Republic of the Marshall Islands COUNTRY ECONOMIC MEMORANDUM AND PUBLIC EXPENDITURE REVIEW Maximizing opportunities, enhancing sustainability © 2021 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Acknowledgment: The team would like to acknowledge and thank all those who provided input to this analysis. The lead authors are Andrew Blackman (Task Team Leader), Donna Andrews, Sophie Brown, Dung Doan, Matthew Dornan, Simone Esler, Ginnie Horscroft, Ahya Ihsan, Darian Naidoo, Nicolas Rosemberg, Georgina McArthur, Michael McCoy, Veronica Piatkov, Maude Ruest, Artessa Saldivar-Sali, John Virdin and the Graduate School USA (Jason Aubuchon, Glenn McKinlay, Kevin O’Keefe and Mark Sturton). Michelle Lee provided valuable administrative support. Vishesh Agarwal, Rashad Hasanov and Jewelwayne Salcedo Cain provided valuable analytical support. The team is grateful to the RMI Government for their cooperation during consultations, for providing data and for sharing feedback on the report. The team is also grateful to several World Bank colleagues who reviewed and provided guidance for this work. The team would like to thank Hassan Zaman, Lars Christian Moller, Ndiame Diop, Michel Kerf, Paul Vallely, David Gould, Robert Utz and Annette Leith for providing overall guidance. The team would also like to thank Frank Chopin, Marie-Helene Cloutier, Demet Kaya, Maude Ruest and Jian Vun for peer reviewing the report. Angela Takats edited the report and Laframboise Design provided graphic design services. Table of Contents EXECUTIVE SUMMARY..........................................................................................................................................8 INTRODUCTION AND COUNTRY CONTEXT..............................................................................................32 PILLAR 1: COUNTRY ECONOMIC MEMORANDUM................................................................................ 40 1.1 Recent Economic Performance............................................................................................................... 40 1.2 Growth Challenges.................................................................................................................................... 50 1.2.1 Limited Access to Land.................................................................................................................52 1.2.2 Congested Transport Infrastructure..........................................................................................53 1.2.3 Aged and Inefficient Electricity Infrastructure...................................................................... 54 1.2.4 Low Access and Quality ICT Services..................................................................................... 56 1.2.5 Small and Underdeveloped Financial Sector...................................................................... 58 1.3 Growth and Development Opportunities.......................................................................................... 63 1.3.1 Maximizing the Benefits from Fisheries Resources.............................................................65 1.3.2 Strengthening the Labor Market and Labor Mobility....................................................... 84 1.3.3 Other Growth and Development Opportunities............................................................... 103 1.4 Key Emergent Risks to Growth and Sustainability..........................................................................110 1.4.1 Climate Change, Natural Hazards and Vulnerabilities....................................................110 1.4.2 Compact Negotiations and Fiscal Sustainability................................................................114 1.4.3 Addressing the Dual Burden of Disease............................................................................... 116 PILLAR 2: PUBLIC EXPENDITURE REVIEW................................................................................................. 118 2.1 Recent Fiscal Trends................................................................................................................................... 118 2.1.1 Revenue Trends............................................................................................................................... 121 2.1.2 Expenditure Trends....................................................................................................................... 124 2 2.2 Public Financial Management and Fiscal Sustainability...............................................................127 2.2.1 Public Financial Management...................................................................................................127 2.2.2 The Budget Process...................................................................................................................... 133 2.2.3 Fiscal Sustainability and Risks................................................................................................... 136 2.2.4 Recommendations........................................................................................................................ 143 2.3 Public Sector Wage Bill and Human Resource Management...................................................146 2.3.1 Evolution of the Public Service Wage Bill and Employment.......................................... 147 2.3.2 Challenges in Public Service Wage Bill and Employment Management.................. 151 2.3.3 Recommendations........................................................................................................................154 2.4 Human Capital............................................................................................................................................157 2.5 Education Sector........................................................................................................................................160 2.5.1 Structure and Service Delivery.................................................................................................. 162 2.5.2 Governance..................................................................................................................................... 170 2.5.3 Outcomes..........................................................................................................................................172 2.5.4 Financing and Expenditure........................................................................................................178 2.5.5 Conclusions and Recommendations...................................................................................... 189 2.6 Health Sector............................................................................................................................................... 194 2.6.1 Structure and Service Delivery.................................................................................................. 195 2.6.2 Governance....................................................................................................................................200 2.6.3 Outcomes and Service Coverage........................................................................................... 202 2.6.4 Financing and Expenditure......................................................................................................205 2.6.5 Conclusions and Recommendations...................................................................................... 221 ANNEX 1: RMI and the World Bank’s CEM 2.0 Framework............................................................... 224 REFERENCES.......................................................................................................................................................... 226 3 Abbreviations and Acronyms ADB Asian Development Bank AE Adult equivalent AIM Air Marshall Islands AKIA Amata Kabua International Airport AML/CFT Anti-Money Laundering/Combating the Financing of Terrorism AUD Australian dollar BCC Budget Coordination Committee BoG Bank of Guam BOMI Bank of Marshall Islands CA Competent Authority CAP Comprehensive Adjustment Program CBR Correspondent banking relationship CEM Country Economic Memorandum CHOW Community Health Outreach Worker CMI College of the Marshall Islands COFA Compact of Free Association CSO community service obligations CTF Compact Trust Fund CSGs Compact Sector Grants DAEF Disaster Assistance Emergency Fund DIDA Division of International Development Assistance DRM Disaster risk management EAP East Asia and Pacific ECD Early childhood development ECE Early childhood education EEZ Exclusive economic zone EPA Economic Partnership Agreement EPPSO Economic Policy, Planning and Statistics Office EU European Union EMIS Education management information system ESN Ebeye Special Needs FAS Freely associated states FATF The Financial Action Task Force FHB First Hawaiian Bank FMA Financial Management Act FMIS Financial management information system 4 FRDMA Fiscal Responsibility and Debt Management Act FSM Federated States of Micronesia FY Fiscal Year GDP Gross Domestic Product GER Gross enrollment ratio GNI Gross National Income GoRMI Government of RMI HCI Human Capital Index HCRF Health Care Revenue Fund HF Health Fund HIES Household Income and Expenditure Survey HRM Human resource management HRMIS HRM information system ICT Information, communication and technology IMO International Maritime Organization ISPS International Ship and Port Facility Security IMF International Monetary Fund JEMFAC RMI-US Joint Economic Management and Financial Accountability Committee JICA Japan International Cooperation Agency LMIS Labor market information system LRA Land Recording and Registration Act MEC Marshalls Energy Company MERIS Medical Records Information System MIDB Marshall Island Development Bank MIMRA Marshall Islands Marine Resources Authority MIRAB Migration, Remittances, Aid and Bureaucracy MISAT Marshall Islands Standards Assessment Test MISC Marshall Islands Shipping Corporation MISGLB Marshall Islands Scholarship, Grant, and Loan Board MISSA Marshall Islands Social Security Administration MOEST Ministry of Education, Sports and Training MOF Ministry of Finance MOHHS Ministry of Health and Human Services MoU memorandum of understanding MTO money-transfer operator MTPBF Medium-term planning and budgeting framework 5 Abbreviations and Acronyms MUORA Military Use and Operating Rights Agreement NAP National Adaptation Plan NCDs Non-communicable diseases NER Net enrollment ratio NDMO National Disaster Management Office NFO Notice of Funding Opportunity NIIP National Infrastructure Investment Plan Nitijela RMI parliament NSP National Strategic Plan 2020–30 NTC National Training Council OAG Office of the Auditor General OCIT Office of Commerce, Investment and Tourism OECD Organisation for Economic Co-operation and Development OMR Overseas medical referrals PCRAFI Pacific Catastrophe Risk Assessment and Financing Initiative PER Public Expenditure Review PEFA Public Expenditure and Financial Accountability PFTAC IMF Pacific Technical Assistance Center PHC Primary health care PNA Parties to the Nauru Agreement PFM Public financial management PFMRR PFM Reform Roadmap PICs Pacific Island Countries PITP Pacific Islands Tuna Provisions PREL Pacific Resources for Education and Learning PSC Public Service Commission PSS Public School System RMI Republic of the Marshall Islands RMIPA Republic of the Marshall Islands Ports Authority RMNCH Reproductive, maternal, neonatal and child health services RPL Recognition of Prior Learning SDA Seventh Day Adventist SEG Supplemental Education Grant SHF Supplemental Health Fund SOEs State-owned enterprises SOEMU SOE Monitoring Unit 6 SOV Sovereign virtual currency TRAM Tax and Revenue Reform and Modernization Commission TSLB Teacher Standard and Licensing Board TVET Technical and vocational education and training UMIC Upper middle-income country UNESCO United Nations Educational, Scientific and Cultural Organization UNFPA United Nations Population Fund US United States of America US$ US dollar USFG US Federal Government Grants USP University of the South Pacific DOI US Department of Interior GAO US Government Accountability Office VDS Vessel Day Scheme VSMT Visiting Specialist Medical Teams WASC Western Association of Schools and Colleges WHO World Health Organization 7 Republic of the Marshall Islands Executive Summary 1. This joint Country Economic Memorandum (CEM) and Public Expenditure Review (PER) aims to support the Government of the Republic of the Marshall Islands (GoRMI) to identify a prioritized and sequenced set of reforms to drive increased economic growth, resilience and fiscal sustainability. The study has two objectives. First, to improve understanding of the challenges, opportunities and risks to achieving sustainable ­ economic growth and job creation in the Republic of the Marshall Islands (RMI). Second, ­ to improve the management of public resources to support long-term economic ­ development, fiscal sustainability and service delivery. The assessment aims to balance the need for reform to drive higher prosperity and resilience with GoRMI’s limited capacity to design and implement reforms and provide public goods and services. The reform priorities identified are also consistent with the RMI’s National Strategic Plan 2020–30, which articulates the nation’s vision to build a resilient, productive and self-supportive RMI. 2. This Executive Summary is structured in three sections. The first section provides a brief background to RMI and the structure of the economy. The second section summarizes the key issues and challenges to achieving GoRMI’s long-term development objectives under five themes: (i) the management of public finances; (ii) public service delivery; (iii) the fisheries sector; (iv) the labor market and labor mobility; and (v) disaster resilience and climate change. The final section outlines key recommendations under the same five themes. 3. RMI is one of the world’s smallest and most isolated nations. Located approximately midway between Hawaii and the Philippines, the country consists of 29 atolls. The nation covers an area of around 2 million square kilometers (around the size of Mexico) but has ­ opulation just 181 square kilometers in land area (around the size of Washington, DC). The p totals around 54,000, of which 28,000 (53 percent) reside in Majuro (the country’s capital) and 10,000 (18 percent) in Ebeye. These two urban centers are among the mostly ­ densely populated in the world, following 30 years of unplanned urbanization. Almost all of the territory is less than two meters above sea level, making RMI one of the most vulnerable nations in the world to climate change and sea level rise. 4. Human development indicators are low relative to regional peers and the nation’s i ­ncome level. RMI is a middle-income country with Gross National Income (GNI) of US$4,838 per capita. Yet, human development is low for the nation’s income level. In 2020, RMI’s Human Capital Index (HCI) was 0.42, meaning that a child born in RMI in 2020 will be 42 percent as productive when they grow up compared to what they would have been if they had enjoyed complete education and full health. This places RMI as the second lowest in the Pacific region in terms of human capital development, reflecting a combination of poor education and health outcomes. The poverty headcount ratio is estimated to be 7.2 percent. However, this masks large differences within the nation, with 21.2 percent of the rural population living in poverty, compared to just 2.3 percent in ­ ­ Majuro. 8 Country Economic Memorandum and Public Expenditure Review 5. Average economic growth has been low by global standards and subject to high ­volatility. Over the past 15 years, real Gross Domestic Product (GDP) has grown by a modest 1.5 percent on average. Growth has also been volatile, with deep recessions in fiscal year 2008 (FY08) and FY11 to FY12 offset by growth spurts over the periods FY09 to FY10 and FY15 to FY19. Fluctuations in growth are directly related to changes in a ­ id- financed construction, public service-related activity and the fisheries sector. Labor productivity has grown at 0.6 percent per year, on average, over the past 15 years. On the demand side, fluctuations in growth are driven by investment in public infrastructure and the ­ fisheries sector. Net exports counterbalance fluctuations in domestic demand, given RMI’s reliance on imported goods and services. The structure of the economy, both by production and expenditure, is similar to that of other Pacific Island Countries (PICs).1 6. The economy is dominated by the public sector. In RMI—as in many other small-island states—the limited economic incentives for private sector development mean that ­ delivery of many core goods and services falls to the public sector. Consequently, the public sector accounts for around 40 percent of GDP and half of formal sector employment. State-owned enterprises (SOEs) are active in most of the key economic ­ sectors, including energy, transport, information, communication and technology (ICT), agriculture and banking. Private sector activity focuses on the fisheries sector, wholesale and retail trade, and construction. 7. Throughout this study RMI’s economic performance is benchmarked against its Pacific neighbors. RMI, like other PICs, shares similar challenges and opportunities as other small and remote island economies: limited natural resources, a narrowly based e ­ conomy, large distances to major markets, a dispersed population and vulnerability to external shocks. Aside from these characteristics, the economic structure of RMI and many of the PICs is also heavily influenced by their reliance on foreign assistance and—more recently—fisheries sector revenues. Hence, in this study, RMI is benchmarked to the PICs ­ when considering cross-country comparisons of economic performance. The Federated States of Micronesia (FSM), Palau and Kiribati are considered RMI’s closest ‘structural’ peers (that is, countries with a broadly similar economic structure). This is due to the ­impacts of their respective Compacts with the US on their economic and fiscal f ­ oundations (FSM and Palau), and the impacts of fisheries sector revenues on their fiscal framework (FSM, Palau and Kiribati). Kiribati’s atoll nature makes it further relevant for comparison with RMI. Fiji and Samoa, as the most developed of the PICs, represent ‘aspirational’ peers (countries with similar economic geography that have achieved superior ­ development outcomes). In some instances, small-island Caribbean nations are also used as aspirational peers. 1 The PICs comprise Fiji, Kiribati, Palau, Federated States of Micronesia, RMI, Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu and Vanuatu. 9 Republic of the Marshall Islands KEY ISSUES AND CHALLENGES 8. The scheduled expiration of financial assistance under the RMI’s Compact of Free Association (‘the Compact’) with the United States (US) in 2023 poses a major risk to ­ RMI’s economic growth and development. Under current arrangements, annual ­ Compact Sector Grants (CSGs) and access to US Federal Government programs are scheduled to expire in 2023, with the CSGs to be replaced by annual distributions from the Compact Trust Fund (CTF). However, the corpus of the CTF is not sufficient to deliver annual distributions that will fully offset the CSGs. Furthermore, the CTF distribution rules create ­ the possibility of highly unstable annual distributions. Such volatility—including the potential for years with zero distributions—would have severe negative consequences for ­ macroeconomic stability and public service delivery. The expiration of Compact-related assistance could precipitate a significant structural change in the RMI’s economy and fiscal framework, as grants and programs from the US account for around 35 percent of GoRMI annual revenues. In a worst-case scenario, the expiration of this financial ­ assistance could lead to a fiscal adjustment equivalent to 13 percent of GDP, an ­ economic contraction of up to 10 percent, a 13 percent reduction in formal sector jobs, and an increase in outmigration. ­ 9. GoRMI and the US Government have begun negotiations to amend the financial agreement of the Compact, with early indications suggesting that key pillars of the existing arrangements are likely to be retained. The likely continuation of substantial financial assistance post-FY23 has reduced the risk that RMI will face a ‘fiscal cliff’ that ­ would necessitate a significant fiscal adjustment. Thus, this study assumes that US ­ financial support to RMI—particularly to the health and education sectors—will remain broadly constant over the medium term. Nevertheless, the details of the scope, size and duration of any agreement remain uncertain. Consequently, measures to increase economic growth and incomes, enhance fiscal sustainability and improve the efficiency ­ and equity of public service delivery remain central to the RMI’s long-term development prospects and economic stability. 10. RMI, like other PICs, faces a unique economic geography that makes achieving sustainable economic growth particularly challenging. Extreme remoteness, small size, ­ geographic dispersion, limited natural resources and increasing climate and disaster ­ vulnerability are the binding constraints to achieving sustainable, inclusive growth in the PICs, including RMI (World Bank, 2011; 2017). These characteristics result in very high costs of production for both the private and public sectors. They also limit the range of economic activities where RMI can be competitive to areas where natural resource rents outweigh the high costs of production. 10 Country Economic Memorandum and Public Expenditure Review 11. The consequences of these structural characteristics, coupled with the uncertainty regarding long-term fiscal sustainability, highlight the importance of a development ­ strategy that aims to reduce the disadvantages imposed by geography while maximizing the benefits of RMI’s limited economic opportunities. RMI’s unique e ­ ­ conomic geography limits the effectiveness of traditional development strategies, such as ­ manufacturing-based, export-led growth. Consequently, reforms to improve the business environment are necessary but unlikely to be sufficient to ensure global competitiveness, given the costs imposed by size and distance from markets. A key implication is that reforms should be targeted toward reducing the disadvantages imposed by geography, ­ and on economic opportunities that are less affected by these disadvantages. This ­ highlights the importance of a development strategy focused on: (i) the role of the public sector as a key supporter of economic activity and source of formal sector employment; (ii) the need for, and sound management of, development assistance to sustain public goods and services and standards of living; (iii) maximizing the benefits of natural ­ resources (fisheries), including through development of the private sector; and (iv) taking full advantage of domestic and overseas labor opportunities available to Marshallese citizens (given that Marshallese have open access to the US labor market under the Compact). 12. The dominance of the public sector in the economy, combined with the implications for long-term fiscal and macroeconomic stability of a change in the financial aspects of the Compact, provide robust motivation for a combined CEM and PER. This strong interdependence is summarized in Figure 1, which provides a concise organizing ­ framework for the combined CEM and PER. Low historical growth and the predominant role of the public sector in key sectors of the economy highlight the need to focus on feasible private sector development opportunities to promote income generation, job creation and greater shared prosperity. The two most prominent of these opportunities are in the fisheries sector and via strengthening the domestic labor market and­ maximizing the benefits of labor mobility. Achieving long-term fiscal sustainability and macroeconomic stability will require focused efforts to: (i) maximize income and public revenue generation; and (ii) increase the efficiency and quality of education and health service delivery. The former is closely related to the development and management of the fisheries sector, domestic labor market and skills, and tax policy. Regarding the latter, education and health services are crucial public-sector enablers to build human capital and increase the quality of the domestic labor pool. This is necessary for RMI to take full advantage of the domestic and overseas labor opportunities available to Marshallese citizens. 11 Republic of the Marshall Islands Figure 1: A concise organizing framework for the combined CEM/PER Public sector dominates economy​ Compact underpins fiscal framework, Need to promote feasible private but a large proportion of revenue is sector development opportunities​ scheduled to expire in 2023 Major source of financing Long-term fiscal sustainability Fisheries Labor market/ for education and health​ and macro and macro stability​ stability​ sector​ mobility​ Maximize revenue and income generation Increased efficiency and quality of education and health services​ 13. Aside from RMI’s economic geography, access to land, public infrastructure ­ (particularly in the transport, electricity and ICT sectors) and the underdeveloped financial sector are key constraints to economic growth and private sector development. While ­broad- economic growth based reforms to address these constraints are unlikely to trigger higher ­ in isolation, relaxing these constraints can reduce production costs and increase service quality for both the private and public sectors. This can help to increase ­competitiveness in the fisheries sector, unlock new opportunities for Marshallese workers, and improve the efficiency and quality of public (and private) service delivery. 14. RMI also needs to manage the effects of key risks to growth and sustainability to ensure these do not undermine long-term development goals. RMI faces three key risks ­ to growth and sustainability: (i) climate change and natural hazards; (ii) the scheduled expiration of the Compact-related grants in 2023; and (iii) the dual burden c­ ommunicable and non-communicable diseases (NCDs). For example, a 0.5-meter sea level rise could lead to regular flooding of 90 percent of Rairok Islet—the site of Majuro’s international airport (World Bank, 2021). Estimates of the best- and worst-case climatic scenarios over the coming 20 years suggest that the annual cost of priority actions in coastal and infrastructure adaptation are 9–25 percent of GDP (World Bank, 2017). In the worst-case ­ macroeconomic scenario, the ending of all Compact-related grants would result in a large ­ shock, resulting in a substantial fall in output, employment and core public service delivery. This highlights the need for a long-term fiscal adjustment to bolster long-term ­ 12 Country Economic Memorandum and Public Expenditure Review fiscal sustainability. Over the long term, the economic burden of NCDs is projected to more than double, from 6.3 percent of GDP in 2015 to 13.6 percent of GDP by 2040 (Hou et al., 2016). Policy measures to address these risks and reduce their costs will be crucial to ensure that their effects do not undermine development gains. In addition to these emerging risks, authorities also need to carefully consider the potential risks to macroeconomic stability from national policy settings, such as the planned introduction of the Sovereign virtual currency (SOV). Introduction of the SOV could heighten the risk of RMI losing its last remaining US dollar correspondent banking relationship (CBR), which could lead to significant negative economic impacts. 15. While the COVID-19 pandemic has caused acute economic and fiscal pressures, the crisis has not fundamentally changed the key drivers, challenges, and opportunities to deliver higher long-term incomes and living standards. Strict border-entry policies drove the economy into recession in FY20, with output projected to contract further in FY21, ­ resulting in substantial job losses. Yet, large parts of government revenues are relatively protected from the downturn in domestic activity—particularly development partner grants and fisheries sector revenues—limiting the fiscal shock. Overall, the crisis is not opportunities expected to have long-term detrimental effects on the fisheries sector or the ­ to access higher incomes in both the domestic and US labor markets. However, the crisis has delayed the fiscal consolidation required to protect long-term fiscal sustainability. It has also diverted limited GoRMI capacity from long-term priorities, such as efforts to improve health and education outcomes and enhance resilience to climate change. (I) FISCAL SUSTAINABILITY AND SERVICE DELIVERY 16. Despite the need to build fiscal buffers to support long-term fiscal sustainability, the recent structural increase in fisheries sector revenues has financed a rapid increase in current spending. GoRMI revenues from fishing license fees increased from US$1.5 million (1 percent of GDP) in FY09 to US$30 million (over 13 percent of GDP) in FY20. This was due to implementation of the Parties to the Nauru Agreement (PNA) purse seine Vessel Day Scheme (VDS)—a regional scheme that establishes the minimum daily price to fish in regional waters and limits the total number of fishing days sold. Despite the risks regarding long-term fiscal sustainability, these windfall revenues fueled a 57 percent ­ increase in current spending over the period FY14 to FY20 (equivalent to 10 percent of ­ GDP). This reflected an increase in repairs and maintenance spending, but also large transfers to SOEs, local governments, and to the social security system to address its large unfunded liabilities. Despite the expansionary fiscal policy, GoRMI registered an average surplus of 2.4 percent of GDP over this period. 13 Republic of the Marshall Islands 17. While fiscal resources have expanded rapidly, public financial management (PFM) ­remains weak. The tax regime is distortionary, inefficient and lacks buoyancy (that is, responsiveness of tax revenues to increases in GNI). The fiscal framework lacks ­expenditure controls and a long-term fiscal strategy. Consequently, windfall fisheries sector revenues have not been used to bolster long-term fiscal sustainability. The legislative and institutional frameworks that govern public borrowing are also weak. The CTF d ­ ­ istribution rules create the possibility of highly unstable annual distributions. Finally, the current ­ financial management information system (FMIS) is outdated and lacks key budget preparation and commitment control modules, inhibiting accurate and timely reporting and the timely exercise of expenditure controls. 18. Given the importance of the public sector to the economy, improving the quality of spending in core public service functions, such as human resource management (HRM) and procurement, is important to providing efficient service delivery. As in other PICs, the wage bill in RMI accounted for around a third of total spending in FY20 (21 percent of GDP), making its management critical to overall fiscal sustainability. Public servants are also a key input to public services, like education and health care, which in turn are critical to development—to improving people’s security, health, skills, and livelihood opportunities. Fair, effective, and efficient civil service HRM systems and processes are ­ thus crucial to support service delivery. 19. Despite having relatively good control of the overall wage bill compared to its peer countries, GoRMI faces several challenges regarding public sector remuneration and HRM. The public sector wage bill has remained contained over the past 15 years, with average wages and the headcount increasing only modestly. As a result, the overall wage bill has fallen as a share of spending and GDP. However, various ministries report that the manual public-sector HRM processes are inefficient, opaque and are among the most serious constraints to improved service delivery. This reflects several challenges: an outdated remuneration framework; delays in implementing an integrated HRM information system (HRMIS); inefficient and ineffective recruitment and promotion; and weak performance management. ­egislative 20. Procurement remains a key bottleneck for efficient service delivery. The current l framework for procurement is outdated, implementing regulations have never been ­ issued, and a 2017 compliance audit found serious deficiencies in the implementation of procurement policies. Overall, this has led to procurement processes that are highly inefficient and fragmented, with line ministries citing procurement inefficiencies as a key ­ constraint to service delivery. 21. Efficient and equitable public service delivery in the social sectors is crucial to build human capital and to take full advantage of RMI’s limited opportunities to generate higher income and jobs. Given the RMI’s economic geography, service delivery in the education and health sectors is predominantly financed and provided by government. Over the past 15 years social sector spending has remained high as a proportion of total 14 Country Economic Memorandum and Public Expenditure Review spending, relative to RMI’s level of income, and compared to RMI’s peer countries. Yet, outcomes are low and have improved only modestly over that period. As a result, RMI’s HCI is among the lowest in the Pacific and low for its level of income. Given the high level of spending and uncertainties regarding the size of the resource envelope p ­ ost-FY23, improving human capital outcomes will need to come from greater spending efficiency. Improving RMI’s human capital is crucial to fully exploit the development opportunities presented by the fisheries sector and domestic and overseas labor markets. 22. Low education quality and completion rates are symptoms of an inefficient education system that fails to prepare Marshallese youth for a productive life. The key challenges are: (i) limited early childhood education; (ii) a low secondary school completion rate; (iii) low education quality, with most students not meeting minimum national standards across all subjects; and (iv) misalignment of secondary and post-secondary education with the needs of the labor market. The result is an education system where children are ill-prepared to enter primary school, most do not complete secondary school, and even while they attend school, the quality of education is not sufficient to prepare them to enter the labor market (either domestically or overseas). As a result, education sector spending is highly inefficient. These challenges are compounded by a lack of ­professional development and training for teachers and principals, insufficient autonomy for schools regarding their operational budgets, and the limited involvement of local communities in education governance. 23. The health sector faces several challenges to improve outcomes and spending ­efficiency stemming from its hospital-centric service delivery model and financing architecture. The key challenges are: (i) low quality of primary level health care; (ii) a shortage of trained health professionals and insufficiently trained staff, particularly at the primary level; and (iii) a high level of fragmentation in health programs and financing. Health services are provided at three levels: health dispensaries (clinics), two hospitals (in Majuro and Ebeye), and overseas medical referrals (OMR) for tertiary level care. Quality of care at dispensaries is low, which is linked to the low level of training of health assistants and a lack of basic supplies. These are due to very limited budget, which reflects the low priority given to primary health care. As a result, patients go to the hospital for services that should be provided in a dispensary. Hospital care is expensive to deliver. Delivering essential services at the hospital level is thus highly inefficient. There is a shortage of trained health professionals across the sector, but the challenge is most acute at dispensaries. Finally, the health system is structured based on RMI’s health financing ­ ­architecture. This results in considerable overlap across health programs and ­fragmentation in planning, budgeting and resource management. This leads to inefficiencies and limits the responsiveness of health spending to emerging priorities, as rigidities in health ­ financing sources determine expenditure priorities. The result is a health system that delivers outcomes and access to services that are low relative to RMI’s level of income ­ and public spending on health. 15 Republic of the Marshall Islands (II) THE FISHERIES SECTOR 24. The fisheries sector is a key driver of economic activity and a crucial source of GoRMI revenues. With an exclusive economic zone (EEZ) of around two million square ­ kilometers, just 181 square kilometers in land area (less than 0.001 percent of its EEZ), RMI is keenly aware of the importance of its tuna resources. Representing over 15 percent of GDP, fluctuations in fisheries output are an important contributor to the volatility of overall ­ economic growth. Furthermore, surging fishing license fees now represent 20 percent of GoRMI revenues. Prudent management of RMI’s purse seine VDS allocation, and fishing resources more generally, is thus crucial for economic growth and public finances. This study outlines a two-pronged approach to maximize the development gains from the fisheries sector: (i) coordinated actions to strengthen regional integration while ­maximizing rents; and (ii) domestic actions to maximize income and jobs and enhance the enabling environment for private sector development. 25. While there are several opportunities to increase national income, the sector also faces important challenges. Aside from the challenges associated with RMI’s economic geography, the sector also faces challenges related to: the long-term decline in tuna ­ resources in RMI’s EEZ due to climate change; inefficient financial incentives; a lack of access to the European Union (EU) market for exports; high workforce turnover; and ­ increased regional competition for fish transshipment. Some of these challenges can be addressed through policy action. The long-term decline in RMI’s tuna resources suggest that it is in the nation’s benefit to pursue closer regional cooperation to maximize the long-term benefits from the jointly managed resource. (III) AN UNSKILLED LABOR FORCE 26. The acute shortage of skilled workers constrains private sector development and limits the opportunities for Marshallese to access better quality jobs, both domestically and overseas. The RMI’s domestic labor pool is currently unable to provide enough workers with the appropriate skills, experience, and personal traits and attitudes required by the private sector. As a result, businesses are forced to look abroad for skilled workers. ­ However, recent changes to the legal framework regarding foreign workers have made this process more complicated in some cases. The unemployment rate remains high, despite unmet private sector demand for unskilled labor. Furthermore, Marshallese living ­ in the US have lower household income relative to other migrant groups, primarily ­ significant, reflecting their lower skills base. Yet inward international remittances to RMI are ­ have been increasing over time, and are predominantly directed towards low income areas—highlighting their role in alleviating poverty. 16 Country Economic Memorandum and Public Expenditure Review (IV) CLIMATE CHANGE AND NATURAL DISASTERS 27. Climate change and natural hazards pose a serious threat to achieving RMI’s development goals in the short to medium term and threaten the nation’s existence in ­ the long term. RMI is already one of the most vulnerable nations in the world to natural hazards, including tropical storms, droughts and flooding. Climate change has the potential to raise the frequency and intensity of these threats. It also brings new threats, ­ particularly in the form of sea level rise. With most land less than two meters above sea level, sea level rise threatens to make numerous parts of the country uninhabitable over the next 30 years. One study indicates that land on which three-quarters of the ­population currently live could be below the annual flood level by 2050 (Australian Bureau of Meteorology and CSIRO, 2014). Climate change adaptation and disaster risk mitigation ­ and management are thus central issues for policy, livelihoods and households but the high costs of adaptation require careful strategic choices. Transformational adaptation and resilience measures will be needed in the short, medium, and long term. RECOMMENDATIONS 28. A summary of the recommendations is provided below and in Table 1. The key ­ recommendations are summarized under five themes: (i) the management of public finances; (ii) public service delivery; (iii) the fisheries sector; (iv) the labor market and labor ­ mobility; and (v) climate change. (I) ENHANCE FISCAL STABILITY AND SUSTAINABILITY 29. Achieving long-term fiscal sustainability and macroeconomic stability will require ­ focused efforts to: (i) maximize public revenue generation; (ii) strengthen the discipline, transparency and efficiency of the fiscal framework; and (iii) increase the efficiency and quality of spending, particularly education and health service delivery. The first is closely related to the development and management of fisheries resources and l ­ong- considered tax policy reform. The second involves unwinding the recent increase in recurrent spending—including through measures to improve the efficiency and accountability of SOEs—combined with reforms to strengthening core PFM frameworks ­ regarding planning and budgeting, fiscal responsibility, debt management, procurement and HRM. Regarding the third, education and health services are crucial public-sector enablers for building human capital and increasing the quality of the domestic labor pool to take full advantage of the domestic and overseas labor opportunities available to Marshallese citizens. 17 Republic of the Marshall Islands 30. Ensuring long-term fiscal sustainability and macroeconomic stability will require a fiscal adjustment of 5–6 percent of GDP over the period FY22 to FY35. The expected ­ continuation of US financial support has alleviated the pressure for a sharp fiscal ­ adjustment in the short term. However, US support is unlikely to continue indefinitely. Consequently, there is a need to undertake a multi-pronged fiscal adjustment of 5–6 percent of GDP over the coming 15 years to maintain long-term fiscal sustainability. Starting early will allow for gradual adjustments to be phased in, while also helping to build fiscal buffers sooner and to higher levels over the long term. The adjustment could be achieved by partially reversing the recent increase in recurrent spending (around 4–5 percent of GDP) while preserving spending on health and education. On the revenue side, implementing growth-friendly tax reform and improving revenue ­ administration could also contribute to the fiscal adjustment (around 1 percent of GDP). This adjustment would help to build the CTF to a level that would allow for future ­ annual disbursements equivalent to the CSGs, while protecting the real value of the CTF. 31. Achieving the necessary long-term fiscal adjustment will require reform to increase tax revenue by modernizing the tax regime and improving its efficiency. To this end, the recommendations from the Tax and Revenue Reform and Modernization Commission (TRAM) from 2010 should be revisited, including: (i) reforming personal income tax; (ii) introducing a net profits tax; (iii) introducing a consumption tax to replace the gross revenue tax; and (iv) replacing existing import duties with excise taxes. Efforts to improve revenue administration and implementation capacity should also continue. Increasing ‘sin taxes’ (excise tax rates on tobacco, alcohol and sugar-sweetened beverages) should also be considered to promote behavior change and address the NCDs crisis. 32. There is a need to modernize and strengthen the legislative and institutional­ frameworks that govern, and provide discipline to, the design of fiscal policy, planning and budgeting, and borrowing decisions. The Financial Management Act (FMA) needs to be reviewed and modernized to be consistent with current practices in budgeting, accounting and reporting. Regulations to support implementation of the FMA should be developed and adopted. The proposed Fiscal Responsibility and Debt Management Act (FRDMA) and associated regulations include several measures designed to improve the consistency and sustainability of long-term fiscal management and enhance­ accountability. They also strengthen the rules governing borrowing and debt­ management. The revised FMA, FRDMA and their regulations—currently under ­ preparation with support from a World Bank-funded project—should be enacted in the short to medium term. Efforts to embed and strengthen the medium-term planning and budgeting framework, including the linkages between capital and recurrent spending, should be continued. 33. Securing long-term fiscal sustainability will also require sustained efforts to reduce current expenditure, including SOE subsidies. Implementation of a medium-term ­ expenditure framework which limits spending growth would promote stability and enhance fiscal and economic sustainability. In the event of a negative fiscal shock, ­ 18 Country Economic Memorandum and Public Expenditure Review a medium-term framework would allow for a more gradual spending adjustment and avoid rapid cuts, reducing economic volatility. In the short term, greater spending discipline will need to include efforts to improve the performance of, and reduce subsidies ­ to, the SOE sector. To improve the efficiency of SOEs, community service obligations (CSOs) for the four key SOEs—Air Marshall Islands (AMI), Marshall Islands Shipping Corporation (MISC), Tobolar Copra Processing Authority and Marshalls Energy Company ­ (MEC)—should be finalized and implemented in the short term. This is being supported by Asian Development Bank (ADB)-funded technical assistance. CSOs should be ­ extended to other SOEs in the medium to long term, along with close monitoring and adjustments to CSOs as required. 34. The efficiency of the copra subsidy2 should be carefully evaluated in the short term, and reform to the scheme considered in the medium to long term. The rapid increase in the copra subsidy in recent years represents a significant fiscal threat. The subsidy is highly inefficient, and its effectiveness to protect livelihoods in neighboring islands is an open question.3 Establishing a formal social protection mechanism or redirecting the subsidy to incentivize production of staple foods could be more efficient mechanisms to support livelihoods. The latter could also help address malnutrition which causes stunting in children and NCDs in adults—two key challenges to building human capital in RMI. ­ 35. Reform to the CTF distribution rules can help to enhance fiscal independence and annual ­stability. The current CTF distribution rules create the possibility of highly unstable ­ distributions post-FY23. Alternative rules provide greater stability and sustainability of the CTF corpus but at the cost of lower annual distributions to the budget. Reform of the CTF rules will require an act of the US Congress. GoRMI should seek amendments to the CTF rules as part of the Compact negotiations. An optimal result would be a change in the rules coupled with additional funding to increase the CTF corpus relative to the ­ target annual distributions. 36. Implementation of the new FMIS will support effective management of public resources and improved financial reporting and accountability. It will do so by allowing the automation and integration of key underlying processes for budget formulation, budget ­ execution and financial reporting. The provision of accurate and comprehensive budget reports is critical to support effective planning, budgeting and monitoring, and ultimately, improved service delivery. Implementation of the new FMIS is a priority in the short term. Embedding the new system and businesses processes, along with the required ongoing capacity building and training, should be pursued over the medium and long term. This is supported by an ongoing World Bank-funded project. 2 GoRMI pays a fixed, subsidized price per pound to incentive copra production. The subsidy is generally viewed as a quasi-social protection scheme, to the extent that it serves as a transfer to households in non-urban areas. 3 ‘Neighboring islands’ refers to atolls, islands and communities outside of the two urban centers of Majuro and Ebeye. 19 Republic of the Marshall Islands 37. Substantial technical assistance and public consultations will be required to achieve this ambitious but necessary reform agenda. Given GoRMI’s capacity constraints, l ­ong- term technical assistance will be required to support the design and implementation of these key PFM reforms. Many are already being supported by development partners. Those that are not should be prioritized for external support. Another key challenge to realizing these reforms is securing public support. Ineffective communication was a major supported factor that derailed tax reform in 2010. Sustained, meaningful public dialogue—­ by technical analysis and advice—will be crucial to achieve politically supportable and administratively feasible reform, particularly to the tax system and SOE management. (II) ACHIEVE EFFICIENT AND EQUITABLE SERVICE DELIVERY Improving public sector human resource management 38. A comprehensive review and modernization of the GoRMI pay scales is required to ensure they are consistent with minimum wage legislation and restore equity across skills sets and pay bands. The pay scale for public servants has been fixed since FY97, with no adjustment for any cost-of-living changes over the subsequent two decades. As the minimum wage has increased, progressively more levels of the public service pay scale have fallen below the minimum wage. In response, it appears that public servants have been pushed to levels above their job or qualifications to avoid paying wages below the minimum wage. This is likely to have led to an increase in inequity across the ­ public service (that is, where employees with lower skills and responsibilities are now paid the same as employees with higher skills and responsibilities). Such distortions can have adverse impacts on the public service’s ability to attract, retain and motivate the people it needs and to deliver the performance it wants. 39. To support improved productivity and service delivery, implementation of the HRMIS is a priority in the short term, while a gradual shift towards a performance-based HRM system should be pursued in the longer term. GoRMI purchased an HRMIS in 2016, but it has yet to be fully implemented. Full implementation of the HRMIS, and interoperability with the new FMIS, are priority actions to support streamlined and effective approaches to managing all aspects of HRM. Effective performance management, including ­ merit- based recruitment and promotion, are crucial to incentivize and reward good ­performance. In the medium and longer term, GoRMI should gradually strengthen the foundational components of a performance-based HRM system, including job ­ descriptions and titles, and job evaluation frameworks. Strengthen procurement to improve value for money 40. Modernizing the legal framework and processes for procurement are essential to improve the value for money of public expenditure and reduce delays that inhibit ­ ­service delivery. Reform is urgently needed to modernize the legal framework and streamline business processes and procedures, which can help to improve the cost ­ effectiveness and timeliness of purchases. Technical assistance under a World­ Bank-funded project is supporting this reform. In line with implementation of the new FMIS, GoRMI should also move to electronic, system-based procurement recording and 20 approvals, which should streamline administration and reduce delays. Country Economic Memorandum and Public Expenditure Review Improve education quality and efficiency 41. Improving education quality and efficiency will require a focus on improving access to early childhood education, the quality of teaching, and the collection and use of data to inform policy and resource allocation. At around 23 percent of total spending (over 15 percent of GDP), RMI’s education system has ample resources relative to regional peers and global averages. Yet, increased inputs are not translating into improved learning outcomes. This indicates that more attention is needed to improve how services ­ are being delivered. Spending allocations by level of education (early education, primary, secondary and tertiary) and by type of spending (wage bill, operational, capital) are not inappropriate, and there is no clear evidence of wastage. Given the expected overall fiscal envelope post-FY23, improving learning outcomes will require doing more with the current level of resources. This will require difficult tradeoffs. Priority areas for­ improvement are: (i) access to early childhood education; (ii) the quality of­ teacher/student interactions in the classroom; and (iii) the collection and use of integrated school-level data to inform policy, planning and budgeting. 42. To better prepare children for primary school, GoRMI should continue to expand the delivery of early childhood stimulation, while also prioritizing the development and implementation of public preschool education. In the short term, the Ministry of ­ Education, Sports and Training (MOEST) should continue efforts to improve the coverage and quality of the home-based parental support program for vulnerable households in Majuro and Ebeye. In the medium and longer term, MOEST should continue to develop quality the institutional, regulatory, physical and human resources required to improve the ­ of existing private preschools and establish new public preschools. Both are being ­ supported by an ongoing World Bank-funded project. Authorities may need to ­ reprioritize some aid-funded capital works for primary schools towards establishing new public preschools; and investigate the potential for shared facilities. ­ 43. Improving the quality of primary and secondary education will require improvements in teaching via enhanced professional development support for principals and­ teachers. Aside from family socioeconomic characteristics, teachers are the most important factor affecting student learning. Numerous studies have shown that i ­ ­mproving the quality of instruction via teacher training and coaching/mentoring can have large and persistent impacts on learning outcomes (Piper & Korda, 2010; Pianta, 2011; Paxson & Schady, 2010). Given widespread poor learning outcomes, such training should focus evaluate on up-skilling teachers to effectively undertake regular classroom assessments to ­ student progress against a set of core skills and standards. This should be complemented by training on differentiated instruction (teaching to support students at different levels of proficiency) and multi-level teaching—especially for teachers in neighboring islands. However, given RMI’s dispersion, centralized coaching/mentoring will be extremely costly. Instead, professional development for principals should focus on enhancing their pedagogical leadership and better equipping them to provide teachers with regular ­ observation, feedback and coaching/mentoring. Support is currently being provided by an ADB-funded project. 21 Republic of the Marshall Islands 44. The Public School System (PSS) should expand and improve the collection and analysis of data on schools, students, teachers and funding to better inform policy design and resource allocation. Integrated school-level data is essential to evaluate the efficiency of spending and inform resource allocation and policies to improve learning outcomes. ­ Issues with the quality and timeliness of data undermine transparency, accountability, and the ability of authorities to set priorities and allocate resources to improve performance. The PSS should continue to focus on improving the education ­ ­ management information system (EMIS), including directly linking school-level data of different types so that it can be accessed in a format that facilitates analysis. At a minimum, this should include data on school funding, enrolments, Marshall Islands Standards Assessment Test (MISAT) scores, teacher qualifications and the school environment. Additional data should also be collected to determine the type and modality of training and support most needed by teachers and principals to enhance learning outcomes. 45. In the longer term, PSS should review and amend the school funding allocation ­ mechanism to ensure that it is transparent, consistent and tied to the needs of schools and students. At present, financing for private and public schools is based on separate formulas, with the public-school funding formula not clearly formalized. Both formulas only partially take into account the needs of schools and students. The formulas should be reviewed and amended to ensure that they: (i) provide efficient and equitable funding that is based on each school’s characteristics; and (ii) incentivize improved performance at the school level. 46. The MISAT should also be reviewed and revised to ensure that it is fully aligned to the curriculum and adequately measures student performance. To improve learning outcomes, authorities need a reliable instrument to measure what students know and ­ evaluate whether recent interventions are leading to improved outcomes. A review should assess the extent to which the MISAT: (i) aligns to the primary and secondary curriculum; and (ii) accurately measures the desired learning outcomes. It should also seek to expand the usefulness of the MISAT to track learning trends over time and create linkages with regional and international assessments (such as the Pacific Islands Literacy and­ Numeracy Assessment). This could be done by including common items across years. Strengthen the health system 47. Strengthening the delivery of a prioritized package of cost-effective essential services at the primary level can help improve health system efficiency and reduce the dual burden of disease. This will require the upskilling of health assistants through more comprehensive pre-service training, as well as periodic in-service training, and reforms to ­ the supply chain to address stock-outs of essential supplies. These reforms should be accompanied by a revision of the medical referral system to ensure that patients are not referred to the hospital for services that could be delivered at health dispensaries ­ (including gate keeping at the dispensary level for residents of Majuro and Ebeye), as well as a revision of the curricula for pre-service training of health assistants. These reforms could deliver a triple win for the health system by reducing: (i) the cost of service delivery; (ii) the burden on hospital staff; and (iii) the future cost on the health system from NCDs. 22 Country Economic Memorandum and Public Expenditure Review 48. In the short term, authorities should focus on improving the coverage of essential services in hospitals and clinics in Majuro and Ebeye and gradually roll-out these ­ programs to neighboring islands. First, GoRMI should establish a package of­ ­ cost-effective primary health services to be piloted in Majuro and Ebeye. Over the longer term, the package should be extended to dispensaries and via outreach. Training ­ curricula and the list of essential supplies (equipment and medicines) should be revised to ensure the readiness of health facilities to deliver the package of essential services. This reform agenda is being supported by a World Bank-funded project. 49. While the reliance on OMR schemes is justified given the high per capita cost of delivering specialized services in RMI, the management of these schemes should be ­ improved. In the medium term, the Medical Records Information System (MERIS) should be updated to include financial data. This information should then be used to monitor the unit cost of referrals per condition, compare costs between different providers of OMR, and inform decision making on which services are eligible for medical referrals and where to send patients. The pre-negotiated OMR agreement with a provider in the ­ Philippines represents a positive step and should be evaluated to understand its financial implications. Multi-country agreements with other PICs should also be explored, as such arrangements could reduce the cost of these schemes. 50. To the extent possible, GoRMI should seek to consolidate US financial assistance to the health sector into a single block grant. The way the health system is financed matters. Spending trends are heavily influenced by the sources of revenue for the health sector. Given the multiple sources of financing, the overall envelope is highly atomized. Furthermore, as several funding sources have strict expenditure eligibility criteria, health ­ financing is rigid. Rigidities limit the health system’s capacity to effectively respond to emerging needs and implement needed reforms. To address this constraint, GoRMI should seek to consolidate US Federal Government grants for health programs and Compact-related health sector grants into a single block grant. This will improve the fungibility of health spending, allowing GoRMI to respond to emerging needs and to ­ implement health system reforms that cannot be financed using vertical, disease-specific grants. Moreover, the consolidation of funding streams can facilitate the consolidation of procurement practices that are inefficient. 23 Republic of the Marshall Islands (III) MAXIMIZE THE BENEFITS FROM FISHERIES RESOURCES 51. At the regional level, reforms to strengthen the property rights characteristics of the VDS have the potential to increase the average vessel day price, allowing PNA members—including RMI—to capture a higher proportion of the rents. Regional ­ ­ cooperation between PICs to limit access to their EEZs by fishing vessels has significantly enhanced their ability to capture resource rents in the form of access fees. Further reforms that provide greater flexibility and transferability of a VDS day would make the access right more valuable. Such reforms comprise: (i) increasing ‘pooling’ of VDS days (multiple PNA members jointly selling a portion of their VDS days and allowing the purchasing vessel to use these days in any of their EEZs); (ii) extending the duration of tuna fishing rights beyond one year; and (iii) allowing transferability of tuna fishing rights between authorized users (that is, permitting the exchange of VDS days on a secondary market). Implementation of these reforms could lead to an annual increase in RMI fisheries sector revenues of US$10–21 million (4.6–9.3 percent of GDP). 52. At the domestic level, there are three key opportunities to maximize the benefits from the tuna fisheries. These comprise: (i) enhancing the effectiveness of current fiscal ­ incentives to the sector; (ii) strengthening the enabling environment for domestic ­value- added activities; and (iii) carefully managing the planned pilot project to create an RMI consolidated tuna trading company. 53. Cost/benefit evaluations are necessary to determine the effectiveness of current ­ financial incentives and—if financial incentives are to continue—GoRMI should consider adjusting their structure to directly incentivize domestic activity. In an attempt ­ to catalyze broader economic development and job creation, over the past decade GoRMI has provided financial incentives to fishing companies to base their vessels in Majuro and invest in on-island processing activities. However, these incentives do not appear to have delivered the expected benefits. In the short term, GoRMI should undertake detailed assessments of the benefits and costs of the current incentive ­ arrangements to make an informed decision about the extent to which foregone­ ­ revenues are generating net economic and social benefit for RMI. Foregone revenues should also be weighed against alternative uses of these resources, such as additional investments in the social sectors, critical infrastructure, and projects to strengthen climate ­ and disaster resilience. Based on the detailed assessment, GoRMI should consider whether the incentives should remain, and if so, consider amending their structure to ­ directly incentivize the desired activity (for example, via a rebate scheme based on the volume of fish processed). In the longer term, all financial incentives should be p­ eriodically reviewed to ensure they are achieving their desired objectives. In an optimal case, the incentives should be time bound. 24 Country Economic Memorandum and Public Expenditure Review 54. Securing duty-free access to the EU market could provide additional incentives for investment in onshore tuna processing. Market access can be a major determinant in ­ attracting investment in tuna processing. To obtain access to the EU market, exporting countries must meet EU-set standards regarding fishing sustainability, food safety and labelling. Meeting these standards involves the establishment of an entity, known as a Competent Authority (CA), that provides independent verification that the EU ­requirements are met. Certification of the Marshall Islands Marine Resources Authority (MIMRA) as RMI’s CA is a priority in the short term. Even if RMI meets EU requirements, RMI exports of value-added tuna products would attract a 20.5 percent duty. This is too high to make RMI processed tuna exports competitive. However, these duties could be reduced or removed as part of bilateral Economic Partnership Agreement (EPA) with the EU. Passage of an EPA (or interim-EPA) in the medium term could encourage additional domestic investment and fish processing. In the region, Papua New Guinea, Fiji and Solomon Islands have approved CAs and interim-EPAs allowing duty-free EU market access for ­ their fish exports. 55. The pilot project to form an RMI-based consolidated tuna trading company represents a compelling opportunity to maximize the development impacts of the RMI’s natural resources. Under a radical reimagining of the industry, GoRMI is planning to create a trading company (named Pacific Islands Tuna Provisions, PITP) that will retain ownership of harvested fish, contracting harvesting, processing, distribution and marketing ­ operations along the value chain. Financed by GoRMI’s private sector joint-venture partners, PITP is designed to derive a higher proportion of the rents from tuna resources ­ caught in RMI’s EEZ, compared to the income generated via selling RMI’s VDS days. 56. However, there are also significant potential risks, which go beyond the immediate financial risks of the venture. As a pilot project, PITP is designed to test the feasibility ­ of the concept. If the pilot demonstrates positive results and there is interest in scaling up the initiative, then GoRMI should seek independent legal, financial and technical advice on the proposed model. Crucially, authorities should avoid providing any financial commitment or guarantee to the venture. If PITP demonstrates success, it may be in RMI’s ­ long-term interest to expand the project to other PNA members, given the projected long-term decline in RMI’s tuna resources. 57. Retaining MIMRA’s independence is crucial to ensuring that RMI continues to maximize the benefits from its fisheries resources. In 2019, a bill was introduced to the Nitijela (RMI parliament) to allocate all fisheries sector revenues to the General Fund, with MIMRA to receive an annual transfer as part of the budget process. If implemented, this reform would seriously undermine MIMRA’s administrative and financial autonomy, which could have significant implications for its management. Maintaining MIMRA’s legal and operational independence is crucial to ensure that it retains its commercial focus and can ­ continue to attract and invest in the quality management, technical staff and technology necessary to efficiently and effectively manage RMI’s fisheries resources. 25 Republic of the Marshall Islands (IV) STRENGTHEN THE LABOR MARKET AND LABOR MOBILITY 58. Improving the quality of education and skills, and linking training with labor market needs, are necessary to improve employability and access to quality jobs both at home and overseas. This requires strengthening education and training quality and access at all levels. The upskilling agenda must include a focus on both technical skills and ­ qualifications, as well as soft skills commonly used in the workplace. Improved labor market information is key to resolving the skills mismatch and better resourcing ­ ­ vocational training. To this end, authorities should establish a labor market information system (LMIS) that includes a database of skills (for example, job seekers, school leavers and higher education graduates) and labor market needs. This information can be used to inform policy, and to provide incentives to training providers to deliver courses focused on occupational skills that are demanded by employers domestically and in key areas of the US. In the medium term, training programs to increase the supply of semi-skilled workers are more likely to yield economic gains, including in construction, wholesale and retail trade, and food manufacture (including fish processing). The LMIS information should also be used to improve the alignment of occupational skills offerings at secondary school with post-secondary providers and labor market needs. Finally, a more comprehensive skills needs assessment would be useful to further investigate the skills ­ (both soft and hard) that Marshallese workers are currently lacking and substituted by foreign workers. This reform agenda is being supported by a World Bank-funded project. 59. Support for Marshallese to enter the workforce, thereby gaining valuable soft skills and workplace experience, should also be a priority. Individualized job counselling services and intermediation services which connect job seekers with employers can assist l ­ow- skilled Marshallese to secure formal sector employment. A temporary wage subsidy which ­ xperience is currently planned for low-skilled jobseekers can also help to provide work e to this group and connect them with employers. 60. Many of the reforms related to upskilling the workforce would support Marshallese seeking work in the US. Improved education and vocational training, coupled with better development of English language proficiency and soft skills required in the workplace, can place Marshallese migrants on an improved footing in the US labor market. This will have long-term benefits for both migrants and for sending households in RMI. Support and guidance for prospective migrants relating to job searching can help to increase employment in the US. Labor market information from key US markets can inform education and training decisions. Authorities should consider establishing employment ­ ­ ountries intermediation services that extend across international boundaries, as occurs in c like the Philippines. Improved information on migration from RMI and on barriers to ­ low- cost remittance should also be collected with a view to informing policy. A focus on Recognition of Prior Learning (RPL) would also be of value, enabling Marshallese with vocational skills gained in the workplace to gain recognition of these through formal qualifications, thereby improving their ability to secure quality employment (including on the US Army’s Kwajalein military base in RMI). 26 Country Economic Memorandum and Public Expenditure Review 61. Reforms to clarify and streamline the process for employing foreign workers are warranted as RMI will always be reliant on foreign labor to some extent due to its small ­ population. First, a review of the Labor (Non-Resident Workers) Act 2018 is required. The legislation has reportedly made it more difficult to bring back foreign workers who have left RMI at the end of a previous work contract, requiring a three-year waiting period before a worker can return to RMI in some cases. This requirement is a constraint on the domestic private sector. A review of the Act and the implementation of supporting ­ r­ egulations could help to clarify the law and strengthen the consistency of its application. Second, streamlining separate work permit and visa applications would help to speed up processing times for foreign worker permit applications. (V) ENHANCE RESILIENCE TO THE EFFECTS OF CLIMATE CHANGE AND ­NATURAL DISASTERS 62. The challenge for RMI is the need to address both immediate disaster risks alongside disaster planning for longer term adaptation needs. In the short term, this requires strong ­ risk management (DRM) planning, better early warning systems for multiple hazards, and improved collection and use of multi-hazard information to guide urban planning and public infrastructure options. These needs are articulated in the National Disaster ­Management Office (NDMO) Roadmap, which identifies priority infrastructure, ­equipment, strategies, action plans and procedures which require strengthening. Activities should be prioritized in line with the Roadmap. There is also a need to better integrate DRM, ­ resilience and climate change adaptation considerations across all national, sector and corporate plans, and the budget process. 63. Resilience to climate change requires a strong adaptation framework and plan, adoption of a national building code, and deeper consideration on land use and ­ ­planning. To guide GoRMI’s long-term adaptation planning, GoRMI has begun ­ preparations of a National Adaptation Plan (NAP) which will include an assessment of medium- and long-term adaptation needs, a prioritized and costed set of investment projects, an analysis of financing options, and a framework for community engagement on longer-term adaptation needs and pathways. Implementation of the NAP is vital to ensure both short- and longer-term resilience. Enhanced adaptation will also require the adoption of a national building code and strengthened zoning plans to improving the resilience of commercial, government and residential buildings. Given the long-term threat of land loss due to sea level rise, there is also a need to consider large-scale or complex land reform, while protecting the social, political and cultural values reflected by customary land tenures. Finally, setting frameworks for community engagement in adaptation planning is important to ensure that citizens are included in decision making ­ regarding how to respond to long-term climate change. Engagement processes could potentially build on existing initiatives such as the Reimaanlok framework, which support community engagement practices for coastal adaptation to climate change in ­neighboring islands. Some of these activities are currently being supported by World Bank technical assistance. 27 Republic of the Marshall Islands 64. While climate change and natural disasters have an overall negative impact on RMI, implementation of climate adaptation measures would not only help to protect jobs, but also create new jobs primarily in the construction sector. For all the opportunities and threats discussed, there will also be increased demand for highly specialized ­ technical and managerial skills. While, at present, many of these skills are imported, with adequate investments in education and training it could be possible to fill at least some of these positions locally. CONCLUSION 65. Addressing RMI’s substantial development needs will require a two-pronged strategy to: (i) maximize development partner grants and international climate financing; and (ii) strengthen the budget process and project prioritization. The nation’s substantial development needs mean that GoRMI faces some difficult policy tradeoffs. Securing long-term fiscal sustainability requires the accumulation of fiscal buffers. Aged public infrastructure requires substantial maintenance and/or replacement. Addressing the ­ ­ urgent need to improve the quality of education and health services requires financial and technical resources. Finally, enhancing resilience to climate change requires substantial investment. Annual financing needs for these priority areas are well over ­ development 10 percent of GDP. Closing this financing gap will require efforts to maximize ­ partner and international climate financing. Authorities should seek all financing on grant terms, given RMI’s high risk rating under the IMF/World Bank Debt Sustainability Analysis. These large financing needs also reinforce the importance of carefully assessing the effectiveness of the copra subsidy and incentives in the fisheries sector. They also highlight the need to improve the quality of current spending and to address rigidities and inefficiencies that limit the responsiveness of spending to emerging priorities. Finally, continued efforts to strengthen the budget process—particularly regarding project screening, appraisal and selection—are important to ensure GoRMI’s scarce resources (both domestic and development assistance) are allocated to achieve maximum social returns. 66. Maximizing the impact of development assistance will also require concerted efforts to build GoRMI capacity for project management and implementation. In recent years, World Bank and ADB financing to RMI has more than doubled. Additional financing will be needed to meet RMI’s substantial development needs. Yet, GoRMI’s limited capacity is already stretched (in FY19, GoRMI recorded over 200 separate aid-financed activities, each with their own rules and reporting requirements). The pressure for more (and increasingly complex) projects will require concerted efforts by development partners to: (i) build GoRMI’s long-term capacity for project management and implementation; (ii) provide complementary capacity to support GoRMI; (iii) enhance donor coordination (including joint projects); and (iv) consider the role of budget support to complement project financing. In the absence of these measures, there is a risk that increasing financing could be accompanied by a decline in development effectiveness. ­ 28 Country Economic Memorandum and Public Expenditure Review Table 1: CEM/PER summary of recommendations Priority actions listed in orange Objective Short-term action (1–2 years) Medium-term action (2–4 years) Longer-term action (4+ years) FISCAL STABILITY AND SUSTAINABILITY Establish a modern • Finalize and implement the Fiscal • Seek the consolidation of health PFM legal framework Responsibility and Debt sector funding into a single block that supports a Management Act (FRDMA) and • Revise, modernize and implement the grant, to reduce fiscal rigidities and prudent, transparent associated regulations. new Public Procurement Code and ensure health spending is responsive and disciplined fiscal • Revise, modernize and implement the associated regulations. to sector needs. regime Financial Management Act (FMA) and regulations. • Continue to embed and strengthen the medium-term planning and budgeting framework, including the linkages Strengthen planning between capital and recurrent spending. and spending execution to support • Implement the new FMIS, including public sector an upgraded Chart of Accounts, and • Gradually transition existing GoRMI financial management systems to the new effectiveness ensure interoperability with the FMIS (including PSS and MOHHS from Abila to the new FMIS). HRMIS. • Develop and implement broad tax reform strategies (revisit the TRAM recommendations) including: (i) reforming the Enhance revenue personal income tax; (ii) introducing a net profits tax; (iii) introducing a consumption tax to replace the gross revenue tax; mobilization to create and (iv) replacing existing import duties with excise taxes. fiscal space • Increase ‘sin taxes’ (excise tax rates on tobacco, alcohol and sugar-sweetened beverages) to raise revenue and promote behavior change to address the NCDs crisis. • Amend the CTF distribution rules. • Monitor implementation of the first phase of SOE CSOs and adjust as required. Improve efficiency of • Finalize and implement CSOs for another set of SOEs. • Finalize and implement the CSOs for SOEs and transparency • Consider (partial or full) replacement of the copra subsidy with an alternative four key SOEs. of resource allocation structure for adaptive social protection payments, including via alternative • Review the Tobolar (copra) subsidy. mechanisms (such as a cash transfer program or greater funding for public services) or via incentives to produce alternative crops for domestic markets. EFFICIENT AND EQUITABLE SERVICE DELIVERY Strengthen public- • Update the PSC remuneration • Strengthen the foundations for • Design and begin implementation of sector HRM and framework. performance-based HRM, including a PSC Performance Management systems to improve • Roll out the HRMIS while ensuring job titles, job descriptions, and job System that introduces performance- service delivery and interoperability with the new FMIS. evaluation framework. based remuneration incentives. reward performance • Increase access to early childhood education via expanded delivery of early childhood stimulation and the establishment of public pre-schools. • Strengthen professional development support for principals and teachers, including: (i) coaching/mentoring training for principals; and (ii) classroom assessment and differentiated (i.e. multi-level) teaching skills for teachers. Improve education system quality and • Collect, compile and analyze data • Disseminate School Report Cards • Review and revise the school funding efficiency on students, teachers, schools and and establish School Boards in all allocation mechanism. • Review and revise the MISAT exam to funding (including by grouping data schools to encourage greater ensure the instrument is fully aligned at the school level) to improve policy community participation in school to the curriculum and adequately design and resource allocation. management and performance. measures student performance. • Develop a package of essential • Expand implementation of the package of essential health services to Strengthen the delivery health services for both urban and neighboring islands, potentially using alternative service delivery models. of essential health neighboring island areas. Implement • Upskill health assistants—such as via the Health Assistant Training Program—to services a pilot of the package in Majuro and be able to address more complex cases, particularly the management of NCDs. Ebeye. Review health assistant’s training curricula accordingly. • Update the Medical Records • Evaluate the Third-Party Review the Medical Information System (MERIS) to Administration scheme in the Referral Schemes include financial data and monitor Philippines and consider similar the costs of inter-island and off-island arrangements in other destinations. referrals. 29 Republic of the Marshall Islands Objective Short-term action (1–2 years) Medium-term action (2–4 years) Longer-term action (4+ years) MAXIMIZE THE BENEFITS FROM FISHERIES RESOURCES Maximize returns in the • Advocate for reforms to strengthen the purse seine Vessel Day Scheme to maximize the economic benefits derived by fisheries sector via the PNA members, including in the following areas: (i) increasing “pooling” of VDS days; (ii) extending the duration of tuna deeper regional fishing rights (e.g. from one year to three, five or even ten years); and (iii) allowing transferability of tuna fishing rights cooperation between authorized users. • Undertake a detailed assessment of • Based on the detailed assessment, • All incentives should be periodically Enhance the the benefits and costs of the current consider: (i) amending/removing the reviewed and presented to the effectiveness of incentive arrangements to determine incentives; or (ii) replacing the existing Nitijela. (In an optimal case, the domestic fishing vessel if the incentives are delivering incentive arrangements with a incentives should also be time and processing sufficient net social benefit to justify rebate-based scheme to processing bound). incentives their continuation. facilities based on tonnage of fish processed. Strengthen the • MIMRA complete the accreditation • Seek to negotiate an Interim Economic Partnership Agreement with the EU to enabling environment process for establishing an RMI increase market access for domestically landed and processed fish exports. for catch onshoring Competent Authority. and domestic processing • Implement the pilot project with the understanding that if it demonstrates • If the pilot demonstrates positive Implement the pilot for positive results and there is interest to fund a scaled-up initiative, external results and there is external funding funding will be utilized and there will be no commitment or guarantee of to scale up the initiative, GoRMI a domestic tuna GoRMI or MIMRA funds. should seek independent legal, trading company, financial and technical advice on the avoiding GoRMI proposed model, paying particular financial liability attention to political and reputational risks. STRENGTHEN THE LABOR MARKET AND LABOR MOBILITY • Develop and implement a regular labor market survey and skills needs assessment, with information from key destination areas in the US to be added over time. • Improve alignment of occupational skills offerings at secondary school with post-secondary providers and labor market needs. • Establish a basic Labor Market • Support development of new • Develop a Recognition of Prior Strengthen the skills Information System (LMIS). vocational training courses that fill Learning system for RMI in key profile of the Mar- • Enhance employment intermediation skills gaps based on analysis of LMIS occupations, selected through the shallese workforce to services offered by the NTC’s data. LMIS and including a focus on work improve employability Employment Center. • Enhance (and in some cases available on the Kwajalein military establish) counselling services in base. and address domestic skills gaps secondary schools, TVET providers, and NTC Employment Centers which offer career guidance/job coaching and referral services to education/ training providers and employers. • Establish a work placement scheme for low skilled jobseekers. • Support training of English skills for • Establish employment services to • Establish employment intermediation Maximize the benefits adults using the existing process for facilitate overseas employment, such services for migrants to the US in from open access to NTC-funding of short courses.. as job search support services for NTC. the US labor and Marshallese and outreach activities education markets to US employers to encourage direct recruitment. Clarify the legal • Streamline separate work permit • Review the Labor (Non-Resident framework and and visa applications for foreign Workers) Act 2018 with a view to streamline processes to workers. resolving the ambiguity regarding employ foreign labor repatriated workers. to help address skills gaps 30 Country Economic Memorandum and Public Expenditure Review Objective Short-term action (1–2 years) Medium-term action (2–4 years) Longer-term action (4+ years) ENHANCE RESILIENCE TO THE EFFECTS OF CLIMATE CHANGE AND NATURAL DISASTERS Establish robust • Continue to strengthen the integration of disaster risk management, resilience and climate change adaptation adaptation planning considerations across all national, sector and corporate plans. that supports resilience • Finalize development of the National • Implement, monitor and review the National Adaptation Plan. to natural hazards and Adaptation Plan, including initial climate change stakeholder consultation. • Implement strengthening of National • Update and operationalize Standard Operating Procedures (SOPs) for the Disaster Management Office NDMO to improve Emergency Preparedness and Response, including Improve capacity for (NDMO) as set out under the NDMO emergency communication, and multi-hazard early warning messaging and disaster early warning Roadmap to improve NDMO communications. and response capacity. • With the support of development partners, develop a package of contingent financing instruments to support disaster resilience appropriate for RMI’s risk profile. • Strengthen and implement zoning plans (implementation of the Planning and Zoning Act 1987) and develop building Strengthen building codes and regulations that support: (i) multi-hazard and risk-informed planning, development and maintenance across and infrastructure public, private and commercial buildings; and (ii) improved resilience of key infrastructure (especially health facilities, planning and schools, ports and key road sections). construction to account for current and future • Devise a land management and administration plan that proposes steps towards a broader national policy dialogue on natural hazards land for public purposes (state land) that would enable longer-term adaptation options. 31 Republic of the Marshall Islands Introduction and Country Context 67. This joint CEM and PER comprises two pillars, which address the report’s two development objectives. The first objective is to improve understanding of the challenges, opportunities, and risks to achieving sustainable economic growth in the RMI. The second objective is to improve the management of public resources to support long-term economic development, fiscal sustainability, and service delivery. The key output of the report is a prioritized and sequenced set of reform actions which can help to: (i) maximize the benefits from RMI’s key economic growth and development opportunities; (ii) strengthen the systems for monitoring and managing public resources to achieve required improvements in efficiency and service delivery; and (iii) enhance resilience to key emergent risks to growth and sustainability. 68. Pillar 1 (CEM pillar) provides recommendations to support the government to maximize the development impacts of the nation’s natural and labor resources, while also enhancing resilience to key emergent risks. This pillar analyzes the structural characteristics that limit the effectiveness of traditional development strategies, and undertakes a detailed analysis of two specific areas of development potential, namely: (i) the fishing sector, including the potential for transshipment and associated services to deliver increased growth and jobs; and (ii) the domestic labor force, including the necessary policy measures to upskill the labor force to take full advantage of domestic labor opportunities and fully utilize the RMI’s open access to the US labor market. The study also analyzes three key risks to growth and sustainability: climate change; the scheduled expiration of the Compact Sector Grants (CSGs) in 2023; and the dual burden of disease (both communicable and non-communicable diseases). 69. Pillar 2 (PER pillar) provides recommendations to support the government to strengthen medium term fiscal sustainability and service delivery. This pillar covers issues related to revenue mobilization, expenditure prioritization, budget formulation and execution, and the nation’s core PFM frameworks regarding fiscal responsibility, debt management, procurement, and others. This analysis is expected to help the government to prepare the groundwork for a new medium-term expenditure framework and provide evidence towards a prioritized PFM reform program.  70. The joint CEM and PER is tightly aligned to the key development objectives articulated in the RMI National Strategic Plan 2020–30 (NSP). This document, which was endorsed by the government in June 2020, sets out a medium-term vision of “sustainable, equitable and measurable development reflecting the priorities and culture of the Marshallese people”. The NSP is organized around five pillars: (i) Social Services and Cultural Identity; (ii) Environment, Climate Change and Resilience; (iii) Infrastructure; (iv) Economic Development; and (v) Governance. These pillars are complemented by a series of cross- cutting issues which include Neighboring Island Development, Resilience, Nuclear Justice, Human Development and Security. The analysis and outputs of the joint CEM and PER support all five pillars of the NSP and several of the cross-cutting themes. 32 Country Economic Memorandum and Public Expenditure Review 71. The scheduled expiration of the financial aspects of the RMI’s Compact with the US in 2023 could precipitate a significant structural change in the RMI’s fiscal framework. At present, structural factors such as the Compact grant management system and rigidities in fiscal policy render PFM highly complex. Under the Compact, the RMI receives significant funding from the US—which account for 35–50 percent of GoRMI annual revenues—earmarked for spending in the infrastructure, education and health sectors (see paragraph 80 and Box 1). The RMI-US Joint Economic Management and Financial Accountability Committee (JEMFAC) reviews and approves grant allocations, which are then incorporated in the GoRMI budget framework. Under current arrangements, many of the grants, programs and services provided to the RMI by the US Federal Government are scheduled to end, to be replaced by annual disbursements from the Compact Trust Fund (CTF).4 In this new scenario, the role of the JEMFAC is unclear. Potentially, GoRMI would assume full responsibility for reviewing and programming of all revenue and expenditure. Under this scenario, GoRMI would require greater capacity for strategic planning, budgeting, monitoring and evaluation. The extent to which GoRMI could maintain or improve budget execution in this new scenario would have significant implications for service delivery and economic activity (including, but not limited to, capital spending). 72. The dominance of the public sector in the economy, combined with the implications for long-term fiscal and macroeconomic stability of a change in the financial aspects of the Compact, provide robust motivation for a combined CEM and PER. This strong interdependence is summarized in Figure, which provides a concise organizing framework for the combined CEM and PER. Low historical growth and the predominant role of the public sector in key sectors of the economy highlight the need to focus on feasible private sector development opportunities to promote income generation, job creation and greater shared prosperity. The two most prominent of these opportunities are in the fisheries sector and via strengthening the domestic labor market and maximizing the benefits of labor mobility. Achieving long-term fiscal sustainability and macroeconomic stability will require focused efforts to: (i) maximize income and public revenue generation; and (ii) increase the efficiency and quality of education and health service delivery. The former is closely related to the development and management of the fisheries sector and domestic labor market and skills. Regarding the latter, education and health services are crucial public-sector enablers to building human capital and increasing the quality of the domestic labor pool to take full advantage of the domestic and overseas labor opportunities available to Marshallese citizens. 4 The RMI and US Governments began negotiations on amending the agreement in 2020, but the details of the scope, size and duration of any amendments remains uncertain. Consequently, the discussion of the transition from CSGs and US Federal Government programs to CTF disbursements remains central to the RMI’s long-term fiscal sustainability. 33 Republic of the Marshall Islands 73. The lack of key data meant the World Bank’s CEM 2.0 Framework and Country Scan Tool could not be utilized for this publication. Nevertheless, to the extent possible and appropriate, the analysis addresses key components outlined in the framework. Annex 1 provides a discussion of the key components of the CEM 2.0 Framework and how these have been applied in this publication. Figure 1: A concise organizing framework for the combined CEM/PER Public sector dominates economy​ Compact underpins fiscal framework, Need to promote feasible private but scheduled expiration of large sector development opportunities​ proportion of revenue envelope Major source of financing Long-term fiscal sustainability Fisheries Labor market/ for Education and Health​ and macro and macro stability​ stability​ sector​ mobility​ Maximize revenue and income generation Increased efficiency and quality of education and health services​ COUNTRY CONTEXT 74. The RMI is one of the world’s smallest and most isolated nations. Located approximately midway between Hawaii and the Philippines, the country consists of 29 atolls (of which 24 are inhabited) and five isolated islands plus numerous small islets. Almost all of the territory is less than two meters above sea level. The country covers an area of around two million square kilometers (around the size of Mexico) but has just 181 square kilometers in land area (around the size of Washington, DC). RMI’s population totals around 54,000, of which 28,000 (53 percent) reside in Majuro (the country’s capital) and 10,000 (18 percent) in Ebeye. 75. RMI’s urban centers are among the mostly densely populated in the world. Urbanization and crowding have intensified over the past 30 years, with migration from the neighboring islands to the urban centers of Majuro and Ebeye primarily due to: (i) a lack of employment opportunities in other locations; and (ii) greater reliance on the cash economy as compared to a subsistence lifestyle. Consequently, Ebeye—with an area of less than 0.4 square kilometers (around the size of four football fields)—has a population density of over 30,000 inhabitants per square kilometer, making it the most densely-populated island in the Pacific and among the most densely populated in the world. Rapid 34 urbanization is also increasing the vulnerability of urban centers to natural hazards and climate risk. Country Economic Memorandum and Public Expenditure Review 76. Population growth has been stagnant since the 1990s due to outmigration. Between 1967 and 1999 the RMI’s population increased by an average of 3 percent per year but has remained relatively stable since then (with average annual growth of around 0.4 percent). The combination of declining real incomes and rising cost of living has resulted in significant outmigration, with Marshallese citizens seeking better jobs and educational opportunities abroad, mainly in Hawaii, the US mainland and Guam. RMI has one of youngest populations in the Pacific with a median age of 20.6 years old.5 Sixty-seven percent of the population are under 29 years old with many facing unemployment, as the economy has struggled to create sufficient jobs for the growing labor market. 77. RMI is also one of the most vulnerable nations in the world to natural disasters and rising sea levels, with sea level rise threatening the physical viability of numerous parts of the country. The country’s small land area means that over 99 percent of the population lives along the coastline, rendering the majority of the country’s economy, infrastructure, and livelihoods highly vulnerable to natural hazards such as cyclones, and climatic hazards such as sea level rise. Climate modelling indicates that RMI will experience sea level rise of 0.13–0.35 meters over the next 30 years (Australian Bureau of Meteorology and CSIRO, 2014), meaning that land on which three-quarters of the population currently live could be below the annual flood level by 2050 (Figure 2). A 0.5-meter sea level rise could lead to regular flooding of 90 percent of Rairok Islet—the site of Majuro’s international airport (World Bank, 2021a). With most land less than two meters above sea level, inundations and large storms are already a substantial threat. The 2014 Intergovernmental Panel on Climate Change models suggest that the cost of sea level rise impacts as a percent of GDP would be highest for FSM, Palau, RMI, and Nauru in the Pacific. The increased frequency and severity of natural disasters, combined with the effects of climate change, mean the costs of extreme weather events is rising. Climate change adaptation and disaster risk mitigation and management are thus central issues for policy, livelihoods and households. 78. Poverty, inequality, and shared prosperity. A Household Income and Expenditure Survey (HIES) was carried out in 2019–20. Based on the 2019–20 HIES data, the poverty headcount ratio is estimated to be 7.2 percent.6 This measure is based on an annual per adult equivalent (AE)7 poverty line of US$1,828, or approximately US$5.0 per AE per day. The highest rate of poverty is for those in rural areas at 21.2 percent. Poverty is much lower in urban areas, at 2.3 percent in Majuro and 3.2 percent in Kwajalein. The Gini index, which measures inequality, is estimated at 35.5 percent based on per capita consumption. This is comparable to the level of inequality in other middle-income countries in East Asia and Pacific (EAP). Inequality between populations in the urban centers and the neighboring islands is exacerbated by high transport costs and limited access and poor quality of public goods and services in remote areas, while increased crowding in Ebeye and Majuro has also increased inequality in the urban centers. Furthermore, informal safety nets are weak as increased urbanization, westernization and aid dependence have undermined traditional customs and values. Coverage of formal social protection programs remains very limited, even when compared to other PICs. 35 5 EPPSO & Secretariat of the Pacific Community (2012). 6 The last HIES was conducted in 2002 using a different methodology, rendering comparison of poverty trends between the two surveys not possible. 7 Adult equivalency measures are used to reflect the differing consumption needs for members of the household, depending on their age. The PICs use a simple adult equivalency scale, where children aged 0–14 are considered as half an adult. Republic of the Marshall Islands Figure 2: Large sections of the RMI land mass are projected to be below annual flood levels in 2050 Kwajalein Atoll Ebeye Source: Climate Central (2020). 79. The public sector dominates the Marshallese economy and transfers to SOEs are a significant drain on public resources. Due to the combination of small population size, extreme remoteness and dispersion, and increasing climate and disaster vulnerability, the challenges faced by RMI are more pronounced and the economic opportunities more limited than those of most other remote regions in the world. RMI’s economic geography increases transport cost and limits economies of scale which—combined with its relatively limited natural resources—result in a narrow production base, constrain the opportunities for exports and make the economy highly dependent on imports. Consequently, the economy is dominated by the public sector, which accounts for around 40 percent of GDP and half of formal-sector employment, while private sector activity focuses on the fisheries sector, wholesale and retail trade, and tourism. SOEs dominate key sectors of the economy, with transfers to support their continued operational losses having expanded from an average of 4 percent of GDP over the period 2004–2013, to over 6.6 percent of GDP in FY17 to FY19. 80. RMI’s relationship with the US underpins the nation’s fiscal framework, but the scheduled expiration of Compact-related grants poses a key risk to economic stability. Following independence in 1986, RMI entered into a Compact of Free Association with the US (‘the Compact’) (see Box 1). Under the Compact, the US provides open migration to the US for RMI citizens in exchange for permission to retain permanent defense forces in, and exclusive access to, RMI’s sovereign territory (among other arrangements). The US Government makes annual lease payments to the traditional landowners as compensation for the use of the land. In addition, the US provides annual financial transfers to RMI and access to a range of US Federal Government services and programs, which were scheduled to expire in 2003. Under an amendment to the Compact in 2004, the ‘financial chapter’ of the agreement was extended for a further 20 years (FY04 to FY23). While the 36 Country Economic Memorandum and Public Expenditure Review Compact itself continues into perpetuity, the amended fiscal chapter—which provides fiscal transfers amounting to around 25 percent of GDP—is scheduled to expire in FY23. Under current arrangements these transfers will be replaced by annual disbursements from the CTF. However, due to lower-than-expected returns over the life of the CTF, current projections indicate that the funds will not be sufficiently large to generate an annual income stream that can fully replace the expiring transfers. Absent a sizeable fiscal adjustment over the coming years (or agreement on an extension of Compact- related transfers), GoRMI revenues would likely fall significantly in FY24. This would put at risk the GoRMI’s capacity to maintain and expand access to and quality of public services, especially those delivered to the poor. 81. While there has been no community-based transmission of COVID-19 in RMI,8 the economic and social impacts of the pandemic have been significant. RMI’s remoteness has helped avoid a COVID-19 outbreak, but the prevention strategies have had significant economic consequences. Since 8 March 2020, all international passenger arrivals by land and sea have been prohibited. Quarantine requirements have also led to delays in goods, food and fuel imports, and steep declines in tuna transshipment and ancillary vessel services. These effects drove the economy into recession in FY20, with output projected to contract further in FY21. Lower economic activity is expected to result in substantial job losses, with formal sector employment falling by as much as 6 percent between FY19 and FY21 (Graduate School USA, 2020). Despite the adverse economic and social impacts, large parts of government revenues are relatively protected from the downturn in domestic economic activity—particularly development partner grants and fisheries sector revenues. These remained relatively robust in 2020. Grants from development partners provided the fiscal space for a US$45.8 million (21 percent of GDP) COVID-19 fiscal response package. Nevertheless, it could take several years for the economy to recover to pre-crisis levels of production and employment, and the crisis has delayed the fiscal consolidation required to protect long-term fiscal sustainability. These factors reinforce the urgent need to address the reform priorities identified in this joint CEM and PER. 8 In October and November 2020, the RMI reported four border quarantine COVID-19 cases at the US military base on Kwajalein Atoll, although effective quarantine procedures avoided domestic transmission. 37 Republic of the Marshall Islands Box 1: The RMI-US Compact of Free Association ‘Til death do us part? In 1982, RMI and the US entered into a ‘Compact of Free Association’ which continues in perpetuity, with financial support provided to RMI from 1986 to 2001. At the end of World War II, the United Nations created the Trust Territory of Pacific Islands and the US accepted the role of Trustee. The RMI was under the civil administration of the US Navy from 1944 to 1951. Administration authority was then transferred to the US Department of Interior (USDOI) until 1979, when RMI voted to become independent. During that period, RMI benefitted from US investments to rebuild infrastructure and expand the provision of public services, including health and education. The Compact continues in perpetuity, unless both sides mutually agree to its termination. Under the original Compact, RMI received yearly financial transfers for 15 years (1986–2001). These financial conditions were extended until 2003, while the RMI and US Governments negotiated a revised Compact. The amended Compact, signed in 2003, provides US financial support for a further 20-year period that began in FY04 and expires in FY23. Under the amended Compact, RMI receives two streams of funds—CSGs and contributions to the CTF—that will total approximately US$864 million in 2004 price terms over the 20-year period.9 This is equivalent to payments of US$42.2 million per year. In 2004, this comprised US$34.7 million as sector grants, US$0.5 million to finance an annual audit, and US$7.0 million paid as contributions into the CTF. Each year, the CSG value is reduced by US$0.5 million and the CTF contribution increased by US$0.5 million. The amended Compact also gave RMI access to a series of US Federal Government programs and services—effectively on terms similar to those of US states. In addition, US$15 million in 2004 price terms (rising to $18 million in 2014) is provided for Kwajalein Impact grants (to compensate landowners for the US military base stationed on Kwajalein Atoll), and Ebeye Special Needs grants (to address the impact of US military presence on the communities in Ebeye and Kwajalein Atoll—these funds are used for affordable housing and the education and health sectors).10 While the Compact has no specified termination date, the annual sector grants will cease in FY23, and are scheduled to be replaced by disbursements from the CTF from FY24. While the open migration and defense provisions of the Compact will continue beyond 2023, it is unclear the extent to which RMI will remain eligible for federal programs and the provision of US services post-2023. The RMI and US governments began negotiating an extension of the fiscal chapter of the amended Compact in 2019, although no agreement has yet been reached. Negotiations of a further amendment to the Compact were announced in August 2019, with the first round of consultations held in May 2020. US authorities had signaled their intention to conclude negotiations by December 2020. However, as of March 2021, no negotiated agreement has yet been announced. The use of the CSGs is guided by the Fiscal Procedures Agreement between the RMI and US governments. This establishes, among others, the requirements on grant governance, disbursement, usage and reporting. The USDOI has the fiduciary responsibility for the approval and implementation of the CSGs, through the JEMFAC. The JEMFAC was established to “strengthen management and accountability with regard to assistance provided under the Compact, and to promote the effective use of funding provided.” The JEMFAC members consist of three representatives from the US and two from RMI, and decisions are reached on a majority basis. 9 The 2004 constant price dollar amounts outlined in the Compact agreement are adjusted each year for inflation by a percentage that equals two-thirds of the percentage change in the US GDP implicit price deflator, or 5 percent, whichever is less in any one year, using the beginning of 2004 as a base. 38 10 The Kwajalein Impact grants and Ebeye Special Needs grants are scheduled to continue as long as the Military Use and Operating Rights Agreement (MUORA) between the RMI and US governments remains in effect. The MUORA covers the period 2003–2066 with an option to extend for a further 20 years. Country Economic Memorandum and Public Expenditure Review CSG guidelines state that the funds must be used for assistance in education, health care, the environment, public sector capacity building, private sector development, and public infrastructure—where infrastructure must account for 30–50 percent of total spending. The CSGs thus finance both current and capital spending. For capital spending, priority is given to education and health-related infrastructure, with secondary priority given to economic development-related projects (for example, transport, electricity, climate change adaptation). Furthermore, 5 percent of the infrastructure spending must be set aside for maintenance, and GoRMI must contribute an additional 5 percent from domestic revenues. CSGs currently finance around half of total public spending and are a major source of funding in the education, health, and infrastructure sectors. These grants have declined in real terms over time due to the annual US$0.5 million decrement and an inflation adjustment (set at two-thirds of the US GDP implicit price deflator) which has generally been below RMI’s annual inflation rate since FY04— reducing resources available for service delivery. From FY23, the annual income distributions from the CTF assets are supposed to replace the real value of the existing CSGs. However, the value of the CTF assets is currently below the projected path to achieving this. Based on current projections, CTF income generated in FY24 is expected to only be able to replace around two- thirds of CSGs (Figure 3). Figure 3: Estimated evolution of CTF asset value and distribution shortfall post-FY23 800 30% 600 25% 11% 20% 400 15% 200 27% 10% 17% 0 5% FY04 FY06 FY08 FY10 FY12 FY18 FY20 FY22 FY14 FY16 0% Target Balance (Moderate Strategy) FY23 CSG FY24 CTF Shortfall Target Balance (Aggressive Strategy) Distribution Projected Balance (Estimate) Note: The target balance estimates are equivalent to the CTF asset value under ‘Moderate’ and ‘Aggressive’ investment strategies as defined by the US Government Accountability Office (GAO) report GAO-19-648T (2019). The projected balance estimate reflects the actual evolution of the CTF balance up to FY19 and the projected CTF balance profile based on the FY19 actual. This is calculated based on the scheduled contributions to the CTF and assuming annual nominal returns equal to the historical average. The FY23 CSG is estimated based on the FY19 actuals adjusted by the annual decrement and two-thirds of the US GDP implicit price deflator, as projected in the IMF World Economic Outlook October 2020. Total spending in FY24 is also taken from the IMF World Economic Outlook October 2020 projections. Distribution from the CTF may vary depending on the financial market return, affecting the magnitude of the shortfall as well. 39 Republic of the Marshall Islands Pillar 1: Country Economic Memorandum This pillar comprises four sections. Section 1.1 outlines recent economic developments, with a focus on key trends over the past decade. Section 1.2 summarizes the key challenges to achieving faster economic growth, private sector development and job creation. Section 1.3 analyzes the opportunities to spur higher incomes in the fisheries sector and by strengthening the labor market and labor mobility, along with a short section addressing other potential drivers of growth. Section 1.4 analyzes key emergent risks to growth and sustainability. 1.1 RECENT ECONOMIC PERFORMANCE 82. Previous World Bank research (2011a, 2017a) has highlighted that the RMI’s economic geography is the binding constraint to achieving sustainable long-term growth. RMI’s economic geography is characterized by extreme remoteness, small size, geographic dispersion, environmental fragility and limited natural resources. Small size and remoteness combine to push up the cost of economic activity in RMI, limiting the competitiveness of its exports of goods and services in world markets and reducing the potential to realize economies of scale (Figure 4). Small size and remoteness also push up the cost of providing public services. High dependence on imports combined with a lack of sufficient size for meaningful diversification makes RMI highly vulnerable to external economic shocks. These factors combine to make achieving sustainable economic growth particularly challenging. Considering their similar economic, geographic, and demographic characteristics, in this study the small PICs are frequently used as a benchmark to assess RMI’s economic performance (Box 2). In some circumstances, Caribbean countries are also included as an indication of a potential ‘aspirational’ point of reference. Figure 4: Smallness and remoteness set the PICs apart, including RMI Source: World Bank (2017a). Note: (i) x-axis in log scale; (ii) y-axis calculated as the average distance from other economies weighted by their GDP. 40 Country Economic Memorandum and Public Expenditure Review Box 2: Measuring Up Defining a set of comparator countries for RMI RMI shares similar challenges and opportunities as other small island states, including those in the Pacific region. These include limited natural resources, narrowly based economies, large distances from major markets, dispersed populations, and vulnerability to external shocks. These characteristics limit the economic incentives for private sector development and make achieving sustainable economic growth particularly challenging. Consequently, the provision of many basic goods and services is left to the government, meaning that the public sector tends to be relatively large in small- island states (both in terms of economic output and formal-sector employment). RMI—as one of the most isolated, vulnerable, and dispersed countries in the world – is an extreme example of these characteristics. RMI’s geographic characteristics, combined with its reliance on aid and fisheries sector revenues, mean that the PICs are RMI’s most appropriate comparator countries. Aside from the characteristics of smallness, dispersion, fragility and distance to markets, the economic structure of many of the small PICs is also heavily influenced by their reliance on foreign assistance and—more recently— fishing sector revenues.11 Hence, in this study, RMI is benchmarked to the small PICs when considering cross-country comparisons of economic performance. Furthermore, the Federated States of Micronesia (FSM), Palau and Kiribati are considered RMI’s closest ‘structural’ peers (that is, countries with broadly similar economic structure). This is due to the impacts of their respective Compacts with the US on their economic and fiscal foundations (FSM and Palau), and the impacts of fisheries sector revenues on their fiscal framework (FSM, Palau and Kiribati). Kiribati’s atoll nature makes it further relevant for comparison with RMI. Fiji and Samoa, as the most developed of the PICs, represent ‘aspirational’ peers (countries with similar economic geography that have achieved superior development outcomes). Further afield, the Caribbean islands have similar characteristics to RMI in terms of smallness, dispersion, and vulnerability to climate change. However, their proximity to large markets (the US), reliance on tourism, and generally much higher GNI per capita mean that they are best seen as a potential benchmark or ‘aspirational’ peers, in certain circumstances. 11 Due to the implementation of the Vessel Day Scheme, a regional agreement that establishes the minimum price of a vessel day and limits the total number of vessel days sold – see Section 1.3.1 for details. 41 Republic of the Marshall Islands 83. Based on potential drivers of growth and sources of foreign exchange to fund welfare- enhancing imports, the literature (Bertram, 2006) identifies three archetypes of small- island economies: a. MIRAB (Migration, Remittances, Aid and Bureaucracy): Welfare and per capita incomes in these economies are determined by two stock-flow relationships: (i) the stock of overseas-resident migrants and their descendants, which sustain the flow of remittances and new migrants; and (ii) the stock of domestic public-sector employment, which is sustained by the flow of aid. b. SITE (Small Island Tourist Economies): In these countries, tourism is the main driver of economic activity. c. PROFIT (People Considerations, Resource Management, Overseas Engagement, Finance, Insurance and Taxation, and Transport): PROFIT economies seek to exploit a broader set of economic opportunities through: (i) shrewd immigration and cyclical migration policy; (ii) engaging in tough external negotiations concerning the use of local mineral, natural, political and other imaginative resources; (iii) securing and controlling viable means of transportation; and (iv) luring foreign direct investment via very low/no taxes. 84. The consequences of these structural characteristics highlight the importance of a development strategy that aims to reduce the disadvantages imposed by geography while maximizing the benefits of RMI’s limited economic opportunities. Bertram (2006) classified RMI as a MIRAB country, with economic growth dependent primarily on inflows of foreign aid. This is confirmed by Duncan (2016) in his review of growth episodes of PICs, which highlights that periods of weak and strong growth in RMI have generally reflected delays or accelerations in Compact spending. Like other PICs, RMI’s unique economic geography limits the effectiveness of traditional development strategies, such as manufacturing-based, export-led growth. Consequently, reforms to improve the business environment are unlikely to be sufficient to ensure global competitiveness given the costs imposed by size and distance from markets. A key implication is that reforms should be targeted toward reducing the disadvantages imposed by geography, and on economic opportunities that are less affected by these disadvantages. This highlights the importance of an alternative development strategy focused on: (i) the role of public sector as a key supporter of economic activity and source of formal sector employment; (ii) the need for, and appropriate management of, development assistance to sustain public goods and services and standards of living; (iii) maximizing the benefits of natural resources (fisheries); and (iv) equipping the labor force to take full advantage of the available national and international labor opportunities. 42 Country Economic Memorandum and Public Expenditure Review 85. Average economic growth has been low by global standards, and subject to high volatility. Since commencement of the amended Compact in 2004, real GDP has grown by a modest 1.5 percent on average. Growth has also been volatile, with deep recessions in FY08 and FY11 to FY12 being offset by growth spurts over the periods FY00 to FY02, FY09 to FY10 and FY15 to FY19 (Figure 5). The sharp recession in FY08 was due to the global economic slowdown combined with rising fuel and food prices, which saw domestic inflation reach 15 percent, eroding real incomes and curbing demand.12 The recession in FY11 to FY12 was due to a decline in fish loining activity, combined with delays in the disbursement of Compact infrastructure grants until GoRMI presented a medium- term budget framework to the JEMFAC.13 The three periods of growth spurts were underpinned by increased fishing and tuna loining activity, combined with aid-financed expansions in infrastructure construction and public service sectors, such as education and health.14 Overall, real GDP per capita remained broadly flat from FY04 to FY15 but has increased in recent years (Figure 6). Nominal GDP per capita remains similar to RMI’s structural and regional peers (Figure 7). 86. More recently, growth has been driven by the fishing sector and aid-related construction activity. Economic output expanded for a fifth consecutive year in FY19, the longest period of sustained economic expansion since 1998. This result highlights the country’s relatively strong economic performance prior to the recent COVID-19 shock. Growth was driven by increased output in the fisheries sector and higher public construction activity, reflecting a pick-up in Compact-related infrastructure spending and the scale-up in ADB, EU and World Bank-funded projects (Figure 8). However, the severe economic impacts of the COVID-19 pandemic are expected to drive the economy into recession in FY20 and FY21, owing to very restrictive border and customs policies that have disrupted trade flows, with flow-on effects to domestic construction and fishing sector-related service exports. 12 High global fuel prices also caused a severe cash flow crisis for the Marshalls Energy Company (MEC), the state-owned utility company. This resulted in supply disruptions and required a substantial cash infusion from GoRMI. 13 The restrictions on grant disbursements were lifted in FY14. 14 The high growth rate in FY19 was partly due a change in operations by a domestic fishing company and its Chinese parent company. In FY19 two vessels that had been on lease from the parent company were returned. These were replaced by three new vessels, domiciled with the domestic company. This resulted in an increase in domestically recorded fishing activity, as well as an increase in fish exports and dividends outflows, combined with one-off impacts on goods imports and foreign direct investment. These arrangements have some characteristics of a boundary shift, rather than completely new production/investment. 43 Republic of the Marshall Islands Figure 5: Growth has been volatile Figure 6: Real GDP per capita was flat for over a Real GDP growth, annual percent change and decade but has increased in recent years periodic growth averages Nominal and real US$ GDP per capita 8% 4500 6% 4000 4% 3500 2% 3000 0% 2500 -2% -4% 2000 -6% 1500 GDP per capita (constant 2015 US$) -8% 1000 GDP per capita (current US$) FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 500 GDP growth Avg (FY01-FY05) Avg (FY06-FY10) 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Avg (FY11-FY15) Avg (FY16-FY19) Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). Figure 7: Nominal GDP per capita is similar to Figure 8: Growth has been linked to fishing, structural and regional peers aid-financed construction and government 2019 nominal US$ GDP per capita services Contributions to real GDP growth 16,000 8 14,000 6 12,000 4 2 10,000 0 8,000 -2 6,000 -4 4,000 -6 2,000 -8 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 0 Fisheries Construction Transport Public Administration Other GDP Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021) and WDI (2021). Note: FSM data is for FY18. 44 Country Economic Memorandum and Public Expenditure Review 87. The pick-up in fishing activity has resulted in a shift in the composition of GDP over the last decade (Figure 9). Nevertheless, the services sector continues to dominate economic activity. On the expenditure side, the structure of the economy has remained relatively stable, albeit with some modest shifts in composition due to fluctuations in aid-related public investment (Figure 10). Overall, the structure of the economy—both in terms of production and expenditure—is similar to RMI’s structural and regional peers (Figure 11, Figure 12). 88. Economic activity continues to be dominated by the public sector. Disaggregating growth by institutional sector shows that while the private sector has expanded slightly faster than the public sector over the last two decades, the public sector remains a key driver of economic activity.15 Indeed, the public sector has remained relatively stable as a share of GDP since FY04, accounting for 44 to 50 percent of GDP. Around half of this activity is attributable to national government-related activities, while another quarter is related to SOEs. Private sector activity has accounted for 29 to 41 percent of GDP over the same period—with fluctuations generally driven by expansions and contractions in fishing activity by RMI-domiciled vessels and tuna processing at the domestic processing facility. Figure 9: Increased fishing activity has led Figure 10: The structure of the economy to a change in the composition of by expenditure has remained relatively ­production stable Composition of GDP by industry Composition of GDP by expenditure 100% 80% 90% 17% 19% 27% 29% 80% 60% 70% 72.5% 70.4% 40% 60% 81.8% 78.2% 139% 133% 134% 123% 50% 20% 40% 30% 0% 4.6% 4.5% 20% 2.8% 8.9% 9.4% -56% -63% -52% -51% 3.2% 10.1% -20% 10% 7.9% 14.1% 15.6% 7.0% 8.9% 0% -40% FY01-FY05 FY06-FY10 FY11-FY15 FY16-FY19 FY04-FY05 FY06-FY10 FY11-FY15 FY16-FY19 Ag, forestry & fishing Industry (incl. construction) Consumption Investment Net Exports Manufacturing Services Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 15 Abstracting from the FY19 boundary change in fishing vessel activity, since FY04 the compound average growth rate for private sector activity was 1.7 percent, compared to 1.2 percent for the public sector. 45 Republic of the Marshall Islands Figure 11: Compared to regional peers, the Figure 12: …and by expenditure economy’s structure is similar by production… Composition of GDP by Expenditure Composition of GDP by industry 100% 200% 90% 32% 80% 150% 70% 27% 33% 27% 60% 100% 18% 50% 151% 40% 123% 113% 50% 104% 90% 30% 20% 10% 0% -8% -30% -44% 0% -51% -79% -50% -100% RMI Kiribati Palau Tonga Fiji Ag, forestry & fishing Industry (incl. construction) Manufacturing Services Consumption Investment Net exports Source: EPPSO & Graduate School USA (2021) and WDI (2021). Source: EPPSO & Graduate School USA (2021) and WDI (2021). 89. Inflation is largely driven by fluctuations in imported food and energy prices, rather than the domestic business cycle. In most economies, the output gap and inflation are related—when the output gap is positive, inflation rises (often with a short lag). However, the narrow production base and dependence on imported goods means that this standard relationship does not hold in RMI (Figure 13).16 Indeed, domestic inflation is largely driven by fluctuations in imported food and energy prices (Figure 14). As a result, RMI remains vulnerable to global commodity price shocks, with high global food and fuel prices putting pressure on the balance of payments and eroding the purchasing power of Marshallese households. For example, inflation spiked to almost 15 percent in FY08, despite the sharp recession. More recently, inflation has remained subdued, despite the relatively strong economic expansion during FY14 to FY19. 16 The output gap is calculated as the difference between the level of potential real GDP (FY15 constant prices) and actual real GDP. Potential real output is calculated by assuming a constant growth rate of 1.5 percent. Using this methodology, real output has remained between 0.3 and 9.2 46 percent below potential since FY04. Country Economic Memorandum and Public Expenditure Review Figure 13: Inflation is driven by imported Figure 14: …rather than fluctuations in food and fuel prices… the business cycle Annual growth rate of CPI, food prices and Annual output gap and inflation rate, transport prices (fuel) percent 25% 20 20% 15 15% 10 10% 5 5% 0 0% -5 -5% -10 -10% -15 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 CPI Food Transport Output gap (% actual GDP) Inflation rate (annual %) Source: EPPSO & Graduate School USA (2021) and WB Source: EPPSO & Graduate School USA (2021) and WB calculations. calculations. 90. Employment growth is largely driven by the public sector, with the share of private sector employment declining steadily over the past decade (Figure 15). Overall employment has grown modestly during the amended Compact period (0.9 percent compound annual growth), underpinned by a steady expansion in public sector employment (1.6 percent compound annual growth). Much of the growth has been in state-owned enterprises, government agencies as well as in local government. In comparison, private sector employment grew strongly from FY05 to FY10, but has declined since then. This has been primarily driven by employment at the Pan Pacific Foods loining plant, which reopened (under new management) in FY08. Employment expanded rapidly from FY08 to FY10, consistent with a peak in production. However, the steady decline in production and employment in the loining plant back towards FY08 levels has seen overall private sector employment return to FY04 levels. These dynamics resulted in the private sector’s share of total formal sector employment fluctuating from 39 percent in FY04 to 44 percent in FY10, before shrinking back to 37 percent in FY19. The public sector accounted for 49 percent of total employment in FY19. Overall, while employment growth has been positive since FY04, the economy has not created enough jobs for a growing labor force (see Section 1.3.2 for further details and analysis of the labor market). 47 Republic of the Marshall Islands Figure 15: The public sector represents almost 50 percent of formal sector employment Employment by sector 6000 5000 4000 3000 2000 1000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Public Sector Private Sector Kwajalein US Base Other Source: EPPSO & Graduate School USA (2021). 91. Labor productivity has been stagnant for 20 years, consistent with RMI’s classification as a MIRAB country (Figure 16). Over the past 20 years economy-wide labor productivity growth has been modest. This is consistent with the economy’s low historical average growth, and the archetypal MIRAB small-island economy—where economic growth depends primarily on inflows of foreign aid and remittances rather than productivity growth (Paragraph 83). Output per worker is higher in the private sector than in the government sector. Although low government productivity is likely at least partially explained by the need for a relatively high number of public employees to provide basic services to a dispersed population (World Bank, 2021b). 92. Modest productivity growth over the past decade was driven by the private sector (Figure 17), predominantly the fishing industry (Figure 18). Manufacturing sector productivity has been volatile, directly reflecting the reopening of Majuro’s primary tuna loining plant in FY08 and the recent decline in loining production as the plant operator has pivoted towards whole fish exporting (see Section 1.3.1). Public sector productivity has grown only modestly, with productivity in the national government flat or slightly declining for 20 years. Despite the modest overall gains, productivity growth in RMI over the past decade has been higher than in its closest structural peers, FSM, and Palau (Figure 23). This highlights the challenges of stimulating productivity-led economic growth in small island economies (Bertram, 2006; Bertram & Poirine, 2018; Duncan, 2016; World Bank, 2017a). 48 Country Economic Memorandum and Public Expenditure Review Figure 16: Economy-wide labor productivity Figure 17: Modest recent productivity growth has been largely unchanged for 20 years was driven by the private sector… US$ thousands per worker. Overall and by Average annual growth, percent key institutional sectors 45,000 8% 2001-2005 2006-2010 40,000 2011-2015 2016-2019 6% 35,000 4% 30,000 2% 25,000 20,000 0% 15,000 -2% 10,000 Private sector Public sector -4% 5,000 SOEs National government Total -6% 0 Private sector Public sector o/w SOEs o/w national Total 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 government Source: EPPSO & Graduate School USA (2021) and WB calculations. Source: EPPSO & Graduate School USA (2021) and WB calculations. Figure 18: …largely driven by the fishing Figure 19: Yet, in the past decade productivity industry. growth in RMI has outperformed its peers. Average annual growth, percent Average annual growth, percent 3.0% 4% 2006-2010 2011-2015 2016-2019 2001-2005 2006-2010 2.5% 3% 2011-2015 2016-2019 2.0% 2% 1.5% 1% 1.0% 0% 0.5% -1% 0.0% -2% -0.5% -3% -1.0% -1.5% -4% Fishing Manufacturing Industry Services Total RMI FSM Palau Source: EPPSO & Graduate School USA (2021) and WB calculations. Source: EPPSO & Graduate School USA (2021) and WB calculations. 49 Republic of the Marshall Islands 1.2 GROWTH CHALLENGES 93. There are a range of constraints to doing business in RMI. RMI scored 50.9 out of 100 in the 2020 Doing Business assessment, putting it in the bottom 20 percent of countries globally, and among the lowest in the Pacific (Figure 20).17 Despite its low overall ranking, some aspects of the business environment perform relatively well compared to regional comparators. For example, regulations related to starting a business, paying taxes, and trading across borders. However, other factors severely restrict business activity, including access to land and registering property, resolving insolvency, access to electricity, and protecting minority investors (Table 2, Figure 21, Figure 22). Both the public and private sectors are cautiously optimistic that there are opportunities to realize stronger, more inclusive economic growth and development in the future. 94. With a narrow export base and limited production capacity, there is broad recognition that maximizing RMI’s limited growth opportunities requires a more conducive business climate. Unlocking these opportunities will require efforts to address challenges related to access to land, public infrastructure (such as the primary commercial seaport and Majuro airport, and electricity and ICT services), access to financial services, and the tax regime. Many of these factors also increase the cost of delivering quality public services. Both the public and private sectors also recognize the need to enhance cooperation, and to provide greater consistency in the application of government policy. Figure 20: RMI ranks as among the most difficult places to do business… World Bank 2020 Doing Business Overall Score (0–100) 70 Easier to do Business 60 Doing Business Score, 2020 50 40 30 20 10 0 SAM FJI TON VUT PNG PICs SLB PLW RMI FSM KIR Source: World Bank (2020). Note: Of the 191 countries in the assessment, scores range from 86.8 (New Zealand) to 20.0 (Somalia). 17 The Doing Business assessment documents the extent to which the regulatory environment supports private sector development across 10 areas of business activity. 50 Country Economic Memorandum and Public Expenditure Review Table 2: …due to multiple constraints… World Bank 2020 Doing Business Scores by topic (0 - 100), compared to regional averages Topic RMI PICs EAP Starting a business 88.4 82.5 83.9 Dealing with construction permits 71.1 62.2 70.0 Getting electricity 59.4 65.7 75.1 Registering property a 0.0 46.8 57.5 Getting credit 50.0 48.3 58.0 Protecting minority investors 20.0 31.3 49.7 Paying taxes 76.1 73.8 73.6 Trading across borders 78.9 67.4 71.6 Enforcing contracts 55.9 50.7 53.0 Resolving insolvency 9.2 27.8 40.9 Source: World Bank (2020). Note: (a) RMI scored 0 in 21 of the 30 components of this topic, resulting in a qualification of ‘No Practice’. Figure 21: …with land and insolvency issues Figure 22: Weak legislative framework and lagging comparator countries government effectiveness are also key challenges World Bank 2020 Doing Business score by sector, Worldwide Governance Indicators, relative to relative to comparator countries comparator countries Starting a Voice and business accountability Resolving Registering insolvency property Control of Political corruption stability Enforcing Getting contracts credit Rule of Government law effectiveness Trading Protecting across minority borders investors Regulatory quality Paying taxes RMI FSM KIR PICs Caribbean RMI FSM KIR PICs Caribbean Source: World Bank (2020). Source: Kaufmann and Kraay (2019). 51 Republic of the Marshall Islands 1.2.1 Limited Access to Land 95. Access to land and land tenure are complex and severely impact private sector development and investment. Public land is not explicitly recognized in law and land registration is voluntary.18 Land is almost exclusively held under customary tenure with complex governance structures. Even transactions between Marshallese are rare. There are two distinct challenges related to land that limit private sector development and investment. First, the very limited amount of land available for development, much of which is at risk of sea level rise due to low elevation. Second, the need to negotiate with multiple landowners over the use of any plot of land. Due to the Constitutional clanbased rights to land, combined with the matrilineal and collective land tenure system, each parcel of land has numerous owners. This is further complicated by the lack of a valid land survey that categorically demarcates one plot from another to prevent overlapping claims to land.19 The lack of secure land tenure also constrains access to finance, as banks are reluctant to take customary land (either owned or leased) as collateral. Reportedly, several public infrastructure projects have been delayed or abandoned because GoRMI cannot secure the rights to occupy land or create encumbrances or easements.20 Past agreements have also faced court challenges on the grounds of partial ownership—creating additional risk, uncertainty, and cost for private sector investment. 96. Land reform is necessary to support growth and economic development but must be balanced with customary tenure rights. Land is the ‘fundamental basis’ of Marshallese culture and society. It is considered sacred, and is central to one’s identity, heritage, legacy, and wellbeing. Yet, it is widely accepted that effective land use is a vehicle for achieving economic goals, and land rights must be established in a way which allows for the economic use of land. There are three basic requirements: (i) the user must have secure tenure; (ii) any necessary payment for that security must be certain; and (iii) the period of the tenure must be specified. In addition, it is highly desirable for the tenure to be transferable, within the terms of its grant. The benefits are clear. Secure tenure can help collateralize properties—thereby improving access to credit—and lower hurdles for long-term land leases—thereby facilitating investment (domestic and foreign, public, and private). While there is agreement on the goals, there is disagreement on how RMI should get there. Land policies and legislation must, therefore, steer a middle course between the need to encourage private sector development and investment, and the fundamental importance of protecting the social, political, and cultural values reflected by customary land tenures.21 18 The Public Lands and Resources Act (1966) is established for the administration of public lands and the Land Acquisition Act 1986 provides for private land to be acquired for public use. However, public land is not explicitly recognized in law as a form of land title. 19 Since 1957, multiple land surveys have been attempted, but have failed to adequately address the grievances of various groups, rendering each exercise inadequate and not recognized by the courts. 20 The Land Acquisition Act 1996 makes ‘provision for the acquisition of lands and servitudes for public use’ including payment of compensation, but in practice GoRMI does not compulsorily acquire land because the Iroij hold customary power which is highly respected. GoRMI and landowners instead engage in leases and Memoranda of Understanding for public infrastructure. 21 In a Public–Private Dialogue held in March 2019, then-President Hilda Heine noted that the country needed to find a way in which the two 52 systems—traditional land ownership and stable and equitable land lease arrangements for development—could function simultaneously. Country Economic Memorandum and Public Expenditure Review 97. Recent indications of a move towards strengthening land policy remain unfulfilled. In 2003, the Land Recording and Registration Act (LRA) introduced a voluntary mechanism for customary landowners to register land and an accessible registry of land transactions. Uptake of the LRA has been minimal, however, with only seven land parcels registered and 35 title applications lodged (Graduate School USA, 2019). Reportedly, this is at least partially due to a lack of clarity regarding the rules and procedures for registration. In 2019, authorities prepared a bill to merge the LRA with the Office of Commerce, Investment and Tourism (OCIT)22 to better coordinate efforts to make lands available for development.23 The reform was designed to strengthen record-keeping, improve communication with the public (including regarding the registration process), and to actively try to identify land available for lease and facilitate the negotiation process with investors. However, the bill is yet to be passed by the Nitijela. Currently, the OCIT does not have any plans to systemically address overlapping land claims, such as another land survey. 1.2.2 Congested Transport Infrastructure 98. Increased congestion at Majuro’s key port and airport have led to calls for large capital investments to expand capacity. RMI imports almost 100 percent of food, clothing, machinery and equipment, and fuel—making transport connectivity crucial to the domestic economy. Republic of the Marshall Islands Ports Authority (RMIPA), a SOE, oversees the two main seaports (the Delap and Uliga Docks24) and the Amata Kabua International Airport (AKIA) in Majuro. Air and maritime facilities are critical infrastructure for passenger and freight transport, as well as the provision of emergency response, including to neighboring islands. In recent years, the business community and parts of GoRMI have raised concerns about increased congestion at AKIA and Delap Dock, which has reportedly led to long delays or sudden changes in schedules. There are proposals for a 100-meter extension of the dock and to build a new AKIA terminal and runway for domestic flights. 22 OCIT is the public authority tasked to lead public sector efforts to address critical constraints to private sector development and improve the environment for doing business. 23 The Land Recording and Registration (Amendment) Act, 2019. 24 The Delap Dock in Majuro is the country’s main international cargo facility, while the Uliga Dock (also in Majuro) is primarily used for inter-island cargo and passenger vessels. 53 Republic of the Marshall Islands 99. Climate-resilient improvements to existing seaport facilities, together with improved maritime services and regulation, should address the congestion at Delap Dock. Delap Dock is the hub for RMI’s cash economy and serves as the gateway for most imports and exports via cargo vessels. As the largest regional tuna transshipment port, fishing vessels comprise 75 percent of traffic. Increased onshore tuna transshipment has increased demand for dock time. Local businesses contend that the dock is not long enough to simultaneously service multiple vessels, leading to long delays. However, RMIPA state that simultaneous docking is prohibited due to noncompliance with International Ship and Port Facility Security (ISPS) Code requirements.25 GoRMI is currently implementing a series of ISPS compliance upgrades which will allow for up to one cargo ship and two fishing vessels to dock simultaneously, without the need for a dock extension. Extension of Delap Dock has been discussed to permit two cargo ships to dock simultaneously. However, this is an infrequent event, meaning that the economic and social returns to this investment would likely exceed the opportunity cost, given competing urgent investment needs.26 100. Similarly, increasing the climate resilience of the existing AKIA facilities site combined with improved schedule management should be prioritized over new investments. AKIA’s one runway and small terminal are used for regular domestic and international flights, irregular refueling stops by US military planes and private jets, and as an emergency facility for aircraft. The daily arrival of private and military planes stopping to refuel reportedly can lead to congestion, long delays and/or sudden changes in schedule for domestic flights. Although AKIA runs at an annual operating loss, there has been a push for a new domestic runway and terminal to improve the reliability of domestic air connectivity and support tourism development.27 AKIA is highly vulnerable to rising sea levels and strategically important for US defense interests.28 Consequently, there is a need to first improve the climate resilience of the AKIA site and ensure sufficient funds are available for a scheduled US$70 million runway rehabilitation, before large capital expansions for a new domestic runway and/or terminal are considered.29 1.2.3 Aged and Inefficient Electricity Infrastructure 101. Access, reliability, and cost of electricity is pushing up operating costs across the economy. MEC, an SOE, is responsible for on- and off-grid electricity generation, transmission, and distribution across RMI.30 Diesel generation produces 98 percent of electric energy, and RMI relies on imported petroleum. Renewable energy courses comprise the remaining 2 percent. At present, much of the electricity supply chain is decrepit. Electricity losses during distribution are estimated to be at least 18 percent (JICA, 2015)—far above regional averages31—and outages, which are increasing, are costing customers several thousands of minutes of lost electricity per year. GoRMI’s Electricity 25 ISPS is a set of security arrangements established by the International Maritime Organization (IMO) is response to the 9/11 terrorist attacks in the US. 26 Under the World Bank-financed Marshall Islands Maritime Investment Project (P161382), GoRMI will also conduct a Needs Assessment to consider options to ease the infrequent bottlenecks at the port. 27 The Japan International Cooperation Agency (JICA) are reportedly considering a request to finance a new terminal, although are said to prefer upgrading the existing terminal. 28 Topographical projections of the RMI under different scenarios of sea-level rise by researchers at the University of Hawaii indicate that the AKIA would not be functional if the average high tide watermark was to rise by 30cm. 29 RMIPA’s Amata Kabua International Airport Master Plan (2012) outlines safety, security and shoreline protection costs of over US$20 million by 2021, along with runway rehabilitation costs of US$70 million by 2031. 54 30 Kwajalein Atoll Joint Utility Resources (KAJUR), a subsidiary of MEC, is responsible for on-grid electricity and water and sanitation services in Ebeye. 31 In 2014 (the last year for which there are comprehensive statistics), distribution losses averaged 6 percent in developing East Asia & Pacific, and 10 percent and 14 percent in middle- and low-income countries, respectively. Country Economic Memorandum and Public Expenditure Review Roadmap 2018 recognizes the pressing need to increase service reliability, energy efficiency and affordability. Most medium and large enterprises have private generators which complement or substitute for the public electricity provider, representing additional costs to businesses. Improving the capacity, affordability and stability of the public grid will support business development including growth opportunities such as tuna cold storage containerization (see Section 1.3.1). However, high maintenance costs for generation and distribution systems in a marine environment pose ongoing issues. RMI has no fossil fuel, geothermal, or hydropower resources but there are opportunities to increase solar power generation.32 Currently, the distribution system in Majuro can accommodate only up to 11.8 percent renewable energy generation (ADB, 2021)—well below the 20 percent national target by 2020 (GoRMI, 2016). 102. Despite RMI’s ambitious renewable energy targets, the existing electricity distribution network will remain critical, and is in urgent need of upgrade. Given the nation’s extreme vulnerability, GoRMI has been a vocal supporter of the United Nations Framework Convention on Climate Change (UNFCCC) Paris Agreement. Numerous national strategic documents—such as the UNFCCC post-2020 Nationally Determined Contribution and RMI 2050 Climate Strategy—outline GoRMI’s commitment to steep reduction in greenhouse gas (GHG) emissions by 2025 and 2030, leading to net zero GHG emissions by 2050.33 The transition from diesel to renewable energy sources is being supported by development partner-funded projects for solar power generation, battery energy storage, and grid management equipment. Achieving these ambitious targets will also require upgrades to the Majuro power plant and distribution network. MEC’s distribution network is aged (over 30 years old), needs significant reinvestment and modernization, and was not designed to accommodate distribution of electricity generated from intermittent renewable resources (such as solar). Furthermore, ongoing reforms to strengthen MEC’s commercial performance and financial sustainability will also support improved service quality. Addressing these multiple constraints will be crucial to support private sector development and reduce costs, including for public service delivery.34 103. Outdated fuel storage facilities threaten public safety, fuel security, and economic stability. The fuel storage facility is ageing, in urgent need of repair, and located 30 meters from the ocean—making it extremely vulnerable to atmospheric corrosion and rising sea levels. RMI houses the largest fuel storage facility in the Central Pacific. Constructed in 1981 to meet increasing electricity demand, the fuel tank farm continues to supply fuel to Majuro, Kwajalein, and maritime customers including fishing fleets and shipping vessels. However, a lack of funds has contributed to limited maintenance and degradation of facility equipment. GoRMI and MEC recognize the importance of upgrades to prevent potential health, safety, economic, and environmental risks associated with tank floor leaks, pipeline leaks, or catastrophic tank failure. 32 RMI has about 2,480 hours of direct sunlight per year. Biomass, wind, and marine energy are also potential energy resources. 55 33 GoRMI has committed to a 32 percent and 45 percent reduction in GHG emissions by 2025 and 2030, respectively, based on 2010 levels. 34 GoRMI efforts to address these various constraints are being supported by World Bank and ADB-funded projects. Republic of the Marshall Islands 1.2.4 Low Access and Quality ICT Services 104. GoRMI has long recognized the need to improve telecommunications and digital connectivity. The majority government-owned Marshall Islands National Telecommunications Authority (NTA) is the sole supplier of telecommunications services. A recent sector review identified a wide range of shortcomings, including poor quality services, lack of availability, unaffordability—and the absence of an adequate legal, regulatory, and institutional environment to encourage investment in new services and protect users.35 Stakeholder consultations focused on the customer experience and the potential benefits of improved access to digital services. The report concluded that: (i) telecommunications infrastructure in RMI is in a poor state and needs significant modernization; (ii) services and service quality are poor and increasingly expensive, and will worsen if action is not taken; and (iii) poor performance reflects a government monopoly with limited ability to source investment capital, expertise and the latest technology. 105. ICT services are characterized by limited access, poor quality and high prices, and represent substantial costs to business (both in financial terms and lost productivity). Majuro and Ebeye were connected to the submarine cable system in 2010, resulting in a five-fold increase in access—although connectivity remains below 40 percent of the population (Figure 23). However, poor quality fixed and wireless services affect users’ internet connections and ability to develop new income-generating opportunities. RMI’s mobile penetration rate of approximately 28 percent is one of the lowest in the Pacific and very low by global standards (Figure 24). Voice and data services on neighboring islands are minimal, leading to an increasing digital divide between the main centers and the neighboring islands. The cost of a basic entry-level monthly mobile broadband service in RMI was around US$22 for a 5 GB package as of March 2018. Access to high- speed internet is limited and costly for both residential and business users. The fastest internet speed available in RMI is about 1 Mbps, far below US and E.U. broadband standards, and costs around US$50 per month (over 12 percent of monthly GNI per capita). This is over six times the affordability target for entry-level broadband services in developing countries (which is less than 2 percent of monthly GNI per capita; ITU– UNESCO Broadband Commission).36 35 Telecommunications Sector Options Report, Great Village International Consultants Inc. (2019). 36 Broadband standards in the US and E.U. mandate minimum speeds of 25 Mbps and 30 Mbps, respectively. 56 Country Economic Memorandum and Public Expenditure Review 106. Very limited access to high-speed Internet constrains the ability of businesses and individuals to unlock the potential of a digital economy. There are no laws to support digital services or support a modern digital economy, such as for digital transactions, e-commerce, data protection, cybersecurity, or cybercrimes. Poor network performance significantly restricts the enabling environment for businesses, and the rollout of digital government services. Better and more affordable ICT services will help reduce the economic cost of distance, create new economic opportunities, and improve delivery of both public and private services—such as online business registration. ICT also provides an essential ‘lifeline’ to isolated communities in the event of a natural disaster, as well as educational opportunities during adverse shocks such as COVID-19. A proposed GoRMI project (financed by the World Bank) to increase access to more affordable ICT services and establish the critical foundations for digital government services will be crucial to improve the business climate. Figure 23: Internet connectivity has improved Figure 24: Mobile phone coverage remains in recent years but remains below 40 percent very low of the population Percent of population with mobile cellular Percent of population using the internet subscription and GNI per capita 70 200 60 175 Mobile cellular subscriptions, 2019 50 150 Palau 40 (per 100 people) 125 Fiji 30 100 Nauru Vanuatu 20 75 Solomon Is. Tuvalu Samoa Tonga 10 50 Kiribati 0 RMI 25 Micronesia 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Lower middle Upper middle Low income income income High income 0 RMI FSM Kiribati 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 Fiji Samoa PICs GNI per capita, 2019 (US$) Caribbean small states Source: GoRMI; World Bank (2020). Note: X-axis expressed in logarithmic scale. Markers in light blue are Caribbean Island economies. Source: GoRMI; World Bank WDI. 57 Republic of the Marshall Islands 1.2.5 Small and Underdeveloped Financial Sector 107. The financial sector is narrow and access to financial services is limited, particularly in the neighboring islands. The financial sector is constituted of three banks—a local private bank (Bank of Marshall Islands, BOMI), a branch of a foreign-owned bank (Bank of Guam), and the Marshall Island Development Bank (MIDB). The sector also has two large money transfer operators (MoneyGram and Western Union), two insurance companies, and a pension fund. The US Department of Agriculture provides residential loans, several private companies offer loan financing through auto dealers, and there are several small money-lending services. There is limited data regarding access to financial services. There are seven commercial bank branches in the two urban centers (Majuro and Ebeye). Populations in neighboring islands have limited access to formal sector financial services. BOMI provides some services and village banking to the neighboring islands. These services are provided via a bank officer who travels on the boat operated by the state’s copra processing authority. Access to financial services thus depend on the shipping schedule and harvesting timetable of the copra authority. 108. Banks are highly liquid, but intermediation costs are high. BOMI and the Bank of Guam (BoG) are regulated by the Banking Commission and are highly liquid, with loans to deposits ratios regularly around 50 percent (the RMI Banking Act permits a ratio of up to 70 percent). There is thus sufficient liquidity in the system and the potential for banks to increase lending to support higher economic activity. In 2017, the GoRMI Cabinet authorized the Banking Commission to conduct prudential supervision of and establish new prudential guidelines for MIDB.37 This addressed an important systemic risk, as MIDB had previously been unregulated, and reportedly was suffering from very high non- performing loans. Ensuring that MIDB meets similar prudential standards to BOMI and BoG will help improve financial system stability. With no independent monetary policy, interest rates on domestic deposit are closely aligned with those in the US. However, lending rates are much higher, reflecting the additional risk, costs of doing business and limited lending competition. Average effective interest rates on consumer loans were 12.1 percent in FY18. 37 MIDB is a wholly owned government bank. The bank was set up to help finance key development in the tourism, fisheries and manufacturing sectors. Contrary to its intended purpose, most of the loans made by the bank are consumer loans. 58 Country Economic Memorandum and Public Expenditure Review 109. Financial institutions provide limited credit to the private sector—particularly commercial credit—hampering private sector development. Financial institutions are profitable but service local businesses poorly. Indeed, around 70 percent of private sector credit is in the form of short-term consumer loans. Private banks mostly invest excess deposit holdings offshore, reportedly reflecting a shortage of viable local investment projects. While large businesses can generally get credit on reasonable terms, small and medium-sized enterprises face significant limitations in accessing credit. Credit information is not widely available and there is no private credit bureau. A secured transactions registry was established in 2009, although it has reportedly improved access to credit only marginally. Insufficient collateral (in part due to land tenure) and weak business practices (lack of capacity to prepare financial statements or business plans), coupled with the existing bankruptcy framework reduce the attractiveness of the private sector to existing lenders. Moreover, the legislated 24 percent maximum cap on interest rates reportedly inhibits the emergence of smaller formal-sector credit providers, and forces borrowers to seek credit from unregulated informal money lenders. 110. Heightened global Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) requirements mean RMI is at risk of losing its last remaining US dollar Correspondent Banking Relationship (CBR), which could have significant repercussions for economic and financial stability. A critical issue facing the domestic financial sector is the possible loss of financial services provided by international banks (referred to as ‘de-risking’).38 In response to the rising costs of complying with heightened AML/CFT financial rules in the US, global banks are reducing CBRs to third-country banks. Having lost three other US dollar CBRs in 2007, RMI is now threatened by the potential withdrawal of the nation’s last US dollar CBR. The IMF (2018) noted that closure of this CBR would have “significant negative economic repercussions” in the absence of alternative arrangements (See Box 3). 111. The plan for GoRMI to create a sovereign virtual currency (the RMI Sovereign, or ‘SOV’) poses another key risk to macroeconomic and financial stability. In 2018, GoRMI passed legislation that provides the legal framework for adoption of a decentralized digital currency, issued by a third party, as a second legal tender in addition to the US dollar. The main objective of the SOV is to raise revenue which GoRMI plans to use to enhance RMI’s long-term fiscal sustainability and improve citizen’s welfare. During the 2018 Article IV consultations, the IMF noted that the issuance raises serious economic, reputational, AML/CFT, and governance risks and will elevate the already high risks of RMI losing its last US dollar CBR. There have been limited advances since 2018 to address these concerns. In 2020 the current administration introduced a bill to repeal the SOV legislation. However, the bill has yet to pass the Nitijela, and the third-party developer continues to prepare for the Initial Coin Offering (see Box 4). 38 The Financial Action Task Force (FATF) defines de-risking as “the phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk in line with the FATF’s risk-based approach.” The FATF is an intergovernmental organization founded in 1989 as part of a G7 initiative to develop policies to combat money laundering. In 2001, its mandate was expanded to include terrorism financing. 59 Republic of the Marshall Islands Box 3: RMI’s Correspondent Banking Relationships Risky business US dollar CBRs are crucial to the efficient functioning of RMI’s domestic banking system and broader economy. CBRs are bilateral arrangements between onshore and offshore banks that allow both parties to settle transactions across jurisdictions, thereby providing an essential link between national financial sectors and the international financial system. A US dollar CBR is vital to the operations of GoRMI, the private sector and households due to RMI’s use of the US dollar as legal tender and the high dependence on Compact-related aid flows. A US dollar CBR is also important to facilitate remittances flows and payment of salaries of Marshallese citizens working for the US military and US-based companies. RMI’s two banks currently have access to the US financial system. BOMI, RMI’s only domestic commercial bank, provides banking services to a substantial portion of the population and operates five branches throughout RMI. BOMI previously had three US dollar CBRs, but two were terminated in 2007 as part of the global ‘de-risking’ phenomenon. The First Hawaiian Bank (FHB), a subsidiary of BNP Paribas, is the BOMI’s only remaining US dollar CBR. The other commercial bank operating in RMI, the BoG, is a foreign-owned bank with only one branch in RMI (in Majuro). It has its own American Bankers Association routing numbers to facilitate wire transfers from international locations and its deposits are insured by the US Federal Deposit Insurance Corporation. BOMI is at risk of losing its last remaining US dollar CBRs. In 2014, FHB notified BOMI of its intention to terminate its CBR due to concerns about the rising costs of complying with heightened AML/CFT financial rules in the US. However, intervention by US agencies highlighting the strategic importance of RMI and the commitments under the Compact led to BNP Paribas granting a temporary exemption for FHB to maintain the current CBR with BOMI until the latter had secured alternative CBR arrangements. BOMI’s CBR is currently renewed every year, conditional on progress in improving its compliance with the AML/CFT framework. The loss of the last US dollar CBR could have significant implications for the RMI economy. In an extreme scenario, external aid and other flows could be severely disrupted, resulting in significant impacts on economic activity, service delivery and household welfare. As part of RMI’s 2018 Article IV consultations, the IMF assessed the threat of BOMI losing the FHB CBR as both a high-likelihood and high-impact event, and the materialization of this risk is expected to have “significant negative economic repercussions” in the absence of alternative arrangements. Authorities agreed with this assessment, though noted that RMI could still be connected to global financial system through BOMI’s Australian dollar (AUD) CBR (via Westpac Bank) and Bank of Guam. The loss of the last US dollar CBR could also have an adverse impact on remittance flows into RMI through an increase in costs to access money-transfer operators (MTOs) such as Western Union and MoneyGram—which would be forced to reorient their operations to utilize BOMI’s AUD CBR or work through Bank of Guam. 60 Country Economic Memorandum and Public Expenditure Review While some progress has been made to address CBR risks, ongoing commitment to implementing the strengthened AML/CFT framework is critical. In 2016 authorities prepared an amended Banking Act with a view to align the AML/CFT provisions with FATF recommendations.39 However, the bill is yet to be passed by the Nitijela. In 2020 authorities finalized a first AML/CFT national risk assessment. The assessment rates the overall money laundering/financing of terrorism risk in RMI to be low— though identifies improved capacity and statistical information as crucial to accurately assess RMI’s risk, and strengthening financial transaction reporting, as well as on-site and off-site supervision of banks, as key measures to enhance AML/CFT provisions. In response, the Banking Commission is re-establishing a framework for prudential banking supervision in line with international standards. The Commission is also undertaking a regulatory reform project for banking legislation and prudential standards, with assistance from IMF Pacific Technical Assistance Center (PFTAC). BOMI also continues to strengthen its own AML/CFT framework by instituting additional controls, including an AML/CFT software upgrade and an independent audit of its AML/CFT system. Nevertheless, there remain important gaps in RMI’s AML/CFT supervision and implementation framework. As an alternative arrangement to CBR, BOMI is seeking to obtain US Federal Reserve approval to establish a clearing house in Hawaii to gain direct access to check-clearing and wire transfer services in the US. If approved, the process is expected to take around two years to complete. In any case, ongoing efforts to strengthen the AML/CFT framework will be important to bolster financial sector stability and address CBR risks. Further efforts to increase transparency and address AML/CFT issues associated with RMI’s ship and corporate registries (see Box 6) will also be necessary. Development of an action plan to address the main risks/weaknesses identified in the national risk assessment would be a good first step. Bank of Guam’s access to the US financial system could mitigate the impact of BOMI losing their US dollar CBR but would not resolve all challenges and risks. Since the BoG is monitored and regulated by US agencies, its direct access to the US financial system is less at risk than BOMI’s CBR with FHB. Nevertheless, the concentration of US dollar cross-border transactions with Bank of Guam raises other challenges. First, its foreign ownership means that its presence in RMI could be determined by corporate decisions unrelated to the RMI domestic context. Second, it has only one branch in the country—significantly restricting access to financial services to those outside of Majuro. Third, while Bank of Guam has established AML/CFT controls, the reliance on one bank as the sole access point to the US financial system would leave the RMI’s financial sector and economy highly exposed in the event that the bank’s operations were restricted due to a violation of US regulations. Implementation of the SOV—a GoRMI-sponsored cryptocurrency—would further heighten the risk that RMI could lose access to the US financial system. As outlines in Box 4, the issuance of the SOV would create further uncertainties and place additional pressure on GoRMI’s nascent AML/CFT supervision framework and implementation capacity. Absent key mitigation measures, the SOV’s issuance would likely heighten the risk of FHB terminating its CBR with BOMI. Introduction of the SOV could also put at risk the continued operations of Bank of Guam in RMI. While the bank has reiterated its commitment to retain its operations in RMI even if BOMI loses its US dollar CBR, it has also publicly stated that this commitment would be reviewed if acceptance of the SOV was made mandatory. It is also not clear what the FDIC’s position might be in relation to the Bank of Guam accepting and holding SOVs on its balance sheet. 39 The FATF’s 40 recommendations on money laundering and nine recommendations on terrorism financing are recognized as the relevant global standard for AML/CFT procedures. They are intended to be implemented at the national level through legislation and other legally binding measures. 61 Republic of the Marshall Islands Box 4: RMI’s Sovereign Virtual Currency Proposal A penny for your thoughts In February 2018, the RMI Parliament passed the ‘Declaration and Issuance of the Sovereign Currency Act 2018’ (the ‘SOV Act’) to issue a sovereign virtual currency based on blockchain technology (known as the Sovereign, or ‘SOV’). According to the Act, the SOV would be recognized as legal tender in RMI, in addition to the US dollar. The SOV would be issued by the RMI Ministry of Finance (MOF) and be introduced via an Initial Currency Offering (ICO) of 24 million units, which would be split in equal proportion (12 million units each) between the GoRMI and the ‘Appointed Organizer’ of the currency. The Appointed Organizer would: (i) be responsible for the development of the blockchain technology and operating software; and (ii) cover all costs associated with issuing the currency and conducting the ICO. The SOV supply would be algorithmically fixed to grow at 4 percent each year in an effort to manage volatility in the value of the SOV and support monetary stability. The main objective of the SOV is to raise revenue for GoRMI. According to the previous administration, the SOV issuance could raise millions of dollars in GoRMI revenues. The assertion is as follows. Bitcoin and other virtual currencies are not recognized as currencies, but as assets. Thus, when a US investor sells a Bitcoin, they must pay capital gains tax. The SOV, however, would be recognized as a national currency rather than an asset, meaning an investor who sells a SOV would not have to pay capital gains tax. This will make the SOV more attractive to investors, resulting in a high unit price during the ICO. According to the SOV Act, these revenues will be used to enhance long-term sustainability and improve citizen’s welfare. Revenues will be allocated to the following four objectives: i. A new RMI National Trust Fund (that is separate from the CTF, to provide the GoRMI with more autonomy in the management and distribution of the fund) ii. A Green Climate Fund to mitigate the effects of climate change, finance renewable energy, protect fisheries and marine resources, manage recycling and waste, and promote ecotourism iii. A Nuclear Legacy and Health Care Fund to support the special needs of those suffering due to the US Nuclear Testing Program iv. An allocation of coins to every RMI citizen. The 2018 IMF Article IV cautioned that—in the form currently articulated in the SOV Act and outlined by authorities—the SOV issuance raises serious economic, reputational, AML/CFT, and governance risks. The IMF state that “in the absence of clear mitigating measures, the macroeconomic and financial integrity risks associated with the SOV exceed the potential benefits. Staff has therefore recommended that the authorities seriously reconsider issuance of the SOV.” In particular, the IMF noted that: i. Unless strong AML/CFT measures are implemented, the issuance of the SOV will elevate the already high risks that the country will lose its last US dollar CBR (see Box 3) 62 Country Economic Memorandum and Public Expenditure Review ii. SOV issuance, in the currently planned form and in the absence of a monetary policy framework, could result in monetary instability and pose significant challenges to macroeconomic management iii. The SOV also raises cybersecurity and operational risks. Under the current design, the management of the SOV protocol will be outside of authorities’ control, and under a foreign legal jurisdiction. The limited telecommunication infrastructure in RMI will likely be an obstacle to the SOV becoming a widely used medium of exchange by RMI citizens for some time. There have been limited advances since 2018 to address these concerns. The previous administration stated that the SOV would only be issued once it was deemed to comply with Financial Action Task Force (FATF) standards regarding AML/CFT40 and US Government regulations for use in the US financial system. According to the SOV Act, AML/CFT provisions of the RMI Banking Act 2002 will apply to the ICO process and exchanging of the SOV. Yet, many of these provisions are only broadly in line with FATF standards. There have been only minor amendments to the AML/CFT regulatory environment in RMI since the passage of the SOV Act. The 2018 IMF AIV report also raised several key questions regarding customer due diligence measures, transparency, recording and reporting, and encryption of the information on the blockchain. The answers to these questions, as well as the level of implementation of the transparency requirements, will be key in establishing the extent to which the planned transparency will deter criminal misuse of the SOV. To date, little additional information is available regarding these questions. The current RMI administration is now considering repealing the SOV Act. In March 2020, a bill was introduced to the Nitijela to repeal the Sovereign Currency Act. However, the bill is yet to be passed. 1.3 GROWTH AND DEVELOPMENT OPPORTUNITIES 112. A recent World Bank regional study identified only modest opportunities to drive higher economic growth and development in RMI. ‘Pacific Possible’, a recent major analytical exercise conducted by the World Bank (2017a), assessed the long-term development challenges and opportunities faced by PICs, including the RMI, focusing on those challenges and opportunities that could have a transformational impact on the countries in the region. A key conclusion of Pacific Possible is that, relative to a baseline ‘business-as-usual’ scenario, there appears only modest opportunities for the RMI to realize additional economic growth, employment or public revenue generation from the four sectors that were identified as providing the greatest potential opportunity to foster shared prosperity in the region, namely: tourism; access to international labor markets; information and communication technologies (ICT); and fisheries (Figure 25). 40 The FATF’s “International standards on combating money laundering and the financing of terrorism and proliferation: the FATF Recommendations” have been endorsed by the IMF as the relevant AML/CFT standard for the purposes of its work. 63 Republic of the Marshall Islands 113. Despite Pacific Possible’s modest projections, developing the fisheries sector and local labor force are two of the most promising opportunities to raise incomes, create jobs and enhance shared prosperity. Given the constraints posed by the RMI’s remoteness, small size, dispersion and environmental fragility, the nation’s prospects for longer-term economic development continue to depend significantly on fully utilizing its citizens’ open access to the US labor market, maximizing the gains from natural resources (especially fishing), and continued external remittance and aid flows. Consequently, this section focuses on the market conditions, public policy settings, and private sector expertise required for the RMI to maximize the benefits from the fisheries sector and enhance the quality and competitiveness of the local labor force. In addition, the section considers selected other sectors that have been previously proposed as potential engines of economic growth and development, including ICT, agriculture, tourism, and other opportunities to realize ‘rents to sovereignty’ (such as the nation’s ship and corporate registries and the proposed SOV). Figure 25: ‘Pacific Possible’ identified only limited potential for higher incomes GDP per capita Government revenue Formal sector jobs per capita (right side) 6,000 1200 18,000 0.8% 1.7% 1.0% annual annual annual growth growth growth 5,000 1000 15,000 0.7% 1.4% 1.0% 2015 constant $US annual annual annual Number of jobs growth growth growth 4,000 800 12,000 3,000 600 9,000 2,000 400 6,000 1,000 200 3,000 0 0 0 2015 2040 2015 2040 2015 2040 Business as Usual Opportunity Source: World Bank (2017a). 64 Country Economic Memorandum and Public Expenditure Review 1.3.1 Maximizing the Benefits from Fisheries Resources 114. The fisheries sector is a key industry of the RMI economy. With an exclusive economic zone (EEZ) of around two million square kilometers and an economic geography that constrains the viability of many other industries, the tuna fisheries sector plays an important role in RMI’s economy. The sustainability of those resources is also crucial to the country’s economy and wellbeing of its populace. Representing over 15 percent of GDP (FY19),41 fluctuations in fisheries activity are an important contributor to the volatility of overall economic growth (Section 1.1). The industry comprises the fish caught by domestic vessels, fish exports, the small tuna loining and processing industry, fish transshipment, and a nascent industry offering fishing vessel services such as containerization, vessel and equipment repairs, crewing, and fuel supplies. 115. While fishing activity and fish experts have increased in recent years, fish processing has contracted, resulting in a fall in employment in the sector. The fisheries sector increased from around 4 percent of GDP in FY98 to FY08, to over 14 percent of GDP in FY19, although output has been volatile over the period. In addition, manufacturing—a significant proportion of which is related to fish processing—rose from less than 3 percent of GDP to almost 6 percent of GDP in FY14, before falling to below 5 percent of GDP in FY19 (Figure 26). Fluctuations in fishing production are predominantly due to seasonal fish migration.42 Fish processing has also fluctuated over time, reflecting the operations and closure of one fish processing company over the period FY99 to FY05, followed by the entry of a new company (Pan Pacific Foods, PPF) in FY08. However, the shift in PPFs focus from fish processing to (unprocessed) fish exporting has led to a significant drop in fisheries-related employment from its peak of 14 percent of total formal sector employment in FY10 to around 6 percent in FY19 (Figure 27 and Figure 28).43 116. The fisheries sector is also a crucial source of GoRMI domestic revenues. Implementation of the purse seine Vessel Day Scheme (VDS)—a regional scheme that establishes the minimum daily price to fish in regional waters and limits the total number of fishing days sold—has seen GoRMI revenues from fishing license fees increase from US$1.5 million (1 percent of GDP) in FY09 to US$30 million (over 13 percent of GDP) in FY20 (Figure 29). Prudent management of RMI’s VDS allocation, and fishing resources more generally, is thus crucial for public finances. 41 Based on ‘Fishing’ and ‘Manufacturing’ industries in the GDP (Industry) breakdown. ‘Fishing’ predominantly refers to fish caught by domestic vessels. ‘Manufacturing’ is a broad industry, but fish processing represents an important share. 42 The spike in activity in FY19 is due to the transfer of fishing vessels by a foreign parent company to its RMI registered company, which resulted in the vessel’s fishing activity being recorded as RMI production starting in FY19. 43 Manufacturing in the tuna fisheries sector employs on average around 300 people, about a third of whom are female. Overall, the sector employs around 730 people, including those employed in shore-based fish processing, vessel support services and onboard RMI-flagged fishing vessels based in Majuro. This excludes public sector employees that work in the fisheries sector. 65 Republic of the Marshall Islands 117. The COVID-19 pandemic is not expected to have significant long-term detrimental effects on the RMI tuna industry. Despite the severe impacts of the pandemic, the global tuna industry has remained resilient, with tuna demand and prices rising in 2020 and fishing activity remaining robust.44 The pandemic is unlikely to have resulted in any long- term structural change to RMI’s tuna industry, although it may have accelerated some adjustments that were already underway. In addition, demand for VDS days has remained solid, meaning that GoRMI revenues from fishing license fees are expected to remain resilient. However, travel restrictions forced Pacific governments to suspend the requirement to have observers on purse seine vessels. This has allowed fishing activities to continue. However, it increases the risk that vessels may not be adhering to relevant regulations, which observers monitor.45 There is strong interest in restoring onboard observers. However, this may only be feasible once Pacific travel restrictions ease. Figure 26: Fishing activity has increased in recent Figure 27: Raw fish exports have increased years, but is volatile substantially as fish processing has contracted Fishing and manufacturing industries, share of Pan Pacific Foods production, tons millions nominal GDP 20% 10000 18% 9000 16% 8000 14% 7000 12% 6000 10% 5000 8% 4000 6% 3000 4% 2000 2% 1000 0% 0 Fishing Manufacturing Fish Processed Raw Fish Exported Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 44 Demand for canned tuna spiked in international markets, particularly in the US where shelf stable (canned and pouched) tuna sales rose 19 percent in 2020 (Blank, 2021). This demand has kept prices for raw material relatively buoyant and factories in Thailand, the world’s largest exporter of canned tuna, have managed the crisis and continue to operate at high capacity. 45 While observer coverage is suspended, electronic monitoring and reporting systems are being used by national regulators to monitor fishing vessel 66 activity and take action if required. Credit: Vlad Sohkin/World Bank Country Economic Memorandum and Public Expenditure Review Figure 28: Fisheries-related employment has fallen Figure 29: The PNA VDS has underpinned dramatically since FY10 a substantial rise in revenue Number of employees and percent of total formal US$ millions, percent of GDP and share of total sector employment revenues 1,600 16% 45 License Fees ($m) 30% 1,400 14% 40 Transfers to General Fund ($m) Transfers to General Fund (% GDP) 25% 1,200 12% 35 Share of Total Revenue 1,000 10% 30 20% 800 8% 25 15% 600 6% 20 400 4% 15 10% 200 2% 10 5% 0 0% 5 0 0% FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2015 FY2016 FY2017 FY2018 Employees (left axis) Percent of Total Employment (right axis) FY2019 Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 118. This section outlines a two-pronged approach to maximize the development gains from the fisheries sector: (i) coordinated actions to strengthen regional integration; and (ii) domestic actions to maximize revenues and jobs and enhance the enabling environment for sector development. The section is organized into four sub-sections. The first provides an overview of the RMI fisheries sector. The second analyzes the current structure and governance of the sector. The third identifies key challenges and constraints facing the sector both at the regional level and domestically. The fourth discusses potential commercially viable opportunities for greater domestic industry development and investment, and the required public policy settings for these opportunities to be realized. 67 Republic of the Marshall Islands The structure and governance of RMI’s fisheries sector 119. Current commercial activities in the sector center around: (i) the catching and processing of tuna; and (ii) services related to transshipping and unloading fish in Majuro. Three companies operate RMI-flagged purse seine fishing vessels: Pan Pacific Foods (PPF), Koo’s Fishing Co Ltd and Marshall Islands Fishing Company (MIFCO)—a joint venture company between Koo’s and the Marshall Islands Marine Resources Authority (MIMRA, see below). Each of these three companies benefit from financial incentives provided by GoRMI. However, the extent to which these incentives deliver net economic and social benefits to RMI is an open question. Two processing activities take place in Majuro. PPF produces frozen loins which are exported for canning elsewhere. Marshall Islands Fishing Venture (MIFV) processes and exports fresh and frozen tuna loins. Majuro has established itself as one of the busiest transshipment ports in the world, with hundreds of purse seine vessels each year transferring tuna caught within and outside of RMI’s EEZ to refrigerated fish carriers in Majuro lagoon. Some services are provided to these visiting vessels, and there is a nascent business activity unloading fish directly into freezer containers on shore for export. 120. RMI has cooperated with its fellow PICs in the management of the tuna fisheries since the creation of MIMRA in 1979. RMI has been a member of the Pacific Islands Forum Fisheries Agency for over 40 years and was one of the founding parties of the Nauru Agreement Concerning Cooperation in the Management of Fisheries of Common Interest (Nauru Agreement) in 1982. RMI was a signatory of the Parties to the Nauru Agreement (PNA) Palau Arrangement at its inception in 1992, and Majuro has hosted the PNA office since 2010. In 2006, RMI supported the adoption of the PNA’s purse seine VDS. The scheme sets a collective cap on purse seine fishing efforts in PNA waters, translates that cap into a common currency (a fishing day by a vessel—a ‘vessel day’), agrees on a minimum ‘benchmark’ price that countries will charge companies for vessel days, and allocates the collective cap of vessel days to the countries according to an agreed formula. The system has several unique features, including enabling the Parties to achieve and maintain a socially optimal minimum price for access that prevents a ‘race to the bottom’ among participants (see Box 5 for a description of the PNA and the VDS). 68 Country Economic Memorandum and Public Expenditure Review Box 5: The Parties to the Nauru Agreement (PNA) and the Purse Seine Vessel Day Scheme (VDS) With a little help from my friends The 1982 Nauru Agreement between eight PICs has provided a basis for cooperation and successful implementation of the purse seine VDS. Known as the Parties to the Nauru Agreement (PNA), FSM, Kiribati, RMI, Nauru, Palau, Papua New Guinea (PNG), Solomon Islands and later Tuvalu cooperate to manage the parties’ tuna resources in the Western and Central Pacific Ocean (WCPO). First introduced in 2007, the purse seine VDS is the major resource management tool used by the PNA. A nascent complementary longline VDS has also been introduced, but implementation has been slow. The purse seine VDS manages access to PNA EEZs by setting a total collective limit on purse seine fishing days each year (Total Allowable Effort, TAE) and allocating that TAE among the Parties (Party Allowable Effort, PAE). The TAE is based on scientific advice on the status of the tuna stocks, catching power of vessels in the fisheries, and other factors. For 2021 and provisionally for 2022 and 2023, the TAE has been set at 44,033 days (with an additional special allocation of 1,000 days for Tokelau as a cooperating non-member). Fishing days are allocated to member countries (their PAE) based on resource endowment and average historical effort over a set number of years. PNG, Kiribati, and FSM have historically had the highest levels of effort in their EEZs, whereas RMI has had one of the smallest and is currently allocated roughly 7 percent of total available days. Members then sell these fishing access days to purse seine vessels. The VDS is thus effectively a ‘cap and trade’ scheme, where PNA members limit total access to the fisheries to maintain the stocks and allocate fishing access days between the members based on an agreed formula, while permitting trading among the members. Parties may sell their vessel-days in several ways, enabling the flow of benefits to better suit the developmental aspirations and revenue targets of individual parties. Given that there is some sales competition amongst the parties, PNA members agree on a floor price below which vessel days cannot be sold. In attempting to maximize benefits in a fishery which is never static, members have several options by which they may dispose of their allocated days. In addition to direct member- to-industry bilateral sales, a party may trade days to another party and split the final revenue.46 In addition, a separate agreement—the FSM Arrangement (FSMA)—allows countries to allocate vessel days to their own FSMA-sponsored domestic (flagged or chartered) vessels, which can then fish at discounted rates in all PNA countries. Doing so can lessen VDS revenue to the country as it must share the proceeds with the country in which the fishing occurred. RMI is known to have supported its flag fleet through FSMA contributions of vessel days. Another way to maximize benefits is through the sub-regional pool. RMI has participated in such a pool with several PNA members who contribute an equal number of days which are put out to tender. Revenue is split equally between parties participating in the pool. Sub-regional pool days are more valuable to vessel operators because of the operational flexibility it affords, generally selling for 30–40 percent more than bilateral days. 46 This inter-party trading has consequences for a country’s PAE. Trading days out will reduce the level of in-country fishing effort and therefor the PAE over time. Trading them inwards will cause the PAE to increase. 69 Republic of the Marshall Islands 121. MIMRA has considerable developmental responsibilities as well as a high degree of administrative and financial autonomy. MIMRA is the statutory authority responsible for the management and development of RMI’s fisheries resources, including fishing access to the EEZ. Independent from government, MIMRA is managed as a corporation, including establishing its own management, human resource, procurement, and operational procedures. This has allowed MIMRA to attract skilled, quality management and staff. Consequently, its performance in areas such as the oversight of purse seine transshipment in Majuro lagoon, its onboard fishing vessel observer program, and projects supporting neighboring island fisheries has generally been professional and efficient. Periodic audits of MIMRA’s activities have found no major shortcomings in its administration. 122. In response to the dramatic rise in VDS revenues, a 2016 reform retained MIMRA’s independence but allowed for a large share of revenues to be transferred to the General Fund. Prior to 2016, only a small part of MIMRA’s revenues were programmed into the annual GoRMI budget, with VDS revenues not part of the annual budget process. In 2016, an amendment to the MIMRA Act codified how money generated by MIMRA’s fisheries management and other activities is to be managed and periodically transferred to GoRMI’s General Fund.47 Among other changes, the amendment stipulated that: (i) an annual transfer to the General Fund would be programmed in MIMRA’s annual budget; and (ii) any revenues in excess of those approved by the MIMRA Board in the annual budget would be deemed ‘unanticipated revenues’ and, as such, would be transferred to the General Fund. 123. Retaining MIMRA’s independence is crucial to ensuring that RMI continues to maximize the benefits from its fisheries resources. In 2019, a further bill was introduced to the Nitijela to allocate all fisheries sector revenues to the General Fund, with MIMRA to receive an annual transfer as part of the budget process. If implemented, this reform would seriously undermine MIMRA’s independence, which could have significant implications for its management. As outlined in Box 5, there are several ways to utilize RMI’s allocation of VDS days. Obtaining maximum benefit through the various sale options requires a deep technical understanding and monitoring of the current state of the fisheries, as well as the short-term needs of the industry. Both also require real-time information systems to track vessels and fish stocks. Maintaining MIMRA’s legal and operational independence is crucial to ensure that it retains its commercial focus and can continue to attract and invest in the quality management, technical staff, and technology necessary to efficiently and effectively manage RMI’s fisheries resources. 70 47 Marshall Islands Marine Resources Authority (Amendment) Act, 2016. Country Economic Memorandum and Public Expenditure Review Challenges to the fisheries sector 124. Despite the recent increase in output, the RMI fisheries sector faces several challenges. As outlined previously, RMI’s economic geography means that production costs across the economy are high, resulting in a narrow production base. These challenges also limit the incentives and opportunities for private sector investment and development in the fisheries sector. GoRMI has tried to address these high costs by offering financial incentives to support domestic industry development, although the incentives have not delivered the expected benefits in terms of job creation. The industry cites achieving access to the EU market as a key opportunity which could provide additional incentive for domestic investment and fish processing. Projections of a long-term decline in tuna stocks within RMI’s EEZ, along with increasing regional competition for transshipment, also represent key challenges. Projected long-term decline in RMI tuna resources 125. Although not currently overfished, tuna stocks in the WCPO are projected to decline and move eastwards by 2050 due to climate change, with potentially substantial impacts for RMI. The latest periodic tuna stock assessments conducted by the Secretariat of the Pacific Commission show that tuna resources in the WCPO are not overfished. However, the biomasses of most tuna stocks continue to decline at the regional level. For RMI, an additional long-term concern is the potential impacts of climate change on the tuna fisheries. Oceanographic changes linked to warming seas are predicted to alter tuna migration patterns and mortality rates. Models predict a decrease in tuna biomasses in the Pacific by 2050 and a shift of the biomasses eastward, resulting in a 15 percent decline in tuna biomass in the RMI EEZ (Conservation International, 2018). 126. Annual volatility and the potential long-term decline in RMI’s tuna catch suggest that it is in RMI’s benefit to pursue closer regional cooperation to maximize the long-term benefits from the jointly managed resource. Despite RMI’s EEZ representing 14 percent of the PNA’s combined EEZ, RMI’s purse seine tuna catch has averaged only 3 percent of the PNA total and is highly volatile.48 In 2019, a year when much of the purse seine fishing shifted eastward beyond RMI’s EEZ, the total purse seine catch in the RMI EEZ was just 18 percent of the 2018 level, and just 7 percent of the 2016 level. Despite the low catch in RMI’s EEZ, in FY19 the purse seine fishery generated over US$28 million in revenues, representing over 85 percent of the total license fees received by MIMRA. It is therefore in RMI’s interest to seek to maximize the unit value of the VDS. Reforms to the VDS via deeper regional integration provide significant opportunities for PNA members, including RMI, to capture additional rents. 48 During the period 2016–18 the estimated annual catch by purse seine in PNA waters was 1.35–1.45 million tons, while the corresponding catch in the RMI’s EEZ was around 43,000 tons. 71 Republic of the Marshall Islands Ineffective financial incentives and contraction in the fish processing industry 127. Incentives for onshoring fish processing have not delivered the expected benefits in terms of domestic economic development and job creation. In an attempt to catalyze broader economic development and job creation, over the past decade GoRMI has provided incentives to fishing companies to base their vessels in Majuro and invest in on-island processing activities via preferential access and discounted prices for VDS days, tax exemptions and other incentives. While ‘domestication’ of vessels and fish processing has the potential to deliver increased economic activity and job creation, it is generally accepted that the expected benefits of these initiatives are not being realized, and that the discounts provided to the companies may exceed the benefits they generate to the domestic economy.49 This calls into question the sustainability and cost effectiveness of the policy. RMI is not alone in not realizing the expected benefits from discounts and concessions. After reviewing several fish processing enterprises in the region, the Pacific Islands Forum Fisheries Agency concluded that “the weight of evidence suggests the granting of concessions to achieve domestic processing outcomes in the Pacific Islands has been largely unsuccessful”.50 128. Despite a six-fold increase in PPF’s vessel fleet since 2010, fish processing has fallen by over 75 percent, suggesting that financial incentives are not delivering the expected benefits in terms of domestic activity and jobs. Over the past 11 years, PPF’s RMI-flagged fleet has grown from one to six vessels. However, fish processing activities have fallen from almost 4,000 tons in 2010 to just 883 in 2019 (and to basically zero for much of 2020—see next paragraph). In comparison, the amount of frozen whole fish exported has been over 3,000 tons every year since FY14—a five-fold increase from the level in FY11—and increased to over 9,500 tons in FY18 due to favorable fishing conditions in the RMI EEZ. This indicates that after a few years of concentrating on fish processing, PPF is now primarily exporting whole fish. This is consistent with employment (in terms of number of days worked) falling from over 102,000 in 2010 to less than 29,000 in 2019. While the company claims that low production is due to difficulties in maintaining a suitably skilled labor force (see paragraph 130), the general high costs of production in Majuro is likely to be a major reason for the decrease in processing. 129. Koo’s Fishing Co. Ltd obtains discounted VDS days for its entire vessel fleet due to its joint venture with MIMRA (MIFCO), although the recent transfer of fishing vessels to FSM calls into question the need for the financial incentive. Koo’s is a Taiwanese fishing company that operates five purse seine vessels flagged in RMI—three owned by the company and two by MIFCO. Unlike PPF, Koo’s does not operate any onshore fish processing to obtain its financial incentives.51 In recent years, Koo’s reportedly transferred some of its vessels from its RMI operation to its FSM operation because of a lack of available VDS days from RMI. This indicates that the cost of VDS days may not be as critical to the company as their availability, calling into question the need for VDS discounts to keep Koo’s in RMI. 49 See an assessment of the costs and benefits of the VDS discounts conducted by the RMI Chief Secretary’s Office (2018). MIMRA has also undertaken a separate analytical study which reportedly came to similar conclusions. 50 Pacific Islands Forum Fisheries Agency (undated). 72 51 In 2008, Koo’s won a land tender to construct an office building. According to the company, the tender also required a processing facility to be built but did not necessarily require it to become operational. Consequently, Koo’s built a small processing plant that has never been put into operation. Country Economic Memorandum and Public Expenditure Review High workforce turnover in fish processing activities 130. PPF has reported problems with labor retention and stability in their processing activities despite paying above the minimum wage. Cheaper raw material supplies from direct offloading should, in theory, make PPF more competitive than processors that rely on transshipped fish. It is not surprising, however, that this savings is more than offset by relatively high costs of labor, electricity, fuel, freight, and other costs in RMI. Stability in the PPF workforce is important because of the time it takes to become proficient in maximizing loin recovery (that is, minimizing waste). According to the company, high workforce turnover is predominantly due to the ability of Marshallese workers to migrate and work in the US, and not as a result of low wages or poor working conditions (loiners reportedly receive US$3.50/hour, above the legislative US$3/hour minimum wage). Recent reports indicate that no loin production occurred during the six-month period April to September 2020. This is despite PPF exporting around 5,750 tons of frozen whole fish during the period—some of which could arguably have been directed to the processing plant. Lack of access to the EU market 131. Due to a lack of key institutions, RMI tuna exports are currently not permitted to enter the EU market. The EU is one of the largest markets for tuna exports in the world (FAO, 2019). However, to obtain access to the EU market, exporting countries must meet EU-set standards regarding fishing sustainability (including measures to combat illegal unreported and unregulated (IUU) fishing), food safety and labelling. Meeting these standards involves the establishment of an entity, known as a Competent Authority (CA), that provides independent verification that the EU requirements are met through inspections of vessels and processing plants, laboratory testing and catch documentation. RMI currently does not have a CA, although MIMRA is in the process of developing the competencies required for accreditation. 132. A bilateral economic agreement with the EU would also be necessary to avoid tariffs that make RMI processed tuna exports uncompetitive. Even if RMI meets EU requirements, under current trade arrangements RMI exports of value-added tuna products (including processed loins) attract a 20.5 percent duty. This is too high to make RMI loins competitive. However, these duties could be reduced or removed as part of a bilateral economic and trade agreement with the EU—which could encourage additional domestic investment and fish processing. 73 Republic of the Marshall Islands Increased competition for transshipment 133. Over the past decade, Majuro has become an increasingly important purse seine transshipping port. In 2010, purse seiners undertook 315 transshipment operations transferring 223,335 tons of tuna to refrigerated fish carriers in Majuro lagoon (McCoy, 2012). In 2019, 449 operations transferred a total of 362,454 tons (a 43 percent increase in operations and 62 percent increase in volume). Until 2020, Majuro was recognized as the top tuna purse seine transshipment port in the WCPO in terms of tonnage transshipped. In 2020, Majuro experienced a significant reduction in transshipment activity with 180 operations transshipping 127,630 tons. The reduction was due to several factors including: (i) the impacts of measures instituted by GoRMI due to COVID-19; (ii) a continued shift in purse seine fishing activities east of the RMI EEZ; and (iii) increased competition from ports in Kiribati. It is too early to tell whether transshipment activity will return to 2019 levels once GoRMI can relax COVID-19 related restrictions. However, long term shifts in tuna stocks and increased regional competition are expected to persist into the medium term, suggesting that competitive pressure will continue. MIMRA’s dual role 134. MIMRA currently has a dual role as both the regulator of tuna resources and an enterprise with a commercial interest in the fisheries sector. MIMRA is responsible for the design, implementation, compliance, and enforcement of fisheries-related regulations. However, it is also joint owner of MIFCO with Koo’s Fishing Co. Ltd that operates two purse seiner fishing vessels.52 Unlike in FSM, for example, which has a National Fisheries Corporation that ostensibly operates on a commercial basis at arms-length from the government’s regulatory body, MIMRA undertakes both activities simultaneously. The issue is whether MIMRA could take required management or conservation measures against its own commercial interests. So far, MIMRA appears to have been able to walk the fine line between exploiter and regulator and has not compromised its conservation role. Opportunities and policy recommendations Enhance regional cooperation to minimize output volatility and maximize long-term benefits 135. Reforms to strengthen the property rights characteristics of the VDS have the potential to increase the average vessel day price, allowing PNA members—including RMI—to capture a higher proportion of the rents from their natural resources. The purse seine VDS has provided PNA members with a powerful tool with which to obtain significant financial benefits from the regional tuna purse seine fishery, but it should not be seen as a static system. Reforms that provide greater flexibility and transferability of a VDS day would make the access right more valuable for fishing companies, potentially increasing the average price. Such reforms comprise: 52 Koo’s is the majority shareholder in MIFCO, holding 51 percent versus MIMRA’s 49 percent. Nevertheless, the two vessels are managed and operated alongside the rest of Koo’s RMI-flagged fleet and catch volumes have been comparable to other vessels in Koo’s fleet. 74 Country Economic Memorandum and Public Expenditure Review i. Increasing ‘pooling’: Pooling of VDS days involves multiple PNA members jointly selling a portion of their VDS days and allowing the purchasing vessel to use these days in any of their EEZs. Pooled VDS days thus expand the space over which current access rights apply, increasing their value. PNA members, including RMI, have already begun experimenting with pooling in recent years with several lessons learned and encouraging results, with prices for pooled days much higher than the VDS minimum of US$8,000/day. Rents could be further increased by: (i) expanding the number of VDS days sold via pooling mechanisms; and (ii) increasing the number of EEZs to which pooled days apply through expanding regional cooperation. ii. Extending the duration of tuna fishing rights beyond one year: PNA members, including RMI, could collectively or individually begin to extend the ‘life’ of a VDS day that they issue (that is, the duration during which the fishing right can be utilized). For example, from the current period of one year (that is, VDS days currently expire at the end of each calendar year) to three, five or even ten years (in the long term). This is currently under discussion in the regional discourse to ‘capitalize’ the VDS allocations.53 iii. Allowing transferability of tuna fishing rights between authorized users: In practice, this involves permitting the exchange of VDS days on a secondary market. Theory and empirical research indicate that allowing transferability between users (that is, fishing companies) increases the overall economic outcomes from a fishery by creating a market mechanism to ensure that marginal benefits are realized.54 It allows users to restructure in response to changes in technology, markets, resource conditions, and the environment— thus making the access right more valuable. 136. Implementation of these reforms could lead to an annual increase in RMI fisheries sector revenues of US$10–21 million (4.6–9.3 percent of GDP). Undertaking any one of these reforms would be expected to increase the value of the property right. However, implementation of all three reforms would likely unlock value that is far higher than the sum of the individual benefits. Recent modeling (Arnason et al., 2015) suggests that implementation of these reforms could see average VDS prices increase to US$13,000 to US$16,500 per day. In 2018, RMI’s allocation of 3,016 vessel days translated into US$28.8 million in VDS access fees, equivalent to US$9,563 per vessel day. An increase in the average sale price would thus have generated an additional US$10.4–20.9 million in revenue in 2018—a 36 to 73 percent increase in annual revenues. At the regional level, the total commercial value of the tuna harvested via purse seine fishing was estimated to be roughly US$2.9 billion, with PNA members capturing almost 19 percent of this value through the VDS. Based on the modeling, the reforms could have increased the proportion of rents captured by PNA members to 21–27 percent. 53 See for example, https://www.pnatuna.com/content/pnao-gears-vds-expansion-business-plan-development-2019 and http://pacifictuna.org/pna-officials-prepare-for-big-agenda-in-palau/ 54 See Aquora et al. (2020) for a detailed discussion of the opportunities, risks and legal requirements for transferability. 75 Republic of the Marshall Islands 137. It is in RMI’s interest to advocate for such reforms, although a cautious approach that includes appropriate safeguards is recommended. RMI can pursue some of these reforms unilaterally, but others will require regional cooperation. Given the projections of a long-term decline in fishing stocks in RMI’s EEZ (paragraph 124), greater regional integration of the VDS is in RMI’s benefit. However, risks must be clearly articulated, and mitigation measures introduced or strengthened. For example, transferability between users should be accompanied by a range of reporting requirements to ensure transparency and mitigate the risk of industry consolidation leading to monopolistic or oligopolistic behavior affecting pricing. 138. The reforms should be sequenced in the order presented above. In terms of the sequence of the reforms, increasing pooling is the most feasible in the short term, as it reflects the expansion and consolidation of a mechanism that is already being implemented on a pilot basis. Extending the duration of access rights could be pursed in the medium term, given that: (i) it could be trialed by one or several PNA members with course-correction over a set period; and (ii) it could be trialed with a small number of days. Transferability between users could be pursued in the longer term, as it is the most logistically demanding and would require the most advanced mitigation measures. Careful negotiations and preparation would be necessary before implementation commenced. Improve transparency and accountability of institutions in the sector 139. Transparency and accountability regarding MIMRA’s dual roles are crucial in the short term, while reform to remove the conflict of interest should be pursued in the longer term. The potential for conflict between the two roles of guardian and exploiter could intensify in the future as resources become more fully utilized. The current situation calls for full transparency as well as a system of strong checks and balances carried out by the MIMRA Board and Nitijela. To enhance MIMRA’s independence, the 2016 amendment to the SOE Act which permits ministers and public officials to be members of SOE boards (including MIMRA) should be reviewed.55 In the longer term, reform should remove any conflict of interest by requiring MIMRA to divest itself of ventures where it has resources management responsibility. If GoRMI wishes to continue its involvement in such ventures, a separate SOE or other arrangement should be established that is independent of the regulator.56 55 Tonga’s Public Enterprise Act could provide a useful model. Under the act, ministers can be named to the board of a new public enterprise if it is deemed necessary to support establishment of the enterprise but must leave the board after 12 months. 56 MIMRA also operates fish markets in Majuro and Kwajalein and the neighboring island fish support program that brings in fish from the neighboring islands to those facilities. These activities are arguably different than MIFCO, as the former are designed to fulfil a social objective, while MIFCO is a commercial investment. 76 Country Economic Memorandum and Public Expenditure Review Review and improve the effectiveness of financial incentives 140. Regular cost/benefit evaluations are necessary to ensure that any financial incentives are achieving their desired outcome(s). Global evidence suggests that the effectiveness of incentives in attracting investments may be limited and, at best, only influence investment decisions at the margins (Echandi, 2015). As mentioned previously, RMI’s economic geography also raises costs of production and limits international competitiveness. There is thus a risk that temporary investment incentives to attract new investment may turn into permanent subsidies to retain activities that would not be competitive without such subsidies. In an extreme case, private providers may maintain ‘shell’ activities only to extract the financial incentives from government. Consequently, the case for new or continued investment incentives should be carefully and regularly studied to ensure that they deliver net economic and social benefits. It is also critical to assess the lifetime cost of any incentives considered. 141. A detailed study of the benefits and costs of PPF’s domestic operations is required for GoRMI to make an informed decision about the extent to which foregone revenues are generating net economic and social benefit for RMI. The major economic benefits from PPF’s fishing and processing come from local employment (around 180 people) and local purchases (averaged US$4.6 million in 2017–19). The catch made by the company’s RMI- flagged vessels (estimated to be around 13 percent of total catch in RMI EEZ in 2018) is registered as part of RMI’s fishing ‘effort’ in future PNA calculations of VDS allocations. If the financial incentives were removed, PPF’s processing facility may close and the vessels may be re-flagged to another jurisdiction. Set against these benefits are the forgone revenues that MIMRA—and by extension, GoRMI—could accrue from selling the VDS days to another company (assuming there was demand, which is judged to be a low risk). Absent the financial incentives, it is unlikely that another company would utilize the loining facility, although it could be retrofitted for other uses, given the severe lack of land for development in Majuro (see Section 91). 142. As in the case of PPF, an assessment of the benefits and costs of Koo’s and MIFCO’s operations is required for GoRMI to make an informed decision about whether the financial incentives provided to Koo’s are delivering sufficient benefit for RMI. The combined operations employ around 60 Marshallese. Both entities also pay gross receipts tax and purchase supplies and fuel from the domestic economy. In recent years, MIMRA’s annual profit share from MIFCO has been around US$0.9 million. According to the Koo’s representative in Majuro, MIMRA has received around US$14 million from MIFCO since 2006. Another key benefit is regarding market intelligence for MIMRA. Because MIFCO’s operations are an integral part of Koo’s, and because Koo’s likely operates in much the same way as most of the Taiwanese purse seine fleet, participation in MIFCO represents an excellent opportunity for MIMRA to better understand segments of the purse seine fishing industry on which information is normally not accessible. This can help MIMRA with industry regulation and in the management of RMI’s VDS allocation. These benefits are set against the foregone revenues related to the discounted VDS days. However, there is no public information on these foregone revenues, meaning an assessment of the costs and benefits is not possible. 77 Republic of the Marshall Islands 143. There is a proposal to restructure GoRMI’s strategy to focus on incentivizing the economic activity that is desired (that is, tonnage of fish processed) through a mechanism that is salient for that activity, rather than via discounted access rights. A common example cited is from PNG, where all fishing vessels pay full price for fishing days, while the government provides a rebate to processing factories based on the tonnage of fish that is processed. The policy is designed to align incentives along the supply chain by giving factories the capacity to provide incentives to the fishing vessels to land their catch with the processing factory.57 If the main reason for the lack of production is high operating costs, a subsidy or rebate based on processing could help ameliorate some of those costs, while ensuring that the desired activity is being incentivized directly. A detailed analysis of domestic production costs and comparison with processing centers elsewhere would be required to determine an appropriate rebate amount. 144. A shift from VDS discounts to a rebate or subsidy system based on loining plant production carries risks and should be carefully analyzed against alternative uses of government revenues. First, there is no guarantee that PPF or new investors would respond to the volume-based processing incentive. PPF may choose to exit RMI rather than accept the new incentive structure. There is also no guarantee that a rebate or subsidy system would address labor constraints (see paragraph 129 and Section 1.3.2). If the labor problem can be overcome, the production of loins could mean fewer containers of frozen whole fish are landed and exported. Other rebate systems employed or contemplated in other PICs have pegged rebates at around US$200–400 per ton of fish processed. Using those figures, a modest amount of processing by PPF of 5,000 tons per year would cost US$1–2 million in rebate/subsidy. The details of PPF’s financial incentives and VDS allocation are not public, making it difficult to evaluate the relative cost of such a rebate versus the current arrangements. However, available information suggests that GoRMI’s forgone revenues could be around US$1.8–4 million per year.58 Secure access to the EU market 145. Establishment of a national Competent Authority (CA) responsible for the inspection and certification of fish and fish products is a prerequisite for EU market access. To export to the EU, GoRMI must demonstrate that RMI fish and fish products: (i) meet EU food safety requirements; (ii) comply with EU rules to combat illegal, unreported, and unregulated (IUU) fishing; and (iii) meet strict standards regarding product labelling. In practice, this involves the appointment of a CA that is responsible for developing and implementing regulations that meet EU requirements in these areas.59 Once approved, a CA undertakes audits of domestic facilities to approve their products for export to the EU. The CA accreditation process is comprehensive and can take many years to complete. 57 The incentive is not provided based on containerization, as fish could simply be transferred to shore and then moved offshore once again, without generating any domestic value added. 58 Based on estimates of the number of VDS days sold to PPF, and the difference between the value of a VDS day sold to PPF under the current arrangements versus RMI’s average VDS day price and the price of RMI’s bilateral VDS days. 59 The CA need not be the same organization. For example, a health department can be the CA for the sanitary and phytosanitary component and the fisheries department can be the CA for the IUU component. In practice, in small countries it is usually more efficient to have one CA handle both components. 78 Country Economic Memorandum and Public Expenditure Review Retaining a CA accreditation also requires a regular audit by EU authorities. First discussed in 2011, MIMRA began the process for CA certification in 2019.60 Progress was first held back due to limited capacity, with key MIMRA staff frequently drawn into urgent matters which crowded out work on progressing the CA. Since early 2020, border restrictions have delayed progress, with EU inspection teams and technical assistance unable to visit Majuro. Completion of the CA process is a priority for MIMRA and is envisaged to be completed in the short term (conditional on the relaxing of border restrictions).61 Aside from being a prerequisite for EU market access, establishment of the CA could also allow RMI tuna and tuna products to obtain premium prices and a wider range of marketing options, given the high health standards and sustainable fishing requirements associated with CA accreditation. Consequently, CA accreditation also provide additional incentives for landing of fish for export processing (containerization or loining) and investment in onshore tuna processing facilities. 146. Duty free access to the EU market for RMI tuna products via a bilateral Economic Partnership Agreement (EPA) could provide additional incentives for investment in onshore tuna processing. Market access can be a major determinant in attracting investment in tuna processing. As mentioned in paragraph 132, under existing EU tariff and concession arrangements, tuna loins from RMI attract a 20.5 percent duty. This is too high to make RMI loins competitive. However, RMI could achieve exemptions from duty on all tuna products as part of an EPA with the EU, or an interim EPA (IEPA), both of which provide the EU with certain reciprocal trade rights and concessions. PNG, Fiji, and Solomon Islands have all obtained duty-free EU market access for their canned tuna and loins via IEPAs. This suggests that removing this tariff barrier could also make RMI tuna exports competitive in the EU market, to the extent that production costs in RMI are comparable to those in these other regional economies. An IEPA also enables global sourcing of tuna for local processors. Current RMI operations utilize only tuna from their own vessels, so the global sourcing aspect is not expected to bring any significant benefit to existing operations. However, this condition could make RMI a more attractive destination for investment in the future.62 Nevertheless, duty exemptions provided under the Compact for RMI tuna products entering the US have not stimulated investment in RMI tuna processing63—suggesting that EU market access alone may not be sufficient to encourage greater domestic investment. 60 Fiji, Kiribati, Solomon Islands and PNG are currently the only Pacific Island countries that have approved CAs. 61 In addition to establishing CA capabilities, MIMRA is also seeking to establish a seafood toxicology lab for both its tuna exports and coastal fish resources consumed domestically. This follows a US Army (2017) study that identified high concentrations of lead in fish caught around Kwajalein, posing a cancer risk to the local population. 62 For example, this was one of the major incentives for PNG to conclude an IEPA, since it has multiple processors that obtain some of their raw material from non-PNG vessels. 63 A provision of the Compact allows duty free entry of RMI tuna products to the US, up to a volume limit equal to 10 percent of total US tuna consumption during the previous calendar year (the quota is shared with the FSM, as an identical provision exists in the FSM-US Compact). However, the duty-free quota has not encouraged development of RMI’s tuna sector, as the exemption does not provide enough of a competitive edge relative to major producers in Southeast Asia (subject to a 6 percent duty up to a quota, and 12.5 percent over the quota) to offset the higher production costs in RMI. 79 Republic of the Marshall Islands Moving up the value chain: An RMI tuna trading company 147. Under a radical reimagining of the industry, GoRMI is planning to create a trading company that will retain ownership of harvested fish, contracting harvesting, processing, distribution, and marketing operations along the value chain. PICs—including RMI— currently capture only a small fraction of the value created by the fishing industry supply chain. While the purse seine VDS has significantly enhanced the PICs capacity to capture resource rents in the form of access fees, substantially greater value could be accessed if PICs were able to increase their participation higher up the value chain. At present, three large trading companies provide services to most of the fleets in the WCPO and buy their catch (rather than taking a commission on its trade), with guaranteed delivery to processors and often with exclusive relationships with vessel owners and fleets (and in some cases vertical integration). Consequently, these three trading companies provide logistics and coordination for much of the supply chain, and thus exert significant influence over the purse seine value chain. Establishment of a PICs tuna trading company was first proposed as a PNA-wide project. When other PNA members declined to participate, GoRMI took on the project as a national initiative. 148. Working with The Nature Conservancy and Bain Consulting, a GoRMI Tuna Commercialization Taskforce64 has developed a pilot project that will attempt to operationalize such a trading company, named Pacific Islands Tuna Provisions (PITP). The objective is to achieve vertical integration of the supply chain by forming long-term relationships with various service providers including the harvesting purse seine vessels, logistics managers, fish processors, and most importantly with retail sellers. Long-term contracting is intended to reduce financial risk and support sustainability in the fishery. The business model is based on positioning PITP as a provider of premium, eco-friendly, sustainably caught tuna products. This premium pricing strategy is expected to offset the higher unit costs associated with PITP contracting out service provision for a relatively small catch volume (relative to the economies of scale obtained by the existing three large trading companies that dominate the WCPO). 149. PITP offers potential opportunities and benefits for RMI. Fundamentally, PITP is designed to derive a higher proportion of the rents from tuna resources caught in RMI’s EEZ, compared to the income generated via selling RMI’s VDS days. Ultimately, the success of the venture will depend on the extent to which a small start-up company will be able to: (i) carve out a profitable niche in the highly competitive premium tuna commercial marketplace (it appears that the US will be the primary market during the pilot phase); (ii) retain competitively priced service contracts in an industry of razor thin margins; and (iii) establish strong, transparent governance arrangements that allow the venture to adequately manage volatility and financial risk. Aside from the potential for higher income to GoRMI, the venture could generate a small increase in employment in Majuro related to fish offloading and containerization. Participation in PITP by MIMRA staff could also result in a better understanding of the industry and lead to more informed policy decisions. 64 The taskforce comprises MIMRA, the PNA Secretariat, Pacific International Inc. (a local private company) and members of the Cabinet, with overall 80 authorization of the President. Country Economic Memorandum and Public Expenditure Review 150. However, there are also significant potential risks, which go beyond the immediate financial risks of the venture. The opportunity carries significant risk given the massive logistic systems and efficiency required for the venture to be profitable, the large volume of storage capacity needed, and requisite strong governance structures, among others. As a pilot project, PITP is designed to test the feasibility of the concept. Details of financing the project are not known, but if the initial start-up and operational costs are covered by the private sector partners, there should be minimal financial risk to RMI at this stage. If the pilot demonstrates positive results and there is interest in scaling up the initiative, then GoRMI should seek independent legal, financial, and technical advice on the proposed model. Crucially, GoRMI should very carefully consider, and avoid to the extent possible, providing any financial commitment or guarantee to the venture. In other words, if PITP is to be extended, the company should be financial sustainable without GoRMI concessions or subsidies. Furthermore, in light of RMI’s experience with its ship and corporate registries, an independent evaluation of a scaled-up PITP should pay close attention to potential political and reputational risks for GoRMI. 151. Beyond the financial risks, GoRMI should also carefully consider how to balance domestic development aspirations with enhanced regionalism. As mentioned in paragraph 126, climate change and long-term tuna migration patterns suggest that it is in RMI’s interest to pursue closer regional cooperation to maximize the long-term benefits from the regional tuna fisheries. PNA members have collaborated on significant advances in tuna management that have brought substantial benefits to all. However, there is also competition amongst members in the commercial sphere, such as in attracting transshipment and fish processing activities. If PITP demonstrates success, other PNA members may reconsider their desire to join the project. Expanding PITP to other countries would create additional complexities and increase risks during the scale up. However, failure to include other interested PNA members could result in competing national initiatives that could better be undertaken collectively. Maximize the benefits from transshipment 152. The outlook for purse seine transshipment in Majuro is generally positive, although opportunities beyond existing activities are limited. Post-COVID-19, transshipment activities are likely to rebound due to Majuro’s strategic position and large, deep, well protected lagoon, which makes it an attractive venue for transshipping purse seine vessels. However, a large expansion in activity is unlikely due to: (i) competition from other ports (particularly Tarawa, Kiribati) and effects of El Niño/La Niña oscillations in the short to medium term; and (ii) the easterly movement of fish stocks in the longer term. A high proportion of vessels that transship in Majuro are Taiwanese. This could work in RMI’s favor. Close bilateral relations and the presence of a Taiwanese embassy that facilitates inspections of vessels as part of Taiwan, China’s overseas fisheries management procedures provide comparative advantages that other regional ports do not. 81 Republic of the Marshall Islands Expand complementary industries servicing visiting vessels 153. There is limited opportunity for local suppliers of basic foodstuffs and other necessities to increase sales to transshipping vessels, as these supplies are generally provided by refrigerated fish carriers that are chartered by the trading companies to pick up fish in Majuro. Tuna trading companies that charter and place refrigerated fish carriers at various ports serving transshipping vessels organize the logistics and provision of needed supplies, including food items, salt for brine tanks, and other basic vessel necessities. Refrigerated fish carriers are usually returning from major industrial cities in Asia where almost all needs of the purse seiners can be obtained. Freight cost for the trading companies that charter the carriers is essentially free on the trip to load fish. While not offered for free, the provision of such supplies may be used as enticement to sell to a particular trading company, or part of a fish supply arrangement with the harvesting purse seiner. It is very difficult for local businesses to compete with carriers in providing these types of supplies, except for certain commodities such as fresh fruit and vegetables and items for the crew’s personal use. At least one tuna trading company sends bulky supplies such as lube oil and salt by container to various transshipment ports. These supplies are generally used to satisfy ‘emergencies’ or cases where it has been impractical to place the supplies onboard carriers. 154. The purse seine net repair yard owned and operated by Pacific International Inc (PII) is slowly gaining customers. Over the past several years, PII has incrementally constructed its own dock and hardstand for use by purse seiners and has plans to expand further. In 2018, the company installed equipment to enable the repair of purse seine nets at the site and began stocking basic net and deck supplies. Most minor net repairs can be handled onboard vessels at anchor, but more serious problems require a large, flat area on which to work—such as that at the PII dock. During its first year of operation in 2018, 18 vessels used PII’s hardstand to repair their nets. There were 45 such repairs in 2019, but activity fell to just three repairs during 2020 due to the reduction in transshipping vessels owing to COVID-19 restrictions. The outlook for this business post-COVID is tightly related to the outlook for transshipment activity in Majuro lagoon. However, there is also increasing competition in the region. There is a net yard in Pohnpei that employs an experienced net repair crew but has a smaller work area than Majuro. There are also plans to start a net repair facility in Tarawa as part of a transshipment hub development. Develop onshore unloading for containerized export 155. While increased onshore containerization of tuna is possible, it is not common in the Pacific and there are several technical and administrative hurdles to overcome to enable successful operations. The use of refrigerated shipping containers has been occasionally used in the WCPO to supplement transshipment by refrigerated fish carriers. However, it is yet to develop into a regular means of transporting tuna from purse seiners. One of the main advantages of using containers is that it provides an opportunity for the catch to be better segregated by size and/or species, which provides greater flexibility in 82 Country Economic Memorandum and Public Expenditure Review marketing. For marketing benefits to be fully realized there must be a CA with approved inspection and certification systems in place to satisfy EU requirements (see paragraph 145). There are also disadvantages. Shipping logistics can be unfavorable and the acquisition of an adequate number of containers can be difficult. Without specialized equipment, overall freight costs (including labor) can be higher and container loading slower than transshipment. Timely access to dock space and adequate container storage areas with a reliable electrical supply are also essential. Resolving the challenges of dock congestion and inefficient electricity supply (Section 91) in Majuro are thus pre-requisites for increasing tuna containerization activities. 156. Major tuna traders and large fishing companies currently do not consider that containerization in PIC ports will become the dominant mode of tuna transport. An indication of attitudes of traders and large fishing companies towards containerization is that although they can benefit from onshore containerization where it occurs, they are not the ones investing significantly in the necessary infrastructure and onshore facilities. Not all ports are suitable for container operations, so refrigerated fish carriers will still be required. Furthermore, carriers can be moved to ports closer to active fishing grounds, and it is easier to reposition a carrier than it is to move many refrigerated containers. Traders will, however, continue to encourage GoRMI and commercial interests in Majuro to pursue improvements in containerized shipment. It is in their interest to have shipping options available for times such as a period in 2019 when there was a dearth of carriers available due to congestion in Bangkok. On the other hand, there may also be times where carriers are more useful, such as in late 2020 and early 2021 when shifting global trading patterns and COVID-19 issues caused a severe global shortage of available shipping containers and led to high container shipping costs. 157. There is some potential to increase onshore containerization activities in Majuro, but it would require more efficient operations which may limit job creation. Current containerization operations rely heavily on manual labor. This is positive in terms of job creation, but takes longer than mechanical processing, meaning that offloading vessels must spend more time in port. Utilizing more advanced shoreside equipment could decrease the time it takes to load fish into containers which would reduce purse seiner turnaround time and could attract more containerization business. However, utilization of more efficient equipment would reduce the need for unskilled labor and substantially curtail one of the current major benefits of containerization to RMI. 83 Republic of the Marshall Islands Expand longline fishing activities 158. Although of much smaller quantity than purse seine fishing, longline fishing remains an important segment of the RMI fisheries sector. Longline fishing accounts for around 20 percent of the total catch in RMI’s EEZ, has been more stable than the purse seine catch, and is dominated by MIFV—an integrated fishing, processing and marketing operation based in Majuro. Over the period FY17 to FY19, MIFV vessels caught 97 percent of the total longline tuna catch. Based at the Majuro fishbase, the company produces fresh and frozen tuna loins for export to Hawaii, the US mainland, Japan, China and elsewhere. 159. MIFV’s operations provide tangible economic benefits to RMI. MIFV employs around 130 Marshallese workers, pays gross receipts tax and purchases around US$3.4 million in services and fuel from the domestic economy. MIFV’s catch is attributed to RMI for future longline quota allocation consideration. The only notable concession provided by GoRMI to MIFV is free use of the fishbase. However, there is no alternative, more profitable use of the fishbase. Overall, MIFV’s operations appear to deliver net economic benefits to RMI. 160. Further studies are required to determine the viability of expanding current MIFV operations. There are currently limited opportunities for expansion of existing MIFV operations due to the restrictive length of the dock facing its facility. Use of other existing docks in Majuro is impractical given the nature of MIFV’s fresh fish operations. GoRMI, jointly with MIFV, could undertake feasibility and cost-benefit studies to see if expansion of the current dock at the fishbase would be both practical and profitable. Labor challenges should also be considered, as expanded operations would only be feasible and profitable if there is sufficient labor for the scaled-up operations.65 1.3.2 Strengthening the Labor Market and Labor Mobility 161. RMI’s labor market is characterized by low employment and limited formal job opportunities. The labor force participation rate was 44.7 percent in 2019, which was relatively low as compared to other countries of similar income level (above 50 percent is more usual at this income level) (Figure 30). Employment levels have been static in the last decade, with the ratio of employed workers over the working age population plateauing between 34 percent and 35 percent during 2011–2019. In addition, the gender gap in labor participation is among the most severe in the Pacific region (Figure 31). 84 65 Like PPF, MIFV reports problems with absenteeism in their labor force despite providing a regular salary and other incentives. Country Economic Memorandum and Public Expenditure Review 162. Unemployment is particularly acute among young Marshallese aged 15–24 years old. Youth unemployment was as high as 58.5 percent (ILO, 2017), well above the corresponding figure in many other PICs, such as Fiji (15 percent), Samoa (19 percent) and the average of developing countries in the Asia and Pacific region (11 percent).66 Moreover, 44 percent of young Marshallese men aged 20–24 years old are defined as not in employment, education, or training, by an estimate by the Secretariat of the Pacific Community (ADB, 2016). This large pool of idle youth, together with the acutely low labor force participation rate among females, represent both a failure of the economy to fully utilize its human capital and an important loss of potential economic gains. Figure 30: Labor force participation rate for population aged 15–64 Source: World Bank (2018a). Figure 31: Gender gap in labor participation rate in PICs Source: Vanuatu HIES 2019, RMI HIES 2019, Fiji EUS 2015–16, WDI. 66 Data are for year 2017, according to the World Development Indicators database. 85 Republic of the Marshall Islands 163. The economy’s capacity to absorb these prospective workers is constrained by a small private sector whose role in generating formal jobs has been diminishing. The share of employment of the private sector (including Kwajalein US military base) has decreased steadily over the last decade, from 53 percent in 2010 to 46 percent in 2019 (Figure 32). Of all workers employed both part- and full-time in 2019, the public sector (including SOEs) accounted for 49 percent of workers (Figure 33). Outside Majuro and Kwajalein, the government tends to employ a relatively larger proportion of the workforce on neighboring islands, likely owing to the minimum scale required to provide public services at even a basic level (World Bank, 2021b), combined with the constraints imposed on private sector development and job creation by RMI’s economic geography, which are amplified in the neighboring islands. 164. Consistent with this sectoral composition, the industrial composition of employment lacks diversity. The largest share of formal jobs is in public administration (35.5 percent) (Figure 34), whereas the number of jobs in manufacturing more than halved between 2010 and 2019 from 1366 to 601. There is limited prospect for job creation in other industries. Unlike tourism-dependent PICs such as Fiji and Vanuatu, but similar to the neighboring atoll nations of Tuvalu and Kiribati, the tourism industry has limited potential for large scale employment with fewer than 6,000 visitor arrivals per year or less than 0.1 arrivals per capita (World Bank, 2016). The significant investment required in infrastructure, marketing, upgrade of hotel stock and capacity building for the industry means that it would be difficult for RMI to gain a positive return on investment from additional tourist spending, even within a long-term horizon (see paragraph 222). The fisheries sector is the largest private sector contributor to the economy but is not a large employer—and opportunities to develop the sector may not generate large numbers of new jobs (see Section 1.3.1). Finally, with much less arable lands than other PICs, the share of workers (formal and informal sectors) in agriculture67 in RMI is also relatively low at 23.1 percent of working-age population in 2012 (World Bank, 2016), the fourth lowest among the eight small PICs. Figure 32: Share of employment in private sector Figure 33: Number of employed workers by sector (including Kwajalein US military base) (2019) 56% 54% 52% 50% 48% 46% 44% 42% FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Source: World Bank staff calculation based on Social Security and ‘non-reported’ estimates by EPPSO. 67 Including hunting, fishing and forestry. 86 Country Economic Memorandum and Public Expenditure Review 165. While data on informal employment is scarce, it is evident that subsistence-based fishing and agriculture are important sources of livelihood outside of Majuro and Ebeye. Home production and sales of agricultural and fishing products account for about 22.6 percent of income of an average rural household, whereas income from employment contributes 20.7 percent (Figure 35). In Majuro and Ebeye, household income has a very different composition, with the income share of agriculture and fishing being negligible, while employment accounts for nearly 48 percent of household income on average. Figure 34: Number of employed workers by industry (2019) Figure 35: Share of household income sources Source: World Bank staff calculation based on Social Security and ‘non-reported’ Source: World Bank staff calculation based on HIES 2019. Note: Rent is estimates by EPPSO. a significant share of gross income, likely due to the high imputed rent values. Labor migration 166. The economy’s low potential to generate quality jobs has several important implications. One is that workers are likely to seek employment overseas, particularly to the US. The Compact allows Marshallese without a visa to reside, study and work in the US. Another implication of the shortage of quality employment is that returns to education are low, which discourages prospective workers to pursue education and training, thereby limiting the country’s stock of skills.68 Difficulties in obtaining quality jobs in the formal sector, particularly amongst those entering the workforce, might also serve to disincentivize participation in the labor force. 68 An ongoing World Bank analytical project, the Pacific Cross-Country Poverty Assessment, will utilize recent HIES data from Fiji, Vanuatu, Samoa, Kiribati and RMI to estimate consistent and comparable returns to education. Results will be published in FY22. 87 Republic of the Marshall Islands 167. Key drivers of labor migration from RMI to the US include both the lack of quality formal sector jobs in RMI and significant wage differences between the two jurisdictions. Salaries in the US are far higher than those in RMI for equivalent occupations: the US federal minimum wage is US$7.25/hour whereas in RMI the minimum wage is only US$3/ hour; the median household income for Marshallese in the US being US$33,600, compared to US$6,467 in RMI. These significant differences mean that Marshallese workers, especially low- and semi-skilled ones, can engage in low-skilled occupations in the US and earn considerably more than they would in similar jobs in RMI. Migration therefore clearly presents earnings opportunities for migrants, even if incomes of Marshallese in the US are below those of the broader US population, including other migrant groups. 168. Non-salary factors also contribute to the emigration flow, including access to better education and healthcare services and the potential for children to be US citizens (IMO, 2019). A recent study on RMI migrants in the US mainland and Hawaii reveals that environmental issues, including drought, lack of fresh water and rising sea levels, are a factor behind emigration decisions, though not yet a major driver (Van der Geest et al., 2019). The study finds that household respondents who perceive that access to food and fuelwood and protection against storms and floods are deteriorating are more likely to intend to migrate in the next 10 years. 169. The number of Marshallese migrants in the US is significant and growing. Between FY03 and FY13, the number of Marshallese that emigrated to the US numbered 7,228, equivalent to 13.9 percent of the RMI’s population over the ten-year period (US Graduate School, 2018a). Cumulatively, the number of Marshallese residing overseas (most of whom are in the US) is equivalent to about 30 percent of the domestic population. Despite these significant numbers, the emigration of Marshallese to the US is relatively recent, as evidenced by the composition of the Marshallese diaspora: about 58 percent of Marshallese residing in the US were ‘foreign’ born (mostly in RMI); the percentages were moderately higher among the Marshallese living in Arkansas and Hawaii at 61 percent (Levin, 2017). 170. Most Marshallese workers in the US engage in low-wage jobs. These are mainly in the poultry industry or in essential jobs that cannot be performed remotely (McElfish, et al., 2021). Data from the American Community Survey 2015 show that 41.9 percent of employed Marshallese aged 16 and above engaged in production, transportation, and material moving occupations, and 26.6 percent worked in service jobs, which are likely to be either low- or semi-skilled (Table 3). 88 Country Economic Memorandum and Public Expenditure Review Table 3: Share of occupation of employed Marshallese aged 16+ in the US in 2015 (percent) Type of occupations US Arkansas Hawaii Management, business, science, arts 9.3 5.1 8.4 Services 26.6 14.1 40.2 Sales and office 15.8 7.8 21.7 Natural resources, construction, maintenance 6.4 8.9 6.2 Production, transportation, material moving 41.9 64.1 23.6 Source: Levin (2017). 171. This occupational profile makes Marshallese migrant workers vulnerable to economic hardship and shocks. The median household income for Marshallese in the US is just 60 percent of the US population. The poverty rate amongst Marshallese families in the US is 40 percent overall—37 percent in Arkansas and 46 percent in Hawaii in 2015. These figures are significantly higher than the national average and also higher than that of other immigrant groups in the US (Levin, 2017). COVID-19 is likely to have made such figures worse, given the skills profile of Marshallese and the disproportionate impacts of social distancing requirements on workers with low work-from-home capacity or high physical proximity jobs—such as sales and services (Mongey and Weinberg, 2020). Foreign labor 172. RMI is reliant on foreign labor notwithstanding its poor domestic labor market outcomes and high level of emigration amongst Marshallese workers. Foreign workers occupy both skilled and semi-skilled positions, with some migrant groups also occupying low- skilled jobs, though to a lesser extent. Between November 2016 and August 2020, 953 foreign workers were employed in the country, half of whom were skilled workers and 43 percent of whom were semi-skilled workers (Figure 36). Unskilled labor accounted for just 1.2 percent of all foreigners legally working in the RMI69, though illegal employment of foreigners who can readily enter the RMI (such as i-Kiribati) means this is likely an underestimate. The demand for foreign workers is driven mostly by a shortage of skilled workers in the domestic market, which is discussed in Section 2.1 in more detail. 69 According to administrative data on work permits and the Public Service Commission. Some permit holders were license holders; hence the cumulative share of skilled, semi-skilled and unskilled foreign workers is slightly smaller than 100 percent. 89 Republic of the Marshall Islands Figure 36: Number of foreign workers by economic sector and skill level Source: Calculated by World Bank staff based on work permits and public service commission data. 173. The economy relies on foreign workers to fill not only short-term but also medium- and long-term jobs. This is demonstrated by the considerable number of two-years work permits and permit renewals. Work permits for non-resident workers in the RMI are issued for a period of up to two years and can be extended for up to three years in total. Amongst foreigners granted work permits during the period since September 2016, a third were issued permits that are valid for two years, two thirds were on permits that had been extended, and 14.3 percent of all foreign workers had their permits renewed between September 2016 and September 2019. 174. The extent of reliance on foreign workers differs between the private and the public sectors. The private sector is not only the main driver of the demand for foreign labor but is also more reliant on these workers. Private businesses employ 82 percent of all foreigners working in RMI, with these workers accounting for 12.7 percent70 of all workers in the private sector. The corresponding share of foreigners working in governmental agencies is 3.2 percent. Challenges Skills shortages and the labor market 175. RMI suffers from a significant skills shortage as both educational attainment and proficiency levels remain low. The secondary net enrollment rate was only 55.9 percent in 2016, well below that of other PICs such as Samoa (86 percent in 2016), Fiji (84 percent in 2019), Tuvalu (67 percent in 2018) and Tonga (82 percent in 2015).71 The country also has the highest proportion of male adolescents out of school in the Pacific region at more than 33 percent in 2019, with the dropout rate amongst grade 9–12 students being 43 percent in 2019. In terms of proficiency, the 2019 Marshall Island Standards Achievement 70 According to the Social Security data and EPPSO ‘non-reported’ estimate, there were 11,325 formally employed Marshallese in 2018 (both part-time and full-time), which include 5,328 workers in the public sector and 5,997 in the private sector. 90 71 According to data from World Bank (2020) and the Fijian Ministry of Education, Heritage and Arts. Country Economic Memorandum and Public Expenditure Review Test (MISAT) results for Marshallese reading indicate that only 38 percent of grade 6 students met or exceeded proficient levels. For English reading, only 19 percent of grade 6 and 27 percent of grade 12 students met or exceeded proficient levels. Math results show that only 19 percent of grade 6 and 14 percent of grade 12 students met or exceeded proficient levels. These results have remained generally static since 2012 (ADB, 2017; MEST, 2019) (see Section 2.5 for a detailed discussion of education outcomes). 176. The shortage of skilled workers in RMI is reflected in the profile of foreign workers, which varies between the public and private sectors. Foreigners working in governmental agencies are for the most highly skilled (92.4 percent of the total), with many being health and medical professionals (67.4 percent). Indeed, 70 percent of foreigners working in GoRMI are employed by the Ministry of Human and Health Services. The remaining 30 percent occupy a wide range of jobs with a considerable proportion being finance and accounting professionals. The picture in the private sector is very different. Private sector employers seek foreign workers with a broader range of skills, including both skilled and semi-skilled workers. The major groups of occupations that foreign workers occupy in private businesses, in descending order of prevalence, are craft and trade workers, professionals, services and sales workers, and managers (see Table 4). Table 4: Number of foreign workers by occupational sector and skill level Private Public Skill level a ISCO sector Total sector sector Managers 11.1% 10.5% 11.0% Skilled Professionals 20.7% 70.9% 29.8% Technicians & associate professionals 9.6% 11.0% 9.9% Clerical support workers 1.4% 0.6% 1.3% Services and sales workers 13.4% 1.7% 11.3% Semi-skilled Craft & related trade workers 32.8% 4.1% 27.6% Plant and machine operators and 3.7% 0.6% 3.1% assemblers Low Elementary occupations 1.3% 0.0% 1.0% FIBL holder 4.9% 0.0% 4.0% N/A Unclassifiable* 1.0% 0.6% 0.9% a: The International Standard Classification of Occupations (ISCO) is an international classification for organizing jobs into a clearly defined set of groups according to the tasks and duties performed in the job. ISCO is under the responsibility of the International Labor Organization and is part of the international family of economic and social classifications of the United Nations . The current version of ISCO, published in 2008, classifies occupations into 10 major groups (or occupational sectors) and subsequently four broad skill levels. ISCO defines skill level as a function of the complexity and range of tasks and duties to be performed in an occupation, with level 1 being the least skilled and level 4 being the most highly skilled. Further information on ISCO groups and skill levels can be found at https://ilostat.ilo.org/resources/methods/classification-occupation/. During the preparation of this note, job titles of each foreign worker in the RMI work permits and public service commission data are matched to an ISCO occupational sector and a corresponding ISCO skill level. The three skill levels presented correspond to ISCO skill levels as follows: ‘Skilled’ is equivalent to ISCO Skill Levels 3 and 4 (High); ‘Semi-skilled’ is equivalent to ISCO Skill Level 2 (Medium), and ‘Low’ is equivalent to ISCO Skill Level 1 (Low). *: Due to lack of data on occupation and job titles. Source: Calculated by World Bank staff based on work permits and public service commission data. 91 Republic of the Marshall Islands 177. Within the private sector, the skills gaps appear most acute in the construction, wholesale and retail trade, and food manufacture industries. Construction, wholesale, and retail businesses account for the largest number of semi-skilled foreigners, whereas wholesale, retail and food manufacture are industries where skilled workers are most demanded (after the public sector) (Figure 37). 178. Poor quality education and lack of access to appropriate training opportunities in areas where there is labor market demand for skills underlie the skills profile of the Marshallese workforce and associated reliance on foreign workers by the private sector. 179. Such challenges are exacerbated in certain locations due to unequal access to quality education and training opportunities. Within the country, the poor are more concentrated in the neighboring islands where schools are of lower quality, which is evidenced by the consistent underperformance of students on neighboring islands in MISAT tests as compared to their urban peers. School enrollment rates among adolescents aged 14–16 years old are markedly lower in rural areas than in urban areas—importantly, the urban/ rural gap is wider than the poor/non-poor gap within each region, signaling a spatial disparity in access to education services (Figure 38). Open access to residency in the US means that well-off Marshallese students can seek better education options in US schools—increasing the likelihood of migration in the long term—while those from disadvantaged backgrounds cannot, due to prohibitive travel and study costs in the US. Figure 37: Number of foreign workers by industrial Figure 38: School enrollment rate among sector and skill level adolescents aged 14–16 years old Source: Calculated by World Bank staff based on work permits and public Source: World Bank staff calculation based on HIES 2019. service commission data. 92 Country Economic Memorandum and Public Expenditure Review 180. Challenges to delivering quality education are discussed in Section 2.5. These include poor teacher quality at all levels, lack of teachers and resources, and poorly translated and adapted teaching materials that are borrowed from the US. The country has one of the lowest percentages of trained teachers in lower secondary education in the Pacific, ranked above only Vanuatu (World Bank, 2020). In 2019, only 32 percent of teachers across the board had a bachelor’s degree or higher. 181. In the TVET sector, vocational training opportunities are limited. This constrains the supply of semi-skilled workers in key occupations and forces employers to rely instead on foreign workers. This situation is inevitable to some extent in a small economy like that of RMI, but it is made worse by fragmentation within the education sector and limited links between training and the labor market. 182. There is no current overarching strategy for the TVET sector, nor are there industry- validated standards, an apprenticeship scheme, or a trades testing and certification regime. For example, vocational courses in secondary school are not linked to courses taught by the College of the Marshall Islands (CMI) or the University of the South Pacific (USP). While coordination of the post-secondary education sector is notionally the responsibility of the National Training Council (NTC), there is no formal administrative structure through which this should occur. NTC also lacks capacity, as acknowledged in its Strategic Plan 2019–21. The absence of a Secretary for Education means that coordination in the education sector is ad hoc, with the various education agencies and institutes reporting directly to the Minister. 183. Linkages between courses, training service providers and the labor market are also lackluster. There is no labor market skills database in place that would enable TVET providers and policymakers to identify skills gaps,72 although a labor market skills assessment was undertaken in 2015 which identified vocational skills as an area requiring immediate attention and investment. Indeed, the NTC Strategic Plan 2019–21 outlines a plan to strengthen linkages with employers and training-to-work transitions, including establishing a technical training program with stronger links to the Kwajalein army base operations. This could be a source of hundreds of high-paying jobs for Marshallese that have the required skills and qualification. 184. The Marshall Islands Scholarship, Grant, and Loan Board (MISGLB) has aimed to promote enrollment in courses that aim to fill those gaps by providing financial assistance to students enrolled in (currently) 11 fields of priority, with the relevancy of these priorities to be reviewed every five years. By covering enrollment in accredited colleges or universities in the US and the Pacific region, and requiring a family contribution based on household income, the scholarship is designed to promote equitable access to quality post-secondary education and training opportunities overseas. 72 A labor market information system was established as part of an ADB-funded Skills Training and Vocational Education Project (2001–2005), however, in the absence of in-house staff capability at the NTC, it was not made fully operational. 93 Republic of the Marshall Islands 185. However, the effectiveness of the scholarship in improving the country’s skills stock is limited due to two factors. One is that the current priority fields are very broad and do not directly correspond to the domestic skills needs.73 Related to this, the MISGLB regulation states that “the financial assistances are normally for study towards an academic, technical or vocational educational degree unless approval is given for study leading to a professional certificate or license.” The focus on degree programs means that insufficient support is provided for training in semi-skilled vocational occupations which foreign workers tend to occupy in the private sector (such as in the case of craft and related trade work). The other issue is the low rate of return to RMI of the students that the scholarship finances to study overseas. The scholarship requires recipients to work in the RMI upon completion of their study for at least the duration of the financial assistance received, otherwise both the recipient and their guarantor are responsible to repay the scholarship. However, there is a lack of data on enforcement and compliance with this requirement. To assess the efficiency of the funding to the MISGLB, compliance should be monitored more closely and reported on. Emigration and continued reliance on foreign workers 186. The combination of emigration and reliance on foreign workers for domestic skills needs presents unique challenges with respect to developing the RMI’s labor force. The equilibrium between foreign workers and emigration seems to be sustained by three factors: (i) skills shortages and mismatches between training provided to Marshallese and labor market needs; (ii) differences between domestic and overseas wages; and (iii) differences between the costs of hiring local and foreign workers. Employers highlight difficulties in finding suitable local workers due to their lack of soft skills, such as conflict resolution skills, basic organizational skills, and timeliness, as well as difficulties in attracting and retaining both skilled and unskilled Marshallese workers. 187. Given the significant investments in education and training required to close the domestic skills gaps, RMI’s reliance on skilled foreign workers is unlikely to diminish in the short and medium term. The challenge of meeting domestic demand for skilled workers is twofold. First, it involves increasing the country’s capacity to upskill the workforce. Second, it involves attracting Marshallese workers with the right skills to employment opportunities. The country’s low level of post-secondary educational attainment represents a bottleneck to the domestic supply of skilled labor—as of 2019, only 6.3 percent of adult Marshallese aged 25 and above had completed a university or professional degree, and another 17.7 percent had had some post-school training but obtained no degree. The open access to the US labor market, where wage levels are significantly higher, is potentially another factor. For skilled occupations like clinical/specialist nurses and physicians, the lack of domestic training facilities that can provide quality courses to meet the required skills and the open access to the US means that many Marshallese go overseas to train, with the result being that many are likely to stay working overseas after their training due to the higher wages. 73 The areas of priority identified in the MISGLB Regulations 2018 are: (i) education, including early childhood, elementary & secondary education, post-secondary counselors, sociology, anthropology & archeology; (ii) health & allied fields, including optometry, prosthesis, medical technology, x-ray, etc.; (iii) ICT, including Information Management; (iv) management, entrepreneurship, business & administration, economics & accounting; (v) fisheries, marine sciences and maritime studies; (vi) trade & industry (degree level); (vii) law and law enforcement; (viii) science, engineering, and technology; (ix) 94 environmental science, including climate change and disaster risk reduction; (x) agriculture & aquaculture; and (xi) energy. Country Economic Memorandum and Public Expenditure Review 188. Challenges relating to recruitment and retainment of Marshallese workers appear to stem at least partly from high reservation wages, although data on this is limited, and the mechanism through which a reservation wage would impact employment operates differently for skilled and unskilled labor. For unskilled workers, the minimum wage in the RMI is among the highest in the PICs, yet this is not underpinned by higher productivity and appears to be below the reservation wage for many working-age adults (interestingly, recent increases in the minimum wage are generally not viewed as problematic by the private sector).74 The combination of the wage gap and the legal ease to migrate to the US creates upward pressure on the reservation wage in RMI, that is, the wage level at which workers are willing to accept a particular type of job. Higher living costs in the US, which might deter emigration, are likely defrayed to some extent by initial support provided by the large Marshallese diaspora in the US. 189. For skilled workers, the returns to their skills are generally higher in the US and thus they can seek better paid jobs overseas. The wage required to attract a skilled Marshallese to stay locally could therefore be higher than the overall cost to search for and hire a foreign skilled worker (including relocation, living costs and other benefits), especially foreign workers from countries with lower wage levels, like the Philippines, China, and Fiji. This is likely to explain why a large number of foreign workers in RMI are from these countries. 190. Other factors that could contribute to a high reservation wage include large rent transfers to landowners and strong structures of social responsibility and obligation, which facilitate the sharing of disposable income amongst the community and extended family networks and dampen incentives to work. Further investigation and better data are needed to fully understand the dynamics between Marshallese labor migration and the need for foreign labor. 191. The potential adverse impacts of labor migration on the domestic labor market are a widely held concern in RMI. High rates of emigration from a small economy pose the risk of brain drain and can potentially contribute to reliance on foreign workers which is problematic insofar as it can create a burden for domestic employers. Such concerns are not unique to RMI; they are also faced by many other small PICs. 74 Nevertheless, this may reflect a type of ‘insider/outsider’ problem—where those businesses that exists are profitable enough to be able to absorb higher labor costs, while the already-high labor costs mean that other businesses that might exist in a lower-wage environment are not viable in the RMI. 95 Republic of the Marshall Islands 192. Migration of highly educated Marshallese can nevertheless also be viewed as positive. Approximately 39 percent of tertiary-educated Marshallese emigrate, or more accurately, remain overseas having completed their studies (Figure 39). This is above all a simple reflection of the opportunities available to graduates overseas, and the fact the RMI economy produces a limited number of quality jobs. Migration opportunities afforded to Marshallese enable such graduates to take up employment in their area of study and at higher income levels—again, an inevitable consequence of migration which is positive for Marshallese migrants and has the potential to benefit family and kinship groupings remaining in RMI. Figure 39: Emigration rate of tertiary-educated population Source: World Bank (2016). 193. Global evidence suggests that such opportunities likely also play a role in decisions to invest in education, with the prospect of migration being significant factor in the decision to undertake tertiary education for many individuals. Viewed in this lens, such investments in education may not occur in the absence of labor migration opportunities (Gibson and McKenzie, 2010). 194. The skills profile of the Marshallese workforce limits the average migrant’s ability to compete for quality overseas employment notwithstanding individual success stories. The country’s low level of post-secondary educational attainment not only poses a major challenge to boost the domestic supply of skilled labor but also means that only a small portion of Marshallese workers can compete for semi- or high-skilled jobs overseas, where post-secondary education is commonly required. Even among Marshallese aged 25 and above already living in the US, only 26.7 percent had some college education in 2015, much lower than the corresponding figures among other migrant groups (Levin, 2017). 96 Country Economic Memorandum and Public Expenditure Review 195. Low levels of English competency also place limits on the employability of Marshallese migrant workers, restricting their ability to fully integrate and reap the benefits of the US residency. Among working-age Marshallese in the US, about 15 percent reported that they either speak English “not well” or “not at all” according to the American Community Survey 2015. The figure among the elderly was significantly higher, at 46 percent. As a result, language barriers have made it difficult for Marshallese migrants, especially the elderly, to access health-care services and the social assistance benefits that they are eligible for, such as the Supplemental Nutrition Assistance Program. During the COVID-19 pandemic it was widely reported that language barriers also hindered their access to public health information (Thompson, 2020; Dreher, 2020). COVID-19 and migrant workers in the US 196. In the short and medium term, Marshallese already in the US face the dual challenges of disproportionally elevated infection risk and adverse employment and income effects as the pandemic continues. The occupational profile of Marshallese migrant workers in the US, which is predominantly in low-skilled work (Table 3), means that they are less likely to perform their job remotely and hence face disproportionally higher risk of infection. 197. The rates of COVID-19 infections, hospitalizations, and deaths were significantly higher among Pacific Islanders in general, and Marshallese in particular, than among other racial and ethnic groups in the US. For example, Marshallese are estimated to make up just 1.5–3 percent of the total population of Benton and Washington counties (Arkansas) yet accounted for 19 percent of all COVID-19 cases in the region. Nationally, the US Centers for Disease Control and Prevention (McElfish et al., 2021) reported that less than 0.01 percent of patients with COVID-19 were hospitalized as of June 2020, but among Marshallese patients during March–June 2020, the hospitalization rate was 9 percent (McElfish et al., 2021). Most alarmingly, Marshallese accounted for 38 percent of the reported deaths in Benton and Washington counties during the same period. Similarly, the Marshallese death toll from COVID-19 in Dubuque country (Iowa) reportedly amounts to 40 percent of the county’s total, despite the Marshallese community making up just 1 percent of the overall population (The Guardian, 2020). 198. At the same time, low-wage jobs involving low skill levels have been hit hardest by the economic fallouts from the pandemic. About 86 percent of jobs that the pandemic has made vulnerable in the US have a wage of less than US$40,000 a year (World Bank, 2020). A rapid assessment by the International Organization for Migration reports that many Marshallese migrants in the US have temporarily been made redundant or are working reduced hours and are experiencing reduced household income as a result. Some people have reported choosing not to work in order to avoid potentially exposing other members of the household, including elderly people with preexisting conditions (IOM, 2020). 97 Republic of the Marshall Islands 199. These problems are compounded by existing issues related to lack of housing, food insecurity, and lack of access to health care that have been documented pre-COVID-19 among Marshallese diaspora members. For nearly 25 years, Marshallese migrants and other Compact migrants were ineligible for Medicaid in the US. Their access to the program has only recently been restored in late December 2020.75 In 2015, the proportion of uninsured Marshallese adults was 48 percent, more than five times higher than the proportion of uninsured adults at the national (8 percent) and state (9.1 percent) levels, most likely due to the lack of Medicaid eligibility (McElfish et al., 2021). The low rate of insurance coverage has placed Marshallese migrants at elevated risk of economic hardship if they fall sick, given their generally low income levels and the prohibitive costs of health care services in the US. While the recent restoration of access to Medicaid is a welcome development, more is needed to protect welfare of migrant workers in the US. 200. The adverse effects of the COVID-19 pandemic in particular and other shocks in general on Marshallese living in the US are also exacerbated by their inadequate access to social assistance measures. While significant economic support has been made available to Marshallese households and diaspora communities across the US under US Federal Government COVID-19 response packages, there is an ongoing risk that access to some economic and welfare support will cease (IOM, 2020). Removal of access to the Supplemental Nutrition Assistance Program, for instance, could threaten food security in migrant communities. Opportunities 201. Despite the current challenges that Marshallese migrant workers face in the US, the open access under the Compact presents an important growth opportunity for RMI in terms of employment, skills acquisition, and remittance income. In the short term, the US economy, although continuing to be affected by the COVID-19 pandemic and efforts to contain it, has performed better than anticipated. The unemployment rate has steadily declined since it peaked in April 2020 and job gains have occurred in various industries (US Department of Labor, 2021). How Marshallese workers can make the most out of their open access to this market depends largely on their competitiveness for quality well-paid jobs, especially in industries that are likely to expand such as healthcare (World Bank, 2020). 202. Migration also has potential to benefit broader family and kinship groupings through sending of remittances. Remittance flows historically have not been as significant in RMI as in Polynesia, but they have increased steadily in the last decade, from US$22 million in 2010 to US$31 million in 2019. Among the top 10 remittance receiving countries in the Asia and Pacific region, RMI ranked third in 2019 when remittances were measured as a percent of GDP (Figure 40). More importantly, remittances are a widespread source of 75 Under the Compact, Marshallese citizens enter the US as ‘legal non-immigrants’. Prior to 1996, this status offered them Medicaid coverage. However, in 1996 the US government passed a welfare reform bill that changed the categories of people qualifying for federal aid programs, including Medicaid. As a result, Marshallese and other Compact nation citizens (FSM, Palau) were made ineligible for the program. 98 Country Economic Memorandum and Public Expenditure Review Credit: Eric Sales / ADB income for Marshallese households, with about half of rural households, a third in Majuro and two thirds in Kwajalein receiving remittances (Figure 41). In absolute terms, the median annual remittance income is highest in Kwajalein/Ebeye at US$530, followed by rural areas (US$452). It is lowest in Majuro, at US$434. Global evidence has demonstrated that remittances provide an important safety net for the poor, with remittance flows often being counter-cyclical (especially where shocks are confined to the receiving country). This suggests that inward remittances help to alleviate poverty in RMI, especially in rural areas where the poverty rate and the number of poor are both higher. Figure 40: Remittance inflows as percent of Figure 41: Share of households that receive GDP (2019) remittances by location Source: World Bank. Source: World Bank staff calculation based on HIES 2019–20. Recommendations 203. Supporting the development of labor market-relevant skills amongst Marshallese is key to both improving the competitiveness of Marshallese overseas and improving labor market outcomes in RMI. This section outlines some practical steps that can be taken in both the short and long term to help achieve this. 99 Republic of the Marshall Islands Employment 204. Education of prospective workers and upskilling of current workers are crucial to improving employability and access to quality jobs, whether at home or overseas. In the long term, an integrated holistic approach is needed at all levels of schooling to address disappointing schooling indicators, raise skill levels in the labor force and improve linkages with the economy. Thus, while a focus in the short and medium term on vocational training is important, it must be complemented in the long term by a focus on education from an early age. The upskilling agenda—one that aims to equip those already in the labor force with new and more employable skills—must include a focus on both technical skills and qualifications, as well as soft skills commonly used in the workplace. Improved English language skills are also important. Strengthening of TVET education should also be focused on occupational skills that are demanded by employers (both domestically and in areas of the US where there is a large Marshallese population). 205. In the medium term, vocational training programs to increase the supply of semi-skilled workers are more likely to yield economic gains. Semi-skilled occupations where skills gaps appear to be most severe, based on foreign worker data, are: (i) craft and trade workers, particularly in construction, wholesale and retail trade and food manufacture, and (ii) services and sales workers, especially in wholesale and retail trade (Table 5). It should also be noted that the occupations in food manufacturing are mainly for fishing and fish processing businesses. A more comprehensive skills needs assessment would be useful to further investigate the skills (both soft and hard) that Marshallese workers are currently lacking. Table 5: Number of foreign workers by industrial sector and occupational sector Craft & Plant & Technicians Clerical Services related machine Elementary Industrial sector Managers Professionals & associate support and sales trade operators/ occupations professionals workers workers workers assemblers Education 0 32 0 0 0 0 0 0 Accommodation 5 9 5 3 20 6 9 1 & food services Manufacture 18 32 21 1 3 32 3 5 (food products) Others 21 30 18 3 21 15 2 2 Government 18 122 19 1 3 7 1 0 Wholesale & retail 31 37 18 2 53 44 0 2 Construction 12 22 13 2 8 159 15 0 Total 105 284 94 12 108 263 30 10 Source: Calculated by World Bank staff based on work permits and public service commission data. Note: FIBL holders and workers with unclassifiable occupations account for a negligible share of all foreign workers. Thus, for presentation purpose they are excluded from the table. 100 Country Economic Memorandum and Public Expenditure Review 206. The government of RMI could also consider better linking training with labor market demand and better resourcing of vocational training in key areas. Improved labor market information is key to such reforms and evidence-based policy interventions. The availability of comprehensive, reliable, and up-to-date labor market data in turn could be fueled by the establishment of a labor market information system that not only consolidates existing data resources and enforces legal requirement to report data, but also facilitate the collection and management of new data related to the supply and demand for workers. Data from comprehensive surveys of the formal and informal economies, as well as annual surveys of school leavers and higher education graduates can be developed into a skills database, while a demand database can be powered by an annual survey of industry needs. These skills and demand databases can form the basis of a comprehensive labor market information system. Moreover, regular labor market analysis that identifies skills in demand and provides incentives to training providers to deliver courses in these areas is needed for more efficient and effective investment in TVET. Beyond providing data to labor market surveys and analyses, employers could also be actively involved in the development of curriculum for training courses and in providing internships to students. Such involvement would not only help training curricula to be tuned to employer’s demands, but also facilitate collaboration between employers and training service providers, as well as networks of employers and graduates. 207. Support for Marshallese to enter the workforce, thereby gaining valuable soft skills and workplace experience, should also be a priority. A recurrent complaint from employers relates to the lack of soft skills amongst the workforce. This is likely to partially explain the high numbers of foreign workers in semi-skilled roles, which include jobs that require generic skills such as mid-level managerial positions and administration. It also likely explains the challenge that low-skilled Marshallese face in securing formal sector employment, though wage levels and a high reservation wage are no doubt also a factor in the low levels of labor force participation evident in RMI. Enhanced support for Marshallese job seekers, including individualized job counselling services and intermediation services which connect job seekers with employers, can assist this group. A temporary wage subsidy which is currently planned for low-skilled jobseekers can also help to provide work experience to this group and connect them with employers.76 76 Wage subsidies will support work placements amongst low skilled Marshallese, with funding provided as part of the World Bank-financed Education and Skills Strengthening project. Under the scheme, temporary work subsidies will decline over time, as the experience and productivity of new labor market entrants increases, with employers covering an increasing portion of the job-seeker’s wage. The work placement program will complement the existing internship scheme that supports paid work experience amongst college graduates, with both schemes to be managed by the NTC. It is expected to commence in 2022. 101 Republic of the Marshall Islands 208. Improving the efficiency of the work permit system is worthwhile as RMI will always be reliant on foreign labor to some extent due to its small population. Although the current work permit system functions reasonably well in terms of filling skills gaps, streamlining separate work permit and visa applications made to the Divisions of Labor and Immigration (respectively), a current focus of GoRMI, would help to speed up processing times for permit applications. So too would addressing bottlenecks and capacity constraints within the implementing agencies: at the time of writing, for example, the Labor Division which processes work permit applications was severely under-staffed. 209. A review of the Labor (Non-Resident Workers) Act 2018 is also warranted. Business sector representatives have reported that the new legislation has made it more difficult to bring back foreign workers who have left the RMI at the end of a previous work contract, with conflicting interpretations of the Act in some cases resulting in the application of a three-year waiting period before a worker can return to the RMI.77 If this waiting period is indeed required by the legislation, it will be problematic from a labor market perspective. A review of the Act and the implementation of supporting regulations could help to clarify the law and strengthen the consistency of its application in this and other areas. Labor mobility and migration 210. Many of the reforms related to upskilling the workforce would support Marshallese migrating to the US. Improved education and vocational training, coupled with better development of English language proficiency and soft skills required in the workplace, would place Marshallese migrants on an improved footing in the US labor market. This would have long-term benefits for both migrants and for sending households in RMI. Support and guidance for prospective migrants relating to job searching could also assist to increase employment in the US; and has the potential to also inform education and training decisions where labor market information from key US markets is relayed to prospective migrants. There is also potential for employment intermediation services to extend across international boundaries, as occurs in countries like the Philippines. Marshallese in RMI could be linked with employers in the US before migrating, with secure employment thereby guaranteed and reliance on family for financial support to migrate lessened. Barriers to low-cost remittances should be investigated with a view to informing policy support to lower the costs of sending and receiving remittances. 77 The confusion appears to be with regard to clause 110(2) which states that: “The Director shall not grant a work permit to any person: within a period of three (3) years from the date at which a person has been repatriated, deported or removed from the Republic.” While the business community considers that this should only apply to workers who were forcibly repatriated, it appears that the clause has been invoked for workers who voluntarily repatriated at the end of their contract. 102 Country Economic Memorandum and Public Expenditure Review 211. In addition, a focus on labor market conditions in key US markets is also needed. One advantage of RMI’s TVET system is that the two major training providers—CMI and USP—are both accredited by the Western Association of Schools and Colleges (WASC). This helps to ensure that graduates can be employed in the US, though ensuring training investments are focused on areas of demand remains a priority. A focus on Recognition of Prior Learning (RPL) would also be of value, enabling Marshallese with vocational skills gained in the workplace to gain recognition of these through formal qualifications, thereby improving their ability to secure quality employment in the formal sector (including on the Kwajalein military base). 1.3.3 Other Growth and Development Opportunities ICT sector as a growth enabler 212. Improved ICT services are a key enabler of growth and development opportunities, while other commonly championed sectors—such as agriculture and tourism—are unlikely to drive sustained economic growth. This section considers selected other sectors that have been previously proposed as potential engines of economic growth and development, including ICT, agriculture, tourism, and other opportunities to realize ‘rents to sovereignty’. 213. Developing and increasing utilization of high quality, lower price ICT services could deliver substantial economic and social benefits. This includes: (i) improving efficiency and productivity of existing businesses; (ii) reducing barriers to entry for new firms and industries (including internet-based services); (iii) more accessible telecommunication services for both retailers and end users; (iv) better access to information resources, education and training; (v) fiscal savings and opportunities for the introduction of new methods and technologies in public service delivery (such as telehealth services); and (vi) an enhanced enabling environment for digital government administration. World Bank (2009) and other studies (Katz & Callorda, 2018) show that broadband deployment in developing countries assists economic growth, with each 10 percent increase in broadband penetration associated with an average increase of 0.25 to 1.5 percent in economic growth. A strong positive relationship is also observed between internet connectivity and employment mobility, job creation and job growth, and improved labor force participation rates of married females (Stevenson, 2006; Shapiro and Hassett, 2012; Dettling, 2015). The ability to work and access training opportunities remotely is also improved, which increases economic and social resilience during adverse shocks such as COVID-19 (Garrote Sanchez, et al., 2020). 103 Republic of the Marshall Islands 214. Successful implementation of GoRMI’s planned structural reform to the ICT sector is crucial to unlock the full potential of the digital economy and support private sector development. GoRMI have set out an ambitious reform plan designed to introduce sustainable, reliable, quality ICT services at affordable prices. The reform agenda involves several phases. Market structure reforms, including to reform NTA and deliver improved connectivity infrastructure, are the first and most urgent. This will involve structural changes to make the sector more attractive to private sector investment and to provide a foundation for the introduction of competition. Core telecommunication assets will be separated out and placed into a wholesale infrastructure access provider. A private sector operator will be selected competitively according to Public Private Partnership (PPP) principles to rollout new climate-resilient infrastructure in Majuro, Ebeye and on neighboring islands. The PPP contract will grant the private operator a three-year period of exclusivity during the build period before the market is opened to competition. The enabling environment will be strengthened through complementary reforms to establish, modernize, and implement strong legal, regulatory and governance frameworks. Full implementation of the reform program is expected to take up to seven years. Ongoing high-level political support and development partner assistance will be crucial to realize the vast economic and social opportunities that the project represents. Agriculture, copra, and social protection 215. Agriculture is crucial to support livelihoods, food security and reduce reliance on imports, but is unlikely to drive economic growth and job creation. Agricultural production (excluding fishing) represents a relatively small proportion of the RMI economy (around 4 percent of GDP), but is a key source of livelihoods and a means to address hardship and poverty, especially on the neighboring islands. There is limited underutilized land with the potential for increased output of agricultural food crops, but soil conditions are generally poor. The most important commercial crops are coconuts and breadfruit. To reduce food scarcity, greater focus needs to be given to increasing productivity of traditional/tolerant crop staples through better husbandry practices and farming systems. There are also limited opportunities for smallholder production of vegetables and fruit for the domestic market, including to the US military base in Kwajalein. Improved rain-fed and irrigated water management will be critical to realize these opportunities. 104 Country Economic Memorandum and Public Expenditure Review 216. Copra remains the primary source of cash income in the neighboring islands, although the industry is not profitable, and is sustained by large GoRMI subsidies. The RMI has been involved in copra production since the 1850s and the atolls are widely planted with coconut trees. Yet, copra accounts for only about 1 percent of GDP. Nevertheless, the coconut is still considered the ‘tree of life’ with high potential to produce multiple valuable products both for food security and income generation.78 Consequently, copra value chain development and coconut plantations rehabilitation and replanting continue to be championed as key pathways to promote economic development and income generation. However, there remain very limited linkages between copra farming and the private sector. The industry is dominated by the Tobolar Copra Processing Authority, an SOE that guarantees the purchase of all coconuts harvested in the country.79 World market prices for coconut oil are highly volatile and generally significantly below the equivalent price paid to growers—which is set by GoRMI. The resulting loss incurred by Tobolar is financed by a GoRMI subsidy. As a result, Tobolar is viewed primarily as a vehicle to provide a social protection to residents on neighboring islands, and a mechanism to slow the pace of urban migration from remote areas. From FY04 to FY14, the subsidy averaged US$1.1 million (1.4 percent of recurrent expenditure). However, political decisions to raise the farmer price in FY17 and FY18 saw the subsidy reach US$8.2 million in FY19 (5.7 percent of recurrent expenditure) (see Section 2.1 and Section 2.2.3 for a discussion of the fiscal impacts and sustainability). 217. Establishing a formal social protection mechanism or redirecting the copra subsidy to incentivize production of staple foods would be a more efficient mechanisms to support livelihoods in neighboring islands and could also help address malnutrition. The copra subsidy is unsustainable and needs urgent reform. There are two options: (i) establish a formal income support mechanism—such as a cash transfer program—to vulnerable households, including those in the neighboring islands; and (ii) repurpose the copra subsidy to support production of healthy staple foods or alternatives to processed imported foods, helping to strengthen food security and address the malnutrition and NCD epidemics in RMI (see Section 2.6 for a discussion of health challenges in RMI).80 Furthermore, there is a natural opportunity for strategic decision making. Up to 70 percent of RMI’s coconut tree population is senile (ADB, 2010). Nevertheless, copra production reached a record high in 2020, in response to the higher regulated price. It is likely that this was at least partially due to premature farming of coconuts, which has accelerated the ageing process. When output begins to fall, farmers will likely turn to government to finance rehabilitation and replanting. Before this occurs, GoRMI should begin to explore the viability of alternative crop production. 78 These include coconut oil, copra cakes (used locally as fertilizer), bar soap, cooking oil and ‘beauty’ oil. 79 Tobolar is responsible for collecting, transporting and processing the raw material, paying farmers for their produce, and selling the final products. 80 There are potentially both household-level and national-level nutritional benefits. At the national level, increased domestic production of healthy alternatives can enhance food security and reduce import dependence. At the household level, recent increases in the copra subsidy have reportedly led households in neighboring islands to substitute from fishing and other agricultural production activities to copra. This is hypothesized to have negative effects on nutrition because households substitute fresh fish and other crops for processed food bought with copra earnings. 105 Republic of the Marshall Islands 218. Option 1: Replace the copra subsidy with a first-generation adaptive social protection system. The advantages would be manifold. Key benefits include: (i) lower overall cost; (ii) targeting based on indicators of vulnerability, rather than capacity to produce copra; (iii) a fixed and regular income for beneficiaries, reducing households income volatility; and (iv) the income support registry could be combined with GoRMI’s conditional cash transfer registry to create a first-generation social registry, which would provide authorities with the ability to provide adaptive, crisis-responsive social protection that can be temporarily scaled up based on a range of individual and household factors. Regarding point (i), compared to the existing copra subsidy, an income support mechanism would be substantially more cost effective, as it would eliminate the costs incurred to collect, transport, and process the raw copra—costs which Tobolar do not cover with revenues generated through the sale of its final products. Consequently, an equivalent level of support could be provided to target households at lower overall fiscal cost. 219. Option 2: Repurpose the copra subsidy to incentivize production of healthy staple foods and alternatives to imported processed foods. RMI’s high dependence on imported food makes the nation susceptible to external shocks. Delays in regular cargo vessel arrivals have raised issues and risks of food shortages in the past. More recently, COVID-19 related quarantine requirements have led to similar concerns. By repurposing the copra subsidy, GoRMI has an opportunity to consider a multi-sectoral intervention that could support livelihoods, improve food security and resilience to shocks, reduce import dependence, and help address the malnutrition and NCDs epidemics. Given limited storage capacity, less-perishable foods—such as root crops—could be prioritized. Supporting coastal fishing to sustain coastal communities and ensure sufficient fish for domestic consumption should also be considered.81 Tourism 220. Prior to COVID-19, authorities were focused on niche opportunities to develop the tourism sector. Blessed with rich cultural and historical attractions, authorities have long advocated the potential for the tourism sector to drive higher economic growth, incomes, and job creation. In its 2019–22 Business Plan, OCIT identifies tourism as one of the three target sectors for private sector development, along with the fisheries sector and Micro, Small and Medium-sized Enterprises (MSME). To preserve the nation’s traditional and cultural heritage, and recognizing the constraints posed by geography and land, authorities have proposed a tourism development strategy focused on three niche markets: (i) conference tourism (that is, Majuro hosting regional public and private sector events and fora); (ii) neighboring island diving; and (iii) neighboring island ‘picnic flights’— where both Marshallese and foreign nationals could enjoy a day excursion to a neighboring island to visit a small village and pristine beaches. Authorities note that neighboring island diving and day trip tourism ventures have been successful in the past, and that local governments have been supportive of the proposal during initial discussions. 81 GoRMI intervention to support healthy coastal ecosystems and coastal fishing is further warranted by recent reporting by the US Department of the Army (2017) which identifies that high concentrations of lead in areas around Kwajalein pose cancer risks to the local population that rely on these coastal fisheries as a key source of nutrition. 106 Country Economic Memorandum and Public Expenditure Review 221. COVID-19 has highlighted the risks of a tourism-led growth strategy and has tempered plans for new investments in the sector. Border restrictions, reduced aviation activity and consumer aversion to international travel has led to severe growth impacts in tourism-led economies, including among RMI’s Pacific peers. For example, Palau, Fiji, and Vanuatu have all seen economic activity drop by 10–21 percent due to the crisis. RMI’s strict border restrictions have had severe impacts on the existing tourism industry—particularly the two main hotels in Majuro. While both operations are expected to survive the crisis (partially due to GoRMI financial support), the experience is likely to temper plans for significant new investments, including upgrades to existing facilities. 222. Developing the tourism sector would require a multi-sectoral reform and investment program which may not deliver substantial returns on investment. Developing the tourism sector as a driver of income- and job-creation will require close coordination and substantial investment by both the public and private sectors. Crucially, this partnership would need to: (i) secure long-term land tenure that would encourage private sector investment and development; (ii) facilitate the significant investment in tourism-related infrastructure and private-sector enterprises that is required to develop the sector;82 and (iii) support improved air connectivity with key East Asian markets. Despite numerous past sector development strategies, visitor arrivals (excluding those in transit) have remained relatively stable at 4,000–6,000 annually since 1991, aside from a brief spike to over 7,000 visitors in 2004 and 2005. However, there are discrete examples of past success. In 2007, a twice-monthly JAL charter flight brought in about 200 tourists per flight. Cruise ship tourism also has the potential to contribute to the local economy, however this will depend on travelers’ willingness to return to cruising following the COVID19 pandemic. The Pacific Asia Travel Association has been investigating the viability of home-porting vessels in Guam that could visit the RMI, along with Palau and FSM. Rents to sovereignty 223. Like other PICs, the RMI has explored innovative methods to generate additional economic rents from sovereignty. In the 1980s, GoRMI authorized a passport investment scheme which sold Marshallese passports (and the associated open access to the US) to foreign nationals. Over the last decade the nation has effectively managed to capture more of the rents from its natural ocean resources via the PNA’s Purse Seine VDS (see Box 5 in Section 1.3.1). The RMI has also generated government revenues from its national ship registry, which is now the second largest in the world, and an associated offshore corporate registry (see Box 6). Most recently, in 2018 authorities passed legislation that provides the legal framework for the issuance of The Sovereign (SOV)—the world’s first sovereign cryptocurrency (see Box 4). 82 For example, there is one 149-room resort and a limited number of small hotels offering basic facilities. 107 Republic of the Marshall Islands 224. While the key potential benefit of these opportunities is their capacity to generate public-sector revenues, these ventures also generate risks which can impact the real economy. For example, the opaque management of the RMI’s ship and corporate registries has led to concerns regarding the extent to which adequate AML/CFT practices are being upheld. This has resulted in the nation being listed as ‘non-cooperative for tax purposes’ by the European Commission, which has had a detrimental effect on the business climate and the RMI’s sovereign reputation. Similarly, the proposed issuance of the SOV has led to a re-evaluation of sovereign risk and could hasten the withdrawal of the nation’s last remaining CBR. This would significantly disrupt cross-border financial flows, and increase the risk that RMI could be cut off altogether from the international financial system (see Box 4 and Box 3). GoRMI is currently renegotiating the financial terms of the joint venture with the private company that manages the RMI’s registries. Improved transparency and oversight could reduce some of these AML/CFT and sovereign risks. The renegotiation also raises the potential for complementary benefits to the RMI, such as increased diplomatic representation, skills training and some job creation. However, these opportunities are likely to be relatively limited (see Box 6). Box 6: The RMI’s Ship and Corporate Registries Flags of convenience The RMI has two separate but related registries—a ship registry and a corporate registry.83 Following 20 years of strong growth, the RMI ship registry is now one of the largest in the world.84 The RMI corporate registry has also grown exponentially and is now around 10 times larger than the ship registry in terms of registered companies.85 In FY19, GoRMI received US$7.4 million in revenues (4.7 percent of total revenues, 3.2 percent of GDP) from the two registries; however, the financial benefits could be far greater. For example, the Liberian Government—whose ship registry is a similar size to the RMI—has reportedly received between US$18–22 million a year from the private corporation contracted to operate their ship and corporate registries. The RMI registries are managed via a joint venture (JV) agreement with a set of private firms, jointly referred to as International Registries, Inc. (IRI). First signed in 1988 and amended regularly over the past 20 years, the terms of the JV have gradually changed. Some of the key changes include: • Revenue sharing: From 1990 to 2003 a formula was used to allocate revenues between GoRMI and IRI. In 2003, the formula was replaced by a pre-determined annual payment to GoRMI. This change delinked GoRMI revenues from the registries’ revenues, despite the registries being the sovereign right and responsibility of the RMI. 83 A ship registry is simply the list of ships and their information. Every sovereign nation has the right to host its own registry and has the flexibility to determine the conditions of that registry. International law requires that every vessel which crosses international borders is registered in a country, called its ‘flag state’. A ship is bound by the rules and regulations of its flag state. The flag state determines the legal and regulatory environment for the vessels contained on its registry, and is responsible for conducting regular vessel inspections, certifying equipment and crew, and issuing safety and pollution prevention documents. Similar to ships, companies must be registered in a country to trade nationally or internationally. International corporate registries attract foreign companies through business-friendly laws, taxation, regulation, and reporting requirements. 84 In 2018 the registry contained around 4,500 ships, representing 12 percent of global registered deadweight tonnage. 85 Available evidence suggests that there are around 48,000 companies registered in the RMI. 108 Country Economic Memorandum and Public Expenditure Review • International representation: The 1990 JV agreement enabled IRI to represent the GoRMI at internal fora, including the International Maritime Organization (IMO, a UN body for shipping regulation) and the International Labour Organisation (ILO). In some instances, the company has reportedly expressed a position that differs from that of GoRMI. For example, regarding IMO shipping industry emissions targets. In recent years, GoRMI has sent representatives to participate in IMO climate negotiations. • Oversight: A 1995 amendment introduced changes to limit audits by the RMI Auditor General of the ship and corporate registry operations. There are no legislative or contractual requirements for IRI to provide regular reporting to GoRMI, and records of the registries are not held in RMI or otherwise available to GoRMI. Limited transparency regarding the registries’ management and listed entities was reportedly a factor in the EU’s decision to place the RMI on its list of ‘non- cooperative jurisdictions for tax purposes’ (that is, tax-haven blacklist) in 2017.86 The registries represent substantial reputational and macroeconomic risks to RMI. GoRMI is not involved in the day-to-day administration of the registries—with IRI running all aspects of the registries’ management. Nevertheless, GoRMI remains exposed to substantial reputational risk in the event of a serious environmental or diplomatic event (for example, an RMI-flagged oil tanker leaking into the sea or an RMI-registered company trading with a country or company currently subject to sanctions). There are risks that GoRMI could be exposed to litigation due to actions arising from the management of the registries, and actions or activities of vessels and companies registered in RMI. Finally, actions or activities relating to the registries deemed to be inconsistent with global norms regarding AML/CFT and tax transparency could expose RMI to remedies in international fora and/ or from bilateral partners. Arguably, the current benefits received by RMI do not adequately compensate for these risks. The financial terms of the JV are currently being renegotiated, providing an opportunity for GoRMI to increase the benefits accruing to RMI. In a 2009 amendment, the overall JV was extended until 2050. However, the financial terms of the JV expired in 2020. Aside from seeking a higher share of registries revenues, GoRMI could also consider seeking non-financial benefits, such as employment and internship opportunities for citizens, student scholarships, and adding consular services to IRI’s network of shipping service offices in 28 countries. During the negotiations GoRMI could also seek to address some of the risks emanating from the registries. This could include by seeking: (i) greater transparency and accountability in the operations of the registries; and (ii) increased GoRMI engagement in key strategic decisions of the registries’ management (such as aligning ship registry conditions to the RMI’s commitment to net zero carbon emissions by 2050). 86 The RMI was removed from the blacklist in March 2018 following amendments to the Association Law which require that reasonable measures be taken to identify the beneficial owners of legal persons established in RMI and to register bearer shares. Despite these efforts, the country’s reputational risks remain elevated due to ongoing concerns related to the registries, tax transparency and the implementation of the amendments to the Association Law. 109 Republic of the Marshall Islands 1.4 KEY EMERGENT RISKS TO GROWTH AND SUSTAINABILITY 225. RMI needs to manage the effects of key risks to growth and sustainability to ensure these do not undermine long-term development goals. RMI faces three key risks to growth and sustainability: (i) climate change and natural hazards; (ii) the scheduled expiration of the Compact-related grants in 2023; and (iii) the dual burden of disease (both communicable and NCDs). If not adequately managed, each of these risks could have substantial impacts on macroeconomic stability, fiscal sustainability, and household prosperity. The following section outlines these risks and measures to address them. 1.4.1 Climate Change, Natural Hazards and Vulnerabilities 226. Climate change and natural hazards pose a serious threat to achieving RMI’s development goals in the short to medium term and threaten the nation’s existence in the long term. RMI is already one of the most vulnerable nations in the world to natural hazards, including tropical storms, droughts and flooding. Climate change has the potential to raise the frequency and intensity of these threats. It also brings new threats, in particular in the form of sea level rise. With most land less than two meters above sea level, sea level rise threatens to make numerous parts of the country uninhabitable over the next 30 years. Climate change adaptation and disaster risk mitigation and management are thus central issues for policy, livelihoods and households but the high costs of mitigation and adaptation require careful strategic choices. Transformational adaptation and resilience measures will be needed in the short, medium, and long term. 227. RMI is exposed to multiple hazards which threaten infrastructure, agriculture, health, and livelihoods. Storm surges and swell waves are one the main source of frequent hazards in RMI, while cyclone events are the main source of less-frequent, larger-scale disasters (Deltares, 2017). In the 36 years between 1979 and 2015, 18 significant inundation events were recorded in Majuro (Ford et al., 2018). Wave overtopping (when sea water flows over coastal protective structures) results in inundation, frequent localized evacuations and damage to infrastructure, homes, and communities (NIWA, 2020). From 2011 to 2061, RMI has a 50 percent chance of experiencing a loss due to cyclones and earthquakes exceeding US$53 million (33 percent of FY10 GDP), and a 10 percent chance of exceeding US$160 million (100 percent of FY10 GDP) (World Bank, 2011b).87 Tropical cyclones alone are expected to cause average annual losses to agriculture and infrastructure of around 2 percent of GDP (World Bank, 2015). The RMI has also been impacted by severe droughts, including those in 2015–16 which had an economic effect equivalent to 3.4 percent of FY15 GDP (GoRMI, 2017). 87 These costs, however, calculate losses due to earthquakes and tropical cyclones but do not include damages as a result from more frequent 110 wave-induced coastal hazards or drought. Country Economic Memorandum and Public Expenditure Review 228. Climate change and seal level rise pose significant risks to RMI’s future. Sea level rise is the dominant process that will increase flooding impacts. In Ebeye, it is suggested that sea levels are likely to rise 0.53–0.78 meter by 2100 (Deltares, 2017). In Majuro a 0.33-meter rise in sea level would result in 50 percent of all high tides being above what is presently considered a king tide (presently 10 percent) (NIWA, 2020). Climate change is likely to increase the frequency and extent of flooding in low-lying areas, salination of groundwater lenses and soil erosion—with knock-on effects to health and nutrition, resilience of infrastructure and residential property, and agriculture productivity. Estimates of the best- and worst-case climatic scenarios over the coming 20 years suggest that the annual cost of priority actions in coastal and infrastructure adaptation in RMI are 9–24 percent of GDP (World Bank, 2017a).88 229. Economic modeling suggests that natural hazards have modest impacts on annual economic growth, but sea level rise is likely to have profound economic impacts in the longer term. Research by the IMF finds that the average likelihood of a severe natural disaster is 5.4 percent per year in RMI, with about 25 percent of the population being affected, on average, by a disaster event (Lee et al, 2018). The study estimates that severe natural disasters reduce long-term economic growth by about 0.1 percent per year, relative to a scenario of no natural disasters. In the case of a one-time extreme natural disaster event, annual GDP growth is estimated to be reduced by about 2 percent compared to the case of no disaster. For the latter, the 2018 IMF/WB Debt Sustainability Analysis for RMI indicated that the debt-to-GDP ratio could rise by about 5 percent. However, these models do not account for the potentially profound economic impacts of sea level rise due to loss of land mass, infrastructure, and severe restrictions of basic commodities such as freshwater. Furthermore, as outlined in Section 1.3.1, climate change is projected to have a significant long-term negative effect on RMI’s fisheries sector (see paragraph 125). The consequences of climate change and natural hazards have also started to influence emigration decisions—and could exacerbate outmigration and labor market challenges in the future (see paragraph 168). 230. While climate change and natural disasters have an overall negative impact on RMI, implementation of climate adaptation measures would not only help to protect jobs, but also create new jobs—primarily in the construction sector. For all the opportunities and threats discussed, there will also be increased demand for highly specialized technical and managerial skills. While, at present, many of these skills are imported, with adequate investments in education and training it could be possible to fill at least some of these positions locally (see Section 1.3.2). 88 This figure includes costs of coastal adaptation and adapting infrastructure to increases in rainfall and temperature but does not include the costs of retrofitting buildings to protect against cyclones. 111 Republic of the Marshall Islands Priority actions to support adaptation and resilience 231. The challenge for RMI is the need to address both immediate disaster risks alongside planning for longer term adaptation needs. In the short term, this requires strong Disaster Risk Management (DRM) planning, improved early warning systems for multiple hazards, small scale coastal defenses and shoreline protection, and potentially small- and medium-scale reclaiming of land with stronger coastal planning and systems to ‘build back better’. It also requires interventions to secure the nation’s food (including seafood) and freshwater sources. 232. There is a need to better integrate DRM, resilience, and climate change adaptation considerations across all national, sector and corporate plans. Recognizing the urgent need to enhance RMI’s resilience to climate change and disasters, GoRMI has undertaken several national strategic planning exercises over the past two decades. These have helped to prioritize key mitigation and adaptation investments and integrate resilience and DRM considerations across the policy agenda. Nevertheless, there remain important gaps in RMI’s institutions and systems to support long-term climate change adaptation and DRM. This includes fully integrating climate change considerations into the national planning framework, by strengthening the linkages between the National Strategic Plan 2020–30 to sector plans, ministry corporate plans, and the budget process (via the MTBIF). 233. Resilience to climate change requires a strong adaptation framework and plan. GoRMI developed the Joint National Action Plan for Climate Change Adaptation and Disaster Risk Management (JNAP, 2014–18) to spell out strategic priorities for disaster risk management and climate change adaptation. Though an important step in adaptation planning, the JNAP has not delivered to expectations. Based on a comprehensive review of the JNAP and relevant institutional frameworks, the Climate Change Directorate (CCD) has begun preparations of a broader and more forward-thinking National Adaptation Plan (NAP)—which will include an assessment of medium- and long-term adaptation needs, a prioritized and costed set of investment projects, an analysis of financing options, and a framework for community engagement on longer-term adaptation needs and pathways. Full development and implementation of the NAP is vital to ensure both short- and longer-term resilience.89 234. As climate conditions continue to change, risks of potential health impacts—including communicable and vector-borne diseases—are likely to increase and require policies and guidelines that include health disasters in early warning and disaster response systems. The COVID-19 pandemic has demonstrated the imperative for integrating health disasters within emergency planning and disaster response. Developing and approving policies and guidelines for the inclusion of health disasters in early warning and disaster response systems could also consider the adaptive use and management of public facilities as evacuation (and health or isolation) centers. 112 89 Preparation of the NAP is supported through the WB-financed Pacific Resilience Project II and Building Resilience in the Pacific Atolls study. Country Economic Memorandum and Public Expenditure Review 235. Implementation of the National Disaster Management Office (NDMO) Roadmap is critical to enhance climate resilience and disaster preparedness and management. Located within the Chief Secretary’s Office, NDMO is the lead GoRMI agency for disaster management programs and activities, the secretariat for the National Disaster Committee, and responsible for coordinating the national disaster response clusters. NDMO also liaises with local governments to support programs specific to each atoll. There is an ongoing need to strengthen DRM governance, improve dissemination of multi-hazard warnings, and strengthen local community disaster response. These activities also require capacity building of NDMO. These needs are articulated in the NDMO Roadmap, which identifies priority infrastructure, equipment strategies, action plans and Standard Operations Procedures (SOPs) which need strengthening. Activities should be prioritized over the coming 2–3 years in line with the Roadmap. This should include strengthening disaster preparedness and response alongside priority investment in core early warning communication systems and SOPs, particularly for neighboring islands. An Emergency Communications Stocktaking Report was recently completed, and a Strategic Emergency Communications Plan with an analysis of additional and replacement equipment should be prioritized for finalization in 2021. 236. Beyond improving DRM and early warning tools, short- and long-term adaptation requires improving the integration of hazard and risk information in infrastructure planning, particularly to account for longer-term uncertainties. Up-to-date hazard and risk planning is critical, and existing coastal vulnerability studies (such as those for Majuro and Ebeye), LiDAR Surveys90 and other hazard information such as estimates of sea level rise should be consistently used to inform design and procurement of civil works, infrastructure construction and planning. 237. Improving the resilience of commercial, government and residential buildings is fundamental to short- and long-term adaptation. RMI currently has no building code. This not only undermines efforts to improve infrastructure resilience, but it also limits opportunities for insurance of property that can be assessed against an adequate set of standards. Improving land planning building codes, for example by requiring raising and elevating the height of buildings or ensuring key infrastructure is rebuilt further back from the coastline, can help reduce inundation related damage in the short- and longer-term. 238. Longer-term adaptation and DRM may require deeper consideration of land use and planning. There is very limited land use planning in place in RMI, and even in a dense urban context such as Majuro, there is no approval of building plans, low municipal revenue collection, underinvestment in basic service infrastructure and underutilization of existing land (vacant and unoccupied dwellings alongside land scarcity) (Butcher-Gollach, 2020). Land is the fundamental basis of Marshallese culture and society and most land is still privately owned and held under customary tenure. In light of the long-term threat posed by climate change, there is a need to consider and compare the status quo with large-scale or complex land use changes that can enable alternative adaptation pathways in the longer term, while protecting the social, political and cultural values reflected by customary land tenures. 90 LiDAR (Light Detection and Ranging) is a method for measuring distance by illuminating the target with laser light and measuring the time of 113 reflection the light takes to return to the sensor. Republic of the Marshall Islands 239. Existing development pathways and resilience measures—though providing some short- to- medium-term solutions—will not protect essential infrastructure and land on which a significant proportion of the population live in the longer term. Many of the coastal defenses that have been constructed in the past have been poorly built, with many failing to provide adequate protection from wave overtopping in storm events (NIWA, 2020). The longer-term adaptation needs require a renewed framework and dialogue. They also require consideration of different types and densities of settlement. The development and finalization of the NAP to include these longer-term adaptation planning considerations is critical. A framework has been developed and the full NAP is targeted to be completed by late 2021. The success of adaptation planning will also depend on clear coordination and cohesion across GoRMI ministries and departments, which requires ensuring adequate ownership and resources through the Adaptation Working Group and the CCD. 240. Setting frameworks for community engagement in adaptation planning is critical to ensure that citizens are included in decision making regarding how to respond to long- term climate change. Given the existential threat, there is an urgent need to ensure that communities consider all possible options and ask questions at a national and local level. Dynamic adaptive pathways provide one way of preparing for climate change while also coping with uncertainties, and a critical part of developing pathways is including the community in planning and decision-making. Local approval, ownership and community understanding to ensure mutually agreed outcomes is vital. Engagement processes could potentially build on existing processes such as the Reimaanlok framework,91 in place to support community engagement practices for coastal adaptation to climate change in the neighboring islands. 241. Substantial additional development partner financial support will be required to strengthen RMI’s capacity to address the economic and fiscal impacts of disasters, and to meet the nation’s very large climate change adaptation costs. These needs are outlined in the Fiscal Sustainability section of the PER (Section 2.2.3). 1.4.2 Compact Negotiations and Fiscal Sustainability 242. The amended Compact was designed to provide a declining level of resources in real terms and has resulted in mounting fiscal pressure. As outlined in Box 1, the majority of the Compact assistance falls into two categories: (i) grants that arise from the economic provisions of the Compact which were renewed under the terms of the amended Compact in 2004; and (ii) US federal programs and services. In FY16–18 these grants averaged 37 percent of total revenues and thus represent the largest single source of revenues. Figure 10 in section 1.1 indicates that both categories have either fallen or remained static as a share of GDP, although with some volatility. The CSGs and Kwajalein- related grants—after allowing for the annual decrement and partial inflation 91 The Reimaanlok Conservation Area Management Planning Framework supports RMI communities to use community-based tools to articulate local objectives and translate national, regional and international goals for conservation and area management. At this stage it is used for managing Protected Area Networks. 114 Country Economic Memorandum and Public Expenditure Review adjustment—are effectively fixed in nominal terms. Thus the Compact, while providing a critical source of resources, is similar to the current tax regime in that it also provides an inelastic source of funds. Until the recent boom in sovereign rents the major sources of RMI’s revenue thus led to a persistent tightening of the fiscal envelope. 243. The Graduate School USA (2020) estimates the economic impacts of the scheduled expiration of the economic provisions of the amended Compact under different scenarios. The study included three scenarios: (i) a baseline scenario outlining the impact of replacement of the annual CSGs with drawdowns from the CTF; (ii) a severe scenario with the additional cessation of all federal programs and services; and (iii) Compact renewal for a further 20-year period with continued funding including funds to shore up the CTF to meet its original objectives of providing a sustainable source of funds. 244. The baseline scenario suggests a fiscal adjustment owing to reduced flows from the CTF could be managed through reductions in discretionary expenses with minor impact on the economy. Under the baseline scenario the CTF would permit a sustainable yield of US$20 million in FY24, down from an estimated US$27 million in FY23.92 That reduction is equivalent to 2.8 percent of GDP. The baseline scenario also assumed that the supplemental education grant (SEG) would expire after FY23. The SEG is projected to be US$5.6 million in FY23 or 2.2 percent of GDP. Combined, the loss of the CSGs and SEG amounts to US$12.7 million or 5 percent of GDP. The base scenario assumes adjustment would be achieved through a reduction in expense in the use of goods and service to a level that existed before the increase in sovereign rents and that outlays on infrastructure would fall in proportion to the reduction in drawdowns from the CTF. The one-time reduction in the level of GDP is modest at 1.3 percent and a loss of 100 jobs in the private sector dependent upon delivery of services to government. 245. Loss of federal programs and services on top of reduced drawdowns from the CTF would impose a large shock on the economy. In the severe case with loss of federal programs and services (which the GSUSA indicates is an extremely unlikely given the US indication of its intention to renew the Compact economic assistance arrangements) the impact would be much worse. Federal programs and services are projected to be US$16.9 million in FY23, and their loss would be equivalent to 6.7 percent of GDP. Coupled with the reductions in the base case there would be an annual loss of US$29.6 million or 11.7 percent of GDP. Adjustments are modeled assuming a 25 percent reduction in general public administration to avoid cuts in education and health and a reduction in transfers to other government entities. In this scenario, GDP is predicted to fall by 10 percent and jobs by 1,400 or 13 percent of the labor market. Outmigration is assumed to spike. The impact of the severe scenario is far greater than that of the baseline due to the need to cut government services rather than cutting back on recent discretionary expense. While the severe case is an unlikely outcome, the potential results indicate the degree of dependency and fragility of the RMI economy. 92 This does not include Kwajalein grants, which will continue and are to compensate landowners, not GoRMI. 115 Republic of the Marshall Islands 246. Compact renewal with continuation of all current programs and full indexation without decrement provides a sustainable basis for the conduct of fiscal policy. The Compact renewal scenario is of course more favorable. GSUSA assumes that sector grants and federal programs and services will all continue without interruption and in the case of CSGs they will become fully adjusted for inflation without the annual decrement. This scenario avoids the continual drag imposed on the economy under the amended Compact estimated to be 0.3 percent of GDP and supports fiscal sustainability combined with modest economic growth. 1.4.3 Addressing the Dual Burden of Disease 247. Health has direct and indirect effects on economic growth (Hou et al. 2016). Global evidence increasingly shows that poor health outcomes result in long-term macroeconomic impacts on labor supply, capital accumulation and GDP growth.93 Communicable diseases and NCDs directly affect the labor force through increased disability and premature death of workers as a result of disease complications. They also affect the quality of the labor force, due to absenteeism, comorbidity (including mental health issues) and disability. Premature death and disability can also have indirect and longer- term effects. Indeed, if young children are taken out of school to work or look after a sick relative, the possibility of the next generation improving their own living standards is compromised. An increased disease burden also affects the savings potential and capital accumulation of individuals due to direct out-of-pocket spending on health, which could otherwise be invested in productive assets for households. 248. While health outcomes have improved slowly over time, RMI continues to face the double burden of communicable and NCDs, while significant challenges remain with maternal, child and newborn health. As with several other countries in the region, RMI is undergoing an epidemiological transition. In 2019, NCDs accounted for 70 percent of the burden of disease, up from 53 percent in 2000 (Figure 42). RMI had the world’s highest age-adjusted comparative diabetes prevalence in adults in 2019 (30.5 percent) and is projected to remain ranked first through to 2030 and 2045 (IDF, 2019). This is higher than both the average for the EAP region (12 percent) and the average for its income group (10 percent). It is estimated that the percent of people affected by NCDs will continue to increase in coming decades, due to the population ageing combined with the high prevalence of NCD risk factors. On the other hand, tuberculosis (TB) is a leading cause of death (lower respiratory infections were the fourth cause of death in 2019) (IHME, 2021) and the country has reported multi-drug resistant TB (WHO, 2018). Immunization rates are low and volatile, and in recent years, RMI has had to manage infectious diseases outbreak such as zika, dengue and measles. As of mid-March 2021, RMI had four cumulative cases of COVID-19, with no community transmission and no death. 93 For examples, see Abegunde and Stanciole (2006), Abegunde et al. (2007), Daar et al. (2007), Mayer-Foulkes (2011), Nikolic, Stanciole, and Zaydman (2011), Suhrcke and Urban (2010). 116 Country Economic Memorandum and Public Expenditure Review Figure 42: Disease burden by case in RMI (2000–2019) Source: IHME, 2021. 249. The projected economic burden of NCDs as a proportion of GDP is projected to increase from 6.3 percent in 2015 to 13.6 percent by 2040 (Hou et al, 2016).94 This is not only much higher than the average burden for middle-income countries (estimated at 5.2 percent in 2010), but also in the higher burden group amongst selected Pacific countries.95 The biggest driver of lost economic output is the potential loss of labor due to early deaths from NCDs. By 2040, the estimated total lost effective labor force due to NCDs is 16.2 percent in RMI. Not only will the growing NCD burden impact the national economy, it will also increasingly drive expenditure on healthcare. 250. Health expenditure is already absorbing a significant share of government expenditure. Health care expenditure is predominantly public, with significant levels of external financing (see Section 2.6). Health expenditure also represents around a quarter of total government expenditure. Per capita expenditure on health in constant 2018 USD increased from US$496 in 2010 to US$643 in 2018, a 30 percent increase. In 2019, RMI had the highest percentage of diabetes-related health expenditure (38.8 percent) of the western pacific region (which averaged 11.1 percent) (IDF, 2019). Increased financing opportunities for health are limited due to the modest macroeconomic growth forecast and the already large share of the national budget allocated to health. Current health challenges, population growth, more expensive chronic diseases management (including overseas medical referrals), longer life expectancy and ongoing health security risks will continue to place further pressure on the health system. Adoption of evidence-based, feasible and cost effective (and in some cases cost-saving) reforms and interventions will be important to improve health outcomes within the sector’s available resource envelope. Without that, the RMI’s capacity to respond to the growing health and NCD challenges will likely be constrained and RMI could lose some of the health gains achieved in the last decades. 94 Estimated effect of cardiovascular diseases, chronic respiratory diseases, diabetes and cancer. 95 PICs analyzed include Fiji, Kiribati, RMI, FSM, Palau, PNG, Samoa, Solomon Islands, Tonga, Tuvalu and Vanuatu. 117 Republic of the Marshall Islands Pillar 2: Public Expenditure Review This pillar comprises six sections. Section 2.1 outlines recent fiscal developments, highlighting some of the key trends over the past decade. Section 2.2 analyzes GoRMI’s key PFM struc- tures and risks to fiscal sustainability, and outlines priority actions to address these challeng- ­ ection 2.3 summarizes the institutional structures and opportunities to strengthen public es. S sector human resource management. Section 2.4 highlights the need for integrated, ­ ­ multi-sectoral approaches to bridge gaps in human capital outcomes. Finally, Sections 2.5 and 2.6 provide structured analysis of the education and health sectors, evaluating each sector’s structure and delivery mechanisms; financing sources and expenditure uses; and is- sues of access and quality. 2.1 RECENT FISCAL TRENDS 251. The RMI’s fiscal framework remains heavily reliant on US development assistance. Under the amended Compact the RMI receives US financial support for a 20-year period from FY04 to FY23 via two streams of funds: (i) CSGs that are predominantly designated for education, health, and infrastructure; and (ii) contributions to the CTF, which was designed to provide an annual disbursement sufficient to replace the CSGs after FY23. The Compact also provides access to a series of US Federal Programs and Services (FPS), which support key public service delivery, including education and health.96 Combined, the fiscal arrangements of the amended Compact have an important impact on the RMI’s fiscal policy and management, with US-sourced assistance representing around half of annual budget revenues over the decade from FY04 to FY13, although this proportion narrowed to an average of 36 percent of annual revenues in FY17–19 (Figure 43). 252. While debt to GDP has fallen substantially in recent years, RMI is rated at high risk of debt distress due to the scheduled expiration of financial assistance under the Compact after FY23. Public debt has fallen from 109 percent of GDP in FY95 to 28 percent of GDP in FY19 and is projected to continue to fall, due to GoRMI continued avoidance of new non-concessional external borrowing. Nevertheless, RMI is rated at high risk of debt distress due to the potential decline in revenues associated with the scheduled expiration of Compact-related grants in FY24. Absent a sizeable fiscal adjustment over the coming years (or agreement on an extension of Compact-related transfers), substantial additional external debt would be needed to maintain current levels of core public goods and services. In addition, the RMI’s vulnerability to climate change presents another major risk to the long-term economic and fiscal outlook that will necessitate substantial additional spending to enhance resilience. Ongoing efforts to strengthen core PFM and debt management practices will be essential to bolster long term fiscal and debt sustainability (see Section 2.2). 96 The RMI has access to a range of US Federal Government programs that are available to US states, along with key services provided by the US Federal Government, such as postal, meteorological and aviation services. 118 Country Economic Memorandum and Public Expenditure Review 253. After a period of fiscal expansion at the start of the amended Compact, a long period of fiscal consolidation set in as the fiscal envelope tightened after the global financial crisis. From FY04 to FY07 expenditures grew rapidly after the repressed years at the end of the initial Compact and reflecting the higher levels of funding under the amended Compact and grants from Taiwan (Figure 44). From FY08 to FY14, the boost from the new funding sources had run its course, as the economy entered the global financial crisis period and revenues remained depressed for several years. As the fiscal envelope contracted, expenditures fell to match, although the economy managed to sustain small fiscal surpluses. Capital grants and matching expenditures on infrastructure peaked in FY07, largely disappearing by FY14 as Compact infrastructure grants declined97 and the FAA airport project was completed. 254. In recent years, RMI has experienced a rapid fiscal expansion buoyed by sovereign rents and multilateral grants. From FY15 to FY20, the fiscal situation entered a new era as revenues increased rapidly. While current grants remained largely flat, capital grants improved, reflecting the lifting of the Compact infrastructure moratorium and full utilization of the annual infrastructure grant. However, the most dominant force was the growth in fisheries sector revenues, which grew from US$2 million in FY10 to US$16 million in FY15, and then further to US$31 million in FY20 (rising from 3.1 to 16.4 percent of GDP, Figure 45).98 This was accompanied by strong rents from the ship and corporate registries. It is anticipated that the current level of receipts from MIMRA of about US$31 million is likely to be maintained in inflation-adjusted terms over the long term. In FY20, tax revenues fell by 12 percent reflecting the impact of COVID-19 but this was offset by a large increase in grants, resulting in 3 percent growth in total revenues. Figure 43: Composition of revenues Figure 44: Composition of expenditure US$ million US$ million $160m $160m Payroll Use of goods and services Taxes Compact Interest Subsidies Federal programs Other coutnry grants $140m $140m Grants Other expense Soverign rents Other $120m $120m $100m $100m $80m $80m $60m $60m $40m $40m $20m $20m $0m $0m Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 97 In FY08 the Compact infrastructure grant was placed on hold awaiting improved capital project planning and procurement. 98 A large spike in fishing fees in FY17 reflects the once off drawdown of accumulated savings. 119 Republic of the Marshall Islands 255. While the new buoyancy in revenues might have resulted in a period of consolidation and an opportunity to save the gains for the post-FY23 period, expenditure growth matched that of revenues. During the six years from FY15 to FY20, payroll expense grew by 3.9 percent annually above the historical average of 2.6 percent over the previous seven years. However, increases in payroll were modest compared with other areas of expense. Use of goods and services grew by 9 percent per annum, although in FY20 with the impact of COVID-19, the main area of fiscal adjustment was a reduction in goods and services of 14 percent. During the FY15 to FY20 period subsidies grew by an astonishing annual average of 14 percent. Similarly, transfers to government agencies and ‘other’ expense also expanded by 13 percent annually, which included transfers to address the social security system’s large unfunded liabilities. Fixed-asset outlays growth was more modest and matched that of capital-grant receipts and was thus highly variable. Despite the strong growth in expenditures and expansionary fiscal policy, the RMI managed to achieve an average surplus of 2.2 percent of GDP (Figure 46). Figure 45: RMI sovereign rents have Figure 46: …fueling a rapid increase in increased rapidly in recent years… expenditure and small surpluses Percent of GDP US$ million 20% $160m Fishing fees Revenues 18% Expenditures Ship registry $140m 16% 14% $120m 12% 10% $100m 8% 6% $80m 4% $60m 2% 0% $40m Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 256. This occurred despite the risk of a substantial step down in revenues in FY23 and broad recognition of the need to build fiscal buffers to support long-term fiscal sustainability. The ability of the RMI CTF to achieve the aspirational—though not guaranteed—goal of fully replacing the expiring CSGs from FY24 onward has been reduced due to a combination of design flaws, an investment period that was shortened by two years at the outset of the 20-year amended Compact period, and marginally lower than expected capital market returns during the accumulation period. A greater threat is posed by the substantial risk that annual disbursements could become highly volatile, including the potential for years where there was no distribution. Securing long-term fiscal sustainability thus requires fiscal discipline to build the CTF. 120 Credit: Vlad Sohkin / World Bank Country Economic Memorandum and Public Expenditure Review 257. Automatic expansion of expenditures to match revenue growth indicates the need for a fiscal framework to guide fiscal policy. The last six years saw a rapid rise in revenues (57 percent) due to booming sovereign rents, which led to a large increase in the fiscal envelope. However, expenditures rose at an identical rate to absorb the available capacity. This trend highlights the need for a fiscal framework to guide fiscal policy, both in the medium and longer term. 2.1.1 Revenue Trends 258. Domestic taxes display a lack of buoyancy and reflect an outdated tax regime. Figure 47 provides information on the structure and trends of major taxes and highlights that all taxes have declined as a share of GDP. Both the shares of the wages tax and import tax displayed a significant decline in the early part of the amended Compact with some stability since FY12. The gross receipts tax (GRT) has also displayed a declining trend. Estimates of tax elasticities99 with respect to compensation of employees for the wages tax, and private sector current price GDP for the GRT, indicate elasticities below unity. In the case of import tax collections with respect to FOB (free on board) imports, the tax elasticity has a negative value. These trends are indicative of two things. First, the low and even negative tax elasticities suggest problems with tax collection and compliance. Second, the performance displays an outdated and inefficient regime. The tax regime needs not only modernization and adoption of efficient taxes, but also substantial improvements in tax administration. In comparison to other PICs, tax effort in the RMI comes in at 14 percent of GDP—below the regional average of 23 percent (see Figure 48). Withholding wage tax rates, comparable to personal income tax rates in other PICs, are considerably lower than regional averages (see Figure 49), and the RMI’s highest marginal rate of 11 percent is low by international standards. Figure 50 indicates regional averages for tariff rates. RMI’s average of 5 percent of CIF (cost, insurance, and freight) imports is low by regional standards. 99 Tax elasticities have been estimated in log-linear form over the period of the amended Compact. 121 Republic of the Marshall Islands Figure 47: Major tax components have declined Figure 48: Tax collection in RMI is low by regional as a share of GDP standards Percent of GDP Percent of GDP, FY17–FY19 average 9% Solomon Islands 8% Samoa 7% Fiji 6% PICS 5% Tonga Palau 4% Kiribati 3% Gross receipts tax Vanuatu 2% Wages tax Tuvalu 1% Import taxes RMI 0% FSM 0% 10% 20% 30% Source: EPPSO & Graduate School USA (2021). Source: IMF Article IV reports and EPPSO & Graduate School USA (2021). Figure 49: Income tax rates in the RMI are low Figure 50: …and RMI’s average applied tariff rate compared to regional peers… is moderate relative to its peers Percent Average rate on CIF imports, percent 30% Solomon Islands Kiribati 25% Fiji 20% Samoa Nauru 15% Palau RMI 10% Vanuatu Tonga 5% PNG Tuvalu 0% 0 2,499 4,999 7,499 9,999 12,49914,99917,49919,99922,49924,99927,49929,999 FSM Tuvalu Kiribati FSM Palau Samoa Tonga RMI 0 10 20 30 40 Source: National sources and World Bank (2017b). Source: National legislation. 122 Country Economic Memorandum and Public Expenditure Review 259. While Compact-related grants remain central to GoRMI’s fiscal framework, multilateral grants have grown in importance in the last three years. CSGs rose in the early years of the amended Compact as capacity limitations were overcome in the use of the infrastructure grant. CSGs fell again from FY10 due to issues in disbursements of the infrastructure grant and have stabilized recently as GDP has expanded. Revenues from US Government federal programs have declined as a share of GDP, from about 9 percent of GDP in FY04 to approximately 5 percent as of FY20. Other grants, comprising development grants from Taiwan, China and more recently an increasing level of multilateral grants, trended down for most of the amended Compact, but since FY17 have grown rapidly reflecting World Bank, ADB and a variety of COVID-19 related grants in FY20. 260. Both CSGs and US Government federal programs are scheduled to expire in FY23. Absent a renewal of Compact-related grants, CSGs will be replaced with distributions from the CTF. At this point it is estimated that the size of the CTF corpus will be insufficient to provide a sustainable level of resources to replace the prior CSGs and an adjustment will be needed equivalent to about US$6.5 million annually or 3.2 percent of GDP (Graduate School USA, 2018b). In this presentation Compact grants include the SEG. Continuation of this grant post-FY23 is uncertain, as it was not included in the list of Compact grants to be replaced through CTF drawdowns. The current value of SEG is about US$5 million annually (2.5 percent of GDP). Post-FY23, federal programs will require renewal of the Federal Programs and Services agreement with the US. It is not clear at this time whether RMI will continue to benefit from all, some, or none of these programs. 261. Under a severe-case scenario the RMI would face potential large and painful fiscal adjustment post-FY23. At present, Compact renegotiations between the RMI and US have been ‘paused’ as the new US administration prepares to pick up the process. The US has indicated its interest to renew the economic assistance terms of the Compact post-FY23. However, under a severe-case scenario, the possible funding shortfall and required adjustment would be large. Summing together, adjustment to sustainable CTF distributions, loss of SEG and federal programs, plus loss of Pell Grants to fund household tertiary education (see Section 2.5), the loss would amount to over US$29 million or 11.7 percent of GDP. An important component in the design of a prudent RMI fiscal strategy must recognize these risks and make provision for contingency planning in the event of a severe-case scenario or even an extended period of delayed renewal of the economic assistance terms of the Compact post-FY23. 123 Republic of the Marshall Islands 2.1.2 Expenditure Trends 262. Current spending is roughly evenly split between payroll, goods and services, and transfers to SOEs and other government agencies. The structure of expense by economic category is shown in Figure 51. Payroll expense is the major category representing an average of 37 percent of total expense during the FY18 to FY20 period, while use of goods and services represents 30 percent. This ratio of intermediate inputs to value added in the delivery of government services indicates an expense structure that is not distorted by fiscal pressure to maintain payroll. Interest payments are negligible and reflect declining (mostly concessional) external debt. The other major area of expense includes subsidies to SOEs, grants to other layers of government and ‘other’ expense, which represents 32 percent of total current spending. This last grouping has grown rapidly in recent years reflecting the rapid expansion in the fiscal envelope. 263. Payroll expense has grown modestly and has not been the main component of recent public expenditure growth. Payroll cost has been the least expansionary of all components of current spending and has declined as a share of GDP from 24 percent in FY04 to 21 percent in FY20 (Figure 52). During the period FY15 to FY20 the size of the civil service grew modestly by 1.3 percent per annum as wages grew by 2.6 percent. 264. After a long period of stability, use of goods and services increased in FY19 with the expanding fiscal envelope. Use of goods and services held a stable relationship in terms of GDP through FY17. However, spending grew strongly in FY19 as revenues boomed allowing greater outlays on repairs and maintenance, and professional services. In FY20, spending on goods and services fell as a percent of GDP despite large additional COVID-19 related spending, as fiscal stimulus and health preparedness spending was more than offset by tight controls on spending in other areas, coupled with inability to travel and falling fuel prices. Figure 51: Composition of current spending Figure 52: Payroll and goods and services spending Percent of total current spending Percent of GDP Other 30% expense 11% 25% Grants Payroll 10% 37% 20% Expenditures 15% Subsidies 3 year average 11% $136.8m 10% Compensation of employees Ues of goods and serices 5% Interest 1% Use of goods and 0% services 30% Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 124 Country Economic Memorandum and Public Expenditure Review 265. Subsidies to the SOE sector have been a long-standing issue for the RMI. Figure 53 highlights the rapid growth in subsidies in recent years. With the improved fiscal environment at the start of the amended Compact, subsidies grew, but then remained constant in relation to GDP as the fiscal position tightened. With the recent growth in fishing fee revenues and greater fiscal space, the level of subsidy has once again grown rapidly. The underperforming SOE sector comprises of a dozen enterprises and places a large burden on the economy.100 Improving SOE performance has been a long-standing issue with attempts at reform going back to the mid-1990s, as yet without a satisfactory outcome. 266. The SOE sector can be grouped into two main areas of service providers: public utilities and service providers to the outer atolls. The public utility sector includes two power producers, and one state owned telecom provider. All operate at less than full cost recovery and require some degree of subsidy. The second group of SOEs includes the national airline, shipping corporation and coconut oil processor. All provide unprofitable community services and require large subsidies to support operations. The subsidy to Tobolar, the agency collecting copra from the outer atolls and producing coconut oil, has grown from an average of US$1.4 million in the five-year period FY11 to FY15 to over US$8 million in the last two years. GoRMI passed new SOE legislation in 2015 paving the way for an improved management and monitoring regime. A monitoring unit in MOF has been established and SOEs are now required to prepare an annual statement of corporate intent and to operate within an established business plan for each entity (see Section 2.2.3 for policy discussion). 267. Grants to other layers of government and ‘other’ expense have also grown rapidly, doubling as a share of GDP since FY10. Grants to other layers of government includes transfers to government agencies, local government, and social security. All elements have grown rapidly reflecting the boom in revenues. Social Security, discussed below as a fiscal risk, now requires close to US$3 million in annual transfers to remain sustainable and avoid collapse. ‘Other’ expense is the final item on the fiscal account and includes transfers to non-profits and households. This item has also grown significantly. 268. Transfers to entities outside the central government have grown rapidly and represent the major area of fiscal risk. While payroll and use of goods and services have either declined or remained stable in relation to the size of the economy, it has been transfers to other entities outside the central government that have grown rapidly and absorbed government’s discretionary funds. Subsidies to SOEs, transfers to other government entities, non-profits and households have grown dramatically from 12 percent to 22 percent of GDP since FY10. That trend and even that level of allocation poses a significant fiscal risk to RMI. 100 Private Sector Development Initiative, Private Sector Assessment for the RMI, Unpublished paper, Sydney, January 2016 125 Republic of the Marshall Islands Figure 53: Transfers to entities outside the central Figure 54: Current spending in education and government have grown rapidly since FY15 health has remained stable as a share of GDP Percent of GDP Percent of GDP 12% Subsidies 40% Public Admin Grants Eductation 35% 10% Other Health 30% 8% 25% 6% 20% 15% 4% 10% 2% 5% 0% 0% Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 269. In terms of sector spending, education and health spending have maintained their share of GDP, while public administration has grown rapidly with the expanded fiscal envelope. The pattern of current spending by function is presented in Figure 54. Public administration, which includes public safety, economic affairs, and other minor services, stabilized from FY10 to FY15, but has increased in line with the recent increase in fiscal space. Education and health spending have broadly maintained their share of GDP in recent years, despite the boom in revenues. The conclusion from Figure 54 is that basic education and health services have been maintained, but the changes in fiscal fortunes have resulted in growth and contraction in general public services. 270. Capital spending rose to high levels in the early 2000s but subsequently collapsed and remains low, including relative to regional peers. Figure 55 indicates a rising trend in infrastructure spending at the start of the amended Compact as greater resources became available through the Compact infrastructure grant and capacity limitations were overcome. RMI has also benefited from a significant level of assistance for capital projects from Taiwan, China (although some projects are classified as recurrent expenses in the statistics). From FY07 to FY12, the level of capital investment declined as projects came to an end and there were procurement issues with the use of the Compact infrastructure grant. While these issues have now been resolved, the level of investment has stagnated at 4–6 percent of GDP for the last nine years. This level of capital spending is low relative to RMI’s regional peers (Figure 56). Significant additional resources from the 126 Country Economic Memorandum and Public Expenditure Review World Bank and ADB should increase capital spending going forward.101 Recent trends indicate a significant under-investment in infrastructure and the need for sustained high investment in the nation’s capital stock. Donor technical assistance will need to address administrative constraints if available resources are to achieve that needed boost in infrastructure investment. Figure 55: Capital expenditure and grants Figure 56: Capital spending in RMI is low compared Percent of GDP to regional peers Percent of GDP, average FY17–FY19 18% Capital grants Kiribati 16% Capital expenditures Tuvalu 14% FSM 12% Tonga 10% Solomon Islands 8% Fiji 6% 4% Vanuatu 2% Samoa 0% RMI 0% 20% 40% 60% Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021). 2.2 PUBLIC FINANCIAL MANAGEMENT AND FISCAL SUSTAINABILITY 271. This section analyzes the key institutional frameworks and practices that underpin PFM, and the key challenges to fiscal sustainability. It comprises three sub-sections: (i) Core PFM matters; (ii) the budget process; and (iii) fiscal sustainability. Key policy recommendations are summarized in the final sub-section. 2.2.1 Public Financial Management 272. The RMI adopted a wide-ranging, though unprioritized, PFM Reform Roadmap in 2014 and has completed three monitoring reviews. Following a 2012 Public Expenditure and Financial Accountability (PEFA) study, the RMI designed and adopted a PFM Reform Roadmap (PFMRR) in 2014 with commitments to 30 components and a total of 150 actions identified within those 30 components. An observed weakness at the time of the first PFMRR review in 2015 was the lack of prioritization of the adopted components and activities and an under-resourcing of the reform efforts. Unsurprisingly, progress was slow and 12 of the 30 components had yielded no actions to report. 101 World Bank resources are accounted for through the national government budget while ADB grants appear ‘off-budget’, except in the case of budgetary support. 127 Republic of the Marshall Islands 273. PFM Reform progress has been accelerated with extensive resource allocation and explicit prioritization of PFMRR components. GoRMI established a Reform Coordination Unit (RCU) within the MOF in 2018. The RCU’s provides periodic reports on PFMRR progress. The most recent report, from January 2020, includes two dimensions (ADB, 2020). First, the RCU reports PFM reform progress based on a restatement and re- grouping of priority reforms in seven key areas: (i) accounting and audit; (ii) budget framework; (iii) budget and aid coordination; (iv) human resource development; (v) SOE reform; (vi) tax reform; and (vii) fiscal responsibility legislation. Second, the RCU produces a full update of the original matrix of 30 PFMRR components. This commitment to accountability vis-à-vis the original roadmap is commendable, while the focus on progress in the priority areas is an enhancement that has arguably led to both improved results and improved recognition of those results and necessary next steps. Key examples of reform progress for each of the seven PFMRR priority areas are highlighted below. 274. There has been modest progress in the first PFMRR focus area— accounting and audit—although the upcoming implementation of the new financial management information system (FMIS) is a key milestone to improve reporting and budget controls. MOF has completed procedural manuals for government embassies, payroll management and fixed asset management. Training was delivered to support the usage of these manuals and to improve performance in each functional area. The progress report notes that true improvements in payroll management rely on adoption and integration of the existing human resource management information system (HRMIS) and the new FMIS, wherein automation will support improved performance and control. 275. There have been nascent improvements in the second PFMRR focus area—budget framework—via introduction of a revised medium-term (three-year) planning and budgeting framework, although full implementation remains a medium-term objective. Cabinet has approved a new national planning framework, a requirement for Key Performance Indicators (KPI’s) for each ministry and agency, and government is implementing a new National Strategic Plan (NSP) expected to inform the FY22 budget process. Ministries are now required to submit budget requests in a performance portfolio format, with output-based budgets required since the FY20 budget submission. Notably, the budget still includes a ‘mini-line-item’ component reflecting funding for each output by line item and by source; thus, this is at its core a transition phase toward true output- based budgeting. Capital budget submissions continue to be deliberated on a standalone basis but over time it is expected there will be an integration of capital budget approvals with recurrent budget approvals for ongoing operation and maintenance costs. Full integration of planning and budgeting processes—though targeted for improvements in FY21—remains an aspirational goal. 128 Country Economic Memorandum and Public Expenditure Review 276. There have been improvements in the third PFMRR focus area—budget and aid coordination—showing modest progress in a challenging area of reform. The most prominent achievement in the realm of aid coordination was the establishment of the Division of International Development Assistance (DIDA) in 2016. DIDA has developed a project database that is currently active and updated on a quarterly (not yet real time) basis. The government has prioritized coordinated and leveraged management of climate change-related development funding sources and this has resulted in a workshop to explore the establishment of a climate finance mechanism. 277. There have been improvements in the fourth PFMRR focus area—human resource development—with modest progress in a few areas and a bottleneck in reducing paper-based processes. This area involves both MOF and PSC in leadership roles and all line ministries and agencies as potential beneficiaries of training and process improvements. There is a catalog of training resources to guide individual training plans for MOF employees. Some courses have been completed on a pilot basis. The Public Service Commission (PSC) is responsible for implementation of the HRMIS. However, the system remains in trial phase, due to a combination of administrative and capacity constraints (see Section 2.3). 278. There have been important institutional reforms in the fifth PFMRR focus area—SOE reform—although implementation has been slow at the same time as subsidies to SOEs have grown to unsustainable levels. The RMI passed the SOE Act in 2015, yet it was almost immediately amended to reverse the reforms that had restricted the involvement of Ministers and government officials on SOE board. Compliance with the law was disappointing until the creation and operations of an SOE Monitoring Unit (SOEMU) within MOF in May 2018. The unit started with training of MOF officials and SOE key officials in the contents and implications of the SOE law. Once internal systems and templates were established to fulfill the unit’s monitoring mandate, the SOEMU’s staff turned to capacity building within each SOE. By FY19, virtually all SOEs had completed business plans as required by the SOE law. Each SOE has also submitted a statement of corporate intent to the Nitijela. The SOEMU has also assisted the four most significant SOEs by asset value—AMI, MISC, Tobolar, and MEC in the identification and costing of community service obligations (CSOs). This is an important input to determine true operational costs to deliver specific obligations. It can also help identify and potentially replace inefficient or poorly specified subsidies with an efficient and well-specified contract which can transparently allocate public resources to achieve desirable CSOs. However, implementation has been slow, with none of the CSOs yet ratified and implemented. While the SOEMU cannot control the growth in subsidies, the technical improvements and compliance support it provides are necessary conditions to the monitoring—and later enforcement—of best practice operations of SOEs. 129 Republic of the Marshall Islands 279. The sixth PFMRR focus area—tax reform—has focused exclusively on improving tax administration rather than tax policy, delivering incremental improvements with limited results. Having set aside a focus on comprehensive tax reform to which GoRMI had previously committed, including introduction of a business profits tax and a broad-based consumption tax, the targeted reforms are now more narrowly focused. A technical tax consultant has identified seven work streams: (i) improved compliance with existing tax law; (ii) improved collection of tax arrears; (iii) advice regarding proposed new taxes; (iv) automation in tax and customs processes and linkage to the FMIS; (v) design of revenue projection templates; (vi) introduction of an independent tax appeals mechanism; and (vii) institutional risk management. Relatedly, GoRMI has discussed the need for an improved IT approach through a revenue management system. Although an IT solution to improve reporting of imports is needed, the revenue management justification for such a system is not the primary reason to consider such an investment. A World Bank review of the need for a new revenue management system found that the need for such an investment would best be aligned with a comprehensive tax reform program. 280. The seventh PFMRR focus area—fiscal responsibility legislation—is a broad area of reform with important recent progress. This focus area is the broadest and perhaps most fundamental area in the PFMRR progress report. In 2020 GoRMI submitted to the Nitijela its Fiscal Responsibility and Debt Management Act (FRDMA). The act specifies six principles of responsible fiscal management that aim to: (i) reduce total debt to a target level by seeking to achieve annual operating surpluses; (ii) once the target level of total debt has been achieved, seek to ensure that total operating expenses do not exceed total operating revenues; (iii) achieve and maintain levels of total net worth that provide a buffer against factors that may impact adversely on total net worth in the future; (iv) manage fiscal risks; (v) pursue policies that are consistent with a reasonable degree of predictability about the level and stability of future tax rates; and (vi) ensure compliance by establishing monitoring and reporting mechanisms. 281. Given recent experience, there is an argument for GoRMI to consider introducing stronger mechanisms to control expenditure growth. The principles outlined in the FRDMA are not equivalent to hard fiscal rules. Given GoRMI’s experience of spending rising in line with windfall revenues, it could be prudent for authorities to consider introducing a stronger mechanism to reduce the procyclicality of spending. Such an approach would modify, at a minimum, principle (i) above. It might also involve the introduction of a principle that explicitly called for the creation of, and allocation towards, a stabilization fund that could be used to mitigate the fiscal impacts of volatile revenues and/or external and climate-induced shocks. This would be in addition to the CTF— given the strict rules about withdrawals from the CTF which are not related to volatility in RMI domestic revenues. 130 Country Economic Memorandum and Public Expenditure Review 282. The FRDMA also adopts a series of elements in the budget cycle that will improve decision-making and accountability in fiscal management. The bill requires preparation and dissemination of: (i) an economic policy statement that sets out the year’s fiscal strategy and that includes an economic and fiscal update; (ii) a long-term fiscal strategy, to be updated periodically; (iii) an annual statement of tax policy; and (iv) a half-yearly economic update. These requirements are designed to enhance transparency and accountability and ensure compliance with the Act’s stated principles—or in the event of a departure from one or more principle(s)—to require GoRMI to outline the cause and the intended path to return to adherence. 283. Finally, the FRDMA also adopts a much-needed external debt management regime that will benefit RMI in the long term. The draft regulations provide specific numerical targets for debt levels, debt servicing and government guaranteed debt, along with a commitment to limit non-concessional loans. The legislation as drafted, taken together with proposed regulations, is an important improvement over the current situation in which there are few domestic checks and balances on the Cabinet’s ability to contract new debt, and limited analysis of the costs and benefits of proposed debt-financed projects. However, there is an argument to raise some of the specific numerical targets into the Act—a reform that GoRMI could consider in the future. The decision is ultimately a policy question. Raising the numerical targets into the Act would reduce the discretionary authority of the Cabinet to adjust these targets due to short-term or project-specific considerations, while also increasing transparency in the policy environment. Leaving the targets in the regulations would make these conditions faster and easier to change. 284. Despite the improvements in the legislation, there remain important gaps in GoRMI’s debt policy and debt management capacity. In 2014, the Auditor General undertook a performance audit on public debt, identifying late payments on public debt and the non- monitoring of guaranteed debt as significant problems. Late payment of debt has resulted in penalty payments. The non-monitoring of guaranteed debt has resulted in the unexpected inability of SOEs to service debt and GoRMI having to raise resources to service SOEs debt at very short notice. At present, the Accounting Division at MOF does not monitor Government guarantees. Specific GoRMI policies on government guarantees and on-lending would help to mitigate the risk of an unsustainable build-up in contingent liabilities on government. Capacity building is also essential to enhance MOF’s capacity for debt monitoring and management. 131 Republic of the Marshall Islands 285. Additionally, there is an urgent need to modernize and strengthen the Financial Management Act (FMA) 1990 and associated regulations to improve the clarity and consistency of core PFM processes, and to maximize the benefits of the new FMIS. The FMA 1990 critically needs to be reviewed in light of current processes and the use of computerized systems in budget management, procurement and payments arrangements. Regulations have not been promulgated. The only guidance provided is within Standard Operating Procedures which, in many cases, are incomplete and not complied with. As a result, many processes and actions are unclear and inconsistently implemented. The roles and responsibilities of key actors within MOF (for example, Assistant Secretaries and Budget Director) are not clearly defined and there appear to be unnecessary duplications of functions especially relating to approvals and certification processes. The lack of up- to-date legislation, regulation and procedures has resulted in a lack of clarity and consistency in the application of business processes, internal controls, and record maintenance. These lead to inefficient operations within MOF and inefficient service delivery to and by line ministries and agencies. 286. Audit coverage and performance have improved, although there remain areas for improvement. Improving the public sector audit functions and ensuring that GoRMI audits are completed on time and without qualifications have been a key priority for the PFM Steering Committee in recent years. The Office of the Auditor General (OAG) has been strengthened considerably, which has substantially improved the timeliness and quality of audit reports. In the past, there had been a high rate of repeated audit findings and claims of a lack of accountability in the use of public money. The performance of public sector spending units has improved in recent years, with several reports receiving an unqualified—or positive—opinion. Nevertheless, there remain areas for improvement, with the OAG and the OCS working together to support spending units that are repeat poor performers. 287. Procurement remains a key bottleneck for efficient service delivery. Various ministries and agencies report that the manual public-sector procurement process led by MOF is time-consuming and inefficient; and one of the most serious constraints to service delivery. Both the PSS and Ministry of Health and Social Services (MOHSS) utilize their own, independent system for processing transactions financed from the General Fund or their own sector-specific funds. Wherever possible, both prefer to use these independent procurement processes because they consider them to be more efficient than the MOF system. While an argument could be made that the devolution of procurement functions could improve efficiency, in the absence of strong oversight it could also lead to less accountability and greater potential for malfeasance. The alternative is to strengthen the centralized systems—a solution that is judged to be more suitable given the small size of the RMI public service relative to other nations where devolution has been pursued. 132 Country Economic Memorandum and Public Expenditure Review 288. While important progress has been made, there remains a need to modernize the legal framework and processes for procurement. The current legislative framework for procurement (the Procurement Code Act of 1988) is outdated, implementing regulations have never been issued, and a 2017 compliance audit found serious deficiencies in the implementation of procurement policies. Overall, this has led to procurement processes that are highly inefficient and fragmented. Reform is urgently needed to modernize the legal framework and streamline business processes and procedures, which can help to improve the cost effectiveness and timelines of purchases. In recent months implementing rules and regulations to the 1988 legislation were drafted and followed up with training across ministries and agencies to improve compliance and efficiency in procurement practices. This is a welcome development that will improve procurement practices until the new legislative framework can be developed and implemented. 2.2.2 The Budget Process 289. The coherence of the budget framework is negatively affected by two fragmenting forces. While RMI follows a documented, stepwise budget cycle to develop, review and adopt its annual budget, that process is challenged by the existence of: (i) two parallel budget processes; and (ii) numerous separate funds to support specific expenses. These are described below. 290. RMI suffers from the existence of two parallel budget processes. Despite recent reform efforts to integrate virtually all revenue sources and their associated expenditures into the budget process, in practice, there remain two parallel tracks through which budget priorities, and hence public resource allocations, are determined. The first track comprises revenues and associated expenditures related to the General Fund, the Special Revenue Funds, and on-budget development assistance from sources other than the US. This track includes funding from the World Bank, programs of the United Nations, and bilateral donors such as Taiwan, China. This first track accounted for roughly 63 percent of total revenues over the period from FY16 to FY18. Spending from these revenue sources, in general, utilizes GoRMI systems, and is subject to the annual budget process led by the Budget Coordination Committee (BCC). The second track comprises Compact-related transfers and US Federal Government programs and grants. This second track accounted for roughly 37 percent of total revenues over the period from FY16 to FY18. Spending from these revenue sources is determined by the JEMFAC for Compact-related resources, and by the conditions of each separate US Federal program or service. These resources are often delivered through parallel GoRMI systems, and—in general—are not contested in the BCC-led budget process. 133 Republic of the Marshall Islands 291. Across both tracks, the various revenue sources impose different reporting requirements, financing conditions and procurement requirements on their use. This places substantial burden on the government’s thin public sector capacity. It also means that a sizeable proportion of the financing available is not fungible. It results in an overall fiscal envelope that is not flexible enough to allow ministries to meet their stated policy objectives. Objectives stated in a Ministerial Strategic Plan may be affected by changes in the US federal program or service rules or priorities. Similarly, JEMFAC decisions may affect ministry-wide resource allocations, although such impacts would be limited to the health and education ministries. Relatedly, authorities have stated that rigidities in the sources of revenues do dictate spending priorities to some extent. 292. There are also a large and growing number of separate funds for specific expense units. The RMI Constitution enables the creation of separate funds under legislative mandates to support expenses in defined activities. Separate funds may receive specific once-off or annual appropriations, but many separate funds are the result of hypothecation—or earmarking—of specific revenue flows. The predominance of this practice adds to the fragmentation of the budget process and limits the degree of contestability in spending allocations. In an extreme scenario, it could limit transparency. The predominance of separate accounts reduces the extent to which changes in policy priorities can be operationalized via adjustments in the annual budget process. Concerns have been raised about the fragmentation of spending units, with one Senator recently stating during a public hearing that “the Government has too many pockets”. From an audit perspective, the proliferation of independent funds also imposes an additional burden on the OAG, which must conduct a separate audit of each fund. Hypothecation is used either to attempt to protect the financing of a particular activity, or to increase political control over specific “pockets” of public resources. 293. Transparency of the budget process is targeted for improvement through enactment of the FRDMA. As noted above, the RMI is considering a legislatively mandated fiscal responsibility regime as a key part of its PFMRR. The adoption of fiscal principles coupled with the mandate for pre-budget and post-budget review of performance against those stated principles ensures a higher level of transparency as the reports will be available for public access and will be available for timely consideration by the BCC, Cabinet, and the Nitijela as they play their consecutive deliberative roles. The draft regulations associated with the Debt Management portion of the Act importantly require submission of a Cabinet report prior to taking on new debt that outlines: (i) how the project fits within the current economic, financial, or fiscal policies of the Government; (ii) how the service and maintenance burdens over the life of the proposed new debt will affect the Government’s overall financial wellbeing; and (iii) an assessment of the sustainability of overall government debt, taking into account the proposed new debt. These regulated requirements could be further strengthened by the inclusion of a cost/benefit analysis of the activity/project to be funded by the debt, and an assessment of alternative funding sources (such as development partner concessional financing or public-private partnerships). 134 Country Economic Memorandum and Public Expenditure Review 294. Accountability for budget decisions and for budget execution is also targeted for improvement through enactment of the FRDMA and through improvements in the new FMIS and the accompanying COA. The rigorous reporting requirements being added to the budget cycle through the enactment of the FRDMA are, by definition, requirements that enhance accountability. Perhaps more importantly, improvements are being made under the PFMRR to adapt the new FMIS and its COA to be able to deliver comprehensive, timely and reliable information to improve budget preparation; to enable robust comparative analysis; and to support the linkage between the planning process and budget adoption. The latter two elements support more robust contestability in the budget review process led by the BCC, the budget approval process completed by the Cabinet, and in the budget oversight and approval processes undertaken by the Nitijela. 295. Analysis of budgeted versus actual revenues and expenditures highlights persistent under-collection of revenues, coupled with weak budget execution (Table 6). GoRMI budgets to a zero fiscal balance each year. This is due to a constitutional mandate against deficit budgeting. However, the accuracy of the budget relative to actual levels of revenues and expenditures is notably weak. Even in categories where projected flows should be relatively well known in advance, such as Compact revenues, there is substantial variation in some years. The tendency to under-collect revenue as compared to budgeted levels would be extraordinarily dangerous if GoRMI didn’t also persistently expend less than budgeted amounts. Specifically, the average actual collection of revenue is just 85.3 percent over the period from FY13 to FY19. The average actual expenditure is just 81.6 percent of budgeted expenditures. 296. High-level findings on the weakness of budget execution indicate the need for deeper analysis to determine precisely why actual flows deviate so much from budgeted levels. While some of the differences could arise due to weaknesses in budget preparation and project/program costing, there are likely other impediments on both the revenue and expenditure sides. Many of the PFMRR components described above will, if implemented in full and effectively, contribute to the improvement of budget execution. Implementation of the new FMIS budget module would improve the timeliness and accuracy of data used to formulate the budget. Ongoing capacity building provided by IMF PFTAC on revenue forecasting and administration can also help to improve both the accuracy of budgeted revenues and tax compliance and enforcement. 135 Republic of the Marshall Islands Table 6: Budget versus actual revenues and expenditures (FY13–FY19) US$ million FY13 FY14 FY15 FY16(a) FY17 FY18 FY19 Avg REVENUE Budget Total 113.5 114.2 139.2 145.2 164.6 166.6 178.9 Domestic Revenues 43.4 46.3 53.7 74.2 92.0 85.1 91.1 Compact (b) 41.9 43.6 42.9 42.9 42.6 42.9 42.4 US Federal Grants 11.6 12.3 12.5 14.3 14.4 15.6 15.7 Other Development Assistance 16.7 12.1 30.2 13.8 15.7 23.0 29.8 Actual Total 102.1 97.5 108.6 122.4 145.5 138.6 157.2 Domestic Revenues 40.8 43.6 49.8 63.3 80.2 71.3 78.3 Compact (b) 33.7 31.0 35.8 36.0 42.4 40.0 42.4 US Federal Grants 10.0 9.7 10.1 11.0 10.7 11.1 11.1 Other Development Assistance 17.5 13.2 12.9 12.0 12.2 16.1 25.4 Actual as % of Budget Total 89.9% 85.3% 78.0% 84.3% 88.4% 83.2% 87.8% 85.3% Domestic Revenues 94.0% 94.2% 92.8% 85.3% 87.2% 83.8% 86.0% 89.1% Compact 80.5% 71.1% 83.3% 84.1% 99.6% 93.3% 100.1% 87.4% US Federal Grants 86.4% 79.0% 81.1% 77.3% 74.1% 71.2% 70.4% 77.1% Other Development Assistance 105.2% 108.8% 42.7% 86.9% 77.5% 70.3% 85.2% 82.4% EXPENDITURE (b) Budget 113.5 114.2 139.2 145.2 164.6 166.6 178.9 Actual 102.5 91.5 102.4 112.3 136.1 133.0 155.7 Actual as % of Budget 90.3% 80.1% 73.5% 77.4% 82.7% 79.9% 87.0% 81.6% FISCAL BALANCE Budget 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Actual -0.4 5.9 6.2 10.0 9.4 5.6 1.5 5.4 Notes: (a) 2016 includes $4.56m from Supplemental Budget for drought reponses. (b) Excludes transfert to CTF and Kwajalein Landowners. 2.2.3 Fiscal Sustainability and Risks Potential for volatile annual CTF distributions 297. CTF distribution rules (known as the COFA rules) generate the possibility of highly unstable distributions to replace the annual sector grants after FY23. As part of the amended Compact, the US and RMI agreed to the establishment of the CTF with the aspirational objective to provide a source of funds to replace the real annual value of the CSGs. While the US indicated that all the risk of a lesser outcome was to be absorbed by RMI, the likelihood of poor outcomes is a risk to both parties. The CTF subsidiary agreement sets a target level of distribution equivalent to the inflation adjusted level of the FY23 level of grants. The objective was to provide a real flow of resources in perpetuity. However, the same agreement establishes a set of distribution rules (referred to as the COFA rules) that would generate a set of potentially highly unstable annual distributions. The CTF is structured in two accounts (i) a main A account known as the corpus and (ii) a C account to serve as a buffer intended to smooth out market fluctuations. Annual 136 Country Economic Memorandum and Public Expenditure Review distributions are based on the earnings of the A account but if that is insufficient to meet distribution needs, the C account may be tapped. However, if annual earnings are weak or negative and the C account has been exhausted, distributions may be below target or even zero. If distributions are below target the CTF subsidiary agreement prohibits the withdrawal of funds from the corpus potentially having disastrous implications for GoRMI fiscal policy. 298. COFA rules are simulated to generate the probability of 25 zero-distribution years over a 40-year horizon which would prove disastrous for fiscal management. A variety of studies have simulated the operating of the CTF and have generated similar results.102 While the CTF is found to be sufficient to provide a constant annual yield to meet the target distribution, it is not sufficient to withstand a series of adverse years of market volatility. Distributions in the early years would likely achieve the target, drawing on the C account as necessary if market returns are weak. However, as time progresses the chances of insufficient yields and a depleted C account increase. Figure 57 is an example of a typical distribution simulated from the RMI CTF. In the early years, distributions proceed as planned. However, after 20 years the C account becomes depleted and in FY41 there is a reduced distribution limited to 28 percent of the FY40 level. In the following years distributions eventually bounce back, but once again fall short in FY50, and FY53 to FY55. At the end of the 40-year simulation the RMI would experience a zero distribution in FY63. The pattern is acceptable in the early years followed by a deteriorating performance over time. This pattern is not atypical under the COFA rules and as noted in Figure 57, is not the result of a low long-term average rate of return. The 7.1 percent in simulation number 9 equals the average return over the 10,000 simulation periods. The COFA rules simply do not work well in the presence of volatile returns—a flaw that needs to be addressed to secure RMI’s long term fiscal sustainability and macroeconomic stability. Figure 57: CTF simulation, corpus, and distributions (FY23–FY63) US$ billions "A" account after distributn "C" account after distributn Target Distribution Distribution $2.0b $80m Average rate of return Geometric rate $70m Sim 9 $1.5b $60m $50m $1.0b $40m $30m $0.5b $20m $10m $0.0b $0m Source: ADB & Graduate School USA (2020). 137 102 For example, see GAO (2018), ADB (2015) and Graduate School USA (2018). Republic of the Marshall Islands 299. Alternative rules provide greater stability and sustainability of the CTF but at the cost of lower distributions in the early years. The main weakness of the COFA rules is the provision of distributions unrelated to the size of the corpus. Several different studies conducted on the CTF have provided alternative solutions. Distributions may be set as a fixed percentage of the corpus, while more sophisticated versions allow for steady growth of drawdowns to support sustainable fiscal policy but with adjustment mechanisms to protect the x over the long-term against market volatility. One such rule known as the SAFER rule proposed by GSUSA projects that the RMI can safely draw only US$20 million in FY24, a reduction of US$7 million below the presumed FY24 target. However, thereafter, real distributions would be protected and are projected to grow toward the original target with minimal annual volatility. Alteration of the CTF rules will require both mutual agreement of the US and RMI followed by an act of the US Congress. The ongoing Compact negotiations could rectify these issues either by changing the rules or by providing additional funding to enable the CTF to attain its objective. An optimal result for the RMI would be a change in the rules coupled with additional funding to increase the size of the CTF relative to the target distributions. Tax regime inefficiencies 300. Tax revenue has fallen as a share of GDP, resulting in a deterioration in fiscal sustainability. Paragraph 258 indicated the lack of buoyancy of the tax regime and the declining ratio of tax to GDP, which fell from 18 percent as a share of GDP in FY04 to 14 percent in FY2012. While the tax effort has stabilized since that time, the structure of the tax regime continues to rely on distortionary and inefficient taxes, namely the gross receipts tax and customs duties. The current share of tax effort to total revenues averaged 23 percent in FY15 to FY19 and represents a smaller but important share of total revenues compared with grants and sovereign rents. However, the long-term erosion of the tax base is clearly detrimental to fiscal sustainability, undermining the government’s ability to deliver services. 301. Comprehensive plans to reform the tax regime and create an efficient, modern system were unsuccessful. A series of tax reform efforts have been initiated in the RMI going back to the late 1990s when a value added tax was legislated but shortly after introduction was repealed due to lack of preparedness of both the tax administration and the private sector. In 2008, GoRMI created the Tax and Revenue Reform and Modernization Commission (TRAM), “to reform the current tax system and structure to meet the current and future financial needs of the Republic of the Marshall Islands”. PFTAC was requested to assist the effort to support the recommendations of the TRAM and to develop and design a tax-reform package. The essence of the tax reforms supported by PFTAC was introducing a modern tax system that was equitable, efficient, and simple while raising sufficient revenue to meet future fiscal challenges. A tax reform advisor was recruited for a two-year period in 2002, a legislative package was drafted, and an implementation program was prepared. However, the package failed to garner support and was not passed into law. The major focus of opposition from the business community was 138 Country Economic Memorandum and Public Expenditure Review concerning the introduction of the VAT which, for the most part, was insufficiently understood. Furthermore, the Majuro local government mounted strong opposition due to misplaced fears about revenue loss due to transfer of local government sales taxes to the national government. 302. Recent donor support has focused on tax administration strengthening but that will not overcome the inherent weakness and lack of buoyancy of the tax regime. Since the tax reform effort of the early 2010s, reform of the tax regime has not been seriously reconsidered. The boom in sovereign rents and reduced need for revenue effort dampened the demand for tax reform. With limited GoRMI commitment for tax reform, development partners have focused their support on administrative strengthening, including for compliance, improved tax collections, internal processes, risk management, etc. While such efforts are highly desirable and will result in increased revenue collections at the margin, they will not overcome the inherent lack of buoyancy of the existing regime. In other words, tax collections will fail to keep up with the growth in the economy and over time will constrain the delivery of public services, unless tax policy reform is pursued. Need for effective expenditure management 303. After the global financial crisis, the government initiated a comprehensive adjustment program (CAP), however, the reforms identified were not implemented. In response to acute fiscal pressure, the cabinet created two groups and commissions tasked with fiscal- reform initiatives: (i) the Comprehensive Adjustment Program (CAP); and (ii) the TRAM (discussed above). The CAP was designed to address the need for fiscal stability while also enhancing medium-term prospects for private sector-led economic growth. Two broad goals were identified for the program: (i) to put GoRMI on a path toward long- term fiscal sustainability; and (ii) to provide GoRMI with a program that could better guide its relations with the external donor community. The CAP Advisory Group outlined general principles of reform, which were for the most part limited to cost reduction and a detailed examination of 11 major areas of expense. The major area of reform was focused on civil service reform and reduction in payroll cost to levels that prevailed during the latter part of the 1990s. However, after a partial improvement in the fiscal position, neither the reduction in the size of the civil service or the other areas of potential cost savings were implemented. 139 Republic of the Marshall Islands 304. Strengthening medium-term fiscal planning is critical to secure long-term fiscal sustainability. Enactment of the FRDMA and associated regulations will provide the legislative framework for improved expenditure management. However, absent hard fiscal rules, greater fiscal prudence will require strong political commitment to delink current spending from windfall sovereign rents. Alternatively, GoRMI could consider introducing a stronger mechanism to limit rapid expenditure growth. Implementation of a medium-term expenditure framework with ceilings would promote stability and enhance fiscal and economic sustainability. In the event of a negative fiscal shock, the benefits of a medium-term framework would allow for more gradual adjustment of expenditures and help avoid sharp spending cuts. Poor SOE performance and increasing subsidies 305. The SOE sector, comprising a dozen public enterprises, continues to underperform and to impose significant risks and burdens on the fiscal accounts and economy. Given RMI’s economic geography, SOEs remain active in numerous crucial sectors of the RMI economy. While in some circumstances there are legitimate reasons for the state to subsidize the provision of key public services, for many years the SOE sector has underperformed, operating at an average annual loss of up to 6 percent of GDP and incurring average subsidies of 4 percent of GDP over the decade from 2005–2014. Furthermore, rates of return on assets and on equity over the period FY15 to FY17 were -2 percent and -4 percent, respectively, indicating the poor performance and a negative return on government’s investments. 306. In 2015, GoRMI enacted a reformed SOE Act to improve accountability, performance, and operation of the sector and to transform ad hoc subsidies into contractual CSOs. The legislation is designed to focus SOEs on achieving commercial viability as well as to strengthen governance structures and accountability, including through the introduction of CSO contracts for some entities. In the first phase, efforts are being focused on the four most significant SOEs by asset value: AMI, MISC, Tobolar and MEC. The objectives of the CSOs are to formally and transparently establish the service quality, distribution and frequency for each SOE, and to provide a basis for evaluating the true revenue and expenditure flows associated with the provision of desired community services. This is expected to facilitate a more informed policy discussion about the viability and sustainability of the services, the true size of public subsidies, and the extent to which current subsidies are deemed to be justified on equity or other grounds. Fiscal risk would be reduced if these CSOs are well-designed and if they become managed in a disciplined manner through the annual budget process. 307. Increases in the copra subsidy represents a significant fiscal threat. Subsidies to the SOE sector have increased from an average of US$8 million prior to the rapid increase in revenues, to an average of US$14 million in the last three years. The growth has almost entirely been due to higher subsidies to Tobolar, the copra processing plant. Tobolar collects copra from household/producers in the outer atolls and exports to world markets 140 Country Economic Memorandum and Public Expenditure Review at prices generally well below the cost of operations and in the last five years has recorded negative value-added. However, support to neighboring island households has become a high-priority social objective for GoRMI. The recent increase in price from US$0.30 per pound to US$0.50 per pound (in 2017) and then US$0.60 per pound (in 2021) represents a significant fiscal threat given the difficulty in restoring grower prices to their original levels in a highly politically sensitive area. Identification of more economically efficient means of neighboring island income support is a key public policy objective that has yet to be seriously addressed. Unsustainable financial position of the social security system 308. Actuarial study in 2011 projects collapse of the social security system in 2023 initiating a series of reforms in 2017 and transfers from government since FY17. The financial position of the Marshall Islands Social Security Administration (MISSA) has been a long- standing issue representing a significant fiscal risk. In 2011, an actuarial study projected the demise of the system and exhaustion of its investments by 2023. As a result of the projections a series of reforms were proposed in 2013 but failed to be acted on by the Nitijela. However, given the imminent collapse of the system a revised but reduced version of the reforms was enacted in 2017 incorporating four basic adjustments to: (i) increase the cap on taxable incomes from US$5,000 to US$10,000 per quarter; (ii) increase the contribution rate from 7 to 8 percent for employees and employers; (iii) reduce benefits by an average of 5 percent; and (iv) increase the retirement age gradually from 60 to 65 in increments of two years to become fully effective by FY25. Compared with the original reform list, it was recognized that these reforms would be insufficient to restore long-term sustainability. The Nitijela acted to provide annual transfers of US$3.6 million in FY17, but subsequently slowed to a US$1.6 million annual appropriation in the FY21 budget. 309. MISSA’s financial position has improved dramatically. The impact of these reforms and cash transfers appears to have been significantly greater than originally projected. In both the FY18 and FY19 audits MISSA indicates that contributions and benefits were evenly matched, thus allowing annual earnings on investments to accumulate in reserves. MISSA reports positive action on collections and that improved compliance has contributed to these results. Based on the current financial position of the fund, updated projected contributions and prior projections of benefit streams, the outlook for MISSA appears considerably brighter. Figure 58 suggests that contributions and benefits are likely to remain evenly balanced. The projections—based on a 4.5 percent return on assets (the rate assumed in the 2017 actuarial assessment) and termination of the annual government transfers after FY23—indicate that reserves will continue to accumulate through FY30, reaching US$100 million. That is more than double their pre-reform nadir of US$50 million at the end of FY16. These results suggest that the degree of fiscal risk presented by MISSA and the need for further reform may be less than had been assumed. However, the benefit projections presented here are based on outdated actuarial studies. Updated studies are essential to determine whether additional reforms are necessary to secure MISSA’s long-term sustainability. 141 Republic of the Marshall Islands Figure 58: Projections of MISSA contributions, benefits, GoRMI transfers and fund reserves (FY12–FY30) US$ millions $120m Fund Investments Benefits SS reforms have improved financial outlook Contributions $100m Nitijela Contributions $80m $60m $40m $20m $0m Source: Graduate School USA calculations. Need for a fiscal stabilization fund 310. There is a compelling need for GoRMI to establish a formal counter-cyclical fiscal buffer to mitigate the impacts of economic shocks. The operation of fiscal policy during the last 20 years has experienced periods of substantial cash flow shortfalls, resulting in fiscal and economic instability including failure to service accounts payable and temporary default on external debt repayments. Lacking access to capital markets and without a central bank to provide emergency liquidity, GoRMI needs to build a pool of savings from which to fund government operations following a shock to revenues. Depositing such funds in the CTF ‘A’ account or ‘C’ account would not be suitable, as these accounts have strict withdrawal rules that are not related to RMI domestic revenue volatility. The special ‘D’ account of the CTF could be utilized, or a separate fund could be established. Rules for withdrawal from the account would be under the unilateral control of GoRMI and would need to be consistent with the principles established by law and rules promulgated by regulation. Reporting on the fund would occur as part of the annual budget reports and via an annual audit. Climate change and disaster financing 311. Additional donor-funded ex-ante financing tools are necessary to strengthen GoRMI’s capacity to address the economic and fiscal impacts of disasters. Ex-ante financing tools to respond to disasters traditionally included GoRMI’s contingency budget and the Disaster Assistance Emergency Fund (DAEF) under the Compact. However, immediate cash available through each source is only around US$0.2–0.3 million (each around 0.1 percent of GDP). GoRMI recently added World Bank and ADB contingent financing instruments to its ex-ante financing tools, which provided fast-disbursing support to respond to the COVID-19 crisis. However, GoRMI continues to rely heavily on donor 142 Country Economic Memorandum and Public Expenditure Review support to fund post-disaster expenditure. Ex-post, for major events GoRMI has access to the US Federal Government disaster response apparatus (as part of the Compact), including from the US Agency for International Development and the Federal Emergency Management Agency. However, response times can be lengthy. Securing additional ex- ante contingent financing from development partners, such as the World Bank’s Development Policy Financing with a Catastrophe Deferred Drawdown Option contingent financing instrument, could help to strengthen GoRMI’s capacity to adequately and rapidly respond to emergency events of various magnitudes.103 312. Substantial international climate finance will be required to meet the nation’s very large climate change adaptation costs. World Bank (2017a) projections of the annual cost of adaptation to climate change (9–24 percent of GDP) are in addition to spending needs required to improve human development and infrastructure. International climate finance is, therefore, critical if climate financing needs are not to crowd out human development and infrastructure funding. While additional revenue from harnessing the growth and public finance opportunities outlined in this CEM/PER will allow GoRMI to increase its contribution to climate-adaptation measures, the financing gap will remain large. Effective international climate finance will thus remain central to RMI’s ability to deal with climate change. 2.2.4 Recommendations 313. Ensuring long-term fiscal sustainability and macroeconomic stability will require a fiscal adjustment of 5–6 percent of GDP over the period FY22 to FY35. The expected continuation of US financial support has alleviated the pressure for a sharp fiscal adjustment in the short term. However, US support is unlikely to continue indefinitely. Consequently, there is a need to undertake a multi-pronged fiscal adjustment of 5–6 percent of GDP over the coming 15 years. The adjustment could be achieved by partially reversing the recent increase in recurrent spending (around 4–5 percent of GDP) while preserving spending on health and education. On the revenue side, implementing growth-friendly tax reform and improving revenue administration could contribute around 1 percent of GDP to the fiscal adjustment. This adjustment would help to build the CTF to a level that would allow for future annual disbursements equivalent to the CSGs, while protecting the real value of the CTF. Reforms considered by GoRMI in the past—such as under the TRAM and CAP—should be revisited. These should be complemented by implementation of a long-term fiscal strategy to help decouple current spending from domestic revenues. Establishment of a stabilization fund is also warranted to help smooth expenditure and avoid the need for sharp spending cuts due to external shocks to domestic revenues. 103 RMI was part of the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) which supported development of risk country profiling and market-based catastrophe risk insurance. In 2020, GoRMI elected to cancel their coverage as they required more bespoke insurance products to better suit RMI’s risk profile (for example, to include coverage of drought and flooding not from cyclones). 143 Republic of the Marshall Islands 314. Reform is required to modernize the tax regime and improve its efficiency. To this end, the recommendations from the Tax and Revenue Reform and Modernization Commission (TRAM) from 2010 should be revisited, including: (i) reforming the personal income tax; (ii) introducing a net profits tax; (iii) introducing a consumption tax to replace the gross revenue tax; and (iv) replacing existing import duties with excise taxes. Efforts to improve revenue administration and implementation capacity should also continue. 315. Securing long-term fiscal sustainability will also require gradual and sustained efforts to reduce current expenditure, including SOE subsidies. Implementation of a medium- term expenditure framework which provides some limits on spending growth would promote stability and enhance fiscal and economic sustainability. In the event of a negative fiscal shock, a medium-term framework would allow for a more gradual spending adjustment and avoid rapid cuts, reducing economic volatility. Greater spending discipline will need to include efforts to improve the performance of, and reduce subsidies to, the SOE sector (particularly for copra). To improve the efficiency of SOEs, CSOs for the four key SOEs should be finalized and implemented in the short term. CSOs should be extended to other SOEs in the medium to long term, along with close monitoring and adjustments to CSOs as required. 316. The efficiency of the copra subsidy should be carefully evaluated in the short term, and reform to the scheme considered in the medium to long term. The rapid increase in the copra subsidy in recent years represents a significant fiscal threat. The subsidy is highly inefficient, and its effectiveness to protect livelihoods in neighboring islands is also an open question. Establishing a formal social protection mechanism or redirecting the subsidy to incentivize production of staple foods could be a more efficient mechanisms to support livelihoods (see Section 1.3.3 for a detailed discussion of these options). 317. There is a need to modernize and strengthen the legislative and institutional frameworks that govern, and provide discipline to the design of fiscal policy, planning and budgeting, and borrowing decisions. The FMA needs to be reviewed and modernized to be consistent with current practices in budgeting, accounting, and reporting. Regulations to support implementation of the FMA should be developed and adopted. The proposed FRDMA and associated regulations include several measures designed to improve the consistency and sustainability of long-term fiscal management and enhance accountability. They also strengthen the rules governing borrowing and debt management. The revised FMA, FRDMA and their regulations should be enacted in the short to medium term. 318. Efforts to embed and strengthen the medium-term planning and budgeting framework, including the linkages between capital and recurrent spending, should be continued. Following recent reforms and IMF PFTAC capacity building efforts, the building blocks are now in place to strengthen budget preparation, review and approval processes while also creating linkages to the NSP and sectoral/corporate plans of line ministries, agencies and SOEs. These should also be linked to the National Infrastructure Investment Plan (NIIP), once it is completed. The reformed medium-term budgeting framework represents a significant change from past practices. Ongoing technical assistance will be required to support its institutionalization. 144 Country Economic Memorandum and Public Expenditure Review 319. RMI’s narrow domestic revenue base and vulnerability to external shocks justifies the creation of a fiscal stabilization fund. Financed from accumulated fiscal surpluses, the fund could be designed to smooth fiscal operations by helping to mitigate the impacts of external shocks on domestic revenues and due to a state of emergency (that is, a health or natural disaster). Rules regarding deposits and withdrawal would need to be promulgated by law and regulation. Establishment of the optimum size of the reserve could be based on a measure of volatility and duration of shortfalls in domestic revenues over the business cycle. The optimal size of the fund should be assessed against the need to build long-term fiscal buffers (that is, CTF ‘A’ account) and RMI’s very large climate adaptation needs. 320. In the longer term, there is a need to strengthen capacity for debt management and introduce policies and processes to govern government guarantees and on-lending. Significant capacity needs to be developed over time for MOF to be able to implement the legal and regulatory framework for debt management defined in the FRDMA and its regulations. Key functions include keeping safe records of debt documentation; recording and monitoring GoRMI debt and (guaranteed) debt of SOEs; reviewing the impact of borrowing on fiscal and debt sustainability; monitoring the financial risks inherent in the debt portfolio; and monitoring the risk of guarantees materializing or (on-)lent loans not being repaid. Furthermore, there is a need to strengthen the policy framework to avoid an unsustainable build-up in contingent liabilities through the implementation of specific government guarantee and on-lending policies. 321. Reform to the CTF distribution rules could help to enhance fiscal independence and stability. Alternative rules provide greater stability and sustainability of the CTF and reduced volatility of distributions, but at the cost of lower annual distributions. Reform of the CTF rules will require an act of the US Congress. GoRMI should seek to amend the CTF rules as part of the ongoing Compact negotiations. An optimal result would be a change in the rules coupled with additional funding to increase the size of the CTF relative to the target distributions. 322. Efforts to strengthen infrastructure project prioritization and management could help to maximize the returns to investments and to enhance resilience and service delivery. Updating and finalizing the NIIP, including by applying a prioritization methodology to rank projects across sectors, could help to strengthen public investment management. Strengthening resilience to climate change and disasters will also require efforts to enhance infrastructure prioritization and asset management. 145 Republic of the Marshall Islands 323. Modernizing the legal framework and processes for procurement are essential to improve the value for money of public expenditure and reduce delays that inhibit service delivery. The current legislative framework for procurement is outdated, implementing regulations have never been issued, and a 2017 compliance audit found serious deficiencies in the implementation of procurement policies. Overall, this has led to procurement processes that are highly inefficient and fragmented, with line ministries citing procurement inefficiencies as one of the greatest constraints on service delivery. Reform is urgently needed to modernize the legal framework and streamline business processes and procedures, which can help to improve the cost effectiveness and timelines of purchases. In the longer term, the publication of procurement key performance indicators could incentivize performance and improve spending efficiency. 324. While MISSA’s financial position has improved significantly in recent years, updated actuarial studies are required to evaluate whether further reforms are necessary to secure financial sustainability. The 2017 reforms and GoRMI annual transfers appear to have returned MISSA to a sustainable path. However, recent assessments are based on outdated actuarial studies. Updated studies are essential to determine whether additional reforms are necessary to secure MISSA’s long-term sustainability. 325. Implementation of the new FMIS will support effective management of public resources and improve financial reporting for management and accountability. It will do so by allowing the automation and integration of key underlying processes for budget formulation, budget execution and financial reporting. The provision of accurate and comprehensive budget reports is critical to support effective planning, budgeting, and monitoring—and ultimately, improved service delivery. Implementation of the new FMIS should be a priority in the short term, while embedding the new system and businesses processes, along with the required ongoing capacity building and training, should be pursed over the medium and longer term. 2.3 PUBLIC SECTOR WAGE BILL AND HUMAN RESOURCE MANAGEMENT 326. Public service wage bill management is crucial to fiscal management and to broader development. Representing 31.7 percent of expenditure in FY19 (21.5 percent of GDP) the wage bill is such a significant component of public expenditure that its management is critical to overall fiscal management. Public servants are also a key input to public services—like education and health care, which in turn are critical to development—to improving people’s security, health, skills, and livelihood opportunities. To have a productive public service, the government needs to be able to attract, retain and motivate the number, types, and quality of public servants it needs. These are multi-faceted challenges, depending on many things for their achievement. But one of the things they depend on is a pay scale that is equitable both horizontally (similar pay for similarly demanding jobs) and vertically (appropriate increases in pay for more demanding jobs). This matters to recruitment and retention, to motivation to perform in order to be promoted, and to broader motivation arising from a sense of equity. This obviously links back to wage bill management, through the composition of the wage bill. Other factors 146 Country Economic Memorandum and Public Expenditure Review also matter – like merit-based selection and promotion, clearly defined organizational and individual objectives, and effective performance management. This section offers a brief overview of each of these issues.104 327. Strengthening of GoRMI’s core human resource management (HRM) systems is crucial to avoid fragmentation and to support service delivery. Various ministries report that the manual public-sector HRM processes—centralized in the Public Service Commission (PSC)—are inefficient, opaque and are among the most serious concerns for spending units. Frustration with the PSC-led public-sector HRM processes was one of the key factors that motivated the PSS to withdraw from the PSC system and establish their own HRM processes as part of the reforms embodied in the PSS Act 2013. Concerned by the ongoing weaknesses in the PSC HRM processes, MOHHS have indicated that they too may seek to establish an independent HRM function. While an argument could be made that the devolution of HRM functions could improve efficiency, in the absence of strong oversight it could also lead to less accountability and greater potential for patronage. The alternative is to strengthen the centralized systems—a solution that is arguably more suitable given the small size of the RMI public service relative to other nations where devolution has been pursued. 2.3.1 Evolution of the Public Service Wage Bill and Employment 328. Examining the trajectory of the public service wage bill over time provides insights into the effectiveness of GoRMI controls on staff numbers and average wages. Figure 59 shows how the nominal wage bill has evolved since FY97, and also shows the trajectory of the real wage bill (the nominal wage bill, adjusted for inflation). Figure 60 shows how the number of public servants, and the share of public servants in the population, has evolved since FY97. Figure 61 breaks down the wage bill growth (or decline) each year into the part that is due to rising (or falling) staff numbers and the part that is due to rising (or falling) average wages. Brief explanations of the different phases in the trajectory of the wage bill since FY97 are attached to Figure 59. Figure 59: Nominal and real wage bill US$ millions Source: EPPSO & Graduate School USA (2021).and WB calculations. 104 Throughout this section, the public service refers to the central government public service and does not include state-owned enterprises. 147 Republic of the Marshall Islands Figure 60: Number of public servants and Figure 61: Breakdown of nominal wage bill share of population growth Compact-related growth Source: EPPSO & Graduate School USA (2021). Source: EPPSO & Graduate School USA (2021) and WB calculations. 329. The evolution of the wage bill suggests that GoRMI has relatively good control over the key drivers of nominal wage bill growth: staff numbers and average wages. When GoRMI sought to reduce the wage bill in the late 1990s during uncertainty over the renewal of Compact-related grants, it implemented a retrenchment program with ADB support (the ‘Reduction in Force’ exercise). This which resulted in a 20 percent decline in staff numbers. In the early 2000s, when GoRMI became confident that the financial chapter of the Compact would be renewed, the previous fiscal constraint on staffing was removed and staff numbers were allowed to increase again. After the new Compact funds began to flow in 2004, there was a large increase in public servant numbers to implement programs in education, health and infrastructure agreed under Compact Sector Grants (including staff transfers from directly managed US programs to GoRMI control). When these policy-based changes were achieved, the growth in staff numbers was restrained to be roughly in line with population growth.105 Overall, increases in average nominal wages have been sufficiently modest to roughly contain the growth of the real wage bill. for example, after the structural increase in the real wage bill related to the amended Compact, the real wage bill declined, only rising back above its FY05 peak in FY19. In many years, increases in average nominal wages contributed to the growth of the nominal wage bill, but in other years decreases in average nominal wages offset some of the impact of staffing increases on the nominal wage bill. Overall, increases in average nominal wages have been modest. 105 Keeping growth in the number of public servants in line with population growth makes intuitive sense, as it aligns changes in the size of the public 148 service with changes in the scale of public services that need to be delivered, due to changes in the size of the population to be served. Country Economic Memorandum and Public Expenditure Review 330. Examining trends in the public service wage bill as a share of revenue, expenditure and GNI also indicates that GoRMI has relatively good control of the wage bill. Figure 62 shows the wage bill shares of domestic revenue plus US-sourced development assistance, current expenditure, and total expenditure. It shows the relatively flat trajectories of these ratios since the structural increase in the wage bill related to the revised Compact, and their decline since FY14 as fisheries sector revenues have increased significantly while the wage bill has been reasonably well contained. The wage bill share of revenue indicates that the affordability of the wage bill remained fairly constant over much of this period, and then improved in recent years. The wage bill shares of current and total expenditure indicate that, following the earlier structural increase, the wage bill has not further squeezed out other recurrent and capital inputs, and in recent years has left more fiscal space for these other inputs. Figure 63 shows how the wage bill as a share of GNI declined during the ‘Reduction in Force’ exercise, increased sharply in the lead up to and early implementation of the revised Compact, and generally declined since.106 Overall, these trends reinforce that GoRMI has relatively good control over the wage bill. Figure 62: Wage bill as a share of Figure 63: Wage bill as a share of GNI revenue and expenditure Source: EPPSO & Graduate School USA (2021) and WB calculations. 106 Given the importance of fisheries revenues and remittances to national income, GNI offers a more consistent indication of national income than GDP. 149 Republic of the Marshall Islands 331. RMI’s public service wage bill is in line with those of RMI’s structural and regional peers. Figure 64 shows that RMI’s wage bill as a share of domestic revenue and current expenditure is close to the average for PICs (as shown by the horizontal lines) and for small states. Figure 65 shows that RMI’s wage bill as a share of GNI is not obviously excessive for such a small country—typically, the smaller the GDP, the higher the wage bill share of GNI, with RMI’s wage bill as a share of GNI in keeping with that trend. Figure 66 shows that RMI’s public servants as a share of the population is close to the average for PICs (as shown by the horizontal line). Figure 67 shows that the ratio of the average wage of public servants to GNI per capita in RMI is somewhat above the average for PICs (as shown by the horizontal line), and similar to the ratio in Kiribati and Solomon Islands. This ratio is a way of comparing, across countries, how well-paid public servants are relative to average income levels in their country. Figure 67 suggests the need to be alert to whether wage levels in the public service in RMI are appropriate relative to those in comparable jobs in the labor markets public servants can access. In RMI, that includes state-owned enterprises and the local private sector, but also in the US—where all Marshallese are entitled to work. This might explain the somewhat high ratio found for RMI in Figure 67. Figure 64: Regional comparison of wage bill as a Figure 65: Regional comparison of wage bill as a share of revenue and expenditure (2018) share of GNI (2018) Source: EPPSO & Graduate School USA (2021) and WB calculations. 150 Country Economic Memorandum and Public Expenditure Review Figure 66: Regional comparison of public servants Figure 67: Regional comparison of average wages as a share of population (2016–2018) to GNI per capita ratio Source: EPPSO & Graduate School USA (2021) and WB calculations. 2.3.2 Challenges in Public Service Wage Bill and Employment Management An outdated remuneration framework 332. Despite having relatively good control of the overall wage bill, GoRMI faces challenges with remuneration management that are important for public service performance. The pay scale for public servants has been fixed since FY97, with no adjustment for any cost-of-living changes over the subsequent two decades. However, average nominal wages have fluctuated over that time and increase overall (Figure 68). Some of these changes may be due to changes in the composition of staff (for example, increases in their skill levels and corresponding appointment grades and pay levels). However, the main driver appears to be the appointment or promotion of staff to levels above what their jobs or qualifications warrant, to avoid paying them below the minimum wage (which increased from US$2/hour to US$2.50/hour in 2016, and then to US$3/hour in 2018). This is because increases in the minimum wage have resulted in progressively more levels of the public service pay scale being below the minimum wage.107 There may be other workarounds that have been found to similarly increase earnings (for example, increasing non-wage elements of remuneration).108 107 An analysis of the distribution of staff across grades over the years that the pay-scale has been fixed would help provide evidence of this. The available data are by sector, not grade, from FY04. They show that major increases in the education, health, and general public administration workforces have occurred at different times from major increases in the average wages of those groups of staff. This suggests that, at least after FY04, the increases in average wages are not due to the recruitment of batches of highly skilled staff. Instead, the wage increases must be for existing staff. 108 Analysis of non-wage components of remuneration from FY04 suggests overtime and life insurance have been stable, but social security and ‘other’ remuneration have increased—but they are small shares of the wage bill. 151 Republic of the Marshall Islands Figure 68: Average public service wages (US$) Source: EPPSO & Graduate School USA (2021) and WB calculations. 333. The widespread use of such workarounds signals significant discretion in public service appointments, promotions, and remuneration decisions. Even if it is only being used to ensure compliance with the minimum wage, it is likely to be generating inequities among public servants (as those with lower skills and responsibility have their salaries increased to be equivalent to those with higher skills and responsibility). Such distortions can have adverse impacts on the public service’s ability to attract, retain and motivate the people it needs and the performance it wants. Lack of implementation of GoRMI’s human resource management information system (HRMIS) 334. Five years after its procurement, RMI’s HRMIS is yet to be fully implemented. Making informed decisions on HRM issues such as pay and grading, attraction/retention and recruitment and promotion requires good quality data. Contemporary organizations use an HRMIS that is designed to support their needs. In 2016, the GoRMI obtained a cloud- based HRMIS (2Interact) with support from the ADB. While the HRMIS has been installed, the data validation process is still underway and user access is still in the process of being established. 152 Country Economic Memorandum and Public Expenditure Review Inefficient and ineffective recruitment and promotion 335. The PSC Annual Report 2019 highlights inefficient and ineffective processing of recruitment and placement of employees as a systematic problem that needs to be dealt with urgently. The GoRMI public service is relatively small, with 1,118 employees. Based on PSC data, there were 12 appointments, 10 promotions and 11 transfers approved by the Commission in 2019.109 Global studies indicate that annual employee turnover rates average around 11 to 15 percent (Zojceska, 2018). Assuming a similar turnover rate in GoRMI, around 120–170 personnel changes would be expected annually. The causes of delays in recruitment and promotions reportedly include unclear policies and/or regulations, over-reliance on paper-based processes and technical and capacity constraints both in line ministries as well as the PSC. This is a problem that requires a deeper and more focused examination to fully understand the systematic nature of the challenge, and how this may be successfully tackled with a combination of policy, behavior change and system utilization. Weak performance management 336. There are significant problems with the current approach to public servant performance management in GoRMI. PSC reports that compliance with the existing performance management system is very weak. In 2018–19, there were 20 ministries and agencies and 1,118 public servants within PSC jurisdiction, all required to submit performance evaluations and self-appraisals annually. In 2018–19, just over one quarter of public servants (295 out of 1,118) submitted performance evaluations. The results of these evaluations showed that 30 percent were assessed as average performers, 63 percent received above average performance ratings and 7 percent received outstanding ratings. No public servant was rated as underperforming. There were eight ministries/agencies that did not submit any employee performance evaluations. While performance management is another area that the PSC has identified as a priority area, this lack of compliance provides some evidence of the challenges to implementing a meaningful performance management system. Focusing solely on compliance with the requirement to submit performance evaluations will not achieve the deeper purpose of performance management which is to incentivize and motivate public servants. This will require behavior change as well as capacity building for supervisors and managers on how to effectively support and motivate their staff. 109 This does not include appointments and promotions in the Ministry of Education, where a separate staff services commission has been established. 153 Republic of the Marshall Islands 2.3.3 Recommendations 337. With control over the public service wage bill relatively well established at the macro level, GoRMI has the opportunity to focus on wider civil service HRM issues. These broader HRM issues are particularly important because the ability, motivation and productivity of public servants are key determinants of government capability and performance. Given the dominant role of the public sector in the economy and provision of core services, improving the efficiency of the public service is also crucial to drive improvements in productivity and efficiency. If GoRMI can: (i) select high-quality people on the basis of merit; (ii) provide them with the necessary resources including equitable pay and grading scales; (iii) motivate them to work toward their organization’s objectives with clear organizational accountability, clear individual accountability and effective performance management processes; and (iv) serve the citizens of RMI, this would be a significant contribution to the economic and social development of the country. Implement the HRMIS and integrate it with the new FMIS 338. Implementation and integration of the HRMIS and new FMIS should remain a priority for GoRMI. A new FMIS is being implemented and includes a payroll module. The FMIS and HRMIS are intended to be fully integrated. Ensuring integration between the HRMIS and the FMIS and payroll supports a streamlined and effective approach to managing all aspects of HRM. The completion of the implementation and integration of these systems should remain a priority for GoRMI. Once both systems are fully implemented and integrated, this will provide the PSC with a wide range of data that can be used to inform and monitor HRM issues. Implement merit-based recruitment and promotion 339. Merit-based recruitment and promotion is a basic pillar in modern public services and research has shown that merit recruitment correlates with economic growth and lower levels of corruption and nepotism.110 For small island states, in particular, where the wage bill often represents a significant portion of government expenditure and there are limited pools of potential applicants for public service roles, employing the best available people and supporting and encouraging them to move to more senior positions is a key element in seeking to achieve service delivery objectives. While the implementation of the HRMIS can assist with streamlining and automating processes, the importance of clear and effective policy and behavior change cannot be understated and needs to be done in parallel with the HRMIS rollout. 110 Rauch and Evans (2000), Meyer-Sahling et al. (2018). 154 Country Economic Memorandum and Public Expenditure Review Ensure fair and equitable job evaluation and pay 340. A comprehensive review and modernization of the GoRMI pay scales is required to ensure they are consistent with minimum wage legislation and restore equity across the pay bands. As already mentioned, despite the pay scale being fixed since FY97, overall average nominal wages have increased. Two drivers of this appear to be the appointment of staff to levels above their job or qualifications to avoid paying wages below the minimum wage, as well as increasing non-wage elements of remuneration. This is also likely to have led to an increase in inequity because not all public servants in all sectors will have been able to access these workarounds. The minimum wage is scheduled to increase by an additional US$0.50 per year until it reaches US$4.00 per hour.111 This would further compound the inequity across the public service. There is a consensus in GoRMI on the need to review the pay scales to correct the inequities that have progressively developed within the public service and also to ensure that there is a mechanism which would allow for periodic adjustments over time, to avoid the return of these problems. 341. A robust and transparent mechanism for regular pay scale review and adjustment is also warranted. The introduction of a regular review of the adequacy of public service pay scales would ensure that wage levels can remain at a desirable level for both staff attraction, retention and purchasing power purposes as well as to have a more transparent, fair and predictable way to adjust wages compared to ad hoc increases or political decisions to adjust wages. A mechanism that would allow for a number of economic and financial considerations, such as affordability in the context of the RMI economy and government budget, fairness to employees and labor market impacts would bring greater rigor and fairness to what is an important decision. 342. Fair and consistent foundational HRM functions, such as job descriptions and evaluation frameworks, are essential to ensure equity, accountability, and effective performance management. One key HRM concept which should underpin the development of a contemporary pay scale is the standardization of pay levels based on the relative complexity, responsibility, and accountability of individual jobs across the public service. This job evaluation framework ensures that there is equity in pay for public servants who are performing jobs with similar levels of complexity, responsibility, and accountability regardless of which ministry they work in. A robust job evaluation framework also supports transparency through a clear and consistent process to ascertain the ‘size’ of each job and therefore, determine the appropriate pay level. Accurate and standardized job descriptions and titles is a prerequisite for implementing an effective job evaluation framework. Having well written job descriptions with clear requirements for performance will also support the recruitment and promotion of good quality candidates as well as form the basis for effective performance management. 111 The Act stipulates that the minimum wage will increase by US$0.50/day each year until it reaches US$4.00/day, subject to an assessment report by a Task Force established by Cabinet. If the Task Force recommends no change to the minimum wage, Nitijela can defer the increase. The increase has been deferred since 2018. 155 Republic of the Marshall Islands 343. While the Public Service Regulations provide for a system of job classification and levels, the specific considerations behind the allocation of classification and level are opaque. All job titles have been allocated a classification and level. Any new roles which are approved will use these existing job titles as guidance for decisions of classification and level. This approach, while requiring less resources and time for PSC, is rather ad hoc, discretionary and does not provide the necessary governance and rigor to ensure that issues of pay equity do not become eroded over time. Given the ad hoc nature of the current approach, it is also likely that this may have been used as a workaround to the challenges of stagnant pay scales with people being appointed to incorrect grades. Strengthen performance management 344. Robust performance management frameworks are required to ensure accountability, provide structured feedback and guidance, and provide incentives for high performance. Performance management should build on the foundations provided through meritocratic recruitment and promotion and a fair and equitable pay and grading system to incentivize and motivate public servants to continuously improve their work performance and productivity. It is important to have access to a mix of financial and non-financial rewards as well as accountability mechanisms to ensure that the performance management system is both meaningful and robust. GoRMI has started some performance management reforms, with all Secretaries being moved on to performance-based contracts in 2019. No information on the success or challenges of this reform has emerged to date. Review and update the PSC regulatory framework 345. Modernization of the Public Service Regulations is required to support the necessary reforms. Another critical part of the overall governance and oversight of public sector HRM arrangements is the legislative and regulatory framework. The current Public Service Commission Act 1979 is short, with only one substantive section which describes the powers of the PSC. There are also provisions in the Constitution which describe the public service, powers of the PSC and appointments and conditions of employment within the public service. However, the detailed provisions for HRM appear in the Public Service Regulations from 2008. Given that the Regulations are almost 13 years old, there are many aspects that need to be updated in order to support the necessary reforms. Updates are required for job grading (job evaluation), PSC pay scales, improved articulation of meritocratic recruitment requirements and strengthening of the performance management system. Amendments to the Regulations could also include additional provisions for workforce planning to ensure talent and succession planning and work- related training and capacity building, particularly where it is linked to regular discussions on improving public servant performance. 156 Country Economic Memorandum and Public Expenditure Review Credit: Eric Sales / ADB 2.4 HUMAN CAPITAL 346. Human capital is a crucial driver of economic growth and development, poverty reduction and improved living standards. Human capital consists of the knowledge, skills, and health that people invest in and accumulate throughout their lives, enabling them to realize their potential as productive members of society. Investing in people through nutrition, health care, quality education, jobs and skills helps develop human capital, and this is key to addressing the drivers of poverty and creating more inclusive societies. Economic growth and development depend on both human capital and physical capital, and on the factors affecting productivity. Investments in these areas complement and reinforce each other.112 At the household level, human capital accumulation delivers private returns in the form of higher income. It also delivers positive externalities to others and across generations. These individual returns and positive spillovers add up to large benefits for the economy. Consequently, in the case of RMI, government action to support increases in human capital—including better quality spending in the education and health sectors—is crucial to maximize the development impacts of the nation’s natural and labor resources (see the concise organizing framework for the joint CEM and PER at Figure in the Introduction). 347. The National Strategic Plan 2020–30 (NSP) highlights RMI’s commitment to improve human capital. The NSP affirms that “At the heart of all development is human development, and at the heart of human development is early childhood and maternal health, nutrition, and care. While RMI’s broad human development indicators such as infant and child mortality rates and educational attainment have steadily improved since independence, the overall progress in building human capital can still be improved”. The NSP seeks to achieve this through strengthening the health system (including to neighboring islands), achieving inclusive and equitable education and lifelong learning opportunities for all, and enhancing the capacity of youth and vulnerable peoples to meet their full potential. 112 Human capital complements physical capital in the production process and is an important input to technological innovation and long-run growth. As a result, between 10 and 30 percent of per capita GDP differences is attributable to cross-country differences in human capital (Hsieh and Klenow, 2010). 157 Republic of the Marshall Islands 348. Despite this commitment, human capital outcomes in RMI are low for the country’s level of income and are among the lowest in the Pacific. In 2020, RMI’s Human Capital Index (HCI) was 0.42 (Figure 69). This means that a child born in RMI in 2020 will be 42 percent as productive when they grow up as they could have been had they enjoyed complete education and full health. This is lower than the average HCI for the EAP region and upper middle-income countries. The HCI is calculated based on six components, three related to education outcomes (expected years of school, harmonized test scores, and learning-adjusted years of school) and three related to health and nutrition outcomes (probability of survival to age five, adult survival rate and the prevalence of childhood stunting). The HCI is designed to highlight the link between investments in health and education and the productivity of future workers. RMI’s low HCI thus emphasizes the need for higher quality social sector spending to underpin improvements in labor productivity and future economic prosperity. 349. RMI’s low HCI is driven by poor results across both education and health components. Relative to the other PICs, RMI ranked the second lowest for expected years of school (9.4 years) and slightly below the average for harmonized test scores (375 out of 625). Combined, this placed RMI as the third lowest in terms of learning-adjusted years of schooling (5.7 years). When compared to the other PICs on the HCI health indicators, RMI has the lowest adult survival rate,113 the highest rate of stunting for children under age 5 (35 percent),114 and the second lowest survival rate to age five (the infant mortality rate is 28 per 1,000 live births). The COVID-19 crisis has likely exacerbated these poor outcomes via the adverse impacts on livelihoods, nutrition, and interruptions of essential health and education services. Figure 69: Human capital outcomes in RMI are low relative to its income level and regional comparators Human Capital Index score versus GNI per capita 0.9 0.8 Human Capital Index, 2020 0.7 0.6 Samoa Palau Tonga Micronesia Fiji Nauru 0.5 Kiribati Vanuatu Tuvalu 0.4 Solomon Is. RMI 0.3 Lower middle Upper middle Low income income income High income 0.2 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 GNI per capita, 2019 (US$) Source: GoRMI; World Bank (2020). Note: X-axis is expressed in logarithmic scale. Markers in light blue are some Caribbean Island economies. 113 This is calculated by subtracting the mortality rate for 15–60-year-olds from 1. 158 114 Stunting refers to low height-for-age and is an indicator of chronic malnutrition. Country Economic Memorandum and Public Expenditure Review 350. RMI also has very limited coverage of formal social protection programs, even when compared to other PICs. RMI has a defined benefit pension scheme for formal sector workers and a school feeding program for primary school children. Beyond these two schemes, there are no formal social protection programs to support vulnerable groups (such as the poor, informal sector, elderly or disabled), and no formal means to provide crisis-responsive support to households. With support from the World Bank, GoRMI is currently implementing a pilot conditional cash transfer program to encourage vulnerable families with young children and pregnant women to increase uptake of essential early childhood and health services. 351. The copra subsidy is recognized as the nation’s quasi-social protection program— designed to deliver livelihood support to residents on neighboring islands and to slow the pace of urban migration. However, when viewed as a social protection transfer mechanism, it is widely accepted that Tobolar is highly inefficient. In the short term, there is a natural opportunity for strategic decision making regarding the future of the copra subsidy, given that over 70 percent of RMI’s coconut tree population is senile. Bold reform to establish a formal social safety net program would be a strong pillar to support improvements in human capital. See paragraphs 216 to 219 for a discussion of options to reform the copra subsidy, including to establish a formal social protection program to support vulnerable households and provide a mechanism for GoRMI to deliver adaptive, crisis-responsive social protection payments. 352. There is a clear need to enhance the foundations of human capital to boost the productivity, competitiveness, and wellbeing of the Marshallese population. At present, the foundations of human capital formation are at risk due to inadequate access and poor-quality health, nutrition and education services, and a lack of protection from poverty and household shocks—such as formal social protection programs. However, there are opportunities to drive improvements in human capital through reforms to enhance the efficiency and equity of health and education service delivery. The following sections of this report detail the challenges and opportunities in the education and health sectors and articulate a prioritized and sequenced set of actions to bolster human capital. However, government actions to support advances in human capital go well beyond spending on health and education. They also include actions to establish social protection programs (see paragraphs 216 to 219), improve water and sanitation, enhance resilience to shocks (such as natural disasters and climate change—see paragraphs 231 to 241), and improve access to key development enablers such as ICT (see paragraphs 213 and 214). Consequently, actions to advance those sectors are also consequential to support the improvements in human capital required to drive higher economic growth, raise incomes, and improve living standards. 159 Republic of the Marshall Islands 2.5 EDUCATION SECTOR 353. This chapter outlines the education sector’s structure and delivery mechanisms; analyzes financing sources and expenditure uses; and evaluates outcomes and issues of efficiency and access. In 2004 the World Bank conducted a review of the RMI education system which highlighted that despite relatively high spending per student by regional standards, RMI’s education outcomes were among the lowest in the Pacific, due to an inefficient allocation of resources (for example, concentrated spending on post-secondary education), a low secondary school completion rate, low teacher quality, and weak Ministry of Education, Sports & Training (MOEST) institutional capacity for sector management. This chapter of the PER finds that these challenges largely remain, based on recent analysis and data on outcomes and education financing. 354. The chapter confirms that outcomes for students remain very low, with results from national standardized testing indicating that most students do not meet minimum national standards across all subjects. RMI conducts yearly national learning assessments called the Marshall Islands Standards Assessment Test (MISAT) in mathematics, Marshallese, English, and science for students in grades 3, 6, 8, 10, and 12.115 Results, which are benchmarked against expected outcomes and presented in terms of proficiency scores, indicate low learning outcomes at all levels. Proficiency scores are below 45 percent in all years, all grades, and all subjects, meaning that most students do not meet the minimum national standards.116 Also, among those who chose to enroll in post- secondary education at CMI and USP in 2017–18, around 95 percent failed to meet the basic requirements for English and mathematics and were required to complete one year of remedial coursework before commencing post-secondary studies. In addition to low levels of learning achievement, enrollments at secondary level are low, and even more so for students from poor backgrounds. 355. The education system is characterized by both low outcomes and high public spending (equivalent to at least 15 percent of GDP). Despite continued high spending and reforms that have focused on improving inputs (teacher qualifications, school accreditation), outcomes have not improved (see paragraph 379). In contrast, outcomes have improved in peer countries over that period, despite substantially lower spending.117 According to the HCI, learning adjusted years of schooling in RMI are the third lowest in the Pacific, at 5.7 years. This is because relative to the other PICs, RMI ranked the second lowest for expected years of school (9.4 years) and slightly below the average for harmonized test scores (375 out of 625). 115 There is no assessment of vocational skills. 116 Proficiency scores are the percentage of objectives that students have mastered per grade level. National averages are reported for each subject tested at each grade level tested. This definition does not allow for comparison with international learning poverty, defined as the percentage of students at age 10 who cannot read fluently and with comprehension. RMI also participates in the Pacific Islands Literacy and Numeracy Assessment. Country-level scores were not available for analysis during preparation of this study. 117 The Pacific Islands Literacy & Numeracy Assessment 2018 Annual Report (Pacific Community, 2019) highlights that the proportion of Grade 4 and Grade 6 students reaching the highest proficiency levels in both literacy and numeracy has increased. While the proportion of students who are not 160 yet performing at the minimum expected levels in literacy has decreased. Country Economic Memorandum and Public Expenditure Review Credit: World Bank 356. High spending and continued low outcomes indicate an education system that is failing to adequately prepare Marshallese youth for a productive life. It is important to understand how expenditure is linked to particular sources of funding in the RMI context (for example, CSGs, the SEG, the General Fund), with large proportions of US-sourced funding being associated with conditionalities beyond the control of GoRMI. For example, while sectoral spending appears skewed towards the tertiary level compared to regional standards, this is largely due to Pell Grants, which could not be used to finance primary or secondary education. Indeed, the proportion of spending for primary and secondary education has increased and is now quite high (at least 70 percent), with no obvious misallocations either between primary and secondary levels, or for particular types of inputs (for example, staff costs are around 65 percent of pre-tertiary education spending, which is within the range of upper middle-income countries). Therefore, there does not appear to be a broad misallocation of spending causing inefficiency. Rather, spending at all levels is not producing the desired outcomes. Sources of structural inefficiency include limited early childhood education, the costs and difficulty of serving a small, dispersed population with small schools on neighboring islands. In addition, poor quality early childhood development (ECD) and primary education may contribute to high drop- outs and low achievement in secondary school and very costly ‘catch up years’ at post- secondary level. This all points to an education system that is failing to adequately prepare Marshallese youth for a productive life. In this context, urgent action is needed to improve the quality of education, and thereby improve the efficiency of education spending. The section concludes with a limited set of policy and institutional recommendations that are deemed to be the most impactful and feasible with existing capacity and financial resources. 357. There is extensive education sector data available from MOEST, albeit with substantial gaps and limited data linkages. There is data available on primary and secondary schooling on categories of inputs such as teachers and their qualifications, and outcomes such as student performance, as well as some data on differences in schools by student characteristics and school accreditation. This data is compared at a high level to information on allocative processes. This allows for some analysis of efficiency and equity of spending. However, it is not possible to analyze the links between spending on particular inputs and student outcomes while controlling for the characteristics of schools and students, as there is no data available that can be linked at the micro level. Therefore, the analysis in this chapter is not as detailed as it would be if it were based on more direct linkages between different types of data. Future analytical work could build on the analysis and findings of this chapter if there are improvements in the collection, consistency, and processing of education data. This section includes recommendations for future education data collection and management and the types of analysis that may be conducted with better data. 161 Republic of the Marshall Islands 2.5.1 Structure and Service Delivery 358. The structure of the education system is similar to the US model but with relatively limited options for post-secondary education. There are four levels: early childhood education (ECE) for ages 3–5, primary school for ages 6–13 (grades 1–8), secondary school for ages 14–17 (grades 9–12), and post-secondary. Education is compulsory for children aged 5–18. Figure 70 summarizes the levels of the education system while Table 7 reports enrollments by school type and level. Kindergarten exists in all public elementary schools but access to ECE is limited. Elementary and secondary education is delivered by both public and private schools. Private schools are run independently but partly financed by GoRMI (via the PSS). There are 93 elementary schools (79 public, 14 private) that employ 840 teachers and serve 10,185 students and 18 secondary schools (7 public, 11 private) employing 249 teachers and serving 3,013 students. According to the language education policy (approved in 2015), Marshallese (or Kajin Aelōñ Kein) is the sole language of instruction up to grade 6, while English is taught as a subject at all grade levels and introduced progressively as a language of instruction starting in grade 7. A narrow range of post-secondary education options are available through the CMI and USP Majuro campus. Figure 70: RMI Education system structure Source: Education Digest 2019, PSS. 162 Country Economic Memorandum and Public Expenditure Review Table 7: Enrollment trends by school level for private and public schools 2016 Total 2017 Total 2018 Total 2019 Total M F M F M F M M ECE 687 628 1315 707 669 1376 632 635 1267 641 621 1262 Private 178 185 363 187 244 431 205 225 430 182 212 394 Public 509 443 952 520 425 945 427 410 837 459 409 868 Primary School 5196 4957 10153 5239 4940 10179 4950 4837 9787 4934 4642 9576 Private 738 740 1478 956 918 1874 897 906 1803 892 899 1791 Public 4458 4217 8675 4283 4022 8305 4053 3931 7984 4042 3743 7785 Secondary 1598 1687 3285 1654 1750 3404 1664 1747 3411 1664 1758 3422 School Private 356 336 692 400 415 815 420 414 834 410 388 798 Public 1242 1351 2593 1254 1335 2589 1244 1333 2577 1254 1370 2624 Grand Total 7481 7272 14753 7600 7359 14959 7246 7219 14465 7239 7021 14260 Source: FY2020–22 Budget Portfolio, MOEST. Early childhood, primary education and secondary education 359. Preschool is provided for three to four-year-olds by private providers while the national kindergarten program has been integrated into public elementary schools and provided free of charge to children who turn five at the start of the school year. Only 5 percent of children aged 36–59 months attend an organized early childhood education program (ICHNS, 2017). Government funding to private preschools is based on enrollment, performance, and accreditation. RMI remains one of the only PICs without a national policy on Early Childhood Care and Education or Early Learning and Development Standards. The World Bank financed Multi-sectoral Early Childhood Development Project will support the development of a National Strategy for ECD. That project will also support the creation of public preschools to cater to three to four-year-old children, aimed at better preparing them to be ready for formal schooling by the time they reach grade 1. Currently, children entering grade 1 are not as well placed as they could be due to poor health and nutrition during pregnancy and early life, lack of early stimulation and learning, and exposure to poverty and severe stress during the early years of life (see Section 2.6). 163 Republic of the Marshall Islands 360. While access and participation in primary education is generally high, this drops considerably for secondary education. Gross enrollment ratios (GER) and net enrollment ratios (NER) are readily available and published annually in the ‘Digest of Education Statistics’. Primary enrollment in RMI has hovered around 80–100 percent GER for the past decade, although population estimates in between census years indicate enrollment has been closer to 100 percent. In 2019, GERs were 44 percent for ECE, 88 percent for elementary, 58 percent for secondary while NERs were 37 percent for ECE, 78 percent for elementary, and 46 percent for secondary. Figure 73 reports enrollment rates by age and level for 2018, which clearly illustrates the large drop in enrollment for students reaching 14 (secondary school age). Retention of students is a longstanding and worsening problem in RMI, with estimates that less than half of all students starting grade 1 will graduate from secondary school. Persistence to the end of primary (grade 8) was 76 percent in 2019. The population projections of school aged children from 2016 to 2019 suggest that enrollment growth in the future will be low and stable (Figure 74). From 2016 to 2019, the average annualized rate of growth in the primary school aged population was projected to be 0.8 percent, and 0.4 percent for the secondary school aged population, with similar rates of growth for the populations of boys and girls. 361. Enrollment rates are lower for those in the bottom two quintiles of the consumption distribution, indicating a degree of inequitable access to education. The NER is 89 percent for primary school aged children in the bottom quintile, which is lower than for children in the top quintile (NER of 96.5 percent) (Figure 71). For children aged 14–17, the NER increases as consumption increases, with a difference of almost 24 percent between those in the top and bottom deciles (69.4 percent versus 45.6 percent). Combined with the much higher rates of primary level enrollment, this indicates that poor children are more likely to drop out of school in the transition to secondary school and, by extension, are likely to end up with a lower level of educational attainments118. There is also evidence of geographically inequitable access to education. Primary school aged children in urban areas who are poor are least likely to be enrolled in primary school, while at secondary level, children in rural areas (neighboring islands) who are poor are least likely to be enrolled (Figure 72). 118 In addition to lower enrollment rates, it is possible that children from lower income backgrounds perform less well in MISAT. School level data on student background is not publicly available, but future data linking and reporting may allow for a deeper investigation into student outcomes and equity. 164 Country Economic Memorandum and Public Expenditure Review Figure 71: Enrollment in school, by age Figure 72: Enrollment in education, group and decile by age group Source: World Bank calculations, RMI HIES 2019–20. Source: World Bank calculations, RMI HIES 2019–20. 362. The provision of primary education on neighboring islands is through smaller schools, which are typically ‘multi-grade’, while in most neighboring islands there are no secondary schools. Small schools with fewer than eight teachers are regarded as multi- grade (at least one teacher having to teach more than one of the eight grades). These schools account for 61 percent of schools and 25 percent of students. Table 8 provides the number of schools and students by the number of teachers. Most primary schools with under eight teachers are located in the neighboring islands, except for the two schools in Kwajalein and three schools in Majuro. Remote small schools lack economies of scale and some are considered to be unviable, with the PSS’s expectation that no school should have less than 15 students enrolled. Even when this requirement is not met, small schools continue to be supported if it is deemed to be in the public interest by the PSS (that is, due to a lack of viable alternatives). No school has ever been closed solely because of reduced enrollments. Year to year variability in enrollments can be substantial, complicating the effective management and resourcing of these school.119 In aggregate though, there is no significant trend of student migration toward the urban centers120 (Table 9). Secondary education is only offered on a few islands (Majuro, Kwajalein, Jaluit, and Wotje), which means that many neighboring islands students must relocate and cover the substantial costs involved (transport, food, and accommodation) to pursue secondary education121. 119 The PSS reports anecdotal evidence of migration across neighboring islands, that may be based on the relative reputations of schools across islands. This suggests an unmet demand for quality schooling in the neighboring islands and that families are willing to incur costs to seek better schools. 120 This is assuming that there is similar population growth in the neighboring islands to urban areas. 121 These students often stay with relatives in conditions that may be relatively precarious and supportive of learning (e.g. poorer nutrition and sleep, little space to study, need to continuously relocate to not overstay their welcome, and so on). 165 Republic of the Marshall Islands Figure 73: Age specific enrollment rates for primary and secondary levels in 2018 Source: Education Digest 2019, PSS. Figure 74: School population by gender and age, school year 2018–19 Source: Education Digest 2019, PSS. 166 Country Economic Memorandum and Public Expenditure Review Table 8: Schools and by number of teachers Number of Number of Percentage Number of Percentage teachers schools of schools students of students 3 20 18.0% 536 3.8% 4 15 13.5% 565 4.0% 5 14 12.6% 706 5.0% 6 9 8.1% 726 5.2% 7 10 9.0% 825 5.9% 8+ 43 38.7% 10644 75.5% Total 111 100% 14092 100.0% Source: Education Digest 2019, PSS. Table 9: Enrollments trends for urban schools and neighboring island schools   2016 2017 2018 2019* All schools N % N % N % N % Urban 10,141 68.7% 10,308 68.9% 10,078 69.7% 9,887 69.3% Neighboring 4,612 31.3% 4,651 31.1% 4,387 30.3% 4,373 30.7% islands Total 14,753   14,959   14,465   14,260   Source: FY 2020–22 Budget Portfolio, MOEST. 363. Student to teacher ratios are reasonable across the country and lower in neighboring islands, although challenges of multi-grade teaching reportedly offset any benefits from smaller class sizes in neighboring islands. Table 10 shows the average number of students per teacher. Neighboring island schools have lower student to teacher ratios compared to urban schools because most schools are small multi-grade schools. Therefore, while the student to teacher ratio may look to be more favorable, the PSS reports that challenges of multi-grade teaching greatly offset any benefits. More generally, given that the majority of schools are multi-grade and that about 30 percent of students are on neighboring islands, it would not be fair to make comparisons of student to teacher ratios in RMI to other contexts without considering issues of the economies of scale available to medium-sized and larger schools. 167 Republic of the Marshall Islands Table 10: Average number of students per teacher Area Level 2016 2017 2018 2019 Primary 17 18 18 15 Majuro Secondary 14 13 14 15 Primary 20 18 17 17 Kwajalein (Ebeye) Secondary 15 10 15 13 Primary 10 10 10 12 Neighboring Islands Secondary 14 15 16 18 Source: Education Digest 2019, PSS. 364. To address the low proficiency levels, additional ‘catching-up’ years have been introduced at entrance in secondary schools, CMI, and USP. Because they fail to meet the minimum requirement to enter grade 9, around 30 percent of students (in 2018) entering secondary schools are enrolled in pre-grade 9 classes. A large majority of students seeking to study at both CMI and USP are required to undertake foundational- level (also called developmental) courses to upgrade their skills and be allowed to enroll in credit-level courses. In 2019, CMI required more than 80 percent of its new students to enroll in such developmental English and math classes (83 percent in English and 86 percent in math). Enrollment in developmental courses extends the duration of the education program, meaning that students often use up their Pell Grant122 for higher education early and are unable to complete their studies as a result. Post-secondary education 365. TVET options are limited and very few offer recognized accreditation. Secondary-level TVET programs are offered as electives in the five public secondary schools. Courses include ICT, bookkeeping and accounting, clothing and textiles, food and nutrition, auto mechanics, education (teaching academy), and health (nursing academy). Many of the facilities and equipment is in disrepair, competencies acquired are not recognized by employers or education institutions, and the intention for students undertaking these courses to be offered the opportunity to do short practicum with local firms is not always realized. CMI offers technical, vocational, and workforce development training and upskilling paid by employers, but its sole accredited vocational course is carpentry. Examples of workforce development and upskilling include ‘advanced accounting’ for civil servants and customer service training for employees in the private sector. Other training providers (governmental and non-government) also offer vocational and technical training in niche areas.123 122 See Box 1, which outlines funding sources, including Pell Grants. 123 For example, Waan Aelon in Majel is a non-government organization with 20 years of experience, offering vocational training courses focused on 168 canoe making and targeting out-of-school children and youth between 8 and 18 years. Country Economic Memorandum and Public Expenditure Review 366. There is considerable fragmentation across these TVET offerings, with little strategic direction or coordination evident in the sector. Pathways for students are often absent, with vocational courses in secondary school not linked to courses taught by CMI or USP at the tertiary level. The MISAT is focused on academic outcomes in non-vocational subjects. This reflects an education system that is not geared towards measuring or improving work-related skills beyond academic subjects like math. Links with labor market needs are weak, with offerings at CMI and USP determined at the institutional level with minimal strategic direction from the GoRMI or the private sector (a task made difficult by the absence of data on labor market outcomes or skills gaps in the economy) (see Section 1.3.2). 367. Tertiary education options are also limited as most subject areas of tertiary education can only be pursued by Marshallese students overseas. Both CMI and USP are accredited by the US-based WASC. They offer a narrow range of programs, so many tertiary-level subject areas can only be pursued abroad. There were 1,248 full and part-time student enrollments in tertiary education in 2018. To gain admittance to overseas degree programs, Marshallese students generally must first complete two years of bridging education. USP delivers certificates, diplomas, and degrees within three faculties: arts, law, and education; business and economics; and science, technology, and environment. However, the USP campus in Majuro doesn’t offer degree programs. It offers a one-year ‘preliminary program’, designed to bridge any gap between high school and the requirements of the RMI-USP Joint Education Program.124 This is followed by one year of Foundation study to prepare students for bachelor’s degree programs (and higher) at any university. Both the preliminary program and Foundation study programs involved students selecting one of two streams: (i) a science stream with subjects such as biology, chemistry, and physics; and (ii) a social science stream including history/politics, geography, accounting, and economics. English and math are compulsory for all students. The Majuro USP campus thus serves as a gateway to other tertiary education opportunities in the region. RMI-USP has a faculty of about 25 staff and enrolled 196 students in 2018.125 CMI delivers certificates, associate degrees, and bachelor’s degrees. It has a faculty of about 50 staff, mostly expats, and had an enrollment of 1,052 students in 2018. Most CMI students are enrolled in liberal arts (46 percent), education (20 percent), nursing (20 percent), and business (8 percent). 124 The RMI-USP Joint Education Program is a partnership in education between RMI and USP, established in 1995, “to prepare Marshallese students to be eligible for admission to degree studies problems at USP and other regional and international post-secondary institutions”. 125 USP has recently become eligible for Pell Grants which may support the attendance of qualifying students in the future. 169 Republic of the Marshall Islands 2.5.2 Governance 368. Institutional arrangements are complex, with the MOEST structure including six agencies. This presents coordination challenges in the sector as there are autonomous and semiautonomous agencies operating outside of a departmental structure and reporting directly to the minister. The six agencies are (i) PSS; (ii) Teacher Standard and Licensing Board (TSLB); (iii) Marshall Islands Scholarship, Grant, and Loan Board (MISGLB); (iv) NTC; (v) CMI; and (vi) USP. PSS manages pre-primary, elementary, and secondary education. This is delivered through public schools that are directly administered by the PSS and non-public (private) schools to which the PSS transfers subsidies, as well as overseeing their operations for compliance with government requirements. NTC is responsible for TVET policy, planning and research, coordination, and regulation. The Scholarships Board offers education scholarships and loans to Marshallese citizens to pursue tertiary education abroad and in RMI. Scholarships are conditional on performance and returning to RMI for work after graduation. The TSLB is responsible for teacher accreditation. 369. The Public School System Act of 2013 provides the foundational legislative framework for primary and secondary education and provides substantial autonomy to PSS. Its purpose was to replace part of the Education Act of 1992, to allow for a more autonomous public school system that would break away from inefficient core public service functions (that is, procurement from MOF and HRM from PSC). Given that the PSC has not been adequately responsive to the needs of service ministries, it may be argued that the devolution of procurement and HRM functions could improve efficiency. Hence, the PSS Act established the Education Fund and independent HRM functions. However, in the absence of strong oversight this could also lead to less accountability and greater potential for malfeasance. The alternative is to strengthen the centralized systems—a solution that may be more suitable given the small size of the RMI public service relative to other nations where devolution has been pursued. The Act also established the National Board of Education to oversee these functions. More broadly the National Board of Education oversees public and private schools, has the power to establish and revise regulations and policies of the PSS, and is responsible for providing fiscal oversight, including review and approval of the PSS budget for presentation to the Cabinet and Nitijela. 370. While greater financial autonomy for PSS has the potential to lead to greater efficiency, it could also exacerbate the challenges of budget fragmentation and reduce accountability. The Education Fund is designed to finance all education-related expenditure. As of 2019, however, only General Fund financing is channeled through the Education Fund. The PSS reports that as governance arrangements of the Education Fund are not sufficiently strong, the US Government will not allow CSG and SEG to be channeled through the Education Fund, and so for this reason, they are still executed from MOF. The existence of the Education Fund, and the practice of channeling a range of earmarked revenues into the fund which are then controlled by the agencies within the 170 Country Economic Memorandum and Public Expenditure Review education sector, is symptomatic of a broader challenge of PFM and budget fragmentation (see Section 2.2.2). The extent to which education sector financing should be centralized under the MOF versus channeled through the Education Fund remains an open question. There are differing perspectives across the public service on the way education funding should be managed, and in particular, the extent to which funding should be channeled through the Education Fund. On the one hand, it is argued that this provides greater autonomy for the PSS and can lead to greater efficiency. On the other hand, it could lead to greater fragmentation of the budget process, and limit contestability and transparency. 371. The Public School System Act also places HRM responsibilities for public schools with PSS, following frustrations with the PSC-led public sector HRM processes. The inefficient, manual, and opaque nature of PSC-led public sector HRM processes was one of the key factors that motivated the PSS to withdraw from the PSC system and establish their own HRM processes as part of the reforms embodied in the PSS Act 2013. Although the PSS is responsible for HRM processes, the payroll processing and payment functions remain with MOF. The PSS Act provides the autonomy for PSS to set its own pay scales, though so far PSS has continued to use the PSC pay scales—which have not been updated since the 1980s. The Act provides for reclassification of teachers and their salaries according to levels of teacher qualifications. The MOEST aims to have all teachers holding a degree and allocates significant resources to teacher training and in-service programs. Part of the reclassification of teachers under the Act involves teacher evaluations which connect teacher performance to student performance. 372. Currently there is limited involvement of local communities in education governance due to uneven progress with the establishment of effective local education boards. Global evidence shows that community involvement leads to superior results, accountability, etc. This is in line with the PSS Act which states that each local government shall form a Local Board of Education that has the function of overseeing the operation of local public schools. One of the goals of the PSS is to revitalize the community-based governance system for primary schools through the establishment of local education boards. This is still a work in progress with most localities not yet having established local education boards. Public schools generally also have Parent Teacher Associations which meet quarterly. 171 Republic of the Marshall Islands 373. Procurement is relatively efficient in some areas of the education system but performance is uneven across the sector. CMI appears to have a well-managed and streamlined system for procurement, utilizing the full potential of the Abila and Microix systems. CMI notes that the electronic system facilitates internal process that were already well-working and relatively fast. The PSS reports that while procurement is relatively fast when using funds from the Education Fund which is under PSS control, procurement can take up to several months when using funding housed at MOF. There is the potential for PSS to learn how to streamline procurement from CMI. The Marshall Islands High School, which is the largest secondary school in the country reports that their leadership team, including a school accountant, do not find procurement of school resources to be a problem, and have a good understanding of procurement rules applicable to their school (for example, needing three quotations for a new photocopy machine). 2.5.3 Outcomes Indicators and data 374. Issues with the quality and timeliness of data undermine transparency, accountability, and the ability of authorities to set priorities and allocate resources to improve performance. MOEST has been tracking and reporting on 20 educational indicators annually in its data management system since 2005.126 In a review of the use and accountability of Compact assistance to RMI in 2013, the US GAO found data reliability issues in the education sector. Only two of the five education indicators reviewed were judged to be sufficiently reliable to measure progress, and only one of those indicators demonstrated progress on the education level of teachers. The report highlighted changes in data sources and missing data being two of the factors of data unreliability. In 2016, GAO highlights that the ongoing problem with the reliability of data has prevented RMI from demonstrating and assessing progress toward Compact goals for education and from using the data to set priorities and allocate resources to improve education sector performance (GAO, 2016). There are also long lags in making data available to the public (as of March 2021 the most recent Education Digest available is for the August 2018–June 2019 school year). There are meant to be school report cards to share MISAT and accreditation scores, but these are not used extensively in practice. In a positive development, PSS has transferred most of the education indicators to an online Education Management Information System (EMIS) with a dashboard providing summary statistics of different key indicators. 126 For a list of the 20 indicators, see Appendix A: RMI Public School System Key Education Indicators, PSS Digest of Education Statistics 2018–19. 172 Country Economic Memorandum and Public Expenditure Review 375. Through the EMIS, the PSS has expanded the MOEST’s data system in a range of areas that will allow for better tracking and reporting on educational outcomes and performance over time. These areas include monitoring and tracking of school facilities/ equipment inventory, staff/teacher professional development and certification, school/ student/teacher reports, and quarterly student attendance reports. While data reporting from schools has improved in recent years, some schools do not comply with submission timelines and the integrity of some school data is uncertain. There are also issues of connectivity and staff training which mean comprehensive good quality system data remains a goal to strive for (PSS Annual Report, 2017–18). In addition, the EMIS is still being developed and areas for improvement include directly linking school level data of different types so that it can be accessed in a format this facilitates analysis. For example, data for school funding, enrollments, MISAT test scores, teacher qualifications are mostly available to the PSS at school level but are not linked and ready to use in decision making. 376. While MISAT data does highlight the problem of poor educational outcomes, it may not align well with the curriculum and does not adequately measure student performance. The MISAT is narrowly focused on academic outcomes in non-vocational subjects which means that the education system is not geared towards measuring or improving work-related skills beyond academic subjects like math and English. The PSS also reports that the MISAT was not designed to adequately match the RMI curriculum and has not changed as the curriculum has changed. For example, the MISAT has not been updated to match the new math curriculum. Additionally, as the MISAT testing is based on multiple choice questions, there is concern that over time, using exactly the same sets of questions (as has been the case with the math questions) could be a risk if the confidentiality of the questions is not maintained. However, the PSS does not have the capacity to update the instruments without consultants and is cautious to do so as changes in the testing instruments may lead to inconsistency (that is, the instrument not testing the same specific learning outcomes). While PSS reports MISAT data trends over time, it is not clear that the year-to-year differences are meaningful. 173 Republic of the Marshall Islands Primary and secondary school quality 377. PSS uses a local school accreditation system which resembles the US system, but many schools have a low level of accreditation and only in recent years have all schools been assessed. Every year, a team visits schools to evaluate their achievement on six standards (leadership; teacher quality; data management; curriculum; facility; school improvement plan) comprising four criteria. This includes observing two classroom lessons. The system includes four levels: 1 (worst) to 4 (best). Schools rated at Level 4 receive additional PSS support (for example, funding for new facilities) to help the school apply for and obtain WASC accreditation. While this may act as in incentive for schools to improve across the measured criteria, the additional funding may serve to increase educational inequality over time. Seventh Day Adventist (SDA) schools are a separate classification of accreditation, but this does not necessarily imply anything about their performance. Lowest performing schools are placed under ‘special measures’ and PSS sends supervisors (from the Curriculum Department) to provide support. Correlation between accreditation levels and MISAT scores is reported to be low but warrants further investigation. There is a high proportion of schools that are only meeting the minimum required standards (Level 2 out of 4 levels). Figure 75 reports changes in accreditation levels from 2015–18. Significant changes across these years include the drastic reduction in the share of schools not visited, and a reduction in the schools listed as ‘special measure’. From 2015 to 2018, the shares of schools with Level 2 and Level 3 accreditation increased. However, as of 2018, only 2 percent of schools have achieved Level 4 status. Schools that meet Level 2 and Level 3 increased in shares but the highest level of accreditation, Level 4, has been achieved by only 2 percent of schools as of 2018. 378. Teacher accreditation and improving teacher qualifications are key PSS objectives. The Teacher Certification Act of 2007 created the Teacher Standards and Licensing Board, requiring all new teachers, excluding kindergarten teachers, to gain an Associate Degree in Education or another subject plus 16 credits in education. A Provisional Certificate can be granted for up to three years for those with a High School Diploma and 30 college credits and who are working towards Professional Certification. While the distribution of education qualifications of teachers has improved over time (Figure 76), there are still a large proportion of teachers that will need to increase their accreditation level. The US Office of Insular Affairs has advised the MOEST that all uncertified teachers should be certified in order to be eligible for salary support from Compact-related grants. In 2014, a JEMFAC Resolution mandated that Compact funding can only be used to pay for salaries of teachers “who are employed pursuant to contracts that include performance evaluations.” While PSS reports that principals are responsible for evaluating teachers, there has not been a strong culture of principals providing feedback to teachers. Furthermore, there is no systematic teacher performance evaluation process currently in place. Nevertheless, the JEMFAC requirement provides an incentive for MOEST to assist teachers to meet minimum standards for certification. 174 Country Economic Memorandum and Public Expenditure Review Figure 75: Accreditation levels (2015–17) Figure 76: Proportion of teachers by education levels (2016–19) Source: PSS Annual Report 2016–17, and Digest of Education Statistics Source: Digest of Education Statistics 2018–19. 2018–19. Primary and secondary school outcomes for students 379. Ongoing poor educational achievement in primary and secondary school stands in contrast to improvements in teacher qualifications and school accreditation. Despite some improvements in grade 3 and grade 8, MISAT results generally indicate low learning outcomes at all levels. In each subject and each grade of MISAT testing, the percentage of students achieving the proficiency standard has never been more than 45 percent. This means that a majority of students in every grade are deemed to not be meeting minimum national standards. For example, for those students that stay in school to grade 10, over 80 percent will not meet the proficiency standard for math and over 70 percent will not meet the standard for English (Figure 77). For grades 10 and 12, there has been no improvement observed in recent years. This suggests that improvements in school accreditation and teacher qualifications are not necessarily translating into improvements in teaching quality. 380. Schools that are urban, larger, and private are positively correlated with performance. Comparing the MISAT performance of students from the neighboring islands with students from urban areas for grades 3, 6 and 8 (Figure 78) shows that neighboring island students are being outperformed slightly in all grades. With regards to gender, girls generally score similarly or slightly higher than boys. Differentiating between public and private school MISAT scores shows significantly lower performance at public schools compared to private schools. However, given that the students that attend private schools are a select group (for example, much less likely to be stunted) (Passmore and Smith, 2019), it is not possible to simply disentangle school effects from student socioeconomic effects. More insightful analysis of performance could be facilitated by MISAT data being linked to other school level data and to some basic data on students. 175 Republic of the Marshall Islands Figure 77: MISAT Grade 10 percent proficient Figure 78: MISAT percent proficient by school (2016–19) location (2019) Source: Digest of Education Statistics, 2018–19. Source: Digest of Education Statistics, 2018–19. Educational attainment and welfare 381. The high level of drop out in the transition from primary to secondary education means that one- fifth of adults have not finished schooling beyond grade 8 and close to half of adults have not finished grade 12. Figure 79 reports national estimated population shares of highest education level achieved. For 20 percent of the population, the maximum level of education completed is some level of primary education, while for 28 percent of the population, the highest level achieved is some level of secondary education below grade 12. Figure 79: Highest level of education attained for population aged 25+ Source: World Bank calculations, RMI HIES 2019–20. 176 Country Economic Memorandum and Public Expenditure Review 382. Higher levels of education are associated with lower levels of poverty, with Figure 80127 reporting poverty rates by education of the household head and the highest education attainment in the household. For households where the household head has some post school qualification, only 2 percent of the population are in poverty. This is a striking contrast to households where the household head has only grade 8 education or lower, for which the poverty rate is 9.4 percent. Having at least one person in the household with some post school education is also associated with a lower poverty rate of 5.8 percent compared to having no one in the household with education beyond grade 8 (10 percent poverty rate). The link between poverty and education likely works in both directions, with poverty leading to lower levels of enrollment and educational attainment, and in turn, lower levels of education attainment leading to a reduced capacity to earn an income. Poverty rates among adults (25 years and older) also decline with increasing levels of education in both urban and rural areas. The most substantial difference is observed in rural areas with a 24 percent poverty rate for those completing Grade 1–8, versus 15.3 percent for those with Grade 9–11 education (Figure 81).128 Figure 80: Poverty, by education Figure 81: Poverty rates for adults (25+), attainment of HH head and of highest by education completion educated member 14% 30% 12% 25% 10% 20% 8% 15% 6% 10% 4% 5% 2% 0% 0% Grade 1 - 8 Grade 9 - 11 Grade 12 / GED Some post- National Rural Urban school, no Grade 1 - 8 Grade 9 - 11 degree Household Head Household highest Grade 12 / GED Some post-school, no degree Source: World Bank calculations, RMI HIES 2019–20. Source: World Bank calculations, RMI HIES 2019–2020. 127 The categories of ‘0-Kindi’ and ‘Degree, university or professional’ are omitted from Figure 80 and Figure 81 due to a low number of observations. Reported poverty rates are for the total population of each household type. 128 It should be noted that the data on education exists only for present household members, and remittance income of more educated ex-household members that have migrated may be a channel for increasing consumption. 177 Republic of the Marshall Islands 2.5.4 Financing and Expenditure The level of public expenditure on education 383. A defining feature of education financing is its large size relative to GDP. Compared to most other countries (regardless of national income), RMI’s public expenditure on education as a share of GDP is very high at over 15 percent129 (Figure 82). Per capita expenditure on education is also very high when compared to countries with a similar GNI (Figure 83). Public expenditure on education has been fairly stable over time, with Figure 84 reporting education expenditure as a share of total expenditure and as a share of GDP from 2012–19. Figure 82: Public expenditure on education Figure 83: Public expenditure on education as a share of GDP vs GNI per capita per capita vs GNI per capita 10,000 RMI 16 Public expenditure on education per capita (US$) 14 2,500 Public expenditure on education Micronesia Kiribati 12 as share of GDP (%) RMI Palau 500 Solomon Is. 10 Micronesia Samoa Fiji 8 Palau Solomon Is. Vanuatu Nauru 100 Kiribati Tonga 6 Samoa Nauru Vanuatu Fiji 4 23 Tonga Tuvalu 2 Lower middle Upper middle Lower middle Upper middle Low income income income High income Low income High income income income 0 4 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 GNI per capita, 2019 (US$) GNI per capita, 2019 (US$) Note: X- and Y-axes expressed in logarithmic scale. Source: GoRMI; World Bank (2020); IMF World Economic Outlook. Note: For Figure 82 and Figure 83, data on public expenditure on education per capita is of the latest year of available data; for RMI, it is for 2019. Markers in light blue are Caribbean Island economies. Figure 84: Public expenditure on education as a share of total expenditure and as a share of GDP Source: RMI Financial Statements, several years. 129 The latest reported figure by PSS is that the PSS budget equates to 15.6 percent of GDP for 2019. This calculation doesn’t include some sources of education expenditure such as Pell Grants, so is a lower estimate than full budget or CMI would suggest. 178 Country Economic Memorandum and Public Expenditure Review 384. The very high level of education expenditure stands in contrast to very low levels of enrollment and achievement, implying a highly inefficient education system. In order for a high level of education expenditure to be efficient, it would need to produce high education outcomes, but as the previous section has established, the education system is low performing at all levels. While it is not possible to compare education outcomes for primary and secondary school internationally, owing to an absence of internationally comparable data, enrollment rates can be compared to education expenditure by country. Figure 85 and Figure 86 report gross primary and secondary enrollment rates relative to per capita public expenditure on education, respectively. Compared to countries with similar levels of per capita education expenditure, both primary and secondary enrollment in RMI is relatively low. Figure 85: Primary gross enrollment vs per capita Figure 86: Secondary gross enrollment vs per public expenditure on education capita public expenditure on education 160 160 140 Secondary gross enrolment ratio (%) Primary gross enrolment ratio (%) 140 120 Palau Nauru Tonga Nauru 100 Samoa 120 Tonga Fiji Fiji Palau Kiribati Samoa Micronesia Vanuatu 80 Solomon Is. Kiribati 100 Micronesia 60 Vanuatu RMI RMI Solomon Is. 40 80 20 60 0 4 20 100 500 2,500 10,000 4 20 100 500 2,500 10,000 Public expenditure on education per capita (US$) Public expenditure on education per capita (US$) Source: GoRMI; World Bank (2020). Note: X-axis is expressed in logarithmic scale. Data on both indicators are of the latest year of available data; for RMI, it is for 2019. Markers in light blue are Caribbean Island economies. 179 Republic of the Marshall Islands Sources of education finance and sectoral allocations 385. Foreign (US) funding sources play a dominant role in education financing, supplementing over US$12 million in domestically sourced expenditure. The main domestic source of financing is the General Fund which accounted for 35 percent of financing in 2019. Financing of primary and secondary education is high largely because of the two main US sources: the CSGs (34 percent in 2019) and SEG (17 percent in 2019). Box 7 provides a brief outline of key education financing sources. A breakdown of 2020 recurrent education financing that includes Pell Grant financing, is provided in Table 11.130 This provides a fuller picture of government financing of the education sector across the six agencies and between school education and tertiary education. ODA funding in the education sector is small and the major financing partners currently are the ADB, the World Bank, the Global Partnership for Education, and Pacific Resources for Education and Learning (PREL).131 Table 11: MOEST agency financing by source (FY2020) Percent PSS TSLB MISGLB NTC CMI USP TOTAL of total General fund 7,685,614 16,600 770,845 93,595 2,935,890 600,000 12,102,544 31.9% Compact funds 9,697,286 592,202 987,003 11,276,491 29.8% Ebeye Special 2,600,899 125,000 2,725,899 7.2% Needs SEG 4,885,389 403,750 288,325 5,577,464 14.7% US federal grants (IDEA Part B, Pell 1,682,329 4,528,999* 6,211,328 16.4% Grant) Total 26,551,517 16,600 1,363,047 497,345 8,865,217 600,000 37,893,726 100.0% Percent of total 70.1% 0.0% 3.6% 1.3% 23.4% 1.6% 100.0% Source: World Bank calculations based on (Appropriation [Financial Year 2020] Act, 2019). Note: Pell Grant Funding is not ordinarily included in the Education Budget Statistics. 130 While little information is available on capital expenditure, there is a Compact Capital Fund from which in FY2020, US$0.6 million is allocated to PSS maintenance, US$0.34 million is allocated to PSS schools and MOH Health Center repairs, and US$0.5 million is allocated to CMI. 131 These sources of finance are not included in Table 11. 180 Country Economic Memorandum and Public Expenditure Review Box 7: Key Education Sector Financing Sources Following the money The RMI General Fund refers to locally generated domestic revenues collected by GoRMI and allocated to the MOEST as part of the standard procedures of revenue appropriation and public expenditure. CSGs are those received under the Compact. The Supplemental Education Grant is an annual grant that originated in 2005 as part of the amended Compact 2004–23 to supplement the CSG, as a way to replace several different US federal grant programs for education, health, and labor that were financing education in RMI. The amended Compact’s enabling legislation authorized annual appropriations of US$6.1 million for SEG, adjusted for inflation. The SEG funds may be used to support direct educational services at the local school level focused on school readiness, early childhood education, primary and secondary education, vocational training, adult and family literacy, and the smooth transition of students from high school to postsecondary educational pursuits (GAO, 2018). Ebeye Special Needs Grant (ESN) is an annual grant that provides specific funding for service delivery in Ebeye and Kwajalein Atoll. The US Individuals with Disabilities Education Act (IDEA Part B) provides funding to Freely Associated States (FAS) for special education and related services, including teacher salaries, staff development, materials and supplies, and other related assistance. There are extensive reporting requirements for the use of the funds and the Office of Special Education (OSEP) of the US Department of Education (USDOE) analyzes states’ performance through ‘differentiated and monitoring supports’ (DMS). While RMI has been determined to meet the requirements of IDEA by OSEP, past DMS have indicated a need to reduce drop-out rates of students with disabilities and increase the percentage of students with a disability graduating from secondary school. A Pell Grant is a subsidy that the US Federal Government provides for students who need it to pay for college. Federal Pell Grants are limited to students with financial need, who have not earned their first bachelor’s degree or who are enrolled in certain post-secondary education. 181 Republic of the Marshall Islands 386. The allocation of expenditure between school education and tertiary education looks to be reasonably balanced so in and of itself, cannot explain the high level of inefficiency in education. ECD, primary and secondary education account for the vast majority of education expenditure (70.1 percent of education financing, and 79.6 percent if the Pell Grant funding is excluded). Including the Pell Grants, the public expenditure on CMI as a share of the total education budget, is 23.4 percent, while USP only receives 1.6 percent of total education expenditure (Table 11). Tertiary education is high by regional and global standards, but this is partly explained by the restrictions of foreign financing sources, particularly the Pell Grants. The 2004 World Bank evaluation found education to be overly concentrated at the post-secondary level, based on the funding combining CMI, NTC and the MISGLB (particularly when measured on a per-student basis). In a positive development, it appears that education spending has been rebalanced somewhat over the past 15 years, with a higher proportion of spending now being allocated to primary and secondary levels. 387. A back of the envelope calculation of the CMI’s annual per student cost seems high, at US$9,341. This is the total CMI expenditure (US$9,294,768) divided by the total student population of 995 (unduplicated headcount, fall semester). Even taking into account that the per-student funding for school students may be miss-measured (and would not in any case be straightforward to estimate given the structure of education financing), per student costs at post-secondary level are much higher than primary and secondary education. While authorities may want to spend more on secondary education, this is not possible due to limited fungibility between resources available for spending across different education levels. The CMI had a reported (unaudited) total budget of US$11.2 million in 2019, with the largest single source of finance being Pell Grants for tuition costs (43 percent of CMI revenue), with 19 percent of the CMI budget being financed by the General Fund,132 9 percent being financed by the Compact, 4 percent from the ESN and SEG, and 4 percent from the Infrastructure Maintenance Fund (CMI Annual Report, 2019). For USP, GoRMI signed a memorandum of understanding (MoU) in May 2017 to provide the annual sum of US$600,000 under the RMI-USP join education program for the purposes of “teaching and operation costs and other reasonable expenses” (USP GRMI MoU, 2017). USP has recently become eligible for Pell Grants which may support the attendance of qualifying students in the future. For the NTC, the main funding source is non-resident workers’ tax, from workers who register with Ministry of Labor. This is mostly used to fund training proposed by providers including small training agencies, neighboring island groups, NGOs, and CMI. 132 Interestingly for historical political economy reasons, another domestic source of finance for the CMI is earmarked funding related to an excise tax for 182 tobacco and alcohol imports (a ‘sin tax’). Country Economic Memorandum and Public Expenditure Review 388. PSS spending by education level does not indicate inefficient prioritization. The PSS budget breakdown is available for the 10 divisions that make up the PSS structure (referred to as ‘focus areas’). The 2017 budget breakdown for these divisions is reported in Table 12, with the primary and ECD division accounting for 41.5 percent of the budget and the secondary education division accounting for 18.1 percent of the budget. As primary and secondary education benefit from some shared functions within the PSS (such as the MISAT testing which falls under the Curriculum, Instruction and Assessment division), it is not possible to determine exactly how much of the budget is allocated to primary and secondary levels of education. Special education covers both primary and secondary schools and is a significant share, at 7.9 percent. It is also difficult to ascertain the exact rates of per student expenditure by primary and secondary levels as funding data are difficult to breakdown and data may be unreliable. Table 13 reports average expenditure per student for public primary and secondary schools, although it appears that the calculation at the primary level changed considerably over the period 2017 to 2019. Table 12: PSS Budget by Focus Areas (FY2017) Budget allocation by Fund Source US$ (1000’s) Percentage 1 Leadership and management 227 0.9% 2 Personnel, budget and administration 2,701 10.7% 3 Policy, planning and standards 567 2.2% 4 Early childhood and primary education 10,503 41.5% 5 Secondary education 4,589 18.1% 6 Curriculum, instruction and assessment 152 0.6% 7 Kwajalein schools management 3,323 13.1% 8 Special education 1,991 7.9% 9 Property and maintenance 1,250 4.9%   Total 25,301 100.0% Source: PSS Annual Report 2016–17. 183 Republic of the Marshall Islands Table 13: Average expenditure (US$) per student for public primary and secondary schools 2017 2018 2019 Per Per Per Level Students Expenditure Students Expenditure Students Expenditure pupil pupil pupil Primary 9,250 $6,762,994 $731 8,821 $9,742,196 $1,104 8,653  4,333,867 $501 Secondary 2,589 $4,519,590 $1,746 2,577 $3,501,895 $1,359 2,624  2,985,644 $1,138 Total 11,839 $11,282,584 $953 11,398 $13,244,091 $1,162 11,277  7,319,511 $649 Source: FY 2020–22 Budget Portfolio, MOEST. 389. The requirements of Compact-related grants and programs dictate spending to a large degree, both in a functional sense and in terms of education levels. Regarding the former, for example, CSGs and SEGs can only be used for teachers’ salaries where the teacher has achieved a minimum level of qualifications. Salaries for teachers who do not meet these minimum qualifications must be financed via the General Fund, which can be used with the greatest flexibly as it is not restricted in the way that CSG’s and SEG’s are. As the rules for Federal Grant programs were not designed specifically for RMI and cannot be changed by GoRMI, it is important to acknowledge the resulting general constraint to funding allocation decisions (though not for the purposes of proposing alternative arrangements, as there is no flexible substitute for these grants). 390. The allocation of funding to teacher salaries and other personnel costs are moderate by international standards, suggesting there is no clear misallocation of resources. Table 14 presents expenditure categories by funding source for the fiscal year 2017 (which is the last published line-item budget from the PSS). At 65 percent of total expenditure, personnel costs for primary and secondary education are in line with international standards. For example, 77 percent of recurrent expenditure for primary and secondary education in Organisation for Economic Co-operation and Development (OECD) countries goes to staff compensation (OECD, 2020). Figure 87 reports staff compensation as a percentage of expenditure on public education in upper middle-income countries. There are two small island states, Mauritius and Dominican Republic, that have proportionately lower levels of expenditure on staff than RMI (47 percent and 51 percent, respectively), while Jamaica ranks higher (76 percent). Therefore, RMI cannot be considered an outlier in terms of proportional spending on personnel. The funding of teachers is not straightforward. While 61 percent of General Fund expenditure is for salaries of local teachers, only 1 percent is spent on foreign teachers. In contrast, 54 percent of CSG expenditure is spend on local teachers with 19 percent spent on foreign teachers. This is because there are a lower proportion of local teachers that meet the qualification requirements to be paid from the Compact. In proportional terms, foreign and local teachers’ salaries are similarly funded by SEG. 184 Country Economic Memorandum and Public Expenditure Review 391. There is no evidence of excessive administration costs or any other areas with unusually high funding. The ‘All other expenses’ category comprises 35 percent of primary and secondary education expenditure (Table 14). The most significant items in this category are food stuff (US$1.77 million), contractual services (US$1.03 million) training and staff development (US$0.98 million), and repairs (US$0.77 million). A significant amount is also spent on books (US$0.39 million), while only US$17,000 is spent on computer supplies. While it isn’t clear to what extent the high expenditure on food may have on educational outcomes, it may have other welfare implications and so cannot be assumed to be inefficient. Natural questions that arise but cannot be answered with available data include: (i) the effectiveness of the training and development; and (ii) the extent to which the contractual services are good value for money. Further investigation into the relationship between inputs and student outcomes at the school level would be insightful. Figure 87: Staff compensation as a percentage of expenditure on public education in upper middle-income countries Source: World Bank, 2018b (World Development Report 2018, using data from UNESCO Institute for Statistics, 2017). Note: RMI calculation is based on data from PSS Annual Report 2016–17 and may not be entirely consistent with the UNESCO data. 185 Republic of the Marshall Islands Table 14: Expenditure categories by funding source PRIMARY AND SECONDARY EDUCATION General Compact Compact ESN IDEA Part ADB SEG TOTAL   Fund PMF Grant Grant B Grant Grant US$ TOTAL 5,769,801 716,000 9,505,208 2,372,699 4,606,515 1,682,329 500,000 25,152,552 Personnel 3,951,232 - 7,783,365 1,021,342 2,200,005 1,374,779 - 16,330,723 All other exp. 1,818,569 716,000 1,721,843 1,351,357 2,406,510 307,550 500,000 8,821,829 Percent of funding source Personnel 68.5% 0.0% 81.9% 43.0% 47.8% 81.7% 0.0% 64.9% Salaries Marsh. 61.4% 0.0% 54.5% 27.5% 37.3% 70.7% 0.0% 48.8% Salaries expat. 1.1% 0.0% 18.8% 6.3% 5.7% 1.2% 0.0% 9.1% Benefits Marsh. 5.3% 0.0% 5.5% 2.9% 3.9% 7.1% 0.0% 4.7% Ebeye differential 0.0% 0.0% 1.0% 5.6% 0.0% 1.3% 0.0% 1.0% Benefits expat. 0.1% 0.0% 1.6% 0.6% 0.6% 0.1% 0.0% 0.8% Emp. insurance 0.5% 0.0% 0.4% 0.1% 0.3% 1.2% 0.0% 0.4% Night differential 0.0% 0.0% 0.2% 0.1% 0.0% 0.0% 0.0% 0.1% Overtime 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% All other exp. 31.5% 100.0% 18.1% 57.0% 52.2% 18.3% 100.0% 35.1% TERTIARY EDUCATION General Compact Compact ESN IDEA Part ADB SEG TOTAL   Fund PMF Grant Grant B Grant Grant TERTIARY TOTAL $3,661,360 - $1,579,205 $325,000 $692,075 - - $6,257,640 Percent of funding source CMI & CLLC 62.4% 0.0% 62.5% 38.5% 41.7% 0.0% 0.0% 58.9% NTC 2.9% 0.0% 0.0% 0.0% 58.3% 0.0% 0.0% 8.1% MISGLB 21.0% 0.0% 37.5% 61.5% 0.0% 0.0% 0.0% 25.0% USP 13.7% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 8.0% Source: PSS Annual Report 2016–17. 186 Country Economic Memorandum and Public Expenditure Review School funding and private expenditure on education 392. Decentralization of financial management responsibilities to public schools is limited, meaning there may be scope to increase school autonomy over financial decisions. On a yearly basis, public schools get a budget allocation mostly based on enrollments and historical precedent, but this is largely apportioned to salaries, while the operational component is small. Public school staff are paid from a central PSS allocation and the number of staff positions per school is set by the PSS, in consultation with school leadership. Financing for private and public schools is based on separate formulas, with the public school funding formula not clearly formalized. There is a discretionary component determined by the PSS based on annual consultations with school principals to understand each school’s unique set of needs. Schools have a small degree of autonomy over their own budget but seek PSS approval for ‘large’ expenditures (for example, photocopy machines). To pay for operational costs (such as fuel for transport), schools need to submit requests to PSS. These are often paid with delays. There are some consultations with parents and community representatives related to the use of available funds which also inform school improvement plans.133 Overall, while it unclear exactly what level of autonomy school principals have of financial management, it seems limited and constrained. 393. The funding allocations for private schools are more formula driven. Individual school allocations have been published in recent years with the latest figure being the 2018 budgeted amount of US$791,000 (PSS Annual Report, 2017–18). The funding formula is based to approximate a total funding distribution that is comprised of 60 percent for enrollments, 30 percent for performance and 10 percent for accreditation. Enrollments are paid at a flat per-capita rate which is comprised of about US$94 per student from the General Fund and for some schools, and additional US$100 per student from the Compact. The rates are the same regardless of whether the school is primary or secondary. For the performance component, the top 10 private elementary schools and the top five private high schools are paid an additional per capita rate, with the remaining and secondary schools not receiving any performance funding. The rate is comprised of about US$94 from the general fund per capita, and for some schools, an additional US$56 per capita from the Compact. As performance (measures by MISAT testing) can change over time and schools may increase their certification level, there is the potential for school allocations to vary significantly. Lastly, there is a flat sum of about US$4,900 that is paid to schools that meet a certain type of accreditation (for example, WASC certified or SDA).134 133 The plans are meant to be informed by the performance of the schools (as measured through the school accreditation process) but the process is not fully formalized or transparent. 134 SDA accreditation is not an academic standard of certification and is not controlled by GoRMI. 187 Republic of the Marshall Islands 394. Private expenditure on education is low, especially in the neighboring islands and for households in lower consumption quintiles. Based on data from the 2019-2020 HIES, Table 15 reports average total education expenditure per enrolled household member (persons of any age enrolled in any level of education, including ECD and post-secondary education), by quintile and by location.135 Almost all of the expenditure reported in table 15 is for ‘school fees’, but the HIES does not contain any additional information on these fees. The HIES clearly classifies expenditure on ‘fees’ and ‘events’ as education expenditure, but does not collect data on other spending associated with education (for example, transportation costs, school lunches, uniforms, and textbooks) For households in the bottom quintile of the consumption distribution, total expenditure averages US$6 a year, compared to US$477 for households in the top quintile. There is also a significant geographic disparity, with private expenditure being negligible in rural areas. This can be mostly explained by the absence of secondary schools and private schools in rural areas. However, it emphasizes the even greater relative importance of public education expenditure in rural areas. Table 15: Annual household education expenditure per student enrolled (US$) Quintile Household expenditure per student (US$) 1 6 2 51 3 97 4 177 5 477 Location Majuro 206 Kwajalien 218 Rural 9 Source: World Bank calculations, RMI HIES 2019–20. 188 135 There is no data in the HIES on the schools and post school institutions that household members attend. Due to the lack of attribution of spending to specific persons in the household, per student funding by school level is not reported. Country Economic Memorandum and Public Expenditure Review 395. The needs of children who have a disability are catered for through special education programs and services, funded by the Individuals with Disabilities Education Act (IDEA),136 though the effectiveness of these programs is not known. Special education programs and series are available on all 24 atolls, in 72 of the 78 public elementary schools and in all five public high schools. In the 2017–18 school year, there were 125 special education teachers employed and there were 606 students with a disability served by these programs.137 While it is not appropriate to compare student–teacher ratios for special education to regular education (as these teachers may teach other students), it is encouraging to see that the ratio of students with a disability to special education teachers is low, averaging 4.8. Comparing the 2017 IDEA Part B Grant funding total of US$1.4 million to the number of students with a disability yields average funding of US$2,268 per student. The PSS has published special education annual performance reports for 2014–16 which includes some statistics on students with disabilities. However, it is not necessarily the case that students with a disability benefit equitably from the funding, nor is there data available to evaluate how this funding may be linked to educational outcomes for the targeted students. 2.5.5 Conclusions and Recommendations 396. The education system is characterized by poor quality outcomes and very high public expenditure on education relative to GDP, implying substantial inefficiencies. There is a complex and rigid set of funding sources, that allows for a very high level of expenditure, but which is not being utilized to maximize education outcomes. The majority of students do not meet the minimum level of proficiency in core subjects such as math and English, while secondary school completion remains low. There are signs that equity is a problem, with lower enrollments for poor students. But low education outcomes are so widespread that fundamental changes to the education system are needed to improve outcomes for all. While there is no singular explanation for the low outcomes and high level of inefficiency, there are least four major structural inefficiencies across the education sector: a. Limited early childhood education, meaning children are not as well prepared for primary school as they could be b. The costs and difficulty of serving a small, dispersed population (which is not uncommon for small island states) c. Costly additional ‘catching-up’ years to compensate for the cumulative effect of poor- quality primary and secondary education d. Misalignment of secondary education and post school education with the needs of the labor market. It is not expected that these fundamental inefficiencies of the education system will be able to be overcome in the near future. Given the depth and breadth of the issues, a wide array or responses are likely to be necessary. This section outlines specific actions judged to be the most feasible and impactful, without overburdening the MOEST or PSS. The first three of these causes of inefficiency are outlined below, while the last it outlined in Section 1.3.2. 136 Of all special education teachers and staff, 95 percent are funded by IDEA Part B US Federal Grant money (PSS Annual Report 2017–18) 137 Including intellectual disabilities, specific learning disabilities, developmental disabilities, hearing or visual impairments, emotional disabilities, or 189 physical disabilities. Republic of the Marshall Islands 397. Young children are disadvantaged across multiple domains, which undermines their potential to fully benefit from primary school and reduces the return on public education expenditure. These disadvantages include: (i) inadequate access to effective and quality maternal and child health services including immunization coverage; (ii) insufficient opportunities for early stimulation and early learning; (iii) lack of support through formalized social protection; and (iv) limited availability, affordability, and consumption of nutritious diets, especially for children from vulnerable families. Cutting across all of these issues is a lack of awareness of the importance of early child stimulation, health, and nutrition. It is difficult to quantify the impact of these issues on primary schools’ outcomes but any resulting loss in learning capacity of children commencing grade 1 would reduce the efficiency of public spending on primary education. It also likely reduces efficiency of public expenditure on all higher levels of education (for example, contributing to grade repetition and poor learning outcomes in secondary education). 398. In terms of inefficiencies arising from a small, dispersed population, it is worth considering the trade-off between providing equitable access to schooling for neighboring island students, versus having fewer and larger schools that benefit from economies of scale but that are less accessible to neighboring island students. Generally, the RMI education system has leaned toward the former for primary education and toward the latter for secondary education. In order to evaluate the efficiency of neighboring island schools, data on student performance and socioeconomic background would need to be compared to data on school resources. Such an analysis would allow for a more accurate assessment of the trade-off between equity and efficiency. 399. Poor quality primary and secondary education is inefficient as most students do not attain 12 years of learning from 12 years of schooling. This inefficiency is compounded by catch-up study at tertiary education institutions, which costs more than students studying at secondary schools. The current system is based on some implicit assumptions. The first is that repetition of grade 12 is either not a suitable or feasible mechanism of bringing grade 12 school leavers up to the necessary standard. The second is that without a catch-up year in a tertiary institution, there would not be enough suitably qualified students to enter tertiary education level programs (diplomas or bachelor’s degree programs). However, having students bridge their learning gap at a tertiary institution is very inefficient. For example, if the average cost of a year of CMI education is US$9,341, and the average cost of secondary education is US$1,414,138 it costs 6.6 times more for students to complete a grade 12 equivalent year at CMI than if they did so at secondary school. While the estimates of per student funding are not precise, the order of magnitude is sufficient to illustrate the high level of inefficiency. 190 138 This estimate is based on the average per-student funding for secondary students from 2017–19. Country Economic Memorandum and Public Expenditure Review 400. Given the economic challenges caused by the COVID-19 pandemic, and the anticipated post-2023 scenario, enhanced strategic decision making by the MOEST and PSS will be important. While the post-2023 scenario remains uncertain, it is possible that this new scenario will entail lower overall resources for the sector, less rigidities in the resources that are available, and a more limited funding-allocation role for the JEMFAC. Such a scenario would provide an opportunity for the MOEST and PSS to critically evaluate sector priorities and align expenditure to deliver on these priorities.139 This would require increased institutional capacity to review existing policies, assess sectoral needs (including through enhanced analysis of available sectoral data) and develop and operationalize new allocative frameworks. It is critically important that the MOEST and PSS find ways to improve outcomes while also maintaining or improving equity. Priority areas for improvement are: (i) access to early childhood education; (ii) the quality of teacher/ student interactions in the classroom; and (iii) school autonomy regarding operational spending and community participation in school management. Recommendations 401. To better prepare children for primary school, GoRMI should continue to expand the delivery of early childhood stimulation, while also prioritizing the development and implementation of public preschool education. In the short term, MOEST should continue efforts to improve the coverage and quality of home-based parental support programs for vulnerable households in Majuro and Ebeye. In the medium and longer term, MOEST should continue to develop the institutional, regulatory, physical and human resources required to improve the quality of existing private preschools and establish new public preschools. Authorities may need to reprioritize some aid-funded capital works for primary schools towards establishing new public preschools; and investigate shared facilities. 139 While greater fungibility in the sector resource envelope would provide an opportunity for positive change, it would also introduce greater risk of poor policy decisions if the institutional capacity of the MOEST and PSS are not supported and developed. 191 Republic of the Marshall Islands 402. The PSS should expand and improve the collection and analysis of data on schools, students, teachers, and funding at all levels, to better inform policy design and resource allocation. Integrated school-level data is essential to evaluate the efficiency of spending and inform resource allocation and policies to improve learning outcomes. Issues with the quality and timeliness of data undermine transparency, accountability, and the ability of authorities to set priorities and allocate resources to improve performance. The PSS should continue to focus on improving the education management information system (EMIS), including directly linking school-level data of different types so that it can be accessed in a format that facilitates analysis. This should include data for school funding, enrollments, MISAT test scores, teacher qualifications etc. However, data collection also needs to be expended and improved to adequately cover the following areas (although it should be noted that most of these data are already being collected to some degree): · Student characteristics: At the student level within each school (and preferably across schools), a student’s MISAT data and other school data (for example, absenteeism) should be able to be linked to their personal and background characteristics (parents’ education, disability status, the student’s previous schooling). Classroom-based assessments should also be introduced to inform improved and better-targeted teaching. · MISAT: To inform education policy and resource allocation, the MISAT should be reviewed and revised to ensure that it is: (i) fully aligned to the primary and secondary curriculum; and (ii) adequately measures the desired learning outcomes and student performance. The review should seek to expand the usefulness of the MISAT to track learning trends over time and create linkages with regional and international assessments (such as the Pacific Islands Literacy and Numeracy Assessment). This could be done by including common items across years. · Teacher training and support needs: Additional data should also be collected to determine the type and modality of training and support most needed by teachers and principals to enhance learning outcomes. Such data could include teacher observations and surveys of their challenges, motivations, and support needs. This data should be able to be linked to a teacher’s position, qualifications, and experience. · School level data: Expenditure data should be collected and compiled to assess where money is being spent. Information relevant to schools improving their level of accreditation and barriers they face would also be useful. 192 Country Economic Memorandum and Public Expenditure Review 403. The PSS could benefit from analysis of the above data for a range of policy areas. MISAT testing data thus far has been used to indicate the performance of students and schools but has not been used to explain why variation in performances exists. To explain why some students and schools perform poorly, MISAT data needs to be compared to educational input data, while controlling for other factors that may impact educational performance. These include factors that are not determined by the education system (for example, the socio-economic status of the parents and the school community). Educational inputs such as teaching qualifications and per-student funding rates can already be measured with existing data. Econometric analysis of the link between the variation in these factors and student performance will enable the PSS to establish what is working to improve student performance and what is not. Ideally, once the MISAT testing data is improved and made more comparable between years, cross sectional analysis over time (longitudinal data analysis), would allow for controlling of ‘fixed effects’ such as a student’s background while separating out the effect of improved inputs (such as the increase in teacher qualifications). Based on this analysis, the PSS could improve the allocation of resources to the input(s) with the highest impact. Where performance is uniformly poor and not responsive to changes in inputs, the problems may be at a higher level, such as the curriculum. 404. Improving the quality of primary and secondary education will require improvements in teaching via enhanced professional development support for principals and teachers. Aside from family/ socioeconomic characteristics, teachers are the most important factor affecting student learning. Numerous studies have shown that improving the quality of instruction via teacher training and coaching/mentoring can have large and persistent impacts on learning outcomes (Piper & Korda, 2010; Pianta, 2011; Paxson & Schady, 2010). Given widespread poor learning outcomes, such training should focus on up-skilling teachers to effectively undertake regular classroom assessments to evaluate student progress against a set of core skills and standards. This should be complemented by training on differentiated instruction (teaching to support students at different levels of proficiency) and multi-level teaching—especially for teachers in neighboring islands. However, given RMI’s dispersion, centralized coaching/mentoring will be extremely costly. Instead, professional development for principals should focus on enhancing their pedagogical leadership and better equipping them to provide teachers with regular observation, feedback, and coaching/mentoring. 193 Republic of the Marshall Islands 405. To support improvements in the classroom and school environment, schools should be provided with more autonomy over their operational budget, accompanied by greater community participation to encourage accountability. Along with improved professional development support, principals and teachers should also be given greater autonomy to determine what is needed to improve learning outcomes within their school. Greater administrative autonomy over the school’s operational budget can provide a triple win for the education system. It can: (i) reduce the administrative burden on the PSS; (ii) improve the efficiency and responsiveness of education services to local needs; and (iii) encourage the community to hold principals and teachers accountable—supporting improved performance. Achieving the latter will require complementary reforms, however. In the short term, school-level data should be disseminated to parents and the community (for example, in the form of School Report Cards) to increase scrutiny of school performance. In the medium term, PSS should encourage greater community participation in school management by requiring all schools to have an active School Board which includes parent and teacher representatives. The long-term goal should be that all schools are required to develop a School Improvement Plan, in consultation with the School Board, parents, and teachers. These plans would become a key input to school and sector budgeting and planning, as well as provide a platform to enhance community participation. 406. In the longer term, PSS should review and amend the school funding allocation mechanism to ensure that it is transparent, consistent, and tied to the needs of schools and students. At present, financing for private and public schools is based on separate formulas, with the public school funding formula not clearly formalized. Both formulas only partially take into account the needs of schools and students. The formulas should be reviewed and amended to ensure they provide efficient and equitable funding that is based on each school’s characteristics and incentivizes improved performance at the school level. 2.6 HEALTH SECTOR 407. This chapter describes the structure and governance of health service delivery, the performance of the health sector in terms of health and nutrition outcomes and analyzes trends in health spending to assess its efficiency, equity, and sustainability. The health chapter builds on the review of health spending conducted by the World Bank in 2004 and highlights the persistence of structural challenges to improve the efficiency of health spending, particularly in terms of the organization of health services and the composition of health spending. The chapter highlights the need to prioritize investments in primary health care and to consolidate funding from external sources to reduce fragmentation and improve the efficiency of public spending on health. 194 Country Economic Memorandum and Public Expenditure Review Credit: Eric Sales / ADB 408. Access to quality and timely data is limited. Data from routine health information systems on the coverage of essential health services is not available and RMI is not included in the World Health Organization (WHO) universal health coverage monitoring reports (WHO, 2019). This makes it difficult to assess and compare RMI’s progress towards universal health coverage. There is also no single repository of health spending data. Thus, the data used in this analysis was compiled from several sources. Further, some funding streams—like the US Federal Grants—have a different fiscal year, which makes the analysis of total spending on health per year very challenging. 2.6.1 Structure and Service Delivery 409. Like other countries in the Pacific, RMI combines three different approaches to health service delivery. The first one consists of the provision of health care (including limited specialized care) in public health facilities within the country. The second approach is the provision of services within the country but delivered by international health professionals. This model is often referred to as Visiting Specialist Medical Teams (VSMT). The third approach is the referral of patients to health facilities abroad and this model is called Overseas Medical Referral (OMR) schemes. 410. The national health system through the public health facilities is organized around two levels of care. The first level is the primary health care (PHC) level which is delivered at 53 health dispensaries (‘dispensaries’), most of them in the neighboring islands. Health dispensaries are manned with one health assistant that delivers only health promotion and prevention services (comparable to a Community Health Worker in other countries). Dispensaries are ill-equipped to deliver services. The second level of care is the secondary level, which is offered at two hospitals, one in Majuro and one in Ebeye. Given the low readiness of the PHC level, most patients in the neighboring islands are referred to Majuro and Ebeye, and the secondary level provides most health services. Tertiary services are referred overseas. There is no essential package of health services established by level of care. 411. The health system is entirely financed and managed by the public sector. There is no private provision of health services. While GoRMI is the largest financier of the health sector, a high share of public health spending is external support under the Compact Sector Grants and individual vertical health programs from the US Federal Government. 195 Republic of the Marshall Islands 412. PHC is delivered mostly at the health facility level and outreach is ad hoc and rare. There are 53 dispensaries, including four managed under Program 177140 and one in Majuro. In November 2019, 92 percent of the dispensaries were staffed. In theory, PHC is delivered at the dispensary level and through outreach. There is no systematic approach to keeping records of the frequency and coverage of outreach patrols (within an atoll or from an atoll with a dispensary to other atolls) but stakeholders interviewed during data collection reported that outreach to other atolls is infrequent, mainly due to the long distance, the high cost of petrol, and the unreliability of government sea and air transportation. 413. Geographic and demographic considerations hinder the capacity of the health sector to operate as a network. Facilities that are integrated to a network can support each other (for example, through sharing of supplies), can allow staff in these facilities to specialize in certain areas—which in turn could reduce the need to refer all patients to Majuro or Ebeye, and can help develop a sense of team work. Evidence shows that health professionals that operate in isolation are less motivated, they perform worse than those who see themselves as part of a team, and they often have higher turnover rates (Peduzzi and Fernandez Agreli, 2018; West & Lyubovnikova, 2013). However, this networking is not possible in RMI as health facilities are very far from each other. The average distance between a dispensary and either Majuro or Ebeye hospitals is almost 250 kilometers, with the furthest dispensary being over 600 kilometers away from a hospital. Covering these distances by sea takes a long time and air transport is very expensive. Given the small population in the neighboring islands, there tends to be only one dispensary per atoll, and the average catchment area for a dispensary (excluding the dispensary in Majuro) is 267 inhabitants. 414. The availability of essential supplies is also an important challenge to the supply of quality care. A service delivery readiness assessment conducted by the United Nations Population Fund (UNFPA) in 2018 revealed critical gaps in the availability of reproductive, maternal, neonatal and child health services (RMNCH) commodities. While the majority of dispensaries reported that they provide RMNCH services such as family planning, deliveries and ante- and postnatal care, few facilities had the necessary equipment to provide these services. In fact, no dispensaries fulfilled the UNFPA criteria to conduct safe deliveries or provide ante or postnatal care. An assessment of dispensaries’ readiness to deliver services conducted in 2019 found that recurrent stock-outs of essential supplies were explained by: (i) poor stock management practices (no dispensary consistently maintained stock cards); (ii) the low number of staff that have received training in logistics management for health supplies (32 percent); and (iii) inadequate levels of supervision (UNFPA, 2019). The unavailability of critical supplies in dispensaries reflects also weak planning and low availability of resources at the central level. This represents a major threat to Marshallese women and babies and needs to be addressed urgently. As a result, almost all RMNCH services are provided by the two hospitals. 196 140 Program 177 supports health service delivery in the four atolls affected by US nuclear activities. Country Economic Memorandum and Public Expenditure Review 415. Lastly, the delivery of services is limited by the shortage of health professionals and the challenges of staffing dispensaries in remote atolls. Dispensaries provide only a limited range of health services and are staffed by one health assistant, whereas Majuro and Ebeye hospitals have a wider range of health professionals, including general practitioners and some specialized doctors supported by nurse practitioners and assistant nurses. Some of these positions are covered by expatriates given the limited number of trained Marshallese health professionals. These expatriates are part of the public payroll. Travel restrictions due to the COVID-19 pandemic have resulted in acute pressure on the health system and the unavailability of specialized services due to the inability to bring in skilled health workers. These pressures could persist until broad international travel resumes. 416. The VSMT model helps strengthen the public health system by compensating for the shortage of RMI-based professionals. Under the VSMT model, foreign doctors spend short stays in RMI and deliver specialized services at Majuro and Ebeye hospital. In 2017, there were eight teams of doctors and the program cost US$142,400 (airfares mostly). Services were delivered by six different VSMT providers141 and included ear, nose, throat, cardiovascular, dermatology, pulmonary, and neurology (Nosal Institute for Global Health and WHO, 2019). Most VSMT teams train national doctors during their visits, although the absence of specialized doctors in most of those areas hinders the transfer of knowledge. There are no official records or reviews of the VSMT, so there is no visibility on the number of patients that were treated, the number of referrals from the neighboring islands, and the outcome of those visits. The efficiency and effectiveness of the VSMT model could be improved by keeping detailed records of the visits, and regularly reviewing outcome performance. 417. Training opportunities for health assistants are limited. Pre-service training consists of an 18-month training course in Majuro. Participants are selected from within their community and chosen by community members. To be eligible for the program, participants must have a High School Diploma and they must have passed the entrance test. After graduation, there is no formal in-service training curriculum. A study conducted in 2018 revealed that the last time that most health assistants had participated in in- service training was in 2009 and that the curriculum for this training was based on outdated clinical guidelines (developed in 1995) (Dever & Durand, 2018). In addition, given that supervision is rare and reactive, the upskilling of health assistants through supportive supervision is not happening. MOHHS is currently considering initiating a new Health Assistant Training Program and training members of community-based organizations to function as Community Health Outreach Worker (CHOW). This might be institutionalized into the CMI’s curriculum and it will have a strong focus on case finding, outreach and improved preventive services coverage. 141 These were ASHM (Australia), Canvasback Mission Inc. (US), Pacific Islands Program (Australia), Shriner’s Hospital for Children (US), Shuang Ho hospital (Taiwan, China), and Taiwan Medical Mission (Taiwan, China). 197 Republic of the Marshall Islands 418. Health assistants are organized in five levels based on their experience and their performance. The Outer Islands team in MOHSS, together with an atoll supervisor, evaluate health assistants’ performance every year. When health assistants receive a positive evaluation, they get a bonus payment. Three years of good performance leads to an upgrade to the next level. Evaluations are mostly based on service utilization data provided by the health assistants on a monthly basis through the radio. Failure to provide these monthly reports can translate into salary deductions (eight hours of salary per report missed). There was no reference to performance reviews as a means to motivate staff and increase the retention of staff in remote areas. 419. While RMI claims to practice the Healthy Islands model, community-based service delivery (including the presence of health volunteers) is very limited. The Healthy Islands model consists of engaging and empowering communities to look after their health and wellbeing through the provision of health promotion and prevention services at the community level. Only three atolls have piloted this model and there has not been an evaluation of its impact. While the implementation of the Healthy Islands model has been challenging in several countries in the region, given the geographic challenges and the limited workforce, it is worth exploring the potential of this model (or similar community- based service delivery models) in RMI’s neighboring islands. 420. The current health service delivery model relies heavily on referral pathways, with all tertiary level care referred to overseas hospitals. The referral system consists of referral from dispensaries in the neighboring islands to a hospital (predominantly Majuro Hospital) and, in the cases where the services needed are not available in country, from Majuro to a hospital abroad. Referrals from the neighboring islands to Majuro or Ebeye are mostly driven by the low readiness of dispensaries to treat patients and to deliver health prevention and promotion services that are meant to be delivered at the dispensary level. Even some basic procedures, like the monitoring of certain NCDs, cannot be performed at the neighboring islands’ dispensaries with their insufficient supplies and the limited training received by health assistants. 421. In terms of OMR schemes, two modalities co-exist in RMI. The first one is the publicly funded system financed through the Health Fund and the Supplemental Health Fund. In the case of the Health Fund, an approval from the Medical Referral Committee is needed and there is a ceiling amount for the services covered. In the case of the Supplemental Health Fund, no approval is required and there is also a coverage ceiling. Both funds do not cover people over 70 years old and exclude terminal conditions, conditions that can be treated locally, end stage cancers and Tuberculosis and related complications. The publicly funded OMR finances the majority of OMRs. The second system of OMR is externally funded. Private providers such as Shriners Hospital for Children in Hawaii cover the costs of treatment and the accommodation for Marshallese patients that need to be referred abroad. The cost of transport is borne by the Health Fund. Beneficiaries of this scheme are identified by VSMT teams from Shriners Hospital. 198 Country Economic Memorandum and Public Expenditure Review 422. OMR schemes are justified but they need to be managed well. OMR in RMI are justified given the high per capita cost of delivering specialized services for a small population, and also because a minimum volume of specialized services is required to maintain quality and safety of these services. Due to the small population, this is not possible for all specialized services. However, there are two ways through which the publicly funded OMR scheme could be improved. The first is to establish billing arrangements142 with specific providers. These arrangements could be negotiated jointly with other Pacific countries that refer patients to the same facilities, bringing down the cost of treatment. The second element consists of the evaluation of health outcomes and the quality of care received through these schemes, similar to what is being recommended for the VSMT scheme. Only French Polynesia evaluates the quality of care of OMR and no country in the region has conducted a formal evaluation of the quality of treatment received. These could help identify the best providers for each condition and improve value-for-money by potentially improving the health impact of these investments. Compared to selected Pacific countries, RMI was the third largest country in terms of number of OMR, but spent below the regional average of US$23,089 per patient in 2019 (Table 16). Table 16: Comparison of OMR schemes in selected PICs Cost of OMR - GoRMI Average cost per Country No. of OMR cases funded (US$) patient Cook Islands 153 500,478 3,271 Fiji 60 583,176 9,720 French Polynesia 669 38,000,000 56,801 Kiribati 149 1,412,129 9,477 RMI 285 3,604,723 12,648 FSM 462 4,231,609 9,159 Nauru 260 3,836,103 14,754 Niue 70 61,957 885 Palau 230 2,693,227 11,710 Samoa 182 3,787,295 20,809 Solomon Islands 10 102,601 10,260 Tokelau 66 283,831 4,300 Tonga 25 581,100 23,244 Tuvalu 178 4,848,400 27,238 Vanuatu 9 307,530 34,170 Total 2,808 64,834,160 23,089 Source: Nosal Institute for Global Health and WHO (2019). 142 At the time of writing, GoRMI was negotiating a third-party contract with a hospital in the Philippines. 199 Republic of the Marshall Islands 2.6.2 Governance 423. The health system is highly centralized. At the policy level, the MOHSS is the main stakeholder involved in the development of strategies and policies (such as the three- year rolling strategic plan). MOHSS is also in charge of setting the standards for service delivery, such as quality standards and infrastructure requirements for health facilities.143 In terms of financing, the majority of the health budget is collected and managed in Majuro. In theory, local level authorities are expected to identify infrastructure gaps and use local taxes to finance refurbishments and general facility maintenance. Subnational budgets were not available for review, but anecdotal evidence suggests that this is not happening in practice. The lack of funds at their disposal hinders the capacity of subnational authorities to play their role, not only in terms of infrastructure maintenance (which could arguably be better financed centrally) but also in terms of supportive supervision and coordination. In terms of service delivery, the MOHSS is also heavily engaged through the design of programs and the monitoring and supervision of health services. While health facilities play an important role in delivering services, their autonomy is weak. In addition, human resources are trained in Majuro (or abroad), they report to the capital city and their payroll is managed centrally.144 424. MOHSS is organized around eight priority programs and there are significant overlaps between them. These programs are: (i) the Bureau of Primary Health Care Services; (ii) Majuro Hospital Services; (iii) the Bureau of Kwajalein Health Care Services; (iv) the Bureau of Administration, Finance and Personnel; (v) the Office of Health Planning, Policy, Preparedness and Epidemiology; (vi) the Outer Island Health Care Services and 177 Health Care Program; (vii) Dental Health Services; and (viii) Human Services. Half of these programs have a geographic focus (for example, Majuro, Ebeye or Rongelap) and two of them focus on PHC. This structure is explained by RMI’s health financing architecture (see Section 2.6.4) but is not efficient. The main issue with the overlap between programs is that it creates fragmentation in programs and reduces opportunities for integration and collaboration. There is no public health reason to treat primary care differently in Rongelap, Ebeye, or other atolls. Further, the fragmentation of primary health care and hospital care does not take into consideration the fact that both Majuro and Ebeye hospitals deliver primary health care services. 425. Decision making power is held primarily by MOHSS, MoF, the PSC, and the MPW. MOF plays a key role during the budget process. It is also responsible for the procurement of goods and services for the health sector under specific funding streams. The PSC is responsible for setting quotas for the number of health human resources and for determining salaries for all civil servants, including all health staff. The MPW, in turn, plays a key role in managing and implementing the capital budget. There is very little documentation on the role of communities in decision-making in health. 143 The Medium-Term Planning and Budgeting Framework describes the mission of the Ministry of Health and Social Services (MOHSS) in terms of the provision of health services, rather than the steering of the health sector. This shows the high level of involvement of MOHSS and the centralized approach to health service delivery in RMI. The document goes further to mention that this role is established in the Constitution of the RMI. 144 It is interesting to note that in RMI a large share of the salary of health workers is paid using external funds. 200 Country Economic Memorandum and Public Expenditure Review 426. The Medium-Term Planning and Budgeting Framework (MTPBF) 2019–21 is the main strategy document for the health sector but does not clearly articulate sector priorities, making it difficult to assess effectiveness. It describes MOHSS’s vision and goals for the health sector organized by branch. The MTPBF is the second three-year rolling strategic plan and was developed following the MOHSS restructuring of 2017. It identifies activities and expected outcomes for each branch of the Ministry and presents an annual, budgeted implementation plan. The outcomes defined in the framework are mostly operational (for example, submission of reports, guidelines developed, etc.) and there is no explicit reference to the expected impact on health service utilization or coverage. For example, the section on the immunization program does not make a reference to the expected number of children vaccinated. This hinders a complete assessment of the effectiveness and efficiency of planned expenditures. As in other parts of GoRMI, to improve budgeting and planning MOHHS needs to continue to strengthen the linkages between the NSP and the medium-term planning and budgeting framework, while also developing MOHHS’ Corporate Plan. 427. The governance of the government OMR scheme is clearly laid out in the Marshall Islands Health Fund Act of 2002. The Act repeals the Social Security Health Fund Act of 1991 and established the Health Fund. It also mandates the creation of a Health Services Board composed of representatives of MOHSS and chaired by the Secretary of Health, and of a Medical Referral Committee integrated by physicians from Majuro hospital and Program 177. Moreover, the Act establishes the Fund’s funding mechanism and the criteria for the allocation of funds (see Section 2.6.4). The creation of the Health Fund is an important milestone towards the collection and administration of financial resources in the health sector. It represents a positive development in the pooling of financial resources, and it contributes to building the capacity of GoRMI to strategically negotiate with service providers. This is best illustrated by the agreement recently signed between the Medical Referral Committee and a service provider in the Philippines. 428. There is no national policy or regulation for the VSMT model. Three countries in the Pacific have established such policies, and developing one in RMI could help improve planning, provide a regulatory framework (including standards for quality of care), standardize reporting requirements, and systematize follow-up of patients after departure. It would also show government ownership over this program and it could help align VSMT activities to government priorities for the sector. 201 Republic of the Marshall Islands 2.6.3 Outcomes and Service Coverage 429. Human capital outcomes in RMI are lower than expected for the country’s level of income. As mentioned in Section 2.4, in 2020, RMI’s HCI was 0.42 (see Figure 69). This means that a child born in the Marshall Islands in 2020 will be 42 percent as productive when she grows up as she could be if she enjoyed complete education and full health. This is lower than the average HCI for East Asia & Pacific (EAP) region and upper middle- income countries (UMICs). 430. RMI’s human capital outcomes are partly explained by the performance of the health sector, the coverage of essential health services and the specific challenges in terms of service delivery. There are three components of the HCI that link directly to the health sector and each of them tells us a different story about the performance of the health sector: • Probability of survival to age five: the first health-related component is the probability of survival to age five. In RMI, the probability of survival to age five was 0.967. This is lower than the average for EAP (0.978) and lower than the average for UMICs (0.983). It should be noted, however, that survival rates in RMI have constantly improved since 2000. Moreover, the probability of survival to age five was higher among girls than among boys. The low coverage of essential health services is a key driver of under-five mortality in RMI. • Adult survival rates: the second health-related component in the HCI is the adult survival rate. This statistic is a proxy for the range of health risks that a child born today would experience as an adult under current conditions. There are several factors that affect adult survival rates and it is often considered a measure of a country’s socioeconomic development. The prevalence of communicable diseases, lifestyle factors, mental health, and health literacy are some examples of factors that affect adult survival rates. In RMI, 70 percent of 15-year-olds will survive until age 60. This is lower than the average EAP adult survival rate (0.86) and lower than the adult survival rate in UMICs (0.86). The main driver of adult mortality rates in RMI is the disproportionally high burden of NCDs. Another important driver of adult mortality is maternal mortality. In RMI, the maternal mortality rate was 193 per 100,000 live births in 2017 (WHO, 2021a). A recent review (Countdown to 2030, 2021) shows that there is no national policy to notify maternal deaths, nor a policy to review them. There is also no national or subnational review committee. As a result, there is no national data on the main cause of maternal mortality in RMI. In the Pacific region, 30 percent of maternal deaths are due to hemorrhage, 15 percent are due to embolism and 14 percent are due to hypertension (Countdown to 2030, 2021). 202 Country Economic Memorandum and Public Expenditure Review • Healthy growth: the third health-related component of the HCI is a nutrition indicator (healthy growth) that measures the share of children under five that are not stunted. Nutrition outcomes are influenced by a myriad of factors, many of them beyond the scope of control of the health sector. To name a few, the availability of food, diverse diets, access to improved water and sanitation and practices such as exclusive breastfeeding can strongly impact the prevalence of stunting. Moreover, the nutritional health of a mother has long-lasting impacts on the development of children even beyond the first 1000 days. 431. While health outcomes have improved slowly over time, RMI continues to face the double burden of communicable and non-communicable diseases (NCDs), while significant challenges remain with maternal, child and newborn health. In 2019, RMI’s general death rate per 100,000 inhabitants was close to the regional average and stood at 743.1. Death rates were higher among men (829 per 100,000 inhabitants) than among women (653 per 100,000 inhabitants) and in both cases the main driver of mortality rates were NCDs. Cardiovascular diseases were the main cause of death, and they have been topping the ranking of leading cause of death in RMI since 1990 (see Figure 88). In terms of disability-adjusted life years (a measure that combines death and disability), outcomes among men are also poorer than those of women and NCDs play an even larger role. Overall, NCDs represented 70 percent of the countries burden of disease in 2019, followed by communicable, maternal, neonatal and nutritional diseases145 (18 percent) and injuries (12 percent). Particularly concerning is the prevalence of diabetes: 31 percent (2019) of the population ages 20–79 has type 1 or type 2 diabetes. This is higher than both the average for its region (12 percent) and the average for RMI’s income group (10 percent) (World Bank, 2020). Figure 88: Cause of death (1990 vs 2019) Source: IHME (2021). 145 Includes maternal and neonatal diseases and nutritional deficiencies, as well as communicable diseases such as HIV/AIDS, Tuberculosis, and malaria. 203 Republic of the Marshall Islands 432. Health outcomes can be partly explained by the performance of the health sector, particularly in terms of the coverage of health services. Overall service coverage improved in RMI from 38.7 percent in 1999 to 42.1 percent in 2010 and 44 percent in 2019 (Figure 89). In terms of reproductive and maternal health services, coverage rates are high but below the level expected for RMI’s level of income. Further, there are significant discrepancies by region within the country. Of the 872 antenatal care services delivered in the last semester of 2018, 36 percent were delivered at Majuro hospital, 60 percent were delivered at Ebeye hospital and only 4 percent were delivered elsewhere in RMI (UNFPA, 2019). This is not surprising given the unavailability of basic supplies to do antenatal care controls in the neighboring islands. It is expected that the majority of women that did not benefit from any antenatal care services reside in the neighboring islands, but coverage data by region was not available at the time of the analysis. In terms of postnatal care, similar trends are observed, and Ebeye hospital concentrated an even higher rate of the services delivered (77.5 percent). This is not consistent with the distribution of deliveries, as more than 70 percent of the babies delivered in the second semester of 2018 were born at Majuro hospital. Family planning services, in turn, were also concentrated in Majuro (94.5 percent). While the high delivery rate at Majuro hospital is consistent with RMI’s service delivery organization (that is, the concentration of specialized services in Majuro and Ebeye), there is no reason why family planning services could not be provided in the neighboring islands. Stock-outs in family planning commodities and insufficient training of staff are potential drivers of low utilization of family planning services in the neighboring islands. In fact, 65 percent of health facilities reported stock-out of any family planning method or product in the second semester of 2018 (UNFPA, 2019). Figure 89: Service coverage across the continuum of care in 2019 Source: Countdown to 2030 (2021). 204 Country Economic Memorandum and Public Expenditure Review 433. The coverage of child health service is lower than comparator countries. Immunization coverage rates are a good tracer for the coverage of child health services as children’s visits to the doctor are often scheduled around the vaccination plan. In RMI, immunization coverage rates are low. For example, only 81 percent of children are fully immunized against diphtheria, tetanus toxoid and pertussis, and 83 percent of children are vaccinated against measles. There is no data on the geographic distribution of immunized children, nor on the coverage rate by gender. Vaccination is a cost-effective intervention to reduce the risk of disease outbreaks and increase population immunity. Further, technology is now available to equip health facilities with solar-powered freezers that could help them stock vaccines in places where the supply of electricity is unreliable. Other useful indicators to measure the coverage of child health services include children treated for pneumonia or diarrhea, which are prevalent among children but cannot be programmed like vaccinations or other growth measurements. There is no recent data to estimate the coverage of these services in RMI. 2.6.4 Financing and Expenditure 434. Health financing is highly fragmented and complex. Fragmentation is not only related to the different funding sources but also to the administration of funds and the reporting requirements associated to each funding stream. The complexity of RMI’s financing architecture is driven by the fact that different funding sources are earmarked for specific expenditures, they do not have the same fiscal year calendar and they operate in different manners (for example, some funds operate on a reimbursement basis whereas other funds operate as an advance payment). However, health financing is centralized in MOHHS. While some funding streams are earmarked to support specific regions of the country, all funds are managed by GoRMI. Even Program 177, which is meant to finance activities in Enewetak, Utirik, Kili, and Rongelap, is managed by a team based in Majuro. Memoranda of Understanding (MoUs) have been signed to enhance service delivery at the sub-national level, but MoUs do not include any financial commitments from local governments. 435. External grants represent around half of public funding for the health sector. The main sources of public funding for the health sector are outlined in Box 8. These include the General Fund, US Federal Grants, Compact Sector Grants, compulsory prepayments (Health Care Fund and Health Care Revenue Fund) and Taiwan, China grants. The General Fund, the Health Care Fund, and the Health Care Revenue Fund are domestic sources of public spending on health. The US Federal Grants, the Compact Sector Grants and Taiwan, China grants are all external sources. 205 Republic of the Marshall Islands Box 8: Health Sector Financing Following the money General Fund: The General Fund is allocated as part of the GoRMI general budgeting cycle, based on a submission made by the MOHSS to the BCC. For the submission, each program within MOHSS is given a ceiling and MOHSS consolidates proposals from the different programs.146 Section 211 - Compact Sector Grants (CSGs): The budgeting process for CSGs follows a different process compared to the General Fund, but both funds have the same fiscal year schedule (October 1 to September 30). CSGs are appropriations under Public Law 99-239, as amended, Title II, Article 1, Section 211 and approved by Nitijela resolution 123. There are cuts to the CSGs every year, with the CSGs scheduled to end in 2023. Expenditures under the CSGs follow the MoF-led GoRMI procurement processes. CSGs finance multiple sectors and to access these funds line ministries need to submit a proposal to Nitijela. There are different sub-grants within the CSGs and they have specific reporting requirements: • Health Sector Grant Fund: This Fund is meant to support and improve the delivery of preventive, curative, and environmental health services. Unlike other streams of funding, the Health Sector Grant Fund is not earmarked for a specific community or region. It covers operational spending, primarily to cover the costs of the administration of MOHSS. • Ebeye Special Needs (ESN): The purpose of the grant is to finance health services in Ebeye and to cover the needs of Marshallese communities within the Kwajalein atoll. The budgeting process for the ESN grant includes an additional step compared to the other CSGs in which the leadership in Ebeye needs to decide how to allocate the funding. ESN funds are not enough to cover all costs at Ebeye hospital, so other sources are also channeled to its operations. Unlike other streams of funding, ESN funds are quite stable from year to year. • Public infrastructure: It is required that no less than 30 percent and no more than 50 percent of all funds appropriated under the CSGs are made available in accordance with a list of specific projects included in the infrastructure and maintenance plan prepared by GoRMI. However, since 2013, the health sector benefited from public infrastructure grants only in 2015 and 2016. • Infrastructure maintenance: It is required that 5 percent of the CSGs is made available for infrastructure maintenance. The GoRMI is requested to make an equal contribution to this Fund. Since 2013, the only time that the health sector benefited from this support was in 2019. US Federal Government Grants (USFG): USFG follow a different process to the CSGs. The process starts when the Government of the US issues a Notice of Funding Opportunity (NFO). US states and territories along with the freely associated states (FAS) the Northern Pacific (including the RMI) have six months to apply, and there are competitive and non-competitive grants. The NFO is shared with the program manager in the case of existing grants, and with the Secretary of Health of a US state or eligible country in the case of new grants. At the time of the assessment, there were 20 active USFG,147 some of them lumped into a single grant but with different funding sources. The length of grants varies from two to 10 years. While some of the grants have a vertical focus (family planning, immunization, HIV prevention, etc.), others are broader in scope (mother and child health services). 146 Programs are referred to as outputs. 206 147 These do not include special grants for COVID-19. Country Economic Memorandum and Public Expenditure Review During the budget process, USFG are included in the submission made by MOHSS to the BCC. The amount included in the submission is an estimate based on the amount that MOHSS expects to receive during that budgeting period, which is influenced by a ceiling set by the grantors. Further, grants are paid on a reimbursement basis.148 This means that MOHHS needs to use domestic resources to achieve performance targets set by each USFG. Carry-overs are only allowed on an annual basis, and during the last year of the grant, all funds need to be spent before it ends. Interviewees indicated that this did not create difficulties in terms of cashflows. However, it is understood that if reimbursements are not processed in a timely fashion, then the funds could be lost. A mid-year review is required every year, as well as a close-up review. There is one template for all USFG reports, and the reporting is done by MOF. There are eligible expenditures under the USFG. They are used to pay for staff costs (only for staff fully dedicated to a specific grant program) and other operational costs of dispensaries. One important grant is Program 177 (or Section 177), which is meant to cover the health costs of delivering services in the four atolls affected by US nuclear activities. This grant is funded by the Department of Interior and it suffices to cover all the operating costs of health services delivery in those atolls. Health funds: these include the Health Fund (HF) and the Health Care Revenue Fund (HCRF), which were created to collect compulsory contribution from the Social Security system. Contributions are collected by MISSA and, since 2002, they are managed by the MOHSS. They consist of a 3.5 percent payroll deduction, plus an 8 percent deduction for retirement benefits. For budgeting purposes, expenditure ceilings for these funds are established based on the average expenditure over the last three years. Revenues used to be allocated following a 55/45 percent split for the HCRF and the HF respectively, but the Health Service Board is now entitled to review this allocation formula. • Health Fund: the HF covers off- and inter-island referrals. • Health Care Revenue Fund: the HCRF is used to procure pharmaceuticals in the essential list of medicines (95 percent) and medical supplies and equipment (5 percent). Supplemental Health Fund (SHF): the SHF is a voluntary private health insurance, primarily meant to cover international referrals. As of March 2019, there were 1020 members of the SHF (around 9 percent of those in formal employment). When patients require an overseas referral, the Medical Referral Committee evaluates the need to refer. If they approve the referral, this is covered by the Health Fund. If it is not approved, members of the SHF can access funding to cover the medical bills for overseas treatment. While the HF covers everything (including the cost of accommodation and an allowance), the SHF only covers medical bills. It also covers pharmaceuticals in RMI that are not covered by the essential list. Taiwan, China Fund: this funding is provided by the Government of China (Taiwan) and it is used primarily to support a new Hospital Management Information System (still at early stages of implementation) and an internship program (mostly pre-service training) for Marshallese students to study in Taiwan. 148 For the reimbursements, draw down requests are submitted once performance objectives have been met. In theory, program/grant managers at MOHSS should have access to the Payment Management System, but in practice only a few do so draw down requests are often submitted by MOF. 207 Republic of the Marshall Islands 436. User fees are collected at certain health facilities. There are three facilities in RMI that collect user fees. These are Majuro hospital, Ebeye Hospital, and Laura clinic (in Majuro). This is done following an official government schedule approved by Cabinet. While there is no explicit waiver or exemption system, it was reported that roughly half of the patients pay. User fees are then transferred to the Health Care Revenue Fund. MoHHS staff indicate that the fee schedule is often not followed, with a US$5 flat fee charged regardless of service. Furthermore, this fee is often waived by the registrar, based on a judgement of the patient’s capacity to pay. This has reportedly led to a funding shortfall in the Health Fund due to uncollected fees, which is covered by a transfer from the General fund. 437. There is no health financing strategy in RMI, although MOHSS are considering several reforms to improve the efficiency and transparency of health financing. While MOHHS has discussed numerous reforms to improve the health financing system, there is no government document that summarizes these reforms and provides strategic guidance for their implementation. One reform proposed by the MOHSS is to consolidate user fees under a different scheme than the Health Care Revenue Fund. While pooling of funds can be an effective way of improving equity and allow for economies of scale, the GoRMI is considering a reform to this system because the Health Care Revenue Fund must be used for the purchase of pharmaceuticals (95 percent) and the funds already collected by MISSA are enough to cover the pharmaceutical needs of the country. Another reform proposed by the MOHSS relates to the use of user fees as a gate keeping mechanism. The objective of this reform is to enforce the government’s fee schedule at the secondary level more strictly to provide prevent patients from skipping the primary health care level and to provide care for free in all dispensaries in the country. While there is no evidence of informal payments, it will be very important to understand if health assistants at the OI are collecting (informal or under-the-table) fees to maintain operations. If this is the case, then the enforcement of free care in the OI should be accompanied by a transfer of funds to that level of care to compensate for the foregone revenue and stronger oversight to address any potential misappropriation of funds. Trends in health expenditure 438. Health spending in RMI is higher than in comparator countries and it has been increasing since 2013. In 2018, current health spending per capita was US$744. This is significantly higher than the average for the Pacific region (US$510) and close to the average for Caribbean countries (US$751). Health spending in RMI is also higher than the average spending in upper middle-income countries (Figure 90). Health spending has been consistently higher than comparator countries and it has increased since 2013. With low levels of inflation over this period, this analysis does not change when looking at trends in real health spending per capita (Figure 91). Furthermore, health spending represents a large share of the country’s GDP (Figure 92). PICs are outliers for this indicator but the high share of health spending to GDP should not be interpreted as a sign of 208 Country Economic Memorandum and Public Expenditure Review overspending or inefficient spending. Instead, this is a reflection of the small size of their economies and the large influx of external funding for the health sector. In this context, it is more relevant to focus on the analysis of the composition of health expenditure rather than the absolute and relative levels. Nevertheless, it is worth highlighting that RMI has a higher share of health spending to GDP than other comparable countries in the Pacific region. Figure 90: Current health expenditure Figure 91: Nominal and real health (US$) per capita (2018) spending (US$) per capita (2013–19) 10,000 Current health expenditure per capita, 2018 (US$) 2,500 Palau RMI Nauru Tuvalu Micronesia 500 Samoa Tonga Kiribati Fiji Vanuatu 100 Solomon Is. 25 Lower middle Upper middle Low income income income High income 5 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 GNI per capita, 2019 (US$) Source: GoRMI and World Bank (2020). Source: GoRMI Audited Financial Reports, various years. Note: X-axis is expressed in logarithmic scale. Markers in light blue are some Caribbean Island economies. Figure 92: Current health spending as a share of GDP by GNI per capita (2019) 23 RMI Tuvalu 15 as a share of GDP, 2018 (%) Micronesia Current health expenditure Kiribati Palau 10 Nauru Samoa Tonga 5 Solomon Is. Vanuatu Fiji 3 Lower middle Upper middle Low income income income High income 2 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 GNI per capita, 2019 (US$) Source: GoRMI and World Bank (2020). Note: X-axis is expressed in logarithmic scale. Markers in light blue are some Caribbean Island economies. 209 Republic of the Marshall Islands 439. In terms of the composition of total health spending, public spending (including external on-budget funds) represents the largest share of the overall envelope for the sector. According to WHO’s Global Health Expenditure Database (WHO, 2021b), in 2018 public spending on health in RMI accounted for 78.9 percent of total spending on health. This is in line with trends in the region (the average contribution of public spending to total health expenditure was 78.3 percent) and higher than the average in the Caribbean region (54.4 percent). There are two ways to interpret this trend. The first one is that public spending is a high proportion of total health spending because private spending levels are low. The second is that public spending is relatively high because health is prioritized in the GoRMI budget. 440. Private spending on health is low, with evidence suggesting that this is at least partially due to a low capacity to pay. Private health spending is the sum of health spending from corporations, households and foreign revenues that are off budget. In RMI, private health spending is low because all of these components are low. Low levels of out-of-pocket spending are worth protecting as user fees are highly inequitable (they are rarely linked to household’s capacity to pay) and inefficient (they hamper risk-sharing strategies and they cannot be easily pooled). However, low levels of out-of-pocket payments could also reflect low levels of health service utilization or barriers to accessing care. While there is no recent data to confirm this hypothesis, affordability was the main barrier to access, reported in the 2007 Demographic and Health Survey, with 44 percent of women indicating that they had serious problems getting the money to pay for services (DHS 2007). Off-budget foreign financing for health—such as donor financing to sub-national governments, non-government organizations or directly to facilities—is low. Finally, GoRMI could mobilize additional resources from private firms to increase health spending (for example, incentivize private health providers to establish facilities in the RMI), but the potential of this option is limited given the population’s low capacity to pay and the small size of the population. 441. Public health spending is high because it is prioritized in the GoRMI budget (with substantial domestic revenues directed to the sector) and due to large external, on- budget transfers. In 2018, public spending on health represented 22.1 percent of general government spending (Figure 93). This is much higher than the average for PICs (12.2 percent) and Caribbean countries (10.7 percent), reflecting both that GoRMI directs a sizeable portion of domestic revenues to health spending (around 11.7 percent of GDP, on average over the period FY13–19), combined with substantial on-budget support from external financiers (around 10.4 percent of GDP, on average). These include the US Federal Grants, CSGs and grants from Taiwan, China. When this is channeled through the government system and it is on-budget (that is, predictable and transparent), and when it is fungible and it does not include restrictions on how these funds can be used, it can increase efficiency by improving financial planning, fostering economies of scale and reducing the risk of redundant spending. However, these benefits are undermined if revenue sources are overly rigid and inhibit GoRMI from directing scarce resources to their highest priority. 210 Country Economic Memorandum and Public Expenditure Review Figure 93: Public health spending as a share of general government expenditure by GNI per capita (2018) General government expenditure on health as share 40 of general government expenditure, 2018 (%) RMI 20 Micronesia Palau Tuvalu Samoa 10 Solomon Is. Tonga Nauru Vanuatu Kiribati Fiji 5 2 1 250 500 1,035 2,000 4,045 7,000 12,535 25,000 50,000 100,000 GNI per capita, 2019 (US$) Source: GoRMI and World Bank (2020). Lower Note: X-axis is expressed in logarithmic scale. Markers in light middle blue middle Upper Caribbean are some Island economies. Low income income income High income 442. External on-budget funds represented the largest component of public spending on health and contributions from the different streams of public spending on health have been stable. Looking deeper at the composition of public spending, the contribution of each source of funding to the overall envelope has remained fairly stable in recent years (Figure 95). Public funds are the sum of domestic budgetary resources (General Fund), contributions to the social security system (Health Fund and Health Care Revenue Fund) and on-budget external funding for health (US Federal Grants, CSGs and other external financing for health). In 2019, domestic budgetary resources represented 17 percent of public spending on health, contributions to the social security system accounted for 32 percent, and on-budget external funding was 51 percent. The largest funding stream of on-budget external support were the CSGs (31 percent of public expenditure on health), followed by the US Federal Grants (18 percent). Figure 94: Composition of public health spending Source: GoRMI Audited Financial Reports, various years. 211 Republic of the Marshall Islands Efficiency of public health spending 443. There is an economic argument in favor of investing in human capital, including in the health sector. As mentioned in Section 2.4, investments in human capital contribute to the acceleration of economic growth as they promote better educational outcomes which lead, in turn, to improved earnings at the household level and improved productivity at the national level. To this end, investments in the health sector invigorate labor markets and provide opportunities for inclusive economic growth and development. However, public health spending is already comparatively high as a share of general government spending suggesting that it is unlikely that funding for the sector could be increased. Instead, improving the quality of spending represents the most viable strategy to improve human capital outcomes. 444. Health outcomes are lower than would be expected given RMI’s level of income and public spending on health, indicating that there is potential room to improve the effectiveness of spending (Figure 95). This perspective on the efficiency of public health spending that evaluates the performance of spending in terms of health outcomes is important given that the ultimate goal of investing in health and in strengthening the health sector is to deliver health services that contribute to better health outcomes. RMI has a lower life expectancy and higher under-five and maternal mortality rates that what is expected for the levels of investments in the health sector (Figure 95). In this regard, there is scope to improve the efficiency of public health spending. Figure 95: Health outcomes by level of public health spending per capita 150 Under-five mortality rate, 2018 (per 1,000 live births) 85 80 70 Kiribati Life expectancy, 2018 (years) Samoa RMI 75 Micronesia Solomon Is. Nauru 32 RMI Vanuatu Tonga Fiji Vanuatu 70 Kiribati Solomon Is. Tuvalu Tonga Palau Fiji Micronesia Samoa 16 65 8 60 4 55 2 50 3 7 17 40 100 250 600 1,500 4,000 10,000 3 7 17 40 100 250 600 1,500 4,000 10,000 General government expenditure on health per capita, 2018 (US$) General government expenditure on health per capita, 2018 (US$) Source: GoRMI and World Bank (2020). 1,200 Note: X-axis is expressed in logarithmic scale. Markers in light blue 500 are some Caribbean Island economies. Maternal mortality ratio, 2017 200 RMI (per 100,000 live births) Solomon Is. Kiribati Micronesia Vanuatu 75 Samoa Tonga Fiji 25 8 3 1 3 7 17 40 100 250 600 1,500 4,000 10,000 General government expenditure on health per capita, 2018 (US$) 212 Country Economic Memorandum and Public Expenditure Review 445. An assessment of the performance of public spending on health relative to the coverage of essential health services also reveals that there is potential room to improve the efficiency of public health spending. While health outcomes can be influenced by factors beyond the control of the health sector (for example, access to improved water and sanitation), the coverage of essential health services is more closely linked to the performance of the health sector. A review of the coverage of maternal and child services relative to public health spending levels reveals that RMI is achieving a lower coverage of these services than expected for the level of spending in the health sector (Figure 96). Figure 96: Health service coverage by level of public health spending per capita 100 Fiji 100 Tonga Tuvalu Fiji Tonga Palau Kiribati Nauru Pregnant women receiving prenatal care, Samoa Nauru DTP3 immunization coverage, 2018 90 Palau 90 Solomon Is. Kiribati (% of one-year-old children) Tuvalu Solomon Is. Vanuatu RMI at least one visit (%) 80 RMI Micronesia 80 Micronesia 70 Vanuatu 70 60 60 50 40 50 15 40 100 250 600 1,500 4,000 10,000 15 40 100 250 600 1,500 4,000 10,000 Current health expenditure per capita, 2018 (US$) Current health expenditure per capita, 2018 (US$) Source: GoRMI and World Bank (2020). Note: X-axis is expressed in logarithmic scale. Markers in light blue are some Caribbean Island economies. 446. The efficiency of public health spending in RMI is constrained by contextual and sector- specific challenges. Contextual factors include the size of RMI’s economy and the dependency on external support, as well as demographic and geographic considerations. The two most salient sector-specific constraints relate to the organization of service delivery (hospital-centric model) and the financing architecture, particularly the high levels of fragmentation. 213 Republic of the Marshall Islands 447. Rigidities in health financing sources determine expenditure priorities, limiting the responsiveness of health spending to emerging priorities. As indicated above, in the absence of a clear set of priorities in RMI’s strategic documents it is difficult to judge whether resources are allocated based on strategic planning basis. Moreover, grant funding priorities do not always match the specific needs of the country. Vertical grants like those supporting HIV/AIDS, Tuberculosis and Hepatitis are good examples as they often skew expenditure towards diseases that do not represent the largest share of the disease burden in the country. NCDs have increased their share in RMI’s burden of disease by more than 10 percent over the last decade but this has not been accompanied by a proportional increase in funding. Interviewees indicated that this was largely due to limitations in grant funding for NCD prevention. Further, grant funding (particularly US Federal Grants) imposes rigidities to the system that limit the country’s capacity to allocate spending based on needs and react to emerging needs. For instance, contracts (including staff contracts) financed by the CSGs and the US Federal Grants are tied to the length of the grant and need to be renewed every year. Flexibility in the use of funds can be particularly critical in the context of disease outbreaks. As a result, domestic resources for health are planned and budgeted for to cover gaps rather than to follow a medium-term strategic approach. Strategic planning should lead DP contributions rather than the other way around. 448. Demographic and geographic considerations affect the cost of service delivery and limit the capacity to achieve economies of scale in health spending. Like most countries in the Pacific region, the most direct impact of RMI’s geography on health spending is linked to the cost of service delivery. Delivering services in the OI is extremely expensive, particularly given that services have to be delivered through outreach as the small size of the communities living in certain atolls does not justify (from a financial perspective) the construction, staffing and supplying of a dispensary. Geographic considerations also affect the efficiency of spending by reducing the health benefits of certain investments. For example, while medical referrals for emergency care are often justified, these are very expensive and given the long distances that need to be traveled, delays in accessing care in Majuro or Ebeye can negatively affect health outcomes. Finally, there are large diseconomies of scale when catering for a small population and this means that the per capita cost of interventions is comparatively much higher. For instance, there are dispensaries in RMI with catchment populations smaller than 100 patients. Other areas with diseconomies of scale are the procurement of pharmaceuticals and investments in health system strengthening (for example, investments in the health management information system and integrated service delivery approaches). There is a large potential for efficiency improvements. 214 Country Economic Memorandum and Public Expenditure Review 449. Strengthening the delivery of a prioritized package of cost-effective essential services at the primary level can help improve health system efficiency and help reduce the dual burden of disease. Quality of care at dispensaries is low and this is linked to the low level of instruction and in-service training offered to health assistants and the unavailability of basic supplies at dispensaries. These in turn can be explained by the very limited budget allocated to the Outer Islands program to address their specific needs (outreach, basic supplies, etc.), which reflect the low priority given to primary health care. As a result, patients need to go to the hospital for services that they should be able to access in a dispensary. In the absence of gate keeping mechanisms at the hospital level, the health system is not providing any incentives for patients to have their first point-of-contact with the health system at the dispensary level.149 Hospital care is expensive and delivering PHC services at the hospital level is thus highly inefficient. Moreover, strengthening the delivery of a prioritized, integrated package of cost-effective essential services at the primary level (particularly in the neighboring islands) can help reduce the longer-term cost to the health system. Global evidence shows that health prevention and promotion and nutrition services delivered at the community-level can significantly reduce the cost of the health system by reducing the burden of disease and by reducing the number of complications that require expensive care. In RMI, this package should integrate NCD prevention and case management as complications derived from NCDs are the main cause for international referrals. 450. While the reliance on the VSMT and OMR schemes is justified given the demographic and geographic factors mentioned above, the management of these schemes could improve. First, the Medical Records Information System (MERIS) used to document referrals is incomplete. Financial data is not adequately captured by MERIS and this hinders the availability of data on the unit cost of referrals per condition. This information is important to guide decisions on which services are eligible for medical referrals. Further, the MERIS system does not allow for comparison of prices between different providers of OMR. Another aspect that could be improved relates to the establishment of third-party agreements with providers. Third-party agreements consist of billing arrangements with one or multiple health providers with which prices for selected services have been negotiated. Given that multiple countries in the Pacific use the same OMR schemes, multi-country negotiation of prices with provider might help reduce the cost of these schemes. The third-party agreement with a provider in the Philippines represents a positive step in this direction and it should be evaluated to understand its financial implications. Finally, additional OMR arrangements could be explored, particularly grant- financed arrangements such as the New Zealand Medical Treatment Scheme. Given that medical referrals represent a large cost driver of RMI’s public health spending, identifying ways to improve their efficiency can be an important driver of better value-for-money. 149 Before enforcing gate keeping mechanisms, it is of utter importance to ensure the readiness of dispensaries to deliver quality health services. 215 Republic of the Marshall Islands 451. RMI’s health financing architecture, with its high level of fragmentation, is inherently inefficient. To illustrate this, Table 17 shows the different sources of funding and eligible expenditure under each of them. As mentioned earlier, earmarking funds for specific regions of the country or specific diseases, for example, adds rigidity to the financing of the health system and limits its capacity to effectively respond to emerging needs. The design and implementation of reforms is also constrained by this financing architecture. Fragmentation leads to the atomization of resources, which in turn limits the capacity of programs to maneuver, bring interventions to scale and pursue quality improvement measures. Table 17: Sources of health financing and eligible expenditure Level of care Type of spending Geographic Disease Secondary Operating Source of funding Referrals focus focus PHC and Salaries costs – Non tertiary salaries General Fund No No Yes Yes No Yes Yes Compact Fund No No Yes Yes No Yes Yes US Federal Grant Some Some Yes Yes No Yes Yes ESN Yes Some No Yes No Yes Yes Program 177 Yes No Yes No Yes Yes Yes Health Fund No No No No Yes No Yes Healthcare Reve- No No Yes Yes No Yes Yes nue Fund Supplementary No No No Yes Yes No Yes Health Fund Taiwan, China No No Yes Yes Yes No No 216 Country Economic Memorandum and Public Expenditure Review 452. Procurement is also subject to high levels of fragmentation which reduces oversight and may increase costs, reinforcing the urgent need to modernize and streamline the MOF- managed procurement system (see paragraph 287). Different sources of funding are managed by different ministries (either MOHSS or MOF) and the procurement process followed by each ministry is different. Firstly, MOHSS has an electronic system (Abila MIP) and MOF has a manual system. Secondly, MOF has more levels of approval and this makes the process more bureaucratic. Unlike transactions processed through MOF, MOHSS procurement does not require the approval of the Chief of Procurement, the Minister of Finance and the Secretary of Finance. For purchases below US$1,000 there is no need to get the Minister’s approval. Also, Abila MIP is time stamped and it takes on average seven days to process payments. Transactions processed by MOF can take up to one month. In emergency cases, approvals at MOHSS can happen within a day and for MOF it would take between three to five days. Another difference between the procurement process at MOF and at MOHSS is that MOHSS, given that most of the vendors are off-island, does not always require an original copy of the quotations. This split in procurement functions reduces the oversight of the MOHSS over certain funding streams and the opportunities to find synergies. Particularly concerning are the separate procurement processes for pharmaceuticals in dispensaries and hospitals. This results in a higher administrative burden and potentially higher prices. Evidence should be gathered to compare the price paid for large pharmaceutical budget items against international reference prices.150 Alternative procurement strategies such as pooled procurement with other countries and multi-year contracts for pharmaceuticals should be explored. Sustainability 453. The heavy reliance on grant funding limits the capacity of GoRMI to plan for the medium- and long-term service delivery and sustainability. While historically there has not been significant volatility in grant funding to the sector, uncertainties around the medium- and long-term availability of funding for key programs—due to uncertainty about the level of annual disbursements from and access to various US Federal Government programs post-FY2023—limits the capacity of the MOHSS to plan effectively. Improvements in health outcomes require sustained investments over an extended period of time and difficulties in long-term planning undermine GoRMI’s potential to implement such programs. 454. In the event that one of the five sources of grant funding to the health sector is stopped, it is unlikely that GoRMI would be able to continue the provision of services at the current level without raising additional resources to the sector. Each of the five sources of grant funding constitutes a significant source of funding for the respective program/ area that they cover, and given the rigidities in the current system, it would be difficult to reallocate funding between programs. Even where reprogramming is possible, this would be difficult without affecting access to services or compromising the quality of these services. 150 It should be noticed, however, that given the geographical remoteness and its small population, it is expected that RMI will pay prices above international reference prices. 217 Republic of the Marshall Islands 455. A fiscal space assessment can help GoRMI identify the potential to mobilize additional resources for the health sector from different sources (Figure 97). The fiscal space framework identifies five potential sources of additional revenue to the health sector. These are: (i) macroeconomic conditions that increase economic growth and create additional resources that can be channeled to the health sector; (ii) sector-specific resources like user fees and sin taxes; (iii) external sources of funding; (iv) the prioritization of health within the GoRMI’s budget; and (v) efficiency gains. Figure 97: Components of fiscal space for health A. Macroeconomic conditions: Accelerations in economic growth, improvements in revenue generation, and low levels of debt are some macroeconomic factors that can contribute to mobilize additional resources for health. Assuming that the health sector would continue to receive the same share of government budget, economic growth and revenue generation would translate into additional resources for the health sector. Economic growth contributed to 60 percent of the 5.2 percent increase in health spending in upper middle-income countries between 2000 and 2015 (World Bank, 2018b). However, in light of RMI’s expected economic growth rates in the aftermath of the COVID-19 crisis, it is unlikely that significant resources could be mobilized to the health sector by economic growth alone. 218 Country Economic Memorandum and Public Expenditure Review B. Sector specific resources: A potential source of revenue for the health sector stems from the collection and earmarking of sin taxes (tobacco, alcohol and sweetened beverages). While RMI currently earmarks the revenues from these taxes to the CMI, these funds could be earmarked for health. Sin taxes may have only limited resource mobilization potential, but they can also contribute to a reduction in health sector expenditure through a reduction in the incidence of diseases linked to the consumption of these goods. There are ongoing discussions to review domestic sin taxes which could potentially lead to increases in revenue collection (see Box 9). Finally, reviewing the health service user fee schedule could lead to increases in fee collection, although this option should be reviewed carefully given the highly regressive nature of user fees. Further, the economic impact of COVID-19 on household’s incomes could impact household’s capacity to pay user fees. C. External financing: while external funding as a share of Total Health Expenditure is already high, development assistance for health consists of non-traditional partners to the health sector, like the US Department of Interior. RMI could explore raising additional resources for the health sector from more traditional health partners like multilateral development banks (such as ADB and WB), bilateral development agencies (such as JICA and DFAT) and health sector agencies like Bill & Melinda Gates Foundation and the Global Fund. In order to avoid increasing the risk of debt distress, RMI should seek all financing to be on grant terms. D. Spending prioritization: In 2018, the health sector accounted for 22.1 percent of general government expenditure. Roughly half of those funds, however, are sourced externally. Contributions from the General Fund to health were only 7.5 percent of the General Fund, so there could still be some room to mobilize additional resources for the health sector through the prioritization of health in the GoRMI’s budget. E. Efficiency: As mentioned above, there are a number of ways RMI could improve efficiency of health spending, including by reducing fragmentation, reviewing expenditure on large budget items like salaries and pharmaceuticals, and by strengthening primary health care services and increasing the utilization of preventive health services that can reduce the costs of the systems. 219 Republic of the Marshall Islands Box 9: Using Tax Policy to Address NCDs Recommendations from a Policy Note by the RMI Office of the Chief Secretary A Policy Note prepared by the Office of the Chief Secretary in 2019 analyzed the economic impact of tax reforms for alcohol, tobacco, betelnut, and soft drinks. A hybrid survey conducted in 2018 revealed that smoking in RMI was slightly more prevalent than in other parts of the world and the consumption of soft drinks was also higher than regional and global estimates. The Policy Note also highlights that the consumption of betelnut increased considerably between 2002 and 2018 (from 2.5 to 14.6 percent of the population). In terms of alcohol consumption, levels were lower than in the US, although the difference was narrow in terms of binge drinking. According to the Policy Note, there is scope to increase taxes for these products. Tobacco taxes in RMI represent 44 percent of the retail price, which is well below the 75 percent target set by the WHO and the 70 percent target adopted by the Joint Forum Economic and Pacific Health Ministers Meeting held in Honiara, Solomon Islands in 2014. The Policy Note estimates that an import duty of 75 percent would reduce consumption by 15 to 48 percent and it could help mobilize up to an additional US$0.8 million per year. Import Retail Estimated change in Estimated duty collected (by price duty per price consumption (by price elasticity of demand) (US$) pack (US$) elasticity of demand) (US$) -0.2 -0.5 -0.8 -0.2 -0.5 -0.8 $1.00 $2.50 0% 0% 0% $188,225 $ 188,225 $188,225 $2.00 $3.54 -7% -16% -24% $351,151 $316,355 $285,007 $3.00 $4.58 -11% -26% -38% $500,279 $417,191 $347,902 $4.00 $5.62 -15% -33% -48% $640,291 $502,156 $393,822 $5.00 $6.66 -18% -39% -54% $773,641 $576,606 $429,753 In terms of taxes to alcoholic and soft drinks, the Policy Notes also identifies scope for increasing their value. For alcoholic beverages, the Note suggests setting the tax value to be proportionate to alcohol content (in bands). This could help mobilize up to US$5.5 million per year. For soft drinks, the Policy Note highlights that this only applies to non-carbonated and artificially flavored drinks, and it recommends extending duty taxes to all sugar sweetened beverages based on their sugar content. Overall, it is estimated that increases in tax rates for alcoholic and soft drinks, tobacco and betelnut could help GoRMI increase revenues and reduce long-term health spending. In addition, given that the demand for alcohol and tobacco can be inelastic, an increase in taxes might lead to increased household spending on these items despite decreases in the volumes consumed. In the case of tobacco taxes, this would disproportionally affect poor households given that consumption levels are similar across income levels. Alcohol consumption is higher among the rich, therefore an increase in the tax rate for alcohol is pro-poor. Finally, an increase in these taxes (which are import duties, and thus only apply to imported items) will not affect local manufacturers and could encourage the production of local substitutes, which often have a lower quality and can have a stronger negative health effect. GoRMI could draw on the recent experience of other PICs—such as Samoa and Tonga—in considering how to address these challenges of policy design and implementation. 220 Country Economic Memorandum and Public Expenditure Review 2.6.5 Conclusions and Recommendations 456. Investments in human capital need to be maintained. Improvements in health outcomes can only be achieved through continuous investments. While it is unlikely that public health spending as a share of general government spending will increase, GoRMI should seek to maintain current spending levels in the event of a reduction of external funding. External support represents a large share of public health spending so—to the extent that there are changes to external health financing, such as via the current renegotiations of Compact-related grants—it is crucial that additional sources of funding are mobilized to sustain spending levels and that reforms that promote better quality health spending are implemented. The development of a Health Financing Strategy could help identify opportunities to mobilize additional funds and ensure that the health financing architecture is in line with the service delivery model adopted. 457. To the extent possible, GoRMI should seek to consolidate Compact-related health sector funding into a single block-grant. The way the health system is financed matters. Spending trends in the health sector are heavily influenced by the architecture of health financing and the sources of revenue for the health sector. Given the multiple sources of revenues for health in RMI, the overall envelope is highly atomized. Furthermore, as several funding sources have strict expenditure eligibility criteria, health financing is rigid. Rigidities limit the health system’s capacity to effectively respond to emerging needs and implement needed reforms. To address this constraint, GoRMI should seek the consolidation of health sector funding into a single block-grant. This will improve the fungibility of health spending, allowing GoRMI to respond to emerging needs and to implement health system reforms that cannot be financed using vertical, disease-specific grants. Moreover, the consolidation of funding streams can facilitate the consolidation of procurement practices that are inefficient. 458. GoRMI should improve the coverage of essential services in hospitals and clinics in Majuro and Ebeye and gradually roll out these programs at dispensaries in the neighboring islands and through outreach. GoRMI should first establish a package of cost-effective RMNCH-N interventions. This package needs to be based on global, regional, and national evidence, and it must be relevant to the RMI’s disease burden. These services will need to be matched with the appropriately skilled health professionals and service contact sites to maximize cost efficiency. Training curricula and the list of essential supplies (equipment and medicines) should then be revised to ensure the readiness of health facilities to deliver the package of essential services, with commensurate human and financial resources allocated to ensure delivery. 221 Republic of the Marshall Islands 459. The provision of services in the neighboring islands needs to be strengthened to ensure the delivery of quality health services. Strengthening primary health service delivery in the neighboring islands can help improve the efficiency of health spending by improving health outcomes, while reducing the cost of the health system. This will require the upskilling of health assistants (or CHOWs) through more comprehensive pre-service training and periodic in-service training, and reforms to the supply chain to address stock-outs of essential supplies. Supportive supervision visits to health assistants and deployment of mid-level providers (such as nurse practitioners) are effective strategies to deliver in-service training and to incentivize practices that can lead to quality improvements. Further, mobile phone-based technologies should be considered, particularly to improve management of stocks in health dispensaries and potentially to provide telehealth services (that is, where a health professional could provide advice on patient care to a health assistant via telephone). Furthermore, these reforms should be accompanied by a revision of the medical referral system to ensure that patients are not referred to the hospital for services that could be delivered at health dispensaries (including gate keeping at the dispensary level for residents of Majuro and Ebeye), as well as a revision of the curricula of pre-service training of health assistants. These reforms could deliver a triple win for the health system: (i) reduce the cost of service delivery; (ii) improve the capacity of health assistants and reduce the burden on hospital staff; and (iii) reduce the future cost on the health system from NCDs. 460. Synergies between the public health system, the VSMT and the OMR scheme need to be explored to improve the functioning of the health system. GoRMI should conduct an evaluation of the VSMT and the OMR arrangements in place. The review should focus both on the quality of care delivered, the health outcomes of the VSMT and OMR, and the cost of these schemes. This information will be crucial to identify services that could be added to the benefit package delivered within the country and to identify the best strategy to deliver care for each specific condition. GoRMI should strengthen the MERIS system to better capture financial data under the GoRMI-funded OMR scheme. In addition, GoRMI should explore access to additional VSMT and OMR schemes, potentially in collaboration with other Pacific countries, including access to the New Zealand Medical Treatment Scheme funded by the Government of New Zealand, which covers Fiji, Kiribati, Tonga, Tuvalu, and Vanuatu, as well as the Cook Islands, Niue, and Tokelau. GoRMI should consider developing a national policy for the VSMT scheme to foster greater ownership, provide a regulatory framework and to ensure that VSMT providers comply with GoRMI standards of care. 222 Country Economic Memorandum and Public Expenditure Review 461. Improvements in health sector procurement could help improve spending efficiency. First, MOHHS should consolidate pharmaceutical procurement processes for dispensaries and hospitals. Second, authorities should consider multi-year contracts for pharmaceutical procurement. Both measures would reduce the administrative burden and reduce costs. Regarding the former, evidence should be gathered to compare the price paid for large pharmaceutical budget items against international reference prices.151 Alternatives for pooled procurement with other jurisdictions (for example, Hawaii) should also be explored. Regarding the latter, health service delivery requires many basic routine products. According to MOHHS, many of these products are procured on an annual basis. Multi- year procurement contracts offer a mechanism to reduce the frequency with which MOHHS is required to undertake procurement processes, while also potentially reducing the unit cost. Regular (for example, every three years) processing of multi-year contracts would allow for sufficient competition to ensure competitive pricing. According to the Chief Procurement Officer, the legislation allows for multi-year contracts. 151 It should be noticed, however, that given the geographical remoteness and its small population, it is expected that RMI will pay prices above international reference prices. 223 Republic of the Marshall Islands ANNEX 1: RMI and the World Bank’s CEM 2.0 Framework The CEM 2.0 and associated Country Scan is an analytical framework and diagnostic exercise consisting of 20 macroeconomic and microeconomic questions. These questions provide a structured framework within which to analyze a country’s growth story, as well as identify key areas for detailed analysis. The Country Scan tool draws on multiple global datasets to ana- lyze the economic characteristics of the target country compared to its structural and aspira- tion peers. However, data scarcity issues for RMI—and for the nation’s structural, regional, and aspirational peers—constrains the use of the CEM 2.0 standard framework. Nevertheless, the RMI CEM/PER has sought to address the key CEM 2.0 questions and provide cross-country comparisons utilizing the available data. The table below outlines the key questions from the CEM 2.0 Country Scan and how these have been addressed in this document. Macroeconomic questions How they have been addressed Is recent economic growth structural or Section 1.1 analyses the drivers of economic growth over cyclical? the past 20 years, with reference to the literature on What are the characteristics of growth small island economy growth dynamics, RMI’s historical (demand and supply side)? growth experience, and relevant national data. It Is the macroeconomic framework includes an analysis of growth by production (supply) adequate? and expenditure (demand), as well as external and Is GDP growth driven by productivity domestic drivers of growth. It also analyzes overall and growth? sectoral productivity growth, and how this relates to RMI’s development model. This section also considers Which sectors are driving jobs growth? the external sector and inflation. Key drivers of fiscal Contributions of structural change to policy are outlined and analyzed in the Introduction & economic growth? Country Context and in Section 2.1. Recent developments What are the domestic and external in the labor market are analyzed in Section 1.1 and drivers of growth? Section 1.3.2. Updated labor market participation and What is the potential contribution of demographic information is not available. The Economic structural reforms to growth? Complexity Index is not available for RMI or key How complex is the economy? structural, regional, and aspirational peers. 224 Country Economic Memorandum and Public Expenditure Review Microeconomic questions How they have been addressed Firm-level productivity dynamics Firm-level survey not available. However, productivity Quality of managerial practices challenges for key firms are discussed in Section 1.3.1. Section 1.3.2 discusses labor market characteristics and weaknesses, and provides recommendations to improve employment outcomes. Section 2.4 outlines RMI’s performance on the Human Capital Index. Section 2.5 Quality and stock of human capital and Section 2.6 discuss key challenges and recommendations to build RMI’s human capital via improving the quality and efficiency of education and health spending. Section 1.2 outlines how poor ICT infrastructure is constraining private sector development. Section 1.3.3 Quality of ICT capital outlines how reform to the sector can unlock key opportunities to support future growth and inclusive development. Research & Development spending by government and Are firms innovating? the private sector is not available. Are product and service markets The Bertelsmann Stiftung’s Transformation Index152 is competitive? not available for RMI or key structural, regional, and aspirational peers. Section 1.1 notes that RMI’s economic geography means that the delivery of many core goods How open is the country to trade and and services falls to the public sector, with SOEs playing investment? a key role in most major economic sectors. It also notes RMI’s reliance on foreign aid and imports. Section 1.2 discusses the business climate and provides Does the legal and regulatory system cross-country comparison using Doing Business support growth? Indicators and Worldwide Governance Indicators. Section 1.2 discusses how the underdeveloped banking sector and risks regarding AML/CFT issues is constraining Are financial markets well developed? private sector development and provides another deterrent to foreign investment. 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