Saturday, two days ago, I had the pleasure of being present at the Berne Pharo sprint. It was not my first contact with Pharo, but close.
If I understand it correctly, then Pharo emerged because Squeak was torn into too many directions. Squeak was the one platform for child education, multimedia websites, and webserver development. Some code in the Squeak image was never released under a free licence, and the Squeak-licence itself is not an OSI-certified open-source licence. Squeak has more than 2000 open issues in its bugtracker, Mantis.
Pharo is a fork from Squeak that aims at removing cruft and turnung Squeak smalltalk into a more traditional programming environment, with a small core, stable and fast-evolving.
I am slightly suspicious about the reducing of the Image size. I don't know anything about it, but I still recall how in an interview, Dan Ingalls spoke about the advantages of an image that is NOT split into packages, where everything calls everything. I recall for myself that when I wrote a web application that was to send emails by itself, I was delighted to see that an SMTP client is included in a standard image already. It was fantastically easy to send an email message. On the other hand, I discovered at least one bug in the SMTP client code.
Still, I will use Pharo, and not Squeak, henceforward. The user interface is revised and does not look childish anymore. The number of open issues is small, and despite the alpha status, Pharo appears to be a lot more stable than Squeak. Pharo is already used as the reference implementation of Seaside, and thus, it is only a matter of time until it will draw a significant share of the Smalltalk world into using it for web development. Depending on how well it will manage to faciliate the installation of external packages, I would like to believe that for non-educational purposes, Pharo will take over all of the Squeak world, and serve as Squeak 2.0.