South Korea's economic crisis: Third oil shock looms

South Korea faces a third oil shock—will history repeat itself?

Korea's responses to the first oil shock in 1973 and the second in 1979 differed sharply. During the first crisis, the Park Chung Hee government relied on administrative power to suppress prices. Officials spoke of tackling inflation 'like swatting flies one by one.' Yet price controls proved ineffective. Even under a strict authoritarian system, the government could not overcome market forces. Consumer prices surged 24 percent in 1974 and 25 percent in 1975.

A critical misstep came in late 1974, when policy shifted from stabilizing prices to stimulating growth. It was a hasty decision. Facing public unease after the Yushin system - an authoritarian constitutional overhaul introduced in 1972 that effectively enabled Park to extend his rule indefinitely - Park sought to ease sentiment through expansion. The administration remained fixated on rapid growth, repeating slogans such as $10 billion in exports and $1,000 per capita income. Funding shortfalls were covered by issuing money through the central bank, increasing government debt. This fueled chronic inflation. Oil money from Middle East construction projects further expanded liquidity in the late 1970s, inflating housing and stock prices before the second shock struck with even greater force.

During the second crisis, the government chose a different path. Economic officials including then-Deputy Prime Minister Shin Hyun-hwak pushed through stabilization policies. It was a reversal of three decades of growth-first strategy. Authorities tightened liquidity, reduced fiscal spending and restrained wage increases. These measures were unpopular and imposed real hardship. The Chun Doo Hwan administration continued the austerity. Inflation fell to 3.4 percent by 1983. After enduring the pain, Korea broke free from decades of inflation, laying the groundwork for the late 1980s boom.

Had Korea continued to prioritize growth during the second shock, it might have fallen behind in Northeast Asia. Many Latin American countries pursued populist expansion during both oil crises, leading to debt crises in the 1980s. Repeated defaults and political instability followed, accompanied by persistent inflation. By contrast, Japan and Taiwan adopted restraint early, choosing stability over expansion. Japan rose to become the world's second-largest economy in the 1980s, while Taiwan was seen as a decade ahead of Korea at the time.

The Iran war has now triggered what could be seen as a third oil shock. Even after hostilities end, a return to previous conditions appears unlikely. International Monetary Fund Managing Director Kristalina Georgieva warned that damage to energy infrastructure, including significant losses in Qatar's natural gas facilities, could take years to repair. Once the conflict subsides, U.S. President Donald Trump is expected to resume tariff pressure, potentially targeting countries that disappointed Washington during the war. Rising prices and slowing growth appear inevitable.

Korea again faces a choice between growth and inflation control. The Lee Jae Myung administration appears confident it can achieve both, seeking to stimulate the economy through fiscal expansion while restraining prices through administrative measures. A similar approach during the first oil shock resulted in stagflation. Pragmatism must not deteriorate into ad hoc responses. Cost-push inflation driven by surging raw material prices has no quick fix. It requires reducing demand and absorbing excess liquidity.

Price controls may have short-term effects but are difficult to sustain. They risk sending distorted signals to the market. A cap on fuel prices, for example, may temporarily ease costs and gain public support, but it is ultimately a stopgap. The gap must be covered by fiscal spending, making it unsustainable. It is contradictory to cap fuel prices while urging reduced consumption through measures such as vehicle restrictions. Excessive intervention leads to such inconsistencies. Allowing prices to reflect higher costs encourages voluntary conservation, as seen during the second oil shock.

Government support should focus on vulnerable groups that cannot withstand such adjustments. Fiscal resources are most effective when used selectively. The administration has proposed a supplementary budget of 26 trillion won, providing payments to about 70 percent of the population. President Lee has rejected the characterization of the plan as a cash handout, but extending benefits to such a large share effectively amounts to broad distribution. Fiscal conditions are not strong enough to support expansive generosity without long-term consequences.

Including the supplementary budget, total spending this year will rise 11.8 percent, marking an exceptionally expansionary stance. Injecting liquidity amid rising global oil prices and disrupted supply chains risks pushing inflation to unmanageable levels. Even if growth improves slightly due to fiscal support, higher inflation could offset any gains. The result would be short-term benefits followed by longer-term losses.

As during the second oil shock, the priority should be stability over populism. The government must be prepared to accept declining approval ratings while persuading the public to share the burden. Growth remains important, but controlling inflation is more urgent.