This essay-type thing was originally posted on the PWoT forums in a slightly altered format.
In answer to the question, "What happened to the George Lucas who said you shouldn't use special effects in place of story?"
It's a combination of a lot of things, but basically the problem is that he doesn't have other people helping him out on these movies any more. The first (or fourth) one was edited by a team of three people (who won Oscars for it, incidentally). The second one was directed by someone who wasn't Lucas, and scripted by two people who weren't Lucas. Lucas is a big ideas guy, and he needs people to help ground the movie, help him translate and interpret his visions and ideas to really get to the meat of the story. Otherwise they're an A.D.H.D.-inspired mess of things that would all work in movies that are not the movie they are being put into.
I mean, his original treatment of Star Wars was fourteen pages long (treatments are usually four to five pages) and began "The story of Mace Windu, a revered Jedi-bendu of Ophuchi who was related to Usby C. J. Thape, a padawaan leader to the famed Jedi." Story elements changed radically, sometimes even back and forth, in drafts separated by a matter of a couple months. The droids were sometimes bureaucrats, Luke was sometimes Annikan, sometimes a General guarding Princess Leia and the rare "aura spice." Han was a weird Greedo-type alien. Utaupau, the planet in Revenge of the Sith where Grevious gets destroyed, is present in Lucas's mind as early as 1974. He's got all these ideas swirling around that could go anywhere--a typical dilemma with any storyteller--but he needs other people to come in and help.
He didn't always, of course. The reason Lucas went through so many drafts was that he was basically writing every possible permutation of the story as he saw it, trying to find one that wasn't "a mess" (his words). Nowadays, he has people working for him who are afraid to cough without running to him and asking if it's okay, if it would fit in with his universe, and he has to go around helping out the computer animators and the makeup artists and the prop master and he doesn't have any more time to sit down and figure out what works and what doesn't, and no one who works for him is going to do that either because all they do--and if you watch the documentaries on the discs you can see this--is say "Yes, Mr. Lucas."
Part of that is due to Hollywood politics. Kirschner, who directed Episode V, gave his okay to Lucas for the ending credits--Director's Guild rules state that the director's name must be placed at the beginning--and when the movie was released the Guild tried to fine him for it. The WGA also tried to go after him for something, I forget what, and so Lucas quit both of them and now can't use Guild directors or writers for his movies. This leads to the people that he does use being generally not very good.
So since everyone relies on Lucas to interpret "the vision," that ends up being the only thing that he can focus on. The reason he's so obsessed with special effects is because he worries about how well he'll be able to tell his "vision" of the universe, and that leads to him overlooking the problem that his vision, in its current form, really isn't worth telling. Lucas gets caught up in a whirlwind of ideas and now throws them out to people who nod approvingly and set about putting them in motion--no one, including Lucas, bothers to separate the wheat from the chaff.
Lucas sometimes even gets the wheat and the chaff confused, obsessing on one scene he always wanted to do that Fox said no to until it becomes so present in his mind that he's convinced it's a crucial part of the story that needs to be told, resulting in Special Editions and CGI Jabbas and whatnot. Some of the things he added were improvements (most of the good ones were cosmetic, enhancing things that were already there). But some of them weren't. And part of that goes back to his frustration with what he feels as studio meddling (he got a lot of it in his lifetime, and not just from Star Wars). He over-compensates for it, even to this day, without realizing that sometimes maybe it worked out for the best. Old Lucas may have been able to acknowledge that contributions from others made his work better. New Lucas doesn't even let them contribute in the first place. Contributions from actors greatly improved the dialog in the first Star Wars. But they were building off of something Lucas created.
Another reason he's so obsessed with new technology is that Lucasfilm, post-Star Wars, was a Utopia of radical innovations in technology. Computer animation owes almost everything to Lucas creating an environment where anyone who showed up with a cool idea could have an interview with him and get to work on it. Things that ended up forming the basis for Photoshop originated or were improved upon at Skywalker Ranch. Pixar was originally a Lucas company. Video games owe their own debt to him and the culture of creativity he encouraged at Lucasfilm. And so on, and so forth.
His reliance on technology could be boiled down to "he's lost sight of what's important", but that's a very basic way of putting it and, technically speaking, I don't think it's true. I just think he's lost sight of how to accomplish what's important.
In closing, the problems with the prequels are that they are all first drafts. They contain the kind of random chaos that you'd find in an early script from the original trilogy. They have moments in them where you can see a certain beauty, a shadow of what might have been, and then they disappear, covered by all the other random bits of ideas that never got properly sorted out.
"So you're saying Lucas wasn't always terrible?"
This is the one thing I think people get a little too excited about with the prequels. Make no mistake, everything that is screwed up about the prequels is the direct fault of George Lucas, and anything good in them is probably an accident or anomaly. However, don't forget that this guy was behind the original Star Wars, and he did a pretty good job with it. Not all of that is because of him, but most of it is--he was, after all, the director and writer.
There's a couple things that happened that made a difference.
Number one is that Lucas had a severe nervous breakdown after directing Star Wars. He was biking from set to set, trying to fix things, arguing with people who didn't really understand what he was trying to do, dealing with special effects artists who got a little too overzealous blowing things up, etc. Directing Star Wars left a very unpleasant taste in his mouth. It was a very ambitious project and he thought maybe he'd been a little too ambitious. So he let other people take care of the business of writing the dialogue and directing.
Number two is that his wife left him. I'm of the opinion that Lucas has never really gotten over this.
Number three is that the guilds (from his point of view) made a cheap attempt to snag some of that sweet, sweet, Star Wars money by starting a spat with him, like I mentioned earlier. So now he can't use Guild directors or writers. Unfortunately, usually anyone worth a damn as either is in a Guild.
Has Lucas always had a couple flaws as a director? Yes, without a doubt. But was he always a bumbling idiot who ruined everything? No.