They don't mean that it's creating anything but just that index funds depend on "real" market participants to buy and sell on good and bad news, forecasts, etc. If you imagine them expanding to where there are no (or almost no) real buyers and sellers, then they don't really work, and also the market doesn't really work. Though I think you'd have to get to a
very (maybe impossibly) high share of passive investors for this to really occur.
That's their analogy to ML/AI art: imagine it takes over and puts most artists out of business... are the models just stuck, taking their own output as input and not really improving? Similarly here it's maybe not possible for this to happen to such an extreme degree that the imagined problem would come to pass.