The Federated States of Micronesia (FSM) is a lower middle income island nation of 104,000 people on 607 islands with a total land area of 271 square miles and an exclusive economic zone (EEZ) of over one million square miles (2.6 million square km) in a remote area of the Western Pacific Ocean. The nation is composed of formerly unrelated cultures and languages organized into four states under a weak national government. The FSM is part of the former U.S.-administered Trust Territory of the Pacific Islands that gained independence in 1986 and continues to use the U.S. dollar as its currency. Since independence, it has operated under a Compact of Free Association (Compact) with the U.S., receiving more than USD $100 million per year in development funding administered mainly by the U.S. Department of the Interior (DOI). The World Bank estimates Gross Domestic Income (GDI 2015) to be $3,438 per person, showing no growth over the previous 10 years.
The FSM currently has no major exports or domestic industry. Its primary sources of income are the sale of fishing rights (approximately USD $65.2 million in 2015) and taxes on offshore corporate registrations for captive insurance (USD $4 million in 2015). It is largely a subsistence economy, except in larger towns where the economy is centered on government employment and a small commercial sector. The cash economy is primarily fueled by government salaries paid by Compact funds (66 percent of employed adults work in the public sector) and, to a much lesser degree, by family remittances. Compact funding will change in 2023 from the current grants to proceeds from a trust fund developed over 20 years, which is currently estimated to lower government revenues from the United States by 20-30 percent.
The FSM GDP for 2015 was USD $315 million, a 0.09 percent decrease from 2014 at constant prices. The economy recorded a trade deficit of USD $142 million in goods and services for the same year. The FSM government currently has low debt, but the lack of development of revenue to supplement Compact funding, the lowest tax-to-GDP ratio in the Pacific, and looming Compact funding reductions in 2023, mean that international development banks classify the country as a grant-only client, concerned with the country’s ability to repay loans.
Foreign investment is almost nonexistent due to prohibitions on foreign ownership of land and businesses, difficulties in registering business (the process requires approvals from the four state governments and at the national level), poor enforcement of contracts, poor protection of minority (foreign) investors, weak courts, and weak settlement of insolvency. Domestic capital formation is very low because the commercial banks are classified as foreign entities and are not allowed to provide mortgages or business financing. The cost of doing business in FSM is high due to the region’s remoteness and dependence on imported materials and services.
Most political power of the nation is delegated to the four states by the constitution, including regulation of foreign investment and restrictions on leases. This means that investors may have to navigate between five different sets of regulations and licenses. U.S. citizens are able to live and work in the FSM indefinitely without visas. National legislators (senators) are directly elected, and the president and vice-president are selected by the senators from among the four at-large senators. There are no political parties. At the state level, all offices are directly elected by the people.