Federated States of Micronesia

Economic Environment

For the past two decades, the economy of the Federated States of Micronesia has been driven largely by grants from the US government. Under the first phase of the Compact of Free Association which ended last year, FSM has received most of the more than $1 billion from the US since 1986, with smaller grants in each succeeding five-year increment.

Since 1986, FSM has grown at an average annual rate of 2.3 %. This modest growth rate has provided an acceptable increase in GDP, as direct payments from the US has declined. By 1998, after two incremental reductions in Compact funding, the government’s contribution to the economy had fallen by an annual average of 0.6 percent. However, this reduction was compensated by an increase in private sector activity, which grew by an annual average rate of 2.8 percent.

The emergence of FSM as a new nation in 1986 created many opportunities for expansion in the private sector. However, private sector growth peaked by the mid-1990’s, and the phased reduction in US funding has dominated FSM’s economic performance. Economic activity slumped between 1994 and 1999, when growth was positive in only two of those years. Between 1995 and 1998, while the government’s contribution to the GDP fell by 7 percent annually, private activity also fell by 5 percent.

Compact and grant funds account for approximately two-thirds of the government budget in FSM. The government has responded by increasing some taxes and reducing work hours and some government programs. However, FSM continues to depend on outside funding. Government leaders are reluctant to lay off large numbers of workers, who are equally reluctant to leave their jobs, which pay more and have more status and job security than private sector jobs. Nevertheless, the FSM national government, with a loan from the Asian Development Bank, implemented an early retirement program to reduce the number of government workers. At the same time, all of the states in the FSM are looking at ways to privatize as many government functions as possible.

However, the private sector economy in the FSM is currently too small to absorb government workers losing their jobs, as unemployment in the FSM is estimated to be 27 percent. Private employers in the FSM pay substantially less than the government and offer few opportunities for trained workers with specialized skills. Unless the private sector expands rapidly and substantially, FSM standard of living will decline and emigration will increase.

Opportunities for growth in the private sector exist, but the barriers that constrain this growth are significant. Some of these barriers include:

  • The FSM is remote. It is expensive to get there, and expensive to ship goods to and from FSM destinations. • The local market is dispersed over thousands of square miles of ocean, which makes it an expensive market to serve.
  • The local market is small. There are no economies of scale to balance the high cost of serving a limited market.
  • The basic infrastructure is often either inadequate or unreliable, due to inconsistent maintenance. Coping with an inadequate infrastructure adds to the cost of doing business.
  • Land tenure laws and foreign investment regulations are costly, time consuming and may discourage investors.
Finally, and probably most important, entrepreneurship, the driving force behind economic development in a capitalist economy, is a relatively foreign concept in the FSM.

Despite these barriers, opportunities exist for growth in tourism, fishing and agriculture.

Tourism: All of the FSM states have unique characteristics that make each a potentially world-class tourist destination. However, FSM's distance from the large tourist markets in the U.S., Europe and Asia makes it more difficult and expensive to visit than other Pacific destinations. Also, FSM destinations do not provide extensive resort accommodations and shopping and sightseeing opportunities tourists find elsewhere in the Pacific. The FSM, however, does offer the dive tourist opportunities unmatched anywhere else in the world. FSM can also be marketed as a sport-fishing destination, with the abundance of tuna, mahimahi, wahoo and giant trevally in its waters. The lack of development in the FSM also presents opportunities in the rapidly growing ecotourism market.

While there is currently an overabundance of hotel rooms, FSM lacks a focused, effective marketing effort. State and national marketing programs to support tourism are limited and inadequate. Almost all of the marketing costs that go with developing a remote-site destination must be borne by the developer.

Fishing & Aquaculture: The FSM is located in the world’s largest tuna fishing grounds. Yellow fin and bigeye tuna command high prices in the Japanese fresh fish market. Demand is also rising for frozen tuna loins in the U.S. and European markets. The national and the state governments have all made substantial investments in infrastructure and processing facilities to capitalize on this rich resource. To date, however, neither the national government nor any of the states has seen a positive return on its investment.

Open ocean fishing is expensive, requiring a fleet of well-equipped boats and experienced fishermen. Both are lacking in the FSM. The distance between the FSM and the major tuna markets also increases the cost and risk. As a recent National Fisheries Policy Study points out, FSM laws and regulations burden foreign fleets with additional costs and risks, leading them to fish in less productive but less costly areas. Thus, much of the facilities FSM has built for tuna processing and shipping is idle.

In contrast with commercial tuna fishing, aquaculture requires much smaller capital investment and less public infrastructure. Good markets exist for several high-end aquaculture products that can be grown in the clean, protected waters that encircle many FSM islands. For example, a sponge farm can be set up for very little money. The farmer can sell a sponge for about two dollars in a market where the demand for natural sponge far exceeds the supply. Sponges are very light and compact and can be shipped by surface carrier. Hard and soft corals, as well as giant clams, can also be grown in the FSM. Surveys must be done to determine what can be grown and where. However, instead of being sponsored by the government, aquaculture projects should be encouraged in the private sector, supported by business plans and commercial loans.

Agriculture: While FSM’s climate is well suited for year-round agriculture, farmland is in short supply, because of the FSM's mountainous terrain. Some export crops, such as copra, pepper and limes, have been raised in sufficient quantity, but all have struggled for a variety of reasons. Copra production in the FSM never recovered from the drop in the world prices for copra in the 1980’s. Attempts to manufacture and market high-end, specialty coconut oil soap have failed due to inconsistent production and marketing. A very successful high-end pepper product failed, when the government intervened on behalf of disgruntled pepper growers who wanted processors to buy all of their harvest, instead of only the best pepper. A government-financed and operated pepper processing plant competed with the private sector pepper manufacturer, leading to the collapse of that industry. Attempts to export lime export also failed, due to inconsistent airfreight service.