I'm no expert at makefiles but I would loose the INCLUDE statement. On a
standard Atari setup the gemlib should be installed in the standard
/usr/include directory. I think you're actually restricting the search for
include files to that directory.
No, this is not the problem -- "-I" stands for *additional* include directories. To be sure you have the right library linked, copy the last output line of gcc (the one when you see -L/usr/GEM/lib -lgem) and paste it back with -Wl,-t -- this will show you what's linked in and from what location. If you think it's, try brute force like 'grep nanosleep /usr/.../libc.a', it should say something as 'binary matches'