Passive Investing

If passive investing grows at the expense of loss-making active investing, it reduces the profits available to active investors with private information but this does not necessarily make stock prices less efficient.
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Index funds largely expand investing to a population that didn't hold stocks. Hedge funds have expanded. Not much evidence that there is less overall informed money, or that markets have become less efficient over time.

I expect that the effect of amount of passive investing is self limiting by the effect on the profits from skilled active investing. These profits would increase as more investing became passive.

We are now relying now on fewer investors to bear firm-specific supply shocks and to do research. Consider for instance the impact of index deletions and additions. Still early, though, to ring the emergency alarm bells. The market may adjust and adapt over time on its own.

If now-passive investors were investing more actively, it's not clear that they would value stocks very rationally.

Researchers have looked at the impact on individual stocks when included in ETFs (passive). Evidence suggests that after inclusion volatility increases and there is also negative autocorrelation (JF 2018-link). These findings are consistent with a negative impact on efficiency.
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What fraction of funds are invested passively is endogenous.

Optimal fraction of passive versus active from a welfare perspective depends on a number of parameters which are difficult to measure.

The evidence so far seems mixed, see (and the references therein)
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The growth in indexing would have a detrimental effect on the market if nothing else simultaneously changed. However, we expect activist investors to 'fill the gap' in information production - to take advantage of inefficiencies.
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In some models, passive investing might make financial market returns more volatile, depending on parameters. Efficiency is a different issue, since even a small number of active traders might be enough for prices to reveal "all relevant information".

While the level of passive investment has gone up substantially over time, it is still at a very low level that likely has no discernable impact on market efficiency. I doubt any impact is discernable in the data and indeed there may be no effect.

The smoking gun of reduced efficiency would be greater aggregate gross outperformance of active managers. No sign of this so far. Trend towards passive did not only take capital away from skilled active managers, but also from noise-trading active managers and retail investors.

Passive investing 1) reduces noise trading by uninformed investors & increases price impact of informed, increasing price informativeness and efficiency of real investment; 2) saves real resources allocated to information fast for trading profits but too slow for real decisions.

Depends on what sources of capital it is substituting for e.g., institutional/retail; and where the capital is housed.

There is some theoretical literature arguing both in favor and against the hypothesis that a change in index investing reduces price efficiency. A recent paper claims an heterogenous effects. Some earlier paper provided evidence for null effects. links provide references
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It is hard to know whether current level is high enough relative to one where market efficiency would be impacted. This includes not just informativeness of prices but also market discipline on firms (discipline).

The amount of indexing is a result, not a cause. It reflects money that cannot be deployed actively, net of costs, to exploit profitably whatever inefficiency remains.

Research suggests that when active funds face more competition from passive funds, the active managers become more active and lower their fees.
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Maybe I'm not fully understanding theq

It’s true that long only mutual funds on average take less active positions, but I believe that this effect has been more than offset by long-short hedge funds.

More passive investing and benchmarking makes a large fraction of assets and asset managers uninterested in information acquisition (information scale effect), it also makes them trade less aggressively on the information they have. Both forces reduce information aggregation.
-see background information here