This analogy has its limitations but let's go with it a small way.
Everyone has the choice to copy who they think is smart or write their own answer.
Each person compares the expected value of writing their own answer with copying whoever they think is smart.
Some win, some lose. As it gets harder to work out who is smart yet everyone is copying, beating that average becomes easier. That proportion of the class who are capable of beating that average have an incentive to try it.
Stock picking has been massively overvalued for a long time. The costs people have paid for that value have been far too high. The index wins because it is /cheap/, the costs of investing in the index are low. As the market is now adjusting to that mispricing, among those stock pickers who can actually do it, there will be some good opportunities. Stock picking, whether buy someone like Buffet, or by an algo shop or whatever isn't going to go away. Every time the market is mispriced there's an opportunity. Price will end up somewhere close to value in the long run. It's amazing that with index funds it took so very long to happen. Malkiel pointed it out pretty clearly in a popular book that hasn't been out of print since, what, 40+ years ago. It's great, everyone should read it for its market insights, especially if you want to pick stocks.
You're absolutely right, it does have its limitations, and they show in the issues you raised with it in a way that doesn't actually apply to the nature of the analogy as it criticises the original situation under examination. The nature of indexing is such that it's treated by practitioners as if it were an "objectively correct" (and obvious, no question about where the volume is flowing, the numbers are right there.) answer to the correct investment allocation, so it isn't actually so much the case that there are people just copying random other picks because they like their haircut or it's a popularity contest or whatever (although I suppose you can still make the argument that you're making some kind of decision in an index based on which index fund you're allocating your investment to, but even there you could take a no favourites approach by indexing index funds.)
The core point I was trying to make though is that the market is efficient in net across a great variety of actors all making their own judgement with regards to how much a given thing is worth because it's assigning so many eyeballs and independent evaluations to the pricing question for a given item.
When you swap that out and replace it with a system in which n% of the trade volume is just copying the rest of the trade volume, that reason applies inversely proportional to the volume that such indexing takes place, until a market with just one guy calling all the shots and everyone else indexing him may as well just be centrally planned, and thus afflicted with all the heinous cancers thereof.
Your point about the deleterious effects of the above also simultaneously lowering the bar on the challenge of beating the average though is something I hadn't thought of, and is completely correct. I guess that is how indexing would collapse when you got to some state where the market was mostly just ignorantly following the tiny minority of organic judgement being exercised, and that tiny minority turns out to be inadequate. The market then recovers by stock picking once again being conducted by specialists, and as you say, this would be a situation wherein stock picking was massively undervalued, as opposed to the (maybe present?) situation where it was massively overvalued.
Thanks for the book reference, I'll definitely check it out.
Everyone has the choice to copy who they think is smart or write their own answer.
Each person compares the expected value of writing their own answer with copying whoever they think is smart.
Some win, some lose. As it gets harder to work out who is smart yet everyone is copying, beating that average becomes easier. That proportion of the class who are capable of beating that average have an incentive to try it.
Stock picking has been massively overvalued for a long time. The costs people have paid for that value have been far too high. The index wins because it is /cheap/, the costs of investing in the index are low. As the market is now adjusting to that mispricing, among those stock pickers who can actually do it, there will be some good opportunities. Stock picking, whether buy someone like Buffet, or by an algo shop or whatever isn't going to go away. Every time the market is mispriced there's an opportunity. Price will end up somewhere close to value in the long run. It's amazing that with index funds it took so very long to happen. Malkiel pointed it out pretty clearly in a popular book that hasn't been out of print since, what, 40+ years ago. It's great, everyone should read it for its market insights, especially if you want to pick stocks.
https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street