Something strange has happened in the U.S. economy. Nearly three years after the Great Recession officially ended in June 2009, unemployment remains stubbornly high at 8.1 percent and real wage growth is nonexistent, but corporate profits and GDP have never been higher. Six million workers have dropped out of the labor force in the last two years—twice the number of people who have found new jobs—but the Dow Jones and NASDAQ are trading above pre-recession levels as if nothing had ever happened. Economists like to call this incongruity a “jobless recovery,” but you might as well call it a recovery for the 1 percent: according to recent data, that small fraction of the nation’s wealthiest captured a stunning 93 percent of a income gains from 2009–10. Income growth for the bottom 99 percent was just 0.2 percent.

This unequal pattern of growth is highly unusual in recent history. For most of the post-war years, periods of economic recovery were defined by a rapid return to high employment and GDP growth. But for the past two decades, there has been an increasing disconnect between the strength of the economy and the health of the labor market. When the economy crashed in 2008, businesses aggressively laid off employees while demanding greater productivity from their remaining workforce. Without a union or effective labor laws to protect them—and with fierce competition for their jobs—many workers resigned themselves to more work for the same salary.

That's not how it used to be. Research shows that until the mid-1980s, labor productivity tended to slow during recessions, as it was difficult for businesses to downsize effectively. But with the sharp decline of unions during the Reagan years, the correlation between productivity and employment turned negative. “These days,” writes economist Brad DeLong, “U.S. labor productivity looks to be countercyclical: firms take advantage of downturns in demand to rationalize operations and increase labor productivity, pleading business necessity in the face of the downturn to their workers.” Which explains why business sector productivity soared 5.3 percent in the depths of the Great Recession, driving corporate profits up 116 percent to a record $1.4 trillion. Although the stock market boom did little for the 70 percent of Americans who received less than 2 percent of their income from capital gains, the returns to the 1 percent were enormous.

Growth of corporate profits per employee and average wages

The divergence between productivity and labor (including wage compensation and employment) is the key to understanding rising income inequality, the stagnation of average wages, and the current state of our jobless, 1-percent-oriented recovery. “Productivity and the compensation of the typical worker grew in tandem over the early postwar period until the 1970s,” writes Lawrence Mishel, president of the Economic Policy Institute. “However, the experience of the vast majority of workers in recent decades has been that productivity growth actually provides only the potential for rising living standards.” In reality, average wage growth has stagnated, while the gap between productivity and compensation has accelerated.

According to Mishel's research, this divergence can be explained primarily by growing income inequality and a recent shift in the allocation of compensation from labor to capital. Part of this story is the rise of the 1 percent, whose earnings grew 156 percent from 1979 to 2007. But Mishel differentiates between this divergence at the top—attributable to the extraordinary growth of executives' compensation (especially in the financial sector)—and the wage stagnation of the middle class, who have suffered disproportionately from “laissez-faire policies . . . including globalization, deregulation, privatization, eroded unionization, and weakened labor standards.” Wage inequality at the bottom is similarly a unique phenomenon, the result of continual high unemployment and the eroding value of the minimum wage.

Average income in the US

Mishel's research strongly suggests that improving labor standards—including a higher, inflation-indexed minimum wage and stronger protections for collective bargaining—must be central to any effort to reestablish the historical link between productivity growth and rising median wages. Here the experience of Europe, with its longstanding support for labor and milder income inequality, should be instructive. Another way to increase workers' leverage would be to return to full employment, putting upwards pressure on wages. But most economists expect that could take years at current trend growth: businesses will continue to squeeze productivity gains from ever-smaller workforces until an increase in consumer demand requires them to begin hiring again. And consumer demand will not return to pre-recession levels until the jobs crisis is resolved.

It sounds like a catch-22. (That is, until you remember the role of the U.S. government, which can borrow cheaply to stimulate the economy, creating outsize returns on investment.) Of course, in the long-term, the market will find equilibrium on its own—it just may not be the equilibrium we want or expect.