved from Ebeye to
    Gugeegue. Ebeye officials told us that the causeway is covered with water in
    places during high tide and is considered an inadequate and unreliable
    connection between Ebeye and the other islands. Construction has been
    suspended.

    Source: GAO.

    FSM: Ponape Coconut Products, Inc., $133,000 in Compact Funding

    In the FSM state of Pohnpei, a company involved with the production and
    distribution of soap and other products made from island-grown coconuts made
    significant investments in production expansion based on a contract with one
    individual. Relying on a 1996 contract with a foreign national, the soap
    company requested and received $133,000 in Compact funding to purchase new
    equipment to meet contract production requirements. According to the
    company's senior accountant, the foreign national disappeared shortly after
    the equipment was installed, and the company is losing money. According to
    the company's 1999 financial statement, losses were $45,000. The senior
    accountant said that the factory stays in business through government loans
    and grants. When we visited, the new machinery was sitting idle and rusting,
    while limited production was underway using old equipment (see fig. 17).

    Source: GAO.

    FSM: Pohnpei Fishing Venture, $21 Million in Compact Funding

    Also in Pohnpei, the state government, in conjunction with the national
    government, spent about $21 million on fishing boats and processing
    facilities that were not compatible. Because of poor management and
    planning, the boats never returned a profit, and the processing plant is
    currently idle. According to the Pohnpei State Lieutenant Governor, the
    government knew nothing about the fishing industry when it made the
    investment and was duped into paying too much for three 25-year old boats
    that were too small for the Pacific environment.44 In addition, the
    processing plant, which cost almost $16 million, was intended to process
    high-grade tuna and not the lower-grade tuna caught by the three boats.

    FSM: Kosrae Road Construction and Paving, $9.3 Million in Compact Funding

    Another example of poor planning that we observed was in the FSM state of
    Kosrae. The state used $9.3 million in Compact capital account funding
    within the last 12 years to construct and pave a road around the island.
    When we visited, the road was in obvious disrepair, and we were told that
    the road surface had been largely removed (see fig. 18). In reviewing the
    project file for road construction, we found that an inferior, though
    cheaper, paving technology had knowingly been employed. Kosrae officials had
    been informed, prior to construction, that a $800,000 grant from the U.S.
    Department of Commerce's Economic Development Authority would not be
    provided if Kosrae chose this inferior method of building a road. Kosrae
    chose the cheaper method, never received the Economic Development Authority
    grant, and is now preparing to pave its roads again.

    Source: GAO.

    Inadequate construction was evident during our site visits and could be
    considered a result of poor planning. At times during our visit, it was
    difficult to distinguish poor construction from inadequate maintenance. The
    tropical climate consists of high temperatures, rain, and exposure to
    salt-laden air, which requires different material standards than does
    construction in more temperate climates. Water leaks were evident in many
    buildings, and corrosion was obvious both in Compact-funded buildings as
    well as on government vehicles.

    RMI: National Capitol,
    $8.3 Million in Compact Funding

    The capitol building in the RMI, built during the 1990s using $8.3 million
    in Compact funding, has visible signs of deterioration (see fig. 19). Stairs
    are rusting, elevators are inoperable, and roof leaks are evident throughout
    the building. In reviewing the construction file for the capitol project, we
    found a letter from the contractor building the capitol to the government's
    engineering representative questioning the suitability of the supplied
    roofing material for the project. According to the contractor, a warranty on
    the roofing material would not be supplied in part because the supplied
    material's original purpose was to be used as a "pond liner," not as roofing
    material. We were unable to ascertain whether the pond liner material was
    subsequently used on the project, but we did observe leaks throughout the
    building. RMI embassy officials in Washington, D.C., told us that funds have
    been recently appropriated to make repairs.45

    Source: GAO.

    FSM: Health and Education,
    $80 Million in Compact Funding

    We found inadequate or nonexistent maintenance in numerous schools and
    hospitals we visited, despite the government's spending $80 million in
    Compact funding designated for health and education in the FSM. For example,
    we visited schools in Pohnpei and Chuuk where sections of ceilings were
    missing, bathrooms were in disrepair, and electricity had been disconnected.
    In general, many schools appeared poorly maintained (see fig. 20). According
    to a 1999 Asian Development Bank assessment of the FSM education system,
    salaries consumed 97 percent of the 1999 elementary education budget in
    Pohnpei and 100 percent in Chuuk, leaving almost no funds for educational
    materials or facility maintenance.

    Source: GAO.

    At the Pohnpei hospital, the Director told us the hospital lacked adequate
    funding, drugs, and supplies (see fig. 21). He said the entire health care
    system would collapse without Compact funds, in part because collection fees
    covered less than 20 percent of health care costs. As a cost-cutting
    measure, the hospital no longer provides sheets to patients. The Director
    said patients who cannot afford sheets simply lie on hospital mattresses,
    where their infections can contaminate the mattresses and infect future
    patients. The U.S. embassy in the FSM reported in January 2000 that, because
    the hospital lacked funding for cleaning products, infectious viruses had
    been found in 37 locations, including 10 sites in the operating and
    emergency rooms.

    Source: GAO.

    RMI: Health and Education,
    $34 million in Compact Funding

    During our visit to the Ebeye hospital in the RMI, water leaks were evident
    in the surgery ward, and supporting roof beams were crumbling from rust (see
    fig. 22). The Ebeye City Manager told us that the Compact provided for
    capital investment but did not supply any funds for maintenance. For
    example, the municipal government takes funds away from other key areas such
    as schools in order to maintain capital projects but still cannot adequately
    maintain these projects. He advocated that capital improvements only be
    undertaken after the costs and funds for maintenance have been
    determined--it would be better to have fewer, well-maintained, investments
    than the current larger, but unsustainable, number of projects.

    Problems in construction were not unique to Compact-funded projects. The new
    Ebeye hospital, which is more than a year away from opening, will need to
    have foundation support beams replaced before construction can continue. The
    support beams were not adequately protected from the corrosive environment
    and are already rusting away. According to an official from the Kwajalein
    Atoll Development Authority, this project received a non-Compact U.S. grant
    totaling $4.5 million.

    Source: GAO.

    Finally, we identified Compact expenditures that appeared to be a misuse of
    funds. The prospect that these projects will promote widespread economic
    advancement is questionable. For example, in the FSM state of Chuuk, the
    Udot road and dock project was intended to upgrade basic social and economic
    infrastructure in Udot. According to government officials, it will not meet
    this goal. The project cost $188,000 in Compact funding. When we visited the
    site, we noted that the dock was built directly in front of the Mayor's
    house (see fig. 23). Chuuk state officials said that the crane used to build
    the dock would be left to rust after the dock was completed. The road led
    from the Mayor's house through the jungle to a small village, with few other
    houses along the road. In contrast, at the end of the Mayor's road was a
    junior high school that received $2,800 in Compact funding to repair the
    one-room schoolhouse. There were no desks or chairs for students. Further,
    we were told that students did not have their own textbooks and were read to
    by the teacher, who used the one set of available textbooks.

    Source: GAO.

    Also in the FSM state of Chuuk, the Fanapanges ice plant was to be built to
    increase income, employment, and nutrition by providing ice to fishermen on
    the island of Fanapanges and other nearby islands so they could store their
    catch for later sale in Weno, the capital of Chuuk, about an hour's boat
    ride away. We identified almost $100,000 in Compact funding that was used
    for this project. When we visited the site, we discovered that the plant had
    never been built. Chuuk State officials told us that, after site preparation
    had begun, the Mayor of Fanapanges had decided to move the ice machine to
    his home in Weno on a different island, about 11 miles away by boat. When we
    visited the Mayor's house in the state capital, we found the ice machine
    sitting by the side of the house, not in use (see fig. 24).

    Source: GAO.

    As another example of what appeared to be a misuse of funds, the FSM used
    funds in what the U.S. embassy in the FSM described as "cars and boats for
    votes." The FSM Public Auditor reported that $1.5 million was spent on cars
    and boats that were simply given away to individuals for their personal
    use.46 Although the procurement documents for purchasing boats stated that
    they were to be used for economic purposes, we learned in interviews with
    two different recipients that they received the boats from the Mayor without
    any restrictions placed on their use (see fig. 25). Furthermore, the embassy
    reported that another 187 cars had arrived in May 1999 and were used for
    "re-election assistance."

    Source: GAO.

    We also found examples of possible misuse of Compact funds in our
    examination of records relating to two RMI government entities that executed
    capital and business development projects. These were the Marshall Islands
    Development Authority and the Kwajalein Atoll Development Authority.

    The Kwajalein Atoll Development Authority received certain Compact capital
    fund transfers for use in the Kwajalein Atoll. We found instances in which
    the independent auditor reported that the Authority had spent more than the
    amount authorized in the Compact for administrative expenses. The Compact
    states that 1.5 percent of capital account funds can be spent for
    administrative purposes. While the independent auditor determined that,
    based upon capital account funds available, the Authority was only
    authorized to spend about $60,000 for administrative expenses in 1992, it
    instead used $1.1 million for the Board of Directors and other costs of
    operation (28 percent of its capital funds for the year). In another
    instance in fiscal year 1992, the independent auditor identified more than
    $9,000 that the Authority had spent to host a party in Hawaii, as a
    questioned cost in its annual audit.

    In addition, the Authority lent five personnel to the RMI President to
    assist in completing his residence in Majuro in 1997. The Authority also
    spent funds on overseas travel. For example, in 1991, about $108,000 was
    spent to send a delegation to the United Nations to witness the RMI's
    official entry into that body. In another instance, the Authority sent five
    members as part of the RMI delegation to the United Nations' "Rio Earth
    Summit" in 1992.

    The Marshall Islands Development Authority served as the agent for
    implementing capital investment decisions made by the government's Cabinet.
    Officials from this agency reported that they did not have a feasibility
    study for any project but implemented decisions of the Cabinet. We found
    several cases in which the RMI Cabinet would reprogram development funds for
    nondevelopment purposes such as to pay for medical referrals, to finance
    foreign travel of an Ambassador, and to pay salaries for the council of
    Traditional Leaders.

    In commenting on the RMI record of Compact expenditures, the Minister of
    Finance characterized the RMI's past expenditures for various projects as
    lacking due diligence on the part of the government. He recommended that any
    future Compact contain better accountability. The RMI Foreign Minister
    reported that financial management of RMI funds responded to politicians'
    goals and had not been for the benefit of the RMI.

    The Two Compact Nations and the United States Have Provided Limited
    Accountability Over Compact Expenditures

    The FSM, the RMI, and the United States have provided limited accountability
    over the use of Compact funds. Although the Compact established
    accountability requirements for all three countries, they have not fully
    complied with the requirements. The FSM and the RMI have usually submitted
    the required development plans and reports, but these documents fell short
    of meeting their intended purposes. In addition, the FSM and the RMI have
    not demonstrated adequate control over the use of Compact funds. Finally,
    limited Interior staff devoted to oversight, interagency disagreements in
    the United States on the level of and responsibility for oversight, and a
    Compact provision guaranteeing payment of Compact funds, have limited the
    U.S. government's ability to oversee the use of Compact funds and ensure
    that they are used effectively.

    States of Micronesia, the Republic of the Marshall Islands, and the United
    States

    The Compact required the FSM, the RMI, and United States to account for the
    use of Compact funds by filing development plans, annual reports, and
    financial audits and by conducting bilateral consultations. The FSM and the
    RMI were responsible for preparing overall economic development plans at
    least every 5 years. Among other things, the plans were required to serve as
    a program for annual development by identifying specific economic goals and
    also by determining specific projects and linking them to development goals.
    The FSM and the RMI were also responsible for preparing annual reports on
    the implementation of the development plans and the use of Compact funds and
    for having annual financial and compliance audits conducted. The Compact
    required the United States to review the development plans for compliance
    and consistency with the Compact and to assist in identifying appropriate
    development goals. The United States was also required to meet annually with
    the FSM and the RMI to review the annual reports and discuss the use of
    Compact funds. The Department of the Interior is designated to provide and
    monitor Compact funds. In addition, a 1986 executive order established an
    interagency group, chaired by the Department of State, to provide policy
    guidance on the Compact.

    Micronesia and the Republic of the Marshall Islands Were Generally
    Incomplete and Insufficient

    While the FSM and the RMI generally met the Compact requirements to submit
    national economic development plans and annual reports to the United States,
    our analysis of these documents, confirmed by officials from the Departments
    of State and the Interior, concluded that both types of documents have been
    insufficient to meet the Compact requirements.

    The FSM and the RMI submitted economic development plans for the first and
    second 5-year periods, covering the period from 1987 to 1997. Our analysis
    of the economic development plans, confirmed by a Department of the Interior
    official and an FSM government document, found that the plans gave
    inadequate attention to broad development goals and plan implementation, as
    required by the Compact. The Interior official said the plans focused on
    spending funds in specific sectors without tying projects to development
    needs. The Department of State Special Negotiator for the Compact of Free
    Association told us that the FSM's most recent planning document, the FSM
    Planning Framework for 1999-2001, has been accepted as that country's third
    economic development plan.

    For fiscal years 1987 through 1999, the FSM submitted annual reports each
    year except for 1999, while the RMI has submitted 7 of the 13 annual
    reports. Department of the Interior officials told us that the annual
    reports, which are required by the Compact as a means of assessing economic
    progress, were also inadequate at describing how Compact funds were used to
    achieve development goals. Additionally, the reports were submitted too late
    to be relevant for timely U.S. oversight, according to U.S. officials.47
    Although State and Interior were generally critical of the quality of the
    reports, a State Department official noted that the quality of FSM annual
    reports has improved over time, while the quality of RMI reports has
    deteriorated.

    In addition to requiring the submission of reports on the overall use of
    Compact funds, a Compact-related agreement requires that each nation submit
    annual plans regarding the use of targeted annual assistance of
    $10 million for health and education. Based on our review of documents held
    by the Department of the Interior, it appears that few of these required
    annual plans have been submitted. For the FSM, four plans were on file, and
    two were available for the RMI. (See app. II for a listing of accountability
    requirements that the FSM, the RMI, and the United States did and did not
    meet.)

    In addition, the FSM and the RMI have failed to adequately control and
    account for Compact expenditures. According to their annual financial
    audits, the FSM and the RMI did not maintain or provide sufficient financial
    records to effectively audit Compact funds. Of the 60 financial reports of
    the FSM national government and its four states from which we obtained
    financial statement data, Deloitte Touche Tohmatsu (the independent auditor
    for the FSM and the RMI) was unable to issue an audit opinion on the
    financial statements in 7 reports, and issued a qualified opinion on the
    financial statements in the other 53 reports.48 Of the seven audits with no
    opinion, the auditor cited accounting deficiencies and a lack of financial
    data from the government entity or one of its component units. The auditor
    cited similar reasons for the qualified opinions in its remaining audits.
    For example, in fiscal year 1998, the Yap Fishing Corporation, in which the
    government has a majority interest, did not provide financial statements.
    Similarly, none of the 12 independent audits we read for the RMI were issued
    without qualification. A frequent reason for the qualification was the lack
    of financial statements provided by government entities. For example, in
    fiscal year 1998, eight entities were not able to produce financial
    statements, including the Marshall Islands Social Security Administration,
    the Marshall Islands Development Bank, the Marshall Islands Drydock, and the
    College of the Marshall Islands.

    Further, the independent audits showed that the two countries, as well as
    the United States, have taken little action to address management weaknesses
    and resolve questioned uses of Compact funds. The annual audit reports list
    questionable uses and accounting of U.S. assistance, including direct
    Compact payments and U.S. program assistance. The United States expects the
    FSM and the RMI to develop and implement corrective action plans to resolve
    these questioned costs. 49 However, under current guidelines, if the FSM and
    the RMI do not take corrective action, and if the U.S. agencies providing
    the assistance do not notify the FSM and the RMI within 2 years that the
    issues are unresolved, then the FSM and the RMI can remove all questioned
    costs that fall outside this 2-year window from the summary audit schedule
    of questioned costs. As a result, by fiscal year 1998, the two countries
    wrote off about $57 million in questioned uses of Compact and other program
    assistance that had been unresolved since the 1980s ($46.3 million for the
    RMI and $10.8 million for the FSM). The FSM created a special committee in
    1998 to address questioned costs directly and work with the government
    agencies to implement corrective action on open recommendations.

    Finally, program audits by the FSM Public Auditor found inappropriate use of
    Compact funds and extensive management weaknesses in accounting for Compact
    funds. For example, an audit of Compact-funded projects for fiscal years
    1997 and 1998 found that 37 of 42 projects examined were not properly
    managed and had deficiencies such as improperly documented payments. An
    audit of Compact-funded projects for fiscal years 1992-96 found problems
    related to misuse of funds. For example, the audit found that nearly
    $600,000 of heavy equipment purchased for a $1.3-million road improvement
    project in Tolensome, Chuuk, was being used at a former mayor's personal
    dock for activities not related to road improvement. According to the
    auditor, funding for the road project continued even after inspections
    identified this instance of inappropriate use of funds. We could not
    identify any similar program audits involving the use of Compact funds
    conducted by the RMI Auditor General.

    The U.S. government has not met many of the Compact's accountability
    requirements to review and consult on Compact expenditures. We found that
    the U.S. government concurred with and praised the initial development plans
    of both countries, although Interior officials informed us that U.S.
    concerns over the plans remained. Despite this concurrence, the Department
    of the Interior was unable to provide us with the reviews of the first plan
    of both countries, and we found no evidence that required reviews of, and
    concurrence with, the second plans took place. Although the Compact requires
    the U.S. government to review each FSM and RMI overall economic development
    plan to, among other things, assess whether they include appropriate
    development goals, we did not find any assessments. We found no evidence
    that Interior consulted with the Agency for International Development or
    other agencies regarding the plans, as required in the Compact.

    With respect to the annual reports prepared by the FSM and the RMI, we were
    unable to identify documentation demonstrating that the Department of the
    Interior reviewed these reports. A Department of the Interior official
    stated that the reports are not assessed to determine if they provide
    adequate information on development plan implementation and the role of
    Compact expenditures in achieving development goals.

    In addition, the United States did not initiate the required annual
    consultations with the two countries until 1994--7 years after the Compact
    went into effect. The United States has held four additional consultations
    with the FSM and three consultations with the RMI since 1994. As a result of
    missed meetings, the FSM and the RMI were not required to demonstrate their
    progress in economic development and justify their Compact expenditures on a
    regular basis. Further, according to a Department of the Interior official,
    the talks that were held have been cordial diplomatic meetings but have not
    included serious discussions of economic growth or compliance with Compact
    spending requirements. A Department of State official disagreed with this
    statement.

    The Compact requires that audits of FSM and RMI Compact expenditures be
    conducted. A Compact-related agreement requires that annual audits be
    conducted within the meaning of the Single Audit Act of 1984. These audits,
    discussed in the previous section, were contracted to an independent auditor
    and have been conducted for both the FSM and the RMI for every year since
    the Compact was enacted. The Department of the Interior pays for the annual
    audits. According to an Interior official, the audits cost over $1 million
    for both countries in fiscal year 1999. Our review of independent audit
    information has demonstrated that U.S. government reliance on the financial
    statements of the FSM and the RMI as a complete accounting of Compact
    expenditures is questionable. The independent auditor has routinely stated
    that it has been unable to audit the financial statements of various
    recipient government subcomponents--entities that may have received Compact
    funding. Further, a large portion of U.S. direct Compact payments were
    placed in a general government fund and commingled with other revenues and
    therefore cannot be further tracked. In addition, due to transfers between
    different types of funds, some Compact assistance is only traced at a high
    level with few details readily available regarding final usage. In addition,
    the Department of the Interior's Inspector General has done few audits of
    its own in either country. Since 1987, the Interior Inspector General has
    issued four reports for the FSM and four for the RMI. Most of these audits
    occurred in the first few years of the Compact. When asked to summarize how
    Compact funds were spent, one Department of the Interior official replied
    that "they were spent."

    As noted in the previous section, U.S. agencies took little action to
    address questioned costs identified in the annual independent audits of the
    FSM and the RMI. However, we did identify documentation demonstrating that,
    in the last few years, the U.S. Ambassador to the RMI raised the issue of
    questioned costs and fiscal mismanagement with the Department of the
    Interior and requested increased attention to audit compliance by the
    Department of the Interior's Inspector General. The Ambassador informed us
    that Interior has not taken any action.

    Finally, Interior resources devoted to Compact oversight are minimal.
    Currently, Interior has one person in Washington, D.C., who works with the
    two Compact nations, as well as one person in the FSM,50 and no one is
    posted in the RMI.51 In 1987, the Department of the Interior reported that
    it would need 15 staff positions to implement the Compact, including 7 field
    positions, but few of these positions were filled. Interior has speculated
    that a larger U.S. presence in the FSM and the RMI might have produced
    better results through moral suasion and encouragement.

    Belief That Compact Provisions Restricted U.S. Actions

    An executive order issued in 1986 shared Compact responsibilities between
    the Departments of State and the Interior. The Department of State was to
    conduct government-to-government relations, while the Department of the
    Interior was responsible for providing the assistance, coordinating and
    monitoring all federal programs in both nations, and monitoring economic
    planning.52 However, disagreements between the Departments of State and the
    Interior regarding the level of and responsibility for Compact oversight
    have led to limited monitoring. These disagreements, discussed in the
    following paragraphs, have not engendered U.S. government action,
    specifically by these two Departments, to assess expenditures and review
    them with both countries. As a result, the United States did not use its
    influence to promote greater progress toward self-sufficiency and more
    effective financial management on the part of the FSM and the RMI.

    Accountability. The Department of State counseled Interior to be lenient in
    reviewing the use of Compact funds in the early years of the Compact because
    State placed a high priority on maintaining friendly relations with the FSM
    and the RMI. State viewed positive relations as key because, for example,
    both countries had a tendency to vote with the United States in the United
    Nations General Assembly. According to a Department of State official, the
    Department did not place greater priority on oversight of Compact funds
    until the early to mid-1990s, after the Cold War had ended. As a result,
    Interior did not aggressively monitor Compact expenditures, according to
    Interior officials.

    Staffing. The Departments disagree regarding authority over Interior staff
    selected to work in the RMI, as well as where Interior staff would be
    located within the country. Specifically, while the Department of State
    reports that U.S. government staff working in the RMI are under the direct
    authority of the Ambassador, who is a State Department official, the
    Department of the Interior disagrees. Further, a Department of State
    official reported that the two departments have disagreed regarding whether
    Interior staff posted in the RMI should be located in the capital, Majuro,
    or in the Kwajalein Atoll. These disagreements partially explain why there
    are currently no Interior staff working in the RMI. Finally, the Departments
    differ on whether Interior is the appropriate agency to be responsible for
    administering a foreign assistance program.

    Roles and Responsibilities. Disagreements over agency responsibilities help
    to explain the lack of consultations with the FSM and the RMI from 1987 to
    1993. Department of the Interior officials told us that the Department of
    State is supposed to initiate discussions regarding Compact issues with the
    FSM and the RMI as part of its responsibility for "government-to-government
    relations" with the two countries and as chair of the interagency group that
    establishes policy regarding the two countries. However, Department of State
    officials maintain that the Department of the Interior, as the agency
    responsible for providing Compact funding, should have requested meetings
    with the FSM or the RMI regarding Compact expenditure issues. Consultations
    began in 1994 and are now supported by both Departments.

    In addition, Department of the Interior officials believe that certain
    Compact provisions limit the Department's ability to require accountability.
    They told us that while the Compact and a related agreement refer to direct
    payments for economic assistance as "grant assistance," these payments are
    not the same as discretionary grant assistance as commonly understood in
    domestic U.S. programs. For discretionary grant assistance, requirements
    such as performance measures can be applied to control the use of funds.
    According to Department of the Interior officials, Interior voiced concerns
    to Compact negotiators, prior to implementation of the Compact, regarding
    the lack of enforceable standards in a Compact-related agreement.

    Further, Interior officials told us that one Compact provision states that
    payments are expressly backed by the "full faith and credit" of the U.S.
    government and are intended to be an enforceable obligation. If the United
    States withholds funds or otherwise fails to make a payment, the FSM and the
    RMI can seek redress in court. As a result, Department of the Interior
    officials told us that they are unable to withhold funding from the FSM and
    the RMI and essentially have no mechanism to ensure that funds are not
    misused. We and the Department of State officials agree that withholding
    funds is impracticable. Interior felt it became simply a "pass-through" for
    the money. Interior officials told us that the guarantee of funding provided
    by the "full faith and credit" provision explains why the agency has not
    pursued questioned costs identified in the independent audits involving
    direct Compact payments.

    While the "full faith and credit" provision may make withholding most funds
    impracticable, the legislation enacting the Compact did identify certain
    funds that could be withheld for noncompliance with Compact requirements. We
    identified one instance in which Interior withheld funds from the FSM. In
    late 1994, Interior withheld a portion of these funds (targeted for health
    and education) from the FSM state of Chuuk due to unpaid bills outstanding
    at a hospital in Guam. Interior reported that this action was effective, and
    Chuuk took quick action to resolve the problem. The funding was then
    provided to Chuuk.

    Conclusions and Recommendations

    Our work reviewing the Compact with the FSM and the RMI has led us to
    conclusions in three specific areas. First, Compact assistance spent on
    economic development has been largely ineffective in promoting significant
    economic growth, with many unsuccessful development efforts. Second, the
    structure of the Compact provided insufficient guidance regarding the
    expenditure and accounting of Compact funds. Third, the accountability
    requirements contained in the Compact were not met by the FSM, the RMI, or
    by the United States. Lastly, our work raises several broad issues that need
    to be resolved as Compact assistance nears its scheduled end and as the
    United States negotiates with both nations regarding possible future
    assistance.

    Compact funds spent on economic development have been largely ineffective in
    promoting economic growth. Neither the FSM nor the RMI can boast a strong
    track record in economic development, despite some improvements in social
    and living conditions. Although the countries have had sporadic success in
    using Compact funds, many development efforts have been unsuccessful because
    the funds were spent without planning or were misused, such as the bad
    investments in business ventures or the maintenance of a large public
    sector. Many projects have failed, and the money has been wasted, because
    the countries did not conduct
    cost-benefit or feasibility analyses or plan for local environmental
    conditions or maintenance needs and were not held accountable for the
    effective use of funds. The persistent problems we found in project
    planning, implementation, and monitoring demonstrate a lack of adequate
    local skills and experience in managing projects and large budgets. Both
    countries remain highly dependent on U.S. assistance and, thus, economic
    self-sufficiency at current living standards remains a distant goal for the
    FSM and the RMI.

    The Compact of Free Association with the FSM and the RMI provides
    insufficient guidance regarding how Compact funds are to be spent and
    accounted for by the FSM, the RMI, and the United States. By issuing Compact
    revenue-backed bonds, both countries took a risk in concentrating spending
    in the early years of the Compact when they had little experience in
    planning and managing economic development investments. Further, the listing
    of eligible capital account expenditures in an agreement related to the
    Compact includes a broad range of expenditures that are not traditionally
    viewed as capital investment. As a result, the determination that both
    countries spent 40 percent of certain Compact funds on capital investment as
    required by the Compact provides little assurance that infrastructure has
    actually received this level of investment. Also, expenditures were not
    subject to performance measures or evaluations. Finally, our review of
    financial statements and audits revealed that it is often not possible to
    track specific uses of Compact funds. Transfers between funds and
    commingling of Compact and local revenues seriously limit the ability to
    track Compact funds to their final usage.

    The Compact contains some accountability requirements, but they were never
    followed with any degree of rigor. Further, the financial data on Compact
    expenditures provided in the audits are not linked to the performance and
    effectiveness of Compact-funded projects. The limited U.S. oversight of
    Compact expenditures, particularly in the early years of the Compact,
    reduced a potentially effective means for the United States to influence
    Compact spending. For example, by not holding the required annual
    consultations with the FSM and the RMI during the first half of the Compact,
    the United States forfeited the chance to review how the countries used
    Compact assistance and to provide input into future spending decisions.
    Further, disagreements between the U.S. Departments of State and the
    Interior on the level of and responsibility for Compact oversight have
    contributed to minimal monitoring efforts. Moreover, the "full faith and
    credit" provision of the Compact, which guarantees most funding to the FSM
    and the RMI, has had the effect of restricting the ability of the United
    States to take actions necessary to ensure Compact funds are spent
    efficiently and effectively. Partly as a result of this provision, the
    Department of the Interior provided limited oversight.

    Our work raises several issues that need to be resolved as Compact
    assistance nears its scheduled end and as U.S., RMI, and FSM negotiators
    discuss the possibility of future assistance. First, unless U.S. policy
    objectives are reassessed and consensus is reached on the appropriate
    objective for U.S. assistance, the United States may continue to provide aid
    without adequate assurance that it will be targeted to high-priority areas
    with a potential for achieving lasting impact. Second, in conjunction with
    determining appropriate policy objectives, consideration should be given to
    the level and the duration of future assistance and mechanisms to ensure
    performance. Policy goals should be consistent with judgments about how much
    funding the United States should spend on aid to Micronesian countries
    versus other competing programs. Third, U.S. policymakers need to determine
    the appropriate composition of U.S. assistance, including support for
    general government operations, targeted assistance for priority areas and
    projects, and whether U.S. domestic programs should continue for the FSM and
    the RMI and be administered separately from the Compact. Finally,
    negotiations on future assistance provide an opportunity to assess and
    clarify or redefine the respective roles of U.S. agencies responsible for
    providing and monitoring U.S. assistance to avoid a continuation of
    oversight problems stemming from disagreements.

    As negotiations to determine the extent and nature of future assistance to
    the FSM and the RMI continue, we recommend that the Secretary of State, in
    consultation with Congress, develop guidelines regarding U.S. policy
    objectives for assistance; the level, duration, and composition of U.S.
    assistance; and the agency responsible for U.S. oversight.

    Further, we recommend that the Secretary of State direct the Special
    Negotiator for the Compact of Free Association to negotiate Compact
    provisions that provide greater control and effectiveness of expenditures
    and that include

    � requiring that funds be provided primarily through specific grants that
    facilitate the ability of the United States to (a) direct the money to
    mutually agreed-upon priority areas and projects; (b) control and monitor
    expenditures through grant requirements such as performance indicators,
    technical and financial planning, incremental funding, and evaluation; and
    (c) provide technical assistance for planning and implementing the use of
    funds;

    � more specifically defining the eligible uses of capital account funds;

    � requiring that funds, either Compact or from local revenues, be set aside
    for maintenance of capital projects; and

    � requiring that consultations that lead to a consensus take place between
    the U.S. and the FSM or RMI governments before either the FSM or the RMI
    issue any Compact revenue-backed bonds.

    To achieve greater oversight over expenditures, we recommend that the
    Secretary of State direct the Special Negotiator for the Compact of Free
    Association to negotiate Compact provisions

    � requiring, in addition to annual financial statement data, expanded annual
    reporting requirements for the FSM and the RMI, including a requirement to
    provide data and information on specific expenditures in mutually determined
    priority areas on an annual and historic basis presented in a format that is
    easily understandable to U.S. policymakers and officials responsible for
    providing and monitoring Compact assistance and

    � ensuring an expanded agenda for the annual consultations that will include
    discussions of (a) progress toward mutually agreed-upon objectives, (b)
    questioned costs and management weaknesses identified in financial and
    program audits, and (c) the role of U.S. program assistance in furthering
    development.

    Finally, to secure an improved U.S. ability to enforce compliance with
    Compact spending and oversight requirements, we recommend that the Secretary
    of State direct the Special Negotiator for the Compact of Free Association
    to exclude a "full faith and credit" provision from any future economic
    assistance agreement and to include provisions that will provide that funds
    can be withheld from the FSM or the RMI for noncompliance with spending and
    oversight requirements.

    In order to strengthen accountability and ensure the effective use of the
    remaining FSM and RMI Compact funds, we recommend that the Secretary of the
    Interior direct the Director of the Office of Insular Affairs to make
    increased use of existing Compact oversight provisions. The Secretary of the
    Interior needs to reassess the level of resources being directed to this
    area and ensure that appropriate agency resources be used to monitor Compact
    assistance. In particular, the Department of the Interior should review
    annual independent audits as well as the annual reports prepared by the FSM
    and the RMI in order to identify, for example, questioned costs, management
    weaknesses, or spending that does not support development goals. The
    Director should ensure that required annual meetings are held with both
    countries and include the participation of other U.S. agencies, as
    appropriate, in order to resolve the issues identified previously.

    Further, in the event Interior retains the responsibility for providing and
    monitoring any additional Compact assistance as a result of the current
    negotiations, in order to strengthen accountability over expenditures, we
    recommend that the Secretary of the Interior direct the Director of the
    Office of Insular Affairs to implement a system to centrally monitor program
    assistance. Further, the Secretary of the Interior should report annually to
    Congress on Compact and program expenditures and how they are specifically
    advancing economic progress in the FSM and the RMI, as well as on compliance
    with oversight responsibilities for all three countries. The Secretary of
    the Interior should also ensure that appropriate resources, including the
    number and skills of staff, are dedicated to monitoring U.S. assistance to
    both nations.

    We received comments on this report from the Departments of State and the
    Interior as well as from the governments of the Federated States of
    Micronesia and the Republic of the Marshall Islands. The Department of State
    agreed with three of our recommendations. It agreed that the Department
    should consult with Congress to determine U.S. policy objectives for future
    Compact assistance; the level, duration, and composition of U.S. assistance;
    and the agency responsible for U.S. oversight. The Department also agreed
    with our two recommendations that it negotiate Compact provisions that
    establish greater control and effectiveness of, and oversight over, future
    U.S. assistance. While the Department of State agreed with us that any
    future Compact provisions should allow for the withholding of funds, the
    Department reserved judgment on our recommendation that any future funding
    exclude a "full faith and credit" provision until the Department better
    understands the ramifications of this action on budget procedures. The
    Department of the Interior did not respond to our recommendations.

    Neither the Department of State nor the Department of the Interior disagreed
    with our conclusion that Compact expenditures have led to little economic
    development. Both departments noted that the circumstances of both countries
    merit further discussion in our report. Both departments stressed that it is
    important to acknowledge the challenges faced by Pacific island nations,
    such as geographic isolation and a lack of natural resources, in achieving
    economic advancement. We further emphasized this point in the report. State
    and Interior also stated that our report downplays successes under the
    Compact. We added information summarizing Interior and State views that
    Compact expenditures to support general government operations were necessary
    to build stable governments, and funding to develop public institutions has
    been important. State and Interior also emphasized the importance of
    investing in infrastructure, including utilities, as being necessary for
    further economic development.

    The governments of the Federated States of Micronesia and the Republic of
    Marshall Islands also expressed some of the views of the Departments of
    State and the Interior previously noted regarding development challenges,
    the limited recognition of successes under the Compact in our report, and
    the importance of infrastructure investment. They further cited their
    experience under the Trust Territory Administration, specifically the
    failure of the United States to promote economic development during this
    period, as a contributing factor to their difficulties in realizing economic
    growth under the Compact. In addition, they cited concern over our view that
    Compact expenditures have led to little economic development in either
    country and provided examples of economic advancement under the Compact. For
    example, the Republic of the Marshall Islands government noted the growth of
    private business under the Compact, while the Federated States of Micronesia
    government reported that the country had experienced respectable economic
    growth during the Compact years. We have responded to such comments by
    noting that increasing private sector activity is dependent upon government
    support and does not reflect sustainable growth, and economic performance
    has been limited. We maintain that our assessment of economic development is
    accurate. Finally, both countries raised several issues that were outside
    the scope of our review. The comments of the Department of the Interior, the
    Department of State, the government of the Republic of the Marshall Islands,
    and the government of the Federated States of Micronesia appear in full,
    along with our specific responses, in appendixes III-VI.

    Compact of Free Association Capital Expenditures, Fiscal Years 1987-98

    (Continued From Previous Page)

         Dollars in
         thousands
                           Federated States of Micronesia
          Capital         National
       expenditures     government    Chuuk   Kosrae  Pohnpei   Yap   FSM total
     Economic
     development        $37,843      $38,399  $17,205 $51,434 $10,758 $155,639
     Infrastructure
     development        6,426        40,875   21,651  36,106  27,967  133,027
     Social services
     development        2,985        14,863   3,723   6,519   2,154   30,244
     Other              3,218        14,312   2,110   2,031   3,003   24,674
     Totala             $50,472      $108,451 $44,690 $96,090 $43,882 $343,583
     Economic
     development
     Marine resources   $7,061       $17,820  $9,953  $18,317 $6,623  $59,774
     Agriculture &
     forestry           974          7,389    814     1,672   2,499   13,348
     Commerce &
     industry           84           8,159    1,980   269     1,038   11,530
     Tourism            55           379      173     512     212     1,331
     Development loans  22,506       2,303    350     1,749   200     27,108
     Other/unspecified  7,163        2,350    3,935   28,913  186     42,548
     Subtotal a         $37,843      $38,399  $17,205 $51,434 $10,758 $155,639
     Infrastructure
     development
     Energy/power       0            $6,201   $4,780  $12,090 $7,689  $30,761
     Water/sewer        $402         11,443   2,569   2,259   844     17,517
     Air/sea
     transportation     2,923        9,448    998     6,194   6,466   26,030
     Roads/bridges      127          7,199    9,258   13,167  11,819  41,571
     Communications     16           399      99      0       495     1,008
     Government
     infrastructure     2,518        6,185    494     871     133     10,202
     Other              439          0        3,452   1,525   521     5,937
     Subtotala          $6,426       $40,875  $21,651 $36,106 $27,967 $133,027
     Social services
     development
     Health             $178         $1,099   $491    $469    $229    $2,467
     Education          1,933        4,843    1,536   2,033   1,212   11,556
     Manpower training  872          46       994     1,094   235     3,241
     Social/community
     services           2            3,159    51      62      278     3,552
     Housing            0            5,716    651     2,860   200     9,427
     Other              0            0        0       0       0       0
     Subtotala          $2,985       $14,863  $3,723  $6,519  $2,154  $30,244
     Other
     Land lease &
     acquisition        0            $3,095   $1,097  $50     $1,491  $5,732
     Resource
     management         $227         429      176     500     373     1,706
     Other/unspecified  2,991        10,789   837     1,480   1,139   17,236
     Subtotala          $3,218       $14,312  $2,110  $2,031  $3,003  $24,674

    (Continued From Previous Page)

        Dollars in thousands
       Republic of the Marshall Islands
        Capital expenditures       Total
     Economic development        $32,518
     Infrastructure development  35,274
     Social services development 7,950
     Other                       64,653
     Totala                      $140,395
     Economic development
     Marine resources            $9,137
     Agriculture & forestry      862
     Commerce & industry         6,864
     Tourism                     3,257
     Development loans           0
     Other/unspecified           12,398
     Subtotala                   $32,518
     Infrastructure development
     Energy/power                $1,429
     Water/sewer                 490
     Air/sea transportation      19,667
     Roads/bridges               809
     Communications              384
     Government infrastructure   11,133
     Other                       1,362
     Subtotala                   $35,274
     Social services development
     Health                      $4,161
     Education                   3,789
     Manpower training           0
     Social/community services   0
     Housing                     0
     Other                       0
     Subtotala                   $7,950
     Other
     Land lease & acquisition    $100
     Resource management         0
     Other/unspecified           64,553
     Subtotala                   $64,653

    Note: These figures include only expenditures listed for projects or
    recipients in country financial statements. Transfers and capital
    expenditures made from bond proceeds are not included.

    aNumbers may not sum due to rounding.

    Source: GAO analysis of FSM data, compiled by the Joint Committee on Compact
    Economic Negotiations, and of RMI financial statements.

    Record of Accountability for the Federated States of Micronesia, the
    Republic of the Marshall Islands, and the United States

     Time period Submitted by the    Submitted by the   The United States
                 FSM                 RMI                concurred
     1987-91     Yes                 Yes                Yesa
     1992-96     Yes                 Yes                No
     1997-01     Yesb                No                 Yes (for the FSM)b

    a While the U.S. government officially concurred with the initial
    development plans submitted by both countries, the Department of the
    Interior was unable to provide us with analyses or reviews of the plans.

    b The Federated States of Micronesia (FSM) submitted a 3-year (1999-2001)
    planning framework document to the U.S. government. The Department of State
    Special Negotiator for the Compact of Free Association informed us on August
    22, 2000, that he has accepted this document as the country's third economic
    development plan.

    Source: GAO analysis of FSM, Republic of the Marshall Islands (RMI), and
    U.S. government documents.

                                                                      Annual
                                                                   meeting held
               Submitted by the FSM       Submitted by the RMI      between the
                                                                      United
                                                                   States and:
     Fiscal Annual   Health/education  Annual    Health/education  The   The
     year   report   report            report    report            FSM   RMI
     1987   Yes      No                No        No                No    No
     1988   Yes      No                No        No                No    No
     1989   Yes      No                Yes       No                No    No
     1990   Yes      No                No        No                No    No
     1991   Yes      No                Yes       No                No    No
     1992   Yes      No                Yes       No                No    No
     1993   Yes      No                No        No                No    No
     1994   Yes      No                Yes       No                Yes   Yes
     1995   Yes      No                Yes       No                Yes   Yes
     1996   Yes      Yes               No        Yes               No    No

     1997   Yes      Yes               Yes       Yes               Yes   Yes
                                       (draft)
     1998   Yes      Yes               No        No                Yes   Yes

     1999   No       Yes               Yes       No                Yes   No
                                       (draft)

    Source: GAO analysis of FSM and RMI government documents and U.S. government
    documents, and discussions with U.S. government officials.

    Comments From the Department of the Interior

    The following are GAO's comments on the Department of the Interior's letter
    dated September 5, 2000.

    1. We have added a paragraph to the report on pp. 40-41 quoting the
    Departments of the Interior and State regarding the importance of Compact
    funding in building independent nations through supporting government
    operations and developing public institutions.

    2. Our report does not establish expectations regarding the level of
    economic development and self-sufficiency that should have been reached by
    the FSM and the RMI during the term of Compact assistance. In chapter 4 of
    our report, on p. 50, we have added information reiterating some of the
    challenges, such as geographic isolation and limited natural resources,
    faced by these two Pacific island nations in realizing economic growth. We
    report on the economic performance of the two countries over the term of
    Compact assistance. Both countries remain highly dependent on U.S.
    assistance to maintain current standards of living that are higher than
    could be sustained without U.S. funding. In our report conclusions, we note
    that U.S. policy objectives regarding the two countries should be
    reassessed.

    3. We have added a footnote at the beginning of chapter 3 of our report
    (p. 34) reflecting the views of the Department of the Interior regarding
    standards of living in the two countries.

    4. A reduction in reliance on U.S. funding does not necessarily signal an
    increasingly productive economy. For example, in the FSM, the reduction in
    reliance on U.S. funding reflects changes in accounting of revenues and
    increased local revenues in the form of fishing license fees and import
    taxes. Regarding investments in infrastructure, our report notes the
    importance of such investment in improving the quality of life and creating
    an environment attractive to private business.

    5. We have added text on p. 83 of the report noting that Interior expressed
    concerns to negotiators over the inability to withhold Compact funds prior
    to implementation of the Compact.

    6. We have no audit responsibilities set forth in the Compact or its
    implementing legislation. However, We are granted authority to conduct
    audits regarding Compact assistance in the FSM and the RMI. As noted in our
    report, required annual audits have been conducted each year in the FSM and
    the RMI by a private accounting firm. The Department of the Interior pays
    for these audits.

    Comments From the Department of State

    The following are GAO's comments on the Department of State's letter dated
    August 18, 2000.

    1. In chapter 4 of our report, on p. 50, we have added information
    reiterating some of the challenges, such as geographic isolation and limited
    natural resources, faced by these two Pacific island nations in realizing
    economic growth.

    2. We do not state or imply in our report that the living standards in the
    FSM and the RMI are "high." Rather, we note that living standards in both
    countries are artificially higher than could be achieved in the absence of
    Compact funding.

    3. We have added a paragraph in chapter 4 on pp. 40-41 quoting the
    Departments of State and the Interior regarding the importance of Compact
    funding in building independent nations through supporting government
    operations and developing public institutions. Our report notes improvements
    in energy, communications, transportation, and education and acknowledges
    that investments in infrastructure have led to improved quality of life and
    are necessary to create an environment attractive to private business.

    Comments From the Republic of the Marshall Islands

    The following are GAO's comments on the letter from the government of the
    Republic of the Marshall Islands dated August 30, 2000.

    1. Compact assistance to the RMI and the FSM is not provided through the
    budgets of the Department of State or the Agency for International
    Development. Compact assistance is provided through the Department of the
    Interior--the agency that has been responsible for providing funding to the
    region since before the RMI and the FSM became sovereign nations. Our past
    analysis of the U.S. government budget has found numerous examples of
    foreign affairs spending not contained in the budgets of the Department of
    State or the Agency for International Development. Our May 2000 report
    included funding associated with U.S. nuclear testing in the region. We
    agree that such funding does not constitute foreign assistance. This report,
    however, emphasizes direct Compact payments intended to further economic
    advancement. Such assistance to sovereign nations would commonly be viewed
    as foreign assistance. We note in our report in footnote 8 of chapter 1, the
    RMI's objection to the use of this term, but we maintain that it is an
    accurate characterization of U.S. Compact assistance to the RMI and the FSM.

    2. Our review concerns the Compact as agreed to between the three sovereign
    nations and does not consider any hypothetical alternative arrangements. At
    the request of Congress, we have recently initiated a review of U.S.
    programs extended to the FSM and the RMI. Programs that are extended include
    weather service, childhood programs, grants for college students, and health
    grants.

    3. The dependence of the private sector on Compact expenditures demonstrates
    the lack of a viable economy. Irrespective of the growth in the number of
    businesses operating, the Asian Development Bank has reported that the
    overwhelming reliance on U.S. assistance has damaged the RMI's ability to
    develop income-generating activities.53 The existing economy could not be
    sustained in the absence of further Compact assistance.

    4. We have added text on p. 41 of our report noting recognition by the U.S.
    embassy in the RMI that reforms, including government personnel reduction,
    appear to be back on track under the new administration that took office in
    January 2000.

    5. We have modified our language in this section of the report to state that
    targeted Compact funds spent on physical and social infrastructure have not
    contributed to significant economic growth. We state that RMI investment in
    infrastructure has not led to "significant" economic growth, rather than our
    prior statement that investment in infrastructure did not directly
    contribute to economic growth.

    6. We have deleted our statement that the dry dock is inoperable based on
    the comments of the RMI government as well as a statement from a private
    businessman in the RMI. We are uncertain as to the dry dock's actual status,
    as a senior RMI government official continues to maintain that the dry dock
    is inoperable.

    7. We did not conduct a comprehensive assessment of government subsidies to
    public enterprises. In 1998, financial statements were not available for
    various public enterprises such as the Marshall Islands Drydock Inc., and
    the Marshall Islands Port Authority. Such information is necessary in order
    to calculate total RMI subsidization to public enterprises. We do note,
    however, that because of scheduled step-downs in Compact funding and
    required payments of bond debt, the RMI government lacks sufficient Compact
    funds to subsidize public enterprises at past levels.

    8. The RMI government was given 45 days to review and comment on our draft
    report, per the terms of a Compact-related agreement.

    Comments From the Federated States of Micronesia

    The following are GAO's comments on the letter from the government of the
    Federated States of Micronesia dated September 1, 2000.

    1. Our report states that U.S. interests have been met in two key areas:
    (1) securing self-government for the FSM and the RMI and (2) assuring
    certain national security rights. However, with respect to the Compact goal
    of advancing economic growth in both countries, we have concluded that
    Compact funds have been spent in a manner that has not furthered such
    progress. Many FSM officials agreed with this conclusion. Further, a Bank of
    Hawaii assessment found that there has "been very little change in the FSM's
    basic economic structure since the Compact went into effect."54 As a result,
    we are recommending that if future Compact assistance is provided, it should
    in fact be more tightly controlled, with a greater emphasis placed on
    accountability. Of note, two FSM state governors and a former FSM president
    told us that future U.S. assistance should be more tightly controlled.

    2. For the sake of consistency and fairness, we evaluated both countries
    using criteria, such as progress toward economic self-sufficiency, listed in
    the Compact. As a result, our discussions of the FSM and the RMI are often
    integrated. However, we clearly distinguish between the two countries in our
    discussion of specific expenditure and project data.

    3. Our review assessed actual progress made by both countries in furthering
    economic self-sufficiency and development as a result of Compact
    expenditures. Our review did not establish or imply levels of economic
    growth that should have been achieved, nor did it suggest the degree to
    which economic self-sufficiency was attainable within the
    15-year term of Compact assistance.

    4. As cited in our report, we conducted a review in 1983 regarding
    Micronesian self-sufficiency.55 This review found that both countries lacked
    sufficient managerial and technical expertise and management systems to
    overcome significant obstacles to growth. This finding may in part explain
    the performance of both nations under the current Compact. The impact of
    U.S. Trust Territory Administration on both countries, whether negative or
    positive, was not part of our current review.

    5. Our analysis began with the first year of the Compact, fiscal year
    1987--a logical point to begin assessing economic progress under the
    Compact. This approach is consistent with that used by the FSM government in
    its response to our report.

    6. In order to identify the principal economic goals of Compact assistance,
    we relied upon the Compact itself. These goals of promoting economic
    advancement and self-sufficiency in the region, as stated in the Compact,
    were reiterated by officials from the Departments of the Interior and State.
    The objectives of maintaining social peace and political stability are not
    contained in the Compact.

    7. In chapter 4 of our report, on p. 50, we have added information
    reiterating some of the challenges, such as geographic isolation and limited
    natural resources, faced by these two Pacific island nations in realizing
    economic growth. Our review focused on identifying the current state of
    economic self-sufficiency and development resulting from Compact
    expenditures and was not intended to encompass a comprehensive comparative
    analysis regarding Pacific islands or other nations. Such analyses are
    available from the Asian Development Bank.

    8. We report on the growth of the FSM economy between 1987 and 1997/98, from
    a gross domestic product (GDP) of $130.3 million to
    $213 million. However, as the FSM government noted on page 7 of its
    comments, economic growth has barely been sufficient to overcome the effects
    of population growth and decreased U.S. assistance. Real per capita GDP
    reached a peak in 1993 of $2,261 and has since fallen to $1,927 in 1999.

    9. While the private sector and private sector employment have grown overall
    during the entire Compact period, this growth was realized only during the
    early years of the Compact. According to the March 2000 FSM Planning
    Framework document (hereafter referred to as the "Framework" in our
    comments),56 real private sector GDP has fallen since 1993, and private
    sector employment has decreased from its 1994 peak.

    10. The question regarding the length of time required to achieve economic
    self-sufficiency was outside the scope of our review.

    11. While our report does not address the issue of the amount of time needed
    for the FSM to achieve economic self-sufficiency, we note that the FSM
    government has not provided an analysis that its current level of government
    services is appropriate or sustainable. An Asian Development Bank assessment
    found that the FSM's public service is both large and unproductive and has
    in part played a welfare function. As a result, this hypothetical projection
    aimed at maintaining government services on a constant per capita basis may
    not be appropriate.

    12. The FSM has cut public sector employment and wage levels in recent
    years. However, inconsistent data make a precise analysis of public and
    private sector wages difficult. For example, the FSM Framework document
    notes that public sector wages are 82 percent higher than private sector
    wages (1996-97). FSM Social Security Administration data, as reported in a
    Bank of Hawaii report,57 show that public sector wages are 147 percent
    higher than private sector wages (1996-97). Similar average data
    inconsistencies also exist regarding the size of public employment. The FSM
    Framework reports 5,862 public sector employees in 1997, while the FSM
    Social Security Administration data show 9,917.

    13. While the FSM has substantially improved its self-sufficiency, with
    dependence on U.S. funding as a percentage of total FSM government revenue
    falling from 83 percent to 54 percent, this situation cannot all be
    attributed to economic growth resulting from the use of Compact funds.
    Social Security Administration revenues were not included in the FSM
    government financial statements until 1991. As a result, since 1991, local
    revenue shows growth due to this change in how government revenues are
    reported. In addition, in 1998 fishing license fees constituted the largest
    single source of local revenue in the FSM (except for Social Security
    revenues). While such fees represent an important means for raising local
    revenue, they do not represent local productivity. Finally, reductions in
    Compact assistance have by definition increased FSM self-sufficiency.

    14. According to the FSM Framework document, "The extensive and expensive
    traveling done by public servants must be reigned-in [sic]…" Further,
    a former President of the FSM told us that travel was not undertaken on the
    basis of government need.

    15. We have added text to our report on pp. 10, 34, and 50 that notes that
    standards of living are higher than could be achieved in the absence of
    Compact funding. The Asian Development Bank report referred to in this
    comment was not the basis for our conclusion that Compact funding has
    maintained artificially higher standards of living in the FSM and the RMI.
    Rather, this conclusion was drawn independently following our assessment of
    the continued dependency of both countries on U.S. assistance. In our view,
    it is clear that current living standards are far higher than can be
    sustained through local resources, given that both countries rely on the
    United States for at least half of total government revenues.

    16. We agree with the comment that the decline in dependency in the FSM on
    U.S. funding equates to substantial progress toward enhanced
    self-reliance--as long as U.S. assistance is not being replaced with other
    external donor assistance.

    17. Officials in all four FSM states told us that fisheries ventures had
    failed due to inexperience and poor judgment. For example, we were told by a
    government official in Pohnpei that FSM officials were novices in their
    knowledge of fisheries, and a Kosraean official told us that fishing
    ventures failed due to a lack of knowledge and foreign partners who took
    advantage of FSM investments.

    18. We agree with this comment. One of our recommendations is to expand
    annual reporting requirements.

    19. In addition to financial management weaknesses identified by Deloitte
    Touche Tohmatsu, the Public Auditor for the FSM has found numerous instances
    of inadequate financial and program controls. Based on these two sources, we
    believe that there has been a general lack of control over the use of funds.

    20. In providing comments on a GAO report published in May 2000 identifying
    the amount of assistance provided to the FSM and the RMI from various U.S.
    agencies,58 the FSM government did not dispute the FSM population figure of
    131,500. Therefore, we were comfortable using this estimate in our draft
    report. However, we have changed the report to reflect the lower population
    estimate. This change does not affect our message in any way.

    21. We have recomputed the U.S. assistance per capita figure based on a
    revised population estimate for 1998 of 111,536. This figure is now
    $895. We added footnote 4 in chapter 3 to our report that identifies our
    data sources for our discussion of U.S. assistance per capita and FSM gross
    domestic product.

    22. A review of the success of the public sector reforms currently underway
    was outside the scope of our work. Our report does note that the FSM is a
    member of international organizations such as the United Nations and that
    infrastructure in the areas of electricity and communications has improved.
    In addition, we added a paragraph to the report quoting the Departments of
    the Interior and State regarding the importance of Compact funding in
    building independent nations through supporting government operations and
    developing public institutions.

    23. In the FSM Framework document, "large public sector employment
    opportunities and higher relative wages" are listed as one of the "specific
    factors limiting private sector growth." This characterization is in line
    with the statement in our report that "[S]ubstantial Compact funds were used
    to support general government operations that have, among other things,
    maintained high levels of public sector employment and wages and have acted
    as a disincentive to private sector growth."

    24. The "unattributed quote from someone saying that in the FSM the reform
    program `seems to have lost its way'" is from an Asian Development Bank
    evaluation of its reform programs in the region,59 and is properly footnoted
    in the paragraph.

    25. Our report now states that investment in infrastructure, which has
    improved the quality of life in the FSM and the RMI and is necessary to
    create an environment attractive to private business, has not contributed to
    "significant" economic growth to date, rather than our prior statement that
    investment in infrastructure did not directly contribute to economic growth.
    For example, the FSM government points out in its comments that growth in
    the tourism industry during the last 13 years would not have been possible
    without improvements in infrastructure. While we agree that improved
    infrastructure may have benefited the tourism industry, we dispute that this
    improvement represents significant economic growth. Over the past 13 years,
    tourism has grown to represent only 2 percent of the FSM economy. The FSM
    Framework document notes that the annual number of visitors to the FSM has
    decreased during the 1990s and points out that "…average hotel
    occupancy rates in FSM are low--less than 30 percent in 1996…"

    26. As the FSM states that it needs additional funding for infrastructure,
    we note that the current level of existing infrastructure in the FSM is not
    sustainable without additional external donor assistance. For example, an
    official from the Pohnpei Utilities Corporation told us that 80 percent of
    the utility's revenues come directly from the government or government
    employees, and thus the Pohnpei Utilities Corporation is very dependent upon
    Compact funding. Further, an official from the FSM telecommunications
    company told us that without Compact payments, consumer demand would
    collapse and the company could not repay its outstanding loans to the U.S.
    government.

    27. As noted previously, we have changed the FSM population estimate for
    1999 from 131,500 to 116,268 to reflect the estimate provided to us by the
    FSM government in its comments. This does not, however, change our reported
    estimate of per capita income growth in the FSM. According to the FSM
    Framework document, real GDP per capita in fiscal year 1987 was $1,881. In
    fiscal year 1999 it had grown to
    $1,927. This represents a growth in real GDP per capita of 2.4 percent over
    a 12-year period. All figures reflect 1998 U.S. dollars.

    28. We agree that there are numerous businesses in operation in the FSM.
    However, according to a Bank of Hawaii report,60 "U.S. funds are the only
    primary income source" in the FSM economy. The report further states that
    "[T]hese funds are used mainly to pay government wages, salaries and
    benefits, and a portion goes towards adding to public
    infrastructure…" The report concludes that "[T]hus, the economy's
    engine is the public sector which, in turn, supports a private sector that
    is made up largely of services and distribution activities. There is very
    little indigenous commercial production economy other than subsistence
    production that has stagnated in the last 10 years."

    29. Improvements in economic management and a shift in policy direction that
    emphasizes private sector growth with the government's role being to improve
    the business environment and provide necessary infrastructure and social
    services are in an early stage. According to the FSM Framework document in
    its discussion of future actions for accelerating private sector
    development, "The initiatives embarked upon within the FSM to restrain
    government employment and wages, improve training, reform public
    enterprises, encourage foreign investment, liberalize banking regulations,
    improve leaseholds, and improve business support indicate that progress is
    being made. But there is still a long way to go to have these initiatives
    fully developed, refined, publicly understood and accepted, passed into law,
    and implemented effectively." The government faces significant challenges in
    implementing reforms that will foster private sector development. For
    example, regarding reforming public enterprises, the Framework points out
    that "[N]o complete inventory of public enterprises is currently available."

    30. We changed the title of this section to reflect the FSM government's
    comment.

    31. During our visit to the FSM, no government fish storage and processing
    facilities were in operation in any of the four states. For example, in
    Pohnpei, officials from the Pohnpei Fisheries Corporation told us that the
    plant had completely shut down as of October 1999, and the refrigeration
    system was inoperable, awaiting parts, at the time of our visit. In Kosrae,
    we were told that the cold storage facility had been closed since January
    2000. In addition, officials in Yap and Chuuk told us that the facilities in
    those states had never been profitable or had not been profitable for years.

    32. We have modified our discussion of the pepper industry to reflect FSM
    government comments. We have also eliminated our statement that there is no
    longer a pepper industry in the FSM. It is our understanding, based on a
    discussion with an official from the Pohnpei Office of Agriculture and
    Forestry, that there is currently one Japanese pepper farmer in Pohnpei with
    10 acres. According to data published in the 1999 FSM Statistical Yearbook
    (the most recent data available), black pepper exports in 1996 and 1997 were
    $0. The Yearbook also shows no purchases of black pepper in major local
    markets in 1998.

    33. In data provided to us by the FSM government detailing Compact capital
    fund expenditures, we were unable to find any Compact funds that went to the
    garment factory in Yap. Regarding the Pohnpei garment factory, we were told
    by the Governor of Pohnpei that the facility received a development bank
    loan (U.S. funds) and had employed foreign workers, but did not receive any
    direct government assistance. The development loan to the company was almost
    $1.8 million. A Department of State official informed us that the facility
    is now closed. The Kosrae slipway is operating but does so at a loss.
    Kosrae's investment in the ship repair facility is almost $1.5 million.

    34. In choosing capital projects for our review, we used the following
    criteria: (1) the largest areas of investment by the governments,
    (2) project expenditures covering a wide range of sectors, and
    (3) project expenditures made at different points in the Compact. Regarding
    the projects listed in the FSM government comment letter as examples of
    well-planned and implemented Compact-funded projects, we questioned FSM
    officials as to the data sources for these projects and were told that this
    information is incorrect. The FSM Capitol and the College of Micronesia were
    not funded using Compact funds but were instead built using funds provided
    outside of the Compact.

    35. At every government location (national and state), we requested access
    to complete project documentation for all projects we reviewed and mentioned
    specifically that we were interested in reviewing documents such as
    feasibility studies, competitive bids, and inspection reports. We believe
    that the burden was on government officials to provide us with access to all
    relevant documentation. Officials from the state of Kosrae mailed us
    documentation after we had returned to the United States.

    36. The Governor of Kosrae told us that the chip-seal roads in the state
    were an example of a project that was not properly designed or built.
    Further, an official from the Kosrae Department of Public Works informed us
    that the chip-seal roads lasted only 4 years but with patches were usable
    for 10 years. He also noted that chip-seal paving is a high-maintenance type
    of pavement and Kosrae did not budget for maintenance.

    37. We reviewed the road and dock project because it was identified by Chuuk
    State officials as an example of a questionable use of Compact funds that
    would not upgrade basic social and economic infrastructure. After visiting
    the site, we concluded that the Mayor would be the chief beneficiary of the
    dock and road since there were few other houses between the Mayor's house
    and the seaside village at the end of the road.

    38. The U.S. embassy in the FSM, the FSM Public Auditor, and we all
    independently concluded that the "boats for votes" had no demonstrable
    economic impact or accountability. The U.S. embassy, in numerous cables,
    reported that the boats were given away to support reelection efforts. The
    FSM Public Auditor concluded that the boats were given away with no
    requirement or evidence that they were used for economic advancement. When
    we spoke with the recipients of these boats, they told us that the mayor
    simply gave them the boats. There is no requirement that they demonstrate
    how the boats would be used for economic advancement and no reporting
    requirements.

    39. Our report notes that the FSM, the RMI, and the U.S. governments all had
    a role to play in ensuring that 5-year economic development plans were
    sufficient. We noted that while the plans had deficiencies, it was the
    responsibility of the U.S. government to discuss and correct these
    deficiencies with the FSM and the RMI. The U.S. Department of State's
    Special Negotiator for the Compact of Free Association informed us that the
    FSM Planning Framework for 1999-2001 has been accepted by the U.S.
    government as the FSM's third economic development plan, thus allowing the
    FSM to meet its Compact obligations in this area.

    GAO Contact and Staff Acknowledgments

    Emil Friberg, Jr., (202) 512-8990

    In addition to the person named above, Leslie Holen, Dennis Richards, and
    Edward George, Jr. made key contributions to this report.

    (711470)

    Table 1: Compact Section 211(a) Annual and Total Funding
    Levels for the Federated States of Micronesia and the
    Republic of the Marshall Islands, Fiscal Years 1987-2001 19

    Table 2: Compact Revenue-backed Bonds Issued by the
    Federated States of Micronesia and the Republic of the
    Marshall Islands, Fiscal Years 1987-98 31

    Table 3: Five-Year Economic Development Plans 95

    Table 4: Annual Reports and Meetings 95

    Figure 1: Location and Map of the Federated States of
    Micronesia and the Republic of the Marshall Islands 15

    Figure 2: FSM and RMI Compact Expenditures by Fund Type as a Percentage of
    Total Compact Expenditures, Fiscal
    Years 1987-98 27

    Figure 3: FSM and RMI Compact Capital Account Expenditures,
    Fiscal Years 1987-98 29

    Figure 4: RMI Debt Service as a Percentage of Annual Compact Expenditures,
    Fiscal Years 1987-98 33

    Figure 5: FSM Dependence on U.S. Assistance, Fiscal Years 1987-98 35

    Figure 6: RMI Dependence on U.S. Assistance, Fiscal Years 1987-98 37

    Figure 7: Compact Investment in Communications 43

    Figure 8: Compact Investment in Energy 44

    Figure 9: Electric Power and Tuna Processing Plant, Majuro, RMI 45

    Figure 10: Investment in Interisland Cargo Transportation, FSM 46

    Figure 11: Investment in Air Transportation, RMI 47

    Figure 12: FSM Investment in College Facilities 48

    Figure 13: FSM Fish Processing and Cold Storage Facilities 53

    Figure 14: Pohnpei Pepper Industry Development, FSM 54

    Figure 15: RMI Investment in Garment Factory 55

    Figure 16: Causeway From Ebeye to Gugeegue, Kwajalein Atoll,
    RMI 58

    Figure 17: Ponape Coconut Products, Inc., FSM 59

    Figure 18: Kosrae Road Pavement, FSM 61

    Figure 19: RMI National Capitol Building, Majuro 63

    Figure 20: Ohmine Elementary School, Pohnpei, FSM 64

    Figure 21: Pohnpei State Hospital, FSM 66

    Figure 22: Old and New Ebeye Hospitals Suffer From Corrosion,
    RMI 68

    Figure 23: Udot Dock Project and Junior High School, Chuuk, FSM 70

    Figure 24: Fanapanges Ice Plant: Planned and Actual Locations,
    Chuuk, FSM 72

    Figure 25: "Boats for Votes," Chuuk, FSM 73

    1. The negotiating delegation for the U.S. government is led by the Special
    Negotiator for the Compact of Free Association, a Department of State
    official.

    2. See Foreign Relations: Better Accountability Needed Over U.S. Assistance
    to Micronesia and the Marshall Islands (GAO/RCED-00-67 , May 31, 2000).

    3. For GAO's assessment of economic self-sufficiency, GAO used total U.S.
    funds, which consist of all direct payments under the Compact as well as
    U.S. program assistance.

    4. The FSM 1999 population estimate is based on the figure provided to GAO
    in the FSM government's comments on our draft report. The RMI figure is from
    the 1999 RMI population census. These figures differ from those used in
    Foreign Relations: Better Accountability Needed Over U.S. Assistance to
    Micronesia and the Marshall Islands (GAO/RCED-00-67, May 31, 2000).

    5. For a history of U.S. assistance, see David Hanlon, Remaking Micronesia:
    Discourses Over Development in a Pacific Territory, 1944-1982 (Honolulu,
    Hawaii: University of Hawaii Press, 1998).

    6. See The Challenge of Enhancing Micronesian Self-Sufficiency (GAO/ID-83-1,
    Jan. 25, 1983).

    7. Francis X. Hezel, S. J., "A Brief Economic History of Micronesia," in
    Past Achievements and Future Possibilities: A Conference on Economic
    Development in Micronesia (Conference held in Kolonia, Ponape, May 22-25,
    1984; published by The Micronesian Seminar, Majuro, RMI, July 1984).

    8. The Compact makes available the services and related programs of the U.S.
    Weather Service, the U.S. Federal Emergency Management Agency, the U.S.
    Federal Aviation Administration, the U.S. Civil Aeronautics Board or its
    successor agencies, and provided pursuant to the 1970 Postal Reorganization
    Act.

    9. Such services and programs include Head Start, Pell Grants, and
    immunization grants.

    10. See Foreign Relations: Better Accountability Needed Over U.S. Assistance
    to Micronesia and the Marshall Islands.

    11. In the title of this report, we refer to Compact economic assistance as
    "foreign assistance" in recognition that the FSM and the RMI are foreign
    nations. Compact funds do not, however, come from the foreign operations
    appropriations act, which includes the budgets of the Department of State
    and the Agency for International Development. Instead, Compact funds are
    provided as a domestic spending program administered by the Department of
    the Interior. The RMI believes that designating Compact funds as "foreign
    assistance" is both confusing and misleading.

    12. Single Audit Act of 1984, P.L. 98-502, and the Single Audit Act
    Amendments of 1996,
    P.L. 104-156. The single audit is meant to advise officials whether
    financial statements are fairly presented and to provide reasonable
    assurance that federal financial assistance programs are managed in
    accordance with applicable laws and regulations. The audit must be conducted
    by an independent auditor on an annual basis, except under specific
    circumstances. Single audit reports contain meaningful information on
    entities' financial status and management of federal funds and can indicate
    where entities have additional problems that need further audit or
    investigation.

    13. Funding for 2002-03 is at a higher level than what the countries
    currently receive, per the terms of the Compact. For example, the Department
    of the Interior estimates that for fiscal years 2002-03, the FSM would
    receive $50.3 million annually and the RMI would receive $22.4 million
    annually under section 211(a). This base section 211(a) funding, as well as
    other Compact assistance, would be further increased to account for
    inflation.

    14. To the extent that assistance from other nations can be used as a
    substitute for U.S. assistance, dependence on all external donor assistance
    (which we did not measure) in the FSM and the RMI is unchanged. We were
    unable to address the size or importance of assistance from other nations as
    this information is not fully identified in the financial statements of
    either country.

    15. When Compact expenditures are converted to constant 1999 fiscal year
    dollars (using the U.S. gross domestic product [GDP] deflator), the FSM
    spent about $1.2 billion, while the RMI spent about $585 million. This
    report uses current dollars throughout.

    16. Figure 2 shows how all funds--general fund, special revenue fund,
    capital fund, and expendable trust fund--were used. The graphic does not
    address the 40-percent capital spending requirement, which is computed based
    on the allocation of section 211(a) funding between the capital and general
    funds.

    17. The Attorney General of Kosrae provided a legal opinion to the Governor
    of Kosrae stating that sending athletes to the games served to promote
    tourism, a permitted use of Compact capital funds for an economic
    development project. The FSM Department of Justice concluded it was a
    qualified manpower training and development project.

    18. We were able to identify specific capital fund expenditures for 6 years
    (fiscal years 1987-91, 1993) in Kwajalein Atoll Development Authority
    financial statements that totaled over
    $34 million. In those years, projects that received large amounts of
    Kwajalein Atoll Development Authority capital funds included the Kwajalein
    (Ebeye) power plant and generators (over $5 million), dock construction
    (over $9 million), and road paving (over
    $2 million).

    19. According to data provided by the Department of the Interior, in fiscal
    year 1998 the United States provided the RMI with $19.1 million in Compact
    section 211(a) payments, an inflation adjustment payment of $11.3 million,
    and other non-nuclear compensation payments of
    $8.9 million.

    20. The legislation enacting the Compact recognizes that there is a lease
    agreement between the government of the RMI and Kwajalein landowners. The
    United States provides funding to the RMI, which is then used to compensate
    landowners, per the lease agreement, for the land used by the U.S. military
    on Kwajalein Atoll. These payments go to approximately
    80 RMI landowners. According to an official at the U.S. embassy in the RMI,
    use of these funds, which are distributed based on acreage owned by each
    landowner, is at the discretion of each landowner. The official reported
    that four landowners receive one-third of the annual payment based on
    acreage owned, with one landowner receiving half of this amount.

    21. The Kwajalein Atoll Development Authority issued bonds on its own. In a
    1989 discussion of gaining access early to Compact funds, the Authority's
    Board of Directors was briefed by the Kwajalein Atoll Development
    Authority's former Comptroller that for every $1 million borrowed via a bond
    issue, the Kwajalein Atoll Development Authority would be forfeiting $1
    million in future projects. Ultimately, the Kwajalein Atoll Development
    Authority issued Compact revenue-backed bonds of $22 million in 1991.

    22. According to a Department of the Interior official, these higher
    standards of living were created by policies of the United States Trust
    Territory. The official went on to note that the idea of establishing
    stable, newly independent nations concurrently with a gross decline in "high
    standards of living" is politically inconceivable.

    23. Total U.S. program assistance outside of the Compact for fiscal years
    1987-98 for both countries was $368 million. This was about 19 percent of
    total U.S. funding provided to both nations, with the remaining 81 percent
    of U.S. funding provided as direct Compact payments.

    24. These data understate the value of U.S. government contributions to the
    governments of the Compact nations. U.S. government services provided
    in-kind, such as weather service, disaster relief, development loans, and
    national defense, do not appear as revenue in the FSM and the RMI government
    financial accounts.

    25. U.S. assistance per capita was calculated using a FSM Statistical
    Yearbook population estimate for 1998 of 111,536. We used an International
    Monetary Fund estimate of FSM gross domestic product of $213 million for
    fiscal year 1998. The FSM reports that its gross domestic product in 1998
    was $227 million.

    26. In both countries, changes in how Social Security revenues are
    incorporated into the government's budget have affected reported government
    revenue. In the FSM, Social Security Administration revenues have been
    included in the FSM financial statements since 1991. In that year, these
    revenues were almost $5 million. In the RMI, Social Security System revenues
    have been excluded from the RMI financial statements since 1996. RMI Social
    Security System revenues in 1995, the last year they were reported, were
    more than
    $13 million, or 13 percent of total revenue in that year.

    27. See Marshall Islands: 1996 Economic Report (Manila, Philippines: Asian
    Development Bank, June 1997).

    28. According to an official at the U.S. embassy in the RMI, other factors
    are more important than public sector wages in restricting private sector
    growth. These include a remote location, a lack of land registration and
    liens, limited comparative advantages, and small economies of scale.

    29. Federated States of Micronesia, The FSM Planning Framework, 1999-2001
    (Pohnpei, FSM: March 17, 2000) (draft).

    30. Bruce Knapman and Cedric Saldanha, Reforms in the Pacific: An Assessment
    of the Asian Development Bank's Assistance for Reform Programs in the
    Pacific (Manila, Philippines: Asian Development Bank, 1999).

    31. The $114 million figure represents FSM and RMI expenditures of general
    health and education funding provided under section 221(b) of the Compact.
    Through additional Compact provisions, sections 216(a)(2) and 216(a)(3), the
    countries spent an additional $56.6 million for purposes such as medical
    referrals and scholarships.

    32. The figures stated for Compact expenditures in energy and communications
    include funds used from the capital account and funds earmarked for use in
    these areas in the Compact. Additional expenditures were possibly made in
    these areas out of the FSM and RMI general funds, which include some Compact
    assistance. We cannot specifically identify the amount of Compact
    expenditures from this fund in any area because Compact funding is
    commingled with local revenues in the FSM and RMI general funds.

    33. The tuna processing venture also was granted certain tax breaks for 10
    years and the right to pay less than the RMI minimum wage. In addition, the
    RMI government deposited
    $2 million in a private bank as a guarantee for a bank loan for the company.

    34. The 1999 RMI statistic is from the 1999 Census of Population and Housing
    for the Republic of the Marshall Islands. This census reflects a
    considerable revision from the population estimates that were most recently
    available. For example, the Central Intelligence Agency's World Factbook
    1999 reported a 1999 RMI population of 65,507. According to the RMI Director
    of Planning and Statistics, the lower population found in the census
    reflects migration to the United States since 1996, when job opportunities
    in the RMI's private and public sector declined.

    35. This estimate is reported in Knapman and Saldanha, Reforms in the
    Pacific. If the revised population data for 1999 are used and the inflation
    adjusted per capita income is recomputed, we estimate that the decrease in
    per capita income has been 27-29 percent since 1990.

    36. A Different Kind of Voyage: Development and Dependence in the Pacific
    Islands (Manila, Philippines: Asian Development Bank, Feb. 1998).

    37. This finding was reported in a U.S. Department of the Interior, Office
    of Inspector General, Audit Report: Marshall Islands Development Bank,
    Republic of the Marshall Islands (Report No. 99-I-952; Sept. 1999) and was
    confirmed during our interview with a bank official.

    38. On June 26, 2000, the RMI, along with 34 other offshore financial
    centers, was listed by the Organization for Economic Cooperation and
    Development (an organization with 29 member countries that conducts analyses
    of economic and social policy issues), as a "harmful" tax haven. RMI
    officials told us that they have initiated steps to meet the organization's
    objections.

    39. The RMI has undertaken other efforts to leverage its sovereignty to
    raise revenue. For example, the RMI has had coin and stamp sales programs.
    Further, over a recent 5-year period, the government reported passport sales
    revenue of about $10 million.

    40. While we were able to identify $60 million in FSM expenditures in
    fisheries from the FSM national and state financial statements, officials in
    that country told us on more than one occasion that losses were more than
    $100 million.

    41. Analysis of the National Fisheries Corporation and its Subsidiaries
    (W.H.G. Burslem, May 1999) (draft). The study explains that the National
    Fisheries Corporation, an entity created to promote the development of the
    fisheries industry in the FSM, is a public corporation with five current
    subsidiaries incorporated under normal FSM company law: Yap Fresh Tuna,
    Chuuk Fresh Tuna, Kosrae Sea Ventures, the Micronesia Longline Fishing
    Company in Pohnpei, and the Yap Fishing Corporation (which is in
    receivership). The National Fisheries Corporation no longer has an interest
    in Pohnpei state's Caroline Fisheries Corporation. All ventures are involved
    in longline tuna fishing for the fresh tuna markets.

    42. Concerns over project control documents were raised by the FSM Office of
    the Public Auditor in its Report on the Audit of Compact CIP [Capital
    Improvement Project] Funds, Fiscal Years 1992-1996. This report noted that
    project control documents were " … too brief to be relied upon to
    make informed decisions. In essence, the documents state that the project
    objective is to receive funds, while the expected benefit is to spend
    funds."

    43. We requested and examined files for the period from 1987 to the present.
    In some cases, files were incomplete or had not been retained. In the RMI,
    the General Manager for the Marshall Islands Development Authority said that
    some files had been lost between office moves. At the Kwajalein Atoll
    Development Authority, we were told that its policy was to retain files for
    a 3-year period.

    44. In the RMI, a similar investment mistake took place. According to
    officials of the Kwajalein Atoll Development Authority, they had undertaken
    an Asian Development Bank fisheries project and bought boats that were too
    small.

    45. We also observed problems with roof leaks in the FSM. We observed
    similar roof leaks in a Kosrae courthouse, completed in 1998, using $560,000
    in Compact funding. In both courtrooms, leaks were apparent along the wall
    that contained a roofing connection.

    46. We were unable to determine the portion of this $1.5 million that was
    comprised of Compact funding.

    47. The annual reports are to be submitted by the first day of the third
    quarter of each fiscal year or as soon as practicable thereafter.

    48. Typically, a qualified opinion results when an auditor identifies one or
    more significant matters that prevent the auditor from issuing an
    unqualified ("clean") opinion on an entity's financial statements.

    49. Audits of States, Local Governments, and Non-Profit Organizations
    (Washington, D.C.: Office of Management and Budget, Circular No. A-133,
    Revised June 24, 1997). This Circular was issued pursuant to the Single
    Audit Act and sets forth standards for obtaining consistency and uniformity
    among federal agencies for the audit of states, local governments, and
    non-profit organizations expending federal awards.

    50. The Interior staff in the FSM monitors federal program assistance, not
    direct Compact funding.

    51. There are three to four additional Interior staff in Washington, D.C.,
    who work with the Compact nations as needed.

    52. Executive Order 12569 issued in 1986 establishes the responsibilities of
    the heads of both Departments with respect to the Compact and notes that the
    Secretary of State shall conduct the government-to-government relations of
    the United States, the FSM, and the RMI, and shall chair the InterAgency
    Group, while the Secretary of the Interior shall be responsible for making
    economic and financial assistance available to the two countries,
    coordinating and monitoring any program or any activity by any department or
    agency of the United States provided to the FSM and RMI, and monitoring
    economic development planning.

    53. Marshall Islands: 1996 Economic Report (Manila, Philippines: Asian
    Development Bank, June 1997).

    54. Bank of Hawaii, Federated States of Micronesia Economic Report
    (Honolulu, Hawaii: July 2000).

    55. See The Challenge of Enhancing Micronesian Self-Sufficiency
    (GAO/ID-83-1, Jan. 25, 1983).

    56. Federated States of Micronesia, The FSM Planning Framework, 1999-2001
    (Pohnpei, FSM: March 17, 2000) (draft). The United States and the FSM
    recently agreed that the Framework represents the FSM's third economic plan
    required under the Compact.

    57. Bank of Hawaii, Federated States of Micronesia Economic Report
    (Honolulu, Hawaii: July 2000).

    58. See Foreign Relations: Better Accountability Needed Over U.S. Assistance
    to Micronesia and the Marshall Islands (GAO/RCED-00-67, May 31, 2000).

    59. Bruce Knapman and Cedric Saldanha, Reforms in the Pacific: An Assessment
    of the Asian Development Bank's Assistance for Reform Programs in the
    Pacific (Manila, Philippines: Asian Development Bank, 1999).

    60. Bank of Hawaii, Federated States of Micronesia Economic Report
    (Honolulu, Hawaii: July 2000).
    *** End of document. ***