3). At the same time, despite relatively high health and  education expenditures, both countries face development challenges in  these sectors. As a result, FSM access to the compact infrastructure  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. 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. The JEMCO meetings have not included discussion of FSM  progress toward its long-term development goals. 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 long-term. 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. Compact Management Committees Have Not Addressed Slow FSM and RMI Progress in Implementing Reforms

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. Recommendations

To maximize FSM and RMI potential for budgetary self-reliance and long- term economic advancement, we recommend that the Secretary of the  Interior direct the Deputy Assistant Secretary for Insular Affairs, as  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. Appendix I: Objectives, Scope, and 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 report 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. 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. 5.
Why GAO Did This Study

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 Found

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 compact-related 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. 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.