Actually, /etc/shadow was created to allow moving away from a publicly readable list of user names and passwords.
Hang in there, this will be a little bit of a history lesson, before we get to the actual answer. If you don't care about history, just scroll down a bit.
In the old days, Unix-like OSes, including Linux, generally all kept the passwords in /etc/passwd. That file was world readable, and still is, because it contains information allowing mapping for example between numeric user IDs and user names. That information is highly useful even to ordinary users for perfectly legitimate purposes, so having the file world readable was of great benefit to usability.
Even back then, people realized that having the passwords in plain text in a file in a well-known location that anyone who could log in could read freely was a bad idea. So passwords were hashed, in a sense. That's the old "crypt" password hashing mechanism, which is almost never used on modern systems, but often supported for legacy purposes.
Take a look at /etc/passwd on your system. See that second field, which says
x everywhere? It used to hold the hashed password for the account in question.
The problem was that people could download /etc/passwd, or even not download it, and work on cracking the passwords. This wasn't a big problem while computers weren't particularly powerful (Clifford Stoll, in The Cuckoo's Egg, gives, as I recall, the time to hash one password on an IBM PC class system in the mid-1980s as about a second), but it became a problem as processing power increased. At some point, with a decent word list, cracking those passwords became too easy. For technical reasons, this scheme also couldn't support passwords longer than eight bytes.
Two things were done to solve this:
- Moving to stronger hash functions. The old crypt() had outlived its useful life, and more modern schemes were devised that were both future-proofed and computationally stronger.
- Move the hashed passwords into a file that wasn't readable by just anyone. This way, even if a password hash function turned out to be weaker than expected, or if someone had a weak password to begin with, there was another obstacle for an attacker to gain access to the hash values to begin with. It was no longer free-for-all.
That file is /etc/shadow.
The software that works with /etc/shadow is generally very small, highly focused, and tends to receive some extra scrutiny in reviews because of the potential for problems. It also runs with special permissions, which allows it to read and modify /etc/shadow, while keeping ordinary users unable to look at that file.
So there you have it: The permissions on /etc/shadow are restrictive (though, as pointed out already, not quite as restrictive as you state) because the whole purpose of that file is to restrict access to sensitive data.
A password hash is supposed to be strong, but if your password is on the Top 500 Passwords on the Internet lists, anyone with access to the hash will still be able to find the password quickly. Protecting the hash prevents that simple attack and raises the bar for a successful attack from simple peeking to requiring one to either be a system administrator on the host already, or go through a privilege escalation attack first. Especially on a correctly administered multi-user system, both of those are significantly more difficult than just looking at a world-readable file.