This paper examines China's rural-urban segmentation and its causes in the context of economic reforms. Household survey and aggregate data indicate a V-shaped process in which the rural-urban consumption and income differentials decreased between 1978-85, but then have continually increased historically high levels. This sectoral division is consistent with production function estimates based on provincial data that reveal higher labor productivity in urban/state-owned industries than in rural industries and agriculture. To explain the V-shaped change, we argue that the precedent of successful rural reforms raised farmers' relative earnings, but the remaining obstacles for an efficient sectoral allocation of labor have prevented China from eliminating dualism. The recent financial policies consisting of urban price subsidies and increased investment credits have also had influential distribution effects biased against the rural sector.