Compact of Free Association
Micronesia Faces Challenges to Achieving Compact Goals Gao ID: GAO-08-859T June 10, 2008From 1987 through 2003, the Federated States of Micronesia (FSM) received more than $1.5 billion in economic assistance under the original Compact of Free Association with the United States. In 2003, the U.S. government approved an amended compact with the FSM that provides an additional $2.3 billion from 2004 through 2023. The Department of the Interior's Office of Insular Affairs (OIA) is responsible for administering and monitoring this assistance. The amended compact identifies the additional 20 years of grant assistance as intended to assist the FSM in its efforts to promote the economic advancement and budgetary self-reliance of its people. The assistance is provided in the form of annually decreasing grants that prioritize health and education, paired with annually increasing contributions to a trust fund intended as a source of revenue for the country after the grants end in 2023. The amended compact also contains several new funding and accountability provisions intended to strengthen reporting and bilateral interaction. Among these provisions is a requirement for the establishment of a joint economic management committee and a trust fund committee to, respectively, among other duties, review the FSM's progress toward compact objectives and assess the trust fund's effectiveness in contributing to the country's economic advancement and long-term budgetary self-reliance. In 2003, we testified that these provisions could improve accountability over the assistance provided but that successful implementation of these provisions would require appropriate resources and sustained commitment from both the United States and the FSM. Drawing on several more recent reports as well as updated information, this report will discuss the FSM's economic prospects, implementation of the amended compact to meet its long-term goals, and potential trust fund earnings.
The FSM has limited prospects for achieving budgetary self-reliance and long-term economic advancement, and the FSM government has not yet implemented policy reforms needed to enable economic growth. The FSM economy depends on public sector spending of foreign assistance; government expenditures, over half of which are funded by external grants, account for about 65 percent of the FSM's gross domestic product (GDP). The FSM government's budget is characterized by limited tax revenue and a growing wage bill, and the two private sector industries identified as having growth potential--fisheries and tourism--face significant barriers to expansion because of the FSM's remote geographic location, inadequate infrastructure, and poor business environment. Moreover, progress in implementing key tax, public sector, land, and foreign investment policy reforms necessary to improve growth has been slow. For example, although the FSM has agreed on principles of reform to address its tax system that has been characterized by experts as inefficient and inequitable, the FSM government has made limited progress in implementing fundamental tax reform. Also, the FSM's failure to implement key public sector reforms to reduce wage and subsidy expenditures resulted in fiscal crisis in Chuuk and Kosrae. In August 2006, nearly 2 years after the amended compact entered into force, the FSM Joint Economic Management Committee (JEMCO) began discussions of economic policy reform and has since approved some funding to support FSM reform efforts; however, challenges to private sector growth remain. Numerous factors have negatively affected the use of the compact grants for FSM development goals. The FSM's grant allocations have reflected compact priorities by targeting education, health, and infrastructure. However, as of April 2008, the FSM had completed only three infrastructure projects and approximately 82 percent of the $82.5 million in infrastructure funds remained unexpended. Lack of progress in this sector is owed to national and state disagreements over infrastructure priorities, problems associated with the project management unit, and Chuuk's inability to secure land leases. Additionally, the FSM has almost $15 million in unspent funds for other sectors, or around 7 percent of funds allocated from 2004 to 2007. Furthermore, the FSM's distribution of grants among its four states has not been based on need, leading to significant differences in per capita funding, while the FSM's long-term planning has not taken into account the likely effects of the annual funding decrement and other budgetary changes. The FSM has also lacked accountability for the use of compact funds, as demonstrated by weaknesses in its yearly financial statements and lack of compliance with requirements of major federal programs. Moreover, the FSM has not consistently monitored day-to-day grant operations or reported on progress toward program and economic goals, owing to inadequate data, a lack of required reporting, and an unwillingness to dedicate the resources necessary. OIA has conducted administrative oversight of the sector grants, but its oversight has been constrained by the need to assist the FSM with its compact implementation activities such as preparing budgets and addressing financial management problems such as the misuse of compact funds by Chuuk and Kosrae in 2006 and 2007, respectively.
GAO-08-859T, Compact of Free Association: Micronesia Faces Challenges to Achieving Compact Goals
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Testimony:
Before the Insular Affairs Subcommittee, House Resources Committee,
U.S. House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 11:00 a.m. EST:
Tuesday, June 10, 2008:
Compact Of Free Association:
Micronesia Faces Challenges to Achieving Compact Goals:
Statement of David Gootnick, Director:
International Affairs and Trade:
Compact of Free Association:
GAO-08-859T:
Madame Chairwoman and Members of the Subcommittee:
I am pleased to be here today to discuss GAO's recent work regarding
the amended Compact of Free Association between the United States and
the Federated States of Micronesia (FSM).[Footnote 1]
From 1987 through 2003,[Footnote 2] the FSM received more than $1.5
billion in economic assistance under the original Compact of Free
Association with the United States.[Footnote 3]
In 2003, the U.S. government approved an amended compact with the FSM
that provides an additional $2.3 billion from 2004 through
2023[Footnote 4]. The Department of the Interior's Office of Insular
Affairs (OIA) is responsible for administering and monitoring this
assistance.
The amended compact identifies the additional 20 years of grant
assistance as intended to assist the FSM in its efforts to promote the
economic advancement and budgetary self-reliance of its people. The
assistance is provided in the form of annually decreasing grants that
prioritize health and education, paired with annually increasing
contributions to a trust fund intended as a source of revenue for the
country after the grants end in 2023.[Footnote 5] The amended compact
also contains several new funding and accountability provisions
intended to strengthen reporting and bilateral interaction. Among these
provisions is a requirement for the establishment of a joint economic
management committee and a trust fund committee to, respectively, among
other duties, review the FSM's progress toward compact objectives and
assess the trust fund's effectiveness in contributing to the country's
economic advancement and long-term budgetary self-reliance. In 2003, we
testified that these provisions could improve accountability over the
assistance provided but that successful implementation of these
provisions would require appropriate resources and sustained commitment
from both the United States and the FSM.[Footnote 6]
Today, drawing on several more recent reports as well as updated
information,[Footnote 7] I will discuss the FSM's economic prospects,
implementation of the amended compact to meet its long-term goals, and
potential trust fund earnings.
Summary:
The FSM has limited prospects for achieving budgetary self-reliance and
long-term economic advancement, and the FSM government has not yet
implemented policy reforms needed to enable economic growth. The FSM
economy depends on public sector spending of foreign assistance;
government expenditures, over half of which are funded by external
grants, account for about 65 percent of the FSM's gross domestic
product (GDP). The FSM government's budget is characterized by limited
tax revenue and a growing wage bill, and the two private sector
industries identified as having growth potential--fisheries and
tourism--face significant barriers to expansion because of the FSM's
remote geographic location, inadequate infrastructure, and poor
business environment. Moreover, progress in implementing key tax,
public sector, land, and foreign investment policy reforms necessary to
improve growth has been slow. For example, although the FSM has agreed
on principles of reform to address its tax system that has been
characterized by experts as inefficient and inequitable, the FSM
government has made limited progress in implementing fundamental tax
reform. Also, the FSM's failure to implement key public sector reforms
to reduce wage and subsidy expenditures resulted in fiscal crisis in
Chuuk and Kosrae. In August 2006, nearly 2 years after the amended
compact entered into force, the FSM Joint Economic Management Committee
(JEMCO) began discussions of economic policy reform and has since
approved some funding to support FSM reform efforts; however,
challenges to private sector growth remain.
Numerous factors have negatively affected the use of the compact grants
for FSM development goals. The FSM's grant allocations have reflected
compact priorities by targeting education, health, and infrastructure.
However, as of April 2008, the FSM had completed only three
infrastructure projects and approximately 82 percent of the $82.5
million in infrastructure funds remained unexpended. Lack of progress
in this sector is owed to national and state disagreements over
infrastructure priorities, problems associated with the project
management unit, and Chuuk's inability to secure land leases.
Additionally, the FSM has almost $15 million in unspent funds for other
sectors, or around 7 percent of funds allocated from 2004 to 2007.
Furthermore, the FSM's distribution of grants among its four states has
not been based on need, leading to significant differences in per
capita funding, while the FSM's long-term planning has not taken into
account the likely effects of the annual funding decrement and other
budgetary changes. The FSM has also lacked accountability for the use
of compact funds, as demonstrated by weaknesses in its yearly financial
statements and lack of compliance with requirements of major federal
programs. Moreover, the FSM has not consistently monitored day-to-day
grant operations or reported on progress toward program and economic
goals, owing to inadequate data, a lack of required reporting, and an
unwillingness to dedicate the resources necessary. OIA has conducted
administrative oversight of the sector grants, but its oversight has
been constrained by the need to assist the FSM with its compact
implementation activities such as preparing budgets and addressing
financial management problems such as the misuse of compact funds by
Chuuk and Kosrae in 2006 and 2007, respectively.
The FSM's trust fund may not provide sustainable income for the country
after compact grants end--a potential outcome that the FSM trust fund
committee has not yet addressed. Market volatility and the choice of
investment strategy could cause the FSM trust fund balance in some
years to fall short of the maximum disbursement level allowed--an
amount equal to the inflation-adjusted compact grants in 2023--or to be
unable to disburse any income. Moreover, the probability of shortfalls
increases over time. The trust fund income could be supplemented from
several sources, including funding from other donors, increased tax
revenue, or securitization. However, the FSM has not attracted other
donors, its limited development prospects constrain its ability to
raise tax revenues, and securitization--issuing bonds against future
U.S. contributions--carries the risk of lower fund balances and reduced
income. Furthermore, because management challenges affecting the FSM
trust fund committee delayed the fund's investment, the fund remained
in a low-interest savings account for 22 months. Additionally, despite
the likely impact of market volatility and investment strategy on the
trust fund balance, the trust fund committee has not assessed the
fund's potential adequacy as a source of revenue after the compact
grants end in 2023.
Our previous reports on the amended compacts recommended, among other
things, that Interior's Deputy Assistant Secretary for Insular Affairs
ensure that the compact management committee addresses the FSM's lack
of progress in implementing economic reforms; work with the FSM to
develop plans for minimizing the impact of the declining grants; work
with the FSM to fully develop a reliable mechanism for measuring
progress toward compact goals; and ensure the trust fund committee's
timely reporting on the fund's likely status as a source of revenue
after 2023. Interior generally concurred with our recommendations and
has taken some actions in response to several of them, although key
challenges to effective compact implementation remain unaddressed.
Background:
Compact of Free Association: 1986-2003:
In 1986, the United States entered into its original Compact of Free
Association with the FSM.[Footnote 8] The compact comprised a framework
for the United States to work toward achieving three main goals: (1) to
secure self-government for the FSM, (2) to ensure certain national
security rights for all parties, and (3) to assist the FSM in its
efforts to advance economic development and self-sufficiency. Under the
original compact, the FSM also benefited from numerous U.S. federal
programs, and their citizens were allowed to live and work in the
United States as nonimmigrants and to stay for long periods of time.
Although the original compact's first and second goals were met, the
FSM did not achieve economic self-sufficiency. The FSM gained
independence in 1978, and key defense rights were established. However,
the compact's third goal was to be accomplished primarily through U.S.
direct financial assistance totaling about $1.5 billion from 1987
through 2003.[Footnote 9] Although U.S. financial assistance maintained
higher income levels than the FSM could have achieved without support,
FSM estimated per capita GDP at the compact's close did not differ
substantially, in real terms, from its per capita GDP in the early
1990s.[Footnote 10] In addition, we found that the U.S. and FSM
governments provided little accountability over compact expenditures
and that many compact-funded projects encountered problems related to
poor planning and management, inadequate construction and maintenance,
or misuse of funds.[Footnote 11]
Amended Compact of Free Association: 2004-2023:
In 2003, the United States approved an amended compact with the FSM
that (1) continues the defense relationship; (2) strengthens
immigration provisions; and (3) provides an estimated $2.3 billion to
the FSM for 2004 through 2023 (see attachment II). The amended compact,
which took effect in June 2004, identifies the additional 20 years of
grant assistance as intended to assist the FSM in its efforts to
promote the economic advancement and budgetary self-reliance of its
people. Financial assistance is provided in the form of annual sector
grants and contributions to the trust fund. [Footnote 12] The amended
compact and its subsidiary agreements, along with the FSM's development
plan, target the 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.[Footnote 13] To provide increasing U.S.
contributions to the FSM's trust fund, grant funding decreases annually
and will likely result in falling per capita grant assistance over the
funding period and relative to the original compact (see attachment
III). For example, in 2004 U.S. dollar terms, FSM per capita grant
assistance will likely fall from around $1,352 in 1987 to around $562
in 2023.
Under the amended compact, annual grant assistance is to be provided
according to an implementation framework with several components (see
attachment IV). For example, prior to the annual awarding of compact
funds, the FSM must submit a development plan that identifies goals and
performance objectives for each sector. The FSM government is also
required to monitor day-to-day operations of sector grants and
activities, submit periodic financial statements and performance
reports for the tracking of progress against goals and objectives, and
ensure annual financial and compliance audits. In addition, the U.S.
and JEMCO are to approve annual sector grants and evaluate the
countries' management of the grants and their progress toward program
and economic goals. The amended compact and subsidiary trust fund
agreement also provide for the formation of an FSM trust fund committee
to, among its other duties, hire a money manager, oversee the fund's
operation and investment, and provide annual reports on the fund's
profitability.
FSM Economic Prospects Remain Limited:
The FSM economy shows limited potential for developing sustainable
income sources other than foreign assistance to offset the annual
decline in U.S. compact grant assistance. Moreover, the FSM has not
enacted economic policy reforms needed to improve its growth prospects.
The FSM's economy shows continued dependence on government spending of
foreign assistance and limited potential for expanded private sector
and remittance income.
* Total government expenditures in 2006, over half of which were funded
by external grants, accounted for about 65 percent of GDP.
* The FSM's government budget is characterized by limited tax revenue
paired with growing government payrolls. For example, FSM taxes have
consistently provided less than 25 percent of total government revenue;
however, payroll expenditures have increased as a percentage of total
government spending, from 38 percent in 2000 to 45 percent in 2006.
* The FSM development plan identifies fishing and tourism as key
potential private sector growth industries. However, the two industries
together provide only about 6 percent of employment. Further, according
to economic experts, growth in these industries is limited by factors
such as the FSM's geographic isolation, lack of tourism infrastructure,
inadequate interisland shipping, limited pool of skilled labor, and
growing danger of overfishing.
* Although remittances from emigrants could provide increasing monetary
support to the FSM, evidence suggests that FSM emigrants are currently
limited in their income-earning opportunities abroad, owing to
inadequate education and vocational skills.
Although the FSM has undertaken some efforts aimed at economic policy
reform, it has made limited progress in implementing key tax, public
sector, land, and foreign investment reforms that are needed to improve
its growth prospects. For example:
* Tax reform. After several years of national policy dialogue to
address a tax system that economic experts describe as inequitable and
inefficient, the FSM established a tax reform executive steering
committee in December 2005. The committee endorsed key elements of tax
reform recommended by experts and the FSM's Tax Reform Task Force, such
as a value-added tax (VAT), a net profit tax, and a unified tax
authority. In April 2007, the committee endorsed a 3-year
implementation plan. However, as of April 2008, legislation required
for implementing these measures had not yet been passed.
* Public sector reform. Although the FSM has endorsed public sector
reform aimed at reducing wage and subsidy expenditures, limited
progress has been made in addressing annual fiscal deficits, which
amounted to about 5 percent of GDP in 2005 and 2006. Slow progress in
implementing public sector reforms, combined with a lower level of
grant assistance, precipitated fiscal crises in Kosrae and Chuuk.
Fiscal adjustment programs were subsequently created for the two states
based on, among other things, reductions-in-force wage savings and
increased state tax rates. Kosrae completed its adjustment program in
2007, but Chuuk's implementation of its program began only
recently.[Footnote 14] Moreover, all FSM governments continue to
conduct a wide array of commercial enterprises that require subsidies.
* Land reform. In attempts to modernize a complex land tenure system,
the FSM has established land registration offices. However, these
offices have lacked a systematic method for registering parcels,
instead waiting for landowners to voluntarily initiate the process.
Continued uncertainties over land ownership and land values create
costly disputes, disincentives for investment, and problems regarding
the use of land as an asset.
* Foreign investment reform. Economic experts and private sector
representatives describe the overall climate for foreign investment in
the FSM as complex and nontransparent. Despite attempts to streamline
the process, foreign investment regulations remain relatively
burdensome, with reported administrative delays and difficulties in
obtaining permits for foreign workers. Some FSM states also require a
certain percentage of local ownership in foreign investment.
Although the FSM development plan includes objectives for economic
reform, JEMCO did not begin to address the country's slow progress in
implementing these reforms until August 2006, 2 years into the amended
compact. Further, while JEMCO recently approved some funding to support
FSM efforts at public sector reform,[Footnote 15] key challenges to
improving private sector growth remain.
Numerous Factors Hinder Use of Compact Funds to Advance FSM Development
Goals:
Although the FSM has allocated compact grants to the sectors targeted
by the compact, immediate problems in some sectors persist, and several
factors have hindered the FSM's use of the funds to meet long-term
development goals. In addition, administrative deficiencies have
limited the FSM's ability to account for its use of the grants for
these long-term goals. Further, although OIA has monitored early
compact activities, program implementation challenges have hampered its
oversight.
In 2004 through 2008, the FSM targeted compact grants largely according
to compact priorities,[Footnote 16] allocating 35 percent of the funds
for education, 27 percent for infrastructure, and 22 percent for health
(see attachment V). However, the FSM has completed only three
infrastructure projects, and more than $67 million of the $82.5 million
(approximately 82 percent) allocated for infrastructure grants in 2004
through 2007 remains unspent. Lack of progress in this sector is owed
to national and state disagreements over infrastructure priorities,
problems associated with the project management unit, and Chuuk's
inability to secure land leases.[Footnote 17] Unspent funds for other
sector grants from 2004 to 2007 amounts to an additional $14.9 million,
or around 7 percent of funds allocated (see attachment VI).
Additionally, numerous factors have limited the government's use of
compact funds to meet long-term development needs. For example:
* Lack of government consensus. Interior and State 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 FSM central government, which is
represented on JEMCO, does not control the majority of compact funds
and has been unable to secure agreement from the state governments
regarding the use of compact funds.
* Lack of needs analysis. The allocation of FSM grants among its four
states is not needs based and has resulted in significant differences
in per capita funding, creating varying levels of government services
across the states. [Footnote 18] For example, in 2006, Yap state
received approximately $1,963 in education funding per student, while
Chuuk state received $626 per student. More recently, in 2007, the
national government's share of grant funding increased from 8.65
percent to 10 percent and the allocation of compact funds to the four
states decreased.
* Lack of planning for declining U.S. assistance. A lack of viable
plans to address the annual decrement in compact funding and the
elimination of nonconforming uses of the public-sector capacity
building (PSCB) grant could limit the FSM's ability to sustain current
levels of government services.[Footnote 19] JEMCO required the FSM in
2004 to develop a plan to eliminate funding for the nonconforming uses
of the PSCB by 2009. While FSM officials indicated that they plan to
replace the PSCB funds with local monies, recent tax revenues have
largely stagnated and, in 2006, the FSM requested that the deadline for
its elimination of nonconforming funding be extended to 2011. OIA
indicated that the steps the FSM takes toward overall public sector
reform will affect whether it recommends to JEMCO to approve this
request.
* Lack of accountability over compact funds. The FSM's accountability
for its use of compact funds has been limited. Although the timeliness
of the FSM's single audits has improved--in 2006, only Chuuk and the
national government submitted audit reports after the deadlines--
auditors have continued to find weaknesses with financial statements
and lack of compliance with requirements of major federal programs. For
example, the lack of audited financial statements for several
subgrantees led the auditors to render qualified and disclaimed
opinions.[Footnote 20]
The FSM has failed to consistently monitor day-to-day sector grant
operations or report on progress.
* Inadequate authority. The FSM's first effort to monitor and report on
compact progress was through the Office of Compact Management (OCM),
which lacked the authority and resources to carry out its function. In
2007, the FSM created a Statistics, Budget and Overseas Development
Assistance and Compact Management (SBOC) office. According to OIA, the
SBOC may have a role in conducting compact coordination, ensuring
sector-by-sector compliance, and providing technical assistance to the
states. Nonetheless, as of April 2008, SBOC had not addressed
performance problems, such as missing reports and data, and had failed
to hold the FSM governments accountable for not meeting JEMCO
resolutions and grant requirements.
* Data deficiencies. Although the FSM established performance
measurement indicators, a lack of complete and reliable data prevents
the use of these indicators to assess progress. For example, the FSM
provided the first complete set of education indicators in 2007.
However, OIA found that the data were not consistently reliable for
monitoring scholastic improvements, owing to problems in establishing
baselines and collecting data for all of the indicators. Likewise,
determining performance in the health sector was difficult due to a
lack of standardized data collection.
* Report problems. The FSM continues to have difficulty in submitting
its required annual report to the U.S. President on time. As of April
2008, the FSM had not begun work on the 2007 annual report to the U.S.
President, which was due in February 2008, and it submitted the 2006
annual report 10 months late. The quarterly reports have also been
regularly incomplete or inconsistent, preventing their use for
monitoring progress. Most recently, OIA rejected the FSM's 2007 fourth
quarter reports, stating that most of the submitted forms were
completely blank or missing data.
* Capacity constraints. The FSM has not allocated available compact
resources to develop the capacity for, and to provide, regular
monitoring of sector grants. As a result, the skills necessary to
improve financial and programmatic reporting are lacking. For example,
the FSM's single audit reports for 2005 and 2006 showed that the FSM's
ability to account for the use of compact funds was limited, as shown
by weaknesses in its financial statements and lack of compliance with
requirements of major federal programs. The FSM's Compact Fiscal
Adjustment and Transition Plan, in August 2006, reiterated that
capacity weaknesses continue, especially in the areas of financial
management, economic planning, and statistics.
OIA has carried out various duties as administrator of the amended
compact grants but has not addressed the FSM's worsening compliance
with compact reporting requirements, and several challenges continue to
hamper its compact oversight. For example, in monitoring the sector
grants, OIA determined that Chuuk, in 2006, and Kosrae, in 2007, had
each misused approximately $1 million in compact funds through the
commingling of compact and general funds. OIA required both states to
repay the misused funds, a requirement met in 2007. However, OIA has
generally failed to hold the FSM accountable for not submitting
required reports, including 2006 and 2007 quarterly performance reports
and the annual report to the U.S. President, and for not meeting
requirements imposed as grant conditions by JEMCO. Additionally, OIA's
oversight continues to be constrained by time-consuming demands
associated with poor compact implementation. For example, because the
FSM state and national government budgets are not presented in unified
format or linked to performance measures, OIA reports that it has
continued to spend an inordinate amount of time reviewing them for the
JEMCO meetings.
FSM Trust Fund May Not Provide Sustainable Income after Compact Grants
End:
FSM trust fund balances in 2023 could vary widely owing to market
volatility and choice of investment strategy, preventing trust fund
disbursements in some years. Moreover, the FSM's ability to supplement
its trust fund balance with additional contributions or other sources
of income is uncertain and entails risks. Further, the FSM's trust fund
committee has faced challenges in managing the fund's investment and
has not evaluated the fund's adequacy as a source of future revenue.
Market volatility and investment strategy could have a considerable
impact on projected trust fund balances in 2023 (see attachment VII).
Our analysis indicates that, under various scenarios, the FSM's trust
fund could fall short of the maximum allowed disbursement
level[Footnote 21]--an amount equal to the inflation-adjusted compact
grants in 2023--after compact grants end, with the probability of
shortfalls increasing over time (see attachment VIII).[Footnote 22] For
example, under a moderate investment strategy, the fund's income is
about 30 percent likely to fall short of the maximum distribution by
2031; however, this probability rises to almost 70 percent by 2050.
Additionally, our analysis indicates a positive probability that the
fund will yield no disbursement in some years; under a moderate
investment strategy, the probability is around 19 percent by 2050.
FSM trust fund income could be supplemented by sources such as other
donors, increased taxes, and securitization. However, this potential is
uncertain.
* Other donors. The trust fund agreement allows the FSM to seek funding
from other donors; however, the FSM has not yet received other
contributions.[Footnote 23]
* Increased taxes. The FSM's limited development prospects constrain
its ability to raise tax revenues to supplement the fund's income.
* Securitization. Securitization--issuing bonds against future U.S.
contributions--could increase the fund's earning potential by raising
its balances through bond sales. However, securitization could also
lead to lower balances and reduced fund income if interest owed on the
bonds exceeds investment returns. In October, 2007, the committee
contracted for a study of securitization.[Footnote 24]
The FSM trust fund committee has experienced management challenges in
establishing the trust fund to maximize earnings and has not yet
evaluated the fund's adequacy as a source of future revenue.
Contributions to the trust fund were initially placed in a low-interest
savings account and were not invested until 22 months after the initial
contribution. The months when the fund remained in a low-interest
account prior to investment likely reduced its potential investment
earnings significantly; we estimate this loss at $720,000 per month,
after taking into account stock market investment fees.[Footnote 25] As
we reported in June 2007, contractual delays and committee processes
for reaching consensus and obtaining administrative support contributed
to the time taken to establish and invest funds. The committee has
since hired an Executive Administrator in September 2007, and some
steps were taken to improve committee processes; however, the
Administrator reports that communication and administrative delays
remain. Also, despite the likely impact of market volatility and
investment strategy, the trust fund committee's reports have not yet
assessed the fund's potential adequacy as a source of revenue for
meeting the FSM's long-term economic goals.
Concluding Remarks and Prior Recommendations:
Since enactment of the amended compact, the U.S. and FSM governments
have made efforts to meet new requirements for implementation,
performance measurement, and oversight. However, after 5 years--one
quarter of the amended compact's duration--the FSM faces significant
challenges in working toward the compact goals of economic advancement
and budgetary self-reliance. The FSM economy shows continued dependence
on government spending of foreign assistance. However, despite the
budgetary impact of declining annual grant assistance, the FSM has made
little progress in implementing key reforms needed to improve tax
income or increase private sector investment opportunities. The FSM has
also been unable to utilize more than $67 million in infrastructure and
almost $15 million in other sector grant monies. Moreover, persistent
deficiencies in needs assessment, long-term planning, and financial
accountability continue to hinder the U.S. and FSM governments and
JEMCO from ensuring effective implementation of those grants that have
been spent. Although OIA has carried out various duties as
administrator of compact grants, U.S. and FSM monitoring of grant
operations remains deficient owing to continued problems with oversight
authority in the FSM, consistently poor data and reporting, and
unaddressed capacity constraints. Further, the FSM trust fund committee
has yet to assess the potential status of the trust fund as an ongoing
source of revenue after compact grants end in 2023. Because the trust
fund's earnings are intended as a main source of U.S. assistance to the
FSM after compact grants end, the fund's potential inadequacy as a
source of sustainable income in some years could impact the FSM's
ability to provide future government services.
To maximize the benefits of compact assistance, our prior
reports[Footnote 26] include recommendations that the Secretary of the
Interior direct the Deputy Assistant Secretary for Insular Affairs, as
chair of the FSM management and trust fund committees, to take a number
of actions, including the following:
* ensure that JEMCO address the lack of FSM progress in implementing
reforms to increase investment and tax income;
* coordinate with other U.S. agencies on JEMCO to work with the FSM to
establish plans to minimize the impact of declining assistance;
* coordinate with other U.S. agencies on JEMCO to work with the FSM to
fully develop a reliable mechanism for measuring progress toward
compact goals; and:
* ensure the FSM trust fund committee's assessment and timely reporting
of the fund's likely status as a source of revenue after 2023.
Interior generally concurred with our recommendations and has taken
actions in response to several of them. However, unless the challenges
we identified are addressed, the U.S. and FSM are unlikely to meet
compact goals of the FSM's economic advancement and budgetary self-
reliance.
Mr. Chairman and members of the subcommittee, this completes my
prepared statement. I would be happy to respond to any questions you
may have at this time.
Contacts and Acknowledgements:
For future contacts regarding this testimony, please call David
Gootnick at (202) 512-3149 or gootnickd@gao.gov. Individuals making key
contributions to this testimony included Emil Friberg, Jr. (Assistant
Director), Ming Chen, Julie Hirshen, Reid Lowe, Mary Moutsos, Kendall
Schaefer, and Eddie Uyekawa.
[End of section]
Attachment I: Related GAO Products:
Compacts of Free Association: Trust Funds for Micronesia and the
Marshall Islands May Not Provide Sustainable Income, GAO-07-513
(Washington, D.C.: July 15, 2007).
Compact of Free Association: Micronesia and the Marshall Island's Use
of Sector Grants, GAO-07-514R (Washington, D.C.: May 25, 2007).
Compacts of Free Association: Micronesia and the Marshall Islands Face
Challenges in Planning for Sustainability, Measuring Progress, and
Ensuring Accountability, GAO-07-163 (Washington, D.C.: Dec. 15, 2006).
Compacts of Free Association: Development Prospects Remain Limited for
the Micronesia and the Marshall Islands, GAO-06-590 (Washington, D.C.:
June 27, 2006).
Compacts of Free Association: Implementation of New Funding and
Accountability Requirements is Well Under Way, but Planning Challenges
Remain, GAO-05-633 (Washington, D.C.: July 11, 2005).
Compact of Free Association: Single Audits Demonstrate Accountability
Problems over Compact Funds, GAO-04-7 (Washington, D.C.: Oct. 7, 2003).
Compact of Free Association: An Assessment of the Amended Compacts and
Related Agreements, GAO-03-988T (Washington, D.C.: June 18, 2003).
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.
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).
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).
[End of section]
Attachment II: U.S. Assistance to the FSM under the Amended Compact,
2004-2023:
(Dollars in millions).
Fiscal year: 2004;
FSM grants (Section 211): $76.2;
FSM trust fund (Section 215): $16.0.
Fiscal year: 2005;
FSM grants (Section 211): 76.2;
FSM trust fund (Section 215): 16.0.
Fiscal year: 2006;
FSM grants (Section 211): 76.2;
FSM trust fund (Section 215): 16.0.
Fiscal year: 2007;
FSM grants (Section 211): 75.4;
FSM trust fund (Section 215): 16.8.
Fiscal year: 2008;
FSM grants (Section 211): 74.6;
FSM trust fund (Section 215): 17.6.
Fiscal year: 2009;
FSM grants (Section 211): 73.8;
FSM trust fund (Section 215): 18.4.
Fiscal year: 2010;
FSM grants (Section 211): 73.0;
FSM trust fund (Section 215): 19.2.
Fiscal year: 2011;
FSM grants (Section 211): 72.2;
FSM trust fund (Section 215): 20.0.
Fiscal year: 2012;
FSM grants (Section 211): 71.4;
FSM trust fund (Section 215): 20.8.
Fiscal year: 2013;
FSM grants (Section 211): 70.6;
FSM trust fund (Section 215): 21.6.
Fiscal year: 2014;
FSM grants (Section 211): 69.8;
FSM trust fund (Section 215): 22.4.
Fiscal year: 2015;
FSM grants (Section 211): 69.0;
FSM trust fund (Section 215): 23.2.
Fiscal year: 2016;
FSM grants (Section 211): 68.2;
FSM trust fund (Section 215): 24.0.
Fiscal year: 2017;
FSM grants (Section 211): 67.4;
FSM trust fund (Section 215): 24.8.
Fiscal year: 2018;
FSM grants (Section 211): 66.6;
FSM trust fund (Section 215): 25.6.
Fiscal year: 2019;
FSM grants (Section 211): 65.8;
FSM trust fund (Section 215): 26.4.
Fiscal year: 2020;
FSM grants (Section 211): 65.0;
FSM trust fund (Section 215): 27.2.
Fiscal year: 2021;
FSM grants (Section 211): 64.2;
FSM trust fund (Section 215): 28.0.
Fiscal year: 2022;
FSM grants (Section 211): 63.4;
FSM trust fund (Section 215): 28.8.
Fiscal year: 2023;
FSM grants (Section 211): 62.6;
FSM trust fund (Section 215): 29.6.
Source: Pub. L. No. 108-188.
Notes:
The annual grant amounts include $200,000 to be provided directly by
the Secretary of the Interior to the Department of Homeland Security,
Federal Emergency Management Agency, for disaster and emergency
assistance purposes. The grant amounts do not include the annual audit
grant, capped at $500,000.
These dollar amounts shall be adjusted each fiscal year for inflation
by the percentage that equals two-thirds of the percentage change in
the U.S. gross domestic product implicit price deflator, or 5 percent,
whichever is less in any one year, using the beginning of 2004 as a
base. Grant funding can be fully adjusted for inflation after 2014,
under certain U.S. inflation conditions.
[End of table]
[End of section]
Attachment III: Estimated FSM Per Capita Compact Grant Assistance,
Fiscal Years 1987-2023:
Figure:
This figure is a line graph showing the estimated FSM per capita
compact grant assistance, fiscal years 1987-2023. The X axis represents
the fiscal year, and the Y axis represents the constant fiscal year
2004 U.S. dollars.
Fiscal year: 1987;
Constant fiscal year 2004 U.S. dollars: $1351.54.
Fiscal year: 1988;
Constant fiscal year 2004 U.S. dollars: $1283.82.
Fiscal year: 1989;
Constant fiscal year 2004 U.S. dollars: $1251.76.
Fiscal year: 1990;
Constant fiscal year 2004 U.S. dollars: $1223.02.
Fiscal year: 1991;
Constant fiscal year 2004 U.S. dollars: $1252.36.
Fiscal year: 1992;
Constant fiscal year 2004 U.S. dollars: $1074.44.
Fiscal year: 1993;
Constant fiscal year 2004 U.S. dollars: $996.787.
Fiscal year: 1994;
Constant fiscal year 2004 U.S. dollars: $979.613.
Fiscal year: 1995;
Constant fiscal year 2004 U.S. dollars: $978.638.
Fiscal year: 1996;
Constant fiscal year 2004 U.S. dollars: $958.804.
Fiscal year: 1997;
Constant fiscal year 2004 U.S. dollars: $787.267.
Fiscal year: 1998;
Constant fiscal year 2004 U.S. dollars: $788.166.
Fiscal year: 1999;
Constant fiscal year 2004 U.S. dollars: $770.585.
Fiscal year: 2000;
Constant fiscal year 2004 U.S. dollars: $773.117.
Fiscal year: 2001;
Constant fiscal year 2004 U.S. dollars: $775.359.
Fiscal year: 2002;
Constant fiscal year 2004 U.S. dollars: $930.913.
Fiscal year: 2003;
Constant fiscal year 2004 U.S. dollars: $920.961.
Fiscal year: 2004;
Constant fiscal year 2004 U.S. dollars: $714.111.
Fiscal year: 2005;
Constant fiscal year 2004 U.S. dollars: $708.099.
Fiscal year: 2006;
Constant fiscal year 2004 U.S. dollars: $703.153.
Fiscal year: 2007;
Constant fiscal year 2004 U.S. dollars: $692.575.
Fiscal year: 2008;
Constant fiscal year 2004 U.S. dollars: $682.378.
Fiscal year: 2009;
Constant fiscal year 2004 U.S. dollars: $672.551.
Fiscal year: 2010;
Constant fiscal year 2004 U.S. dollars: $663.1.
Fiscal year: 2011;
Constant fiscal year 2004 U.S. dollars: $653.948.
Fiscal year: 2012;
Constant fiscal year 2004 U.S. dollars: $645.031.
Fiscal year: 2013;
Constant fiscal year 2004 U.S. dollars: $636.355.
Fiscal year: 2014;
Constant fiscal year 2004 U.S. dollars: $627.973.
Fiscal year: 2015;
Constant fiscal year 2004 U.S. dollars: $619.885.
Fiscal year: 2016;
Constant fiscal year 2004 U.S. dollars: $612.024.
Fiscal year: 2017;
Constant fiscal year 2004 U.S. dollars: $604.339.
Fiscal year: 2018;
Constant fiscal year 2004 U.S. dollars: $596.832.
Fiscal year: 2019;
Constant fiscal year 2004 U.S. dollars: $589.54.
Fiscal year: 2020;
Constant fiscal year 2004 U.S. dollars: $582.476.
Fiscal year: 2021;
Constant fiscal year 2004 U.S. dollars: $575.595.
Fiscal year: 2022;
Constant fiscal year 2004 U.S. dollars: $568.849.
Fiscal year: 2023;
Constant fiscal year 2004 U.S. dollars: $562.236.
Note: Compact grant assistance under the original compact decreased in
1991, 1996, and 2001 and 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 (2004-2024) decreases annually.
U.S. contributions to the FSM's compact trust fund increase by the same
amount as the grant decrement. Funding for compact-authorized federal
services and trust fund contributions is not included.
[End of figure]
[End of section]
Attachment IV: Amended Compact Implementation Framework:
Figure:
This figure is a line graph showing amended compact implementation
framework.
[See PDF for image]
Source: GAO analysis of amended compacts and U.S. Census projections.
[End of figure]
[End of section]
Attachment V: FSM Sector Grant Allocations, Fiscal Years 2004-2008:
This figure is a combination of four vertical bar graphs showing FSM
unspent compact grants by sector, fiscal years 2004-2008. The X axis
for each graph represents the sector grants, and the Y axis represents
the dollars in millions.
Sector grants: Education;
Fiscal year 2004: $25,965,602;
Fiscal year 2005: $27,105,002;
Fiscal year 2006: $26,132,102;
Fiscal year 2007: $28,051,602;
Fiscal year 2008: $28,423,802.
Sector grants: Environment;
Fiscal year 2004: $2,023,190;
Fiscal year 2005: $2,389,950;
Fiscal year 2006: $2,137,450;
Fiscal year 2007: $1,408,630;
Fiscal year 2008: $1,889,940.
Sector grants: Health;
Fiscal year 2004: $15,443,101;
Fiscal year 2005: $17,430,702;
Fiscal year 2006: $16,394,901;
Fiscal year 2007: $17,309,502;
Fiscal year 2008: $17,741,502.
Sector grants: Infrastructure;
Fiscal year 2004: $17,119,202;
Fiscal year 2005: $17,249,102;
Fiscal year 2006: $24,335,702;
Fiscal year 2007: $23,753,302;
Fiscal year 2008: $24,090,002.
Sector grants: Private Sector;
Fiscal year 2004: $3,786,120;
Fiscal year 2005: $4,038,910;
Fiscal year 2006: $4,039,160;
Fiscal year 2007: $1,011,050;
Fiscal year 2008: $2,506,350.
Sector grants: Public Sector;
Fiscal year 2004: $11,662,801;
Fiscal year 2005: $7,786,241;
Fiscal year 2006: $6,175,911;
Fiscal year 2007: $5,609,691;
Fiscal year 2008: $7,205,421.
Source: GAO analysis of FSM sector grant agreement, fiscal years 2004
to 2008.
[End of figure]
[End of section]
Attachment VI: FSM Unspent Compact Grants by Sector, Fiscal Years 2004
to 2007:
This figure is a combination bar graph showing FSM unspent compact
grants by sector, fiscal years 2004 to 2007. The X axis is the sector,
and the Y axis is the dollars (in millions).
Sector: Education;
Unspent sector grant funds: $7,129,212;
Spend sector grant funds: $100,125,024.
Sector: Environment;
Unspent sector grant funds: $664,731;
Spend sector grant funds: $7,294,501.
Sector: Health;
Unspent sector grant funds: $3,812,840;
Spend sector grant funds: $62,765,504.
Sector: Infrastructure;
Unspent sector grant funds: $67,968,208;
Spend sector grant funds: $14,489,101.
Sector: Private Sector;
Unspent sector grant funds: $720,475;
Spend sector grant funds: $12,154,803.
Sector: Public Sector;
Unspent sector grant funds: $2,591,690;
Spend sector grant funds: $28,643,002.
Source: GAO analysis of Department of the Interior data.
[End of table]
[End of section]
Attachment VII: Projections of FSM Account Balance with Three Possible
Investment Strategies:
This figure is a combination of increasing line graphs showing
projections of FSM account balance with three possible investment
strategies.
[See PDF for image]
Source: GAO.
[End of figure]
[End of section]
Attachment VIII: Probability of FSM Trust Fund Income Not Reaching the
Maximum Disbursement Levels Allowed, Fiscal Years 2024-2050:
This figure is a combination bar graph showing probability of FSM trust
fund income not reaching the maximum disbursement levels allowed,
fiscal years 2024-2050. The X axis represents the year, and the Y axis
represents the percentage.
[See PDF for image]
Source: GAO.
Notes: The chart depicts results from 1,000 trial runs. The change from
one year to the next may not always be monotonic, but the general time
trend is clear. As the number of trial runs increase, the time trend
becomes smoother.
[End of figure]
[End of section]
Footnotes:
[1] The FSM comprises four states--Chuuk, Kosrae, Pohnpei, and Yap--
with 50 percent of the FSM population residing in Chuuk state. A list
of relevant GAO reports on the FSM is included in attachment I.
[2] In this testimony, all years cited are fiscal years (Oct. 1-Sept.
30).
[3] Under the original Compact of Free Association, the United States
also provided about $579 million of economic assistance to the Republic
of the Marshall Islands (RMI). In 2000, we reviewed assistance under
the compact and determined that the U.S., FSM, and RMI governments had
provided limited accountability over spending and that U.S. assistance
had resulted in little impact on economic development in the FSM and
RMI. See GAO/NSIAD-00-216.
[4] This figure is based on a Department of the Interior projection
included in its Fiscal Year 2009 Budget Justification. The United
States also signed an amended compact with the RMI that provides about
$1.5 billion from 2004 through 2023.
[5] According to U.S. officials, the trust fund income is intended to
be one source of income, and the amended compact does not guarantee
that the trust fund will provide the maximum disbursements allowed by
the trust fund agreements.
[6] See GAO-03-988T, a testimony before the Committee on Resources,
House of Representatives.
[7] The amended compacts' implementing legislation instructs GAO to
report 3 years following the enactment of the legislation and every 5
years thereafter on the FSM's use and effectiveness of U.S. financial,
program, and technical assistance as well as the effectiveness of
administrative oversight by the United States. To update information
for this testimony, we met with U.S. and FSM officials and reviewed
documentation from, among other things, the April 2008 technical
working group and the FSM's 2007 economic report. We conducted these
performance audits in accordance with generally accepted government
auditing standards. See list of related GAO products in attachment I.
[8] Under the initial Compact of Free Association, the United States
also entered into a compact with the RMI, with a similar set of goals
and compact framework.
[9] This estimate represents total nominal outlays. It does not include
investment development funds provided under section 111 of Public Law
99-239 or the cost of compact-authorized federal services.
[10] In fiscal year 2003 dollars, estimated FSM per capita GDP was
around $2,150 in 2003, compared with an average of around $2,120 in
1991-1995. See GAO-06-590.
[11] See GAO/NSIAD-00-216.
[12] U.S. contributions to trust funds were conditioned on the FSM
making its own required contribution. The FSM made its required initial
contribution of $30 million to its trust fund on October 1, 2004, one
day after the September 30, 2004 deadline.
[13] In the compacts' implementing legislation, Congress also suggested
that the FSM allocate for infrastructure improvement and maintenance at
least 30 percent of its total sector grant allocation.
[14] Chuuk's debt levels currently amount to about $37 million, and the
anticipated time required to complete its adjustment program, including
the servicing of this debt, is 5 to 7 years. Chuuk's efforts to reduce
its public sector workforce are ongoing. Although Chuuk has reduced the
work week for certain public sector employees, the list of positions
for elimination has not yet been published.
[15] In August 2007 and February 2008 respectively, JEMCO approved use
of public-sector capacity building grant funds to provide one-year's
annual salary as a buy-out to support public sector reforms in Kosrae
and Chuuk.
[16] The priority for infrastructure spending was designated by a sense
of the U.S. Congress laid out in the Compact's enabling legislation.
[17] Additionally, only Pohnpei has contributed to the FSM
infrastructure maintenance fund. None of the other states have made
their required contribution to this fund and are therefore unable to
use it.
[18] The FSM distributed overall compact funding among its four states
according to a formula established in an FSM law enacted in January
2005 and in force through 2006 that allotted a set percentage to each
state and the national government without fully accounting for states'
differing population sizes or funding needs. The states decide their
own distribution of funds between the sectors, from their allocation.
[19] The FSM has been using PSCB funds to support basic government
operations, rather than for the grant's intended purpose to support the
efforts of the FSM to develop internal expertise needed to build an
effective, accountable, and transparent government.
[20] A "qualified" opinion is given when the auditor finds conditions,
such as a lack of supporting evidence or a restriction on the scope of
the audit. An auditor issues a "disclaimer" of opinion when unable to
perform all of the procedures necessary to complete an audit,
indicating the reliability of the financial statements is not known. An
"adverse" opinion is given when the auditor concludes that the
financial statements are not fairly presented. Pohnpei and Kosrae
states' reports for 2006 contained an unqualified opinion on the
financial statements. However, other reports contained qualified,
adverse, or disclaimed opinions.
[21] The FSM trust fund agreement specifies that in 2024 and
thereafter, the FSM trust fund committee may disburse amounts up to the
annual grant assistance in 2023, fully adjusted for inflation, provided
that this amount is available.
[22] Our methodology for projecting the trust fund income is base on a
technique known as Monte Carlo simulation. We built a Monte Carlo
simulation model--based on the trust fund agreements, contributions to
date, and historical returns of the market--to project the trust fund's
likely income levels given market volatility as well as historical
returns of various asset classes, including large company stocks,
treasury bills, and international stocks from 1970 to 2005. See GAO-07-
513.
[23] In contrast, in May 2005, the RMI and Taiwan reached an agreement
that Taiwan will contribute a total of $40 million to the RMI's trust
fund from 2004 to 2023.
[24] We previously reported that some members of the trust fund
committee believe that securitization could bring great financial
benefits, as a company that performs securitization had asserted in
presentations to the committee. Others raised concerns of whether the
trust fund could pursue securitization under the current amended
compact and trust fund agreement or whether amendments to the agreement
would be required. See GAO-07-513.
[25] From October 2004 through August 2006, the FSM trust fund--with an
October 2005 balance of approximately $80 million--earned about 3
percent interest, compared with potential stock market earnings of
about 15 percent. See GAO-07-513.
[26] GAO-05-633, GAO-06-590, GAO-07-163, GAO-07-513, GAO-07-514R.
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