IN theory, this island nation ought to be close to paradise: coconuts and bananas for the picking, fish waiting to be caught. And this nation receives $1.2 billion in economic aid, compliments of the United States government.In reality, the Federated States of Micronesia (FSM) is underemployed and only a portion of the allotted US aid goes toward investment to provide for the future. How to turn the islands into paradise has proved a challenge for the politicians from the four island states of Yap, Chuuk, Pohnpei, and Kosrae, which make up Micronesia. Political decisionmaking, however, is a recent development here. Only five years ago, the US administered these islands as a United Nations Trust Territory. Micronesia gained its independence in November 1986 by implementing a Compact of Free Association with the US. The US retains responsibility for defending the nation of 607 volcanic islands. The UN formally recognized the Compact last year, making Micronesia one of the youngest nations in the world. It is a young nation in other respects. Driving along the roads of Chuuk, one sees children everywhere; some naked, some clothed, most wearing rubber thongs, the national shoe. The state of Chuuk (formerly Truk) covers only 46 square miles but is home to an estimated 55,000 people, over half of them under the age of 15. And the birth rate is about 3 percent per year, among the highest in the world. Nationhood is not easy. Although the people are all Carolinians (named for the Caroline Islands group), there are eight major indigenous languages. Micronesians communicate through English, the second language. Distance also works against the islands. From Kosrae in the east to Yap in the west is a distance of about 1,800 miles. Only one airline, Continental Airlines/Air Micronesia, connects the four major islands. A boat stops every six weeks to unload supplies and pick up copra (crushed coconut). Islanders also travel the way they have for generations: on outrigger sailing canoes. "We just follow the stars," says Benjamin Manuere, a resident of Puluwat, an island about 100 miles southwest of Chuuk. One thing the islands do have in common is a history of being conquered. Evidence of Spanish, German, Japanese, and US domination is scattered across the island chain. Spain claimed many of the islands in the late 16th century. On Pohnpei (formerly Ponape), tourists can walk around the "Spanish wall," built in 1887 as a defense for Fort Alphonse. The Germans arrived in 1899 after buying the Caroline Islands from the Spanish. Germans cut a shipping canal through the mangroves on Yap. Many Carolinians have kept German surnames. The Japanese took over in 1914. They introduced sugar cane and cultivated ornamental shells. Evidence of Japanese influence is everywhere. Stone road markers in Pohnpei have miniature Buddhist shrines perched on top. Remains of "zero" fighter-planes from World War II sizzle in the sun on Yap. FSM became a UN member yesterday. Aurelia Erskine Brazeal, the US ambassador to the country, says UN membership was a logical step. "There is a nation-building aspect to it and it gives more of a sense of legitimacy to be recognized by the world community," Ms. Brazeal says. UN membership will also allow Micronesia to apply for development aid from UN agencies. Any aid will fill a funding gap left by the scaling down of US aid. According to the terms of the Compact, the US will give FSM $1.2 billion over 15 years, ending in 2001. The amount of aid is scaled down every five years. Micronesia will receive $11.8 million less this year as the first step-down takes effect. The reduction has caused cutbacks nationwide. On Pohnpei, for example, all programs are being reduced by 10 percent. Education and health are exceptions and will take a 5 percent cut. Nearly 40 percent of the Compact money has been spent on infrastructure and government agencies, according to Brazeal. This has swelled the public sector: More than 30 percent of the budget is spent on government salaries. Not counting the Compact money, annual per capita income is estimated at $600 to $800. Critics say the government should be preparing for the day the Compact money runs out. But on Chuuk there is little evidence the money is going into investment. Willie Bisalen, Chuuk's state treasurer, says $3 million of Compact funds has gone into a coconut-processing plant and a fishing project. Although Mr. Bisalen says some boats have been purchased, the fishing project is "taking a while to get off the ground." Similarly, the Chuuk coconut factory, where crushed coconut is made into coconut soap or oil, has faced delays. During a visit, the Monitor found the factory doors closed as workers waited for a machine part to arrive. Even when the factory is working, it has trouble selling soap, says chemist Eddie Perce. "We need better packaging and refining," he explains. Some educated islanders have left in frustration at the slow pace of development. Sapuro Rayphand, a former assistant attorney general, is now teaching high school students in Saipan. On a recent visit, he said the future for Chuuk is "bleak" with the reduction in Compact funds. "There is nothing to replace that kind of money," he says. But businessman Ray Lomongo believes the islands need to make a better effort to attract tourists. "That's our only future," says Mr. Lomongo, a member of the Chuuk Visitors Board. While Chuuk still appears to be trying to figure out what to do with the Compact money, the Yap state government can point to specific investments designed to help make the government self-sufficient. According to Sebastian Anefal, director of the Office of Planning and Budget, Yap has invested the $72 million in Compact funds received over the past five years. A joint-venture tuna-fishing project was given $24 million, which is now catching yellowfin and skipjack for export to Thailand. Over the longer term, Yap intends to buy larger "mother ships" so it can get the income from transshipping the tuna to Thailand. And it hopes to build a processing plant to help export directly to Bumblebee and other buyers of processed tuna. Finding outside investors for economic development is not easy. On most of the islands, electric power is erratic. Power lines have only recently reached the northern part of Yap. Despite these shortcomings, Brazeal believes the country may one day perform data processing tasks the same way Haitians send out bills for retailers in the US.