The effectiveness of China’s incremental industrial reform between 1980–89 is investigated using a panel data set of 272 state enterprises. This paper applies a method that measures marginal products of factors and changes in total factor productivity (TFP) by comparing actual changes in output to actual changes in inputs and in the institutional environment. This paper finds that there were marked improvements in the marginal productivity of factors and in TFP between 1980–89. More importantly, the evidence shows that over 87 percent of the TFP growth was attributable to improved incentives, intensified product market competition, and improved factor al- location.