Objective To assess the change in efficiency and total factor productivity (TFP) of the local public hospitals in Japan after the local public hospital reform launched in late 2007, which was aimed at improving the financial capability and operational efficiency of hospitals. Data Sources and Data Collection Secondary data were collected from the Ministry of Internal Affairs and Communications on 213 eligible medium‐sized hospitals, each operating 100–400 beds from FY2006 to FY2011. Study Design The improved slacks‐based measure nonoriented data envelopment analysis models (Quasi‐Max SBM nonoriented DEA models) were used to estimate dynamic efficiency score and Malmquist Index. Principal Findings The dynamic efficiency measure indicated an efficiency gain in the first several years of the reform and then was followed by a decrease. Malmquist Index analysis showed a significant decline in the TFP between 2006 and 2011. The financial improvement of medium‐sized hospitals was not associated with enhancement of efficiency. Hospital efficiency was not significantly different among ownership structure and law‐application system groups, but it was significantly affected by hospital location. Conclusions The results indicate a need for region‐tailored health care policies and for a more comprehensive reform to overcome the systemic constraints that might contribute to the decline of the TFP.