It seems easier to justify universities starting from the research end. As Sean Carroll has remarked, this is really the only way one (or, more precisely, an intelligent Martian) can make sense of the setup. To put it crudely, the core function of the university is to act as a patronage system for scientists, artists, and other scholars working on things that are arguably valuable but, for various reasons, do not offer a "market-based" livelihood. (In the simplest-to-justify cases, as with medical research, the reasons have to do with the problems of secrecy and/or free-riders in market-based alternatives.) In order to keep its patrons (rich -- and/or, for state schools, powerful -- alumni) loyal and happy the university admits their kids (which gives them "cultural" prestige markers, which include a possibly undeserved reputation for intelligence -- this is partly why elite universities need to admit smart kids!), arranges sports and alumni events, etc. The elite university serves two further purposes: (a) it perpetuates knowledge, and itself, by training academics as well as various people who are in the broad penumbra of the academic world -- editors, certain kinds of journalist, etc., (b) it provides a channel for a few people from disadvantaged backgrounds to leapfrog the various middle classes and land in the elite, or at least impress their existence on the elite. In political-economy terms (b) is important as most decisions are made by elites and the extent to which they are even aware of how the poor live determines the extent to which their policies hurt the poor.
One can also argue that a task like teaching, which -- as Robert Lowell remarked -- "you're always up to, or more or less up to," is a good thing for a creative artist. One doesn't have teacher's block. Cf. Lowell's contemporary Richard Feynman, famously, on the Institute for Advanced Study --
When I was at Princeton in the 1940s I could see what happened to those great minds at the Institute for Advanced Study, who had been specially selected for their tremendous brains and were now given this opportunity to sit in this lovely house by the woods there, with no classes to teach, with no obligations whatsoever. These poor bastards could now sit and think clearly all by themselves, OK? So they don’t get any ideas for a while: They have every opportunity to do something, and they’re not getting any ideas. I believe that in a situation like this a kind of guilt or depression worms inside of you, and you begin to worry about not getting any ideas. And nothing happens. Still no ideas come.[Along these lines there is a wonderfully snide remark in Auden's "Letter to Lord Byron" about the newly financially independent poet of Byron's generation: "he sang and painted and drew dividends / but lost responsibilities and friends." The flip side is that you've got to guard against the complacency that comes from being engrossed in unimportant tasks even as your real agenda languishes. I must admit that my choice of graduate school was not unaffected by a desire to avoid teaching, on the (all-too-plausible) grounds that it would be work and I'd be crap at it.]
Nothing happens because there’s not enough real activity and challenge: You’re not in contact with the experimental guys. You don’t have to think how to answer questions from the students. Nothing!
I tend to think that these functions are important, and that the modern university is the minimal setup that performs all of them and locks in enough interests to form a sustainable ecosystem. It doesn't scale well because it is so heavily about access, which doesn't scale at all. One is left with two questions: (a) if access is to be rationed, who should get it? (b) what about everyone else? I think the "fairness" aspects of (a) are over-pondered; any conceivable admissions process would be unfair in some respects. (b) is an interesting issue but I don't think one could discuss it in detail without lapsing into futurism. There are motivated, clever, and unlucky people for whom (e.g.) the secondary campuses of state schools offer just about enough by way of resources to get a good education or sustain a decent research program; one supposes, however, that the majority of students are there as a way of getting ahead, which means that they are demonstrating their willingness to do arbitrary tasks to deadlines in a rather expensive way. There must be simpler arrangements... (Of course college is also about access to booze while under 21, which does scale, and this shouldn't be underrated.) Before one thinks of such rearrangements, though, it would be nice if graduate schools were more open to applicants with nontraditional backgrounds.
This is really in the spirit of "closing tabs," but re justifying research: last semester I was at a KITP talk on giving talks that was notable mostly for a spirited exchange near the end between Tony Zee and Bill Phillips on how to sell physics (say to the DoD/DoE/Congress). Zee took the line that one should assert that the sciences (and humanities) are what make a civilization worth defending; Phillips objected, reasonably enough, that this wouldn't work with any actual congressmen, and that one had to focus on concrete possibilities. I mostly agree with the destructive half of Phillips's point but I don't think that carving out little bits of academia as "obviously useful" is much of a solution. To some extent it plays into the hands of the large fraction of Congress that is explicitly anti-academic, by setting up their salami tactics for them. It isn't clear to me that we aren't doomed. (See Michael Berube on this.)
I remember Phillips and Zee disagreeing, too, about the utility of structuring talks to make them exciting (which was what the meta-talk was about). There is an ideal of complete spontaneity and informality in many corners of physics -- the ideal talk is a lucid extemporaneous (if blackboard-assisted) lecture delivered in one's bedclothes, and any too-obvious sign of preparation -- fancy slides or pictures, a prepared text (the horror!) -- is vaguely frowned upon, and marks you as possibly an experimentalist. Far worse, though, to come off as making your work sound more interesting than it is, even if that is obviously what everyone wants to do; the most admired talks are the kind described in this post (via Ross McKenzie's blog):
He showed up in the convention center wearing a brightly colored short-sleeved shirt, shorts, and, if I remember correctly, sandals. Not only had he forgotten to dress for Boston's weather, he'd also left his laptop in California. [...] Using hastily prepared, hand-written viewgraphs, he gave one of the best talks of the meeting. Indeed, it's conceivable that in creating his viewgraphs, Heath was forced to focus more on his message than on its presentation.
"Pure content" is a myth, of course, but a widely held one. There is an implied arrogance behind all of this that is pervasive in academia but is perhaps exacerbated by the overwhelming maleness of physics, and that hurts us when we have to deal with the possessors of real power. (This is related to Nozick's notion, in some typically obnoxious essay, that academics have a sense of entitlement that businessmen do not.) I remember saying once that I was a trust fund brat without a trust fund; this is true of all academics, to a degree (ineluctable pun).