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«Compacts of Free Association with the Federated States of Micronesia and the Republic of the Marshall Islands For Fiscal Year 2005 Table of Contents ...»

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In the FSM, tourism and the fishing industry are about the only realistic options at this stage for future traditional economic development. To haul large quantities of fresh fish from the region to Asian markets such as Japan would require not only runways and the associated facilities but commercial aircraft or other means of transport that carry large quantities of perishable products over long distances. To process some of the fish in the islands so some of the value added stays would require processing facilities.

Taking steps to create the next economy of the FSM, and for that matter, of the Republic of the Marshall Islands (RMI) and the Republic of Palau, (Palau) may require the direct involvement of not only regional and global institutions, but regional economic powers such as Japan, Taiwan and Australia. Engaging global and regional resource centers also falls within the scope and spirit of the FSM’s own Strategic Development Plan (SDP), which is required by the amended Compact. Realization of the sustainable growth strategy, as outlined in the SDP, would require, more or less, the same infrastructure.

Prospects for Growth in Tourism

One industry that has played a critical role in increasing the private sector in small and isolated economies of the Pacific is tourism, especially in markets near main transport routes, such as Guam and Saipan. The FSM’s tourism statistics reflect, quite realistically, the difficulties associated with small and remote markets, especially those with tourist facilities that are not considered regionally competitive.

Tourist traffic has been erratic and unpredictable in recent years. In 1996, total arrivals numbered 18,305, but dropped to 14,526 in 1998, the nadir of the Asian financial crisis.

Arrivals climbed back to 19,497 in 2000, reflecting the post crisis recovery in East Asia.

They dropped again in 2001 to 15,884, perhaps because of the effects of the terrorist attacks on the United States, only to rise again to 18,301 in 2004 and an estimated 19,242 in 2005. What these numbers show, apart from the variations connected to regional economic and financial realities, is how small and unpredictable the FSM’s tourism has been. (By comparison, Guam receives more than one million tourists a year, most of them from Japan.) With the exception of Chuuk, which is just over an hour of flight from Guam, the other FSM states are off main regional transport routes. This makes it costly to fly to the islands and inter-island transport among the main inhabited islands is dependent upon a single commercial carrier. Moreover, tourism suffers from rudimentary facilities, even in the national capital on the island of Pohnpei. The FSM still does not have a world-class hotel with meeting and other commercial facilities. Finally, tourism offerings are limited with few attractions for mainstream tourists. The market now focuses on adventure tourists, primarily divers and sport fishermen, from Asia and North America.

Business travelers provide another potential market. The Compact provides that, for purposes of Internal Revenue Code section 274(h)(3)(A), the FSM is included in the “North American Area” for purposes of the allowance of deductions for foreign conventions. Deductions for foreign conventions, meetings, or seminars are otherwise generally disallowed under the Internal Revenue Code, unlike events occurring in jurisdictions included in the “North American Area.” The question of whether tourists follow facilities or vice versa has been the topic of local discussion for decades. With the certainty of Compact funding, some would argue, there has been little financial incentive to create tourist facilities that would bring more affluent tourists and, therefore, more private activity to these islands. More study may be required on tourism to examine the issues of transport routes, the effects of new seating capacity, and the absence of tourist-class facilities. However, what is not in question is the long-term need to create an infrastructure that would make it possible to make use of all of the country’s economic resources.

Migration from the Freely Associated States

Migration from the freely associated states (FAS) to the United States and its territories began after the Compact took effect in 1986, but it did not get much attention until recently when Hawaii, Guam and Commonwealth of the Northern Mariana Islands (CNMI) raised concerns about the cost of public services for migrants from Micronesia.

These concerns became the basis of funding to these United States jurisdictions that is a part of Public Law 108-188. Based on 2003 data, there were 20,808 Micronesians in the

United States island areas, with the following distribution:

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(Migrants to the mainland United States have not been enumerated, but may be expected to equal or exceed those in the island areas.) As these numbers show, Micronesian migrants to the United States and its territories, although not a large number or a significant portion of all immigrants, are a large percent of the population of the area. The total of 20,808 is about 11.5 percent of the total population of the FSM, the RMI and Palau. Thus far, the bulk of the migrants are coming from the FSM, especially Chuuk; it is expected that future trends in Micronesian migration are likely to mirror the past.

Republic of the Marshall Islands (RMI): Background

As measured by GDP, the RMI economy is about half of that of the FSM, as is its population. In 1999, the last time a national census was taken, the RMI population was enumerated at 50,840. In 2004, it was an estimated 55,447, according to the RMI Economic Policy, Planning and Statistics Office (EPPSO). Population growth rate from the previous census in 1988 had dropped to less than half. In 1980-88, population growth was 4.3 percent a year. It was one of the highest population growth rates in the Pacific as well as the world and often got the attention of demographers. In 1988-99, population growth rate had dropped to a mere 1.5 percent per year, mainly as a result of emigration.

The natural rate of increase, the difference between crude death rates and crude birth rates, had remained high. It was 3.7 percent in 1999, according to EPPSO.

The difference between the FSM and the RMI economies is not limited to the level of output and the populations they have to support. They are different in other ways also.

The capacity constraints to generate and disseminate macroeconomic information in the RMI are not the same as those in the FSM, although there are similarities. The RMI Government compiles and disseminates basic statistics on the various components of the economy, the labor force, employment, wages and salaries and other commonly followed factors such as tourist traffic. As is their practice, world and regional organizations such as the World Bank, the International Monetary Fund (IMF) and the Asian Development Bank (ADB) often produce their own assessments of economic growth and development conditions and prospects in the country through field visits. Although these assessments are made intermittently, they provide the outside world’s views of the RMI economy, its financial foundation and its evolution and often offer a useful second opinion.

Despite challenges that arise from local technical capacity and financial constraints, the RMI Government is making an effort to develop the skills to provide economic, financial and demographic data and analysis independently. In its current stage of engagement, the ADB has had technical assistance grants to strengthen EPPSO, which is a part of the Office of the President. The rationale behind attaching EPPSO to the Office of the President of the RMI is to make it more visible and perhaps a more viable organization to monitor economic progress, report its findings and make policy recommendations. This report is based mainly on the Annual Compact Report for Fiscal Year 2004 submitted by the RMI Government, subsequent preliminary national income data which have only recently been developed, and other data provided by EPPSO.

Institutionalizing the efforts to produce economic and financial data and policy advice requires time and permanent commitment of resources for which the amended Compact makes certain provisions. Meanwhile, both the RMI and United States governments are required to report on the RMI’s progress every year through 2023. Assistance for moving more rapidly toward self-reliance in economic and financial data and policy analysis and advice may be found within the amended Compact’s provision for capacity building. Putting those resources together with those from others, such as the ADB, would make it possible to establish a collaborative mechanism and fund it consistently.

As this effort progresses and becomes a part of the institutional structure, it would make economic and financial data a part of the public good that the government of the RMI offers its citizens and others.

The amended Compact with the RMI provides for a certain level of economic and financial aid every year (through fiscal year 2023), as did the first one, but places greater and more explicit emphasis than did the original Compact on expanding the productive capacity of the economy in an orderly manner through fiscal year 2023. This is to take place through improvements in public health, public education, public infrastructure, capacity building and other aspects such as institutional reforms that would make the RMI a more attractive market to overseas capital and skills. Public Law 108-188 section 140(h)(1) requires this annual economic and financial report on the RMI by the United States Government. This report will give the Congress information on, among other things, the use and effectiveness of United States financial, program, and technical assistance; the status of economic policy reforms; and the status of the efforts to increase investment.

Unlike the first Compact, the amended agreement provides for the creation of a trust fund for the people of the RMI that, if maintained with the care that successful public trust funds require, will generate a reliable income stream after 2023. Starting in 2004, the United States and the RMI deposited funds into the trust funds. Annually thereafter, the United States is depositing specific amounts into the trust fund until 2023. Over the 20year period ending in 2023, the trust fund will have accumulated a reserve level that would generate a significant amount of income that may or may not replace the operational (sector) grant payments from the United States. To express this differently, interest income from the trust fund is not guaranteed to replace U.S. sector grants, but to offer the RMI Government a reliable source of income as the amended Compact provides. Concerns about the adequacy of funds post 2023 may cause the RMI government to plan for increased private sector and business growth.

Another new feature of the amended Compact is that total U.S. sector grant drops by a certain amount every year until 2023, with the amount of the reduction going into the trust fund. To compensate for the operational (sector) grant reduction every year until 2023, the RMI government will have to make the necessary adjustments in its budget proposals to the Joint Economic Management and Financial Accountability Committee (JEMFAC). Alternatively, the RMI government may find other sources of income such as taxes and fees in its own private sector, especially if it is expanding, to make up for the decrements in the operating grants from the United States. With 18 years of reliable operational grant and trust fund deposits from the United States, the amended Compact offers the people of the RMI a horizon of sufficient length in which to plan and put in place the foundation of the post-Compact RMI economy.

As with the FSM, the year 2023 may appear so far in the future as to give the RMI leaders a false sense of security. However, long-term viability of the RMI economy, beyond a steady flow of U.S. assistance (Compact grants and other U.S. aid), requires that hard work starts now. This would entail identifying those areas of the economy, current and future, where scarce resources would be best invested. With those areas of the economy that would require development policies and investment plans, the RMI leadership would then start the search for resources that would make it possible to move toward a more self-sufficient economy that would be based on the private sector and market forces. The main objective of this plan would be to steer the RMI economy toward a sustainable, self-supporting standard of living beyond 2023.

Some of the resources to make prosperity possible in the post-2023 era may come from global and regional assistance providers such as the World Bank, the Asian Development Bank, other bi- and multilateral agencies and governments in the Asia-Pacific region such as Japan and Taiwan which already provide a significant amount of assistance to the region. To secure the necessary funds from these providers that would make a difference in the RMI economy (especially in its small and remote atolls and islands), the work has to begin immediately. An important part of that work has to be continued assessment of what the economy’s productive capacity is, how it performs, its highest potential and what it would take to get there.

A somewhat unique aspect of the RMI’s economy that is also a major financial advantage is the strategic link between the United States and the RMI, namely the Ronald Reagan Ballistic Missile Defense Test Site (Reagan Test Site, RTS) and other military facilities situated on Kwajalein Atoll. To the extent that the U.S. military remains engaged in activities that benefit from the infrastructure on Kwajalein, it is an important source of income to the RMI that would be hard to replace with civilian ventures. The U.S.

military may be present in the RMI for years, possibly decades, but that should not prevent the RMI Government from pursuing ways and means for developing the country’s private sector, which would lead to increased employment and expansion of the national tax base.

Blending Democratic Institutions with Tradition

Economic and financial reviews of the RMI may reveal a challenging picture in the years 1986–2004 when the economic provisions of the original Compact were in effect.

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