But the upscaling isn't applied live/on viewing, right? The video being upscaled is still stored on their server and then streamed. How does it reduce storage costs?

Do you know that for a fact?

Maybe Google has done the math and realized it's cheaper to upscale in realtime than store videos at high resolution forever. Wouldn't surprise me considering the number of shorts is probably growing exponentially.

The economics don't make sense, each video is stored ~ once (+ replication etc. but let's say O(1)) but viewed n times, so server-side upscaling on the fly is way too costly and currently not good enough client-side.

Are you considering that the video needs to be stored for potentially decades?

Also shorts seem to be increasing exponentially... but Youtube viewership is not. So compute wouldn't need to increase as fast as storage.

I obviously don't know the numbers. Just saying that it could be a good reason why Youtube is doing this AI upscaling. I really don't see why otherwise. There's no improvement in image quality, quite the contrary.