Summary

From 1987 through 2003, the Federated States of Micronesia (FSM) received more than $1.5 billion in economic assistance under the original Compact of Free Association with the United States. In 2003, the U.S. government approved an amended compact with the FSM that provides an additional $2.3 billion from 2004 through 2023. The Department of the Interior's Office of Insular Affairs (OIA) is responsible for administering and monitoring this assistance. The amended compact identifies the additional 20 years of grant assistance as intended to assist the FSM in its efforts to promote the economic advancement and budgetary self-reliance of its people. The assistance is provided in the form of annually decreasing grants that prioritize health and education, paired with annually increasing contributions to a trust fund intended as a source of revenue for the country after the grants end in 2023. The amended compact also contains several new funding and accountability provisions intended to strengthen reporting and bilateral interaction. Among these provisions is a requirement for the establishment of a joint economic management committee and a trust fund committee to, respectively, among other duties, review the FSM's progress toward compact objectives and assess the trust fund's effectiveness in contributing to the country's economic advancement and long-term budgetary self-reliance. In 2003, we testified that these provisions could improve accountability over the assistance provided but that successful implementation of these provisions would require appropriate resources and sustained commitment from both the United States and the FSM. Drawing on several more recent reports as well as updated information, this report will discuss the FSM's economic prospects, implementation of the amended compact to meet its long-term goals, and potential trust fund earnings.

The FSM has limited prospects for achieving budgetary self-reliance and long-term economic advancement, and the FSM government has not yet implemented policy reforms needed to enable economic growth. The FSM economy depends on public sector spending of foreign assistance; government expenditures, over half of which are funded by external grants, account for about 65 percent of the FSM's gross domestic product (GDP). The FSM government's budget is characterized by limited tax revenue and a growing wage bill, and the two private sector industries identified as having growth potential--fisheries and tourism--face significant barriers to expansion because of the FSM's remote geographic location, inadequate infrastructure, and poor business environment. Moreover, progress in implementing key tax, public sector, land, and foreign investment policy reforms necessary to improve growth has been slow. For example, although the FSM has agreed on principles of reform to address its tax system that has been characterized by experts as inefficient and inequitable, the FSM government has made limited progress in implementing fundamental tax reform. Also, the FSM's failure to implement key public sector reforms to reduce wage and subsidy expenditures resulted in fiscal crisis in Chuuk and Kosrae. In August 2006, nearly 2 years after the amended compact entered into force, the FSM Joint Economic Management Committee (JEMCO) began discussions of economic policy reform and has since approved some funding to support FSM reform efforts; however, challenges to private sector growth remain. Numerous factors have negatively affected the use of the compact grants for FSM development goals. The FSM's grant allocations have reflected compact priorities by targeting education, health, and infrastructure. However, as of April 2008, the FSM had completed only three infrastructure projects and approximately 82 percent of the $82.5 million in infrastructure funds remained unexpended. Lack of progress in this sector is owed to national and state disagreements over infrastructure priorities, problems associated with the project management unit, and Chuuk's inability to secure land leases. Additionally, the FSM has almost $15 million in unspent funds for other sectors, or around 7 percent of funds allocated from 2004 to 2007. Furthermore, the FSM's distribution of grants among its four states has not been based on need, leading to significant differences in per capita funding, while the FSM's long-term planning has not taken into account the likely effects of the annual funding decrement and other budgetary changes. The FSM has also lacked accountability for the use of compact funds, as demonstrated by weaknesses in its yearly financial statements and lack of compliance with requirements of major federal programs. Moreover, the FSM has not consistently monitored day-to-day grant operations or reported on progress toward program and economic goals, owing to inadequate data, a lack of required reporting, and an unwillingness to dedicate the resources necessary. OIA has conducted administrative oversight of the sector grants, but its oversight has been constrained by the need to assist the FSM with its compact implementation activities such as preparing budgets and addressing financial management problems such as the misuse of compact funds by Chuuk and Kosrae in 2006 and 2007, respectively.