Buying the index just inflates the prices of all large companies held in the index without any due diligence into which ones have future potential. Not only are you failing to allocate your own capital into the economy productively, but you are counter-acting the investments of those who have made diligent investment decisions (while also providing them with alpha and a means to profit from your inefficiency).

Think about what it means to buy into an index fund. When my next paycheck comes in, I'm going to use 20% of it to invest in the stock of some S&P 500 companies, even though I don't know most of their names and have no idea what results can be expected from them. Tossing money blindly at random companies isn't completely unproductive, since capital is valuable, but in terms of the underlying social purposes of investing it doesn't accomplish much.

Index investors are not really tossing money blindly. They are investing in a diversified portfolio and then constantly re-weighting their investment by market cap.

The alternative to that, before the rise and acceptance of index investing, was people using their 401k money to buy individual stocks. But we all know that your standard mom and pop investor is not going to have time to cut through the bullshit and effectively research companies when they have a 40hr/wk job, a family, hobbies, etc. So those 401k investments were based mostly on personal hunches, word of mouth, and pump and dump schemes. That was really dumb money, and did even less for the economy.

So while I agree with you that index investing isn't doing a ton to push corporate management to do better in the way "smart money" does (in theory), when you consider the world before index investing was a thing you have to admit that money today is on average "smarter."

The alternative is to not invest in companies or asset classes you don't understand. Most people are capable of understanding real estate, cash, and bonds, but the latter two have become severely weakened in the post-Bretton Woods economy. This has also coincided with a huge increase in wealth inequality, and index funds haven't changed that.

Average people should be able to grow their wealth over time without throwing money into inefficient instruments.

Before the rise of index investing, mom and pop didn't invest in stocks at all. They had a defined-benefit pension and kept their savings in a portfolio of CDs and government bonds.

Yeah, I certainly can't dispute that.