The biggest problem with grades is that they start with the assumption that it is the student and not the system that needs changing. This is a huge obstacle to improving the education system.
It also biases students towards studying subjects they already know, given this raises the probability of demonstrating mastery.
One of my son Blake's buddies is in Nepal, studying Tibetan Buddhism and living in a monastery. He is taking a class that had 21 students at the onset, a number that has dwindled to 8. Many of the students were among our best and brightest - mostly American and from places like Harvard. The students were frustrated by the course material, the teacher, and the difficulty of the subject and rather than let their GPA take a hit, they dropped the course.
Grades, in this case, are an obstacle to the students learning something that runs so contrary to their current thinking that they are unlikely to do well at it. And yet this would be the kind of thing that - whether learned well or poorly - is most likely to stretch their minds to new dimensions.
Grades date back to the very early days of the Information Age. Buyers of cotton in the south, on behalf of British manufacturers, would send single letter grades to report the quality of the cotton. In these early days of transatlantic communication, even a single letter was expensive to send and they had to find ways to minimize the cost of communication. This is hardly the case today.
This is just one more story that points to the perverse incentive of grades to avoid learning. There are others. Essentially, there is little evidence that grades assist with learning or improving the educational system. It is, however, a practice that is so ingrained that teachers and students can hardly imagine a world without grading. Once a practice achieves this level of acceptance, it doesn't even need to be defended. It's just the way things are.