United States Government Accountability Office

GAO Report to Congressional Committees

COMPACTS OF FREE 

ASSOCIATION 

Development 

Prospects Remain 

Limited for Micronesia 

and Marshall Islands 

June 2006 

 

GAO-06-590 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

June 2006

COMPACTS OF FREE ASSOCIATION

Development Prospects Remain Limited 

Highlights of GAO-06-590, a report to for Micronesia and Marshall Islands 

congressional committees 

In 1987, the United States began 

providing economic aid to the

Federated States of Micronesia 

(FSM) and the Republic of the 

Marshall Islands (RMI) through a 

Compact of Free Association. In 

2004, through amended compacts

with the FSM and the RMI, the 

United States committed to provide

more than $3.5 billion until 2023. 

Joint U.S-FSM and U.S.-RMI 

compact management committees

are required, among other things,

to monitor progress toward

specified development goals and 

address implementation of policy 

reforms to stimulate investment. 

The legislation implementing the

amended compacts (P.L. 108-188) 

requires that GAO periodically

report on political, social, and 

economic conditions in the FSM 

and the RMI. In compliance with 

this requirement, GAO examined

each country’s (1) political and

social environment, (2) economic

environment, and (3) status of

economic policy reforms.

What GAO Recommends

GAO recommends that the 

Secretary of the Interior direct the 

Deputy Assistant Secretary for 

Insular Affairs, as Chairman of the 

compact management committees,

to ensure they meet requirements

to address the lack of FSM and RMI 

progress in implementing reforms 

to increase investment and tax 

income. Interior, Health and 

Human Services, the FSM and the

RMI generally agreed with the

recommendation and the need to 

find development opportunities. 

FSM and RMI political and social conditions challenge, respectively, 

effective compact grant implementation and health and education progress. 

Regarding political conditions, for example, the FSM states and national 

government have been unable to agree on implementation of the compact 

infrastructure grant, while the RMI government has had difficulty securing 

agreement from land owners regarding its use of leased land for compactrelated projects. Social challenges in both countries include persistent health 

and education problems despite substantial expenditures. For instance, the 

FSM and the RMI have low immunization rates relative to other countries 

with similar income levels. 

The FSM and the RMI economies show limited potential for achieving longterm development objectives. Both economies depend on public sector 

expenditures—funded largely by external assistance—and government 

budgets have growing wage expenditures, heightening the negative fiscal 

impacts they will face as compact grants decline (see figure). As a result, 

long-term economic growth must come from the private sector and 

increased income sent home from FSM and RMI emigrants (“remittances”). 

However, poor business environments hamper private industry in both 

countries, and FSM and RMI emigrants’ lack of marketable skills hinders 

increasing revenue from remittances. Compact management committees

have not discussed the countries’ progress toward budgetary self-reliance 

and long-term economic advancement at their annual meetings. 

FSM and RMI progress in key policy reforms has been slow. Country 

officials reported passing some new mortgage and bankruptcy laws, but 

other needed reforms have not been implemented. For example, according 

to economic experts, tax systems remain inequitable and inefficient and 

foreign investment regulations remain confusing and relatively burdensome. 

FSM and RMI development plans include reform objectives in each of these

areas; however, compact management committees have not addressed the 

nations’ slow progress in implementing reforms. 

Estimated Per Capita Compact Grant Assistance for Fiscal Years 1987-2023 

Fiscal year

Constant fiscal year 2004 U.S. dollars

Source: GAO analysis of amended compacts and U.S. Census population projections.

0

300

600

900

1,200

1,500

RMI

FSM

2023

201

2019

2020

2021

2022

8

201

2014

2015

2016

2017

3

200

2009

2010

2011

2012

8

200

2004

2005

2006

2007

3

199

1999

2000

2001

2002

8

199

1994

1995

1996

1997

3

19

1990

1991

1992

89

1988

1987

www.gao.gov/cgi-bin/getrpt?GAO-06-590.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact David B. 

Gootnick at (202) 512-3149 or 

gootnickd@gao.gov. 
Contents 

Letter 1

Results in Brief 3

Background 6

FSM and RMI Face Key Political and Social Challenges 13 

FSM and RMI Economies Show Limited Potential for Self-reliance 

and Long-term Advancement 18 

FSM and RMI Progress on Key Economic Policy Reforms Has Been 

Slow 29

Conclusions 36

Recommendations 36

Agency Comments 37 

Appendix I Objectives, Scope, and Methodology 40 

Appendix II Some Regional Socioeconomic Data for the Pacific 44 

Appendix III The FSM and RMI Private Sector Environment 46 

Appendix IV Comments from the Department of the Interior 47 

GAO Comments 56 

Appendix V Comments from the Department of Health and Human 

Services 57 

GAO Comment 61 

Appendix VI Comments from the Federated States of Micronesia 62 

GAO Comment 65 

Appendix VII Comments from the Republic of the Marshall Islands 66 

GAO Comments 71 

Appendix VIII GAO Contact and Staff Acknowledgments 74 

Page i GAO-06-590 Compacts of Free Association 
Tables 

Table 1: Annual U.S. Assistance for the FSM and the RMI under the 

Amended Compacts, Fiscal Years 2004 to 2023 11 

Table 2: Estimated Levels of Economic Assistance by Major 

Donors to the FSM and the RMI, Average from Fiscal 

Years 2002 to 2004 24 

Table 3: FSM and RMI Emigrants in Hawaii, Guam, and the CNMI, 

2003 28 

Table 4: FSM and RMI Government Commercial Enterprises 34 

Table 5: Some Estimated Socioeconomic Indicators for Select 

Pacific Island Nations 45 

Figures 

Figure 1: Annual Compact Assistance to the FSM and the RMI, 

Fiscal Years 1987-2003 7 

Figure 2: Estimated FSM and RMI Real Per Capita GDP 9 

Figure 3: Estimated FSM and RMI per Capita Compact Grant 

Assistance for Fiscal Years 1987-2023 12 

Figure 4: FSM and RMI External Grants and Estimated Real GDP 19 

Figure 5: Structure of FSM Revenues and Expenditures, Fiscal 

Years 2000-2005 21 

Figure 6: Structure of RMI Revenues and Expenditures, Fiscal 

Years 2000-2005 23 

Figure 7: Some Noted Problems with the FSM and the RMI Private 

Sector Environment 46 

Page ii GAO-06-590 Compacts of Free Association 
Abbreviations 

ADB Asian Development Bank 

CNMI Commonwealth of the Northern Marianas Islands 

FSM Federated States of Micronesia 

GDP gross domestic product 

HHS Department of Health and Human Services 

IMF International Monetary Fund 

JEMCO Joint Economic Management Committee (FSM) 

JEMFAC Joint Economic Management and Financial Accountability 

Committee (RMI) 

MCC Millennium Challenge Corporation 

NGO nongovernmental organization 

RMI Republic of the Marshall Islands 

WDI World Development Indicators 

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately. 

Page iii GAO-06-590 Compacts of Free Association 
United States Government Accountability Office

Washington, DC 20548 

June 27, 2006 

Congressional Committees: 

From 1987 to 2003, the United States provided about $2.1 billion in 

economic assistance to the Federated States of Micronesia (FSM)1

 and the 

Republic of the Marshall Islands (RMI) through a Compact of Free 

Association.2

 In 2003, the U.S. government negotiated new compact 

provisions with the FSM and the RMI that established an estimated $3.6 

billion in continued U.S. assistance from fiscal year 2004 through fiscal 

year 2023.3

 These “amended” compacts provide for decreasing annual

grant assistance over the 20-year period, paired with increasing 

contributions to trust funds that are to provide income for each country 

after compact grants cease. The amended compacts identify the twenty 

years of grant assistance as intended to assist the FSM and the RMI 

governments in their efforts to promote the economic advancement and 

budgetary self-reliance of their people. To this end, the amended compacts 

provide for continued economic assistance in the form of grants to sectorspecific areas, such as education, health, public infrastructure, and private 

sector development, prioritizing education and health. 

The amended compacts and their subsidiary agreements include 

requirements that the FSM and the RMI submit development plans and 

provide regular financial and performance reports. The amended 

compacts also require that the U.S. and the FSM Joint Economic 

 1

The FSM comprises the four states of Chuuk, Kosrae, Pohnpei, and Yap. Each state has its 

own constitution, elected legislature, and governor and maintains considerable power, 

relative to the central government, to implement budgetary policies. 

2

A key goal for this assistance was to advance economic development and self-reliance for 

both countries. In 2000, we reviewed the impact of compact funding and found that U.S.

assistance had resulted in little economic development for either the FSM or the RMI. See

GAO, Foreign Assistance: U.S. Funds to Two Micronesian Nations Had Little Impact on 

Economic Development, GAO/NSIAD-00-216 (Washington, D.C.: Sept. 22, 2000). 

3

For the purpose of this report, all annual references refer to the fiscal year rather than the 

calendar year. Note that the $3.6 billion in assistance includes (a) compact grants; (b) trustfund contributions; (c) Kwajalein impact funding provided to the RMI government, which 

in turn compensates Kwajalein Atoll landowners, for U.S. access to the atoll for military 

purposes; and (d) estimated values of compact-authorized federal services such as

weather, aviation, and postal services, at around $200 million over the 20-year period. 

Services associated with the Federal Emergency Management Agency have been excluded. 

Page 1 GAO-06-590 Compacts of Free Association
Management Committee (JEMCO) and the U.S. and the RMI Joint 

Economic Management and Financial Accountability Committee 

(JEMFAC) meet at least once annually to evaluate FSM and RMI progress 

in achieving the objectives specified within their development plans,4

 to 

identify problems encountered, and to recommend ways to increase the 

effectiveness of compact grant assistance.5

Regarding specific objectives within the development plans, the legislation 

implementing the amended compacts 6

directs JEMCO and JEMFAC to 

address objectives related to the implementation of policy reforms to 

encourage investment and to improve tax income.7

 The fiscal procedures

agreements direct JEMCO and JEMFAC to monitor FSM and RMI progress 

toward budgetary self-reliance and long-term economic advancement.8

 The 

legislation implementing the amended compacts also requires that the 

United States and GAO periodically report on political, social, and 

 4

The amended compact with the FSM requires the FSM government to prepare an official 

overall development plan. The RMI amended compact requires the RMI government to 

prepare an official medium-term budget and investment framework. The RMI has also

prepared two strategic development reports entitled “Meto 2000” and “Vision 2018.” In our 

report, we refer to the three RMI documents combined, as its development plans. 

5

JEMCO and JEMFAC were created under the amended compacts to strengthen 

management and accountability and to promote the effective use of compact funding. Each 

committee has five members, three from the United States and the other two from the FSM

for JEMCO and from the RMI for JEMFAC. The Departments of the Interior, State, and 

Health and Human Services supply the three U.S. representatives, with the Interior

representative serving as Chairman. 

6

P.L. 108-188. 

7

Specifically, the implementing legislation directs that the scope of the JEMCO and 

JEMFAC annual meeting, as outlined in the amended compacts, shall be construed as to 

read that the JEMCO and JEMFAC review required audits and reports, evaluate FSM and 

RMI progress in meeting objectives identified within their development plans, with 

particular focus on priority sectors and implementation of economic policy reforms to 

encourage investment and achieve self-sufficient tax rates, identify problems encountered, 

and recommend ways to increase the effectiveness of U.S. assistance. In this report, we use 

the term “address objectives” to refer to these actions. 

8

The fiscal procedure agreement for the FSM specifically states that JEMCO shall monitor 

FSM progress toward sustainable economic development and budgetary self-reliance in 

relation to its written goals and performance measures. The fiscal procedure agreement for 

the RMI specifically states that JEMFAC shall evaluate RMI progress to foster economic 

advancement and budgetary self-reliance in relation to its written goals and performance. 

In this report, we refer to both requirements as “monitoring.” Also, FSM and RMI 

development plans broadly refer to the terms “sustainable economic development” and

“economic self-sufficiency” in reference to their goals for long-term economic 

advancement.

Page 2 GAO-06-590 Compacts of Free Association
economic conditions in the FSM and the RMI as well as on the use and 

oversight of U.S. assistance to those nations. In compliance with the 

legislation’s requirement, this report9

 examines each country’s (1) political

and social environment regarding, respectively, compact grant 

implementation and health and education conditions; (2) economic 

environment, particularly respecting potential for achieving budgetary 

self-reliance and long-term economic advancement; and (3) status of 

economic policy reforms. 

To address our reporting objectives, we reviewed U.S., FSM, and RMI 

annual compact reports for 2004; FSM and RMI development plans; FSM 

and RMI economic reports and statistics; political assessments by the U.S. 

Department of State (State) and Transparency International;10 and Asian 

Development Bank (ADB), World Bank, and International Monetary Fund 

(IMF) reports on both economies. We interviewed officials from State and 

the U.S. Department of the Interior (Interior) as well as country experts at 

the ADB, the IMF, the World Bank, and the Pacific Islands Development 

Program at the East-West Center.11 We also interviewed relevant officials, 

banks, and numerous representatives from private industry (including 

local chambers of commerce) in the four FSM states and in the RMI. We 

determined that the social and economic data presented in this report are 

sufficiently reliable for our purposes. We conducted our review from 

August 2005 through March 2006 in accordance with generally accepted 

government auditing standards. A detailed description of our scope and 

methodology is included in appendix I of this report. 

Although the FSM and the RMI are stable democracies, each country’s 

political and social environments present significant challenges regarding, 

respectively, effective compact grant implementation and health and 

education conditions. Although reports by State and Interior emphasize 

Results in Brief 

 9

A separate report will examine the use and oversight of U.S. assistance to the FSM and the

RMI. 

10Transparency International is a global nongovernmental organization (NGO) devoted to

combating corruption. The organization consists of more than 90 locally established 

national chapters and chapters in formation that bring together relevant players from

government, civil society, business and the media to promote transparency in elections, in 

public administration, in procurement and in business.

11The East-West center is an education and research organization established by the U.S.

Congress in 1960 to strengthen relations and understanding among the peoples and nations

of Asia, the Pacific, and the United States. 

Page 3 GAO-06-590 Compacts of Free Association
that both countries are established democracies with free and peaceful 

elections, interviews with U.S. and country officials revealed that, in each

country, political factors have hindered compact implementation. For 

example, in the FSM, the states and national government have been unable

to agree on implementation of the compact infrastructure grant. In the 

RMI, the national government has had difficulty securing agreement from 

Kwajalein Atoll land owners regarding management of public entities and

the RMI governments’ use of leased land for compact-related development 

projects. With regard to the social environment, both countries face 

challenging health and education conditions despite substantial 

expenditures. For example, both countries have relatively low rates of 

immunization and significant percentages of teachers who lack basic 

qualifications. 

The economic environments in the FSM and the RMI have not improved 

significantly in recent years, and both countries show limited potential for 

development objectives of budgetary self-reliance and long-term economic 

advancement. As in the original compact period, both countries’ 

economies are dependent on public sector expenditures; government 

spending, which accounts for about 60 percent of the gross domestic 

product (GDP) in each country, is funded largely by external assistance 

rather than domestic production. Both governments’ budgets are also 

characterized by growing wage expenditures, exacerbating the substantial 

negative fiscal impacts they are likely to face with the decline of compact 

grants through fiscal year 2023. Increased economic assistance from other 

countries could support FSM and RMI budget needs and standards of 

living, but the degree to which such opportunities could annually offset 

decreased compact moneys is uncertain. Over the long term, economic 

growth will likely have to originate from the private sector and increased 

income sent home from Micronesians living abroad (“remittances”). 

However, the two private sector industries that the United States, the FSM, 

and the RMI have identified as having growth potential—fisheries and 

tourism—face significant barriers to expansion because of the FSM’s and 

the RMI’s remote geographic location, inadequate infrastructure, and poor 

business environments. At the same time, FSM and RMI emigrants’ current 

lack of marketable skills, due to insufficient education and vocational 

training, is an obstacle to increased revenue from remittances. To date,

JEMCO and JEMFAC have not discussed the countries’ limited progress in 

creating conditions for budgetary self-reliance and long-term economic 

advancement at their annual meetings. 

FSM and RMI progress in key policy reforms has been slow. Country 

officials reported that each of the FSM states and the RMI has 

Page 4 GAO-06-590 Compacts of Free Association
implemented some legislative reforms aimed at improving the private

sector environment, including bankruptcy and mortgage laws. However, 

according to the IMF, the ADB, and other economic experts, although 

such laws are necessary for an effective private sector environment, they 

are insufficient for stimulating investment and improving tax income 

without key reforms in taxes, land ownership, foreign investment 

regulations, and public sector management. These experts argue that the 

current tax systems in the FSM and the RMI are inequitable and inefficient. 

However, country officials reported that neither country has begun 

implementing fundamental tax reform, although the FSM has generally

agreed on principles of a new tax system. In addition, interviews with 

economic experts, officials, and private sector representatives suggest that 

land ownership structures provide inadequate access to land for public 

and private investment, a problem that has not eased with the 

establishment of land registration offices. Economic experts and private 

sector representatives further describe foreign investment regulations as 

confusing and relatively burdensome, whereas public sector reform efforts 

have failed to reduce public sector competition with the private sector. 

FSM and RMI development plans include objectives for reforms in each of 

these areas, yet JEMCO and JEMFAC have not addressed these nations’ 

slow progress in implementing reforms. 

In this report, we recommend that the Secretary of the Interior direct the

Deputy Assistant Secretary for Insular Affairs, as Chairman of JEMCO and 

JEMFAC, to ensure that they meet requirements to address the lack of 

FSM and RMI progress in implementing their specified reforms to improve 

the business environment and encourage increased investment and tax 

income. 

We provided a draft of this report to the Departments of the Interior, State, 

HHS, and Treasury, as well as to the FSM and the RMI governments. We 

received comments from Interior, HHS, the FSM and the RMI. 

Reproductions of these letters, as well as our responses to the letters, can

be found in appendixes IV through VII. Interior concurred with our 

recommendation and expressed its intention to implement it, partly 

through pursuing additional information on the FSM and the RMI 

economies. We agree with the importance of further economic 

information, but we believe that sufficient information is available for the 

committees to meet their requirement to address FSM and RMI progress in 

implementing policy reform. HHS also agreed with our recommendation 

and requested that it be expanded to include JEMCO and JEMFAC 

requirements for establishing reform implementation timelines. While 

establishing timelines is not a requirement under the amended compact or

Page 5 GAO-06-590 Compacts of Free Association
its subsidiary agreements, we encourage the JEMCO and JEMFAC to 

consider this idea as one method to improve U.S. assistance. The FSM 

agreed with our report findings, but disagreed with our conclusion that its 

development prospects remain limited. We assert that the FSM could 

advance its compact goals through an improved business environment and 

actions to maximize its’ unique economic opportunities. However, we 

maintain the importance of frank JEMCO discussion of current FSM 

economic realities. Finally, the RMI advocated for further JEMFAC 

support in policy reform implementation—highlighting the particular 

importance of public sector reform—and emphasized that the government 

has met its requirement to contribute an initial $30 million to its trust fund. 

While we agree with the importance of public sector reforms, the RMI’s 

trust-fund contribution does not alter the characteristic dependence of the 

RMI economy on external assistance. 

After more than 40 years under U.S. administration as part of the United 

Nations Trust Territory of the Pacific Islands,12 the FSM and the RMI 

became sovereign nations in 1978 and 1979, respectively. For the last 20

years, the United States’ relationship with the two countries has been 

defined by the original Compact of Free Association and the subsequent 

amended Compacts of Free Association. 

In 1986, the United States, the FSM, and the RMI entered into the original 

Compact of Free Association. Representing a new phase of the unique 

relationship between the United States and these island areas, the 

compact provided a framework for the United States to work toward 

achieving its three main goals: (1) to secure self-government for the FSM 

and the RMI, (2) to ensure certain national security rights for all of the 

parties, and (3) to assist the FSM and the RMI in their efforts to advance 

economic development and self-sufficiency. The first goal was met; the 

FSM and the RMI are independent nations. The second goal has also been 

achieved with the compact’s establishment of several key defense rights 

for all three countries. The defense relationship continues with, among 

other things, U.S. access to military facilities on Kwajalein Atoll in the RMI 

through 2016. The compact’s third goal was to be accomplished primarily 

Background 

Compact of Free 

Association, 1986 to 2003 

 12The U.S. Department of the Navy began civil administration of these islands on July 18, 

1947; this responsibility was transferred to Interior in July 1951. See GAO, Foreign 

Assistance: Effectiveness and Accountability Problems Common in U.S. Programs to 

Assist Two Micronesian Nations, GAO-02-70 (Washington, D.C.: Jan. 22, 2002). 

Page 6 GAO-06-590 Compacts of Free Association
through U.S. direct financial assistance to the FSM and the RMI. For the 

15-year period covering 1987 to 2001, funding was provided at levels that 

decreased every 5 years. For 2002 and 2003, during negotiations to renew 

expiring compact provisions, funding levels increased (see fig. 1) to equal 

an average of the funding provided during the previous 15 years plus 

inflation. For 1987 through 2003, compact financial assistance to the FSM 

and the RMI was estimated, on the basis of Interior data, to be about $2.1 

billion.13

Figure 1: Annual Compact Assistance to the FSM and the RMI, Fiscal Years 1987-

2003 

Source: GAO analysis of U.S. Department of Interior data.

U.S. dollars in millions U.S. dollars in millions

0

20

40

60

80

100

FSM

2002- 

2003

1997-

2001

1992-

1996

1987-

1991

0

10

20

30

40

50

RMI

2002- 

2003

1997-

2001

1992-

1996

1987-

1991

Economic development and self-sufficiency were not achieved under the 

original compact. Both nations remained dependent on U.S. funds; total 

U.S. assistance accounted for more than 50 percent of government 

 13This estimate represents total nominal outlays. It does not include payments for compactauthorized federal services or U.S. military use of Kwajalein Atoll land, nor does it include 

investment development funds provided under section 111 of Public Law 99-239. 

Page 7 GAO-06-590 Compacts of Free Association
revenues throughout the compact period.14 In addition, FSM and RMI GDP 

estimates reveal that per capita GDP at the close of the compact had not 

exceeded, in real terms, early 1990s levels in either country (see fig. 2).15

Although U.S. direct assistance maintained standards of living that were 

higher than could be achieved without support, we found previously that 

compact funds spent on economic development were largely ineffective in

promoting economic growth.16 For example, compact funds were used to 

support general government operations that, among other things, 

maintained high levels of public sector employment and wages, creating 

disincentives to private sector growth. Compact funds were also used to 

support business ventures, most of which have failed. In our examination 

of a wide range of projects funded under the compact, we found that many 

projects experienced problems due to poor planning and management, 

inadequate construction and maintenance, or misuse of funds. In 2000, we 

recommended, among other things, that the Secretary of State direct the

Special Negotiator for the Compact of Free Association to negotiate 

amended compact provisions that include assistance provided through 

grants targeted to priority areas, expanded reporting and consultation 

requirements, and the ability to withhold funds for noncompliance with 

compact terms and conditions.17

 14In addition to providing compact grants, the United States gave the FSM and the RMI

access to programs from various agencies, such as the Departments of Education and 

Health and Human Services. Total U.S. assistance, therefore, includes compact grants and 

U.S. program assistance. 

15In the FSM, however, state per capita GDP performance varied. For example, real per 

capita GDP declined from 1987 to 2003 in Chuuk and Kosrae while it increased in Pohnpei 

and Yap.

16GAO/NSIAD-00-216. 

17GAO/NSIAD-00-216. 

Page 8 GAO-06-590 Compacts of Free Association
Figure 2: Estimated FSM and RMI Real Per Capita GDP 

Fiscal year

Constant fiscal year 2003 U.S. dollars

Source: GAO analysis of FSM and RMI national accounts data.

0

500

1,000

1,500

2,000

2,500

3,000

RMI

FSM

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Note: For the RMI, real GDP was determined using the U.S. price deflator for 1990 to 1995 and the 

RMI price deflator for 1996 to 2003. 

The compact also gave citizens of both nations the rights to live and work

in the United States as “nonimmigrants” and to stay for long periods of 

time. Further, the compact exempted FSM and RMI citizens from meeting 

U.S. passport, visa, and labor certification requirements when entering the 

United States. In 2001, we reported that during the compact, a significant 

number of FSM and RMI citizens had migrated to the United States and 

U.S. island areas.18

 18We use the term “U.S. island areas” to refer collectively to Guam, Hawaii, and the 

Commonwealth of the Northern Mariana Islands. See GAO, Foreign Relations: Migration

from Micronesian Nations Has Had Significant Impact on Guam, Hawaii, and the

Commonwealth of the Northern Mariana Islands, GAO-02-40 (Washington, D.C.: Oct. 5,

2001). 

Page 9 GAO-06-590 Compacts of Free Association
The United States negotiated separate amended compacts with the RMI 

and the FSM that went into effect on May 1, 2004, and June 25, 2004, 

respectively.

19 The amended compacts continue the defense relationship, 

including a new agreement providing U.S. military access to Kwajalein 

Atoll in the RMI through 2086;20 strengthen immigration provisions; and 

provide direct financial assistance, in the form of grants, to the FSM and 

the RMI for fiscal years 2004 to 2023 (see table 1). To promote FSM and 

RMI budgetary self-reliance and economic advancement, the amended 

compacts and their subsidiary agreements, along with the countries’ 

development plans, target grant assistance to six sectors—education, 

health, public infrastructure, the environment, public sector capacity 

building, and private sector development—prioritizing two sectors, 

education and health. In addition to providing grant assistance, the

amended compacts provide for the establishment of trust funds for both 

countries that can provide income after annual compact grants cease. The 

amended compacts, their subsidiary agreements, and the U.S. 

implementing legislation also establish numerous reporting and 

accountability requirements—including the legislation’s direction to the 

JEMCO and JEMFAC to specifically address economic policy reforms to 

encourage investment and improve tax income. 

Amended Compacts of 

Free Association 

 19The amended compacts and related agreements addressed most of the recommendations 

that we had made in past reports. See GAO, Compact of Free Association: An Assessment 

of the Amended Compacts and Related Agreements, GAO-03-890T (Washington, D.C.: June

18, 2003). 

20Both the original and the amended compacts provide for the United States’ use of 

portions of the Kwajalein Atoll for military and defense purposes. The new agreement 

provides U.S. military access to Kwajalein Atoll through 2066, with an option to extend 

access through 2086. See GAO, Foreign Relations: Kwajalein Atoll Is the Key U.S. Defense

Interest in Two Micronesian Nations, GAO-02-119 (Washington, D.C.: Jan. 22, 2002). 

Page 10 GAO-06-590 Compacts of Free Association
Table 1: Annual U.S. Assistance for the FSM and the RMI under the Amended

Compacts, Fiscal Years 2004 to 2023 

Dollars in millionsa

Fiscal year FSM grants FSM trust fund RMI grants RMI trust fund

2004 $76.2 $16.0 $35.2 $7.0

2005 76.2 16.0 34.7 7.5

2006 76.2 16.0 34.2 8.0

2007 75.4 16.8 33.7 8.5

2008 74.6 17.6 33.2 9.0

2009 73.8 18.4 32.7 9.5

2010 73.0 19.2 32.2 10.0

2011 72.2 20.0 31.7 10.5

2012 71.4 20.8 31.2 11.0

2013 70.6 21.6 30.7 11.5

2014 69.8 22.4 32.2b12.0

2015 69.0 23.2 31.7 12.5

2016 68.2 24.0 31.2 13.0

2017 67.4 24.8 30.7 13.5

2018 66.6 25.6 30.2 14.0

2019 65.8 26.4 29.7 14.5

2020 65.0 27.2 29.2 15.0

2021 64.2 28.0 28.7 15.5

2022 63.4 28.8 28.2 16.0

2023 62.6 29.6 27.7 16.5

Source: Compact of Free Association as Amended, Between the Government of the United States of America and the Government of 

the Federated States of Micronesia and the Government of the Republic of the Marshall Islands, P.L. 108-188. 

Note: These figures do not include funding for Kwajalein Atoll landowners in the RMI or the $500,000 

annual audit grant that will be provided to both countries.

a

The amounts shown in table 1 will be partially adjusted for inflation, with fiscal year 2004 as the base

year. Grant funding can be fully adjusted for inflation after fiscal year 2014 under certain economic 

conditions. 

b

Beginning in 2014, an additional $2 million will be added to RMI annual grants to address the special 

needs of Kwajalein Atoll. 

Including estimated inflation adjustments, total combined compact grant 

assistance to the two countries is projected at an estimated $3.6 billion 

over the 20-year assistance period. However, to provide increasing U.S. 

contributions to the FSM’s and the RMI’s trust funds, grant funding will 

decrease annually. Assuming current population growth estimates from 

the U.S. Census Bureau, this decrease in grant funding will result in falling 

Page 11 GAO-06-590 Compacts of Free Association
per capita grant assistance over the funding period and relative to the 

original compact (see fig. 3). 

Figure 3: Estimated FSM and RMI per Capita Compact Grant Assistance for Fiscal 

Years 1987-2023 

Fiscal year

Constant fiscal year 2004 U.S. dollars

Source: GAO analysis of amended compacts and U.S. Census population projections.

0

300

600

900

1,200

1,500

RMI

FSM

2023

201

2019

2020

2021

2022

8

201

2014

2015

2016

2017

3

200

2009

2010

2011

2012

8

200

2004

2005

2006

2007

3

200

2001

2002

0

199

1999

8

199

1994

1995

1996

1997

3

19

1990

1991

1992

89

19881987

Note: Compact grant assistance was decreased in 1991, 1996, and 2001, then increased in 2002 and 

2003 to equal an average of the funding provided during the previous 15 years. Compact grant 

assistance under the amended compacts (2004 to 2024) is decreased annually. Funding for compactauthorized federal services, trust-fund contributions, and U.S. military use of Kwajalein Atoll land is

not included. 

While the level of annual grant assistance to both countries decreases each 

year, contributions to trust funds—meant to provide an ongoing source of

revenue after fiscal year 2023—increase annually by a comparable amount.

In comparing projected trust fund revenue with the fiscal year 2023 grant 

level, we reported earlier that, under certain conditions, the trust fund 

revenue available in 2024 may be less than even the lower level of grant 

Page 12 GAO-06-590 Compacts of Free Association
funding in 2024.21 For example, at an assumed annual 6 percent rate of 

return, earnings from the FSM’s trust fund would be lower than expiring 

grant assistance in 2024, while earnings from the RMI’s trust fund would 

encounter the same problem by 2040.22 If the trust funds consistently earn

a higher rate of return, or if additional contributions to the funds are 

provided, the probability rises that the trust funds could provide a 

sustainable income source at the level of fiscal year 2024 grants. However, 

if the trust funds experience market volatility with years that have 

negative returns, the probability that these funds would yield income 

sufficient to replace expiring grant assistance declines. 

Although the FSM and the RMI are stable democracies, both countries face 

political and social challenges with regard to improving grant 

implementation and health and education conditions. U.S. and country 

officials told us that political conditions, including a weak federation in 

the FSM; disputes over public institutions’ and government use of land on

Kwajalein Atoll in the RMI; and both governments’ lack of communication 

with their constituencies have hindered compact implementation and 

service delivery. At the same time, despite relatively high health and 

education expenditures, both countries face development challenges in

these sectors. For example, although the Millennium Challenge 

Corporation (MCC)—which evaluates indicators with a relationship to 

growth and poverty reduction—ranks the FSM and the RMI in the top 20 

percent for health expenditures relative to other lower-middle-income 

FSM and RMI Face 

Key Political and 

Social Challenges 

 21For our earlier analysis, see GAO-03-890T. Since 2003, the RMI has also secured trust-fund 

contributions from the authorities on Taiwan. However, both the FSM and RMI trust-funds

experienced delays in getting invested. The RMI stated in its comments to this report that

such delays will impact performance of its trust-fund in the long run. To reflect the most 

recent market and trust-fund information, we will be updating our trust-fund analysis in a 

separate report, forthcoming.

22In designing the trust funds, the Department of State assumed that the trust fund would 

earn a 6 percent rate of return in order to reflect a conservative investment strategy. This 

rate of return can be compared with the current average forecasted return for long-term 

U.S. government bonds of 5.2 percent by the Congressional Budget Office. 

Page 13 GAO-06-590 Compacts of Free Association
countries, it ranks both countries in the bottom third for a key health 

indicator, immunizations.23

Despite Stable Democratic

Systems, Political Factors 

in the FSM and the RMI 

Challenge Compact 

Implementation 

The FSM and the RMI are established democracies with free and peaceful

elections. According to State and Interior, each democracy is stable 

despite the challenges of having hierarchical traditional structures; islands 

with scattered populations; and a citizenry of distinct cultures, languages, 

and histories. Each country also has a vocal civil society evidenced by

religious organizations and nongovernmental organizations (NGO) that 

have been active on some political issues. Internationally, both countries 

also participate in various regional organizations, many of which address 

trade, energy, and environmental challenges faced by island nations. For 

example, the FSM and the RMI are members of the Forum Fisheries 

Agency—which promotes sustainable management of fisheries in the 

Pacific—and the South Pacific Applied Geoscience Commission, which 

promotes sustainable development of offshore resources for member 

countries. 

Despite the two countries’ stable democratic systems, interviews with 

U.S., FSM, and RMI officials and civil society representatives indicated 

that key aspects of the FSM’s and the RMI’s political environments hinder 

effective compact grant implementation. 

• Lack of government consensus. State and Interior officials reported 

that the FSM’s weak federal structure inhibits compact grant 

implementation. Because each state has its own constitution and authority

over budgetary policies, the central government that is represented on 

JEMCO does not control the majority of compact funds and have been 

unable to secure agreement from the state governments regarding 

compact needs.24 As a result, FSM access to the compact infrastructure 

 23The Millennium Challenge Act of 2003 (P.L. 108-199) established the Millennium 

Challenge Corporation (MCC) in January 2004; MCC administers the Millennium Challenge

Account. Through this account, the United States provides development assistance to 

lower-income and lower-middle income countries that demonstrate, among other factors, a

commitment to just and democratic governance, economic freedom, and investing in their 

people. According to the World Bank’s World Development Indicators, the FSM and the

RMI are lower-middle income countries. 

24For example, the central government manages less than 10 percent of compact sector 

grants. Further, due to confusion about how the FSM consolidated budget translates into 

specific state resource flows, for the fiscal year 2007 budget consultations, the Department

of the Interior will consult with the state governments directly, rather than through the 

central government. 

Page 14 GAO-06-590 Compacts of Free Association
grant, for example, has been delayed for more than 2 years owing to 

national and state disagreements over infrastructure priorities. Similarly, 

the RMI government and landowners on Kwajalein Atoll have been 

disputing government use of leased land and management of public 

entities on the atoll. Such tensions have negatively affected the 

construction of schools funded by compact grants and the management of

the Kwajalein utility company and the Kwajalein development authority, 

two entities that also receive compact funds.25

• Lack of government communication. Interviews with U.S., FSM and 

RMI departmental officials, private sector representatives, NGOs, and 

external economic experts revealed a lack of communication and 

dissemination of information by each government on wide-ranging issues, 

including JEMCO and JEMFAC decisions, departmental budgets, 

economic reforms, legislative decisions, fiscal positions of public 

enterprises, and economic statistics. Additionally, private sector 

representatives in several FSM states reported that the public radio station 

serves as the government’s primary means of disseminating information 

but is often nonoperational or censored—a complaint confirmed by the 

U.S. State Department’s 2004 Report on Human Rights Practices in the 

FSM. In the RMI, a State official and an official from the RMI Council of 

NGO’s reported that the government had been criticized—most strongly 

by environmental NGO’s and a leading women’s NGO (Women United 

Together Marshall Islands)—for not holding public hearings or

disseminating sufficient information regarding a proposed dry dock.26

According to the World Bank, Transparency International, and other 

development experts, lack of information about government activities 

creates uncertainty for public, private, and community leaders, which can 

inhibit grant performance and improvement of social and economic 

conditions. 

 25In addition to these examples, land issues remain a problem for U.S. access to Kwajalein 

Atoll through the defense provisions of the amended compact. The RMI government is

bound by an agreement with the U.S. government that allows for U.S. access to Kwajalein 

Atoll until 2086. To date, the RMI government has not reached an agreement with 

Kwajalein Atoll landowners (who own the land under use by the U.S. government) that

allows for this long-term access. 

26In June 2004, RMI officials announced plans for a Taiwanese-funded floating dry dock to

be placed in downtown Majuro (the capital city of the RMI). Members of the RMI’s NGO 

community opposed this plan owing to potential negative impacts on the reef, sea life, and 

the downtown community. 

Page 15 GAO-06-590 Compacts of Free Association
Although FSM and RMI health and education expenditures are relatively 

high, certain conditions in both countries’ health and education sectors are 

poor. According to the World Bank, among 171 countries for which it 

reports aid per capita, the RMI and the FSM ranked 5th and 6th highest, 

respectively, with per capita aid greater than $900 in 2003.27 Much of this 

aid is directed toward health and education.28 MCC provides economic 

assistance to developing countries, with eligibility determined partially by

evaluating a country’s performance—relative to other countries within its 

income group—on select indicators associated with economic growth and 

poverty reduction. MCC ranks the FSM in the top 35 percent (in the 81st 

and 67th percentile, respectively) for expenditures on health and primary 

education, and it ranks the RMI in the top 1 percent for both indicators, 

relative to other lower-middle income countries that qualify for MCC 

assistance. However, for another health-related indicator—

immunizations—MCC ranks both countries in the bottom third: the FSM in 

the 33rd percentile and the RMI in the 13th percentile.29 According to the 

World Bank’s World Development Indicators (WDI), the FSM also 

performs relatively poorly in provision of safe water or sanitation—a 

service necessary for improved health outcomes. According to WDI, only 

28 percent of FSM citizens have access to improved sanitation, compared

with an average of 57 percent in all lower-middle income countries. In the

RMI, the 1999 census suggests that 85 percent of the population has access 

to safe water, although the RMI 2003 statistical yearbook reports that 

recent tests in urban and rural areas indicate that a significant number of 

potable water sources, such as groundwater wells and water catchments—

30 percent or more in some cases—are contaminated and deemed unsafe 

for human consumption. (For further information on socioeconomic 

Despite High 

Expenditures, Both 

Countries Remain 

Challenged in Improving 

Health and Education 

Conditions 

 27Countries with higher per capita aid levels include French Polynesia, New Caledonia,

Mayotte, and Palau, which also has a Compact of Free Association with the United States. 

28As directed by the amended compacts, the FSM and the RMI have placed a priority on the 

health and education sectors. For example, education expenditures amounted to $221 per 

capita in the RMI and $192 per capita in the FSM. In the FSM, however, per capita health 

and education expenditures varied widely by state, reflecting variations in per capita 

assistance received. For example, although Chuuk state represents an estimated 50 percent

of the FSM population, it receives only 38 percent of compact funds. 

29MCC also examines girls’ primary education completion, but data for this indicator were 

not available for either the FSM or the RMI. Regarding immunizations, the RMI had a large 

measles outbreak in 2003. In response to this outbreak, HHS initiated steps to improve 

vaccine coverage, including, among other things, assigning a public health advisor to the

Pacific Islands Health Officers Association in 2005; continuing its commitment to fund a

regional immunization epidemiologist to be based in the FSM; and committing to place a 

public health advisor in Chuuk State. 

Page 16 GAO-06-590 Compacts of Free Association
conditions in the FSM and the RMI, particularly in relation to regional 

averages, refer to app. II.) 

Country studies and health and education officials in the FSM and the RMI 

also highlight other challenges—for example, the increasing prevalence of

lifestyle diseases such as diabetes or hypertension; youth health issues; 

and poor teaching skills. According to the FSM Department of Health, 80 

percent of 35 to 64 year-olds are overweight, and the number of cases 

involving diabetes, hypertension, heart disease, and cancer increased in 

the late nineties. Likewise, the RMI Ministry of Health reports that 

diabetes figured as the leading cause of adult morbidity in 2000 and 2001. 

Although the RMI has made progress in reducing overseas referrals since 

2001, the rising prevalence of lifestyle diseases poses challenges for 

delivery of health services in both nations. The care and treatment of such 

diseases often involves expensive referrals abroad, lowered funding for 

public health programs that serve impoverished populations, and burdens

on household and national budgets. Future health outlays will also be 

affected by health challenges facing FSM and RMI youths.30 FSM and RMI 

health officials indicated concern about growing youth problems such as 

suicides, sexually transmitted diseases, and teen pregnancy. With regard to

teacher qualifications, the FSM Department of Education reports that 90 

percent of teachers need to upgrade skills to meet new certification 

standards (a bachelor’s degree with courses in child development). In the 

RMI, a 2004 Ministry of Education assessment reported that more than 50

percent of teachers had failed basic English literacy tests.31

 30A World Bank study highlights suicide as a serious risk for RMI youths, with 66 cases of

attempted or completed suicides in 2003 (an increase of 20 percent from 2002). See World 

Bank, East Asia and the Pacific Region, Opportunities That Change People’s Lives: 

Human Development Review of the Pacific Islands - RMI Country Case Study

(Washington, D.C.: 2005). The RMI has pursued a vigorous outreach program to address

this problem, however, and reported suicides fell significantly in 2005.

31According to the RMI’s Economic Policy, Planning, and Statistics Office, only 14 percent

of Marshallese staff who took the test passed both the reading and writing components. 

Page 17 GAO-06-590 Compacts of Free Association
In the past 2 years, the FSM and the RMI economies have performed 

modestly and have been characterized by continued dependence on 

external assistance, suggesting limited prospects for achieving

development goals of budgetary self-reliance and long-term economic 

advancement. Private sector employment has largely stagnated in both 

countries, whereas public sector expenditures continue to account for 

almost two-thirds of GDP. Despite the amended compacts’ structure of 

declining grant assistance, the FSM and the RMI public sectors have grown 

while tax revenues remain relatively small. Unless each nation can secure

other donor assistance, maintenance of living standards over the long term 

will likely require private sector expansion or increased remittances.32 The 

FSM and the RMI private sectors face significant constraints to growth, 

however, and FSM and RMI emigrants’ current lack of marketable skills is 

a hurdle to increased remittance revenue. Although the amended 

compacts’ fiscal procedures agreements require JEMCO and JEMFAC to 

monitor FSM and RMI progress toward budgetary self-reliance and longterm economic advancement, neither organization has discussed these 

issues at its annual meeting or defined what actions they will undertake to

meet this requirement. 

As in the original compact period, FSM and RMI economic conditions in 

2004 and 2005 were characterized by dependence on foreign assistance. In

the FSM, 2004 and 2005 GDP fell owing to compact delays and a lower 

level of assistance relative to 2003.33 For the RMI, the IMF estimates that 

GDP expanded moderately owing to increased public sector expenditure 

(see fig. 4).34 While the RMI also experienced compact delays in 2004, RMI 

public expenditure increased in both 2004 and 2005, reflecting expected 

compact funding at levels roughly equivalent to fiscal years 2002 and 2003,

when compact funds were temporarily increased. Both countries’ 2005 

public sector expenditure—about two-thirds of which is funded by 

external grants—remained at about 60 percent of GDP. 

FSM and RMI 

Economies Show 

Limited Potential for 

Self-reliance and 

Long-term 

Advancement 

FSM and RMI Economies 

Depend on Government 

Spending of Foreign 

Assistance Instead of 

Private Sector Production 

 32In this report, we use “remittances” to refer to funds voluntarily transferred by emigrants

to their home countries. 

33Earlier estimates by the IMF and the FSM predicted minimal GDP growth in 2005, based 

on an assumption of increased government expenditure; however, compact delays 

continued into 2005. 

34IMF and RMI government estimates of GDP growth differ due to different inflation 

assumptions. According to RMI economic consultants, RMI estimates will be updated to 

reflect new inflation assumptions to accord more closely to those used by the IMF. 

Page 18 GAO-06-590 Compacts of Free Association
Figure 4: FSM and RMI External Grants and Estimated Real GDP 

Source: GAO analysis of FSM national accounts data and IMF estimates of RMI national accounts data. 

GDP, constant fiscal year

2003 U.S. dollars

External grants,

U.S. dollars in millions

GDP, constant fiscal year

2003 U.S. dollars

External grants,

U.S. dollars in millions

210 

220 

230 

240 

FSM GDP 

 

2001 2002 2003 2004 2005 

100 

110 

120 

130 

140 

150 

RMI GDP 

 

2001 2002 2003 2004 2005 

0 

30 

60 

90 

120 

FSM external grants

0 

15 

30 

45 

60 

RMI external grants

0 0

In both the FSM and the RMI, however, private sector activity has 

remained relatively stagnant and exists largely to provide services to the 

public sector. Since 2000, the estimated private sector share of GDP has 

fallen in both countries and only Pohnpei state in the FSM has had modest 

growth in private sector employment, principally in wholesale and retail 

operations.35 Institutions such as the IMF and the ADB characterize the 

private sector in both the FSM and the RMI as isolated from international 

opportunities, given each economy’s high dependence on imports and 

negligible foreign investment.36

 35Both the FSM and the RMI have limited data on private sector profits. Employment data 

and interviews with private sector representatives confirm the lack of private sector 

growth. 

36Reliable exact trade data are not available. However, current information suggests that 

imports exceed exports almost sevenfold in the FSM and almost fivefold in the RMI. 

Page 19 GAO-06-590 Compacts of Free Association
FSM and RMI Will Likely 

Face Significant Budgetary 

Pressure with Declining 

Compact Assistance. 

Given the recent performance and structure of FSM and RMI government

budgets, both nations are likely to face significant budgetary pressure as 

compact grants decline through 2023. Apart from 2002 and 2003, when 

compact assistance was temporarily increased, FSM national and state 

budgets have varied widely from year to year; however, each has had 

recent budget deficits. RMI government finance statistics reported by the 

IMF suggest that the RMI fiscal balance deteriorated after 2003 as well, 

with an estimated deficit equivalent to 2 percent of GDP in 2005. 

Economic experts emphasize that, structurally, both country’s budgets are 

characterized by a small local revenue base and recent increases in 

government payroll. As a result, unless other donors provide additional 

assistance, expenditure reductions will be required as compact grants 

decline.37

• FSM budget structure. Although tax revenue in the FSM increased 

slightly in 2005, the FSM tax base is small and the growing wage bill is high 

relative to regional standards. In 2005, FSM taxes provided an estimated 

$29 million in revenue, or 23 percent of total revenue (compared with an 

average of 17 percent from 2000 to 2004).38 In addition, the FSM 

government receives fishing access fees from foreign vessels that fish in 

its exclusive economic zone. However, the largest income source is 

external grants, which, at $76 million, accounted for 60 percent of 

revenues in 2005 (see fig. 5). In terms of expenditure, the largest FSM 

expenditure component is public sector wages and salaries at an estimated

$60 million.39 This component grew from 36 percent of total expenditures 

in 2000 to 2004 to 42 percent of total expenditures in 2005.

40

 37Both economies scaled back public sector employment and total wage expenditures in

the late 1990s as part of an ADB-financed public sector restructuring program. FSM public 

sector employment has varied since 2000, but the level in 2005 is the highest over the past 5 

years. In the RMI, public sector employment steadily increased from 2000 to 2005. 

38FSM tax revenue accounts for about 11 percent of GDP, compared with Fiji, Palau, Papua 

New Guinea, Solomon Islands, or Kiribati tax revenues, each of which accounts for more 

than 20 percent of GDP. 

39The FSM public sector wage bill accounts for about 25 percent of GDP. In contrast, the 

public sector wage bills in Fiji, the Solomon Islands, Papua New Guinea, and Samoa

account for less than 12 percent of GDP. 

40However, the FSM fiscal outlook is complicated by varied state budget structures that

create differences in fiscal vulnerabilities. For example, 2005 tax revenues ranged from 28

percent of total revenues in Pohnpei to 16 percent of total revenues in Kosrae, while the

2005 wage bill ranged from 30 percent in Yap to 57 percent in Chuuk. Moreover, the FSM

will face an additional element of fiscal adjustment as it is required to phase out over 5 

years its ineligible use of the compact capacity building grant for general government

operations.

Page 20 GAO-06-590 Compacts of Free Association
Figure 5: Structure of FSM Revenues and Expenditures, Fiscal Years 2000-2005 

60% 

8% 

68% 17% 23% 

11% 

7% 6% 

5% 5% 

17% 

36% 

37% 

4% 

42% 

5% 

12% 

37% 

Taxes

Other 

Grants

Fishing fees

Capital 

Transfers

Other 

Travel 

Source: GAO analysis of IMF and FSM government finance data.

2000-2004 Revenues: Average of $150 million 2005 Revenues: $127 million

2000-2004 Expenditures: Average of $153 million 2005 Expenditures: $145 million

Wages

Note: Transfers include subsidies and represent payments for which no goods or services are

received. “Other” revenues comprise dividend and interest income, service charges, and fees. “Other” 

expenditures consist primarily of current expenditures on goods and services. 

Page 21 GAO-06-590 Compacts of Free Association
• RMI budget structure. As a percentage of total revenue, the RMI’s tax 

base is slightly larger than the FSM’s. As a percentage of total expenditure,

the RMI’s public sector wage bill is also relatively smaller, although its 

wage bill increases have exceeded the FSM’s. Taxes in the RMI provide 

about $22 million in revenue to the government, or roughly 26 percent of 

total revenues (see fig. 6). The RMI also receives fishing access fees. At 64 

percent of total revenues, external grants are the largest income 

component, providing $54 million in 2005. The structure of RMI revenues 

remained roughly the same over the past 5 years. However, RMI payroll 

expenditures increased. In 2005, the RMI’s wage bill comprised 34 percent 

of total expenditures, compared with the 2000 to 2004 wage bill of 31 

percent. In actual value, the RMI’s wage bill increased from around $17 

million in 2000 to around $30 million in 2005. 

Page 22 GAO-06-590 Compacts of Free Association
Figure 6: Structure of RMI Revenues and Expenditures, Fiscal Years 2000-2005 

65% 64% 

26% 26% 

6% 6% 

3% 2% 

8% 

12% 

31% 

49% 

12% 

34% 

20% 

34% 

Taxes

Other 

Grants

Fishing fees

Capital 

Transfers

Other 

Source: GAO analysis of IMF and RMI government finance data. 

2000-2004 Revenues: Average of $79 million 2005 Revenues: $84 million

2000-2004 Expenditures: Average of $74 million 2005 Expenditures: $87 million

Wages

Note: Transfers include subsidies and represent payments for which no goods or services are

received. “Other” revenues are comprised of dividend and interest income, service charges, and fees. 

“Other” expenditures are comprised primarily of current expenditures on goods and services. 

Page 23 GAO-06-590 Compacts of Free Association
In addition to receiving compact grant assistance, the FSM and the RMI 

receive substantial U.S. program assistance from agencies such as the U.S. 

Departments of Agriculture, Education, and Health and Human Services. 

The RMI also receives large grants from Japan and Taiwan and the FSM 

receives large grants from Japan (see table 2) and reports having received

grants from China. As compact grants decline through 2023, government 

fiscal balances and GDP could be supported, at least partially, by 

increased noncompact assistance. However, such increases in assistance 

are not guaranteed, may vary from year to year, and may not be flexible

enough to meet FSM and RMI budget needs.41

Table 2: Estimated Levels of Economic Assistance by Major Donors to the FSM and 

the RMI, Average from Fiscal Years 2002 to 2004 

U.S. dollars in millions 

Compact grants U.S. programsaJapan Taiwan

FSM $83b$45 $8 n/a

RMI 29b20 5 $10

Source: The U.S. Department of the Interior, FSM and RMI government finance statistics, the IMF, and the Organization for Economic 

Cooperation and Development (OECD). 

Note: Some of the noncompact assistance, such as development assistance from Japan, is not 

included in FSM and RMI government budgets as grant assistance. In addition, China provides 

assistance to the FSM, although we were unable to determine the estimated amount. 

a

These figures do not include occasional emergency assistance provided by Federal Emergency 

Management Agency. 

b

The FSM and the RMI received less compact grant assistance than the amended compact provides,

owing to delays in compact grant implementation. 

Tax reform may provide opportunities for increasing annual government 

revenue in the FSM and the RMI. For example, business tax schemes in 

both nations are considered to be inefficient by the IMF, the ADB, and 

other economic experts owing to a poor incentive structure and weak tax

collection. Various expert and country studies have concluded that 

substantial tax reform could bring revenue growth by broadening the tax 

base, altering the structure to be more equitable and business friendly, and

 41In addition, the RMI’s ADB debt repayments will be increasing in the future. The RMI 

estimates that annual ADB debt repayments will rise from approximately $1 million in 2005

to almost $4 million by 2012. 

Page 24 GAO-06-590 Compacts of Free Association
improving administration.

42 However, although the FSM and the RMI 

governments have made some improvement in tax administration, tax 

revenues have largely stagnated. Revenue potential from further tax 

reform will also vary by government (national and state) and will require 

factors such as a sound design; adequate resources and capacity for tax 

enforcement; government commitment for reform; and, ultimately, private 

sector growth. 

Key FSM and RMI 

Industries Face Multiple

Constraints to Growth 

FSM and RMI development plans identify fishing and tourism as key 

potential growth industries. However, in both nations, fishing enterprises 

have shown poor performance, and the number of tourists has been small 

relative to other Pacific islands.43 In the FSM, the fisheries and tourism 

sectors together provide about 6 percent of employment; commercial 

fishing has been plagued by poor government investments in vessels and 

infrastructure that have resulted in high debt levels, according to ADB 

experts; and visitor arrivals have remained flat over the past 10 years 

despite growth in Pacific island tourism. In the RMI, the fisheries and 

tourism sectors together provide less than 5 percent of employment; 

commercial fishing within the RMI’s exclusive economic zone has been 

declining, and although visitor arrivals have increased modestly, they 

remain small in number relative to other Pacific island nations.44 Economic 

experts suggest that the FSM and the RMI fishing and tourism industries 

could grow within specialized niche markets such as high-end tourism or 

dock services. Such opportunities remain limited in scale, however, and 

the IMF, the ADB and other economic experts suggest that growth in these 

 42ADB and IMF studies broadly estimate that the FSM could raise tax revenues by 25 to 30

percent by implementing a value-added tax (VAT). See Mark Sturton, Strengthening of 

Public Sector Management and Administration: Compact Fiscal Adjustment and

Transition, a report prepared for ADB TA-4258, 2004 and the 2004 IMF Article IV Staff 

Report and Statistical Appendix for the FSM. For the RMI, estimates of revenue potential 

are less certain. One ADB study estimates that the RMI could raise tax revenues by about 

20 percent by altering its income tax structure and streamlining import taxes. (See Fuat 

Andic, Tax Policy and Administration in the RMI, a report prepared for ADB TA-6245-

REG, 2005.) However, another ADB consultant suggested that revenue gains from tax 

reform would be limited to less than 3 percent. 

43The World Bank reports that international visitor arrivals in 2003 totaled approximately 

18,000 in the FSM and 7,000 in the RMI, compared with 431,000 in Fiji; 92,000 in Samoa; 

68,000 in Palau; 56,000 in Papua New Guinea; and 50,000 in Vanuatu. 

44The RMI stated in its comments to this report that tax income from the fisheries and 

tourism sectors is also volatile. 

Page 25 GAO-06-590 Compacts of Free Association
industries in both countries may be limited by current structural barriers 

such as the following: 

• geographic isolation and small fragmented markets; 

• high airfares and poor flight connections; 

• lack of adequate hotel and airport infrastructure; 

• low freight capacities and poor interisland shipping; 

• inadequate transshipment facilities in some areas; 

• a growing threat of overfishing; 

• limited pool of skilled labor; and 

• high production costs in terms of labor, fuel, and other supplies. 

In addition to facing structural barriers to growth, private industry in 

general faces a costly business environment in both the FSM and the RMI 

according to economic experts and U.S. and country officials. In 

interviews, private sector representatives also expressed concern with 

poor government provision of power, water, and infrastructure services 

and government failures to pay bills owed to the private sector for services 

rendered—a complaint confirmed by several government officials 

including those from the Chuuk State legislature, the RMI Ministry of 

Resources and Development, and the FSM Department of Economic 

Affairs (see app. III for further information). 

FSM and RMI emigrants could provide increasing monetary support to 

their home nations in the future, although evidence suggests that they are 

currently limited in their income-earning opportunities abroad. World 

Bank data show that remittances, or the personal funds that the foreign 

born voluntarily send to their home countries, have become an important 

source of financial flows to developing countries—in some cases 

Prospects for Increased 

Remittance Income to the 

FSM and RMI Require 

More Skilled Migrants 

Page 26 GAO-06-590 Compacts of Free Association
exceeding official development assistance and foreign direct investment.45

For the FSM and the RMI, many citizens have taken advantage of U.S. 

migration rights established by the original compact and extended by the 

amended compacts.46 As of 2005, RMI data suggest that about 15,000 

Marshallese have immigrated to the United States. FSM data suggests that 

almost twice as many Micronesians live overseas.47 However, the current 

level of remittance income provided by these emigrants is unknown. In the 

RMI, the 2002 household survey suggests that RMI citizens send more 

money out to RMI emigrants than they receive in remittances, owing to the 

emigrants’ lack of high-paying jobs and inability to afford repatriation of 

funds. Our previous work has shown that RMI and FSM emigrant 

populations have limited income-earning opportunities abroad, largely 

because of inadequate education and vocational skills.48 The 2003 U.S. 

census of FSM and RMI migrants in Hawaii, Guam, and the 

Commonwealth of the Northern Marianas Islands (CNMI) confirms this 

characterization, showing that almost half of the emigrants live below the 

poverty line (see table 3).

49 Nonetheless, economic experts emphasize that 

with an upgrading of skills, the FSM’s and the RMI’s free access and strong 

historical links to the U.S. market create potential for the two nations to 

achieve an expansion in remittance income that could contribute to longterm economic advancement.50

 45Remittances are also an important source of income to maintain standards of living for 

families in home countries since they are resilient to economic downturns. We reported

that, for several countries, including El Salvador and the Philippines, remittances from the 

United States received by households on a monthly basis tend to substantially exceed the 

monthly minimum wage income for these countries. See GAO, International Remittances: 

Different Estimation Methodologies Produce Different Results, GAO-06-210 (Washington,

D.C.: Mar. 28, 2006). 

46U.S. Census surveys of Guam, the Commonwealth of the Northern Mariana Islands

(CNMI), and Hawaii suggest that a large portion of Micronesian migrants live in these

areas. 

47As a result of emigration, FSM population growth has slowed from about 2 percent in the

early 1990s to virtually zero since 1995. 

48GAO-02-40. 

49FSM and RMI migrants also live in other areas of the United States. A preliminary survey

of RMI emigrants in Springdale, Arkansas suggests that the emigrant population there has

higher education levels and lower poverty levels relative to the emigrant population in

Hawaii, Guam, and the CNMI. 

50In addition to income support from remittances, experts also suggest that returning

emigrants may bring back newly acquired skills and capital that could support growth in

the home economy. 

Page 27 GAO-06-590 Compacts of Free Association
Table 3: FSM and RMI Emigrants in Hawaii, Guam, and the CNMI, 2003 

FSM RMI

Population 17,286 3,304

Percentage that migrated for employment (includes dependents) 47 25

Percentage of labor-force participants that were unemployed 21 18

Percentage of persons 25 years and older with college degree 6 7

Percentage of individuals with income below poverty level 45 49

Source: U.S. Census Bureau. 

To date, JEMCO and JEMFAC have not discussed FSM and RMI progress 

toward budgetary self-reliance and long-term economic advancement or 

the role for compact grants in attaining these development goals. FSM and 

the RMI development plans specify the objectives of increased private 

sector development, strengthened education and training, and improved 

public sector management as means of achieving the goals of budgetary 

self-reliance and long-term economic growth. The amended compacts’ 

fiscal procedures agreements requires the JEMCO and JEMFAC to 

monitor FSM and RMI progress toward their long-term development 

objectives, however the oversight committees have not defined what 

actions they will undertake to meet this requirement.51 At the fiscal year 

2004 and 2005 annual JEMCO and JEMFAC meetings, as well as at a March 

2006 JEMCO meeting, compact management committees focused on 

approving sector grants and discussing grant administration issues. For 

example, to approve the FSM health and education sector grants, JEMCO 

has required supplementary information on health insurance programs 

and that a certain amount of the FSM’s education grant is spent on 

textbooks. The JEMCO meetings have not included discussion of FSM 

progress toward its long-term development goals. At the 2005 JEMFAC 

meeting, the RMI government provided a brief overview of GDP and 

employment data, yet the presenting official reported that there was no 

meaningful JEMFAC discussion of RMI long-term growth issues resulting 

from the presentation. For example, while the RMI government presented 

data on migration to the United States, JEMFAC did not discuss the 

linkage between compact education spending and improving RMI 

emigrant’s skills to encourage increased remittance income over the longCompact Management 

Committees Have Not 

Discussed Progress toward 

Self-reliance and Longterm Advancement 

 51Department of the Interior officials reported that their Office of Insular Affairs has 

contracted with the U.S. Department of Agriculture’s Graduate School to assist them in 

preparing an economic statistics dataset for the FSM and the RMI, economic reviews for

the FSM and the RMI, and a policy review for both countries. 

Page 28 GAO-06-590 Compacts of Free Association
term. Through agency comments, HHS emphasized that an annualized 

schedule for committee meetings does not provide enough frequency for 

addressing both grant administration issues and long-term growth issues, 

particularly given the relative lack of communication between JEMCO and 

JEMFAC members in between meetings. HHS suggested that 

communication be improved through periodic teleconference and 

videoconference updates. 

FSM and RMI officials report that they have implemented a few legislation 

actions to improve the private sector environment, such as bankruptcy 

and mortgage laws, yet progress on key policy reforms required to 

stimulate investment has been slow. According to FSM and RMI private 

sector representatives as well as various U.S., IMF, ADB, and country 

reports, an enabling business environment in either country requires 

substantial reforms in taxes, land ownership, and foreign investment 

regulations as well as a reduction in public sector competition with the 

private sector. Despite several years of policy dialogue on taxes, the FSM 

has agreed on elements of tax reform but has no plan for implementation 

and the RMI has not agreed on structural change to its tax system. In 

attempts to modernize complex, traditional land tenure systems, land 

registration offices have been established in both countries; however, in 

both countries, inadequate access to land and uncertainties over land 

ownership and land values continue to create costly disputes, 

disincentives for investment, and problems regarding the use of land as an 

asset. Further, despite amendments to foreign investment regulations, the 

regulations in both countries continue to be confusing and relatively 

burdensome, according to economic experts and private sector 

representatives. Finally, several years of public sector reform efforts have 

also failed to reduce government involvement in private sector activities.

Thus far, the JEMCO and JEMFAC committees have not evaluated the lack

of FSM and RMI progress in implementing economic reforms to stimulate 

investment and improve tax income, identified problems encountered or 

recommended ways to improve assistance for these objectives. 

Both the FSM and the RMI identified the need for economic reform within 

their national development plans, and both countries have implemented or

are pursuing some legislative actions. For example, FSM officials report 

that newly enacted legislation, although varying by state and national 

government, include laws for bankruptcy, mortgages, long-term leases, 

and secured transactions to allow movable assets to serve as collateral. 

FSM and RMI 

Progress on Key 

Economic Policy 

Reforms Has Been 

Slow 

FSM and RMI Have 

Implemented Some 

Legislative Reforms 

Page 29 GAO-06-590 Compacts of Free Association
Some governments have also tried to improve foreign investment 

processes or created small business development centers. 

To create continued and strengthened demand for reform, the ADB has 

also recently assisted both countries in holding several “Dialogue for 

Action” retreats that enable public and private sector representatives to 

develop a common vision for sustainable development through economic 

reform. Our interviews with ADB and country participants suggested that 

these retreats can be helpful for improving the public sector/private sector

dialogue on economic challenges facing each society. However, ADB 

experts also emphasized that, in developing country commitment to 

reform, the FSM and the RMI will need to overcome the “aid curse”—or 

the distorted incentives for effective public sector management through, 

e.g., public sector downsizing, which result from dependency on large 

external aid flows.52

Despite several years of commitment to, and recommendations for, policy 

reforms to stimulate investment in the FSM and the RMI, key reforms have 

not yet been implemented. According to FSM and RMI private sector 

representatives and a number of economic and country experts, policy 

reforms are needed in the areas of tax, land, foreign investment, and the

public sector to improve business incentives and create an enabling 

environment for domestic and foreign investment. 

Tax structures in the FSM and the RMI remain complex and unequal and 

engender business disincentives. 

Key Policy Reforms to 

Stimulate Investment Have 

Not Been Implemented 

Tax Reform 

• The FSM tax system has been criticized by economic experts, the FSM 

government, and the FSM private sector for (1) multiple taxation of the 

same products (2) weak administrative collection, audit, and enforcement 

capacity (3) taxation on a gross rather than net basis,53 and (4) duplicative 

 52According to ADB experts, large aid transfers to the FSM and the RMI resulted in an

economic development strategy where the public sector served as the engine of growth. 

For example, during the original compact period, large investments were made into public 

sector enterprises that were protected through subsidies or tax exemptions. These 

activities created distorted incentives for tax reform, public sector downsizing, and 

creation of a more open foreign investment regime. 

53The FSM Office of Customs and Tax estimated that it collects between 40 to 60 percent of

owed taxes. It attributed this low collection rate to inadequate collection and enforcement

capacity and to the inability of businesses with net losses to pay taxes levied on a gross 

basis. 

Page 30 GAO-06-590 Compacts of Free Association
national and state tax administrations. Since 1994, the IMF and other 

experts have recommended, among other tax reforms, implementing a 

value-added tax (VAT), a simplified net profit tax, and a single modernized 

independent tax authority. In 2005, the FSM Task Force on Tax Reform 

developed a tax reform proposal, endorsed by the FSM President, that 

included these principles. Nonetheless, despite the fact that such reforms 

are estimated to require 2 to 3 years for implementation, the FSM 

government has neither begun to implement the proposal nor specified an 

implementation plan.54 Although the FSM government has made some 

efforts to improve tax administration, actions by existing tax authorities in 

the national government and each state government continue to exhibit 

duplication and inefficiency. 

• The RMI government and economic experts have recognized for several 

years that the RMI tax system is complex and regressive, taxing on a gross 

rather than net basis and having weak collection and administration 

capacity. The RMI stated in its comments to this report that their private 

sector representatives’ most common complaint on the RMI tax system is 

the need for better and tighter enforcement. The RMI Office of Tax and 

Revenue reported that it has focused on improving tax administration and 

has raised some penalties and tax levels. However, legislation for income 

tax reform has failed and needed changes in government import tax 

exemptions have not yet been addressed. 

Inadequate access to land and uncertainties over land ownership and land

values continue to create costly land disputes, disincentives for 

investment, and problems regarding the use of land as an asset in both the 

FSM and the RMI. 

Land Reform

• Land tenure systems in each nation are complex and based on traditional

and customary rights, often for multiple individuals, such that most 

parcels do not have a registered, legal title. Our interviews with FSM and 

RMI officials and private sector representatives suggested that costly 

boundary disputes are common. 

 54According to the Task Force on Tax Reform, the FSM will need to pass a constitutional 

amendment to implement the tax reform proposal that revises state and national tax

authorities or each state will have to pass identical tax reform legislation. FSM officials 

report that such an amendment had been previously introduced and failed. Our interviews

with state governments suggested that they support the proposal in principle but are not

yet aware of a detailed plan. Our interviews with private sector representatives suggested 

some resistance to the tax reform proposal. 

Page 31 GAO-06-590 Compacts of Free Association
• Land values are also uncertain owing to the lack of a developed land 

market or price data on lease transactions, such that banks are unable to 

effectively conduct mortgage secured lending. Given that a major 

proportion of FSM and RMI wealth lies in property, the inability to use it to

secure financing for development is problematic. 

• Using land for foreign investment in the FSM and the RMI is even more 

difficult. Economic experts report that foreigners are prohibited from 

owning land in both nations and are also unable to secure a valid lease 

when land values or ownership is uncertain.55

Land reform issues have been discussed in the FSM and the RMI for 

several years, and land registration offices have been established. 

However, such offices have lacked a systematic method for registering 

parcels, instead waiting for landowners to voluntarily initiate the process. 

Both the FSM and the RMI land registration offices reported that 

landowners have shown little interest in land registration, partly owing to 

the cultural issues associated with traditional land ownership structures. 

In the RMI, for example, only 5 parcels have been, or are currently being, 

registered by the land registration office. The functionality of land 

registration offices in both the FSM and the RMI has also been limited by a 

lack of registered surveyors and trained staff. 

Although the FSM and the RMI have amended various aspects of their 

foreign investment laws to streamline the process, the overall climate for 

foreign investment remains complex and nontransparent, according to 

economic experts and private sector representatives. In the FSM, experts 

report that foreign investment regulations vary between states, creating 

confusion and additional requirements for investors who want to invest in

several states. In both the FSM and the RMI, foreign investment 

regulations remain relatively burdensome, with reported administrative 

delays and difficulties in obtaining permits for foreign workers. According 

to an Interior official, a shipping company with service from the U.S. West

Coast to Guam has for years been seeking permission to provide shipping

service to the FSM and the RMI but has consistently been refused entry by

those nations. The climate for foreign investment is also reportedly 

affected by private and public interests’ protecting local businesses from 

Foreign Investment 

Regulations 

 55The two commercial banks that operate in the FSM (Bank of Guam and Bank of FSM) 

also have some degree of foreign ownership such that they are unable to accept land as 

collateral. In the RMI, the Bank of Guam and the Bank of the Marshall Islands also have

foreign-ownership that prevents them from owning land. 

Page 32 GAO-06-590 Compacts of Free Association
foreign competition. For example, experts report that foreign investment 

is restricted from some industries in both the FSM and the RMI, and some 

FSM states require a certain percentage of local ownership in foreign 

investment. Pohnpei state, for instance, requires 30 percent local 

ownership for foreign investment and prohibits foreign activity in retail, 

according to its Foreign Investment Board. Interviews with country 

officials, private sector representatives, and an ADB expert also suggest 

that local businesses sometimes lobby the foreign investment boards 

against approval of certain applications. 

Extensive FSM and RMI government involvement in commercial activities

continues to hinder private sector development, owing to high public 

sector wages and government enterprises that directly compete with 

private industry. The FSM’s and the RMI’s public sector reform efforts 

since the 1990s have been based on restructuring government operations 

to (1) reduce the size and cost of the civil service, (2) reduce government 

involvement in market-oriented enterprises that could be more efficiently

operated by the private sector, and (3) improve government provision of 

critical support services. One example of a reform success highlighted by

economic experts is the RMI’s restructuring of its Social Security 

Administration to reduce operating costs and improve service provision.56

However, despite government endorsement of public sector reform 

principles, early efforts to reduce public sector employment have 

generally failed in both the FSM and the RMI, and the share of public 

sector employment has increased over the past few years. FSM and RMI 

public sector wages also remain about twice the level of private sector 

wages, contributing to the large government wage bill and effectively 

drawing the most skilled employees out of the private sector into public 

sector jobs. In addition, the FSM and the RMI governments continue to 

conduct a wide array of commercial enterprises that compete with private 

enterprises, although the share of employment accounted for by these 

enterprises, as well as estimated direct public enterprise subsidies, has 

declined in recent years (see table 4). 

Public Sector Reform 

 56In January of 2000, the RMI Cabinet appointed a new board for the Marshall Islands Social 

Security Administration (MISSA) that in turn appointed new management. The newly 

appointed management implemented wide ranging reforms including closer justification of

expenditures, streamlining salaries and wages, elimination of job duplication, and

improved use of information technology. 

Page 33 GAO-06-590 Compacts of Free Association
Table 4: FSM and RMI Government Commercial Enterprises 

FSM enterprises RMI enterprises 

Share of employment 

 1997-2002 average 

 2003-2005 averagea

6.2% 

5.2% 

7.4% 

7.0% 

Annual direct subsidies 

 1997-2002 average 

 2003-2005 averagea 

$4.3 million 

$1.9 million 

$2.4 million 

$1.8 million 

Estimated number of 

existing enterprisesb

 

45 16

Examples of existing 

enterprises with financial 

losses or receiving 

subsidiesc

Micronesian Petroleum 

Corporation 

(2001 subsidy = $500,000) 

Copra Production Scheme 

(2004 subsidy = $900,000) 

Pohnpei Fisheries

Corporation 

(2003 loss = $517,000) 

Marshalls Energy Company 

(2004 loss = $2 million) 

Kosrae Utility Authority 

(2004 loss = $427,000) 

National Telecom Authority 

(2004 loss = $980,000) 

Chuuk Public Utilities 

Corporation 

(2001 loss = $1 million) 

Majuro Water and Sewer 

Company 

(2004 subsidy = $100,000) 

Source: GAO analysis of FSM and RMI government finance statistics and government audit data. 

a

RMI data are available only through 2004. 

b

The FSM estimate is from a 2001 report on public enterprise reform prepared for the ADB by the 

Aires Group Ltd., in association with Deloitte & Touche. The list represents entities either fully owned 

or jointly owned by the state or national governments in 2000. The RMI estimate is derived from the 

2004 RMI Statistical Yearbook. 

c

Financial losses represent expenditures minus revenues or the net change in assets. Economic 

experts highlighted several public enterprises with large financial losses (such as the FSM National 

Fisheries Corporation and Air Marshall Islands). These examples are not included in the table 

because their audit reports were qualified or contained material weaknesses. 

Nonetheless, IMF and ADB officials expressed concern that the FSM and

the RMI governments are not committed to reducing their participation in

commercial activities, despite the fact that most of the enterprises have 

drained public finances through poor financial performance, requiring 

subsidization or entailing debt (see examples in table 4). In conjunction 

with the ADB, the FSM prepared a comprehensive program for public 

sector enterprise reform in 1999 that identified two enterprises per state 

and national government for privatization (such privatizations later 

became a condition for receiving ADB loan assistance) and entailed plans 

Page 34 GAO-06-590 Compacts of Free Association
for the creation of a Public Sector Enterprise Unit.57 This unit has not yet 

been fully staffed, and the ADB loan requirement was reduced to one 

enterprise per state and national government, a condition that has not yet

been met. The RMI has yet to prepare a comprehensive policy for public

enterprise reform. Our interviews with economic experts and FSM and 

RMI officials suggested that although they plan to privatize some public 

enterprises, they intend to expand others. 

To date, JEMCO and JEMFAC have not addressed the lack of FSM and 

RMI progress in implementing reforms that their development plans 

specify are needed to stimulate investment and improve tax income. 

Different from the original compact, the legislation implementing the 

amended compacts specifically directs the JEMCO and JEMFAC to 

address FSM and RMI policy reforms by (1) evaluating progress in 

implementing these policy reforms, (2) identifying problems encountered, 

and (3) recommending ways to increase the effectiveness of U.S. 

assistance.58 In the 2004 and 2005 JEMCO and JEMFAC meetings, as well 

as in a 2006 JEMCO meeting, compact management committees focused 

on grant approval and administration and did not address the status of 

reforms or include discussions of how compact grant assistance could be 

leveraged to improve the policy environment for private sector growth and 

investment.59 Specifically, compact management committees did not 

discuss the lack of FSM and RMI progress in tax, land, foreign investment, 

or public sector reform; factors that contributed to this lack of progress; or 

the interdependence of policy reform implementation with effective 

compact grant implementation. Opportunities exist to create linkages 

between grant administration and economic reforms. For example, sector 

Compact Management 

Committees Have Not 

Addressed Slow FSM and 

RMI Progress in 

Implementing Reforms 

 57See The Aires Group Ltd., Privatization of Public Enterprises and Corporate 

Governance Reforms, a special report prepared at the request of the Asian Development

Bank, 2001. 

58The implementing legislation, P.L. 108-188, directs that the scope of the JEMCO and 

JEMFAC annual meeting, as outlined in the amended compacts, shall be construed as to 

read that the JEMCO and JEMFAC review required audits and reports and (1) evaluate

FSM and RMI progress in meeting objectives identified within their development plans, 

with particular focus on priority sectors and implementation of economic policy reforms to

encourage investment and achieve self-sufficient tax rates; (2) identify problems 

encountered; and (3) recommend ways to increase the effectiveness of U.S. assistance. In 

this report, we use the term “address objectives” to refer to these actions. 

59FSM and RMI offices related to reform efforts, such as land registration offices, have been 

funded with compact grants. 

Page 35 GAO-06-590 Compacts of Free Association
grants in public sector capacity building could be used to address capacity 

constraints that have been identified as an obstacle to reform 

implementation (e.g., the lack of certified land surveyors for land reform). 

Further, compact management committees could establish linkages 

between, for example, grants to tourism promotion agencies and progress 

in reforming foreign investment regulations to improve the private sector 

environment for investment or grants to private sector development 

offices and progress in reforming public enterprises that compete with 

private industry. 

The FSM and the RMI face notable challenges to achieving budgetary selfreliance and long-term economic advancement, given their current health

and education hardships; dependence on grant assistance; and need to 

effect reforms that are often politically, culturally, and technically difficult 

to implement. Tax, land, foreign investment regulation and public-sector 

reforms, when implemented, will improve the business environment, in 

turn facilitating the private sector expansion that may help the countries 

advance their compact goals. However, even with the needed reforms, 

growth in the FSM’s and the RMI’s private sectors may be limited by 

structural constraints such as geographic isolation and high transport 

costs. As a result, the FSM and the RMI may need to expand economic 

activities beyond their borders—including, as some experts suggest, 

expanding remittance income by equipping emigrants with better skills 

and, therefore, stronger income-earning opportunities abroad. 

Because the amended compacts have been in place for only a few years, it 

is difficult to determine whether the assistance they provide will 

contribute to the fundamental changes in FSM and RMI economic 

structures and institutions necessary to achieve budgetary self-reliance 

and economic advancement. Expanding FSM and RMI private sector 

activity and remittance income will require effective compact grant 

implementation, just as successful compact grant implementation will 

require FSM and RMI commitment to policy reform. The scheduled 

coming reductions in U.S. grants to both countries create urgency for the 

implementation of policy reforms if they require fiscal resources and for 

capitalizing on opportunities to leverage compact assistance to improve 

social and economic conditions through reform. 

To maximize FSM and RMI potential for budgetary self-reliance and longterm economic advancement, we recommend that the Secretary of the 

Interior direct the Deputy Assistant Secretary for Insular Affairs, as 

Conclusions 

Recommendations 

Page 36 GAO-06-590 Compacts of Free Association
Chairman of JEMCO and JEMFAC, to ensure—in coordination with other 

U.S. agencies participating in these committees—that they fulfill their 

requirements in the following three areas: 

• evaluate FSM and RMI progress in implementing policy reforms needed to 

improve the business environment and encourage increased investment 

and tax income, 

• identify problems encountered with policy reform implementation, and 

• recommend ways to improve U.S. assistance for these objectives. 

We received comments from the Departments of the Interior and HHS, as 

well as from the FSM and the RMI. A more detailed presentation and 

response to the comments can be found in appendixes IV through VII. We 

also received technical comments from Interior, State, Treasury, HHS and 

the RMI. We incorporated technical comments into our report, as 

appropriate.

The Department of Interior concurred with our recommendation and 

stated that it is pursuing additional information on the FSM and the RMI 

economies to support its implementation of the recommendation. The RMI 

advocated for JEMFAC support in policy reform implementation and 

emphasized that public sector reforms are particularly vital. HHS also 

agreed with our recommendation and requested that it be expanded to 

include JEMCO and JEMFAC requirements for establishing timelines for 

policy reform implementation. While establishing timelines is not a 

requirement under the amended compact or its subsidiary agreements, we 

encourage the JEMCO and JEMFAC to consider this idea as one method to 

improve U.S. assistance in support of an improved FSM and RMI 

environment for investment and tax income. Further, Interior, HHS, and 

the FSM emphasized that the JEMCO and JEMFAC have thus far focused 

their attention on accountability issues and problems that have arisen 

within the various sector grants. HHS suggested that, in order to ensure 

the JEMCO and JEMFAC can address all pertinent short-term and longterm issues, mechanisms to improve communication and information 

between annual meetings—such as periodic teleconferences and 

videoconferences—should be pursued. The FSM viewed the report as a 

potentially constructive contribution to ongoing efforts to pursue 

budgetary self-reliance and economic advancement, yet disagreed with our 

conclusion that FSM development prospects remain limited. 

Agency Comments 

Page 37 GAO-06-590 Compacts of Free Association
In addition to providing copies of this report to your offices, we will send 

copies of this report to other appropriate committees. We will also provide 

copies to the Secretaries of the Interior, State, and Health and Human 

Services, as well as the President of the Federated States of Micronesia 

and the President of the Republic of the Marshall Islands. We will make 

copies available to other interested parties upon request. 

If you or your staff have any questions regarding this report, please 

contact me at (202) 512-3149 or gootnickd@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on the 

last page of this report. GAO staff who made major contributions to this 

report are listed in appendix VIII. 

David Gootnick 

Director, International Affairs 

 and Trade 

Page 38 GAO-06-590 Compacts of Free Association
List of Committees 

The Honorable Pete V. Domenici 

Chairman 

The Honorable Jeff Bingaman 

Ranking Minority Member 

Committee on Energy and Natural Resources 

United States Senate 

The Honorable Richard G. Lugar 

Chairman 

The Honorable Joseph R. Biden, Jr. 

Ranking Minority Member 

Committee on Foreign Relations 

United States Senate 

The Honorable Richard W. Pombo 

Chairman 

The Honorable Nick J. Rahall, II 

Ranking Minority Member 

Committee on Resources 

House of Representatives 

The Honorable Henry J. Hyde 

Chairman 

The Honorable Tom Lantos 

Ranking Minority Member 

Committee on International Relations 

House of Representatives 

Page 39 GAO-06-590 Compacts of Free Association
Appendix I: Objectives, Scope, and Appendix I: Objectives, Scope, and Methodology 

Methodology 

The amended compacts implementing legislation requires that we report 

on political, social, and economic conditions in the Federated States of 

Micronesia (FSM) and the Republic of the Marshall Islands (RMI) as well 

as the use and oversight of U.S. assistance to those nations. In compliance 

with the legislation’s requirement, this report1

 examines each country’s (1) 

political and social environment for compact grant implementation; (2) 

economic conditions, including overall growth, fiscal balances, and private 

investment; and (3) status of economic policy reforms. 

To identify key aspects of the FSM and the RMI political and social 

environment for compact grant implementation, we reviewed the U.S., 

FSM, and RMI annual compact reports for 2004; U.S. Department of State 

reports on FSM and RMI political systems and human rights practices; 

political assessments by nongovernmental organizations such as 

Transparency International and the University of Hawaii; and information 

from the Pacific Islands Forum regarding FSM and RMI participation in 

regional agreements and organizations.2

 We identified key areas of 

concern in delivery of health and education services by reviewing FSM and 

RMI development plans, and reports prepared in conjunction with the 

Asian Development Bank (ADB), the World Bank, or the United Nations 

Development Program.3

 We obtained FSM and RMI socioeconomic 

statistics on noncommunicable diseases, access to safe water and 

sanitation, teacher certifications and literacy skills, and Pacific Island 

Literacy Level student test scores from the FSM Departments of Health 

 1

Our forthcoming report on the use and oversight of U.S. assistance to the FSM and the

RMI will be published by December 17, 2006. 

2

The Pacific Islands Forum represents the governments of 16 Pacific islands and houses a

secretariat to perform administrative tasks in support of the forum’s goal of regional 

cooperation. 

3

These reports include: World Bank, East Asia and the Pacific Region, Opportunities That

Change People’s Lives: Human Development Review of the Pacific Islands - RMI Country

Case Study (Washington, D.C.: 2005); Secretariat of the Pacific Community, in cooperation 

with the United Nations Development Program, Pacific Islands Regional Millennium 

Development Goals Report (Noumea, New Caledonia: 2004); United Nations Development

Program, in joint publication with the RMI, RMI Millennium Development Goals National

Progress Report (Majuro, RMI: 2005); and Asian Development Bank, Priorities of the 

People Series ( http://www.adb.org/Documents/Reports/Priorities_Poor/default.asp). 

Page 40 GAO-06-590 Compacts of Free Association
Appendix I: Objectives, Scope, and 

Methodology 

and Education and the RMI Ministries of Health and Education.4 We 

obtained regional socioeconomic statistics on population trends, teenage 

fertility, child mortality rates, immunizations, human poverty, and GDP 

and aid per capita from the World Bank’s World Development Indicators, 

the U.S. Census International Database, and the 2005 United Nations 

Human Development Report. 

To assess FSM and RMI economic conditions, we reviewed the U.S., FSM, 

and RMI annual compact reports for 2004; FSM and RMI development 

plans; recent International Monetary Fund (IMF) Article IV documents for 

each nation;5

 ADB Country Strategies and Program Updates; 2005 FSM and 

RMI Pacific Island Economic Reports (PIER) prepared in conjunction with 

the ADB; and expert reviews of FSM and RMI fiscal structures and tax 

systems.6

 We obtained data on FSM and RMI economic indicators such as 

gross domestic product (GDP), employment, government finances, 

migration, and private sector development from the IMF; the FSM’s 2005 

Statistical Tables; the RMI’s 2004 Annual Yearbook and 2005 Employment 

Statistics; the OECD’s international development statistics; the U.S. 

Department of Census; and the World Bank’s World Development 

Indicators. 

To describe the status of economic policy reforms in the FSM and the RMI, 

we reviewed the documents mentioned above; the FSM Tax Reform Task 

 4

Safe water and sanitation is defined as access to an improved water source and sanitation, 

which the World Bank defines as access to a household water connection, public 

standpipe, borehole, protected well or spring, or rainwater collection and access to 

sanitation facilities (private or shared, but not public) that can effectively prevent human, 

animal, and insect contract with excreta. RMI teacher literacy levels were determined from

the RMI Ministry of Education’s 2004 administered Marshall Islands English Literacy Test

for Teachers (MIELTT). The Pacific Islands Literacy Level (PILL) test is a test administered 

by the South Pacific Board for Educational Assessment. 

5

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions

with members and prepares supporting documentation on economic developments and 

policies. 

6

These reviews include assessments by the IMF’s Pacific Financial Technical Assistance 

Center; Fuat Andic, Tax Policy and Administration in the RMI, a report prepared for ADB 

TA-6245-REG, 2005; Mark Sturton, Strengthening of Public Sector Management and

Administration: Compact Fiscal Adjustment and Transition, a report prepared for ADB 

TA-4258, 2004; Enterprise Research Institute, Republic of the Marshall Islands Private 

Sector Assessment: Promoting Growth through Reform, report prepared for ADB TA 6037,

2003; and The Aires Group Ltd., Privatization of Public Enterprises and Corporate 

Governance Reforms, a special report prepared at the request of the Asian Development

Bank, 2001. 

Page 41 GAO-06-590 Compacts of Free Association
Appendix I: Objectives, Scope, and 

Methodology 

Force 2005 Report to the President; the RMI 2005 Budget Statement; ADB 

progress reports on the RMI Private Sector Development Project and the 

FSM Private Sector Development Loan; and RMI Final Reports from the 

2005 Dialogue For Action Retreats sponsored by the ADB. We obtained

data on FSM and RMI public sector enterprises from the FSM’s 2005 

Statistical Tables; the RMI’s 2004 Annual Yearbook; and the most recent 

available public enterprise audit reports. 

In addition, we held extensive interviews with officials from the U.S. 

Department of the Interior (Washington, D.C.; Honolulu; the FSM; and the 

RMI) and the Department of State (Washington, D.C.; the FSM; and the 

RMI). We also interviewed officials from the U.S. Departments of Treasury 

and Health and Human Services (Washington, D.C., and Honolulu) and 

experts from the ADB (Manila, the Philippines), the IMF (Washington, 

D.C.), the World Bank (Washington, D.C.) and the Pacific Islands 

Development Program at the East-West Center (Honolulu). We traveled to

all four states in the FSM and to the RMI (Majuro). We met with the 

governor’s and legislature’s offices in each of the FSM states and the 

President’s office in the RMI. We had detailed discussions with FSM 

(national and state governments) and RMI officials from foreign affairs, 

finance and budget, economic affairs, health, education, land management, 

tourism and fisheries, environmental protection, and audit agencies. In 

each location, we also met with numerous representatives from private 

sector businesses, banks, and community organizations. 

To ensure accuracy in our report, we asked experts at the ADB, the IMF, 

the World Bank, the Boston Institute of Development Economics, and the 

University of Hawaii’s East-West Center with knowledge of the FSM and 

the RMI economies, as well as former members of the FSM’s Economic 

Management and Policy Advisory Team, to provide a technical review of 

our findings and information on the reliability of data used to support 

those findings. In conjunction with our own assessment, we determined 

that trade data, remittance data, and data on the private sector profits 

contained weaknesses. Exact data for these elements were not presented 

in the report and related findings were corroborated with other reliable 

data. For other social and economic data included in the report, we 

determined they are sufficiently reliable for our purposes. 

Nonetheless, our interviews with U.S., country, and international officials 

revealed important constraints to the FSM’s and the RMI’s capacity to 

prepare regular, reliable, and complete data that would allow for a more 

thorough analysis of social and economic trends, particularly in the future. 

Trend data on a variety of social indicators, such as teacher qualifications 

Page 42 GAO-06-590 Compacts of Free Association
Appendix I: Objectives, Scope, and 

Methodology 

and student drop-outs, could assist in evaluation of the effectiveness of 

compact education assistance. However, much of this data are just now 

being collected in a systematic way. Also, given that both nations have 

weak domestic capacity to produce statistics, they rely heavily on external

consultants for this purpose. In the FSM, the contract for statistical 

assistance from external consultants has now expired. As such, both FSM 

and Interior officials have expressed concern for that nations’ capacity to 

produce future statistics. 

We conducted our review from August 2005 through March 2006 in 

accordance with generally accepted U.S. government auditing standards. 

We requested written comments on a draft of this report from the 

Departments of the Interior, State, Health and Human Services, and 

Treasury, as well as the governments of the FSM and the RMI. All 

comments are discussed in the report and are reprinted in appendixes IV 

through VII. Further, we considered all comments and made changes to 

the report, as appropriate. 

Page 43 GAO-06-590 Compacts of Free Association
Appendix II: Some Regional Socioeconomic Appendix II: Some Regional Socioeconomic Data for the Pacific

Data for the Pacific 

Economic studies of small island economies suggest common challenges 

for socioeconomic development. According to international development 

organizations, developing nations in the Pacific have exhibited relatively 

poor economic performance and face common constraints to growth such 

as geographic isolation and high transport costs. Such nations have also 

exhibited the need for improvements in delivery of health and education 

services, a challenge heightened when youths account for a large share of

the population. Environmental challenges from climate change and

increasing population density are also common threats to ensuring 

sustainable livelihoods in the Pacific. Table 5 provides estimated 

socioeconomic data on various Pacific island nations in order to illustrate 

some of these commonalities as well as areas where the FSM and the RMI 

characteristically differ. For example: 

• The RMI has a relatively small population, but both the RMI and the FSM 

have a relatively large population density at 331 and 181 people per square

kilometer, respectively. The RMI also has a very high teenage fertility rate. 

• Except for Palau—also a nation with a Compact of Free Association with 

the United States—the FSM and the RMI have the highest levels of aid per 

capita. 

• The FSM’s child mortality rates are significantly lower than the RMI’s, and 

its immunization rates are significantly higher. The RMI provides a 

significantly higher proportion of the population access to improved 

sanitation. 

Page 44 GAO-06-590 Compacts of Free Association
Appendix II: Some Regional Socioeconomic 

Data for the Pacific

Table 5: Some Estimated Socioeconomic Indicators for Select Pacific Island Nations

Year RMI FSM Fiji Kiribati Palau

Papua

New 

Guinea Samoa 

Solomon 

Islands Tonga Vanuatu

Population, total 2005 59,071 108,105 893,354 103,092 20,303 5,545,268 177,287 538,032 112,422 205,754

Population ages 0-20 

(% of total) 

2005 50.1 48.9 41.5 49.9 33.5 48.0 39.8 53.1 49.1 44.6

Population density 

(people per sq km) 

2004 331 181 46 134 43 12 63 17 141 18

Population growth 

(annual %) 

2005 2.3 0.0 1.4 2.3 1.4 2.3 -0.2 2.8 2.0 1.6

Life expectancy at birth, 

total (years) 

2005 70 70 67 62 70 65 71 73 70 63

Teenage fertility rate 

(ages 15-19) 

2005 87 36 42 56 62 58 21 59 42 32

Mortality rate,under age 5 

(per 1,000) 

2003 61 23 20 66 28 93 24 22 19 38

Immunization, DPT(% 

children ages12-23 

months) 

2003 68 92 94 99 99 54 94 71 98 49

Access to improved 

sanitation facilities (% of 

population with access) 

2002 82 28 98 39 83 45 100 31 97 50

Aid per capita 

(current U.S.$) 

2003 991 923 61 191 1,295 40 186 132 270 154

GDP per capita (constant 

2000 U.S.$) 

2004 1,738 1,745 2,232 532 6,360 622 1,417 621 1,638 1,110

Sources: Population, population growth, life expectancy, and teenage fertility rates are from the U.S. Census international database. All

other data are from the World Bank’s World Development Indicators.

Page 45 GAO-06-590 Compacts of Free Association
Appendix III: The FSM and RM

Sec

I Private 

tor Environment 

Page 46 GAO-06-590

Appendix III: The FSM and RMI Private 

Sector Environment 

Private sector representatives in the FSM and the RMI characterized the 

business environment in their nation as obstructive and costly. They

attribute this characterization to elements of the political environment 

(e.g., poor information), lack of progress in economic reforms (both legal 

and financial), and poor government performance in providing services. 

World Bank national business environment surveys suggest that a high

cost of doing business is a common problem for small island states. 

However, the survey results show that FSM and RMI business 

environments are particularly costly in several areas.1

 For example, of 155 

countries surveyed, the FSM and the RMI are among the worst 10 to 20 

countries in terms of the cost of enforcing contracts and the degree of 

investor protection. In interviews with private sector representatives, 

problems were noted with FSM and RMI business environments (see fig. 

7). 

Figure 7: Some Noted Problems with the FSM and the RMI Private Sector Environment 

 

• Lack of public sector transparency 

and accountability

• Poor access to, and quality of, public 

information

• Lack of sufficient private sector input 

into economic planning

• No established mechanisms for 

public sector/private sector dialogue

• Lack of government commitment to 

reforms creating uncertain economic 

environment

• Uncertain property rights and 

inadequate access to land

• Lack of secure financial transactions

• High monetary cost of enforcing 

contracts

• High degree of bureaucratic 

discretion and lengthy reviews of 

applications and permits

• Inconsistent and nontransparent 

foreign investment regulations

• Difficulty in hiring foreign workers

• Lack of effective tax administration

• Public enterprises that compete with 

private businesses

• High public sector/private sector 

wage differentials that limit the skilled 

labor pool for private businesses

• Costly or ineffective public provision 

of power, water, communication, 

transportation, and infrastructure 

services

• Unpaid bills by the government to 

private sector for goods and services

Poor information Poor legal and regulatory environment Poor market and financial support

FSM and RMI Private Sector Environment

Source: GAO interviews with economic experts and FSM and RMI private sector representatives.

1

See the World Bank’s Doing Business web site at http://www.doingbusiness.org/. 

Compacts of Free Association
Appendix IV: Comments from the Department Appendix IV of the Interior : Comments from the 

Department of the Interior 

Note: GAO comments 

supplementing those in 

the report text appear at 

the end of this appendix. 

Page 47 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

See comment 1. 

See comment 2. 

Page 48 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 49 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 50 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 51 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 52 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 53 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 54 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

Page 55 GAO-06-590 Compacts of Free Association
Appendix IV: Comments from the Department 

of the Interior 

The following are GAO’s comments on the Department of the Interior 

letter dated May 16, 2006. 

1. Regarding our finding that compact management committees have not 

discussed FSM and RMI progress toward budgetary self-reliance and

long-term economic advancement at their annual meetings, we 

recognize that the Deputy Assistant Secretary submitted a statement 

for the record at the opening of the 2005 JEMCO meeting that

mentioned the lack of sustainability in the FSM’s economic 

dependence on government expenditures. However, the Deputy 

Assistant Secretary did not read his statement to the committee and 

the issue of FSM progress toward their long-term development goals 

was not discussed by the JEMCO. 

GAO Comments 

2. We recognize that Interior has contracted with the U.S. Department of 

Agriculture’s Graduate School to obtain further economic information 

on the FSM and the RMI. While we agree with the importance of 

gaining this further information, we believe that sufficient information 

is available for the committees to begin meeting their requirement to 

evaluate FSM and RMI progress in implementing reforms, identify 

problems encountered, and recommend ways to improve U.S. 

assistance for these objectives. For example, multiple expert studies as 

well as FSM and RMI commitment to, and recommendations for policy 

reforms in the areas of tax, land, foreign investment, and the public 

sector have existed since the 1990s.1

1

Documents discussing these issues include, for example, IMF Article IV documents for 

both the FSM and RMI, dating back to 1998; ADB country assistance plans, country

economic reports, and Public Sector Reform Program loan documentation, dating back to

1997 for the FSM and 1996 for the RMI; the RMI’s 2000 Statement of Development 

Strategies entitled Meto 2000; the FSM’s 2000 Economic Review; and the documents and 

information sources listed in appendix I.

Page 56 GAO-06-590 Compacts of Free Association
Appendix V: Comments from the Department Appendix V of Health and Human Services : Comments from the Department 

of Health and Human Services 

Note: GAO comment 

supplementing those in 

the report text appear at 

the end of this appendix. 

Page 57 GAO-06-590 Compacts of Free Association
Appendix V: Comments from the Department 

of Health and Human Services 

See comment. 

See comment. 

Page 58 GAO-06-590 Compacts of Free Association
Appendix V: Comments from the Department 

of Health and Human Services 

See comment. 

Page 59 GAO-06-590 Compacts of Free Association
Appendix V: Comments from the Department 

of Health and Human Services 

See comment. 

Page 60 GAO-06-590 Compacts of Free Association
Appendix V: Comments from the 

Department of Health and 

Human Services

The following is GAO’s comment on the Department of Health and Human 

Services letter dated May 23, 2006. 

HHS agreed with our recommendation and requested that it be expanded 

to include JEMCO and JEMFAC requirements for establishing policy 

reform implementation timelines. The amended compacts’ U.S. 

implementing legislation does not include establishing timelines for policy 

as a specific required action for the JEMCO and JEMFAC. Nonetheless, in

fulfilling their requirement to identify problems encountered with policy 

reform implementation and recommend ways to improve U.S. assistance, 

the JEMCO and JEMFAC should consider this suggestion. As noted in our 

conclusions and by HHS, the urgency of pursuing policy reform suggests 

that establishing timelines for such reforms could be a useful method to 

improve U.S. assistance. We also appreciate HHS’s suggestion to improve 

communication and information between annual meetings through 

periodic teleconferences and videoconferences and have added language

to the report to reflect this suggestion. We have also added language to the 

report recognizing HHS’s efforts to improve vaccine coverage. 

GAO Comment 

Page 61 GAO-06-590 Compacts of Free Association
Appendix VI: Comments from the Federated Appendix VI: Comments from the Federated States of Micronesia 

States of Micronesia 

GAO comment 

supplementing those in 

the report text appear at 

the end of this appendix. 

Page 62 GAO-06-590 Compacts of Free Association
Appendix VI: Comments from the Federated 

States of Micronesia 

See comment. 

See comment. 

See comment. 

Page 63 GAO-06-590 Compacts of Free Association
Appendix VI: Comments from the Federated 

States of Micronesia 

Page 64 GAO-06-590 Compacts of Free Association
Appendix VI: Comments from

the Federated States of 

Micronesia

The following is GAO’s comment on the Federated States of Micronesia 

letter dated May 30, 2006. 

Regarding the FSM’s disagreement with our conclusion that its 

development prospects remain limited—the FSM confirms the accuracy of

our description of its recent economic performance, its constraints to 

growth, and its need for economic policy reforms. Given these current 

realities, we maintain that prospects for long-term economic growth in the 

FSM remain limited. We do not assert, however, that economic

development cannot be attained. If key policy reforms were implemented, 

the business environment would likely improve and facilitate private 

sector expansion that may help the FSM advance its compact goals. 

Further, we agree that implementation of policy reforms will not, in of 

itself, produce economic development. As such, the FSM will also likely 

need to identify and capitalize on niche market opportunities as well as to 

create conditions to maximize remittance income, particularly through 

improving the education and health of its citizens. Establishing 

connections with the overseas business community may be one way to 

pursue such opportunities and should be included in meaningful JEMCO 

discussions of FSM progress toward their economic goals. As we 

emphasized earlier, the scheduled coming reductions in U.S. grants creates 

urgency for implementation of policy reforms and for capitalizing on 

opportunities to leverage compact assistance. The coming reductions in 

U.S. grants, paired with current economic realities, also suggests the need

for JEMCO discussions to be based on frank assessments of current 

limited prospects for economic growth in the FSM and what actions need 

to be pursued to improve those options. 

GAO Comment 

Page 65 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from the Republic of Appendix VII: Comments from the Republic the Marshall Islands 

of the Marshall Islands 

Note: GAO comments 

supplementing those in 

the report text appear at 

the end of this appendix. 

Page 66 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from the Republic of 

the Marshall Islands 

See comment 2. 

See comment 3. 

See comment 1. 

See comment 4. 

Page 67 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from the Republic of 

the Marshall Islands 

See comment 4. 

See comment 10. 

See comment 5. 

See comment 10. 

See comment 6. 

Page 68 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from the Republic of 

the Marshall Islands 

See comment 7. 

See comment 1. 

See comment 4. 

See comment 2. 

See comment 10. 

Page 69 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from the Republic of 

the Marshall Islands 

See comment 8. 

See comment 10. 

See comment 9. 

See comment 10. 

See comment 1. 

Page 70 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from 

the Republic of the Marshall 

Islands 

The following are GAO’s comments on the Republic of the Marshall 

Islands letter dated June 1, 2006. 

1. Regarding our recommendation, we believe that economic reforms in 

each of the areas discussed (e.g., tax, land, foreign investment, and 

public sector) are needed to improve the RMI’s prospects for long-term 

economic growth and have clarified the report language. We also agree 

that the annual decrement in compact grant funding is a major 

challenge to achieving this objective, particularly if implementation of 

key policy reforms requires fiscal resources. 

GAO Comments 

2. We recognize that the FSM and the RMI were required under the 

amended compacts to contribute an initial $30 million to their trust 

funds. Recent RMI GDP performance may have differed if this funding 

were used to provide current goods and services rather than for 

savings. Nonetheless, the RMI’s contribution to their trust fund does 

not alter the extent of RMI economic dependence on external 

assistance. Our description of RMI economic performance was also 

based on broad trends from 2000 to 2005, rather than exclusively on

the 2 years of bump-up assistance in 2002 and 2003. 

3. We will address amended compact implementation issues and trustfund issues in two separate reports, forthcoming. We have also added 

language to this report indicating the RMI’s concern over delays in 

setting up its trust fund. 

4. We have clarified our estimates and figures with regards to funding 

streams they include and exclude. Section 177 funds are not included 

in our analysis.1

 1

The compact served as a vehicle to reach a full settlement of all compensation claims 

related to U.S. nuclear tests conducted on Marshallese atolls between 1946 and 1958. In a 

compact-related agreement (pursuant to Section 177), the U.S. government agreed to

provide $150 million to create a trust fund. While the compact and its related agreements 

represented a full settlement of all nuclear claims, it provided the RMI with the right to

submit a petition of “changed circumstance” to the U.S. Congress requesting additional

compensation. The RMI government submitted such a petition in September 2000. In

November 2004, the U.S. Department of State issued a report evaluating the legal and 

scientific basis of this petition. The report concludes that there is no legal basis for 

considering additional payments. The House Committee on Resources and the 

Subcommittee on Asia and the Pacific of the House Committee on International Relations 

held a joint hearing on the petition on May 25, 2005. The Senate Committee on Energy and 

Natural Resources held an oversight hearing on the effects of the U.S. nuclear testing 

program on the Marshall Islands on July 19, 2005. 

Page 71 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from 

the Republic of the Marshall 

Islands 

5. Section 211 of Title Two of the Amended Compact with the RMI states 

that compact grants shall be used for assistance in education, health 

care, the environment, public sector capacity building, and private 

sector development, or for other areas as mutually agreed, with 

priorities in the education and health sectors. 

6. We have added language regarding RMI consultations with the private 

sector and their desire for improved tax enforcement. The 

effectiveness of U.S. and ADB technical assistance to the RMI is 

outside the scope of this report. We note, however, that the RMI 

allocated no compact funding to a public sector capacity building grant 

in fiscal year 2004 and less than 1 percent of compact sector grant 

funding to such a grant in fiscal year 2005. 

7. We discuss remittances in our report as one option that the RMI may 

consider in pursuing the economic goals under the amended compact 

and that the JEMFAC may consider when discussing compact grant 

implementation. In the RMI’s METO 2000 Statement of Development 

Strategies and its 2001 Strategic Development Plan entitled “Vision 

2018,” the RMI estimates that between 500 to 800 new job entrants will 

need to find employment each year from 1999 to 2009. To meet this 

objective, the ready access provided under the compact for 

Marshallese to live and work in the U.S. must be preserved. These 

documents also emphasize that the education system needs to equip 

Marshallese to succeed both in the RMI and abroad. Economic experts 

have emphasized that the RMI’s free access and strong historical links 

to the U.S. market provide the RMI with relatively good opportunities 

to expand remittance income, particularly if migrants had upgraded 

skills. Improved skill provision should benefit both RMI emigrants as 

well as domestic economic prospects. 

8. We have clarified our reference that 2003 data on international visitor 

arrivals are for other Pacific island nations. Such data are not available 

for Kiribati and Nauru. The World Bank has estimated that, in 2002, 

Kiribati had 5,000 international visitors. However, Kiribati also has a 

per capita GDP that is less than one-third of the RMI’s. 

9. RMI employment data indicate that the RMI did succeed in reducing 

public sector employment from about 3,760 jobs in 1997 to about 3,530 

Page 72 GAO-06-590 Compacts of Free Association
Appendix VII: Comments from 

the Republic of the Marshall 

Islands 

jobs in 2001.2 However, since then, public sector employment has risen 

to about 4,320 jobs in 2005. 

10. We have modified language in the report to clarify each of these points. 

We have added language to the report to include the volatility in tax 

income from the fisheries and tourism sectors and the fact that RMI 

offices related to reform efforts, such as land registration offices, have 

been funded with compact grants. 

 2

Public sector employment data includes jobs in the RMI national and local governments, 

government agencies, and public-sector enterprises. 

Page 73 GAO-06-590 Compacts of Free Association
Appendix VIII: 

and Staff A

GAO Contact 

cknowledgments 

Page 74 GAO-06-590

Appendix VIII: GAO Contact and Staff 

Acknowledgments 

GAO Contact David Gootnick, (202) 512-3149 

In addition to the persons named above, Emil Friberg, Assistant Director; 

Leslie Holen; Reid Lowe; Mary Moutsos; Kendall Schaefer; and Seyda 

Wentworth made key contributions to this report. 

Compacts of Free Association

Staff 

Acknowledgments 

(320371) 
This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately. 
GAO’s Mission The Government Accountability Office, the audit, evaluation and 

investigative arm of Congress, exists to support Congress in meeting its 

constitutional responsibilities and to help improve the performance and 

accountability of the federal government for the American people. GAO 

examines the use of public funds; evaluates federal programs and policies; 

and provides analyses, recommendations, and other assistance to help

Congress make informed oversight, policy, and funding decisions. GAO’s 

commitment to good government is reflected in its core values of 

accountability, integrity, and reliability. 

The fastest and easiest way to obtain copies of GAO documents at no cost

is through GAO’s Web site (www.gao.gov). Each weekday, GAO posts 

newly released reports, testimony, and correspondence on its Web site. To

have GAO e-mail you a list of newly posted products every afternoon, go 

to www.gao.gov and select “Subscribe to Updates.” 

The first copy of each printed report is free. Additional copies are $2 each. 

A check or money order should be made out to the Superintendent of 

Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 

more copies mailed to a single address are discounted 25 percent. Orders 

should be sent to: 

U.S. Government Accountability Office 

441 G Street NW, Room LM 

Washington, D.C. 20548 

To order by Phone: Voice: (202) 512-6000 

TDD: (202) 512-2537 

Fax: (202) 512-6061 

Contact: 

Web site: www.gao.gov/fraudnet/fraudnet.htm

E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470 

Gloria Jarmon, Managing Director, JarmonG@gao.gov (202) 512-4400 

U.S. Government Accountability Office, 441 G Street NW, Room 7125 

Washington, D.C. 20548 

Paul Anderson, Managing Director, AndersonP1@gao.gov (202) 512-4800

U.S. Government Accountability Office, 441 G Street NW, Room 7149 

Washington, D.C. 20548 

Obtaining Copies of 

GAO Reports and 

Testimony

Order by Mail or Phone 

To Report Fraud,

Waste, and Abuse in 

Federal Programs 

Congressional 

Relations 

Public Affairs 

PRINTED ON RECYCLED PAPER