[Insight & Opinion] The Vicious Economic Cycle Triggered by Public Utility Rate Hikes

Potential to Cause Inflation and Economic Recession
Caution Needed in Timing and Scale of Rate Hikes

[Asia Economy] Following the increase in electricity and heating costs, transportation fares including bus and subway fees are also on the rise. With public utility rate hikes combined with increased tax burdens and interest payments due to high interest rates, citizens are expressing dissatisfaction using terms like "tax bomb" and "heating cost bomb." The problem is that such excessive taxes, interest, and public utility rate increases could have a severe negative impact on our economy.

First, it excessively raises the burden on households. The previous government significantly increased housing costs by imposing excessive taxes on housing ownership and acquisition to stabilize rising housing prices. Under the current administration, rising interest rates have increased loan interest burdens for ordinary citizens, and during the winter season, heating costs, electricity, and transportation fares have also increased, further raising household expenses.

Even if international crude oil and raw material prices justify public utility rate hikes, it is undesirable to increase household burdens excessively all at once. Public utility rate increases push up prices and eventually lead to higher interest rates, causing an economic downturn. Since the end of last year, international crude oil prices have fallen, leading to a gradual decline in inflation and expectations that the Bank of Korea would halt interest rate hikes. However, with public utility rates rising from the new year, consumer prices in January have turned upward again. Increases in electricity, gas, and transportation fares raise costs across all sectors of the economy, driving up prices. When inflation rises, interest rates inevitably increase again, leading to more corporate bankruptcies and a higher likelihood of a real estate bubble collapse. This raises concerns about financial market instability.

Additionally, it pushes the economy into a wage-inflation spiral. Public utility rate hikes ultimately lead to wage increases. When tax and interest burdens rise alongside increases in electricity, heating, and transportation costs, households cannot bear the growing expenses, and workers inevitably demand higher wages. The problem is that wage increases then cause further price and housing price rises, trapping our economy in a vicious cycle of wage and price increases similar to those seen in Latin American economies. In this scenario, Korea’s export-dependent economy faces risks of weakened export competitiveness, worsening trade balances, capital outflows, and economic crisis exposure.

The top priority for policymakers this year should be to prevent an excessive economic downturn. With the U.S. interest rate hikes deepening the global recession, our exports have sharply declined since the second half of last year. The January trade deficit reached a record high of $12.6 billion. Domestic demand has also frozen due to previous interest rate hikes, with consumption and investment stalling. The simultaneous downturn in exports and domestic demand points to a hard landing for the economy. Economic recession raises concerns as it leads to corporate bankruptcies and real estate bubble collapse, destabilizing financial and foreign exchange markets.

In this situation, policymakers need to carefully weigh the pros and cons of public utility rate policies. The benefits of rate hikes include compensating for losses incurred by Korea Electric Power Corporation, Korea Gas Corporation, and subway operators, as well as encouraging energy conservation through higher prices. On the other hand, the downsides include increased household burdens, heightened public dissatisfaction, inflation, wage hikes, economic recession, and financial market turmoil. While cost increases due to rising international crude oil and gas prices cannot be ignored, policymakers must be cautious in choosing the timing and extent of public utility rate hikes, considering their impact on household and national economies.

Kim Jeong-sik (Professor Emeritus, Department of Economics, Yonsei University)