So what is the difference between literary and genre fiction?

A thread.
As both literary fiction and genre fiction are products of mass culture, it makes little sense to describe the categories by examining the attributes of the members of the categories. There are too many and thus too many exceptions.
So we should look at when, where, and how the concepts emerged. Once upon a time there was no such distinction made. "There were witches in Shakespeare!" cry people who write books about witches, though their stuff will never be mistaken for Shakespeare.
So let's go back to the dawn of mass culture—the industrial revolution! Remember that? It was kind of a big deal. Urbanization, industrial manufacture, colonial/settler imperialism, that whole bit.
And along with this came attempts at mass education and also the popular magazine. But let's imagine life for the newly literate working person at this time...
Work in the industrial sector was hard, and controlled by the pace set not even by the foreman but by the machine itself. Living conditions were squalid and dangerous thanks to poverty and crime. (Police forces professionalized.) The old vision of noblesse oblige had faded away.
For their managers, things had changed as well. The new middle class that emerged was wedged between the working class, into which they could fall if they made mistakes, and the ossified ruling class, to which they hoped to ascend.
Over at the newsstand, there was also a split—cheap magazines for workers, more expensive ones for management, which included the educated middle stratum of society (teachers, clergy, bookkeepers, the lower echelon of people who just had "an income.")
So those cheap poor magazines. What was in them? Well, what would working people want to read? About themselves, but not directly, given that they were mostly miserable. Reinforce that misery and you might have a revolution on your hands.
But, how about a genre where the life is dominated by strange new technology? (SF) Or a genre about social trespass, which was common, and justice, which was lacking? (Crime) Or, about the golden age of the rural past? (Fantasy.)
Or about love, which proles were encouraged to participate in over arranged marriage—which is more important than money, right?? *wink* (Romance.) Or about escaping the pressure of urbanity while also identifying with the white ruling class. (Westerns/colonial adventures.)
Gosh, those are all types of genre fiction! Right in those working-class pulp magazines.

But what about that middle-class, and their fancy slick magazines...?
Something else emerged along with the industrial revolution—theology was dead (it's to keep the suckers working for their heavenly reward) and philosophy in flux, so along came the new way of contemplating humanity: psychology.
Psychology was largely individualistic and was concerned with the state of the mind, and specifically the middle-class mind. (Industrial psychology, focusing on IQ, "race science" and the like, was for the masses.) And boy was the middle-class mind a wreck!
How could it not be, given that the middle class was wedged between a giant and restive working class which it had to manage but not identify with, and a remote and nearly omnipotent ruling class it had to identify while remaining utterly alienated from it?
Good question! Well, the middle-class slick magazines of the day had an answer: stories about neurotic middle-class people coming to some epiphany after experiencing social and individual mental pressure.
Remember when I said that the middle-class managed education and the working class? Well, the educational establishment thus got to decide which fiction was worthy of reading and which was not.
And thus the fiction they decided was worthy was declared literary and the fiction not was categorized as genre fiction.
Now, the tendencies of these categories of fiction have blended (mass culture does that), and there have been innovations since (postmodernity, new genres, other genres all but dying) but the central cores of psychological realism and SF/Crime/Romance/Fantasy/Western remain.
And so when you hear people say literary fiction is about character and genre about plot, that's a 150-year echo leaving their mouths.

And outside of the Anglophone world, fiction categories look quite different except insofar as hegemonic Anglophone mass culture influenced it.
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