Abstract China's economic reforms have brought rapid growth in rural off-farm employment, raising questions about the assumption that rural China is labor surplus and has poorly functioning factor markets. We investigate this by testing for separability between household labor demand and supply using panel data. We find that separability is rejected overall, indicating that factor markets remain underdeveloped. Nonseparability, however, is associated with labor surplus in some areas and labor shortage in others. Moreover, separability holds where substantial employment opportunities exist in the wider township, suggesting that such employment promotes competitive allocation within villages as well as the inter-village movement of resources.