Traditional tea leaves sorting
Traditionally, tea leaves are progressively selected for quality and sold as loose tea before packaging what is left over as tea bags.
Fuller leaves with optimal colour and shape are chosen first for the higher grade teas. Often the broken leaves mixed with the tea dust are what is then bagged at the end of the process.
Loose tea being made from fuller and healthier leaves will generally be of better quality and have a smoother taste than tea bags.
Traditional stigma about tea bags
Tea bags have been traditionally associated with low quality teas, and to a degree lack of sophistication in Chinese tea culture: The low quality tea dust is bagged and used in a mug for the purpose of convenience, often by the time poor office workers or in low class hotels; While the sophisticated way of consuming a premium tea has been to sit down with a Gongfu tea set and Pin Cha (品茶) - tasting tea.
Modern tea bags
The reality now however is the combination of fast pace lifestyle and desire for good quality teas. Various 'modern' tea bags have been created during the last a couple of decades to accommodate the two, pyramid tea bag being an example - putting quality teas in quality three dimension tea bags so that they can be conveniently used with certain quality standard without a Gong Fu tea set.
The real fact is still, the top quality teas are never used to stuffed these tea bags, at least under the current Chinese tea culture. For example, an important aspect of enjoying a premium Chinese green tea is to enjoy the elegant tip leaves unfolding in a glass tea vessel - this is literally impossible in a tea bag.
Some potential differences between loose leaf teas and tea bags
Loose leaf tea preserves a greater concentration of the compounds that provide benefits in tea ( ie antioxidants, plant polyphenols) than tea dust. These compounds are release more gradually into the tea brew to offer a smoother texture and more dynamic flavor through various infusions.
There are also more choices regarding to the type of tea(s) and quality grades to buy.