In this blog post, we calmly examine the relationship between economic growth and price increases through the lenses of supply and demand, exchange rates, oil prices, and wage structures, and explore the limits of this ‘naturalness’.
How to avoid the price bomb?
In children’s cartoons, it’s clear who the hero is and who the villain is, but real life isn’t like that. Especially in economics, there is no such thing as absolute good or evil. It’s like how prices naturally rise when the economy grows.
Why do prices rise when the economy grows? When the economy improves, spending increases. In economic terms, this means demand increases. Generally, supply lags behind demand. This is an inevitable phenomenon because producing and distributing goods requires a certain amount of time. Eventually, a point is reached where demand exceeds supply, and as a result, the price of goods rises. In other words, prices increase.
People generally view economic growth as a positive phenomenon. However, if the economy becomes ‘too’ good, problems arise. The most feared situation in economics is one of unpredictability. It is desirable for both the inflation rate and the economic growth rate to be maintained at moderate levels. Even if the economic growth rate is somewhat low, if it is predictable, there is no major problem. But the moment it strays beyond the expected range, the risk escalates sharply. This risk of unpredictability is referred to as a ‘black swan’.
Four Factors Driving Prices
The factors driving prices can be broadly divided into four categories. The first is household demand, mentioned earlier. This refers to increased demand arising from people spending more.
The second factor is the exchange rate. The exchange rate is a variable that must be considered when importing and exporting. The exchange rate directly impacts prices especially when importing foreign goods. For example, suppose there is an imported item costing 1,000 won. If the won-dollar exchange rate rises from 1,000 won to 1,500 won, an increase in the exchange rate means the value of our currency has fallen by that amount. This is often described as the currency being ‘devalued’. Previously, 1,000 won could buy 1 dollar, but now 1,500 won is needed to exchange the same amount. If all other conditions remain unchanged, what would the price of that imported item be now? Naturally, it becomes 1,500 won. Recently, with ‘overseas direct purchasing’ becoming commonplace, many people are directly experiencing how prices fluctuate with exchange rates.
“Honey, buy some flour. I’ll fill up the car with gas”… Prices are rising further (“Money Today”, May 18, 2022)
The third factor is the price of imported raw materials. There are raw materials essential to Korea that cannot be produced domestically and must be imported. The prices of these raw materials often fluctuate based on international market conditions, even if the exchange rate or domestic household demand remains unchanged. The most representative example is crude oil, or petroleum.
Oil prices are one of the most decisive factors driving Korea’s inflation. This is because crude oil is an indispensable core material in manufacturing. Crude oil is used in most industrial products, including various chemical products, plastics, vinyl, and asphalt. It also serves as fuel for transportation vehicles like automobiles and ships, as well as various machinery, and is utilized as a heating energy source during winter. Finding an area in the modern industrial structure that does not require crude oil is nearly impossible. For this reason, even if crude oil prices rise, imports cannot be halted. Ultimately, when oil prices increase, overall prices also rise accordingly. Commodities like flour, feed grains, natural gas, and iron ore also significantly impact South Korea’s prices, though not to the same extent as crude oil.
Rising oil prices (commodity) → Increased unit costs of products using crude oil (commodity) as raw material → Higher selling prices → Rising prices
The fourth and final factor is the rising cost of domestically produced goods. When production costs increase, higher selling prices are a natural consequence. This is also why businesses and households are in sharp conflict over wages. Companies hire workers to produce goods and pay wages as compensation.
Since wages are included in production costs, they must be reflected when determining product prices. Therefore, companies argue that “excessive wage increases raise production costs, ultimately leading to price hikes.” Conversely, wage earners counter that “wages account for a small portion of total production costs, and refusing to raise wages due to cost increases is sacrificing workers to maximize corporate profits.”
The Economic Tsunami Caused by Prices: Inflation
The dictionary definition of inflation is ‘a phenomenon where the value of money declines due to an increase in the money supply, leading to a sustained rise in overall prices.’ If the rate of price increases becomes excessively high, the value of money plummets sharply; in severe cases, money becomes little more than worthless paper. Consequently, during periods of inflation, the value of goods becomes higher than that of money.
For example, suppose you have a loaf of bread costing 100 won. If prices double, the bread’s price becomes 200 won. What if prices rise by 200 million percent? The bread’s price becomes 200 million won. The bread’s size or shape hasn’t changed at all, but its value has risen beyond imagination. In such a situation where the value of money plummets, those holding tangible assets are relatively advantaged.
“Wages Can’t Keep Up with Prices… Middle Class Sees Decline in Real Income” (“SBS”, 2022.07.06.)
For salaried workers whose wages make up the bulk of their income without significant assets, inflation is a hellish situation. If wages rose at the same pace as prices, it wouldn’t be a major problem, but reality is different. Wage increases mostly fail to keep up with price hikes. Consequently, wage earners whose only income source is cash face a situation where their real income steadily declines without any action on their part, and the value of their hard-earned savings rapidly erodes.
On the other hand, those holding tangible assets are relatively less affected by inflation. Since asset prices rise alongside prices, the value of their holdings may even increase significantly. Of course, if inflation worsens, the entire national economy suffers, so even those with real assets will be harmed. Nevertheless, compared to those holding only cash, those with real assets are in a much more advantageous position.
Among these, there is also a group that benefits from inflation: those heavily in debt. Debt can be viewed as ‘negative cash,’ so when the value of cash falls, the real value of debt also decreases. For example, suppose you owe 100 million won, and inflation causes the value of money to drop to one-hundredth of its original value. In this case, the real value of the debt would decrease to around 1 million won. Of course, this is merely a theoretical possibility, and in reality, only a very small minority actually profit significantly from inflation. Therefore, taking out loans indiscriminately just because inflation seems likely is an extremely risky choice.
The wealthy hold an absolute advantage when it comes to profiting during inflationary periods. If you were suddenly faced with inflation while possessing immense wealth, how would you act? You could leverage your cash reserves and borrowing capacity to bulk-buy essential goods. As prices keep rising, the value of these pre-purchased essentials would also continuously increase. However, ordinary citizens find it difficult to implement such a strategy. They often lack sufficient available cash and face barriers to obtaining loans. Even if they strain to buy goods, they lack the financial resilience to hold onto them long enough to realize any profit. Thus, when inflation occurs, ordinary citizens bear the brunt of the impact.
The Two Faces of Inflation
Inflation can be broadly categorized into two types. One is ‘demand-pull inflation,’ where prices rise due to increased demand. The other is ‘cost-push inflation,’ where production costs increase, driving up selling prices.
First, let’s examine demand-pull inflation. Demand typically increases when the economy overheats. Regardless of how much money is actually circulating in the market, when people themselves feel that ‘money is overflowing,’ the economy can be said to be overheated. For example, suppose the U.S. announces a benchmark interest rate cut. Discussions then begin in Korea about whether to lower its own benchmark rate, and simultaneously, news articles appear about the real estate market becoming restless. At this point, even if money hasn’t actually flooded the market yet, the perception spreads among people that ‘extra money will become available’.
As this perception spreads, demand increases, and simultaneously, speculative demand, or fake demand, also arises. Speculative demand refers to consumption where people buy in advance, anticipating price increases even when they don’t need the goods immediately. A similar concept is “hoarding.” It’s easier to understand if you recall the strategy from the classic novel “The Tale of Heo Saeng,” where the protagonist Heo Saeng buys up all the fruit nationwide, then sells it at a premium when prices rise due to supply shortages. To curb demand-pull inflation, policies are needed to reduce the excessive amount of money circulating in the market. This includes raising interest rates, increasing taxes, or scaling back government public investment. However, the effects of these policies are often not as immediate or certain as hoped in reality.
A bigger problem is cost-push inflation. As mentioned earlier, rising oil prices are a prime example. There are few effective countermeasures against rising oil prices. Since it’s a resource that cannot be substituted with domestic production, when prices rise, we have little choice but to accept it. Countries entirely dependent on imported crude oil can only reduce consumption—for instance, by cutting back on heating or using public transportation instead of private cars. Manufacturers can make long-term efforts to improve energy efficiency, but drastically reducing crude oil usage in the short term is difficult.
Here, it’s necessary to add one more point about crude oil prices. Who actually determines crude oil prices, which wield such powerful influence in the global economy? While multiple factors play a role, the most significant entity to watch is the Organization of the Petroleum Exporting Countries, or OPEC. This organization, formed primarily by Middle Eastern oil-producing nations, should not be dismissed as merely a loose coalition of wealthy oil-exporting countries. By controlling crude oil production levels and prices, they possess the power to effectively dictate the economies of countless oil-importing nations worldwide. This group, which also includes major oil producers like Russia, is sometimes referred to as OPEC Plus. The reason the United States persistently seeks to exert influence over the Middle East and major oil-producing nations is not solely for the sake of international justice. It is important to remember that within the international community, it is common for just causes to be ignored or unjust actions to be supported based on economic interests.
The Fear Brought by Falling Prices: Deflation
Deflation is the phenomenon of persistently falling prices, representing the exact opposite of inflation. Hearing that prices are dropping might initially sound positive. After all, wouldn’t it be good to finally afford items that were previously too expensive? However, this perception is extremely dangerous. Deflation must not be mistaken for large-scale discount events or situations like Black Friday.
For example, if an item you wanted is discounted among many products, it’s welcome news for consumers, and sellers also suffer no major loss as long as they sell a lot. But deflation isn’t just a simple price reduction; it signifies an economic downturn caused by demand plummeting relative to supply. It’s a situation where people’s wallets are closed. In such an environment, even so-called ‘tearful clearance sales’ won’t sell the goods.
The ‘paradox of thrift’ also emerges during deflation. Individuals naturally reduce spending when money is tight. However, problems arise when this behavior occurs simultaneously across society as a whole, not just at the individual level. Declining consumption reduces profits for companies selling goods. Initially, they might respond by cutting production. But if inventory keeps piling up and profits don’t improve, they eventually resort to laying off employees to reduce labor costs. People who lose their jobs through no fault of their own inevitably cut back on spending even further, deepening the economic downturn.
As this vicious cycle repeats, the economy sinks deeper and deeper into a downward spiral. The solution to break this cycle is to stimulate demand and get money circulating in the market, but artificially creating demand is extremely difficult. This is why deflation is often considered more frightening than inflation. A prime example is the Great Depression that struck the United States in 1929. Although President Roosevelt attempted economic recovery through New Deal policies based on Keynesian theory, the Great Depression remains one of the most significant crises in American economic history.
Falling prices → Declining demand → Reduced production → Rising unemployment → Declining income → Further reduced demand → Falling prices → Reduced production → Rising unemployment → Chronic economic stagnation
Adding insult to injury: Stagflation
Stagflation, a term combining ‘stagnation’ and ‘inflation,’ refers to the phenomenon where prices rise while an economic downturn simultaneously occurs. The media often refers to this as the ‘Fear of S’. If inflation is the problem of rising prices and deflation is the problem of falling prices and economic stagnation, then stagflation can be considered the worst combination: rising prices and economic stagnation occurring simultaneously.
The first documented case of stagflation occurred during the oil crises of the 1970s. Oil prices, which were only about $4 per barrel in 1973, surged to $13.4 in 1974 and $40 in 1979 after two oil crises. This represented a roughly tenfold increase in just a few years. As is the case today, rising oil prices directly impacted inflation back then. In the wake of the oil crisis, U.S. inflation rose by about 12% in 1974-1975 and 13% in 1979. The U.S. unemployment rate reached 9% in 1975, marking the worst situation since the Great Depression. It was a classic stagflation scenario: prices were rising, unemployment was increasing, and the economy was stagnating.
Typically, during inflationary periods, the economy is booming, so unemployment rates are not significantly high. However, in stagflation, both prices and unemployment rise simultaneously, making policy choices extremely difficult. This is because attempting to curb inflation causes unemployment to rise further, while efforts to lower unemployment drive prices up even more. The stagflation in the U.S. at that time occurred because the sharp rise in oil prices, a key cost factor, simultaneously stifled both production and consumption.
The most effective way to overcome stagflation is to revitalize the economy by reducing costs, specifically production expenses, through technological innovation. The recent active investment by advanced economies, including the US, in the renewable energy industry is not solely driven by environmental concerns. It is also a strategy to counter the significant volatility in oil prices that occurs whenever international conflicts, like the Russia-Ukraine war, or heightened political tensions in the Middle East arise. South Korea, which remains highly dependent on crude oil, inevitably becomes more vulnerable to the risk of stagflation as oil prices surge.
Inflation, deflation, and stagflation all share characteristics similar to cancer. While countermeasures can be prepared to some extent in the early stages, once the situation worsens and reaches the terminal phase, there is almost nothing that can be done. Therefore, prevention is paramount. For this reason, even at the slightest sign, the media sends warning signals using expressions like ‘the fear of I’, ‘the fear of D’, and ‘the fear of S’. This serves a necessary role to some extent. However, some media outlets excessively fuel fear through sensationalist articles to expand their influence or serve the interests of specific groups. Therefore, amid the flood of articles, discernment is needed to distinguish mere rumors from genuine warnings and practical advice.
Should the minimum wage be raised? Or should it not be raised?
This is not to definitively state whether the current minimum wage level is excessively low or whether self-employed individuals are struggling due to minimum wage hikes. The topic addressed in this chapter is simply the question: ‘Does wages affect prices?’ To state the conclusion upfront: wages clearly influence prices and the broader economy. However, opinions vary significantly regarding the magnitude and direction of this influence.
“Yoon Administration’s Minimum Wage Set at 9,620 Won… Deepening the Divide Between Labor and Management” (“E-Daily”, June 30, 2022)
An increase in wages directly means a rise in production costs. When costs increase and businesses struggle to absorb them, they have no choice but to raise prices, i.e., their selling prices. If goods continue to sell even after a price hike, there’s no major problem. However, the situation changes if the price increase is expected to reduce demand and lead to decreased profits. Consider the perspective of small business owners, often featured in news reports. If a restaurant owner raises meal prices, customers may immediately decrease. Convenience store owners often lack even the authority to set prices. So how can they manage the increased costs from a minimum wage hike? If sales remain unchanged, they must reduce profits. If there are no further profits to cut, they ultimately choose to reduce labor costs. This means cutting staff or part-time workers to lower costs.
If more businesses cut employment to handle these increased costs, the economy slows down. This is because people who lose their jobs reduce their spending. For this reason, opponents of minimum wage hikes argue that steep increases place excessive burdens on employers, ultimately leading to lower employment rates and economic downturns. Claims that minimum wage hikes ruin the national economy emerge from this context.
So, is not raising the minimum wage the right answer? Now, let’s consider the opposing viewpoint. Supporters of minimum wage increases attribute the current economic stagnation to people lacking the money to spend, even if they want to. They argue that fixed costs, especially housing expenses, are excessively high, making the current minimum wage insufficient to stimulate increased consumption. They explain that raising the minimum wage increases household income, which naturally leads to expanded consumption and economic revitalization. Furthermore, they emphasize that the minimum wage is fundamentally a legal system established to protect low-wage workers.
Finding the definitive answer to this issue in the short term is difficult. Economic policies inherently require long-term observation to assess their effectiveness. However, it is clear that the minimum wage is a matter of significant impact on our economy. Consequently, the media, politicians, and experts across various fields are vigorously advancing their arguments based on their respective evidence. Merely observing this debate will not change reality. To achieve a faster social consensus, each party must choose arguments aligned with their position and interests and lend their weight to those arguments. Otherwise, as the article headline suggests, the minimum wage debate risks deepening conflicts only among the powerless ‘underlings’.
