Well, simply put, there are number of very important skills we should be teaching students that are not easily tested on a multiple guess exam. Critical thinking skills, application of known skills to unfamiliar problems, experimentation.

The extreme example of these are the Japanese Jukart (sp?) schools, the test drilling schools. While in grad. school I encountered several japanese grad students who attended those schools, and who had absolutely amazing physics gre scores. But in the end they had a very hard time making it, because they had only been taught how to take tests, but not how to apply any of their schooling in real world situations.

So how do you change things? Well, don't eliminate the tests, tests should be given, but should not be relied upon to give the complete picture of a student's achievement. The problem is that other methods (student observations, interviews) have a tendancy to be subjective and much more expensive to administer. I admit I don't know what the solution is, but I do know that going down the path of using standardized tests as the only measure of a student's potential is a really stupid idea.