**An Update on the Economy of Palau**

By

Wali M. Osman, Ph.D.

Regional Economist

May 2004

I. Introduction

In the last 3-4 years, the same factors that have beset the economies of
Guam, Commonwealth of the Northern Mariana Islands (CNMI) and, to a
certain degree, Hawaii, have hindered economic growth in Palau.
Beginning with the Asian financial crisis in 1997-98, the West Pacific
economies entered what turned out to be a relatively long period of
stagnation and decline. Just about the time that a weak but discernable
recovery was beginning to take shape in the Western Pacific economies
and Hawaii in late 2000 to mid-2001, the terrorist attacks on New York
and Washington on September 11, 2001 derailed it. The attacks and their
aftermath not only disrupted air traffic in the United States but
substantially affected travel from Japan, especially to the United
States and U.S. affiliated destinations in the Western Pacific.

Japan is a major supplier of tourists not only to Guam and CNMI but
Palau as well, and the economic and financial impact of reductions in
Japanese travel and spending extends to this market. However, since
Palau is not as dependent on Japanese tourists as Guam and CNMI are,
where Japanese tourists make up to 70-75 percent of all tourists, the
impact of Japanese travel dollars is smaller but not insignificant.
Although Palau did not suffer from debilitating natural disasters as
Guam and, to a lesser extent, CNMI, did in 2000-2002, the cumulative
impact of global and regional economic and security difficulties
affecting regional tourism caused Palau's travel industry to suffer in
ways similar to the rest of the West Pacific's.

In the meantime, what has lessened the negative impact of losses of
tourist dollars in the last few years has been the ongoing work on the
country's major public infrastructure projects. The largest of these is
the so-called Compact Road, which is under construction. It was included
as a special economic development project in the financial package of
Palau's Compact of Free Association with the United States. The 53-mile
long two-lane highway around Palau's main island, Babeldaob, will be an
important addition to Palau's infrastructure and basis for economic
growth.

Another major project nearing completion is the national capital on
Babeldaob, largely funded by soft loans from Taiwan. Major projects
completed recently are the bridge connecting Bebeldaob to Koror (funded
by Japan) and the airport terminal building which now makes Palau's
airport terminal facility comparable to other small but modern and
functional facilities of the region. With the Compact Road's completion,
Palau's major public infrastructure projects that started after the
Compact o Free Association was signed in 1994 will have been completed.

A major private project completed recently is the Papago International
Resort near the airport area. Completed in late 2002, the resort has 100
rooms and other amenities, targeting mainly Taiwanese tourists. The
capital for the project came from Taiwan, along with management, and
labor is provided by China. Beside the well-known Palau Pacific Resort
and Palasia Hotel Palau, Koror now has three major hotels with 100 or
more rooms and world-class facilities and services. Putting all hotel
and motel rooms together, Palau now has a total room count of just over
1,000. That counts is still much smaller than CNMI's more than 4,000 and
Guam's 8,000-9000 rooms, but a big increase from a decade ago.

II\. The Compact Road and Economic Development

The Compact Road is scheduled for completion in 2005-06, depending on
various factors, of which weather seems to be one of the most
influential. The texture of the soil in certain areas through which the
Road must pass presents challenges from time to time. The type of soil
that occurs in some areas retains moisture and causes landslides in
steeply-sloping areas during heavy rains, which occur frequently in
Palau. The landslides delay the ongoing work and may even force
rerouting parts of the road or drainage ducts and other adjustments.
Still, the road is expected to be finished within the next two years.

With completion of the Compact road and these other infrastructure
projects, Palau is to enter a new phase of economic growth with better
production and distribution possibilities which would lead to greater
self-sufficiency from within. Babeldaob, the region's second largest
island after Guam accounting for nearly 80 percent of Palau's landmass,
has so far remained pretty much untouched; opening the island's landmass
to commercial possibilities and connecting to urban Koror appears to
hold great promise.

The question is what type of production and distribution activities
would come into being with completion of the Compact Road that would
make a difference in Palau's economic development evolution. Its
potential contribution to economic growth and development have not been
studied, but it appears that there is greater expectation attached to
the Road than what it may contribute, at least in the short run.

The road will connect the outlaying areas of Babeldaob to Koror and the
new national capital. It will also make it possible for individuals and
household in Koror, which is congested, to acquire land on Babeldaob for
personal and business uses. Migration from Koror to the various points
on Babeldaob will create its own issues as there is little other
infrastructure to support urbanization of the island. At least
initially, the Road may not turn out to be the economic and financial
miracle it is often expected to be. Nor is there much of a commercially
viable economy on the island that the Road would connect to Koror.

One of the most talked about potential projects is a golf course as part
of a luxury condominium project that may attract affluent foreign
visitors and part-time residents. To enable part-time foreign residents
to claim legal residence in Palau, existing law may have to be changed.
Even with the change in law, there is no assurance that wealthy foreign
residents will rush to Babeldaob, whose only major assets will be a road
around the island and a brand new national capital. There has yet to be
a plan for other infrastructure the island would need to fuel economic
growth of a magnitude that would have national impact.

There have also been discussions about the Road encouraging farming and
eventually commercial agricultural production. Establishing an
agricultural industry in an area which does not have such a history will
be a challenge. A useful example in this regard is the establishment of
a beef industry in Vanuatu. It took decades of work and significant sums
of money, in addition to land and other facilities to make it
commercially viable. An important factor in making Vanuatu's beef
industry viable has been its success with obtaining export license to
Japan. More recent successes with obtaining export licenses to Australia
and New Caledonia, both established beef producers themselves, have
added to Vanuatu's credibility as a commercial beef producer. The
important ingredient in Vanuatu's success with commercial beef
production is access to export markets, since domestic demand for beef
is not sufficient to keep the enterprise going.

III\. Focus on Tourism

Among the perennial issues in the context of economic development in the
Pacific is economic diversification. The region's geography and physical
isolation limit the range of activities that can beneficially be
undertaken. However, one of the industries most Pacific islands share,
with varying degrees of commercial success, is tourism. This is true as
much in Palau as anywhere in the Western Pacific and Palau's ecosystem
certainly is a major asset for tourism.

Given present conditions and Palau's established comparative economic
advantages, a more practical argument for economic growth and
development in the immediate future is focus on tourists, both divers
and others. Aiding Palau's economic recovery, just as it does Guam's,
CNMI's and Hawaii's, is economic recovery in Japan which still supplies
about half of Palau's tourists. The other half consists of Taiwanese and
others, including American and European divers and business travelers.
Based on figures for late last year and earlier this year, Palau expects
about 70,000 tourists this year. That figure would put the total near
the previous peak in 1996-97.

Palau is a small economy. It needs, proportionately, smaller doses of
capital and skills to reinvigorate it. Meanwhile, improving tourism and
tourist infrastructure should make it possible to pursue other roads to
growth, development and prosperity.