The worldwide phenomenon of shrub encroachment in grass-dominated dryland ecosystems is commonly associated with desertification. Studies of the purported desertification effects associated with shrub encroachment are often restricted to relatively few study areas, and document a narrow range of possible impacts upon biota and ecosystem processes. We conducted a study in degraded Mediterranean grasslands dominated by Stipa tenacissima to simultaneously evaluate the effects of shrub encroachment on the structure and composition of multiple biotic community components, and on various indicators of ecosystem function. Shrub encroachment enhanced vascular plant richness, biomass of fungi, actinomycetes and other bacteria, and was linked with greater soil fertility and N mineralization rates. While shrub encroachment may be a widespread phenomenon in drylands, an interpretation that this is an expression of desertification is not universal. Our results suggest that shrub establishment may be an important step in the reversal of desertification processes in the Mediterranean region.