Beginning with lower income level in 1980, China's 2006 per capita GDP stands more than twice that of India's. We investigate the role of business environment in explaining China's productivity advantage using recent firm-level survey data. We find that China has better infrastructure, more skilled workers and more labour-hiring flexibility than India, but worse access to finance and a higher regulatory burden. Infrastructure appears to be a key constraint for India: it lags significantly behind China, yet it has important indirect effects for the effectiveness of labour flexibility. Labour flexibility also appears to be a major constraint for India, as evident in the predominance of small firms, the importance of firm size in accounting for India's disadvantage in productivity and the complementarity of proxies of labour flexibility with infrastructure and access to finance. Interestingly, regulatory uncertainty has adverse effects in India but not in China. Our empirical analysis suggests that it is important to consider country-specific growth bottlenecks and the indirect effects of policy reforms.