The reason is because when your dataset is in the petabytes, any algorithm bigger than O(N log N) is not going to terminate. You're not going to get any answer at all; your MapReduce is going to sit there burning CPU time for a day, and then you'll kill it, and you won't have any idea what went wrong. (This is learned from experience, if you couldn't tell.)
In a startup context, I'd certainly agree with you - that's exactly the approach I'm taking with my startup, where I'm doing a lot of the debugging and code-wrangling on my local laptop after verifying that the data I want exists and calculating its size with a couple cloud-computing passes. It can sometimes be useful to prototype & iterate with a small subset of the data until you've got the algorithms down.
But many of the algorithms Google cares about don't give any useful results on small data sets. I remember running a few collaborative-filtering algorithms and finding that they gave zero answers because within my small sample of 0.01% of the total data, nobody liked anything else that anybody else did.