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«Compacts of Free Association with the Federated States of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) For Fiscal Year 2006 Table ...»

-- [ Page 1 ] --

Report to the Congress

on the

Compacts of Free Association

with

the Federated States of Micronesia (FSM)

and the Republic of the Marshall Islands (RMI)

For Fiscal Year 2006

Table of Contents

Introduction ……………………………………………………………….. 3

A) General Social, Political and Economic Conditions ………………………... 3

Federated States of Micronesia (FSM): Background ……… ……………….. 4

Economic and Financial Review of the FSM ……… ……………….. 8 Prospects for Private Sector and Economic Growth ………………………. 12 Migration from the Freely Associated States ………………………. 15 Republic of the Marshall Islands (RMI): Background ………………. 16 Economic Review of the RMI ………………………………. 17 Prospects for Private Sector Growth in the RMI …………………… 20

B) Use and Effectiveness of United States Financial, Program and Technical Assistance Funds ………………………………………………………. 24 Compact Sector Grants ………………………………………. 24 Fiscal year 2006 Sector Allocations for the FSM ………. 26 Fiscal Year 2006 Allocations for the RMI ………………. 33 Ebeye Special Needs ………………………………. 40 Introduction The United States entered into a Compact of Free Association (Compact) with the Federated States of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) in

1986. The purpose of the Compact was to establish close and mutually beneficial relationships between the United States and the FSM, and between the United States and the RMI as they emerged from the Trust Territory of the Pacific Islands and became sovereign states.

The Compact was made a part of and approved in Public Law 99-239. The Compact set out mutual obligations with regard to governmental, economic, security and defense relationships. One part of the Compact dealt with economic support provided the FSM and the RMI by the United States. Between fiscal years 1986 and 2003, the last year of funding under the Compact’s original terms, the FSM and the RMI received approximately $1.5 billion and $1 billion, respectively, from the United States. The funds were used for general government operations, including health and education, economic development, capital improvements, and special purposes.

Some of the provisions of the original, 1986 Compact, including the economic assistance provisions, were to expire in 15 years. The Compact provided that, starting in 1999, the parties were to enter into negotiations regarding these expiring provisions. The negotiations culminated in separate amended Compacts with the FSM and the RMI, which were made a part of and approved in Public Law 108-188, the Compact of Free Association Amendments Act of 2003. The amended Compacts provide United States support for a 20-year period that began in fiscal year 2004. The FSM will receive approximately $2.1 billion and the RMI $1.5 billion during that period, including large annual and increasing contributions to trust funds designed to provide an annual source of revenue when the annual United States assistance terminates at the end of fiscal year

2023. Through fiscal year 2023, United States assistance will be for grants for education, health care, private sector development, the environment, public sector capacity building, and public infrastructure, with priorities in the education and health care sectors.

The amended Compacts created new accountability requirements for the use and reporting of United States assistance. One of the requirements of Public Law 108-188 is this report.

(A) General Social, Political, and Economic Conditions:

Section 104(h) of Public Law 108-188 requires the President of the United States to report on general social, political, and economic conditions in the FSM and the RMI, including, among other things, estimates of economic growth, per capita income, and migration rates. This reporting requirement has been delegated to the Secretary of the Interior.

Federated States of Micronesia (FSM) Background The strategic and economic relationship between the FSM and the United States that goes back to the end of World War II has had three distinct phases: (1) the period from the end of World War II to the end of the Trust Territory of the Pacific Islands in the 1970s, (2) the first financial package of the Compact of Free Association, 1986-2003, and (3) the terminal phase of the financial package, the amended Compact, 2004-2023.

The principal outcome in the first phase was putting in place modern institutions of selfgovernment, based mainly on American style of democratic principles and practices. It was during this period that the FSM, an archipelago in the Central Pacific that stretches 1,700 miles from east to west and inhabited by a population of under 110,000, evolved into a self-governing entity and joined the community of nations as a sovereign state. A steady income source in the form of U.S. grant assistance during the second phase helped the FSM expand its infrastructure and explore various economic growth and development programs that would expand domestic production and distribution. The expectation was that higher levels of output from local sources and resources would increase economic and financial self-reliance. An important measure of self-reliance was envisaged to be a steady and sustained increase in the domestic tax base as the economy’s productive capacity increased, mainly through the private sector.





The third phase, the amended Compact, took effect in fiscal year 2004. The principal task during this phase is to build upon the work of the second phase and help the FSM lay the foundation for a more self-reliant economy that would be based more on the private sector than at any time during this relationship. It was with this objective in mind that the FSM and U.S. negotiators agreed to an important new element in the third phase. With respect to Compact grants under the amended Compact, a Joint Economic Management Committee (JEMCO) was established to strengthen management and accountability and to promote effective use of the Compact grants. JEMCO, in which the United States retains permanent majority (three of five votes), enables United States Government to monitor progress more closely and focus grant assistance on areas that would help the FSM get on the track to a greater degree of self-reliance. The areas of particular emphasis are public health and public education, which will receive the largest share of the total grant assistance every year through the end of fiscal year 2023. Other areas to receive U.S. grant assistance are private sector development, the environment, public sector capacity building, and public infrastructure.

Another important part of the amended Compact is a trust fund for the people of the FSM that, after its 20-year accumulation period, would generate a source of income to be used for the same purposes as the 2004-2023 grant assistance once annual U.S. assistance grants end.

Apart from reviewing and approving grant allocations each fiscal year, JEMCO also has responsibility for identifying ways to increase the effectiveness of U.S. assistance, and to attach special conditions to grants to improve program performance and fiscal accountability and ensure progress toward macroeconomic goals. It is in this context that JEMCO can encourage institutional reforms crucial to prosperity in the market place of the global economy. These new features, focusing grant assistance on targeted segments, identifying areas for reform and provision for an income stream beyond the terminal phase, make the amended Compact a pivotal chapter in the evolution of the FSM as an economy and a society. The reliable operational grant and trust fund deposits the United States will provide over the next 17 years offer the people of the FSM a horizon of sufficient length in which to lay the foundation of the post-Compact FSM economy. It is in this context that the economy of the FSM needs to be reviewed and both its challenges and promises outlined clearly.

Meanwhile, the change in allocation and spending control has slowed implementation of the amended Compact. It has taken the four FSM state and national governments longer to adjust to JEMCO’s role in reviewing and approving grant allocations. Also, unlike the beginning of the second phase where large startup funds boosted total economic output rather quickly, there were no large upfront grants at the start of the third phase to cause a large increase in the flow of funds in the economy and, eventually, in total output and the average standard of living.

According to the FSM’s report to the President of the United States for fiscal year 2005, real gross domestic product (GDP) was projected to be down in fiscal year 2006 from fiscal year 2005. However, this is in line with what can reasonably be characterized to have been a stagnant FSM economy through most of the new decade. The main reason for stagnation has been lackluster performance in the FSM’s private sector economy. In fact, the private sector and households as a share of the FSM’s GDP in fiscal year 2006 was down for the second consecutive year.

–  –  –

Information in the report to the President also shows that the FSM’s private sector output as a share of GDP has changed little in recent years. In fiscal year 2006, the private sector’s output was 27.6 percent of GDP, down slightly from the year before but in line with the long-term trend. In 1995-2006, private sector output averaged 28.6 percent, ranging from a high of 29.8 percent in 2000 to a low of 26.6 percent in 1997.

Now that the amended Compact is in the fourth year of implementation and there is no prospect for bump-up funds, the near term outlook for the FSM economy does not appear very bright. Taking this argument to its logical end and assuming no large sums of external funds from other sources suggests that the only practical option to increase the FSM’s total output and, therefore, the average standard of living is to increase its private sector’s share of national income. Given the economic and political history of the FSM, at least since the beginning of the U.S.-FSM relationship, this will not be an easy task.

Meanwhile, the Office of Insular Affairs, the U.S. Government agency responsible for monitoring Compact progress, has made it clear, specifically at the 2006 JEMCO meetings, that there is no alternative to private-sector growth if the FSM economy is to deliver the income a growing population will need. Migration to the United States and its territories, an important provision of the Compact, undoubtedly relieves some of the population pressure, but migration alone is not a sufficient condition for improved standards of living, especially for those who have to stay behind in the islands.

–  –  –

Public Law 108-188 section 140(h)(1), requires this annual report on the FSM by the United States Government. It provides information on, among other things, the use and effectiveness of United States financial, program, and technical assistance funds, the status of the economy and economic policy reforms, and the status of the efforts to increase investment in the FSM’s overall productive capacity.

This report for fiscal year 2006, the third since the amended Compact has been in effect, is submitted in fulfillment of that requirement. The report is based on three principal sources of information. The quantitative economic analysis is based mainly on the data contained in the FSM’s Report to the President of the United States, required by section 214 of the amended Compact. This Report discusses the use of United States grant assistance, the FSM economy and progress in meeting mutually agreed program and economic goals. 1 The quantitative analysis of United States sector grants and overall U.S. assistance is based on information gathered from the various FSM governments.

The third source of information and insight is a team of Federal employees with the specific task of monitoring progress of the amended Compact. The team’s extensive experiences and expertise cover practically all of the FSM islands. Most members of this team are experts in their respective fields and they collectively constitute the most The FSM’s second report, for fiscal year 2005, to the President of the United States was received by the Department of the Interior in September 2006. The FSM has not yet submitted its report for fiscal year 2006.

authoritative body of knowledge on the Compact, implementation challenges and promises and what lies ahead for the FSM and the FSM-U.S. relationship.

Economic and Financial Review of the FSM Economic statistics for the FSM over the last decade present a picture of an economy besieged by large fluctuations, followed by stagnation and decline. The economy recovered from a steep decline in the late 1990s to a somewhat steady and predictable course during 2000-2003. Since 2003, it has stagnated. In 1995-2006, FSM’s real GDP increased a scant 0.1 percent a year. The State of Yap, the second smallest state in terms of population but economically the strongest of the four states since the beginning of the first Compact, was the only economy of the four states that grew. However, the growth rate was less than one percent a year in 1995-2006. During the same period, Chuuk’s economy grew 0.2 percent a year, followed by 0.1 percent decline annually for both Pohnpei and Kosrae.

As a share of the FSM’s GDP, the public sector declined more than the private sector, owing to cuts in U.S. assistance and reforms in the public sector intended to cut cost and streamline government operations. In 1995-2006, government as a share of GDP declined 0.9 percent a year while private sector’s share dropped 0.3 percent annually.

The states followed the FSM’s GDP change during the period, with the private sector’s share growing in Yap (1.2 percent a year) and Chuuk (0.7 percent a year) and declining in Pohnpei (1.2 percent) and Kosrae (1.0 percent). Government as a share of GDP during the 1995-2006 period remained unchanged in Kosrae, but declined in every other state.



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