The idea has already be done way back when with PeoplePC. And while that was terribly unsuccessful, there are two very different things in play at this point. One, those PCs were never really free. They were offered more like mobile phones, in exchange for using their Internet services.
Secondly, Google has access to their own OS and the ability to strip out unneeded processes. This means that users can use a very low-end netbook but will not come out at the bottom with performance. At least in theory, that is.
Google is banking on technology vendor Teracent, to provide the kind of experience for the end user in which advertising could be solid enough to support the cost of super-low end netbooks. Where I see real issues up front however, is the upfront cash needed to get this off the ground. Even on a smaller scale, this will cost a fortune in start-up costs.