*EPF410 06/29/00
Text: Dept. of the Interior Official on Aid to Freely Associated States
(Micronesia, Marshall Islands not yet self-sufficient) (3160)

Although the Compact of Free Association has achieved its strategic goals in the Freely Associated States (FAS) of Micronesia and the Marshall Islands, it has not yet established economic self-sufficiency, according to Ferdinand Aranza, director of insular affairs at the Department of the Interior.

In testimony before a June 28 hearing of the House International Relations Subcommittee on Asia and the Pacific, Aranza explained that U.S. strategic interest in maintaining a strong alliance with friendly Pacific governments and the desire to respect the sovereign status of the nations were more important in the original Compact of Free Association negotiations than assuring economic results from assistance.

"The final fiscal procedures are a reflection of policy considerations overriding management interests," he said.

Aranza suggested that aid to the FAS should be given through a system of sectoral grants rather than annual payments.

According to Aranza, audits on the current quarterly transfer of money to the FAS provide limited oversight and no evaluation of the effectiveness and efficiency of expenditures, since audits occur only after money has been spent.

"Grant funds, on the other hand, are transferred only when needed for immediate payments. Grant funds may not be invested. Grants are subject to conditions and performance expectation. Allowable costs are defined," he said.

Aranza said that the Department of the Interior should continue to administer assistance to Micronesia and the Marshall Islands because of its success with technical assistance, record for protecting taxpayer interests on structured grants and "strong ties to the government and people of the islands."

Following is the text of Aranza's statement, as prepared for delivery:

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STATEMENT of FERDINAND ARANZA, DIRECTOR
OFFICE OF INSULAR AFFAIRS
UNITED STATES DEPARTMENT OF THE INTERIOR

BEFORE THE
SUBCOMMITTEE ON ASIA AND THE PACIFIC
COMMITTEE ON INTERNATIONAL RELATIONS
UNITED STATE HOUSE OF REPRESENTATIVES

REGARDING
THE U.S. COMPACTS WITH THE FEDERATED STATES OF MICRONESIA
AND THE REPUBLIC OF THE MARSHALL ISLANDS

JUNE 28, 2000

Mr. Chairman and members of the Subcommittee on Asia and the Pacific, I am pleased to appear today to discuss the Compact of Free Association with the Federated States of Micronesia (FSM) and the Marshall Islands, also called freely associated states (FAS). As the Compact negotiations for further financial assistance proceed, we view this hearing as an essential part of the consultative process. We look forward to your input.

The Compact of Free Association has been very successful in meeting the well-defined political goals of the FAS and the United States. It ended the Trust Territory of the Pacific Islands and helped establish two(1) stable democratic governments in the western Pacific. The defense and security interests of the United States have been preserved in what remains a strategically important geographic area. In the economic arena, the goal of the Compact is "to assist the Governments of the Marshall Islands and the FSM in their efforts to advance the economic self-sufficiency of their peoples." The results of the Compact in this area are mixed. Despite almost fifteen years of Compact financial support for the general operations of the FAS' governments and a program of capital investment, the FAS are not yet self-sufficient. Part of the reason is that the Compact did not require a system of goal-setting and accountability for results tied to the receipt of United States' funding. The Compact act and its related agreements instead created a system that allowed financial assistance to flow uninterruptedly to these nations while limiting the United States' ability to affect the results of this spending. It is the view of the Department of the Interior that the economic goals of the freely associated states can better be met if future United States assistance is provided with clear expectations about results and with clear standards of performance. We believe that a system of sectoral grants with agreed-upon goals and targets, coupled with the appropriate administrative tools to ensure compliance and provisions that will lead to a termination of annual payments by the United States, will make future United States Compact assistance more effective.

Political Goals Predominate in the Compact

The Compact of Free Association was implemented in the mid-1980s, when United States political goals in the western Pacific dominated other policy concerns. After forty years, the United States wanted to divest its responsibility for the neo-colonial Trust Territory of the Pacific Islands (TT), an increasingly anachronistic remnant of the Second World War. Cold War competition with the Soviet Union in the Pacific Ocean made the trustee relationship embarrassing, but the strategic needs of the United States still required a strong alliance with friendly area governments. The Compact provided solutions to both problems, and it has since been a successful underpinning with our relations with the FAS and the United States continuing presence in the western Pacific.

Respect for New Political Status

Although the United States pledged large sums of money in the agreement, assuring results from Compact assistance was not the highest priority. More attention was paid to completing the agreement, which had been under negotiation since 1969. The costs to the United States, spelled out in detail in the Compact itself, were well known and viewed as fair and reasonable. Clearly, the decisions on how to use this money were largely in the hands of the new governments. Both the United States and the FAS recognized that the change of political status required new respect for the islanders' restored exercise of sovereignty. Under the TT, the United States administration was responsible for all domestic affairs within the islands. The decision of any local government was never final; it could be suspended by the American High Commissioner. The purpose of the Compact was not to create the TT under a different guise. The United States deliberately withdrew itself from FAS internal affairs and planned to treat the FAS with the same respect and deference to local affairs as it would with any sovereign nation. The arrangements of the Compact, especially in the Fiscal Procedures Agreement(2), reflect the desire of the FAS to minimize United States interference in its newly won sovereign status. This desire to enhance the new found exercise of sovereign status by limiting United States oversight ability was nobly wrought, but as it presented significant obstacles to oversight of United States assistance, it was not the best management policy.

Policy Overrode Management Concerns

The Department of the Interior was highly skeptical of the Compact's financial management regime as it was negotiated, and noted its concerns then. Interior was quite aware that the institutional abilities of the FAS were not developed enough to manage, invest, or plan the expenditure of the large amounts of Compact funding. The FAS governments had controlled their own bank accounts only since 1982. At the time of Compact implementation, neither FAS government had a single certified public accountant. More troublesome for Interior was the fact that financial management provisions of the agreement did not provide enforceable terms for accountability.

The management regime for United States assistance described in the Compact of Free Association is unique to Federal grant management practice. The negotiators created a system that bears little resemblance to established accountability measures that characterize the normal use of Federal funds.

Interior Secretary Hodel protested this situation in a letter to Secretary of State Shultz in early 1986, but the final fiscal procedures are a reflection of policy considerations overriding management interests. The result is a system of payments largely bereft of performance standards, cost principles, and procurement rules found in OMB circular A-102, the "Common Rule" for grant management.

Compact Assistance is Distinct from "Federal Grants"

The Public Law approving the Compact of Free Association assigned to the Department of the Interior responsibility for providing financial assistance under Compact section 211 (approximately 80 percent of Compact funding) and coordinate United States Federal programs (approximately 20 percent of Compact funding). United States Federal program assistance is subject to all rules and regulations of domestic Federal programs and are enforceable by the grantor agencies.

The financial assistance cannot be considered "grants" as usually defined by Federal government practice. The distinction was first drawn in a Department of the Interior Solicitor's opinion that concluded that the only rules that could apply to Compact funds were found in the Fiscal Procedures Agreement, the Compact Act, and the laws of the freely associated states. This conclusion precluded application of normal Federal rules to Title Two funding.

For example, the Compact Fiscal Procedures Agreement requires the quarterly transfer of money to the FAS into interest-bearing accounts. Grant funds, on the other hand, are transferred only when needed for immediate payments. Grant funds may not be invested. Grants are subject to conditions and performance expectation. Allowable costs are defined. The Compact is silent on most performance measures, and the seventeen definitions of "capital expenditures," for example, are not consistent with generally accepted accounting principles. Compact payments are further guaranteed by a pledge of the "full faith and credit" of the United States, enforceable in United States Court of Claims. Grant funds, of course, are not similarly guaranteed.

Limited Withholding Authority

The ultimate leverage a Federal agency has on grant funds is its ability to withhold or delay payments when compliance problems are discovered, and to require repayment when performance conditions are not met or funds are misspent. These tools are essentially absent from the guaranteed Compact funding with a few notable exceptions. Funding under section 221(b) -- an annual amount of $ 10 million for health and education, funding not subject to the "full faith and credit" provision -- may be withheld for limited purposes if advance notice is given. The United States may also suspend its obligations to the FAS if they take actions incompatible with United States security and defense responsibilities, a provision that has not been tested. Notwithstanding these limited exceptions, there is nothing else in the Compact Act, the Fiscal Procedures Agreement, or FAS law that explicitly provides for delays in the payment of Compact funds. The lack of clear standards of performance expectations by another sovereign entity and government-to-government foreign policy considerations have overridden enforcement as a policy goal through most of the Compact's history.

Audits are a Limited Oversight Tool

The Compact's principal oversight tool is its audit provisions. Discussions of United States audit authority are found in the text of the Compact, the public law, and the fiscal procedures agreement. The executive branch inspector general, the, General Accounting Office and public accountants under the Single Audit Act are authorized to perform audits of Compact funding. Negotiators of the Compact agreed to use the provisions of the Single Audit Act as a measure of financial performance. The Single Audit Act applies to all recipients of Federal grant funds throughout the United States, and was designed to coordinate and simplify auditing of grantees. It is the United States government's primary audit tool, and operates under the standard of the Comptroller General, under the supervision of the Inspectors General.

The Single Audit reports on the adequacy of the auditee's annual financial statement, its compliance with Federal laws and regulations, and its internal controls. Its scope, however, is generally limited to tests of financial transactions and the accounting systems. The Single Audit does not address performance -- i.e., whether or not funds were spent effectively and efficiently. As in any audit, Single Audits review expenditures only after they are made. By the time a Single Audit is in the hands of the Inspector General for review, more than fifteen months have passed since the first dollar of a fiscal year was spent. Single Audits are a limited tool for oversight.

The Department of the Interior Inspector General has performed an occasional performance audit of Compact-funded programs. The office's resources are limited, and they have chosen to concentrate more efforts in areas where they can demand resolution and enforcement of audit findings. The General Accounting Office, despite a 1987 request from the Congressional oversight committee chairmen, has not undertaken the annual audits it is authorized to perform.

FAS Deficiencies Addressed by Technical Assistance

The deficiencies in the Compact's management schemes were recognized early by the Department of the Interior. Lacking normal grant management tools, we addressed the roots of inadequate local management performance through our technical assistance programs. Working in partnership with the FAS, we have seen steady improvements in those governments' technical skills in budget and financial management skills. Our program with the USDA Graduate School has provided, a curriculum of management classes meeting the needs of individual governments.

Recognizing that advice from the United States, the former administering authority, was not always welcome, we also joined with the Asian Development Bank to provide in-country policy advisory teams (PAT) to bolster the analytical capacities of the FAS. The results of this have been very encouraging. On the advice of the PAT teams, the decisions made by the FAS regarding economic development strategies included substantial reductions in government payrolls.

We have consistently provided special attention to local audit capabilities, supporting the strong Public Auditor's office in the Federated States of Micronesia. The Single Audits are managed by the independent local audit agencies, making them a more visible and effective presence. In recent years, additional funding was given the FSM Public Auditor to provide for the hiring of trained law enforcement personnel as investigators.

Use of Available Enforcement Mechanisms

Interior has used the few tools available to it under the Compact. In 1994, section 221(b) health and education funding was withheld from the FSM until the State of Chuuk settled medical debts with the Guam Memorial Hospital. Interior non-Compact grant funds have been managed strictly by Federal regulations. Interior has suspended capital improvement and maintenance grants in the Marshall Islands and FSM until grant terms were met and professional personnel were put in key positions. When effective enforcement tools are available, we believe we can ensure that United States funds are used in the FAS as intended.

Sectoral Grants Part of the Solution

The Department's dissatisfaction with the Compact's management practices and our success with administering Federal grants leads directly to the current proposal to restructure future Compact assistance. We believe that limiting United States funding to well-defined sectoral grants subject to standard grant conditions will result in a much more effective Compact assistance package. The basic sectoral grant approach that the Office of Compact Negotiations is putting forward was fully developed in 1998 by the staff of the Office of Insular Affairs. We believe it plays to the strengths of the Office of Insular Affairs to manage United States funds in off-shore locations while respecting the political autonomy of the local governments.

Grant Rules Must Apply

The Office of Insular Affairs promotes the application of the Common Rule and the Code of Federal Regulations to Compact grants. These rules, which are familiar to the FAS as they administer domestic Federal programs, call for basic commonsense practices in government management. The rules require effective accounting and reporting, as well as free and open competition in procurement, and define criteria for acceptable expenditures. Grants developed under these rules will require performance goals and standards and the approval of scopes of work and project budgets. Federal funds will flow to the FAS when needed, but can be withheld to enforce compliance with terms and conditions. In short, these Compact grants will have the specificity and controls current funding lacks. It will be a much more effective system. We do not intend, however, to dictate the goals and purposes to which the FAS dedicate Compact funding. Those decisions are properly the purview of the FAS governments. Once those decisions are made, application of grant standards will make success much more likely.

Oversight Resources Required

Despite the current Compact's limits on United States authority, we often speculate that a larger United States presence in the FAS may have produced better results through moral suasion and encouragement. Whatever those results might have been, the Office of Insular Affairs and its predecessor Office of Territorial and International Affairs has not had the resources to support fulltime in-country field representatives. In the waning years of the TT, at least 43 FTE were involved in monitoring and controlling the $93 million dollar program. Over 20 positions were engaged in the administration of Federal programs. In comparison, the Office of Insular Affairs has been unable to dedicate more than 4 FTE to the freely associated states, including Palau, for the $145 million program. The reality of the budget process has been such that other priorities in the territories were funded while field positions were not. The current Office of Insular Affairs is a smaller version of OTIA after a reorganization in 1995. Despite fewer FTE's, the office's responsibilities have remained unchanged.

The new sectoral grant approach to Compact assistance funding will require additional resources to administer. Getting results will require more personnel in-country. Interior is currently studying how best to configure an administrative unit that will best balance United States interests in results with respect for the sovereignty of the FAS governments. We have no interest in reestablishing a new Trust Territory with a heavy United States presence. Our interest lies in establishing and enforcing a workable system of accountability for United States funds.

Interior Well-Suited for FAS Special Relationship

We believe it is appropriate for the Department of the Interior to continue administration of an assistance program for the two sovereign countries. The Compact of Free Association was intended to be, and is, a special relationship with countries that have unique historical ties to the United States. This relationship is of benefit to the United States in the still strategically important western Pacific. The Department of the Interior itself has strong ties to the government and people of the islands. Where Compact funds were structured by the negotiators as true "grants" that are subject to rules and regulations, rather than a pass-through, the Department has been careful to protect taxpayer interests. Maintaining Interior's relationship with the freely associated states, which we know works well, will complement the idea of future Compact sectoral grants that have discrete goals and requirements.

1. Palau became a freely associated state under a separate compact of free association.

2. The financial management provisions of the Compact of Free Association are found in the "Agreement Concerning Procedures for the Implementation of United States Economic Assistance, Programs and Services Provided in the Compact of Free Association Between the United States and the Government of the Federated States of Micronesia" and the "Agreement between the United States and the Government of the Marshall Islands". Both agreements were signed in July 1986 after the enactment of the Compact Act. The shorthand for either Agreement is the "Fiscal Procedures Agreement."

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(Distributed by the Office of International Information Programs, U.S. Department of State. Web site: http://usinfo.state.gov)

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