Creating and selling knock offs is definitely illegal. It's considered trademark infringement, since the person doing it is making copies of another product they were never given permission to recreate. Also, this is a form of piracy, since someone is basically stealing revenue away from the company it is basing its knock offs on. For example, if a company puts out $500 bags, and someone recreates and sells it, each sale the pirate makes is $500 that should have gone to the company instead.
The production and sales of knock-offs in my opinion is legal and by any means should not be made illegal. Knock-offs are another way for people to feel special or feel good about wearing something that could be expensive, but still affordable. It is a way for someone to represent themselves in a higher class without the price tag.