How does gmail space continue to grow?

Google continues to add physical drives to a storage area network (SAN) and allocating more storage to the email servers. SAN servers can be clustered to hundreds of Terabytes. 1000 Gigabytes makes up 1 Terabyte. So you can well imagine the scalability!

They also compress older email (which saves space).
Basic emails don't take much space and 'text' compresses really easily. 

Google has several clusters in various locations across the world. When an attempt to connect to Google is made, Google's DNS servers perform load balancing to allow the user to access Google's content most rapidly. This is done by sending the user the IP address of a cluster that is not under heavy load, and is geographically proximate to them. Each cluster has a few thousand servers, and upon connection to a cluster further load balancing is performed by hardware in the cluster, in order to send the queries to the least loaded Google Web Server.

Racks are custom-made and contain 40 to 80 servers (20 to 40 1U servers on either side), new servers are 2U Rackmount systems. Each rack has a hub. Servers are connected via a 100 Mbit/s Ethernet link to the local hub. Hubs are connected to core gigabit hub using one or two gigabits uplinks

Courtesy:http://en.wikipedia.org/wiki/Google_platform