The Wii was made to keep costs down, and to be the system "for everyone", not just "the rich/wealthy" or "the hardcore gamer".
And considering that they've sold more Wiis than PS3s and 360s combined, they've been pretty successfull at exactly what they were planning on.
The Wii didn't have to go HD, the Wii didn't have to have 160gigs of internal storage.
I expect that the next model will be HD, since more and more families are getting digital monitors in their houses, now that analog brodcasting has ended, but for a system released 3 years ago, it wasn't needed.
For 480p, the Wii is capable of generating some nice graphics. Not true-to-life graphics that the others can come close to, but as I said, they don't have to. Any graphics that are so poor as to being "worse than PS2" is simply laziness on the developers.