DraftThis study seeks a better understanding on how education is rewarded. Drawing on the recent experiences of reforms in rural China, I estimate household net profit function using China Household Income Project (CHIP) for 2002. I find strong support that education influences household net profits through two channels: (1) education improves allocation of factor inputs and hence increases net profits; (2) education directly increases profits. It is estimated that an additional year of education is associated with 2.5 percent increase in net profits: 1.1 percent comes from more efficient allocation of labor; 0.35 percent comes from better utilization of capital investment; 1.09 percent comes directly from increasing profits. The study has potentially important policy implications for completing China’s market reforms. It also sheds light on how schooling should be financed, particularly focusing on a few rather than universal provision of schooling may have direct impact on income
