One of the key ideas behind the stock market is that is allows capital to efficiently allocated - perform well and have good potential more people buying their shares, and companies that perform badly or have poor potential get fewer. So money should go towards more productive companies, although how well this works in practice is debatable.

Passive investment breaks that approach, because you're basically buying shares in every company in an index, regardless of its performance or future prospects.

And if passive investment is 1% (as it was back in the 90s) of the market then that's not a big deal, because most of the investment should still be based around performance and productivity. Nowadays its more like 50% - but what happens when that gets even higher? Does the stock market still work effectively if 90% of the money is just blindly invested without any regard of individual company performance or merit? 99%? 100%?

I don't know. But we may well reach a point where the inefficiency of passive investment creates serious problems.

There will always be active investors who look to profit off the inefficiency of passive investing. As long as we maintain healthy competition among them price discovery isn't a problem IMO.