The HTC Magic (known as the T-Mobile myTouch 3G in the US, and the docomo HT-03A in Japan) also had 192MB of storage for apps.
I'm not rooted, and I use a G1, and the storage capacity does affect me, but isn't a big deal for me. I don't need 100+ apps on my phone, and I look at the positive side and glad I don't have that many to search through to find the 1 game I might be playing at the time, or one of the few apps I actually use every day.
Still, I'd love more storage space.
Google have stated that they will address the fragmentation issue. They have not said when though. Most likely they will do the same kind of thing Microsoft did with Windows 7, and make the OS more backwards compatible. That will mean that apps that are written for 1.6 (for example) that don't currently work on 2.1, may work on some later version that Google have addressed the fragmentation issue in.
If they don't address fragmentation by making the OS more compatible, they could address it by making the APIs compatible from now on. This would mean that any app written in Android 2.5 (lets pretend this is the version where they address fragmentation), will work in all future versions.
The only other way to address fragmentation is to reduce it by making sure every phone is running the same version. They simply can't do this at present, as the G1 doesn't have the memory to install the latest versions of Android, and as phones are doubling in processor power every year or so, current older phones will simply be to slow to run the likes of Android 3.0 or 4.0 or whatever. So I imagine they'll use one of the first two ways to address the problem.