It's vastly testable, there are thousands of different markets with different sets of regulations.
But your talking about two different issues, the liquidity issue mainly applies to exchange traded assets while more complex instruments tend to be OTC (i.e. custom agreements).
With liquidity you can be a sophisticated buyer and still be willing to pay for it. For example look at when MtGox was lagging by 600 seconds when bitcoin was in freefall, many buyers would happily have paid a hefty fee to be able to trade out of their position instantly without having to worry about what the price would be when the transaction was finally able to get through.
Some of these people are high-net-worth individuals. I sometimes ask them why, instead of trading, they don't take that money and invest it in new research or technology or product development or services. At least then, there would be jobs created, technological progress, more money exchanging hands. But, to them, it doesn't make sense to do that; they make much higher returns, more quickly through trading.
To me, a lot of this money seems to be 'locked up' in liquidity trading, that would otherwise be doing good things for the economy and human progress. Right now, it doesn't seem like the traders have incentive to do other things with the money.
When a friend of mine 'clicks a button' and makes a few million from a trade, how is that adding equivalent 'value' to the overall economy than if he would have taken that money and invested it in a new start-up? Again, this is my total ignorance, but something doesn't seem right. To an ignorant person like me, it just seems like wealth exchanging hands, but how is clicking a button better than employing hundreds of people?
It's "clicking a button" in the same way programming is "typing on a keyboard" - people execute trades of different asset classes for a huge variety of reasons and with different motivations and outcomes.
Let's talk fundamentals: if we didn't have an equity/bond market it'd be much much harder for companies to raise money for growth and investment. If we didn't have an IPO market you wouldn't have company exits - the most common forms of company exits are IPO or sale to a listed company. Without exits it wouldn't be economical for VCs to invest in startups.
All of these things are interconnected, having liquid public markets play a huge part in economic growth by both directly and indirectly financing the growth-makers.
That's how Wall Street works. You give money to Wall Street, and Wall Street in turn chooses to distribute the money to technology or research companies like Google or Merck (or even venture capital funds which in turn invest in start ups). Wall Street adds value by allocating resources.
But your talking about two different issues, the liquidity issue mainly applies to exchange traded assets while more complex instruments tend to be OTC (i.e. custom agreements).
With liquidity you can be a sophisticated buyer and still be willing to pay for it. For example look at when MtGox was lagging by 600 seconds when bitcoin was in freefall, many buyers would happily have paid a hefty fee to be able to trade out of their position instantly without having to worry about what the price would be when the transaction was finally able to get through.