Why Do Financially Illiterate Students Perceive Lower Education Returns? Evidence From a Survey in Rural China

This paper studies how students’ financial literacy affects their perceptions of returns to schooling and consequently their schooling decisions. We first propose a model of human capital accumulation where financially illiterate students exhibit a cognitive bias of “ironing heuristic.†With this decision heuristic, students tend to linearize the relationship between educational investments and future earnings, resulting in underestimated returns to education and inadequate study efforts. Using survey data from four rural middle schools in Southwest China, we then find a positive correlation between financial literacy and students’ perceived returns to education. In particular, the estimate of students’ perceived earnings function shows that its curvature significantly increases with students’ financial knowledge of compound interest, supporting the assumption in the theory. Our findings suggest that promoting students’ financial literacy may be an effective policy to motivate students to learn at school, especially in poor rural areas. JEL: I26, G53 (Financial Literacy), D91, J24