The FTC is finally following through on its stern words on “sponsored content” on social media:

Each letter reads: “The FTC’s Endorsement Guides state that if there is a ‘material connection’ between the endorser and the marketer of a product — in other words, a connection that might affect the weight or credibility that consumers give the endorsement — that connection should be clearly and conspicuously disclosed, unless the connection is already clear from the context of the communication containing the endorsement.

I have a paper on some of the basic economics behind targeted product launch in social networks, and so just a couple brief thoughts about the relationship of this new enforcement to the theory.

I came at this question through signaling theory. One theory of advertising in economics is as a “money burn” to try to convince consumers your product is good. The idea is that you’re so confident your product will be successful and customers will keep coming back that you can afford to set a bunch of money on fire; someone with a bad product couldn’t afford to do that since they’d never make the money back.

What I was arguing in my paper is that the amount of money you have to burn is smaller if you can more quickly blanket a social network with your message. Consumers can infer something more about the quality of your product by observing the set of people you choose to put your product in the hands of when you launch. Money burning has to do less heavy lifting since inference from word-of-mouth is also in play.

The weird aspect here is that in equilibrium it takes time for the good and bad products to be sorted out from each other—both good and bad products at first get put in the hands of the network-spanning people, and then learning and word-of-mouth sorts them out. I thought of this during the recent Fyre Festival debacle, in which “influencers” spread the word about a product that it’s fair to say did not exactly live up to expectations. Lots of people were left looking foolish, which, delightfully, is an equilibrium outcome in my analysis. Economics!

Anyway, all of this is a convoluted way of saying that it’s not clear whether the FTC’s intervention here is good news or bad news for brands (sorry, #brands). Money burning theory—whether complementary to social media seeding or in its traditional form—says that we need the costliness of the action to be demonstrated. That is the source of its effectiveness as a signal. An interesting question is whether consumers infer the cost of the sponsored content differently when it is explicitly rather than implicitly paid for. In any case if money burning is the motivation here the disclosure may help rather than hurt the advertiser, since it puts an exclamation point on the costliness.

Then again, maybe none of this is money burning at all, but an illusion that these product recommendations are spontaneous rather than sponsored, with consumers either fooled or playing along. In my reading that seems to be the posture of the FTC: you are tricking these poor suckers into thinking that Celebrity Instagrammer just happens to be hanging out with your product in their kitchen. If this was the motivation, the mandated disclosure would hurt rather than help, since it would shatter the illusion. This is a question of media literacy and consumer psychology.

Still another possibility is that the whole issue of quality signaling is the wrong theoretical frame for this whole issue. In another paper, I’ve thought about the distinct issue of just how to let people know your product exists in a world of competitive seeding of social media. In this reading, I would be completely ambivalent towards the FTC’s letters as an advertiser, since all I need is to get the word out. The risk in this conception would just be that people get grumpy and stop following celebrities who push products.

Lots to chew on, then, for the interested economist. My prior here is that the “principle of the thing” is probably worth the fuss (maybe I’m being old fashioned) but that on balance I wouldn’t expect this to shake things up that much. I conjecture that the “fear” of slapping a sponsored label on these paid-for posts might not amount to so much in the end.