This is a core question for literature enthusiasts and I am glad you asked it. Certainly there are no objective criteria to differentiate 'literary fiction' from 'popular fiction.' Since much of literature discussion is necessarily subjective I shall try to answer your answer based on my own experience as a constant and dedicated reader of novels -- both popular fiction and literature.
The 4 most important (admittedly subjective) criteria that I tend to use to differentiate literary and popular fiction are
- content, scope and themes;
- quality of writing;
- treatment: plot driven vs character driven, as you mentioned; and
- literary reputation.
Content, scope and themes
Popular fiction tends to have more interesting/ adventurous/ sensational/ entertaining subject matter and many popular works are genre fiction such as detective fiction, crime, romance, science fiction, horror, fantasy, Westerns etc. The whole novel typically 'sticks' to the theme: that means the content is well defined and predictable; and the scope is relatively narrow. Moreover authors maintain consistent style and are unlikely to mix elements of multiple genres.
On the other hand literary fiction has a wide range of content: its themes are drawn from the whole of human life. So its scope is extremely broad and the writers can draw on a variety of styles to suit their purposes. Literary novels typically focus on life experiences and the best of them are profoundly philosophical about human nature and the meaning of life. Since it is not required to conform to a 'genre' the audience expectations are less important for such works.
Treatment and quality of writing
The best-written popular fiction certainly has very high standards but I have found much of popular fiction to have a slightly lower quality of writing. This is because aspiring authors come from various backgrounds and actually improve as their career progresses. Since popular fiction is often more focused on plot than characterisation, a slightly lower quality of language does not affect the work by much. Whereas literary fiction is mainly character-driven, and authors tend to be very committed to attaining the highest standards of writing because readers read these books as much for the 'writing' as the 'story.' So literary fiction usually has uniformly high standards of writing, compared to popular fiction.
The overall reputation of a work is built over many years. Literary fiction is often (as you said) popular fiction that has been elevated to literary status over years by the common agreement and approval of writers, literary critics and readers. So the best literary works are read by successive generations of readers and 'stand the test of time' to become highly respected literary classics. By contrast much of popular fiction is forgotten within a couple of generations. However the best popular fiction works can become 'genre classics' and get read by many generations of readers who are interested in and devoted to that genre. The finest genre works also illuminate our world-view and are often very close to great Literature!
Summary: What makes a work of fiction great is the approval of many readers and the literary community. Popular fiction is intended more to please the audience while literary fiction aims to reflect upon the 'human condition.' Please note that somebody can set out to write 'literary fiction' but end up writing a mediocre book that won't pass the test of literary standards. It is also very possible for a work of popular fiction to fulfil most of the criteria of literary fiction and eventually be celebrated as a great literary work!