Following the Second World War, Palau was administered by the United States as a United Nations Trust Territory. In 1979, the people of Palau voted against joining the Federated States of Micronesia because of language and cultural differences. After voting several times to reject a proposed Compact of Free Association with the United States, the country finally became self governing in free association with the United States in 1994. Palau adopted its Constitution on January 1, 1981. The Compact of Free Association between the United States and Palau is primarily focused on the issues of government relations, economic relations, and security and defence relations. The special relationship with the US gives Palau access to many US domestic programs, including disaster response and recovery and hazard mitigation programs under the Federal Emergency Management Agency, the National Weather Service, the United States Postal Service, Federal Aviation Administration. As citizens of an associated state, Palauans may live and work in the United States. The November 2008 congressional elections were held jointly with the presidential elections, as well as a referendum on proposed constitutional amendments. In the previous elections held in November 2004, Palauans also approved several constitutional amendments, including a three-term limit for members of congress, and the election of a presidential ticket composed of a president and vice president. Based on the recommendation of the Reapportionment Committee of July 2005, the statutory number of members of the Senate increased from nine to 13 starting from the 2008 elections. Forty three candidates, including a record seven women, ran for the Senate, and another 44 candidates, including three women, stood for election to the 16-member House of Delegates. Ms Kathy Kesolei and Ms Regina Mesebeluu became the first women senators in Palau. No women were elected to the House of Delegates. As there are no political parties in Palau, all candidates stood as non- partisans. Palau is a democratic republic in free association with the United States, with a bicameral National Congress or Olbiil Era Kelulau, consisting of the Senate (13 seats with members elected by popular vote on a population basis to serve four-year terms) and the House of Delegates (16 seats representing each of the states with members elected by popular vote to serve four-year terms). Independence was gained on 1 October 1994 from the United Nations Trust Territory.

Palau’s National Master Development Plan 2020 (NMDP) articulates the country’s overarching development strategies. The NMDP aims to transform Palau’s economy to one that is more private sector driven, to strengthen and streamline government institutions and activities, and to pursue strategies to help finance development goals. While the NMDP, adopted in 1996, is still considered the underlying framework for development, Palau has also recently prepared a medium term development strategy (MTDS) – Actions for Palau’s Future, The Medium-Term Development Strategy 2009–2014 -that articulates three thematic priorities: paying the ‘right price’ (an emphasis on cost recovery and well defined, targeted, transparent subsidies); reducing costs and ensuring conservation; and generating income opportunities. The preparation of the MTDS included three years of public consultations and leadership conferences, although it has yet to be officially adopted by the government. While Palau performs relatively well across a range of public financial and economic management indicators, recent developments signal emerging challenges over the medium term, especially as Palau adjusts to new financial arrangements under its renegotiated economic program under the Compact with the United States. Palau’s stable economy and relatively well run services have helped it achieve the highest human development levels in the Pacific. Nevertheless, it faces its own set of challenges that require continued reform commitment and action, especially if the effectiveness and efficiency of the public sector is to improve and meet expectations. Palau’s public financial management system and broader economy are heavily influenced by the Compact of Free Association with the US and its provisions. Financial health and performance has generally been stable, although in the 2008 financial year, expenditure exceeded revenue, raising some concern on the country’s fiscal position. The government has made a number of commitments to strengthen fiscal and financial policy and management, including moving towards a medium-term budget framework. In 2008 a Medium Term Fiscal Strategy (MTFS) was presented to the government leadership but has yet to be adopted. The MTFS promotes greater fiscal self-reliance and calls for tax reforms, expenditure compression, and efficiency improvements. Grants, primarily from the US through the Compact, have consistently made up over 50 percent of total government revenues. The government has also tended to supplement revenue with annual withdrawals of US$5m from its Compact Trust Fund, the current balance of which is approximately US$170 million. In early 2010, Palau and the US reached a tentative agreement (yet to be approved by the US congress) on a new economic assistance program that will provide Palau with US$13.5 million annually through to 2023. The transition to the new program will likely require considerable, but manageable, fiscal adjustment. Coupled with stagnant revenue trends and expenditure pressure, the government may need to consider strong expenditure controls and revenue raising measures over the medium term. Electricity and water services are highly subsidised. The issue of subsidies and the performance of public enterprises and utilities are a medium term reform priority with corporatisation and privatisation to be considered under the Medium Term Development Strategy. Country performance ratings for debt policy and management exceed regional averages. Total external debt as of 2008 was around 14 percent of GDP, one of the lowest in the Pacific region. Some public enterprises do, however, carry significant liabilities.

Palau Medium Term Development Strategy 2009-14^[6]

Overall goal

A sustained and widespread improvement in general standards of living while preserving cultural and environmental values for the people of Palau.

Strategic priorities

Preserving key values and advantages which are: The environment, cultural values, political stability, public security and civil order, effective relationships with development partners. Achieving consensus for change through transparency and opportunities for consultation. Addressing binding constraints to economic development which are: – The expectation that someone else should pay for a wide array of government, reflected in a ‘lack of willingness to pay, work productively and support effective policies’. – Conflicts of interest that make it difficult to gain acceptance for and to implement effective governance arrangements and policies for the benefit of the community as a whole.

Labour market‚ Formal sector (2005)

Palau laws provide for freedom of speech, freedom of the press, and freedom of assembly and association and the government upholds these rights in practice.

Palau maintains a national police force, including a sea patrol operation, but maintains no regular military forces. Under the Compact, defence is the responsibility of the US. Moreover, the Compact grants the US military access to the islands for 50 years, although it has not yet exercised this option. Surveillance and monitoring exercises, including Australian and New Zealand coast guards, are occasionally conducted in Palau and the surrounding region. Palau has provided police officers to work as part of the Regional Assistance Mission to Solomon Islands since May 2006, and also sends police officers to UN peacekeeping missions. There is a small police force under civilian control. There are no armed forces. Under the Compact, defence is the responsibility of the United States.

Official transfers account for just over half the national budget. The United States is the major aid donor to Palau under the terms of the Compact of Free Association. US aid to Palau has included direct budgetary assistance to the Palau national government, including investment in a trust fund intended to provide $15 million annually from 2010 through 2044; federal postal, weather, and aviation services; and construction of a major road. US assistance to Palau has also included discretionary federal programs, such as health, education, and infrastructure services, that are not provided for in the compact. Other donors and development partners include Japan, Taiwan, Australia, New Zealand, European Union. Australian bilateral development assistance to Palau is modest – approximately AUD$150,000 in 2008-09. Education is a priority of the Australian program, which concentrates on scholarships and a small grants scheme supporting community organisations. Australia also provides ongoing funding for the Pacific Patrol Boat Program and its regional development program also supports Palau across a range of areas including: health (HIV/AIDS, non-communicable diseases) land, energy efficiency, environment, gender equity and governance. Palau also works closely with a range of regional and international organisations, including a United Nations joint presence (UNDP, UNICEF and UNFPA), the Asian Development Bank, World Bank, and International Monetary Fund. Recent and ongoing public sector related projects include implementing the Medium-Term Budget Framework and development of a Sustainable Health Financing Scheme by the Asian Development Bank.