Personally, I think this could work as ONE possible game strategy!
As is touched on in the 'Is civ an outdated concept' thread, the 50-100 cities per civ thing is just another symptom of the 'bigger is better' phenomenon that needs to be knocked on the head. This syndrome is whats behind Rexing, ICS and land-grabbing!
The way Runedots idea could work is as follows:
1) Break 'corruption' up into two components-crime and waste.
-crime is based on distance, technology, government and city size factors. The more overpopulated a city becomes, the more crime you have. Prior to certain techs, distance from your capital would also be a factor. i.e. the 'Wild West' phenomenon. Crime would also be effected by trade in 'contraband'! The more crime you have, the more unhappy your people are!
-Waste represents lost production via ineffiency. Smaller cities have a bigger waste problem than bigger ones. Crime can increase waste and certain technologies/improvements can either increase and/or decrease waste in a city! Distance should NOT be a factor in waste. Waste contributes to pollution.
2) With this new approach to waste/crime, there is no inherent disadvantage in either 'building up' or 'building out' (i.e. small empire big cities OR big empire smaller cities.) Each one has its pro's and cons. Smaller empires have more problems of overcrowding, crime and pollution. Larger empires avoid many of these problems, but have an increased risk of negative events impacting on them, such as Civil Wars, plagues and Dark Ages.
3) To further balance out the two building strategies, it should be possible to build multiple improvements of the same type. i.e. multiple libraries, multiple factories etc. This will allow a civ with a small but dense nation to be competitive with a more 'spread out' civ. However, there would be inherent limitations to this approach. First, you would only be able to build as many, of one improvement, as your city size allows-so a size 4 city would allow you to build 4 libraries. Secondly, these multiple improvements would be subject to the 'law of diminishing returns', where each new improvement grants, perhaps, half of the bonus that the one before did! So, for instance, if a factory gives you a +50% bonus to production, then 2 factories would only give you +75%, 3 would grant you +87% and so on. Yet you would still have to pay the full maintainance cost for each improvement! This would, therefore, still make the spread out approach to empire building a viable one-especially in the early game!
Anyway, thats how I see it working

!!
Yours,
Aussie_Lurker.