The purpose of the present study was to investigate developmental differences in lexical processing and sensitivity to the positional information of constituent morphemes with reference to Chinese word-reading ability. One hundred mainland Chinese children (50 second graders and 50 third graders) and 22 high school students were tested with a lexical decision task. The primary school children were also tested for Chinese character reading, morphological awareness, phonological awareness, and non-verbal intelligence. We found that although both primary school children and high school students performed worse in the "reversed" condition (i.e., the pseudo-words were created by reversing the order of the two characters in real Chinese words) than in the "real" (i.e., real Chinese compound words) and "random" conditions (i.e., the pseudo-words were constructed by randomly combining the characters in the "reversed" condition), the performances of high school students in the "reversed" condition were closer to their performances in the other two conditions. Correlational analyses conducted on the primary school children revealed that the responses of second- and third-grade children on the lexical decision task were moderately correlated with their Chinese character reading. We also found that, after controlling for age and non-verbal IQ, the reaction time difference between the "real" and "reversed" conditions significantly predicted Chinese character reading. The results were discussed by exploring the nature of the lexical decision task, the sensitivity of Chinese children to the positional information of morphemes inside compound words, and the association of such sensitivity with their word-reading performance.