Besides the issue of corporate ownership / concentration, index funds are also increasing the risk of a market crash. One of the selling points for index funds is that they supposedly offer great diversification and this might be true in normal times but in a financial panic people will pull out of index funds and drive correlations to 1. E.g. if there's a crash in health care, panicked investors won't just be pulling out of health care they'll be pulling out of the market as a whole.
I'm not sure that a market crash is a prima facie bad thing. Market crashes often precede or accompany economic recessions but I'm inclined to believe that they are a symptom or result rather than a cause. An economic recession is a bad thing due to increased unemployment, among other reasons.
If there is a real contraction in the health care sector and people react by pulling out of the market entirely then that is a good thing for people looking to put money into the market; the rest of the market is on sale (relative to its "real" value). Even if the market is made up entirely of indices, the market as a whole will end up appropriately priced. Those who panic sell will lose money but the index will bounce back assuming non-health care assets truly were undervalued.
Yes, but this does not diminish the value of the companies in the long term. Remember that index funds are an investment vehicle for decades, not months.
Only if enough people stick with the long term. If everyone tries to hop off the boat for the short term, it can be a self fulfilling prophecy that growth will slow for a decade or more as the market hit effects real business returns.
