Foreign Assistance: U.S. Funds to Two Micronesian Nations Had Little
Impact on Economic Development and Accountability Over Funds Was Limited
(Testimony, 06/28/2000, GAO/T-NSIAD/RCED-00-227).

Pursuant to a congressional request, GAO discussed economic assistance
provided by the United States under the Compact of Free Association,
focusing on the: (1) use of the Compact funding by the Federated States
of Micronesia and the Republic of the Marshall Islands; (2) progress
made by both nations in advancing economic self-sufficiency; (3) role of
Compact funds in supporting economic progress; and (4) amount of
accountability over Compact expenditures.

GAO noted that: (1) Micronesia and 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 (FY) 1987 through 1998; (2) Micronesia used about 47
percent of its $1.08 billion in Compact funds to support general
government operations such as salaries and travel; (3) the Marshall
Islands spent 45 percent of its $507 million in Compact funds on capital
projects such as developing physical infrastructure, establishing
businesses, and servicing debt; (4) 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; (5) Micronesia and the Marshall Islands have made some
progress in achieving economic self-sufficiency since 1987, though both
countries remain highly dependent on U.S. assistance which has
maintained artificially high standards of living; (6) GAO used
dependence on U.S. assistance, or total U.S. funds as a percentage of
total government revenues in each country, as an indicator to gauge
economic self-sufficiency; (7) the reliance on U.S. funding as a
percentage of total government revenue in Micronesia fell from 83
percent in FY 1987 to 54 percent in 1998; (8) the Marshall Islands also
reduced its reliance on U.S. funding from 78 percent in 1987 to 68
percent in 1998; (9) Compact expenditures to date have led to little
improvement in economic development in Micronesia and the Marshall
Islands; (10) substantial Compact expenditures used to maintain high
levels of public sector employment have acted as a disincentive to
private sector growth; (11) both countries have also spent Compact funds
on infrastructure projects that they viewed as critical to creating an
environment attractive to private businesses; (12) however, these
projects have not generated significant private sector activity; (13)
many Compact-funded projects had experienced problems because of poor
planning and management, inadequate construction and maintenance, or
misuse of funds; (14) the governments of Micronesia, the Marshall
Islands and the United States have provided limited accountability over
Compact expenditures; (15) while Micronesia and the Marshall Islands
generally prepared planning and reporting documents required under the
Compact, most of these documents could not be used to determine if
Compact funds were being spent to promote economic development; and (16)
in addition, the U.S. government did not meet many of its oversight
obligations.

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

 REPORTNUM:  T-NSIAD/RCED-00-227
     TITLE:  Foreign Assistance: U.S. Funds to Two Micronesian Nations
	     Had Little Impact on Economic Development and
	     Accountability Over Funds Was Limited
      DATE:  06/28/2000
   SUBJECT:  Foreign economic assistance
	     Accountability
	     Foreign governments
	     Program graduation
	     Economic development
	     International relations
	     International economic relations
	     Financial management
IDENTIFIER:  Compact of Free Association with Micronesia
	     Micronesia
	     Marshall Islands
	     Pell Grant

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GAO/T-NSIAD/RCED-00-227

FOREIGN ASSISTANCE U. S. Funds to Two Micronesian Nations Had Little Impact
on Economic Development and Accountability Over Funds Was Limited Statement
of Susan Westin, Associate Director, International Relations and Trade
Issues, National Security and International Affairs Division

United States General Accounting Office

GAO Testimony Before the Subcommittee on Asia and the Pacific,

Committee on International Relations, House of Representatives

For Release on Delivery Expected at 2: 00 p. m., EDT Wednesday, June 28,
2000

GAO/ T- NSIAD/ RCED- 00- 227

1 Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to provide information you requested regarding
economic assistance provided by the United States from 1987 through 1998,
under the Compact of Free Association, to the Federated States of Micronesia
and the Republic of the Marshall Islands. In 1986, the U. S. government
entered into an international agreement, the Compact of Free Association,
with each nation. This Compact represents a continuation of U. S. financial
support that had been supplied to these areas for almost 40 years after
World War II under the United Nations Trust Territory of the Pacific
Islands. Specifically, my testimony will address (1) the use of Compact
funding by the Federated States of Micronesia and the Republic of the
Marshall Islands, (2) the progress made by both nations in advancing
economic self- sufficiency, (3) the role of Compact funds in supporting
economic progress, and (4) the amount of accountability over Compact
expenditures. My statement will be accompanied by photographs of sites we
visited that were funded with Compact money in the Federated States of
Micronesia and the Republic of the Marshall Islands. In addition, we will
publish a report discussing these issues in more detail in September 2000.

The information I will provide is based on our review of annual financial
statements and audits, planning and reporting documents from both nations,
and discussions with senior officials from the Departments of the Interior
and State. We also visited the Federated States of Micronesia and the
Republic of the Marshall Islands and discussed the Compact with government
and other officials, visited projects funded by the Compact, and reviewed
documentation related to Compact expenditures maintained by both countries.

U. S. direct financial assistance under the Compact, which ends in 2001, is
intended to help the governments of the two countries in their efforts to
advance their economic selfsufficiency. Direct payments, or transfers of
Compact funds, to both island nations are made by the Department of the
Interior, the agency responsible for providing and monitoring Compact
assistance. 1 These payments can be used for general government operations;
capital projects (such as building roads or schools); and to support
targeted sectors, such as energy and communications, specified in the
Compact. In addition to receiving direct payments, both countries are
eligible to use numerous U. S. federal services and programs such as the U.
S. Weather Service, Pell grants for higher education, and business or home
loans. The FSM and the RMI also receive some assistance from other
countries. In the fall of 1999, negotiations between the Department of State
and the two nations began on how to renew economic assistance and certain
national security provisions in the Compact that will expire in 2001.

In May, we reported that the United States had provided over $2.6 billion in
total U. S. assistance to both countries from fiscal years 1987 through
1999, based on figures given

1 The Department of the Interior's Office of Insular Affairs currently has
two people that work exclusively with the two Compact nations, one in
Washington, D. C., and one in the Federated States of Micronesia. No
Interior personnel live in the Republic of the Marshall Islands. There are
three to four additional Interior staff in Washington, D. C. that work with
the Compact nations as needed.

2 to us by 19 U. S. government agencies. 2 This assistance included direct
payments under

the Compact for economic growth and compensation for nuclear testing, as
well as U. S. program assistance. In our May report, we concluded that the
U. S. Department of the Interior had not maintained reliable data on the
amount of U. S. assistance provided to the FSM and the RMI by all U. S.
agencies. We recommended that, should the Department of the Interior retain
oversight responsibility as a result of the current negotiations, the
Department develop a system to obtain and maintain data on all U. S.
assistance by, for example, making agreements with other U. S. agencies to
regularly report assistance provided to both countries.

In this testimony, I will discuss how the FSM and the RMI spent direct
payments provided under the Compact by the Department of the Interior to
both countries to promote economic growth during the years 1987 through
1998. I will, however, refer to total U. S. assistance, which includes
program assistance provided by all U. S. government agencies, during my
discussion of economic self- sufficiency.

SUMMARY The Federated States of Micronesia and the Republic of the Marshall
Islands spent about $1.6 billion in Compact funds on general government
operations, capital projects, and targeted sectors, such as energy and
communications, from fiscal years 1987 through 1998. The two countries have
used the funding differently. The Federated States of Micronesia used about
47 percent ($ 510 million) of its $1.08 billion in Compact funds to support
general government operations such as salaries and travel. The Republic of
the Marshall Islands spent 45 percent ($ 230 million) of its $507 million in
Compact funds on capital projects such as developing physical
infrastructure, establishing businesses, and servicing debt. Both countries
together issued $389 million in Compact revenue- backed bonds from the late
1980s to the mid- 1990s in order to obtain more funding during the earlier
years of the Compact. As a result of issuing these bonds, the Republic of
the Marshall Islands has spent 42 percent ($ 217 million) of its Compact
funds for debt service, leaving limited Compact funds available for current
government operations and investment.

The Federated States of Micronesia and the Republic of the Marshall Islands
have made some progress in achieving economic self- sufficiency since 1987,
though both countries remain highly dependent on U. S. assistance which has
maintained artificially high standards of living. We used dependence on U.
S. assistance, or total U. S. funds 3 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. Scheduled decreases in Compact
direct payments as well as increases in locally

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 our assessment of economic self- sufficiency we use total U. S. funds,
which consist of all direct

payments under the Compact as well as U. S. program assistance.

3 generated funds in areas such as fishing license fees are examples of why
reliance on

U. S. funding has decreased. 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. Substantial Compact expenditures
used to maintain high levels of public sector employment have acted as a
disincentive to private sector growth. 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. Finally, investment of
Compact funds in business ventures has been a failure. During our work, we
found that many Compact- funded projects had experienced problems because of
poor planning and management, inadequate construction and maintenance, or
misuse of 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. Although the Compact established accountability
requirements for all 3 countries, none of the governments fully used these
mechanisms to ensure that Compact funds were spent effectively or
efficiently. While the Federated States of Micronesia and the Republic of
the Marshall Islands generally prepared planning and reporting documents
required under the Compact, most of these documents could not be used to
determine if Compact funds were being spent to promote economic development.
Furthermore, neither nation provided adequate financial or programmatic
control over Compact funds, as documented in audit reports since 1987. In
addition, the U. S. government did not meet many of its oversight
obligations. For example, it did not hold required annual consultations to
assess progress under the Compact until 1994, losing a valuable opportunity
to provide guidance on the goals and uses of Compact funds. Moreover,
disagreements between the Departments of State and the Interior over Compact
responsibilities, as well as Interior's view that the Compact contained
restrictive provisions that impaired its ability to act, further limited
oversight.

BACKGROUND 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 Kosrae, Pohnpei, Chuuk, and Yap), or FSM, and the
Republic of the Marshall Islands, or RMI. These two small island nations are
located just north of the equator in the Pacific Ocean with populations of
131,500 and 50,500, respectively, as of 1999. Through this 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. 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.

4 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.
(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 nonimmigrants.) Additionally, national
security objectives were achieved. 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. These security provisions will continue indefinitely unless
mutually terminated. 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. The largest
funding provision provides specific levels of funding for the FSM and the
RMI 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.

THE FEDERATED STATES OF MICRONESIA AND THE REPUBLIC OF THE MARSHALL ISLANDS
USED $1.6 BILLION IN COMPACT DIRECT FUNDING

For fiscal years 1987 through 1998, the FSM spent about $1.08 billion and
the RMI spent about $507 million in funding provided by the Compact (see
fig. 1). 4 Each government has used the money differently. The largest area
of expenditures in the FSM was for general government operations, which
accounted for over 47 percent ($ 510 million) of total Compact expenditures.
In the RMI, the largest amount of total expenditures, 45 percent or $230
million, went to support capital fund activities such as building
infrastructure, supporting economic activities, and servicing debt. 5

4 When Compact expenditures are converted to constant 1999 fiscal year
dollars (using the U. S. gross domestic product deflator), the FSM spent
about $1.2 billion, while the RMI spent about $582 million. This report uses
current dollars throughout. 5 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.

5 Figure 1: FSM and RMI Compact Expenditures by Fund Type as a Percentage of
Total

Compact Expenditures, Fiscal Years 1987- 98 Note 1: The special revenues
fund consists of Compact assistance earmarked for specific uses, such as
medical referrals, scholarships, and marine surveillance. Note 2: 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. Note 3: Figures may not add to 100
percent due to rounding.

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

The financial statements of the FSM and the RMI list projects that were paid
for from the capital fund. 6 Of these projects, the FSM and the RMI together
spent $484 million from 1987- 98 for purposes that included building
infrastructure such as roads and schools, and supporting economic
development. The FSM spent a total of $344 million in this area, with $156
million (45 percent) of these capital project funds going for economic
development, such as for fishing boats or processing plants (see fig. 2).
Expenditures on infrastructure, followed closely at $133 million, or 39
percent. For the RMI, 46 percent ($ 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. RMI expenditures for
infrastructure and economic development accounted for 25 percent ($ 35
million) and 23 percent ($ 33 million), respectively, of these capital
funds.

6 These expenditure data for the FSM and the RMI include only expenditures
listed in country financial statements. Capital fund transfers and capital
expenditures made from bond proceeds are not included.

6 Figure 2: FSM and RMI Compact Capital Account Expenditures, Fiscal Years
1987- 98

Note 1: “Other” expenditures include land lease and acquisition,
resource management, and unspecified uses of funds. Note 2:
“Social” expenditures include spending on health, education,
housing, training, and social services projects.

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

The Compact does not have guidelines to control the timing of the
expenditures. 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. By fiscal year 1998, the FSM had
repaid $119 million in bond debt, with these repayments accounting for 11
percent of total Compact expenditures. However, the RMI has used a higher
percentage than the FSM of its Compact funding to repay bond debt (42
percent or $217 million) over the life of the Compact. This has limited RMI
Compact discretionary spending options, particularly in recent years (see
fig. 3). For example, in 1998, the RMI spent $39 million in Compact funds.
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. 7 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.

7 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. 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. This official
reported that four landowners receive one- third of the annual payment based
on acreage owned, with one landowner receiving half of this amount.

7 Figure 3: RMI Debt Service as a Percentage of Annual Compact Expenditures,
Fiscal

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

THE FEDERATED STATES OF MICRONESIA AND THE REPUBLIC OF THE MARSHALL ISLANDS
HAVE MADE SOME IMPROVEMENTS IN ECONOMIC SELFSUFFICIENCY BUT REMAIN DEPENDENT
ON U. S. ASSISTANCE

The FSM and the RMI are among the largest recipients of U. S. assistance
worldwide on a per capita basis. In 1998, total U. S. assistance equated to
about $760 per capita in the FSM and about $1,095 per capita in the RMI.
This high level of per capita funding has maintained artificially high
standards of living in both countries that would, according to the Asian
Development Bank, collapse in the absence of U. S. assistance. 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. Total U. S. assistance (Compact and all
other U. S. program assistance) 8 still accounts for at least half of total
government revenue in both countries, though government dependence on U. S.
funds has fallen from 1987 levels in both countries. 9

8 Total U. S. program assistance outside of the Compact for fiscal years
1987- 98 for both countries was $368 million. This was 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. 9 These data understate the
value of U. S. government contributions to the government of the Compact

nations. U. S. government services provided in- kind, such as weather
service, disaster relief, development

8 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. 4).
This change is due to scheduled reductions in direct Compact funds,
increases in locally generated revenue stemming from higher fishing license
revenues, and a change in how government revenues are reported.

Figure 4: FSM Dependence on U. S. Assistance, Fiscal Years 1987- 98 Note:
Total FSM government revenues are comprised of direct Compact funds, U. S.
program assistance, and local revenues.

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

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. Compact assistance represented 78 percent of RMI
government revenue (see fig. 5). This figure fell to 68 percent by fiscal
year 1998. However, the 1998 level of dependence represents an increase from
1995, when dependence on total U. S. funding reached a low of 51

loans, and national defense, do not appear as revenue in the FSM and RMI
government financial accounts. A complete assessment of changes in self-
sufficiency would include contributions of other external donors. To the
extent that other external donor revenue is growing while U. S. assistance
is decreasing, then self- sufficiency is not improving.

9 percent. The increase since 1995 is due to decreased local fees, sales,
and taxes, and to a

change in how government revenues are reported. 10 Figure 5: RMI Dependence
on U. S. Assistance, Fiscal Years 1987- 98

Note: Total RMI government revenues are comprised of direct Compact funds,
U. S. program assistance, and local revenues.

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

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 where Compact expenditures have not led to apparent improvements in
economic development are government operations, physical infrastructure, and
business ventures. 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, and construction.

10 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 in the RMI financial statements since 1996. RMI Social
Security System revenues in 1995, the last year they were reported, were
over $13 million.

10 Substantial Compact funds ($ 616 million in both countries combined) were
used to

support general government operations that have 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 . For example, 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. These higher wages make the private sector less
competitive in international markets.

The FSM and the RMI also spent at least $255 million combined in Compact
funds for physical infrastructure improvements and operations. The FSM and
the RMI viewed this area as critical to improving quality of life and
creating an environment attractive to private businesses. For example, in
both countries combined, Compact funds of at least $97 million and $22
million have been spent to operate and improve energy (including electrical
power) and communications (including telecommunications) systems,
respectively. Access to and dependability of these services have increased.
However, such improvements have not been sufficient to promote significant
private sector growth, although we identified one tuna processing plant in
the RMI that located to the country in part as a result of dependable
electricity.

We identified $188 million in Compact funds spent in the FSM and the RMI for
business ventures. During our visit, FSM and RMI government officials
reported that virtually no 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. One example of this
strategy is the $60 million in Compact funds we identified that the FSM
spent on fisheries activities. 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, 11 on the
basis of expected future cash flows, was zero. We visited one storage and
processing facility in each of the four FSM states; none of the facilities
were operating at the time of our visit. Officials from Yap and Chuuk said
that ventures in fisheries were failures due to inexperience and poor
business judgment.

After a review of financial records and/ or project files 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/ or misuse. These problems have

11 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 the Caroline Fisheries Corporation. All ventures are involved in longline
tuna fishing for the fresh tuna markets.

11 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.

Poor planning and management were evident for many failed projects we
visited. One example occurred in the RMI, where the government spent an
estimated $9.4 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.
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
to 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.

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. In reviewing the project file for
road construction, we found that an inferior, though cheaper, paving
technology had knowingly been employed. Kosrae 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.

We also identified instances of poor construction and maintenance. For
example, the capitol building in the RMI, built during the 1990s using $8.3
million in Compact funds, has visible signs of deterioration. Metal stairs
are rusting, elevators are inoperable, and roof leaks are evident throughout
the building.

Finally, we identified Compact expenditures that appeared to be a misuse of
funds. 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. However, Chuuk state officials indicated that in their opinion, this
project would not meet this goal. The project cost at least $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 and 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 had 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.

In the FSM, the Public Auditor as well as officials from the U. S. embassy
have cited other instances of misused funds, including the purchase of
numerous boats and automobiles

12 in Chuuk to distribute to individuals in what embassy officials have
called the “cars for

votes” and “boats for votes” projects. THE FEDERATED
STATES OF MICRONESIA, THE REPUBLIC OF THE MARSHALL ISLANDS, 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,
interagency disagreements in the United States on the level of and
responsibility for oversight, as well as a Compact provision guaranteeing
payment of Compact funds, have limited the U. S. government's ability to
meet its accountability requirements.

Compact Required Accountability for Use of Funds From the Federated 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 through development plans, annual reports, financial
audits, and 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 to identify
specific projects and link 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 performing annual
financial and compliance audits. 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 Compact
designated the Department of the Interior to provide and monitor Compact
funds. A 1986 executive order established an interagency group, chaired by
the Department of State, to provide policy guidance on the Compact.

Planning and Reporting Documents of the Federated States of 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,
12 both types of documents have been insufficient to meet the Compact
requirements. Our analysis of the economic development plans, confirmed by
Department of the Interior officials and

12 The FSM and the RMI submitted economic development plans for the first
and second 5- year periods, covering the period from 1987 to 1997. The FSM
presented other development documents in lieu of a third 5- year plan, which
the United States has accepted. The FSM submitted annual reports each year
from 1987 to 1998, while the RMI has submitted 7 of the 12 annual reports.

13 an FSM government document, found that the plans gave inadequate
attention to broad

development goals and plan implementation, as required by the Compact.
Department of the Interior officials said the plans focused on spending
funds in specific sectors without tying projects to development needs.
However, a Department of State official said an FSM planning document for
the 1999- 2001 period represents an improved effort. Further, 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. Without this annual assessment, Interior officials were unable to
determine whether the use of Compact funds was contributing to Compact
goals. 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, 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. Further, 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 project 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, as
mentioned earlier. 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. Finally, the independent audits
showed that the two countries have taken little action to address management
weaknesses and resolve questioned uses of Compact funds. For example, by
fiscal year 1998, the two countries wrote off over $50 million in questioned
uses of Compact and other program assistance that had been unresolved since
the 1980s. 13

The U. S. Government Did Not Meet Many Accountability Requirements 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. Further, 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 found references that only two (the first plans for the FSM and
the RMI) of the four submitted plans had been reviewed. In addition, the
United States did not initiate the required annual consultations with the
two countries until 1994. The United States has held four additional
consultations with the FSM and three consultations with the RMI since 1994.
According to a Department of the Interior

13 While the FSM and the RMI were responsible for providing plans to address
these questioned costs, the U. S. government never pursued final resolution
of these costs.

14 official, the talks have been cordial diplomatic meetings but have not
included serious

discussions of economic growth or compliance with Compact spending
requirements. As a result, the FSM and the RMI were not required to
demonstrate their progress in economic development and justify their Compact
expenditures on a regular basis.

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

Disagreements between the Departments of State and the Interior on the level
of and responsibility for Compact oversight have led to reduced monitoring
efforts. The following examples illustrate areas of disagreements:

15 measures can be applied to control the use of funds. Further, Interior
officials told us

that the Compact payments are expressly backed by the “full faith and
credit” of the United States 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. Department of State
officials agree that withholding funds is impracticable. Interior and State
officials also said that even if they could withhold funds, the broad range
of acceptable Compact expenditures listed in the agreement on fiscal
procedures would make it difficult to demonstrate that a questionable
expenditure was not allowed.

OBSERVATIONS Throughout the course of our work, officials from all three
countries identified issues that they feel need to be resolved during the
course of negotiations. These issues include (1) defining the objective of
future economic assistance, (2) establishing the duration and amount of
funding, (3) determining the funding mechanism (block grants, project
funding, or a trust fund), (4) specifying the degree of accountability over
expenditures, and (5) determining how this future assistance will be
administered.

---- Mr. Chairman and Members of the Subcommittee, this concludes my
prepared remarks. I will be happy to respond to any questions you may have.

CONTACTS AND ACKNOWLEDGEMENT For future contacts regarding this testimony,
please call Susan Westin or Emil Friberg at (202) 512- 4128. Individuals
making key contributions to this testimony included Edward George, Jr.,
Leslie Holen, and Dennis Richards.

(711541)

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