Although projections of precipitation change indicate increases in variability, most studies of impacts of climate change on ecosystems focused on effects of changes in amount of precipitation, overlooking precipitation variability effects, especially at the interannual scale. Here, we present results from a 6-y field experiment, where we applied sequences of wet and dry years, increasing interannual precipitation coefficient of variation while maintaining a precipitation amount constant. Increased precipitation variability significantly reduced ecosystem primary production. Dominant plant-functional types showed opposite responses: perennial-grass productivity decreased by 81%, whereas shrub productivity increased by 67%. This pattern was explained by different nonlinear responses to precipitation. Grass productivity presented a saturating response to precipitation where dry years had a larger negative effect than the positive effects of wet years. In contrast, shrubs showed an increasing response to precipitation that resulted in an increase in average productivity with increasing precipitation variability. In addition, the effects of precipitation variation increased through time. We argue that the differential responses of grasses and shrubs to precipitation variability and the amplification of this phenomenon through time result from contrasting root distributions of grasses and shrubs and competitive interactions among plant types, confirmed by structural equation analysis. Under drought conditions, grasses reduce their abundance and their ability to absorb water that then is transferred to deep soil layers that are exclusively explored by shrubs. Our work addresses an understudied dimension of climate change that might lead to widespread shrub encroachment reducing the provisioning of ecosystem services to society.