Federated States of Micronesia- Strategic Development Plan FINAL

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FSM Strategic Development Plan

ECONOMIC OVERVIEW 2004-2023
As part of the design and development of the Strategic Development Plan (SDP) 2024-
2043, a macroeconomic overview report was completed. A summary overview of this
report is provided below.
Introduction
The Federated States of Micronesia (FSM), a remote and climate-vulnerable Small-Island
Development State (SIDS), has faced significant economic challenges over the period of
time from 2004 to 2023. The FSM can be classified as a MIRAB economy — reliant on
Migration, Remittances, Aid, and Bureaucracy — with limited natural resources, a small
labor force, and heavy dependence on external resource transfers. The FSM’s economy
is heavily supported by the Compact of Free Association (COFA) with the United States,
which provides substantial direct grant assistance. As a small-open economy, the FSM is
vulnerable to external shocks, such as the 2008 Global Financial Crisis and the COVID-
19 pandemic, both of which caused sharp contractions in gross domestic product (GDP).
Macroeconomic Performance and Growth
From 2004 to 2023, FSM’s economic growth was weak, with real GDP increasing by less
than 5% over the 20-year period, translating to an annualized growth rate of less than
0.3%. This is well below the regional average annual growth rate of 2.7% for Pacific Island
nations. FSM’s economic performance can be divided into two phases: a “lost decade”
from 2004 to 2013, marked by significant volatility and stagnation, followed by modest
growth from 2014 to 2023, driven largely by increases in fishing license revenues,
increased corporate tax receipts, and the resumption of COFA-funded infrastructure
projects.
As the economy is highly reliant on imports, particularly of consumable goods, it is
vulnerable to external price shocks. The Consumer Price Index (CPI) saw significant
inflation during the “lost decade” period, with domestic and imported goods rising by an
annual average of 4.1% and 5.3%, respectively. However, these price increases
moderated significantly in the second decade. The FSM does not have control over
monetary policy and instead must rely on fiscal measures to manage inflationary
pressures.
Balance of Payments and Economic Structure
FSM runs a persistent trade deficit, importing far more in goods and services than it
exports. The economy’s balance of payments (BOP) is supported by fishing license fees
and foreign aid. Fishing license revenues surged between 2014 and 2021, and these,
combined with large one-off corporate tax receipts, helped FSM achieve occasional
current account surpluses. Foreign Direct Investment (FDI) has been minimal, averaging
less than $1 million per year. The FSM economy is largely dominated by the public sector
and household activities, with the private sector making up only 20% of GDP over the
period. Most private sector activity is focused on non-tradable services like wholesale and
retail trade.
Federated States of Micronesia Strategic Development Plan 2024-2043
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Regional Disparities
The FSM’s economy is also characterized by significant regional disparities. Of the four
States — Pohnpei, Chuuk, Kosrae, and Yap — only Pohnpei has shown marked growth,
with its economy growing by over 30% from 2004 to 2022. The other states have seen
minimal or negative growth, with Chuuk and Yap experiencing contractions. This disparity
is largely due to Pohnpei’s role as the center of government and host to many international
organizations, while Chuuk and Yap, with significantly more dispersed populations, have
economies that are more reliant on subsistence production. Pohnpei's per capita GDP in
2022 was over $6,600, whereas Chuuk’s was significantly lower, at around $2,200.
Fiscal Policy and Financial Stability
The FSM’s fiscal stability over the past 20 years has been largely sustained by COFA
grants and revenues from fishing licenses. The FSM government has two major trust
funds: The Compact Trust Fund (CTF) and the Domestic Trust Fund (DTF). The CTF,
established in 2004 to ensure long-term financial stability, was originally projected to
accumulate $1.8 billion by 2023 but fell short, reaching $1.036 billion. However, with the
infusion of an additional $500 million as part of the 2023 Amended Compact, the CTF is
now expected to grow to $4.7 billion, providing a solid fiscal foundation for the FSM once
COFA sector grants end in 2043. Combined, the CTF and DTF are projected to provide
between $200 to $300 million in revenue annually from 2044 onward, well in excess of
the current COFA grants.
Employment and Private Sector Challenges
Employment in FSM is dominated by the public sector, with public employees making up
over 50% of all formal employment. The private sector, mainly comprising retail and
hospitality, has struggled due to low wages and reliance on imported labor. Public sector
wages are substantially higher than private sector wages, creating a significant wage
premium and further limiting the competitiveness of the private sector. Real wages across
the economy have stagnated or declined since 2004 due to a lack of indexing of COFA
grants for inflation, limiting the ability of the public sector to support wage growth.
Growth Prospects and Models (2024-2043)
Looking forward, the FSM faces several potential growth scenarios:
1. Baseline Scenario: Continuation of the current MIRAB economy with no substantial
reforms. Under this scenario, GDP growth remains modest, reaching an estimated
$309 million by 2043 (in 2004 constant USD).
2. MIRAB Max Scenario: Increased remittances from FSM citizens abroad would
modestly improve economic growth, with GDP reaching $330 million by 2043.
3. Tradable Goods Scenario: Growth through increased production of exportable goods.
This requires substantial public investment in infrastructure and labor productivity
improvements. Under this scenario, GDP could grow to $403 million by 2043.
4. Tradable Services Scenario: Expansion of tourism and business services through
institutional and regulatory reforms could propel growth to $660 million by 2043,
representing a 150% increase over the 20-year period.
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5. Combined Scenario: This scenario envisions growth driven by a mix of remittances,
tradable goods, and services. If successful, GDP could reach $735 million by 2043,
an increase of 185%.
Conclusions
The FSM’s economy has stagnated over the past two decades, hindered by external
shocks and dependency on foreign aid. However, the continuation of COFA grants and
trust fund investments provides long-term fiscal stability, allowing the FSM to pursue
aggressive fiscal policies in support of private sector growth. This will require significant
policy and institutional reforms to attract investment and stimulate productivity, potentially
moving FSM toward a higher income status by 2043.