I find your arguments somewhat convincing, but I've got the feeling that the "size of the financial industry" is one of the major reasons why it's not working. The housing bubble, for instance, shows that it can make very bad decisions -- I wonder if there is more money seeking a place to invest than there are places where the money can be profitably invested.
There was some prominent economist (Greenspan? Krugman?) who agreed with you, and blamed the recent string of bubbles on a "global savings glut", caused mainly by Asian development and the high savings rates of the newly-wealthy Asian middle class.
Anyway, I think there's a lot of truth to that, but you've got to work with the zeitgeist you're given. When the financial industry is large, index funds perform well relative to actively managing your own money. They may still perform poorly on an absolute scale. When capital is abundant, rates of return for everything go down.
You could also broaden things a bit to look at the economy as a whole. One of the reasons I'm interested in entrepreneurship is that capital is abundant, labor is abundant, and so logically the scarce resource would be their complement: innovation. You'd expect rates of return for entrepreneurship to skyrocket in a low-capital-cost, low-labor-cost environment like today. Which seems to be the case. Innovation has a high barrier to entry though: you need to have the skills and foresight to make something happen that wouldn't otherwise happen. It seems, perhaps, that the best rates of return come from investing in education in a narrow field of specialty that's broadly applicable to many emerging technologies.
